analyzing transactions

Analyzing Analyzing

TransactionsTransactions

Chapter 2Chapter 2Chapter 2Chapter 2

Learning ObjectivesLearning Objectives

1.1. Describe the characteristics of an account Describe the characteristics of an account and a chart of accounts.and a chart of accounts.

2.2. Describe and illustrate journalizing Describe and illustrate journalizing transactions using the double-entry transactions using the double-entry accounting system.accounting system.

3.3. Describe and illustrate the journalizing and Describe and illustrate the journalizing and posting of transactions to accounts.posting of transactions to accounts.

4.4. Prepare an unadjusted trial balance and Prepare an unadjusted trial balance and explain how it can be used to discover errors.explain how it can be used to discover errors.

5.5. Describe and illustrate the use of horizontal Describe and illustrate the use of horizontal analysis in evaluating a company’s analysis in evaluating a company’s performance and financial condition.performance and financial condition.

Learning Learning Objective

Objective Describe the characteristics of

Describe the characteristics of

an account and a chart of

an account and a chart of accountsaccounts

Using Accounts to Record TransactionsUsing Accounts to Record Transactions

o Accounting systems are designed to show Accounting systems are designed to show the increases and decreases in each the increases and decreases in each accounting equation element as a accounting equation element as a separate record. This record is called an separate record. This record is called an accountaccount..

USING USING ACCOUNTS TO ACCOUNTS TO

RECORD RECORD TRANSACTIONSTRANSACTIONS

THE T THE T ACCOUNTACCOUNT

The T account has a title

The left side of the account is called the debitdebit

The right side of the account is

called the creditcredit side.

Credit

Cash(a) 25,000 (b) 20,000(d) 7,500 (e) 3,650

(f) 950(h) 2,000

Balance 5,900

Debit Side of Account

Credit Side of Account

Balance of the account

Chart of AccountsChart of Accounts

o A group of accounts for a business entity A group of accounts for a business entity is called ais called a ledger ledger..

o A list of the accounts in the ledger is A list of the accounts in the ledger is called a called a chart of accountschart of accounts..

o AssetsAssets are resources owned by the are resources owned by the business. Some examples of assets follow:business. Some examples of assets follow: CashCash

SuppliesSupplies

Accounts receivableAccounts receivable

BuildingsBuildings

o LiabilitiesLiabilities are debts owed to outsiders are debts owed to outsiders (creditors). Some examples of liabilities (creditors). Some examples of liabilities follow:follow: Accounts payableAccounts payable

Notes payableNotes payable

Wages payableWages payable

Interest payableInterest payable

o Owner’s equityOwner’s equity is the owner’s right to the is the owner’s right to the assets of the business after all liabilities assets of the business after all liabilities have been paid. For a proprietorship, the have been paid. For a proprietorship, the owner’s equity is represented by the owner’s equity is represented by the balance of the owner’s balance of the owner’s capital accountcapital account..

o AA drawing drawing account represents the account represents the amount of withdrawals made by the amount of withdrawals made by the owner.owner.

o RevenuesRevenues are increases in owner’s equity are increases in owner’s equity as a result of selling services or products as a result of selling services or products to customers. Some examples of revenue to customers. Some examples of revenue accounts follow:accounts follow: Fees earnedFees earned

Commission revenueCommission revenue

Rent revenueRent revenue

o The using up of assets or consuming The using up of assets or consuming services in the process of generating services in the process of generating revenues results in revenues results in expensesexpenses. Some . Some examples of expenses follow:examples of expenses follow: Wages expenseWages expense

Rent expenseRent expense

Miscellaneous expenseMiscellaneous expense

CHART OF CHART OF ACCOUNTSACCOUNTS

ObjectiveDescribe and illustrate

Describe and illustrate

journalizing transactions using

the double-entry accounting

the double-entry accounting systemsystem

Double-Entry Accounting SystemDouble-Entry Accounting System

o All businesses use what is called the All businesses use what is called the double-entry accounting systemdouble-entry accounting system. This . This system is based on the accounting system is based on the accounting equation and requires:equation and requires: Every business transaction to be recorded in at Every business transaction to be recorded in at

least two accounts.least two accounts.

The total debits recorded for each transaction The total debits recorded for each transaction to be equal to the total credits recorded.to be equal to the total credits recorded.

Balance Sheet AccountsBalance Sheet Accounts

o The debit and credit rules for balance The debit and credit rules for balance sheet accounts are as follows:sheet accounts are as follows:

Income Statement AccountsIncome Statement Accounts

o The debit and credit rules for income The debit and credit rules for income statement accounts are based on their statement accounts are based on their relationship with owner’s equity.relationship with owner’s equity.

Owner WithdrawalsOwner Withdrawals

• The debit and credit rules for The debit and credit rules for recording owner withdrawals are recording owner withdrawals are based on the effect of owner based on the effect of owner withdrawals on owner’s equity.withdrawals on owner’s equity.

Normal BalancesNormal Balances

o The sum of the increases in an account The sum of the increases in an account is usually equal to or greater than the is usually equal to or greater than the sum of the decreases in the account. sum of the decreases in the account. Thus, the Thus, the normal balance ofnormal balance of an accountan account is either a debit or a credit depending is either a debit or a credit depending on whether increases in the account are on whether increases in the account are recorded as debits or credits.recorded as debits or credits.

Rules of Debit and Credit – Normal Balances of Rules of Debit and Credit – Normal Balances of AccountsAccounts

Normal BalancesNormal Balances

Increases (Normal Bal.) Decreases

Balance sheet accounts:AssetDebit CreditLiability Credit DebitOwner’s Equity:

Capital Credit DebitDrawing Debit

CreditIncome statement accounts:

Revenue Credit DebitExpense DebitCredit

Transaction ATransaction A

o On November 1, Chris Clark opens a new On November 1, Chris Clark opens a new business and deposits $25,000 in a bank account in business and deposits $25,000 in a bank account in the name of NetSolutions.the name of NetSolutions.

TRANSACTION TRANSACTION AA

Step 1 Step 4 Step 5

Step 3

Assets = Liabilities + Owner’s Equity (investment)Assets = Liabilities + Owner’s Equity (investment)

Accounting Equation ImpactAccounting Equation Impact

increaseincrease increaseincrease

Step 2Step 3

(continued)

JournalizingJournalizing

Journalizing requires the following steps:Journalizing requires the following steps:

oStep 1.Step 1. The date of the transaction is The date of the transaction is entered in the Date column.entered in the Date column.

oStep 2.Step 2. The title of the account to be The title of the account to be debited is recorded at the left-hand margin debited is recorded at the left-hand margin under the Description column, and the under the Description column, and the amount to be debited is entered in the Debit amount to be debited is entered in the Debit column.column.

(continued)

o Step 3.Step 3. The title of the account to be The title of the account to be credited is listed below and to the right of credited is listed below and to the right of the debited account title, and the amount the debited account title, and the amount to be credited is entered in the Credit to be credited is entered in the Credit column.column.

o Step 4.Step 4. A brief description may be A brief description may be entered below the credited account.entered below the credited account.

o Step 5.Step 5. The Post. Ref. (Posting The Post. Ref. (Posting Reference) column is left blank when the Reference) column is left blank when the journal entry is initially recorded. This journal entry is initially recorded. This column is used later when the journal column is used later when the journal entry amounts are transferred to the entry amounts are transferred to the accounts in the ledger.accounts in the ledger.

o A transaction is initially entered in a record A transaction is initially entered in a record called a called a journaljournal..

o A transaction is initially entered in a record A transaction is initially entered in a record called a journal.called a journal.

o The process of recording a transaction in The process of recording a transaction in the journal is called the journal is called journalizingjournalizing..

o A transaction is initially entered in a record A transaction is initially entered in a record called a journal.called a journal.

o The process of recording a transaction in The process of recording a transaction in the journal is called journalizing.the journal is called journalizing.

o The entry in the journal is called a The entry in the journal is called a journal journal entryentry..

Transaction BTransaction B

o On November 5, NetSolutions paid On November 5, NetSolutions paid $20,000 for the purchase of land as a $20,000 for the purchase of land as a future building site.future building site.

TRANSACTION TRANSACTION BB

Accounting Equation ImpactAssets = Liabilities + Owner’s Equity

increaseincrease

decreasedecrease

Transaction CTransaction C

o On November 10, NetSolutions purchased On November 10, NetSolutions purchased supplies on account for $1,350.supplies on account for $1,350.

TRANSACTION TRANSACTION CC

Transaction DTransaction D

o On November 18, NetSolutions received On November 18, NetSolutions received cash of $7,500 from customers for cash of $7,500 from customers for services provided.services provided.

Accounting Equation ImpactAssets = Liabilities + Owner’s Equity (Revenue)

in revenuesin revenues

TRANSACTION TRANSACTION DD

Transaction ETransaction E

o On November 30, NetSolutions incurred On November 30, NetSolutions incurred the following expenses: wages, $2,125; the following expenses: wages, $2,125; rent, $800; utilities, $450; and rent, $800; utilities, $450; and miscellaneous, $275.miscellaneous, $275.

Accounting Equation ImpactAssets = Liabilities + Owner’s Equity (Expense)

decreasedecrease

All four All four expense expense accounts accounts increaseincrease

TRANSACTION TRANSACTION EE

Transaction FTransaction F

o On November 30, NetSolutions paid On November 30, NetSolutions paid creditors on account, $950.creditors on account, $950.

decreasedecreasedecreasedecrease

TRANSACTION TRANSACTION FF

Transaction GTransaction G

o NetSolutions purchased $1,350 of supplies NetSolutions purchased $1,350 of supplies on November 10. Chris Clark determined on November 10. Chris Clark determined that the cost of supplies on hand on that the cost of supplies on hand on November 30 was $550.November 30 was $550.

decreasedecrease increaseincrease

in expensein expense

TRANSACTION TRANSACTION GG

Supplies used = $1,350 - $550 = $800

Transaction HTransaction H

o On November 30, Chris Clark withdrew On November 30, Chris Clark withdrew $2,000 from NetSolutions for personal use.$2,000 from NetSolutions for personal use.

Accounting Equation ImpactAssets = Liabilities + Owner’s Equity (Drawing)

decreasedecrease increaseincrease

in drawingin drawing

TRANSACTION TRANSACTION HH

ObjectiveDescribe and illustrate the

Describe and illustrate the

journalizing and posting of

transactions to accounts.

Posting Journal Entries to AccountsPosting Journal Entries to Accounts

o The process of transferring the debits and The process of transferring the debits and credits from the journal entries to the credits from the journal entries to the accounts is called accounts is called postingposting..

Posting Journal Entries to AccountsPosting Journal Entries to Accounts

o On December 1, NetSolutions paid a On December 1, NetSolutions paid a premium of $2,400 for an insurance policy premium of $2,400 for an insurance policy for liability, theft, and fire. The policy for liability, theft, and fire. The policy covers a one-year period.covers a one-year period.

POSTING POSTING JOURNAL JOURNAL

ENTRIES TO ENTRIES TO ACCOUNTSACCOUNTS

increaseincrease

decreasedecrease

Exhibit 4 - Steps in PostingExhibit 4 - Steps in Posting

o Step 1.Step 1. The date of the transaction is The date of the transaction is entered in the Date column of Prepaid entered in the Date column of Prepaid Insurance.Insurance.

2,400 2,400

o Step 2.Step 2. The amount (2,400) is entered The amount (2,400) is entered in the Debit column of Prepaid Insurance.in the Debit column of Prepaid Insurance.

o Step 3.Step 3. The journal page number (2) is The journal page number (2) is entered in the account’s Post. Ref. column.entered in the account’s Post. Ref. column.

o Step 4.Step 4. The account number (15) is The account number (15) is entered in the journal’s Post. Ref. column.entered in the journal’s Post. Ref. column.

Recording and Posting of a Debit and a CreditRecording and Posting of a Debit and a Credit

These steps These steps are are repeated to repeated to post to the post to the Cash Cash account.account.

December TransactionsDecember Transactions

o On December 1, NetSolutions paid rent for On December 1, NetSolutions paid rent for December, $800. The company from December, $800. The company from which NetSolutions is renting its store which NetSolutions is renting its store space now requires the payment of rent space now requires the payment of rent on the first of each month, rather than at on the first of each month, rather than at the end of the month.the end of the month.

DECEMBER DECEMBER TRANSACTIONSTRANSACTIONS

decrease increase

in expense

o On December 1, NetSolutions received an On December 1, NetSolutions received an offer from a local retailer to rent the land offer from a local retailer to rent the land purchased on November 5. The retailer plans purchased on November 5. The retailer plans to use the land as a parking lot for its to use the land as a parking lot for its employees and customers. NetSolutions employees and customers. NetSolutions agreed to rent the land to the retailer for agreed to rent the land to the retailer for three months, with the rent payable in three months, with the rent payable in advance. NetSolutions received $360 for advance. NetSolutions received $360 for three months’ rent beginning December 1. three months’ rent beginning December 1.

o The liability created by receiving the cash in The liability created by receiving the cash in advance of providing the service is called advance of providing the service is called unearned revenueunearned revenue..

increaseincrease

o On December 4, NetSolutions purchased On December 4, NetSolutions purchased office equipment on account from office equipment on account from Executive Supply Co. for $1,800.Executive Supply Co. for $1,800.

increase increase

o On December 6, NetSolutions paid $180 On December 6, NetSolutions paid $180 for a newspaper advertisement.for a newspaper advertisement.

decrease increase

in expense

o On December 11, NetSolutions paid On December 11, NetSolutions paid creditors $400.creditors $400.

decrease decrease

o On December 13, NetSolutions paid a On December 13, NetSolutions paid a receptionist and a part-time assistant receptionist and a part-time assistant $950 for two weeks’ wages.$950 for two weeks’ wages.

decreaseincrease

in expense

o On December 16, NetSolutions received On December 16, NetSolutions received $3,100 from fees earned for the first half $3,100 from fees earned for the first half of December.of December.

Accounting Equation Impact

Assets = Liabilities + Owner’s Equity (Revenue)

increase increase

in revenues

o Fees earned on account totaled $1,750 for Fees earned on account totaled $1,750 for the first half of December.the first half of December.

increase increase

in revenues

o On December 20, NetSolutions paid $900 On December 20, NetSolutions paid $900 to Executive Supply Co. on the $1,800 to Executive Supply Co. on the $1,800 debt owed from the December 4 debt owed from the December 4 transaction.transaction.

Assets = Liabilities + Owner’s Equity

decreasedecrease

o On December 21, NetSolutions received On December 21, NetSolutions received $650 from customers in payment of their $650 from customers in payment of their accounts.accounts.

increase

decrease

o On December 23, NetSolutions paid On December 23, NetSolutions paid $1,450 for supplies.$1,450 for supplies.

increase

decrease

o On December 27, NetSolutions paid the On December 27, NetSolutions paid the receptionist and the part-time assistant receptionist and the part-time assistant $1,200 for two weeks’ wages.$1,200 for two weeks’ wages.

Assets = Liabilities + Owner’s Equity (Expense)

increase

in expense

decrease

o On December 31, NetSolutions paid its On December 31, NetSolutions paid its $310 telephone bill for the month.$310 telephone bill for the month.

increase

in expense

decrease

o On December 31, NetSolutions paid its On December 31, NetSolutions paid its $225 electric bill for the month.$225 electric bill for the month.

increase

in expense

decrease

o On December 31, NetSolutions received On December 31, NetSolutions received $2,870 from fees earned for the second $2,870 from fees earned for the second half of December.half of December.

increase increase

in revenues

o On December 31, fees earned on account On December 31, fees earned on account totaled $1,120 for the second half of totaled $1,120 for the second half of December.December.

increase increase

in revenues

o On December 31, Chris Clark withdrew On December 31, Chris Clark withdrew $2,000 for personal use.$2,000 for personal use.

Assets = Liabilities + Owner’s Equity (Drawing)

increase

in drawing

decrease

ObjectivePrepare an unadjusted trial

Prepare an unadjusted trial

balance and explain how it can

be used to discover errors

Trial BalanceTrial Balance

o The equality of debits and credits in the The equality of debits and credits in the ledger should be proven at the end of ledger should be proven at the end of each accounting period by preparing a each accounting period by preparing a trial balancetrial balance..

UNADJUSTED UNADJUSTED TRIAL BALANCETRIAL BALANCE

Trial Balance Errors - TranspositionTrial Balance Errors - Transposition

o A A transpositiontransposition occurs when the order of occurs when the order of the digits is changed by mistake, such as the digits is changed by mistake, such as writing $542 as $452 or $524.writing $542 as $452 or $524.

Trial Balance Errors - SlideTrial Balance Errors - Slide

o In a In a slideslide, the entire number is moved one , the entire number is moved one or more spaces to the right or the left by or more spaces to the right or the left by mistake, such as writing $542.00 as mistake, such as writing $542.00 as $54.20 or $97.50 as $975.00.$54.20 or $97.50 as $975.00.

Errors Not Affecting the Trial BalanceErrors Not Affecting the Trial Balance

o If an error has already been journalized If an error has already been journalized and posted to the ledger, a and posted to the ledger, a correcting correcting journaljournal entryentry is normally prepared. is normally prepared.

Errors Not Affecting the Trial BalanceErrors Not Affecting the Trial Balance

o Another type of error is a posting error.Another type of error is a posting error.

o Assume that on May 5 a $12,500 purchase Assume that on May 5 a $12,500 purchase of office equipment on account was of office equipment on account was incorrectly journalized and posted as a incorrectly journalized and posted as a debit to Supplies and a credit to Accounts debit to Supplies and a credit to Accounts Payable for $12,500.Payable for $12,500.

o The entry to correct the error is:The entry to correct the error is:

ObjectiveDescribe and illustrate the use of

Describe and illustrate the use of

horizontal analysis in evaluating

a company’s performance and

a company’s performance and financial condition.

financial condition.

Horizontal AnalysisHorizontal Analysis

o In In horizontal analysishorizontal analysis, the amount of each , the amount of each item on a current financial statement is item on a current financial statement is compared with the same item on an compared with the same item on an earlier statement.earlier statement.

Horizontal AnalysisHorizontal Analysis

o In horizontal analysis, the amount of each In horizontal analysis, the amount of each item on a current financial statement is item on a current financial statement is compared with the same item on an compared with the same item on an earlier statement.earlier statement.

o When two statements are being When two statements are being compared, the earlier statement is used as compared, the earlier statement is used as the base for computing the amount and the base for computing the amount and the percent of change.the percent of change.

HORIZONTAL HORIZONTAL ANALYSISANALYSIS

Analyzing Analyzing

TransactionsTransactions

The EndThe EndThe EndThe End

analyzing transactions

examples of revenue

owners capital account

drawing account

examples of assets

cengage learning

titletitlethe t accountthe

accounting equation

chart of accountsassets

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