IMPORTANT: Rotate your smartphone to landscape mode or use a laptop for proper display of journal entries.
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Journal Entries Only
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On January 1st, the owner invested $100,000 cash into Survive Company in exchange for common stock. Record the journal entry for Survive Company.
Cash 100,000
Common Stock 100,000
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On January 1st, the owner invested $100,000 of equipment, $50,000 of land, and a $20,000 truck into Survive Company in exchange for common stock. Record the journal entry for Survive Company.
Equipment 100,000
Land 50,000
Truck 20,000
Common Stock 170,000
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On Jan 5th, Survive Company pays $1000 cash for supplies.
Supplies 1,000
Cash 1,000
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On Jan 5th, Survive Company purchases $1000 worth of supplies on credit.
Supplies 1,000
Accounts Payable 1,000
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On January 1st, Survive Company purchases $1000 worth of supplies on credit.
Original Entry on Jan 1:
Supplies 1,000
Accounts Payable 1,000
On January 10th, Survive Company pays $1000 cash for the supplies previously purchased on credit.
Subsequent Entry on Jan 10:
Accounts Payable 1,000
Cash 1,000
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On Jan 5th, Survive Company pays $10,000 cash for equipment.
Equipment 10,000
Cash 10,000
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On Jan 5th, Survive Company purchases $10,000 worth of supplies on credit.
Equipment 10,000
Accounts Payable 10,000
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On January 1st, Survive Company purchases $1000 worth of supplies on credit.
Original Entry on Jan 1:
Supplies 1,000
Accounts Payable 1,000
On January 10th, Survive Company pays $1000 cash for the supplies previously purchased on credit.
Subsequent Entry on Jan 10:
Accounts Payable 1,000
Cash 1,000
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On July 1st, 2023, Survive Company pays $12,000 in cash for a 12-month insurance policy.
Original Entry on July 1:
Prepaid Insurance 12,000
Cash 12,000
Looking to get a headstart on Chapter 3? Here's an explanation of the Adjusting Entry on 12/31.
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Adjusting Entry on Dec 31: On December 31st, 2023, an adjusting entry is required to recognize the insurance expense for the portion used during the year, a concept we’ll delve into in chapter 3. Insurance Expense 6,000 Prepaid Insurance 6,000
The $6,000 Insurance Expense that was debited is calculated as follows:
- The $12,000 paid for the 12-month policy works out to a monthly cost of $1,000.
- From July 1st to December 31st, a total of six months have elapsed.
- Six months at $1,000 per month gives us an Insurance Expense of $6,000.
- We debited the expense to increase it, which is how we recognize an expense — since all expense accounts work like (+/-).
The $6,000 Prepaid Insurance that was credited is calculated as follows:
- On July 1st, we debited Prepaid Insurance for $12,000.
- By December 31st, six months of the policy have been utilized, leaving only half of the initial policy value intact.
- If we don't reduce the Prepaid Insurance account by crediting it, our balance sheet would inaccurately represent an overstated value for our prepaid insurance.
- Consequently, we must credit Prepaid Insurance, an asset account, to decrease it to the correct remaining amount.
- Refer to the T Account below for reference.
On August 31st, 2023, Survive Company pays $24,000 in cash for a 12-month lease on a building. The journal entry is:
Original Entry on Aug 31:
Prepaid Rent 24,000
Cash 24,000
Looking to get a headstart on Chapter 3? Here's an explanation of the Adjusting Entry on 12/31.
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Adjusting Entry on Dec 31: On December 31st, 2023, an adjusting entry is required to recognize the rent expense for the portion used during the year, a concept we’ll delve into in chapter 3.
Rent Expense 8,000 Prepaid Rent 8,000
The $8,000 Rent Expense that was debited is calculated as follows:
- The $24,000 paid for the 12-month lease works out to a monthly cost of $2,000.
- 24,000 / 12 months = 2,000 per month
- From August 31st to December 31st, a total of four months have elapsed.
- Four months at $2,000 per month gives us an Rent Expense of $8,000.
- We debited the expense to increase it, which is how we recognize an expense — since all expense accounts work like (+/-).
The $8,000 Prepaid Rent that was credited is calculated as follows:
- On August 31st, we debited Prepaid Insurance for $24,000.
- By December 31st, four months (4/12) of the lease have been used, leaving eight months (8/12) of the lease remaining.
- If we don't reduce the Prepaid Rent account by crediting it, our balance sheet would inaccurately represent an overstated value for our prepaid rent.
- Consequently, we must credit Prepaid Rent, an asset account, to decrease it to the correct remaining amount.
- Refer to the T Account below for reference.
On January 1st, Survive Company pays $180,000 in cash for a 36-month advertising contract. The contract will be delivered evenly each month.
Original Entry on Jan 1:
Prepaid Advertising 180,000
Cash 180,000
Looking to get a headstart on Chapter 3? Here's an explanation of the Adjusting Entry on 12/31.
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Adjusting Entry on Dec 31: On December 31st, an adjusting entry is required to recognize the advertising expense for the amount used during the year, concept we’ll discuss in Chapter 3. Advertising Expense 60,000 Prepaid Advertising 60,000
The $60,000 Advertising Expense that was debited is calculated as follows:
- The $180,000 paid for the 36-month advertising contract works out to a monthly cost of $5,000.
- 180,000 / 36 months = 5,000 per month
- From January 1st to December 31st, a total of twelve months have elapsed.
- Twelve months at $5,000 per month gives us an Advertising Expense of $60,000.
- We debited the expense to increase it, which is how we recognize an expense — since all expense accounts work like (+/-).
The $60,000 Prepaid Advertising that was credited is calculated as follows:
- On January 1st, we debited Prepaid Advertising for $180,000.
- By December 31st, twelve months out of thirty six (12/36) of the contract have been used, leaving 24 months (24/36) remaining.
- If we don't reduce the Prepaid Advertising account by crediting it, our balance sheet would inaccurately represent an overstated value for our prepaid advertising.
- Consequently, we must credit Prepaid Advertising, an asset account (+/-), to decrease it to the correct remaining amount.
- Refer to the T Account below for reference.
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On Nov 30th, Survive Company pays $10,000 cash for utilities over the previous month.
Utilities Expense 10,000
Cash 10,000
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On Nov 30th, Survive Company pays $150,000 cash for an advertising contract that concluded last month.
Advertising Expense 150,000
Cash 150,000
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On October 31st, Survive Company receives $240,000 cash in advance for a 12-month consulting contract delivered evenly each month.
Record the journal entry on 10/31 for Survive Company, and any necessary adjusting entry on 12/31.
Cash 240,000
Unearned Revenue 240,000
Looking to get a headstart on Chapter 3? Here's an explanation of the Adjusting Entry on 12/31.
Deeper Explanation for why Unearned Revenue was debitedDeeper Explanation for why Fees Earned was credited
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Adjusting Entry on Dec 31: On December 31st, 2023, an adjusting entry is required to recognize the unearned revenue that was “earned” during the year, a concept we’ll delve into in chapter 3.
Unearned Revenue 40,000 Fees Earned 40,000
Here's how we get the $40,000:
- The total contract value of $240,000 is split evenly over the course of 12 months, leading to an 'earned' revenue of $20,000 per month.
- (240,000 / 12 = 20,000)
- By the end of December, two months of service have been delivered, thereby earning $40,000 in revenue (2 months x $20,000 per month).
- This earned amount of $40,000 is then debited from Unearned Revenue, a liability account (-/+), and credited to Fees Earned, a revenue account (-/+), reflecting a decrease in the liability and an increase in revenue.
This adjustment ensures that the financial statements of the company accurately represent its financial position and earnings performance. It adheres to the revenue recognition principle which mandates that revenues must be recognized in the accounting period in which the services were actually delivered.
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- On December 31st, we debited Unearned Revenue, a liability account (-/+), in order to decrease it.
- This accurately shows that we now owe $40,000 less for the consulting contract as we've already provided two out of twelve months of contract.
- To view it differently: If we failed to debit (i.e. decrease) Unearned Revenue, our balance sheet would falsely represent a higher liability. It would seem as though we owe more services than we actually do.
- To illustrate, imagine the company forgot to record this adjusting entry. Consequently, our balance sheet on 12/31 would incorrectly show $240,000 in services owed, whereas the actual figure should be $200,000!
- Therefore, it's essential to debit Unearned Revenue to adjust it to the accurate remaining value of services we're obligated to deliver.
- Refer to the T Account below for reference.
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- On December 31st, we credited Fees Earned, a revenue account (-/+), in order to increase it.
- This accurately captures that we've earned $40,000 from the consulting contract, having delivered two out of twelve months of service.
- To view it differently: If we didn't credit (increase) Fees Earned, our income statement would not fully represent our earnings.
- For instance, if we neglected to record this adjusting entry, our income statement on 12/31 would fall short by $40,000 in revenue.
- Therefore, it's crucial to credit Fees Earned to record the accurate amount of revenue we've generated from services performed.
- This adjusting entry also ensures adherence to the revenue recognition principle. It states that revenues must be captured as they're earned, and in the same period they occur. In other words, failing to record this adjusting entry on 12/31, the final day of the year, would mean missing out on reporting this revenue in the correct year!
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On Sept 30th, Survive Company receives $200,000 cash for services completed for a customer.
Cash 200,000
Fees Earned 200,000
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On Sept 30th, Survive Company provided $200,000 worth of services for a customer on credit.
Accounts Receivable 200,000
Fees Earned 200,000
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On Sept 30th, Survive Company provided $200,000 worth of services for a customer on credit.
Original Entry on Sept 30:
Accounts Receivable 200,000
Fees Earned 200,000
On October 10th, Survive Company receives $200,000 cash for the services previously performed on credit.
Subsequent Entry on Oct 10:
Cash 200,000
Accounts Receivable 200,000
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On Dec 31st, Survive Company pays $220,000 in cash dividends to it’s owners and investors.
Dividends 220,000
Cash 220,000
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📌 Accounts Receivable and Accounts Payable are often confused by students. Check out this brief comparison below to help you avoid common mistakes on exams.
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- Accounts Receivable is an asset account (+/-) that tracks the cash we anticipate receiving from customers in the future.
- In other words, “receivable” means we will receive cash later.
- We increase the Accounts Receivable account when we expect cash to be received in the future, such as when we offer services on credit and invoice the customer for future payment.
- We decrease the Accounts Receivable account when we receive the cash the customer originally owed us, indicating less cash is due. If a customer settles the full amount, the balance on Accounts Receivable returns to zero.
- See journal entry examples in sequential order below.
- To make Receivables easier to remember, consider visualizing these situations in reverse order.
- For instance, imagine you're receiving cash for services previously offered on a credit basis.
- From the Cash Cheat Code, would already know that receiving cash must mean we are debiting cash, so Accounts Receivable must be the credit!
- However, we can’t just credit Accounts Receivable out of thin air. It had to have originated from another transaction — such as providing services on credit!
- To summarize:
- If we're aware that Accounts Receivable represents expected future cash receipts, then when the cash is received, we would debit the cash account and credit Accounts Receivable.
- This indicates that in the prior transaction, Accounts Receivable was debited!
- This type of “forward and backward” understanding really levels up your game to ensure you don’t fall for the tricks around Receivables in your exam.
Entry for when we provide services on credit.
→ Accounts Receivable 200,000
Fees Earned 200,000
Entry for when we receive cash for those services provided on credit.
Cash 200,000
→ Accounts Receivable 200,000
→ Notice that we first debit Accounts Receivable, an asset account (+/-), to indicate that expect to receive cash from a customer later.
→Later, when we receive this amount, we credit Accounts Receivable, reducing its balance to reflect the decrease in our future cash receipts.
See Also: Memorization Trick for Receivables
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Entry for when we receive cash for those services provided on credit.
Cash 200,000
→ Accounts Receivable 200,000
Entry for when we provide services on credit.
→ Accounts Receivable 200,000
Fees Earned 200,000
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- Accounts Payable is a liability account (-/+), representing the amount of cash we anticipate to pay to our suppliers or creditors (i.e. those we owe money to) in the future.
- In other words, “payable” means we will pay cash later.
- We increase the Accounts Payable account when we expect cash to flow out in the future, such as when we purchase supplies on credit and agree to pay the supplier at a later date.
- We decrease the Accounts Payable account when we pay off the cash that we originally owed to our suppliers, indicating less cash is due. If a supplier is paid the full amount, the balance on Accounts Payable returns to zero.
- See journal entry examples in sequential order below.
- To make Payables easier to remember, consider visualizing these situations in reverse order.
- For instance, imagine you're paying cash for supplies previously purchased on credit.
- From the Cash Cheat Code, would already know that paying cash must mean we are crediting cash, so Accounts payable must be the credit!
- However, we can’t just payable Accounts Payable out of thin air. It had to have originated from another transaction — such as purchasing supplies on credit!
- To summarize:
- If we're aware that Accounts Payable represents expected future cash payments, then when the cash is paid, we would credit the cash account and debit Accounts Payable.
- This indicates that in the prior transaction, Accounts Payable was credited!
- This type of “forward and backward” understanding really levels up your game to ensure you don’t fall for the tricks around Payables in your exam.
Entry for when we purchase supplies on credit.
Supplies 100,000
→ Accounts Payable 100,000
Entry for when we later pay cash for those same supplies purchased on credit.
→ Accounts Payable 100,000
Cash 100,000
→ Notice that we first credit Accounts Payable, a liability account (-/+), to indicate that we owe an amount.
→Later, when we pay this amount off, we debit Accounts Payable, reducing its balance to reflect the decrease in our outstanding liability.
See Also: Memorization Trick for Payables
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Entry for when we later pay cash for those same supplies purchased on credit.
→ Accounts Payable 100,000
Cash 100,000
Entry for when we purchase supplies on credit.
Supplies 100,000
→ Accounts Payable 100,000
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- One common error is attempting to include both Accounts Receivable and Accounts Payable in the same journal entry. This isn't feasible because a single transaction cannot simultaneously increase the cash we expect to receive (Accounts Receivable) and the cash we owe to others (Accounts Payable). In other words, you can’t be on both sides of a transaction at the same time. Don’t twist your head up too much!
- Another common misunderstanding is that Accounts Receivable indicates money we owe others when, in fact, it represents money others owe us. The opposite is true for Accounts Payable - it doesn't signify money others owe us, but what we owe to others.
The list above showcases commonly-tested journal entries.
Please remember, these are illustrative examples, utilizing hypothetical numbers purely for explanatory purposes. They're designed to help you understand the mechanics of interpreting business transactions into journal entries.
While these examples serve as a foundation, they might not encompass every possible scenario. Always consult with your professor regarding any additional or specific entries that might be vital for your exam.
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Journal Entries with Explanations
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📌 When owners invest cash or other assets in the business, the company often issues common stock in return.
On January 1st, the owner invested $100,000 cash into Survive Company in exchange for common stock. Record the journal entry for Survive Company.
Cash 100,000
Common Stock 100,000
ExplanationsEntry on Jan 1Is A = L + E in balance?
Common MistakesWhy is this incorrect?
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- Debiting cash, an asset account (+/-), increases the cash balance in Survive Company. This reflects the increase in cash from the company's internal perspective.
- This follows the Cash Cheat Code, where an increase in the company's cash is always recorded as a debit since cash is an asset (+/-).
- Crediting common stock, an equity account (-/+), increases the common stock balance. This accounts for the total investment made by the owner, representing the value of their equity (i.e., ownership).
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- By recording this journal entry, we can see that A = L + E remains in balance. Both sides increased by $100k.
- Remember, if A = L + E doesn’t balance, it means your journal entry is not correct!
Assets = Liabilities + Equity ↑ 100k ↑ 100k
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⚠️ Beware of viewing this transaction from the owner's perspective instead of the company's perspective.
- When recording journal entries, we are solely focused on the accounting from company in the problem’s perspective (i.e. Survive Company).
- The payment of cash by the owner is completely irrelevant to the company's accounting. Don't fall into this trap!
- See the example below that illustrates this point further.
On January 1st, the owner invested $100,000 cash into Survive Company in exchange for common stock. Record the journal entry for Survive Company.
❌ Incorrect Entry
Common Stock100,000Cash100,000 Your exam may attempt to trick you selecting this option. It is incorrect!
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- Students often assume that since the owner "invested cash into the company," the cash has been “paid” and must be decreased in the journal entry.
- Therefore, they mistakenly credit cash (+/-) to reduce it’s balances.
- However, from the company's perspective, the cash has actually increased! Therefore, we need to debit it!
✅ Correct Entry Cash 100,000 Common Stock 100,000
Remember to always approach problems from the "internal perspective of the company" rather than focusing on the owners.
Pro Tips for ExamsAdopt the Internal Company Perspective
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Understanding and solving accounting problems requires adopting the viewpoint of the company, rather than that of the business owner.
- Approach with an Internal Lens:
- Always consider how a transaction affects the company's financial position. Remember, the company and its owner are separate entities; the impact on one might not mirror the other.
- The Business Entity Principle:
- This concept reinforces the need for adopting the company's perspective. The Business Entity Principle, one of the fundamental concepts in accounting, emphasizes that a business is separate and distinct from its owners.
- Therefore, financial transactions and decisions should be analyzed based on their impact on the company, rather than how they affect the owner.
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📌 When owners invest cash or other assets in the business, the company often issues common stock in return.
On January 1st, the owner invested $100,000 of equipment, $50,000 of land, and a $20,000 truck into Survive Company in exchange for common stock. Record the journal entry for Survive Company.
Equipment 100,000
Land 50,000
Truck 20,000
Common Stock 170,000
ExplanationsEntry on Jan 1Is A = L + E in balance?
Common MistakesWhy is this incorrect?
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- Debiting Equipment, Land, and the Truck, all asset accounts (+/-), increases their respective balances in Survive Company. This reflects the increase in each asset from the company's internal perspective.
- The concept of debiting assets in this journal entry applies whenever our company acquires or receives any asset — such as supplies, equipment, prepaid insurance, buildings, trucks, and more.
- Another way to understand it: whenever we acquire any asset, we must increase its balance by debiting it — because we now own more of that asset!
- Crediting common stock, an equity account (-/+), increases the common stock balance. This accounts for the total investment made by the owner, representing the value of their equity (i.e., ownership).
- Importantly, the credit to Common Stock is $170,000, equal to the sum of the contributed assets' values.
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- By recording this journal entry, we can see that A = L + E remains in balance. Both sides increased by a total of $170k.
- Remember, if A = L + E doesn’t balance, it means your journal entry is not correct!
Assets = Liabilities + Equity ↑ 100k ↑ 170k ↑ 50k ↑ 20k
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⚠️ Beware of viewing this transaction from the owner's perspective instead of the company's perspective.
- When recording journal entries, we are solely focused on the accounting from company in the problem’s perspective (i.e. Survive Company).
- The loss of assets by the owner is completely irrelevant to the company's accounting. Don't fall into this trap!
- See the example below that illustrates this point further. On January 1st, the owner invested $100,000 of equipment, $50,000 of land, and a $20,000 truck into Survive Company in exchange for common stock. Record the journal entry for Survive Company.
❌ Incorrect Entry
Common Stock 170,000
Equipment 100,000
Land 50,000
Truck 20,000
Your exam may attempt to trick you selecting this option. It is incorrect!
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- Students often assume that since the owner "invested assets into the company," the assets have been "lost” and must be decreased in the journal entry.
- Therefore, they mistakenly credit asset accounts (+/-) to reduce their balances.
- However, from the company's perspective, the assets have actually increased! Therefore, we need to debit all the asset accounts.
✅ Correct Entry
Equipment 100,000 Land 50,000 Truck 20,000 Common Stock 170,000
Remember to always approach problems from the "internal perspective of the company" rather than focusing on the owners.
Pro Tips for ExamsAdopt the Company's PerspectiveEmbrace Mistakes!
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Understanding and solving accounting problems requires adopting the viewpoint of the company, rather than that of the business owner.
- Approach with an Internal Lens:
- Always consider how a transaction affects the company's financial position. Remember, the company and its owner are separate entities; the impact on one might not mirror the other.
- The Business Entity Principle:
- This concept reinforces the need for adopting the company's perspective. The Business Entity Principle, one of the fundamental concepts in accounting, emphasizes that a business is separate and distinct from its owners.
- Therefore, financial transactions and decisions should be analyzed based on their impact on the company, rather than how they affect the owner.
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- Learning accounting can sometimes feel like a challenging journey, especially when you're just starting out.
- When attempting a new problem, it might be tempting to aim for perfection on your first try, but it's crucial to remember that mistakes are an integral part of the learning process in the course.
- Mistakes Are Part of the Process:
- When you're first starting to understand accounting concepts, you might make mistakes while attempting problems. And that's completely okay!
- The key is to acknowledge these errors and learn from them. After all, you need to first understand how things can go wrong before you can make them right.
- The Learning Curve:
- • Many students try to avoid making mistakes while studying or preparing for exams, which is counterproductive. The goal isn't to avoid mistakes but to learn from them.
- Imagine being on an exam, encountering a problem, and realizing (for the first time) that you’re going down the wrong path. That's not a good feeling!
- Now, consider this opposite scenario: You're in the middle of an exam, and you start going down the wrong path with a problem. It's uncomfortable, but if you've already encountered this situation during your studies, you'll recognize it.
- You'll have developed the resilience and skills to identify and correct your errors. (This, in the heat of an exam, is a powerful skill!)
- The Power of Practice:
- This is why it's crucial to thoroughly read all the “Exam Pro Tips” and “Common Mistakes By Students” included in these cheat sheets. They'll help you fully understand the potential pitfalls.
- Additionally, attempting the practice exams is highly recommended. They're designed to lead you down the wrong paths intentionally, so you can learn how to steer yourself back on track.
- The more you practice, the better you'll become at navigating these errors. Over time, you'll find that you're able to solve problems correctly, whether it's on your first, second, or third attempt!
Remember, the objective isn't to avoid making mistakes but to learn from them. The more mistakes you make and correct during your study sessions, the more capable and confident you'll be during your exams. Embrace your mistakes!
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📌 Don’t forget to utilize the Cash Cheat Code!
On Jan 5th, Survive Company pays $1000 cash for supplies.
Supplies 1,000
Cash 1,000
ExplanationsEntry on Jan 5Is A = L + E in balance?
Common MistakesMisunderstanding the Cash Cheat CodeWhy is this incorrect?
The “Cash Cheat Code”Trick for every time you pay cash in a transaction Trick for every time you receive cash in a transaction
Misunderstanding when to debit Supplies vs. Supplies ExpenseWhy is this incorrect?
Pro Tip for Understanding Expenses:
“Expenses are about paying cash, right?” (Wrong!)How could I possibly pay cash and it not be an expense?
Conversely, how could I possibly record an expense and not pay any cash?
More examples!
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- Debiting Supplies, an asset account (+/-), increases its balance in Survive Company. This reflects the increase in supplies from the company's internal perspective.
- The concept of debiting assets in this journal entry applies whenever our company acquires or receives any asset — such as supplies, equipment, prepaid insurance, buildings, trucks, and more.
- Another way to understand it: whenever we acquire any asset, we must increase its balance by debiting it — because we now own more of that asset!
- Crediting cash, an asset account (+/-), decreases the cash balance.
- This follows the Cash Cheat Code, where paying cash is always recorded as a credit, as cash is an asset (+/-) and needs to be decreased.
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- By recording this journal entry, we can see that A = L + E remains in balance.
- The cash payment decreased assets by $1,000, while the purchase of supplies increased assets by $1,000. This transaction effectively traded one asset for another.
Assets = Liabilities + Equity ↓ 1k ↑ 1k
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Ensure that you have a solid grasp of the Cash Cheat Code, as it can be immensely helpful.
For instance, if you're aware of the cheat code and encounter a transaction where you're paying cash, you can be certain that the journal entry must include a credit to cash.
Let's look at an example:
On Jan 5th, Survive Company pays $1000 cash for supplies.
❌ Incorrect Entry
Cash 1,000
Supplies 1,000
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- Recall the Cash Cheat Code. When you pay cash in a transaction, it MUST always include a credit to cash, as cash is an asset (+/-) and all assets decrease with a credit.
- Debiting cash makes zero sense. This would increase your cash balance, which is incorrect because we actually paid cash.
✅ Correct Entry Supplies 1,000 Cash 1,000
Confused? Get a recap on the Cash Cheat Code below.
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📌 Cash, a fundamental asset account used in every business, is involved in over half of the journal entries you'll encounter in this course.
- Fortunately, understanding cash is super straightforward. It boils down to only two possibilities: paying cash or receiving cash.
- What if I told you that the journal entries for cash follow a consistent pattern when it comes to debits and credits?
⚔️ Discover your secret weapon below ⚔️
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- Obviously, every time you pay cash — your cash balance decreases!
- Since cash is an asset (+/-) and all assets decrease with a credit…
- you must credit cash for all journal entries involving cash payments.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) payment of cash, that transactions journal entry will ALWAYS include a CREDIT to cash.
- At last, we have something consistent to rely on!
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- Conversely, every time you receive cash — your cash balance increases!
- Since cash is an asset (+/-) and all assets increase with a debit…
- you must debit cash for all journal entries involving receiving cash.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) receipt of cash, that transactions journal entry will ALWAYS include a DEBIT to cash.
- At last, we have something consistent to rely on!
Remember this "Cheat Code" to confidently handle cash transactions. It will make some journal entries on exams so easy — you’ll literally feel like you're cheating. 😉
Pro Tip For Exams:See the Cash Cheat Code in action to learn how to use it effectively during exams!Process of elimination, baby!
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- The Cash Cheat Code offers an additional benefit beyond its simplicity. By quickly identifying the appropriate debit or credit for cash, you can free up mental energy.
- Rather than searching for both sides of the transaction, you already have one side resolved. This allows you to concentrate on determining the other side of the journal entry with more precision.
- Furthermore, The Cash Cheat Code can be a valuable strategy during multiple choice exam questions.
- For instance, if a question involves a cash payment transaction, any option that doesn't credit cash is automatically incorrect. See a quick example below.
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⚠️ Be extremely careful not to debit Supplies Expense when simply purchasing Supplies!
❌ Incorrect Example
On January 5th, Survive Company purchases $1000 worth of supplies on credit.
Supplies Expense 1,000
Cash 1,000
Your exam will attempt to trick you into doing this. It is incorrect!
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- Purchasing supplies does not mean we should debit an expense account. Why not? Well, simply purchasing supplies doesn't mean we've used any of them!
- Recall the expense recognition principle: we only record expenses when they're consumed or used (the true 'cost'), not just when we purchase or pay for them.
✅ Correct Example On January 5th, Survive Company purchases $1000 worth of supplies on credit. Supplies 1,000 Cash 1,000
Confused? I’ve included my Pro Tip for Understanding Expenses below, if you need a refresher.
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- It's a common misconception to associate expenses solely with the outflow of cash. That's not always accurate!
- Understanding the timing of expense recognition is crucial for interpreting its impact on financial statements. This is where the matching principle comes in handy: expenses are recognized when the resources or services are used to generate revenue, not necessarily when cash is paid.
- Let's consider an example. If we purchase supplies by paying cash, we're essentially trading one asset (cash) for another (supplies). At this point, no expense is recognized. Why not? Because we haven't used these supplies yet.
- The expense hits our books only when we actually use the supplies in our operations. The act of buying the supplies doesn't equate to an expense—it's the usage that counts!
- So, remember: expenses aren't about cash payments but about resource consumption. This understanding will be particularly useful in Chapter 3, where we delve into adjusting journal entries. So keep practicing!
‣
⚠️ CAUTION ⚠️ Often, students confuse expenses to only refer to paying cash. This is not always the case!
- Understanding the timing of expense recognition is crucial for interpreting its impact on financial statements. This is where the matching principle comes in handy: expenses are recognized when the resources or services are used to generate revenue, not necessarily when cash is paid.
- Let's consider an example. If we purchase supplies by paying cash, we're essentially trading one asset (cash) for another (supplies). At this point, no expense is recognized. Why not? Because we haven't used these supplies yet.
- The expense hits our books only when we actually use the supplies in our operations. The act of buying the supplies doesn't equate to an expense—it's the usage that counts!
Confused? Check out more examples below.
‣
- Paying cash for a building (an asset) is NOT an expense.
- However, as it depreciates over time, we will recognize depreciation expense!
- Paying cash for inventory (an asset) is NOT an expense.
- However, we will record Cost of Goods Sold (an expense) once it’s sold!
- Paying cash for Prepaid Rent (an asset) is NOT an expense.
- However, we will record Rent Expense later as the lease term elapses.
- Paying cash for Prepaid Insurance (an asset) is NOT an expense.
- However, we will record Insurance Expense later as our coverage expires.
‣
- Consider the one-word definition of expenses: "costs." Can costs occur without involving any cash payment? Absolutely!
- One example that illustrates this well is depreciation expense. Depreciation refers to the gradual decrease in value over time of long-term assets such as buildings and equipment.
- Let's paint a scenario: You've owned a building for a year, and your accountant estimates that its value has decreased by $10,000. This depreciation is undoubtedly an expense or "cost."
- However, did you have to make any cash payment to anyone for this decline in value? Certainly not! There's no need to write a check to anyone.
- Depreciation is a cost that simply “occurs” as time passes, completely independent of any cash payment!
‣
- Amortization: Similar to depreciation, amortization represents the gradual reduction in value of intangible assets (e.g., patents, copyrights) over time.
- Therefore, Amortization is an expense recorded without any cash payment associated with it, a topic we’ll elaborate further in Chapter 8.
- Accrued Expenses: Suppose a company has incurred employee salaries and wages for the current month but hasn't yet paid them.
- Even without a cash outflow, the company recognizes the expense by accruing the salaries and wages payable, a topic we’ll elaborate further in Chapter 3.
- Bad Debts: If a company has provided goods or services to a customer on credit and later determines that the customer is unable to pay, it records a bad debt expense.
- This expense is recognized despite no cash payment being received from the customer, a topic we’ll elaborate further in Chapter 7.
Remember: expenses aren't about cash payments but about resource consumption. This understanding will be particularly useful in Chapter 3, where we delve into adjusting journal entries. So keep practicing!
Pro Tips For ExamsUsing process of elimination for MCQ’s involving journal entries
Embrace Mistakes!
‣
Consider the impact of debits and credits on each type of account and ask yourself if a choice logically aligns with the transaction.
Why it’s horrifically incorrect
Additional advice
Let's use a hypothetical example to illustrate this point:
- On Jan 5th, Survive Company pays $1000 cash for supplies. Choose the correct journal entry for this transaction from the options below.
Now, imagine you encounter the following journal entry as one of your choices. Does it seem correct to you? (hint: it’s not.)
Supplies 1,000 Supplies Expense 1,000
‣
⚠️⚠️⚠️ DANGER ⚠️⚠️⚠️ This journal entry would be horrifically incorrect! Please, don’t choose it! Okay, but why?
- Debiting supplies is correct, as we discussed previously.
- Remember, debiting Supplies, an asset account (+/-), increases its balance in Survive Company. This reflects the increase in supplies from the company's internal perspective.
- However, it’s the credit to Supplies Expense that makes no logical sense.
Supplies 1,000
Supplies Expense 1,000
- Why? Recall that expense accounts (+/-) increase with debits and decrease with credits.
- When we are purchasing supplies, does it make any logical sense to credit an expense account (+/-), which would decrease it? 🗣️ Absolutely not!
- Why would purchasing supplies create a reduction in expenses (i.e. our “costs”?)
- This makes zero sense and clearly indicates something is wrong with that entry — so it should not be chosen on your exam. Scratch it out!
‣
- Mastering accounting exams goes beyond simply knowing the correct answer; it involves understanding why certain answers are incorrect or, in some cases, horrifically wrong!
- This kind of strategic thinking, where we evaluate the logical nature of each choice, is incredibly powerful. It's a crucial aspect to acing exams that your professors likely aren’t telling you about. (perhaps because they prefer to keep their tricks hidden!)
- By developing the ability to spot and eliminate incorrect choices that may seem tempting, you'll be better equipped to navigate the notoriously tricky nature of accounting exams.
- Remember, it's not just about knowing the right answer; it's about fully understanding why certain answers are incorrect — so, on your exam, you can avoid them like the plague!
Hey there! If you're reading these Pro Tips, I want you to know that I'm genuinely thrilled you're here, and I hope that Survive Accounting is helpful to you. With some hard work — I wholeheartedly believe you're going to ace your exams. Your partner in exam domination, - Lee lee@surviveaccounting.com PS — I'd love to hear from you! Drop me a line or introduce yourself via email. I personally reply to every email.
‣
- Learning accounting can sometimes feel like a challenging journey, especially when you're just starting out.
- When attempting a new problem, it might be tempting to aim for perfection on your first try, but it's crucial to remember that mistakes are an integral part of the learning process in the course.
- Mistakes Are Part of the Process:
- When you're first starting to understand accounting concepts, you might make mistakes while attempting problems. And that's completely okay!
- The key is to acknowledge these errors and learn from them. After all, you need to first understand how things can go wrong before you can make them right.
- The Learning Curve:
- • Many students try to avoid making mistakes while studying or preparing for exams, which is counterproductive. The goal isn't to avoid mistakes but to learn from them.
- Imagine being on an exam, encountering a problem, and realizing (for the first time) that you’re going down the wrong path. That's not a good feeling!
- Now, consider this opposite scenario: You're in the middle of an exam, and you start going down the wrong path with a problem. It's uncomfortable, but if you've already encountered this situation during your studies, you'll recognize it.
- You'll have developed the resilience and skills to identify and correct your errors. (This, in the heat of an exam, is a powerful skill!)
- The Power of Practice:
- This is why it's crucial to thoroughly read all the “Exam Pro Tips” and “Common Mistakes By Students” included in these cheat sheets. They'll help you fully understand the potential pitfalls.
- Additionally, attempting the practice exams is highly recommended. They're designed to lead you down the wrong paths intentionally, so you can learn how to steer yourself back on track.
- The more you practice, the better you'll become at navigating these errors. Over time, you'll find that you're able to solve problems correctly, whether it's on your first, second, or third attempt!
Remember, the objective isn't to avoid making mistakes but to learn from them. The more mistakes you make and correct during your study sessions, the more capable and confident you'll be during your exams. Embrace your mistakes!
‣
📌 Confused about what "on credit" means? Check out my Common Mistakes section below for clarification.
On Jan 5th, Survive Company purchases $1000 worth of supplies on credit.
Supplies 1,000
Accounts Payable 1,000
ExplanationsEntry on Jan 5
Is A = L + E in balance?
Common MistakesMisunderstanding “on credit” or “on account” when we make purchases from suppliers
Misunderstanding when to debit Supplies vs. Supplies ExpenseWhy is this incorrect?
Pro Tip for Understanding Expenses:
‣
- Debiting Supplies, an asset account (+/-), increases its balance in Survive Company. This reflects the increase in supplies from the company's internal perspective.
- The concept of debiting assets in this journal entry applies whenever our company acquires or receives any asset — such as supplies, equipment, prepaid insurance, buildings, trucks, and more.
- Another way to understand it: whenever we acquire any asset, we must increase its balance by debiting it — because we now own more of that asset!
- Crediting Accounts Payable, a liability account (-/+), increases the liability balance. This indicates that Survive Company owes $1,000 cash in the future as payment for the supplies.
‣
- By recording this journal entry, we can see that A = L + E remains in balance. Both sides increased by $1k.
- Assets = Liabilities + Equity ↑ 1k ↑ 1k
‣
‣
- "On credit” or “on account” are commonly confused by students — be very careful!
- In the real world, suppliers often provide this arrangement to businesses, allowing them to receive goods immediately and defer the payment to a later date, usually within 30, 60, or 90+ days.
- Both of these terms are used interchangeably. They refer to the practice of purchasing goods or services now and deferring the payment of cash to a later date.
- Importantly, “on credit” does not impact the debits and credits involved in journal entries. Instead, "on credit" signifies that the cash payment is delayed in the transaction. Confusing, right?
‣
⚠️ Be extremely careful not to debit Supplies Expense when simply purchasing Supplies!
❌ Incorrect Example
On January 5th, Survive Company purchases $1000 worth of supplies on credit.
Supplies Expense 1,000
Cash 1,000
Your exam will attempt to trick you into doing this. It is incorrect!
‣
- Purchasing supplies does not mean we should debit an expense account. Why not? Well, simply purchasing supplies doesn't mean we've used any of them!
- Recall the expense recognition principle: we only record expenses when they're consumed or used (the true 'cost'), not just when we purchase or pay for them.
✅ Correct Example On January 5th, Survive Company purchases $1000 worth of supplies on credit. Supplies 1,000 Cash 1,000
Confused? I’ve included my Pro Tip for Understanding Expenses below, if you need a refresher.
‣
- It's a common misconception to associate expenses solely with the outflow of cash. That's not always accurate!
- Understanding the timing of expense recognition is crucial for interpreting its impact on financial statements. This is where the matching principle comes in handy: expenses are recognized when the resources or services are used to generate revenue, not necessarily when cash is paid.
- Let's consider an example. If we purchase supplies by paying cash, we're essentially trading one asset (cash) for another (supplies). At this point, no expense is recognized. Why not? Because we haven't used these supplies yet.
- The expense hits our books only when we actually use the supplies in our operations. The act of buying the supplies doesn't equate to an expense—it's the usage that counts!
- So, remember: expenses aren't about cash payments but about resource consumption. This understanding will be particularly useful in Chapter 3, where we delve into adjusting journal entries. So keep practicing!
Pro Tips For ExamsHow to master multiple choice questions involving journal entries
Why it’s horrifically incorrect
Additional adviceEmbrace Mistakes!
‣
Consider the impact of debits and credits on each type of account and ask yourself if a choice logically aligns with the transaction.
Let's use a hypothetical example to illustrate this point:
- On Jan 5th, Survive Company purchases $1000 worth of supplies on credit. Choose the correct journal entry for this transaction from the options below.
Now, imagine you encounter the following journal entry as one of your choices. Does it seem correct to you?
Supplies 1,000 Supplies Expense 1,000
‣
⚠️⚠️⚠️ DANGER ⚠️⚠️⚠️ This journal entry would be horrifically incorrect! Please, don’t choose it! Okay, but why?
- Debiting supplies is correct, as we discussed previously.
- Remember, debiting Supplies, an asset account (+/-), increases its balance in Survive Company. This reflects the increase in supplies from the company's internal perspective.
- However, it’s the credit to Supplies Expense that makes no logical sense.
Supplies 1,000
Supplies Expense 1,000
- Why? Recall that expense accounts (+/-) increase with debits and decrease with credits.
- When we are purchasing supplies, does it make any logical sense to credit an expense account (+/-), which would decrease it 🗣️ Absolutely not!
- Why would purchasing supplies create a reduction in expenses (i.e. our “costs”?)
- This makes zero sense and clearly indicates something is wrong with that entry — so it should not be chosen on your exam. Scratch it out!
‣
- Mastering accounting exams goes beyond simply knowing the correct answer; it involves understanding why certain answers are incorrect or, in some cases, horrifically wrong!
- This kind of strategic thinking, where we evaluate the logical nature of each choice, is incredibly powerful. It's a crucial aspect to acing exams that your professors likely aren’t telling you about. (perhaps because they prefer to keep their tricks hidden!)
- By developing the ability to spot and eliminate incorrect choices that may seem tempting, you'll be better equipped to navigate the notoriously tricky nature of accounting exams.
- Remember, it's not just about knowing the right answer; it's about fully understanding why certain answers are incorrect — so, on your exam, you can avoid them like the plague!
Hey there! If you're reading these Pro Tips, I want you to know that I'm genuinely thrilled you're here, and I hope that Survive Accounting is helpful to you. With some hard work — I wholeheartedly believe you're going to ace your exams. Your partner in exam domination, - Lee lee@survivestudios.com PS — I'd love to hear from you! Drop me a line or introduce yourself via email.
‣
- Learning accounting can sometimes feel like a challenging journey, especially when you're just starting out.
- When attempting a new problem, it might be tempting to aim for perfection on your first try, but it's crucial to remember that mistakes are an integral part of the learning process in the course.
- Mistakes Are Part of the Process:
- When you're first starting to understand accounting concepts, you might make mistakes while attempting problems. And that's completely okay!
- The key is to acknowledge these errors and learn from them. After all, you need to first understand how things can go wrong before you can make them right.
- The Learning Curve:
- • Many students try to avoid making mistakes while studying or preparing for exams, which is counterproductive. The goal isn't to avoid mistakes but to learn from them.
- Imagine being on an exam, encountering a problem, and realizing (for the first time) that you’re going down the wrong path. That's not a good feeling!
- Now, consider this opposite scenario: You're in the middle of an exam, and you start going down the wrong path with a problem. It's uncomfortable, but if you've already encountered this situation during your studies, you'll recognize it.
- You'll have developed the resilience and skills to identify and correct your errors. (This, in the heat of an exam, is a powerful skill!)
- The Power of Practice:
- This is why it's crucial to thoroughly read all the “Exam Pro Tips” and “Common Mistakes By Students” included in these cheat sheets. They'll help you fully understand the potential pitfalls.
- Additionally, attempting the practice exams is highly recommended. They're designed to lead you down the wrong paths intentionally, so you can learn how to steer yourself back on track.
- The more you practice, the better you'll become at navigating these errors. Over time, you'll find that you're able to solve problems correctly, whether it's on your first, second, or third attempt!
Remember, the objective isn't to avoid making mistakes but to learn from them. The more mistakes you make and correct during your study sessions, the more capable and confident you'll be during your exams. Embrace your mistakes!
‣
📌 Confused about what "on credit" means? Check out my Common Mistakes section below for clarification.
On January 1st, Survive Company purchases $1000 worth of supplies on credit.
Original Entry on Jan 1:
Supplies 1,000
Accounts Payable 1,000
On January 10th, Survive Company pays $1000 cash for the supplies previously purchased on credit.
Subsequent Entry on Jan 10:
Accounts Payable 1,000
Cash 1,000
ExplanationsOriginal Entry on Jan 1Subsequent Entry on Jan 10
Is A = L + E in balance?
Common MistakesMisunderstanding “on credit” or “on account” when we make purchases from suppliers
Misunderstanding the Cash Cheat CodeWhy is this incorrect?
The “Cash Cheat Code”Trick for every time you pay cash in a transaction Trick for every time you receive cash in a transaction
Misunderstanding when to debit Supplies vs. Supplies ExpenseBut why is this incorrect?
Pro Tip for Understanding Expenses:
“Expenses are about paying cash, right?” (Wrong!)How could I possibly pay cash and it not be an expense?
Conversely, how could I possibly record an expense and not pay any cash?
More examples!
‣
- Debiting Supplies, an asset account (+/-), increases its balance in Survive Company. This reflects the increase in supplies from the company's internal perspective.
- Another way to understand it: whenever we acquire any asset, we must increase its balance by debiting it — because we now own more of that asset!
- Notice how also, in this sequence, we initially credited Accounts Payable, a liability account (-/+), to reflect the amount owed of $1,000.
‣
- When we pay cash toward a liability, we debit Accounts Payable by the amount we’ve paid, which is $1000.
- This will decrease the amount owed by $1000, leaving a $0 balance in Accounts Payable, effectively cancelling out the liability. See this in the T Account below.
- Crediting cash, an asset account (+/-), decreases the cash balance.
- This follows the Cash Cheat Code, where paying cash is always recorded as a credit, as cash is an asset (+/-) and needs to be decreased.
‣
- By recording this journal entry, we can see that A = L + E remains in balance. Both sides increased by $1k.
- Original Entry on Jan 1
- Assets = Liabilities + Equity ↑ 1k ↑ 1k
- Subsequent Entry on Jan 10
- Assets = Liabilities + Equity ↓ 1k ↓ 1k
‣
‣
- "On credit” or “on account” are commonly confused by students — be very careful!
- In the real world, suppliers often provide this arrangement to businesses, allowing them to receive goods immediately and defer the payment to a later date, usually within 30, 60, or 90+ days.
- Both of these terms are used interchangeably. They refer to the practice of purchasing goods or services now and deferring the payment of cash to a later date.
- Importantly, “on credit” does not impact the debits and credits involved in journal entries. Instead, "on credit" signifies that the cash payment is delayed in the transaction. Confusing, right?
‣
Ensure that you have a solid grasp of the Cash Cheat Code, as it can be immensely helpful.
For instance, if you're aware of the cheat code and encounter a transaction where you're paying cash, you can be certain that the journal entry must include a credit to cash.
Let's look at an example:
On January 10th, Survive Company pays $1000 cash for the supplies previously purchased on credit.
❌ Incorrect Entry
Cash 1,000
Accounts Payable 1,000
‣
- Recall the Cash Cheat Code. When you pay cash in a transaction, it MUST always include a credit to cash, as cash is an asset (+/-) and all assets decrease with a credit.
- Debiting cash makes zero sense. This would increase your cash balance, which is incorrect because we actually paid cash.
✅ Correct Entry Accounts Payable 1,000 Cash 1,000
Confused? Get a recap on the Cash Cheat Code below.
‣
📌 Cash, a fundamental asset account used in every business, is involved in over half of the journal entries you'll encounter in this course.
- Fortunately, understanding cash is super straightforward. It boils down to only two possibilities: paying cash or receiving cash.
- What if I told you that the journal entries for cash follow a consistent pattern when it comes to debits and credits?
⚔️ Discover your secret weapon below ⚔️
‣
- Obviously, every time you pay cash — your cash balance decreases!
- Since cash is an asset (+/-) and all assets decrease with a credit…
- you must credit cash for all journal entries involving cash payments.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) payment of cash, that transactions journal entry will ALWAYS include a CREDIT to cash.
- At last, we have something consistent to rely on!
‣
- Conversely, every time you receive cash — your cash balance increases!
- Since cash is an asset (+/-) and all assets increase with a debit…
- you must debit cash for all journal entries involving receiving cash.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) receipt of cash, that transactions journal entry will ALWAYS include a DEBIT to cash.
- At last, we have something consistent to rely on!
Remember this "Cheat Code" to confidently handle cash transactions. It will make some journal entries on exams so easy — you’ll literally feel like you're cheating. 😉
Pro Tip For Exams:See the Cash Cheat Code in action to learn how to use it effectively during exams!Process of elimination, baby!
‣
- The Cash Cheat Code offers an additional benefit beyond its simplicity. By quickly identifying the appropriate debit or credit for cash, you can free up mental energy.
- Rather than searching for both sides of the transaction, you already have one side resolved. This allows you to concentrate on determining the other side of the journal entry with more precision.
- Furthermore, The Cash Cheat Code can be a valuable strategy during multiple choice exam questions.
- For instance, if a question involves a cash payment transaction, any option that doesn't credit cash is automatically incorrect. See a quick example below.
‣
⚠️ Be extremely careful not to debit Supplies Expense when simply purchasing Supplies!
❌ Incorrect Example
On January 1st, Survive Company purchases $1000 worth of supplies on credit.
Supplies Expense 1,000
Cash 1,000
Your exam will attempt to trick you into doing this. It is incorrect!
‣
- Purchasing supplies does not mean we should debit an expense account. Why not? Well, simply purchasing supplies doesn't mean we've used any of them!
- Recall the expense recognition principle: we only record expenses when they're consumed or used (the true 'cost'), not just when we purchase or pay for them.
✅ Correct Example On January 1st, Survive Company purchases $1000 worth of supplies on credit. Supplies 1,000 Cash 1,000
Confused? I’ve included my Pro Tip for Understanding Expenses below, if you need a refresher.
‣
- It's a common misconception to associate expenses solely with the outflow of cash. That's not always accurate!
- Understanding the timing of expense recognition is crucial for interpreting its impact on financial statements. This is where the matching principle comes in handy: expenses are recognized when the resources or services are used to generate revenue, not necessarily when cash is paid.
- Let's consider an example. If we purchase supplies by paying cash, we're essentially trading one asset (cash) for another (supplies). At this point, no expense is recognized. Why not? Because we haven't used these supplies yet.
- The expense hits our books only when we actually use the supplies in our operations. The act of buying the supplies doesn't equate to an expense—it's the usage that counts!
- So, remember: expenses aren't about cash payments but about resource consumption. This understanding will be particularly useful in Chapter 3, where we delve into adjusting journal entries. So keep practicing!
‣
⚠️ CAUTION ⚠️ Often, students confuse expenses to only refer to paying cash. This is not always the case!
- Understanding the timing of expense recognition is crucial for interpreting its impact on financial statements. This is where the matching principle comes in handy: expenses are recognized when the resources or services are used to generate revenue, not necessarily when cash is paid.
- Let's consider an example. If we purchase supplies by paying cash, we're essentially trading one asset (cash) for another (supplies). At this point, no expense is recognized. Why not? Because we haven't used these supplies yet.
- The expense hits our books only when we actually use the supplies in our operations. The act of buying the supplies doesn't equate to an expense—it's the usage that counts!
Confused? Check out more examples below.
‣
- Paying cash for a building (an asset) is NOT an expense.
- However, as it depreciates over time, we will recognize depreciation expense!
- Paying cash for inventory (an asset) is NOT an expense.
- However, we will record Cost of Goods Sold (an expense) once it’s sold!
- Paying cash for Prepaid Rent (an asset) is NOT an expense.
- However, we will record Rent Expense later as the lease term elapses.
- Paying cash for Prepaid Insurance (an asset) is NOT an expense.
- However, we will record Insurance Expense later as our coverage expires.
‣
- Consider the one-word definition of expenses: "costs." Can costs occur without involving any cash payment? Absolutely!
- One example that illustrates this well is depreciation expense. Depreciation refers to the gradual decrease in value over time of long-term assets such as buildings and equipment.
- Let's paint a scenario: You've owned a building for a year, and your accountant estimates that its value has decreased by $10,000. This depreciation is undoubtedly an expense or "cost."
- However, did you have to make any cash payment to anyone for this decline in value? Certainly not! There's no need to write a check to anyone.
- Depreciation is a cost that simply “occurs” as time passes, completely independent of any cash payment!
‣
- Amortization: Similar to depreciation, amortization represents the gradual reduction in value of intangible assets (e.g., patents, copyrights) over time.
- Therefore, Amortization is an expense recorded without any cash payment associated with it, a topic we’ll elaborate further in Chapter 8.
- Accrued Expenses: Suppose a company has incurred employee salaries and wages for the current month but hasn't yet paid them.
- Even without a cash outflow, the company recognizes the expense by accruing the salaries and wages payable, a topic we’ll elaborate further in Chapter 3.
- Bad Debts: If a company has provided goods or services to a customer on credit and later determines that the customer is unable to pay, it records a bad debt expense.
- This expense is recognized despite no cash payment being received from the customer, a topic we’ll elaborate further in Chapter 7.
Remember: expenses aren't about cash payments but about resource consumption. This understanding will be particularly useful in Chapter 3, where we delve into adjusting journal entries. So keep practicing!
Pro Tips For ExamsRemember, transactions are often linked together! (Purchasing “on credit”)Embrace Mistakes!
‣
Transactions are often interconnected and not isolated events. There may be preceding transactions that have already occurred or upcoming transactions in the future.
- By being able to see the full picture and understand the sequence of transactions as a whole, journal entries become much clearer.
- For example, When you initially purchase supplies on credit, you will credit Accounts Payable, a liability account (-/+) to increase it, indicating that you owe cash to a supplier in the future.
- Later, when you make a cash payment towards the supplies purchased on credit, you will debit Accounts Payable to decrease it, as the amount owed is reduced.
- Take a look at the two connected transactions below, paying close attention to the flow of Accounts Payable: On January 1st, Survive Company purchases $1000 worth of supplies on credit.
- On the date of purchasing supplies, credit Accounts Payable to increase it, indicating the balance owed to a supplier.
- On the date of paying cash to the supplier, debit Accounts Payable to decrease it, reflecting the reduced amount owed to the supplier.
Original Entry on Jan 1: Supplies 1,000 → Accounts Payable 1,000
On January 10th, Survive Company partially pays $400 cash toward the supplies previously purchased on credit. Subsequent Entry on Jan 10: → Accounts Payable 400 Cash 400
- In essence, when you first set up a liability account (-/+) like accounts payable by crediting it, it logically follows that at some point, we will settle this liability (either fully or partially) and need to debit the liability to decrease it.
- i.e. — first, you credited A/P, later, you’ll debit it!
- Having this big picture perspective and anticipating what comes next will undoubtedly help you ace exams.
- It’s a thought-provoking mental exercise that, in my experience, made me feel significantly more confident about getting journal entries correct.
Hey there! If you're reading these Pro Tips, I want you to know that I'm genuinely thrilled you're here, and I hope that Survive Accounting is helpful to you. With some hard work — I wholeheartedly believe you're going to ace your exams. Your partner in exam domination, - Lee lee@surviveaccounting.com PS — I'd love to hear from you! Drop me a line or introduce yourself via email. I personally reply to every email.
‣
- Learning accounting can sometimes feel like a challenging journey, especially when you're just starting out.
- When attempting a new problem, it might be tempting to aim for perfection on your first try, but it's crucial to remember that mistakes are an integral part of the learning process in the course.
- Mistakes Are Part of the Process:
- When you're first starting to understand accounting concepts, you might make mistakes while attempting problems. And that's completely okay!
- The key is to acknowledge these errors and learn from them. After all, you need to first understand how things can go wrong before you can make them right.
- The Learning Curve:
- • Many students try to avoid making mistakes while studying or preparing for exams, which is counterproductive. The goal isn't to avoid mistakes but to learn from them.
- Imagine being on an exam, encountering a problem, and realizing (for the first time) that you’re going down the wrong path. That's not a good feeling!
- Now, consider this opposite scenario: You're in the middle of an exam, and you start going down the wrong path with a problem. It's uncomfortable, but if you've already encountered this situation during your studies, you'll recognize it.
- You'll have developed the resilience and skills to identify and correct your errors. (This, in the heat of an exam, is a powerful skill!)
- The Power of Practice:
- This is why it's crucial to thoroughly read all the “Exam Pro Tips” and “Common Mistakes By Students” included in these cheat sheets. They'll help you fully understand the potential pitfalls.
- Additionally, attempting the practice exams is highly recommended. They're designed to lead you down the wrong paths intentionally, so you can learn how to steer yourself back on track.
- The more you practice, the better you'll become at navigating these errors. Over time, you'll find that you're able to solve problems correctly, whether it's on your first, second, or third attempt!
Remember, the objective isn't to avoid making mistakes but to learn from them. The more mistakes you make and correct during your study sessions, the more capable and confident you'll be during your exams. Embrace your mistakes!
‣
📌 How would the journal entries change if we only partially paid the amount we owed?
On January 1st, Survive Company purchases $1000 worth of supplies on credit.
Original Entry on Jan 1:
Supplies 1,000
Accounts Payable 1,000
On January 10th, Survive Company partially pays $400 cash toward the supplies previously purchased on credit.
Subsequent Entry on Jan 10:
Accounts Payable 400
Cash 400
ExplanationsOriginal Entry on Jan 1Subsequent Entry on Jan 10
Is A = L + E in balance?
Common MistakesMisunderstanding “on credit” or “on account”
Misunderstanding the Cash Cheat CodeWhy is this incorrect?
The “Cash Cheat Code”Trick for every time you pay cash in a transaction Trick for every time you receive cash in a transaction
Misunderstanding when to debit Supplies vs. Supplies ExpenseWhy is this incorrect?
Pro Tip for Understanding Expenses:
“Expenses are about paying cash, right?” (Wrong!)How could I possibly pay cash and it not be an expense?
Conversely, how could I possibly record an expense and not pay any cash?
More examples!
‣
- Debiting Supplies, an asset account (+/-), increases its balance in Survive Company. This reflects the increase in supplies from the company's internal perspective.
- Another way to understand it: whenever we acquire any asset, we must increase its balance by debiting it — because we now own more of that asset!
- Notice how also, in this sequence, we initially credited Accounts Payable, a liability account (-/+), to reflect the amount owed of $1,000.
‣
- When we only partially pay cash toward a liability, we debit Accounts Payable by the amount we’ve paid, which is $400.
- This will decrease the amount owed by $400, leaving a $600 balance in Accounts Payable, reflecting the new amount owed. See this in the T Account below.
- Crediting cash, an asset account (+/-), decreases the cash balance.
- This follows the Cash Cheat Code, where paying cash is always recorded as a credit, as cash is an asset (+/-) and needs to be decreased.
‣
- By recording this journal entry, we can see that A = L + E remains in balance. Both sides decreased by 400.
- Assets = Liabilities + Equity ↓ 400 ↓ 400
‣
‣
- "On credit” or “on account” are commonly confused by students — be very careful!
- In the real world, suppliers often provide this arrangement to businesses, allowing them to receive goods immediately and defer the payment to a later date, usually within 30, 60, or 90+ days.
- Both of these terms are used interchangeably. They refer to the practice of purchasing goods or services now and deferring the payment of cash to a later date.
- Importantly, “on credit” does not impact the debits and credits involved in journal entries. Instead, "on credit" signifies that the cash payment is delayed in the transaction. Confusing, right?
‣
Ensure that you have a solid grasp of the Cash Cheat Code, as it can be immensely helpful.
For instance, if you're aware of the cheat code and encounter a transaction where you're paying cash, you can be certain that the journal entry must include a credit to cash.
Let's look at an example:
On Jan 5th, Survive Company pays $1000 cash for supplies.
❌ Incorrect Entry
Cash 1,000
Supplies 1,000
‣
- Recall the Cash Cheat Code. When you pay cash in a transaction, it MUST always include a credit to cash, as cash is an asset (+/-) and all assets decrease with a credit.
- Debiting cash makes zero sense. This would increase your cash balance, which is incorrect because we actually paid cash.
✅ Correct Entry Supplies 1,000 Cash 1,000
Confused? Get a recap on the Cash Cheat Code below.
‣
📌 Cash, a fundamental asset account used in every business, is involved in over half of the journal entries you'll encounter in this course.
- Fortunately, understanding cash is super straightforward. It boils down to only two possibilities: paying cash or receiving cash.
- What if I told you that the journal entries for cash follow a consistent pattern when it comes to debits and credits?
⚔️ Discover your secret weapon below ⚔️
‣
- Obviously, every time you pay cash — your cash balance decreases!
- Since cash is an asset (+/-) and all assets decrease with a credit…
- you must credit cash for all journal entries involving cash payments.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) payment of cash, that transactions journal entry will ALWAYS include a CREDIT to cash.
- At last, we have something consistent to rely on!
‣
- Conversely, every time you receive cash — your cash balance increases!
- Since cash is an asset (+/-) and all assets increase with a debit…
- you must debit cash for all journal entries involving receiving cash.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) receipt of cash, that transactions journal entry will ALWAYS include a DEBIT to cash.
- At last, we have something consistent to rely on!
Remember this "Cheat Code" to confidently handle cash transactions. It will make some journal entries on exams so easy — you’ll literally feel like you're cheating. 😉
Pro Tip For Exams:See the Cash Cheat Code in action to learn how to use it effectively during exams!Process of elimination, baby!
‣
- The Cash Cheat Code offers an additional benefit beyond its simplicity. By quickly identifying the appropriate debit or credit for cash, you can free up mental energy.
- Rather than searching for both sides of the transaction, you already have one side resolved. This allows you to concentrate on determining the other side of the journal entry with more precision.
- Furthermore, The Cash Cheat Code can be a valuable strategy during multiple choice exam questions.
- For instance, if a question involves a cash payment transaction, any option that doesn't credit cash is automatically incorrect. See a quick example below.
‣
⚠️ Be extremely careful not to debit Supplies Expense when simply purchasing Supplies!
❌ Incorrect Example
On January 1st, Survive Company purchases $1000 worth of supplies on credit.
Supplies Expense 1,000
Cash 1,000
Your exam will attempt to trick you into doing this. It is incorrect!
‣
- Purchasing supplies does not mean we should debit an expense account. Why not? Well, simply purchasing supplies doesn't mean we've used any of them!
- Recall the expense recognition principle: we only record expenses when they're consumed or used (the true 'cost'), not just when we purchase or pay for them.
✅ Correct Example On January 1st, Survive Company purchases $1000 worth of supplies on credit. Supplies 1,000 Cash 1,000
Confused? I’ve included my Pro Tip for Understanding Expenses below, if you need a refresher.
‣
- It's a common misconception to associate expenses solely with the outflow of cash. That's not always accurate!
- Understanding the timing of expense recognition is crucial for interpreting its impact on financial statements. This is where the matching principle comes in handy: expenses are recognized when the resources or services are used to generate revenue, not necessarily when cash is paid.
- Let's consider an example. If we purchase supplies by paying cash, we're essentially trading one asset (cash) for another (supplies). At this point, no expense is recognized. Why not? Because we haven't used these supplies yet.
- The expense hits our books only when we actually use the supplies in our operations. The act of buying the supplies doesn't equate to an expense—it's the usage that counts!
- So, remember: expenses aren't about cash payments but about resource consumption. This understanding will be particularly useful in Chapter 3, where we delve into adjusting journal entries. So keep practicing!
‣
⚠️ CAUTION ⚠️ Often, students confuse expenses to only refer to paying cash. This is not always the case!
- Understanding the timing of expense recognition is crucial for interpreting its impact on financial statements. This is where the matching principle comes in handy: expenses are recognized when the resources or services are used to generate revenue, not necessarily when cash is paid.
- Let's consider an example. If we purchase supplies by paying cash, we're essentially trading one asset (cash) for another (supplies). At this point, no expense is recognized. Why not? Because we haven't used these supplies yet.
- The expense hits our books only when we actually use the supplies in our operations. The act of buying the supplies doesn't equate to an expense—it's the usage that counts!
Confused? Check out more examples below.
‣
- Paying cash for a building (an asset) is NOT an expense.
- However, as it depreciates over time, we will recognize depreciation expense!
- Paying cash for inventory (an asset) is NOT an expense.
- However, we will record Cost of Goods Sold (an expense) once it’s sold!
- Paying cash for Prepaid Rent (an asset) is NOT an expense.
- However, we will record Rent Expense later as the lease term elapses.
- Paying cash for Prepaid Insurance (an asset) is NOT an expense.
- However, we will record Insurance Expense later as our coverage expires.
‣
- Consider the one-word definition of expenses: "costs." Can costs occur without involving any cash payment? Absolutely!
- One example that illustrates this well is depreciation expense. Depreciation refers to the gradual decrease in value over time of long-term assets such as buildings and equipment.
- Let's paint a scenario: You've owned a building for a year, and your accountant estimates that its value has decreased by $10,000. This depreciation is undoubtedly an expense or "cost."
- However, did you have to make any cash payment to anyone for this decline in value? Certainly not! There's no need to write a check to anyone.
- Depreciation is a cost that simply “occurs” as time passes, completely independent of any cash payment!
‣
- Amortization: Similar to depreciation, amortization represents the gradual reduction in value of intangible assets (e.g., patents, copyrights) over time.
- Therefore, Amortization is an expense recorded without any cash payment associated with it, a topic we’ll elaborate further in Chapter 8.
- Accrued Expenses: Suppose a company has incurred employee salaries and wages for the current month but hasn't yet paid them.
- Even without a cash outflow, the company recognizes the expense by accruing the salaries and wages payable, a topic we’ll elaborate further in Chapter 3.
- Bad Debts: If a company has provided goods or services to a customer on credit and later determines that the customer is unable to pay, it records a bad debt expense.
- This expense is recognized despite no cash payment being received from the customer, a topic we’ll elaborate further in Chapter 7.
Remember: expenses aren't about cash payments but about resource consumption. This understanding will be particularly useful in Chapter 3, where we delve into adjusting journal entries. So keep practicing!
Pro Tip For ExamsRemember, transactions are often linked together! (Purchasing “on credit”)
‣
Transactions are often interconnected and not isolated events. There may be preceding transactions that have already occurred or upcoming transactions in the future.
- By being able to see the full picture and understand the sequence of transactions as a whole, journal entries become much clearer.
- For example, When you initially purchase supplies on credit, you will credit Accounts Payable, a liability account (-/+) to increase it, indicating that you owe cash to a supplier in the future.
- Later, when you make a cash payment towards the supplies purchased on credit, you will debit Accounts Payable to decrease it, as the amount owed is reduced.
- Take a look at the two connected transactions below, paying close attention to the flow of Accounts Payable: On January 1st, Survive Company purchases $1000 worth of supplies on credit.
- On the date of purchasing supplies, credit Accounts Payable to increase it, indicating the balance owed to a supplier.
- On the date of paying cash to the supplier, debit Accounts Payable to decrease it, reflecting the reduced amount owed to the supplier.
Original Entry on Jan 1: Supplies 1,000 → Accounts Payable 1,000
On January 10th, Survive Company partially pays $400 cash toward the supplies previously purchased on credit. Subsequent Entry on Jan 10: → Accounts Payable 400 Cash 400
- In essence, when you first set up a liability account (-/+) like accounts payable by crediting it, it logically follows that at some point, we will settle this liability (either fully or partially) and need to debit the liability to decrease it.
- i.e. — first, you credited A/P, later, you’ll debit it!
- Having this big picture perspective and anticipating what comes next will undoubtedly help you ace exams.
- It’s a thought-provoking mental exercise that, in my experience, made me feel significantly more confident about getting journal entries correct.
Hey there! If you're reading these Pro Tips, I want you to know that I'm genuinely thrilled you're here, and I hope that Survive Accounting is helpful to you. With some hard work — I wholeheartedly believe you're going to ace your exams. Your partner in exam domination, - Lee lee@surviveaccounting.com PS — I'd love to hear from you! Drop me a line or introduce yourself via email. I personally reply to every email.
‣
📌 Many other examples of prepaids exist, but these three scenarios offer a sufficient starting point for understanding the concept.
‣
On July 1st, 2023, Survive Company pays $12,000 in cash for a 12-month insurance policy.
Original Entry on July 1:
Prepaid Insurance 12,000
Cash 12,000
Looking to get a headstart on Chapter 3? Here's an explanation of the Adjusting Entry on 12/31.
‣
Adjusting Entry on Dec 31: On December 31st, 2023, an adjusting entry is required to recognize the insurance expense for the portion used during the year, a concept we’ll delve into in chapter 3. Insurance Expense 6,000 Prepaid Insurance 6,000
The $6,000 Insurance Expense that was debited is calculated as follows:
- The $12,000 paid for the 12-month policy works out to a monthly cost of $1,000.
- From July 1st to December 31st, a total of six months have elapsed.
- Six months at $1,000 per month gives us an Insurance Expense of $6,000.
- We debited the expense to increase it, which is how we recognize an expense — since all expense accounts work like (+/-).
The $6,000 Prepaid Insurance that was credited is calculated as follows:
- On July 1st, we debited Prepaid Insurance for $12,000.
- By December 31st, six months of the policy have been utilized, leaving only half of the initial policy value intact.
- If we don't reduce the Prepaid Insurance account by crediting it, our balance sheet would inaccurately represent an overstated value for our prepaid insurance.
- Consequently, we must credit Prepaid Insurance, an asset account, to decrease it to the correct remaining amount.
- Refer to the T Account below for reference.
ExplanationsOriginal Entry on July 1Is A = L + E in balance?
Common MistakesMisunderstanding when to debit Prepaid Insurance vs. Insurance Expense
Why is this incorrect?
Pro Tip for Understanding Expenses:
Misunderstanding the Cash Cheat CodeWhy is this incorrect?
The “Cash Cheat Code”Trick for every time you pay cash in a transaction Trick for every time you receive cash in a transaction
Misunderstanding T Accounts
‣
- Notice how, in this sequence, we initially debited Prepaid Insurance, an asset account (+/-), to reflect that we now own $12,000 worth of insurance that we will use later.
- Crediting cash, an asset account (+/-), decreases the cash balance.
- This follows the Cash Cheat Code, where paying cash is always recorded as a credit, as cash is an asset (+/-) and needs to be decreased.
‣
- By recording this journal entry, we can see that A = L + E remains in balance.
- Original Entry on July 1: Assets = Liabilities + Equity ↓ 12k ↑ 12k
- The cash payment decreased assets by $12,000, while the purchase of prepaid insurance increased assets by $12,000. This transaction effectively traded one asset for another.
- For now, ignore checking A = L + E for the adjusting entry example. This relates to a concept from Chapter 3, which we'll delve into later.
‣
‣
⚠️ Be extremely careful not to debit Insurance Expense when prepaying for insurance!
❌ Incorrect Example
On July 1st, 2023, Survive Company pays $12,000 in cash for a 12-month insurance policy.
Insurance Expense 12,000
Cash 12,000
Your exam will attempt to trick you into doing this. It is incorrect!
‣
- Prepaying for insurance does not mean we should debit an expense account. Why not? Well, simply purchasing prepaid insurance doesn't mean we've used any of it!
- Recall the expense recognition principle: we only record expenses when they're consumed or used (the true 'cost'), not just when we purchase or pay for them.
✅ Correct Example On July 1st, 2023, Survive Company pays $12,000 in cash for a 12-month insurance policy. Prepaid Insurance 12,000 Cash 12,000
Confused? I’ve included my Pro Tip for Understanding Expenses below, if you need a refresher.
‣
- It's a common misconception to associate expenses solely with the outflow of cash. That's not always accurate!
- Understanding the timing of expense recognition is crucial for interpreting its impact on financial statements. This is where the matching principle comes in handy: expenses are recognized when the resources or services are used to generate revenue, not necessarily when cash is paid.
- Let's consider an example. If we purchase supplies by paying cash, we're essentially trading one asset (cash) for another (supplies). At this point, no expense is recognized.
- Why not? Because we haven't used these supplies yet!
- The expense hits our books only when we actually use the supplies in our operations. The act of buying the supplies doesn't equate to an expense—it's the usage that counts!
- So, remember: expenses aren't about cash payments but about resource consumption.
‣
Ensure that you have a solid grasp of the Cash Cheat Code, as it can be immensely helpful.
For instance, if you're aware of the cheat code and encounter a transaction where you're paying cash, you can be certain that the journal entry must include a credit to cash.
Let's look at an example:
On Jan 5th, Survive Company pays $1000 cash for supplies.
❌ Incorrect Entry
Cash 1,000
Supplies 1,000
‣
- Recall the Cash Cheat Code. When you pay cash in a transaction, it MUST always include a credit to cash, as cash is an asset (+/-) and all assets decrease with a credit.
- Debiting cash makes zero sense. This would increase your cash balance, which is incorrect because we actually paid cash.
✅ Correct Entry Supplies 1,000 Cash 1,000
Confused? Get a recap on the Cash Cheat Code below.
‣
📌 Cash, a fundamental asset account used in every business, is involved in over half of the journal entries you'll encounter in this course.
- Fortunately, understanding cash is super straightforward. It boils down to only two possibilities: paying cash or receiving cash.
- What if I told you that the journal entries for cash follow a consistent pattern when it comes to debits and credits?
⚔️ Discover your secret weapon below ⚔️
‣
- Obviously, every time you pay cash — your cash balance decreases!
- Since cash is an asset (+/-) and all assets decrease with a credit…
- you must credit cash for all journal entries involving cash payments.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) payment of cash, that transactions journal entry will ALWAYS include a CREDIT to cash.
- At last, we have something consistent to rely on!
‣
- Conversely, every time you receive cash — your cash balance increases!
- Since cash is an asset (+/-) and all assets increase with a debit…
- you must debit cash for all journal entries involving receiving cash.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) receipt of cash, that transactions journal entry will ALWAYS include a DEBIT to cash.
- At last, we have something consistent to rely on!
Remember this "Cheat Code" to confidently handle cash transactions. It will make some journal entries on exams so easy — you’ll literally feel like you're cheating. 😉
Pro Tip For Exams:See the Cash Cheat Code in action to learn how to use it effectively during exams!Process of elimination, baby!
‣
- The Cash Cheat Code offers an additional benefit beyond its simplicity. By quickly identifying the appropriate debit or credit for cash, you can free up mental energy.
- Rather than searching for both sides of the transaction, you already have one side resolved. This allows you to concentrate on determining the other side of the journal entry with more precision.
- Furthermore, The Cash Cheat Code can be a valuable strategy during multiple choice exam questions.
- For instance, if a question involves a cash payment transaction, any option that doesn't credit cash is automatically incorrect. See a quick example below.
‣
It's crucial to understand that the values recorded in a T Account are not arbitrary; they're directly tied to the journal entries made earlier in the accounting cycle.
For example, the $12,000 listed in the debit column of the Prepaid Insurance T Account is a direct reflection of the $12,000 debit to Prepaid Insurance in the original entry!
Pro Tip For ExamsTransactions are often linked together! (Prepaying for Insurance)
‣
Transactions are often interconnected and not isolated events. There may be preceding related transactions that have already occurred or upcoming transactions in the future.
- By being able to see the full picture and understand the sequence of transactions as a whole, journal entries become much clearer.
- For example, When you prepay for rent (i.e. a lease agreement), the subsequent step is to analyze at year-end how much of this lease has been utilized (i.e. how much time has passed.)
- You then record an adjusting entry, recognizing rent expense for the amount of the lease that has been used.
- This topic is further elaborated in chapter 3 — but it’s always beneficial to get a headstart!
Hey there! If you're reading these Pro Tips, I want you to know that I'm genuinely thrilled you're here, and I hope that Survive Accounting is helpful to you. With some hard work — I wholeheartedly believe you're going to ace your exams. Your partner in exam domination, - Lee lee@surviveaccounting.com PS — I'd love to hear from you! Drop me a line or introduce yourself via email. I personally reply to every email.
‣
On August 31st, 2023, Survive Company pays $24,000 in cash for a 12-month lease on a building. The journal entry is:
Original Entry on Aug 31:
Prepaid Rent 24,000
Cash 24,000
Looking to get a headstart on Chapter 3? Here's an explanation of the Adjusting Entry on 12/31.
‣
Adjusting Entry on Dec 31: On December 31st, 2023, an adjusting entry is required to recognize the rent expense for the portion used during the year, a concept we’ll delve into in chapter 3.
Rent Expense 8,000 Prepaid Rent 8,000
The $8,000 Rent Expense that was debited is calculated as follows:
- The $24,000 paid for the 12-month lease works out to a monthly cost of $2,000.
- 24,000 / 12 months = 2,000 per month
- From August 31st to December 31st, a total of four months have elapsed.
- Four months at $2,000 per month gives us an Rent Expense of $8,000.
- We debited the expense to increase it, which is how we recognize an expense — since all expense accounts work like (+/-).
The $8,000 Prepaid Rent that was credited is calculated as follows:
- On August 31st, we debited Prepaid Insurance for $24,000.
- By December 31st, four months (4/12) of the lease have been used, leaving eight months (8/12) of the lease remaining.
- If we don't reduce the Prepaid Rent account by crediting it, our balance sheet would inaccurately represent an overstated value for our prepaid rent.
- Consequently, we must credit Prepaid Rent, an asset account, to decrease it to the correct remaining amount.
- Refer to the T Account below for reference.
ExplanationsOriginal Entry on Aug 31Is A = L + E in balance?Common MistakesMisunderstanding the Cash Cheat CodeWhy is this incorrect?
The “Cash Cheat Code”Trick for every time you pay cash in a transaction Trick for every time you receive cash in a transaction
Misunderstanding when to debit Prepaid Rent vs. Rent ExpenseWhy is this incorrect?
Pro Tip for Understanding Expenses:
Misunderstanding T Accounts
‣
- Notice how, in this sequence, we initially debited Prepaid Rent, an asset account (+/-), to reflect that we now own $24,000 worth of rent that we will use later.
- Crediting cash, an asset account (+/-), decreases the cash balance.
- This follows the Cash Cheat Code, where paying cash is always recorded as a credit, as cash is an asset (+/-) and needs to be decreased.
‣
- By recording this journal entry, we can see that A = L + E remains in balance.
- Original Entry on Aug 31 Assets = Liabilities + Equity ↓ 24k ↑ 24k
- The cash payment decreased assets by $24,000, while the purchase of prepaid rent increased assets by $24,000. This transaction effectively traded one asset for another.
- For now, ignore checking A = L + E for the adjusting entry example. This relates to a concept from Chapter 3, which we'll delve into later.
‣
‣
Ensure that you have a solid grasp of the Cash Cheat Code, as it can be immensely helpful.
For instance, if you're aware of the cheat code and encounter a transaction where you're paying cash, you can be certain that the journal entry must include a credit to cash.
Let's look at an example:
On Jan 5th, Survive Company pays $1000 cash for supplies.
❌ Incorrect Entry
Cash 1,000
Supplies 1,000
‣
- Recall the Cash Cheat Code. When you pay cash in a transaction, it MUST always include a credit to cash, as cash is an asset (+/-) and all assets decrease with a credit.
- Debiting cash makes zero sense. This would increase your cash balance, which is incorrect because we actually paid cash.
✅ Correct Entry Supplies 1,000 Cash 1,000
Confused? Get a recap on the Cash Cheat Code below.
‣
📌 Cash, a fundamental asset account used in every business, is involved in over half of the journal entries you'll encounter in this course.
- Fortunately, understanding cash is super straightforward. It boils down to only two possibilities: paying cash or receiving cash.
- What if I told you that the journal entries for cash follow a consistent pattern when it comes to debits and credits?
⚔️ Discover your secret weapon below ⚔️
‣
- Obviously, every time you pay cash — your cash balance decreases!
- Since cash is an asset (+/-) and all assets decrease with a credit…
- you must credit cash for all journal entries involving cash payments.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) payment of cash, that transactions journal entry will ALWAYS include a CREDIT to cash.
- At last, we have something consistent to rely on!
‣
- Conversely, every time you receive cash — your cash balance increases!
- Since cash is an asset (+/-) and all assets increase with a debit…
- you must debit cash for all journal entries involving receiving cash.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) receipt of cash, that transactions journal entry will ALWAYS include a DEBIT to cash.
- At last, we have something consistent to rely on!
Remember this "Cheat Code" to confidently handle cash transactions. It will make some journal entries on exams so easy — you’ll literally feel like you're cheating. 😉
Pro Tip For Exams:See the Cash Cheat Code in action to learn how to use it effectively during exams!Process of elimination, baby!
‣
- The Cash Cheat Code offers an additional benefit beyond its simplicity. By quickly identifying the appropriate debit or credit for cash, you can free up mental energy.
- Rather than searching for both sides of the transaction, you already have one side resolved. This allows you to concentrate on determining the other side of the journal entry with more precision.
- Furthermore, The Cash Cheat Code can be a valuable strategy during multiple choice exam questions.
- For instance, if a question involves a cash payment transaction, any option that doesn't credit cash is automatically incorrect. See a quick example below.
‣
⚠️ Be extremely careful NOT to debit Rent Expense when prepaying for rent! ❌ Incorrect Example: On August 31st, 2023, Survive Company pays $24,000 in cash for a 12-month lease on a building.
Rent Expense 24,000
Cash 24,000
Your exam will attempt to trick you into doing this. It is incorrect!
‣
- Prepaying for rent does not mean we should debit an expense account. Why not? Well, simply purchasing prepaid rent doesn't mean we've used any of it!
- Recall the expense recognition principle: we only record expenses when they're consumed or used (the true 'cost'), not just when we purchase or pay for them.
✅ Correct Example On August 31st, 2023, Survive Company pays $24,000 in cash for a 12-month lease on a building. The journal entry is: Prepaid Rent 24,000 Cash 24,000
Confused? I’ve included my Pro Tip for Understanding Expenses below, if you need a refresher.
‣
It's a common misconception to associate expenses solely with the outflow of cash. That's not always accurate!
Understanding the timing of expense recognition is crucial for interpreting its impact on financial statements. This is where the matching principle comes in handy: expenses are recognized when the resources or services are used to generate revenue, not necessarily when cash is paid.
Let's consider an example. If we purchase supplies by paying cash, we're essentially trading one asset (cash) for another (supplies). At this point, no expense is recognized. Why not? Because we haven't used these supplies yet.
The expense hits our books only when we actually use the supplies in our operations. The act of buying the supplies doesn't equate to an expense—it's the usage that counts!
So, remember: expenses aren't about cash payments but about resource consumption. This understanding will be particularly useful in Chapter 3, where we delve into adjusting journal entries. So keep practicing!
‣
It's crucial to understand that the values recorded in a T Account are not arbitrary; they're directly tied to the journal entries made earlier in the accounting cycle.
For example, the $24,000 listed in the debit column of the Prepaid Rent T Account is a direct reflection of the $24,000 debit to Prepaid Rent in the original entry!
Pro Tips For ExamsTransactions are often linked together! (Prepaying for Rent)
Embrace Mistakes!
‣
‣
- Learning accounting can sometimes feel like a challenging journey, especially when you're just starting out.
- When attempting a new problem, it might be tempting to aim for perfection on your first try, but it's crucial to remember that mistakes are an integral part of the learning process in the course.
- Mistakes Are Part of the Process:
- When you're first starting to understand accounting concepts, you might make mistakes while attempting problems. And that's completely okay!
- The key is to acknowledge these errors and learn from them. After all, you need to first understand how things can go wrong before you can make them right.
- The Learning Curve:
- • Many students try to avoid making mistakes while studying or preparing for exams, which is counterproductive. The goal isn't to avoid mistakes but to learn from them.
- Imagine being on an exam, encountering a problem, and realizing (for the first time) that you’re going down the wrong path. That's not a good feeling!
- Now, consider this opposite scenario: You're in the middle of an exam, and you start going down the wrong path with a problem. It's uncomfortable, but if you've already encountered this situation during your studies, you'll recognize it.
- You'll have developed the resilience and skills to identify and correct your errors. (This, in the heat of an exam, is a powerful skill!)
- The Power of Practice:
- This is why it's crucial to thoroughly read all the “Exam Pro Tips” and “Common Mistakes By Students” included in these cheat sheets. They'll help you fully understand the potential pitfalls.
- Additionally, attempting the practice exams is highly recommended. They're designed to lead you down the wrong paths intentionally, so you can learn how to steer yourself back on track.
- The more you practice, the better you'll become at navigating these errors. Over time, you'll find that you're able to solve problems correctly, whether it's on your first, second, or third attempt!
Remember, the objective isn't to avoid making mistakes but to learn from them. The more mistakes you make and correct during your study sessions, the more capable and confident you'll be during your exams. Embrace your mistakes!
‣
On January 1st, Survive Company pays $180,000 in cash for a 36-month advertising contract. The contract will be delivered evenly each month.
Original Entry on Jan 1:
Prepaid Advertising 180,000
Cash 180,000
Looking to get a headstart on Chapter 3? Here's an explanation of the Adjusting Entry on 12/31.
‣
Adjusting Entry on Dec 31: On December 31st, an adjusting entry is required to recognize the advertising expense for the amount used during the year, concept we’ll discuss in Chapter 3. Advertising Expense 60,000 Prepaid Advertising 60,000
The $60,000 Advertising Expense that was debited is calculated as follows:
- The $180,000 paid for the 36-month advertising contract works out to a monthly cost of $5,000.
- 180,000 / 36 months = 5,000 per month
- From January 1st to December 31st, a total of twelve months have elapsed.
- Twelve months at $5,000 per month gives us an Advertising Expense of $60,000.
- We debited the expense to increase it, which is how we recognize an expense — since all expense accounts work like (+/-).
The $60,000 Prepaid Advertising that was credited is calculated as follows:
- On January 1st, we debited Prepaid Advertising for $180,000.
- By December 31st, twelve months out of thirty six (12/36) of the contract have been used, leaving 24 months (24/36) remaining.
- If we don't reduce the Prepaid Advertising account by crediting it, our balance sheet would inaccurately represent an overstated value for our prepaid advertising.
- Consequently, we must credit Prepaid Advertising, an asset account (+/-), to decrease it to the correct remaining amount.
- Refer to the T Account below for reference.
ExplanationsOriginal Entry on Jan 1 Is A = L + E in balance?Common Mistakes Misunderstanding when to debit Prepaid Advertising vs. Advertising ExpenseBut why is this incorrect?
Pro Tip for Understanding Expenses:
Misunderstanding the Cash Cheat CodeWhy is this incorrect?
The “Cash Cheat Code”Trick for every time you pay cash in a transaction Trick for every time you receive cash in a transaction
Misunderstanding T Accounts
‣
- Notice how, in this sequence, we initially debited Prepaid Advertising, an asset account (+/-), to reflect that we now own $180,000 worth of advertising that we will evenly use over the next 36 months.
- Crediting cash, an asset account (+/-), decreases the cash balance.
- This follows the Cash Cheat Code, where paying cash is always recorded as a credit, as cash is an asset (+/-) and needs to be decreased.
‣
- By recording this journal entry, we can see that A = L + E remains in balance.
- Original Entry on Jan 1 Assets = Liabilities + Equity ↓ 180k ↑ 180k
- The cash payment decreased assets by $180,000, while the purchase of prepaid rent increased assets by $180,000. This transaction effectively traded one asset for another.
- For now, ignore checking A = L + E for the adjusting entry example, as we will elaborate on this further in Chapter 3.
‣
‣
⚠️ Be extremely careful NOT to debit Advertising Expense when prepaying for advertising! ❌ Incorrect Example On January 1st, Survive Company pays $180,000 in cash for a 36-month advertising contract. The contract will be delivered evenly each month.
Advert. Expense 180,000
Cash 180,000
Your exam will attempt to trick you into doing this, especially on multiple choice. It is incorrect!
‣
- Prepaying for advertising does not mean we should debit an expense account. Why not? Well, simply purchasing prepaid advertising doesn't mean we've used any of it!
- Recall the expense recognition principle: we only record expenses when they're consumed or used (the true 'cost'), not just when we purchase or pay for them.
Remember, the correct entry is: ✅ Correct Example On January 1st, Survive Company pays $180,000 in cash for a 36-month advertising contract. The contract will be delivered evenly each month. Prepaid Advertising 180,000 Cash 180,000
Confused? I’ve included my Pro Tip for Understanding Expenses below, if you need a refresher.
‣
It's a common misconception to associate expenses solely with the outflow of cash. That's not always accurate!
Understanding the timing of expense recognition is crucial for interpreting its impact on financial statements. This is where the matching principle comes in handy: expenses are recognized when the resources or services are used to generate revenue, not necessarily when cash is paid.
Let's consider an example. If we purchase supplies by paying cash, we're essentially trading one asset (cash) for another (supplies). At this point, no expense is recognized. Why not? Because we haven't used these supplies yet.
The expense hits our books only when we actually use the supplies in our operations. The act of buying the supplies doesn't equate to an expense—it's the usage that counts!
So, remember: expenses aren't about cash payments but about resource consumption. This understanding will be particularly useful in Chapter 3, where we delve into adjusting journal entries. So keep practicing!
‣
Ensure that you have a solid grasp of the Cash Cheat Code, as it can be immensely helpful.
For instance, if you're aware of the cheat code and encounter a transaction where you're paying cash, you can be certain that the journal entry must include a credit to cash.
Let's look at an example:
On Jan 5th, Survive Company pays $1000 cash for supplies.
❌ Incorrect Entry
Cash 1,000
Supplies 1,000
‣
- Recall the Cash Cheat Code. When you pay cash in a transaction, it MUST always include a credit to cash, as cash is an asset (+/-) and all assets decrease with a credit.
- Debiting cash makes zero sense. This would increase your cash balance, which is incorrect because we actually paid cash.
✅ Correct Entry Supplies 1,000 Cash 1,000
Confused? Get a recap on the Cash Cheat Code below.
‣
📌 Cash, a fundamental asset account used in every business, is involved in over half of the journal entries you'll encounter in this course.
- Fortunately, understanding cash is super straightforward. It boils down to only two possibilities: paying cash or receiving cash.
- What if I told you that the journal entries for cash follow a consistent pattern when it comes to debits and credits?
⚔️ Discover your secret weapon below ⚔️
‣
- Obviously, every time you pay cash — your cash balance decreases!
- Since cash is an asset (+/-) and all assets decrease with a credit…
- you must credit cash for all journal entries involving cash payments.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) payment of cash, that transactions journal entry will ALWAYS include a CREDIT to cash.
- At last, we have something consistent to rely on!
‣
- Conversely, every time you receive cash — your cash balance increases!
- Since cash is an asset (+/-) and all assets increase with a debit…
- you must debit cash for all journal entries involving receiving cash.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) receipt of cash, that transactions journal entry will ALWAYS include a DEBIT to cash.
- At last, we have something consistent to rely on!
Remember this "Cheat Code" to confidently handle cash transactions. It will make some journal entries on exams so easy — you’ll literally feel like you're cheating. 😉
Pro Tip For Exams:See the Cash Cheat Code in action to learn how to use it effectively during exams!Process of elimination, baby!
‣
- The Cash Cheat Code offers an additional benefit beyond its simplicity. By quickly identifying the appropriate debit or credit for cash, you can free up mental energy.
- Rather than searching for both sides of the transaction, you already have one side resolved. This allows you to concentrate on determining the other side of the journal entry with more precision.
- Furthermore, The Cash Cheat Code can be a valuable strategy during multiple choice exam questions.
- For instance, if a question involves a cash payment transaction, any option that doesn't credit cash is automatically incorrect. See a quick example below.
‣
It's crucial to understand that the values recorded in a T Account are not arbitrary; they're directly tied to the journal entries made earlier in the accounting cycle.
For example, the $180,000 listed in the debit column of the Prepaid Advertising T Account is a direct reflection of the $180,000 debit to Prepaid Advertising in the original entry!
Pro Tips For ExamsTransactions are often linked together! (Prepaying for Advertising)
Embrace Mistakes!
‣
Transactions are often interconnected and not isolated events. There may be preceding related transactions that have already occurred or upcoming transactions in the future.
- By being able to see the full picture and understand the sequence of transactions as a whole, journal entries become much clearer.
- When you prepay for advertising, the subsequent step is to analyze at year-end the extent to which it has been utilized.
- Then, you record an adjusting entry that recognizes the advertising expense based on the amount of the contract that has been used.
- This topic is further elaborated in chapter 3 — but it’s always beneficial to get a headstart!
Hey there! If you're reading these Pro Tips, I want you to know that I'm genuinely thrilled you're here, and I hope that Survive Accounting is helpful to you. With some hard work — I wholeheartedly believe you're going to ace your exams. Your partner in exam domination, - Lee lee@surviveaccounting.com PS — I'd love to hear from you! Drop me a line or introduce yourself via email. I personally reply to every email.
‣
Learning accounting can sometimes feel like a challenging journey, especially when you're just starting out.
- When attempting a new problem, it might be tempting to aim for perfection on your first try, but it's crucial to remember that mistakes are an integral part of the learning process in the course.
- Mistakes Are Part of the Process:
- When you're first starting to understand accounting concepts, you might make mistakes while attempting problems. And that's completely okay!
- The key is to acknowledge these errors and learn from them. After all, you need to first understand how things can go wrong before you can make them right.
- The Learning Curve:
- • Many students try to avoid making mistakes while studying or preparing for exams, which is counterproductive. The goal isn't to avoid mistakes but to learn from them.
- Imagine being on an exam, encountering a problem, and realizing (for the first time) that you’re going down the wrong path. That's not a good feeling!
- Now, consider this opposite scenario: You're in the middle of an exam, and you start going down the wrong path with a problem. It's uncomfortable, but if you've already encountered this situation during your studies, you'll recognize it.
- You'll have developed the resilience and skills to identify and correct your errors. (This, in the heat of an exam, is a powerful skill!)
- The Power of Practice:
- This is why it's crucial to thoroughly read all the “Exam Pro Tips” and “Common Mistakes By Students” included in these cheat sheets. They'll help you fully understand the potential pitfalls.
- Additionally, attempting the practice exams is highly recommended. They're designed to lead you down the wrong paths intentionally, so you can learn how to steer yourself back on track.
- The more you practice, the better you'll become at navigating these errors. Over time, you'll find that you're able to solve problems correctly, whether it's on your first, second, or third attempt!
Remember, the objective isn't to avoid making mistakes but to learn from them. The more mistakes you make and correct during your study sessions, the more capable and confident you'll be during your exams. Embrace your mistakes!
‣
📌 Many other examples of recording expenses exist, but these three scenarios offer a sufficient starting point for understanding the concept.
‣
On Nov 30th, Survive Company pays $10,000 cash for utilities over the previous month.
Utilities Expense 10,000
Cash 10,000
ExplanationsEntry on Nov 30Is A = L + E in balance?Why does incurring Expenses decrease Equity?
Common MistakesMisunderstanding the Cash Cheat CodeWhy is this incorrect?
The “Cash Cheat Code”Trick for every time you pay cash in a transaction Trick for every time you receive cash in a transaction
‣
- It's important to note that we debited Utilities Expense, an expense account (+/-), to indicate that we have incurred a $10,000 cost from utilities.
- Why wouldn’t we record this to an asset account, like Prepaid Utilities?
- We don’t record this to a prepaid asset account, because the word problem indicates this payment was for utilties that were already used. Therefore, per the expense recognition principle, we must record this cost as an expense now!
- Crediting cash, an asset account (+/-), decreases the cash balance.
- This follows the Cash Cheat Code, where paying cash is always recorded as a credit, as cash is an asset (+/-) and needs to be decreased when we receive cash.
‣
- By recording this journal entry, we can see that A = L + E remains in balance.
- Original Entry on Nov 30 Assets = Liabilities + Equity ↓ 10k ↓ 10k
- The cash paid decreases assets by $10,000, while the debit to Utilities Expense simultaneously decreased Equity by $10,000.
- Therefore, both sides of the equation have increased by the same amount, ensuring it remains balanced.
‣
- Incurring Expenses (i.e. “costs”) decrease equity because expenses negatively contribute to a business's net income (Revenue - Expenses).
- Think of it this way: if expenses capture our ‘costs' incurring while providing services or delivering goods, and equity represents our company's 'value', naturally, incurring more costs would decrease our company's value or equity.
- Furthermore, net income contributes to Retained Earnings, an element of equity, therefore:
- An increase in expenses has a negative effect on net income…
- Which subsequently lowers Retained Earnings…
- And in turn decreases overall equity, since R/E is an equity account!
- We'll delve deeper into how Net Income affects Retained Earnings in Chapter 3 when we examine the closing entry process.
‣
‣
Ensure that you have a solid grasp of the Cash Cheat Code, as it can be immensely helpful.
For instance, if you're aware of the cheat code and encounter a transaction where you're receiving cash, you can be certain that the journal entry must include a debit to cash.
Let's look at an example:
On Sept 30th, Survive Company receives $200,000 cash for services completed for a customer.
❌ Incorrect Entry
Fees Earned 200,000
Cash 200,000
‣
- Recall the Cash Cheat Code. When you receive cash in a transaction, it MUST always include a debit to cash, as cash is an asset (+/-) and all assets increase with a debit.
- Crediting cash makes zero sense. This would decrease your cash balance, which is incorrect because we actually received cash.
✅ Correct Entry Cash 200,000 Fees Earned 200,000
Confused? Get a recap on the Cash Cheat Code below.
‣
📌 Cash, a fundamental asset account used in every business, is involved in over half of the journal entries you'll encounter in this course.
- Fortunately, understanding cash is super straightforward. It boils down to only two possibilities: paying cash or receiving cash.
- What if I told you that the journal entries for cash follow a consistent pattern when it comes to debits and credits?
⚔️ Discover your secret weapon below ⚔️
‣
- Obviously, every time you pay cash — your cash balance decreases!
- Since cash is an asset (+/-) and all assets decrease with a credit…
- you must credit cash for all journal entries involving cash payments.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) payment of cash, that transactions journal entry will ALWAYS include a CREDIT to cash.
- At last, we have something consistent to rely on!
‣
- Conversely, every time you receive cash — your cash balance increases!
- Since cash is an asset (+/-) and all assets increase with a debit…
- you must debit cash for all journal entries involving receiving cash.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) receipt of cash, that transactions journal entry will ALWAYS include a DEBIT to cash.
- At last, we have something consistent to rely on!
Remember this "Cheat Code" to confidently handle cash transactions. It will make some journal entries on exams so easy — you’ll literally feel like you're cheating. 😉
Pro Tip For Exams:See the Cash Cheat Code in action to learn how to use it effectively during exams!Process of elimination, baby!
‣
- The Cash Cheat Code offers an additional benefit beyond its simplicity. By quickly identifying the appropriate debit or credit for cash, you can free up mental energy.
- Rather than searching for both sides of the transaction, you already have one side resolved. This allows you to concentrate on determining the other side of the journal entry with more precision.
- Furthermore, The Cash Cheat Code can be a valuable strategy during multiple choice exam questions.
- For instance, if a question involves a cash payment transaction, any option that doesn't credit cash is automatically incorrect. See a quick example below.
Pro Tip for Exams“Expenses are about paying cash, right?” (Wrong!)
‣
Often, students confuse expenses to only refer to paying cash. This is not always the case!
How could I possibly pay cash and it not be an expense?
Conversely, how could I possibly record an expense and not pay any cash?
More examples!
Are there examples of paying cash and recording an expense at the same time?
- Understanding the timing of expense recognition is crucial for interpreting its impact on financial statements. This is where the matching principle comes in handy: expenses are recognized when the resources or services are used to generate revenue, not necessarily when cash is paid.
- Let's consider an example. If we purchase supplies by paying cash, we're essentially trading one asset (cash) for another (supplies). At this point, no expense is recognized. Why not? Because we haven't used these supplies yet.
- The expense hits our books only when we actually use the supplies in our operations. The act of buying the supplies doesn't equate to an expense—it's the usage that counts!
Confused? Check out more examples below.
‣
- Paying cash for a building (an asset) is NOT an expense.
- However, as it depreciates over time, we will recognize depreciation expense!
- Paying cash for inventory (an asset) is NOT an expense.
- However, we will record Cost of Goods Sold (an expense) once it’s sold!
- Paying cash for Prepaid Rent (an asset) is NOT an expense.
- However, we will record Rent Expense later as the lease term elapses.
- Paying cash for Prepaid Insurance (an asset) is NOT an expense.
- However, we will record Insurance Expense later as our coverage expires or is used.
‣
- Consider the one-word definition of expenses: "costs." Can costs occur without involving any cash payment? Absolutely!
- One example that illustrates this well is depreciation expense. Depreciation refers to the gradual decrease in value over time of long-term assets such as buildings and equipment.
- Let's paint a scenario: You've owned a building for a year, and your accountant estimates that its value has decreased by $10,000. This depreciation is undoubtedly an expense or "cost."
- However, did you have to make any cash payment to anyone for this decline in value? Certainly not! There's no need to write a check to anyone.
- Depreciation is a cost that simply “occurs” as time passes, completely independent of any cash payment!
‣
- Amortization: Similar to depreciation, amortization represents the gradual reduction in value of intangible assets (e.g., patents, copyrights) over time.
- Therefore, Amortization is an expense recorded without any cash payment associated with it, a topic we’ll elaborate further in Chapter 8.
- Accrued Expenses: Suppose a company has incurred employee salaries and wages for the current month but hasn't yet paid them.
- Even without a cash outflow, the company recognizes the expense by accruing the salaries and wages payable, a topic we’ll elaborate further in Chapter 3.
- Bad Debts: If a company has provided goods or services to a customer on credit and later determines that the customer is unable to pay, it records a bad debt expense.
- This expense is recognized despite no cash payment being received from the customer, a topic we’ll elaborate further in Chapter 7.
‣
- Of course! However, it's vital to understand that expense is attributed to the cost incurred, not the cash paid.
- The cash paid does not trigger the expense; it is the incurring of costs or usage of resources that does.
- For example, if we pay cash for utilities consumed, we would immediately record a debit to Utilities Expense as the same time we paid cash — since the Utilities have already been used, so the cost has been incurred!
Remember: expenses aren't about cash payments but about resource consumption. This understanding will be particularly useful in Chapter 3, where we delve into adjusting journal entries. So keep practicing!
‣
On Nov 30th, Survive Company pays $150,000 cash for an advertising contract that concluded last month.
Advertising Expense 150,000
Cash 150,000
ExplanationsEntry on Nov 30Is A = L + E in balance?Why does incurring Expenses decrease Equity?
Common MistakesMisunderstanding the Cash Cheat CodeWhy is this incorrect?
The “Cash Cheat Code”Trick for every time you pay cash in a transaction Trick for every time you receive cash in a transaction
‣
- It's important to note that we debited Advertising Expense, an expense account (+/-), to indicate that we have incurred a $150,000 cost from utilities.
- Why wouldn’t we record this to an asset account, like Prepaid Advertising?
- We don’t record this to a prepaid asset account, because the word problem indicates this payment was for advertising that was already used. Therefore, per the expense recognition principle, we must record this cost as an expense now!
- Crediting cash, an asset account (+/-), decreases the cash balance.
- This follows the Cash Cheat Code, where paying cash is always recorded as a credit, as cash is an asset (+/-) and needs to be decreased when we receive cash.
‣
- By recording this journal entry, we can see that A = L + E remains in balance.
- Original Entry on Nov 30 Assets = Liabilities + Equity ↓ 150k ↓ 150k
- The cash paid decreases assets by $10,000, while the debit to Utilities Expense simultaneously decreased Equity by $10,000.
- Therefore, both sides of the equation have increased by the same amount, ensuring it remains balanced.
‣
- Incurring Expenses (i.e. “costs”) decrease equity because expenses negatively contribute to a business's net income (Revenue - Expenses).
- Think of it this way: if expenses capture our ‘costs' incurring while providing services or delivering goods, and equity represents our company's 'value', naturally, incurring more costs would decrease our company's value or equity.
- Furthermore, net income contributes to Retained Earnings, an element of equity, therefore:
- An increase in expenses has a negative effect on net income…
- Which subsequently lowers Retained Earnings…
- And in turn decreases overall equity, since R/E is an equity account!
- We'll delve deeper into how Net Income affects Retained Earnings in Chapter 3 when we examine the closing entry process.
‣
‣
Ensure that you have a solid grasp of the Cash Cheat Code, as it can be immensely helpful.
For instance, if you're aware of the cheat code and encounter a transaction where you're receiving cash, you can be certain that the journal entry must include a debit to cash.
Let's look at an example:
On Sept 30th, Survive Company receives $200,000 cash for services completed for a customer.
❌ Incorrect Entry
Fees Earned 200,000
Cash 200,000
‣
- Recall the Cash Cheat Code. When you receive cash in a transaction, it MUST always include a debit to cash, as cash is an asset (+/-) and all assets increase with a debit.
- Crediting cash makes zero sense. This would decrease your cash balance, which is incorrect because we actually received cash.
✅ Correct Entry Cash 200,000 Fees Earned 200,000
Confused? Get a recap on the Cash Cheat Code below.
‣
📌 Cash, a fundamental asset account used in every business, is involved in over half of the journal entries you'll encounter in this course.
- Fortunately, understanding cash is super straightforward. It boils down to only two possibilities: paying cash or receiving cash.
- What if I told you that the journal entries for cash follow a consistent pattern when it comes to debits and credits?
⚔️ Discover your secret weapon below ⚔️
‣
- Obviously, every time you pay cash — your cash balance decreases!
- Since cash is an asset (+/-) and all assets decrease with a credit…
- you must credit cash for all journal entries involving cash payments.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) payment of cash, that transactions journal entry will ALWAYS include a CREDIT to cash.
- At last, we have something consistent to rely on!
‣
- Conversely, every time you receive cash — your cash balance increases!
- Since cash is an asset (+/-) and all assets increase with a debit…
- you must debit cash for all journal entries involving receiving cash.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) receipt of cash, that transactions journal entry will ALWAYS include a DEBIT to cash.
- At last, we have something consistent to rely on!
Remember this "Cheat Code" to confidently handle cash transactions. It will make some journal entries on exams so easy — you’ll literally feel like you're cheating. 😉
Pro Tip For Exams:See the Cash Cheat Code in action to learn how to use it effectively during exams!Process of elimination, baby!
‣
- The Cash Cheat Code offers an additional benefit beyond its simplicity. By quickly identifying the appropriate debit or credit for cash, you can free up mental energy.
- Rather than searching for both sides of the transaction, you already have one side resolved. This allows you to concentrate on determining the other side of the journal entry with more precision.
- Furthermore, The Cash Cheat Code can be a valuable strategy during multiple choice exam questions.
- For instance, if a question involves a cash payment transaction, any option that doesn't credit cash is automatically incorrect. See a quick example below.
Pro Tips for Exams“Expenses are about paying cash, right?” (Wrong!)
‣
Often, students confuse expenses to only refer to paying cash. This is not always the case!
How could I possibly pay cash and it not be an expense?
Conversely, how could I possibly record an expense and not pay any cash?
More examples!
Are there examples of paying cash and recording an expense at the same time?
- Understanding the timing of expense recognition is crucial for interpreting its impact on financial statements. This is where the matching principle comes in handy: expenses are recognized when the resources or services are used to generate revenue, not necessarily when cash is paid.
- Let's consider an example. If we purchase supplies by paying cash, we're essentially trading one asset (cash) for another (supplies). At this point, no expense is recognized. Why not? Because we haven't used these supplies yet.
- The expense hits our books only when we actually use the supplies in our operations. The act of buying the supplies doesn't equate to an expense—it's the usage that counts!
Confused? Check out more examples below.
‣
- Paying cash for a building (an asset) is NOT an expense.
- However, as it depreciates over time, we will recognize depreciation expense!
- Paying cash for inventory (an asset) is NOT an expense.
- However, we will record Cost of Goods Sold (an expense) once it’s sold!
- Paying cash for Prepaid Rent (an asset) is NOT an expense.
- However, we will record Rent Expense later as the lease term elapses.
- Paying cash for Prepaid Insurance (an asset) is NOT an expense.
- However, we will record Insurance Expense later as our coverage expires or is used.
‣
- Consider the one-word definition of expenses: "costs." Can costs occur without involving any cash payment? Absolutely!
- One example that illustrates this well is depreciation expense. Depreciation refers to the gradual decrease in value over time of long-term assets such as buildings and equipment.
- Let's paint a scenario: You've owned a building for a year, and your accountant estimates that its value has decreased by $10,000. This depreciation is undoubtedly an expense or "cost."
- However, did you have to make any cash payment to anyone for this decline in value? Certainly not! There's no need to write a check to anyone.
- Depreciation is a cost that simply “occurs” as time passes, completely independent of any cash payment!
‣
- Amortization: Similar to depreciation, amortization represents the gradual reduction in value of intangible assets (e.g., patents, copyrights) over time.
- Therefore, Amortization is an expense recorded without any cash payment associated with it, a topic we’ll elaborate further in Chapter 8.
- Accrued Expenses: Suppose a company has incurred employee salaries and wages for the current month but hasn't yet paid them.
- Even without a cash outflow, the company recognizes the expense by accruing the salaries and wages payable, a topic we’ll elaborate further in Chapter 3.
- Bad Debts: If a company has provided goods or services to a customer on credit and later determines that the customer is unable to pay, it records a bad debt expense.
- This expense is recognized despite no cash payment being received from the customer, a topic we’ll elaborate further in Chapter 7.
‣
- Of course! However, it's vital to understand that expense is attributed to the cost incurred, not the cash paid.
- The cash paid does not trigger the expense; it is the incurring of costs or usage of resources that does.
- For example, if we pay cash for utilities consumed, we would immediately record a debit to Utilities Expense as the same time we paid cash — since the Utilities have already been used, so the cost has been incurred!
Remember: expenses aren't about cash payments but about resource consumption. This understanding will be particularly useful in Chapter 3, where we delve into adjusting journal entries. So keep practicing!
‣
On Dec 31st, Survive Company estimates that the total depreciation on Equipment is $22,000.
Depreciation Expense 22,000
Accumulated Depreciation 22,000
ExplanationsEntry on Dec 31
Is A = L + E in balance?Why does increasing Accumulated Depreciation decrease Assets?
Why does incurring Expenses decrease Equity?
Common MistakesMisunderstanding the Cash Cheat CodeWhy is this incorrect?
The “Cash Cheat Code”Trick for every time you pay cash in a transaction Trick for every time you receive cash in a transaction
‣
- It's important to note that we debited Depreciation Expense, an expense account (+/-), to indicate that we have incurred a $22,000 cost from our equipment depreciating.
- Crediting Accumulated Depreciation, a contra asset account (-/+), increases that account.
- We increased this account to show that more depreciation has accumulated. We'll explore depreciation further in Chapter 8.
- Also, consider in this example that we've recognized an expense, even though no cash has been paid.
- Imagine if you owned a building. The building would naturally depreciate every year due to use and wear and tear. As we’ll discover in chapter 8, accountants estimate this depreciation and record it as an expense each year. Even though this cost is real, it doesn't require any cash outlay. It’s simply a cost being incurred and recorded.
- This concept of depreciation perfectly illustrates the expense recognition principle and demonstrates that it's possible to incur expenses without any immediate cash payments.
‣
- By recording this journal entry, we can see that A = L + E remains in balance.
- Entry on Dec 31 Assets = Liabilities + Equity ↓ 22k ↓ 22k
- The increase in Accumulated Depreciation, a contra asset, actually decreases assets by $22,000, while the debit to Utilities Expense simultaneously decreased Equity by $22,000.
- Therefore, both sides of the equation have increased by the same amount, ensuring it remains balanced.
‣
- As depreciation accumulates, the asset's value decreases. As contra assets have an opposite impact on total assets, an increase in Accumulated Depreciation reduces total asset value.
- Again, we'll explore depreciation further in Chapter 8!
‣
- Incurring Expenses (i.e. “costs”) decrease equity because expenses negatively contribute to a business's net income (Revenue - Expenses).
- Think of it this way: if expenses capture our ‘costs' incurring while providing services or delivering goods, and equity represents our company's 'value', naturally, incurring more costs would decrease our company's value or equity.
- Furthermore, net income contributes to Retained Earnings, an element of equity, therefore:
- An increase in expenses has a negative effect on net income…
- Which subsequently lowers Retained Earnings…
- And in turn decreases overall equity, since R/E is an equity account!
- We'll delve deeper into how Net Income affects Retained Earnings in Chapter 3 when we examine the closing entry process.
‣
‣
Ensure that you have a solid grasp of the Cash Cheat Code, as it can be immensely helpful.
For instance, if you're aware of the cheat code and encounter a transaction where you're receiving cash, you can be certain that the journal entry must include a debit to cash.
Let's look at an example:
On Sept 30th, Survive Company receives $200,000 cash for services completed for a customer.
❌ Incorrect Entry
Fees Earned 200,000
Cash 200,000
‣
- Recall the Cash Cheat Code. When you receive cash in a transaction, it MUST always include a debit to cash, as cash is an asset (+/-) and all assets increase with a debit.
- Crediting cash makes zero sense. This would decrease your cash balance, which is incorrect because we actually received cash.
✅ Correct Entry Cash 200,000 Fees Earned 200,000
Confused? Get a recap on the Cash Cheat Code below.
‣
📌 Cash, a fundamental asset account used in every business, is involved in over half of the journal entries you'll encounter in this course.
- Fortunately, understanding cash is super straightforward. It boils down to only two possibilities: paying cash or receiving cash.
- What if I told you that the journal entries for cash follow a consistent pattern when it comes to debits and credits?
⚔️ Discover your secret weapon below ⚔️
‣
- Obviously, every time you pay cash — your cash balance decreases!
- Since cash is an asset (+/-) and all assets decrease with a credit…
- you must credit cash for all journal entries involving cash payments.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) payment of cash, that transactions journal entry will ALWAYS include a CREDIT to cash.
- At last, we have something consistent to rely on!
‣
- Conversely, every time you receive cash — your cash balance increases!
- Since cash is an asset (+/-) and all assets increase with a debit…
- you must debit cash for all journal entries involving receiving cash.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) receipt of cash, that transactions journal entry will ALWAYS include a DEBIT to cash.
- At last, we have something consistent to rely on!
Remember this "Cheat Code" to confidently handle cash transactions. It will make some journal entries on exams so easy — you’ll literally feel like you're cheating. 😉
Pro Tip For Exams:See the Cash Cheat Code in action to learn how to use it effectively during exams!Process of elimination, baby!
‣
- The Cash Cheat Code offers an additional benefit beyond its simplicity. By quickly identifying the appropriate debit or credit for cash, you can free up mental energy.
- Rather than searching for both sides of the transaction, you already have one side resolved. This allows you to concentrate on determining the other side of the journal entry with more precision.
- Furthermore, The Cash Cheat Code can be a valuable strategy during multiple choice exam questions.
- For instance, if a question involves a cash payment transaction, any option that doesn't credit cash is automatically incorrect. See a quick example below.
Pro Tip for Exams“Expenses are about paying cash, right?” (Wrong!)
‣
Often, students confuse expenses to only refer to paying cash. This is not always the case!
How could I possibly pay cash and it not be an expense?
Conversely, how could I possibly record an expense and not pay any cash?
More examples!
Are there examples of paying cash and recording an expense at the same time?
- Understanding the timing of expense recognition is crucial for interpreting its impact on financial statements. This is where the matching principle comes in handy: expenses are recognized when the resources or services are used to generate revenue, not necessarily when cash is paid.
- Let's consider an example. If we purchase supplies by paying cash, we're essentially trading one asset (cash) for another (supplies). At this point, no expense is recognized. Why not? Because we haven't used these supplies yet.
- The expense hits our books only when we actually use the supplies in our operations. The act of buying the supplies doesn't equate to an expense—it's the usage that counts!
Confused? Check out more examples below.
‣
- Paying cash for a building (an asset) is NOT an expense.
- However, as it depreciates over time, we will recognize depreciation expense!
- Paying cash for inventory (an asset) is NOT an expense.
- However, we will record Cost of Goods Sold (an expense) once it’s sold!
- Paying cash for Prepaid Rent (an asset) is NOT an expense.
- However, we will record Rent Expense later as the lease term elapses.
- Paying cash for Prepaid Insurance (an asset) is NOT an expense.
- However, we will record Insurance Expense later as our coverage expires or is used.
‣
- Consider the one-word definition of expenses: "costs." Can costs occur without involving any cash payment? Absolutely!
- One example that illustrates this well is depreciation expense. Depreciation refers to the gradual decrease in value over time of long-term assets such as buildings and equipment.
- Let's paint a scenario: You've owned a building for a year, and your accountant estimates that its value has decreased by $10,000. This depreciation is undoubtedly an expense or "cost."
- However, did you have to make any cash payment to anyone for this decline in value? Certainly not! There's no need to write a check to anyone.
- Depreciation is a cost that simply “occurs” as time passes, completely independent of any cash payment!
‣
- Amortization: Similar to depreciation, amortization represents the gradual reduction in value of intangible assets (e.g., patents, copyrights) over time.
- Therefore, Amortization is an expense recorded without any cash payment associated with it, a topic we’ll elaborate further in Chapter 8.
- Accrued Expenses: Suppose a company has incurred employee salaries and wages for the current month but hasn't yet paid them.
- Even without a cash outflow, the company recognizes the expense by accruing the salaries and wages payable, a topic we’ll elaborate further in Chapter 3.
- Bad Debts: If a company has provided goods or services to a customer on credit and later determines that the customer is unable to pay, it records a bad debt expense.
- This expense is recognized despite no cash payment being received from the customer, a topic we’ll elaborate further in Chapter 7.
‣
- Of course! However, it's vital to understand that expense is attributed to the cost incurred, not the cash paid.
- The cash paid does not trigger the expense; it is the incurring of costs or usage of resources that does.
- For example, if we pay cash for utilities consumed, we would immediately record a debit to Utilities Expense as the same time we paid cash — since the Utilities have already been used, so the cost has been incurred!
Remember: expenses aren't about cash payments but about resource consumption. This understanding will be particularly useful in Chapter 3, where we delve into adjusting journal entries. So keep practicing!
‣
On October 31st, Survive Company receives $240,000 cash in advance for a 12-month consulting contract delivered evenly each month.
Record the journal entry on 10/31 for Survive Company, and any necessary adjusting entry on 12/31.
Cash 240,000
Unearned Revenue 240,000
Looking to get a headstart on Chapter 3? Here's an explanation of the Adjusting Entry on 12/31.
Deeper Explanation for why Unearned Revenue was debitedDeeper Explanation for why Fees Earned was credited
‣
Adjusting Entry on Dec 31: On December 31st, 2023, an adjusting entry is required to recognize the unearned revenue that was “earned” during the year, a concept we’ll delve into in chapter 3.
Unearned Revenue 40,000 Fees Earned 40,000
Here's how we get the $40,000:
- The total contract value of $240,000 is split evenly over the course of 12 months, leading to an 'earned' revenue of $20,000 per month.
- (240,000 / 12 = 20,000)
- By the end of December, two months of service have been delivered, thereby earning $40,000 in revenue (2 months x $20,000 per month).
- This earned amount of $40,000 is then debited from Unearned Revenue, a liability account (-/+), and credited to Fees Earned, a revenue account (-/+), reflecting a decrease in the liability and an increase in revenue.
This adjustment ensures that the financial statements of the company accurately represent its financial position and earnings performance. It adheres to the revenue recognition principle which mandates that revenues must be recognized in the accounting period in which the services were actually delivered.
‣
- On December 31st, we debited Unearned Revenue, a liability account (-/+), in order to decrease it.
- This accurately shows that we now owe $40,000 less for the consulting contract as we've already provided two out of twelve months of contract.
- To view it differently: If we failed to debit (i.e. decrease) Unearned Revenue, our balance sheet would falsely represent a higher liability. It would seem as though we owe more services than we actually do.
- To illustrate, imagine the company forgot to record this adjusting entry. Consequently, our balance sheet on 12/31 would incorrectly show $240,000 in services owed, whereas the actual figure should be $200,000!
- Therefore, it's essential to debit Unearned Revenue to adjust it to the accurate remaining value of services we're obligated to deliver.
- Refer to the T Account below for reference.
‣
- On December 31st, we credited Fees Earned, a revenue account (-/+), in order to increase it.
- This accurately captures that we've earned $40,000 from the consulting contract, having delivered two out of twelve months of service.
- To view it differently: If we didn't credit (increase) Fees Earned, our income statement would not fully represent our earnings.
- For instance, if we neglected to record this adjusting entry, our income statement on 12/31 would fall short by $40,000 in revenue.
- Therefore, it's crucial to credit Fees Earned to record the accurate amount of revenue we've generated from services performed.
- This adjusting entry also ensures adherence to the revenue recognition principle. It states that revenues must be captured as they're earned, and in the same period they occur. In other words, failing to record this adjusting entry on 12/31, the final day of the year, would mean missing out on reporting this revenue in the correct year!
ExplanationsOriginal Entry on Oct 31Is A = L + E in balance?Common MistakesMisunderstanding Unearned Revenue
“Revenue is about receiving cash, right?”
Misunderstanding T Accounts
‣
- It's important to note that we initially credited Unearned Revenue, a liability account, to indicate that we now owe $240,000 worth of consulting services to be delivered over the next 12 months.
- Remember, as of October 31st, this is classified as 'unearned revenue' because we haven't yet provided the services. As we proceed to deliver these services, we'll record adjusting entries to transition unearned revenue into earned revenue.
- Debiting cash, an asset account (+/-), increases the cash balance.
- This follows the Cash Cheat Code, where receiving cash is always recorded as a debit, as cash is an asset (+/-) and needs to be increased when we receive cash.
‣
- By recording this journal entry, we can see that A = L + E remains in balance.
- Original Entry on Oct 31 Assets = Liabilities + Equity ↑ 240k ↑ 240k
- The cash received increased assets by $240,000, while the credit to Unearned Revenue simultaneously increased liabilities by $240,000.
- Therefore, both sides of the equation have increased by the same amount, ensuring it remains balanced.
- For now, ignore checking A = L + E for the adjusting entry example. This relates to a concept from Chapter 3, which we'll delve into later.
‣
‣
📌 What is Unearned Revenue? This is for cash received in advance for products or services yet to be provided. It is considered a liability because, despite already being paid upfront, the company still owes the goods or services.
- You might be asking yourself, 'How can receiving cash become a liability, suggesting we owe something?' Though this seems counterintuitive, understanding the revenue recognition principle clarifies it.
- The principle asserts that revenue is only recognized when earned, i.e., when the service is delivered. Therefore, money received for a service not yet provided is 'unearned revenue' until we actually deliver the service.
- Consider this another way: you've received upfront cash, but the service remains undelivered. What if the service isn't provided, or the customer cancels the contract?
- In that case, you might need to refund the money! Given these uncertainties, can we truly claim we've 'earned' that cash?
- Isn't it logical to set up a liability account to earmark these funds until we genuinely earn them?
- That's exactly our strategy. At the year end, we'll evaluate how much of our unearned revenue has been earned (i.e., the proportion of the service actually delivered and what remains outstanding).
- Following this, we'll record an adjusting entry to effectively convert unearned revenue into earned revenue.
- We’ll expand much deeper on Unearned Revenue adjusting entries in Chapter 3. With practice, it'll become second nature to you.
‣
⚠️ CAUTION ⚠️ Often, students confuse revenue to only refer to receiving cash. This is not always the case!
- Example #1: When we provide services on credit, the customer pays later, but the revenue is recognized as soon as the services are delivered, as per the revenue recognition principle.
- Example #2: If we receive cash in advance for services we will provide later, this is recorded as Unearned Revenue — a prime example that receiving cash doesn’t always equate to generating revenue!
- Example #3: What if we receive cash immediately upon providing services — is this reveune? Yes, this is considered revenue.
- Nevertheless, it's important to understand that revenue is attributed to the services rendered, not the cash received. The cash received does not trigger the revenue; it is the completion of the services that does.
- Refer back to example #1, where revenue is generated without any cash received yet. It's revenue because the services are delivered!
- This can be confusing, but it's a vital distinction to grasp. For determining revenue under accrual accounting, the key factor isn't whether we've received cash, but rather if we've completed the work. Understanding this is best achieved through practicing problems!
‣
It's crucial to understand that the values recorded in a T Account are not arbitrary; they're directly tied to the journal entries made earlier in the accounting cycle.
For example, the $240,000 listed in the credit column of the Unearned Revenue T Account is a direct reflection of the $240,000 credit to Unearned Revenue in the original entry!
Pro Tip For ExamsTransactions are often linked together! (Unearned Revenue)
Embrace Mistakes!
‣
Transactions are often interconnected and not isolated events. There may be preceding related transactions that have already occurred or upcoming transactions in the future.
- By being able to see the full picture and understand the sequence of transactions as a whole, journal entries become much clearer.
- When you receive cash upfront for a service to be delivered later, the subsequent step is to analyze at year-end how much of the service has been delivered and record an adjusting entry to account for earned revenue, a topic elaborated in chapter 3.
Hey there! If you're reading these Pro Tips, I want you to know that I'm genuinely thrilled you're here, and I hope that Survive Accounting is helpful to you. With some hard work — I wholeheartedly believe you're going to ace your exams. Your partner in exam domination, - Lee lee@surviveaccounting.com PS — I'd love to hear from you! Drop me a line or introduce yourself via email. I personally reply to every email.
Hey there! If you're reading these Pro Tips, I want you to know that I'm genuinely thrilled you're here, and I hope that Survive Accounting is helpful to you. With some hard work — I wholeheartedly believe you're going to ace your exams. Your partner in exam domination, - Lee lee@survivestudios.com PS — I'd love to hear from you! Drop me a line or introduce yourself via email.
‣
- Learning accounting can sometimes feel like a challenging journey, especially when you're just starting out.
- When attempting a new problem, it might be tempting to aim for perfection on your first try, but it's crucial to remember that mistakes are an integral part of the learning process in the course.
- Mistakes Are Part of the Process:
- When you're first starting to understand accounting concepts, you might make mistakes while attempting problems. And that's completely okay!
- The key is to acknowledge these errors and learn from them. After all, you need to first understand how things can go wrong before you can make them right.
- The Learning Curve:
- • Many students try to avoid making mistakes while studying or preparing for exams, which is counterproductive. The goal isn't to avoid mistakes but to learn from them.
- Imagine being on an exam, encountering a problem, and realizing (for the first time) that you’re going down the wrong path. That's not a good feeling!
- Now, consider this opposite scenario: You're in the middle of an exam, and you start going down the wrong path with a problem. It's uncomfortable, but if you've already encountered this situation during your studies, you'll recognize it.
- You'll have developed the resilience and skills to identify and correct your errors. (This, in the heat of an exam, is a powerful skill!)
- The Power of Practice:
- This is why it's crucial to thoroughly read all the “Exam Pro Tips” and “Common Mistakes By Students” included in these cheat sheets. They'll help you fully understand the potential pitfalls.
- Additionally, attempting the practice exams is highly recommended. They're designed to lead you down the wrong paths intentionally, so you can learn how to steer yourself back on track.
- The more you practice, the better you'll become at navigating these errors. Over time, you'll find that you're able to solve problems correctly, whether it's on your first, second, or third attempt!
Remember, the objective isn't to avoid making mistakes but to learn from them. The more mistakes you make and correct during your study sessions, the more capable and confident you'll be during your exams. Embrace your mistakes!
‣
📌 When analyzing word problems, the hint that you've earned revenue is as follows:For service-based businesses (consultants, lawyers, etc.)‣
- Phrases such as 'performed, delivered, or completed services' serve as clear signs of earned revenue.
- These phrases indicate that the service has been provided, obliging us, under the revenue recognition principle, to record an increase in revenue in the journal entry.
For inventory-based businesses (manufacturers, retailers, etc.)‣
- Phrases to look out for are 'sold, delivered, or shipped goods'. These signify that revenue has been earned and must, therefore, be recognized.
- Keep in mind, we will explore inventory-related transactions in more depth in Chapter 4.
- In Chapters 1-3, our focus is on service-based transactions.
‣
On Sept 30th, Survive Company receives $200,000 cash for services completed for a customer.
Cash 200,000
Fees Earned 200,000
ExplanationsEntry on Sept 30Is A = L + E in balance?Why does generating Revenue increase Equity?
Common MistakesMisunderstanding the Cash Cheat CodeWhy is this incorrect?
The “Cash Cheat Code”Trick for every time you pay cash in a transaction Trick for every time you receive cash in a transaction
‣
- It's important to note that we credited Fees Earned, a revenue account (-/+), to indicate that we have earned $200,000 worth of service revenue.
- This revenue is earned because, as the example problem above states, these are “services completed.”
- Per the revenue recognition principle, we must record this as revenue once the services are delivered.
- Debiting cash, an asset account (+/-), increases the cash balance.
- This follows the Cash Cheat Code, where receiving cash is always recorded as a debit, as cash is an asset (+/-) and needs to be increased when we receive cash.
‣
- By recording this journal entry, we can see that A = L + E remains in balance.
- Original Entry on Oct 31 Assets = Liabilities + Equity ↑ 200k ↑ 200k
- The cash received increased assets by $200,000, while the credit to Fees Earned simultaneously increased Equity by $200,000.
- Therefore, both sides of the equation have increased by the same amount, ensuring it remains balanced.
‣
- Generating revenue increases equity because revenue directly contributes to a business's net income (Revenue - Expenses).
- Think of it this way: if revenue captures what we 'earn' by providing services or delivering goods, and equity represents our company's 'value', naturally, earning more would increase our company's value or equity.
- Furthermore, net income contributes to Retained Earnings, an element of equity, therefore:
- An increase in revenue has a positive effect on net income…
- Which subsequently raises Retained Earnings…
- And in turn boosts overall equity, since R/E is an equity account!
- We'll delve deeper into how Net Income increases Retained Earnings in Chapter 3 when we examine the closing entry process.
‣
‣
Ensure that you have a solid grasp of the Cash Cheat Code, as it can be immensely helpful.
For instance, if you're aware of the cheat code and encounter a transaction where you're receiving cash, you can be certain that the journal entry must include a debit to cash.
Let's look at an example:
On Sept 30th, Survive Company receives $200,000 cash for services completed for a customer.
❌ Incorrect Entry
Fees Earned 200,000
Cash 200,000
‣
- Recall the Cash Cheat Code. When you receive cash in a transaction, it MUST always include a debit to cash, as cash is an asset (+/-) and all assets increase with a debit.
- Crediting cash makes zero sense. This would decrease your cash balance, which is incorrect because we actually received cash.
✅ Correct Entry Cash 200,000 Fees Earned 200,000
Confused? Get a recap on the Cash Cheat Code below.
‣
📌 Cash, a fundamental asset account used in every business, is involved in over half of the journal entries you'll encounter in this course.
- Fortunately, understanding cash is super straightforward. It boils down to only two possibilities: paying cash or receiving cash.
- What if I told you that the journal entries for cash follow a consistent pattern when it comes to debits and credits?
⚔️ Discover your secret weapon below ⚔️
‣
- Obviously, every time you pay cash — your cash balance decreases!
- Since cash is an asset (+/-) and all assets decrease with a credit…
- you must credit cash for all journal entries involving cash payments.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) payment of cash, that transactions journal entry will ALWAYS include a CREDIT to cash.
- At last, we have something consistent to rely on!
‣
- Conversely, every time you receive cash — your cash balance increases!
- Since cash is an asset (+/-) and all assets increase with a debit…
- you must debit cash for all journal entries involving receiving cash.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) receipt of cash, that transactions journal entry will ALWAYS include a DEBIT to cash.
- At last, we have something consistent to rely on!
Remember this "Cheat Code" to confidently handle cash transactions. It will make some journal entries on exams so easy — you’ll literally feel like you're cheating. 😉
Pro Tip For Exams:See the Cash Cheat Code in action to learn how to use it effectively during exams!Process of elimination, baby!
‣
- The Cash Cheat Code offers an additional benefit beyond its simplicity. By quickly identifying the appropriate debit or credit for cash, you can free up mental energy.
- Rather than searching for both sides of the transaction, you already have one side resolved. This allows you to concentrate on determining the other side of the journal entry with more precision.
- Furthermore, The Cash Cheat Code can be a valuable strategy during multiple choice exam questions.
- For instance, if a question involves a cash payment transaction, any option that doesn't credit cash is automatically incorrect. See a quick example below.
Pro Tips for Exams
‣
On Sept 30th, Survive Company provided $200,000 worth of services for a customer on credit.
Accounts Receivable 200,000
Fees Earned 200,000
ExplanationsEntry on Sept 30Is A = L + E in balance?Why does generating Revenue increase Equity?
Common MistakesMisunderstanding “on credit” or “on account” when we are selling to customers
Misunderstanding the Cash Cheat CodeWhy is this incorrect?
The “Cash Cheat Code”Trick for every time you pay cash in a transaction Trick for every time you receive cash in a transaction
‣
- It's important to note that we credited Fees Earned, a revenue account (-/+), to indicate that we have earned $200,000 worth of service revenue.
- This revenue is earned because, as the example problem above states, these are “services provided.”
- Per the revenue recognition principle, we must record this as revenue once the services are delivered.
- Debiting Accounts Receivable, an asset account (+/-), increases it’s balance.
- Accounts Receivable is used to track cash owed to us by customers for services we’ve provided them.
- When we anticipate receiving future cash receipts from customers, we increase the balance in the Accounts Receivable account by debiting it.
- Later, when the customer pays the cash, we will then decrease the Accounts Receivable balance back down by crediting it, showing that the amount is not owed to us by the customer any longer.
- Once the customer makes the payment, we credit the Accounts Receivable balance to decrease it’s balance, signifying that the amount owed to us (i.e. the cash we anticipate receiving) is no longer outstanding.
- To gain a better understanding of this process and to clarify any common misconceptions, I strongly encourage you to review the "Recap of Payables and Receivables" section below.
- Accounts Receivable is considered an asset because it represents the amount of cash that we expect to receive from customers, particularly after we’ve sold goods or provided services “on credit.
- In essence, Accounts Receivable represents the company's ownership of future cash inflows. Since these outstanding balances are expected to be collected and converted into cash within a reasonably short period, usually within one year, they are categorized as current assets on the balance sheet.
‣
‣
- By recording this journal entry, we can see that A = L + E remains in balance.
- Original Entry on Oct 31 Assets = Liabilities + Equity ↑ 200k ↑ 200k
- The cash received increased assets by $200,000, while the credit to Fees Earned simultaneously increased Equity by $200,000.
- Therefore, both sides of the equation have increased by the same amount, ensuring it remains balanced.
‣
- Generating revenue increases equity because revenue directly contributes to a business's net income (Revenue - Expenses).
- Think of it this way: if revenue captures what we 'earn' by providing services or delivering goods, and equity represents our company's 'value', naturally, earning more would increase our company's value or equity.
- Furthermore, net income contributes to Retained Earnings, an element of equity, therefore:
- An increase in revenue has a positive effect on net income…
- Which subsequently raises Retained Earnings…
- And in turn boosts overall equity, since R/E is an equity account!
- We'll delve deeper into how Net Income increases Retained Earnings in Chapter 3 when we examine the closing entry process.
‣
‣
- "On credit” or “on account” are commonly confused by students — be very careful!
- In the real world, businesses often offer this arrangement to customers, enabling them to obtain goods or services immediately while deferring payment to a later date, typically within 30, 60, or 90+ days.
- Just like in the previous examples, "on credit" and "on account" are used interchangeably in this context. They represent the practice of allowing customers to make purchases now and defer the payment of cash to a later date.
- It's important to note that "on credit" does not directly affect the debits and credits involved in journal entries. Instead, it signifies that the customer's cash payment will be delayed as part of the transaction. Confusing, right?
‣
Ensure that you have a solid grasp of the Cash Cheat Code, as it can be immensely helpful.
For instance, if you're aware of the cheat code and encounter a transaction where you're paying cash, you can be certain that the journal entry must include a credit to cash.
Let's look at an example:
On Sept 30th, Survive Company receives $200,000 cash for services completed for a customer.
❌ Incorrect Entry
Fees Earned 200,000
Cash 200,000
‣
- Recall the Cash Cheat Code. When you receive cash in a transaction, it MUST always include a debit to cash, as cash is an asset (+/-) and all assets increase with a debit.
- Crediting cash makes zero sense. This would decrease your cash balance, which is incorrect because we actually received cash.
✅ Correct Entry Cash 200,000 Fees Earned 200,000
Confused? Get a recap on the Cash Cheat Code below.
‣
📌 Cash, a fundamental asset account used in every business, is involved in over half of the journal entries you'll encounter in this course.
- Fortunately, understanding cash is super straightforward. It boils down to only two possibilities: paying cash or receiving cash.
- What if I told you that the journal entries for cash follow a consistent pattern when it comes to debits and credits?
⚔️ Discover your secret weapon below ⚔️
‣
- Obviously, every time you pay cash — your cash balance decreases!
- Since cash is an asset (+/-) and all assets decrease with a credit…
- you must credit cash for all journal entries involving cash payments.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) payment of cash, that transactions journal entry will ALWAYS include a CREDIT to cash.
- At last, we have something consistent to rely on!
‣
- Conversely, every time you receive cash — your cash balance increases!
- Since cash is an asset (+/-) and all assets increase with a debit…
- you must debit cash for all journal entries involving receiving cash.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) receipt of cash, that transactions journal entry will ALWAYS include a DEBIT to cash.
- At last, we have something consistent to rely on!
Remember this "Cheat Code" to confidently handle cash transactions. It will make some journal entries on exams so easy — you’ll literally feel like you're cheating. 😉
Pro Tip For Exams:See the Cash Cheat Code in action to learn how to use it effectively during exams!Process of elimination, baby!
‣
- The Cash Cheat Code offers an additional benefit beyond its simplicity. By quickly identifying the appropriate debit or credit for cash, you can free up mental energy.
- Rather than searching for both sides of the transaction, you already have one side resolved. This allows you to concentrate on determining the other side of the journal entry with more precision.
- Furthermore, The Cash Cheat Code can be a valuable strategy during multiple choice exam questions.
- For instance, if a question involves a cash payment transaction, any option that doesn't credit cash is automatically incorrect. See a quick example below.
Pro Tips for ExamsCarefully observe the wording in each problem!“Revenue is about receiving cash, right?” (Wrong!)
‣
- If a problem clearly states that services have been 'completed, delivered, provided, or performed' (or any similar indication of completion), it means that revenue has been earned and should be recorded!
‣
Often, students confuse revenue to only refer to receiving cash. This is not always the case!
- Example #1: When we provide services on credit, the customer pays later, but the revenue is recognized as soon as the services are delivered, as per the revenue recognition principle.
- Example #2: If we receive cash in advance for services we will provide later, this is recorded as Unearned Revenue — a prime example that receiving cash doesn’t always equate to generating revenue!
- Example #3: What if we receive cash immediately upon providing services — is this reveune? Yes, this is considered revenue.
- Nevertheless, it's important to understand that revenue is attributed to the services rendered, not the cash received. The cash received does not trigger the revenue; it is the completion of the services that does.
- Refer back to example #1, where revenue is generated without any cash received yet. It's revenue because the services are delivered!
- This can be confusing, but it's a vital distinction to grasp. For determining revenue under accrual accounting, the key factor isn't whether we've received cash, but rather if we've completed the work. Understanding this is best achieved through practicing problems!
‣
On Sept 30th, Survive Company provided $200,000 worth of services for a customer on credit.
Original Entry on Sept 30:
Accounts Receivable 200,000
Fees Earned 200,000
On October 10th, Survive Company receives $200,000 cash for the services previously performed on credit.
Subsequent Entry on Oct 10:
Cash 200,000
Accounts Receivable 200,000
ExplanationsEntry on Sept 30Subsequent Entry on Oct 10
Is A = L + E in balance?Why does generating Revenue increase Equity?
Common MistakesMisunderstanding “on credit” or “on account” when we are selling to customers
Misunderstanding the Cash Cheat CodeWhy is this incorrect?
The “Cash Cheat Code”Trick for every time you pay cash in a transaction Trick for every time you receive cash in a transaction
‣
- It's important to note that we credited Fees Earned, a revenue account (-/+), to indicate that we have earned $200,000 worth of service revenue.
- This revenue is earned because, as the example problem above states, these are “services provided.”
- Per the revenue recognition principle, we must record this as revenue once the services are delivered.
- Debiting Accounts Receivable, an asset account (+/-), increases it’s balance.
- Accounts Receivable is used to track cash owed to us by customers for services we’ve provided them.
- When we anticipate receiving future cash receipts from customers, we increase the balance in the Accounts Receivable account by debiting it.
- Later, when the customer pays the cash, we will then decrease the Accounts Receivable balance back down by crediting it, showing that the amount is not owed to us by the customer any longer.
- Accounts Receivable is considered an asset because it represents the amount of cash that we expect to receive from customers, particularly after we’ve sold goods or provided services “on credit.
- In essence, Accounts Receivable represents the company's ownership of future cash inflows. Since these outstanding balances are expected to be collected and converted into cash within a reasonably short period, usually within one year, they are categorized as current assets on the balance sheet.
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- When we receive cash from a customer who had a balance owed to us, we credit Accounts Receivable, an asset account (-/+) by the amount we’ve received, which is $200,000.
- This will decrease the amount expected from the customer by $200,000, leaving a $0 balance in Accounts receivable, effectively cancelling out the account. See this in the T Account below.
- To gain a better understanding of this process and to clarify any common misconceptions, I strongly encourage you to review the "Recap of Payables and Receivables" section below.
- Debiting cash, an asset account (+/-), increases the cash balance.
- This follows the Cash Cheat Code, where receiving cash is always recorded as a debit, as cash is an asset (+/-) and needs to be increased.
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- By recording these journal entries, we can see that A = L + E remains in balance.
- Original Entry on Sept 30 Assets = Liabilities + Equity ↑ 200k ↑ 200k
- The increase in Accounts Receivable increases assets by $200,000, while the credit to Fees Earned simultaneously increased Equity by $200,000.
- Therefore, both sides of the equation have increased by the same amount, ensuring it remains balanced.
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- Generating revenue increases equity because revenue directly contributes to a business's net income (Revenue - Expenses).
- Think of it this way: if revenue captures what we 'earn' by providing services or delivering goods, and equity represents our company's 'value', naturally, earning more would increase our company's value or equity.
- Furthermore, net income contributes to Retained Earnings, an element of equity, therefore:
- An increase in revenue has a positive effect on net income…
- Which subsequently raises Retained Earnings…
- And in turn boosts overall equity, since R/E is an equity account!
- We'll delve deeper into how Net Income increases Retained Earnings in Chapter 3 when we examine the closing entry process.
- Subsequent Entry on Oct 10 Assets = Liabilities + Equity ↓ 200k ↑ 200k
- The cash received increased assets by $200,000, while the credit towards the Accounts Receivable decreased assets by $200,000. This transaction effectively traded one asset for another.
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‣
- "On credit” or “on account” are commonly confused by students — be very careful!
- In the real world, businesses often offer this arrangement to customers, enabling them to obtain goods or services immediately while deferring payment to a later date, typically within 30, 60, or 90+ days.
- Just like in the previous examples, "on credit" and "on account" are used interchangeably in this context. They represent the practice of allowing customers to make purchases now and defer the payment of cash to a later date.
- It's important to note that "on credit" does not directly affect the debits and credits involved in journal entries. Instead, it signifies that the customer's cash payment will be delayed as part of the transaction. Confusing, right?
‣
Ensure that you have a solid grasp of the Cash Cheat Code, as it can be immensely helpful.
For instance, if you're aware of the cheat code and encounter a transaction where you're paying cash, you can be certain that the journal entry must include a credit to cash.
Let's look at an example:
On Sept 30th, Survive Company receives $200,000 cash for services completed for a customer.
❌ Incorrect Entry
Fees Earned 200,000
Cash 200,000
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- Recall the Cash Cheat Code. When you receive cash in a transaction, it MUST always include a debit to cash, as cash is an asset (+/-) and all assets increase with a debit.
- Crediting cash makes zero sense. This would decrease your cash balance, which is incorrect because we actually received cash.
✅ Correct Entry Cash 200,000 Fees Earned 200,000
Confused? Get a recap on the Cash Cheat Code below.
‣
📌 Cash, a fundamental asset account used in every business, is involved in over half of the journal entries you'll encounter in this course.
- Fortunately, understanding cash is super straightforward. It boils down to only two possibilities: paying cash or receiving cash.
- What if I told you that the journal entries for cash follow a consistent pattern when it comes to debits and credits?
⚔️ Discover your secret weapon below ⚔️
‣
- Obviously, every time you pay cash — your cash balance decreases!
- Since cash is an asset (+/-) and all assets decrease with a credit…
- you must credit cash for all journal entries involving cash payments.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) payment of cash, that transactions journal entry will ALWAYS include a CREDIT to cash.
- At last, we have something consistent to rely on!
‣
- Conversely, every time you receive cash — your cash balance increases!
- Since cash is an asset (+/-) and all assets increase with a debit…
- you must debit cash for all journal entries involving receiving cash.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) receipt of cash, that transactions journal entry will ALWAYS include a DEBIT to cash.
- At last, we have something consistent to rely on!
Remember this "Cheat Code" to confidently handle cash transactions. It will make some journal entries on exams so easy — you’ll literally feel like you're cheating. 😉
Pro Tip For Exams:See the Cash Cheat Code in action to learn how to use it effectively during exams!Process of elimination, baby!
‣
- The Cash Cheat Code offers an additional benefit beyond its simplicity. By quickly identifying the appropriate debit or credit for cash, you can free up mental energy.
- Rather than searching for both sides of the transaction, you already have one side resolved. This allows you to concentrate on determining the other side of the journal entry with more precision.
- Furthermore, The Cash Cheat Code can be a valuable strategy during multiple choice exam questions.
- For instance, if a question involves a cash payment transaction, any option that doesn't credit cash is automatically incorrect. See a quick example below.
Pro Tip for ExamsCarefully observe the wording in each problem!“Revenue is about receiving cash, right?” (Wrong!)
‣
- If a problem clearly states that services have been 'completed, delivered, provided, or performed' (or any similar indication of completion), it means that revenue has been earned and should be recorded!
‣
Often, students confuse revenue to only refer to receiving cash. This is not always the case!
- Example #1: When we provide services on credit, the customer pays later, but the revenue is recognized as soon as the services are delivered, as per the revenue recognition principle.
- Example #2: If we receive cash in advance for services we will provide later, this is recorded as Unearned Revenue — a prime example that receiving cash doesn’t always equate to generating revenue!
- Example #3: What if we receive cash immediately upon providing services — is this reveune? Yes, this is considered revenue.
- Nevertheless, it's important to understand that revenue is attributed to the services rendered, not the cash received. The cash received does not trigger the revenue; it is the completion of the services that does.
- Refer back to example #1, where revenue is generated without any cash received yet. It's revenue because the services are delivered!
- This can be confusing, but it's a vital distinction to grasp. For determining revenue under accrual accounting, the key factor isn't whether we've received cash, but rather if we've completed the work. Understanding this is best achieved through practicing problems!
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On Sept 30th, Survive Company provided $200,000 worth of services for a customer on credit.
Original Entry on Sept 30:
Accounts Receivable 200,000
Fees Earned 200,000
On October 10th, Survive Company receives $75,000 cash as partial payment for the services previously performed on credit.
Subsequent Entry on Oct 10:
Cash 75,000
Accounts Receivable 75,000
ExplanationsEntry on Sept 30Subsequent Entry on Oct 10
Is A = L + E in balance?Why does generating Revenue increase Equity?
Common MistakesMisunderstanding “on credit” or “on account” when we are selling to customers
Misunderstanding the Cash Cheat CodeWhy is this incorrect?
The “Cash Cheat Code”Trick for every time you pay cash in a transaction Trick for every time you receive cash in a transaction
‣
- It's important to note that we credited Fees Earned, a revenue account (-/+), to indicate that we have earned $200,000 worth of service revenue.
- This revenue is earned because, as the example problem above states, these are “services provided.”
- Per the revenue recognition principle, we must record this as revenue once the services are delivered.
- Debiting Accounts Receivable, an asset account (+/-), increases it’s balance.
- Accounts Receivable is used to track cash owed to us by customers for services we’ve provided them.
- When we anticipate receiving future cash receipts from customers, we increase the balance in the Accounts Receivable account by debiting it.
- Later, when the customer pays the cash, we will then decrease the Accounts Receivable balance back down by crediting it, showing that the amount is not owed to us by the customer any longer.
- Accounts Receivable is considered an asset because it represents the amount of cash that we expect to receive from customers, particularly after we’ve sold goods or provided services “on credit.
- In essence, Accounts Receivable represents the company's ownership of future cash inflows. Since these outstanding balances are expected to be collected and converted into cash within a reasonably short period, usually within one year, they are categorized as current assets on the balance sheet.
‣
‣
- When we partially receive cash from a customer who had a balance owed to us, we credit Accounts Receivable, an asset account (-/+) by the amount we’ve received, which is $75,000.
- This will decrease the amount expected from the customer by $75,000, leaving a $125,000 balance in Accounts receivable—the remaining amount we expect to receive from the customer. See this in the T Account below.
- To gain a better understanding of this process and to clarify any common misconceptions, I strongly encourage you to review the "Recap of Payables and Receivables" section below.
- Debiting cash, an asset account (+/-), increases the cash balance.
- This follows the Cash Cheat Code, where receiving cash is always recorded as a debit, as cash is an asset (+/-) and needs to be increased.
‣
- By recording these journal entries, we can see that A = L + E remains in balance.
- Original Entry on Sept 30 Assets = Liabilities + Equity ↑ 200k ↑ 200k
- The increase in Accounts Receivable increases assets by $200,000, while the credit to Fees Earned simultaneously increased Equity by $200,000.
- Therefore, both sides of the equation have increased by the same amount, ensuring it remains balanced.
‣
- Generating revenue increases equity because revenue directly contributes to a business's net income (Revenue - Expenses).
- Think of it this way: if revenue captures what we 'earn' by providing services or delivering goods, and equity represents our company's 'value', naturally, earning more would increase our company's value or equity.
- Furthermore, net income contributes to Retained Earnings, an element of equity, therefore:
- An increase in revenue has a positive effect on net income…
- Which subsequently raises Retained Earnings…
- And in turn boosts overall equity, since R/E is an equity account!
- We'll delve deeper into how Net Income increases Retained Earnings in Chapter 3 when we examine the closing entry process.
- Subsequent Entry on Oct 10 Assets = Liabilities + Equity ↓ 75k ↑ 75k
- The cash received increased assets by $75,000, while the credit towards the Accounts Receivable decreased assets by $75,000. This transaction effectively traded one asset for another.
‣
‣
- "On credit” or “on account” are commonly confused by students — be very careful!
- In the real world, businesses often offer this arrangement to customers, enabling them to obtain goods or services immediately while deferring payment to a later date, typically within 30, 60, or 90+ days.
- Just like in the previous examples, "on credit" and "on account" are used interchangeably in this context. They represent the practice of allowing customers to make purchases now and defer the payment of cash to a later date.
- It's important to note that "on credit" does not directly affect the debits and credits involved in journal entries. Instead, it signifies that the customer's cash payment will be delayed as part of the transaction. Confusing, right?
‣
Ensure that you have a solid grasp of the Cash Cheat Code, as it can be immensely helpful.
For instance, if you're aware of the cheat code and encounter a transaction where you're paying cash, you can be certain that the journal entry must include a credit to cash.
Let's look at an example:
On Sept 30th, Survive Company receives $200,000 cash for services completed for a customer.
❌ Incorrect Entry
Fees Earned 200,000
Cash 200,000
‣
- Recall the Cash Cheat Code. When you receive cash in a transaction, it MUST always include a debit to cash, as cash is an asset (+/-) and all assets increase with a debit.
- Crediting cash makes zero sense. This would decrease your cash balance, which is incorrect because we actually received cash.
✅ Correct Entry Cash 200,000 Fees Earned 200,000
Confused? Get a recap on the Cash Cheat Code below.
‣
📌 Cash, a fundamental asset account used in every business, is involved in over half of the journal entries you'll encounter in this course.
- Fortunately, understanding cash is super straightforward. It boils down to only two possibilities: paying cash or receiving cash.
- What if I told you that the journal entries for cash follow a consistent pattern when it comes to debits and credits?
⚔️ Discover your secret weapon below ⚔️
‣
- Obviously, every time you pay cash — your cash balance decreases!
- Since cash is an asset (+/-) and all assets decrease with a credit…
- you must credit cash for all journal entries involving cash payments.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) payment of cash, that transactions journal entry will ALWAYS include a CREDIT to cash.
- At last, we have something consistent to rely on!
‣
- Conversely, every time you receive cash — your cash balance increases!
- Since cash is an asset (+/-) and all assets increase with a debit…
- you must debit cash for all journal entries involving receiving cash.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) receipt of cash, that transactions journal entry will ALWAYS include a DEBIT to cash.
- At last, we have something consistent to rely on!
Remember this "Cheat Code" to confidently handle cash transactions. It will make some journal entries on exams so easy — you’ll literally feel like you're cheating. 😉
Pro Tip For Exams:See the Cash Cheat Code in action to learn how to use it effectively during exams!Process of elimination, baby!
‣
- The Cash Cheat Code offers an additional benefit beyond its simplicity. By quickly identifying the appropriate debit or credit for cash, you can free up mental energy.
- Rather than searching for both sides of the transaction, you already have one side resolved. This allows you to concentrate on determining the other side of the journal entry with more precision.
- Furthermore, The Cash Cheat Code can be a valuable strategy during multiple choice exam questions.
- For instance, if a question involves a cash payment transaction, any option that doesn't credit cash is automatically incorrect. See a quick example below.
Pro Tip for ExamsCarefully observe the wording in each problem!“Revenue is about receiving cash, right?” (Wrong!)
‣
- If a problem clearly states that services have been 'completed, delivered, provided, or performed' (or any similar indication of completion), it means that revenue has been earned and should be recorded!
‣
Often, students confuse revenue to only refer to receiving cash. This is not always the case!
- Example #1: When we provide services on credit, the customer pays later, but the revenue is recognized as soon as the services are delivered, as per the revenue recognition principle.
- Example #2: If we receive cash in advance for services we will provide later, this is recorded as Unearned Revenue — a prime example that receiving cash doesn’t always equate to generating revenue!
- Example #3: What if we receive cash immediately upon providing services — is this reveune? Yes, this is considered revenue.
- Nevertheless, it's important to understand that revenue is attributed to the services rendered, not the cash received. The cash received does not trigger the revenue; it is the completion of the services that does.
- Refer back to example #1, where revenue is generated without any cash received yet. It's revenue because the services are delivered!
- This can be confusing, but it's a vital distinction to grasp. For determining revenue under accrual accounting, the key factor isn't whether we've received cash, but rather if we've completed the work. Understanding this is best achieved through practicing problems!
‣
📌 Dividends are NOT considered an expense. Instead, they are distributions of earnings, often referred to as 'drawings', which go back to owners and investors, reducing the Retained Earnings account—a part of equity. From this perspective, dividends can be viewed as a "contra equity” account. Contrary to other equity accounts, an increase in dividends leads to a decrease in total equity.
On Dec 31st, Survive Company pays $220,000 in cash dividends to it’s owners and investors.
Dividends 220,000
Cash 220,000
ExplanationsEntry on Dec 31
Is A = L + E in balance?Why does increasing Dividends decrease Equity?
Common MistakesMisunderstanding the Cash Cheat CodeWhy is this incorrect?
The “Cash Cheat Code”Trick for every time you pay cash in a transaction Trick for every time you receive cash in a transaction
Misunderstanding why we debit Dividends and not Dividends ExpenseWhy is this incorrect?
‣
- It's important to note that we debited Dividends, a contra equity account (+/-), to indicate that we have paid $220,000 in dividends.
- Crediting cash, an asset account (+/-), decreases the cash balance.
- This follows the Cash Cheat Code, where paying cash is always recorded as a credit, as cash is an asset (+/-) and needs to be decreased when we receive cash.
‣
- By recording this journal entry, we can see that A = L + E remains in balance.
- Entry on Dec 31 Assets = Liabilities + Equity ↓ 220k ↓ 220k
- The increase in Dividends, a contra equity, actually decreases equity by $220,000, while the credit to Cash simultaneously decreased assets by $220,000.
- Therefore, both sides of the equation have increased by the same amount, ensuring it remains balanced.
‣
- Recall in the Statement of Retained Earnings formula from Chapter 1 that Dividends decrease our retained earnings, meaning our equity.
- Contra equity means opposite of equity. Therefore, in other words, when we debit dividends, a contra asset (+/-), it increases that account — which in turn decreases our equity.
- This is because dividends are paid out of our retained earnings, so paying a dividend reduces retained earnings. Reducing retained earnings reduces our equity!
‣
‣
Ensure that you have a solid grasp of the Cash Cheat Code, as it can be immensely helpful.
For instance, if you're aware of the cheat code and encounter a transaction where you're receiving cash, you can be certain that the journal entry must include a debit to cash.
Let's look at an example:
On Sept 30th, Survive Company receives $200,000 cash for services completed for a customer.
❌ Incorrect Entry
Fees Earned 200,000
Cash 200,000
‣
- Recall the Cash Cheat Code. When you receive cash in a transaction, it MUST always include a debit to cash, as cash is an asset (+/-) and all assets increase with a debit.
- Crediting cash makes zero sense. This would decrease your cash balance, which is incorrect because we actually received cash.
✅ Correct Entry Cash 200,000 Fees Earned 200,000
Confused? Get a recap on the Cash Cheat Code below.
‣
📌 Cash, a fundamental asset account used in every business, is involved in over half of the journal entries you'll encounter in this course.
- Fortunately, understanding cash is super straightforward. It boils down to only two possibilities: paying cash or receiving cash.
- What if I told you that the journal entries for cash follow a consistent pattern when it comes to debits and credits?
⚔️ Discover your secret weapon below ⚔️
‣
- Obviously, every time you pay cash — your cash balance decreases!
- Since cash is an asset (+/-) and all assets decrease with a credit…
- you must credit cash for all journal entries involving cash payments.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) payment of cash, that transactions journal entry will ALWAYS include a CREDIT to cash.
- At last, we have something consistent to rely on!
‣
- Conversely, every time you receive cash — your cash balance increases!
- Since cash is an asset (+/-) and all assets increase with a debit…
- you must debit cash for all journal entries involving receiving cash.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) receipt of cash, that transactions journal entry will ALWAYS include a DEBIT to cash.
- At last, we have something consistent to rely on!
Remember this "Cheat Code" to confidently handle cash transactions. It will make some journal entries on exams so easy — you’ll literally feel like you're cheating. 😉
Pro Tip For Exams:See the Cash Cheat Code in action to learn how to use it effectively during exams!Process of elimination, baby!
‣
- The Cash Cheat Code offers an additional benefit beyond its simplicity. By quickly identifying the appropriate debit or credit for cash, you can free up mental energy.
- Rather than searching for both sides of the transaction, you already have one side resolved. This allows you to concentrate on determining the other side of the journal entry with more precision.
- Furthermore, The Cash Cheat Code can be a valuable strategy during multiple choice exam questions.
- For instance, if a question involves a cash payment transaction, any option that doesn't credit cash is automatically incorrect. See a quick example below.
‣
⚠️ Be extremely careful not to debit Dividends Expense when paying Dividends!
❌ Incorrect Example
On Dec 31st, Survive Company pays $220,000 in cash dividends to it’s owners and investors.
Dividends Expense 220,000
Cash 220,000
Your exam will attempt to trick you into doing this. It is incorrect! The idea of "Dividends Expense" does not exist in accounting!
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- Dividends aren't expenses or “costs” incurred during revenue generation. They're separate from business operations.
- Dividends are instead a method for owners and investors to "withdraw" retained earnings from the business (which is why Dividends are sometimes known as “drawings”).
- Dividends are similar to expenses in that they both reduce equity, but they do so for different reasons.
- Consider this perspective:
- Expenses decrease equity due to their negative effect on Net Income, which reduces Retained Earnings. This happens before the distribution of a dividend.
- Dividends, on the other hand, reduce equity after net income has been consolidated into retained earnings. Thus, it’s not an expense—it's a deduction from previously earned net income!
- Per the expense recognition principle, expenses must be reported in the same period they’re incurred. So, recording Dividends as an expense doesn't comply with this principle.
- Instead, be sure to record Dividends as a contra equity account.
✅ Correct Example On Dec 31st, Survive Company pays $220,000 in cash dividends to it’s owners and investors. Dividends 220,000 Cash 220,000
Pro Tip for Exams“Expenses are about paying cash, right?” (Wrong!)
‣
Often, students confuse expenses to only refer to paying cash. This is not always the case!
How could I possibly pay cash and it not be an expense?
Conversely, how could I possibly record an expense and not pay any cash?
More examples!
Are there examples of paying cash and recording an expense at the same time?
- Understanding the timing of expense recognition is crucial for interpreting its impact on financial statements. This is where the matching principle comes in handy: expenses are recognized when the resources or services are used to generate revenue, not necessarily when cash is paid.
- Let's consider an example. If we purchase supplies by paying cash, we're essentially trading one asset (cash) for another (supplies). At this point, no expense is recognized. Why not? Because we haven't used these supplies yet.
- The expense hits our books only when we actually use the supplies in our operations. The act of buying the supplies doesn't equate to an expense—it's the usage that counts!
Confused? Check out more examples below.
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- Paying cash for a building (an asset) is NOT an expense.
- However, as it depreciates over time, we will recognize depreciation expense!
- Paying cash for inventory (an asset) is NOT an expense.
- However, we will record Cost of Goods Sold (an expense) once it’s sold!
- Paying cash for Prepaid Rent (an asset) is NOT an expense.
- However, we will record Rent Expense later as the lease term elapses.
- Paying cash for Prepaid Insurance (an asset) is NOT an expense.
- However, we will record Insurance Expense later as our coverage expires or is used.
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- Consider the one-word definition of expenses: "costs." Can costs occur without involving any cash payment? Absolutely!
- One example that illustrates this well is depreciation expense. Depreciation refers to the gradual decrease in value over time of long-term assets such as buildings and equipment.
- Let's paint a scenario: You've owned a building for a year, and your accountant estimates that its value has decreased by $10,000. This depreciation is undoubtedly an expense or "cost."
- However, did you have to make any cash payment to anyone for this decline in value? Certainly not! There's no need to write a check to anyone.
- Depreciation is a cost that simply “occurs” as time passes, completely independent of any cash payment!
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- Amortization: Similar to depreciation, amortization represents the gradual reduction in value of intangible assets (e.g., patents, copyrights) over time.
- Therefore, Amortization is an expense recorded without any cash payment associated with it, a topic we’ll elaborate further in Chapter 8.
- Accrued Expenses: Suppose a company has incurred employee salaries and wages for the current month but hasn't yet paid them.
- Even without a cash outflow, the company recognizes the expense by accruing the salaries and wages payable, a topic we’ll elaborate further in Chapter 3.
- Bad Debts: If a company has provided goods or services to a customer on credit and later determines that the customer is unable to pay, it records a bad debt expense.
- This expense is recognized despite no cash payment being received from the customer, a topic we’ll elaborate further in Chapter 7.
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- Of course! However, it's vital to understand that expense is attributed to the cost incurred, not the cash paid.
- The cash paid does not trigger the expense; it is the incurring of costs or usage of resources that does.
- For example, if we pay cash for utilities consumed, we would immediately record a debit to Utilities Expense as the same time we paid cash — since the Utilities have already been used, so the cost has been incurred!
Remember: expenses aren't about cash payments but about resource consumption. This understanding will be particularly useful in Chapter 3, where we delve into adjusting journal entries. So keep practicing!
‣
📌 Accounts Receivable and Accounts Payable are often confused by students. Check out this brief comparison below to help you avoid common mistakes on exams.
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- Accounts Receivable is an asset account (+/-) that tracks the cash we anticipate receiving from customers in the future.
- In other words, “receivable” means we will receive cash later.
- We increase the Accounts Receivable account when we expect cash to be received in the future, such as when we offer services on credit and invoice the customer for future payment.
- We decrease the Accounts Receivable account when we receive the cash the customer originally owed us, indicating less cash is due. If a customer settles the full amount, the balance on Accounts Receivable returns to zero.
- See journal entry examples in sequential order below.
- To make Receivables easier to remember, consider visualizing these situations in reverse order.
- For instance, imagine you're receiving cash for services previously offered on a credit basis.
- From the Cash Cheat Code, would already know that receiving cash must mean we are debiting cash, so Accounts Receivable must be the credit!
- However, we can’t just credit Accounts Receivable out of thin air. It had to have originated from another transaction — such as providing services on credit!
- To summarize:
- If we're aware that Accounts Receivable represents expected future cash receipts, then when the cash is received, we would debit the cash account and credit Accounts Receivable.
- This indicates that in the prior transaction, Accounts Receivable was debited!
- This type of “forward and backward” understanding really levels up your game to ensure you don’t fall for the tricks around Receivables in your exam.
Entry for when we provide services on credit.
→ Accounts Receivable 200,000
Fees Earned 200,000
Entry for when we receive cash for those services provided on credit.
Cash 200,000
→ Accounts Receivable 200,000
→ Notice that we first debit Accounts Receivable, an asset account (+/-), to indicate that expect to receive cash from a customer later.
→Later, when we receive this amount, we credit Accounts Receivable, reducing its balance to reflect the decrease in our future cash receipts.
See Also: Memorization Trick for Receivables
‣
Entry for when we receive cash for those services provided on credit.
Cash 200,000
→ Accounts Receivable 200,000
Entry for when we provide services on credit.
→ Accounts Receivable 200,000
Fees Earned 200,000
‣
- Accounts Payable is a liability account (-/+), representing the amount of cash we anticipate to pay to our suppliers or creditors (i.e. those we owe money to) in the future.
- In other words, “payable” means we will pay cash later.
- We increase the Accounts Payable account when we expect cash to flow out in the future, such as when we purchase supplies on credit and agree to pay the supplier at a later date.
- We decrease the Accounts Payable account when we pay off the cash that we originally owed to our suppliers, indicating less cash is due. If a supplier is paid the full amount, the balance on Accounts Payable returns to zero.
- See journal entry examples in sequential order below.
- To make Payables easier to remember, consider visualizing these situations in reverse order.
- For instance, imagine you're paying cash for supplies previously purchased on credit.
- From the Cash Cheat Code, would already know that paying cash must mean we are crediting cash, so Accounts payable must be the credit!
- However, we can’t just payable Accounts Payable out of thin air. It had to have originated from another transaction — such as purchasing supplies on credit!
- To summarize:
- If we're aware that Accounts Payable represents expected future cash payments, then when the cash is paid, we would credit the cash account and debit Accounts Payable.
- This indicates that in the prior transaction, Accounts Payable was credited!
- This type of “forward and backward” understanding really levels up your game to ensure you don’t fall for the tricks around Payables in your exam.
Entry for when we purchase supplies on credit.
Supplies 100,000
→ Accounts Payable 100,000
Entry for when we later pay cash for those same supplies purchased on credit.
→ Accounts Payable 100,000
Cash 100,000
→ Notice that we first credit Accounts Payable, a liability account (-/+), to indicate that we owe an amount.
→Later, when we pay this amount off, we debit Accounts Payable, reducing its balance to reflect the decrease in our outstanding liability.
See Also: Memorization Trick for Payables
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Entry for when we later pay cash for those same supplies purchased on credit.
→ Accounts Payable 100,000
Cash 100,000
Entry for when we purchase supplies on credit.
Supplies 100,000
→ Accounts Payable 100,000
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- One common error is attempting to include both Accounts Receivable and Accounts Payable in the same journal entry. This isn't feasible because a single transaction cannot simultaneously increase the cash we expect to receive (Accounts Receivable) and the cash we owe to others (Accounts Payable). In other words, you can’t be on both sides of a transaction at the same time. Don’t twist your head up too much!
- Another common misunderstanding is that Accounts Receivable indicates money we owe others when, in fact, it represents money others owe us. The opposite is true for Accounts Payable - it doesn't signify money others owe us, but what we owe to others.
Hang in there!
While mastering so many different Journal Entries might seem impossible, it's actually more manageable than you think—especially once you start to recognize the recurring patterns among these entries.
Explore examples of these Journal Entry patternsExplore how, often, Journal Entries are simply variations of each other
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- Anytime cash is received, we must include a debit to cash (aka The Cash Cheat Code)
- Anytime cash is paid, we must include a credit to cash (aka The Cash Cheat Code)
- Anytime a transaction is “on credit” or “on account”, Accounts Payable or Accounts Receivable will always be involved.
- If you’re “pre-paying” cash for an asset you’ll use up later (e.g. insurance, rent, supplies, advertising, etc.), your journal entry will include a credit to cash (Cash Cheat Code) and a debit to a Prepaid account, which is also an asset.
- Whenever we receive cash upfront from a customer for services we'll provide (i.e., owe) later, the journal entry will include a debit to cash (Cash Cheat Code) and a credit to unearned revenue, which is a liability account.
- Anytime we “earn” revenue, we must include a credit to a revenue account, regardless of whether cash has been received yet.
- Anytime we “incur costs”, we must include a debit to an expense account, regardless of whether we’ve paid cash.
- Want to ace your exam easily? Memorize and understand the patterns explaining the underlying mechanics—versus simply the journal entries alone!
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- Notice some entries are variations of another, as illustrated below:
On January 1st, the owner invested $100,000 cash into Survive Company in exchange for common stock. Record the journal entry for Survive Company.
Cash 100,000
Common Stock 100,000
vs.
On January 1st, the owner invested $100,000 of equipment, $50,000 of land, and a $20,000 truck into Survive Company in exchange for common stock. Record the journal entry for Survive Company.
Equipment 100,000
Land 50,000
Truck 20,000
Common Stock 170,000
- The only difference is that, instead of the company receiving cash in exchange for common stock — we’re receiving multiple assets (Equipment, Land, and a Truck).
- In other words, the mechanics are still the same, we’re receiving assets (+/-), so we need to increase those accounts by debiting them.
- And, we’re issuing common stock, an equity account (-/+), in exchange for these assets—so we need to increase that account by crediting it.
- So, are these two different entries or actually the same concept in two forms? Identifying such patterns enhances your foundational understanding over simple memorization.
- As you review other journal entries in this chapter, I encourage you to actively look for your own patterns between entries—and internalize them. This active engagement will strengthen your recall better than passive learning.
- Running through my Chapter 2 Flashcards would be a great strategy for solidying these patterns for you!
The list above showcases commonly-tested journal entries.
Please remember, these are illustrative examples, utilizing hypothetical numbers purely for explanatory purposes. They're designed to help you understand the mechanics of interpreting business transactions into journal entries.
While these examples serve as a foundation, they might not encompass every possible scenario. Always consult with your professor regarding any additional or specific entries that might be vital for your exam.
