needles powers crosson principles of accounting 12e analyzing and recording business transactions 2...

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Principles of Accounting

12e

Analyzing and Recording Business Transactions2

C H A P T E R

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Concepts Underlying Business Transactions

Business transactions are economic events that should be recorded in the accounting records.

The concepts of recognition, valuation, and classification underlie all business transactions.

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Concepts Underlying Business Transactions

Recognition refers to the decision as to when to record a business transaction.

Valuation is the process of assigning a monetary amount to business transactions and the resulting assets and liabilities. GAAP states that all business transactions should be valued at fair value when they occur. – Fair value is the exchange price of an actual or potential

business transaction between market participants.– Recording transactions at the exchange price at the point

of recognition is called the cost principle.

Classification is the process of assigning all the transactions in which a business engages to appropriate categories, or accounts.


Double-Entry System and Accounts

In the double-entry system, each transaction must be recorded with at least one debit and one credit, and the total amount of the debits must equal the total amount of the credits.

Accounts are the basic storage units for accounting data and are used to accumulate amounts from similar transactions.– An accounting system has a separate account for

each asset, each liability, and each component of owner’s equity, including revenues and expenses.


Chart of Accounts

In a manual accounting system, each account is kept on a separate page or card. These pages or cards are placed together in a book or file called the general ledger. In computerized systems, accountants still refer to the group of accounts as the general ledger, or simply the ledger.– A chart of accounts is a table of contents for

the ledger. It lists the account titles and the numbers that have been assigned to them. It usually lists the accounts in the order in which they appear in the ledger (the order in which they appear in the financial statements).


The T Account(slide 1 of 2)

The T account is a tool used to analyze transactions. It has three parts:– a title, which identifies the asset, liability,

or owner’s equity account– a left side, which is called the debit side

(abbreviated Dr., from the Latin debere)– a right side, which is called the credit side

(abbreviated Cr., from the Latin credere)


The T Account(slide 2 of 2)

– For the Cash account, receipts are recorded on the left (debit) side of a T account and payments on the right (credit) side, as shown below.

– The totals in smaller, blue figures are simply working totals, or footings.

– The difference between the total debit footing and the total credit footing is called the account balance.


Rules of Double-Entry Accounting

The double-entry system follows two rules:– Every transaction affects at least two

accounts.– Total debits must equal total credits.

For every transaction:– one or more accounts must be debited, or

entered on the left side of a T account.– one or more accounts must be credited, or

entered on the right side of a T account.



Keep the accounting equation in mind:Assets = Liabilities + Owner’s Equity



Withdrawals and expenses are deductions from owner’s equity, so transactions that increase withdrawals or expenses decrease owner’s equity.


Normal Balance

The normal balance of an account is its usual balance and is the side (debit or credit) that increases the account.


Business Transaction Analysis

The details of business transactions are supported by source documents—invoices, receipts, checks, or contracts.

A journal entry is a notation that records a single transaction in the chronological accounting record known as a journal. Each entry must be in proper journal form.


The Trial Balance

The trial balance is a device used to ensure that the total of debits and credits in the accounts are equal.


Finding Trial Balance Errors

If the debits and credits in a trial balance are not equal, look for one or more of these errors:– A debit was entered in an account as a credit, or vice

versa.– The balance of an account was computed incorrectly.– An error was made in carrying the account balance to

the trial balance. Recording an account as a credit when it usually carries a

debit balance, or vice versa, causes the trial balance to be out of balance by an amount divisible by 2.

Transposing two digits when transferring an amount to the trial balance causes the trial balance to be out of balance by an amount divisible by 9.

– The trial balance was summed incorrectly.


Recording and Posting Transactions

Although transactions can be entered directly into the ledger accounts, identifying individual transactions or finding errors is difficult because the debit is recorded in one account and the credit in another.

The solution is to record all transactions chronologically in a journal and then transfer the debit and credit portions of each transaction to the appropriate accounts in the ledger.

The simplest and most flexible kind of journal is the general journal.


General Ledger

While the general journal is used to record the details of each transaction, the general ledger is used to update each account. Transferring transactions from the journal to the ledger is called posting.

The ledger account form is a form of the account that contains four columns for dollar amounts.


Ethical Financial Reporting and Business Transactions

Recognition, valuation, and classification, as specified under generally accepted accounting principles, are important factors in ethical financial reporting.

The recognition issue can be particularly difficult to resolve.– The predetermined time at which a transaction

should be recorded is the recognition point.– A purchase transaction should be recorded when

title to merchandise passes from the supplier to the purchaser and creates an obligation to pay.


Recognition

Examples of economic events that should and should not be recorded as business transactions include:


Cash Flows and the Timing of Transactions

To avoid financial distress, a company must be able to pay its bills on time. Consider the transactions of Blue Design studio shown below. Blue must perform a delicate balancing act with its cash flows to ensure that it can remain profitable.


needles powers crosson principles of accounting 12e analyzing and recording business transactions 2...

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