© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Chapter 2 Analyzing and Recording Business Transactions

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-2 Conceptual Learning Objectives C1: Explain the steps in processing transactions C2: Describe source documents and their purpose C3: Describe an account and its use in recording transactions C4: Describe a ledger and a chart of accounts C5: Define debits and credits and explain their role in double-entry accounting

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-3 Analytical Learning Objectives A1: Analyze the impact of transactions on accounts and financial statements A2: Compute the debt ratio and describe its use in analyzing financial performance

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-4 Procedural Learning Objectives P1: Record transactions in a journal and post entries to a ledger P2: Prepare and explain the use of a trial balance P3: Prepare financial statements from business transactions

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-5 External Transactions occur between the organization and an outside party. Internal Transactions occur within the organization. Analyzing and Recording Process Exchanges of economic consideration between two parties. C 1

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-6 Analyze each transaction and event from source documents Analyzing and Recording Process Record relevant transactions and events in a journal Post journal information to ledger accounts Prepare and analyze the trial balance C 1

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-7 Sales Tickets Bank Statements Purchase Orders Checks Source Documents Bills from Suppliers Employee Earnings Records C 2

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-8 An account is a record of increases and decreases in a specific asset, liability, equity, revenue, or expense item. The Account and its Analysis The general ledger is a record containing all accounts used by the company. C 3

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-9 Assets Accounts = The Account and its Analysis + Liability Accounts Equity Accounts C 3

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-10 Land Equipment Buildings Cash Notes Receivabl e Supplies Prepaid Accounts Accounts Receivable Asset Accounts C 3

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-11 Accrued Liabilities Unearned Revenue Notes Payable Accounts Payable Liability Accounts C 3

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-12 Equity Accounts Revenues Common Stock Dividends Expenses Equity Accounts C 3 Retained Earnings Retained Earnings

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-13 Liabilities Equity Assets =+ The Account and its Analysis Common Stock Dividends Revenues Expenses ++ –– C 3

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-14 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 number of accounts needed. The chart of accounts is a list of all accounts and includes an identifying number for each account. C 4

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-15 A T-account represents a ledger account and is a tool used to understand the effects of one or more transactions. Debits and Credits C 5

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-16 Liabilities Equity Assets =+ Double-Entry Accounting Debit Credit ASSETS + - LIABILITIES - + EQUITIES - + C 5

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-17 Revenues Expenses Common Stock Dividends _ _ + + _ _ Debit Credit Stock - + Debit Credit Dividends + - Debit Credit Expenses + - Debit Credit Revenues - + Double-Entry Accounting Equity C 5

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-18 Double-Entry Accounting An account balance is the difference between the increases and decreases in an account. Notice the T-Account C 5

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-19 Journalizing & Posting Transactions Step 1: Analyze transactions and source documents. Liabilities Equity Assets =+ Step 2: Apply double- entry accounting Step 4: Post entry to ledger Step 3: Record journal entry P1

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-20  Dollar amount of debits and credits Journalizing Transactions  Transaction Date  Transaction explanation  Titles of Affected Accounts P1

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-21 T-accounts are useful illustrations, but balance column ledger accounts are used in practice. Balance Column Account P1

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Identify the debit account in ledger. Posting Journal Entries P1

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Enter the date. Posting Journal Entries P1

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Enter the amount and description. Posting Journal Entries P1

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Enter the journal reference. Posting Journal Entries P1

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Compute the balance. Posting Journal Entries P1

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-27 Enter the ledger reference. 6 6 Posting Journal Entries P1

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-28 Analyzing Transactions Analysis: Double entry: Posting: A1

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-29 Analyzing Transactions Analysis: Double entry: Posting: A1

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-30 Analyzing Transactions Double entry: Posting: A1 Analysis:

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-31 Analyzing Transactions Analysis: Double entry: Posting: A1

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-32 Analyzing Transactions Analysis: Double entry: Posting: A1

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-33 After processing its remaining transactions for December, FastForward’s Trial Balance is prepared. DebitsCredits Cash4,350$ Accounts receivable- Supplies9,720 Prepaid Insurance2,400 Equipment26,000 Accounts payable6,200$ Unearned consulting revenue3,000 Common stock30,000 Dividends200 Consulting revenue5,800 Rental revenue300 Salaries expense1,400 Rent expense1,000 Utilities expense230 Total45,300$ $ FastForwar d Trial Balance December 31, 2007 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. A1

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-34 Six Steps for Searching 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 account balances are correctly entered from the ledger.  See if debit or credit accounts are mistakenly placed on the trial balance.  Recompute each account balance in the ledger.  Verify that each journal entry is posted correctly.  Verify that each original journal entry has equal debits and credits. P2

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-35 Using a Trial Balance to Prepare Financial Statements Statement of Cash Flows Income Statement Statement of Retained Earnings Beginning Balance Sheet Ending Balance Sheet Period of Time Point in Time P3

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-36 Income Statement P3

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-37 Statement of Retained Earnings P3

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-38 Balance Sheet P3

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-39 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 Ratio A2

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2-40 End of Chapter 2