chapter02 uml 2010

8/12/2019 Chapter02 UML 2010

1/25

Ch. 2: T Accounts, Debits, Credits 1

Chapter 2

T Accounts, Debits, and Credits

I n t hi s chapt er you wi l l cont i nue l ear ni ng about t he pr ocess of account i ng.You wi l l see how t he account i ng sys t em mai nt ai ns t he equal i t y of t he account i ng

equat i on.

The Accounting Equation

As di scussed i n Chapt er 1, r esour ces and where they come f r omare at t hehear t of moder n f i nanci al account i ng syst ems. I n busi ness t er mi nol ogy, r esour cesar e cal l ed asset s. Sour ces of bor r owed r esour ces ar e cal l ed l i abi l i t i es.Sour ces of r esources i nvest ed by owner s and gener at ed by management and ret ai nedi n t he company ar e cal l ed st ockhol ders ' equi t y. The r el at i onshi p bet weenr esour ces and t hei r sour ces i s r epr esent ed by t he accounting equation:

Asset s = Li abi l i t i es + St ockhol ders ' Equi t y

Remember , st ockhol ders' equi t y i ncl udesboth t he dol l ar amount of r esour ces

i nvest ed by owner s and t he dol l ar amount of r esour ces generat ed t hroughmanagement oper at i ons and r et ai ned i n the company because owner s have a r i ght t ot he amount of r esour ces t hey i nvest and t he amount of r esour ces gener at ed bymanagement .

The cor r ect use of t he account i ng equat i on guar antees mat hemat i cal l yl ogi cal f i nanci al st at ement s even i f event s ar e i ncor r ect l y anal yzed. That i s,as l ong as t he equal i t y of asset s to l i abi l i t i es pl us stockhol der s' equi t y i smai nt ai ned, t he i ncome st at ement wi l l pr oper l y rel ate t o t he st at ement ofr et ai ned ear ni ngs, t he st at ement of r et ai ned ear ni ngs wi l l pr oper l y r el at e t o t hebal ance sheet , and t he bal ance sheet wi l l bal ance. I f t he account i ng equat i ondoes not bal ance, t he bal ance sheet wi l l not bal ance. I f t he f i nanci alst at ement s are not mat hemat i cal l y l ogi cal , t hey cannot be r el i ed upon f ori nf ormat i on about a company' s r esour ces.

Mat hemat i cal l y l ogi cal f i nanci al st at ement s do not aut omat i cal l y cont ai n

usef ul i nf or mat i on, however . Mai nt ai ni ng t he equal i t y of t he account i ng equat i oni s necessar y f or usef ul f i nanci al st at ement s, but i t i s not t he onl y requi r ement .

Thi s chapter and t he f ol l owi ng chapter s wi l l exami ne t he r equi r ements ofaccount i ng syst ems t hat pr oduce usef ul i nf ormat i on.

** You now have t he background t o do exer ci se 2. 1.

Maintaining the Equality

of the Accounting Equation

I n or der f or t he account i ng system t o pr ovi de usef ul i nf or mat i on, onei mpor t ant r equi r ement i s that t he account i ng equat i on must al ways bal ance. Thus,i t i s i mper at i ve we have a syst em t hat wi l l const ant l y mai nt ai n t he account i ngequat i on' s equal i t y.

Remember t he syst em exami ned i n Chapter 1. I n t hat syst em we anal yzedevent s of t he Par ks Comput er Servi ce Corpor at i on, det er mi ned the ef f ect s of t heevent s on speci f i c r esour ces, such as cash and suppl i es, and sour ces ofr esour ces, such as account s payabl e and r etai ned ear ni ngs. We used a pl us ( +)si gn t o show an i ncr ease i n an account or a mi nus ( - ) si gn t o show a decrease.I n order t o determi ne i f t he account i ng equat i on was i n bal ance we had t o taket he f ol l owi ng t wo st eps.

Step 1: Fi r st we had t o determi ne t he bal ance i n each account . Forexampl e, t o determi ne t he cash bal ance we had t o add al l of

8/12/2019 Chapter02 UML 2010

2/25

2 Ch. 2: T Accounts, Debits, Credits

t he pl us dol l ar amount s and subt r act al l of t he mi nus dol l aramounts i n t he cash account .

Step 2: Once we det ermi ned t he bal ance i n each account , we had t oadd al l t he asset account bal ances t o det er mi ne the t otalasset s dol l ar amount , and t hen add al l t he l i abi l i t i es andst ockhol der s' equi t y account bal ances t o deter mi ne t he t otall i abi l i t i es and st ockhol der s' equi t y dol l ar amount .

Af t er t aki ng t hese two st eps we coul d det er mi ne i f t ot al asset s equal ed t ot all i abi l i t i es and st ockhol der s' equi t y. Unt i l we compl et edboth st eps, we coul dnot be sur e the account i ng equat i on was i n bal ance.

What we need i s a more ef f i ci ent way to make sur e t he account i ng equat i oni s al ways i n bal ance. We need a syst em t hat wi l l mai nt ai n t he bal ance of t heaccount i ng equat i on wi t hout r equi r i ng each account bal ance t o be determi ned andwi t hout r equi r i ng t ot al asset s and t ot al l i abi l i t i es and st ockhol der s' equi t y t obe cal cul at ed af t er each event .

A more ef f i ci ent way of mai nt ai ni ng t he equal i t y of t he account i ng equat i onwas devel oped hundr eds of year s ago and i s known as the doubl e- ent r y syst em. I twas f i r st pr esent ed i n a book wr i t t en i n 1494 by a Fr anci scan monk, Fr a LucaPaci ol i .

The doubl e- ent r y syst em was devel oped i n r esponse t o t he mat hemat i cal

probl em: how can i ndi vi dual i t ems i n t he account i ng equat i on change whi l e al waysmai nt ai ni ng t he asset s = l i abi l i t i es + st ockhol der s' equi t y equat i on? Today t hesol ut i on appear s to be qui t e si mpl e. I f t he l ef t si de of t he equat i on ( asset s)i ncreases, t hen t he ri ght si de (l i abi l i t i es and st ockhol der s' equi t y) must al soi ncr ease by t he same dol l ar amount . Si mi l ar l y, i f t he l ef t si de of t he equat i ondecr eases, t he r i ght si de must al so decrease by t he same dol l ar amount . Fr omt hi s r easoni ng, t he f ol l owi ng si mpl e gui del i nes evol ved.

I f an asset i ncreases, one of t he f ol l owi ng must occur :( 1) anot her asset must decr ease by t he same amount . As

a r esul t , t otal asset s r emai n const ant and asset s =l i abi l i t i es + st ockhol der s' equi t y. For exampl e,i f suppl i es i ncr ease by $50 and cash decreases by$50, t otal asset s remai n unchanged. The account i ngequat i on i s st i l l i n bal ance.

( 2) a l i abi l i t y must i ncr ease by t he same amount . As ar esul t , t ot al asset s and t ot al l i abi l i t i es i ncreaseby t he same amount and asset s = l i abi l i t i es +st ockhol der s' equi t y. For exampl e, i f suppl i esi ncrease by $125 and accounts payabl e i ncrease by$125, t otal asset s i ncr ease by $125 and t otall i abi l i t i es and st ockhol der s' equi t y i ncrease by$125. The account i ng equat i on i s st i l l i n bal ance.

( 3) st ockhol ders' equi t y must i ncr ease by t he sameamount . As a r esul t , t ot al asset s and t ot alst ockhol ders' equi t y i ncr ease by t he same amountand asset s = l i abi l i t i es + st ockhol der s' equi t y.For exampl e, i f cash i ncr eases by $1, 000 and commonst ock i ncr eases by $1, 000, t ot al asset s i ncr ease by$1, 000 and t ot al l i abi l i t i es and st ockhol der s'equi t y i ncr ease by $1, 000. The account i ng equat i oni s s t i l l i n bal ance.

Fromt hi s basi c mat hemat i cal pr ocess, i t can be concl uded that each eventaf f ect i ng a busi ness has t wo par t s. One par t r esul t s i n a change i n one asset ,l i abi l i t y, or st ockhol der s' equi t y account and t he ot her par t r esul t s i n an equalchange i n anot her asset , l i abi l i t y, or st ockhol der s' equi t y account . I t i s

8/12/2019 Chapter02 UML 2010

3/25


i mpossi bl e f or an event t o r esul t i n onl y an i ncr ease or decr ease i n one account ,because t he r esul t woul d be an unbal anced account i ng equat i on. For exampl e, i fcash i ncreased by $100 and everyt hi ng el se r emai ned unchanged, asset s woul d nol onger equal l i abi l i t i es pl us stockhol der s' equi t y. Asset s woul d be $100 l ar gert han l i abi l i t i es pl us st ockhol der s' equi t y. Remember f r om Chapt er 1, anunbal anced account i ng equat i on r esul t s i n unr el i abl e i nf or mat i on.

The T Account

The basi c el ement of t he doubl e- ent r y syst em i s t he T account . T account sar e used t o r ecor d each event ' s t wo par t s di scussed i n the pr evi ous par agr aphs.As you can see f r om t he i l l ust r at i on bel ow, i t i s f ai r l y obvi ous wher e t he name Taccount came f r om: t he account st r ongl y r esembl es t he l et t er T. The l ef t si de ofa T account i s cal l ed t he debi t si de ( f r om t he Lat i n debere) and t he ri ght si dei s the credi t s i de ( f r om t he Lat i n credere) . Remember , t hi s syst em and i t st ermi nol ogy have been i n exi st ence f or hundr eds of years!

Account NameDebi t

( Lef t s i de)Cr edi t

( Ri ght si de)

The doubl e- ent r y sys t em makes use of t he T account t o make sure bot h par t s ofeach event ar e account ed f or . Remember , when bot h par t s of each event ar eaccount ed f or , t he account i ng equat i on must bal ance, as t he f ol l owi ng sect i oni l l ust r at es.

Using T Accounts

To see how t he doubl e- ent r y syst em makes use of T account s, l et us agai nconsi der t he J ul y event s of t he Par ks Comput er Ser vi ce Corpor at i on di scussed i nChapt er 1. We wi l l see how t he doubl e- ent r y syst emguarant ees t he account i ngequat i on i s al ways i n bal ance.

Gett i ng r esour ces f r omt he owner On J ul y 1, Ni ck Par ks i nvest s $5, 000 cash i nhi s new company, Par ks Comput er Ser vi ce Corporat i on. Ni ck i nvest s hi s cash byopeni ng a checki ng account i n t he company' s name at t he Somervi l l e Nat i onal Bank.As you r emember f r om Chapter 1, an owner ' s $5, 000 cash i nvest ment i n a companyr esul t s i n a $5, 000 i ncr ease i n the company' s r esour ces and a $5, 000 i ncr ease i ni t s sour ces of r esour ces. The r esour ce t hat i ncr eases i s cash. Si nce t her esour ce comes f r omt he owner , t he sour ce of r esour ces t hat i ncr eases i sst ockhol der s' equi t y, i n t hi s case common st ock.

Tot alResources

=

Sour ces ofBor r owedResources

+

Sour ces ofOwner I nvest ed

Resources

+

Sour ces ofManagement Gener at ed

ResourcesAsset s = Li abi l i t i es + St ockhol der s' Equi t y

+ $5, 000 = + $5, 000

The company' s cash and common st ock both i ncr ease by $5, 000. Thi s event wi l lhave t he f ol l owi ng ef f ect s on t he company' s T account s.

8/12/2019 Chapter02 UML 2010

4/25


Asset s =

Li abi l i t i es +

St ockhol ders'

Equi t y

Event Cas h = Common St ock

Owner' s cash

i nvest ment 5, 000

5, 000

Bal ances 5, 000 5, 000[ - $5, 000 - ] = [ - - - - - - - - - - $5, 000 - - - - - - - - - ]

Not i ce t he $5, 000 i ncr ease i n cash was ent er ed on t he l ef t , or debi t , si deof t he cash T account . I n other words, t he $5, 000 was ent ered as a debi t t ocash. Si nce t hi s i s t he f i r st event we anal yzed, we coul d have ent er ed i t asei t her a debi t or a credi t . Si nce we ent er ed i t as a debi t , we have devel oped anaccount i ng r ul e: assets increase through debits. Noti ce, however , t he i ncr easei n common st ock was ent ered as a cr edi t ( r i ght si de) t o t he common st ock account .We have j ust devel oped another account i ng rul e: stockholders' equity increasesthrough credits. The t wo r ul es we devel oped agr ee wi t h t he account i ng processused i n modern f i nanci al account i ng syst ems.

Why di d we ent er t he i ncrease i n asset s as a debi t and t he i ncr ease i nst ockhol ders' equi t y as a cr edi t ? Remember what we are t r yi ng t o do. We are

t r yi ng t o devel op a syst em t hat wi l l const ant l y mai nt ai n t he equal i t y of t heaccount i ng equat i on af t er each event . Does ent er i ng equal dol l ar amount s ofdebi t s and cr edi t s keep t he account i ng equat i on i n bal ance? Consi der t hi s f i r stevent of t he Par ks Comput er Ser vi ce Corporat i on. Cash was debi t ed f or $5, 000 andcommon st ock was cr edi t ed f or $5, 000. Cl ear l y, debi t s equal ed cr edi t s: debi t swer e $5, 000 and cr edi t s wer e $5, 000. Di d asset s = l i abi l i t i es + st ockhol der s'equi t y? Af t er t he event , asset s ( cash) wer e $5, 000 and l i abi l i t i es +st ockhol ders ' equi t y ( common st ock) wer e $5, 000. Thus, usi ng t he doubl e- ent r ymethod of r ecor di ng equal dol l ar amount s of debi t s and cr edi t s enabl ed us t oeasi l y mai nt ai n the equal i t y of t he account i ng equat i on!

So f ar , t he f ol l owi ng debi t and cr edi t r ul es have been devel oped.Assets increase through debits.

Stockholders equity increases through credits.

Usi ng r esour ces t o buy ot her r esources On J ul y 3, t he company pays $25 cash f orsuppl i es t o be used t o r epai r and servi ce comput ers . Thi s event both i ncr easest he company' s r esour ces when t he suppl i es are bought and decreases i t s r esour ceswhen t he cash i s pai d. The suppl i es r esour ce i ncr eases and t he cash r esour cedecr eases. Si nce t otal r esour ces do not change, t otal sour ces of r esour ces donot change.

Tot alResources

=


+


Resources

+


ResourcesAsset s = Li abi l i t i es + St ockhol der s' Equi t y$5, 000 = $5, 000+ $25

- $25$5, 000 = $5, 000

The company' s suppl i es account i ncr eases by $25 whi l e i t s cash account decr easesby $25. These ef f ects woul d be shown i n t he company' s T accounts as f ol l ows.

8/12/2019 Chapter02 UML 2010

5/25


Asset s =

Li abi l i t i es +

St ockhol ders'

Equi t y

Event Cash + Suppl i es = Common St ock

Owner' s cash

i nvest ment 5, 000 5, 000

Suppl i espur chased

f or cash 25 25

Bal ances 4, 975 25 5, 000

[ - - - - - - - - - - $5, 000 - - - - - - - ] = [ - - - - - - - - - - $5, , 000 - - - - - - - - ]

Not i ce t he $25 i ncr ease i n suppl i es was r ecor ded as a debi t ( l ef t si de) t ot he suppl i es account . Thi s agr ees wi t h t he r ul e we devel oped ear l i er , t hatasset s i ncr ease wi t h debi t s. But what about t he decr ease i n cash? I f asset si ncr ease wi t h debi t s, shoul d t hey decr ease wi t h cr edi t s? Thi s seems l ogi cal andi t i s t he r eason t he cash account was cr edi t ed ( r i ght si de) f or $25 above. Wehave j ust devel oped another account i ng rul e: assets decrease through credits.

Af t er we ent ered debi t s and cr edi t s of $25 each, does our account i ngequat i on st i l l bal ance? Af t er t he suppl i es pur chase, t he company has asset s of

$5, 000 ( cash of $4, 975 and suppl i es of $25) and l i abi l i t i es and st ockhol der s'equi t y of $5, 000 ( common st ock) . Thus, once agai n, i f we r ecor d each event i nsuch a way t hat t he t otal dol l ar amount of debi t s equal s t he total dol l ar amountof cr edi t s, we easi l y mai nt ai n t he equal i t y of t he account i ng equat i on.

Not i ce al so i n the above cash account , t he $4, 975 debi t bal ance resul t edf r om subt r act i ng t he $25 cr edi t f r om t he $5, 000 debi t . The $4, 975 bal ance i sshown as a debi t because t he debi t dol l ar amount s t otal ( $5, 000) was gr eat er t hant he t ot al cr edi t dol l ar amount s ( $25) . I f t he credi t dol l ar amount s t ot al hadbeen l arger t han t he t otal debi t dol l ar amount s, t he bal ance woul d have beenshown as a cr edi t bal ance.

So f ar , t he f ol l owi ng debi t and cr edi t r ul es have been devel oped.Asset s i ncr ease thr ough debi t s.

Assets decrease through credits.

St ockhol der s equi t y i ncr eases t hr ough cr edi t s.

Bor r owi ng r esour ces On J ul y 7, t he company buys addi t i onal suppl i es of $135.The company does not i mmedi at el y pay cash f or t he suppl i es, but agrees t o paycash wi t hi n t he next 30 days. When t he Par ks Comput er Servi ce Cor por at i on buyst he suppl i es by agr eei ng t o pay f or t hem l at er , i t s r esour ces and sour ces ofr esour ces both i ncr ease by $135. The suppl i es r esour ce i ncr eases. Si nce t hesuppl i es ar e not pai d f or i mmedi at el y, t he sour ce of r esour ces t hat i ncr eases i sl i abi l i t i es, i n t hi s case account s payabl e. Remember , si nce t he company does notpay f or t he suppl i es i mmedi at el y, i n ef f ect t hey ar e borr owed.

Tot al Resources

=


+


Resources

+


Resources

Asset s = Li abi l i t i es + St ockhol der s' Equi t y$5, 000 = $5, 000+ $135 = + $135$5, 135 = $135 + $5, 000

As t he company buys suppl i es, i t s asset s i ncr ease. Asset s i ncr ease wi t h debi t s,so t he suppl i es T account shoul d show a $135 debi t . Because t he suppl i es must bepai d f or i n t he f ut ur e, t he l i abi l i t y account s payabl e shoul d al so be i ncreased.Usi ng t he debi t s equal cr edi t s r ul e and remember i ng we have al r eady debi t edsuppl i es f or $135, t he account s payabl e T account shoul d show a $135 cr edi t ,

8/12/2019 Chapter02 UML 2010

6/25


whi ch r epr esent s an increase i n t he account . We have j ust devel oped anot heraccount i ng r ul e: liabilities increase through credits. The r esul t of t hi st r ansact i on can be seen as f ol l ows.

Assets =

Li abi l i t i es +

St ockhol ders'

Equi t y

Event Cash +

Suppl i es =

Account s

Payabl e +

Common St ock

Owner' s cash

i nvest ment 5, 000 5, 000

Suppl i es

pur chased

f or cash 25 25

Suppl i es

pur chased

on account 135 135

Bal ances 4, 975 160 135 5, 000

[ - - - - - - - - - - $5, 135 - - - - - - - - - ] = [ - - - - - - - - - - $5, 135 - - - - - - - - - - ]

Af t er we ent ered debi t s and cr edi t s of $135 each, does our account i ng

equat i on st i l l bal ance? Af t er t he suppl i es pur chase, t he company has asset s of$5, 135 ( cash of $4, 975 and suppl i es of $160) and l i abi l i t i es and st ockhol der s'equi t y of $5, 135 ( accounts payabl e of $135 and common st ock of $5, 000) . Thus,once agai n, i f we record each event i n such a way t hat t he t otal dol l ar amount ofdebi t s equal s t he t otal dol l ar amount of cr edi t s, we easi l y mai nt ai n t he equal i t yof t he account i ng equat i on.

So f ar , t he f ol l owi ng debi t and cr edi t r ul es have been devel oped.Asset s i ncr ease thr ough debi t s.Asset s decr ease t hr ough cr edi t s.Liabilities increase through credits.

St ockhol der s equi t y i ncreases t hr ough cr edi t s.

Generat i ng r esour ces through management operat i ons On J ul y 10, Ni ck advi ses a

cust omer on t he cust omer ' s needs f or a computer syst em. I n r etur n f or t hi sservi ce, t he Par ks Comput er Servi ce Corporat i on r ecei ves $200 cash. The act ofprovi di ng servi ce t o a cust omer and r ecei vi ng cash i ncr eases t he company' sr esour ces and sour ces of r esources by $200. The cash r esour ce i ncr eases. Si ncet he cash came f r omt he ef f or t s of management , t he sour ce of r esour ces t hati ncr eases i s st ockhol der s' equi t y, i n t hi s case r et ai ned ear ni ngs. Remember ,owner s have r i ght s t o r esour ces gener at ed by management and owner s' r i ght s ar eshown i n st ockhol der s' equi t y.

Tot alResources

=


+


Resources

+


ResourcesAsset s = Li abi l i t i es + St ockhol der s' Equi t y$5, 135 = $135 + $5, 000+ $200 = + $200$5, 335 = $135 + $5, 000 + $200

When t he company recei ves t he cash, i t s assets ( cash) i ncr ease and i t sst ockhol der s' equi t y i ncr eases thr ough r et ai ned ear ni ngs. Si nce asset s i ncr easewi t h debi t s, t he cash account shoul d now show a debi t of $200. Becausest ockhol der s' equi t y i ncr eases wi t h cr edi t s, t he r et ai ned ear ni ngs account shoul dshow a cr edi t of $200. These ef f ects can be seen bel ow.

8/12/2019 Chapter02 UML 2010

7/25


Asset s = Li abi l i t i es + St ockhol der s' Equi t y

Event Cash +

Suppl i es =

Account s

Payabl e +

Common St ock +

Retai ned

Ear ni ngs

Owner' s cash

i nvest ment 5, 000 5, 000

Suppl i espur chased

f or cash 25 25

Suppl i es

pur chased

on account 135 135

Servi ce

provi ded to

cust omer 200 200

Bal ances 5, 175 160 135 5, 000 200

[ - - - - - - - - - $5, 335 - - - - - - - - ] = [ - - - - - - - - - - - - - - - - - $5, 335 - - - - - - - - - - - - - - - - ]

Once we ent ered debi t s and credi t s of $200 each, our account i ng equat i onst i l l bal ances. Af t er pr ovi di ng t he ser vi ce, t he company has asset s of $5, 335

( cash of $5, 175 and suppl i es of $160) and l i abi l i t i es and st ockhol der s' equi t y of$5, 335 ( accounts payabl e of $135, common st ock of $5, 000, and r et ai ned ear ni ngsof $200) . Thus, once agai n, i f we r ecor d each event i n such a way t hat t he t otaldol l ar amount of debi t s equal s t he t ot al dol l ar amount of cr edi t s, we easi l ymai nt ai n t he equal i t y of t he account i ng equat i on.

I n busi ness t er mi nol ogy, when asset s ( r esour ces) i ncr ease thr ough t hepr ocess of pr ovi di ng ser vi ces t o cust omer s, t he i ncr ease i n r et ai ned ear ni ngs i scal l ed a revenue. The $200 i ncr ease i n r et ai ned ear ni ngs f r om pr ovi di ng ser vi cet o a cust omer woul d be cal l ed Fees Revenue. As r evenues get l ar ger , par t of t heef f ect i s t o i ncr ease r et ai ned ear ni ngs: an i ncr ease i n r evenues i s an i ncr easei n r etai ned ear ni ngs. Remember , r evenues i ncr ease r etai ned ear ni ngs becauseowner s have a r i ght t o the addi t i onal r esour ces generat ed by management provi di ngser vi ces t o cust omers. I n debi t and cr edi t t erms, how shoul d we r ecor d ani ncr ease i n a r evenue? Si nce r evenues i ncr ease ret ai ned ear ni ngs and r et ai ned

earni ngs i ncr eases wi t h cr edi t s, we shoul d r ecord i ncr eases i n r evenues ascr edi t s. So now we have devel oped another r ul e: revenues increase throughcredits.

So f ar , t he f ol l owi ng debi t and cr edi t r ul es have been devel oped.Asset s i ncr ease thr ough debi t s.Assets decr ease t hr ough cr edi t s.Li abi l i t i es i ncrease t hr ough credi t s.St ockhol der s equi t y i ncr eases t hr ough cr edi t s.Revenues increase through credits.

Payi ng f or borr owed r esources On J ul y 16, t he company pays $70 of t he $135 owedf or suppl i es pur chased on J ul y 7. The r emai ni ng $65 wi l l be pai d i n August .

Thi s cash payment of an amount owed t o a suppl i er r educes t he company' s r esour cesand i t s sour ces of r esour ces by $70. The cash r esour ce decreases. The sour ce ofr esour ces t hat decreases i s l i abi l i t i es, i n t hi s case account s payabl e. Bypayi ng $70 t o the suppl i er , t he amount owed t o the suppl i er ( account s payabl e)decr eases by $70.

8/12/2019 Chapter02 UML 2010

8/25


Tot alResources

=


+


Resources

+


ResourcesAsset s = Li abi l i t i es + St ockhol der s' Equi t y$5, 335 = $135 + $5, 000 + $200- $70 = - $70

$5, 265 = $65 + $5, 000 + $200

The company' s payment of $70 f or suppl i es purchased ear l i er i n t he month r educest he asset cash and r educes t he l i abi l i t y account s payabl e. Asset s i ncr ease wi t hdebi t s and decrease wi t h cr edi t s. Thus, t he $70 cash r educt i on shoul d appear asa cr edi t . Once we cr edi t cash, we need a debi t . As a r esul t , we woul d show t her educt i on of accounts payabl e as a $70 debi t . So now we have devel oped anot herrul e: liabilities decrease through debits.


Event Cash +

Suppl i es =

Account s

Payabl e +

Common St ock +

Retai ned

Ear ni ngs

Owner' s cash

i nvest ment 5, 000 5, 000Suppl i es

pur chased

f or cash 25 25

Suppl i es

pur chased

on account 135 135

Servi ce

provi ded to

cust omer 200 200

Cash payment

on account 70 70

Bal ances 5, 105 160 65 5, 000 200

[ - - - - - - - - - - $5, 265 - - - - - - - ] = [ - - - - - - - - - - - - - - - - - - $5, 265 - - - - - - - - - - - - - - - ]

Once we ent ered debi t s and credi t s of $70 each, our account i ng equat i onst i l l bal ances. Af t er payi ng par t of i t s l i abi l i t y, t he company has asset s of$5, 265 ( cash of $5, 105 and suppl i es of $160) and l i abi l i t i es and st ockhol der s'equi t y of $5, 265 ( account s payabl e of $65, common st ock of $5, 000, and retai nedear ni ngs of $200) . Thus, once agai n, i f we r ecor d each event i n such a way t hatt he t otal dol l ar amount of debi t s equal s t he t ot al dol l ar amount of cr edi t s, weconst ant l y mai nt ai n the equal i t y of t he account i ng equat i on.

So f ar , t he f ol l owi ng debi t and cr edi t r ul es have been devel oped.Asset s i ncr ease thr ough debi t s.Asset s decr ease t hr ough cr edi t s.Li abi l i t i es i ncrease t hr ough credi t s.Liabilities decrease through debits.

St ockhol der s equi t y i ncreases t hr ough cr edi t s.Revenues i ncr ease t hr ough cr edi t s.

Generat i ng r esour ces t hr ough management operat i ons On J ul y 20, Ni ck assi st s i nt he desi gn of a comput er system f or another cust omer . I n r et ur n f or t hi sservi ce, t he Parks Comput er Servi ce Corporat i on does not r ecei ve cash, but t hecust omer agrees t o pay $250 by August 19. The act of per f ormi ng a ser vi ce f or acust omer and r ecei vi ng a pr omi se of cash i ncreases t he company' s r esour ces andsour ces of r esour ces by $250. The r esour ce t hat i ncr eases i s account s

8/12/2019 Chapter02 UML 2010

9/25


r ecei vabl e. Once agai n, si nce t he r esour ce comes f r omt he ef f ort s of management ,t he sour ce of r esour ces t hat i ncreases i s st ockhol der s' equi t y ( r et ai nedear ni ngs) .

Tot alResources

=


+


Resources

+


Resources

Asset s = Li abi l i t i es + St ockhol der s' Equi t y$5, 265 = $65 + $5, 000 + $200+ $250 = + $250$5, 515 = $65 + $5, 000 + $450

The company' s asset account s r ecei vabl e i ncr eases by $250 and i t s st ockhol ders'equi t y account r etai ned earni ngs i ncr eases by $250. Asset s i ncr ease wi t h debi t swhi l e st ockhol der s' equi t y i ncr eases wi t h credi t s. The ef f ect s of t hi s event ont he company' s T accounts can be seen bel ow.


Event Cash +

Account s

Recei vabl e +

Suppl i es =

Account s

Payabl e +

Common St ock +

Retai ned

Ear ni ngs

Owner' s cashi nvest ment 5, 000 5, 000

Suppl i es

pur chased

f or cash 25 25

Suppl i es

pur chased

on account 135 135

Servi ce

provi ded to

cust omer 200 200

Cash payment

on account 70 70

Servi ce

provi ded to

cust omer 250 250

Bal ances 5, 105 250 160 65 5, 000 450

[ - - - - - - - - - - - - - - - - - - $5, 515 - - - - - - - - - - - - - - - ] = [ - - - - - - - - - - - - - - - - - - $5, 515 - - - - - - - - - - - - - - - ]

Af t er we ent ered debi t s and cr edi t s of $250 each, our account i ng equat i onst i l l bal ances. The company now has assets of $5, 515 ( cash of $5, 105, account sr ecei vabl e of $250, and suppl i es of $160) and l i abi l i t i es and st ockhol der s'equi t y of $5, 515 ( account s payabl e of $65, common st ock of $5, 000, and retai nedear ni ngs of $450) . Thus, once agai n, i f we r ecor d each event i n such a way t hatt he t ot al dol l ar amount of debi t s equal s t he t ot al dol l ar amount of cr edi t s, weeasi l y mai nt ai n t he equal i t y of t he account i ng equat i on.

Remember , when assets ( r esour ces) i ncr ease t hr ough t he pr ocess of pr ovi di ngser vi ces t o cust omer s, t he i ncr ease i n r et ai ned ear ni ngs i s cal l ed a r evenue.

The $250 i ncr ease i n r et ai ned earni ngs f or provi di ng ser vi ce t o a cust omer woul dbe cal l ed Fees Revenue, j ust l i ke t he J ul y 10t h event i n whi ch $200 cash wasr ecei ved f or ser vi ce t o a cust omer .

So f ar , t he f ol l owi ng debi t and cr edi t r ul es have been devel oped.Asset s i ncr ease thr ough debi t s.Assets decr ease t hr ough cr edi t s.Li abi l i t i es i ncrease t hr ough credi t s.Li abi l i t i es decrease t hr ough debi t s.

8/12/2019 Chapter02 UML 2010

10/25


St ockhol der s equi t y i ncreases t hr ough cr edi t s.Revenues i ncr ease t hr ough cr edi t s.

Conver t i ng one r esour ce i nt o another On J ul y 25, cash of $100 i s r ecei ved f r omt he cust omer servi ced on J ul y 20. No addi t i onal work i s done f or t he cl i ent on

J ul y 25. Thi s event r esul t s i n bot h an i ncr ease i n t he company' s r esour ces whent he cash i s r ecei ved and a decr ease i n the company' s r esour ces when account s

r ecei vabl e are r educed. Remember , t he cl i ent owes t he company $100 l ess af t ert he cl i ent pays t he $100 t o the company. The cash r esour ce i ncr eases and t heaccount s r ecei vabl e r esour ce decr eases. Si nce t otal r esour ces do not change,t otal sour ces of r esour ces do not change.

Tot alResources

=


+


Resources

+


ResourcesAsset s = Li abi l i t i es + St ockhol der s' Equi t y$5, 515 = $65 + $5, 000 + $450+ $100- $100$5, 515 = $65 + $5, 000 + $450

The r ecei pt of $100 cash f r om t he cl i ent i ncr eases t he company' s asset cash anddecr eases t he asset account s r ecei vabl e. Because asset s i ncr ease wi t h debi t s anddecr ease wi t h cr edi t s, t he cash T account shoul d be debi t ed f or $100 and t heaccount s r ecei vabl e T account shoul d be cr edi t ed f or $100, as r ef l ect ed bel ow.


Event Cash +

Account s

Recei vabl e +

Suppl i es =

Account s

Payabl e +

Common St ock +

Retai ned

Ear ni ngs

Owner' s cash

i nvest ment 5, 000 5, 000

Suppl i es

pur chased

f or cash 25 25

Suppl i es

pur chased

on account 135 135

Servi ce

provi ded to

cust omer 200 200

Cash payment

on account 70 70

Servi ce

provi ded to

cust omer 250 250

Cash

col l ected

from

cust omer

100 100

Bal ances 5, 205 150 160 65 5, 000 450

[ - - - - - - - - - - - - - - - - - - - $5, 515 - - - - - - - - - - - - - - ] = [ - - - - - - - - - - - - - - - - - - - $5, 515 - - - - - - - - - - - - - - - ]

Af t er we ent ered debi t s and cr edi t s of $100 each, our account i ng equat i onst i l l bal ances. The company st i l l has asset s of $5, 515 ( cash of $5, 205, account sr ecei vabl e of $150, and suppl i es of $160) and l i abi l i t i es and st ockhol der s'equi t y of $5, 515 ( account s payabl e of $65, common st ock of $5, 000, and retai nedear ni ngs of $450) . Thus, once agai n, i f we r ecor d each event i n such a way t hat

8/12/2019 Chapter02 UML 2010

11/25


t he t ot al dol l ar amount of debi t s equal s t he t ot al dol l ar amount of cr edi t s, weeasi l y mai nt ai n t he equal i t y of t he account i ng equat i on.

So f ar , t he f ol l owi ng debi t and cr edi t r ul es have been devel oped.Asset s i ncr ease thr ough debi t s.Assets decr ease t hr ough cr edi t s.Li abi l i t i es i ncrease t hr ough credi t s.

Li abi l i t i es decrease t hr ough debi t s.St ockhol der s equi t y i ncr eases t hr ough cr edi t s.Revenues i ncr ease t hr ough credi t s.

Usi ng up r esour ces i n management operat i ons On J ul y 30, Ni ck exami nes hi ssuppl i es and det ermi nes that of t he $160 suppl i es pur chased, onl y $110 ar e st i l ll ef t . I n other words, management used $50 of suppl i es i n pr ovi di ng servi ces t ocust omers i n J ul y. As a company' s suppl i es ar e used up, i t s r esour ces andsour ces of r esour ces bot h decrease by $50. The suppl i es r esour ce decreases.Si nce t he suppl i es were used up by management , t he source of r esour ces t hatdecr eases i s st ockhol der s' equi t y, i n t hi s case r et ai ned ear ni ngs. Remember ,owner s have r i ght s t o r esour ces gener ated by management , but owner s ar e al sor esponsi bl e f or r esour ces used up by management . Owner s' r i ght s ar e shown i nst ockhol der s' equi t y.

Tot alResources

=


+


Resources

+



$5, 465 = $65 + $5, 000 + $400

As t he company uses up i t s suppl i es, i t s asset suppl i es account decr eases and i t sst ockhol der s' equi t y r et ai ned ear ni ngs account decr eases. Asset s i ncr ease wi t hdebi t s and decr ease wi t h cr edi t s. Thus, t he $50 suppl i es decr ease shoul d appearas a cr edi t . Once we cr edi t suppl i es, we need a debi t . As a r esul t , we woul dshow t he ret ai ned ear ni ngs r educt i on as a $50 debi t .


Event Cash +

Account s

Recei vabl e +

Suppl i es =

Account s

Payabl e +

Common St ock +

Retai ned

Ear ni ngs

Owner' s cash

i nvest ment 5, 000 5, 000

Suppl i es

pur chased

f or cash 25 25

Suppl i es

pur chased

on account 135 135

Servi ce

provi ded to

cust omer 200 200

Cash payment

on account 70 70

Servi ce

provi ded to

cust omer 250 250

8/12/2019 Chapter02 UML 2010

12/25



Event Cash +

Account s

Recei vabl e +

Suppl i es =

Account s

Payabl e +

Common St ock +

Retai ned

Ear ni ngs

Cash

col l ected

fromcust omer

100 100

Suppl i es used 50 50

Bal ances 5, 205 150 110 65 5, 000 400

[ - - - - - - - - - - - - - - - - - - $5, 465 - - - - - - - - - - - - - - - ] = [ - - - - - - - - - - - - - - - - - - - $5, 465 - - - - - - - - - - - - - - - ]

Af t er we ent er ed debi t s and credi t s of $50 each, our account i ng equat i onst i l l bal ances. The company now has asset s of $5, 465 ( cash of $5, 205, account sr ecei vabl e of $150, and suppl i es of $110) and l i abi l i t i es and st ockhol der s'equi t y of $5, 465 ( account s payabl e of $65, common st ock of $5, 000, and retai nedear ni ngs of $400) . Thus, once agai n, i f we r ecor d each event i n such a way t hatt he t otal dol l ar amount of debi t s equal s t he t ot al dol l ar amount of cr edi t s, weeasi l y mai nt ai n t he equal i t y of t he account i ng equat i on.

I n busi ness t ermi nol ogy, when asset s ( r esour ces) ar e used up i n the pr ocessof pr ovi di ng ser vi ces t o cust omer s, t he decr ease i n r et ai ned ear ni ngs i s cal l edan expense. The $50 decrease i n r etai ned ear ni ngs f or suppl i es used woul d becal l ed Supplies Expense. As expenses get l ar ger , par t of t he ef f ect i s to r educer et ai ned ear ni ngs: an i ncr ease i n expenses i s a decr ease i n r et ai ned ear ni ngs.I n debi t and cr edi t t erms, how shoul d we r ecor d an i ncrease i n an expense? Si ncei ncr eases i n expenses decrease r etai ned ear ni ngs, and r etai ned ear ni ngs decreaseswi t h debi t s, we shoul d r ecor d i ncr eases i n expenses as debi t s. So now we havedevel oped another r ul e: expenses increase through debits. Be car ef ul wi t h t hi sr ul e. I t i s somet i mes a di f f i cul t one f or st udent s t o accept .

So f ar , t he f ol l owi ng debi t and cr edi t r ul es have been devel oped.Asset s i ncr ease thr ough debi t s.Asset s decr ease t hr ough cr edi t s.

Li abi l i t i es i ncrease t hr ough credi t s.Li abi l i t i es decrease t hr ough debi t s.St ockhol der s equi t y i ncreases t hr ough cr edi t s.Revenues i ncr ease t hr ough cr edi t s.Expenses increase through debits.

Di st r i but i ng r esour ces t o the owner On J ul y 31, t he company pays a $75 cashdi vi dend t o i t s owner. Thi s event r esul t s i n a decr ease i n t he company' sr esour ces and i t s sour ces of r esour ces. Cash r esour ces decr ease. Si nce t heowner r ecei ves t he cash, t he sour ce of r esour ces t hat decr eases i s st ockhol der s'equi t y, i n t hi s case r et ai ned ear ni ngs. The cash r ecei ved by t he owner r educest he owner ' s r i ght s t o t he company s r esour ces because t he owner has t aken somer esour ces out of t he company. Si nce owner s' r i ght s ar e shown i n st ockhol der s'equi t y, st ockhol der s' equi t y decreases.

Tot alResources

=


+


Resources

+



$5, 390 = $65 + $5, 000 + $325

8/12/2019 Chapter02 UML 2010

13/25


As t he company' s $75 cash goes t o t he owner , t he company' s asset cash accountdecr eases and i t s st ockhol der s' equi t y r etai ned ear ni ngs account decr eases.Asset s i ncr ease wi t h debi t s and decr ease wi t h cr edi t s. Thus, t he $75 cashdecrease shoul d appear as a cr edi t . Once we cr edi t cash, we need a debi t . As ar esul t , we woul d show t he ret ai ned ear ni ngs r educt i on as a $75 debi t .


Event Cash +

Account s

Recei vabl e +

Suppl i es =

Account s

Payabl e +

Common St ock +

Retai ned

Ear ni ngs

Owner' s cash

i nvest ment 5, 000 5, 000

Suppl i es

pur chased

f or cash 25 25

Suppl i es

pur chased

on account 135 135

Servi ce

provi ded to

cust omer 200 200

Cash payment

on account 70 70

Servi ce

provi ded to

cust omer 250 250

Cash

col l ected

from

cust omer

100 100


Cash di vi dend 75 75

Bal ances 5, 130 150 110 65 5, 000 325

[ - - - - - - - - - - - - - - - - - - $5, 390 - - - - - - - - - - - - - - - ] = [ - - - - - - - - - - - - - - - - - - - $5, 390 - - - - - - - - - - - - - - - ]

Af t er we ent er ed debi t s and credi t s of $75 each, our account i ng equat i onst i l l bal ances. The company now has assets of $5, 390 ( cash of $5, 130, account sr ecei vabl e of $150, and suppl i es of $110) and l i abi l i t i es and st ockhol der s'equi t y of $5, 390 ( account s payabl e of $65, common st ock of $5, 000, and retai nedear ni ngs of $325) . Thus, once agai n, i f we r ecor d each event i n such a way t hatt he t ot al dol l ar amount of debi t s equal s t he t ot al dol l ar amount of cr edi t s, weeasi l y mai nt ai n t he equal i t y of t he account i ng equat i on.

I n busi ness termi nol ogy, when asset s ( r esour ces) t hat were generatedt hrough management operat i ons ar e di st r i but ed t o owners, t he decrease i n r etai nedear ni ngs i s cal l ed a dividend. A di vi dend i s not a r et urn to owner s of some oft he r esour ces i nvest ed by t hem. As di vi dends get l ar ger , par t of t he ef f ect i st o r educe r et ai ned ear ni ngs: an i ncr ease i n di vi dends i s a decr ease i n ret ai nedearni ngs. I n debi t and cr edi t t er ms, how shoul d we r ecord an i ncr ease i n a

di vi dend? Si nce i ncr eases i n di vi dends decr ease r etai ned earni ngs, and r et ai nedearni ngs decr eases wi t h debi t s, we shoul d r ecord i ncr eases i n di vi dends asdebi t s. So now we have devel oped anot her r ul e: dividends increase throughdebits. Be car ef ul wi t h t hi s r ul e, al so. I t i s somet i mes a di f f i cul t one f orst udent s t o accept .

So f ar , t he f ol l owi ng debi t and cr edi t r ul es have been devel oped.Asset s i ncr ease thr ough debi t s.Assets decr ease t hr ough cr edi t s.Li abi l i t i es i ncrease t hr ough credi t s.

8/12/2019 Chapter02 UML 2010

14/25


Li abi l i t i es decrease t hr ough debi t s.St ockhol der s equi t y i ncreases t hr ough cr edi t s.Revenues i ncr ease t hr ough cr edi t s.Expenses i ncr ease t hr ough debi t s.Dividends increase through debits.

** You now have the background t o do exer ci ses 2. 2, 2. 3, 2. 4, and 2. 5.

Debits and Credits Summarized

As i l l ust r at ed i n Chapt er 1, f i nanci al st at ement s ar e pr epar ed t o pr ovi deanswer s t o speci f i c quest i ons about company r esour ces. Mathemat i cal l y l ogi calf i nanci al st at ement s can be pr epar ed onl y i f t he account i ng equat i on, asset sequal l i abi l i t i es pl us st ockhol der s' equi t y, i s const ant l y i n bal ance.

As shown i n the pr evi ous secti on of t hi s chapt er , t he pr ocess of conver t i ngeach event i nt o equal dol l ar amount s of debi t s and cr edi t s guar ant ees t heaccount i ng equat i on al ways bal ances. Thus, mat hemat i cal l y l ogi cal f i nanci alst atement s can be generated f r omaccount i ng syst ems t hat mai nt ai n t he dol l arequal i t y of debi t s and cr edi t s f or each event .

The debi t equal s cr edi t process conver t s each event i nt o debi t s and cr edi t sas f ol l ows:

Account Debits Credits

Asset s I ncr eases DecreasesLi abi l i t i es Decreases I ncr easesSt ockhol ders ' equi t y Decr eases I ncr eases

Revenues Decr eases I ncr easesExpenses I ncreases Decr easesDi vi dends I ncr eases Decreases

Al t hough the above t abl e mi ght appear t o r equi r e a l ot of memor i zat i on, i nr eal i t y, i t i s actual l y qui t e si mpl e. I n account i ng f or t he vast maj or i t y ofbusi ness event s, al l you need t o r emember ar e t he f ol l owi ng:

Poi nt 1. Asset s i ncr ease wi t h debi t sPoi nt 2. Debi t s = cr edi t s

These t wo poi nt s can be easi l y appl i ed. Consi der agai n t he J ul y 1 event i n whi cht he Par ks Comput er Ser vi ce Corporat i on r ecei ves $5, 000 f r om i t s owner i n r et ur nf or common st ock. Si nce t he company r ecei ves $5, 000 i n cash, you know t he assetcash shoul d i ncr ease by $5, 000. I f you r emember Poi nt 1, asset account s i ncr easewi t h debi t s, you know you must debi t t he cash account f or $5, 000. Remember i ngal so Poi nt 2, debi t s must equal cr edi t s, you know you must now cr edi t someaccount f or $5, 000. Logi cal l y, your $5, 000 cr edi t shoul d be t o the common st ockaccount si nce the owner r ecei ved common st ock i n retur n f or hi s i nvest ment i n thecompany. As a r esul t of memor i zi ng t he t wo si mpl e poi nt s above ( assets i ncr easewi t h debi t s and debi t s = cr edi t s) , you shoul d be abl e to conver t most busi nessevent s i nt o debi t s and cr edi t s, i f you can under st and t he event s. As you get

more pr act i ce i n anal yzi ng event s, t he debi t and cr edi t pr ocess wi l l becomeeasi er . I n f act , as you get mor e pr act i ce you wi l l see i t i s not t he debi t andcredi t process t hat i s di f f i cul t . I t i s under st andi ng busi ness event s t hat i st he most di f f i cul t par t of account i ng. I t i s ext r emel y di f f i cul t t o cor r ectl yaccount f or an event i f you do not underst and how t he event af f ects t he company.

Information from Financial Statements

Remember, t he pur pose of t he debi t and credi t process i s t o mai nt ai n t heequal i t y of t he account i ng equat i on. I f a company s event s have been cor r ect l y

8/12/2019 Chapter02 UML 2010

15/25


under st ood and t he account i ng equat i on i s i n bal ance, t he r esul t i ng f i nanci alst atement s can be used t o answer speci f i c quest i ons about t he company' sr esour ces. The f ol l owi ng f i nanci al st at ement s resul t f r om t he Par ks Comput erServi ce Corpor at i on' s account i ng syst em.

Income Statement

The i ncome st at ement provi des i nf or mat i on about what a company' s managementdi d wi t h i t s r esour ces. The i ncome st at ement r epor t s t he dol l ar amount ofr esour ces generat ed t hrough management operat i ons. The i ncome st atement f or t he

J ul y operat i ons of t he Parks Comput er Servi ce Cor porat i on appears as f ol l ows.

Par ks Comput er Servi ce Corporat i onI ncome St at ement

f or t he Mont h Ended J ul y 31

Fees Revenue $450Suppl i es Expense $50Net I ncome $400

Fr om t he Par ks Comput er Ser vi ce Corpor at i on' s i ncome st atement we can see t hecompany' s management used t he company' s r esources i n J ul y t o gener at ed $400 ofaddi t i onal r esour ces. The i ncome st atement shows management brought i n r esour cesof $450 ( f ees r evenue) and used $50 of r esour ces ( suppl i es expense) .


Statement of Retained Earnings

The st at ement of r et ai ned earni ngs provi des i nf or mat i on about what acompany di d wi t h the r esources management gener at ed t hrough operat i ng t hecompany. The Par ks Comput er Ser vi ce Corpor at i on' s J ul y st atement of r etai nedear ni ngs appear s as f ol l ows.

Par ks Comput er Servi ce Corporat i onSt atement of Retai ned Earni ngsf or t he Mont h Ended J ul y 31

Ret ai ned Ear ni ngs, J ul y 1 $0Pl us: Net I ncome f or J ul y $400Subtotal $400Less: Di vi dends $75Ret ai ned Ear ni ngs, J ul y 31 $325

Fr omt he Par ks Comput er Ser vi ce Corpor at i on' s st at ement of r et ai ned earni ngs wecan see that of t he $400 of r esour ces gener ated t hrough management operat i ons i n

J ul y ( net i ncome) , $75 wer e di st r i buted t o t he owner ( di vi dends) . I n ot herwords, t he company r etai ned f or f ut ure use $325 of t he resources generated

t hrough management oper at i ons.


Balance Sheet

The bal ance sheet pr ovi des i nf or mat i on about what a company' s r esour ces ar eand wher e t hey came f r om. The Par ks Comput er Servi ce Corpor at i on' s J ul y 31bal ance sheet appear s as f ol l ows.

8/12/2019 Chapter02 UML 2010

16/25


Par ks Comput er Servi ce Corpor at i onBal ance Sheet

J ul y 31

Asset s Li abi l i t i es & St ockhol der s' Equi t yCash $5, 130 Li abi l i t i esAccounts Recei vabl e $150 Accounts Payabl e $65

Suppl i es $110Tot al Asset s $5, 390 St ockhol ders' Equi t y Common St ock $5, 000 Retai ned Ear ni ngs $325 Tot al St ockhol der s' Equi t y $5, 325 Tot al Li abi l i t i es & St ockhol der s' Equi t y $5, 390

The company' s bal ance sheet shows on J ul y 31 t he company had r esour ces ( asset s)of $5, 390. $65 of t he asset s wer e bor r owed ( l i abi l i t i es) . $5, 000 of t he asset swere i nvest ed by t he owner ( common st ock) . $325 of asset s were generated t hrough

nagement operat i ons and retai ned i n the company ( r etai ned ear ni ngs) .ma

Unequal Debits and Credits: Revisited

I t i s i mper at i ve you under st and why account i ng syst ems make use of t hedebi t s equal s credi t s rul e. As emphasi zed sever al t i mes i n t hi s chapt er , i f eachevent af f ect i ng a company i s account ed f or i n such a manner t hat t he total dol l aramount of debi t s equal s t he total dol l ar amount of cr edi t s, t he account i ngequat i on must al ways be i n bal ance. A bal anced account i ng equat i on l eads t omat hemat i cal l y l ogi cal f i nanci al st at ement s. Mat hemat i cal l y l ogi cal f i nanci alst at ement s r esul t i ng f r om t he cor r ect under st andi ng of busi ness event s provi dei nf ormat i on usef ul t o answer quest i ons about t he company' s r esour ces. Thus, t heusef ul ness of t he i nf ormat i on pr ovi ded i n f i nanci al st at ement s depends upon t hedebi t s equal s cr edi t s r ul e and the cor r ect under st andi ng of busi ness event s.

Consi der what woul d happen to t he i nf ormat i on pr ovi ded i n f i nanci alst at ement s i f t he debi t s equal s cr edi t s r ul e was not f ol l owed i n t he J ul y 20event of t he Parks Comput er Ser vi ce Cor por at i on. Remember , on J ul y 20 management

per f or med ser vi ces f or a cust omer who agr eed to pay $250 by August 19. When weaccount ed f or t hi s event cor r ect l y i t r esul t ed i n a $250 debi t t o account sr ecei vabl e and a $250 cr edi t t o r etai ned ear ni ngs ( Fees Revenue) . Suppose,however , we incorrectly r ecor ded i t as a $250 debi t t o account s r ecei vabl e and a$25 cr edi t t o r et ai ned ear ni ngs, as shown i n the f ol l owi ng T account s.


Event Cash +

Account s

Recei vabl e +

Suppl i es =

Account s

Payabl e +

Common St ock +

Retai ned

Ear ni ngs

Owner' s cash

i nvest ment 5, 000 5, 000

Suppl i es

pur chased

f or cash 25 25

Suppl i es

pur chased

on account 135 135

Servi ce

provi ded to

cust omer 200 200

Cash payment

on account 70 70

8/12/2019 Chapter02 UML 2010

17/25



Event Cash +

Account s

Recei vabl e +

Suppl i es =

Account s

Payabl e +

Common St ock +

Retai ned

Ear ni ngs

Servi ce

provi ded to

cust omer 250 25

Cashcol l ected

from

cust omer

100 100


Cash di vi dend 75 75

Bal ances 5, 130 150 110 65 5, 000 100

[ - - - - - - - - - - - - - - - - - - $5, 390 - - - - - - - - - - - - - - - ] = [ - - - - - - - - - - - - - - - - - - $5, 165 - - - - - - - - - - - - - - - - ]

Af t er we ent er t he debi t of $250 and t he credi t of onl y $25, our account i ngequat i on does not bal ance. At t he end of J ul y, t he company' s T accounts showasset s of $5, 390 ( cash of $5, 130, account s r ecei vabl e of $150, and suppl i es of$110) and l i abi l i t i es and st ockhol der s' equi t y of $5, 165 ( account s payabl e of$65, common st ock of $5, 000, and r et ai ned ear ni ngs of $100) . Cl ear l y, asset s of

$5, 390 do not equal l i abi l i t i es and st ockhol der s' equi t y of $5, 165! You shoul dconcl ude f r om t hi s t hat i f you do not r ecord each event i n such a way t hat t het ot al dol l ar amount of debi t s equal s t he t ot al dol l ar amount of cr edi t s, you wi l lnot mai nt ai n t he equal i t y of t he account i ng equat i on.

Addi t i onal l y, i f asset s do not equal l i abi l i t i es and st ockhol der s' equi t y,of what val ue i s the i nf or mat i on pr ovi ded i n t he f i nanci al st at ement s? I f t hebal ance sheet r epor t s more resour ces ( assets) t han t he dol l ar amount s t hat camef r ombor r owi ng, f r omst ockhol ders , or t hr ough management operat i ons, f r omwher edi d t he company get t he addi t i onal r esour ces? Di d t he asset s j ust magi cal l yappear ? I f t he f i nanci al st at ement s ar e t o be r el i ed upon f or usef uli nf or mat i on, i t i s ext r emel y i mpor t ant t he debi t s equal s cr edi t s r ul e bef ol l owed.

** You now have t he background t o do exerci se 2. 8 and probl ems 2. 1 and 2. 2.

Chapter 2 Critical Points

The account i ng equat i on, asset s = l i abi l i t i es + st ockhol der s' equi t y i si mpor t ant i n f i nanci al r epor t i ng because i f i t i s i n bal ance i tguar ant ees t he f i nanci al st at ement s wi l l be mat hemat i cal l y l ogi cal .

The debi t s = cr edi t s pr ocess guarant ees t he account i ng equat i on i sal ways i n bal ance.

Asset account s i ncr ease t hr ough debi t s and decrease t hroughcredi t s .

Li abi l i t y account s i ncr ease t hr ough cr edi t s and decr ease t hr oughdebi t s.

St ockhol der s' equi t y account s i ncr ease t hr ough cr edi t s anddecr ease t hr ough debi t s.

Revenue accounts i ncrease t hrough cr edi t s and decr ease t hroughdebi t s.

Expense accounts i ncrease t hrough debi t s and decr ease t hroughcredi t s .

Di vi dends accounts i ncrease t hrough debi t s and decrease t hr oughcredi t s .

I f debi t s do not equal credi t s, t he account i ng equat i on wi l l notbal ance and t he i nf ormat i on pr ovi ded i n t he f i nanci al st at ement scannot be rel i ed upon.

8/12/2019 Chapter02 UML 2010

18/25


Chapter Two Questions

1. I n account i ng t ermi nol ogy, what does t he t erm assets mean?

2. What does t he t er m l i abi l i t i es mean?

3. What does t he t erm st ockhol ders' equi t y mean?

4. I dent i f y t he t wo separ at e par t s of st ockhol der s' equi t y.

5. Why i s i t i mpor t ant t hat t he f i nanci al st at ement s ar e l ogi cal ?

6. What cont r i but i on di d Fra Luca Paci ol i make t o account i ng?

7. What i s t he l ef t si de of a T account cal l ed?

8. What i s t he r i ght si de of a T account cal l ed?

9. How does the debi t s = cr edi t s rul e af f ect t he account i ng equat i on?

10. What t er m i s used t o i dent i f y the i ncr ease i n r esour ces t hr ough t hepr ocess of pr ovi di ng servi ce t o cust omers?

11. What af f ect do revenues have on r etai ned ear ni ngs?

12. What t er m i s used t o i dent i f y t he decr ease i n r esour ces t hr ough t hepr ocess of pr ovi di ng servi ce t o cust omers?

13. What af f ect do expenses have on r et ai ned ear ni ngs?

14. What t er m i s used t o i dent i f y t he decr ease i n r esour ces t hr ough payment smade t o owners?

15. What af f ect do di vi dends have on r etai ned ear ni ngs?

8/12/2019 Chapter02 UML 2010

19/25


16. Compl et e t he f ol l owi ng, usi ng t he t er ms debi t s and cr edi t s.Asset s i ncr ease t hr ough _______ and decr ease t hr ough _______.Li abi l i t i es i ncrease t hr ough _____ __ and decrease t hr ough _____ __.St ockhol der s' equi t y i ncr eases t hr ough _______ and decr ease thr ough

______.Revenues i ncr ease thr ough __ ____ _ and decrease thr ough __ ____ _.Expenses i ncr ease t hr ough _______ and decr ease t hr ough _______ .

Di vi dends i ncr ease thr ough _______ and decr ease thr ough _______.

Chapter Two Exercises

Exer ci se 2. 1: Asset s = Li abi l i t i es + St ockhol der s' Equi t y

Peopl es Corporat i on began busi ness on J ul y 10. Between J ul y 10 andAugust 31, t he owner s i nvest ed $35, 000, t he company bor r owed $7, 000,management gener at ed $2, 200 resources t hrough operat i ons, and the owner s wer epai d di vi dends of $250.

1. Det er mi ne the Peopl es Cor por at i on' s t ot al l i abi l i t i es on August 31.

2. Det er mi ne t he Peopl es Corpor at i on' s t otal st ockhol der s' equi t y on August31.

3. Det ermi ne the Peopl es Corporat i on' s t otal asset s on August 31.

Exer ci se 2. 2: Cash T Account

On Febr uar y 1, t he Bussey Corpor at i on had $18, 500 cash on hand. Dur i ngFebr uary, t he company engaged i n many cash event s, i ncl udi ng ( a) r ecei vi ng a$2, 500 addi t i onal i nvest ment f r om owner s, ( b) payi ng $1, 800 f or suppl i es, ( c)r ecei vi ng $6, 000 f r om cust omers, ( d) payi ng $3, 200 on accounts payabl e, and( e) payi ng $500 di vi dends t o owners.

1. Set up a T account f or t he Bussey Corpor at i on' s cash.

2. Usi ng debi t s and cr edi t s, show how each of t he f i ve above events af f ectedt he company' s cash T account .

3. Cal cul at e the Bussey Corporat i on' s cash bal ance at t he end of Febr uar y.

8/12/2019 Chapter02 UML 2010

20/25


Exer ci se 2. 3: Ret ai ned Earni ngs T Account

On November 1, t he Raymond Cor por at i on had r et ai ned ear ni ngs of $46, 900.Dur i ng November , t he company engaged i n many event s, i ncl udi ng ( a) r ecei vi ng$1, 000 addi t i onal i nvest ment f r om owner s, ( b) r ecei vi ng $4, 500 cash f r omcust omer s f or servi ces provi ded t o t hem i n November , ( c) payi ng $1, 200 toempl oyees f or work t hey di d f or t he company i n November , ( d) r ecei vi ng $2, 900

account s r ecei vabl e f r omcust omer s f or ser vi ces pr ovi ded t o t hemi n November ,and (e) payi ng $300 di vi dends t o owners.

1. Set up a T account f or t he Raymond Corporat i on' s r etai ned ear ni ngs.

2. Usi ng debi t s and cr edi t s, show how each of t he f i ve above event s af f ectedt he company' s r et ai ned ear ni ngs T account . Hi nt : one event does not af f ectr et ai ned ear ni ngs!

3. Cal cul ate t he Raymond Corporat i on' s r etai ned ear ni ngs bal ance at t he end ofNovember .

4. Cal cul at e t he Raymond Corpor at i on' s net i ncome f or November .

Exerci se 2. 4: Cash, Suppl i es, and Account s Payabl e T Account s

On Apr i l 1, t he Gat el y Corpor at i on had cash of $18, 000, suppl i es of$5, 600, and account s payabl e of $6, 700. Dur i ng Apr i l , t he company engaged i nmany event s, i ncl udi ng ( a) payi ng $2, 000 f or addi t i onal suppl i es, ( b) payi ng$3, 400 f or suppl i es pur chased i n J anuar y, ( c) buyi ng $2, 500 addi t i onalsuppl i es on account , and ( d) usi ng a t otal of $4, 000 of suppl i es t o pr ovi deser vi ces t o cust omer s i n Apr i l .

1. Set up T account s f or t he Gat el y Corporat i on' s cash, suppl i es, and account spayabl e.

2. Usi ng debi t s and cr edi t s, show how each of t he f our above event s af f ectedt he company' s cash, suppl i es, and account s payabl e T account s.

3. Cal cul at e t he bal ances i n t he Gat el y Cor por at i on' s cash, suppl i es, andaccount s payabl e account s.

8/12/2019 Chapter02 UML 2010

21/25


Exer ci se 2. 5: Cash, Account s Recei vabl e, and Retai ned Ear ni ngs T Account s

On December 1, t he Bi ckf or d Cor por at i on had cash of $24, 000, accountsr ecei vabl e of $9, 200, and r etai ned ear ni ngs of $67, 000. Dur i ng December , t hecompany engaged i n many event s, i ncl udi ng ( a) r ecei vi ng $12, 000 f r omcust omersf or ser vi ces pr ovi ded dur i ng December , ( b) payi ng $700 t o owners f ordi vi dends, ( c) r ecei vi ng a t ot al of $5, 000 f r om cust omer s f or ser vi ces

pr ovi ded t o t hemi n Oct ober and November, and (d) r ecei vi ng pr omi ses of $7, 000f r omcust omers f or ser vi ces pr ovi ded t o t hem i n December.

1. Set up T account s f or t he Bi ckf or d Cor por at i on' s cash, account s r ecei vabl e,and r et ai ned ear ni ngs.

2. Usi ng debi t s and cr edi t s, show how each of t he f our above events af f ectedt he company' s cash, account s r ecei vabl e, and r etai ned ear ni ngs T account s.

3. Cal cul at e the bal ances i n t he Bi ckf or d Cor por at i on' s cash, account sr ecei vabl e, and ret ai ned ear ni ngs account s.

Exer ci se 2. 6: I ncome St atement

The Al mei da Cor porat i on' s i ncome st at ement f or t he mont h ended J anuar y31, i s shown bel ow.

Al mei da Corporat i onI ncome St at ement

For t he Mont h Ended J anuar y 31

Revenues $24, 000Expenses $15, 000Net I ncome $9, 000

1. Det ermi ne the dol l ar amount of r esour ces obt ai ned f r omcust omers f or

ser vi ces pr ovi ded t o them i n J anuar y.

2. Det ermi ne the dol l ar amount of r esour ces used up i n pr ovi di ng ser vi ce t ocust omer s i n J anuar y.

3. Determi ne t he net dol l ar amount by whi ch t he company' s r esour ces i ncreasedt hrough management operat i ons i n J anuar y.

8/12/2019 Chapter02 UML 2010

22/25


Exer ci se 2. 7: St at ement of Ret ai ned Ear ni ngs

The Al mei da Cor porat i on' s st at ement of r et ai ned earni ngs f or t he mont hended J anuar y 31, i s shown bel ow.

Al mei da Corporat i onSt atement of Retai ned Earni ngs

For t he Mont h Ended J anuar y 31

Begi nni ng Bal ance $43, 000Net I ncome $9, 000Subt otal $52, 000Di vi dends $3, 000Endi ng Bal ance $49, 000

1. Det ermi ne t he dol l ar amount of r esources gener at ed t hrough managementoperat i ons and r etai ned i n the company pr i or t o J anuar y 1.

2. Det ermi ne t he net dol l ar amount by whi ch the company' s r esour ces i ncreasedt hrough management operat i ons i n J anuar y.

3. Det er mi ne the dol l ar amount of r esour ces pai d to owner s i n J anuar y.

4. Det ermi ne t he dol l ar amount of r esources gener at ed t hrough managementoperat i ons and retai ned i n t he company by J anuar y 31.

Exer ci se 2. 8: Bal ance Sheet

The Al mei da Cor porat i on' s bal ance sheet on J anuar y 31, i s shown bel ow.

Al mei da Corporat i onBal ance SheetJ anuar y 31

Asset s Li abi l i t i esCash $55, 000 Account s Payabl e $27, 000Account s Recei vabl e $32, 000 St ockhol der s' Equi t ySuppl i es $6, 000 Common Stock $17, 000

Tot al Asset s $93, 000 Ret ai ned Earni ngs $49, 000 Tot al Li ab. & St ock. Eq. $93, 000

1. Determi ne t he dol l ar amount of r esources on J anuary 31.

2. Determi ne the dol l ar amount of bor r owed r esour ces.

3. Determi ne t he dol l ar amount of r esources i nvest ed by owners.

4. Det ermi ne t he dol l ar amount of r esources gener at ed t hrough managementoperat i ons and r etai ned i n the company as of J anuary 31.

8/12/2019 Chapter02 UML 2010

23/25


Chapter Two Problem

Pr obl em 2. 1: Tr ansact i ons, Account s, and Fi nanci al St at ement s

Hender son Corpor at i on engaged i n the f ol l owi ng t r ansact i ons dur i ngApr i l .

Apr i l 1 Rebecca Hender son i nvest ed $6, 000 i n t he company and r ecei ved 6, 000shar es of $1 par common st ock.

Apr i l 4 Hender son Corporat i on pr ovi ded $300 servi ces t o a cl i ent and r ecei vedf ul l payment i n cash.

Apr i l 7 Henderson Corporat i on pur chased $500 suppl i es on account . Thesuppl i es wi l l be pai d i n f ul l by May 7.

Apr i l 10 Henderson Corporat i on pr ovi ded $200 ser vi ces t o a cl i ent who agr eedt o pay on Apr i l 19.

Apr i l 15 Hender son Cor por at i on pai d $125 to an empl oyee f or work done i n t hef i r st t wo weeks of Apr i l .

Apr i l 18 Hender son Corporat i on pai d $300 cash f or addi t i onal suppl i es.

Apr i l 19 Hender son Corporat i on r ecei ved f ul l payment f r omt he cust omerser vi ced on Apr i l 10.

Apr i l 22 Hender son Corporat i on pai d $250 as par t i al payment f or t he suppl i espur chased on Apr i l 7.

Apr i l 25 Henderson Corporat i on pai d a $100 cash di vi dend t o i t s owner .

Apr i l 28 Henderson Corporat i on pr ovi ded $400 ser vi ces t o a cl i ent who agr eedt o pay on May 5.

Apr i l 30 A r evi ew of suppl i es r eveal ed $225 of suppl i es had been used up byt he end of Apr i l .

1. By addi t i on and subt r act i on, show t he ef f ect s of t he t r ansact i ons on Hender sonCor por at i on' s r esour ces and sour ces of r esour ces. Not i ce t he f i r stt r ansact i on has been pr ocessed f or you.

Resources


Sour ces ofOwner

I nvest edResources

Sour ces ofManagementGener at edResources

Asset s Li abi l i t i es St ockhol der s Equi t yApr i l 1 + $6, 000 _______ + $6, 000 _______Apr i l 4 ________ _______ ________ _______Apr i l 7 ________ _______ ________ _______Apr i l 10 ________ _______ ________ _______Subt ot al s __$7, 000 ___$500 __$6, 000 ___$500Apr i l 15 ________ _______ ________ _______Apr i l 18 ________ _______ ________ _______Apr i l 19 ________ _______ ________ _______Subt ot al s __$6, 875 ___$500 __$6, 000 ___$375

8/12/2019 Chapter02 UML 2010

24/25


Resources


Sour ces ofOwner

I nvest edResources

Sour ces ofManagementGener at edResources

Asset s Li abi l i t i es St ockhol der s Equi t ySubt ot al s __$6, 875 ___$500 __$6, 000 ___$375Apr i l 22 ________ _______ ________ _______Apr i l 25 ________ _______ ________ _______Apr i l 28 ________ _______ ________ _______Apr i l 30 ________ _______ ________ _______

Tot al s __$6, 700 ___$250 __$6, 000 ___$450

2. By addi t i on and subt r act i on, show t he ef f ect s of t he Apr i l t r ansact i ons ont he T account s of t he Hender son Cor por at i on. Not i ce t he f i r st t r ansact i onhas been pr ocessed f or you. Cal cul ate t he bal ance i n each T account at t heend of Apr i l .


Dat e Cash +

Account s

Recei vabl e +

Suppl i es =

Account s

Payabl e +

Common St ock +

Retai ned

Ear ni ngs

Apri l 1 6, 000 6, 000

Apri l 4

Apri l 7

Apri l 10

Apri l 15

Apri l 18

Apri l 19

Apri l 22

Apri l 25

Apri l 28

Apri l 30

Bal ances 5, 725 450

8/12/2019 Chapter02 UML 2010

25/25


3. Pr epar e t he Hender son Corpor at i on' s Apr i l f i nanci al st at ement s.

Hender son Corpor at i onI ncome Stat ement

For t he Mont h Ended Apr i l 30

Revenues $_________

Expenses $_________Net I ncome $____ _____

Hender son Cor por at i onSt atement of Retai ned Ear ni ngsFor t he Mont h Ended Apr i l 30

Ret ai ned Ear ni ngs, Apr i l 1 $______ __0Net I ncome $____ _____Subt ot al $_____ ____Di vi dends $_____ ____Ret ai ned Ear ni ngs, Apr i l 30 $______ 450

Hender son Corpor at i onBal ance Sheet

Apr i l 30

Asset s Li abi l i t i esCash $______ ___ Account s Payabl e $___ ______Account s Recei vabl e $_____ ____ St ockhol der s' Equi t ySuppl i es $_________ Common St ock $_________

Tot al Asset s $__ __6, 700 Ret ai ned Earni ngs $__ _______ Tot al Li ab. & St ock. Eq. $_____ ____

4. The dol l ar amount of Hender son Corporat i on' s t otal r esour ces at t he end ofApr i l i s $_______________.

5. The dol l ar amount of r esour ces on hand at t he end of Apr i l t hat HendersonCor por at i on obt ai ned t hr ough bor r owi ng i s $______ ___ ______ .

6. The dol l ar amount of r esour ces on hand at t he end of Apr i l t hat HendersonCor por at i on obt ai ned thr ough owner ' s i nvest ment s i s $__________ _____.

7. The net dol l ar amount of r esour ces Henderson Corporat i on generated t hr oughmanagement oper at i ons i n Apr i l i s $_____ ___ ______ _.

chapter02 uml 2010

Documents