chapter 2

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

Chapter 2

Analyzing and Recording Business Transactions


2-2

Conceptual Learning Objectives

C1: Explain the steps in processing transactions

C2: Describe source documents and their purpose

C3: Describe an account and its use in recording transactions

C4: Describe a ledger and a chart of accountsC5: Define debits and credits and explain their

role in double-entry accounting


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Analytical Learning Objectives

A1: Analyze the impact of transactions on accounts and financial statements

A2: Compute the debt ratio and describe its use in analyzing financial performance


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Procedural Learning Objectives

P1: Record transactions in a journal and post entries to a ledger

P2: Prepare and explain the use of a trial balance

P3: Prepare financial statements from business transactions


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External Transactions occur between the

organization and an outside party.

Internal Transactions occur within the

organization.

Analyzing and Recording Process

Exchanges of economic consideration between two parties.

C 1


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Analyze each transaction and event from source documents

Analyzing and Recording Process

Record relevant transactions and events in a journal

Post journal information

to ledger accountsPrepare and analyze

the trial balance

C 1


2-7

Sales Tickets

Bank Statements

Purchase Orders

Checks

Source Documents

Bills from Suppliers

Employee EarningsRecords

C 2


2-8

An account is a record of

increases and decreases in a specific asset, liability, equity,

revenue, or expense item.

An account is a record of

increases and decreases in a specific asset, liability, equity,

revenue, or expense item.

The Account and its Analysis

The general ledger is a record

containing all accounts used by

the company.

The general ledger is a record

containing all accounts used by

the company.

C 3


2-9

AssetsAccountsAssets

AccountsAssets

AccountsAssets

AccountsAssets

AccountsAssets

Accounts =


+LiabilityAccountsLiability

AccountsLiability

AccountsLiability

AccountsLiability

AccountsLiability

AccountsEquity

AccountsEquity

AccountsEquity

AccountsEquity

AccountsEquity

AccountsEquity

Accounts

C 3


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LandLand

EquipmentEquipment

BuildingsBuildings

CashCash

Notes Receivabl

e

Notes Receivabl

e

SuppliesSupplies

Prepaid AccountsPrepaid

Accounts

Accounts ReceivableAccounts

Receivable

AssetAccounts

AssetAccounts

Asset AccountsC 3


2-11

Accrued LiabilitiesAccrued

LiabilitiesUnearned Revenue

Unearned Revenue

Notes PayableNotes

PayableAccounts Payable

Accounts Payable

LiabilityAccountsLiability

Accounts

Liability AccountsC 3


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EquityAccounts

EquityAccounts

RevenuesRevenues

CommonStock

CommonStock DividendsDividends

ExpensesExpenses

Equity AccountsC 3

RetainedEarningsRetainedEarnings


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LiabilitiesLiabilities EquityEquityAssetsAssets = +


CommonStock

CommonStock Dividends Dividends RevenuesRevenues ExpensesExpenses

+ +– –

C 3


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Ledger and Chart of Accounts

The ledger is a collection of all accounts for aninformation system. A company’s size anddiversity of operations affect the numberof accounts needed.

The ledger is a collection of all accounts for aninformation system. A company’s size anddiversity of operations affect the numberof accounts needed.

The chart of accounts is a list of all accounts andincludes an identifying number for each account.The chart of accounts is a list of all accounts andincludes an identifying number for each account.

101 Cash 319 Dividends106 Accounts receivable 403 Revenues126 Supplies 406 Rental revenue128 Prepaid insurance 622 Salaries expense167 Equipment 637 Insurance expense

201 Accounts payable 640 Rent expense

236 Unearned revenue 652 Supplies expense

307 Common stock 690 Utilities expense

C 4


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A T-account represents a ledger account and is a tool used to understand the effects of one or more transactions.

Debits and Credits

(Left side) (Right side)Debit Credit

T- Account

C 5


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Double-Entry Accounting

Debit Credit Debit Credit Debit Credit

ASSETS

+ - + -

LIABILITIES

- + - +

EQUITIES

- + - +

C 5


2-17

RevenuesRevenues ExpensesExpensesCommon

StockCommon

StockDividendsDividends__ ++ __

Debit Credit

Stock

- + - + Debit Credit

Dividends

+ - + - Debit Credit

Expenses

+ - + -Debit Credit

Revenues

- + - +


EquityEquity

C 5


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An account balance is the difference between the increases and decreases in an account.

Notice the T-Account

C 5


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Journalizing & Posting Transactions

Step 1: Analyze transactions and source

documents.


Step 2: Apply double-entry accounting

(Left side) (Right side)Debit Credit

T- Account

ACCOUNT NAME: ACCOUNT No.

Date Description PR Debit Credit Balance

Step 4: Post entry to ledger Step 3: Record journal entry

P1


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Dollar amount of debits and credits

Dollar amount of debits and credits

Journalizing Transactions

Transaction Date

Transaction Date

Transaction explanation

Transaction explanation

Titles of Affected Accounts

Titles of Affected Accounts

P1


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T-accounts are useful illustrations, but balance column ledger accounts are used in practice.

Balance Column AccountP1


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11 Identify the debit account in ledger.

Posting Journal EntriesP1


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22 Enter the date.



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33 Enter the amount and description.



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44 Enter the journal reference.



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55 Compute the balance.



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Enter the ledger reference.66



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Analyzing Transactions

Analysis:

(1) Cash 101 30,000 Common stock 301 30,000

Double entry:

(1) 30,000Cash 101

(1) 30,000Common Stock 301

Posting:

A1


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Analysis:

(2) Supplies 126 2,500 Cash 101 2,500

Double entry:

(2) 2,500Supplies 126

(1) 30,000 (2) 2,500Cash 101

Posting:

A1


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(3) Equipment 167 26,000 Cash 101 26,000

Double entry:

(1) 30,000 (2) 2,500(3) 26,000

Cash(3) 26,000

Equipment 167 101

Posting:

A1

Analysis:


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Analysis:

(4) Supplies 126 7,100 Accounts payable 201 7,100

Double entry:

(2) 26,000(4) 7,100

Supplies 126

(4) 7,100Accounts Payable 201

Posting:

A1


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Analysis:

(5) Cash 101 4,200 Consulting Revenue 403 4,200

Double entry:

(1) 30,000 (2) 2,500(5) 4,200 (3) 26,000

Cash(5) 4,200

Consulting Revenue 403 101

Posting:

A1


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After processing its remaining transactions for December, FastForward’s Trial Balance is prepared.

After processing its remaining transactions for December, FastForward’s Trial Balance is prepared.

Debits CreditsCash 4,350$ Accounts receivable - Supplies 9,720 Prepaid Insurance 2,400 Equipment 26,000 Accounts payable 6,200$ Unearned consulting revenue 3,000 Common stock 30,000 Dividends 200 Consulting revenue 5,800 Rental revenue 300 Salaries expense 1,400 Rent expense 1,000 Utilities expense 230 Total 45,300$ 45,300$

FastForwardTrial Balance

December 31, 2007

The trial balance lists all account balances in the general ledger.

If the books are in balance, the total

debits will equal the total credits.

The trial balance lists all account balances in the general ledger.

If the books are in balance, the total

debits will equal the total credits.

A1


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Six Steps for Searching for and Correcting Errors

If the trial balance does not balance, the error(s) must be found and corrected.

Make sure the trial balance columns are correctly added.Make sure the trial balance columns are correctly added.

Make sure account balances are correctly entered from the ledger.

Make sure account balances are correctly entered from the ledger.

See if debit or credit accounts are mistakenly placed on the trial balance.

See if debit or credit accounts are mistakenly placed on the trial balance.

Recompute each account balance in the ledger.Recompute each account balance in the ledger.

Verify that each journal entry is posted correctly.Verify that each journal entry is posted correctly.

Verify that each original journal entry has equal debits and credits.

Verify that each original journal entry has equal debits and credits.

P2


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Using a Trial Balance to Prepare Financial Statements

Statement of Cash Flows

Income StatementStatement of Retained Earnings

Beginning Balance Sheet

Ending Balance Sheet

Period of TimePoint inTime

Point inTime

P3


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Income Statement

Revenues: Consulting revenue 5,800$ Rental revenue 300 Total revenues 6,100$ Expenses: Rent expense 1,000 Salaries expense 1,400 Utilities expense 230 Total expenses 2,630 Net income 3,470$

FASTFORWARDIncome Statement

For the Month Ended December 31, 2007

P3


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Statement of Retained Earnings

Balance, 1/1/07 -$ Net income for December 3,470

3,470 Less: Dividends (200) Balance, 12/31/07 3,270$

FASTFORWARDStatement of Retained Earnings


Revenues: Consulting revenue 5,800$ Rental revenue 300 Total revenues 6,100$ Expenses: Rent expense 1,000 Salaries expense 1,400 Utilities expense 230 Total expenses 2,630 Net income 3,470$

FASTFORWARDIncome Statement


P3


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Balance Sheet

AssetsCash 4,350$ Supplies 9,720 Prepaid insurance 2,400 Equipment 26,000 Total assets 42,470$

LiabilitiesAccounts payable 6,200$ Unearned revenue 3,000 Total liabilities 9,200

EquityCommon stock 30,000 Retained earnings 3,270 Total equity 33,270 Total liabilities and equity 42,470$

FASTFORWARDBalance Sheet

December 31, 2007

Balance, 1/1/07 -$ Net income for December 3,470

3,470 Less: Dividends 200 Balance, 12/31/07 3,270$

FASTFORWARDStatement of Retained Earnings


P3


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o Describes the relationship between the amounts of the company’s liabilities and assets.

o Helps to assess the risk that a company will fail to pay its debts.

Debt RatioA2


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End of Chapter 2