© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin1 Analyzing and Recording Transactions Chapter 2 2

© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin1

Analyzing and Recording Transactions

Chapter

22


Learning objectiveLearning objective Explain the steps in processing transactions. Describe source documents and their purpose. Describe an account and its use in recording

transactions. Define debits and credits and explain their role in

double-entry accounting. Analyze business transactions using the

accounting equation. Analyze the impact of transactions on accounts. Identify and prepare basic financial statements

and explain how they interpret


Analyzing and Recording ProcessAnalyzing and Recording Process

Transactions: Exchanges of economic consideration between two parties.

External Transactions occur between the

organization and an outside party.

Internal Transactions occur within the

organization.

Events refer to those happenings that affect an entity’s accounting equation and can be reliably measured.


Learning objectiveLearning objective

Describe source documents and their purpose.


Source documentsSource documents

Source documents identify and describe transactions and events entering the accounting process.

They are the sources of accounting information.

Source documents obtained from outside the organization, provide objective and reliable evidence about transactions and events and their amount.


Sales Tickets

Bank Statement

Purchase Orders

Checks

Source DocumentsSource DocumentsBills from Suppliers

Employee EarningsRecord



Describe an account and its use in recording transactions.


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 AnalysisThe 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.


LandLand

EquipmentEquipment

BuildingsBuildings

CashCash

Notes Receivabl

e

Notes Receivabl

e

SuppliesSupplies

Prepaid AccountsPrepaid

Accounts

Accounts ReceivableAccounts

Receivable

AssetAccounts

AssetAccounts

Asset AccountsAsset Accounts


Asset accountAsset account

Cash: reflects a company’s cash balance. Account receivable: held by a seller and refer

to promises of payment from customers to sellers. → credit sales or sales on account

Note receivable: a written promise of another entity to pay a definite sum of money on a specified future date to the holder of the note.

Prepaid account: represent prepayments of future expenses. (ex. prepaid insurance)


Asset accountAsset account

Supplies: belong to asset until they are used. When they are used, their costs are transferred from the asset accounts to expense accounts.

Equipment: When it is used and gets worn down its cost is gradually reported as an expense (called depreciation).


Accrued LiabilitiesAccrued

LiabilitiesUnearned RevenuesUnearned Revenues

Notes PayableNotes

PayableAccounts Payable

Accounts Payable

LiabilityAccountsLiability

Accounts

Liability AccountsLiability Accounts


Liability accountsLiability accounts

Accounts payable: oral or implied promises to pay later, commonly arise from purchases of merchandise.

Note payable: a formal promise, usually denoted by the signing of a promissory note, to pay a future amount.

Accrued liabilities: They are amounts owed that are not yet paid (ex. Wages payable, taxes payable).


Liability accountsLiability accounts

Unearned revenue: a liability that is settled in the future when a company delivers its products or services. When customers pay in advance for products or services (before revenue is earned), the revenue recognition principle requires that the seller consider this payment as unearned revenue (ex. Unearned ticket revenue).


EquityAccounts

EquityAccounts

RevenuesRevenues

Owner’s Capital

Owner’s Capital

Owner’s Withdrawals


ExpensesExpenses

Equity AccountsEquity Accounts


LiabilitiesLiabilities EquityEquityAssetsAssets = +

Equity AccountsEquity Accounts

Owner’s Capital

Owner’s Capital


Owner’s Withdrawals RevenuesRevenues ExpensesExpenses

+ +– –


Equity accountsEquity accounts

Revenues: gross increase in equity from a company’s earnings activities.

Expenses: the cost of assets or services used to earn revenue. Expenses decrease owner’s equity.

Owner investments: the amounts an owner puts into the company.

Owner withdrawals: the amounts take away from the company for personal use.



Define debits and credits and explain their role in double-entry accounting.


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

transactions.

Debits and Credits ( 借 & 貸 )Debits and Credits ( 借 & 貸 )

(Left side) (Right side)Debit Credit

T- Account



Double-Entry AccountingDouble-Entry Accounting

Debit Credit Debit Credit Debit Credit

ASSETS

+ - + -

LIABILITIES

- + - +

EQUITIES

- + - +Normal Balance

Normal Balance

Nomal Balance


RevenuesRevenues ExpensesExpensesOwner’s Capital

Owner’s Capital



__ ++ __

Debit Credit

Capital

- + - + Debit Credit

Withdrawals

+ - + - Debit Credit

Expenses

+ - + -Debit Credit

Revenues

- + - +


EquityEquity

Exh.3.8

Normal Balance

Normal Balance

Normal Balance

Normal Balance



When there is a debited account, there must be a credited account.

The total amount debited must be equal to the total amount credited for each transaction.

The left side is the normal balance side for assets, and the right side is the normal balance side for liabilities and equity.

有借必有貸，借貸必相等。



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


Analyzing and Recording ProcessAnalyzing and Recording Process

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


Dollar amount of debits and credits

Dollar amount of debits and credits

Journalizing TransactionsJournalizing Transactions

Transaction Date

Transaction Date

Transaction explanation

Transaction explanation

Titles of Affected Accounts

Titles of Affected Accounts


General journal (普通日記賬 )General journal (普通日記賬 )

General journal is used to record any transaction and includes the following information about each transaction: (1) date of transaction; (2) titles of affected accounts; (3) dollar amount of each debit and credit, and (4) explanation of the transaction.


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

Balance Column AccountBalance Column Account


11 Identify the account.

Posting Journal EntriesPosting Journal Entries


22 Enter the date.



33Enter the amount and description.



44Enter the journal reference.



55

Compute the balance.



Enter the ledger reference. 66



Analyzing Transactions – An IllustrationAnalyzing Transactions – An Illustration

Analysis:

(1) Cash 101 30,000 C. Taylor, Capital 301 30,000

Double entry:

(1) 30,000Cash 101

(1) 30,000C. Taylor, Capital 301

Posting:



Analyze business transactions using the accounting equation.

Analyze the impact of transactions on accounts.


The accounting equation must remain in balance after each transaction.


Transaction Analysis EquationTransaction Analysis Equation


The accounts involved are:

(1) Cash (asset)

(2) Taylor, Capital (equity)

Chuck Taylor, the owner, contributed $30,000 cash to start the business,

FastForward.

Transaction Analysis (1)Transaction Analysis (1)


Transaction Analysis (1) Transaction Analysis (1)

Chuck Taylor, the owner, contributed $30,000 cash to start the business.



(1) 30,000Cash 101

(1) 30,000C. Taylor, Capital 301

Dr. Cash 30,000

Cr. C. Taylor, Capital 30,000



(1) Cash (asset)

(2) Supplies (asset)


FastForward purchased supplies paying $2,500 cash.



Purchased supplies paying $2,500 cash.



(2) 2,500Supplies 126

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

Dr. Supplies 2,500

Cr. Cash 2,500



(1) Cash (asset)

(2) Equipment (asset)

Transaction Analysis (3) Transaction Analysis (3)

FastForward purchased equipment for testing athletic shoes for $26,000 cash.



Purchased equipment for $26,000 cash.



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

Cash(3) 26,000

Equipment 167 101

Dr. Equipment 26,000

Cr. Cash 26,000



(1) Supplies (asset)

(2) Accounts Payable (liability)


FastForward purchased Supplies of $7,100 on credit from CalTech.



Purchased Supplies of $7100 on credit.



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

Supplies 126

(4) 7,100Accounts Payable 201

Dr. Supplies 7,100

Cr. Accounts Payable 7,100



(1) Cash (asset)

(2) Revenues (equity)


FastForward earned revenues of $4,200 from consulting with clients about test results on

athletic shoes.



Earned revenues of $4,200.



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

Cash

(5) 4,200Consulting Revenue 403 101

Cr. Cash 4,200

Dr. Consulting revenue 4,200


Transaction AnalysisTransaction Analysis

The balances so far appear below. Note that the Balance Sheet Equation is still in balance.

Now let’s look at some other transactions.



(1) Cash (asset)

(2) Expense (equity)

Transaction Analysis (6)(7)Transaction Analysis (6)(7)Paid $1000 rent to the landlord of the building where the store is located, and paid biweekly

$700 salary to employee.


Transaction Analysis (6)(7)Transaction Analysis (6)(7)

Remember that the balance in the rent and salaries expense accounts actually

increases.

But, equity actually decreases because expenses reduce equity.


Transaction Analysis (6) (7)Transaction Analysis (6) (7)Paid $1000 rent to the landlord and biweekly $700 salary to employee.


Transaction Analysis (6) (7)Transaction Analysis (6) (7)

Remember that expenses decrease equity.



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

(6) 1,000

Cash

(6) 1000Rent Expense 640



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

(6) 1,000 (7) 700

Cash

(7) 700Salaries Expense

Dr. Rent Expense 1,000

Dr. Salaries Expense 700

Cr. Cash 1,700



Provided services of $1600 and rent its test facilities for $300. The cash will be received in the future.


(1) Accounts Receivable (asset)

(2) Revenue (equity)



Provided services of $1600 and rent its test facilities for $300.



(8) 1,900Accounts Receivable

(5) 4,200(8) 1,600

Consulting Revenue

(8) 300Rental Revenue

Dr. Accounts Receivable 1,900

Cr. Consulting Revenue 1,600

Cr. Rental Revenue 300



The client in transaction 8 paid $1900 to FastForward 10 days later.

The accounts involved are:(1) Cash (asset) (2) Accounts Receivable (asset)



The client in transaction 8 paid $1900 to Fastforward.



(1) 30,000 (2) 2,500(2) 4,200 (3) 26,000(9) 1,900 (6) 1,000

(7) 700

Cash

(8) 1,900 (9) 1,900Accounts Receivale

Dr. Cash 1,900

Cr. Accounts Receivable 1,900



Paid $900 cash as partial payment for its earlier $7100 purchase of supplies, leaving $6200 unpaid.

The accounts involved are:(1) Cash (asset) (2) Accounts Payable (liability)



Paid $900 cash as partial payment for its earlier purchase on credit.



(10) 900 (4) 7,100Accounts Payable

(1) 30,000 (2) 2,500(2) 4,200 (3) 26,000(9) 1,900 (6) 1,000

(7) 700 (10) 900

Cash

Dr. Accounts Payable 900

Cr. Cash 900



(1) Cash (asset)

(2) Taylor, Withdrawals (equity)

Transaction Analysis (11)Transaction Analysis (11)Taylor withdrew $600 from the

business for personal use.



Remember that the balance in the Taylor, Withdrawals account actually increases.

But, equity actually decreases because withdrawals reduce equity.



Taylor withdrew $600 from the business for personal use.



Remember that withdrawals decrease equity.



(11) 600Taylor, Withdrawals

(1) 30,000 (2) 2,500(2) 4,200 (3) 26,000(9) 1,900 (6) 1,000

(7) 700 (10) 900 (11) 600

Cash

Dr. Taylor, Withdrawals 600

Cr. Cash 600


Ending Balance = Beginning Balance + Total Increase – Total Decrease


Ending balance = Beginning balance + total debits – total creditsEnding balance = Beginning balance + total debits – total credits

(1) 30,000 (2) 2,500(2) 4,200 (3) 26,000(9) 1,900 (6) 1,000

(7) 700 (10) 900 (11) 600

Total Debits 36,100 Total Credits 31,700Ending Balance 4,400

Cash


Ending balance = Beginning balance + total credits – total debitsEnding balance = Beginning balance + total credits – total debits

(10) 900 (4) 7,100Balance 6200

Accounts Payable


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 4,400$ Accounts receivable - Supplies Prepaid Insurance 2,400 Equipment 26,000 Accounts payable 6,200$ Unearned consulting revenue 3,000 C. Taylor, Capital 30,000 C. Taylor, Withdrawals 600 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, 2004

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.

9,270


Searching for and Correcting ErrorsSearching 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 into the ledger.

Make sure account balances are correctly entered into 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.


Using a Trial Balance to Prepare Financial StatementsUsing a Trial Balance to Prepare Financial Statements

Income Statement of Cash Flows

Income Statement

Statement of Owner’s Equity

Beginning Balance Sheet

Ending Balance Sheet

Period of TimePoint inTime

Point inTime



Identify and prepare basic financial statements and explain how they

interpret.


Financial StatementsFinancial StatementsLet’s prepare the Financial Statements

reflecting the transactions we have recorded.

1. Income Statement

2. Statement of Owner’s Equity

3. Balance Sheet

4. Statement of Cash Flows


Financial StatementsFinancial Statements

Income Statement: revenues and expenses together with the how much profit the firm makes.

Statement of Owner’s Equity: reports information how equity changes over the reporting period.

Balance Sheet: a company’s financial position at a point of time.

Statement of cash flows: cash receipts and cash payments over a period of time.


Net income is the difference between

Revenues and Expenses.

The income statement describes a company’s revenues and expenses along with the resulting net income or loss over a period of time due to earnings

activities.


The net income of $4,400 increases

Scott’s capital by $4,400.

The Statement of Owner’s Equity

explains changes in equity from net

income (or net loss) and from

owner investments and withdrawals for

a period of time.


The Balance Sheet describes a company’s

financial position at a point in time.

The Balance Sheet describes a company’s

financial position at a point in time.


The Statement of Cash Flows identifies cash inflows and cash outflows over a period of time.


Net income ÷ Average total assets

ROA is viewed as an indicator of operating

efficiency.

ROA is viewed as an indicator of operating

efficiency.

Return on Assets (ROA)Return on Assets (ROA)


ROA of mobile phone service companies in HKROA of mobile phone service companies in HK

SUNDAY: 0.34% SMARTONE: 9.92% Hutchison Telecommunications: 0.18% PEOPLES: 15.47% City Telecom: 2.94%

- Which company is better?


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 RatioDebt Ratio


Review of Chap 2Review of Chap 2

Identify asset accounts, liability accounts and equity accounts.

Know the meaning of double-entry accounting and how to do journals and post journal entries correctly.

Prepare trial balance and use a trial balance to prepare income statement, statement of owner’s equity and balance sheet statement.

ROA and debt ratio.


Homework of chapter 2Homework of chapter 2

Ex 2-1, 2-3, 2-4, 2-19 Problem 2-1A, 2-4A Due on June 12 (Monday)


End of Chapter 2End of Chapter 2