Analyze transactions using double-entry accounting.
In Chapter 1, transactions for Big Dog Carworks Corp. were analyzed to determine the change in each item of the accounting equation. In this next section, these same transactions will be used to demonstrate double-entry accounting. Double-entry accounting means each transaction is recorded in at least two accounts where the total debits ALWAYS equal the total credits. As a result of double-entry accounting, the sum of all the debit balance accounts in the ledger must equal the sum of all the credit balance accounts. The rule that debits = credits is rooted in the accounting equation:
\(^1\): The issuance of share capital and revenues cause equity to increase; as indicated above, increases in equity are recorded as credits. Dividends and expenses cause equity to decrease; decreases in equity are recorded as debits.
Illustrative Problem—Double-Entry Accounting and the Use of Accounts
In this section, the following debit and credit summary will be used to record the transactions of Big Dog Carworks Corp. into T-accounts.
|Increases are DEBITED.||Increases are CREDITED.|
|Decreases are CREDITED.||Decreases are DEBITED.|
Jan. 1 – Big Dog Carworks Corp. issued 1,000 shares to Bob Baldwin, a shareholder, for a total of $10,000 cash.
*Note: An alternate analysis would be that the issuance of shares causes equity to increase and increases in equity are always recorded as a credit.
Jan. 2 – Borrowed $3,000 from the bank.
Jan. 3 – Equipment is purchased for $3,000 cash.
Jan. 3 – A truck was purchased for $8,000; Big Dog paid $3,000 cash and incurred a $5,000 bank loan for the balance.
Note: Transaction 4 involves one debit and two credits. Notice that the total debit of $8,000 equals the total credits of $8,000 which satisfies the double-entry accounting rule requiring that debits ALWAYS equal credits.
Jan. 5 – Big Dog Carworks Corp. paid $2,400 cash for a one-year insurance policy, effective January 1.
Jan. 10 – The corporation paid $2,000 cash to reduce the bank loan.
Jan. 15 – The corporation received an advance payment of $400 for repair services to be performed as follows: $300 in February and $100 in March.
Jan. 31 – A total of $10,000 of automotive repair services is performed for a customer who paid $8,000 cash. The remaining $2,000 will be paid in 30 days.
Jan. 31 – Operating expenses of $7,100 were paid in cash: Rent expense, $1,600; salaries expense, $3,500; and supplies expense of $2,000. $700 for truck operating expenses (e.g., oil, gas) were incurred on credit.
Note: Each expense is recorded in an individual account.
Jan. 31 – Dividends of $200 were paid in cash to the only shareholder, Bob Baldwin.
After the January transactions of Big Dog Carworks Corp. have been recorded in the T-accounts, each account is totalled and the difference between the debit balance and the credit balance is calculated, as shown in the following diagram. The numbers in parentheses refer to the transaction numbers used in the preceding section. To prove that the accounting equation is in balance, the account balances for each of assets, liabilities, and equity are added. Notice that total assets of $19,100 equal the sum of total liabilities of $7,100 plus equity of $12,000.