April 7, 2011

What is synergy?
In business the term synergy is often associated with the merger or acquisition of companies. 
Synergy implies that the outcomes resulting from the merger of two companies will be greater
than the sum of the outcomes that would have been achieved if the organizations had not
merged. Synergy is sometimes described as 1 + 1 = 3.

Let’s use an example. Suppose a company operates solely in the U.S. Another company operates
in Asia. The two companies decide to merge because they believe the combined company will
have greater results than the total of the two companies operating independently. The synergy
might come from shared research, ability to meet the needs of each other’s customers, ability to
attract new customers that want a single global supplier, elimination of duplicate information
technology, and so on.

Synergy is not automatic since the merging organizations may experience problems caused by
vastly different leadership styles and company cultures.

Why is there a large difference between share value and stockholders’

equity?

There can be many reasons why the market value of a corporation’s stock is much greater than
the amount of stockholders’ equity reported on the balance sheet. Let’s start by defining
stockholders’ equity as the difference between the asset amounts reported on the balance sheet
minus the liability amounts. Next, the accountant’s cost principle requires that only the cost of
items purchased can be reported as an asset. This means that valuable trade names that were
never purchased (but were developed over time) are not reported on the balance sheet. The same
holds for a great management team and an amazing reputation. The cost principle also means
that many long-term assets are reported at cost (and not at their current higher market value).
Many plant assets are reported at minimal amounts because their costs have been reduced by the
cumulative amount of depreciation taken over the years.

Other factors contributing to a high market value might be a corporation’s earnings and
dividends that are consistently growing and/or a special niche for its products or services that is
recognized by the market.

Lastly, a corporation’s stockholders’ equity may have been reduced from the purchase of
treasury stock at a high cost.
What is the earnings per share (EPS) ratio?

The earnings per share ratio, or simply earnings per share, or EPS, is a corporation’s net income
after tax that is available to its common stockholders divided by the weighted average number of
shares of common stock that are outstanding during the period of the earnings.

Net income available for common stock is the corporation’s net income after income taxes minus
the required dividend for the corporation’s preferred stock, if it has preferred stock outstanding.

Additional information on the calculations and presentation of a corporation’s earnings per

share are contained in the Financial Accounting Standards Board’s Statement of Financial
Accounting Standards No. 128, Earnings per Share. It can be read at no c

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What is responsibility accounting?

Responsibility accounting involves a company’s internal accounting and budgeting. The

objective is to assist in the planning and control of a company’s responsibility centers—such as
decentralized departments and divisions.

Responsibility accounting usually involves the preparation of annual and monthly budgets for
each responsibility center. Then the company’s actual transactions are classified by responsibility
center and a monthly report is prepared. The reports will present the actual amounts for each
budget line item and the variance between the the budget and actual amounts.

Responsibility accounting allows the company and each manager of a responsibility center to
receive monthly feedback on the manager’s performance.

How do I calculate the after-tax cost of debt?

The after-tax cost of debt is the interest rate on the debt multiplied by (100% minus the
incremental  income tax rate).

For instance, if a corporation’s debt has an annual interest rate of 10% and the corporation’s
combined federal and state income tax rate is 30%, the after-tax cost of debt is 7%. The
computation is: [10% interest rate X (100% minus 30% tax rate)] = [10% X 70%] = 7%.

Here is the example in dollars. If the corporation has a loan of $100,000 with an annual interest
rate of 10%, the interest paid to the lender will be $10,000 per year. This interest expense will
reduce the corporation’s taxable income by $10,000 thereby saving the corporation $3,000 in
income taxes (30% tax rate on $10,000 reduction in taxable income). The after-tax cost of the
debt is computed as follows: $10,000 paid to the lender minus $3,000 of income tax savings
equals a net cost of $7,000 per year on the $100,000 loan. This means the after-tax cost is 7%
($7,000 divided by $100,000).

What is accrued interest?

Accrued interest is the amount of loan interest that has already occurred, but has not yet been
paid to the lender by the borrower.

The accrued interest will be reported by the borrower as both

1. an expense on its income statement, and

2. a current liability on its balance sheet.

The accrued interest will be reported by the lender as both

1. revenue on its income statement, and

2. a current asset on its balance sheet.

Accrued interest is likely to require adjusting entries by both the borrower and the lender prior to
issuing their financial statements.

What is cost behavior?

Cost behavior is associated with learning how costs change when there is a change in an
organization’s level of activity. The costs which vary proportionately with the changes in the
level of activity are referred to as variable costs. The costs that are unaffected by changes in the
level of activity are classified as fixed costs.

Cost behavior is not required for external reporting under U.S. GAAP. However, the
understanding of cost behavior is very important for management’s efforts to plan and control its
organization’s costs. Budgets and variance reports are more effective when they reflect cost
behavior patterns.

The understanding of cost behavior is also necessary for calculating a company’s break-even
point and for any other cost-volume-profit analysis.
What are term bonds and serial bonds?

Term bonds are bonds which mature or come due on a single date.

Serial bonds are bonds which do no not mature or come due on a single date. Instead, serial
bonds have maturity dates which are staggered over several or many years. You could say that
serial bonds come due over a series of dates.

To learn more about bonds see [Link]’s free explanation of

Accounting Basics

Important Disclaimer

Important Note: The text in this chapter is intended to clarify business-related concepts. It is not
intended nor can it replace formal legal advice. Before taking any actions relating to your business,
always consult your accountant or a business law/tax attorney.

The Need for Accounting

Every organization needs to maintain good records to track how much money they have, where it came
from, and how they spend it. These records are maintained by using an accounting system.

Accounting for Windows Accounting Basics 5

These records are essential because they can answer such important questions as:

• Am I making or losing money from my business?

• How much am I worth?

• Should I put more money in my business or sell it and go into another business?

• How much is owed to me, and how much do I owe?

• How can I change the way I operate to make more profit?

Even if you do not own or run a business, as an accountant you will be asked to provide the valuable
information needed to assist management in the decision making process. In addition, these records are
invaluable for filing your organization’s tax returns.

The modern method of accounting is based on the system created by an Italian monk Fra Luca Pacioli.
He developed this system over 500 years ago. This great and scientific system was so well designed that
even modern accounting principles are based on it.
In the past, many businesses maintained their records manually in books – hence the term
“bookkeeping” came about. This method of keeping manual records was cumbersome, slow, and prone
to human errors of translation.

A faster, more organized, and easier method of maintaining books is using Computerized Accounting
Programs. With the decrease in the price of computers and accounting programs, this method of
keeping books has become very popular.

Accounting and Business

Accounting is the system a company uses to measure its financial performance by noting and classifying
all the transactions like sales, purchases, assets, and liabilities in a manner that adheres to certain
accepted standard formats. It helps to evaluate a Company’s past performance, present condition, and
future prospects.

6 Accounting Basics Accounting for Windows

A more formal definition of accounting is the art of recording, classifying, and summarizing in a
significant manner and in terms of money, transactions and events which are, in part at least, of a
financial character and interpreting the results thereof.

What Accountants Do

We have said that accounting consists of these functions:

• Recording

• Classifying

• Summarizing

• Reporting and evaluating the financial activities of a business

Before any recording can take place, there must be something to record. In accounting, the something
consists of a transaction or event that has affected the business. Evidence of the transaction is called a
document.

For example:

• A sale is made, evidenced by a sales slip.

• A purchase is made, as evidenced by a check and other documents such as an invoice and a purchase
order.
• Wages are paid to employees with the checks and payroll records as support.

• Accountants do not record a conversation or an idea. They must first have a document.

In almost any business, these documents are numerous and their recording requires some sort of logical
system. Recording is first carried out in a book of original entry called the journal. A journal is a record,
listing transactions in a chronological order.

At this point, we have a record of a great volume of data. How can this data best be used? Aside from
writing down what has occurred for later reference, what has been accomplished? The answer is, of
course, that the accountant has only started on his task. This great

Accounting for Windows Accounting Basics 7

volume of data in detailed listings must be summarized in a meaningful way.

When asked, the accountant must turn to these summaries to answer questions like:

• What were total sales this month?

• What were the total expenses and what were the types and amounts of each expense?

• How much cash is on hand?

• How much does the business owe?

• How much are the accounts receivable?

The next task after recording and classifying is summarizing the data in a significant fashion.

The records kept by the accountant are of little value until the information contained in the records is
reported to the owner(s) or manager(s) of the business. These records are reported to the owners by
preparing a wide variety of financial statements.

The accountant records, classifies, summarizes, and reports transactions that are mainly financial in
nature and affect the business. The reporting, of course, involves placing his interpretation on the
summarized data by the way he arranges his reports.

Every business has a unique method of maintaining its accounting books. However, all accounting
systems are similar in the following manner:

• Business documents representing transactions that have taken place. (A business transaction occurs
when goods are sold, a contract is signed, merchandise is purchased, or some similar financial
transaction has occurred).

• Various journals where the documents are recorded in detail and classified
• Various ledgers where the details recorded in the journals are summarized

• Financial reports where the summarized information is presented

Where variations exist, they have to do with the way the business transaction is assembled, processed,
and recorded.

8 Accounting Basics Accounting for Windows

These methods are partly arbitrary. First, you must understand certain simple principles of accounting.
When you have a firm grasp of the fundamentals you can deal with any kind of accounting problem.

Advantages of Computerized Accounting

Some of the advantages of using a computerized accounting system are:

• The arithmetic of adding up debits and credits columns is done automatically and with total accuracy
by the computer.

• Audit trails or details are automatically maintained for you.

• Produce financial statements simply by selecting the appropriate menu item.

• A computerized system lets you retrieve the latest accounting data quickly, such as today’s inventory,
the status of a client’s payment, or sales figures to date.

• Data can be kept confidential by taking advantage of the security password systems that most
accounting programs provide.

Computerized accounting programs usually consist of several modules.

The principal modules commonly used are:

• General Ledger

• Inventory

• Order Entry

• Accounts Receivable

• Accounts Payable

• Bank Manager

• Payroll
In a good accounting system, the modules are fully integrated. When the system is integrated, the
modules share common data. For example, a client sales transaction can be entered in as an invoice,
which automatically posts to the General Ledger module without re-entering any data. This is one of the
greatest advantages of a

Accounting for Windows Accounting Basics 9

computerized accounting system – you need to enter the information only once. As a result of this:

• Data entry takes less time.

• There is less chance that errors will occur.

• You do not have to re-enter data for posting.

Types of Business Organizations

Three principal types of organizations have developed as ways of owning and operating business
enterprise.

In general, business entity or organizations are:

• Sole proprietorship

• Partnerships

• Corporations

Let us discuss these concepts starting with the simplest form of business organization, the single or sole
proprietorship.

Sole Proprietorship

A sole proprietorship is a business wholly owned by a single individual. It is the easiest and the least
expensive way to start a business and is often associated with small storekeepers, service shops, and
professional people such as doctors, lawyers, or accountants. The sole proprietorship is the most
common form of business organization and is relatively free from legal complexities.

One major disadvantage of sole proprietorship is unlimited liability since the owner and the business are
regarded as the same, from a legal standpoint.

10 Accounting Basics Accounting for Windows

Partnerships
A partnership is a legal association of two or more individuals called partners and who are co-owners of
a business for profit. Like proprietorships, they are easy to form. This type of business organization is
based upon a written agreement that details the various interests and right of the partners and it is
advisable to get legal advice and document each person’s rights and responsibilities.

There are three main kinds of partnerships

• General partnership

• Limited partnership

• Master limited partnership

General Partnership

A business that is owned and operated by 2 or more persons where each individual has a right as a co-
owner and is liable for the business’s debts. Each partner reports his share of the partnership profits or
losses on his individual tax return. The partnership itself is not responsible for any tax liabilities.

A partnership must secure a Federal Employee Identification number from the Internal Revenue Service
(IRS) using special forms.

Each partner reports his share of partnership profits or losses on his individual tax return and pays the
tax on those profits. The partnership itself does not pay any taxes on its tax return.

Limited Partnership

In a Limited Partnership, one or more partners run the business as General Partners and the remaining
partners are passive investors who become limited partners and are personally liable only for the
amount of their investments. They are called limited partners because they cannot be sued for more
money than they have invested in the business.

Accounting for Windows Accounting Basics 11

Limited Partnerships are commonly used for real-estate syndication.

Master Limited Partnership

Master Limited Partnerships are similar to Corporations trading partnership units on listed stock
exchanges. They have many advantages that are similar to Corporations e.g. Limited liability, unlimited
life, and transferable ownership. In addition, they have the added advantage if 90% of their income is
from passive sources (e.g. rental income), then they pay no corporate taxes since the profits are paid to
the stockholders who are taxed at individual rates.

Corporations
The Corporation is the most dominant form of business organization in our society. A Corporation is a
legally chartered enterprise with most legal rights of a person including the right to conduct business,
own, sell and transfer property, make contracts, borrow money, sue and be sued, and pay taxes. Since
the Corporation exists as a separate entity apart from an individual, it is legally responsible for its actions
and debts.

The modern Corporation evolved in the beginning of this century when large sums of money were
required to build railroads and steel mills and the like and no one individual or partnership could hope to
raise. The solution was to sell shares to numerous investors (shareholders) who in turn would get a cut
of the profits in exchange for their money. To protect these investors associated with such large
undertakings, their liability was limited to the amount of their investment.

Since this seemed to be such a good solution, Corporations became a vibrant part of our nation’s
economy. As rules and regulations evolved as to what a Corporation could or could not do, Corporations
acquired most of the legal rights as those of people in that it could receive, own sell and transfer
property, make contracts, borrow money, sue and be sued and pay taxes.

12 Accounting Basics Accounting for Windows

The strength of a Corporation is that its ownership and management are separate. In theory, the owners
may get rid of the Managers if they vote to do so. Conversely, because the shares of the company
known as stock can sold to someone else, the Company’s ownership can change drastically, while the
management stays the same. The Corporation’s unlimited life span coupled with its ability to raise
money gives it the potential for significant growth.

A Company does not have to be large to incorporate. In fact, most corporations, like most businesses,
are relatively small, and most small corporations are privately held.

Some of the disadvantages of Corporations are that incorporated businesses suffer from higher taxes
than unincorporated businesses. In addition, shareholders must pay income tax on their share of the
Company’s profit that they receive as dividends. This means that corporate profits are taxed twice.

There are several different types of Corporation based on various distinctions, the first of which is to
determine if it is a public, quasi-public or Private Corporation. Federal or state governments form Public
Corporations for a specific public purpose such as making student loans, building dams, running local
school districts etc. Quasi-public Corporations are public utilities, local phones, water, and natural gas.
Private Corporations are companies owned by individuals or other companies and their investors buy
stock in the open market. This gives private corporations access to large amounts of capital.

Public and private corporations can be for-profit or non-profit corporations. For-profit corporations are
formed to earn money for their owners. Non-profit Corporations have other goals such as those
targeted by charitable, educational, or fraternal organizations. No stockholder shares in the profits or
losses and they are exempt from corporate income taxes.
Professional Corporations are set up by businesses whose shareholders offer professional services (legal,
medical, engineering, etc.) and can set up beneficial pension and insurance packages.

Accounting for Windows Accounting Basics 13

Limited Liability Companies (LLCs as they are called) combine the advantages of S Corporations and
limited partnerships, without having to abide by the restrictions of either. LLCs allow companies to pay
taxes like partnerships and have the advantage of protection from liabilities beyond their investments.
Moreover, LLCs can have over 35 investors or shareholders (with a minimum of 2 shareholders).
Participation in management is not restricted, but its life span is limited to 30 years.

Subchapter S Corporation

Subchapter S Corporation, also known as an S Corporation is a cross between a partnership and a

corporation. However, many states do not recognize a Subchapter S selection for state tax purposes and
will tax the corporation as a regular corporation.

The flexibility of these corporations makes them popular with small-and medium-sized businesses.
Subchapter S allows profits or losses to travel directly through the corporation to you and to the
shareholders. If you earn other income during the first year and the corporation has a loss, you may
deduct against the other income, possibly wiping out your tax liability completely subject to the
limitations of Internal Revenue Service tax regulations.

Subchapter S corporations elect not to be taxed as corporations; instead, the shareholders of a

Subchapter S corporation include their proportionate shares of the corporate profits and losses in their
individual gross incomes. Subchapter S corporations are excellent devices to allow small businesses to
avoid double taxation. If your company does produce a substantial profit, forming a Subchapter S
Corporation would be wise, because the profits will be added to your personal income and taxed at an
individual rate. These taxes may be lower than the regular corporate rate on that income.

To qualify under Subchapter S, the corporation must be a domestic corporation and must not be a
member of an affiliated group. Some of the other restrictions include that it must not have more than 35
shareholders – all of who are either individuals or estates. Subchapter S corporations can have an
unlimited amount of passive income from rents, royalties, and interest. For more information on the
rules that apply to a Subchapter S corporation, contact your local IRS office.

14 Accounting Basics Accounting for Windows

Limited Liability Company

Limited Liability Companies (LLCs as they are called) combine the advantages of S Corporations and
limited partnerships, without having to abide by the restrictions of either. LLCs allow companies to pay
taxes like partnerships and have the advantage of protection from liabilities beyond their investments.
Moreover, LLCs can have over 35 investors or shareholders (with a minimum of 2 shareholders).
Participation in management is not restricted, but its life span is limited to 30 years.

The Business Entity Concept

It is an important accounting principle that the business is treated as an entity separate and distinct
from its owners and any other people associated with it. This principle is called the Business Entity
Concept. It simply means that accounting records and reports are concerned with the business entity,
not with the people associated with the business. Now, lets us review the two main accounting
methods.

Types of Accounting

The two methods of tracking your accounting records are:

• Cash Based Accounting

• Accrual Method of Accounting

Cash Based Accounting

Most of us use the cash method to keep track of our personal financial activities. The cash method
recognizes revenue when payment is received, and recognizes expenses when cash is paid out. For
example, your personal checkbook record is based on the cash

Accounting for Windows Accounting Basics 15

method. Expenses are recorded when cash is paid out and revenue is recorded when cash or check
deposits are received.

Accrual Accounting

The accrual method of accounting requires that revenue be recognized and assigned to the accounting
period in which it is earned. Similarly, expenses must be recognized and assigned to the accounting
period in which they are incurred.

A Company tracks the summary of the accounting activity in time intervals called Accounting periods.
These periods are usually a month long. It is also common for a company to create an annual statement
of records. This annual period is also called a Fiscal or an Accounting Year.

The accrual method relies on the principle of matching revenues and expenses. This principle says that
the expenses for a period, which are the costs of doing business to earn income, should be compared to
the revenues for the period, which are the income earned as the result of those expenses. In other
words, the expenses for the period should accurately match up with the costs of producing revenue for
the period.

In general, there are two types of adjustments that need to be made at the end of the accounting
period. The first type of adjustment arises when more expense or revenue has been recorded than was
actually incurred or earned during the accounting period. An example of this might be the pre-payment
of a 2-year insurance premium, say, for $2000. The actual insurance expense for the year would be only
$1000. Therefore, an adjusting entry at the end of the accounting period is necessary to show the
correct amount of insurance expense for that period.

Similarly, there may be revenue that was received but not actually earned during the accounting period.
For example, the business may have been paid for services that will not actually be provided or earned
until the next year. In this case, an adjusting entry at the end of the accounting period is made to defer,
that is, to postpone, the recognition of revenue to the period it is actually earned.

16 Accounting Basics Accounting for Windows

Although many companies use the accrual method of accounting, some small businesses prefer the cash
basis. The accrual method generates tax obligations before the cash has been collected. This benefits
the Government because the IRS gets its tax money sooner.

Cash versus Accrual Accounting

Accounts Receivable is an asset that is owed to you but you do not have money in the bank or property
to show you own something -it is intangible, on paper. It grows or accumulates as you issue invoices;
therefore, Accounts Receivable is part of an accrual accounting system.

Double-entry accounting is the most accurate and best way to keep your financial records. With a
computer, you don’t have to fully understand all the accounting details. Basically, in double entry
accounting each transaction affects two or more categories or accounts, so everything stays in balance.
Therefore, if you change an asset balance by issuing an invoice some other category balance changes as
well. In this case, when you issue an invoice, the category that balances the asset called Accounts
Receivable is an income or a sales account.

When you bill your client, there is an increase in income (on paper) and hence an increase in Accounts
Receivable. When you are paid, the paper asset turns into money you put in the bank – a tangible asset.
Through a process of recording the payment and the deposit, Accounts Receivable decreases and the
bank balance increases. This accounting program takes care of all the accounting details.

This paper income can be confusing if you don’t understand that it is the total of all invoiced work, both
paid and unpaid. If you have invoiced clients for a total of $10,000 but only $2,000 has been paid, your
income will be $10,000 and your Accounts Receivable balance will be $8,000, and your bank account has
increased by the $2,000 you received. An accountant would call this an accrual accounting method.
A cash accounting method only counts income when money is received, and it does not keep track of
Accounts Receivable.

Accounting for Windows Accounting Basics 17

However, in real life, small businesses tend to use both methods without realizing the difference until
income tax time.

This program can handle both accrual and cash based accounting. You can use the G/L Setup option in
the G/L module to select either Cash or Accrual based accounting. We recommended that you consult
with your accountant to determine which system will work best for you.

Accounts

The accounting system uses Accounts to keep track of information. Here is a simple way to understand
what accounts are. In your office, you usually keep a filing cabinet. In this filing cabinet, you have
multiple file folders. Each file folder gives information for a specific topic only. For example you may
have a file for utility bills, phone bills, employee wages, bank deposits, bank loans etc.

A chart of accounts is like a filing cabinet. Each account in this chart is like a file folder. Accounts keep
track of money spent, earned, owned, or owed. Each account keeps track of a specific topic only. For
example, the money in your bank or the checking account would be recorded in an account called Cash
in Bank. The value of your office furniture would be stored in another account. Likewise, the amount you
borrowed from a bank would be stored in a separate account.

Each account has a balance representing the value of the item as an amount of money. Accounts are
divided into several categories like Assets, Liabilities, Income, and Expense accounts. A successful
business will generally have more assets than liabilities. Income and Expense accounts keep track of
where your money comes from and on what you spend it. This helps make sure you always have more
assets than liabilities.

18 Accounting Basics Accounting for Windows

Account Types

In order to track money within an organization, different types of accounting categories exist. These
categories are used to denote if the money is owned or owed by the organization. Let us discuss the
three main categories: Assets, Liabilities, and Capital.

Assets

An Asset is a property of value owned by a business. Physical objects and intangible rights such as
money, accounts receivable, merchandise, machinery, buildings, and inventories for sale are common
examples of business assets as they have economic value for the owner. Accounts receivable is an
unwritten promise by a client to pay later for goods sold or services rendered.

Assets are generally listed on a balance sheet according to the ease with which they can be converted to
cash. They are generally divided into three main groups:

• Current

• Fixed

• Intangible

Current Asset

A Current Asset is an asset that is either:

• Cash – includes funds in checking and savings accounts

• Marketable securities such as stocks, bonds, and similar investments

• Accounts Receivables, which are amounts due from customers

• Notes Receivables, which are promissory notes by customers to pay a definite sum plus interest on a
certain date at a certain place.

• Inventories such as raw materials or merchandise on hand

• Prepaid expenses – supplies on hand and services paid for but not yet used (e.g. prepaid insurance)

Accounting for Windows Accounting Basics 19

In other words, cash and other items that can be turned back into cash within a year are considered a
current asset.

Fixed Assets

Fixed Assets refer to tangible assets that are used in the business. Commonly, fixed assets are long-lived
resources that are used in the production of finished goods. Examples are buildings, land, equipment,
furniture, and fixtures. These assets are often included under the title property, plant, and equipment
that are used in running a business. There are four qualities usually required for an item to be classified
as a fixed asset. The item must be:

• Tangible

• Long-lived

• Used in the business

• Not be available for sale

Certain long-lived assets such as machinery, cars, or equipment slowly wear out or become obsolete.
The cost of such as assets is systematically spread over its estimated useful life. This process is called
depreciation if the asset involved is a tangible object such as a building or amortization if the asset
involved is an intangible asset such as a patent. Of the different kinds of fixed assets, only land does not
depreciate.

Intangible Assets

Intangible Assets are assets that are not physical assets like equipment and machinery but are valuable
because they can be licensed or sold outright to others. They include cost of organizing a business,
obtaining copyrights, registering trademarks, patents on an invention or process and goodwill. Goodwill
is not entered as an asset unless the business has been purchased. It is the least tangible of all the assets
because it is the price a purchaser is willing to pay for a company’s reputation especially in its relations
with customers.

20 Accounting Basics Accounting for Windows

Liabilities

A Liability is a legal obligation of a business to pay a debt. Debt can be paid with money, goods, or
services, but is usually paid in cash. The most common liabilities are notes payable and accounts
payable. Accounts payable is an unwritten promise to pay suppliers or lenders specified sums of money
at a definite future date.

Current Liabilities

Current Liabilities are liabilities that are due within a relatively short period of time. The term Current
Liability is used to designate obligations whose payment is expected to require the use of existing
current assets. Among current liabilities are Accounts Payable, Notes Payable, and Accrued Expenses.
These are exactly like their receivable counterparts except the debtor-creditor relationship is reversed.

Accounts Payable is generally a liability resulting from buying goods and services on credit

Suppose a business borrows $5,000 from the bank for a 90-day period. When the money is borrowed,
the business has incurred a liability – a Note Payable. The bank may require a written promise to pay
before lending any amount although there are many credit plans, such as revolving credit where the
promise to pay back is not in note form.

On the other hand, suppose the business purchases supplies from the ABC Company for $1,000 and
agrees to pay within 30 days. Upon acquiring title to the goods, the business has a liability – an Account
Payable – to the ABC Company.
In both cases, the business has become a debtor and owes money to a creditor. Other current liabilities
commonly found on the balance sheet include salaries payable and taxes payable.

Another type of current liability is Accrued Expenses. These are expenses that have been incurred but
the bills have not been received

Accounting for Windows Accounting Basics 21

for it. Interest, taxes, and wages are some examples of expenses that will have to be paid in the near
future.

Long-Term Liabilities

Long-Term Liabilities are obligations that will not become due for a comparatively long period of time.
The usual rule of thumb is that long-term liabilities are not due within one year. These include such
things as bonds payable, mortgage note payable, and any other debts that do not have to be paid within
one year.

You should note that as the long-term obligations come within the one-year range they become Current
Liabilities. For example, mortgage is a long-term debt and payment is spread over a number of years.
However, the installment due within one year of the date of the balance sheet is classified as a current
liability.

Capital

Capital, also called net worth, is essentially what is yours – what would be left over if you paid off
everyone the company owes money to. If there are no business liabilities, the Capital, Net Worth, or
Owner Equity is equal to the total amount of the Assets of the business.

Key Accounting Concepts

The two fundamental accounting concepts which were developed centuries ago but remain central to
the accounting process are:

• The accounting equation

• Double-entry bookkeeping

22 Accounting Basics Accounting for Windows

The Accounting Equation

Now let us discuss the accounting equation, which keeps all the business accounts in balance. We will
create this equation in steps to clarify your understanding of this concept. In order to start a business,
the owner usually has to put some money down to finance the business operations. Since the owner
provides this money, it is called Owner’s equity. In addition, this money is an Asset for the company. This
can be represented by the equation:

ASSETS = OWNER’S EQUITY

If the owner of the business were to close down this business, he would receive all its assets. Let’s say
that owner decides to accept a loan from the bank. When the business decides to accept the loan, their
Assets would increase by the amount of the loan. In addition, this loan is also a Liability for the company.
This can be represented by the equation:

Assets = Liabilities + Owner’s Equity

Now the Assets of the company consist of the money invested by the owner, (i.e. Owner’s Equity), and
the loan taken from the bank, (i.e. a Liability). The company’s liabilities are placed before the owners’
equity because creditors have first claim on assets.

If the business were to close down, after the liabilities are paid off, anything left over (assets) would
belong to the owner.

The Double Entry System

As we had mentioned earlier that today’s accounting principles are based on the system created by an
Italian Monk Fra Luca Pacioli. He developed this system over 500 years ago. Pacioli had devised this
method of keeping books, which is today known as the Double Entry system of accounting. He explained
that every time a transaction took place whether it was a sale or a collection – there were two

Accounting for Windows Accounting Basics 23

offsetting sides. The entry required a two-part “give-and-get” entry for each transaction.

Here is a simple explanation of the double entry system. Say you took a loan from the bank for $5,000.
Now if you can recall in an earlier discussion we had mentioned that:

ASSETS = LIABILITIES + OWNER’S EQUITY

Since the company borrowed money from the bank, the $5,000 is a liability for the company. In
addition, now that the company has the extra $5,000, this money is an asset for the company. If we
were to record this information in our accounts, we would put $5,000 in an account called Loan Taken
from the Bank, and $5,000 in an account called Cash Saved in the Bank. The former account will be a
Liability and the second account would be an Asset. As you can see, we created two entries. The first
one is to show from where the money was received (i.e. the source of the money). The second entry is
to show where the money was sent (i.e. the destination of the money received).
In a double entry accounting system, every transaction is recorded in the form of debits and credits.
Even for the simplest double entry, transaction there will be a debit and a credit. In simpler terms, a
debit is the application of money, and credit is the source of money.

Let us discuss some examples to help you understand the concept of debits and credits:

Example 1

Let’s say you wrote a check for $100 to purchase some stationary. This transaction would be recorded as
a Credit of $100 to the Cash in Bank account, and a Debit of $100 to the Stationary account. In this case,
we made a credit to the Cash in Bank, as it was the source of the money. The Stationary account was
debited, as it was the application of the money.

24 Accounting Basics Accounting for Windows

Example 2

Let’s say you received $200 cash for services rendered to a client. This transaction would be recorded as
a Credit of $200 to the Income from Services account, and a Debit of $200 to the Cash in Bank account.
In this case, we made a credit to the Income from Services, as it was the source of the money. The Cash
in Bank account was debited, as it was the application of the money.

Example 3

Let’s say you received a $10,000 loan from a bank. This transaction would be recorded as a Credit of
$10,000 to the Loan Payable account, and a Debit of $10,000 to the Cash in Bank account. In this case,
we made a credit to Loan Payable, as it was the source of the money. The Cash in Bank account was
debited, as it was the application of the money.

Example 4

Let’s say you made out a payroll check to an employee for $300. This transaction would be recorded as a
Credit of $300 to the Cash in Bank account, and a Debit of $300 to the Payroll Expense account. In this
case, we made a credit to the Cash in Bank, as it was the source of the money. The Payroll Expense
account was debited, as it was the application of the money.

Example 5

Let’s say you invested $10,000 in starting a new business. This transaction would be recorded as a Credit
of $10,000 to the Owner’s equity account, and a Debit of $10,000 to the Cash in Bank account. In this
case, we made a credit to the Owner’s equity, as it was the source of the money. The Cash in Bank
account was debited, as it was the application of the money.
You may remember from our discussion earlier that in order to start a business, the owner usually has to
put some money down to finance the business operations. Since the owner provides this money, it is
called Owner’s Equity.

Accounting for Windows Accounting Basics 25

Overview

The previous examples illustrated some of the transactions that are recorded in a double entry
accounting system. These transactions are also referred to as Journal Entries. Your accounting
application automatically creates the journal entries for you. In example 1 above, you would create a
check in the system, and on the check you would give the expense account number for stationary. The
checkbook program would then automatically credit the cash account, and debit the stationary expense
account.

Journals

Looking at the ledger account alone, it is difficult to trace back all the accounts that were affected by a
transaction. For this reason, another book is used to record each transaction as it takes place and to
show all the accounts affected by the transaction. This book is called the General Journal, or Journal.

Each transaction is first recorded in the journal and then the appropriate entries are made to the
accounts in the G/L. Because the journal is the first place a transaction is recorded it is called the book of
original entry. The advantage of the journal is that it shows all the accounts that are affected by a
transaction, and the amounts the appropriate accounts are debited and credited, all in one place.

Also included with each transaction is an explanation of what the transaction is for. Transactions are
recorded in the journal as they take place, so the journal is a chronological record of all transactions
conducted by the business. There is a standard format for recording transactions in the journal. A
journal transaction usually consists of the following:

• Journal Transaction Number

• Transaction Date

• Journal Type (General Journal, Sales Journal etc.)

• Actual Journal entries adjusting the account balances

26 Accounting Basics Accounting for Windows

In addition to the General Journal, other specialized journals contain entries from other accounting
modules to track sales, purchases, and the disbursement of cash. Some of the important journals are:
• Invoice Journal Report

• The Cash Receipts Report

• The Purchases Journal

• A/P Journal (Transactions & Payments) Reports

This program comes with sample chart of accounts already installed. If you prefer, you can modify these
accounts or create your own chart of accounts. In addition, all the Debits, Credit, and Journals are
automatically maintained for you. When you create invoices, checks and other transactions in the
system all the journal entries are created for you automatically. It is that easy!

Managing Your Business

We have covered the areas of accounts, debits, credits, and the accounting equation. In order to control
your business you must manage key areas. These areas are Cash, Sales, Income, Expenses, Assets,
Inventory, and Payroll. We will discuss each of these areas in the following sections.

Managing Cash

Bank Reconciliation

Typically, a business will use a bank checking account to help control the flow of cash. Cash received
during the day is deposited periodically in the bank account and checks are written on the account
whenever cash is paid out.

When the bank account is opened, each authorized person signs a signature card. The bank can use the
signature card at any time to

Accounting for Windows Accounting Basics 27

make sure that the signature on the check is authentic and that money can be paid out of that account.

When cash is deposited into the account, a deposit ticket is filled out listing the check number and the
amount of each check and any additional currency.

As the business makes payments, it will write checks on the bank account and record each check
payment in the checkbook or on the check stub. Every month, the bank will send the business a bank
statement, along with the cancelled checks paid that month.

The bank statement shows the balance at the beginning of the month, it lists each check paid, each
deposit, any other charges or credits to the account, and it shows the balance at the end of the month.

Usually the ending balances on the bank statement will not match the current cash account balance
shown in the checkbook. This is because there may be checks that have been written and recorded in
the checkbook but have not yet been processed and paid by the bank. There may also be service or
other charges the bank has deducted from the bank statement balance but which have not yet been
recorded and deducted from the checkbook balance.

For this reason, it is necessary at the end of each month to reconcile your bank statement. This is simply
the process of making the proper adjustments to both the bank statement balance and to the
checkbook balance to prove that they do in fact balance.

There are three steps to reconcile your bank statement.

Step 1: Compare the deposits shown in the checkbook with those shown on the bank statement. Any
deposits not yet shown on the bank statement are deposits in transit, that is, they are not yet received
and recorded by the bank. Subtract the total of the deposits in transit from the final balance in your
checkbook.

Step 2: Compare the canceled checks as shown on the bank statement with those recorded as written in
the checkbook. Checks that have been written but not yet

28 Accounting Basics Accounting for Windows

processed and paid by the bank are called outstanding checks. Add the total of the outstanding checks
to the final balance in your checkbook.

Step 3: Now look at the bank statement and see if there are any service charges or credits that are not
yet recorded in the checkbook. Add the credits and subtract the charges from the final balance of your
checkbook. The adjusted balances of your checkbook will now be equal to the ending balance on the
bank statement.

All the checks and deposits entered in this program automatically list on the checkbook reconciliation
screen. This saves time and makes the reconciliation process quick and easy.

Petty Cash

As we had discussed earlier, the principal method for maintaining internal control of cash is using a
checking account. However, a business usually has minor expenses, such as postage or minor purchases
of supplies that are easier to pay for with currency rather than with a check.

To handle these minor expenses, a petty cash fund is set up. A small amount of money, like $100, is
placed in a petty cash box or drawer and an individual is given responsibility for the funds. This
individual is the petty cashier.

When money is needed for an expense, the cashier prepares a petty-cash ticket, which shows the date,
amount, and purpose of the expense and includes the signature of the person receiving the money. This
ticket is then placed in the petty cash box. At any time, the total amount of cash in the box plus the total
amount of all tickets should equal the original fixed amount of cash originally placed in the box.

As expenditures are made, the petty cash fund will eventually need to be replenished. This is usually
done by writing a check to bring the amount in the fund back to the original amount of $100.

Accounting for Windows Accounting Basics 29

Managing Sales

sSales made by businesses can be broken down into the following main categories:

• Cash sales

• Sales on account

Cash Sales

Some businesses sell merchandise for cash only, while others sell merchandise either for cash or on
account. A variety of practices are followed in the handling of cash sales. If such transactions are
numerous, it is probable that one or more types of cash registers will be used. In this instance, the
original record of the sales is made in the register.

Often, registers have the capability of accumulating more than one total. This means that by using the
proper key, each amount that is punched in the register can be classified by type of merchandise, by
department, or by salesperson. Where sales tax is involved, the amount of the tax may be separately
recorded. In accounting terms, a cash sale means that the asset Cash is increased by a debit and the
income account Sales and a liability account Sales Tax Payable are credited. This displays in the table
below:

Debit

Credit

Cash

110.00

Sales

100.00

Sales Tax

10.00
Total

110.0

110.00

In many retail establishments, the procedure in handling cash sales is for the sale clerks to prepare sale
tickets in triplicate. Sometimes the preparation of the sales tickets involves the use of a cash register
that prints the amount of the sale directly on the ticket. Modern electronic cash registers serve as input
terminals that are online with computers, that is, in direct communication with the central

30 Accounting Basics Accounting for Windows

processor. At the end of each day, the cash received is compared with the record that the register
provides. The receipts may also be compared with the total of the cash-sales tickets, if the system makes
use of the latter.

Sales on Account

Sales on account are often referred to as charge sales because the seller exchanges merchandise for the
buyer’s promise to pay. In accounting terms, this means that the asset Accounts Receivable of the seller
is increased by a debit or charge, and the income account sales is increased by a credit. Selling goods on
account is common practice at the retail level of the distribution process.

Firms that sell goods on account should investigate the financial reliability of their clients. A business of
some size may have a separate credit department whose major function is to establish credit policies
and decide upon requests for credit from persons and firms who wish to buy goods on account.

Seasoned judgment is needed to avoid a credit policy that is so stringent that profitable business may be
refused, or a credit policy that is so liberal that uncollectable account losses may become excessive.

Generally, no goods are delivered until the salesclerk is assured that the buyer has established credit
-that there is an account established for this client with the company. In the case of many retail
businesses, clients with established credit are provided with credit cards or charge plates, which provide
evidence that the buyer has an account. These are used in mechanical or electronic devices to print the
client’s name and other identification on the sales tickets. In the case of merchants who commonly
receive a large portion of their orders by mail or by phone, this confirmation of the buyer’s status can be
handled as a matter of routine before the goods are delivered.

Accounting for Windows Accounting Basics 31

Managing Expenses
The Expense Authorization system is a commonly used method to keep track of and control expenses. It
is based upon the use of tickets. These tickets are written authorizations prepared for each expense.

With this system, before a check is written, a ticket is prepared authorizing payment. This system
provides an excellent control over expenses. It does this by making sure that each expense is justified
and by requiring more than one person to be responsible for preparing and authorizing the payment. A
ticket is prepared for every transaction that results in an expense.

When an invoice for a purchase is received, it is attached to a ticket, which is then filled out and signed.
The information that goes on the front side of the ticket verifies the information on the invoice. Once
the information is verified, an approval signature is required to authorize the expense. Once the ticket is
approved, it is recorded in an expense register.

Tickets are recorded in the register in date order. Once recorded, the ticket is put into an Unpaid Ticket
File where it remains until it is paid. The tickets are filed according to the date they should be paid in
order to take advantage of discounts.

When it comes time to pay a ticket, it is removed from the Unpaid Tickets File and a check is issued. The
check number and payment date is recorded on the ticket and in the Ticket Register next to that ticket
entry. Each ticket is paid by check. As each ticket is paid, the payment is recorded in a Check Register.
With the ticket system, the Check Register is the book of original entry for recording payments and it
takes the place of a cash payments journal.

In a computerized accounting system, the function for controlling expenses is controlled by the Accounts
Payable program. You would enter, track and pay your invoices with Accounts Payable.

32 Accounting Basics Accounting for Windows

Managing Inventory

Merchandise Inventory

Merchandise inventories are the goods that are on hand for the production process or available for sale
to final customers. There are two basic methods for determining inventory:

• Perpetual inventory method

• Periodic inventory method

With the perpetual inventory method, the cost of each item in the inventory is recorded when
purchased. When an item is sold, its cost is deducted from the inventory. This results in a perpetual
record of exactly what is in inventory.

The perpetual inventory method is best suited for those businesses that have a relatively low number of
sales each day and whose merchandise has a high unit value. For example, a car dealer might use the
perpetual inventory method to keep track of inventory because it is easy to keep track of each item as it
is purchased by the business and then resold.

This program uses the perpetual method and automatically tracks your inventory value. This program
makes it easy for businesses such as department and grocery stores that have a large number of sales
each day to track inventory value on a real-time basis.

For businesses that manually maintain track inventory value, it wouldn’t be practical to adjust the cost
of inventory each time an item is sold. Instead, these types of business use the periodic inventory
method, which involves periodically taking a physical count of the merchandise on hand, usually once a
year at the end of the accounting period.

Once the physical count is done, the exact quantity of merchandise on hand is known. The costs of all
items on hand are then totaled to give a total cost of the inventory on hand at the end of the year.

Accounting for Windows Accounting Basics 33

Calculating Inventory Value

A company can raise or lower its earnings by changing the way it calculates the cost of goods sold. As
inventory items are purchased during the accounting period, their unit cost may vary. A costing method
is a way of calculating the cost of goods sold. The first time you purchase a product, the value is
whatever you paid. Once you receive more stock at a different price, it is necessary to use one of the
three standard methods to determine the value of what you sell. The three most popular methods used
to determine the value of the ending inventory are:

• First in, First out (FIFO)

• Last in, First out (LIFO)

• Average cost

Important Note: You should consult your accountant regarding the method that best suits your needs.

First in, First out (FIFO)

This method assumes that the first item to come into the inventory are the first items sold, so the most
recent unit cost is used to determine the inventory’s value. FIFO assumes that the oldest stock you have
is sold first. At a time when your cost is constantly increasing, the first items sold are the least expensive
ones, therefore your cost of goods sold is low and your income is greater.

Last in, First out (LIFO)

This method assumes that the last item to come into the inventory are the first items sold, so the oldest
unit cost is used to determine the inventory’s value. With LIFO, the newest stock is sold first. An
inventory value should generally reflect the replacement cost of your stock and that is what LIFO does.
When prices are increasing LIFO will calculate cost of goods sold at the most recent price, resulting in a
higher cost of goods and lower income.

Average Cost

This method uses the average unit cost for all items that were available for sale during the accounting
period. The Average method

34 Accounting Basics Accounting for Windows

is the total cost of all goods divided by the number in stock. This has the effect of leveling out price
fluctuations, providing a constant cost of goods and income.

Let us discuss an example that will clarify this concept. For example, suppose you sell Boxes. On August
1, you purchase 100 Boxes for $1.00 each for a total cost of $100. On August 2, you purchase another
100 Boxes, this time at $1.25 per box for a total cost of $125. You now have purchased 200 Boxes for
$225.

On August 3, you sell 50 Boxes for $1.50 each for a total of $75. Depending which costing method you
are using, your income will be different:

FIFO: This method would assume the 50 boxes you sold were from the first 100 boxes you bought (at $1
each). Your cost of goods would be $50 and your profit would be $25.

LIFO: It is assumed that the 50 boxes sold were from the last 100 boxes you purchased (at $1.25 each).
Your cost of goods is then $62.50 for a profit of $12.50.

Average: This method will consider only that you bought 200 boxes for $225, for an average cost of
$1.125 each. Your cost for the 50 boxes sold is $56.25 and you will have a profit of $18.75.

When the income statement is prepared, the cost of inventory on hand is subtracted from the Cost of
Goods Available for Sale during the year. This yields the Cost of Goods Sold for the year. You should
check with your accountant to determine which method suits your needs.

Break-Even Point

One of the first steps in evaluating a business is determining your break-even point. This is the number
of units of your product, which must be sold for income to equal all expenses incurred in producing the
merchandise. Logic would dictate that if you are in a high rent area and need to sell half your stock of art
objects each month in order to break even, you have started a losing business.

Accounting for Windows Accounting Basics 35

•

Assuming your product or service is a worthwhile one, the control of your overhead is the key to your
profit.

Overhead consists of fixed costs, such as rent, insurance, and payment on bank notes, etc., which will
not vary if your production increases. It also includes variable and semi-variable costs. Variables mean
such items as commissions to salespeople, purchases of raw materials; and other overhead, which
increase in direct proportion to changes in production volume. That is to say, if a company that has been
making 10,000 snow shovels per month, for example, doubled production to the 20,000 level, then
purchase of raw materials, sales commissions, and other expenses would also increase. Semi-variable
costs will vary with volume, but not in direct proportion. The cost of lighting and power will increase
with greater production.

Each unit produced should provide some margin for fixed costs and profits. Or expressed a different
way, at no point should the direct cost, not the fixed cost, of producing a unit be greater than its sales
price. Your fixed cost per unit will vary inversely with changes in volume. Since your fixed overhead will
not increase as a result of greater production, and semi-variable costs will increase by a percentage
considerably lower than the rate of increased production, it follows that your cost per unit will lessen as
greater quantities are produced.

The experienced businessman uses his break-even charts to indicate profit margins at a given rate of
production. However, the chart is useful only when fixed costs remain the same, when variable
percentage can be plotted with reasonable accuracy, and when a company produces only one item.

Managing Payroll

Payroll Records

An employer, regardless of the number of employees, must maintain all records pertaining to payroll
taxes (income tax withholding, Social Security, and federal unemployment tax)

36 Accounting Basics Accounting for Windows

There are several different kinds of employment records that must be maintained to satisfy federal
requirements. These records are summarized below:

Income-Tax-Withholding Records

• Name, address, and Social Security number of each employee

• Amount and date of each payment of compensation

• Amount of wages subject to withholding in each payment

• Amount of withholding tax collected from each payment

• Reason that the taxable amount is less than the total payment

• Statement relating to employees’ non-resident alien status

• Market value and date of non-cash compensation

• Information about payments made under sick-pay plans

• Withholding exemption certificates

• Agreements regarding the voluntary withholding of extra cash

• Dates and payments to employees for non-business services

• Statements of tips received by employees

• Requests for different computation of withholding taxes

Social Security (FICA) Tax Records

• Amount of each payment subject to FICA tax

• Amount and date of FICA tax collected from each payment

• Explanation for the difference, if any

Unemployment and Disability Records

• Total amount paid during calendar year

• Amount subject to unemployment tax

• Amount of contributions paid into the state unemployment fund

• Any other information requested on the unemployment tax return

• State disability contributions

Financial Statements

In order to manage your business effectively you need reports that tell you how your business is
performing. For example, you may want to know the value of your assets like, Cash you have on hand,

Accounting for Windows Accounting Basics 37

•
Cash in bank, and Inventory in stock. In addition, you would like to know the value of your liabilities,
loans, income earned, and expenses incurred. Accountants prepare financial statements that summarize
these transactions. Two of the most important reports for managing your business are Income
Statement and the Balance Sheet.

Income Statement

An Income Statement is also called a Profit and Loss Report. In addition, the word Revenue is often used
in place of the word Income. An Income Statement is used to inform you about the income earned,
expenses incurred, and the total profit or loss in a particular period. Two common periods for creating
an income statement are monthly and annually.

This report summarizes all Income (or sales), the amounts that have been or will be received from
customers for goods delivered or services rendered to them, and all expenses, the costs that have arisen
in generating revenues. To show the actual profit or loss of a company, the expenses are subtracted
from the revenues to show the Net Income – profit or the “bottom line”.

Income Accounts: These accounts are used to track income earned during the process of operating your
business. The income of a business comes from sales to customers or fees for services or both. Some of
the common names for income accounts are:

• Income from Sales

• Income from Freight

• Other Income

Expense Accounts: These accounts are used to track expenses incurred during the process of operating
your business. Expenses include both the costs directly associated with creating products and general
operating expenses. Some of the common names for expense accounts are:

• Cost of Sales

• Office Supplies

• Utilities

38 Accounting Basics Accounting for Windows

• Payroll Expenses • Tax Expenses A very simple form of an income statement displays in the following
example: Joe’s Bicycle Company 123 Main Street Any Town CA 99999 Income Statement Income Income
from Sales 15,000.00 Income from Freight 1,000.00 Other Income 250.00 Total Income 16,250.00
Expenses Cost of Sales 2,000.00 Office Supplies 250.00 Telephone Expense 500.00 Utilities 100.00
Consulting Fees 750.00 Maintenance 300.00 Insurance 250.00 Miscellaneous Expenses 375.00 Travel &
Entertainment 650.00 Bank Charges 25.00 Payroll Expense 4,000.00 Tax Expense 2,500.00 Total
Expenses 11,700.00 Net Income/Loss 4,550.00

Accounting for Windows Accounting Basics 39

Balance Sheet

A Balance sheet is like a “snapshot” that gives you the overall picture of the financial health of a
company at one moment in time. This report lists the assets, liabilities, and owner’s equity in the
business. Unlike the income statement, this report is always created to show the financial status as of a
certain date. Two common ending periods to create a balance sheet are the end of a month and the end
of the year.

The Balance Sheet has two sections. The first section lists all the Asset accounts and their balances. At
the end of the list, the totals of all assets are listed. In the second section, the Liability and Owner’s
Equity accounts are listed. There are two sub-totals for the Liability and the Equity accounts. At the end,
there is a combined total of the Liabilities and Owner’s Equity. As discussed earlier in the accounting
equation, the Assets equal the sum of the Liabilities and the Equities. You will also notice that the Profit
from the income statement is listed in the Equity section of the balance sheet. Some of the important
accounts in the balance sheet are:

Current Assets: Current assets are always listed first and include cash and other items that can be
converted into cash within the following year. This includes funds in checking and savings accounts.

Accounts Receivable: Accounts Receivable represents money owed to the business. These usually result
from the sale of merchandise or performance of services for a client on account. The phrase On Account
indicates that on the date the goods were sold to the client, or the service performed for him, the
business did not receive full payment. However, it did obtain an asset – the right to collect payment for
merchandise sold or Services performed. The claim a business has against a credit client is referred to as
an Account Receivable. It is an asset because it represents a legal claim to cash.

Inventory: Inventories may represent merchandise purchased for resale as well as the raw materials
acquired by a manufacturing firm to put into the product. In the case of a manufacturer, the term
inventories also includes manufacturing supplies, purchased parts, the work that is in process, and
finished goods. Inventory is also an asset account.

40 Accounting Basics Accounting for Windows

Accounts Payable: When you purchase goods or services on account, you are usually required to pay
within a fixed period of time. These amounts you owe for the goods or services purchased are called
accounts payable. The payment of these purchases is usually due within a relatively short period of time.
Usually this period is one year or less. Typical periods are thirty to sixty days. The payment for these
short-term liabilities requires the use of existing resources like the Cash or The Checking Account.

A very simple form of a balance sheet displays in the following example:

Joe’s Bicycle Company 123 Main Street Any Town CA 99999 Balance Sheet Assets Checking Account
25,000.00 Investments 75,000.00 Inventory 25,000.00 Accounts Receivable 10,000.00 Machinery &
Equipment 22,500.00 Investments 100,000.00 Total Assets 257,500.00 Liabilities & Equity Accounts
Payable 15,000.00 Loans Payable 60,450.00 Salaries Payable 75,000.00 Taxes Payable 2,500.00 Total
Liabilities 152,950.00 Owner’s Equity 100,000.00 Profit/Loss 4,550.00 Total Equity 104,550.00 _ Total
Liabilities & Equity 257,500.00

Accounting for Windows Accounting Basics 41

This program automatically creates the Balance Sheet and the Income Statements for you. All the
accounts are automatically updated when you create invoices, checks, and transactions in the system.
To create a Balance Sheet or an Income Statement all you have to do is to select the report from the
menu and print it.

Linking the Income and Balance Sheet

Generally, a balance sheet and an income statement are prepared and issued together because in a way
they are twin reports, the income statement showing what happened over a period of time and the
balance sheet showing the resulting condition at the end of that period.

Since these statements are usually studied in relation to one another, it is highly desirable for them to
tie together with one common figure. You will see that the Net Profit/Loss on the bottom of the income
statement discussed earlier was $4,550.00. If you look at the Equity section of the balance sheet shown
earlier, you will notice that the $4,550.00 Profit/Loss lists as a part of the total equity. This ties the
income statement to the balance sheet report.

42 Accounting Basics Accounting for Windows

Management accounting or managerial accounting is concerned with the provisions and use
of accounting information to managers within organizations, to provide them with the basis to
make informed business decisions that will allow them to be better equipped in their
management and control functions.

In contrast to financial accountancy information, management accounting information is:

 designed and intended for use by managers within the organization, instead of being
intended for use by shareholders, creditors, and public regulators;
 usually confidential and used by management, instead of publicly reported;
 forward-looking, instead of historical;
 computed by reference to the needs of managers, often using management information
systems, instead of by reference to general financial accounting standards.

So, you want to learn

Bookkeeping!

by Bean Counter's Dave Marshall

Lesson 4

Recording Business Transactions

Introduction Lesson 1 Lesson 2 Lesson 3 Lesson 4 Lesson 5 Lesson

6 Lesson 7

Bean Counter
If you thought you we're going to be able to sit back and relax on the beach, I'm sorry to disappoint you.
I'm the only one currently entitled to this luxury (I already know bookkeeping but you're getting there).

Let's reflect a little on what we've covered so far.

In the Introduction we discussed the types of business organizations, types of business activities, users
of financial information, bookkeeping systems, accounting rules, and the cash and accrual basis of
accounting.

Lesson 1 introduced you to some of the terminology and definitions used in the accounting and
bookkeeping language.

Lesson 2 explained Property & Property Rights, the Accounting Equation, double entry bookkeeping, and
how business transactions affect the equation.

Lesson 3 introduced and explained Debits and Credits and how they affect the Accounting Equation and
are used to record business transactions.

If you feel you need a refresher on any of these topics now would be a good time to review any prior
lessons before continuing on.

Introduction Lesson 1 Lesson 2 Lesson 3

Under the light again to see what stuck to your many brain cells. I'm a firm believer in "show
me", so let's see what you know at this time.

Basic Accounting Review Quiz

Even if you did well on the review quiz and feel fairly comfortable with the material that has already
been presented, a quick review of some of the prior material will be beneficial for understanding the
material presented in this lesson.

Type Of Accounts
In prior lessons, we mainly used "The Big Three" (Assets, Liabilities, and Owner's Equity) and "Ma
Capital's (Owners Equity) Kids" (Revenue, Expense, Investment, and Draws) as our "accounts" to learn
how business transactions affect account balances.

These seven "big" type of accounts were defined in Lesson 1 as follows:

Assets

Formal Definition:The properties used in the operation or investing activities of a business.

Informal Definition:All the good stuff a business has (anything with value). The goodies.

Liability

Formal Definition:Claims by creditors to the property (assets) of a business until they are paid.

Informal Definition:Other's claims to the business's stuff. Amounts the business owes to others.

Owner's Equity also called Owner's Capital

Formal Definition:The owner's rights to the property (assets) of the business; also called proprietorship
and net worth.

Informal Definition:What the business owes the owner. The good stuff left for the owner assuming all
liabilities (amounts owed) have been paid.

# "Ma Capital's (Owner's Equity) Four Kids" Revenue

Formal Definition:The gross increase in owner's equity resulting from the operations and other activities
of the business.

Informal Definition:Amounts a business earns by selling services and products. Amounts billed to
customers for services and/or products.

# Expense

Formal Definition:Decrease in owner's equity resulting from the cost of goods, fixed assets, and services
and supplies consumed in the operations of a business.
Informal Definition:The costs of doing business. The stuff we used and had to pay for or charge to run
our business.

# Draws

Formal Definition: Decrease in owner's equity resulting from withdrawals made by the owner.

Informal definition: Amounts the owner withdraws from his business for living and personal expenses.

# Owner's Investments

Formal Definition: Increase in owner's equity (capital) resulting from additional investments of cash
and/or other property made by the owner.

Informal definition: Additional amounts, either cash or other property, that the owner puts in his
business.

In the real bookkeeping world, we want to know the detail types of assets, liabilities, equity (capital),
revenues, expenses, and draws.

In Lesson 1 we discussed some of the detail types of assets, liabilities, equity, revenue, and expenses.
Can You name a few ? I'll help you.

Examples of Assets-Cash, Accounts Receivable, Notes Receivable, Buildings, and Equipment

Examples Of Liabilities-Accounts Payable, Notes Payable, and Mortgage Payable

Examples Of Revenue-Product Sales, Rental Income, and Service Revenue

Examples Of Expenses-Employee Wages, Building Rental, Telephone, Utilities, Advertising, Office

Supplies

Rules for Debits and Credits that we will use in this lesson were just covered in Lesson 3. If you've slept
since then, the following procedure is what you use in order to use and apply the Debit and Credit Rules
when recording bookkeeping transactions.

All You Need To Know About Debits and Credits

Summarized In One Sentence:

Enter an amount in the Normal Balance Side of an Account to Increase the Balance of an Account and in
the Opposite Side of an Account to Decrease the Balance of an Account.

Additional Clarification:

Since Assets, Draw, and Expense Accounts normally have a Debit Balance, in order to Increase the
Balance of an Asset, Draw, or Expense Account enter the amount in the Debit or Left Side Column and in
order to Decrease the Balance enter the amount in the Credit or Right Side Column.

Likewise, since Liabilities, Owner's Equity (Capital), and Revenue Accounts normally have a Credit
Balance in order to Increase the Balance of a Liability, Owner's Equity, or Revenue Account the amount
would be entered in the Credit or Right Side Column and the amount would be entered in the Debit or
Left Side column to Decrease the Account's Balance.

How To Use and Apply The Debit and Credit Rules:

(1) Determine the type of account(s) the transactions affect-asset, liability, revenue, or expense account.

(2) Determine if the transaction increases or decreases the account's balance.

(3) Apply the debit and credit rules based on the type of account and whether the balance of the
account will increase or decrease.

Let's revisit another definition and term that was defined in Lesson 1 and discussed in Lesson 3.

Account-a separate record for each type of asset, liability, equity, revenue, and expense used to show
the beginning balance and to record the increases and decreases for a period and the resulting ending
balance at the end of a period.

Any of these or any others that our business needs or wants to track have their own separate and
individual account. What officially do we call this detail listing of accounts that we set up for our
business ? Simply a Chart Of Accounts.
In this lesson and future lessons we are going to stray away from analyzing and recording transactions
using the "Big Accounts" and start using the detail accounts to record and analyze our business
transactions.

Let's take a step in this direction by setting up a simple chart of accounts for ABC Mowing.

Simple Chart Of Accounts For ABC Mowing

Assets

Account Name:Cash

Description:Currency and checks and balance in bank

Account Name:Accounts Receivable

Description:Amounts due from customer's for services rendered

Account Name:Inventory-Office Supplies

Description:On hand supplies of such items as copier & computer paper, pens, pencils and other office
supplies

Account Name:Mowing Equipment

Description:Mowers purchased

Liabilities

Account Name:Accounts Payable

Description:Amounts owed suppliers for business purchases and expenses

Account Name:Note Payable-Bank

Description:Mortgages and loans owed to bank

Equity

Account Name:Owner's Capital

Description:Amounts invested by owner and earned by operations

Account Name:Owner's Draws

Description:Amounts withdrawn by owner for personal expenses

Revenue

Account Name:Mowing Revenues

Description:Earnings from mowing yards

Expenses

Account Name:Advertising Expense

Description:Expenditures for TV, radio, newspaper, and other promotions.

Account Name:Mulch Expense

Description:Expenditures for mulch used for yard work

In order to record the information in our accounts, we also need to be familiar with the source
documents that provide us with the necessary information for recording our transactions.

Source Documents
The original sources of information that provide documentation (proof) that a transaction has occurred
are sales invoices (tickets), invoices from suppliers, contracts, checks written and checks received ,
promissory notes, and various other types of business documents. These documents provide us with the
information needed to record our financial transactions in our bookkeeping records.

Typical Types Of Business Transactions

and the Debits and Credits and Accounts Used To Record Them

In a typical business transaction we get something and we give up something.

* Sale-Sell goods and/or services

o Cash Sale-customer pays at the time of sale

The business gets cash or a check from their customer and gives up a product or service to their
customer.

Accounts Used:

Debit: Cash

Credit: Sales

o On Account Sale-business allows the customer time to pay

The business gets a promise to pay from their customer and gives up a product or service to their
customer.

Accounts Used:

Debit: Accounts Receivable

Credit: Sales

* Purchase goods and/or services

 o Cash Purchase-business pays the supplier at the time of purchase

The business gets a product or service from their supplier and gives up cash or a check to their
supplier.

Accounts Used:

Debit: Expense or Inventory Account

Credit: Cash

o On Account Purchase-supplier allows the business time to pay

The business gets a product or service from a supplier and gives up a promise to pay to their
supplier.

Accounts Used:

Debit: Expense or Inventory Account

Credit: Accounts Payable

* Pay Supplier Charge Purchases -pay suppliers for products and/or services that we promised to pay
for later (charge).

The business gets the amount of their promise to pay the supplier reduced and gives up cash or a
check.

Accounts Used:

Debit: Accounts Payable

Credit: Cash

* Receive Customer Charge Payments -receive payments from a customer that promised to pay us
later (charge sale).

The business gets cash or a check from their customer and gives up (reduces the amount of) their
customer's promise to pay.

Accounts Used:
 Debit: Cash

Credit: Accounts Receivable

* Borrow Money (Loans) The business gets cash or equipment and gives up a promise to pay.

Accounts Used:

Debit: Cash or Equipment

Credit: Note Payable

* Repay a Loan

The business gets the amount of their promise to pay reduced and gives up cash or a check.

Accounts Used:

Debit: Note Payable

Credit: Cash

* Draw

The business gets the owner's claim to the business assets reduced and gives up cash or a check.

Accounts Used:

Debit: Owner's Draw

Credit: Cash

* Payroll (not covered in this tutorial)

The business gets services from their employees and gives up a check.

Accounts Used:

Debit: Salary & Wages Expense

Credit: Cash
T-Accounts

We're going to record our transactions using our ole buddy the T-Account.

Notice that Assets, Draws, and Expense Type of Accounts are increased using the Left Side (Column) of
the account (debited) and decreased using the Right Side (Column) of the account (credited). The
reverse is true for the Liability, Equity, and Revenue Type of Accounts. These Type Of Accounts are
increased using the Right Side (Column) of the account (credited) and decreased using the Left Side
(Column) of the account (debited).

Asset Accounts

Account Name

Increase Decrease

Debit Credit

Left Side or Debit Side of Account Right Side or Credit Side of Account

Liability Accounts

Account Name

Decrease Increase

Debit Credit

Left Side or Debit Side of Account Right Side or Credit Side of Account
Equity (Capital) Accounts

Account Name

Decrease Increase

Debit Credit

Left Side or Debit Side of Account Right Side or Credit Side of Account

Revenue Accounts

Account Name

Decrease Increase

Debit Credit

Left Side or Debit Side of Account Right Side or Credit Side of Account

Expense Accounts

Account Name
Increase Decrease

Debit Credit

Left Side or Debit Side of Account Right Side or Credit Side of Account

Draw Accounts

Account Name

Increase Decrease

Debit Credit

Left Side or Debit Side of Account Right Side or Credit Side of Account

Now, I think we should be ready to revisit our ABC Mowing Company and record the transactions
presented in prior lessons in our detailed accounts (T-Accounts). We are going to assume that ABC has
beginning balances already recorded in their accounts. These balances are as of December 1, xxxx.

Note: If these balances were as of the beginning of the year the nominal or temporary accounts -
revenues, expenses, and draws would all have zero balances.
Lastly, we are going to thoroughly review each transaction for December xxxx and show you the hows
and whys to properly recording each transaction and present the steps for properly analyzing and
recording a transaction.

ABC's Beginning Account Balances as of December 1, xxxx

Assets Liabilities Equity

Cash $5,500 Dr

Accounts Receivable $1,600 Dr

Mowing Equipment $2,500 Dr

Inventory-Office Supplies $0 Dr

Accounts Payable $2,000 Cr

Owner's Capital $7,500 Cr

Mowing Revenue $1,000 Cr

Advertising Expense $200 Dr

Mulch Expense $100 Dr

Owner Draws $600 Dr

Notice I used the symbols Dr and Cr to abbreviate the Debit and Credit balances in the table of ABC's
beginning balances. While this is a common method of representing debits and credits, other symbols
that we discussed in Lesson 3 are also used.

You'd better check me out to see if our books balance before we start recording ABC's transactions.
We're going to perform two checks that relate to what we've been learning in prior lessons.
The first check is to see if our Accounting Equation balances and the second to make sure that the debit
balances equal the credit balances.

Equation Check Calculations

Total Assets = Cash + Accounts Receivable + Mowing Equipment

Total Assets = 5,500 + 1,600 + 2,500

Total Assets = 9,600

Total Liabilities is easy because there is only one account (Accounts Payable) with a balance of 2,000.

Total Liabilities = 2,000

Total Equity = Owner's Capital + Revenues - Expenses - Draws

Since we have more than one expense let's summarize them before we use them in our equation.

Total Expenses = Mulch Expense + Advertising

Total Expenses = 100 + 200

Total Expenses = 300

Total Equity = Owner's Capital + Revenues - Expenses - Draws

Total Equity = 7,500 + 1000 - 300- 600

Total Equity = 7,600

Substituting our totals into the Accounting Equation we find that our equation balances.

Assets = Liabilities + Owner's Equity

9,600 2,000 7,600

Our second check is to see if our debit account balances equal our credit account balances.

Let's total our Debit Balances

Cash 5,500

Accounts Receivable 1,600

Mowing Equipment 2,500

Advertising Expense 200

Mulch Expense 100

Owner's Draw 600

Total Debits 10,500

Now we'll total our Credit Balances

Accounts Payable 2,000

Owner's Capital 7,500

Mowing Revenue 1,000

Total Credits 10,500

It looks like we passed muster again.

ABC Transactions

Let's revisit that mowing business once again. This time we're going to record our transactions using our
detail type of accounts such as Cash, Accounts Receivable, Mowing Equipment, Mowing Revenues, etc.
to record our transactions.

Navigation:
Interactive Links are provided in this table.

# Click on the Underlined Transaction Number Link (1,2,3,etc.) to go to the Detailed Information
Pertaining to the Transaction.

1. ABC mows a client's yard and receives a check from the customer for $50 for the service provided.

2. ABC purchases $100 worth of office supplies and stores them in their storage room. The office supply
store gives them an invoice that allows them to pay for them in 15 days (on account).

3. ABC places an ad in the local newspaper receives the invoice from the supplier and writes a check for
$25 to the newspaper.

4. ABC purchases five mowers for $10,000 and finances them with a note from the local bank.

5. ABC mows another customer's yard and sends the customer a $75 bill (invoice) for the service they
performed. They allow their customer ten (10) days to pay them for this service (on account).

6. The owner of ABC needs a little money to pay some personal bills and writes himself a check for $500.

7. ABC pays the office supply company $100 with a check for the office supplies that they charged
(promised to pay).

8. ABC receives a check from the customer who they billed (invoiced) $75 for services and allowed 10
days to pay.

9. ABC purchased some mulch for $60 and received an invoice from their supplier who allows them 15
days to pay. The mulch was used on a customer's yard.

10. ABC bills (prepares an invoice) the customer $80 for the mulch and mowing his yard and receives a
check for $80 from the customer.

We will discuss each transaction and "post" the entry to the appropriate account (T-Account). Keep in
mind that each entry will have a debit and a credit.

In your actual formal General Ledger, which will be discussed and explained in Lesson 5, each account
has an amount column for debits (left side or first column) and an amount column for credits (right side
or second column).
Detail Transaction Information

Navigation:

Interactive Links are included for each transaction that return you to the List Of Transactions.

# Click On the Underlined Return To Transaction Link to Return To The List Of Transactions.

For each transaction for ABC Mowing, we will identify the Source Document, Type Of Transaction,
Accounts Affected, and determine and explain the Debits and Credits needed to properly record and
post to our T-Accounts.

Entry 1

1. ABC mows a client's yard and receives a check from the customer for $50 for the service provided.

Source Document:Customer's Check

Type Of Transaction:Cash Sale

Accounts Affected:Cash Sales

Debits and Credits:

Increase (Left Side) Cash: Debit

Increase (Right Side) Mowing Revenue (Sales): Credit

Explanation Using Our Debit/Credit Rules:The asset cash is increased. An increase is recorded by
entering the amount in the normal balance side of an account. The normal balance side of cash, which is
an asset, is the left (debit) side of the account so we increase cash by entering the amount in the left
side as a debit. Mowing Revenue (Equity) is also increased. Again, an increase is recorded by entering
the amount in the normal balance side of an account. The normal balance side of a revenue account is
the right (credit) side of the account so we increase mowing revenue (sales) by entering the amount in
the right side as a credit.
Asset Account

Cash

Increase Decrease

Debit Credit

Beg Bal. 5,500

(1) 50

Revenue (Equity) Account

Mowing Revenues

Decrease Increase

Debit Credit

Beg Bal. 1,000

(1) 50

Return To Transaction Listing

Entry 2
2. ABC purchases $100 worth of office supplies and stores them in their storage room. The office supply
store gives them an invoice that allows them to pay for them in 15 days (on account).

Source Document:Supplier's Invoice

Type Of Transaction:On Account Purchase

Accounts Affected:Inventory-Office Supplies Accounts Payable

Debits and Credits:

Increase (Left Side) Inventory-Office Supplies: Debit

Increase (Right Side) Accounts Payable: Credit

Explanation Using Our Debit/Credit Rules:The asset inventory-office supplies is increased. An increase is
recorded by entering the amount in the normal balance side of an account. The normal balance side of
inventory-office supplies, which is an asset, is the left (debit) side of the account so we increase
inventory-office supplies by entering the amount in the left side as a debit. The liability accounts payable
is also increased. Again, we record an increase by entering the amount in the normal balance side of an
account. The normal balance side of accounts payable, which is a liability, is the right (credit) side of the
account so we increase accounts payable by entering the amount in the right side as a credit.

Asset Account

Inventory-Office Supplies

Increase Decrease

Debit Credit

(2) 100
Liability Account

Accounts Payable

Decrease Increase

Debit Credit

Beg Bal. 2,000

(2) 100

Return To Transaction Listing

Entry 3

3. ABC places an ad in the local newspaper receives the invoice from the supplier and writes a check for
$25 to the newspaper.

Source Document:Supplier's Invoice and Company Check

Type Of Transaction:Cash Purchase

Accounts Affected:Advertising Expense (Equity) Cash

Debits and Credits:

Increase (Left Side) Advertising Expense (Decrease Equity): Debit

Decrease (Right Side) Cash: Credit

Explanation Using Our Debit/Credit Rules:The expense advertising expense is increased. An increase is
recorded by entering the amount in the normal balance side of an account. The normal balance side of
advertising expense, which is an expense account, is the left (debit) side so we increase advertising
expense by entering the amount in the left side as a debit. The asset cash is decreased. We record a
decrease by entering the amount in the opposite side of the normal balance side of an account. The
normal balance side of cash, which is an asset, is the left (debit) side so we decrease cash by entering
the amount in the opposite side which is the right (credit) side of the account as a credit.

Some additional clarification might be useful in order to clarify why an expense is recorded as an
increase with a debit. The actual amount of the advertising expense has increased. The business now
has spent more for advertising. More expenses are not what a business or an individual wants. Increased
personal expenses reduce our personal equity and likewise increased business expenses reduce the
owner's equity of a business. Since an increase in an expense reduces equity it is recorded as an increase
using a debit.

Asset Account

Cash

Increase Decrease

Debit Credit

Beg Bal. 5,500

(3) 25

(1) 50

Expense (Equity) Account

Advertising Expense

Increase Decrease

Debit Credit
Beg Bal. 200

(3) 25

Return To Transaction Listing

Entry 4

4. ABC purchases five mowers for $10,000 and finances them with a note from the local bank.

Source Document:Bank Note

Type Of Transaction:Borrow Money

Accounts Affected:Mowing Equipment Note Payable-Bank

Debits and Credits:

Increase (Left Side) Mowing Equipment: Debit

Increase (Right Side) Note Payable-Bank: Credit

Explanation Using Our Debit/Credit Rules:The asset mowing equipment is increased. An increase is
recorded by entering the amount in the normal balance side of an account. The normal balance side of
mowing equipment, which is an asset account, is the left (debit) side so we increase mowing equipment
by entering the amount in the left side as a debit. The liability note payable-bank is also increased.
Again, an increase is recorded by entering the amount in the normal balance side of an account. The
normal balance side of note payable-bank, which is a liability account, is the right (credit) side , so we
increase note payable-bank by entering the amount in the right side as a credit.

Asset Account
Mowing Equipment

Increase Decrease

Debit Credit

Beg Bal. 2,500

(4) 10,000

Liability Account

Note Payable-Bank

Decrease Increase

Debit Credit

(4) 10,000

Return To Transaction Listing

Entry 5

5. ABC mows another customer's yard and sends the customer a $75 bill (invoice) for the service they
performed. They allow their customer ten (10) days to pay them for this service (on account).
Source Document:Sales Invoice

Type Of Transaction:On Account Sale

Accounts Affected:Accounts Receivable Mowing Revenue (Sales)

Debits and Credits:

Increase (Left Side) Accounts Receivable: Debit

Increase (Right Side) Mowing Revenue (Sales): Credit

Explanation Using Our Debit/Credit Rules:The asset accounts receivable is increased. An increase is
recorded by entering the amount in the normal balance side of an account. The normal balance side of
accounts receivable, which is an asset, is the left (debit) side of the account so we increase accounts
receivable by entering the amount in the left side as a debit. Mowing Revenue (Equity) is also increased.
Again, an increase is recorded by entering the amount in the normal balance side of an account. The
normal balance side of a revenue account is the right (credit) side of the account so we increase mowing
revenue (sales) by entering the amount in the right side as a credit.

Asset Account

Accounts Receivable

Increase Decrease

Debit Credit

Beg Bal. 1,600

(5) 75
Revenue (Equity) Account

Mowing Revenues

Decrease Increase

Debit Credit

Beg Bal. 1,000

(1) 50

(5) 75

Return To Transaction Listing

Entry 6

6. The owner of ABC needs a little money to pay some personal bills and writes himself a check for $500.

Source Document:Check

Type Of Transaction:Draw

Accounts Affected:Cash Draw

Debits and Credits:

Increase (left Side)Owner's Draw (Decrease Equity): Debit

Decrease (Right Side) Cash: Credit

Explanation Using Our Debit/Credit Rules:The draw account owner's draw is increased. An increase is
recorded by entering the amount in the normal balance side of an account. The normal balance side of
owner's draw, which is a draw account, is the left (debit) side so we increase owner's draw by entering
the amount in the left side as a debit. The asset cash is decreased. We record a decrease by entering the
amount in the opposite side of the normal balance side of an account. The normal balance side of cash,
which is an asset, is the left (debit) side so we decrease cash by entering the amount in the opposite side
which is the right (credit) side of the account as a credit.

Asset Account

Cash

Increase Decrease

Debit Credit

Beg Bal. 5,500

(3) 25

(1) 50

(6) 500

Draw (Equity) Account

Owner's Draw

Increase Decrease

Debit Credit

Beg Bal. 600

(6) 500

Return To Transaction Listing

Entry 7

7. ABC pays the office supply company $100 with a check for the office supplies that they charged
(promised to pay).

Source Document:Check

Type Of Transaction:Pay Supplier Charge Purchases

Accounts Affected:Cash Accounts Payable

Debits and Credits:

Decrease (Left Side) Accounts Payable: Debit

Decrease (Right Side) Cash: Credit

Explanation Using Our Debit/Credit Rules: The asset cash is decreased. We record a decrease by
entering the amount in the opposite side of the normal balance side of an account. The normal balance
side of cash, which is an asset, is the left (debit) side so we decrease cash by entering the amount in the
opposite side which is the right (credit) side of the account as a credit. The liability account accounts
payable is also decreased. We record a decrease by entering the amount in the opposite side of the
normal balance side of an account. The normal balance side of accounts payable, which is a liability, is
the right (credit) side so we decrease accounts payable by entering the amount in the opposite side
which is the left (debit) side of the account as a debit.

Asset Account

Cash
Increase Decrease

Debit Credit

Beg Bal. 5,500

(3) 25

(1) 50

(6) 500

(7) 100

Liability Account

Accounts Payable

Decrease Increase

Debit Credit

(7) 100

Beg Bal. 2,000

(2) 100
Return To Transaction Listing

Entry 8

8. ABC receives a check from the customer who they billed (invoiced) $75 for services and allowed 10
days to pay.

Source Document:Customer Check

Type Of Transaction:Receive Customer Charge Payments

Accounts Affected:Cash Accounts Receivable

Debits and Credits:

Increase (Left Side) Cash: Debit

Decrease (Right Side) Accounts Receivable: Credit

Explanation Using Our Debit/Credit Rules:The asset cash is increased. An increase is recorded by
entering the amount in the normal balance side of an account. The normal balance side of cash, which is
an asset, is the left (debit) side of the account so we increase cash by entering the amount in the left
side as a debit. Another asset account, accounts receivable decreased. We record a decrease by entering
the amount in the opposite side of the normal balance side of an account. The normal balance side of
accounts receivable, which is an asset, is the left (debit) side so we decrease accounts receivable by
entering the amount in the opposite side which is the right (credit) side of the account as a credit. We
actually "swapped" one asset accounts receivable for another asset cash.

Asset Account

Cash

Increase Decrease

Debit Credit

Beg Bal. 5,500

(3) 25

(1) 50

(6) 500

(8) 75

(7) 100

Asset Account

Accounts Receivable

Increase Decrease

Debit Credit

Beg Bal. 1,600

(8) 75

(5) 75

Return To Transaction Listing

Entry 9
9. ABC purchased some mulch for $60 and received an invoice from their supplier who allows them 15
days to pay. The mulch was used on a customer's yard.

Source Document:Supplier's Invoice

Type Of Transaction: Purchase on Account

Accounts Affected:Mulch Expense Accounts Payable

Debits and Credits:

Increase (Left Side) Mulch Expense (Decrease Equity): Debit

Increase (Right Side) Accounts Payable: Credit

Explanation Using Our Debit/Credit Rules:The expense mulch expense is increased. An increase is
recorded by entering the amount in the normal balance side of an account. The normal balance side of
mulch expense, which is an expense account, is the left (debit) side so we increase mulch expense by
entering the amount in the left side as a debit. The amount owed to a supplier increased. The liability
accounts payable is increased. An increase is recorded by entering the amount in the normal balance
side of an account. The normal balance side of accounts payable, which is a liability, is the right (credit)
side of the account so we increase accounts payable by entering the amount in the right side as a credit.

Liability Account

Accounts Payable

Decrease Increase

Debit Credit

(7) 100

Beg Bal. 2,000

(2) 100
(9) 60

Expense (Equity) Account

Mulch Expense

Increase Decrease

Debit Credit

Beg Bal. 100

(9) 60

Return To Transaction Listing

Entry 10

10. ABC bills (prepares an invoice) the customer $80 for the mulch and mowing his yard and receives a
check for $80 from the customer.

Source Document:Sales Invoice and Customer Check

Type Of Transaction:Cash Sale

Accounts Affected:Cash Mowing Revenue (Sales)

Debits and Credits:

Increase (Left Side) Cash: Debit

Increase (Right Side) Mowing Revenue (Equity): Credit

Explanation Using Our Debit/Credit Rules: The asset cash is increased. An increase is recorded by
entering the amount in the normal balance side of an account. The normal balance side of cash, which is
an asset, is the left (debit) side of the account so we increase cash by entering the amount in the left
side as a debit. Mowing Revenue (Equity) is also increased. Again, an increase is recorded by entering
the amount in the normal balance side of an account. The normal balance side of a revenue account is
the right (credit) side of the account so we increase mowing revenue (sales) by entering the amount in
the right side as a credit.

Asset Account

Cash

Increase Decrease

Debit Credit

Beg Bal. 5,500

(3) 25

(1) 50
(6) 500

(8) 75

(7) 100

(10) 80

Revenue (Equity) Account

Mowing Revenue

Decrease Increase

Debit Credit

Beg Bal. 1,000

(1) 50

(5) 75

(10) 80
Return To Transaction Listing

ABC's Calculated Ending Account Balances After Posting

Me, being the nice guy that I am, calculated the ending account balances for you.

Assets Liabilities Equity

Cash $5,080 Dr

Accounts Receivable $1,600 Dr

Mowing Equipment $12,500 Dr

Inventory-Office Supplies $100 Dr

Accounts Payable $2,060 Cr

Note Payable-Bank $10,000 Cr

Owner's Capital $7,500 Cr

Mowing Revenue $1,205 Cr

Advertising Expense $225 Dr

Mulch Expense $160 Dr

Owner Draws $1,100 Dr

Let's perform our checks on our ending balances after posting.

The first check is to see if our Accounting Equation balances and the second to make sure that the debit
balances equal the credit balances.
Equation Check Calculations

Total Assets = Cash + Accounts Receivable + Mowing Equipment +Office Supplies

Total Assets = 5,080 + 1,600 + 12,500 + 100

Total Assets = 19,280

Total Liabilities = Accounts Payable + Notes Payable

Total Liabilities = 2,060 + 10,000

Total Liabilities = 12,060

Total Equity = Owner's Capital + Revenues - Expenses - Draws

Since we have more than one expense let's summarize them before we use them in our equation.

Total Expenses = Mulch Expense + Advertising

Total Expenses = 160 + 225

Total Expenses = 385

Total Equity = Owner's Capital + Revenues - Expenses - Draws

Total Equity = 7,500 + 1205 - 385- 1100

Total Equity = 7,220

Substituting our totals into the Accounting Equation we find that our equation balances.

Assets = Liabilities + Owner's Equity

19,280 12,060 7,220

Our second check is to see if our debit account balances equal our credit account balances.
Let's Total Our Debit Balances

Cash 5,080

Accounts Receivable 1,600

Mowing Equipment 12,500

Inventory-Office Supplies 100

Advertising Expense 225

Mulch Expense 160

Owner's Draw 1100

Total Debits 20,765

Now we'll total our Credit Balances

Accounts Payable 2,060

Note Payable-Bank 10,000

Owner's Capital 7,500

Mowing Revenue 1,205

Total Credits 20,765

Looks like everything is still in balance after we posted our transactions.

Assets = Liabilities + Owner's Equity

and our Debit Balance Accounts = our Credit Balance Accounts.

Oh no, more debit and credit testing ! Yeah, you're back under the grilling lights once again. At
least it's not a padded cell.
Look at the good side. At least by now you should be very familiar with our mowing guy's transactions.

Debit/Credit Skills Test III

Note:Skill Tests use JavaScript which is enabled on most computers.

That wasn't too bad was it ? Get a grip on yourself. We still have three more lessons to
complete. Let's tackle the next lesson that covers the General Ledger and Journals.

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Introduction Lesson 1 Lesson 2 Lesson 3 Lesson 4 Lesson 5 Lesson

6 Lesson 7

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