Chapter 2

In accounting, T-accounts are used to record the increases and decreases of individual accounts found on the balance sheet. Debits are entries on the left side of a T-account, representing an increase in an asset account but a decrease in a liability or equity account. Conversely, credits are entries on the right side, signifying a decrease in an asset account but an increase in a liability or equity account.

Typically, asset accounts maintain debit balances, while liability and equity accounts normally carry credit balances. Within equity, two special accounts are Revenues and Expenses. Revenues are treated as increases in equity and generally have a credit balance. Expenses, however, are decreases in equity and usually have a debit balance. While revenues are debited and credited similarly to other equity accounts, expenses follow the same debit and credit rules as asset accounts.

To summarize the impact on different account types: a debit increases Assets and Expenses, while it decreases Liabilities, Equity, and Revenues. Conversely, a credit increases Liabilities, Equity, and Revenues, while it decreases Assets and Expenses. To calculate net income, the following formula is used: Net Income $=$ Total Revenues $-$ Total Expenses.

Regarding financial statements, Balance Sheets capture a company’s financial position at a specific point in time, whereas Income Statements measure a company’s financial performance over a defined period. The General Journal serves as the chronological record of every transaction, following the same debit and credit rules as a T-account. The General Ledger is the comprehensive collection of all T-accounts.

It's important to distinguish between temporary and permanent accounts. Revenues and Expenses are temporary accounts; their balances are closed out at the end of an accounting period and transferred to the income statement. Other accounts, such as assets, liabilities, and the remaining equity accounts, are considered permanent accounts. These are not closed out, and their balances are carried forward to the balance sheet.

For example, consider Pete’s Pizza Income Statement for the year ended 12/31/19 (in $000’s): Revenue was $2,000$, Cost of Goods Sold was $1,400$, resulting in a Gross Profit of $600$. After $300$ in SG&A, Operating Profit (EBIT) stood at $300$. Deducting Interest Expense of $40$ and Taxes of $104$ led to a Net Income of $156$.

The Wallace Cinema provides an example of journal entries and ledger postings. On April 1, 2014, Cash was debited $20,000$ and Paid-in Capital was credited $20,000$. On April 2, Cash was debited $10,000$ and Notes Payable was credited $10,000$. On April 3, Cash was debited $500$ and Revenues credited $500$, and later that day, Expenses were debited $300$ while Cash was credited $300$. On April 7, Inventory was debited $800$ and Accounts Payable credited $800$, and again on April 7, Revenues were debited $400$ while Inventory was credited $$400$