03 Every transaction (sentence in the story of what happened to the money) has to have a debit and a credit.
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1 EBB Presentation 4: Debits and Credits 01 Chapter 2: Debits and Credits 02 For the remainder of this presentation we re going to step away from the Landscaper and go back to some accounting. Now, you re ready to write a story. In this chapter you ll learn how to think through and record transactions (write sentences) using T accounts and journal entries. 03 Every transaction (sentence in the story of what happened to the money) has to have a debit and a credit. Accounting professionals use T-accounts to help them think through transactions and journal entries to record them. 04 In the pen and paper days all debit and credit transactions were recorded as journal entries. Today, computer programs like QuickBooks do the journal entries for you in the background. But, if you can t think through the transactions yourself, which means understanding what journal entries are being entered by which modules in your computer program, you ll end up with a story that doesn t make sense. 05 Journal entries can and often do contain more than one transaction. T-accounts drill each transaction down to the account level. Every T depicts an individual debit or credit under the account that it relates to. All transactions contain at least two T s, a debit and a credit. T-accounts break transactions down to their individual account components. Using them to work through transactions will help you recognize and properly record complicated transactions that sometimes seem like one transaction, but are actually several transactions. Debits and credits are confusing at first, but tracking them will begin to make sense when you start working through transactions. 06 This is my debit and credit cheat sheet. The general journal view helps you think through the whole journal entry. The T-account views help you think through individual lines in the journal entry. Green indicates an account balance increase. Black indicates an account balance decrease Educating Bookkeepers for Business, Inc. 1
2 Download it from handouts now so you can to refer to it during the presentation. 07 You can use this cheat sheet to untangle the most convoluted accounting transactions. You only have to figure out two things. Did you get or give away any money in exchange for a good or service? If you didn t get or give away any money in exchange for the good or service what did you get or give away? 08 Total debits always equal total credits. Plus and minus signs depict how an account behaves, increases or decreases not positive or negative. Debits and credits can be assigned to multiple accounts as long as total debits in the transaction equal total credits in the transaction. 09 Normal balance is the type of balance, debit or credit, a particular account is expected to have based on its classification or account type. Asset and expense accounts normally have debit balances. Equity, liability and income accounts normally have credit balances. On the cheat sheet normal balances are green. Balance sheet account balances in QuickBooks are normally positive. Exceptions are contra accounts. 10 Debiting an asset account increases the account balance. Crediting an asset account decreases the account balance. 11 Debiting a liability or equity account decreases the account balance. Crediting a liability or equity account increases the account balance. 12 Debiting an income account decreases the account balance. Crediting an income account increases the account balance. 13 Debiting an expense or cost of goods sold account increases the account balance. Crediting an expense or cost of goods sold account decreases the account balance. 14 Let s go back the new business example and start with your parents contributions to your business. You open a bank account with your parent s money. The company bank account is a current asset. The loan your father gave you is a long-term liability, since you re not likely to be able to repay it within your first year of operation. The money your mother gave you is equity. She decided to just give you the money so it s your equity. When you make the deposit you increase your bank, liability and equity account balances. You got money in exchange for a liability and some equity Educating Bookkeepers for Business, Inc. 2
3 In this transaction you have one debit and two credits, but total debits still equal total credits. The money in your bank account came from two sources, a loan from your father and a gift from your mother. 15 To record this transaction in QuickBooks, simply make a deposit. Make deposits is in the banking menu. Debit and credit entries QuickBooks makes in the background are designated by the green bubbles. Choosing a bank account makes the debit entry. Assigning the deposited money to the loan liability and owner equity accounts makes the credit entries. 16 Let s say you re a carpenter. You decide to use some of your parent s money to buy tools. These tools are assets of your business. They re fixed assets because you expect to use them for more than one year. When you buy tools you increase your tools fixed asset account balance and decrease your bank account balance. You used money to buy tools. 17 To record this transaction, in QuickBooks write a check. If you use a debit card or pay online replace the check number with the letters EFT which stand for electronic funds transfer. Write checks is in the banking menu. Assigning the check to the tools fixed asset account makes the debit entry. Choosing a bank account makes the credit entry. 18 Let s say that instead of writing a check for the tools you put them on a newly acquired company credit card. When you charge the tools to your credit card you increase your tools fixed asset and credit card liability account balances. You bought tools but you didn t give away any money. You borrowed it from the credit card company. 19 To record this transaction in QuickBooks, enter a credit card charge. Enter credit charges is in the banking menu. Assigning the credit card charge to the tools fixed asset account makes the debit entry. Entering the credit card charge makes the credit entry. 20 You pay the credit card bill in full online the day it is due. When pay your credit card bill you decrease your credit card liability and bank account balances. You used money to repay a short term loan from the credit card company. 21 To record this transaction in QuickBooks, write an EFT check to the credit card company. Write checks is in the banking menu. Assigning the check to the credit card liability account makes the debit entry. Choosing a bank account makes the credit entry Educating Bookkeepers for Business, Inc. 3
4 22 Or you could avoid credit card fees and have the tool vendor bill you. The tool vendor will give you terms like net 30 which means that you have to pay the bill within 30 days to avoid a finance charge or 2% 10, net 30 which means you will get a 2% discount if you pay within 10 days, the full amount is due in 30 days. By entering a bill into your accounting system you create an accounts payable, abbreviated A/P. When you enter the vendor bill you increase your tools fixed asset and accounts payable account balances. You bought tools but you didn t give away any money. This time you borrowed it from your vendor. 23 To record this transaction in QuickBooks, enter a bill. Enter bills is in the vendors menu. Assigning the bill to the tools fixed asset account makes the debit entry. The bill is QuickBooks way of recording the accounts payable credit entry. 24 You don t pay the bill until it s due so you get to keep the money for 30 days without paying fees or interest. When you pay the bill you decrease your accounts payable and bank account balances. You used money to pay your vendor. 25 To record this transaction in QuickBooks, pay the bill. Pay bills is in the vendors menu. Checking the bill to pay makes the accounts payable debit entry. Choosing a bank account makes the credit entry. 26 Now you re ready to get to work. You do a job and invoice the customer. By entering the invoice into your accounting system you are creating an accounts receivable, abbreviated A/R. On the invoice you indicate your terms, like due upon receipt, that tell the customer when you expect to be paid. When you enter the invoice you increase your accounts receivable and labor income account balances. You did the work, but you didn t get any money you got an accounts receivable or promise to pay. 27 To record this transaction in QuickBooks, create an invoice. Create invoices is in the customers menu. The invoice is QuickBooks way of recording the accounts receivable debit entry. Choosing the labor service item makes the labor income credit entry. All items are assigned to income accounts. Terms are assigned to particular customers, but can be customized on individual invoices Educating Bookkeepers for Business, Inc. 4
5 28 You receive payment from the customer in the form of a check. When you receive the check you increase your undeposited funds balance and decrease your accounts receivable balance. Undeposited funds are monies received from customers that have not yet been deposited. The customer fulfilled a promise to pay by giving you money, but you haven t deposited it in the bank. 29 To record this transaction in QuickBooks, you receive payment against the customers account. Receive payments is in the customers menu. Receiving payment against a customer s account is QuickBooks way of recording both the undeposited funds debit and the accounts receivable credit entries. 30 When you make the deposit you increase your bank account balance and decrease your undeposited funds balance. 31 To record this transaction in QuickBooks, make a deposit. Make deposits is in the banking menu. Click the green payments button to open the payments to deposit window. One deposit can contain multiple payments. In this case you are only depositing one check. Unchecked amounts are undeposited funds. Accountants refer to undeposited funds as cash in transit. 32 Now make the deposit. Choosing a bank account makes both the bank account debit and undeposited funds credit entries. By making these entries in the correct QuickBooks modules you are using double entry accounting to apply the matching and realization principles. 33 Once your business is established i.e. you have a steady stream of customers you decide that you need to start maintaining a parts inventory so you purchase some parts from your tool vendor who also sells parts. You bring the parts back to your shop to be stored until you sell them to a customer or use them on a job. Inventory is a current asset. Inventory does not become cost of goods sold until you take it off the shelves or out of inventory, and sell it to a customer. 34 There are a number of acceptable ways to determine the value of your inventory. The four inventory valuation methods you re most likely to see are LIFO, FIFO, average cost and standard cost Educating Bookkeepers for Business, Inc. 5
6 LIFO stands for last in first out which means that the last unit purchased is the first unit sold. An example of an industry that uses this method is the garment business. Last year s outfit is worth less this year because it is no longer in vogue. FIFO stands for first in first out which means that the first unit purchased is the first unit sold. Most small businesses that don t use average cost use FIFO. QuickBooks values inventory using the average cost method which is computed by dividing the total cost of units available for sale by the total number of units available for sale. Standard cost is generally used by companies that have long term contracts with their vendors. Most high end accounting systems default to the standard cost method. The cost of a unit is set and any variance from the set price is accrued or accumulated in a variance account. The inventory valuation method used is determined by the company accountant. You just need to know which one your business is using. 35 This is the way QuickBooks calculates average cost. The average cost of an item is the total cost of items currently in stock divided by the number of units of the item in stock. QuickBooks recalculates the average cost of an item every time more units of the item are purchased. It adds the cost of the new items to the cost of the old stock then divides by the total number of new and old items. FIFO is also available, but only as an add-on to the enterprise version of QuickBooks. The add-on is called Enterprise Solutions Advanced Inventory. 36 This is the back-of-the envelope cost of goods sold calculation. Start with your beginning inventory balance and add total purchases for the period to get the cost of goods available for sale. Then subtract your ending inventory balance to get the cost of goods sold. This is a quick way to double check your cost of goods sold number. 37 In an inventory scenario freight is usually considered a cost of goods sold. This is the accounting vernacular that identifies the party responsible for paying the shipping costs. Freight in also known as freight or free on board shipping point means that the buyer pays. Freight out also known as freight or free on board destination point means that the seller pays. You avoid freight costs by picking up your parts up instead of having them delivered. 38 When you enter the parts bill from your vendor you increase your inventory and accounts payable account balances. You bought parts by borrowing money from your vendor for 30 days Educating Bookkeepers for Business, Inc. 6
7 39 To record this transaction, in QuickBooks enter a bill. Enter bills is in the vendors menu. By choosing an item instead of an expense you are assigning individual items to an inventory account through the item module. Inventory quantities are also maintained in the item module. Using an inventory item on the bill records the inventory account debit entry. Entering the bill makes the accounts payable credit entry. 40 Selling inventory is one of those transactions that seems like one transaction but is actually two. Inventory becomes cost of goods sold when you use it on a job or sell it to a customer. In the first transaction, you take parts off the shelves to sell them to a customer or use them on a job. When you take the parts out of inventory you increase your cost of goods sold balance and decrease your inventory balance. 41 In the second transaction, you generate income because now you ve sold the parts to a customer. Recording the sale increases either your undeposited funds or accounts receivable and materials income balances. QuickBooks makes both of these entries for you in the background when you record the sale. The first transaction is done in the items module. The second transaction is done one of two ways, through a sales receipt or an invoice. 42 If you sell the parts to a customer at the point of sale you use a sales receipt. Point of sale is like a cash register. Payment is received at the point of sale. Entering a sales receipt increases your undeposited funds and materials income account balances. You sold parts and got money but you haven t deposited it in the bank. 43 To record this transaction, in QuickBooks enter a sales receipt. Enter sales receipts is in the customers menu. The payment method you choose makes the undeposited funds debit entry. Payment methods are payment items. By choosing an inventory item instead of an expense you are assigning individual items to income, cost of goods sold and inventory accounts through the item module. All items are assigned to income accounts. Some items are also assigned to cost of goods sold or expense accounts. Inventory items are assigned to income, cost of goods sold and inventory accounts so that QuickBooks can make the materials income credit, cost of goods sold debit and inventory credit entries for you in the background. 44 If you use the parts on a job you create an invoice. When you create the invoice you increase your accounts receivable and materials income account balances. You didn t get paid for the parts you got a promise to pay Educating Bookkeepers for Business, Inc. 7
8 45 To record this transaction in QuickBooks, create an invoice. Create invoices is in the customers menu. The invoice makes the accounts receivable debit entry. When you add an inventory item to the invoice QuickBooks makes the materials income credit, cost of goods sold debit, and inventory credit entries for you in the background. 46 Now that you ve gotten the idea, download the debit and credit exercise and answer key PDFs from handouts and practice working through some transactions on your own. You can also download a PDF transcript of this chapter. 47 Take some time to think about debits and credits. Again, don t over think them. Tracking debits and credits will make more sense when you start entering transactions. The landscaper file is now set up. In Presentation 5 you will enter transactions Educating Bookkeepers for Business, Inc. 8
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