Chapter 2 Recording Business Transactions

Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson Slide 1 of 23

Chapter 2Chapter 2

Recording Business

Transactions


The Accounting Process

Recordtransactionsin the journal

Copy (post) tothe ledger

Prepare thetrial balance


The AccountThe Account• Basic summary device• Detailed record of all changes that have

occurred in a particular asset, liability, or stockholders’ equity

• Covers a specific period of time• Grouped in three broad categories

– Assets– Liabilities– Stockholders’ Equity


The Journal and The LedgerThe Journal and The Ledger• Journal

– Chronological record of transactions– Organized by date

• Ledger– The book holding all the accounts and their

balances– Organized by account


Trial BalanceTrial Balance

• Listing of all accounts and their balances


AssetsAssetsEconomic resources that will benefit the business in the future:•Cash•Accounts receivable•Notes receivable•Prepaid expenses•Land•Building•Equipment, Furniture, Fixtures


LiabilitiesLiabilitiesA debt (something owed):

•Accounts payable

•Notes payable

•Accrued liabilities


Stockholders’ EquityStockholders’ EquityOwners’ claim to the assets:•Common stock•Retained earnings•Dividends•Revenues •Expenses


Ledger • Asset, Liability, and Stockholders’ equity

Accounts


Double Entry SystemDouble Entry System• Record dual effects of each transaction• Each transaction has a:

– Receiving side– Giving side

• Examples:– Company purchases supplies (receiving) with cash (giving)– Company issues stock (giving) and receives cash (receiving)


T-AccountT-AccountTool for analyzing and determining the balance in a given account

DrDebit

CrCredit

CrCredit


Increases and Decreases in Increases and Decreases in AccountsAccounts

• Whether an account is increased by debit or a credit is determined by the account type– Asset, liability, or equity

• Debits are not good or bad– Neither are credits


Rules of Debit and CreditRules of Debit and CreditThe account category governs the increase side or decrease side

Increases are recorded on one sideDecreases are recorded on the opposite side

Rules of debits and credits


Illustrate Debits and CreditsIllustrate Debits and Credits• The first transaction involves receiving $30,000 cash

and issuing common stock • The second transaction is a $20,000 purchase of land

for cash


S2-2: EXPLAINING ACCOUNTS AND THE RULES OF DEBITS AND CREDITS

Margaret Alves is tutoring Timothy Johnson, who is taking introductory accounting. Margaret explains to Timothy that debits are used to record increases in accounts and credits record decreases. Timothy is confused and seeks your advice.

1.When are debits increases?

When are debits decreases?

2. When are credits increases?

When are credits decreases?

Debits are increases in the Assets, Dividends, and Expenses.

Debits are decreases in the Liabilities, Stockholders’ equity, Retained earnings and Revenues.

Credits are decreases in the Assets, Dividends, and Expenses.

Credits are increases in the Liabilities, Stockholders’ equity, Retained earnings and revenues.


Steps in the Transaction Steps in the Transaction Recording ProcessRecording Process

Use the rules of debit and

credit


Illustrating a Journal EntryIllustrating a Journal Entry• Journalize the first transaction of Smart Touch—

the receipt of $30,000 cash and issuance of common stock– Step 1: The accounts affected are Cash and

Common stock. Cash is an asset. Common stock is equity.

– Both accounts increase by $30,000. Assets increase with debits. Equity increases with credits.


Illustrating a Journal Entry Illustrating a Journal Entry (continued)(continued)

• Four parts:a) Date of transaction

b) Title of account debited with dollar amount

c) Title of account credited with dollar amount

d) Brief explanation of transaction


S2-5: JOURNALIZING TRANSACTIONS

Ned Brown opened a medical practice in San Diego, California.1. Record the preceding transactions in the journal of Ned Brown, M.D., P.C. Include an explanation.

Jan 1 The business received $29,000 cash and issued common stock.

2 Purchased medical supplies on account, $14,000.

2 Paid monthly office rent of $2,600.

3 Recorded $8,000 revenue for service rendered to patients on account.


Jan 1: The business received $29,000 cash and issued common stock

– Cash received indicates cash increases• Cash is an Asset; Assets increase with debits

– Issued common stock; indicates equity is increasing• Increase equity with credits

GENERAL JOURNALDATE DESCRIPTION REF DEBIT CREDIT

Jan 1 Cash 29,000

Common Stock 29,000

Issued stock.


Jan. 2: Purchased medical supplies on account, $14,000

– Medical Supplies, an asset, is increasing• Assets increase with debits

– On account, increases accounts payable, a liability• Increase liabilities with credits


Jan 2 Medical supplies 14,000

Accounts payable 14,000

Purchased supplies on account.


Jan. 2: Paid monthly office rent of $2,600– Paid rent, an expense, expense is increasing

• Expenses increase with debits

– Paid cash, cash is an asset• Increase assets with debits


Jan 2 Rent Expense 2,600

Cash 2,600

Paid office rent.


Jan. 3: Recorded $8,000 revenue for service rendered to patients on account

– On account indicates Accounts receivable increase• Accounts receivable is an Asset, Assets increase

with debits– Rendered services, services are revenues, indicates

revenues are increasing

• Increase revenues with credits

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Jan 3 Accounts receivable 8,000

Service revenue 8,000

Performed service on account.


Posting from the Journal to the Posting from the Journal to the LedgerLedger

• Copying amounts from the journal to the ledger


Expanding Debit/Credit Rules to Expanding Debit/Credit Rules to Include Revenues and ExpensesInclude Revenues and Expenses

Assets

Liabilities Liabilities Stockholders’ equity

Stockholders’ equity

+ Common stock + Retained earnings+ Revenues – Expenses– Dividends

+ Common stock + Retained earnings+ Revenues – Expenses– Dividends


Complete Rules of Debit and Complete Rules of Debit and CreditCredit


Normal Balance of an AccountNormal Balance of an Account


Flow of Accounting Data from Flow of Accounting Data from the Journal to the Ledgerthe Journal to the Ledger


Source DocumentsSource Documents• Origin of accounting transactions• Examples:

– Bank deposit tickets– Invoices– Checks– Stock certificates


Cash Common stock

GENERAL JOURNAL

DATE DESCRIPTION REF DEBIT CREDIT

Cash 30,000

Common stock 30,000

Issued stock.

30,000 30,000


Practice Journalizing and Practice Journalizing and Posting Posting Transaction 2Transaction 2

Cash Common stockLand

GENERAL JOURNAL


Land 20,000

Cash 20,000Received payment on account.

30,000 30,00020,000 20,000

10,000



Cash Accounts payableOffice supplies

GENERAL JOURNAL


Office supplies 500

Accounts payable 500Received payment on account.

30,000 20,000

Cash

30,000 20,000

10,000

500500



Cash Service revenue

GENERAL JOURNAL


Cash 5,500

Service revenue 5,500Received payment on account.

30,000 20,000

Cash

30,000 20,000

5,500

5,500


The Ledger Accounts After The Ledger Accounts After PostingPosting


S2-10 : PREPARING A TRIAL BALANCE

• Oakland Floor Coverings, Inc. reported the following summarized data at December 31, 2012. Accounts appear in no particular order.

Revenues $34,000 Other liabilities $18,000

Equipment 45,000 Cash 12,000

Accounts payable 2,000 Expenses 19,000

Common stock 22,000


S2-10 : PREPARING A TRIAL BALANCE

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Oakland Floor Coverings, Inc.

Trial Balance

December 31, 2012

Cash

Equipment

Accounts Payable

Other Liabilities

Common Stock

Revenues

Expenses

$ 12,000 45,000 $ 2,000

18,000 22,000 34,000 19,000 $76,000 $76,000


S2-9: POSTING, BALANCING T-ACCOUNTS, AND PREPARING A TRIAL BALANCE

Use the January transaction data for Ned Brown, M.D., P.C. given in Short Exercise 2-5.

2. After making the journal entries in Short Exercise 2-5, post to the T-accounts. No dates or posting references are required. Compute the balance of each account, and denote it as Bal

Jan 1 The business received $29,000 cash and issued common stock.

2 Purchased medical supplies on account, $14,000.

2 Paid monthly office rent of $2,600.

3 Recorded $8,000 revenue for service rendered to patients on account.



Jan 1 Cash 29,000

Common Stock 29,000

Issued stock.

Cash Common stock

29,000 29,000



Jan 1 Medical supplies 14,000

Accounts payable 14,000

Purchased supplies on account.

Medical supplies Accounts payable

14,000 14,000



Jan 2 Rent Expense 2,600

Cash 2,600

Paid office rent.

Cash Rent expense

2,600 2,60029,000


GENERAL JOURNALDATE DESCRIPTION RE

FDEBIT CREDIT

Jan 3 Accounts receivable 8,000

Service revenue 8,000

Performed service on account.

Accounts receivable Service revenue8,000 8,000


S2-9: COMPUTE THE BALANCE OF EACH ACCOUNT, AND DENOTE IT AS Bal

Service revenue

8,000

Cash

29,000 2,600

Accounts receivable

8,000

Accounts payable

14,000

Common stock

29,000

Medical supplies

14,000

Rent expense

2,600

Bal 26,400 Bal 14,000

Bal 8,000 Bal 8,000

Bal 14,000 Bal 2,600

Bal 29,000


Ned Brown, M.D., P.C.

Trial Balance

January 3, 2012

Cash

Accounts receivable

Medical supplies

Accounts payable

Common stock

Service revenue

Rent expense

Total

$ 26,400 8,000 14,000

$ 14,000 29,000 8,000 2,600 $51,000 $51,000

S2-9: PREPARE THE TRIAL BALANCE


Trial BalanceTrial Balance• Summary of the ledger• Lists all accounts with their balances• Accuracy check

– Debits should equal credits

• NOT a balance sheet


Trial BalanceTrial Balance


Detecting Trial Balance ErrorsDetecting Trial Balance Errors• Search for missing account

• Divide the difference between total debits and total credits by two– Is there a debit/credit balance for this

amount posted in the wrong column?

• Divide out-of-balance amount by nine – Slide–Adding or dropping a zero ($100

instead of $1,000)– Transposition–Reversing two digits ($2,100

instead of $1,200)


Details of the JournalDetails of the Journal


Four-Column AccountFour-Column Account