REVIEW OF ACCOUNTING FUNDAMENTALS

THE ACCOUNTING EQUATION

Assets = Liabilities + Equity

Equity = Contributed Capital + Retained Earnings

Retained Earnings = Beginning Retained Earnings + Net Income for the Period – Dividends

Net Income = Revenues – Expenses + Gains – Losses

Assets Probable future economic benefits obtained or controlled by a particular accounting entity as a result of past transactions or events

Liabilities Probably future sacrifices of economic benefits arising from present obligations of a particular accounting entity to transfer assets or provide services to other entities in the future as a result of past transactions or events.

Equity Residual interest in the assets of an entity that remains after deducting its liabilities.

ACCOUNTS

A company may have many assets and liabilities, and many revenues, expenses, gains and losses. The effects of transactions that cause changes in the various financial statement elements are summarized in “accounts”.

An “account” in T-account form, is:

Account Number and Title

Debit side Credit side

A dollar amount is debited to an account when it is entered on the left side and credited to an account when it is entered on the right side.

Debits Indicate Credits IndicateAsset increases Asset decreasesLiability decreases Liability increasesEquity decreases Equity increasesExpenses RevenuesLosses GainsRevenue reductions Expense reductionsGain reductions Loss reductions

RELATIONSHIP BETWEEN THE FINANCIAL STATEMENT ELEMENTS AND THE PRINCIPLE OF DEBIT AND CREDIT

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Assets = Liabilities + Equity Revenues/Gains – Expenses/Losses

Assets Liabilities Equity Revenues ExpensesIncreases Decrease

sDecrease

sIncreases Decrease

sIncreases Decrease

sIncreases Increases Decrease

sDebit Credit Debit Credit Debit Credit Debit Credit Debit Credit

Contributed Capital

Gains Losses

Decreases

Increases Decreases

Increases Increases Decreases

Debit Credit Debit Credit Debit Credit

Retained Earnings

Decreases

Increases

Debit Credit

Note:

Each transaction has a dual effect on the accounting equations Dollar amounts of the transactions are entered into the appropriate accounts as

increases and decreases in accordance with the rules of debit and credit For every debit made to an account, a corresponding credit is made to another

account double-entry system A = L + E is maintained after each transaction

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Example:

Economic Event

Analysis of Event Accounting Entry Assets = Liabilities + Equity

Cash EquityA dentist invested $10,000 in a dental practice.

Assets (cash) increased by $10,000. Equity increased by $10,000.

Debit 10,000

Credit

Debit

Credit 10,000

+10,000 +10,000

SuppliesAccounts Payable

The dental practice purchased supplies on account at a cost of $800.

Assets (supplies) increased by $800. Liabilities (accounts payable) increased by $800.

Debit800

Credit

Debit

Credit800

+800 +800

Accounts Receivable Revenues

Dental services were performed for patients on account, $1000.

Assets (accounts receivable) increased by $1,000. Equity (revenue) increased by $1,000.

Debit1,000

Credit

Debit

Credit1,000

+1,000 +1,000

Supplies Expense Supplies

Supplies costing $300 were used.

Assets (supplies) decreased by $300. Equity (expenses increased) decreased by $300

Debit300

Credit

Debit

Credit300

-300 -300

Accounts Payable Cash

The practice paid $600 on accounts payable

Assets (cash) decreased by $600. Liabilities (accounts payable) decreased by $600

Debit600

Credit

Debit

Credit600

-600 -600

Totals 10,900 200 10,700

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ASSIGNMENT DUE AT THE BEGINNING OF SESSION 3

Assume that it is the end of May 2011. The transactions listed below took place during the month, the first month in business.

1. May 1, corporate charter was received authorizing the issuance of 100,000 shares of $5 par common stock. Issued 16,250 shares at $8 per share for cash.

2. May 1, borrowed $30,000 from City Bank by issuing a $30,000 note due in two years. Interest at 10% is payable annually.

3. May 1, purchased the assets of Zenith Hardware Corporation for $75,000 in cash. The assets consisted of inventory of $60,000, supplies of $4,000, and fixtures and equipment of $11,000.

4. May 2, paid rent on a building for 12 months in advance, $7,200.5. May 3, purchased display equipment for $10,000 from Northern Supply Company.

Paid $2,000 cash, the balance to be paid in 60 days.6. May 4, purchased merchandise on account from Quick Wholesale for a cost of

$45,000.7. May 4, paid $1,800 cash for office supplies.8. May 5, sold miscellaneous hardware (i.e., merchandise) items totaling $25,000 to

Ace Builders on account.9. May 9, purchased merchandise costing $30,000 from Nails, Inc. on account. The

transportation cost on the merchandise totaled $250 and was paid in cash.10. May 11, received $12,000 of the amount due from Ace Builders.11. May 12, paid sales salaries totaling $3,000.12. May 20, cash sales of items, $15,000.13. May 20, subleased the top floor of the building rented on May 2 for $300 per

month. Cash was received.14. May 22, received $5,000 from sale of gift certificates. 15. May 24, purchased temporary investments for cash at a cost of $3,600.16. May 25, returned defective merchandise costing $1,200 to Nails, Inc.17. May 26, sold miscellaneous hardware totaling $24,000 to Rite-Way Construction.

Rite-Way paid $6,000 cash and the balance was on account.18. May 28, paid the amount due to Quick Wholesale. Received a 2% discount for

prompt payment.19. May 29, purchased merchandise on account from Handy Dandy Supply at a cost

of $6,000.20. May 30, cash sales of hardware, $18,000.21. May 30, depreciation for the month on fixtures and furniture is $350.22. May 30, management estimates uncollectible accounts to be .5% of total credit

sales.23. May 30, ending inventory, based on a physical count of merchandise on hand and

priced at cost, $72,000.24. May 30, salaries of $2,500 since the last pay period haven’t been paid.25. May 30, office supplies of $1,300 were used during the month.26. May 30, earned revenue on rent needs to be adjusted.27. May 30, sales from redemption of gift certificates totaled $3,500.28. May 30, interest on the loan from the bank needs to be accrued.29. May 30, the tax rate for the month was estimated to be 40%.

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Prepare journal entries for the above transactions using the following format – the first entry is shown. It is probably easier to use Excel.

Date Ref Accounts Debit Credit Assets Liabilities EquityMay 1 1 Cash 130,000 130,000

Common stock 81,250 81,250

Paid-in surplus 48,750 48,750

Next, construct an income statement and balance sheet for the month using Excel.

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