Accounting Process Steps

ACCOUNTING PROCESS
BY
S C MALHOTRA
ASSOCIATE PROFESSOR
SHRI RAM COLLEGE OF COMMERCE
UNIVE$ITY OF DELHI, DELHI-110007
Accounting Process
Various Steps in Accounting Process:
1.
2.
Identify transactions and events.

Analyze transactions and events in terms of the basic accounting
equation.
3.
4.
5.
Translate the transaction analysis into debits and credits.

Pass journal entries and post them to the general ledger.
Prepare trial balance
6.
7.
8.
Pass adjustment entries and post them to the general ledger.

Prepare adjusted trial balance
Pass closing entries and post them to the ledger.
9. Prepare profit and loss account

10. Prepare the balance sheet.
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Analysis of transactions and events

The analysis of transactions and events under double
entry system of book-keeping may be explained in any
of the following two ways:
1. Accounting Equation approach

2. Traditional approach
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Accounting Equation Approach

The financial position of a business concern at
any given point of time may be expressed in
the form of following accounting equation:
Liabilities
Owners equity =
Or
Assets
Liabilities + (Capital + Retained Earnings) = Assets

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Illustration 1
Show how each of the following transactions of Rama Stores for the month of July, 2010 will be
analyzed under accounting equation approach:
1.
Mr. Ram invested $ 50,000 in cash to commence the business as owner of Rama Stores.
2.
Machine is purchased for $25,000 cash.
3.
Purchased furniture for $8,000 on credit from Rahul.
4.
Paid salary to the manager, Gaurav $10,000.
5.
Purchased merchandise $20,000 on credit from the supplier Preetam.
6.
Sold merchandise costing $ 15,000 for $35,000 cash.
7.
Machine is depreciated by $2,000.
8.
9.
10.
Furniture is depreciated by $500.

Paid $9,000 to Preetam, supplier of goods.
Proprietor Mr. Ram withdrew $7,000 for meeting personal expenses.
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Record through accounting equation

Transaction Capital
No.
Retained
Earnings
Liabili
-ties
= Cash
+50,000
+50,000
2
New Bal
-25,000
+50,000
+50,000
+8,000
+8,000
= +25,000
-10,000
+50,000
-10,000
5
New Bal
+25,000
+8,000
4
New Bal
+25000
= +25,000
3
New Bal
Goods
Assets
Machine Furni
-10,000
+8,000
= +15,000
+20,000
+50,000
-10,000
+25,000 +8,000
+28,000
+25,000 +8,000
+20,000
= +15,000
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+20,000
+25,000
+8,000
Transaction Capital
No.
Retained
Earnings
Liabili
-ties
= Cash
Goods
Assets
Machine Furni
New Bal
-10,000
+28,000
= +15,000
+20,000
+25,000
+8,000
+35,000
-15,000
= +50,000
+5,000
+25,000
+8.000
+50,000
6
New Bal
+20,000
+50,000
New Bal
+28,000
-2,000
+50,000
8
New Bal
+10,000
+8,000
-2,000
+28,000
= +50,000
+5,000
+23,000
-500
+50,000
+7,500
-500
+28,000
= +50,000
-9,000
New Bal
+50,000
10
-7,000
New Bal
43,000
+7,500
+8,000
+19,000
+5,000
+23,000
+7,500
+5,000
23,000
+7,500
5,000
23,000
7,500
-9,000
= +41,000
-7,000
7,500
19,000
= 34,000
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Solution 1
Analysis of transactions:
Sl. Capital
No
1
2
3
4
5
6
7
8
9
10
Retained
Earnings
Liabilities
+50,000
Cash
Goods
+50,000
-25,000
Assets
Machin
e
+25,000
+8,000
+8,000
-10,000
-10,000
+20,000
+20,000
-2,000
-500
+35,000
-500
-9,000
-7,000
-7,000
7,500
+20,000
-15,000
-2,000
-9,000
43,000
Furni
19,000
34,000
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5,000
23,000
7,500
Balance Sheet of Rama Stores

as at 31st July, 2010
Liabilities
Rams Capital
Retained Earnings
Creditors
Assets
43,000 Machine
7,500 Furniture
19,000 Stock
Cash
--------69,500
---------
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$
23,000
7,500
5,000
34,000
--------69,500
---------
The procedure just discussed appears to be quite suitable. But it is not so when it
comes to the record of large number of transactions that occur in actual business
operations.
Where the number of items under different heads is many, the record of transaction
through accounting equation becomes unmanageable. To overcome this problem, an
improvement is made to the above procedure on the following lines:
1.
Each element of accounting equation has plus and minus items. To have
convenience in finding the balance of an element, it is suggested that all plus
items of an element be shown on one side and all minus items on the other.
2.
Instead of showing all the elements of an equation on one page, show them on
different pages.
In accounting, the device developed for this purpose is called an account.
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ACCOUNT
An account is a record of the transactions that affect a particular
type of asset, liability, or an element of owners equity.
The two sides of an account, usually, take the following form. As
this form resembles the English letter T, it is known as T
form account:
Title of the item
Dr.___________________________________________Cr.
Left side
(Debit)
Right side
(Credit)
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One basic characteristic of account form is that entries recording increases (plus items)
and decreases (minus items) are separated. Conventionally, for showing increases
and decreases the following procedure is followed:
Liabilities + Owners equity

________________________________
(Debit)
(Credit)
-
Symbols:
Assets
________________
(Debit)
(Credit)
Debit means the left hand side

Credit means the right hand side
+ indicates side for recording increases
- indicates side for recording decreases
* indicates side for normal balance
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Liabilities + *Owners Capital + Net Profit]
= Assets
Liabilities + [Capital + (Revenues - Expenses)] = Assets

Liabilities + Capital + Revenues
Liabilities + Capital + Revenues

(Debit)
-
(Credit)
+
*
Assets + Expenses
Assets + Expenses
(Debit)
+
*
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(Credit)
-
13
RULES OF RECORDING TRANSACTIONS

The above system of recording transactions may be explained as follows in the form of
rules of double entry system of book-keeping:
Liabilities. When a particular liability increases, credit that liability account and when a
particular liability decreases, debit that liability account.
Owners capital. When owners capital increases, credit owners capital account and
when owners capital decreases, debit owners capital account.
Revenues. When a particular item of revenue increases, credit that revenue account
and when a particular item of revenue decreases, debit that revenue account.
Since increases in liabilities, owners equity and revenues are credited to these
relevant accounts, they usually have credit balances.
In the case of assets and expenses, the rules are just the reverse.
Assets. When a particular asset increases, debit the relevant asset account and when
a particular asset decreases, credit the relevant asset account.
Expenses. When a particular expense increases, debit the relevant expense account
and when a particular expense decreases, credit the relevant expense account.
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The above procedure of recording the transactions in the ledger accounts

appears to be satisfactory. It is definitely superior to recording the
transactions in different elements of financial statements in the form of
accounting equation. But it has serious limitations when it comes to recording
large number of transactions. These limitations are as follows:
1.
Difficulty in recording.
2.
Identity of individual transaction is lost.
3.
Difficulty in understanding the entries.
In view of the above limitations, it is considered necessary to keep record of

all the transactions, initially at one place in a chronological order. It is
done in such a way that the impact of each transaction on different
accounts is determined and shown at one place with relevant
explanation of that transaction. A book containing such type of records is
called the Journal.
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Format of journal
Date
Particulars
January
L.F.
Dr.
Amount
Cash Account
Dr.
To Rams Capital
(Being a cash of $ 5,85,000 brought
in by Ram as his capital)
___________________________
Alternatively,
Debit Cash
Credit Rams Capital
5,85,000
Machine Account
Dr.
To Cash
(Being purchase of a machine of $
3,40,000 for Solid Machines for
cash vide .)
____________________________
Alternatively,
Debit Machine
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Credit Cash
3,40,000
Cr.
Amount
5,85,000
5,85,000
5,85,000
3,40,000
3,40,000
3,40,000
16
An Illustration Of Accounting Procedures

Assume that Dharma Engineers began operations in January 2010 and
engaged in a number of transactions. His transactions are used here
to demonstrate the accounting procedures just discussed.
Transaction 1: Dharma contributed $50,000 as capital.
Analysis: Increase cash; increase Dharmas capital.
Debits and credits: Increase cash (an asset) by a debit; increase
Dharmas capital (an equity account) by a credit.
Journal entry: January 1

Cash Account
Dr
To Dharmas Capital Account
[Capital contributed by Dharma
In cash $ 50,000]
$50,000
$50,000
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Transaction 2: Dharma Engineers borrowed $20,000

from a bank as loan.
Analysis: Increase cash; increase bank loan.
Debits and credits: Increase cash by a debit; increase
bank loan by a credit.

Cash Account
Dr.
To Bank Loan Account
[Borrowed $ 20,000 from
A bank as loan]
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$20,000
$20,000
18
Transaction 3: Dharma Engineers paid in advance one years

rent of $12,000.
Analysis: Increase prepaid rent; decrease cash.

Debits and credits: Increase prepaid rent by a debit; decrease
cash by a credit.
Prepaid Rent Account
To Cash Account
[To record prepayment of
one years rent]
Dr.
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$12,000
$12,000
19
Transaction 4: Purchased inventory on account from Z, $30,000.

Analysis: Increase inventory; increase amount payable to Z, a creditor.
Debits and credits: Increase inventory by a debit; increase accounts
payable by a credit.

Purchases Account
To Z (Accounts Payable)
[To record the purchase
of inventory on account]
Dr.
$30,000
Alternatively,
Inventory Account
Dr.
To Z (Accounts payable) Account
$ 30,000
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$30,000
$ 30,000
20
Transaction 5: Purchased equipment for $25,000.

Analysis: Increase equipment; decrease cash.
Debits and credits: Increase equipment by a debit;

decrease cash by a credit.
Equipment Account
Dr.
To Cash Account
[Purchase of Equipment
of $ 25,000 for cash]
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$25,000
$25,000
21
Transaction 6: Rendered services to customer Rahim for $600;

received cash of $ 200 plus a promised future payment of $400.
Analysis: Increase cash; increase accounts receivable; increase service

revenue.
Debits and credits: Debit cash by $200; debit accounts receivable by
$400; credit service revenue by $600.
Journal Entry: January 3
Cash Account
Rahims A/c (Accounts Receivable)
To Service Revenue Account
[Service revenue of $ 600 earned;
Received $ 200 in cash and a
Promise to pay $ 400 in future]
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Dr.
Dr.
$200
$400
$600
22
Transaction 7: Received $100 from a customer for

services to be performed at a later date.
Analysis: Increase cash; increase unearned revenue
[remember that unearned revenue is a liability].
Debits and credits: Debit cash; credit unearned revenue.

Cash Account
Dr.
To Unearned revenue Account
[Received unearned revenue
Of $ 100 from a customer in
In advance]
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$100
$100
23
Transaction 8: Paid salaries to employees of $700.

Analysis: Increase salary expense; decrease cash.
Debits and credits: Debit salary expense; credit cash
Salary Expense Account

To Cash Account
Dr.
$700
$700
[Salary of $ 700 paid]
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Transaction 9: Received a utility bill of $ 120 for services

already used. Payment was not immediately made.
Analysis: Utilities expense increases; utilities payable
increases.
Debits and Credits: Debit utilities expense; credit utilities
payable.
Utilities Expense Account Dr.
To Utilities Payable Account
$120
$ 120
[ Utility bill for services used

Still payable]
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Transaction 10: Sold inventory costing $ 2,200 to Khalifa on credit for

$4,000.
Analysis: Amount receivable from Khalifa (Accounts receivable) increases;
sales (an income) increases.
Debits and credits: Debit Khalifa (accounts receivable) Account; credit sales
an income account
Khalifas Account (accounts receivable) A/c
To Sales Account
[Sold goods on credit to Khalifa for $ 4,000]
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Dr.
$ 4,000
$ 4,000
26
Alternatively (when purchase of goods is treated as asset),

(a)
Khalifas Account (Accounts Receivable) Dr.$4,000
To Sales Account
$4,000
[Sold goods on credit to
Khalifa for $ 4,000]
(b)
Analysis: Expense cost of goods sold increases; asset inventory
decreases.
Debits and credits: Debit cost of goods sold; credit inventory.
Cost Of Goods Sold Account
To Inventory
[Sold goods to Khalifa
costing $ 2,200]
Dr.
SC Malhotra
$2,200
$2,200
27
Transaction 11: Interest expense of $150 incurred but did not

pay.
Analysis: Increase interest expense; increase interest payable

a liability.
Debits and credits: Debit interest expense; credit interest
payable.
Interest Expense Account
To Interest Payable Account
[Interest expense of $ 150
Is outstanding]
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Dr.
$150
$150
28
Transaction 12: Used $1,000 of prepaid rent.
Analysis: Increase rent expense; decrease prepaid

rent, an asset.
Debits and credits: Debit rent expense; credit
prepaid rent.
Rent Expense Account
Dr. $1,000
To Prepaid Rent Account
[Rent expense for the
month of January recorded]
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$1,000
29
Transaction 13: Depreciation on equipment amounted to $210.
Analysis: Increase depreciation expense; decrease equipment or

increase the balance in the contra-asset account, accumulated
depreciation.
Debits and credits: Debit depreciation expense; credit equipment or
accumulated depreciation.
Depreciation Expense Account Dr.
To Equipment Account
or
To Accumulated Depreciation Account
[Depreciation expense on equipment
amounted to $ 210]
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$210
$210
30
Transaction 14: Earned $ 50 of the $100 advance

payment previously made by customer.
Analysis: Decrease unearned revenue (a liability);
increase service revenue (an income).
Debits and credits: Debit unearned revenue; credit
service revenue.
Unearned Revenue Account
To Service Revenue
[Service revenue earned $ 50
out of unearned revenue]
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Dr.
$50
$50
31
Transaction 15: Paid for taxes $100.

Analysis: Tax expense increases; cash decreases.
Debits and credits: Debit tax expense; credit
cash.
Taxes Expense Account
Dr.
To Cash
$100
$100
[Taxes of $ 100 paid]

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Format of General Journal

Date
Particulars
L.F.
SC Malhotra
Dr.
Amount
Cr.
Amount
33
Date
Jan.
Particulars
L.F.
Cash Account
Dr.
To Dharmas Capital Account
[Capital contributed by Dharma
In cash $ 50,000]
______________________________
Cash Account
Dr.
To Bank Loan
[Borrowed $ 20,000 from a bank as loan]
______________________________
Prepaid Rent Account
Dr.
To Cash Account
[To record prepayment of one years rent]
______________________________
Purchases Account
Dr.
To Z (Accounts Payable)
[To record the purchase of inventory on
account]
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Dr.
Amount
Cr.
Amount
$50,000
$50, 000
$20,000
$20,000
$12,000
$12,000
$30,000
$30,000
34
Date
Jan.
Particulars
Equipment Account
To Cash Account
L.F.
Dr.
Dr.
Amount
Cr.
Amount
$25,000
$25,000
[Purchase of Equipment of $ 25,000 for cash]

_____________________________________
Cash Account
Dr.
Rahims A/c (Accounts Receivable)
Dr.
To Service Revenue
[Service revenue of $ 600 earned; received
$ 200 in cash and a promise to pay $ 400
in future]
_________________________________
Cash Account
Dr.
To Unearned revenue
or
To Revenue received in advance
[Received unearned revenue of $ 100 from
a customer in advance]
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$200
$400
$600
$100
$100
35
Date
Jan.
Particulars
15
Salary Expense Account

To Cash Account
L.F.
Dr.
Dr.
Amount
Cr.
Amount
$700
$700
[Salary of $ 700 paid]

________________________________________
18
Utilities Expense Account

To Utilities Payable Account
Dr.
$120
$ 120
[ Utility bill for services used still payable]

________________________________________
20
25
Khalifas (accounts receivable) Account Dr.

To Sales Account
[Sold goods on credit to Khalifa for $ 4,000]
____________________________________
Interest Expense Account
Dr.
To Interest Payable
[Interest expense of $ 150
Is outstanding]
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$ 4,000
$ 4,000
$150
$150
36
Date
Jan.
Particulars
31
Rent Expense Account

To Prepaid Rent
L.F.
Dr.
Dr.
Amount
Cr.
Amount
$1,000
$1,000
[Rent expense for the month of January recorded]

__________________________________________
31
31
Depreciation Expense Account

Dr.
To Equipment Account
or
To Accumulated Depreciation Account
[Depreciation expense on equipment
amounted to $ 210]
_____________________________________
Unearned Revenue Account Dr.
To Service Revenue
$210
$210
$50
$50
[Service revenue earned $ 50 out of unearned

revenue]
__________________________________________
31
Taxes Expense Account

To Cash
Dr.
$100
$100
[ Taxes of $ 100 paid]

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37
1.Post journal entries to ledger

accounts
2.Find the balancing amount of each of

the ledger account
3.Prepare trial balance
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38
Format of an Account
Dr.
Date
Cr.
Particulars
JF
Amount
Date
SC Malhotra
Particulars
JF
Amount
39
Trial Balance as at 31st January, 2010
Debit balances
Cash
Prepaid rent
Equipment
Debtors:
Rahim
Khalifa
Purchases
Salary expense
Utility expense
Interest
Rent
Depreciation
Tax
Amount
Credit Balances
32,500 Dharamas Capital

11,000 Bank loan
24,790 Creditors
Z
400 Unearned revenue
4,000 Utility expense payable
30,000 Interest payable
700 Service revenue
120 Sales
150
1,000
210
100
_________
1,04,970
_________
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Amount
50,000
20,000
30,000
50
120
150
650
4,000
__________
1,04,970
__________
40
Select the correct option in each of the following cases:

1. On purchase of equipment for cash, owners equity would:
a.
b.
c.
2.
Purchase of government securities for cash would:

a.
b.
c.
3.
Reduce assets
Increase assets, or
Keep assets unchanged.
The accounting equation is satisfied by:

a.
b.
c.
4.
Increase ,
Decrease, or
Remain unchanged
Capital = Assets + Liabilities

Liabilities = Capital Assets
Capital = Net assets
On sale of old machine at profit, owners equity would:

a.
b.
c.
Increase
Decrease
Remain unchanged
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41
5. Withdrawals by the proprietor would:

a. Reduce both assets and owners equity
b. Reduce assets and increase liabilities
c. Reduce owners equity and increase liabiliities
6. Both assets and owners equity would be increased by:
a. Proprietors withdrawals
b. Purchasing a building on credit
c. Selling goods on credit
7. Payment of salary is recorded by:
a. Debiting salary account and crediting cash account
b. Debiting employee account and crediting cash account
c. Debiting cash account and crediting employee account
8. Purchase of goods on credit from Rohan is recorded as:
a. Debit Purchases account and credit Cash account
b. Debit Rohan account and credit Purchases account
c. Debit Purchases account and credit Rohan account
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2. Traditional Approach
Under this approach, the above accounts are first classified as
a) personal accounts,
b) real accounts and
c) nominal accounts,
and then rules of recording transactions therein are enumerated.
Rules of recording transactions:
a) Personal accounts: Debit the receiver and credit the giver
b) Real accounts: Debit what comes in and credit what goes
out
c) Nominal accounts: Debit all expenses and losses and credit
all incomes and gains
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Accounting Process Steps

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Accounting Process Steps

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ACCOUNTING PROCESS

Identify transactions and events.

Translate the transaction analysis into debits and credits.

Pass adjustment entries and post them to the general ledger.

9. Prepare profit and loss account

Analysis of transactions and events

1. Accounting Equation approach

Accounting Equation Approach

Liabilities + (Capital + Retained Earnings) = Assets

Machine is purchased for $25,000 cash.

Purchased furniture for $8,000 on credit from Rahul.

Paid salary to the manager, Gaurav $10,000.

Purchased merchandise $20,000 on credit from the supplier Preetam.

Sold merchandise costing $ 15,000 for $35,000 cash.

Machine is depreciated by $2,000.

Furniture is depreciated by $500.

Record through accounting equation

Balance Sheet of Rama Stores

In accounting, the device developed for this purpose is called an account.

Liabilities + Owners equity

Debit means the left hand side

Liabilities + *Owners Capital + Net Profit]

Liabilities + [Capital + (Revenues - Expenses)] = Assets

Liabilities + Capital + Revenues

RULES OF RECORDING TRANSACTIONS

The above procedure of recording the transactions in the ledger accounts

Identity of individual transaction is lost.

Difficulty in understanding the entries.

In view of the above limitations, it is considered necessary to keep record of

An Illustration Of Accounting Procedures

Journal entry: January 1

Transaction 2: Dharma Engineers borrowed $20,000

Journal entry: January 1

Transaction 3: Dharma Engineers paid in advance one years

Analysis: Increase prepaid rent; decrease cash.

Transaction 4: Purchased inventory on account from Z, $30,000.

Journal entry: January 1

Transaction 5: Purchased equipment for $25,000.

Debits and credits: Increase equipment by a debit;

Transaction 6: Rendered services to customer Rahim for $600;

Analysis: Increase cash; increase accounts receivable; increase service

Transaction 7: Received $100 from a customer for

Debits and credits: Debit cash; credit unearned revenue.

Transaction 8: Paid salaries to employees of $700.

Salary Expense Account

[Salary of $ 700 paid]

Transaction 9: Received a utility bill of $ 120 for services

[ Utility bill for services used

Transaction 10: Sold inventory costing $ 2,200 to Khalifa on credit for

Alternatively (when purchase of goods is treated as asset),

Transaction 11: Interest expense of $150 incurred but did not

Analysis: Increase interest expense; increase interest payable

Transaction 12: Used $1,000 of prepaid rent.

Analysis: Increase rent expense; decrease prepaid

Transaction 13: Depreciation on equipment amounted to $210.

Analysis: Increase depreciation expense; decrease equipment or

Transaction 14: Earned $ 50 of the $100 advance

Transaction 15: Paid for taxes $100.

[Taxes of $ 100 paid]

Format of General Journal

[Purchase of Equipment of $ 25,000 for cash]

Salary Expense Account