Chapter 2: The Accounting Process

Report
2-1
CHAPTER 2
Recording Business
Transactions
2-2
The Body of
Accounting Knowledge
Chapter 1
2-3
Tools of The Recording Process

Debits and Credits

Journal Entries

Ledger Accounts
2-4
First, however, let’s look at...
The
Accounting
Cycle
2-5
Steps in The Accounting Cycle
Analyze
source
documents.
Journalize
transactions
in the general
journal.
Post entries to
the accounts
in the general
ledger.
Prepare a trial
balance.
Prepare financial
statements.
Let’s start with
The General Ledger Account
A ledger account is a tool used for
classifying and summarizing
information about increases,
decreases, and balances of
financial statements items.

Think of it as a storage
container like a bucket.

Dollars, which are used to measure
economic transactions, are “poured”
into and out of the container.
2-6
2-7
General Ledger
Was not a Civil War Hero
2-8
Two General Ledger Account
Formats
Three-Amount Column Format
(Debit, Credit, Balance)

Used in general ledgers in the business
world
T-Account Format

Used primarily for teaching and analysis
of complex transactions
2-9
General Ledger Account
Three-Amount Column Format
ACCOUNT NAME:
Date
Description
ACCOUNT No.
1
2
3
PR
Debit
Credit
Balance
2-10
General Ledger Account
T-Account Format
For the sake of
simplicity, we
often use this
format in teaching
accounting even
though it is no
longer used in
practice.
Account Name
Debit
Credit
2-11
The T-Account
Increases to the
T-account are
recorded on
one side of the
T-account, and
decreases are
recorded on the
other side.
Account Name
Debit
Credit
2-12
The T-Account
The side which
increases and
the side which
decreases is
determined by
the type of
account.
Account Name
Debit
Credit
2-13
What Are Debits and Credits?

Tools used for recording transactions
Debit (DR)
 Credit (CR)

Debit refers to the LEFT and Credit to
the RIGHT side of the T-Account.
 Debit and Credit are neutral terms and
do not connote value judgments.
Neither is “good” or “bad”!

2-14
[Baltimore Sun,
September 23, 1998]
2-15
What Are Debits and Credits?

Tools used for recording transactions
Debit (DR)
 Credit (CR)


Debit refers to the LEFT and Credit to
the RIGHT side of the T-Account
Account Name
LEFT
RIGHT
2-16
What Are Debits and Credits?

Tools used for recording transactions
Debit (DR)
 Credit (CR)


Debit refers to the LEFT and Credit to
the RIGHT side of the T-Account
Account Name
LEFT
Used as
Adjectives:
DEBIT
SIDE
RIGHT
CREDIT
SIDE
2-17
What Are Debits and Credits?

Tools used for recording transactions
Debit (DR)
 Credit (CR)


Debit refers to the LEFT and Credit to
the RIGHT side of the T-Account
Account Name
LEFT
Used as
Verbs:
DEBIT
RIGHT
CREDIT
Synonym
for Debit?
2-18
Common Business Terminology
2-19
Names of Ledger Accounts

There are no “magic” names for many
accounts


e.g., either “Heat, Light & Power” or
“Utilities Expense” could be used for an
account name.
Other accounts have names which must
be used

e.g., “Cash”, “Accounts Receivable” and
“Accounts Payable”.
2-20
Types of Ledger Accounts
Let’s see how
debits and
credits affect
the different
types of
accounts.
Account Name
Debit
Credit
2-21
Types of Ledger Accounts
Assets
Liabilities
Stockholders’ Equity
Revenues
Expenses
2-22
Using Debits and Credits

Again, debits and credits are used to
increase or decrease account balances.

Determining whether to use a debit or
credit to record an increase or decrease
depends on the type of account in
question.

The Balance Sheet equation is the basis
for the determination.
2-23
Balance Sheet Model
(Revisited)
A = L + SE
2-24
Balance Sheet Model
(Revisited)
Assign a T-Account to each element of the
Balance Sheet Model
A = L + SE
Account Name
Account Name
Account Name
Debit
Debit
Debit
Credit
Credit
Credit
2-25
Balance Sheet Model
(Revisited)
Debits and credits affect the Balance Sheet
Model as follows:
A = L + SE
Account Name
Account Name
Account Name
Debit
Debit
Debit
Credit
Credit
Credit
2-26
Balance Sheet Model
(Revisited)
Debits and credits affect the Balance Sheet
Model as follows:
A = L + SE
ASSETS
Debit
Credit
for
for
Increase Decrease
Account Name
Account Name
Debit
Debit
Credit
Credit
2-27
Balance Sheet Model
(Revisited)
Debits and credits affect the Balance Sheet
Model as follows:
A = L + SE
ASSETS
LIABILITIES
Debit
Credit
for
for
Increase Decrease
Debit
Credit
for
for
Decrease Increase
Account Name
Debit
Credit
2-28
Balance Sheet Model
(Revisited)
Debits and credits affect the Balance Sheet
Model as follows:
A = L + SE
ASSETS
LIABILITIES
EQUITIES
Debit
Credit
for
for
Increase Decrease
Debit
Credit
for
for
Decrease Increase
Debit
Credit
for
for
Decrease Increase
Stockholders’ Equity
2-29
A Closer Look
Recall that Stockholders’ Equity consists
of the following components:
Capital Stock + Retained Earnings
C/S + R/E
Stockholders’ Equity
A Closer Look
Therefore, the Capital Stock and Retained
Earnings accounts are affected in the
following manner by debits and credits
because they are part of Stockholders’
Equity:
CAPITAL STOCK
RET. EARNINGS
Debit
Credit
for
for
Decrease Increase
Debit
Credit
for
for
Decrease Increase
2-30
Stockholders’ Equity
A Closer Look
Also, because Revenue accounts increase
Stockholders’ Equity, they are affected by
debits and credits as follows:
REVENUES
Debit
Credit
for
for
Decrease Increase
2-31
Stockholders’ Equity
A Closer Look
And because Expense accounts decrease
Stockholders’ Equity, they are affected by
debits and credits as follows:
EXPENSES
Debit
Credit
for
for
Increase Decrease
2-32
2-33
Normal Balances
Each of the 5 account types also has a
normal balance side. It is always the
side which is used to record increases
in the account.
2-34
Normal Balances
The normal balances for each of the FIVE
types of accounts are as follows:
Account Name
Debit Balance
Assets
Expenses
Credit Balance
Liabilities
Stockholders’
Equity
Revenues
2-35
Three Alternative Approaches
For Learning Debits and Credits

Alternative #1


The textbook approach on p. 59
Alternative #2
Expanded Accounting Equation
 This is Rice’s preferred approach


Alternative #3

“A L O R E” acronym
2-36
Alternative Approach #1
Textbook Approach
59
Check it out at
top of page!
2-37
Alternative Approach #2
Expanded Accounting Equation
ASSETS + EXP. = LIAB. + S/H EQUITY + REV.
A + E = L + S/E + R
Bal.
Dr.
Cr.
Dr.
Cr.
+
-
-
+
Bal.
2-38
Alternative Approach #3
“A L O R E” Acronym
Debit Credit
A (ssets)
+
-
L (iabilities)
-
+
O (wners' equity) R (evenues)
-
+
E (xpenses)
-
+
+
2-39
Debits and Credits
Question 1
Which of the following accounts would
normally be expected to have a debit
(or left-side) balance?
a.
b.
c.
d.
Accounts Payable
Buildings
Interest Revenue
Capital Stock
2-40
Debits and Credits
Solution 1
Which of the following accounts would
normally be expected to have a debit
(or left-side) balance?
a.
b.
c.
d.
Accounts Payable
Buildings
Interest Revenue
Capital Stock
BUILDINGS is an asset
account and normally
has a DEBIT balance.
The other three
accounts normally
have CREDIT balances.
2-41
Debits and Credits
Question 2
Which of the following accounts would
normally be expected to have a credit
(or right-side) balance?
a.
b.
c.
d.
Accounts Receivable
Salary Expense
Salary Payable
Land
2-42
Debits and Credits
Solution 2
Which of the following accounts would
normally be expected to have a credit
(or right-side) balance?
a.
b.
c.
d.
Accounts Receivable
Salary Expense
Salary Payable
Land
2-43
Debits and Credits
Solution 2
Which of the following accounts would
normally be expected to have a credit
(or right-side) balance?
SALARY PAYABLE is a
liability account and
Accounts Receivable
normally has a CREDIT
Salary Expense balance.
a.
b.
c. Salary Payable
d. Land
The other three accounts
normally have DEBIT
balances.
2-44
Debits and Credits
Example
If the balance in Accounts Receivable
(an asset) is $750 (debit side balance),
Accounts Receivable
750
2-45
Debits and Credits
Example
If the balance in Accounts Receivable
(an asset) is $750 (debit side balance),
Accounts Receivable
750
What would we do to increase the account by
$200?
2-46
Debits and Credits
Example
If the balance in Accounts Receivable
(an asset) is $750 (debit side balance),
Accounts Receivable
750
200
What would we do to increase the account by
$200?
2-47
Debits and Credits
Example
If the balance in Accounts Receivable
(an asset) is $750 (debit side balance),
Accounts Receivable
750
200
What would we do to increase the account by
$200?
What would we do to decrease the account by
$350?
2-48
Debits and Credits
Example
If the balance in Accounts Receivable
(an asset) is $750 (debit side balance),
Accounts Receivable
750
200
350
What would we do to increase the account by
$200?
What would we do to decrease the account by
$350?
2-49
Debits and Credits
Example
Accounts Receivable
750
200
350
Note the lack of $. It is understood that
the yardstick is dollars.
It is not “money”!
2-50
Balancing The T-Account
To get the balance of the T-Account . . .
Accounts Receivable
750
200
350
. . . net the totals on the two sides
against each other. Place the residual
amount on the appropriate side.
2-51
Balancing The T-Account
To get the balance of the T-Account . . .
Accounts Receivable
750
200
350
600
. . . net the totals on the two sides
against each other. Place the residual
amount on the appropriate side.
2-52
Balancing The T-Account
To get the balance of the T-Account . . .
Accounts Receivable
750
200
350
600
(Can use the either the approach above
to show the balance, the text’s
approach or Rice’s approach)
2-53
Three Alternative Approaches to
Balancing The T-Account
Using the example at the bottom of p. 57
Approach on
Previous slide
Text Approach
Rice’s Approach
Cash
Cash
Cash
(1) 10,000 (4) 600 (1) 10,000 (4) 600 (1) 10,000 (4) 600
(2) 5,000 (5) 2,000 (2) 5,000 (5) 2,000 (2) 5,000 (5) 2,000
(3) 1,000
(3) 1,000
(3) 1,000
16,000
2,600
13,400
bal 13,400
13,400
ALL 3 are O.K.!
Debits and Credits
Question 3
The Cash account has three entries: a
debit for $1,200, a credit for $300, and
another credit for $400. What is the
balance in the Cash account?
a.
b.
c.
d.
$ 1,900 Debit.
$ 500 Credit.
$ 700 Credit.
$ 500 Debit.
2-54
Debits and Credits
Question 3
The Cash account has three entries: a
debit for $1,200, a credit for $300, and
another credit for $400. What is the
balance in the Cash account?
a.
b.
c.
d.
$ 1,900 Debit.
$ 500 Credit.
$ 700 Credit.
$ 500 Debit.
Cash
$1,200
$ 500
$ 300
$ 400
2-55
2-56
Implications Of Debits And Credits
Debits and Credits are used to indicate
that something happened to an
account.
Interpreting the implications requires an
analysis of the entire journal entry.
2-57
Implications
Question 1
If the company made a Credit entry to
Notes Payable, would the account
increase or decrease?
2-58
Implications
Question 1
If the company made a Credit entry to
Notes Payable, would the account
increase or decrease?
ANSWER:
Notes Payable would increase.
2-59
Implications
Question 2
Notes Payable is the account where we
record long-term borrowings. What
event would cause us to record an
increase in our long-term borrowings?
2-60
Implications
Question 2
Notes Payable is the account where we
record long-term borrowings. What
event would cause us to record an
increase in our long-term borrowings?
ANSWER:
Such an increase could imply that the
company borrowed money.
2-61
Implications
Question 3
If the company borrowed money, which
account would also be affected and in
what way?
2-62
Implications
Question 3
If the company borrowed money, which
account would also be affected and in
what way?
ANSWER:
There would also be an equal-sized
increase in the Cash account.
2-63
Implications
Question 4
Suppose instead of an increase to Cash,
you find an increase to the Land
account. How do you interpret the
increase in Notes Payable?
2-64
Implications
Question 4
Suppose instead of an increase to Cash,
you find an increase to the Land
account. How do you interpret the
increase in Notes Payable?
ANSWER:
The company acquired land and gave a
note that promised to pay for the land
in the future.
2-65
Recording Transactions

Initially, all transactions are recorded in
the General Journal.
2-66
Recording Transactions

Initially, all transactions are recorded in
the General Journal.

Each transaction always affects at least
two different accounts.
One account has a debit effect.
 The second account has a credit effect.


This methodology was named “double
entry” accounting by whom?
Pacioli
2-67
General Journal Page
GENERAL JOURNAL
Page:
Date
Description
PR
Debit
Credit
2-68
Journal Entries
Example 1
On January 1, 19X7, Caldwell Company
borrows $10,000 from the bank.
Prepare the appropriate general journal
entry for the above transaction.
2-69
Journal Entries
Solution 1

Two accounts are affected:
Cash is increased by $10,000.
 Notes Payable is increased by $10,000.

2-70
Journal Entries
Solution 1

Two accounts are affected:
Cash is increased by $10,000.
 Notes Payable is increased by $10,000.

GENERAL JOURNAL
1
Page:
Date
Description
PR
Debit
Credit
2-71
Journal Entries
Solution 1

Two accounts are affected:
Cash is increased by $10,000.
 Notes Payable is increased by $10,000.

GENERAL JOURNAL
1
Page:
Date
1-Jan
Description
Cash
Notes Payable
to record loan from bank
PR
Debit
100
201
10,000
Credit
10,000
2-72
Journal Entries
Solution 1
Typically,
accounts
 Two accounts
areare
affected:
numbered.
Cash is increased
The by $10,000.
 Notesnumbers
Payable isare
increased by $10,000.
account
used as references
for
GENERAL JOURNAL
Page:
posting to the General
DateLedger. More
Description on
PR
Debit
Credit
1-Jan
Cash
100
10,000
account
will
Notesnumbers
Payable
201
10,000
tocome
record loan from
bank
later.
1
2-73
Journal Entries
Example 2
On January 15, 19X7, Caldwell
Company purchases a truck for
$19,500 cash.
Prepare the appropriate journal entry
for the above transaction.
2-74
Journal Entries
Solution 2

Two accounts are affected:
Trucks is increased by $19,500.
 Cash is decreased by $19,500.

2-75
Journal Entries
Solution 2

Two accounts are affected:
Trucks is increased by $19,500.
 Cash is decreased by $19,500.

GENERAL JOURNAL
1
Page:
Date
Description
PR
Debit
Credit
2-76
Journal Entries
Solution 2

Two accounts are affected:
Trucks is increased by $19,500.
 Cash is decreased by $19,500.

GENERAL JOURNAL
1
Page:
Date
Description
15-Jan
Trucks
Cash
to record purchase of truck
PR
Debit
150
100
19,500
Credit
19,500
2-77
Journal Entries
Example 3
On January 20, 19X7, Caldwell Co. pays
the $400 electric bill for January.
Prepare the appropriate journal entry
for the above transaction.
2-78
Journal Entries
Solution 3

Two accounts are affected:
Utility Expense is increased by $400.
 Cash is decreased by $400.

2-79
Journal Entries
Solution 3

Two accounts are affected:
Utility Expense is increased by $400.
 Cash is decreased by $400.

GENERAL JOURNAL
1
Page:
Date
Description
PR
Debit
Credit
2-80
Journal Entries
Solution 3

Two accounts are affected:
Utility Expense is increased by $400.
 Cash is decreased by $400.

GENERAL JOURNAL
1
Page:
Date
20-Jan
Description
Utility Expense
Cash
to record payment of January
electric bill
PR
511
100
Debit
Credit
400
400
2-81
More About The General Ledger

It is a complete collection of all the
accounts of a company

Accounts are individually numbered for
easy reference

It is used to collect the information about
all of the transactions affecting a specific
account

A cumulative, running balance is
maintained when using the 3-column type
2-82
Categories of
General Ledger Accounts
The five types of accounts fall into
one of two categories
Real Accounts
Nominal Accounts
2-83
Real Accounts

This category includes Assets,
Liabilities, and Stockholders’ Equities
(i.e., Balance Sheet accounts)

Accounts are permanent.

Account balances are carried forward
from one fiscal year to the next.
2-84
Nominal Accounts

Nominal accounts include revenues
and expenses.

Nominal accounts are temporary.

Nominal account balances are closed
out to zero at the end of the fiscal year.

Closing Entries will be discussed in
Chapter 4.
2-85
Numbering Accounts
The listing of all accounts and their
account numbers is called the chart of
accounts.
2-86
Numbering Accounts
The listing of all accounts and their
account numbers is called the chart of
accounts.
A typical account numbering scheme
might appear as follows:
Assets
100-199
Liabilities 200-299
Equities 300-399
Revenues 400-499
Expenses 500-599
(See page 63 and inside back cover)
2-87
Posting to the GL
Example
GENERAL JOURNAL
1
Page:
Date
Description
1-Jan Cash
Notes Payable
to record loan from bank
PR
Debit
Credit
10,000
10,000
Start with the journal entry from the
General Journal.
2-88
Posting to the GL
Example
GENERAL JOURNAL
Date
Page: page
Next, find the appropriate
Description
PR forDebit
in the General
Ledger
Cash. Credit
1-Jan Cash
Notes Payable
to record loan from bank
10,000
10,000
ACCOUNT NAME: CASH
Date
Description
Beginning Balance
1
ACCOUNT No.
PR
Debit
Credit
0
100
Balance
0
2-89
Posting to the GL
Example
GENERAL JOURNAL
Post the account
referencePage:
number.
Date
Description
1-Jan Cash
Notes Payable
to record loan from bank
Description
Beginning Balance
Debit
100
10,000
Credit
10,000
ACCOUNT NAME: CASH
Date
PR
1
ACCOUNT No.
PR
Debit
Credit
0
100
Balance
0
2-90
Posting to the GL
Example
GENERAL JOURNAL
1
Page:
Date
Description
1-Jan Cash
Notes Payable
to record loan from bank
Description
Beginning Balance
1-JanLoan
Debit
100
10,000
Credit
10,000
ACCOUNT NAME: CASH
Date
PR
ACCOUNT No.
PR
Debit
G1
0
10,000
Credit
Post the transaction info to the GL.
100
Balance
0
2-91
Posting to the GL
Example
GENERAL JOURNAL
1
Page:
Date
Description
1-Jan Cash
Notes Payable
to record loan from bank
Description
Beginning Balance
1-JanLoan
Debit
100
10,000
Credit
10,000
ACCOUNT NAME: CASH
Date
PR
ACCOUNT No.
PR
Debit
G1
0
10,000
Credit
Update the General Ledger balance.
100
Balance
0
10,000
2-92
Posting to the GL
Example
GENERAL JOURNAL
Date
Page:
Next, find the Notes Payable
PR Ledger.
Debit
pageDescription
in the General
1-Jan Cash
Notes Payable
to record loan from bank
100
Description
Beginning Balance
Credit
10,000
10,000
ACCOUNT NAME: Notes Payable
Date
1
ACCOUNT No.
PR
Debit
Credit
0
201
Balance
0
2-93
Posting to the GL
Example
GENERAL JOURNAL
Post the account
referencePage:
number.
Date
Description
1-Jan Cash
Notes Payable
to record loan from bank
ACCOUNT NAME: Notes Payable
Date
Description
Beginning Balance
PR
Debit
100
201
10,000
1
Credit
10,000
ACCOUNT No.
PR
Debit
Credit
0
201
Balance
0
2-94
Posting to the GL
Example
GENERAL JOURNAL
1
Page:
Date
Description
1-Jan Cash
Notes Payable
to record loan from bank
ACCOUNT NAME: Notes Payable
Date
Description
Beginning Balance
1-JanLoan
PR
Debit
100
201
10,000
Credit
10,000
ACCOUNT No.
PR
G1
Debit
Credit
0
10,000
Post the transaction info to the GL.
201
Balance
0
2-95
Posting to the GL
Example
GENERAL JOURNAL
1
Page:
Date
Description
1-Jan Cash
Notes Payable
to record loan from bank
ACCOUNT NAME: Notes Payable
Date
Description
Beginning Balance
1-JanLoan
PR
Debit
100
201
10,000
Credit
10,000
ACCOUNT No.
PR
G1
Debit
201
Credit
Balance
0
10,000
0
10,000
Update the General Ledger balance.
2-96
Posting to the GL
Example
GENERAL JOURNAL
Examine the next journalPage:
entry.
Date
Description
PR
Debit
15-Jan Trucks
Cash
to record purchase of truck
Description
Beginning Balance
1-JanLoan from bank
Credit
9,500
9,500
ACCOUNT NAME: CASH
Date
1
ACCOUNT No.
PR
Debit
G1
0
10,000
Credit
100
Balance
0
10,000
2-97
Posting to the GL
Example
GENERAL JOURNAL
Record the account reference.
Page:
Date
Description
PR
15-Jan Trucks
Cash
to record purchase of truck
Description
Beginning Balance
1-JanLoan from bank
Credit
9,500
100
ACCOUNT NAME: CASH
Date
Debit
1
9,500
ACCOUNT No.
PR
Debit
G1
0
10,000
Credit
100
Balance
0
10,000
2-98
Posting to the GL
Example
GENERAL JOURNAL
3
Page:
Date
Description
PR
15-Jan Trucks
Cash
to record purchase of truck
Description
Beginning Balance
1-JanLoan from bank
15-JanPurchase of truck
Credit
9,500
100
ACCOUNT NAME: CASH
Date
Debit
9,500
ACCOUNT No.
PR
G1
G3
Debit
Credit
0
10,000
Post the entry to the GL.
100
Balance
0
10,000
9,500
2-99
Posting to the GL
Example
GENERAL JOURNAL
3
Page:
Date
Description
PR
15-Jan Trucks
Cash
to record purchase of truck
Description
Beginning Balance
1-JanLoan from bank
15-JanPurchase of truck
Credit
9,500
100
ACCOUNT NAME: CASH
Date
Debit
9,500
ACCOUNT No.
PR
G1
G3
Debit
Credit
0
10,000
9,500
Update the General Ledger balance.
100
Balance
0
10,000
500
2-100
TRIAL BALANCE

Used to periodically test whether the
General Ledger is in balance.

Consists of a listing of each account
with its balance as of a specific date.
All Debit balances are in one column.
 All Credit balances are in another column.

2-101
Trial Balance Illustration
(Text example is on p. 79)
First Company
Trial Balance
12/31/X8
Cash
Accounts Receivable
Equipment
Accounts Payable
Notes Payable
Capital Stock
Retained Earnings - 1/1/X8
Dividends
Revenues
Salary Expense
Utility Expense
Rent Expense
Debits
$
500
1,200
3,800
Credits
$
700
1,450
3,000
-
250
11,000
5,000
3,000
2,400
$ 16,150
$ 16,150
2-102
Trial Balance Illustration
(Text example is on p. 79)
First Company
Trial Balance
12/31/X8
NoticeCash
that Total
Accounts Receivable
DebitsEquipment
are equal
Accounts Payable
to Total
NotesCredits.
Payable
Capital Stock
Retained Earnings - 1/1/X8
Dividends
Revenues
Salary Expense
Utility Expense
Rent Expense
Debits
$
500
1,200
3,800
Credits
$
700
1,450
3,000
-
250
11,000
5,000
3,000
2,400
$ 16,150
$ 16,150
2-103
Trial Balance Errors
Click picture to view video
2-104
Loose Ends

Questions on the 15
transactions on pp. 64-71?
2-105
Loose Ends
Questions on the 15
transactions on pp. 64-71?
 Don’t read the chapter!


First full par. on p. 75
2-106
Loose Ends
Questions on the 15
transactions on pp. 64-71?
 Don’t read the chapter!



First full par. on p. 75
Skip Analyzing and Using the
Financial Results

p. 81
2-107
Loose Ends
Questions on the 15
transactions on pp. 64-71?
 Don’t read the chapter!



Skip Analyzing and Using the
Financial Results


First full par. on p. 75
p. 81
The Dividends account is not a
primary type of account as
implied on pp. 58-59!
2-108
Dividends Account
The Dividends account is a contra account
to Retained Earnings. Therefore, it is
affected by debits and credits as follows:
DIVIDENDS
Debit
Credit
for
for
Increase Decrease
2-109
Have you ever
had that “I’vejust-been-runover-by-atrain” feeling?

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