1. After studying this chapter, you should be able to: CHAPTER 2 THE RECORDING PROCESS 1 Explain what an account is and how it helps in the recording process. 2 Define debits and credits and explain how they are used to record business transactions. 3 Identify the basic steps in the recording process. 4 Explain what a journal is and how it helps in the recording process.

2. 5 Explain what a ledger is and how it helps in the recording process. 6 Explain what posting is and how it helps in the recording process. 7 Prepare a trial balance and explain its purpose. After studying this chapter, you should be able to: Trial Balance CHAPTER 2 THE RECORDING PROCESS

3. THE ACCOUNT An account is an individual accounting record of increases and decreases in a specific asset, liability, or stockholders’ equity item. A company will have separate accounts for such items as cash, salaries expense, accounts payable, and so on.

4. DEBITS AND CREDITS The terms debit and credit mean left and right, respectively. The act of entering an amount on the left side of an account is called debiting the account and making an entry on the right side is crediting the account. When the debit amounts exceed the credits, an account has a debit balance; when the reverse is true, the account has a credit balance.

5. Cash DebitsCredits 15,000 Example: The owner (stockholder) invests $15,000 cash to start the business. Cash is debited and Common Stock is credited for $15,000. DEBITING AN ACCOUNT

6. CREDITING AN ACCOUNT Example: Monthly rent of $7,000 is paid. Cash is credited as Rent Expense is debited. Cash DebitsCredits 7,000

7. DEBITING AND CREDITING AN ACCOUNT Cash DebitsCredits 15,0007,000 8,000 Example: Cash is debited for $15,000 and credited for $7,000, leaving a debit balance of $8,000.

8. DOUBLE-ENTRY SYSTEM In a double-entry system, equal debits and credits are made in the accounts for each transaction. Total debits will always equal total credits and the accounting equation will always stay in balance. AssetsLiabilitiesEquity

9. ILLUSTRATION 2-3 DEBIT AND CREDIT EFFECTS - ASSETS AND LIABILITIES DebitsCredits Increase assets Decrease assets Decrease liabilities Increase liabilities

10. NORMAL BALANCE Normal balance is the side where an increase in the account is recorded. Every account has a normal balance, whether it is a debit or credit. The opposite side entries should not exceed the normal balance.

11. Normal Normal Balance Balance Assets Liabilities Increase Decrease Decrease Increase Debit Credit Debit Credit ILLUSTRATION 2-4 NORMAL BALANCES - ASSETS AND LIABILITIES

12. ILLUSTRATION 2-5 DEBIT AND CREDIT EFFECT - COMMON STOCK DebitsCredits Decrease common stock Increase common stock

13. ILLUSTRATION 2-6 NORMAL BALANCE - COMMON STOCK Common Stock Decrease Increase Debit Credit Normal Balance

14. Decrease Increase Debit Credit Normal Balance ILLUSTRATION 2-7 DEBIT AND CREDIT EFFECT AND NORMAL BALANCE - RETAINED EARNINGS Retained Earnings

15. Dividends Increase Decrease Debit Credit Normal Balance ILLUSTRATION 2-8 DEBIT AND CREDIT EFFECT AND NORMAL BALANCE - DIVIDENDS

16. ILLUSTRATION 2-9 DEBIT AND CREDIT EFFECTS - REVENUES AND EXPENSES Decrease revenues Increase revenues Increase expenses Decrease expenses DebitsCredits

17. ILLUSTRATION 2-10 NORMAL BALANCES - REVENUES AND EXPENSES Normal Normal Balance Balance Revenues Expenses Decrease Increase Increase Decrease Debit Credit Debit Credit

18. ILLUSTRATION 2-11 STOCKHOLDERS ’ EQUITY RELATIONSHIPS Stockholders ’ Equity Balance Sheet Common Stock (Investments by stockholders) Retained Earnings (Net income retained in business) Retained Earnings Statement Dividends Net income or Net loss (Revenues less expenses) Income Statement

19. Dr. Revenues - + ILLUSTRATION 2-12 EXPANDED BASIC EQUATION AND DEBIT/CREDIT RULES AND EFFECTS Expanded Basic Equation + Assets Dr.Cr. + - Liabilities Dr.Cr. - + Dr.Cr. Retained Earnings - + Dr.Cr. Common Stock - + + Cr. + Basic Equation Liabilities Assets + Stockholders’ Equity = = - Dr.Cr. Expenses + - - Dr.Cr. + - Dividends

20. The basic steps in the recording process are: 1.Analyze each transaction in terms of its effect on the accounts. 2.Enter the transaction information in a journal (book of original entry). 3.Transfer the journal information to the appropriate accounts in the ledger (book of accounts). STEPS IN THE RECORDING PROCESS

21. ILLUSTRATION 2-13 THE RECORDING PROCESS 1 Analyze each transaction 2 Enter transaction in a journal 3 Transfer journal information to ledger accounts JOURNAL LEDGER

22. THE JOURNAL Transactions are initially recorded in chronological order in a journal before being transferred to the accounts. Every company has a general journal which contains: 1 spaces for dates, 2 account titles and explanations, 3 references, and 4 two amount columns.

23. The journal makes several significant contributions to the recording process: 1 It discloses in one place the complete effect of a transaction. 2 It provides a chronological record of transactions. 3 It helps to prevent or locate errors because the debit and credit amounts for each entry can be readily compared. THE JOURNAL

24. JOURNALIZING Entering transaction data in the journal is known as journalizing. Separate journal entries are made for each transaction. A complete entry consists of: 1 the date of the transaction, 2 the accounts and amounts to be debited and credited, and 3 a brief explanation of the transaction.

25. ILLUSTRATION 2-14 TECHNIQUE OF JOURNALIZING The date of the transaction is entered in the date column.

26. The debit account title is entered at the extreme left margin of the Account Titles and Explanation column. The credit account title is indented on the next line. ILLUSTRATION 2-14 TECHNIQUE OF JOURNALIZING

27. The amounts for the debits are recorded in the Debit column and the amounts for the credits are recorded in the Credit column. ILLUSTRATION 2-14 TECHNIQUE OF JOURNALIZING

28. A brief explanation of the transaction is given. ILLUSTRATION 2-14 TECHNIQUE OF JOURNALIZING

29. A space is left between journal entries. The blank space separates individual journal entries and makes the entire journal easier to read. ILLUSTRATION 2-14 TECHNIQUE OF JOURNALIZING

30. The Ref. column is left blank at the time journal entry is made and is used later when the journal entries are transferred to the ledger accounts. ILLUSTRATION 2-14 TECHNIQUE OF JOURNALIZING

31. THE LEDGER The entire group of accounts maintained by a company is referred to as the ledger. A general ledger contains all the assets, liabilities, and stockholder’s equity accounts. GENERAL LEDGER

32. Individual Liabilities Individual Assets Individual Stockholders’ Equity ILLUSTRATION 2-16 THE GENERAL LEDGER Equipment Land Supplies Cash Salaries Expense Service Revenue Common Stock Retained Earnings Interest Payable Salaries Payable Notes Payable Accounts Payable

33. Sept. 1J115,000 COMMON STOCK NO. 311 ExplanationRef.DebitCredit 2002 J115,000 GENERAL JOURNAL J1 DateAccount Titles and ExplanationRef.DebitCredit 2002 Sept. 1Cash10115,000 Common Stock31115,000 (issued shares of stock for cash) GENERAL LEDGER CASH NO. 101 DateExplanationRef.DebitCreditBalance 2002 DateBalance Sept. 115,000 ILLUSTRATION 2-18 POSTING A JOURNAL ENTRY In the ledger, enter in the appropriate columns of the account (s) debited the date, journal page, and debit amount shown in the journal. COMMON STOCK

34. Sept. 1J115,000 COMMON STOCK NO. 311 DateExplanationRef.DebitCreditBalance 2001 Sept. 1 J1 GENERAL JOURNAL J1 DateAccount Titles and ExplanationRef.DebitCredit 2002 Sept. 1Cash10115,000 Common Stock 311 15,000 (issued shares of stock for cash) GENERAL LEDGER CASH NO. 101 DateExplanationRef.DebitCreditBalance COMMON STOCK 15,000 In the reference column of the journal, write the account number to which the debit amount was posted. ILLUSTRATION 2-18 POSTING A JOURNAL ENTRY 2002 Sept 1 2002 Sept 1

35. Sept. 1J115,000 COMMON STOCK NO. 311 DateExplanationRef.DebitCreditBalance 2002 Sept. 1J115,000 In the ledger, enter in the appropriate columns of the account(s) credited the date, journal page, and credit amount shown in the journal. ILLUSTRATION 2-18 POSTING A JOURNAL ENTRY

36. Sept. 1J115,000 COMMON STOCK NO. 311 DateExplanationRef.DebitCreditBalance 2002 Sept. 1J115,000 In the reference column of the journal, write the account number to which the credit amount was posted. ILLUSTRATION 2-18 POSTING A JOURNAL ENTRY

37. Most companies have a chart of accounts that lists the accounts and the account numbers which identify their location in the ledger. ILLUSTRATION 2-19 CHART OF ACCOUNTS

38. Basic Analysis Debit -Credit Analysis Transaction October 1, stockholders invest $10,000 cash in an advertising venture to be known as the Pioneer Advertising Agency Inc. The asset Cash is increased $10,000, and stockholders’ equity (specifically Common Stock) is increased $10,000. Debits increase assets: debit Cash $10,000. Credits increase stockholders’ equity: credit Common Stock $10,000. ILLUSTRATION 2-20 INVESTMENT OF CASH BY STOCKHOLDERS

39. Journal Entry Posting ILLUSTRATION 2-20 INVESTMENT OF CASH BY STOCKHOLDERS 10,000

40. ILLUSTRATION 2-21 PURCHASE OF OFFICE EQUIPMENT Basic Analysis Debit -Credit Analysis Transaction October 1, office equipment costing $5,000 is purchased by signing a 3-month, 12%, $5,000 note payable. The asset Office Equipment is increased $5,000, and the liability Notes Payable is increased $5,000. Debits increase assets: debit Office Equipment $5,000. Credits increase liabilities: credit Notes Payable $5,000.

41. Posting Journal Entry 5,000 5,000 ILLUSTRATION 2-21 PURCHASE OF OFFICE EQUIPMENT 5,000

42. ILLUSTRATION 2-22 RECEIPT OF CASH FOR FUTURE SERVICE Basic Analysis Debit -Credit Analysis Transaction October 2, a $1,200 cash advance is received from R. Knox, a client, for advertising services that are expected to be completed by December 31. The asset Cash is increased $1,200; the liability Unearned Revenue is increased $1,200 because the service has not been rendered yet. Note that although many liabilities have the word “payable” in their title, unearned revenues are considered a liability even though the word payable is not used. Debits increase assets: debit Cash $1,200. Credits increase liabilities: credit Unearned Revenues $1,200.

43. Journal Entry Posting Unearned Rev 209 Oct. 2 1,200 ILLUSTRATION 2-22 RECEIPT OF CASH FOR FUTURE SERVICE

44. ILLUSTRATION 2-23 PAYMENT OF MONTHLY RENT Transaction October 3, office rent for October is paid in cash, $900. Basic Analysis The expense Rent is increased $900 because the payment pertains only to the current month; the asset Cash is decreased $900. Debit-Credit Analysis Debits increase expenses: debit Rent Expense $900. Credits decrease assets: credit Cash $900.

45. Journal Entry Posting Rent Expense 729 Oct. 3 900 ILLUSTRATION 2-23 PAYMENT OF MONTHLY RENT

46. ILLUSTRATION 2-24 PAYMENT FOR INSURANCE Transaction October 4, $600 is paid for a one-year insurance policy that will expire next year on September 30. Basic Analysis The asset Prepaid Insurance is increased $600 because the payment extends to more than the current month; the asset Cash is decreased $600. Note that payments of expenses that will benefit more than one accounting period are identified as prepaid expenses or prepayments. When a payment is made, an asset account is debited in order to show the service or benefit that will be received in the future. Debit -Credit Analysis Debits increase assets: debit Prepaid Insurance $600. Credits decrease assets: credit Cash $600.

47. Journal Entry Posting Cash 101 Oct. 1 10,000 Oct. 3 900 2 1,200 4 600 ILLUSTRATION 2-24 PAYMENT FOR INSURANCE

48. ILLUSTRATION 2-25 PURCHASE OF SUPPLIES ON CREDIT Basic Analysis Debit -Credit Analysis Transaction October 5, an estimated 3-month supply of advertising materials is purchased on account from Aero Supply for $2,500. The asset Advertising Supplies is increased $2,500; the liability Accounts Payable is increased $2,500. Debits increase assets: debit Advertising Supplies $2,500. Credits increase liabilities: credit Accounts Payable $2,500.

49. Journal Entry Posting 2,500 ILLUSTRATION 2-25 PURCHASE OF SUPPLIES ON CREDIT

50. ILLUSTRATION 2-26 HIRING OF EMPLOYEES Basic Analysis Debit -Credit Analysis Transaction October 9, hire four employees to begin work on October 15. Each employee is to receive a weekly salary of $500 for a 5-day work week, payable every 2 weeks - - first payment made on October 26. A business transaction has not occurred. There is only an agreement between the employer and the employees to enter into a business transaction beginning on October 15. A debit-credit analysis is not needed because there is no accounting entry.

51. ILLUSTRATION 2-27 DECLARATION AND PAYMENT OF DIVIDEND BY CORPORATION ILLUSTRATION 2-27 DECLARATION AND PAYMENT OF DIVIDEND BY CORPORATION Basic Analysis Debit -Credit Analysis Transaction October 20, the board of directors declares and pays a $500 cash dividend to stockholders. The dividends account is increased $500; the asset Cash is decreased $500. Debits increase dividends: debit Dividends $500. Credits decrease assets: credit Cash $500.

52. Journal Entry Posting Dividends 332 Oct. 20 500 ILLUSTRATION 2-27 DECLARATION AND PAYMENT OF DIVIDEND BY CORPORATION ILLUSTRATION 2-27 DECLARATION AND PAYMENT OF DIVIDEND BY CORPORATION

53. ILLUSTRATION 2-28 PAYMENT OF SALARIES Basic Analysis Debit -Credit Analysis Transaction October 26, employee salaries of $4,000 are owed and paid in cash. (See October 9 transaction.) The expense account Salaries Expense is increased $4,000; the asset Cash is decreased $4,000. Debits increase expenses: debit Salaries Expense $4,000. Credits decrease assets: credit Cash $4,000.

54. Journal Entry Posting 4,000 ILLUSTRATION 2-28 PAYMENT OF SALARIES

55. ILLUSTRATION 2-29 RECEIPT OF CASH FOR FEES EARNED Basic Analysis Debit -Credit Analysis Transaction October 31, received $10,000 in cash from Copa Company for advertising services rendered in October. The asset Cash is increased $10,000; the revenue acct. Service Revenue is increased $10,000. Debits increase assets: debit Cash $10,000. Credits increase revenues: credit Service Revenue $10,000.

56. Journal Entry Posting S ervice Revenue 400 Oct. 31 10,000 10.000 10,000 ILLUSTRATION 2-29 RECEIPT OF CASH FOR FEES EARNED

57. THE TRIAL BALANCE A trial balance is a list of accounts and their balances at a given time. The primary purpose of a trial balance is to prove the mathematical equality of debits and credits after posting. A trial balance also uncovers errors in journalizing and posting. The steps for preparing a trial balance are: 1 List the account titles and their balances. 2 Total the debit and credit columns. 3 Prove the equality of the two columns.

58. PIONEER ADVERTISING AGENCY Trial Balance October 31, 2002 DebitCredit Cash$ 15,200 Advertising Supplies2,500 Prepaid Insurance600 Office Equipment5,000 Notes Payable$ 5,000 Accounts Payable2,500 Unearned Revenue1,200 Common Stock10,000 Dividends500 Service Revenue10,000 Salaries Expense4,000 Rent Expense900 $ 28,700 ILLUSTRATION 2-32 A TRIAL BALANCE The total debits must equal the total credits.

59. LIMITATIONS OF A TRIAL BALANCE A trial balance does not prove that all transactions have been recorded or that the ledger is correct. Numerous errors may exist even though the trial balance columns agree. The trial balance may balance even when: 1 a transaction is not journalized, 2 a correct journal entry is not posted, 3 a journal entry is posted twice, 4 incorrect accounts are used in journalizing or posting, 5 offsetting errors are made in recording the amount of the transaction.