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Chap 02 transaction analysis

financial statement analysis

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Chap 02 transaction analysis

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  1. Transaction Analysis Lecture 2-3 Chapter 2 ©2008 Pearson Prentice Hall. All rights reserved.

  2. Transactions • Any event that impacts the financial position of a business • Can be measured reliably • Two sides: • Business gives something • Business receives something • Accounting records both sides of a transaction ©2008 Pearson Prentice Hall. All rights reserved.

  3. The Account • Record of all changes in a particular asset, liability or equity • Remember the accounting equation • Assets = Liabilities + Owner’s Equity ©2008 Pearson Prentice Hall. All rights reserved.

  4. Common Asset Accounts • Cash • Bank accounts, cash on hand • Accounts Receivable • Customer promise to pay for goods or services provided • Represents future collection of cash • Notes receivable • Written promise to pay • Bear interest ©2008 Pearson Prentice Hall. All rights reserved.

  5. Inventory Products held for sale Prepaid expenses Expenses paid for in advance Provide future benefit Includes prepaid rent, prepaid insurance and supplies Land Common Asset Accounts ©2008 Pearson Prentice Hall. All rights reserved.

  6. Common Asset Accounts • Buildings • Equipment • Furniture and Fixtures ©2008 Pearson Prentice Hall. All rights reserved.

  7. Common Liability Accounts • Accounts payable • Company’s promise to pay for goods or services received • Notes payable • Signed agreements to pay • Include interest • Accrued liabilities • Expenses that have not been paid • Include interest payable and salaries payable ©2008 Pearson Prentice Hall. All rights reserved.

  8. Equity Accounts • Common stock • Shareholders’ investment in the company • Retained earnings • Earnings kept by the company • Cumulative net income minus dividends paid to shareholders • Revenues • Earned by providing goods or services • Expenses • Costs of operating a business ©2008 Pearson Prentice Hall. All rights reserved.

  9. Learning Objective 1 Analyze Transactions ©2008 Pearson Prentice Hall. All rights reserved.

  10. Every transaction has at least two parts The accounting equation always balances before and after each transaction A common transaction for a new business is to issue stock to its owners How would this impact the accounting equation? Transaction Analysis ©2008 Pearson Prentice Hall. All rights reserved.

  11. Example Transaction (1) • Three friends decide to start a salon • They invest $50,000 to begin the business • The business issues common stock to the owners ©2008 Pearson Prentice Hall. All rights reserved.

  12. Stockholders’ Equity Type of Equity Transaction + Assets = Liabilities Cash Common stock (1) +$50,000 (1) +$50,000 Issued stock ©2008 Pearson Prentice Hall. All rights reserved.

  13. Example Transaction (2) • The salon purchases chairs and massage tables for $12,000 ©2008 Pearson Prentice Hall. All rights reserved.

  14. Stockholders’ Equity = + Assets Liabilities Cash Supplies Equip. Accts Pay Common stock Retained Earnings (1) +$50,000 (1) + $50,000 (2) - $12,000 (2) + $12,000 $38,000 + $12,000 = $50,000 ©2008 Pearson Prentice Hall. All rights reserved.

  15. Example Transactions (3) The salon purchases hair styling and other supplies on account for $5,000 ©2008 Pearson Prentice Hall. All rights reserved.

  16. Stockholders’ Equity = + Assets Liabilities Cash Supplies Equip. Accts Pay Common stock Retained Earnings (1) +$50,000 (1) + $50,000 (2) - $12,000 (2) + $12,000 (3) +$5,000 (3) +$5,000 $38,000 $5,000 $12,000 $5,000 $50,000 $55,000 $55,000 ©2008 Pearson Prentice Hall. All rights reserved.

  17. Example Transaction (4) The salon earns $6,000 from providing services to customers. The business collected cash. ©2008 Pearson Prentice Hall. All rights reserved.

  18. Stockholders’ Equity = + Assets Liabilities Cash Supplies Equip. Accts Pay Common stock Retained Earnings (1) +$50,000 (1) + $50,000 (2) - $12,000 (2) + $12,000 (3) +$5,000 (3) +$5,000 (4) +$6,000 (4) +$6,000 Revenue $44,000 $5,000 $12,000 $5,000 $50,000 $6,000 $61,000 $61,000 ©2008 Pearson Prentice Hall. All rights reserved.

  19. Example Transaction (5) The salon paid monthly rent of $4,000 ©2008 Pearson Prentice Hall. All rights reserved.

  20. Stockholders’ Equity Liabilities = + Assets Cash Supplies Equip. Accts Pay Common stock Retained Earnings (1) +$50,000 (1) + $50,000 (2) - $12,000 (2) + $12,000 (3) +$5,000 (3) +$5,000 (4) +$6,000 (4) +$6,000 Revenue (5) - $4,000 (5) - $4,000 Expense $40,000 $5,000 $12,000 $5,000 $50,000 $2,000 $57,000 $57,000 ©2008 Pearson Prentice Hall. All rights reserved.

  21. Learning Objective 2 Understand how accounting works ©2008 Pearson Prentice Hall. All rights reserved.

  22. Each transaction affects at least two accounts Double-entry Accounting ©2008 Pearson Prentice Hall. All rights reserved.

  23. The T-account Account Title Debits on the left side Credits on the right side Every transaction has both a debit and a credit ©2008 Pearson Prentice Hall. All rights reserved.

  24. Debit and Credit Rules • Debit and credit are neutral terms • Not good or bad • Mean either a decrease or increase depending on the type of account ©2008 Pearson Prentice Hall. All rights reserved.

  25. Debits and Credits STOCKHOLDERS’ EQUITY = + ASSETS LIABILITIES Debit - Credit + Debit + Credit - Debit - Credit + ©2008 Pearson Prentice Hall. All rights reserved.

  26. Stockholders’ Equity Debit & Credits • Common stock and Retained Earnings are increased by credits • Dividends reduce Retained Earnings • Dividends are increased by debits • Net income increases Retained Earnings • Net Income = Revenues minus Expenses • Revenues are increased by credits • Expenses are increased by debits ©2008 Pearson Prentice Hall. All rights reserved.

  27. Debit to increase Assets Dividends Expenses Credits to increase Liabilities Revenue Common stock Retained earnings Debits and Credits Do NOT proceed until you learn these rules! ©2008 Pearson Prentice Hall. All rights reserved.

  28. Practicing Debits and Credits • Increase cash • Debit • Increase accounts payable • Credit • Decrease accounts receivable • Credit • Increase revenue • Credit ©2008 Pearson Prentice Hall. All rights reserved.

  29. Practicing Debits and Credits • Increase rent expense • Debit • Increase common stock • Credit • Decrease notes payable • Debit • Decrease cash • __________________________ What type of account is cash? How is it increased? ©2008 Pearson Prentice Hall. All rights reserved.

  30. Learning Objective 3 Record transactions in the journal ©2008 Pearson Prentice Hall. All rights reserved.

  31. The Journal • Chronological record of transactions • Three steps • Identify accounts impacted by transaction • Apply debit/credit rules for the increase or decrease in the accounts • You should have at least one debit and one credit • Record transactions in journal ©2008 Pearson Prentice Hall. All rights reserved.

  32. Journal entry • Write the account debited first and the amount in the left column • Write (and indent) the account credited next and the amount in the right column • Debits must equal credits ©2008 Pearson Prentice Hall. All rights reserved.

  33. E2-18 Apr 1 – Received $25,000 and issued common stock ©2008 Pearson Prentice Hall. All rights reserved.

  34. E2-18 • April 2 - Purchased $800 of office supplies on account ©2008 Pearson Prentice Hall. All rights reserved.

  35. E2-18 • April 4 - Paid $20,000 cash for land to use as a building site ©2008 Pearson Prentice Hall. All rights reserved.

  36. E2-18 • April 6 - Performed service for customers and received cash of $2,000 ©2008 Pearson Prentice Hall. All rights reserved.

  37. E2-18 • April 9 Paid $100 on accounts payable ©2008 Pearson Prentice Hall. All rights reserved.

  38. E2-18 • April 17 – Performed services for FedEx on account totaling $1,200 What account is credited when services are performed? ©2008 Pearson Prentice Hall. All rights reserved.

  39. E2-18 • Apr 23 – Collected $900 from FedEx on account ©2008 Pearson Prentice Hall. All rights reserved.

  40. E2-18 • Apr 30 – Paid the following expense: salary, $1,000; rent, $500 ©2008 Pearson Prentice Hall. All rights reserved.

  41. Posting • Transferring information from the journal to the ledger • The collection of accounts and their balances ©2008 Pearson Prentice Hall. All rights reserved.

  42. Posting CASH SERVICE REVENUE $2,000 $2,000 ©2008 Pearson Prentice Hall. All rights reserved.

  43. Flow of Accounting Data • Transaction occurs • Transaction analyzed • Accounts identified • Debit/Credit rules applied • Transaction recorded in the Journal • Amounts posted to the Ledger ©2008 Pearson Prentice Hall. All rights reserved.

  44. Determining Account Balance • After transactions are posted, the amount in each ledger account is computed • The debit side and credit side are totaled • The difference between the two sides is computed • If the debit side is larger, the account has a debit balance • If the credit side is larger, the account has a credit balance ©2008 Pearson Prentice Hall. All rights reserved.

  45. Determining Account Balance Cash $10,000 $7,000 The credits total to $19,000 $12,000 $15,000 The debits total to $33,000 $ 8,000 $14,000 Cash has a debit balance of $14,000 ($33,000 - $19,000) ©2008 Pearson Prentice Hall. All rights reserved.

  46. Learning Objective 4 Use a trial balance ©2008 Pearson Prentice Hall. All rights reserved.

  47. Trial Balance • Lists all accounts with their balance • Debit amounts in the left column • Credit amounts in the right column • Begins with assets, then liabilities and stockholders’ equity • The columns are totaled and should equal each other • Shows if debits equal credits ©2008 Pearson Prentice Hall. All rights reserved.

  48. Correcting Errors • Sometimes the trial balance columns don’t equal • Steps to find the error: • Search for any missing accounts • Divide the out-of-balance amount by two • This will help find a debit that was listed as a credit, and vice versa • Divide the out-of-balance amount by nine • Slide – misstating an amount by omitting or adding a zero ($4000 as $400) • Transposition – switching figures within a number ($1342 as $1423) ©2008 Pearson Prentice Hall. All rights reserved.

  49. Chart of Accounts • Each account is assigned a number • Assets usually begin with 1 • 100s or 1000s • Liabilities usually begin with 2 • 200s and 200s • Stockholders’ Equity (Common Stock, Dividends and Retained Earnings) begin with 3 • Revenues with a 4 and Expenses with a 5 ©2008 Pearson Prentice Hall. All rights reserved.

  50. Normal Balance • What increases the account (debit or credit) is the normal balance • Assets are increased by debits, so assets have a normal debit balance • If the balance is not “normal”, it indicates a negative amount • If cash has a credit balance, it means the company has overdrawn its bank account ©2008 Pearson Prentice Hall. All rights reserved.

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