Solve It
Chapter 2
Getting Down to Bookkeeping Basics
In This Chapter
Keeping business records
Navigating the accounting cycle
Choosing between cash-basis and accrual accounting
Deciphering double-entry bookkeeping
All businesses need to keep track of their financial transactions; that’s why bookkeeping and bookkeepers are so important. Without accurate records, how can you tell whether your business is making a profit or taking a loss?
In this chapter, I cover the key parts of bookkeeping by introducing you to the language of bookkeeping, familiarizing you with how bookkeepers manage the accounting cycle, and showing you how to understand the most difficult type of bookkeeping — double-entry bookkeeping.
Bookkeepers: The Record Keepers of the Business World
Bookkeeping, the methodical way in which businesses track their financial transactions, is rooted in accounting. Accounting is the total structure of records and procedures used to record, classify, and report information about a business’s financial transactions. Bookkeeping involves the recording of that financial information into the accounting system while adhering to solid accounting principles.
Bookkeepers are the ones who toil day in and day out to ensure that transactions are accurately recorded. Bookkeepers need to be very detail oriented and love to work with numbers, because numbers and the accounts they go into are just about all these people see all day. Bookkeepers aren’t required to be certified public accountants (CPAs).
Many small businesspeople who are just starting up their businesses initially serve as their own bookkeepers until the business is large enough to hire someone dedicated to keeping the books. Few small businesses have accountants on staff to check the books and prepare official financial reports; instead, they have bookkeepers on staff who serve as the outside accountants’ eyes and ears. Most businesses do seek an accountant with a CPA certification.
In many small businesses today, a bookkeeper enters the business transactions on a daily basis while working inside the company. At the end of each month or quarter, the bookkeeper sends summary reports to the accountant, who then checks the transactions for accuracy and prepares financial statements.
In most cases, the accounting system is initially set up with the help of an accountant to be sure it uses solid accounting principles. That accountant periodically stops by the office and reviews the system’s use to be sure transactions are being handled properly.
Accurate financial reports are the only way you can know how your business is doing. These reports are developed by using the information you, as the bookkeeper, enter into your accounting system. If that information isn’t accurate, your financial reports are meaningless. As the old adage goes, “Garbage in, garbage out.”
Basic Bookkeeping Lingo
Before you can take on bookkeeping and start keeping the books, the first things you must get a handle on are key accounting terms. What follows is a list of terms that all bookkeepers use on a daily basis.
Note: This section isn’t an exhaustive list of all the unique terms you need to know as a bookkeeper. For full coverage of bookkeeping terminology, turn to the glossary in Appendix A.
Accounts for the balance sheet
Here are a few terms you want to know about the balance sheet:
Balance sheet: The financial statement that presents a snapshot of the company’s financial position (assets, liabilities, and equity) as of a particular date in time. It’s called a balance sheet because the things owned by the company (assets) must equal the claims against those assets (liabilities and equity).
On an ideal balance sheet, the total assets should equal the total liabilities plus the total equity. If your numbers fit this formula, the company’s books are in balance. (I discuss the balance sheet in greater detail in Chapter 18.)
Assets: All the things a company owns, such as cash, buildings, land, tools, equipment, vehicles, and furniture, in order to successfully run its business.
Liabilities: All the debts the company owes, such as bonds, loans, and unpaid bills.
Equity: All the money invested in the company by its owners. In a small business owned by one person or a group of people, the owner’s equity is shown in a Capital account. In a larger business that’s incorporated, owner’s equity is shown in shares of stock. Another key Equity account is Retained Earnings, which tracks all company profits that have been reinvested in the company rather than paid out to the company’s owners. Small, unincorporated businesses track money paid out to owners in a Drawing account, whereas incorporated businesses dole out money to owners by paying dividends (a portion of the company’s profits paid by share of common stock for the quarter or year).
Accounts for the income statement
These important terms related to the income statement are worth knowing:
Income statement: The financial statement that presents a summary of the company’s financial activity over a certain period of time, such as a month, quarter, or year. The statement starts with Revenue earned, subtracts out the Costs of Goods Sold and the Expenses, and ends with the bottom line — Net Profit or Loss. (I show you how to develop an income statement in Chapter 19.)
Revenue: All money collected in the process of selling the company’s goods and services. Some companies also collect revenue through other means, such as selling assets the business no longer needs or earning interest by offering short-term loans to employees or other businesses. (I discuss how to track revenue in Chapter 9.)
Costs of goods sold: All money spent to purchase or make the products or services a company plans to sell to its customers. (I talk about purchasing goods for sale to customers in Chapter 8.)
Expenses: All money spent to operate the company that’s not directly related to the sale of individual goods or services. (I review common types of expenses in Chapter 3.)
Other common bookkeeping terms
Some other common terms include the following:
Accounting period: The time for which financial information is being tracked. Most businesses track their financial results on a monthly basis, so each accounting period equals one month. These businesses usually also create quarterly reports and annual reports (a year-end summary of the company’s activities and financial results) based on the information they gather. Some businesses choose to do financial reports on a quarterly basis, so the accounting periods are three months. Other businesses only look at their results on a yearly basis, so their accounting periods are 12 months.
Accounts Receivable: The account used to track all customer sales that are made by store credit. Store credit refers not to credit card sales but rather to sales in which the store directly gives the customer credit and needs to collect payment from the customer at a later date. (I discuss how to monitor Accounts Receivable in Chapter 9.)
Accounts Payable: The account used to track all outstanding bills from vendors, contractors, consultants, and any other companies or individuals from whom the company buys goods or services. (I talk about managing Accounts Payable in Chapter 8.)
Depreciation: An accounting method used to track the aging and use of assets. For example, if you own a car, you know that each year you use the car, its value is reduced (unless you own one of those classic cars that goes up in value). Every major asset a business owns ages and eventually needs replacement, including buildings, factories, equipment, and other key assets. (I discuss how you monitor this depreciation of assets in Chapter 12.)
General Ledger: Where all the company’s accounts are summarized. The General Ledger provides a good history of your transactions chronologically. (I discuss posting to the General Ledger in Chapter 5.)
Interest: The money a company needs to pay if it borrows money from a bank or other company. For example, when you buy a car by using a car loan, you must pay not only the amount you borrowed but also additional money, or interest, based on a percent of the amount you borrowed. (I discuss how to track interest expenses in a business’s books in Chapter 13.)
Inventory: The account that tracks all products that will be sold to customers. (I review inventory valuation and control in Chapter 8.)
Journals: Where bookkeepers keep records (in chronological order) of daily company transactions. Each of the most active accounts, including Cash, Accounts Payable, and Accounts Receivable, has its own journal. (I discuss entering information into journals in Chapter 4.)
Payroll: The way a company pays its employees. Managing payroll is a key function of the bookkeeper and involves reporting many aspects of payroll to the government, including taxes to be paid on behalf of the employee, unemployment taxes, and worker’s compensation. (I discuss employee payroll in Chapter 10 and the government side of payroll reporting in Chapter 11.)
Trial balance: How you test to be sure the books are in balance before pulling together information for the financial reports and closing the books for the accounting period. (I discuss how to do a trial balance in Chapter 16.)
Practice: Account Basics
Q. Where in the books would you find cars owned by the company?
A. In an asset account that tracks vehicles owned by the company.
Q. On which statement and where in that statement would you find the value of the buildings owned by the company?
A. In the Asset section of the Balance Sheet in an account called Buildings.
1. Where in the books would you find bills due to vendors?
2. Where in the books would you find inventory you have on hand to sell to customers?
Solve It
3. Where in the books would you find money put into the company when the owners first started the business?
Solve It
4. Where in the books would you find the mortgage that you must pay off for the store that your company owns?
Solve It
5. On which statement and where in that statement would you find the value of the mortgages due to be paid to lenders?
Solve It
6. On which statement and where in that statement would you find your business’s total sales for the year?
Solve It
7. On which statement and where in that statement would you find the total amount your business spent to purchase the products it planned to sell?
Solve It
8. On which statement and where in that statement would you find the value of the inventory your company had on hand to sell to its customers?
Solve It
Pedaling through the Accounting Cycle
As a bookkeeper, you complete your work by completing the tasks of the accounting cycle. It’s called a cycle because the workflow is circular: entering transactions, manipulating the transactions through the accounting cycle, closing the books at the end of the accounting period, and then starting the entire cycle again for the next accounting period.
The accounting cycle has eight basic steps:
1. Transactions: Financial transactions start the process. Transactions can include the sale or return of a product, the purchase of supplies for business activities, or any other financial activity that involves the exchange of the company’s assets, the establishment or payoff of a debt, or the deposit from or payout of money to the company’s owners. All sales and expenses are transactions that must be recorded. I cover transactions in greater detail throughout the book as I discuss how to record the basics of business activities — recording sales, purchases, asset acquisition, or sale, taking on new debt, or paying off debt.
2. Journal entries: Each transaction is listed in the appropriate journal, maintaining the journal’s chronological order of transactions. (The journal is also known as the “book of original entry” and is the first place a transaction is listed.) I talk more about journal entries in Chapter 5.
3. Posting: Each transaction is posted to the account that it impacts. These accounts are part of the General Ledger, where you can find a summary of all the business’s accounts. I discuss posting in Chapters 4 and 5.
4. Trial balance: At the end of the accounting period (which may be a month, quarter, or year depending on your business’s practices), you calculate a trial balance.
5. Worksheet: Unfortunately, your first calculation of the trial balance often shows that the books aren’t in balance. If that’s the case, you look for errors and make corrections called adjustments, which are tracked on a worksheet. Adjustments are also made to account for the depreciation of assets and to adjust for one-time payments (such as insurance) that should be allocated on a monthly basis to more accurately match monthly expenses with monthly revenues. After you make and record adjustments, you take another trial balance to be sure the accounts are in balance.
6. Adjusting journal entries: You post any corrections needed to the affected accounts after your trial balance shows that making the needed adjustments will balance the accounts. You don’t need to make adjusting entries until the trial balance process is completed and all needed corrections and adjustments have been identified.
7. Financial statements: You prepare the balance sheet and income statement by using the corrected account balances.
8. Closing: You close the books for the revenue and expense accounts and begin the entire cycle again with zero balances in those accounts.
As a businessperson, you want to be able to gauge your profit or loss on month by month, quarter by quarter, and year by year bases. To do that, Revenue and Expense accounts must start with a zero balance at the beginning of each accounting period. In contrast, you carry over Asset, Liability, and Equity account balances from cycle to cycle because the business doesn’t start each cycle by getting rid of old assets and buying new assets, paying off and then taking on new debt, or paying out all claims to owners and then collecting the money again.
Tackling the Big Decision: Cash-Basis or Accrual Accounting
Before starting to record transactions, you must decide whether to use cash-basis or accrual accounting. The crucial difference between these two processes is in how you record your cash transactions.
Waiting for funds with cash-basis accounting
With cash-basis accounting, you record all transactions in the books when cash actually changes hands, meaning when the company receives cash payment from customers or pays out for purchases or other services. Cash receipt or payment can be in the form of cash, check, credit card, electronic transfer, or other means used to pay for an item.
Cash-basis accounting can’t be used if a store sells products on store credit and bills the customer at a later date, because this accounting method has no provision to record and track money due from customers at some time in the future.
That’s also true for purchases. With the cash-basis accounting method, the owner records the purchase of supplies or goods that will later be sold only when he actually pays cash. If he buys goods on credit to be paid later, he doesn’t record the transaction until the cash is actually paid out.
Depending on the size of your business, you may want to start out with cash-basis accounting. Many small businesses run by a sole proprietor or a small group of partners use cash-basis accounting because it’s easy. But as the business grows, the business owners find it necessary to switch to accrual accounting in order to more accurately track revenues and expenses (see the nearby sidebar for more on that jump). Businesses that should never use cash-basis accounting include businesses that carry an inventory, businesses that incorporated as a C corporation (more on incorporation in Chapter 21), and businesses with gross annual sales that exceed $5 million.
Cash-basis accounting does a good job of tracking cash flow, but it does a poor job of matching revenues earned with money laid out for expenses. This deficiency is a problem particularly when, as it often happens, a company buys products in one month and sells those products in the next month. For example, you pay $1,000 cash for products in June with the intent to sell. You don’t sell the products until July, and that’s when you receive cash for the sales. When you close the books at the end of June, you have to show the $1,000 expense with no revenue to offset it, meaning you have a loss that month. When you sell the products for $1,500 in July, you have a $1,500 profit. So, your monthly report for June shows a $1,000 loss, and your monthly report for July shows a $1,500 profit, when in actuality you had revenues of $500 over the two months.
As I note in the Introduction, I concentrate on the accrual accounting method in this book. If you choose to use cash-basis accounting, don’t panic: You can still find most of the bookkeeping information here useful, but you don’t need to maintain some of the accounts I list, such as Accounts Receivable and Accounts Payable, because you aren’t recording transactions until cash actually changes hands. If you’re using a cash-basis accounting system and sell things on credit, though, you’d better have a way to track what people owe you.
Recording right away with accrual accounting
With accrual accounting, you record all transactions in the books when they occur, even if no cash changes hands. For example, if you sell on store credit, you record the transaction immediately and enter it into an Accounts Receivable account until you receive payment. If you buy goods on credit, you immediately enter the transaction into an Accounts Payable account until you pay out cash.
Like cash-basis accounting, accrual accounting has its drawbacks. It does a good job of matching revenues and expenses, but it does a poor job of tracking cash. Because you record revenue when the transaction occurs and not when you collect the cash, your income statement can look great even if you don’t have cash in the bank. For example, suppose you’re running a contracting company and completing jobs on a daily basis. You can record the revenue upon completion of the job even if you haven’t yet collected the cash. If your customers are slow to pay, you may end up with lots of revenue but little cash. But don’t worry just yet; in Chapter 9, I tell you how to manage Accounts Receivable so that you don’t run out of cash because of slow-paying customers.
Practice: Accrual versus Cash Accounting
Q. You buy products for sale on June 15 on credit with the vendor and get a bill with the purchase. You don’t have to pay that bill until July 1. How do you record this transaction in your books if you’re using cash-basis accounting, and how do you record it by using accrual accounting?
A. For cash-basis accounting, you don’t record anything in the books until you pay for the products with cash on July 1. For accrual accounting, you’d record the purchase on June 15 in Accounts Payable, as well as in the account where you record purchases.
Q. You’re keeping the books for a carpenter who contracted to do a job on December 15 for $15,000 and received 50 percent, or $7,500, upfront. He spent $5,000 in cash on materials December 16 and paid his workers $5,000 in cash on December 31 when the work was completed. The contractor didn’t meet with the customer for final approval of the work and final payment until January 3. How and when do you record these transactions with the cash-basis accounting method, and how and when do you record them with the accrual accounting method?
A. If you’re keeping the books by using the cash-basis accrual method, you record the $7,500 cash received on December 15. You record the $5,000 cash spent on materials on December 16, and you record the payment to workers of $5,000 cash on December 31. When you close your books for the year on December 31, this job shows revenues of $7,500 and expenses of $10,000, or a loss of $2,500. You then record the $7,500 cash received on January 3 and have no corresponding expenses, so at the end of that year, you’d have an additional $7,500 in profits for work performed for the previous year with the expenses for the work recorded in the previous year.
If you’re using the accrual method, you record the receipt of $7,500 revenue on December 15; you record the $5,000 cash spent on materials on December 16. You record the payment to your workers of $5,000 in revenue on December 31. You also record the final payment of $7,500 due in an account called Accounts Receivables, which tracks customer payments due, at the same time. When you close your books at the end of the year, you’d show a $5,000 profit on this job.
9. You buy products you plan to sell, paying cash on delivery on June 15. How and when do you record this transaction in your books if you’re using cash-basis accounting, and how and when do you record it with accrual accounting?
Solve It
10. You contract with a painter to paint your storefront on May 9, and he completes the work on June 1 and gives you a bill for the work. You pay for the work with cash on June 5. How and when do you record this transaction in your books with cash-basis accounting, and how and when do you record it with accrual accounting?
Solve It
11. You order office supplies on credit on June 12 and receive them on June 20. You’re billed for them on July 1 but don’t pay for them with cash until July 15. How and when do you first record this transaction in your books if you’re using cash-basis accounting, and how and when do you record it with accrual accounting?
Solve It
12. You sell your products to a customer on store credit on February 10 and send a bill to the customer on March 1. You receive payment in cash from the customer on March 15. How and when do you first record this transaction in your books if you’re using cash-basis accounting, and how do you record it with accrual accounting?
Solve It
13. You purchase $1,500 in products with cash on December 12 that you intend to sell to your customers, and the products completely sell out by December 25. Your total revenue for them was $2,500, but only $1,500 of that revenue is in cash; you sell the other $1,000 in products by using store credit. The customers won’t be billed for that credit until January 2, and you won’t receive payment until mid-January. How do you record these transactions with the cash-basis accounting method, and how do you record them with the accrual accounting method? How do your revenues and expenses differ between these methods when you close the books on December 31?
Solve It
14. You purchase $1,500 in products on credit on December 15 that you intend to sell to your customers. You won’t be billed for these products until December 31 and won’t have to pay for them with cash until January 10. These products completely sell out by December 25, and your total revenue for them is $2,500 in cash. How do you record these transactions with the cash-basis accounting method, and how do you record them with the accrual accounting method? How do your revenues and expenses differ between these methods when you close the books on December 31?
Solve It
Seeing Double with Double-Entry Bookkeeping
All businesses, whether they use the cash-basis accounting method or the accrual accounting method (see the section “Tackling the Big Decision: Cash-Basis or Accrual Accounting” for details), use double-entry bookkeeping to keep their books. A practice that helps minimize errors and increase the chance that your books balance, double-entry bookkeeping gets its name because you enter all transactions twice.
In double-entry bookkeeping, the key formula for the balance sheet (Assets = Liabilities + Equity) plays a major role.
In order to adjust the balance of accounts in the bookkeeping world, you use a combination of debits and credits. You may think of a debit as a subtraction because you’ve found that debits usually mean a decrease in your bank balance. On the other hand, you’ve probably been excited to find unexpected credits in your bank or credit card statements that mean more money has been added to the account in your favor. Great; you’ve got a head start, right? Nope. Forget all that you ever learned about debits or credits. In the world of bookkeeping, their meanings aren’t so simple. (Don’t worry, though; I give you a handy guide to making the distinction in the later section “Differentiating Debits and Credits.”)
The only definite thing when it comes to debits and credits in the bookkeeping world is that a debit is on the left side of a transaction and a credit is on the right side of a transaction. Everything beyond that can get very muddled. I show you the basics of debits and credits in this chapter, but don’t worry if you’re finding this concept very difficult to grasp. I offer plenty of practice at using these concepts throughout this book.
Before I get into all the technical mumbo jumbo of double-entry bookkeeping, here’s an example of the practice in action. Suppose you purchase a new $1,500 desk for your office. This transaction actually has two parts: You spend an asset — cash — to buy another asset — furniture. So, you must adjust two accounts in your company’s books: the Cash account and the Furniture account. (At the bottom of any journal entry, you should also include a brief explanation that explains the purpose for the entry, such as “To purchase a new desk for the office.”) Here’s what the transaction looks like in a bookkeeping entry (I talk more about how to do initial bookkeeping entries in Chapter 4):
|
Account |
Debit |
Credit |
|
Furniture |
$1,500 |
|
|
Cash |
$1,500 |
|
|
To purchase a new desk for the office. |
||
In this transaction, you record the accounts impacted by the transaction. The debit increases the value of the Furniture account, and the credit decreases the value of the Cash account. For this transaction, both accounts impacted are asset accounts, so you can see from the effect on the balance sheet that the only changes are to the asset side of the balance sheet equation:
Assets = Liabilities + Equity
Furniture increase = No change to this side of the equation
Cash decrease
In this case, the books stay in balance because the exact dollar amount that increases the value of your Furniture account decreases the value of your Cash account.
To show you how you record a transaction that impacts both sides of the balance sheet equation, here’s an example that records the purchase of inventory. Suppose that you purchase $5,000 worth of widgets on credit. (Haven’t you always wondered what widgets were? Can’t help you. They’re just commonly used in accounting examples to represent something that’s purchased.) These new widgets add value to both your Inventory Asset account and your Accounts Payable account. (Remember, the Accounts Payable account is a Liability account where you track bills that need to be paid at some point in the future.) Here’s how the bookkeeping transaction for your widget purchase looks:
|
Account |
Debit |
Credit |
|
Inventory |
$5,000 |
|
|
Accounts Payable |
$5,000 |
|
|
To purchase widgets for sale to customers. |
||
Here’s how this transaction affects the balance sheet equation:
Assets = Liabilities + Equity
Inventory increases = Accounts Payable increases + No change
In this case, the books stay in balance because both sides of the equation increase by $5,000.
You can see from the two example transactions how double-entry bookkeeping helps to keep your books in balance — as long as you make sure each entry into the books is balanced. Balancing your entries may look simple here, but sometimes bookkeeping entries can get very complex when more than two accounts are impacted by the transaction.
Don’t worry, you don’t have to understand it totally now. I show you how to enter transactions (depending upon the type of transaction that is being recorded) throughout the book. I’m just giving you a quick overview to introduce the subject right now.
Differentiating Debits and Credits
Because bookkeeping’s debits and credits are different from the ones you’re used to encountering, you’re probably wondering how you’re supposed to know whether a debit or credit will increase or decrease an account. Believe it or not, identifying the difference becomes second nature as you start making regular entries in your bookkeeping system. But to make things easier for you, Table 2-1 is a chart that all bookkeepers and accountants commonly use. Yep, everyone needs help sometimes.
Table 2-1 How Credits and Debits Impact Your Accounts
|
Account Type |
Debits |
Credits |
|
Assets |
Increase |
Decrease |
|
Liabilities |
Decrease |
Increase |
|
Income |
Decrease |
Increase |
|
Expenses |
Increase |
Decrease |
Copy Table 2-1 and post it at your desk when you start keeping your own books. I guarantee it will help you keep your debits and credits straight.
Practice: Double-Entry Accounting
Q. How do you develop a journal entry to enter the purchase of furniture for cash totaling $1,000?
A. Here is what the transaction looks like:
|
Account |
Debit |
Credit |
|
Furniture |
$1,000 |
|
|
Cash |
$1,000 |
So how does this impact the accounting equation? Both accounts are asset accounts, so a debit to the Furniture account increases the ending balance of that account. The credit to the Cash account decreases the total balance of the Cash account. So the total value of the assets doesn’t change and keeps the asset side of the equation equal to the liabilities and equity side.
Q. How do you develop a journal entry to enter the financial transaction from the preceding example in your books?
A. Here is what the transaction looks like:
|
Account |
Debit |
Credit |
|
Furniture |
$1,000 |
|
|
Cash |
$1,000 |
As mentioned in the preceding example, the debit to the Furniture account increases the ending balance of that account. The credit to the Cash account decreases the total balance of the Cash account. So the total value of the assets doesn’t change and keeps the assets equal to the liabilities and equity.
15. You buy new products on credit for $3,000 to be sold in your store. How do you enter this transaction in your books?
Solve It
Account Debit Credit
16. You sell $5,000 worth of goods and receive $5,000 in cash. How do you enter this transaction in your books?
Solve It
Account Debit Credit
17. You sell $3,000 worth of goods on store credit (meaning you didn’t get cash — customers will pay you after you bill them). How do you record the sales transaction?
Solve It
Account Debit Credit
18. You buy office supplies for $500 by using a check. How do you record the transaction?
Solve It
Account Debit Credit
19. Copy the journal entry you developed in Problem 15 and then indicate whether the transaction action increases or decreases the accounts involved.
Solve It
Account Debit Credit
20. Copy the journal entry you developed in Problem 16 and then indicate whether the transaction action increases or decreases the accounts involved.
Solve It
Account Debit Credit
21. Copy the journal entry you developed in Problem 17 and then indicate whether the transaction action increases or decreases the accounts involved.
Solve It
Account Debit Credit
22. Copy the journal entry you developed in Problem 18 and then indicate whether the transaction action increases or decreases the accounts involved.
Solve It
Account Debit Credit
Answers to Problems on the Basics
The following are the answers to the practice questions presented throughout this chapter.
1 In a liability account called Accounts Payable where you track bills.
2 In an asset account called Inventory.
3 In an equity account called Capital.
4 In a liability account called Mortgages Payable.
5 In the liability section of the Balance Sheet in a line item called Mortgages Payable.
6 In the revenues section of the Income Statement in a line item called Sales.
7 In the cost of goods sold section of the Income Statement in a line item called Purchases.
8 In the assets section of the Balance Sheet in a line item called Inventory.
9 You record the transaction the same way whether you’re using cash-basis or accrual accounting. Cash was paid on June 15, so you note the transaction as a cash transaction in cash-basis accounting. The transaction was completed on June 15, so you record it in accrual accounting as well.
10 You don’t record the transaction until June 5 when you pay the painter in cash if you’re using cash-basis accounting. In accrual accounting, you record the money due the painter on June 1 (when the work is completed) in the Accounts Payable account.
11 You record the payment on July 15 when you pay with cash if you’re using cash-basis accounting. If you’re using accrual accounting, you record the bill on July 1 in the Accounts Payable account.
12 You record the transaction on March 15 if you’re using cash-basis accounting. If you’re using accrual accounting, you record the transaction on February 10 (when you first make the sale) in the Accounts Receivables account, where you track sales to customers who buy on store credit.
13 If you’re keeping the books by using cash-basis accounting, you record the $1,500 purchase of the products on December 12. You record the cash sales of $1,500 as they were received. You don’t record the sales to customers on store credit until you receive the money in mid-January. You show $0 profit on these product sales on December 31.
If you’re keeping the books by using the accrual accounting method, you record the $1,500 purchase of the products on December 15. You record the sales on the days they were made, but you’ll have recorded the total revenue of $2,500 by December 25. You note the cash sales in the Cash account and store credit sales in the Accounts Receivable account. You show a profit on these product sales of $1,000 on December 31. To compare, the accrual method of accounting shows a $1,000 profit when you close the books on December 31, while the cash-method shows a $0 profit.
14 If you’re keeping the books by using cash-basis accounting, you record the cash sales as they’re made, but you total $2,500 by December 25. You don’t record the cash payment of $1,500 for the products bought until you pay that bill with cash on January 10. Your revenues for these sales totals $2,500, and you don’t show any costs on December 31.
If you’re keeping the books by using the accrual accounting method, you record the sales as they’re made but total $2,500 by December 25. You record the bill to cover the costs of the goods on December 31 in Accounts Payable. Your revenues for these sales total $2,500, and the costs of goods sold total $1,500 on December 31. To compare, the cash-basis method shows revenues of $2,500 and no costs when you close the books December 31, while the accrual method shows revenues of $2,500 and costs of $1,500.
15 In this transaction, you debit the Purchases account to show the additional purchases made during that period and credit the Accounts Payable account. Because you’re buying the goods on credit, you will have to pay the bill at some point in the future.
|
Account |
Debit |
Credit |
|
Purchases |
$3,000 |
|
|
Accounts Payable |
$3,000 |
16 As you think about the journal entry, you may not know whether something is a credit or a debit. A debit to the Cash account increases the balance in that account. In this question, you know that the Cash account needs to be a debit because you did receive cash. So your only choice is to make the Sales account the account to be credited. Check out Table 2-1 to become familiar with which accounts are increased by a credit or a debit and which accounts are decreased by a debit or a credit.
|
Account |
Debit |
Credit |
|
Cash |
$5,000 |
|
|
Sales |
$5,000 |
17 In this question, the customers were allowed to pay on credit instead of paying in cash, so you need to debit the asset account Accounts Receivable. You credit the Sales account to track the additional revenue.
|
Account |
Debit |
Credit |
|
Accounts Receivable |
$3,000 |
|
|
Sales |
$3,000 |
18 In this question, you’re paying with a check, so you record the payment in your Cash account. The Cash account tracks the amount in your bank account. Any cash, checks, debit cards, or other types of transactions that will be taken directly from your bank account are always entered as a credit. All money paid out for expenses is always a debit.
|
Account |
Debit |
Credit |
|
Office Supplies |
$500 |
|
|
Cash |
$500 |
19 In this transaction, the debit increases the balance of the Purchases account to show the additional money spent, and the credit increases the balance of the Accounts Payable account to show the additional bill that must be paid at some point in the future.
|
Account |
Debit |
Credit |
|
Purchases |
$3,000 |
|
|
Accounts Payable |
$3,000 |
20 The Cash account balance increases to show the newly received cash, and the Sales account increases to show the new sales.
|
Account |
Debit |
Credit |
|
Cash |
$5,000 |
|
|
Sales |
$5,000 |
21 The Accounts Receivable account balance increases to show the new customer purchases that will be paid at some point in the future. The Sales account increases to show the new sales.
|
Account |
Debit |
Credit |
|
Accounts Receivable |
$3,000 |
|
|
Sales |
$3,000 |
22 The Office Supplies account balance increases to show the additional expenses. The Cash account decreases to track the use of cash.
|
Account |
Debit |
Credit |
|
Office Supplies |
$500 |
|
|
Cash |
$500 |