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Lesson 02 (printer-friendly version)

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Chapter 1

Introduction

When you have finished this lesson, you will be able to analyze various business transactions, enter
the amounts into General Ledger accounts, and prepare a Balance Sheet. In Lesson 1 you learned
about T-accounts and how to increase and decrease various accounts. This lesson will reinforce
that concept, as you'll be entering dollar amounts into the increase and decrease sides of various
accounts. You'll also be preparing a Balance Sheet, which proves the accounting equation:

The accounts that you are going to use in this chapter are slightly different from those used in
Lesson 1. Look at the General Ledger account forms, one of the forms you printed out, while I
explain it to you. Each account has a section at the very top of the account for the account name
and the account number. There are also two columns for the date entries. Please disregard the Item
column at this time. The Post Ref. column will be explained in detail later and should be left blank
for now.

Important points to remember:

A debit entry in an account with a debit

balance will have a larger debit balance
because you add the debit entry to the debit
balance.

A credit entry in an account with a credit balance

will have a larger credit balance because you
add the credit entry to the credit balance, giving
the account a larger credit balance.

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When you're entering an amount into an account with the opposite balance, the account balance is
carried by the larger number. For example, if you enter a debit entry of $500.00 into an account with
a credit balance of $300.00, the account would have a debit balance of $200.00. Because the debit
entry is greater than the credit, the debit takes over the balance. You would subtract the credit
balance from the debit entry to get your new account balance.

Likewise, if you have an account with a $700.00 debit balance and you make a credit entry of
$1,000.00, the account would have a new credit balance of $300.00. The balance is the difference
between the debit balance and the credit entry.

As we continue this lesson and you enter amounts into the General Ledger pages, you will see how
the entries affect the account balances.

Below is an illustration of an account from the General Ledger. Notice how the account title, account
number, and date are entered. Also notice how the entries affect the account balance. Cash is an
asset account with a normal debit balance. It is increased with a debit entry and decreased with a
credit entry. Follow through each entry so that you are aware of how each balance was calculated.
This is just a sample General Ledger page; your Cash account will have different entries. You can
also click the image or its caption to bring up a window containing an interactive version of this
General Ledger page.

General Ledger account example

Chapter 2

Chart of Accounts

From this point on, I will refer to the T-accounts simply as accounts or the General Ledger. The
General Ledger is a book of all the accounts a business uses. You will be figuring the account
balance in each account after you enter the dollar amount of a transaction. Because you will be
entering the dollar amount for each transaction into two separate accounts, one as a debit entry and
the other as a credit entry, your debit account balances and your credit account balances should
remain equal after each transaction.

To help you better understand the organization of the General Ledger, below is a Chart of Accounts

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for Children's Capers, a fictitious business that I'll use throughout this course for instructional
purposes. A Chart of Accounts is a list of all the accounts used by a business, organized by
account classification. This business is a merchandise business that sells children's books, videos,
and toys. This business is owned and operated by Joan Caldwell and Stacy Hall, equal partners.

Chart of Accounts
Balance Sheet Accounts

(1000) Assets

1110 Cash
1120 Petty Cash
1130 Accounts Receivable
1140 Merchandise Inventory
1150 Office Supplies
1160 Store Supplies
1170 Prepaid Insurance

(2000) Liabilities

2110 A Children's Haven, Inc.

2115 Accounts Payable
2120 Costco Wholesalers, Inc.
2125 Employee Tax Payable
2130 FICA Tax Payable
2135 Health Insurance Premiums Payable
2140 Jamison Booksters, Inc.
2145 Sales Tax Payable
2150 Toys for Less, Inc.
2155 Unemployment Tax Payable—Federal
2160 Unemployment Tax Payable—State
2165 United Way Donations Payable
2170 U.S. Savings Bonds Payable

(3000) Owners' Equity

3110 Joan Caldwell, Capital

3120 Joan Caldwell, Drawing
3130 Stacy Hall, Capital
3140 Stacy Hall, Drawing
3150 Income Summary

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Income Statement Accounts

(4000) Revenue

4100 Sales

(5000) Cost of Merchandise

5100 Purchases

(6000) Expenses

6110 Advertising Expense

6120 Credit Card Fee Expense
6130 Insurance Expense
6140 Miscellaneous Expense
6150 Payroll Tax Expense
6160 Rent Expense
6170 Salary Expense
6180 Supplies Expense—Office
6185 Supplies Expense—Store
6190 Utilities Expense

You'll find a printer-friendly copy of this Chart of Accounts in the Supplementary Material for
this lesson. Please print it and keep it handy for reference as we continue through the
course. The printer-friendly version is a PDF file, so you'll need a current version of Adobe
Reader to view and print it. There are many more PDF forms that you'll need to view and
print to get the most out of this course, so please don't skip this important step! You can download
the current version of Adobe Reader for free by going to the first link in the Lesson 1 Supplementary
Material section.

Chapter 3

Entering Transaction Amounts into the General Ledger

Okay! Whew! That was a lot of information, but all very necessary. Take a second look at it. Reread
it to make sure you understand about accounts and the General Ledger. Remember that each
account is exactly the same. The difference is where transaction amounts are entered and where
the account balance appears, either as a credit balance or a debit balance. Also notice that liability
accounts and expense accounts are arranged alphabetically. The accounts are numbered in
increments of 10 so that additional accounts can be added at a future time without having to assign
new numbers to already existing accounts.

Let's stop talking about it and begin doing it! Using the blank General Ledger forms required for this
lesson's assignment, I would like you to open each account in the General Ledger using the Chart
of Accounts in the previous chapter. To open an account, you put the account title and the account
number on one account for each of the accounts.

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When you make an entry into an account, put the year in the Date column, using only the top half of
the first line under the Date column, a very small space. Then on the same line in the bottom half of
the line, put the month abbreviation, Dec., and in the box to the right, still under the Date column,
enter the day of the month. You do not need to repeat the year or the month as long as the month
remains the same. When you move on to another month, you will enter that month's abbreviation
once in the Date column and then only the day of that month for each entry into the account. If you
need to, refer to the Chart of Accounts in Chapter 2 of this lesson.

We are now going to journalize a few transactions:

Transaction #1: December 1, The owner, Joan Caldwell, gave the business $10,000.00
as an investment.

Note:

The proprietors or owners of a

business often invest their personal
money in the business to get it up and running.

To journalize this transaction, we would enter $10,000.00 in the Cash account as a debit. This will
make the account have a debit balance of $10,000.00. So you would put the $10,000.00 entry in the
first column, debit, and then carry it over to the Debit Balance column, the third column. This makes
the Cash account have a debit balance of $10,000.00. Whenever cash is received, no matter from
what source, cash is always debited.

Next, you have to enter this same amount in an account as a credit so your debits and credits
equal. Go to the Joan Caldwell, Capital account and enter the $10,000.00 as a credit in the second
column and bring it over into the Credit Balance column, the fourth column.

By doing this, we are saying that the company now has $10,000.00 in cash
represented by a debit balance in the Cash account and the owner now has
$10,000.00 worth of equity in the business represented by a credit balance in
her Capital account.

Put a check mark in the Post Ref. column of each account in the General
Ledger that we post to in this lesson. This Post Ref. box is usually for the
journal page that the transaction is being posted from, but in this lesson we
are not entering the transactions into a Journal, so we will enter check marks
in the Post Ref. columns.

Transaction #2: December 1, Paid cash for office supplies, $200.00.

The first account to be affected will be Cash. We paid out cash this time, so we'll credit the Cash
account for $200.00. Whenever cash is paid out for any reason, the Cash account is always
credited. The Cash account has a debit balance of $10,000.00. We'll enter the $200.00 in the Credit
column, column 2. We will now subtract the $200.00 credit entry from the $10,000.00 debit balance.
This will leave the account with a debit balance of $9,800.00. Remember that cash has a normal
debit balance and increases with a debit entry and decreases with a credit entry.

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First two Cash account entries

The second account to be affected by this transaction is Office Supplies. This is an asset account
with a normal debit balance. Because we are increasing our asset office supplies, we will enter the
$200.00 in the Debit column and bring the $200.00 over to the Debit Balance column. We can now
see that we have $200.00 less in our asset account, Cash, but we have $200.00 in our Office
Supplies account, another asset account.

What we have done in the last transaction is change the configuration of

one asset into another asset. Our debits and credits will still be equal; we
have simply added to one asset account and subtracted from another
asset account. The accounting equation remains in balance.

Chapter 4

More Transactions and Balance Sheets

Our next transaction will involve the owners purchasing insurance coverage for their business.
When you purchase insurance coverage, you pay in advance for that protection. For example,
Children's Capers has to pay for six months' coverage all at once, due on
December 1 for the period December 1 through May 31 of the following
year. This insurance coverage is considered as asset until one month has
elapsed. At that point, the portion of the payment allocated for one month is
taken out of the asset account, Prepaid Insurance, and entered into an
expense account, Insurance Expense. In other words, it is not considered
an expense until after a certain amount of time has gone by.

In this case, if Children's Capers pays $600.00 for coverage from December
1 through May 31, it is paying $100.00 per month. However, until the end of
the month, all $600.00 will be entered into an asset account, Prepaid
Insurance. In a future lesson, you will make an adjustment to this asset
account and subtract the monthly allotment to be put into Insurance Expense.

So let's put this transaction into its proper General Ledger accounts:

Transaction #3: December 1, Paid for insurance coverage, $600.00.

We will enter a debit for $600.00 in the Prepaid Insurance account. This will make this account have
a debit balance of $600.00.

We will then enter a credit of $600.00 in our Cash account. We will subtract the $600.00 credit entry
from the $9,800.00 debit balance, leaving the account with a debit balance of $9,200.00.

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Again, we have simply changed one asset, cash, into another form of asset, prepaid insurance. The
debit balances and the credit balances should agree.

Moving right along, let's do another type of transaction:

Transaction #4: December 1, Bought store supplies on account from Costco

Wholesalers, Inc., $350.00.

We are going to make a debit entry in store supplies for $350.00 and make a credit entry in Costco
Wholesalers, Inc. for $350.00. Enter a $350.00 debit in Store Supplies. Bring this $350.00 over into
the Debit Balance column. Store Supplies now has a debit balance of $350.00. Enter a $350.00
credit in Costco Wholesalers, Inc., account in column 2. Bring this $350.00 entry over into the fourth
column, Credit Balance. This gives this account a credit balance of $350.00.

Let's take time to check our account balances before we complete more transactions. Cash should
have a debit balance of $9,200.00; Joan Caldwell, Capital should have a credit balance of
$10,000.00; Office Supplies should have a debit balance of $200.00; Prepaid Insurance should
have a debit balance of $600.00; Store Supplies should have a debit balance of $350.00; and
Costco Wholesalers, Inc. should have a credit balance of $350.00. Our debits and credits both
equal $10,350.00.

Transaction #5: December 1, Paid Costco Wholesalers, Inc., $200.00 on account.

Okay, what this transaction is telling you is that Children's Capers is paying off some of its debt to
Costco Wholesalers, Inc. You will credit cash by entering $200.00 in column 2. Figure the new
balance in cash by subtracting the $200.00 credit entry from the $9,200.00 debit balance to get a
new debit balance of $9,000.00.

The debit entry for this transaction will be made in the Costco Wholesalers, Inc. account. Put a
$200.00 entry in the Debit column, then refigure the account balance by subtracting the $200.00
debit entry from the $350.00 credit balance. This will give the account a new credit balance of
$150.00. The credit balance represents the amount we now owe this company. In liability accounts,
a credit represents a purchase your business made on account and a debit represents a payment
on account made by your business. Therefore, a liability account should have a credit balance or
none at all if you don't owe that creditor any money.

The final job in this lesson is to prepare a Balance Sheet. This is a financial report that shows the
account balances and also proves the equality of debits and credits in the General Ledger.

You will need the Balance Sheet form, which is one of the forms that are necessary for this lesson's
assignment.

Below is an illustration of a Balance Sheet for you to look at as I explain how to prepare one.

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Balance Sheet example

On the very first line of this form, put the company's name, Children's Capers. On the next line, put
the name of the report, Balance Sheet, and on the third line in the heading, put the date, December
1, 20--.

Next, put the word Assets on the first line on the left-hand side of the report form. You can center it
by eye on that first line. Then, list all the asset account titles and the ending balance in each asset
account as it appears in the General Ledger accounts. The account titles should start as far to the
left as possible on the line. Do not total this column yet.

Center the word Liabilities on the first line on the right-hand side of the report form. List all the
liability account titles from the General Ledger accounts that have balances in them. You don't need
to list the name of a liability account that does not show a balance. If you have listed more than one
liability account and its balance, put Total Liabilities on the line following the last liability account
balance and enter the total of the liability account balances. On the next line, still on the right-hand
side of the form, center Owners' Equity. Under this heading, put Joan Caldwell, Capital, and enter
the balance in her capital account. On the next line on the right-hand side, put Total Liabilities and
Owners' Equity and total the liabilities and the capital balances. Be sure you do not add the
individual liability account balances and then the total liabilities amount, as this will double the
amount of your liabilities. Use only the total liabilities amount to add to the capital account balance.

Next, go back to the left-hand side of the form. On the same line as you entered the total on the
right-hand side, put Total Assets and enter the dollar amount of all the asset account balances.

You may have to leave one or more blank lines on the left-hand side in order to put your totals on
the same line, but that is appropriate.

When you total the assets on the left-hand side of the report and the liabilities and owners' equity on
the right-hand side, the totals should be the same. If they're not, you've made an error somewhere
and you need to backtrack until you find it. It can be as simple as adding your account balances
again, or you may have to go back to each account and refigure the account balance.

If this is not where the error is, you may have to go back to the original transaction and check to
make sure you entered both the debit and credit amounts correctly in your General Ledger
accounts. Locating errors in this type of work can take time and is sometimes frustrating, but errors
must be found and corrected or they will carry through the entire system and you will not have a

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true picture of the finances. You should also feel a sense of pride when you discover your own error
rather than having someone point out your mistake.

Once the totals agree, draw two lines close together under each column total. This is called double
ruling. This shows that the assets equal liabilities plus owners' equity. This is the accounting
equation that must remain equal at any given point.

Please feel free to check your work by viewing the solutions located in the Supplementary Material
section for this lesson.

Chapter 5

Conclusion

You've been exposed to a great deal of information in this lesson. You've opened and made entries
into the General Ledger accounts, figured the new balance in these accounts, and prepared a
Balance Sheet to prove the equality of debits and credits in the General Ledger. These concepts
are the basis of this course, which you will build on in future lessons.

Please keep the General Ledger accounts used in this chapter. In future chapters, we will build on
the previous chapters' work. To make locating the accounts easier, I would like you to arrange them
in the order shown in the Chart of Accounts in Chapter 2 of this lesson. I would then like you to put
them in a three-ring binder with sections to separate the categories of forms. You could label one
category General Ledger and the other Balance Sheet. Keeping your work organized this way will
be very valuable as we continue on and learn how to prepare more forms and reports.

When you feel you have mastered the concepts in this lesson, I would like you to take a short,
multiple quiz. Good luck!

Supplementary Material

Chart of Accounts
/crs/pix/fun/L02-Accounts.pdf
Here's a Chart of Accounts for Children's Capers.
Please print a copy of this chart and keep it handy as
you continue through the exercises for this course.
You'll need to refer to it often!

Opening General Ledger Printout

/crs/pix/fun/L02-Opening_GL_Printout.pdf
Here's the first set of forms you'll need to complete the
exercises in this course. This is the General Ledger for
Children's Capers. There are 37 accounts in this ledger.
It prints on 19 pages, with all of the names and account
numbers already entered. If you're working on a slow
Internet connection, you may have trouble downloading
this file. If so, go to the link below for an alternative
method.

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Blank Opening General Ledger Printout

/crs/pix/fun/L02-Blank_Opening_GL_Printout.pdf
If your Internet connection is slow or if you're having
trouble downloading and printing the file in the link
above, you'll need to fill out the General Ledger forms
by hand. You will need a total of 19 copies of the blank
form. Then just copy all of the information from the
Chart of Accounts for Children's Capers into the
individual accounts on the blank forms.

Balance Sheet
/crs/pix/fun/L02-Balance_Sheet.pdf
Here's the Balance Sheet that you'll need to complete
this lesson's work.

Lesson 2 Solutions
/crs/pix/fun/L02-Solutions.pdf
All finished? Click here to check your work against this
lesson's solution forms. You can either print them or
check the amounts online. Unfortunately, some of the
wider forms can only appear sideways, so printing may
be your better option. If you don't mind tilting your head,
you'll be able to see what you need to see on the screen
while saving some printer ink and paper!

Note: Only those forms and accounts with new entries

in them will appear in each lesson's solutions. If you're
curious about a transaction in a previous lesson, you'll
have to go back to that lesson's Solutions link.

All Bookkeeping Resource

http://www.allbookkeepingresource.com/art-
basicacc.html
Step-by-step instruction of entire accounting process.
Excellent definitions and examples.

ABC News: Business Glossary

http://abcnews.go.com/Business/story?
id=88881&page=1
An extensive glossary of business and accounting
terms.

Understanding Accounting
http://www.kat.elmvalefarm.com/bk01.htm
Good resource for all aspects of accounting.

A Bookkeeping and Accounting Primer

http://www.webcom.com/duane/acct1.html
Excellent explanations of all phases of accounting.

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FAQs

Q: Why is it necessary for a business to have a Chart of Accounts?

A: A Chart of Accounts makes for easier location of accounts the business

uses. Anyone who needs this information can quickly and easily see what
accounts are used in the bookkeeping of the business by looking at the one-
page Chart of Accounts.

Q: Why should a Balance Sheet be prepared at least once a month?

A: A Balance Sheet report proves the equality of the debit and credit entries
in the General Ledger. If there is a mistake in the General Ledger accounts, it
should be located and corrected before the next month's transactions are
recorded

Q: Why is it so important that each transaction have a debit and a credit part
for the same amount?

A: Each transaction must have a debit part and a credit part for the same
amount because the debits and credits must remain equal after each
transaction. This is referred to as double entry accounting, and the
accounting equation must remain in balance at any given time in the
accounting cycle.

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