1. Recording Business Transactions
Chapter 2
Recording Business Transactions

2. The Accounting Process
Record
transactions
in the journal
Copy (post) to
the ledger
This diagram summarizes the accounting process covered in this chapter. Accountants record transactions first in a journal, which is the chronological record of transactions. Accountants then post (copy) the data to the book of accounts called the ledger. A list of all the ledger accounts and their balances is called a trial balance. The third step is to prepare a trial balance. This is a listing of all the accounts and their amounts. All of these steps and terms will be explained later in this presentation.
Prepare the
trial balance

3. The 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 Account is a detailed record of all the changes that have occurred in a particular asset, liability, or stockholders’ equity. Accounts are grouped in three broad categories, according to the accounting equation: Assets = Liabilities + Stockholder’s equity.

4. The Journal and The Ledger
Chronological record of transactions
Organized by date
Ledger
The book holding all the accounts and their balances
Organized by account
Accountants first record transactions in a journal, which is the chronological record of transactions. The transactions are posted to the appropriate accounts in the ledger – the “book” where account balances are maintained. The journal is organized by date and the ledger is organized by account.
If you want to see a particular transaction, you would look in the journal. If you want to look at the activity in a particular account, such as Cash, you would go to the ledger.

5. Trial Balance Listing of all accounts and their balances
A list of all the ledger accounts and their balances is called a trial balance. It is shown in order of account types: Assets, Liabilities, Equity, Dividends, Revenues, and Expenses.

6. Assets
Economic resources that will benefit the business in the future:
Cash
Accounts receivable
Notes receivable
Prepaid expenses
Land
Building
Equipment, Furniture, Fixtures
Assets are economic resources that will benefit the business in the future, or simply, something that the business owns that has value. Most firms use the following asset accounts:
1. Cash: This account is a record of the cash effects of transactions. Cash includes money, such as a bank balance, paper currency, coins, and checks.
2. Accounts Receivable: Most businesses sell goods or services in exchange for a promise of future cash receipts. Such sales are made on credit (“on account”), and Accounts receivable is the account that holds these amounts.
3. Notes Receivable: A business may sell goods or services and receive a note receivable, also called a promissory note. A note receivable is a written pledge that the customer will pay a fixed amount of money by a certain date.
4. Prepaid Expenses: A business often pays certain expenses, such as rent and insurance, in advance. A prepaid expense is an asset because the prepayment provides a future benefit. Prepaid rent, Prepaid insurance, and Office supplies are separate prepaid expense accounts.
5. Land: This account shows the cost of land a business holds for use in operations.
6. Building: The cost of buildings—an office or a warehouse—appears in this account.
7. Equipment, Furniture, and Fixtures: A business has a separate asset account for each type of equipment—Computer equipment, Office equipment, and Store equipment, for example. The Furniture account shows the cost of this asset. Similarly, the Fixtures account shows the cost of light fixtures and shelving, for example.

7. Liabilities A debt (something owed): Accounts payable Notes payable
Accrued liabilities
Liabilities are debts owed to outsiders. Shown here are common liability accounts:
1. Accounts payable is the opposite of Accounts receivable. The promise to pay a debt arising from a credit purchase is an Account payable. Such a purchase is said to be made on account.
2. Notes payable is the opposite of Notes receivable. Notes payable represents debts the business owes because it signed promissory notes to borrow money or to purchase something.
3. An accrued liability is an expense for which the business knows the amount owed but the bill has not been paid. Taxes payable, Interest payable, and Salary payable are accrued liability accounts.

8. Stockholders’ Equity Owners’ claim to the assets: Common stock
Retained earnings
Dividends
Revenues
Expenses
The owners’ claim to the assets of the business is called stockholders’ equity. A corporation has separate accounts for the various elements of stockholders’ equity.
1. Paid-in capital is paid into the corporation by outsiders. This is done most often thru the purchase of common stock.
2. The Common stock account is paid-in capital from the issuance of stock by the corporation. All corporations have common stock, and the common stockholders are the owners of the business.
3. A business must earn a profit to remain in operation. The Retained earnings account shows the cumulative net income earned by the corporation over its lifetime, minus cumulative net losses and dividends. The title Retained earnings is thus well chosen—earnings kept (retained) by the business.
4. The stockholders often demand cash from a corporation. After profitable operations, the board of directors may declare a dividend to be paid in cash at a later date. Dividends are not required. They are optional and depend upon the action of the board of directors. The corporation can keep a separate account titled Dividends, which indicates a decrease in Retained earnings.
5. The increase in equity created by delivering goods or services to customers is called revenue. The ledger contains as many revenue accounts as needed. If a company lends money to an outsider, it needs an Interest revenue account for the interest earned on the loan. If the business rents out a building to a tenant, it needs a Rent revenue account.
6. Expenses use up assets or create liabilities in the course of operating a business. Expenses have the opposite effect of revenues. Expenses decrease equity. A business needs a separate account for each type of expense, such as Salary expense, Rent expense, Advertising expense, and Utilities expense. Businesses strive to minimize their expenses in order to maximize net income.

9. Ledger Asset, Liability, and Stockholders’ equity Accounts
The ledger is the book holding all the accounts with their balances. Each individual account has a “page” in the ledger.

10. Double 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)
Accounting uses the double-entry system, which means that we record the dual effects of each transaction. As a result, every transaction affects at least two accounts. It would be incomplete to record only the giving side, or only the receiving side, of a transaction. For example, a company purchases supplies (which represents receiving) and pays cash (which represents giving). Or, the company issues, or gives, stock and receives cash.

11. T-Account
Tool for analyzing and determining the balance in a given account
Account Name
(Left Side)
(Right Side) Dr
Debit Cr
Credit
A shortened form of the general ledger account is called the T-account because it takes the form of the capital letter T. The vertical line divides the account into its left and right sides, with the title at the top. The left side of the account is called the Debit (dr) side, and the right side is called the Credit (cr) side. The account category (asset, liability, equity) determines how to record increases and decreases. For any given account, increases are recorded on one side, and decreases are recorded on the opposite side. To become comfortable using these terms, remember the following: Debit = Left, Credit = Right.
The words debit and credit abbreviate the Latin terms debitum and creditum.

12. Increases and Decreases in Accounts
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
Whether an account is increased or decreased by a debit or a credit depends on the type of account. Debits are not "good" or "bad." Neither are credits. Debits are not always increases or–neither are credits.
Remember, we create accounts as needed. The process of creating a new account is called opening the account.

13. Rules of Debit and Credit
The account category governs the increase side or decrease side
Increases are recorded on one side
Decreases are recorded on the opposite side
Rules of debits and credits
Assets are on the left side of the accounting equation and debits are on the left side of a T-account. Therefore, assets are increased by debits.
Liabilities and equity are on the right side of the equation, and credits are on the right side of a T-Account. Therefore, liabilities and equity are increased by credits.

14. Illustrate 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
To illustrate the idea of debits and credits, let us look at a transaction. The first transaction involves receiving $30,000 cash and issuing common stock. The business’s assets and equity would increase by $30,000.
The second transaction is a $20,000 purchase of land for cash. Cash has a $10,000 debit balance (from decreasing cash for the $20,000) and Land has a debit balance of $20,000Common stock has a $30,000 credit balance. Both assets, cash and land are equal to the common stock account.
The accounting equation must always balance after each transaction is recorded. To achieve this balance, we record transactions using a double entry accounting system. Debits ALWAYS equal credits.

15. 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.
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 increases in the Liabilities, Stockholders’ equity, Retained earnings and revenues.
The exercise continues on this slide, where we review the rules of debits and credits.
Credits are decreases in the Assets, Dividends, and Expenses.

16. Steps in the Transaction Recording Process
Identify each account affected and its type
Determine if each account is increased or decreased
Record transaction in the journal
Use the rules of debit and credit
In practice, accountants record transactions in a journal. The journalizing process has three steps:
Identify each account affected and its type (Asset, Liability, or Stockholders’ equity).
Determine whether each account is increased or decreased. Use the rules of debit and credit.
3. Record the transaction in the journal, including a brief explanation. The debit side of the entry is entered first. Total debits should always equal total credits. This step is also called “making the journal entry” or “journalizing the transaction.”
These steps are the same whether done by computer or manually.

17. Illustrating 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.
Let’s journalize the first transaction of Smart Touch Learning—the receipt of $30,000 cash and issuance of common stock.
STEP 1: The accounts affected by the receipt of cash and issuance of stock are Cash and Common stock. Cash is an asset; Common stock is equity.
STEP 2: Both accounts increase by $30,000. Assets increase with debits. Therefore, we debit Cash because it is an asset. Equity increases in the business because common stock was issued. To increase equity, we credit. Therefore, we credit the Common stock account.
STEP 3: The journal entry is shown.

18. Illustrating a Journal Entry (continued)
Four parts:
Date of transaction
Title of account debited with dollar amount
Title of account credited with dollar amount
Brief explanation of transaction
The journal entry includes four parts:
Date of the transaction
Title of the account debited, along with the dollar amount
Title of the account credited, along with the dollar amount
Brief explanation of the transaction
Dollar signs are omitted because it is understood that the amounts are in dollars.

19. 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.
Paid monthly office rent of $2,600. 3
Recorded $8,000 revenue for service rendered to patients on account.
In Short Exercise 2-5, we see that Ned Brown opened a medical practice in San Diego, California. We record the transactions in the journal.

20. S2-5: JOURNALIZING TRANSACTIONS
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 JOURNAL
DATE
DESCRIPTION
REF
DEBIT
CREDIT
Jan 1 Cash ,000
The exercise continues on this slide.
Common Stock ,000
Issued stock.

21. S2-5: JOURNALIZING TRANSACTIONS
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
GENERAL JOURNAL
DATE
DESCRIPTION
REF
DEBIT
CREDIT
Jan 2 Medical supplies ,000
The exercise continues on this slide.
Accounts payable ,000
Purchased supplies on account.

22. S2-5: JOURNALIZING TRANSACTIONS
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
GENERAL JOURNAL
DATE
DESCRIPTION
REF
DEBIT
CREDIT
Jan 2 Rent Expense ,600
On this slide, we continue recording transactions.
Cash ,600
Paid office rent.

23. S2-5: JOURNALIZING TRANSACTIONS
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
GENERAL JOURNAL
DATE
DESCRIPTION
REF
DEBIT
CREDIT
The exercise continues on this slide.
Jan 3 Accounts receivable ,000
Service revenue ,000
Performed service on account.

24. Posting from the Journal to the Ledger
Copying amounts from the journal to the ledger
Journalizing a transaction records the data only in the journal—but not in the ledger. The data must also be copied to the ledger. The process of copying from the journal to the ledger is called posting.
Debits in the journal are posted as debits in the ledger and credits as credits—no exceptions.

25. Expanding Debit/Credit Rules to Include Revenues and Expenses
Assets
Liabilities
Stockholders’ equity
+ Common stock + Retained earnings
+ Revenues – Expenses
– Dividends
As we have noted, revenues are increases in equity that result from providing goods or services for customers. Expenses are decreases in equity that result from using up assets or increasing liabilities in the course of operations. Revenues are earned. Expenses are incurred. Therefore, we must expand the accounting equation to include revenues and expenses. There are several elements of stockholders’ equity.

26. Complete Rules of Debit and Credit
We can now express the rules of debit and credit in complete form as shown. Note that the accounting equation now includes revenues and expenses.

27. Normal Balance of an Account
An account’s normal balance appears on the side—either debit or credit—where we record an increase (+) in the account’s balance.
To summarize the debit and credit rules, remember that the normal balance of assets, dividends, and expenses are debits. The normal balance of liabilities, retained earnings, common stock, and revenues are credits. The normal balance is also what increases the account.

28. Flow of Accounting Data from the Journal to the Ledger
A transaction occurs and is recorded on a source document. Then, we identify the account names affected by the transaction and determine whether the accounts increased or decreased using the rules of debit and credit for the six main account types. We then record in the journal, listing the debits first. Debits must equal credits. Then, we post all transactions to the ledger in the T-account.

29. Source Documents Origin of accounting transactions Examples:
Bank deposit tickets
Invoices
Checks
Stock certificates
Accounting data come from source documents. There are many different types of source documents in business. For example, the bank deposit ticket is the document that shows the amount of cash received by the business, and the stock certificate issued by the company shows the number of stock shares issued. When a business buys supplies on account, the vendor sends an invoice requesting payment. The purchase invoice is the source document that tells the business to pay the vendor.

30. Practice Journalizing and Posting Transaction 1
Cash
Common stock
30,000
30,000
GENERAL JOURNAL
DATE
DESCRIPTION
REF
DEBIT
CREDIT
Cash
30,000
Common stock
Issued stock.
In Transaction 1, we see that Smart Touch received $30,000 cash on April 1 from Sheena Bright and issued common stock to her. The business deposited the money in its bank account, as shown in the text in the following deposit ticket:
To post the transaction, the amounts are transferred to the appropriate T-account by debiting Cash for $30,000 and crediting Common stock for $30,000.

31. Practice Journalizing and Posting Transaction 2
Cash
Land
Common stock
30,000
20,000
20,000
30,000
10,000
GENERAL JOURNAL
DATE
DESCRIPTION
REF
DEBIT
CREDIT
Land
20,000
Cash
Received payment on account.
In Transaction 2, we see that on April 2, Smart Touch paid $20,000 cash for land. The purchase decreased cash. Therefore, we credit Cash. The asset–land–increased, so we debit the Land account.
This transaction is also posted to the appropriate T-accounts. Cash and Common stock each have one transaction posted to their T-accounts. Therefore, that amount is their current balance. Now post the new transaction. Debit Land for $20,000 and credit Cash for $20,000.
To determine the balance of Cash, use the rules of debit and credit. Since Cash is an asset, the balance is calculated as +30,000 – 20,000 = 10,000. The balance in Cash after the two transactions is $10,000.

32. Practice Journalizing and Posting Transaction 3
Cash
Cash
Office supplies
Accounts payable
30,000
30,000
20,000
20,000
500
500
10,000
GENERAL JOURNAL
DATE
DESCRIPTION
REF
DEBIT
CREDIT
Office supplies
500
Accounts payable
Received payment on account.
In Transaction 3, Smart Touch purchased $500 of office supplies on account on April 3, as shown on the purchase invoice provided in the text. On account means to charge it to an account and pay it later.
To post the transaction, the amounts are transferred to the appropriate T-account by debiting Office supplies for $500 and crediting Accounts payable for $500.

33. Practice Journalizing and Posting Transaction 4
Cash
Cash
Service revenue
30,000
30,000
20,000
20,000
5,500
5,500
GENERAL JOURNAL
DATE
DESCRIPTION
REF
DEBIT
CREDIT
Cash
5,500
Service revenue
Received payment on account.
In Transaction 4, we see that on April 8, Smart Touch collected cash of $5,500 for service revenue that the business earned by providing e-learning services for clients. The source document is Smart Touch’s sales invoice in the text. Debit cash for $5,500 and credit Service revenue $5,500. The rest of the transactions are found in the text.

34. The Ledger Accounts After Posting
The ledger accounts after posting all of the transactions are shown here and on Page 79 in the text.

35. S2-10 : PREPARING A TRIAL BALANCE
Oakland Floor Coverings, Inc. reported the following summarized data at December 31, 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
In Short Exercise 2-10, you’re asked to prepare a trial balance.

36. S2-10 : PREPARING A TRIAL BALANCE
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, $76,000
The exercise continues on this slide.

37. 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 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.
Paid monthly office rent of $2,600. 3
Recorded $8,000 revenue for service rendered to patients on account.
In Short Exercise 2-9, we post the journal entries from a previous exercise to T-accounts.

38. S2-5 : JOURNALIZING TRANSACTIONS
GENERAL JOURNAL
DATE
DESCRIPTION
REF
DEBIT
CREDIT
Jan 1 Cash ,000
Common Stock ,000
Issued stock.
Cash
Common stock
We continue the exercise on this slide.
29,000
29,000

39. S2-5 : JOURNALIZING TRANSACTIONS
GENERAL JOURNAL
DATE
DESCRIPTION
REF
DEBIT
CREDIT
Jan 1 Medical supplies ,000
Accounts payable ,000
Purchased supplies on account.
Medical supplies
Accounts payable
We continue posting to T-accounts on this slide.
14,000
14,000

40. S2-5 : JOURNALIZING TRANSACTIONS
GENERAL JOURNAL
DATE
DESCRIPTION
REF
DEBIT
CREDIT
Jan 2 Rent Expense ,600
Cash ,600
Paid office rent.
Cash
Rent expense
The exercise continues on this slide.
29,000
2,600
2,600

41. S2-5 : JOURNALIZING TRANSACTIONS
GENERAL JOURNAL
DATE
DESCRIPTION
REF
DEBIT
CREDIT
Jan Accounts receivable ,000
Service revenue ,000
Performed service on account.
Accounts receivable
Service revenue
The exercise continues on this slide.
8,000
8,000

42. S2-9: COMPUTE THE BALANCE OF EACH ACCOUNT, AND DENOTE IT AS Bal
Cash
29,000
2,600
Accounts payable
14,000
Common stock
29,000
Bal 14,000
Bal 26,400
Bal 29,000
Accounts receivable
8,000
Service revenue
8,000
Bal 8,000
Bal 8,000
Medical supplies
14,000
Rent expense
2,600
We return to Short Exercise 2-9 to compute the balance of each account.
Bal 14,000
Bal 2,600

43. S2-9: PREPARE THE TRIAL BALANCE
3. Prepare the trial balance, complete with a proper heading, at January 3, 2012.
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
2,600
$51, $51,000
To continue the exercise, we prepare a trial balance.

44. Trial Balance Summary of the ledger
Lists all accounts with their balances
Accuracy check
Debits should equal credits
NOT a balance sheet
A trial balance summarizes the ledger by listing all the accounts with their balances—assets first, followed by liabilities, and then stockholders' equity. In a manual accounting system, the trial balance provides an accuracy check by showing whether total debits equal total credits. In all types of systems, the trial balance is a useful summary of the accounts and their balances because it shows the balances on a specific date for all accounts in a company's accounting system. Do not confuse the trial balance with the balance sheet. A trial balance is an internal document used only by company insiders. Outsiders see only the company’s financial statements, not the trial balance.

45. Trial Balance
Shown is the trial balance of Smart Touch at April 30, 2013, the end of the first month of operations, created from the balances calculated after all transactions have been posted. Notice the debit total equals the credit total.

46. Detecting 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)
Throughout the accounting process, total debits should always equal total credits. If they don't, there is an error. Errors can be detected by computing the difference between total debits and total credits on the trial balance. Then perform one or more of the following actions:
Search the trial balance for a missing account. Trace each account from the ledger to the trial balance, and you will locate the missing account.
Divide the difference between total debits and total credits by 2. A debit treated as a credit, or vice versa, doubles the amount of error. Suppose the accountant mistakenly posted a $500 credit as a debit. Total debits contain the $500, and total credits omit the $500. The out-of-balance amount is $1,000. Dividing the difference by 2 identifies the $500 amount of the transaction. Then search the trial balance for a $500 transaction and trace to the account affected.
Divide the out-of-balance amount by 9. If the result is evenly divisible by 9, the error may be a slide (example: writing $1,000 as $100 or writing $100 as $1,000) or a transposition (example: treating $1,200 as $2,100).
Total debits can equal total credits on the trial balance; however, there still could be errors in individual account balances because an incorrect account might have been selected in an individual journal entry.

47. Details of the Journal
The journal and the ledger provide details to create a “trail” through the records. The journal should always have the following parts–the date of the transaction, the accounts and the amounts debited and credited, and the posting reference. This indicates whether or not the entry has been posted to the ledger.
Posting means copying information from the journal to the ledger. This diagram shows the posting process.

48. Four-Column Account
The ledger accounts illustrated previously appear as T-accounts, with the debit on the left and the credit on the right. The T-account clearly separates debits from credits and is used for teaching, where there isn't much detail.
Another account format has four amount columns, as illustrated here. The first pair of Debit/Credit columns is for transaction amounts posted to the account from the journal, such as the $30,000 debit. The second pair of amount columns shows the balance of the account as of each date. For this reason, the four-column format is used more often in practice than the T-account. Cash has a debit balance of $30,000 after the first transaction and a $10,000 balance after the second transaction.