Outline for Stevens Institute of Technology
Introduction to Accounting Tutorial
 

Introduction

 

Balance Sheet

 

Income Statement

 

Accounts

 

Journals and Registers

 

Trial Balance  



Review Questions

Introduction

  • What is the purpose of this tutorial?

The purpose of this tutorial is to permit you to become familiar with the basics of financial accounting.  Specifically, the tutorial will cover only the fundamentals and definitions that will allow us to move ahead with the consideration of the principal aspects of financial and managerial accounting and the use of financial data in management decision-making.  In this tutorial we will first define accounting data and who uses it for what.  We will then define the fundamental descriptors of the financial state and performance of an entity, the Financial Statements. Definition of assets, liabilities and owners’ equity lead to the statement of the basic equation of financial accounting.  The analysis and posting of transactions into accounts completes the tutorial.

Each section is accompanied by questions and problems to help you determine if you understand the concepts.

  • What is accounting data and who uses it for what?

 ACCOUNTING, at its simplest, is SCOREKEEPING – it is the observing, measuring, recording, classifying and summarizing of the data associated with the multitude of transactions occurring in the operation of a business.  It does all of this for a defined entity and all in monetary terms only.  As such, the accounting function is historical not predictive.  Other non-accounting instruments are predictive, such as Sales Forecasts, Production Plans, Expense Budgets and Cash Flows, but are usually based, as least in part, on solid historical accounting data.

 One might ask why keep score, if that is the only purpose.  In reality, the main purpose of keeping financial data is as an aid in DECISION MAKING.

 The principal players who may be interested in some or all of the financial data are:  managers, customers, shareholders, bankers and various government agencies.  Each has its own unique set of questions it can use financial data to answer.  

The fundamental descriptors of the financial state and performance of an entity (e.g., company, partnership, etc.) are the Financial Statements which describe the entity in terms of Assets, Liabilities ,Owners’ Equity, Revenues, Expenses and Profits:

Assets, liabilities and owners’ equity describe the financial state of an entity at a specific point in time.

Assets:  Are the value of things owned by the entity, both tangible and intangible.

Liabilities:  Are the amounts of money owed by the entity to outside individuals or companies.

Owner’s Equity: Is what’s left over from the assets if all liabilities were paid off


This leads directly to a form of The Accounting Equation:

             Assets – Liabilities = Owners’ Equity

 Or more usually stated as:

                         Assets = Liabilities + Owners’ Equity


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Balance Sheet

The balance sheet presents a summary statement of the firm’s financial position at a given point in time. The statement balances the firm’s assets (what it owns) against its financing, which can be either debt (what it owes) or equity (what was provided by owners). Baker Corporation’s balance sheets on December 31 of 2000 and 1999 are presented in Table 1.1. They show a variety of asset, liability (debt), and equity accounts. An important distinction is made between current assets and long-term non current assets and current liabilities and long-term liabilities. The current assets and current liabilities are short-term assets and liabilities. This means that they are expected to be converted to cash (current assets) or paid (current liabilities) within one year or less. All other assets and liabilities, along with stockholders’ equity, which is assumed to have an infinite life, are considered long-term, or fixed, because they are expected to remain on the firm’s books for 1 year or more.

As is customary, the assets are listed beginning with the most liquid down to the least liquid. Current assets therefore precede fixed assets. Marketable securities represent very liquid short-term investments, such as U.S. Treasury bills or certificates of deposit, held by the firm. Because of  their highly liquid nature, marketable securities are frequently viewed as a form of cash. Accounts receivable represent the total monies owed the firm by its customers on credit sales made to them. Inventories include raw materials; work in process (partially finished goods), and finished goods held by the firm. The entry for gross fixed assets is the original cost of all fixed (non-current) assets owned by the firm. Net fixed assets represent the difference between gross fixed assets and accumulated depreciation- the total expense recorded for the depreciation of fixed assets. (The net value of fixed assets is called their book value)

Like assets, the liabilities and equity accounts are listed on the balance sheet from short-term to long-term. Current liabilities include accounts payable, amounts owed for credit purchases by the firm; notes payable, outstanding short-term loans, typically from commercial banks; and accruals, amounts not yet paid but owed for which a bill may not have been received. (Examples of accruals include taxes due the government and wages due employees.) Long-term debt represents that part of any debt for which payment is not due in the current year.

Stockholders’ equity represents the owners’ claims on the firm. Two types of stocks are: The preferred stock ($ 100,000 for Baker Corporation), in table 1.1, and the amount paid in by the original purchasers of  


Table 1.1           Baker Corporation Balance Sheets
 ($000)

December 31

Assets 

2000

1999

Current assets

Cash                                                                   

400

300

Marketable securities

600

200

Account receivable                    

400

500

Inventories                   

600

900

Total current assets

2000

1900

Gross fixed assets (at cost)
Land and buildings          

1200

1050

Machinery and equipment

850

800

Furniture and fixtures

300

220

Vehicles

100

80

Other (includes certain leases)

50

50

Total gross fixed assets (at cost)

2500

2200

Less: Accumulated depreciation

1300

1200

Net fixed assets

1200

1000

Total assets

3200

2900


Liabilities and stockholders’ equity
               
Current liabilities

Accounts payable

700

500

Notes payable 

600

700

Accruals          

100

200

Total current liabilities

1400

1400

Long-term debt   600   400

Total liabilities

2000

1800


Stockholders’ equity

 

 

Preferred stock

100

100

Common stock-$1.20 par, 100,000 shares
Outstanding In 2000 and 1999

120

120

Paid-in capital in excess of par on common stock

380

380

Retained earnings

600

500

Total stockholders’ equity  

1200

1100


Total liabilities and stockholders’ equity
 3200  2900
                                                                               


common stock is shown by two entries: common stocks and paid in capital in excess of par on common stock. The common stock entry reflects the par-value of common stocks. Paid-in capital in excess of par represents the amount of proceeds in excess of the par value received from the original sale or subsequent sales of common stock. The sum of the common stock and paid in capital accounts divided by the number of shares outstanding represents the original price per share received by the firm on a single issue of common stock. Baker Corporation therefore received $5.00 per share (($120,000 par+ $380,000 paid in capital in excess of par)/100,000 shares) from the sale of its common stock. Finally, retained earnings represent the cumulative total of all earnings, net of dividends that have been retained and reinvested in the firm since its inception. It is important to recognize that retained earnings are not cash but rather are net profits that have been utilized to finance the firm’s assets.

Baker Corporation’s balance sheet show that the firm’s total assets increased from $2,900,000 in 1999 to $3,200,000 in 2000. The $300,000 increase was due primarily to the $200,000 increase in net fixed assets. The asset increase in turn appears to have been financed primarily by an increase of $200,000 in long-term debt. Better insight in to these changes can be derived from the statement of cash flows.

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Income Statement  

The income statement provides a financial summary of the firm’s operating results during a specified period. In fact ; it shows the detail of the change in retained earnings on the balance sheet. Most common are income statements covering a 1 year period ending at a specified date, ordinarily December 31 of the calendar year. Many large firms, however, operate on a 12th month financial cycle, or fiscal year, that ends at a time other than December 31. Monthly income statements are typically prepared for use by management, and quarterly statements must be made available to the stockholders of publicly owned corporations.

Table 1.2     Baker Corporation Income Statement       
Year ended December 31,2000
($1000)

Sales revenue $1,700
Less: Cost of goods sold 1,000
Gross profits  700
Less: Operating expenses
          Selling expense 80
General and administrative expense 150
Depreciation expense            100
          Total operating expense 330
Operating profits   370
Less: Interests expense 70
Net profits before taxes 300
Less: Taxes (@40%) 120
Net profits after taxes 180
____________________________________________ _______ _______
Less: Preferred stock dividends 10
Earnings available for common stockholders 170
Earnings per share (EPS) 1.70


Table 1.2 presents Baker Corporation’s income statement for the year ended December 31, 2000. The statement begins with sales revenue- the total dollar amount of sales during the period from which the cost of goods sold is deducted. The resulting gross profits of $ 700,000 represent the amount remaining to satisfy operating, financial, and tax costs after meeting the costs of producing or purchasing the products sold. Next, operating expenses, which include selling expense, general and administrative expense, and depreciation expense, are deducted from gross profits. The resulting operating profits of $370,000 represent the profits earned from producing and selling products; this amount does not consider financial and tax costs. (Operating profit is often called earnings before interests and taxes, or EBIT) Next, the financial cost-interest expense- is subtracted from operating profits to find net profits (or earnings) before taxes. After subtracting $70,000 in 2000 interest, Baker Corporation had $ 300,000 of net profits before taxes.

After the appropriate tax rates have been applied to before tax profits; taxes are calculated and deducted to determine net profits (or earnings) after taxes.

Baker Corporation’s net profits after taxes for 2000 were $180,000. Next, any preferred stock dividends must be subtracted from net profits after taxes to arrive at earnings available for common stockholders. This is the amount earned by the firm on behalf of the common stockholders during the period. Dividing earnings available for common stockholders by the number of shares of common stock outstanding results in earnings per share (EPS). EPS represents the amount earned during the accounting period on each outstanding share of common stock. In 2000, Baker Corporation earned $170,000 for its common stockholders, which represents $1.70 for each outstanding share.  

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Accounts

 

Double Entry System:  

An feature of the design of most accounting systems is that each transaction requires at least two entries. This arises because the accounting equation needs to be in balance before and after each transaction is entered into the accounting system.  

Erasing the old amounts and writing in the new amounts would not be a practical method for handling the large number of transactions that occur in most entities. Instead of changing balance sheet amounts directly, in practice accountants use a device called an account to record each change. In its simplest form, an account looks like a large letter T, and it is therefore called a T-account. The title of the account is written on top of the T.

 

Account: 

An account is a location for collecting information about one specific asset, liability or item of equity. In the manual or graphic representation each account contains two columns. One column is used to record increases and the other, decreases in the balance (net value) of the account.

This is how a T-account might look at the beginning of an accounting period.

                                                                                                                                                                                                

                                                           

From this, we can tell the amount of cash at the beginning of the accounting period was $10,000. Note that although the amounts are in dollars, the dollar sign is not used.

            Transactions that affect the Cash account during the accounting period can either increase cash or decrease cash. The left side of the account is for increases and the right side is for decreases.

            Example. The following changes in Cash are recorded in the T-account shown below:

a.      The entity received $300 cash from a customer.

b.      The entity borrowed $5,000 from a bank.

c.      The entity paid $2,000 cash to a supplier.

d.      The entity sold merchandise for $800 cash.

This example only shows one of the two entries for each of these transactions. We will see the others later.

 

DEBIT AND CREDIT 

In the language of accounting, the left side of an account is called the debit side, and the right side is called the credit side. Thus, instead of saying that increases in cash are recorded on the left side, accountants say that increases in cash or any asset are recorded on the debit side and decreases in cash (or any asset) are recorded on the credit side.

            Debit and credit are also verbs. To record an increase in cash, you debit the Cash account. To record a decrease in cash, you credit the Cash account. Instead of saying, “ Record an amount on the left side of the Cash account.” The accountant simply says, “Debit Cash”.

            The rules we just developed in terms of “left side” and “right side” can now be stated in terms of debit and credits.

                         Increases in assets are ……………debits

                        Decreases in assets are……………credits

                        Increases in liabilities are…………credits

                        Decreases in liabilities are…………debits

                        Increases in equity are.…………….credits

                        Decreases in equity………………...debits

In everyday language the word credit sometimes means  GOOD and debit sometimes means “bad”. In the language of accounting, debit only means left, and credit only means right. There is no consistent “good” or “bad” or “increase” or “decrease”- it depends on what type account is being used.

The word debit is abbreviated as “Dr.” and the word credit is abbreviated as “Cr.”.

Because the total of debit entries for any transaction should always equal the total of the credit entries, it is easy to check the accuracy with which bookkeeping is done.

 

Reminder:

The fundamental Accounting Equation is Assets = Liabilities + Owners' Equity

Assets: Any increase on the assets is recorded in the column on the left-that is called the Debit Side.

Liabilities and Owners' Equity: Any increase in the liabilities and owners' equity is recorded on the right, that is called the Credit Side.



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Journals and Registers

 

A group of accounts is called a ledger. There is no standard form, so long as there is space to record the debits and credits to each account. Exhibit. 1 is the ledger of Glendale Market.

Glendale Market Ledger

 In practice, transactions are not recorded directly in the ledger. First, they are written in a record such as Exhibit 1.1, called a Journal. The record made for each transaction is called a journal entry.

As Exhibit 1.1 shows, for each journal entry, the amount to be debited is listed first, and the Dr. amount is entered in the first of the two money columns. The amount to be credited is listed below, and is indented. The Cr. amount is entered in the second money column.

Journal entries are transferred to the ledger by the process called posting. The entries through January 8 have already been posted, as indicated by check mark opposite each.

To summarize any transaction requires at least two changes in the accounts. These changes are recorded first in the journal. They are then posted to the ledger.

Exhibit 1.1

Journal

Listed below are the January transactions for Big Ben Clock Repair Store, owned by David McDonald. Record them in general Journal form.

January1               Invested $7,000 cash and equipment with a book value of $ 2,8000
           
3               Paid first month’s rent, $700
            5               Cash repairs, $1,400
           
7               Purchased supplies on account, $325
            8               Repaired a grandfather clock on account, $900
           
8               Paid wages, $275
            11             Purchased equipment, $550 cash
           
12             Cash repairs, $2,700
           
15             Purchased equipment on account, $400
           
17             Paid for advertising, $325
           
19             Withdrew $500 for personal expenses
           
21             Received $500 on account from Jan. 8 transaction
           
22             Paid wages, $325
           
25             Cash repairs, $3,400
           
26             Paid $400 on account from Jan. 15 transaction
           
29             Repaired a clock on account, $345 

 

Date

 

Debit

Credit

Jan.     1

Cash

7,000

 

 

Equipment

2,800

 

 

          David McDonald, Capital

 

9,800

         

 

 

 

          3

Rent Expense

700

 

 

          Cash

 

700

 

 

 

 

          5

Cash

1,400

 

 

 

 

1,400

 

 

 

 

          7

Supplies

325

 

 

          Account Payable

 

325

 

 

 

 

          8

Accounts Receivable

900

 

 

          Repair Income

 

900

 

 

 

 

          8

Wage Expense

275

 

 

          Cash

 

275

 

 

 

 

          11

Equipment

550

 

 

          Cash

 

550

 

 

 

 

          12

Cash

2,700

 

 

          Repair Income

 

2,700

 

 

 

 

          15

Equipment

400

 

 

          Accounts Payable

 

400

 

 

 

 

          17

Advertising Expense

325

 

 

          Cash

 

325

 

 

 

 

          19

David McDonald, Drawing

500

 

 

          Cash

 

500

 

 

 

 

          21

Cash

500

 

 

          Accounts Receivable

 

500

 

 

 

 

          22

Wage Expense

325

 

 

          Cash

 

325

 

 

 

 

          25

Cash

3,400

 

 

          Repair Income

 

3,400

          26

Accounts Payable

400

 

 

          Cash

 

400

 

 

 

 

          29

Accounts Receivable

345

 

 

          Repair Income

 

345

 

 

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TRIAL BALANCE
 

A trial balance is a list that shows all of the accounts with each balance.  The order of the list is a follows:  assets, liabilities and then the owner’s equity.
The balance has three columns, one with the name of the accounts, and the other two have the credit and the debit accounts.  The total of the amounts in the debits column must be equal to the total of the amounts in the credit column.
            Commonly the Trial Balance is done at the end of a period.  This list is prepared to check the account’s balances and see if the total of credits and debits is equal.  When the trial balance is done, then the company can proceed to do the financial statements.  The financial statements are prepared from the adjusted trial balance.

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REVIEW QUESTIONS

 
Part I  :   Questions 1- 20
Part II :    Questions 1-20
Part III:    Questions 1-10  
Part IV:    Questions 1-20

QUESTIONS PART I 

FILL IN THE BLANK

  1. The are the fundamental descriptors of the financial state and performance of an entity (e.g., company, partnership, etc.).

  2. Assets, liabilities and owners’ equity describe the financial state of an entity at a in time.

  3. Assets are the value of things owned by the entity, both .

  4. are the amounts of money owed by the entity to outside individuals or companies.

  5. After all liabilities are paid off from the assets, what is left over is the .

  6. Finish the following equation. ASSETS - =OWNERS' EQUITY.

  7. is also referred to as "book value".

  8. Rent, salaries, electricity and gas are examples of business .

  9. The economic obligations (debts) of a company to outsiders are called .

  10. The following equation is referred as the .

                             Assets = liabilities + owners' expense

  11. When revenues decrease the decreases.

  12. Money a company earns by delivering goods or services to a market (customer) is called .

  13. The account that shows the amount of money and any other face value that a bank accepts, such as paper currency, checks, .

  14. The account that reflects the quantity of merchandise that a company has ready for sale and is recorded as an asset when the merchandise is purchased or when it is manufactured is the account.

  15. When expenses decrease the decreases.

  16. A location for collecting information about one specific asset, liability or item of equity is known as an .

  17. is known as the characteristic of the design of an accounting system in which each transaction has an effect in at least TWO accounts.

  18. Debits are the entry on the left side of an account. Debits INCREASE asset accounts, and liability and equity accounts.

  19. The method for keeping track of business transactions is the system.

  20. The reports the total value of assets, liabilities, and owners' equity for the company at the end of a fiscal period.   

QUESTIONS PART II 

TRUE AND FALSE QUESTIONS

  1. In order for a building to be an asset, it has to be owned.   
    True
    False

  2. The employees working at Stevens are considered an asset of the Institution.  
    True
    False

  3. A brand name such as FORD, SONY, etc, is not considered an asset. 
    True
    False

  4. REVENUE - EXPENSES = PROFIT . This equation belongs to the Income Statement.  
    True
    False

  5. Assets, Liabilities and Owner’s Equity form part of the Balance Sheet.
    True
    False

  6. Rent, electricity, salaries are found in the Income Statement.
    True
    False

  7. Owner’s Equity is also referred to as “book value”.
    True
    False

  8. A building, a computer, and a car are some examples of liabilities of a company.
    True
    False

  9. The inventory account reflects the quantity of merchandise that a company has ready for sale.  This merchandise is recorded as an asset when is purchased or when it is manufactured.  When inventory merchandise is sold, this account balance decreases. 
    True
    False

  10.  The balance sheet is sometimes called the Statement of Financial Position.
    True
    False

  11. A transaction is an event that affects the financial position of a business/organization. Not all transactions are required to be recorded.
    True
    False

  12. An event that affects the financial position of a business/organization should always be recorded.
    True
    False

  13. Accounting records reflect original cost as long as organization holds assets.
    True
    False

  14. The account is a basic unit to record data in accounting.
    True
    False

  15. The Double Entry System is an aspect of the design of an accounting system in which each transaction has an effect on one account.  
    True
    False

  16. LEDGERS are groups of accounts.  Ledgers help the business keep track of transactions such as sales to significant customers and purchases from significant suppliers.
    True
    False

  17. All transactions affect only one account. 
    True
    False

  18. The difference between the revenue and the expenses over the accounting period is the net income (net profit) for that period.
    True
    False

  19. The balance sheet is developed from the revenue and expense account balances in the Adjusted Trial Balance. 
    True
    False

  20. Equipment and buildings are considered Assets Accounts. 
    True
    False
     

QUESTIONS PART III 

 

MULTIPLE CHOICE QUESTIONS

  1. Which of the following examples are considered assets of a company.
    A rented building
    A debt to the providers
    An employee’s car
    Computers bought last year

     

  2. Which of the following are audiences for Accounting Information?
    Management, Employees, Customers
    Investors, Labor Unions, General Public
    Creditors, Tax Collector
    All of the above.  

  3. A building is considered a
    Fixed asset
    Non fixed asset
    A liability
    None of the above
  4. The principal financial statements listed below are prepared directly from the Adjusted Trial Balance.
    Income Statement, Statement of Owners' Equity, Balance Sheet
    Income Statement
    Balance sheet and T accounts
    Ledger accounts

  5. Each financial statement contains the following information
    Name of the firm and title of the statement
    Name of the firm (entity), Title of the Statement, Date of statement or period covered by the statement, Body of the statement
    Title of the Statement and date of the statement
    None of the above

  6. If a company buys a computer for $2,000 what transaction do you have to make?
    Charge 2,000 on the debit side of the Fixed Assets Account and 2,000 on the credit side of the Cash Account
    Charge 2,000 on the credit side of the Assets Account and 2,000 on the debit side of the Cash Account
    Charge only 2000 on the Fixed Assets Account
    Charge only 2000 on the Cash Account

  7. The balance sheet reports:
    Assets, liabilities, and owner’s equity at a specific date
    Assets and liabilities.
    Assets and owner’s equity
    Liabilities and owner’s equity 

     

  8. In the Income Statement, revenues are listed first followed by
    Expenses
    Cash
    Accounts Receivable
    Equipment

  9. Transactions should be recorded in at least how many accounts?
    3 or more
    At least 2 accounts
    1 account
    At least one account

  10. The current assets and current liabilities are ________ assets and liabilities.
    short-term
    long term
    Short and long term
    None of the above.

     

 

QUESTIONS PART IV 

Show the account entries for the following questions.

  1. A company bought a piece of land where they are going to build their offices.   The amount of money paid for the land was 70,000 dollars.  Register the transaction

    Cash

     

    Land

                          

  2.  Little Mary’s school bought office supplies.  The total amount for the supplies was $500.  Register the transaction

    Cash

     

    Office Expenses

                                                       

  3. The STARTUP COMPANY has the following transactions during the month of May.   
    Show the account entries:

    A. Initial investment in STARTUP COMPANY $100,000
    B. Bought inventory with cash for $55,000
    C. Bought inventory on credit for $25,000

    CASH

     

    INVENTORY B

     

    INVENTORY C

     

    ACCOUNTS PAYABLE

     

    PAID IN CAPITAL

     

  4. STARTUP COMPANY bought a company car for one of their employees for $18,000.  Show the account entries:

    CASH

     

    CAR

     

  5. The owner of STARTUP COMPANY withdraws $1,400 in cash from the business for his personal use.

    CASH

     

    PARTNERS’ CAPITAL

     

  6. NEW COMPANY bought offices supplies to last for 10 months.  The office supply company agreed to make the sale on credit. The total amount was $1,500

    ACCOUNTS PAYABLE

     

    OFFICE SUPPLIES

     

  7. NEW CORPORATION receives $3,000 cash from customers for consulting services it has provided.

    CASH

     

    REVENUE

     

  8. NEW CORPORATION provides consulting services of $10,000 for customers XYZ.  Customers XYZ pay $4,500 in cash, and the balance of $5,500 is billed to the customers on account.

    CASH

     

    ACCOUNTS RECEIVABLE

     

    REVENUE

     

  9. NEW CORPORATION received payment of $5,500 that Customers XYZ owed.

    CASH

     

    ACCOUNTS RECEIVABLE

     

  10. NEW CORPORATION placed an ad in a magazine.  The price of the ad was $1,250. The payment was done in cash.

    CASH

     

    ADVERTISING EXPENSE

     

  11. COMPANY UNKNOWN borrowed $500 cash from a bank on a short-term note.

    CASH

     

    NOTES PAYABLE

     

  12. COMPANY UNKNOWN paid $900 for June rent on office 

    CASH

     

    RENT EXPENSE

     

  13. COMPANY UNKNOWN paid monthly expenses: utilities, $450; salaries, $700; Telephone, $150.

    CASH

     

    TELEPHONE EXPENSE

     

    UTILITIES EXPENSE

     

    SALARIES EXPENSE

     

    For questions 14 to 20, Use the following information.

    Ana opened a beauty salon on July 1.  On July 31, the balance sheet showed Cash $10,000, Accounts Receivable $1,500, Supplies $700, Office Equipment $4,000, Accounts Payable $5,500, and Ana’s Capital, $10,700.

  14. Paid 1,500 cash on accounts payable.

    CASH

     

    ACCOUNTS PAYABLE

     

  15. Collected $500 on accounts receivable.

    CASH

     

    ACCOUNTS RECEIVABLE

     

  16. Purchased additional office equipment for $1,000, paying $500 in cash and the balance on account.

    CASH

     

    ACCOUNTS PAYABLE

     

    OFFICE EQUIPMENT

     

  17. Withdrew $400 in cash for personal use

    CASH

     

    OWNERS' EQUITY

     

  18. Bought $1000 worth of office supplies for the month of August. It was paid in cash

    CASH

     

    OFFICE SUPPLIES

     

  19. Borrowed money from the bank on a note payable, for $3,000.

    CASH

     

    NOTES PAYABLE

  20. Incurred utility expenses for the month on account, $200

    ACCOUNTS PAYABLE

     

        UTILITIES EXPENSES