SIMPLIFYING ACCOUNTING TRANSACTIONS

1. SIMPLIFYING ACCOUNTING TRANSACTIONS Two Rules for Debits and Credits: Outside Rule & AWE/LRC M. PiczakNovember 2006

2. Debits and Credits • Novices to accounting find debits and credits confusing • Confusion is often overcome by memorizing the transactions and hoping new transactions are not thrown at them • One mistake will not permit a trial balance to balance • Banks do not help as they will credit your bank account with money put into your account, yet such ‘credits’ actually represent debits to your T account for tracking purposes

3. SOLUTION • The Outside Rule* and here’s how: • Set up a large balance sheet with subaccounts shown in their respective positions • Increases to an account result in entries on the outer edge of a t account set up under Assets, Liabilities and Owner’s Equity • Decreases to an account result in entries on the inside of the Asset, Liability and Owner’s Equity accounts • Remember that there are two entries to each transaction with an increase in one having an attendant decrease in another *My thanks to colleague Reid MacWilliam for pointing out this simple rule that I wish I had learned when I was in School instead of memorizing entries…

4. THE OUTSIDE RULE Assets Liabilities - + + - decreases increases increases decreases Cash A/R Equipment Loans Payable A/P Sal.Payable + - - + + - - + - + - + Expense Summary/ Expired Assets Expenses Owner’s Equity + - - + decreases increases Withdrawals Capital R/E Revenues - + - + - + + - Think of debit and credit entries as increases or decreases to T accounts arising out of day to day accounting transactions

5. HANDLING THE EXPENSES - - + + Assets Liabilities Sales & revenues continue to be recorded using the Outside Rule - + Owner’s Equity Revenue Sale 1 Rent X Expenses are offsets to the full revenue claims held by owners Revenue 2 Adv. X. Sale 3 Utilities X. profit loss

6. HANDLING THE EXPENSES - - + + Assets Liabilities Split the expenses out when entering transactions on the left side since these serve as offsets to revenues - + Owner’s Equity Rent X Revenue 2000 Sale 1 Sale 2 Separate T accounts permit the process of business analysis and control to proceed Adv. X. Sale 3 1100 profit loss Utilities X. 500

7. 2 BIRDS WITH 1 STONE - - + + Assets Liabilities - + Owner’s Equity The income statement is nearly finished Rent X Revenue 2000 Sale 1 Sale 2 Adv. X. Sale 3 1100 profit loss Utilities X. 500

8. THE NEXT STEP: CLOSING OUT T ACCOUNTS + - - + Assets Liabilities Loans Payable A/P Sal.Payable Cash A/R 500 500 200 500 300 700 300 300 200 200 500 100 100 900 400 700 1800 - + Owner’s Equity Rent Exp. Equipment Sales Capital 1700 300 2700 1000 300 1700 1000 2700 Adv. Exp. Cell Exp. 200 100 200 100

9. STEP 3: THE TRIAL BALANCE • The purpose of the trial balance is to ensure that all debits = credits prior to preparing the final income statement and balance sheet • Involves transferring all T account closing balances to the trial balance • Arrange all accounts into debits (good things for the company) and credits (claims against the company by creditors/owners)

10. DEBITS/RETIRED ASSETS CREDITS/CLAIMS Cash $1800 A/R 400 Equipment 1700 Sal. Payable $200 A/P 100 Loan Payable 500 Sales 1000 Expenses 600 O/E 2700 TOTAL $4500 = $4500 THE COMPLETED TRIAL BALANCE

11. ABC Income Statement For the period ending Dec. 31, 20xx Sales $1000 Expenses Rent 300 Cell 100 Advertising 200 TOTAL X. $600 NET INCOME $400 THE INCOME STATEMENT Transfers to the O/E section of the balance sheet

12. Balance Sheet ABC Company As at Dec. 31, 20xx ASSETSLIABILITIES CA CL Cash $1800 A/P $100 A/R 400 Sal Pay. 200 Loan Pay. 500 NCA NCL - none Equipment 1700 O/E Capital $2700 Net Income 400 TOTAL ASSETS TOTAL LIABS + O/E $3900 = $3900 THE BALANCE SHEET

13. INCREASES TO ACCOUNTS • A customer cheque is deposited into the company’s bank account (asset, cash, increase; receivables, decrease) • Company owner puts more of their own money into the company to fund future expansion (owner’s equity, increase; cash increase) • Shipment of inventory is accepted and payment is to be made in 30 days (liabilities, accounts payable, increase; inventory increase)

14. DECREASES TO ACCOUNTS • Company owner takes money out in form of dividend to pay themselves (owner’s equity, decrease; cash, decrease) • Employee payday (liabilities, employees payables decrease; cash decrease) • You sell an old piece of equipment for cash (assets, equipment, decrease; cash increase)

15. IN SUMMARY • The procedure to be used is: • Set up your ‘large T Account’ • Double enter transactions using the Outside Rule • Remember how to handle expenses (they are retired assets and appear on the same side as assets) as a contra account against Revenues • Close out T accounts and transfer to Trial Balance • Balance Trial Balance • Prepare Income Statement first • Prepare Balance Sheet (balance)

16. ONE FINAL RULE(courtesy Gord Bereza) • AWE: Assets, Withdrawals and Expenses increase on the left/debit side AWE + - • LRC: Liabilities, Revenues and Capital additions increase on the right/credit side LRC + -

17. SIMPLIFYING ACCOUNTING TRANSACTIONS Two Rules for Debits and Credits: Outside Rule & AWE/LRC M. PiczakNovember 2006 The end