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2-1 CHAPTER 2 Recording Business Transactions 2-2 Inverted Pyramid The Body of Accounting Knowledge Chapter 1.

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Presentation on theme: "2-1 CHAPTER 2 Recording Business Transactions 2-2 Inverted Pyramid The Body of Accounting Knowledge Chapter 1."— Presentation transcript:

1

2 2-1 CHAPTER 2 Recording Business Transactions

3 2-2 Inverted Pyramid The Body of Accounting Knowledge Chapter 1

4 2-3 Tools of The Recording Process l Debits and Credits l Journal Entries l Ledger Accounts

5 2-4 The Accounting Cycle First, however, let’s look at...

6 2-5 Analyze source documents. Journalize transactions in the general journal. Post entries to the accounts in the general ledger. Prepare financial statements. Prepare a trial balance. Steps in The Accounting Cycle

7 2-6 Let’s start with The General Ledger Account A ledger account is a tool used for classifying and summarizing information about increases, decreases, and balances of financial statements items. u Think of it as a storage container like a bucket. u Dollars, which are used to measure economic transactions, are “poured” into and out of the container.

8 2-7 General Ledger Was not a Civil War Hero

9 2-8 Two General Ledger Account Formats ÊThree-Amount Column Format (Debit, Credit, Balance) u Used in general ledgers in the business world ËT-Account Format u Used primarily for teaching and analysis of complex transactions

10 2-9 General Ledger Account Three-Amount Column Format ACCOUNT NAME:ACCOUNT No. DateDescriptionPRDebitCreditBalance 1 2 3

11 2-10 For the sake of simplicity, we often use this format in teaching accounting even though it is no longer used in practice. DebitCredit Account Name General Ledger Account T-Account Format

12 2-11 The T-Account Increases to the T-account are recorded on one side of the T-account, and decreases are recorded on the other side. DebitCredit Account Name

13 2-12 The T-Account The side which increases and the side which decreases is determined by the type of account. DebitCredit Account Name

14 2-13 What Are Debits and Credits? l Tools used for recording transactions u Debit (DR) u Credit (CR) LEFT RIGHT l Debit refers to the LEFT and Credit to the RIGHT side of the T-Account. l Debit and Credit are neutral terms and do not connote value judgments. Neither is “good” or “bad”!

15 2-14 [Baltimore Sun, September 23, 1998]

16 2-15 l Tools used for recording transactions u Debit (DR) u Credit (CR) LEFT RIGHT l Debit refers to the LEFT and Credit to the RIGHT side of the T-Account Account Name LEFTRIGHT What Are Debits and Credits?

17 2-16 l Tools used for recording transactions u Debit (DR) u Credit (CR) LEFT RIGHT l Debit refers to the LEFT and Credit to the RIGHT side of the T-Account Account Name LEFTRIGHT DEBIT SIDE CREDIT SIDE Used as Adjectives: What Are Debits and Credits?

18 2-17 l Tools used for recording transactions u Debit (DR) u Credit (CR) LEFT RIGHT l Debit refers to the LEFT and Credit to the RIGHT side of the T-Account Account Name LEFTRIGHT DEBITCREDIT Used as Verbs: Synonym for Debit? What Are Debits and Credits?

19 2-18 Common Business Terminology

20 2-19 Names of Ledger Accounts l There are no “magic” names for many accounts u e.g., either “Heat, Light & Power” or “Utilities Expense” could be used for an account name. l Other accounts have names which must be used u e.g., “Cash”, “Accounts Receivable” and “Accounts Payable”.

21 2-20 Let’s see how debits and credits affect the different types of accounts. DebitCredit Account Name Types of Ledger Accounts

22 2-21  Assets  Liabilities  Stockholders’ Equity  Revenues  Expenses  Assets  Liabilities  Stockholders’ Equity  Revenues  Expenses Types of Ledger Accounts

23 2-22 l Again, debits and credits are used to increase or decrease account balances. l Determining whether to use a debit or credit to record an increase or decrease depends on the type of account in question. l The Balance Sheet equation is the basis for the determination. Using Debits and Credits

24 2-23 Balance Sheet Model ( Revisited) A = L + SE

25 2-24 Account Name DebitCredit Account Name DebitCredit Assign a T-Account to each element of the Balance Sheet Model A = L + SE Account Name DebitCredit Balance Sheet Model ( Revisited)

26 2-25 Account Name DebitCredit Account Name DebitCredit Debits and credits affect the Balance Sheet Model as follows: A = L + SE Account Name DebitCredit Balance Sheet Model ( Revisited)

27 2-26 Account Name A A = L + SE Account Name DebitCredit DebitCredit Debits and credits affect the Balance Sheet Model as follows: ASSETS Debit for Increase Credit for Decrease Balance Sheet Model ( Revisited)

28 2-27 AL A = L + SE Account Name DebitCredit Debits and credits affect the Balance Sheet Model as follows: LIABILITIES Debit for Decrease Credit for IncreaseASSETS Debit for Increase Credit for Decrease Balance Sheet Model ( Revisited)

29 2-28 ALSE A = L + SE Debits and credits affect the Balance Sheet Model as follows: ASSETS Debit for Increase Credit for DecreaseEQUITIES Debit for Decrease Credit for IncreaseLIABILITIES Debit for Decrease Credit for Increase Balance Sheet Model ( Revisited)

30 2-29 Recall that Stockholders’ Equity consists of the following components: + Retained EarningsCapital Stock C/S + R/E Stockholders’ Equity A Closer Look

31 2-30 Therefore, the Capital Stock and Retained Earnings accounts are affected in the following manner by debits and credits because they are part of Stockholders’ Equity: CAPITAL STOCK Debit for Decrease Credit for Increase RET. EARNINGS Debit for Decrease Credit for Increase Stockholders’ Equity A Closer Look

32 2-31 Revenue Also, because Revenue accounts increase Stockholders’ Equity, they are affected by debits and credits as follows: REVENUES Debit for Decrease Credit for Increase Stockholders’ Equity A Closer Look

33 2-32 Expense And because Expense accounts decrease Stockholders’ Equity, they are affected by debits and credits as follows: EXPENSES Debit for Increase Credit for Decrease Stockholders’ Equity A Closer Look

34 2-33 Normal Balances normalbalance Each of the 5 account types also has a normal balance side. It is always the side which is used to record increases in the account.

35 2-34 Normal Balances FIVE The normal balances for each of the FIVE types of accounts are as follows: Account Name Debit BalanceCredit Balance Assets Assets Expenses Expenses Liabilities Liabilities Stockholders’ Stockholders’ Equity Equity Revenues Revenues

36 2-35 Three Alternative Approaches For Learning Debits and Credits l Alternative #1 u The textbook approach on p. 59 l Alternative #2 u Expanded Accounting Equation u This is Rice’s preferred approach l Alternative #3 u “A L O R E” acronym

37 2-36 Alternative Approach #1 Textbook Approach 59 Check it out at top of page!

38 2-37 Alternative Approach #2 Expanded Accounting Equation ASSETS + EXP. = LIAB. + S/H EQUITY + REV. A + E = L + S/E + R Dr. Cr. + - Bal. Dr. Cr. + - Bal.

39 2-38 Alternative Approach #3 “ A L O R E” Acronym A (ssets) L (iabilities) O (wners' equity) R (evenues) E (xpenses) Debit Credit

40 2-39 Debits and Credits Question 1 Which of the following accounts would normally be expected to have a debit (or left-side) balance? a.Accounts Payable b.Buildings c.Interest Revenue d.Capital Stock

41 2-40 Debits and Credits Solution 1 Which of the following accounts would normally be expected to have a debit (or left-side) balance? a.Accounts Payable b.Buildings c.Interest Revenue d.Capital Stock BUILDINGS is an asset account and normally has a DEBIT balance. The other three accounts normally have CREDIT balances. BUILDINGS is an asset account and normally has a DEBIT balance. The other three accounts normally have CREDIT balances.

42 2-41 Debits and Credits Question 2 Which of the following accounts would normally be expected to have a credit (or right-side) balance? a.Accounts Receivable b.Salary Expense c.Salary Payable d.Land

43 2-42 Debits and Credits Solution 2 Which of the following accounts would normally be expected to have a credit (or right-side) balance? a.Accounts Receivable b.Salary Expense c.Salary Payable d.Land

44 2-43 Which of the following accounts would normally be expected to have a credit (or right-side) balance? a.Accounts Receivable b.Salary Expense c.Salary Payable d.Land SALARY PAYABLE is a liability account and normally has a CREDIT balance. The other three accounts normally have DEBIT balances. SALARY PAYABLE is a liability account and normally has a CREDIT balance. The other three accounts normally have DEBIT balances. Debits and Credits Solution 2

45 2-44 Debits and Credits Example If the balance in Accounts Receivable (an asset) is $750 (debit side balance), Accounts Receivable 750

46 2-45 Debits and Credits Example increase If the balance in Accounts Receivable (an asset) is $750 (debit side balance), What would we do to increase the account by $200? 750 Accounts Receivable

47 2-46 increase If the balance in Accounts Receivable (an asset) is $750 (debit side balance), What would we do to increase the account by $200? Debits and Credits Example Accounts Receivable

48 2-47 Debits and Credits Example increase If the balance in Accounts Receivable (an asset) is $750 (debit side balance), What would we do to increase the account by $200? decrease What would we do to decrease the account by $350? Accounts Receivable

49 2-48 Debits and Credits Example increase If the balance in Accounts Receivable (an asset) is $750 (debit side balance), What would we do to increase the account by $200? decrease What would we do to decrease the account by $350? Accounts Receivable

50 2-49 Debits and Credits Example Note the lack of $. It is understood that the yardstick is dollars. It is not “money”! Accounts Receivable

51 2-50 Balancing The T-Account To get the balance of the T-Account net the totals on the two sides against each other. Place the residual amount on the appropriate side Accounts Receivable

52 2-51 To get the balance of the T-Account net the totals on the two sides against each other. Place the residual amount on the appropriate side. Balancing The T-Account Accounts Receivable

53 2-52 Balancing The T-Account To get the balance of the T-Account... (Can use the either the approach above to show the balance, the text’s approach or Rice’s approach) Accounts Receivable

54 2-53 Approach on Previous slide Using the example at the bottom of p. 57 Three Alternative Approaches to Balancing The T-Account (1) 10,000 (2) 5,000 (3) 1,000 13,400 Cash (4) 600 (5) 2,000 Text Approach (1) 10,000 (2) 5,000 (3) 1,000 16,000 13,400Cash (4) 600 (5) 2,000 2,600 bal (1) 10,000 (2) 5,000 (3) 1,000 13,400 Cash (4) 600 (5) 2,000 Rice’s Approach ALL 3 are O.K.!

55 2-54 Debits and Credits Question 3 The Cash account has three entries: a debit for $1,200, a credit for $300, and another credit for $400. What is the balance in the Cash account? a.$ 1,900 Debit. b.$ 500 Credit. c.$ 700 Credit. d.$ 500 Debit.

56 2-55 The Cash account has three entries: a debit for $1,200, a credit for $300, and another credit for $400. What is the balance in the Cash account? a.$ 1,900 Debit. b.$ 500 Credit. c.$ 700 Credit. d.$ 500 Debit. Debits and Credits Question 3 $1,200 $ 400 $ 500 Cash $ 300

57 2-56 Implications Of Debits And Credits Debits and Credits are used to indicate that something happened to an account. Interpreting the implications requires an analysis of the entire journal entry.

58 2-57 Implications Question 1 If the company made a Credit entry to Notes Payable, would the account increase or decrease?

59 2-58 Implications Question 1 If the company made a Credit entry to Notes Payable, would the account increase or decrease? ANSWER: Notes Payable would increase.

60 2-59 Implications Question 2 Notes Payable is the account where we record long-term borrowings. What event would cause us to record an increase in our long-term borrowings?

61 2-60 Implications Question 2 Notes Payable is the account where we record long-term borrowings. What event would cause us to record an increase in our long-term borrowings? ANSWER: Such an increase could imply that the company borrowed money.

62 2-61 Implications Question 3 If the company borrowed money, which account would also be affected and in what way?

63 2-62 Implications Question 3 If the company borrowed money, which account would also be affected and in what way? ANSWER: There would also be an equal-sized increase in the Cash account.

64 2-63 Implications Question 4 Suppose instead of an increase to Cash, you find an increase to the Land account. How do you interpret the increase in Notes Payable?

65 2-64 Implications Question 4 Suppose instead of an increase to Cash, you find an increase to the Land account. How do you interpret the increase in Notes Payable? ANSWER: The company acquired land and gave a note that promised to pay for the land in the future.

66 2-65 Recording Transactions General Journal l Initially, all transactions are recorded in the General Journal.

67 2-66 Recording Transactions l Each transaction always affects at least two different accounts. u One account has a debit effect. u The second account has a credit effect. l This methodology was named “double entry” accounting by whom? Pacioli General Journal l Initially, all transactions are recorded in the General Journal.

68 2-67 General Journal Page GENERAL JOURNAL Page: DateDescriptionPRDebitCredit

69 2-68 Journal Entries Example 1 On January 1, 19X7, Caldwell Company borrows $10,000 from the bank. Prepare the appropriate general journal entry for the above transaction.

70 2-69 Journal Entries Solution 1 l Two accounts are affected: u Cash is increased by $10,000. u Notes Payable is increased by $10,000.

71 2-70 Journal Entries Solution 1 l Two accounts are affected: u Cash is increased by $10,000. u Notes Payable is increased by $10,000. GENERAL JOURNAL Page: 1 DateDescriptionPRDebitCredit

72 2-71 Journal Entries Solution 1 l Two accounts are affected: u Cash is increased by $10,000. u Notes Payable is increased by $10,000. GENERAL JOURNAL Page: 1 DateDescriptionPRDebitCredit 1-JanCash10010,000 Notes Payable20110,000 to record loan from bank

73 2-72 Journal Entries Solution 1 l Two accounts are affected: u Cash is increased by $10,000. u Notes Payable is increased by $10,000. GENERAL JOURNAL Page: 1 DateDescriptionPRDebitCredit 1-JanCash10010,000 Notes Payable20110,000 to record loan from bank Typically, accounts are numbered. The account numbers are used as references for posting to the General Ledger. More on account numbers will come later.

74 2-73 Journal Entries Example 2 On January 15, 19X7, Caldwell Company purchases a truck for $19,500 cash. Prepare the appropriate journal entry for the above transaction.

75 2-74 Journal Entries Solution 2 l Two accounts are affected: u Trucks is increased by $19,500. u Cash is decreased by $19,500.

76 2-75 Journal Entries Solution 2 l Two accounts are affected: u Trucks is increased by $19,500. u Cash is decreased by $19,500. GENERAL JOURNAL Page: 1 DateDescriptionPRDebitCredit

77 2-76 Journal Entries Solution 2 l Two accounts are affected: u Trucks is increased by $19,500. u Cash is decreased by $19,500. GENERAL JOURNAL Page: 1 DateDescriptionPRDebitCredit 15-JanTrucks15019,500 Cash10019,500 to record purchase of truck

78 2-77 Journal Entries Example 3 On January 20, 19X7, Caldwell Co. pays the $400 electric bill for January. Prepare the appropriate journal entry for the above transaction.

79 2-78 Journal Entries Solution 3 l Two accounts are affected: u Utility Expense is increased by $400. u Cash is decreased by $400.

80 2-79 Journal Entries Solution 3 l Two accounts are affected: u Utility Expense is increased by $400. u Cash is decreased by $400. GENERAL JOURNAL Page: 1 DateDescriptionPRDebitCredit

81 2-80 Journal Entries Solution 3 l Two accounts are affected: u Utility Expense is increased by $400. u Cash is decreased by $400. GENERAL JOURNAL Page: 1 DateDescriptionPRDebitCredit 20-JanUtility Expense Cash to record payment of January electric bill

82 2-81 More About The General Ledger l It is a complete collection of all the accounts of a company l Accounts are individually numbered for easy reference l It is used to collect the information about all of the transactions affecting a specific account l A cumulative, running balance is maintained when using the 3-column type

83 2-82 Categories of General Ledger Accounts The five types of accounts fall into one of two categories Real Accounts Nominal Accounts Real Accounts Nominal Accounts

84 2-83 Real Accounts l This category includes Assets, Liabilities, and Stockholders’ Equities (i.e., Balance Sheet accounts) l Accounts are permanent. l Account balances are carried forward from one fiscal year to the next.

85 2-84 Nominal Accounts l Nominal accounts include revenues and expenses. l Nominal accounts are temporary. l Nominal account balances are closed out to zero at the end of the fiscal year. u Closing Entries will be discussed in Chapter 4.

86 2-85 Numbering Accounts chart of accounts The listing of all accounts and their account numbers is called the chart of accounts.

87 2-86 Numbering Accounts chart of accounts The listing of all accounts and their account numbers is called the chart of accounts. A typical account numbering scheme might appear as follows: Assets Revenues Liabilities Expenses Equities Assets Revenues Liabilities Expenses Equities (See page 63 and inside back cover)

88 2-87 Start with the journal entry from the General Journal. GENERAL JOURNAL Page: 1 DateDescriptionPRDebitCredit 1-JanCash10,000 Notes Payable10,000 to record loan from bank Posting to the GL Example

89 2-88 GENERAL JOURNAL Page: 1 DateDescriptionPRDebitCredit 1-JanCash10,000 Notes Payable10,000 to record loan from bank ACCOUNT NAME: CASHACCOUNT No.100 DateDescriptionPRDebitCreditBalance Beginning Balance00 Next, find the appropriate page in the General Ledger for Cash. Posting to the GL Example

90 2-89 GENERAL JOURNAL Page: 1 DateDescriptionPRDebitCredit 1-JanCash10010,000 Notes Payable10,000 to record loan from bank Post the account reference number. Posting to the GL Example ACCOUNT NAME: CASHACCOUNT No.100 DateDescriptionPRDebitCreditBalance Beginning Balance00

91 2-90 GENERAL JOURNAL Page: 1 DateDescriptionPRDebitCredit 1-JanCash10010,000 Notes Payable10,000 to record loan from bank ACCOUNT NAME: CASHACCOUNT No.100 DateDescriptionPRDebitCreditBalance Beginning Balance00 1-JanLoanG110,000 Posting to the GL Example Post the transaction info to the GL.

92 2-91 GENERAL JOURNAL Page: 1 DateDescriptionPRDebitCredit 1-JanCash10010,000 Notes Payable10,000 to record loan from bank ACCOUNT NAME: CASHACCOUNT No.100 DateDescriptionPRDebitCreditBalance Beginning Balance00 1-JanLoanG110,000 Update the General Ledger balance. Posting to the GL Example

93 2-92 GENERAL JOURNAL Page: 1 DateDescriptionPRDebitCredit 1-JanCash10010,000 Notes Payable10,000 to record loan from bank ACCOUNT NAME: Notes PayableACCOUNT No.201 DateDescriptionPRDebitCreditBalance Beginning Balance00 Posting to the GL Example Next, find the Notes Payable page in the General Ledger.

94 2-93 GENERAL JOURNAL Page: 1 DateDescriptionPRDebitCredit 1-JanCash10010,000 Notes Payable20110,000 to record loan from bank ACCOUNT NAME: Notes PayableACCOUNT No.201 DateDescriptionPRDebitCreditBalance Beginning Balance00 Posting to the GL Example Post the account reference number.

95 2-94 GENERAL JOURNAL Page: 1 DateDescriptionPRDebitCredit 1-JanCash10010,000 Notes Payable20110,000 to record loan from bank ACCOUNT NAME: Notes PayableACCOUNT No.201 DateDescriptionPRDebitCreditBalance Beginning Balance00 1-JanLoanG110,000 Posting to the GL Example Post the transaction info to the GL.

96 2-95 GENERAL JOURNAL Page: 1 DateDescriptionPRDebitCredit 1-JanCash10010,000 Notes Payable20110,000 to record loan from bank ACCOUNT NAME: Notes PayableACCOUNT No.201 DateDescriptionPRDebitCreditBalance Beginning Balance00 1-JanLoanG110,000 Posting to the GL Example Update the General Ledger balance.

97 2-96 GENERAL JOURNAL Page: 1 DateDescriptionPRDebitCredit 15-JanTrucks9,500 Cash9,500 to record purchase of truck ACCOUNT NAME: CASHACCOUNT No.100 DateDescriptionPRDebitCreditBalance Beginning Balance00 1-JanLoan from bankG110,000 Examine the next journal entry. Posting to the GL Example

98 2-97 GENERAL JOURNAL Page: 1 DateDescriptionPRDebitCredit 15-JanTrucks9,500 Cash1009,500 to record purchase of truck Posting to the GL Example ACCOUNT NAME: CASHACCOUNT No.100 DateDescriptionPRDebitCreditBalance Beginning Balance00 1-JanLoan from bankG110,000 Record the account reference.

99 2-98 GENERAL JOURNAL Page: 3 DateDescriptionPRDebitCredit 15-JanTrucks9,500 Cash1009,500 to record purchase of truck ACCOUNT NAME: CASHACCOUNT No.100 DateDescriptionPRDebitCreditBalance Beginning Balance00 1-JanLoan from bankG110, JanPurchase of truckG39,500 Posting to the GL Example Post the entry to the GL.

100 2-99 GENERAL JOURNAL Page: 3 DateDescriptionPRDebitCredit 15-JanTrucks9,500 Cash1009,500 to record purchase of truck ACCOUNT NAME: CASHACCOUNT No.100 DateDescriptionPRDebitCreditBalance Beginning Balance00 1-JanLoan from bankG110, JanPurchase of truckG39, Posting to the GL Example Update the General Ledger balance.

101 2-100 TRIAL BALANCE l Used to periodically test whether the General Ledger is in balance. l Consists of a listing of each account with its balance as of a specific date. u All Debit balances are in one column. u All Credit balances are in another column.

102 2-101 Trial Balance Illustration (Text example is on p. 79) First Company Trial Balance 12/31/X8 DebitsCredits Cash500$ Accounts Receivable1,200 Equipment3,800 Accounts Payable700$ Notes Payable1,450 Capital Stock3,000 Retained Earnings - 1/1/X8 - Dividends250 Revenues11,000 Salary Expense5,000 Utility Expense3,000 Rent Expense2,400 16,150$ $

103 2-102 First Company Trial Balance 12/31/X8 DebitsCredits Cash500$ Accounts Receivable1,200 Equipment3,800 Accounts Payable700$ Notes Payable1,450 Capital Stock3,000 Retained Earnings - 1/1/X8 - Dividends250 Revenues11,000 Salary Expense5,000 Utility Expense3,000 Rent Expense2,400 16,150$ $ Notice that Total Debits are equal to Total Credits. Trial Balance Illustration (Text example is on p. 79)

104 2-103 Trial Balance Errors Click picture to view video

105 2-104 Loose Ends l Questions on the 15 transactions on pp ?

106 2-105 Loose Ends l Questions on the 15 transactions on pp ? l Don’t read the chapter! u First full par. on p. 75

107 2-106 Loose Ends l Questions on the 15 transactions on pp ? l Don’t read the chapter! u First full par. on p. 75 l Skip Analyzing and Using the Financial Results u p. 81

108 2-107 Loose Ends l Questions on the 15 transactions on pp ? l Don’t read the chapter! u First full par. on p. 75 l Skip Analyzing and Using the Financial Results u p. 81 l The Dividends account is not a primary type of account as implied on pp !

109 2-108 Dividends The Dividends account is a contra account to Retained Earnings. Therefore, it is affected by debits and credits as follows: DIVIDENDS Debit for Increase Credit for Decrease Dividends Account

110 2-109 Have you ever had that “I’ve- just-been-run- over-by-a- train” feeling?


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