Accounting Basics
The fundamental accounting equation is: Assets = Liabilities + ____________.
What is Equity?
Explanation: The accounting equation is Assets = Liabilities + Equity. Assets are what the business owns, liabilities are what the business owes, and equity represents the owner's interest in the business.
Exam Tip: Remember: A = L + E
Of the following accounts—Cash, Revenue, and Accounts Payable—the account that normally carries a debit balance is ________.
What is Cash?
Explanation: Cash is an asset, and asset accounts normally have debit balances. Revenue and liability accounts, such as Accounts Payable, normally have credit balances.
Exam Tip: Remember: Assets increase with debits.
Money owed to a business by its customers is recorded in ________.
What is Accounts Receivable?
Explanation: Accounts Receivable is an asset representing money customers owe the business for goods or services already provided on credit.
Exam Tip: A/R = Customers owe us.
Money a business owes to its vendors or suppliers is recorded in ________.
What is Accounts Payable?
Explanation: Accounts Payable is a liability representing amounts the business owes vendors for goods or services purchased on credit.
Exam Tip: A/P = We owe vendors.
A/R = Customers owe us.
The financial statement that reports revenues and expenses and determines whether a business earned a profit or experienced a loss is the ________.
What is the Income Statement?
Explanation: The Income Statement aka (Profit and Loss or P/L reports revenues and expenses for a specific period and determines Net Income or Net Loss.
Exam Tip: Revenue − Expenses = Net Income or Net Loss.
An owner's $10,000 cash investment increases Asset and ________.
What is Equity?
Explanation: An owner's investment is not revenue or a loan. Cash increases assets, while the owner's investment increases equity by the same amount.
Exam Tip: Owner contributions increase equity.
When a business pays the current month's rent, the account that is debited is ________.
What is Rent Expense?
Explanation: Rent used during the current accounting period is an expense. Expenses increase with a debit, while Cash decreases with a credit.
Journal Entry:
Debit Rent Expense
Credit Cash
Exam Tip: Expenses normally increase with debits.
A customer pays $2,400 that was previously recorded as Accounts Receivable. Cash is debited, and ________ is credited.
What is Accounts Receivable?
Explanation: When the customer pays, Cash increases and the amount the customer owes decreases. Revenue is not recorded again because it was recognized when the original sale or service occurred.
Journal Entry:
Debit Cash $2,400
Credit Accounts Receivable $2,400
Exam Tip: Collecting an existing receivable does not create new revenue.
A business purchases $900 of supplies on account. The account that is credited is ________.
What is Accounts Payable?
Explanation: Supplies increase because the business received an asset. Since the business has not paid the vendor yet, it also creates a liability.
Journal Entry:
Debit Supplies $900
Credit Accounts Payable $900
Exam Tip: When you see “purchased on account,” think Accounts Payable.
The financial statement that reports Assets, Liabilities, and Equity at a specific date is the ________.
What is the Balance Sheet?
Explanation: The Balance Sheet shows the company's financial position and is based on:
Assets = Liabilities + Equity
Exam Tip: The Balance Sheet must balance.
A trial balance with equal debit and credit totals proves ________, but does not prove every transaction is correct.
What is mathematical balance?
Explanation: Equal debit and credit totals show that the ledger is mathematically balanced. However, transactions can still be recorded in the wrong accounts or omitted entirely.
Exam Tip: A balanced trial balance does not guarantee error-free records.
A business provides $5,000 of services to a customer on account. The account that is debited is ________.
What is Accounts Receivable?
Explanation: “On account” means the customer has received the service but will pay later. The amount owed by the customer becomes Accounts Receivable, which is an asset and increases with a debit.
Journal Entry:
Debit Accounts Receivable $5,000
Credit Service Revenue $5,000
Exam Tip: When a customer owes the business money, think Accounts Receivable.
A business performs $3,000 of services for a customer on account. The account that is credited is ________.
What is Service Revenue?
Explanation: Under accrual accounting, revenue is recognized when it is earned, even if the customer has not paid yet. Accounts Receivable increases with a debit, and Service Revenue increases with a credit.
Journal Entry:
Debit Accounts Receivable $3,000
Credit Service Revenue $3,000
Exam Tip: Earned revenue increases with a credit.
A business pays a $3,500 vendor balance that was previously recorded in Accounts Payable. The account that is debited is ________.
What is Accounts Payable?
Explanation: The company is paying an existing liability. Accounts Payable decreases with a debit, while Cash decreases with a credit.
Journal Entry:
Debit Accounts Payable $3,500
Credit Cash $3,500
Exam Tip: Don't record the purchase or expense again when paying an existing bill. The transaction was already recorded when the payable was created.
A company's Income Statement shows Revenue of $125,000 and Expenses of $92,000. The company's Net Income is ________.
What is $33,000?
Explanation:
Revenue − Expenses = Net Income
$125,000 − $92,000 = $33,000
Because revenue is greater than expenses, the company earned Net Income.
Exam Tip: If expenses exceed revenue, the result is a Net Loss.
Total assets are $150,000 and total liabilities are $65,000. Total equity is ________.
What is $85,000?
Explanation:
Equity = Assets − Liabilities
$150,000 − $65,000 = $85,000
Exam Tip: Rearrange A = L + E to E = A − L.
Under a perpetual inventory system, a $4,000 purchase of merchandise on account is recorded with a debit to ________.
What is Inventory?
Explanation: Under a perpetual inventory system, merchandise purchased for resale is recorded directly in the Inventory account. Because the merchandise was purchased on account, Accounts Payable increases.
Journal Entry:
Debit Inventory $4,000
Credit Accounts Payable $4,000
Exam Tip: With a perpetual system, merchandise purchases are recorded directly in Inventory.
A business receives $12,000 from a customer before providing the agreed-upon services. The account credited when the cash is initially received is ________.
What is Unearned Revenue?
Explanation: The business has received the cash but has not earned the revenue yet. Because the business still owes the customer services, the amount represents a liability.
Journal Entry when cash is received:
Debit Cash $12,000
Credit Unearned Revenue $12,000
Once the services are performed, the appropriate amount is transferred from Unearned Revenue to Revenue.
Exam Tip: Cash received does not always mean revenue has been earned. (Unearned Revenue is a Liability account).
A company borrows $25,000 from a bank. Cash is debited, and ________ is credited.
What is Notes Payable?
Explanation: Borrowing money increases Cash, but the money must be repaid. Therefore, the company records a liability rather than revenue.
Journal Entry:
Debit Cash $25,000
Credit Notes Payable $25,000
Exam Tip: Loan proceeds are not revenue. Borrowing money creates a liability.
A company's Balance Sheet shows Total Assets of $150,000 and Total Liabilities of $65,000. Total Equity is ________.
What is $85,000?
Explanation: Start with:
Assets = Liabilities + Equity
Rearrange it:
Equity = Assets − Liabilities
$150,000 − $65,000 = $85,000
Therefore:
$150,000 = $65,000 + $85,000
Exam Tip: Use the accounting equation to find a missing Balance Sheet amount.
Equipment is purchased for $18,000 using $6,000 cash and a note for the remainder. The amount credited to Notes Payable is ________.
What is $12,000?
Explanation:
$18,000 − $6,000 = $12,000 financed
The journal entry is:
Debit Equipment $18,000
Credit Cash $6,000
Credit Notes Payable $12,000
Exam Tip: Record the asset at its total cost, then separate the cash paid from the amount financed.
At year-end, employees have earned $4,800 in wages that have not yet been paid. The expense account that must be debited is ________.
What is Wages Expense?
Explanation: Under accrual accounting, expenses are recognized when they are incurred, even when payment will occur later. The business records Wages Expense and creates a liability called Wages Payable.
Adjusting Entry:
Debit Wages Expense $4,800
Credit Wages Payable $4,800
Exam Tip: Earned by employees but not yet paid = accrued wages.
Under the allowance method, a company estimates that $2,500 of its Accounts Receivable will be uncollectible. The contra-asset account that is credited is ________.
What is Allowance for Doubtful Accounts?
Explanation: Businesses using the allowance method estimate how much of their Accounts Receivable may not be collected. The estimate creates Bad Debt Expense and increases the Allowance for Doubtful Accounts, a contra-asset account.
Adjusting Entry:
Debit Bad Debt Expense $2,500
Credit Allowance for Doubtful Accounts $2,500
The allowance reduces Accounts Receivable to its estimated net realizable value—the amount the business expects to collect.
Exam Tip: Don't confuse the estimate with the later write-off.
Estimate → Bad Debt Expense + Allowance
Write-off → Allowance + Accounts Receivable
A company purchases $18,000 of equipment by paying $6,000 cash and financing the remaining balance. The amount recorded as Notes Payable is ________.
What is $12,000?
Explanation: The equipment is recorded at its full cost of $18,000. The company pays $6,000 immediately, so the remaining amount owed is:
$18,000 − $6,000 = $12,000
Journal Entry:
Debit Equipment $18,000
Credit Cash $6,000
Credit Notes Payable $12,000
Exam Tip: A purchase can involve more than one form of payment. Record the asset at its total cost and identify how much was paid now versus how much is owed.
An Income Statement prepared in Excel shows Sales Revenue of $95,000, Cost of Goods Sold of $52,000, and Operating Expenses of $31,000. The company's Net Income is ________.
What is $12,000?
Explanation: First calculate Gross Profit:
Sales Revenue − Cost of Goods Sold = Gross Profit
$95,000 − $52,000 = $43,000
Then calculate Net Income:
Gross Profit − Operating Expenses = Net Income
$43,000 − $31,000 = $12,000
Exam Tip: Follow the Income Statement in order:
Sales → COGS → Gross Profit → Operating Expenses → Net Income
In Excel, this same logic can be built using formulas so the financial statement automatically recalculates when amounts change.