Accounting Basics

 Accrual basis of accounting: when revenues are recognized when they are earned, not when they
are paid (i.e. when the work is actually completed)

Debits and Credits

 Debits entered in on the left side of an account

 Credits entered in on the right side of an account
 Types of accounts in a Balance Sheet:
o Assets: Resources owned by a company that have future economic value
 Cash
 Investments
 Accounts Receivable
 inventory,
 supplies,
 land,
 buildings,
 equipment,
 and vehicles.
 Assets are reported on the balance sheet usually at cost or lower.
 Assets are also part of the accounting equation: Assets = Liabilities + Owner's
(Stockholders') Equity.
 Some valuable items that cannot be measured and expressed in dollars include
the company's outstanding reputation, its customer base, the value of successful
consumer brands, and its management team. As a result, these items are not
reported among the assets appearing on the balance sheet.
o Liabilities: Obligations of a company or organization
 Amounts owed to lenders and suppliers.
 Liabilities often have the word "payable" in the account title.
 Liabilities also include amounts received in advance for a future sale or for a
future service to be performed.
o Owner’s (Stockholder’s) Equity: The book value of a company equal to the recorded
amounts of assets minus the recorded amounts of liabilities.
o Revenues or Income
 Revenue: Fees earned from providing services and the amounts of merchandise
sold
 Under the accrual basis of accounting, revenues are recorded at the time
of delivering the service or the merchandise, even if cash is not received
at the time of delivery
 Examples of revenue accounts include: Sales, Service Revenues, Fees
Earned, Interest Revenue, Interest Income
 Revenue accounts are credited when services are performed/billed and
therefore will usually have credit balances
 At the time that a revenue account is credited, the account debited might
be Cash, Accounts Receivable, or Unearned Revenue depending if cash
 was received at the time of the service, if the customer was billed at the
time of the service and will pay later, or if the customer had paid in
advance of the service being performed
 If the revenues earned are a main activity of the business, they are
considered to be operating revenues
 If the revenues come from a secondary activity, they are considered to be
nonoperating revenues
 For example, interest earned by a manufacturer on its investments is a
nonoperating revenue. Interest earned by a bank is considered to be part
of operating revenues
 Income: use the word to signify a net amount, such as income from operations
(revenues minus expenses in the company's main operating activities). Still
others use it when referring to nonoperating revenues, such as interest income
o Expenses: Costs that are matched with revenues on the income statement
 Cost of Goods Sold is an expense caused by Sales
 Insurance Expense, Wages Expense, Advertising Expense, Interest Expense are
expenses matched with the period of time in the heading of the income statement
 Under the accrual basis of accounting, the matching is NOT based on the date
that the expenses are paid
 Expenses associated with the main activity of the business are referred to as
operating expenses
 Expenses associated with a peripheral activity are nonoperating or other expenses
 For example, a retailer's interest expense is a nonoperating expense. A bank's
interest expense is an operating expense
 Generally, expenses are debited to a specific expense account and the normal
balance of an expense account is a debit balance. When an expense account is
debited, the account credited might be Cash (if cash was paid at the time of the
expense), Accounts Payable (if cash will be paid after the expense is recorded),
or Prepaid Expense (if cash was paid before the expense was recorded.)
o Gains: Gains result from the sale of an asset (other than inventory). A gain is measured
by the proceeds from the sale minus the amount shown on the company's books
 Since the gain is outside of the main activity of a business, it is reported as a
nonoperating or other revenue on the company's income statement
o Losses: Losses result from the sale of an asset (other than inventory) for less than the
amount shown on the company's books
 Since the loss is outside of the main activity of a business, it is reported as a
nonoperating or other loss
 The term “losses” is also used to report the write-down of asset amounts to
amounts less than cost
 It is also used to refer to several periods of net losses caused by expenses
exceeding revenues

 Double Entry Accounting

o When a company borrows $1,000 from the bank, it affects the company’s Cash account
and the company’s Notes Payable account
 o If a company buys supplies for cash, its Supplies account and its Cash account will be
affected
 If it buys supplies on credit, the accounts involved would be Supplies and AP
o When a company pays rent for the current month, Rent Expense and Cash are involved
o If a company provides a service and gives its customer 30 days to pay, Service Revenues
and AR are affected
o A loan payment to the bank would involve: Cash, Notes Payable, and Interest Expense
 Debits and Credits
o Debit means left, credit means right
o Generally, these types of accounts are increased with a debit:
 Dividends (Draws)
 Expenses
 Assets
 Losses
o Generally, these types of accounts are increased with a credit:
 Gains
 Income
 Revenues
 Liabilities
 Stockholder’s (Owner’s) Equity
o Whenever cash is received, debit Cash
o Whenever cash is paid, credit Cash
o Revenues and Gains are usually credited
o Expenses and Losses are usually debited
o Asset, Liability, and most Equity accounts are referred to as permanent accounts or real
accounts
 Not closed at the end of the accounting year; balances are carried forward
o Temporary Accounts or nominal accounts include revenue, expense, owner drawing,
and income summary accounts
 These balances increase throughout the year and are zeroed out and closed at the
end of the year
 Zeroed out by closing/transferring/clearing to the Income Summary
Account
 Net amount in income summary is then transferred to Retained Earnings

 Note, the owner drawing account is a temporary account and is not

transferred to an income summary account and is instead directly
transferred to an owner capital account
 Bank Debits and Credits
o On a bank’s balance sheet, Cash, Investment Securities, and Loans Receivable are
reported as assets
o Deposits are reported as liabilities
Difference between Accrual and Cash method
Example Transactions

Example Accounting Transaction

General Ledger Account Examples

 Balance Sheet Accounts (Permanent Accounts, Real Accounts)

o Assets (Cash, AR, Land, Equipment)
o Liabilities (Loans Payable, AP, Bonds Payable)
o Stockholder’s Equity (Common Stock, Retained Earnings)
o These are not closed at the end of the FY. They are rolled over
 Income Statement Accounts (Temporary Accounts)
o Operating Revenues (Sales, Service Fees)
o Operating Expenses (Salaries Expense, Rent Expense, Depreciation Expense)
o Non-operating Revenues and Gains (Investment Income, Gain or Disposal of Truck)
o Non-operating Expenses and Losses (Interest Expense, Loss or Disposal of Equipment)
o Balances in these accounts will be closed out at the end of the FY and amounts will be
moved to Retained Earnings
Chart of Accounts
  There will always be more accounts in the CoA than in the GL
o This is because accounts with no activity will be in the CoA but not in the GL
 CoA sometime used to designate where an account will be reported in the financial statements
Debits and Credits in the Accounts