you’re confused about this cost-of-goods-sold transaction — it represents the first transaction that doesn’t use cash — read Book 1, Chapter 1, where I describe the two accounting principles. In short, these two principles go like this:
Expense principle: This principle says that an expense gets counted when the item gets sold. This means that the inventory isn’t counted as cost of goods sold or as an expense when it’s purchased. Rather, the expense of each hot dog and bun you sell gets counted when the item is actually sold to somebody.
Matching principle: This principle says that expenses or cost of a sale get matched with the revenue of the sale. This means that you recognize the cost of goods sold at the same time that you recognize the sale. Typically, in fact, you can combine journal entries 7 and 8.
Recording the payoff of accounts payable
Suppose that one thing you do at the end of the day is write a check to pay off the accounts payable. The accounts payable are the amounts that you owe vendors — probably the suppliers from which you purchased the hot dogs and buns. To record the payoff of accounts payable, you debit accounts payable for $2,000 and credit cash for $2,000, as shown in Table 2-13.
TABLE 2-13 Journal Entry 9: Recording the Payoff of Accounts Payable
| Account | Debit | Credit |
|---|---|---|
| Accounts payable | $2,000 | |
| Cash | $2,000 |
Recording the payoff of a loan
Suppose also that you use cash profits from the day to pay off the $1,000 loan that the balance sheet shows (refer to Table 2-2 earlier in this chapter). To record this transaction, you debit loan payable for $1,000 and credit cash for $1,000, as shown in Table 2-14.
TABLE 2-14 Journal Entry 10: Recording the Payoff of the Loan
| Account | Debit | Credit |
|---|---|---|
| Loan payable | $1,000 | |
| Cash | $1,000 |
Calculating account balance
You may already be able to guess that if you know an account’s starting balance and have a way to add up the debits and the credits to the account, you can easily calculate the ending account balance.
Take the case of the cash account balance of the hot dog stand. If you look at the balance sheet shown in Table 2-2, you see that the beginning balance for cash is $1,000. You can easily construct a little schedule of how the account balance changes — this schedule is called a T-account — that calculates the ending balance. (In case you’re wondering, a T-account is a visual aid to help in accounting. You start by drawing a big capital T, with debits on the left side and credits on the right side.) In fact, Table 2-15 does just this. If you look closely at Table 2-15, you see that the cash beginning balance is $1,000. Then, on the following lines of the T-account, you see the effects of journal entries 4, 5, 6, 7, 9, and 10. Some of these journal entries credit cash. Some of them debit cash. You can calculate the ending cash balance by combining the debit and credit amounts.
TABLE 2-15 A T-Account of the Cash Account
| Debit | Credit | |
|---|---|---|
| Beginning balance | $1,000 | |
| Journal Entry 4 | $1,000 | |
| Journal Entry 5 | 4,000 | |
| Journal Entry 6 | 1,000 | |
| Journal Entry 7 | 13,000 | |
| Journal Entry 9 | 2,000 | |
| Journal Entry 10 | _____ | $1,000 |
| Ending balance | $5,000 |
The information shown in Table 2-15 should make sense to you. But in case you’re still trying to memorize what debits and credits mean, I’m going to give you a bit more detail. To calculate the ending balance shown in Table 2-15, you add up the debits, add up the credits, and combine the two sums. The net amount in the cash account equals the $5,000 debit. If you recall from the preceding paragraphs, a debit balance in an asset account, such as cash, represents a positive amount. A $5,000 debit balance in the cash account, therefore, indicates that you have $5,000 of cash in the account.
Cash is usually the trickiest account to analyze with a T-account because so many journal entries affect cash. In many cases, however, a T-account analysis of an account balance is much more straightforward. If you look at Table 2-16, you see a T-account analysis of the inventory account. This T-account analysis shows that the beginning inventory account balance equals $3,000. But when Journal Entry 8 credits inventory for $3,000 — this is the journal entry that records the cost of goods sold — the inventory balance is wiped out.
