Analyzing Transactions

1. Analyzing Transactions Chapter 2

2. Learning Objectives • Describe the characteristics of an account and a chart of accounts. • Describe and illustrate journalizing transactions using the double-entry accounting system. • Describe and illustrate the journalizing and posting of transactions to accounts. • Prepare an unadjusted trial balance and explain how it can be used to discover errors. • Describe and illustrate the use of horizontal analysis in evaluating a company’s performance and financial condition.

3. Learning Objective 1 Describe the characteristics of an account and a chart of accounts

4. Using Accounts to Record Transactions • Accounting systems are designed to show the increases and decreases in each accounting equation element as a separate record. This record is called an account.

5. Using Accounts to Record Transactions

6. The T Account Title The T account has a title

7. The T Account Title The left side of the account is called the debitside.

8. The T Account Title Debit Credit The right side of the account is called the creditside.

9. The T Account Cash (a) 25,000(b) 20,000 (d) 7,500(e) 3,650 Credit Side of Account (f) 950 Debit Side of Account (h) 2,000 Balance 5,900 Balance of the account

10. Chart of Accounts • A group of accounts for a business entity is called a ledger. • A list of the accounts in the ledger is called a chart of accounts.

11. Chart of Accounts • Assets are resources owned by the business. Some examples of assets follow: • Cash • Supplies • Accounts receivable • Buildings

12. Chart of Accounts • Liabilities are debts owed to outsiders (creditors). Some examples of liabilities follow: • Accounts payable • Notes payable • Wages payable • Interest payable

13. Chart of Accounts • Owner’s equity is the owner’s right to the assets of the business after all liabilities have been paid. For a proprietorship, the owner’s equity is represented by the balance of the owner’s capital account. • A drawing account represents the amount of withdrawals made by the owner.

14. Chart of Accounts • Revenues are increases in owner’s equity as a result of selling services or products to customers. Some examples of revenue accounts follow: • Fees earned • Commission revenue • Rent revenue

15. Chart of Accounts • The using up of assets or consuming services in the process of generating revenues results in expenses. Some examples of expenses follow: • Wages expense • Rent expense • Miscellaneous expense

16. Chart of Accounts

17. Learning Objective 2 Describe and illustrate journalizing transactions using the double-entry accounting system

18. Double-Entry Accounting System • All businesses use what is called the double-entry accounting system. This system is based on the accounting equation and requires: • Every business transaction to be recorded in at least two accounts. • The total debits recorded for each transaction to be equal to the total credits recorded.

19. Balance Sheet Accounts • The debit and credit rules for balance sheet accounts are as follows:

20. Income Statement Accounts • The debit and credit rules for income statement accounts are based on their relationship with owner’s equity.

21. Owner Withdrawals • The debit and credit rules for recording owner withdrawals are based on the effect of owner withdrawals on owner’s equity.

22. Normal Balances • The sum of the increases in an account is usually equal to or greater than the sum of the decreases in the account. Thus, the normal balance ofan account is either a debit or a credit depending on whether increases in the account are recorded as debits or credits.

23. Rules of Debit and Credit – Normal Balances of Accounts

24. Normal Balances Increases (Normal Bal.) Decreases Balance sheet accounts: Asset Debit Credit Liability Credit Debit Owner’s Equity: Capital Credit Debit Drawing Debit Credit Income statement accounts: Revenue Credit Debit Expense Debit Credit

25. Transaction A • On November 1, Chris Clark opens a new business and deposits $25,000 in a bank account in the name of NetSolutions.

26. Accounting Equation Impact Assets = Liabilities + Owner’s Equity (investment) Transaction A Step 2 Step 3 Step 1 Step 5 Step 4 Step 3 increase increase

27. Journalizing Journalizing requires the following steps: • Step 1. The date of the transaction is entered in the Date column. • Step 2. The title of the account to be debited is recorded at the left-hand margin under the Description column, and the amount to be debited is entered in the Debit column. (continued)

28. Journalizing • Step 3. The title of the account to be credited is listed below and to the right of the debited account title, and the amount to be credited is entered in the Credit column. • Step 4. A brief description may be entered below the credited account. (continued)

29. Journalizing • Step 5. The Post. Ref. (Posting Reference) column is left blank when the journal entry is initially recorded. This column is used later when the journal entry amounts are transferred to the accounts in the ledger.

30. Journalizing • A transaction is initially entered in a record called a journal.

31. Journalizing • A transaction is initially entered in a record called a journal. • The process of recording a transaction in the journal is called journalizing.

32. Journalizing • A transaction is initially entered in a record called a journal. • The process of recording a transaction in the journal is called journalizing. • The entry in the journal is called a journal entry.

33. Transaction B • On November 5, NetSolutions paid $20,000 for the purchase of land as a future building site.

34. Accounting Equation Impact Assets = Liabilities + Owner’s Equity Transaction B increase decrease

35. Transaction C • On November 10, NetSolutions purchased supplies on account for $1,350.

36. Accounting Equation Impact Assets = Liabilities + Owner’s Equity Transaction C increase increase

37. Transaction D • On November 18, NetSolutions received cash of $7,500 from customers for services provided.

38. Accounting Equation Impact Assets = Liabilities + Owner’s Equity (Revenue) Transaction D increase in revenues increase

39. Transaction E • On November 30, NetSolutions incurred the following expenses: wages, $2,125; rent, $800; utilities, $450; and miscellaneous, $275.

40. Accounting Equation Impact Assets = Liabilities + Owner’s Equity (Expense) Transaction E All four expense accounts increase decrease

41. Transaction F • On November 30, NetSolutions paid creditors on account, $950.

42. Accounting Equation Impact Assets = Liabilities + Owner’s Equity Transaction F decrease decrease

43. Transaction G • NetSolutions purchased $1,350 of supplies on November 10. Chris Clark determined that the cost of supplies on hand on November 30 was $550.

44. Accounting Equation Impact Assets = Liabilities + Owner’s Equity (Expense) Transaction G Supplies used = $1,350 - $550 = $800 increase in expense decrease

45. Transaction H • On November 30, Chris Clark withdrew $2,000 from NetSolutions for personal use.

46. Accounting Equation Impact Assets = Liabilities + Owner’s Equity (Drawing) Transaction H decrease increase in drawing

47. Learning Objective 3 Describe and illustrate the journalizing and posting of transactions to accounts.

48. Posting Journal Entries to Accounts • The process of transferring the debits and credits from the journal entries to the accounts is called posting.

49. Posting Journal Entries to Accounts • On December 1, NetSolutions paid a premium of $2,400 for an insurance policy for liability, theft, and fire. The policy covers a one-year period.

50. Accounting Equation Impact Assets = Liabilities + Owner’s Equity 0 Posting Journal Entries to Accounts decrease increase