Chapter 2: Accounting for Transactions

1. Chapter 2:Accounting for Transactions

2. The first step in the accounting process is transaction analysis (introduced in Chapter 1). The second step is the recording of transactions and events (journal entries). The third step is the posting of the information to the ledger accounts (general ledger). The fourth step is the preparation of the trial balance (this is used to construct the financial statements). The Accounting Process

3. The first step in the accounting process is transaction analysis. This process examines relevant, objectively- measurable economic events through their effect on the accounting equation: Assets = Liabilities + Equity This activity was introduced with a spreadsheet in Chapter 1. The Accounting Process

4. Note that the transaction analysis was relatively simple with a few transactions and a few accounts. However, with thousands of transactions and hundreds of accounts, the spreadsheet program is not sufficient. Therefore accountants use a “double entry” system based on debits and credits. The Double Entry System

5. Debit (dr) - means an entry to the left- hand side of an account. Credit (cr) - means an entry to the right- hand side of an account. Note that a debit or credit, per se, does not indicate increase or decrease. To decide the effect of a debit or credit, the type of account must be considered. Double Entry Accounting

6. Based on the accounting equation, we can increase or decrease various accounts depending on their classification: Assets = Liabilities + Equity Increase DR = CR CR Decrease CR = DR DR Note that we use debits and credits instead of plusses and minuses. Note also that bank terminology is reversed from the customer perspective. Effect of Debits and Credits

7. Assets have normal debitbalances and are increased with a debit. Liabilities and equitieshave normal creditbalances and are increased with a credit. Revenues (a part of equity) have normal credit balances and are increased with a credit. Expenses (which decrease equity) have normal debitbalances and are increased with a debit. Dividends (which decrease equity) have a normal debit balance and are increased with a debit. The following rules can be derived from the basic formula:

8. To initially record transactions, we use a journal entry to represent the debits and credits. For example, in the Chapter 1 Class Problem, Item 1: Debit Credit Cash 30,000 Common Stock 30,000 Note that the debit is to the left and the credit is to the right. First, we list the account (left hand entry on top), then the amount. The Format of a Journal Entry

9. 2: Purchased land for $20,000 cash. 3: Borrowed $9,000 cash from bank. Now back to the Class Problem and prepare the other journal entries:

10. 4: Provided services (on account) $8,000. 5: Paid $5,500 cash for expenses. Now back to the Class Problem and prepare the other journal entries:

11. 6: Paid $500 cash dividend to owners. Note that dividends is a contra equity account and reduces retained earnings. Now back to the Class Problem and prepare the other journal entries:

12. Components of the basic accounting cycle include: A. Preparation of Journal Entries (Chapter 2) >Post to the General Ledger >Unadjusted Trial Balance B. Preparation of Adjusting Journal Entries (Chapter 3) >Post to the General Ledger >Adjusted Trial Balance C. Financial Statements (Chapter 3) D. Closing Journal Entries (Chapter 3) >Post-Closing Trial Balance The Accounting Cycle

13. The first step in the accounting process. Prepared for daily activity. Usually journalized in special journals for efficiency but we will record in “General Journal” format. Identified through a document flow: cash receipt, record a cash sale charge receipt, record a sale on account bank note, record a notes payable employee time card, record wages The Journal Entries from the Class Problem are GJEs. A. General Journal Entries (GJEs)

14. The G/L serves as a place to “total” amounts by account titles. After GJEs (and later, adjusting journal entries) are recorded, they are posted (by account) to the G/L. We will use “T” accounts to represent G/L accounts where needed. The General Ledger (G/L)

15. Back to Class Problem: Posting to G/LNow post transactions (for Cash) to “T” account: Cash

16. Trial balances are prepared throughout the accounting cycle. The Unadjusted Trial Balance represents G/L totals (by account) at a particular point in time. From the Chapter 1 Class Problem, the Unadjusted Trial Balance would consist of a list of all of the ending debit or credit balances taken from the various “T” account totals (illustrated on the next slide). The Unadjusted Trial Balance is a preliminary total and is a starting point for the Adjusting Journal Entries (discussed in next chapter). Unadjusted Trial Balance

17. Debit Credit Cash 13,000 Accounts Receivable 8,000 Land 20,000 Notes Payable 9,000 Common Stock 30,000 Retained Earnings-Begin 0 Revenues 8,000 Expenses 5,500 Dividends 500 Totals $47,000 $47,000 Unadjusted Trial Balance – Class Problem(after posting and totaling G/L accounts)

18. The Unadjusted Trial Balance is the starting point for the financials but other analyses must be performed and recorded before the financial statements are complete. These analyses are discussed in Chapter 3. Unadjusted Trial Balance