Study: Analyze Transactions and Record Journal Entries - Part B
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Welcome to Introduction to Accounting Preparing for a User’s Perspective
Analyze transactions and record journal entries – Part B
Hopefully you did well recording the transactions from Part A, this is now Part B, good luck on the quiz at the end of this part.
Slide 11 (3m:54s)
Links to an external site.
Now we are to one of the hardest journal entries for students to learn because there are actually two pieces of this transaction going on, there is what you gave and what you received. So what I want you to do whenever you have a transaction when you are selling inventory to a customer and receiving payment or getting promised to receive payment, think of it as two different things (i.e. transactions).
March 6, 20X1: We sold inventory costing $3,000. Let’s just focus on that part. You gave away inventory costing $3,000 and when you give away inventory to bring about a sale, that’s an expense. Your assets are flowing out in order to generate a sale, so we’ve got to record an expense. We have more of this expense.
So as you can see, assets went down and as this [expense] comes up, this debit will flow up and become a negative over here in equity. So assets will go down and equity will go down. That’s the first part of this transaction.
The second part is “What did we get in return?”. So we gave something up and incurred and expense, but what did we get in return? We got a promise to be paid $5,000. From prior videos you would know that a promise to be paid, is called an account receivable. That’s an asset so we have more of this promise to be paid of $5,000 and how did we get it? How did we finance this promise to be paid? Well we financed it not because we borrowed the money but because of running the business successfully; therefore, equity for the owners will go up because we made a sale, we have more sales revenue.
Let’s put down the account names, so here on March 6th we have more assets called account receivable, as you notice, we have more of it. How much more? $5,000. If we have more assets, that’s going to be a debit. You can see I am going through all four questions , line-by-line.
What’s the matching part of this entry? We have more assets. Why? Because we made a sale. That is called sales revenue. We have more sales revenue as you can see. When we have more sales revenue, as you can see, it’s on the credit side. So we have to record it as a credit. As you can see, debits equal credits. That will make sure the balance sheet balances.
Next, we have less inventory, so less assets and more expenses. I like to put the debit side first. So I am going to write that down, cost of goods sold. We have more of that, so we need to say we have more of that. That’s an increase of $3,000. When you increase an expense, as you can see, that’s a debit. We decrease an asset, this asset is inventory because that is what we gave away. We decreased it $3,000. When you decrease an asset, that will be a credit entry.
I strongly recommend you study this entry because students really, really struggle with this. If you see how this winds up keeping the balance sheet in balance, [the net of] your revenues and expenses will effectively increase net income by $2,000. These [revenues and expenses] will be closed out [into net income] those will become zero, and then net income gets closed into retained earnings $2,000, and your equity will effectively be increased by $2,000 because capital stock and retained earnings added together will be equity.
Over on the asset side, we have a net change, it went up by $5,000 and went down by $3,000. That’s a net increase of $2,000 and equity [had] a net increase of $2,000. So, if you just kind of look at it from here above, it’s in balance isn’t it? The net change, increase of $5,000 minus $3,000, will be $2,000 and it balances.
Slide 12 (1m:24s)
Links to an external site.March 7th, 20X1: Incurred, but didn't pay yet, a $100 sales commission (i.e. 2% of the sale) to the independent sales contractor who helped generate the March 6th sale.
2% of $5,000 [representing the sales amount] is going to be $100. So, in this case, we have to recognize that we have an expense related to this sale. So we have more expense. This is a commission, representing more commission expense, but we haven’t paid yet, so we are not going to reduce our assets. We do have to say we owe more, this is like commissions payable, or something like that. You will see this expense rolls up into net income by reducing net income, retained earnings will be reduced and overall equity will be reduced.
So we have our liabilities go up $100 and our equity goes down by $100.
Let’s put it into journal entry form.
We have commission expense that went up by $100. If an expense goes up, it’s a debit entry. And commission payable, also increased by $100, but since it is a liability, that is a credit entry. You should see that assets were not affected by this entry, but liabilities went up by the same amount that equity went down and that is why this remains in balance.
Slide 13 (1m:12s)
Links to an external site.March 8, 20X1: Paid off $4,000 of the accounts payable owed [from the March 2nd inventory purchase]. When you hear “paid off”, that means, cash was used. So we paid off, got rid of some assets called cash $4,000 and we paid off accounts payable, so our accounts payable are not going up, they are going down $4,000. As you can see, assets went down, liabilities went down.
Let’s record the entry. We have cash going down and accounts payable going down, so let’s do accounts payable going down first. The reality is it doesn’t really matter which order you put it in as long as you get your debits and credits correct.
So, accounts payable decreased by $4,000. A decrease in a liability, which is what accounts payable are, requires a debit.
And a decrease in asset, in this case this is a cash asset, it’s going to be decreased $4,000. So, if you decrease an asset, that’s got to be on the credit side $4,000 and as you can see, debits equal credits and the decrease on the asset side equals the decrease on the liability and equity side and we stay in balance. Every one of these entries will keep this equation in balance.
Slide 14 (1m:08s)
Links to an external site.March 10, 20X1: Collected $4,000 from the sale made to the customer on March 6th. Now be careful, we already recorded the sale[s revenue]. So, do not record the sales revenue again, otherwise you would be double-counting and you’re going to go to prison. So, don’t do that. That’s a bad idea.
But we collected $4,000, so if you collected, that means you got more asset called cash and got it from the customer. Well that means they already owed us, so we have an account receivable, which we’ve now given up because we got paid. So that means an asset called account receivable went down.
Let’s record the entry.
The accounts are cash, which we got more of, by $4,000, an increase in cash would be a debit, and we have less account receivable because we had a customer who satisfied their obligation to pay us. So that means our asset called account receivable is going down, if you reduce an asset, that will be a credit.
There you go. Isn’t this fun?
That’s the end of Part B, I hope you do well on the journal entries of the quiz and then move on to Part C.