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How to Solve Accounting Problems

(Taken from College AccountingWorking Papers and Study Guide, Houghton Mifflin Company

Solving means to fin! or provi!e a satisfactory answer or e"planation for a problem# A solution to aproblem, whether in accounting or in any other !iscipline, involves more than $ust %getting the answer#%This is what most of us search for, but other preliminary steps lea! to the final solution#

&efore you can solve any problem, you nee! to un!erstan! accounting fun!amentals an! strategies forsolving problems# 'irst, we will look at these fun!amentals, an! then we will review problemsolvingstrategies#

The fundamental accounting equation (Assets ) *iabilities + wner-s ./uity is the basis for double-entry accounting. Assets are things owne!# Liabilities are amounts owe! to cre!itors# Owner's equityis the financial interest of the owner in the company#

0e can think of owner-s e/uity as an umbrella that covers the Capital account. The Capital accountincreases with investments an! revenues, an! !ecreases with with!rawals by the owner an! e"pensesincurre!#

Revenues e!penses an! the "rawing account are consi!ere! temporary owner-s e/uity accounts, ornominal accounts# They are open for the accounting perio! to keep track of changes to owner-s e/uity!ue to revenue earne! an! e"penses incurre!# At the en! of the accounting perio!, they are close! outan! the !ifference between the revenue an! e"penses is transferre! to the Capital account# A net profitincreases Capital, an! a net loss !ecreases it#

ur e"pan!e! fun!amental accounting e/uation now rea!s1

Assets ) *iabilities + wner-s ./uity + 2evenue ."penses

&oth si!es of any e/uation must balance#

The e/uation elements or classifications are broken !own into sub!ivisions calle! accounts. .achaccount can be represente! by a # account3avisuali4ation of the information presente! in a formalle!ger account# The T account provi!es a structure to !emonstrate the rules of debit an! credit. 5t hastwo si!es, a left si!e calle! the !ebit si!e an! a right si!e calle! the cre!it si!e# 6ou must clear# 6ourmin! of your emotional attachment to the term cre!it# A cre!it is neither goo! nor ba!, plus nor minus#5ncreases can be shown by !ebits or cre!its, !epen!ing on which account is involve!#

The first accounting rule is that debits must equal credits in any entry# Another rule is that the normalbalance of an account is the plus si!e, which can be either the !ebit or cre!it si!e#

The problems at the en! of the chapter provi!e the opportunity to apply the fun!amentals that you havelearne!# 7ow let-s look at some basic problemsolving techni/ues#

Scan the entire problem to get an overview of what is involve! an! what is e"pecte!# Most of theproblem sets in your te"tbook have three sections that you must rea! carefully#The first section inclu!es a list of learning ob$ectives, a problem number, an! information about theproblem an! the business#

There is a list of transactions or other information provi!ing the basis for solving the problem#

There are stepbystep instructions to gui!e you through the problem#

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2ea! an! follow each instruction carefully# 8o them in or!er an! !o not skip any# 0rite !own any/uestions you have, an! remember to ask them#

Most of the problems in your book inclu!e narrative transactions sentences!escribing the transaction#

The secret for solving this kin! of problem is fin!ing an! un!erstan!ing $ey words. Here are some

translations of some of the more common wor!s you will encounter in the problems1

Paid means cash going out, cash!ecrease!#Invested may mean cash was investe! by the owner, but an investment can also mean another asset

besi!es cash, such as personal e/uipment, one-s law library, or other assets which are then givena fair market value#

Received cash means cash coming in, cash increase!#Bought means purchase! something with cash or maybe on account or with a promissory note# 5n either

of the latter two cases a promise has been ma!e to pay cash at a later !ate agree! upon by bothparties#

Receivedand paid a bill is the same as pai!9 Cash went out, cash !ecrease!# Received a bill, withoutany reference to paying means cash is not pai! out at this time# The bill has been put away forpayment at a later !ate#

Billed customers or services means no cash was receive!, but customers have promise! to pay us afterthey receive the bill# (The accrual basis of accounting allows us to book revenue when earne!an! e"penses when incurre!, the opposite of the cash basis most people use for their personalaccounting#

Another way of looking at key wor!s in transactions is to group phrases which you can e"pect to seetogether in certain types of transactions# Here are some wor!s an! phrases that you might encounter in aproblem involving a customer1Issued a credit memo Sales Returns and Allo!ancesSales Accounts ReceivableSold Accounts Receivable "edger Sales #iscount

6ou will not see these customerrelate! key phrases mi"e! with phrases involving ven!ors an!suppliers#

Here are some wor!s an! phrases associate! with ven!ors an! suppliers1

Received a credit memo Purchases Returns and Allo!ances

Purchases Accounts Payable

Purchases #iscount Accounts Payable "edger

Bought

0e have $ust looke! at key wor!s in transactions !escribe! in sentences, but in realworl! situations,

transactions are primarily generate! by source documents. A source !ocument is a piece of paper thatevi!ences a transactionsome change in the financial con!ition of the businessfor e"ample an invoice ora check# However, most of the problems in your book are base! on sentences !escribing transactions#0hether the transaction is generate! by a sentence or a !ocument, analy4e the transaction to !eci!e whataccounts are !ebite! an! cre!ite!# The steps taken to analy4e a transaction are1

1. 0hich accounts are involve!92. 0here !o the accounts fall in the fun!amental accounting e/uation1 Assets, *iabilities, wner-s

./uity, 2evenues, or ."penses93. Are the accounts increase! or !ecrease!9

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4. 0hich accounts are !ebite! an! which accounts are cre!ite!95. 8o total !ebits e/ual total cre!its9

These steps work for every transaction, no matter how comple"# Analy4ing each transaction using thesesteps is critical to your success in accounting#

5n summary, you nee! a firm base in accounting fun!amentals before you begin to $ournali4etransactions# 6ou nee! to un!erstan! the fun!amental ac counting e/uation, the rules of !ebiting an!

cre!iting, an! how to analy4e each transaction base! on these rules# 7e"t you must un!erstan! the

problem pose!# Scan the problem, an! then rea! it carefully# 'ollow, in or!er, the specific instructions

liste! at the en! of each problem#

5f you follow these rules an! steps, your accounting e"perience will be more successful an! satisfying#

Try them, they work#