Recording Business Transactions

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.

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

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
  • 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
  • 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
  • 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
  • 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).

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

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.

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

Let's total our Debit Balances

Now we'll total our Credit Balances

It looks like we passed muster again.

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

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.

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.

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.

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.

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.

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.

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.

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.

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.

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.

ABC's Calculated Ending Account Balances After Posting

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

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.

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

Let's Total Our Debit Balances

Now we'll total our Credit Balances