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Week 3
The Double Entry System
Student Handout
Lecturer:Dr. Youngdeok Lim
School of AccountingUNSW
Business SchoolACCT1501 Accounting and Financial Management 1A
Session 1 2016
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WEEK 3: The Double Entry System
1. Introduction
Last week we discussed the importance of the balance sheet and income statement tomanagers. It is therefore critical that every manager understand the impact of transactionson these financial reports. This week covers those skills by extending transaction analysis,which considers the impact of specific transactions on the accounting equation. Thedouble entry system involving debits and credits, which forms the basis of modernaccounting, is then addressed.
Learning objectives
At the end of this topic you should be able to:
• Carry out transaction analysis and determine the impact of transactions on elementsof balance sheets and income statements
• Describe how debits and credits work in the double entry accounting system.
• Understand debits and credits in the context of transaction analysis
Required reading
Trotman, Gibbins & Carson Chapter 3
2. Tutorial Questions – Week 4
Students should attempt these questions before the tutorial.
Preparation Questions:
DQ3.1, 3.2, 3.4,
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3. Lecture example – P3.6
Find the unknowns given the following information
$m $m
Assets 1 July 2015 600 Assets 30 June 2016 ?
Liabilities 1 July 2015 ? Liabilities 30 June 2016 300
Share capital 1 July 2015 180 Share capital 30 June 2016 190
Retained profits 1 July 2015 200 Retained profits 30 June 2016 ?
Revenue for the year 800
Expense for the year 650
Dividends 50
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ACCT1501Semester 1, 2016
Week 3
The Double Entry System
Dr. Youngdeok LimQuad 3069
1
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Today’s lecture objectives:
Carry out transaction analysis and determine the impact oftransactions on elements of balance sheets (i.e. A, L, and SE) andincome statements (i.e. R and E)
o transaction 1-7.
o LRM ltd (transaction 8-14).
Hot: Describe how debits and credits work in the double entryaccounting system.
Understand debits and credits in the context of transaction analysis
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Revisit the definition of an asset
To be reported on a balance sheet, assets must
(1) Meet definition criteria
And THEN (2) Meet recognition criteria!
A resource that is controlled by an entity as a result of past events, andfrom which future economic benefits are expected to flow to the
entity.Assets recognition criteria:
(a) It is probable that any future economic benefit associatedwith the item will flow to the entity, and
(b) The item has a cost or value that can be measuredreliably
4
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Revisit balance sheet and income statement
5
A t-1L t-1
SE t-1
A tL t
SE t
RE
R – E = Profit for the period
Beginning period (t-1) Ending Period (t)
A t-1 = L t-1 + SE t-1 A t = L t + SE t
Incorporated into B/S
Capture of income
Retained profits: the sum of net profits earned over the life of a company less dividends
declared to shareholders
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Revisit the accounting equation expanded
6
Where:
SC = Share capitalRP = Retained profits
R = Reen!e
" = "#penses
$ = $iidend %declared&
t = time t %at the endin' period&
t(1 = time t(1 %at the )e'innin' period&
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Revision question 1 – Lecture example (P3.6)
7
Find the unknowns given the following information
$m $m
Assets 1 July 2015 600 Assets 30 June 2016 ?
Liabilities 1 July 2015 ? Liabilities 30 June 2016 300
Share capital 1 July 2015 180 Share capital 30 June 2016 190
Retained profits 1 July 2015 200 Retained profits 30 June 2016 ?
Revenue for the year 800
Expense for the year 650
Dividends 50
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Watch ICAA clip which provides an overview of
the financial statements
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Business Model
9
Company
(e.g. Woolworths)
Customers
(e.g. You)
Suppliers
(e.g. farmers)
Purchase of inventory Sale of inventory
Payment
(Cash/ Accounts
Payable)
Payment
(Cash/ Accounts
Receivable)
Investors (e.g. banks,
shareholders)Financing
Property Plant and Equipment,
financial securities etc
Investing
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Consolidated B/S –Woolworths Limited
Current Assets $7,661 M Current Liabilities $9,168 M
Noncurrent
Assets
$17,675 M Noncurrent Liabilities $5,036 M
Total Liabilities $14,204 M
Equities $11,132 M
Total Assets $25,336 M Total Liabilities andEquities
$25,336 M
As at 28 June 2015
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Revenue $60,968 M
- Cost of sales (Cost of goods sold) ($44,344 M)
Gross profit $16,524 M
+/- other revenue/expense ($14,387 M)
Net profit $2,137 M
For the 52 weeks ended on 28 June 2015
Consolidated I/S –Woolworths Limited
11
The fiscal year is the 52 or 53 week period that ends on the last Sunday of June.
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Transactions
Transactions are events that affect the operations orfinances of an organisation.
Analyze each transaction from the perspective of a company!
Accounting systems record transactions.
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Transaction analysis
Transaction analysis involves an examination of each
business transaction with the aim of understanding its effecton the accounting equation (i.e. A=L+SE).
Example: Borrow $10 000 from the bank.• A liability (source) has increased Loan
• An asset (resource) has increased Cash
After this transaction the accounting equation is in balance.
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Transaction analysis: The accounting equationextended
The equation you were introduced to earlier is asfollows:
Assets = Liabilities + Equity
This is extended to:
A = L + SE
CA + NCA = CL + NCL + SE
What is SE made up of?
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Expanding the accounting equation
A = L + SECA + NCA = CL + NCL + SEWhere SE:
SC + opening RP at the start of the period + RP for the period SC + opening RP + profit – dividends SC = Capital contributions by equity holders (share capital)
RP = Retained profits Op RP = Opening retained profits Profit = R – E R = Revenue E = Expenses
Dividends = Distributions to equity holders
CA + NCA = CL + NCL + SC + Op. RP + R – E – D
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Link between the balance sheet and the income
statement
Income statement
16
Balance sheet
CA + NCA = CL + NCL + SC + Op. RP + R – E – D
CA + NCA = CL + NCL + SE
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Let’s consider seven transactions.
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Transaction 1
Issued shares for $300 000 cash.
A = L + SE
Does the accounting equation balance?
YES! It must balance!
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Share capitalCash
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Transaction 1
Issued shares for $300 000 cash.
19
= Liabilities +
CashAccounts
Receivable Equipment Bank LoanShare
CapitalRetainedProfits
1 +300,000 +300,000
Assets Shareholders’ equity
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Transaction 2
Borrowed $50 000 cash from the bank.
A = L + SE
Does the accounting equation balance?
YES! It must balance!
20
Bank LoanCash
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Transaction 2
Borrowed $50 000 cash from the bank.
21
= Liabilities +
Cash
Accounts
Receivable Equipment Bank Loan
Share
Capital
Retained
Profits1 +300,000 +300,000
2 +50,000 +50,000
Assets Shareholders’ equity
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Transaction 3
Purchase equipment for $100 000 cash.
A = L + SE
Does the accounting equation balance?
YES! It must balance!
22
Equipment
Cash
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Transaction 3
Purchase equipment for $100 000 cash.
23
= Liabilities +
Cash
Accounts
Receivable Equipment Bank Loan
Share
Capital
Retained
Profits
1 +300,000 +300,000
2 +50,000 +50,000
3 -100,000 +100,000
Assets Shareholders’ equity
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Transaction 4
Signed six-month agreement to provide catering service for
a monthly fee of $2500 starting next month.
A = L + SE
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Transaction 4
Not a transaction:
no service provided.
no current right to receive.
no cash movement that needs to be recorded.
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Transaction 5
Catering services provided for an office function; billed
customer for $2500.
A = L + SE
Does the accounting equation balance?
YES! It must balance!
26
Accountsreceivable
Revenue
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Transaction 5
Catering services provided for an office function; billed
customer for $2500.
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= Liabilities +
Cash
Accounts
Receivable Equipment Bank Loan
Share
Capital
Retained
Profits1 +300,000 +300,000
2 +50,000 +50,000
3 -100,000 +100,000
4
5 +2,500 +2,500
Assets Shareholders' equity
Revenue
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Transaction 6
Customer paid $2500 they owed on their account.
A = L + SE
Does the accounting equation balance?
YES! It must balance!
28
Accountsreceivable
Cash
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Transaction 6
Customer paid $2500 they owed on their account.
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Assets = Liabilities + Shareholders’ equity
Cash Accsrec.
Equipment Bank loan Sharecapital
Retainedprofits
1 !""#""" !""#"""
$ %"#""" %"#"""
! &1""#""" 1""#"""
'
% $#%"" $#%""
( $#%"" &$#%""
Revenue
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Transaction 7
Paid the bank $5000 as part repayment of the loan.
A = L + SE
Does the accounting equation balance?
YES! It must balance!
30
Bank loanCash
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Transaction 7
Paid the bank $5000 as part repayment of the loan.
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Assets = Liabilities + Shareholders’ equity
Cash Accsrec.
Equipment Bank loan Sharecapital
Retainedprofits
1 !""#""" !""#"""
$ %"#""" %"#"""
! &1""#""" 1""#"""
'
% $#%"" $#%""
( $#%"" &$#%""
) &%#""" &%#"""
Revenue
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Transaction analysis complete
Assets = Liabilities + Shareholders’ equity
Cash Accsrec.
Equipment Bank loan Sharecapital
Retainedprofits
1 !""#""" !""#"""
$ %"#""" %"#"""
! &1""#""" 1""#"""
'
% $#%"" $#%""
( $#%"" &$#%""
) &%#""" &%#"""
$')#%"" " 1""#""" = '%#""" + !""#""" $#%""
!')#%"" = '%#""" + !"$#%""
A = L + SE
Revenue
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Assets = Liabilities + Shareholders’ equity
Balance sheet
33
ASSETS LIABILITIES
Cash $') %"" Bank loan '% """
Equipment 1"" """
SHAREHOLDERS’ EQUITY
Share capital !"" """Retained profits $ %""
!') %"" !') %""
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Income statement
34
Re*enue $ %""
E+pense "
,et profits $ %""
Revision Question 2
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Inventory was purchased for cash, when:
1. an asset increased and another asset decreased
2. an asset decreased and an expense increased
3. an asset decreased and a liability decreased
4. a liability increased and an expense increased
Revision Question 2
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An illustrative example: Prepare transaction analysis
LRM Ltd: Balances as at 1 April 2016
Cash 140 000Inventory 55 000
Land and buildings 300 000
Equipment 90 000
Accounts payable 15 000Notes payable 70 000
Loans 300 000
Share capital 200 000
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Transactions for April 2016
8 Cash sales of $30 000; Cost of goods sold = $12 000.
9 Credit sales of $40 000; Cost of goods sold = $16 000.
10 $8000 payments to suppliers on the account.
11 $20 000 wages paid for first 2 weeks of April.
12 Received invoice for $2000 for an advertisement onApril 5.
13 Received $25 000 from accounts receivable.
14 At end of month: $18 000 wages is owing for last 2weeks of the month. Due to be paid on May 1.
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LRM Ltd: Exhibit 3.3, page 90
38
Transaction Cash
Accounts
receivable Inventory
Land and
building Equipment
Accounts
payable
Notes
payable
Wages
payable Loans
Share
Capital
Retained
profitsOpening
balance
140,000 0 55,000 300,000 90,000 15,000 70,000 0 300,000 200,000 0
8 30,000 30,000 Revenues
-12,000 -12,000 Expenses
9 40,000 40,000 Revenues
-16,000 -16,000 Expenses
10 -8,000 -8,000
11 -20,000 -20,000 Expenses
12 2,000 -2,000 Expenses
13 25,000 -25,000
14 18,000 -18,000 Expenses
Closingbalance 167,000 15,000 27,000 300,000 90,000 9,000 70,000 18,000 300,000 200,000 2,000
Assets 599,000 Liabilities 397,000
Stockholder's
equity 202,000
A=L+SE
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LRM Ltd
-ncome statement for the month ended !" April $"1(
. .
Sales )" """Cost of /oods sold $0 """
ross profit '$ """2peratin/ e+penses3a/es !0 """Ad*ertisin/ $ """ '" """
,et profit $ """
LR4 Ltd5 E+hibit !.'# pa/e 61
39
LR4 L d E hibi ! % 61
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LRM Ltd
Balance sheet as at !" April $"1(
Assets Liabilities and shareholders e!it"
. .#!rrent assets #!rrent liabilities
Cash 1() """ Accounts payable 6 """Accounts recei*able 1% """ ,otes payable )" """-n*entory $) """ 3a/es payable 10 """
$"6 """ 6) """
$on%&!rrent assets $on%&!rrent liabilities
Land and buildin/ atcost !"" """ Loans !"" """
2ffice equipment atcost
6" """ Total liabilities !6) """
!6" """Shareholders’ e!it" Share capital $"" """
Retained profit 7 $ """Total shareholders’
e!it" $"$ """
Total assets %66 """Total liabilities and
shareholders’ e!it" %66 """
7 Retained profit 8 openin/ retained profits 9": profit 9$""":; di*idends declared 9": 8 $"""
LR4 Ltd5 E+hibit !.%# pa/e 61
40
Revision Question 3
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Additional credit sales of $2m (cost of sales $1.5m)
are made on credit. This transaction will:
1. increase net profit, increase cash, and increasetotal assets
2. increase net profit, increase total assets but not
affect cash3. increase net profit, and not affect cash or total
assets
4. increase net profit, increase cash.
Revision Question 3
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Double entry accounting
A = L + SE
42
The accounting equation ust al!a"s #alance
$t eans De#its = C%e&its.
The 'ol&en Rule(
$n accounting !e use &e#it )D%* an& c%e&it )C%* to &esc%i#e
changes in accounts
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Debit–credit convention
• Remember the equation:
Assets = Liabilities + Equity
• We define increases in Assets to be debits (DR) – decreases in Assets therefore must be credits (CR).
• DR = CR, therefore increases in Liabilities (and Equity)
must be credits, decreases must be debits.
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Assets (+A) Liabilities (+L)
Capital (+SE)
Expenses (+E) Revenues (+R)
Uses of Funds Sources of Funds Always record on the
right-hand side
Always record on the
left-hand side
Simultaneous
recording of the use of
funds and the source of
funds
Basic orientation of the “double-entry bookkeeping system”
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Double entry system: Debit and Credit
Debit Credit
+A +L+SE
+E +R
-L -A
-SE
-R -E
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Remembering debits/credits
Type Normal Incr. Decr.
Assets Debit Debit Credit
Liabilities Credit Credit Debit
Shareholder’s equity Credit Credit Debit
Revenues Credit Credit Debit
Expenses Debit Debit Credit
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Debit and credit (Critical thinking)
Company record v.s. Bank statement
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Journal entries
• Journal entries are, essentially, a shorthand version ontransaction analysis.
• They are prepared using the rules of debit and credit.• Debits must always equal credits.
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Journal entries
Example
Machinery is purchased for $10 000 cash.
Journal entry:
Dr Machinery 10 000
Cr Cash 10 000
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Revision Question 4
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Which of the following accounts does NOT normally have a creditbalance?
1. accounts payable
2. retained profits
3. tax payable4. prepaid expenses.
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Revision Question 5
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Identify the journal entry required to correctly record the followingtransactions.
Cash received from accounts receivable
1. Dr Accounts Receivable Cr Cash
2. Dr Cash Cr Accounts Payable
3. Dr Cash Cr Accounts Receivable
4. none of the above
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Revision Question 6
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Identify the journal entry required to correctly record the followingtransactions.
Cash dividends of $20,000 declared and paid.
1. Dr Retained profits 20,000 Cr Dividends payable 20,000
2. Dr Cash 20,000 Cr Retained profits 20,000
3. Dr Retained profits 20,000 Cr Cash 20,000
4. none of the above
52
Appendix Dividends
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Appendix- Dividends
53
The dividends recommended by directors are authorised by shareholders at an
annual meeting: (Declaration)
Dr Retained profits 20,000 (-SE)
Cr Dividends payable 20,000 (+L)
When the final dividends are paid: (Payment)
Dr Dividends payable 20,000 (-L)
Cr Cash 20,000 (-A)
Revision Question 7
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Which of the following are debits?
1. contributions of capital
2. increases in revenues
3. increases in liabilities
4. decreases in owners’ equity.
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Link transaction analysis and journal entries
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Link transaction analysis and journal entries
Back to the previous transactions.
Prepare journal entries for transaction 1-7. Prepare journal entries for LRM ltd.
55
Transaction 1 7
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Transaction 1-7
1: Issued shares for $300 000 cash.
2: Borrowed $50 000 cash from the bank.
3: Purchase equipment for $100 000 cash.
4: Signed six-month agreement to provide cateringservice for a monthly fee of $2500 starting next month.
5: Catering services provided for an office function; billedcustomer for $2500.
6: Customer paid $2500 they owed on their account.
7: Paid the bank $5000 as part repayment of the loan.
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Solution: Transaction 1 7
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Solution: Transaction 1-7
1.
2.
3.
4.
5.
6.
7.
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Transactions for April 2016
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Transactions for April 2016
8 Cash sales of $30 000; Cost of goods sold = $12 000.
9 Credit sales of $40 000; Cost of goods sold = $16 000.
10 $8000 payments to suppliers on the account.
11 $20 000 wages paid for first 2 weeks of April.
12 Received invoice for $2000 for an advertisement on
April 5.
13 Received $25 000 from accounts receivable.
14 At end of month: $18 000 wages is owing for last 2
weeks of the month. Due to be paid on May 1.
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Solution: LRM ltd case 8.
9.
10.
11. 12.
13.
14.
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Application of journal entries
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Application of journal entries
Depreciation: The more details will be covered
in week 8 (noncurrent assets)
Dr Depreciation expense xxx (+E)Cr Accumulated depreciation xxx (-A)
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Wrap-Up
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• Double entry system: Debits and Credits – Debits Credits
+A +L
+SE+E +R
-L -A
-SE
-R -E
Relationship between transaction analysis and journal
entries Negative values in transaction analysis mean theabnormal side in journal entries.
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Next Lecture…
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62
Record-Keeping
Please bring comprehensive class example fromthe moodle.
Appendix
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pp
Accounts payable (AP)
Accounts payable are dollar amounts owed to othersfor goods, supplies, and services purchased on openaccount.
Notes payable (NP)
Notes payable is evidenced by a promissory note orbill of exchange. (e.g. credit purchase of equipment)
The interest-bearing characteristic and the writtendocumentation distinguish NP from AP.
63