Analyzing and Recording Transactions Chapter 2 Analyzing and Recording Transactions In this chapter, we are going to discuss in-depth the proper procedures to follow in using the double-entry accounting process. You will find this in-depth look a little confusing as you go through the chapter. By the time we get to the last screen, we think you will see just how the system works. The material discussed in this chapter will be used continuously in the remaining chapters devoted to financial accounting. It is a great idea to go slowly though this chapter material. Let’s start the process with a little review.

Analyzing and Recording Process Record relevant transactions and events in a journal Analyze each transaction and event from source documents Post journal information to ledger accounts We begin the accounting process by analyzing source documents. For example, you usually receive a receipt when you pay cash for something. Think about the last time you went to a fast food restaurant. When you received your order you were given a receipt, a source document. If you want a company to reimburse you for a meal because you were traveling on company business, you must present evidence of your expenditure. This evidence takes the form of a source document, the receipt. Once we identify a business transaction, we record it in a journal. A journal is arranged in chronological order. Transactions are recorded by date of occurrence. At the end of the accounting period, usually a month, transactions in the journal are posted to a ledger account. Posting is the systematic process of transferring information from the journal to the ledger. The ledger groups transactions by the accounts impacted. For example, we will have a ledger account for cash. All transactions that result in increases or decreases in the cash account will be posted to the cash ledger account. Once all transactions have been posted, we prepare a trial balance. The purpose of the trial balance is to make sure that all information has been transferred properly. The trial balance is a listing of all account balances. Prepare and analyze the trial balance 2-2

Employee Earnings Records Source Documents – Transactions are recorded from these items. You do not ever want to record a transaction unless you have paperwork. Bills from Suppliers Checks Purchase Orders Employee Earnings Records Bank Statements Almost all businesses use sales orders, purchase orders, statements from suppliers, canceled checks, bank statements, shipping notices, packing slips, and the like to support the existence of a transaction. In today’s highly computerized environment, many source documents are stored digitally. Knowing how to access these digital source documents is an important part of accounting. Sales Tickets 2-3

C 2 The Account and Its Analysis – We identified accounts on the accounting equation paper An account (cash, supplies, accounts receivable, utility expense, etc…)is a record of increases and decreases in a specific asset, liability, equity, revenue, or expense item. The general ledger is a record containing all accounts used by the company. You can add or remove accounts at any time. Here are more complete definitions of account balances and ledger accounts. 2-4

Ledger and Chart of Accounts The ledger is a collection of all accounts for an Information system. A company’s size and diversity of operations affect the numberof accounts needed. The chart of accounts is a list of all accounts and includes an identifying number for each account. A chart of accounts is a listing of all accounts in the ledger. Notice that all asset accounts begin with an account number of 1, all liabilities with 2, equities with 3, revenues with 4, and expenses with 6. 2-5 5

Chart of Accounts A chart of accounts is a listing of all accounts in the ledger. Notice that all asset accounts begin with an account number of 1, all liabilities with 2, equities with 3, revenues with 4, and expenses with 6.

Debits and Credits C4 A T-account represents a ledger account and is a tool used to understand the effects of one or more transactions. Accountants often use a T-account to represent a general ledger account. It is a quick way to analyze a transaction before we enter the information in the journal. The left side of a T-account is always called the debit side, and the right side is always called the credit side. (This terminology comes from the time when the first double-entry system was developed.) The words do not have any significant meaning other than that they stand for the left and right side of a T-account. To enter amounts on the left side of an account is to debit the account. To enter amounts on the right side is to credit the account. The type of account determines if a debit or credit increases or decreases an account. Refer to accounting equation page we willed out in class. 2-7

Double-Entry Accounting An account balance is the difference between the increases and decreases in an account. Notice the T-Account The final balance is on the side with the larger amount. We have determined the balance in accounts in the last chapter, but in this chapter we will look at a more comprehensive way to determine an account balance. The Cash account is an asset, so increases, or receipts, are shown on the debit, or left, side and decreases, or payments, are shown on the credit, or right, side. To determine if an account has a debit or credit balance, we total the right and left sides and place the balance on the larger side. In this example, our increases in cash amount to $36,100 and the decreases total $31,300 so the Cash account has a debit, or positive, balance of $4,800. 2-8

Journalizing and Posting Transactions Step 1: Analyze transactions and source documents. Liabilities Equity Assets = + Step 2: Apply double-entry accounting Step 3: Record journal entry In the accounting process, we first analyze a transaction by looking at proper source documentation. Next, we apply the rules of double-entry accounting and record a general journal entry. The general journal is a chronological listing of the transactions. At the end of the accounting period, we post the information from the general journal to the proper general ledger account. The general ledger groups all transactions that impact a particular account. That is, all the transactions that increase or decrease the cash account are posted to the cash general ledger account. Step 4: Post entry to ledger 2-9

Journalizing Transactions P1 Journalizing Transactions Transaction Date Titles of Affected Accounts Here is an example of the proper recording of a general journal transaction. We have seen a similar transaction before. In this case, the owner of the business contributes $30,000 cash to start the business and receives shares of common stock. Let’s see how we get the various pieces. Part I The transaction occurred on December 1, 2013. The date is important when recording general journal transactions and is recorded on the left side of the journal. Part II Next we identify the accounts affected by the transactions. Debits are always listed first in the journal followed by credited accounts that will be slightly indented below the debited accounts. The Cash account is an asset that has increased. We show increases in asset accounts with a debit. The common stock account also increased and we show increases in equity accounts with a credit. Part III The dollar amount is placed in the appropriate debit or credit column. In this case, the Cash account was debited for $30,000, so we place that amount in the debit column. Part IV Finally, we prepare a brief description of the transaction so that other people who view our work will understand the nature of the transaction. This explanation is indented about half as far as the credited account titles to avoid confusing it with accounts and can be italicized. Transaction Explanation Dollar Amount of Debits and Credits 2-10

Balance Column Account P1 Balance Column Account T-accounts are useful illustrations, but balance column accounts are used in practice. Here is the balance column account for Cash. It looks similar to your checkbook. We have a debit, or increase column; a credit, or decrease column; and a running balance. You can see the cash receipts and payments. The current balance in the Cash account at December 10, 2013, is $5,700. In the upper right corner of the ledger account, we assign an account number to the Cash account. In computer processing of information, numbers are more efficient to use than alpha characters. When we speak of account number one-zero-one, we are referring to the Cash account. 2-11

Posting Journal Entries 6 Enter the ledger reference into the general journal. Back in the general journal, we enter a posting reference of the account number in the proper column. This tells the accountant that the amount has been posted to account number one-zero-one. Now we can go back and forth between the general journal and the general ledger. This is known as a cross-reference. We would follow the same procedures for the common stock account. Let’s begin using the double-entry accounting system. 2-12

The following examples show the transaction, the analysis of accounts debited and credited and the way it would appear in t-accounts.

Analyzing Transactions Shareholder invested $30,000 in FastForward on Dec. 1 Analysis: Double entry: Let’s see if we can analyze transactions and get them into the proper form for double-entry accounting. This will be helpful when you turn to your homework. In the first transaction, on December 1, Chas Taylor invests $30,000 to start a company called FastForward. From our previous work we know that the Cash account and the Common Stock account will increase. We record this information in the general journal with a debit, increase, to Cash, and a credit, increase, to Common Stock. Notice that the account number for the Cash account is one-zero-one and Common Stock is three-zero-seven. We are going to post the information in the journal to the general ledger. We will use T-accounts to accomplish this. We place the $30,000 on the left, or debit, side of the Cash account and on the right, or credit, side of the Common Stock account. Our books are in balance because total assets are equal to total liabilities plus equity. Let’s move to another transaction. Posting: 101 Common Stock 307 (1) 30,000 2-14

Analyzing Transactions FastForward purchases supplies by paying $2,500 in cash Analysis: Double entry: In our second transaction, FastForward purchases office supplies paying $2,500 cash. We have exchanged one asset, cash, for another asset, supplies. The Cash account will decrease and the Supplies account will increase. Can you make the general journal entry to record this transaction? We increase the Supplies account with a debit and decrease the asset account, Cash, with a credit. Let’s post the amounts. The general ledger account for Supplies increased by $2,500 so the amount is placed on the debit side of the account. The Cash account, an asset, decreased by $2,500, so the amount is placed on the credit side of the general ledger account. Let’s move on to another transaction. 126 101 Posting: 2-15

Analyzing Transactions FastForward purchases equipment by paying $26,000 cash. Analysis: Double entry: In our third transaction, FastForward purchases equipment paying $26,000 cash. Once again, we have exchanged one asset, cash, for another asset, equipment. The Cash account will decrease and the Equipment account will increase. This general journal entry will look similar to the one we just completed. We increase the Equipment account with a debit and decrease the asset account, Cash, with a credit. Let’s post the amounts. The general ledger account for Equipment increased by $26,000 so it is placed on the debit side of the account. The Cash account, an asset, decreased by $26,000, so the amount is placed on the credit side of the general ledger account. Let’s look at another transaction. 167 101 Posting: 2-16

There should be another file showing examples of a couple of problems and how the numbers are calculated for a trial balance, income statement, statement of retained earnings and balance sheet.

P2 Trial Balance After processing its remaining transactions for December, FastForward’s trial balance is prepared. FASTFORWARD Trial Balance December 31, 2013 Debits Credits Cash $ 4,350 Accounts receivable - 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. Supplies 9,720 Prepaid insurance 2,400 Equipment 26,000 Accounts payable $ 6,200 Unearned consulting revenue 3,000 On the trial balance we list all the accounts in our general ledger and their related balances. The total of all our debit account balances must equal all our credit account balances. If this is not the case, we may have made an error posting the journal entry into the ledger. We cannot prepare the financial statements until the books are in balance as determined by the trial balance. Common stock 30,000 Dividends 200 Consulting revenue 5,800 Rental revenue 300 Salaries expense 1,400 Rent expense 1,000 Utilities expense 230 Totals $ 45,300 $ 45,300 2-18

Income Statement P3 Here is the information for FastForward for the month ended December 31, 2013. The company had total revenues of $6,100 and total expenses of $2,630. For the month FastForward generated $3,470 in net income. Look back at the trial balance to verify the amounts shown on the income statement. 2-19

Statement of Retained Earnings P3 The beginning balance in retained earnings was zero because the company was started on December 1, 2013. It earned income of $3,470. During the month, dividends of $200 were paid. The ending balance in retained earnings is $3,270. This amount will appear in the equity section of the balance sheet. Let’s look at the balance sheet now. 2-20

Balance Sheet P3 Total assets equal $42,470. Total liabilities are $9,200 and the equity balance is $33,270. The accounting equation is in balance because assets are equal to liabilities plus equity. 2-21

End of Chapter 2 Wow! We covered a great deal of material in this chapter. The new terms and their meanings will be reinforced by your homework. It is probably a good idea to start on your homework while this presentation is still fresh. Good luck. 2-22