Chapter 6 Notes: The Bookkeeping Process
Chapter 6: The Bookkeeping Process
Bookkeeping
Bookkeeping is the initial function within the accounting department.
It involves recording business transactions.
Evidential matter is required for these transactions.
Business Transaction
A business transaction is an exchange of property, goods, or services for cash or a promise to pay.
Examples include purchases and sales transactions.
Account payable: Money owed by a business to its suppliers shown as a liability on a company's balance sheet.
Account receivable: Money owed to a business by its clients shown as an asset on a company's balance sheet.
Double Entry Accounting
Most transactions with external parties involve an exchange where the business entity gives up something and receives something in return.
Every business transaction affects two or more bookkeeping accounts.
Bookkeeping Accounts
Bookkeeping accounts provide an organized format for companies to accumulate the dollar effects of transactions.
Examples: Cash, Equipment, Inventory, Notes Payable.
Sample Chart of Accounts
Assets
Cash
Marketable Securities
Accounts Receivable
Food Inventory
Prepaid Expenses
Long-Term Investments
Equipment
Buildings
Land
Intangibles
Liabilities
Accounts Payable
Accrued Expenses
Notes Payable
Taxes Payable
Unearned Revenue
Bonds Payable
Stockholders’ Equity
Contributed Capital
Retained Earnings
These are components of the Balance Sheet.
Sample Chart of Accounts (Income Statement)
Revenues
Room Sales
Food Sales
Beverage Sales
Expenses
Cost of Goods Sold
Wages Expense
Rent Expense
Interest Expense
Depreciation Expense
Employee Meals Expense
Insurance Expense
Repair Expense
Income Tax Expense
These are components of the Income Statement.
Chart of Accounts, Ledger, and Account Numbers
Chart of Accounts: A list of account titles and numbers showing the location of each account in a ledger.
Ledger: A group of accounts.
General Ledger: A ledger containing all accounts needed to prepare financial statements.
Account Number: A number assigned to an account.
Analyzing Business Transactions
Every transaction affects at least two accounts (duality of effects).
The accounting equation must remain in balance after each transaction: A = L + SE (Assets = Liabilities + Stockholders’ Equity).
Steps for Analyzing Business Transactions
Step 1: Accounts and Effects
Identify the accounts affected and classify them by type of account (A, L, SE).
Determine the direction of the effect (increase or decrease) on each account.
Step 2: Balancing
Verify that the accounting equation (A = L + SE) remains in balance.
Examples of Analyzing Transactions
Example A: Cash food sales for the day total 8,000. Identify & Classify the Accounts: Cash (asset), Food Sales (Revenue). Increase/Decrease: Cash increases, Food Sales increases.
Example B: The owner of a proprietorship invests personal cash of 50,000. Identify & Classify the Accounts: Cash (asset), Capital. Increase/Decrease: Cash increases, Capital increases.
Example C: On June 1, a restaurant purchases advertising for 1,000 on open account. The Newspaper ad will run on June 11 and 12. Identify & Classify the Accounts: Advertising (Expense), Account payable (Liability). Increase/Decrease: Advertising expense increases, Account payable increases.
Example D: The restaurant in example C pays the open account of 1,000. Identify & Classify the Accounts: Cash (Asset), Account payable (Liability). Increase/Decrease: Cash decreases, Account payable decreases.
Example #1: A motel writes a 1,500 check to pay its current monthly rent. Identify & Classify the Accounts: Cash (Asset), Rent Expense (Expense). Increase/Decrease: Cash decreases, Rent expense increases.
Example #2: A lodging operation writes a 1,500 check on April 15, paying the rent for May. Identify & Classify the Accounts: Cash (Asset), Prepaid Rent (Asset). Increase/Decrease: Cash decreases, Prepaid rent increases.
Example #3: A lodging operation writes a 1,500 check on August 1, paying its rent for August. Identify & Classify the Accounts: Cash (Asset), Rent Expense (Expense). Increase/Decrease: Cash decreases, Rent expense increases.
Example #4: A customer’s invoice was 50 for meals, plus 3 for sales tax. Identify & Classify the Accounts: Cash (Asset), Food sales (Revenue), Sales tax Payable (Liability). Increase/Decrease: Cash increases, Food sales increases, Sales tax payable increases.
Example #5: A customer’s invoice was 50 for meals, plus 3 for sales tax. The customer uses an open account authorized by the restaurant. Identify & Classify the Accounts: Account receivable (Asset), Food sales (Revenue), Sales tax Payable (Liability). Increase/Decrease: Account receivable increases, Food sales increases, Sales tax payable increases.
Example #6: One week after the transaction of Example 5 the restaurant receives personal check for 53 from the customer. Identify & Classify the Accounts: Cash (Asset), Account receivable (Asset). Increase/Decrease: Cash increases, Account receivable decreases.
Example #7: A hotel buys 65 worth of food provisions for its storerooms and pays cash on delivery. The perpetual inventory system is used. Identify & Classify the Accounts: Cash (Asset), Food inventory (Asset). Increase/Decrease: Cash decreases, Food inventory increases.
Example #8: A hotel buys 1,200 worth of food provisions for its storerooms and uses an open account. The perpetual inventory system is used. Identify & Classify the Accounts: Account payable (Liability), Food inventory (Asset). Increase/Decrease: Account payable increases, Food inventory increases.
Example #9: the hotel in example 8 remits a check for 1,200 to the supplier in payment of inventory purchase made on open account. Identify & Classify the Accounts: Account payable (Liability), Cash (Asset). Increase/Decrease: Account payable decreases, Cash decreases.
Example #10: A hotel buys 55 worth of food provisions for its storeroom and pays cash on delivery. The periodic inventory is system. Identify & Classify the Accounts: Food purchase (Expense), Cash (Asset). Increase/Decrease: Food purchase increases, Cash decreases.
Example #11: A hotel buys 900 worth of food provisions for its storeroom and uses an open account. The periodic inventory is system. Identify & Classify the Accounts: Food purchase (Expense), Account payable (Liability). Increase/Decrease: Food purchase increases, Account payable increases.
Example #12: Ken is starting a new business (proprietorship). Ken invests cash of 55,000, plus land and building with a basis, respectively, of 40,000 and 175,000. Identify & Classify the Accounts: Cash (Asset), Land (Asset), Building (Assets), Capital (Equity). Increase/Decrease: Cash increases, Land increases, Building increases, Capital increases.
Example #13: Brentwood invests 50,000 into an incorporation business for 4,000 shares of 1 par value common stock. Identify & Classify the Accounts: Cash (Asset), Common stock (Equity), Additional paid-in (Equity). Increase/Decrease: Cash increases, Common stock increases, Additional paid-in increases.
Example #14: Stephens is starting a new incorporation business and invests 50,000 for 4,000 shares of no-par common stock. Identify & Classify the Accounts: Cash (Asset), Common stock (Equity). Increase/Decrease: Cash increases, Common stock increases.
How Companies Keep Track of Account Balances
Journal entries
T-accounts
Direction of Transaction Effects
The left side of the T-account is always the debit side.
The right side of the T-account is always the credit side.
The Debit-Credit Framework
A = L + SE
Assets: Debit for Increase, Credit for Decrease
Liabilities: Debit for Decrease, Credit for Increase
Equities: Debit for Decrease, Credit for Increase
Stockholders’ Equity includes Contributed Capital and Retained Earnings.
The Account and the Debit-Credit Convention
Account Type | Increase | Decrease |
|---|---|---|
Asset | Debit | Credit |
Expense | Debit | Credit |
Revenue | Credit | Debit |
Liability | Credit | Debit |
Equity | Credit | Debit |
The Debit-Credit Convention Summary
Debit entries in an asset account: Balance increases
Debit entries in an expense account: Balance increases
Credit entries in a liability account: Balance increases
Credit entries in Equity account: Balance increases
Credit entries in a revenue account: Balance increases
Credit entries in an asset account: Balance decreases
Credit entries in an expense account: Balance decreases
Debit entries in a liability account: Balance decreases
Debit entries in Equity account: Balance decreases
Debit entries in a revenue account: Balance decreases
Need to Maintain Two Equalities
Debits must equal credits
Assets must equal liabilities plus equities
Analytical Tool: The Journal
A typical journal includes Date, Account Titles and Explanation, Reference, Debit, and Credit columns.
The Journal Entry
Example::
Date | Account Titles and Explanation | Ref. | Debit | Credit |
|---|---|---|---|---|
Jan. 1 | Cash | 20,000 | ||
Contributed Capital | 20,000 |
The Journal Entry - Details
Provide a reference date for each transaction.
Debits are written first.
Credits are indented and written after debits.
Total debits must equal total credits.
Journal Entry and T-Account Example
Cash in Bank T-Account: Debit (+), Credit (-)
Maria Sanchez, Capital T-Account: Credit (+), Debit (-)
Journal Entry:
DATE
DESCRIPTION
POST. REF.
DEBIT
CREDIT
2 Oct.
Cash in Bank
25000.00
Maria Sanchez, Capital
25000.00
Memorandum 1
Post Ledger
Posting to the Ledger: After journal entries are prepared, the accountant posts (transfers) the dollar amounts to each account that was affected by the transaction.
The Journal Entry Examples
Example: The owner of a proprietorship invests personal cash of 20,000
Date
Account Titles and Explanation
Ref.
Debit
Credit
Jan. 1
Cash
20,000
Contributed Capital
20,000
Example #1: A motel writes a 1,500 check to pay its current monthly rent.
Date
Account Titles and Explanation
Ref.
Debit
Credit
Rent Expense
1,500
Cash
1,500
Example #2: A lodging operation writes a 1,500 check on April 15, paying the rent for May. (Journal Entry Omitted)
Example #3: A lodging operation writes a 1,500 check on August 1, paying its rent for August. (Journal Entry Omitted)
Example #4: A customer's invoice was 50 for meals, plus 3 for sales tax.
Date
Account Titles and Explanation
Ref.
Debit
Credit
Cash
53
Food Sales
50
Sales Tax Payable
3
Example #5: A customer’s invoice was 50 for meals, plus 3 for sales tax. The customer uses an open account authorized by the restaurant (Journal Entry Omitted)
Example #6: One week after the transaction of Example 5 the restaurant receives personal check for 53 from the customer. (Journal Entry Omitted)
Example #7: A hotel buys 65 worth of food provisions for its storerooms and pays cash on delivery. The perpetual inventory system is used. (Journal Entry Omitted)
Example #8: A hotel buys 1,200 worth of food provisions for its storerooms and uses an open account. The perpetual inventory system is used. (Journal Entry Omitted)
Example #9: the hotel in example 8 remits a check for 1,200 to the supplier in payment of inventory purchase made on open account. (Journal Entry Omitted)
Example #10: A hotel buys 55 worth of food provisions for its storeroom and pays cash on delivery. The periodic inventory is system. (Journal Entry Omitted)
Example #11: A hotel buys 900 worth of food provisions for its storeroom and uses an open account. The periodic inventory is system. (Journal Entry Omitted)
Example #12: Ken is starting a new business (proprietorship). Ken invests cash of 55,000, plus land and building with a basis, respectively, of 40,000 and 175,000. (Journal Entry Omitted)
Example #13: Brentwood invests 50,000 into an incorporation business for 4,000 shares of 1 par value common stock. (Journal Entry Omitted)
Example #14: Stephens is starting a new incorporation business and invests 50,000 for 4,000 shares of no-par common stock. (Journal Entry Omitted)
T-Accounts: Calculating Account Balances
Draw a line across the T-account under the last posted entry.
Add the amounts on the left side (debit) and the amounts on the right side (credit) of the account.
Subtract the two totals and put the difference on the side with the larger total.
An example is given: see source document
Normal Account Balance
Assets are increased with debits.
Assets include: Cash, A/R, Inventory, Supplies, Prepaid Insurance, Prepaid Rent, Equipment.
Liabilities and Owners’ Equity accounts are increased with credits.
Liabilities include: all PAYABLES, all UNEARNED revenues
Equity accounts include: Common Stock, Retained Earnings
Expense Accounts and Dividends are increased with debits.
Revenue accounts are increased with credits.
Revenue accounts include: Sales, Service Revenue, Fees Earned, Interest Revenue or Interest Income or Interest Earned
Contra Accounts
Contra Assets
Allowance for doubtful account: Credit
Accumulated depreciation: Credit
Contra Equity Accounts
Withdrawals: Debit
Treasury Stock: Debit
Contra Revenue: Sales allowances: Debit
Withdrawals: Journal Entry
Example: Ken owns a proprietorship company. A business check is issued for 1,000, payable to Ken.
Journal entry for the withdrawal of 1000 from Ken's proprietorship company
Withdrawals: Journal Entry
Example: An aging of account receivable indicates that the Allowance for Doubtful account should be increased by 1,000.
Accumulated Depreciation: Journal Entry
Example: An asset depreciation study shows that depreciation for the current month is 2,000.
Date
Account Titles and Explanation
Ref.
Debit
Credit
Date 14
Depreciation expense
2,000
Accumulated depreciation
2,000