Study: Analyze Transactions and Record Journal Entries - Part C
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Welcome to Part C of Analyze Transactions and Record Journal Entries
Remember to take the quiz at the end of this section.
Slide 15 (1m:21s)
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Invested $5,000 in the stock of ABC Co. a toy manufacturer. So that means we took $5,000, this is cash and we bought stock in another company. So we’re buying ownership in something that is worth value, part ownership of another company. That’s valuable to us. So we’re giving away cash, and in exchange we’re receiving shares of stock in a company. That’s an investment. So, let’s right this down and we’re going to say that we have investments, we have more investment by $5,000. If we have more investment, as you can see that will be a debit entry and how did we get this more investment?
We didn’t finance it, as you notice, we didn’t finance it by borrowing, or having owners contribute more, or [obtain it through our earnings], instead, we exchanged one asset for another asset. So, we gave up cash, reduced cash $5,000, and credited $5,000. As you can see, in this case, liabilities and equity are not affected at all but we have an increase in assets and a decrease in assets by exactly the same amount and we stay in balance.
Slide 16 (1m:38s)
Links to an external site.Received a $200 dividend from ABC Co. We’re receiving a dividend check, now we’re going to consider checks as cash. Now later on if the check bounces we’ll have to deal with that but, hey, when we get paid a check we’re going to assume that is cash. So, on March 28th, we received a dividend check of $200.
Now why did we get that? We got it because we earned it through a good investment. So, we’re going to have to put that down in our revenues. This will be dividend income $200 and that will flow up into our net income, and that will increase our retained earnings, you know all through the closing process, which we will talk about later, and our equity will go up.
So, as you can see, assets went up by $200. How did we finance that $200 of assets, we earned it, and we kept it in the business as owners.
What are the accounts affected? We have more cash $200 more, that would be a debit entry. And we have more dividend income. Now these dividends [income] are not the same thing as dividends that we pay, which is something that reduces our retained earnings. This [dividend income] is something we are bringing in by making a good investment. So we have more dividend income. That’s on the credit side of revenues, so we record that as a credit.
And there you go. I hope you are getting the rhythm of how these work, so you want to know this expanded accounting equation and think through what you are giving up and what you are receiving. Or, if you get an asset, how that asset was financed. That thinking will help you keep this pretty clear in your mind.
Slide 17 (1m:24s)
Links to an external site.Now STC, this is our company, we declared and paid a $100 dividend. We’re giving up $100, how does that affect equity? If we give away assets to our owners, their equity in the company is going to go down isn’t it? So we’ve got to record an entry that’s going to be a debit entry that will wind up reducing equity.
By having a journal entry that records more dividends, you can see it’s net income, this would be net income over here. Net income minus your dividends equals retained earnings. This $100 [increase in dividends] actually winds up going there [as a reduction to retained earnings], and that one’s going there [to reduce total equity]. As you can see, assets went down $100 and equity went down $100.
So let’s go back and record that entry. We have dividends that we paid, so our dividends are going up. This is not dividends we’ve earned but dividends that we’ve paid instead. We have more of those dividends and that winds up being a debit entry. As you can see it’s on the left-hand side [of dividends].
Now how did we pay it? We actually paid it in cash already. Now if we hadn’t paid it yet, if we had only declared it and we’re going to pay later, we’d have to say a liability went up, dividends payable, rather than an asset [cash] going down. Be we did pay, so we’re going to say assets went down $100 and that will be a credit.
And that’s that entry and, as you can see, it balances out.
Slides 18-19 (1m:57s)
Links to an external site.Now finally on March 31st we receive a $500 utility bill for the month of March, but to conserve cash, STC has decided not to pay it off until the following month April 15th.
Let’s think about what’s going on here. We’ve already used up a service. So, there’s no future benefit to the utilities we’ve received. So we’ve got to indicate that we’ve used up this service, by recording more expense. We’ve got utilities expense.
Now how did we pay for it? Did we already pay the cash? The answer is no, we didn’t pay yet. So, we owe payment. So we’re going to have to say we owe $500 more. So, we’ll follow this through here. You’re going to see that this increase in expenses will decrease net income, which will decrease retained earnings, which will decrease equity. So you see, equity is going down, liability is going up, assets are not affected at all.
Let’s do the journal entry. We show that we have more expense. We’re going to say utilities expense. We have more of that utility expense, $500 more. When we have more expense, that’s a debit entry as you can see, debit meaning left, and we have more liability, now this liability is going to be a payable to the utility company, so we just call it utilities payable. We have more of that liability, $500. The way we show we have more liabilities, as you can see, is to credit the account. Liabilities went up, equity went down. This whole side [liabilities + equity] has a net change of $0, that’s why [total] assets are not affected at all.
So, we’ve just run through a bunch of journal entries. I hope you’ve been able to follow the rationale and logic.
I tell you, one of the things I really enjoyed about accounting was that there was some logic to it. If I could just sit down and think “What would make sense?”, it tended to be the right answer, and that’s one thing I really, really enjoyed about accounting.
That’s the end of Part C on Analyze Transactions and Record Journal Entries. I hope you have your journal entries down now and that you’ll do great on the quiz.