Comprehensive study notes: The accounting cycle, T-accounts, and the Dead Clover rules

Accounting Cycle, T-Accounts, and the Dead Clover Rules

• Overview of the full accounting cycle (four steps)

  • Step 1: Record events and transactions as they occur (day-to-day recording throughout the year).
  • Step 2: Adjusting entries for accruals and deferrals at year-end (true-up of values when cash timing, revenue recognition, or expense recognition differ due to accruals/deferrals).
  • Step 3: Prepare the four financial statements (FS).
  • Step 4: Closing process (conceptual end of Chapter 3) – closing temporary accounts to permanent accounts; exam two often covers this via an example.
  • Practical takeaway: memorize the order and purpose of each step; understand what changes and why, not just what to do.

• Key concepts introduced in Chapter 2 (recap)

  • Accruals vs deferrals are new types of transactions that still fall under Step 1 (record events/transactions).
  • Adjusting entries (Step 2) are made to align cash flow with revenue/expense recognition across the period.
  • Prepaid assets (e.g., prepaid rent) illustrate why end-of-year adjustments are needed.

• Chapter 3 focus: From horizontal financial statements to T-accounts

  • T-accounts are a visualization tool used to understand accounts, their properties, and how to record journal entries.
  • The goal is to learn the properties first, then use them to prepare journal entries and record transactions.
  • T-accounts will be used in exam two; for now, understand the properties and the workflow between horizontal statements and T-accounts.

• Why memorize T-account properties?

  • The properties govern how increases and decreases are recorded for each account type.
  • Asset accounts increase with a debit and decrease with a credit.
  • Liability and stockholders’ equity (claims) increase with a credit and decrease with a debit.
  • There is an explicit exception for expenses and dividends (they behave like assets/claims in certain respects): they increase with a debit and decrease with a credit, and they affect retained earnings.
  • The general ledger holds the collection of all T-accounts.
  • The end balance in a T-account represents the account balance at the end of the period and is the balance that appears on the balance sheet.
  • The side on which the ending balance is recorded is the “normal balance” side for that account.

• Tape the essentials: the basic accounting equation and double-entry basics

  • The core equation: ext{Assets} = ext{Liabilities} + ext{Stockholders' Equity}
  • Every transaction affects at least two accounts (double-entry): total debits = total credits.
  • Debit side is always on the left; credit side is always on the right.
  • The effect of debits/credits depends on account type (see the Dead Clover memo below).

• How to think about a T-account (step-by-step workflow for recording)

  • Step 1: Determine which elements (accounts) are affected by the transaction.
  • Elements come from the accounting equation: Assets, Liabilities, and Stockholders’ Equity.
  • Step 2: Determine how the transaction affects those elements (increase or decrease).
  • Step 3: Apply the properties to show increases and decreases (debits vs credits).
  • Step 4: Identify the specific accounts affected and record the debit or credit to each account.
  • Quick rule: a debit increases assets; a credit increases liabilities and stockholders’ equity; with the exception that expenses and dividends are increased by debits (and decrease retained earnings).

• Abstract notation and shorthand used in practice

  • Debits are abbreviated as DR; credits as CR.
  • The general ledger keeps the accumulated T-accounts by element (e.g., an Asset T-account may include Cash, Accounts Receivable, Supplies, etc.).
  • The normal balance side of an account is where the ending balance is recorded; this is the side that increases the account.

• The Dead Clover mnemonic (to memorize normal balance tendencies)

  • The idea is to remember which accounts have their balances increased by a debit vs a credit.
  • DEAD CLOVER (overview):
  • D = Debit side is the normal/increase side for:
    • Assets, Expenses, Dividends
  • C = Credit side is the normal/increase side for:
    • Liabilities, Owner's Equity, Revenue
  • Important nuance: Expenses and Dividends are the exception in the sense that they increase with a Debit (and decrease retained earnings), while Revenue increases Owner's Equity via Credits.
  • Recap of the impact by account type:
  • Assets: Debit increases; Credit decreases
  • Liabilities: Credit increases; Debit decreases
  • Stockholders’ Equity (including Common Stock and Retained Earnings): Credit increases; Debit decreases
  • Revenue (part of Stockholders’ Equity): Credit increases; Debit decreases
  • Expenses: Debit increases; Credit decreases (exception to the typical equity rule)
  • Dividends: Debit increases; Credit decreases (exception to the typical equity rule)

• Worked example: from horizontal model to T-accounts (conceptual bridge)

  • Horizontal model example: “Acquire cash from the issue of common stock”
  • Affects: Cash (Asset) and Common Stock (Stockholders’ Equity)
  • Increases: Cash (Asset) and Common Stock (Equity)
  • T-account translation rules for this transaction:
  • Since Asset (Cash) increases, Debit Cash: DR Cash +$X
  • Since Equity (Common Stock) increases, Credit Common Stock: CR Common Stock +$X
  • Balance check: Debits must equal Credits for the transaction (double-entry).
  • This shows the equivalence between the horizontal FS model and the T-account representation.

• Example transaction mapping (from the Montgomery Co., Year 1 narrative)

  • The following transactions are used to illustrate the T-account technique (amounts are taken from the transcript):

  1) Issued common stock for cash: 36,000

  • DR Cash 36,000

  • CR Common Stock 36,000
    2) Performed services and earned revenue on account: 48,000

  • DR Accounts Receivable 48,000

  • CR Revenue (Service Revenue) 48,000
    3) Incurred other operating expenses on account: 6,500

  • DR Other Operating Expenses 6,500

  • CR Accounts Payable 6,500
    4) Paid cash for salaries expense: 21,000

  • DR Salaries Expense 21,000

  • CR Cash 21,000
    5) Collected cash from customers (on account previously): 34,000

  • DR Cash 34,000

  • CR Accounts Receivable 34,000
    6) Paid cash dividend: 3,000

  • DR Dividends 3,000

  • CR Cash 3,000
    7) Performed services for cash: 95,000

  • DR Cash 95,000

  • CR Revenue 95,000
    8) Paid cash on accounts payable: 5,500

  • DR Accounts Payable 5,500

  • CR Cash 5,500

    • Takeaway: Each transaction has a DR and a CR with the amounts balancing to keep the accounting equation in balance.
    • End balances concept: After posting all entries, you sum the debits and credits for each T-account and place the final balance on the normal balance side (the side that increases that account). The ending balances are what appear on the Balance Sheet as of that date.

• Practical tips and exam-oriented practices

  • Learn the T-account shapes and where to place DR and CR on the left and right sides, respectively.
  • Always start by identifying the affected element(s) and whether they increase or decrease.
  • Use the Dead Clover mnemonic to quickly determine the normal balance side and how to increase/decrease the account.
  • Practice converting horizontal FS entries to T-accounts and vice versa to build fluency.
  • For accruals/deferrals (Step 2), remember adjusting entries are recorded to align revenues and expenses with the period in which they are earned or incurred, not necessarily when cash changes hands.
  • Understand the closing process: closing temporary accounts (revenues, expenses, dividends) to permanent accounts (retained earnings) to start the next period with a clean slate.

• Quick reference: key equations and mappings (LaTeX)

  • Accounting equation: ext{Assets} = ext{Liabilities} + ext{Stockholders' Equity}
  • Normal balance sides:
  • Assets, Expenses, Dividends: Debit increases (normal balance is on the Debit side)
  • Liabilities, Stockholders' Equity, Revenue: Credit increases (normal balance is on the Credit side)
  • Transaction structure (double-entry): For every transaction, total debits = total credits.
  • Example journal-entry translation (illustrative):
  • If an asset increases and equity increases, you would DR the asset and CR the equity account.
  • End balance side notation: the star on the normal balance side represents where the ending balance is recorded for the balance sheet.

• Real-world relevance and philosophical note

  • The accounting cycle provides a structured framework to capture economic events systematically throughout a period, ensuring transparency and comparability across periods and entities.
  • The balancing nature of double-entry accounting enforces discipline in financial reporting and reduces the chance of undiscovered errors.
  • The accrual basis (through accruals/deferrals and adjusting entries) aligns financial results with the period in which economic activities occur, which is critical for decision-making by managers, investors, and creditors.

• Summary takeaway

  • The four-step cycle, combined with the T-account visualization, offers a robust mental model for recording and analyzing transactions.
  • Memorize the core rules (assets increase by debit; liabilities/equity increase by credit; expenses/dividends are exceptions that increase with debit and reduce retained earnings).
  • Use DR/CR consistently and verify that the transaction totals balance in every entry.