Chapter 5
1
Expanding the
Ledger
2
Real Life: Personal Net Worth
Statement and the Budget
3
Expanding the Ledger
Through the first four chapters we have
looked at the fundamental accounting
equation …
Assets = Liabilities + Owner’s Equity
This resulted in a single account for
owner’s equity.
By “default”, what types of entries have
you charged to owner’s equity?
4
Types of OE Entries?
1. Owner’s investment in the company.
2. Revenues from the sale of goods or
by providing a service.
3. Expenses related to the operation of
the business and the generation of
revenues.
4. Drawings or owner’s withdrawals
from the business for personal use.
5
Expanding the Ledger
 The focus of Chapter 5 is the specific
identification and use of accounts to
track …
REVENUES
EXPENSES
DRAWINGS
6
Expanding the Ledger
 The purpose of expanding the ledger
is to provide essential information
about the progress of the business.
 This information is needed to assess
the ongoing profitability of the
company.
 What do we mean when we say a
company is profitable or making a
profit?
 What is meant by loss?
7
Example of Expanding the Ledger
What do we know about profitability of
this firm in the month of January?
Did they make a profit or a loss?
8
Example of Expanding the Ledger
How much was spent on

advertising?

Are the wages fair?

Is the rent too high?
How much did the

owner withdraw from
the business?
What types of economic events can we
“speculate” impacted the owner’s
equity account?
9
Example of Expanding the Ledger
Now … what can we
determine
Owner’s Equity
about the profitability of
this firm?
$26,137
10
Expanding the Ledger
There are four types of accounts in the
equity section:
1. Capital – this account will now contain
only the equity figure at the beginning
of the fiscal period plus new capital
from the owner.
2. Revenues – increases in equity
resulting from the sale of goods or
services. A revenue account normally
has a credit balance.
11
Expanding the Ledger
3. Expenses – decreases in equity
resulting from the costs of the materials
or services used to produce the
revenue. An expense account normally
has a debit balance.
4. Drawings – decreases in equity resulting
from the owner’s personal withdrawals.
A drawings account normally has a debit
balance. Drawings are NOT a factor in
calculating net income or loss.
12
Revenue
 What is revenue?
 Selling goods or services produces
revenue.
 What impact does revenue have
on equity?
 Revenue is an increase in equity
resulting from the sale of goods or
services in the usual course of
business.
13
Revenue
 A company is paid $500 for
services rendered.
 Before using revenue accounts:
Dr. Cash
$500
Cr. Owner’s Equity
$500
 Using revenue accounts:
Dr. Cash
$500
Cr. Revenue
$500
14
Revenue
How do revenue accounts “behave”?
Assets
Debit Credit
(DR)
Normal
Balance
(CR)
=
Liabilities
Debit Credit
(DR)
+
(CR)
Normal
Balance
Owner’s Equity
Debit Credit
(DR)
(CR)
Normal
Balance
Revenue
Debit Credit
Revenue represents an increase in equity.
(DR)Revenue
(CR)
Is
Does
the
“Normal
An increase in equity requires a credit entry.
Therefore, to book revenue, credit the revenue Balance”
Normal
typically
of a
account.
Balance
increase
Revenue or
a DR
decrease
or CR?
Owner’s Equity?
15
Expenses
 What are expenses?
 The costs associated with
producing revenue.
 What impact do expenses have
on equity?
 Expenses represent a decrease in
equity resulting from the cost of
producing revenue.
 Examples????
16
Expenses
 A company pays wages of $250.
 Before using expense accounts:
Dr. Owner’s Equity
Cr. Cash
$250
$250
 Using expense accounts:
Dr. Wages Expense
Cr. Cash
$250
$250
17
Expenses
How do expense accounts “behave”?
Assets
Debit Credit
(DR)
Normal
Balance
(CR)
=
Liabilities
Debit Credit
(DR)
(CR)
Normal
Balance
+
Owner’s Equity
Debit Credit
(DR)
(CR)
Normal
Balance
Expenses
Debit Credit
(DR) “Normal
(CR)
Do Expenses
Is the
typically
Expenses represent a decrease in equity.increase
Normalor decrease
Balance”
of an
A decrease in equity requires a debit entry.
Balance
Owner’s
a DR
Equity?
or CR?
Therefore, expense accounts are typicallyExpense
debited.
18
Drawings
 The owner usually looks to the
profits of the business to provide a
livelihood.
 In a healthy business, the owner is
able to take funds (generated by
profits) out of the business.
 These withdrawals of funds, by the
owner, are known as Drawings and
decrease equity.
19
Drawings
 Drawings are NOT expenses.
 They are not associated with
producing revenue.
 Drawings have nothing to do with the
determination of the net income or
net loss.
 Cash is the most common item
withdrawn by an owner for personal
use.
20
Drawings
 An owner withdraws $500 for
personal use.
 Before using expense accounts:
Dr. Owner’s Equity
$500
Cr. Cash
$500
 Using drawings accounts:
Dr. O. Owner, Drawings $500
Cr. Cash
$500
21
Expanded Basis Equation and Debit
/ Credit Rules
Assets
Assets
Dr.
Cr.
=
=
Liabilities
Liabilities
Dr.
Cr.
+
+
Owner’s Equity
Owner’s
Capital
Dr.
+
-
Cr.
Dr.
Revenues
Dr.
Owner’s
Drawings
Cr.
-
Cr.
Expenses
Dr.
Cr.
22
Chart of Accounts


To help organize the expanded ledger, it is
customary to number the accounts in the
ledger. These numbers are used for
identification and reference, particularly in
computer systems.
We will be using a computer system, Simply
Accounting, later in the semester. The chart of
accounts used by Simply Accounting is:





Assets
Liabilities
Capital & Drawings
Revenue
Expenses
1000 – 1999
2000 – 2999
3000 – 3999
4000 – 4999
5000 – 5999
23
Class / Homework
Complete each statement with a DR or CR
a)
The Bank account normally has a ____ balance.
b)
A Revenue account normally has a ____ balance.
c)
An Expense account normally has a ____ balance.
d)
Paying a creditor involves a ____ entry to the creditor’s
account.
e)
The Drawings account receives a ____ entry when the
owner withdraws money for personal use.
f)
A lawyer gives a cash refund to a customer. The Bank
account will receive a ____ entry and the Revenue
account will receive a ____ entry.
g)
Supplies are bought on credit. The Supplies account will
receive a ____ entry and the supplier’s account payable
24
will receive a ____ entry.
Class / Homework
Complete each statement with a DR or CR
h)
The Drawings account will not normally receive ____
entries.
i)
An increase in equity can be thought of as a ____ to the
Capital account.
j)
Net Income can be thought of as a ____ to the Capital
account.
k)
Net Loss can be thought of as a ____ to the Capital
account.
l)
The owner takes a computer from the business for his
personal (permanent) use. The Drawings account will
receive a ____ entry.
25
The
Income
Statement
26
Income Statement

REVENUES
Some of the information from these
&
new accounts will be used to prepare
EXPENSES
an Income Statement.
 What do you think an Income
Statement is?

An Income Statement
What accounts do
you in
think
we
shows,
detail,
whether
the business
is profitable or
would use to prepare
in Income
not … it shows if the
Statement?
company made a
profit or loss.
27
Note
Whatthe
does
Sample
this show?
formatting
Income Statement
28
Net Income or Net Loss
 Using the revenue and expense
accounts, a business can determine if
they have earned a net income
(profit) or a net loss.
 Net Income is the difference between
the total revenues and total
expenses, where the revenues are
greater than the expenses.
 A Net Loss is created if expenses are
greater than the revenues.
29
The Income Statement
 The income statement tells the
owners and the managers how the
business is doing.
 By definition, an income statement is
a financial statement that
summarizes the items of revenue
and expense, and shows the net
income or net loss of a business for a
given period of time.
30
The Income Statement
 Who uses the Income Statement?
1. Owners and Managers
 Shows if the business is making profit.
 Used for setting goals and policy.
 When compared to previous years, it
provides a trend … highlighting potential
problems.
2. Bankers
 Supports loan decisions.
 Past profitability is one indicator of future
potential.
31
The Income Statement
 Who uses the Income Statement?
3. Income Tax Authorities
 Every business is required by law to
prepare an income statement.
 The net income figure of a proprietorship
must be included on the owner’s income
tax return.
 Corporations must file their own tax
returns.
 The income statement must be sent to the
government along with the tax returns.
32
The word
“expense” is not
always required.
Why?
Date?
In what
order are
The accounting
expenses
listed?
period for which
the figures have
been
accumulated
A company
can
have more than
one source of
Net Income
is not
revenue.
cash. It is the
difference
between total
revenues and total
expenses.
33
Homework
Section 5.1 Review
Questions 1-3,7-16,18-21
Section 5.1 Exercises 1-4
34
Equity Transactions
and Accounting
Principles
35
Revenue
 A company is paid $500 for
services rendered.
 Before using revenue accounts:
Dr. Cash
$500
Cr. Owner’s Equity
$500
 Using revenue accounts:
Dr. Cash
$500
Cr. Revenue
$500
36
Expenses
 A company pays wages of $250.
 Before using expense accounts:
Dr. Owner’s Equity
Cr. Cash
$250
$250
 Using expense accounts:
Dr. Wages Expense
Cr. Cash
$250
$250
37
Drawings
 An owner withdraws $500 for
personal use.
 Before using expense accounts:
Dr. Owner’s Equity
$500
Cr. Cash
$500
 Using drawings accounts:
Dr. O. Owner, Drawings $500
Cr. Cash
$500
38
Expanded Basis Equation and Debit
/ Credit Rules
Assets
Assets
Dr.
Cr.
=
=
Liabilities
Liabilities
Dr.
Cr.
+
+
Owner’s Equity
Owner’s
Capital
Dr.
+
-
Cr.
Dr.
Revenues
Dr.
Owner’s
Drawings
Cr.
-
Cr.
Expenses
Dr.
Cr.
39
Fiscal Period
 Net income is measured over a
specific length of time, known as the
fiscal period.
 The formal fiscal period is typically
one year.
 The fiscal year does not have to be
the calendar year … it just has to
run for 12 consecutive months (or in
some cases, 52 consecutive weeks)
40
Accounting Period

The text indicates that the fiscal period is
sometimes referred to as the accounting
period.

Companies prepare financial statements
periodically in order to assess their financial
condition and operating results. Accounting
periods are typically one month, one quarter,
or one year.

If a company uses a one year accounting period
(i.e. they only prepare financial statements at
year end) it is referred to as their fiscal period
or fiscal year.
41
GAAP
The Time Period Concept
The time period concept provides
that accounting will take place over
specific time periods known as fiscal
periods.
What does this mean?
Companies must use fiscal periods of
equal length when measuring financial
progress.
42
GAAP - Revenue Recognition
The revenue recognition convention
states that revenue must be recorded
in the accounts (i.e. recognized)
at the time the transaction is
completed.
What does this mean?
Revenue is recorded when the bill is
sent to the customer.
For a cash transaction, revenue is
recorded when the sale is complete and
the cash is received.
43
GAAP
The Matching Principle
The matching principle states that
each expense item related to
revenue earned must be recorded in
the same period as the revenue it
helped earn.
What does this mean?
Expenses must be recorded in the
period in which the revenue is
recognized.
To do this, accountants make a number
of mathematical adjustments in the
accounts at the end of a fiscal year.
44
Homework
Section 5.2 Review
Questions 2, 4, 6, 8
Section 5.2 Exercises 1-5
45
Equity
Relationship
and the Balance
Sheet
46
Beginning
Capital
$21,878
Drawings
$3,950
Ending
Capital
$26,137
(Beg + Inc)
Total
Income
$23,660
Increase
in Equity
$4,259
(NI – Drawings)
Net
Income
$8,209
(Rev – Exp)
Total
Expenses
$15,451
Beginning
Net
Net
Ending
Drawings
Capital + Income -- Loss -= Capital
$21,878
$8,209
$n/a
$26,137
$3,950
47
For
Thethis
equity
balance
section
sheet,
clearly
the describes
what
ASSETS
happened
section during
is placed
the month of
January.
on top ofEve
the Boa
LIABILITIES
started the month
with
and aEQUITY
$21,878
sections
claim on
… the assets.
Since
instead
the
ofNet
beside
Income
them.
was greater
This
thanformat
her drawings
is referred
by $4,259,
to
her
asclaim
the report
on theform
assets
ofincreased
the
to
balance$26,137.
sheet.
48
Homework
Section 5.3 Review
Questions 1-7
Section 5.3 Exercises 1-3
49
Chapter Review
Review Exercises 1-2, 4-7
50