Analyzing Transactions Chapter 2 Analyzing Transactions Accounting, 21st Edition Warren Reeve Fess © Copyright 2004 South-Western, a division of Thomson Learning. All rights reserved. Task Force Image Gallery clip art included in this electronic presentation is used with the permission of NVTech Inc. PowerPoint Presentation by Douglas Cloud Professor Emeritus of Accounting Pepperdine University

Each financial statement item, called an account, is included in the ledger.

A group of accounts for a business entity is called a ledger.

A list of the accounts in a ledger is called a chart of accounts.

Major Account Classifications Assets are resources owned by the business. Liabilities are debts owed to outsiders (creditors). Cash Supplies Building Accounts receivable Accounts payable Notes payable Wages payable

Major Account Classifications Liabilities are often identified on the balance sheet by titles that include payable. Assets are resources owned by the business. Liabilities are debts owed to outsiders (creditors). Cash Supplies Building Accounts receivable Accounts payable Notes payable Wages payable

Major Account Classifications Owner’s equity is the owner’s right to the assets of the business. Revenues are increases in owner’s equity as a result of selling services or products. Expenses are the using up of assets or consuming of services to generate revenue. Chris Clark, Capital Chris Clark, Drawing Rent Expense Salary Expense Utilities Expense Fees Earned Fares Earned Commission Revenue

To assist you in learning, an account can be drawn to resemble the letter T.

The T-account has a title. Cash The T-account has a title.

The left side of the account is the debit side. The T-Account Cash Left side debit The left side of the account is the debit side.

The right side of the account is the credit side. The T-Account Cash Left side debit Right side credit The right side of the account is the credit side.

The T-Account Cash 3,750 4,300 2,900 850 1,400 700 2,900 Typical entries

Balancing a T-Account

First, foot the debit side. Cash First, foot the debit side. 3,750 4,300 2,900 850 1,400 700 2,900 10,950

Cash 3,750 4,300 2,900 850 1,400 700 2,900 Next, foot the credit side. 10,950 5,850

Subtract total credits from total debits to obtain the account balance. Cash 3,750 4,300 2,900 850 1,400 700 2,900 5,100 10,950 5,850

Transactions and Balance Sheet Accounts

(A) On November 1, Chris Clark deposits $25,000 in a bank account in the name of NetSolutions. JOURNAL Date Description Debit Credit Page 1 Post. Ref. Nov. 1 2005 1 2 3 4 Cash 25 000 00 Chris Clark, Capital 25 000 00 Invested cash in NetSolutions.

Effects of this entry in the Ledger (A) On November 1, Chris Clark deposits $25,000 in a bank account in the name of NetSolutions. Effects of this entry in the Ledger Cash Chris Clark, Capital Nov. 1 25,000 Nov. 1 25,000

(B) On November 5, NetSolutions bought land for $20,000, paying cash. 4 5 6 7 8 9 10 5 Land 20 000 00 Cash 20 000 00 Purchased land for building site.

Effects of this entry in the Ledger (B) On November 5, NetSolutions bought land for $20,000, paying cash. Effects of this entry in the Ledger Cash Land Nov. 1 25,000 Nov. 5 20,000 Nov. 5 20,000

(C) On November 10, NetSolutions purchased supplies on account for $1,350. 11 12 13 14 15 16 10 Supplies 1 350 00 Accounts Payable 1 350 00 Purchased supplies on account.

Effects of this entry in the Ledger (C) On November 10, NetSolutions purchased supplies on account for $1,350. Effects of this entry in the Ledger Supplies Accounts Payable Nov. 10 1,350 Nov. 10 1,350

(F) On November 30, NetSolutions paid creditors on account, $950. 31 32 33 34 35 36 30 Accounts Payable 950 00 Cash 950 00 Paid creditors on account.

Effects of this entry in the Ledger (F) On November 30, NetSolutions paid creditors on account, $950. Effects of this entry in the Ledger Cash Accounts Payable Nov. 1 25,000 Nov. 5 25,000 Nov. 30 950 Nov. 10 1,350 18 7,500 30 3,650 30 950

Rules of Debit / Credit Balance Sheet Accounts Debits Credits Asset accounts………. Increase (+) Decrease (-) Liability accounts…… Decrease (-) Increase (+) Owner’s equity (capital) accounts…. Decrease (-) Increase (+)

Balance Sheet Accounts ASSETS Asset Accounts LIABILITIES Liability Accounts Debit for increases (+) Credit for decreases (-) Debit for decreases (-) Credit for increases (+) Owner’s Equity Accounts OWNER’S EQUITY Debit for decreases (-) Credit for increases (+)

(D) On November 18, NetSolutions received fees of $7,500 from customers for services provided . 14 15 16 17 18 19 20 18 Cash 7 500 00 Fees Earned 7 500 00 Received fees from customers.

Effects of this entry in the Ledger (D) On November 18, NetSolutions received fees of $7,500 from customers for services provided . Effects of this entry in the Ledger Cash Fees Earned Nov. 1 25,000 Nov. 5 25,000 Nov. 18 7,500 18 7,500

(E) Throughout the month, NetSolutions incurred the following expenses: wages, $2,125; rent, $800; utilities, $450; and miscellaneous, $275 . 18 19 20 21 22 23 24 30 Wages Expense 2 125 00 Rent Expense 800 00 Utilities Expense 450 00 Miscellaneous Expense 275 00 Cash 3 650 00 Paid expenses.

Effects of this entry in the Ledger (E) Throughout the month, NetSolutions incurred the following expenses: wages, $2,125; rent, $800; utilities, $450; and miscellaneous, $275 . Effects of this entry in the Ledger Cash Wages Expense Nov. 1 25,000 Nov. 5 25,000 Nov. 30 2,125 18 7,500 30 3,650 Rent Expense Utilities Expense Nov. 30 800 Nov. 30 450 Miscellaneous Expense Nov. 30 275

In every entry the sum of the debits always equal the sum of the credits.

(G) On November 30, a count revealed that $800 of the supplies inventory had been used. 25 26 27 28 29 30 31 30 Supplies Expense 800 00 Supplies 800 00 Supplies used during November.

Effects of this entry in the Ledger (G) On November 30, a count revealed that $800 of the supplies inventory had been used. Effects of this entry in the Ledger Supplies Supplies Expense Nov. 10 1,350 Nov. 30 800 Nov. 30 800

Double-Entry Accounting “ Double-entry accounting is based on a simple concept: each party in a business transaction will receive something and give something in return. In bookkeeping terms, what is received is a debit and what is given is a credit. The T account is a representation of a scale or balance.” Scale or Balance T account Left Side Receive DEBIT Right Side Give CREDIT Luca Pacioli Developer of Double-Entry Accounting Receive DEBIT Give CREDIT

Rules of Debit / Credit Income Statement Accounts Expense Accounts Revenue Accounts Debit for increases (+) Credit for decreases (-) Debit for decreases (-) Credit for increases (+)

Income Statement Accounts Debits Credits Revenue accounts…… Decrease (-) Increase (+) Expense accounts…… Increase (+) Decrease (-)

Withdrawals by the Owner

(H) On November 30, Chris Clark withdrew $2,000 in cash from NetSolutions for personal use. JOURNAL Date Description Debit Credit Page 2 Post. Ref. Nov. 30 2005 1 2 3 4 Chris Clark, Drawing 2 000 00 Cash 2 000 00 Chris Clark withdrew cash for personal use.

Effects of this entry in the Ledger (H) On November 30, Chris Clark withdrew $2,000 in cash from NetSolutions for personal use. Effects of this entry in the Ledger Cash Chris Clark, Drawing Nov. 1 25,000 Nov. 5 25,000 Nov. 30 2,000 Nov. 10 1,350 18 7,500 30 3,650 30 950 30 2,000

Normal Balances of Accounts Increase (Normal Balances) 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

Flow of Business Transactions 1 Transaction authorized 2 Transaction takes place 3 Document prepared 4 Entry recorded in journal 5 Entry posted to ledger

System to Analyze Transactions 1. Determine whether an asset, a liability, owner’s equity, revenue, or expense account is affected by the transaction. 2. For each account affected by the transaction, determine whether the account increases or decreases. 3. Determine whether each increase or decrease should be recorded as a debit or a credit.

Journalizing and Posting

Dec. 1 NetSolutions paid a premium of $2,400 for a comprehensive insurance policy covering two years. JOURNAL Date Description Debit Credit Page 2 Post. Ref. Dec. 31 2005 1 2 3 4 Prepaid Insurance 2 400 00 Cash 2 400 00 Paid premium on two-year policy.

JOURNAL Page 2 Dec. 1 1 2 3 4 Prepaid Insurance 2 400 00 Cash 2 400 00 Date Description Debit Credit Page 2 Post. Ref. Dec. 1 2005 1 2 3 4 Prepaid Insurance 2 400 00 Cash 2 400 00 Paid premium on two-year policy. ACCOUNT Prepaid Insurance ACCOUNT NO. 15 Balance Post. Ref. Date Item Debit Credit Debit Credit Dec. 1 2005 2 400 00 2 400 00

JOURNAL Page 2 Dec. 1 1 2 3 4 Prepaid Insurance 2 400 00 15 Date Description Debit Credit Page 2 Post. Ref. Dec. 1 2005 1 2 3 4 Prepaid Insurance 2 400 00 15 Cash 2 400 00 Paid premium on two-year policy. ACCOUNT Prepaid Insurance ACCOUNT NO. 15 Balance Post. Ref. Date Item Debit Credit Debit Credit Dec. 1 2005 2 2 400 00 2 400 00

JOURNAL Page 2 1 2 3 4 Dec. 1 Prepaid Insurance 2 400 00 Cash 2 400 00 Post. Ref. JOURNAL Date Description Debit Credit Page 2 1 2 3 4 Dec. 1 2005 Prepaid Insurance 2 400 00 Cash 2 400 00 Paid premium on two-year policy. 15 ACCOUNT Cash ACCOUNT NO. 11 Balance Post. Ref. Date Item Debit Credit Debit Credit Nov. 30 2005 2 2 000 00 5 900 00 Dec. 1 2 400 00 3 500 00

JOURNAL Page 2 1 2 3 4 Dec. 1 Prepaid Insurance 2 400 00 Cash 2 400 00 Post. Ref. JOURNAL Date Description Debit Credit Page 2 1 2 3 4 Dec. 1 2005 Prepaid Insurance 2 400 00 Cash 2 400 00 Paid premium on two-year policy. 15 11 ACCOUNT Cash ACCOUNT NO. 11 Balance Post. Ref. Date Item Debit Credit Debit Credit Nov. 30 2005 2 2 000 00 5 900 00 Dec. 1 2 2 400 00 3 500 00

Trial Balance

NetSolutions Trial Balance December 31, 2005 Cash 2 065 00 Accounts Receivable 2 220 00 Supplies 2 000 00 Prepaid Insurance 2 400 00 Land 20 000 00 Office Equipment 1 800 00 Accounts Payable 900 00 Unearned Rent 360 00 Chris Clark, Capital 25 000 00 Chris Clark, Drawing 4 000 00 Fees Earned 16 340 00 Wages Expense 4 275 00 Rent Expense 1 600 00 Utilities Expense 985 00 Supplies Expense 800 00 Miscellaneous Expense 455 00 42 600 00 42 600 00

Balance Sheet Items NetSolutions Trial Balance December 31, 2005 Cash 2 065 00 Accounts Receivable 2 220 00 Supplies 2 000 00 Prepaid Insurance 2 400 00 Land 20 000 00 Office Equipment 1 800 00 Accounts Payable 900 00 Unearned Rent 360 00 Chris Clark, Capital 25 000 00 Chris Clark, Drawing 4 000 00 Fees Earned 16 340 00 Wages Expense 4 275 00 Rent Expense 1 600 00 Utilities Expense 985 00 Supplies Expense 800 00 Miscellaneous Expense 455 00 42 600 00 42 600 00 Balance Sheet Items

Statement of Owner’s Equity Item NetSolutions Trial Balance December 31, 2005 Cash 2 065 00 Accounts Receivable 2 220 00 Supplies 2 000 00 Prepaid Insurance 2 400 00 Land 20 000 00 Office Equipment 1 800 00 Accounts Payable 900 00 Unearned Rent 360 00 Chris Clark, Capital 25 000 00 Chris Clark, Drawing 4 000 00 Fees Earned 16 340 00 Wages Expense 4 275 00 Rent Expense 1 600 00 Utilities Expense 985 00 Supplies Expense 800 00 Miscellaneous Expense 455 00 42 600 00 42 600 00 Statement of Owner’s Equity Item

Income Statement Items NetSolutions Trial Balance December 31, 2005 Cash 2 065 00 Accounts Receivable 2 220 00 Supplies 2 000 00 Prepaid Insurance 2 400 00 Land 20 000 00 Office Equipment 1 800 00 Accounts Payable 900 00 Unearned Rent 360 00 Chris Clark, Capital 25 000 00 Chris Clark, Drawing 4 000 00 Fees Earned 16 340 00 Wages Expense 4 275 00 Rent Expense 1 600 00 Utilities Expense 985 00 Supplies Expense 800 00 Miscellaneous Expense 455 00 42 600 00 42 600 00 Income Statement Items

Errors

Errors that will not cause the trial balance to be unequal: 1. Failure to record a transaction or to post a transaction. 2. Recording the same erroneous amount for both the debit and the credit parts of a transaction. 3. Recording the same transaction more than once. 4. Posting a part of a transaction correctly as a debit or credit but to the wrong account.

Correction of Errors Error Correction Procedure Error Correction Procedure 1. Journal entry is incorrect Draw a line through the error but not posted. and insert correct title or amount.

Correction of Errors Error Correction Procedure Error Correction Procedure 1. Journal entry is incorrect Draw a line through the error but not posted. and insert correct title or amount. 2. Journal entry is correct Draw a line through the but posted incorrectly. posted error and post correctly.

Correction of Errors Journal entry is incorrect Journalize and post a Error Correction Procedure Error Correction Procedure Journal entry is incorrect Journalize and post a and posted correcting entry.

Correcting Errors – An Example On May 5, a purchase of office equipment on account was incorrectly journalized and posted as shown. Journal – As recorded and posted Date Description Debit Credit May 5 Supplies 12,500 Accounts Payable 12,500 What would be the necessary correcting entry?

Correcting Errors – An Example On May 5, a purchase of office equipment on account was incorrectly journalized and posted as shown. Journal – As recorded and posted Date Description Debit Credit May 5 Supplies 12,500 Accounts Payable 12,500 Date Description Debit Credit May 5 Office Equipment 12,500

Correcting Errors – An Example On May 5, a purchase of office equipment on account was incorrectly journalized and posted as shown. Journal – As recorded and posted Date Description Debit Credit May 5 Supplies 12,500 Accounts Payable 12,500 Date Description Debit Credit May 5 Office Equipment 12,500 Supplies 12,500

Financial Analysis and Interpretation Comparing an item in a current statement with the same item in prior statements is called horizontal analysis.

Supplies expense 2,700 3,000 (300) (10.0)% J Holmes, Attorney-at-Law Income Statement For the Year Ended December 31, 2005 and 2006 Increase (Decrease) 2006 2005 Amount Percent Fees earned $187,500 $150,000 $37,500 25.0% Operating expenses: Wages expense $ 60,000 $ 45,000 $15,000 33.3% Rent expense 15,000 12,000 3,000 25.0% Utilities expense 12,500 9,000 3,500 38.9% Supplies expense 2,700 3,000 (300) (10.0)% Misc. expense 2,300 1,800 500 27.8% Total operating expenses $ 92,500 $ 70,800 $21,700 30.6% Net income $ 95,000 $ 79,200 $15,800 19.9%

Chapter 2 The End