KEY ACCOUNTING CONCEPTS

1. ACCOUNTING PROCESS
2. ACCOUNTING CONVENTIONS
3. USERS OF ACCOUNTING INFORMATION
4. ACCOUNTING COMPONENTS
5. ACCOUNTING EQUATION
6. FINANCIAL STATEMENTS

CHAPTER 1 & 2

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 ACCOUNTING

It is the process to identify economic events (viz-a-

viz business transactions which are recorded and
communicated to users of the financial
information.

This process collects, classifies, summarizes,

records and reports financial information.

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 INTERNAL & EXTERNAL USERS

Type Who?
Internal Users Management, Marketing, Finance,
(inside the organization) Technical, Human Resource,
Administration

External Users Owners, Customer, Suppliers, Lenders,

(outside the organization) Government

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 ACCOUNTING CONVENTIONS

Key assumptions Meaning Example

Historical Transactions recorded at their Purchased computer for
historical costs and not adjusted or $4,000 in 2018. This cost
revalued in the future. will remain in the books
until asset is disposed.
Monetary Transactions can only be recorded XYZ Co. salaries of
if they can be expressed in $40,000 to all staff in the
monetary terms. company.
Going concern Transactions are recorded and XYZ Co. is expected to
reported on the basis that the continue the business in
business will continue to operate. the next year so we can
record transactions this
year.
Separate entity Transactions of the owners are XYZ Co. paid owner’s
separated from the transactions of personal expenses. This
the business. will be recorded as
drawings and not as
company expenses.
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 State the accounting equation, and define its components.

Owner's
Assets = Liabilities +
Equity

Basic Accounting Equation

 Provides the underlying framework for recording and
summarizing economic events.
 Assets are claimed by either creditors or owners.
 If a business is liquidated, claims of creditors must be paid
before ownership claims.

1-5
 Basic Accounting Equation

Owner's
Assets = Liabilities +
Equity

Assets
 Resources a business owns.
 Provide future services or benefits.
 Cash, Supplies, Equipment, etc.

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 Basic Accounting Equation

Owner's
Assets = Liabilities +
Equity

Liabilities
 Claims against assets (debts and obligations).
 Creditors (party to whom money is owed).
 Accounts Payable, Notes Payable, Salaries and Wages
Payable, etc.

1-7
 Basic Accounting Equation

Owner's
Assets = Liabilities +
Equity

Owner's Equity
 Ownership claim on total assets.
 Referred to as residual equity.
 Investment by owners and revenues (+)
 Drawings and expenses (-).

1-8
 Owner’s Equity Illustration 1-6
Expanded accounting
equation

Increases in Owner’s Equity

 Investments by owner are the assets the owner puts into the
business.
 Revenues result from business activities entered into for the
purpose of earning income.
► Common sources of revenue are: sales, fees, services,
commissions, interest, dividends, royalties, and rent.

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 Owner’s Equity Illustration 1-6
Expanded accounting
equation

Decreases in Owner’s Equity

 Drawings An owner may withdraw cash or other assets for
personal use.
 Expenses are the cost of assets consumed or services used in
the process of earning revenue.
► Common expenses are: salaries expense, rent expense,
utilities expense, tax expense, etc.

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 DO IT! 1 Owner's Equity Effects

Classify the following items as investment by owner, owner’s

drawings, revenue, or expenses. Then indicate whether each
item increases or decreases owner’s equity.

Classification Effect on Equity

1. Rent Expense Expense Decrease

2. Service Revenue Revenue Increase

3. Drawings Drawings Decrease

4. Capital/Investment
Capital Increase

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 Analyze the effects of business transactions on the
accounting equation.

Transactions are a business’s economic events recorded

by accountants.
 May be external or internal.
 Not all activities represent transactions.
 Each transaction has a dual effect on the accounting
equation.

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 Transaction Analysis

Illustration: Are the following events recorded in the accounting

records?
Illustration 1-7
Discuss product
Purchase
Event design with Pay rent
computer
potential customer

Criterion Is the financial position (assets, liabilities, or

owner’s equity) of the company changed?

Record/
Don’t Record

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 Transaction Analysis

TRANSACTION 1. INVESTMENT BY OWNER Ray Neal decides to start

a smartphone app development company which he names Softbyte. On
September 1, 2017, he invests $15,000 cash in the business. This
transaction results in an equal increase in assets and owner’s equity.

Assets = Liabilities + Owner's Equity

Trans- Accounts Accounts Owner's Owner's
Cash + + Supplies + Equipment = + - + Rev. - Exp.
action Receivable Payable Capital Drawings

1. +15,000 +15,000

Illustration 1-8
Tabular summary of
Softbyte transactions

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 TRANSACTION 2. PURCHASE OF EQUIPMENT FOR CASH Softbyte
Inc. purchases computer equipment for $7,000 cash.
Illustration 1-8

Assets = Liabilities + Owner's Equity

Trans- Accounts Accounts Owner's Owner's
Cash + + Supplies + Equipment = + + + Rev. - Exp.
action Receivable Payable Capital Drawings

1. +15,000 +15,000
2. -7,000 +7,000
3. +1,600 +1,600
4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $4,700 - $1,950 - $1,300
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 TRANSACTION 3. PURCHASE OF SUPPLIES ON CREDIT Softbyte Inc.
purchases for $1,600 headsets and other accessories expected to last
several months. The supplier allows Softbyte to pay this bill in October.
Illustration 1-8 Assets = Liabilities + Owner's Equity
Trans- Accounts Accounts Owner's Owner's
Cash + + Supplies + Equipment = + + + Rev. - Exp.
action Receivable Payable Capital Drawings

1. +15,000 +15,000
2. -7,000 +7,000
3. +1,600 +1,600
4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $4,700 - $1,950 - $1,300
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 TRANSACTION 4. SERVICES PERFORMED FOR CASH Softbyte Inc.
receives $1,200 cash from customers for app development services it has
performed. Illustration 1-8

Assets = Liabilities + Owner's Equity

Trans- Accounts Accounts Owner's Owner's
Cash + + Supplies + Equipment = + + + Rev. - Exp.
action Receivable Payable Capital Drawings

1. +15,000 +15,000
2. -7,000 +7,000
3. +1,600 +1,600
4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $4,700 - $1,950 - $1,300
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 TRANSACTION 5. PURCHASE OF ADVERTISING ON CREDIT Softbyte
Inc. receives a bill for $250 from the Daily News for advertising on its
online website but postpones payment until a later date. Illustration 1-8

Assets = Liabilities + Owner's Equity

Trans- Accounts Accounts Owner's Owner's
Cash + + Supplies + Equipment = + + + Rev. - Exp.
action Receivable Payable Capital Drawings

1. +15,000 +15,000
2. -7,000 +7,000
3. +1,600 +1,600
4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $4,700 - $1,950 - $1,300
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 TRANSACTION 6. SERVICES PERFORMED FOR CASH AND CREDIT.
Softbyte performs $3,500 of services. The company receives cash of
$1,500 from customers, and it bills the balance of $2,000 on account.
Illustration 1-8 Assets = Liabilities + Owner's Equity
Trans- Accounts Accounts Owner's Owner's
Cash + + Supplies + Equipment = + + + Rev. - Exp.
action Receivable Payable Capital Drawings

1. +15,000 +15,000
2. -7,000 +7,000
3. +1,600 +1,600
4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $4,700 - $1,950 - $1,300
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 TRANSACTION 7. PAYMENT OF EXPENSES Softbyte Inc. pays the
following expenses in cash for September: office rent $600, salaries and
wages of employees $900, and utilities $200. Illustration 1-8

Assets = Liabilities + Owner's Equity

Trans- Accounts Accounts Owner's Owner's
Cash + + Supplies + Equipment = + + + Rev. - Exp.
action Receivable Payable Capital Drawings

1. +15,000 +15,000
2. -7,000 +7,000
3. +1,600 +1,600
4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $4,700 - $1,950 - $1,300
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 TRANSACTION 8. PAYMENT OF ACCOUNTS PAYABLE Softbyte Inc.
pays its $250 Daily News bill in cash. The company previously (in
Transaction 5) recorded the bill as an increase in Accounts Payable.
Illustration 1-8 Assets = Liabilities + Owner's Equity
Trans- Accounts Accounts Owner's Owner's
Cash + + Supplies + Equipment = + + + Rev. - Exp.
action Receivable Payable Capital Drawings

1. +15,000 +15,000
2. -7,000 +7,000
3. +1,600 +1,600
4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $4,700 - $1,950 - $1,300
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 TRANSACTION 9. RECEIPT OF CASH ON ACCOUNT Softbyte Inc.
receives $600 in cash from customers who had been billed for services
(in Transaction 6). Illustration 1-8

Assets = Liabilities + Owner's Equity

Trans- Accounts Accounts Owner's Owner's
Cash + + Supplies + Equipment = + + + Rev. - Exp.
action Receivable Payable Capital Drawings

1. +15,000 +15,000
2. -7,000 +7,000
3. +1,600 +1,600
4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $4,700 - $1,950 - $1,300
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 TRANSACTION 10. WITHDRAWAL OF CASH BY OWNER Ray Neal
withdraws $1,300 in cash in cash from the business for his personal use.
Illustration 1-8
Assets = Liabilities + Owner's Equity
Trans- Accounts Accounts Owner's Owner's
Cash + + Supplies + Equipment = + + + Rev. - Exp.
action Receivable Payable Capital Drawings

1. +15,000 +15,000
2. -7,000 +7,000
3. +1,600 +1,600
4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $1,300 - $4,700 - $1,950

1-23 $18,050 $18,050

 Summary of Transactions

1. Each transaction is analyzed in terms of its effect on:

a. The three components of the basic accounting
equation.

b. Specific of items within each component.

2. The two sides of the equation must always be equal.

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 DO IT! 2 Tabular Analysis

Transactions made by Virmari & Co., a public accounting firm, for

the month of August are shown below. Prepare a tabular analysis
which shows the effects of these transactions on the expanded
accounting equation, similar to that shown in Illustration 1-8.
1. The owner invested $25,000 cash in the business.
2. The company purchased $7,000 of office equipment on credit.
3. The company received $8,000 cash in exchange for services
performed.
4. The company paid $850 for this month’s rent.
5. The owner withdrew $1,000 cash for personal use.

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 DO IT! 2 Tabular Analysis

1. The owner invested $25,000 cash in the business.

Assets = Liabilities + Owner's Equity

Trans- Accounts Owner's Owner's
Cash + Equipment = + + + Rev. - Exp.
action Payable Capital Drawings
1. +25,000 +25,000

2. +7,000 +7,000

3. +8,000 +8,000

4. -850 -850

5. -1,000 -1,000

$31,150 + $7,000 = $7,000 + $25,000 + $8,000 - $850 - $1,000

$18,050 $18,050
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 DO IT! 2 Tabular Analysis

2. The company purchased $7,000 of office equipment on credit.

Assets = Liabilities + Owner's Equity

Trans- Accounts Owner's Owner's
Cash + Equipment = + + + Rev. - Exp.
action Payable Capital Drawings
1. +25,000 +25,000

2. +7,000 +7,000

3. +8,000 +8,000

4. -850 -850

5. -1,000 -1,000

$31,150 + $7,000 = $7,000 + $25,000 + $8,000 - $850 - $1,000

$18,050 $18,050
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 DO IT! 2 Tabular Analysis

3. The company received $8,000 cash in exchange for services

performed.
Assets = Liabilities + Owner's Equity
Trans- Accounts Owner's Owner's
Cash + Equipment = + + + Rev. - Exp.
action Payable Capital Drawings
1. +25,000 +25,000

2. +7,000 +7,000

3. +8,000 +8,000

4. -850 -850

5. -1,000 -1,000

$31,150 + $7,000 = $7,000 + $25,000 + $8,000 - $850 - $1,000

$18,050 $18,050
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 DO IT! 2 Tabular Analysis

4. The company paid $850 for this month’s rent.

Assets = Liabilities + Owner's Equity

Trans- Accounts Owner's Owner's
Cash + Equipment = + + + Rev. - Exp.
action Payable Capital Drawings
1. +25,000 +25,000

2. +7,000 +7,000

3. +8,000 +8,000

4. -850 -850

5. -1,000 -1,000

$31,150 + $7,000 = $7,000 + $25,000 + $8,000 - $850 - $1,000

$18,050 $18,050
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 DO IT! 2 Tabular Analysis

5. The owner withdrew $1,000 cash for personal use.

Assets = Liabilities + Owner's Equity

Trans- Accounts Owner's Owner's
Cash + Equipment = + + + Rev. - Exp.
action Payable Capital Drawings
1. +25,000 +25,000

2. +7,000 +7,000

3. +8,000 +8,000

4. -850 -850

5. -1,000 -1,000

$31,150 + $7,000 = $7,000 + $25,000 + $1,000 + $8,000 - $850

$38,150 $38,150
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LEARNING Describe the four financial statements
5
OBJECTIVE and how they are prepared.

Companies prepare four financial statements :

Owner’s Statement
Income Balance
Equity of Cash
Statement Sheet
Statement Flows

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 Net income is needed to determine the
Financial Statements ending balance in owner’s equity.

SOFTBYTE
Income Statement
For the Month Ended September 30, 2017

Illustration 1-9
Financial statements and
their interrelationships

SOFTBYTE
Owner’s Equity Statement
For the Month Ended September 30, 2017

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 SOFTBYTE
Owner’s Equity Statement
For the Month Ended September 30, 2017

Illustration 1-9
The ending
balance in SOFTBYTE
owner’s equity Balance Sheet
is needed in September 30, 2017
preparing the
balance sheet.

Illustration 1-9
Financial statements
and their
interrelationships

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 SOFTBYTE
Financial Balance Sheet
September 30, 2017

Statements

Balance sheet and

income statement
are needed to
prepare statement of
cash flows.
SOFTBYTE
Statement of Cash Flows
For the Month Ended September 30, 2017

Illustration 1-9
Financial statements
and their
interrelationships

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 Income Statement

 Reports the revenues and expenses for a specific

period of time.
 Lists revenues first, followed by expenses.
 Shows net income (or net loss).
 Does not include
investment and
withdrawal transactions
between the owner and
the business in
measuring net income.

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 Owner’s Equity Statement

 Reports the changes in owner’s equity for a specific

period of time.
 The time period is the same as that covered by the
income statement.

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 Balance Sheet

 Reports the assets, liabilities, and owner's equity at a

specific date.
 Lists assets at the top, followed by liabilities and owner’s
equity.
 Total assets must equal total liabilities and owner's
equity.
 Is a snapshot of the company’s financial condition at a
specific moment in time (usually the month-end or year-
end).

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 Statement of Cash Flows

 Information on the cash receipts and payments for a

specific period of time.
 Answers the following:
► Where did cash come from?
► What was cash used for?
► What was the change in the
cash balance?

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 DO IT! 3 Financial Statement Items

Presented below is selected information related to Flanagan Company

at December 31, 2017. Flanagan reports financial information monthly.
Equipment $10,000 Utilities Expense $ 4,000
Cash 8,000 Accounts Receivable 9,000
Service Revenue 36,000 Salaries and Wages Expense 17,500
Rent Expense 11,000 Notes Payable 16,500
Accounts Payable 2,000 Owner’s Capital 5,000

(a) Determine the total assets of at December 31, 2017.

(b) Determine the net income reported for December 2017.
(c) Determine the owner’s equity at December 31, 2017.

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 DO IT! 3 Financial Statement Items

Presented below is selected information related to Flanagan Company

at December 31, 2017. Flanagan reports financial information monthly.
Equipment $10,000 Utilities Expense $ 4,000
Cash 8,000 Accounts Receivable 9,000
Service Revenue 36,000 Salaries and Wages Expense 17,500
Rent Expense 11,000 Notes Payable 16,500
Accounts Payable 2,000 Owner’s Capital 5,000

(a) Determine the total assets of at December 31, 2017.

The total assets are $27,000, comprised of

• Cash $8,000,
• Accounts Receivable $9,000, and
• Equipment $10,000.

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 DO IT! 3 Financial Statement Items

Presented below is selected information related to Flanagan Company

at December 31, 2017. Flanagan reports financial information monthly.
Equipment $10,000 Utilities Expense $ 4,000
Cash 8,000 Accounts Receivable 9,000
Service Revenue 36,000 Salaries and Wages Expense 17,500
Rent Expense 11,000 Notes Payable 16,500
Accounts Payable 2,000 Owner’s Capital 5,000

(b) Determine the net income reported for December 2017.

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 DO IT! 5 Financial Statement Items

Presented below is selected information related to Flanagan Company

at December 31, 2017. Flanagan reports financial information monthly.
Equipment $10,000 Utilities Expense $ 4,000
Cash 8,000 Accounts Receivable 9,000
Service Revenue 36,000 Salaries and Wages Expense 17,500
Rent Expense 11,000 Notes Payable 16,500
Accounts Payable 2,000 Owner’s Capital 5,000

(c) Determine the owner’s equity at December 31, 2017.

Owner’s equity = Capital – Drawings + Net Income

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 Describe how accounts, debits, and credits are used to record
business transactions.

The  Record of increases and decreases

in a specific asset, liability, owners’
Account equity, revenue, or expense item.
 Debit = “Left”
 Credit = “Right”

An account can
be illustrated in a
T-account form.

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 The Account

DEBIT AND CREDIT PROCEDURES

Double-entry system
 Each transaction must affect two or more accounts to
keep the basic accounting equation in balance.
 Recording done by debiting at least one account and
crediting at least one other account.
 DEBITS must equal CREDITS.

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 Debits and Credits

If the sum of Debit entries are greater than the sum of

Credit entries, the account will have a debit balance.

Transaction #1 $10,000 $3,000 Transaction #2

Transaction #3 8,000

Balance $15,000

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 Debits and Credits

If the sum of Credit entries are greater than the sum of

Debit entries, the account will have a credit balance.

Transaction #1 $10,000 $3,000 Transaction #2

8,000 Transaction #3

Balance $1,000

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 Debits/Credits Rules

Balance Sheet Income Statement

Asset = Liability + Equity Revenue - Expense

Debit

Credit

1-47
 Debits/Credits Rules

Question
Debits:

a. increase both assets and liabilities.

b. decrease both assets and liabilities.

c. increase assets and decrease liabilities.

d. decrease assets and increase liabilities.

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 Debits/Credits Rules

Question
Accounts that normally have debit balances are:

a. assets, expenses, and revenues.

b. assets, expenses, and equity.

c. assets, liabilities, and owner’s drawing.

d. assets, owner’s drawing, and expenses.

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 Summary of Debit/Credit Rules

Relationship among the assets, liabilities and owner’s equity

of a business:
Illustration 2-11
Basic
Equation Assets = Liabilities + Owner’s Equity

Expanded
Equation
Debit/Credit
Effects

The equation must be in balance after every transaction. Total

Debits must equal total Credits.

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 Indicate how a journal is used in the recording process.

Steps in the Recording Process

Illustration 2-12

Analyze each transaction Enter transaction in a journal Transfer journal information to

ledger accounts

Business documents, such as a sales slip, a check, or a bill,

provide evidence of the transaction.
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 Steps in the Recording Process

The Journal
 Book of original entry.
 Transactions recorded in chronological order.
 Contributions to the recording process:
1. Discloses the complete effects of a transaction.

2. Provides a chronological record of transactions.

3. Helps to prevent or locate errors because the debit

and credit amounts can be easily compared.

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 Steps in the Recording Process

JOURNALIZING - Entering transaction data in the journal.

Illustration: On September 1, Ray Neal invested $15,000 cash in
the business, and Softbyte purchased computer equipment for
$7,000 cash.
Illustration 2-13

GENERAL JOURNAL

Sept. 1 Cash 15,000

Owner’s Capital 15,000

Equipment 7,000
Cash 7,000
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 Steps in the Recording Process

SIMPLE AND COMPOUND ENTRIES

Illustration: On July 1, Butler Company purchases a delivery truck
costing $14,000. It pays $8,000 cash now and agrees to pay the
remaining $6,000 on account. Illustration 2-14
Compound journal entry

GENERAL JOURNAL

July 1 Equipment 14,000

Cash 8,000
Accounts payable 6,000

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 4 Recording Business Activities

Kate Browne engaged in the following activities in establishing

her salon, Hair It Is:

1. Opened a bank account in the name of Hair It Is and

deposited $20,000 of her own money in this account as her
initial investment.

2. Purchased equipment on account (to be paid in 30 days) for

a total cost of $4,800.

3. Interviewed three persons for the position of hair stylist.

Prepare the entries to record the transactions.

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 DO IT! 4 Recording Business Activities

Prepare the entries to record the transactions.

1. Opened a bank account and deposited $20,000.

Cash 20,000
Owner’s Capital 20,000

2. Purchased equipment on account (to be paid in 30 days) for

a total cost of $4,800.
Equipment 4,800
Accounts Payable 4,800

3. Interviewed three persons for the position of hair stylist.

No entry
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 Explain how a ledger and posting help in the recording process.

The Ledger
 General Ledger contains all the asset, liability, and owner’s
equity accounts.
Illustration 2-15

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 The Ledger

STANDARD FORM OF ACCOUNT Illustration 2-16

Three-column form
of account

1-58
 Ledger

POSTING
Transferring
journal entries
to the ledger
accounts.

Illustration 2-17
Posting a journal
entry

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 Chart of Accounts
Illustration 2-18

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Summary Journalizing and Posting
Illustration 2-29

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1-62 Illustration 2-29
 Illustration 2-30
1-63
 Prepare a trial balance.

1-64 Illustration 2-31

 5 Trial Balance Illustration

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 5 Trial Balance

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