Chapter Two Transaction Analysis

1. Chapter TwoTransaction Analysis

2. Transactions • Business Transactions are events that have a financial impact on the business (assign a $$ amount) and can be measured reliably. • Transactions will impact the Assets, Liabilities, and Owners’ Equity of a firm • To analyze, determine how this impacts the accounting equation (Assets = Liabilities + Owners’ Equity) of a firm

3. Accounts • Accounts are a summary device that record the changes that have occurred during a period. • Organizational system for businesses that allow them to analyze the cumulative effects of transactions. • Each account shows the effect of all of the increases and decreases during a period. • Accounts are organized via the basic accounting equation (Assets = Liabilities + Owners’ Equity.)

4. Accounts • Use a separate account for each particular: • Asset • Liability • Stockholders’ Equity (Owners’ Equity) that is involved in a transaction. • Each transaction will affect at least two accounts. This is reflective of the double-entry system used in accounting, which keeps the accounting equation in balance. **Know the different types of accounts on pages 55-57. You should also review the lecture material for Chapter 1.

5. Transaction Analysis • Remember, the accounting equation helps to analyze the impact of transactions on financial position: Assets = Liabilities + Owners’ Equity **There are many examples of the analysis of business transactions on pages 57-63 in the text. Make sure to study and understand these examples.

6. In-Class Exercise! • Form groups of 2-3 with people around you. • I will distribute an in-class exercise, in which you will analyze the effect of a series of events. • Nominate someone in your group to serve as a team spokesperson. • We will then discuss as a larger group. • Be sure to keep this handout, since we will build upon this later in the chapter.

7. Debits and Credits • Recall that each transaction affects at least two accounts. • In accounting, accounts can be represented by the letter “T” and referred to as T-accounts. • Accountants designate: • Left side of account = Debits • Right side of account = Credits Total Debits alwaysequal total credits

8. Debits and Credits Visualization of the T-Account Adapted from Harrison (2006)

9. Debits and Credits • Rules for Assets – on the left-hand side of the accounting equation: • Assets have a normal debit balance.* • Increases in assets are recorded on the left (debit) side. • Decreases in assets are recorded on the right (credit) side. *The “balance” in the account is calculated as the beginning balance (what was in the account at the beginning of the period) + increases - decreases

10. Debits and Credits • Rules for Liabilities and Owners’ Equity – on the right-hand side of the accounting equation: • Liabilities and Owners’ Equity (LOE) have a normal credit balance.* • Increases in LOE are recorded on the right (credit) side. • Decreases in LOE are recorded on the left (debit) side. *The “balance” in the account is calculated as the beginning balance (what was in the account at the beginning of the period) + increases - decreases

11. Accounting Equation: Assets = Liabilities + Stockholders’ Equity Rules of Debit and Credit: Debit + Credit – Debit – Credit + Debit – Credit + Debits and Credits Adapted from Harrison (2006)

12. Debits and Credits • Rules of debit and credit for Stockholders’ Equity are slightly different, since stockholders’ equity is affected by different types of accounts. Common Stock Retained Earnings Dividends - + - + + - Debit Credit Debit Credit Debit Credit Expenses Revenues + - - + Debit Credit Debit Credit

13. Debits and Credits The following types of accounts: (1) have a normal balance as a debit or credit and (2) increase with a debit or credit. Normal Balance Assets Liabilities Expenses Revenues Dividends Retained Earnings Common Stock (DEBIT) (CREDIT) Remember: Debit Expenses Assets Dividends (DEAD) All other accounts = Credit Refer to Exhibit 2-7 on page 65 and Exhibit 2-14 on page 73 for charts summarizing these rules.

14. Journal Entries • In addition to T-accounts, companies record transactions in a journal. • The journal gives a chronological record of all of a company’s transactions. Steps • Specify accounts involved in the transaction, • Determine whether each account increased or decreased and apply the rules of debits and credits, and • Enter the transaction into the journal.

15. Journal Entries The example below demonstrates proper journal entry form for the purchase of $500 of supplies for cash.

16. In-Class Exercise! • Form groups of 2-3 with people around you. • I will distribute an in-class exercise. This builds off of the prior exercise, and asks you to prepare journal entries. • We will then discuss as a larger group. • Be sure to keep this handout.

17. Posting Journal Entries • The General Ledger is a group of all T-accounts, with their balances. • The Posting process transfers information from the journal to the ledger. • (1) Record items via the journal, via journal entries. • (2) Post items to the ledger, by recording the journal entries in the T-accounts.

18. Cash Common Stock 50,000 50,000 Posting Journal Entries Adapted from Harrison (2006)

19. In-Class Exercise! • We will perform another in-class exercise. This builds off of the prior exercise. Using T-accounts, you will post the journal entries that you just prepared. • Use the previous in-class activity (Chapter 2, Parts 1) for the transactions.

20. Trial Balance • A trial balance lists all accounts with their balances in the following order: • Assets • Liabilities • Stockholders’ Equity • Goal: to ensure that total debits = total credits. Examine for recording or posting errors. • Provides that the ledger is in balance, but is not one of the financial statements.

21. Chart of Accounts • A chart of accounts is a listing of all of a company’s accounts and their account numbers. • Referenced when posting journal entries or deciding how to code transactions. • Additional accounts may be added as a company participates in additional transactions.

22. Questions? • Any questions or concerns?