Double-Entry Accounting, Financial Statements, and Payroll Management Study Guide

Foundational Accounting Terminology and Definitions

Double-Entry Accounting: A method of record-keeping providing a system of checks and balances where every transaction is recorded in a dual format.
Debit: The left side of a T-account.
Credit: The right side of a T-account.
T-account: A simplified visual form of an account representing the ledger.
Ledger: A collection of all accounts and their respective balances for an information system. The size and diversity of a company's operations determine the number of accounts required.
Journal: Known as the "book of original entry," it provides a chronological record of all transactions.
Chart of Accounts: A comprehensive list of every account used by a business, each paired with a unique identifying account number.
Trial Balance: A listing of every ledger account and its balance as either a debit or a credit. This tool is used to prove that the total debits equal total credits.
Posting: The mechanical process of copying information from the journal into the ledger.
Account Balance: The calculated difference between the total increases and total decreases recorded in a specific account.

The Double-Entry Framework and the Accounting Equation

The Basic Accounting Equation: $\text{Assets} = \text{Liabilities} + \text{Equity}$
Expanded Accounting Equation (Equity Breakdown): $\text{Assets} = \text{Liabilities} + [\text{Common Stock} - \text{Dividends} + \text{Revenues} - \text{Expenses}]$

Rules of Debits, Credits, and Normal Balances

Assets:
- Increases: Recorded as Debits ( $+$ ).
- Decreases: Recorded as Credits ( $-$ ).
- Normal Balance: Debit.
Liabilities:
- Increases: Recorded as Credits ( $+$ ).
- Decreases: Recorded as Debits ( $-$ ).
- Normal Balance: Credit.
Equity:
- Increases: Recorded as Credits ( $+$ ).
- Decreases: Recorded as Debits ( $-$ ).
- Normal Balance: Credit.
Common Stock:
- Increases: Recorded as Credits ( $+$ ).
- Decreases: Recorded as Debits ( $-$ ).
- Normal Balance: Credit.
Dividends:
- Increases: Recorded as Debits ( $+$ ).
- Decreases: Recorded as Credits ( $-$ ).
- Normal Balance: Debit.
Revenues:
- Increases: Recorded as Credits ( $+$ ).
- Decreases: Recorded as Debits ( $-$ ).
- Normal Balance: Credit.
Expenses:
- Increases: Recorded as Debits ( $+$ ).
- Decreases: Recorded as Credits ( $-$ ).
- Normal Balance: Debit.

The Four-Step Cycle for Analyzing and Processing Transactions

Identify: Review transactions and source documents (e.g., Services Contracts, Client Billings, Notes Payable, Purchase Tickets, Bank Statements).
Analyze: Determine the effect on the accounting equation ( $\text{Assets} = \text{Liabilities} + \text{Equity}$ ).
Record: Enter the transaction into the General Journal as a journal entry.
Post: Transfer the journal entry information into the General Ledger.

Transaction Analysis and Journalization Examples

Investment by Owner:
- Identify: FastForward receives $\$30,000$ cash from Chas Taylor for common stock.
- Analyze: Assets (Cash) increase by $\$30,000$ ; Equity (Common Stock) increases by $\$30,000$ .
- Record: Debit Cash (101) $\$30,000$ ; Credit Common Stock (307) $\$30,000$ .
Purchasing Supplies for Cash:
- Identify: FastForward pays $\$2,500$ cash for supplies.
- Analyze: Assets (Supplies) increase by $\$2,500$ ; Assets (Cash) decrease by $\$2,500$ . Total assets remain unchanged; only the composition changes.
- Record: Debit Supplies (126) $\$2,500$ ; Credit Cash (101) $\$2,500$ .
Purchasing Equipment for Cash:
- Identify: FastForward pays $\$26,000$ cash for equipment.
- Analyze: Assets (Equipment) increase by $\$26,000$ ; Assets (Cash) decrease by $\$26,000$ .
- Record: Debit Equipment (167) $\$26,000$ ; Credit Cash (101) $\$26,000$ .
Purchasing Supplies on Credit:
- Identify: FastForward purchases $\$7,100$ of supplies on credit.
- Analyze: Assets (Supplies) increase by $\$7,100$ ; Liabilities (Accounts Payable) increase by $\$7,100$ .
- Record: Debit Supplies (126) $\$7,100$ ; Credit Accounts Payable (201) $\$7,100$ .
Providing Services for Cash:
- Identify: FastForward provides consulting services and collects $\$4,200$ cash.
- Analyze: Assets (Cash) increase by $\$4,200$ ; Equity (Revenue) increases by $\$4,200$ .
- Record: Debit Cash (101) $\$4,200$ ; Credit Consulting Revenue (403) $\$4,200$ .
Providing Services on Credit:
- Identify: The company provides $\$540$ of services for a client on credit.
- Analyze: Assets (Accounts Receivable) increase by $\$540$ ; Equity (Revenue) increases by $\$540$ .
- Record: Debit Accounts Receivable $\$540$ ; Credit Services Revenue $\$540$ .

The Trial Balance

Preparation Steps:
1. List every account title and its balance from the ledger. If the balance is zero, it may be listed as zero or omitted.
2. Total the debit balances and the credit balances separately.
3. Verify that the total debits equal the total credits.
Case Study: Apple Trial Balance (September 29, 20X2):
- Debits:
  - Cash: $\$10,746$
  - Accounts Receivable: $\$10,930$
  - Land and Equipment: $\$15,452$
  - Investments and Other Assets: $\$138,936$
  - Dividends: $\$2,523$
  - Cost of Sales (Expense): $\$101,876$
  - Selling and Other Expense: $\$12,899$
  - Total Debits: $\$293,362$
- Credits:
  - Accounts Payable: $\$21,175$
  - Other Liabilities: $\$36,679$
  - Common Stock: $\$16,422$
  - Retained Earnings: $\$62,578$
  - Revenues: $\$156,508$
  - Total Credits: $\$293,362$

Financial Statements

Income Statement: Reports revenues and expenses to show net income or loss over a period of time.
Statement of Retained Earnings: Details changes in retained earnings due to net income (or loss) and dividends declared over a period of time.
Balance Sheet: Snapshots the company's financial position (Assets, Liabilities, and Equity) at a specific point in time.
Statement of Cash Flows: Highlights cash inflows and outflows over a period of time.
Interconnectivity of Statements:
- Net income from the Income Statement flows into the Statement of Retained Earnings.
- The ending balance of Retained Earnings flows from its specific statement to the Equity section of the Balance Sheet.

Payroll Accounting: Journal Entries and Taxes

ACME Payroll Data Example (January 28, 20XX):
- Gross Pay: $\$20,000.00$
- Withholdings (Employee Share):
  - Federal Income Tax (FIT): $\$2,500.00$
  - FICA Social Security: $\$1,240.00$
  - FICA Medicare: $\$290.00$
  - State Income Tax: $\$1,110.00$
  - $401(k)$ Contributions: $\$1,000.00$
  - Health Insurance Premiums: $\$500.00$
  - United Way: $\$180.00$
- Net Pay: $\$13,160.00$
Employer Obligations:
- The employer matches the employee's share of FICA Social Security and Medicare taxes.
- Employer Payroll Taxes:
  - Social Security: $\$1,240.00$
  - Medicare: $\$290.00$
  - FUTA (Federal Unemployment Tax): $\$120.00$
  - SUTA (State Unemployment Tax): $\$800.00$
  - Total Payroll Tax Expense: $\$2,450.00$
Remittance Guidelines:
- Federal Government Payments: Shared FICA (Employer + Employee shares) + FIT withheld + FUTA.
- State Government Payments: State Income Tax withheld + SUTA.

Worker Classification

Employees:
- Control: Employer has significant control over the work performed.
- Taxes: Employer withholds income taxes and FICA.
- Benefits: Entitled to health insurance, retirement plans, and paid time off.
- Legal: Protected by various labor laws.
- Reporting: Receive a W-2 form at year-end.
Independent Contractors:
- Control: The contractor controls their own work setting.
- Taxes: Responsible for paying their own self-employment taxes (Income tax and FICA).
- Benefits: Not eligible for employer-sponsored benefits.
- Legal: Generally not covered by labor laws.
- Reporting: Receive a 1099-NEC form.