Recording Transactions using
Debit & Credit Approach
Service Company Example
The current presentation will cover the basics of recording transactions using the Debit & Credit approach. It may take a little time to get used to thinking in terms of debits and credits. You will need to lose any preconceived ideas about the meaning of the terms Debit and Credit. They are in fact meaningless unless one knows what type of account (e.g., asset, liability) is being debited or credited. You will also want to keep in mind that for any transaction, and all transactions taken together, that debits must always equal credits just like assets must always equal the sum of liabilities and equity.
We will use the same transactions as used in the Mike’s Barbershop example. This will be done in order to remind you of the meaning of the debits and credits for the financial statements. A couple of initial slides will be devoted to the basics of debits and credits.
(1) ASSETS
To Demonstrate an Increase in Assets → DEBIT the asset account
To Demonstrate a Decrease in Assets → CREDIT the asset account
(2) LIABILITIES
To Demonstrate an Increase in Liabilities → CREDIT the liability account
To Demonstrate a Decrease in Liabilities → DEBIT the liability account
(3) EQUITY
To Demonstrate an Increase in Equity → CREDIT the equity account
To Demonstrate a Decrease in Equity → DEBIT the equity account
Notice, the rules for debiting & crediting an equity account also show the rule for income statement accounts. If you recall that the revenues and expenses get incorporated into the retained earnings account within the equity portion of the balance sheet, then we have the following rules.
To Demonstrate an Increase in Net Income (e.g., Revenue) → CREDIT revenue
To Demonstrate a Decrease in Net Income (e.g., Expense) → DEBIT expense
The following slide summarizes these relationships with (+) for increase (-) for decrease.
ASSETS = LIABILITIES + OWNERS’ EQUITY
(+) (-) (-) (+) (-) (+)
DEBIT CREDIT DEBIT CREDIT DEBIT CREDIT
Dividends Capital Stock
Retained Earnings
EXPENSES REVENUE
Assets: (e.g.,) Liabilities: (e.g.,)
Cash & Cash Equivalents Expenses: (e.g.,)
Marketable Securities Accounts Payable Cost of Goods Sold
Accounts Receivable Wages Payable Selling expenses
Inventory Utilities Payable General & Administrative
Prepaid Expenses Interest Salaries
Prepaid insurance Current portion of L-T debt Wages
Other Current Assets Accrued Expenses Interest
Pre-Paid Expenses Salaries Taxes
Property, Plant, & Equipment (PPE) Unearned Revenue Depreciation & Amortization
Land Other Current Liabilities Revenue: (e.g.,)
Buildings Notes payable Revenue
Less Accumulated Depreciation Mortgages payable Sales
Intangibles Bonds Payable Net Sales
Goodwill Other Long-Term Liabilities Interest
Patents
Copyrights
Less Accumulated Amortization
Other Long-Term Assets
1. Mike transfers $500 from the shop’s savings account to its checking account.
ASSETS = / LIABILITIES + / EQUITY / REVENUE / - EXPENSES / = NET INCOME
Account / Debit / Credit
1. Mike transfers $500 from the shop’s savings account to its checking account.
Balance Sheet / Income StatementASSETS = / LIABILITIES + / EQUITY / REVENUE / - EXPENSES / = NET INCOME
+500 Cash
- 500 Savings
Account / Debit / Credit
Cash / 500
Savings Account / 500
2. Mike purchases $100 worth of equipment (e.g., scissors, clippers, etc.) for the shop by writing a check.
Balance Sheet / Income StatementASSETS = / LIABILITIES + / EQUITY / REVENUE / - EXPENSES / = NET INCOME
Account / Debit / Credit
2. Mike purchases $100 worth of equipment (e.g., scissors, clippers, etc.) for the shop by writing a check.
Balance Sheet / Income StatementASSETS = / LIABILITIES + / EQUITY / REVENUE / - EXPENSES / = NET INCOME
+100 Equipment
-100 Cash
Account / Debit / Credit
Equipment / 100
Cash / 100
3. Mike purchases a blow dryer for the shop. The dryer costs $50. Mike has asked the seller to bill him for the dryer.
Balance Sheet / Income StatementASSETS = / LIABILITIES + / EQUITY / REVENUE / - EXPENSES / = NET INCOME
Account / Debit / Credit
3. Mike purchases a blow dryer for the shop. The dryer costs $50. Mike has asked the seller to bill him for the dryer.
Balance Sheet / Income StatementASSETS = / LIABILITIES + / EQUITY / REVENUE / - EXPENSES / = NET INCOME
+50 Equipment / + 50 Accounts Payable
Account / Debit / Credit
Equipment / 50
Accounts Payable / 50
4. Mike receives the bill for the purchase of the dryer and immediately pays it by putting a check in the mail for the full amount.
Balance Sheet / Income StatementASSETS = / LIABILITIES + / EQUITY / REVENUE / - EXPENSES / = NET INCOME
Account / Debit / Credit
4. Mike receives the bill for the purchase of the dryer and immediately pays it by putting a check in the mail for the full amount.
Balance Sheet / Income StatementASSETS = / LIABILITIES + / EQUITY / REVENUE / - EXPENSES / = NET INCOME
-50 Cash / -50 Accounts Payable
Account / Debit / Credit
Accounts Payable / 50
Cash / 50
5. Mike provides a $15 haircut to a customer that pays cash.
Balance Sheet / Income StatementASSETS = / LIABILITIES + / EQUITY / REVENUE / - EXPENSES / = NET INCOME
Account / Debit / Credit
5. Mike provides a $15 haircut to a customer that pays cash.
Balance Sheet / Income StatementASSETS = / LIABILITIES + / EQUITY / REVENUE / - EXPENSES / = NET INCOME
+15 Cash / +15 Retained Earnings / 15 / 15
Account / Debit / Credit
Cash / 15
Revenue / 15
Notice here that we do not actually credit retained earnings directly. Rather, the credit to retained earnings (and, equity more broadly) is implied by the credit of the revenue account. In actual fact, a business would ‘close’ the revenue account into the retained earnings account just prior to constructing their financial statements. We’ll talk more about closing accounts later, for now note that the same will be true for expenses.
6. Mike provides a $20 haircut to a customer. The customer – a loyal and steady one for Mike – has asked Mike to bill him for the haircut.
Balance Sheet / Income StatementASSETS = / LIABILITIES + / EQUITY / REVENUE / - EXPENSES / = NET INCOME
Account / Debit / Credit
6. Mike provides a $20 haircut to a customer. The customer – a loyal and steady one for Mike – has asked Mike to bill him for the haircut.
Balance Sheet / Income StatementASSETS = / LIABILITIES + / EQUITY / REVENUE / - EXPENSES / = NET INCOME
+20 Accounts Receivable / +20 Retained Earnings / 20 / 20
Account / Debit / Credit
Accounts Receivable / 20
Revenue / 20
7. Mike receives a $20 check from the customer in question 6.
Balance Sheet / Income StatementASSETS = / LIABILITIES + / EQUITY / REVENUE / - EXPENSES / = NET INCOME
Account / Debit / Credit
7. Mike receives a $20 check from the customer in question 6.
Balance Sheet / Income StatementASSETS = / LIABILITIES + / EQUITY / REVENUE / - EXPENSES / = NET INCOME
+20 Cash
-20 Accounts Receivable
Account / Debit / Credit
Cash / 20
Accounts Receivable / 20
8. Mike pays $400 in rent to the owner of his building.
Balance Sheet / Income StatementASSETS = / LIABILITIES + / EQUITY / REVENUE / - EXPENSES / = NET INCOME
Account / Debit / Credit
8. Mike pays $400 in rent to the owner of his building.
Balance Sheet / Income StatementASSETS = / LIABILITIES + / EQUITY / REVENUE / - EXPENSES / = NET INCOME
-400 Cash / - 400 Retained Earnings / 400 / - 400
Account / Debit / Credit
Rent Expense / 400
Cash / 400
9. Mike receives his $200 utility bill. However, he does not plan to actually pay this until next month (after he constructs this period’s financial statements).
Balance Sheet / Income StatementASSETS = / LIABILITIES + / EQUITY / REVENUE / - EXPENSES / = NET INCOME
Account / Debit / Credit
9. Mike receives his $200 utility bill. However, he does not plan to actually pay this until next month (after he constructs this period’s financial statements).
Balance Sheet / Income StatementASSETS = / LIABILITIES + / EQUITY / REVENUE / - EXPENSES / = NET INCOME
+200 Accounts Payable / -200 Retained Earnings / 200 / -200
Account / Debit / Credit
Utility Expense / 200
Accounts Payable / 200
10. Mike receives a $5,000 small business loan from his bank.
Balance Sheet / Income StatementASSETS = / LIABILITIES + / EQUITY / REVENUE / - EXPENSES / = NET INCOME
Account / Debit / Credit
10. Mike receives a $5,000 small business loan from his bank.
Balance Sheet / Income StatementASSETS = / LIABILITIES + / EQUITY / REVENUE / - EXPENSES / = NET INCOME
+5,000 Cash / +5,000 Bank Loan
Account / Debit / Credit
Cash / 5,000
Bank Loan (or, Long-term Debt) / 5,000
11. Mike makes the first payment of $300 on his bank loan. Of the entire payment, $200 will go towards the principal of the loan and $100 towards interest on the loan.
Balance Sheet / Income StatementASSETS = / LIABILITIES + / EQUITY / REVENUE / - EXPENSES / = NET INCOME
Account / Debit / Credit
11. Mike makes the first payment of $300 on his bank loan. Of the entire payment, $200 will go towards the principal of the loan and $100 towards interest on the loan.
Balance Sheet / Income StatementASSETS = / LIABILITIES + / EQUITY / REVENUE / - EXPENSES / = NET INCOME
-300 Cash / - 200 Bank Loan / -100 Retained Earnings / 100 / - 100
Account / Debit / Credit
Bank Loan / 200
Interest Expense / 100
Cash / 300
12. The $50 blow dryer that Mike purchased way back in question 3 has worn out completely (it is now worthless with no salvage value at all).
Balance Sheet / Income StatementASSETS = / LIABILITIES + / EQUITY / REVENUE / - EXPENSES / = NET INCOME
Account / Debit / Credit
12. The $50 blow dryer that Mike purchased way back in question 3 has worn out completely (it is now worthless with no salvage value at all).
Balance Sheet / Income StatementASSETS = / LIABILITIES + / EQUITY / REVENUE / - EXPENSES / = NET INCOME
- 50 Equipment / -50 Retained Earnings / 50 / - 50
Account / Debit / Credit
Depreciation Expense / 50
Equipment / 50