1、Lesson Two:The Balance Sheet and Double-entry.Aims:1.To construct a balance sheet in a format used by business.2.To identify the essential features of a record bookkeeping system.3.To apply the double entry rule to simple transactions of a sole trader.4.To understand the aim of the trial balance in
2、the bookkeeping system.5.To examine the inter-relationship between the daily business records and the final accounts.2.1Introduction All organizations must prepare financial statements periodically,usually at least once a year.These normally comprise three main financial statements:(1)The Balance Sh
3、eet;(2)The Income Statement;(3)The Statement of Cash Flow.2.2The Effect of Transactions on the Balance Sheet John starts a business,selling denim clothes,trading as“John Clothing Co.”.On January 1st John opens a business bank account with$60 000 of his own money.John Clothing Co.Balance Sheet As at
4、January 1stAssetsCash&Bank$60 00060 000EquityJohns Capital60 000$60 0002.3The Two Sections of a Balance Sheet A Balance Sheet is divided into two sections.The totals of each section of the Balance Sheet are always equal in value.This is known as the accounting equation.Every transaction of the busin
5、ess will affect TWO items on the Balance Sheet.In this example the two items are:(1)Asset:cash at bank;(2)Equity:Johns capital.2.4Business Entity For accounting purposes,the owner and the business are treated as two separate.On January 2nd,John buys a second hand delivery van for$16 000 paying with
6、a business cheque.AssetsCash&Bank$44 000Motor Vehicles16 00060 000EquityJohns Capital60 000$60 0002.5Buy Jeans Not Yet to Pay On January 5th the business buys denim jeans from the manufacturer to sell to customers.The jeans cost$12 000.John Clothing Co.will pay the supplier next month.AssetsCash&Ban
7、k$44 000Stock12 000Motor Vehicles16 00072 000Account Payable12 000EquityJohns Capital60 00072 000 2.6The Ordering and Classification of Assets and Liabilities.In the above example,the assets were listed in a random order.This is clearly an unsatisfactory method of communication;therefore the items o
8、n the Balance Sheet are ordered and classified.2.7The Classification of Assets Assets are listed on the Balance Sheet in terms of liquidity,which means the most temporary assets(cash)listed first.1 The assets on the Balance Sheet are classified into two categories:(1)Current Assets are acquired by a
9、 business to be converted into other assets or consumed,in the normal course of business,within one year.(2)Fixed Assets are long life assets normally acquired by a business to be used over more than one year in the production of goods and services.2.8The Classification of Liabilities The creditors
10、on the Balance Sheet are classified into two categories:(1)Creditors:amounts falling due within one year.These are sometimes called Current Liabilities.(2)Creditors:amounts falling due after more than one year.These are sometimes called Long Term Liabilities.2.9Working Capital Net Current Assets(Wor
11、king Capital)is the difference between current assets and current liabilities.2.10Janes Business On the business balance sheet,the assets owned by the business less the liabilities(creditors)owed by the business equal the capital,the owners stake in the business.2.11Recording Business Transactions T
12、he Balance Sheet and other final accounts of a business are drawn up at the end of the accounting period.All organizations will,however,need to record their transactions on a regular basis during the accounting period.For each transaction it will be necessary to record the following:(1)the amount($)
13、;(2)the date;(3)a description of the transaction.2.12Basic Rules for Recording Business Transactions The rules for recording business transactions are that every transaction will at least affect two items.2.13An Example of Dual Aspect Concept A motor vehicle is bought for cash of$16 000.The two item
14、s affected are:(1)Motor Vehicle(+$16 000);(2)Cash(-$16 000).Each item must have its own record i.e.“account”in the books(ledgers)of the business.2.14Double Entry Rule ASSETS e.g.and EXPENSES e.g.DebitCreditINCREASES(+)DECREASES(-)EQUITY,CREDITORS,INCOME and PROVISIONSDebitCredit DECREASES(-)INCREASE
15、S(+)2.15T-accountAccount TitleDecreases&IncreasesIncreases&Decreases The left side of the T-account is called Debit,and the right side is called Credit.2.16Two Important Rules about Double-entry Recording System(1)Debits increase assets and decrease liabilities and equity;(2)Credits increase liabili
16、ties and equity and decrease assets.2.17Application of the Double Entry Rule 1.Identify the two items involved in the transaction(e.g.Cash and Capital).2.Ensure there is an account for each item(e.g.Cash A/c).3.Taking each item independently:4.Repeat the process in 3 with the other item involved in
17、the transaction.5.Check that one account has been debited and the other has been credited.2.18An Example of the Double Entry Rule On January 1st John starts in business,trading as“John Clothing Co.”.He puts$60 000 of his own money into a business bank account.Cash&Bank AccountDebit(=+)$Credit(=-)$Ja
18、n 1Capital60 000Jan 2Motor Vehicles16 0002.20Transaction No.1:Starting the Operations Hikes Consultants started its operations on January 31st when the owner made$20 000 cash contribution.Assets=Liabilities+EquityCashContributed CapitalDebitCredit+(1)20 000(1)20 0002.21Transaction No.2:Purchasing Of
19、fice Supplies On May 15th,Hikes Consultants purchased$800 of office supplies from a local supply company on account.Assets=Liabilities+EquitySuppliesAccounts PayableDebitCredit+(2)800(2)8002.22Transaction No.3:Providing Services on Account On May 20th,the company provided services on account(i.e.,it
20、 will collect cash later,even though it had already provided services)to Mercy Food Store.Mr.Mercys business was billed for$3 200.Assets=Liabilities+EquityAccounts ReceivableConsulting RevenueDebitCredit+(3)1 600(3)1 6002.23Transaction No.4:Paying Cash for Operating Expenses On April 5th,the company
21、 paid$1 200 cash for operating expenses.Assets=Liabilities+EquityCash Operating ExpenseCreditDebit-+Expense-Equity(4)1 200(4)1 200 2.24Transaction No.5:Borrowing Money from Bank On May 31st,due to cash limits Hikes Consultants decided to borrow$8 000 from the Local Business Bank.The company issued a
22、 note that had a one-year term and carried 7%annual interest rate.Assets=Liabilities+EquityCashNotes PayableDebitCredit+(5)8 000(5)8 0002.25Transaction No.6:Paying Rent On June 1st,Mr.Hike saw that the business was growing and in this connection made a decision to rent a larger office.$4 800 cash wa
23、s paid in advance for a one-year rent of a new office.Assets=ClaimsPrepaid Rent+CashDebit+(6)4 800Credit-(6)4 8002.26Transaction No.7:Receiving Cash for the Provided Services On June 15th,Hikes Consultants received$3 000 cash from Mercy Food Store for the provided services(see Transaction No.3).Asse
24、ts=ClaimsCash+Accounts ReceivableDebit+(7)3 000Credit-(7)3 0002.27Transaction No.8:Receiving an Advanced Cash Payment On June 31st,Mr.Hike signed up a contract with Mike Company to perform consulting services.Hikes Consultants received an advanced cash payment in the amount of$7 200 and the term of
25、the contract was one year.Assets=Liabilities+EquityCashUnearned RevenueDebit+(8)7 200Credit+(8)7 2002.28Transaction No.9:Receiving Cash for Operating Activity On June 31st,Hikes Consultants represented Mr.Ebert(a client)in the court,for what the company received$1 400 cash.Assets=Liabilities+EquityC
26、ashConsulting RevenueDebit+(9)1 400Credit+(9)1 4002.29Transaction No.10:Loaning to other Company On June 31st,Hikes Consultants loaned Jam Building Company(Investment Activity)$6 000.Jam Building Company issued a one-year,8%note.Assets=ClaimsNotes Receivable+CashDebit+(10)6 000Credit-(10)6 0002.30Tr
27、ansaction No.11:Paying Cash to Purchase Office Equipment On June 31st,Mr.Hike paid$4 000 cash to purchase a new table and several chairs.The office equipment is expected to have a useful life of 2 years and a salvage value of$800.Assets=ClaimsOffice Equipment+Cash Debit+(11)4 000Credit-(11)4 0002.31
28、Transaction No.12:Paying Cash to Accounts Payable On August 14th,Hikes Consultants paid$800 of accounts payable from a local supply company.Assets=Liabilities+EquityCashAccounts PayableCredit-(12)800Debit-(12)8002.32Transaction No.13:Receiving a Bill for Office Cleaning Services On September 18th,Hi
29、kes Consultants received a$1 600 bill from Sulk Cleaners for office cleaning services.Mr.Hike plans to pay the bill later.Assets=Liabilities+EquityAccounts PayableOffice Maintenance ExpenseCredit+(13)1 600Debit+Expense-Equity(13)1 6002.33Transaction No.14:Paying Cash Distribution to the Owner On Nov
30、ember 31st,Hikes Consultants paid$600 cash distribution to its owner.Assets=Liabilities+EquityCashCash DistributionCredit-(15)600Debit+Dist.-Equity(15)6002.34Making Adjusting Entries When we have seen all the transactions pertaining to the accounting period,we need to make adjusting entries.Adjustin
31、g entries are made at the end of a year(or any other fiscal period)to recognize revenue or expenses(accruals or deferrals).2.35Adjustment No.1:Recognizing Interest Expense On May 31st,Hikes Consultants borrowed$8 000 cash from a bank and agreed to return the money in a year and pay 7%annual interest
32、(see Transaction No.5).For the accounting period interest expense on the note amounted to$327(i.e.,$8 0007%(7 months/12 months).Assets=Liabilities+EquityInterest PayableInterest ExpenseCredit+(A1)327Debit+Expense-Equity-(A1)3272.36Adjustment No.2:Recognizing Rent Expense On June 1st,Hikes Consultant
33、s paid$4 800 cash in advance for a new 1-year office rent(see Transaction No.6).The rent expense to be recognized at the end of the period is calculated as follows:$4 800(7 months/12 months)=$2 800.Assets=Liabilities+EquityPrepaid RentRent ExpenseCredit-(A2)2 800Debit+Expense-Equity(A2)2 8002.37Adju
34、stment No.3:Recording a Revenue for the Provided Services On June 31st,Hikes Consultants received in advance cash payment of$7 200 for services to be performed during a year after signing up the contract(see Transaction No.8).By December 31st the company had provided services for 6 months,so the amo
35、unt to be recorded as a revenue is$7 200(6 months/12 months)=$3 600.This amount should be removed from liabilities(Unearned Revenue)and placed into equity(Consulting Revenue).Assets=Liabilities+EquityUnearned RevenueConsulting RevenueDebit-(A3)3 600Credit+(A3)3 6002.38Adjustment No.4:Recording Inter
36、est Revenue On July 31st,Hikes Consultants loaned$6 000 to Jam Building Company and received for it a note carrying a 1-year term and obligation to pay 8%annually(see Transaction No.10).In this connection,Hikes Consultants have to record$200(i.e.,$6 0008%(5 months/12 months)as interest revenue.Asset
37、s=Liabilities+EquityInterest ReceivableInterest RevenueDebit+(A4)200Credit+(A4)2002.39Adjustment No.5:Recognizing Depreciation Expense On June 31st,office equipment of$4 000 was bought.The useful life of this assets was expected to be 2 years with a salvage value of$800.Hikes Consultants have to rec
38、ognize the amount of office equipment used during a year as a depreciation expense.The amount to be recorded is$1 600(i.e.,($4 000-$800)/2 years).Assets=Liabilities+EquityAccumulated DepreciationDepreciation ExpenseCredit+Acc.Depr.-Assets(A5)1 600Debit+Expense-Equity(A5)1 6002.40Adjustment No.6:Reco
39、gnizing Salaries Expense At the end of the period Hikes Consultants accrued$1 200 salaries that will be paid off in the next accounting period(2013).Assets=Liabilities+EquitySalaries PayableSalaries ExpenseCredit+(A6)1 200Debit+Expense-Equity-(A6)1 2002.41Adjustment No.7:Expensing the Supplies On Ma
40、y 15th,Hikes Consultants bought$800 of supplies.At the end of the accounting period$200 of supplies remained on hand.Others($600=$800-$200)were used during the year,and,therefore,must be expensed.The adjustment decreases assets and equity.Assets=Liabilities+EquitySuppliesSupplies ExpenseCredit-(A7)6
41、00Debit+Expense-Equity(A7)6002.42Transferring Date to T-accounts Now we will transfer all the data to T-accounts.Note that we meet the two requirements about the double-entry recording process:Total Debits=Total Credits;Total Assets=Total Liabilities+Total Equity.2.43A Summary of the Principles of A
42、ccounts To facilitate your understanding the basic principals of T-accounts,a table of accounts and how they are increased or decreased is presented below:AccountDebitCreditAssetsIncreaseDecreaseContra AssetsDecreaseIncreaseLiabilitiesDecreaseIncreaseEquityDecreaseIncreaseContributed CapitalDecrease
43、IncreaseRevenueDecreaseIncreaseExpensesIncreaseDecreaseDistributionsIncreaseDecrease2.44The Procedures of Accounting In general,all the steps are:(1)Analyzing source documents;(2)Making entries to the general journal;(3)Posting the date to the ledger;(4)Comparing debit and credit balances for equali
44、ty;(5)Preparing financial statements.2.45The JournalDateAccount TitlesDebitCreditJan.31CashContributed Capital20 00020 000May 15SuppliesAccounts Payable800800May 20Accounts ReceivableConsulting Revenue3 2003 200April 5Operating ExpenseCash1 2001 200May 31CashNotes Payable8 0008 000June 1Prepaid Rent
45、Cash4 8004 800June 15CashAccounts Receivable3 0003 000June 31CashUnearned Revenue7 2007 200June 31CashConsulting Revenue1 4001 400June 31Notes ReceivableCash6 0006 000June 31Office EquipmentCash4 0004 000Aug.14Accounts PayableCash800800Sept.18Office Maintenance ExpenseAccounts Payable1 6001 600Nov.3
46、1DistributionsCash600600Adjusting EntriesDec.31Interest ExpenseInterest Payable327327Dec.31Rent ExpensePrepaid Rent2 8002 800Dec.31Unearned RevenueConsulting Revenue3 6003 600Dec.31Interest ReceivableInterest Revenue200200Dec.31Depreciation ExpenseAccumulated Depreciation800800Dec.31Salaries Expense
47、Salaries Payable1 2001 200Dec.31Supplies ExpenseSupplies600600Totals of debits and credits71 62771 6272.46Closing Entries In addition to adjusting entries,closing entries must be made at the end of an accounting period.Closing entries main goal is to free up(to zero)the nominal accountsrevenue,expen
48、se,and distribution onesfor the next accountingDateAccount titlesDebitCreditJohn Closing entriesDec.31Consulting RevenueInterest RevenueRetained Earnings6 8002007 000Dec.31Retained EarningsOperating ExpenseOffice Maintenance ExpenseInterest ExpenseRent ExpenseDepreciation ExpenseSalaries ExpenseSupp
49、lies Expense9 3271 2001 6003272 8001 6001 200600Dec.31Retained EarningsDistributions6006002.47The Trial Balance The aim of the Trial Balance is to prove that for every debit entry a corresponding credit entry has been made.John Clothing Co.Trial Balance as at January 2ndDrCrCash&Bank60 00016 000Capital60 000Motor Vehicles16 00076 00076 000 After balancing-off:John Clothing Co.Trial Balance as at January 2ndDrCrCash&Bank44 000Capital60 000Motor Vehicles16 00060 00060 000
