Recording Business Transactions Chapter 2 2-1Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall

What Is an Account? Each element of the Accounting Equation contains smaller elements called accounts. AccountAccount—the detailed record of all increases and decreases that have occurred in an individual asset, liability, equity, revenue or expense during a specified period. Basic Summary Device 2-2Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall ASSETSLIABILITIESEQUITY

Asset Accounts Economic resources that will benefit the business in the future: Cash Accounts receivable Notes receivable Prepaid expenses Land Building Equipment, Furniture, Fixtures 2-3

Liability Accounts A debt (something owed): Accounts payable Notes payable Accrued liabilities Unearned(deferred) revenue 2-4

Equity Accounts Owner’s claim to the assets: Common Stock Dividends Revenues Expenses 2-5

Chart of Accounts Chart of AccountsCompanies typically maintain a listing of all of the accounts that they use in their accounting system, called the Chart of Accounts. Often accounts are numbered. –The numbers will usually be grouped by account type. Large companies can have thousands of different accounts that are used in their accounting system. It is easier to reference a specific account if there is a number assigned to it. 2-6Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall

Chart of Accounts 2-7Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall

What Is Double-Entry Accounting? Transactions always have two impacts on the accounting equation. –When Smart Touch bought land, the Land account increased, but the Cash account decreased by the same amount. –These “double” entries help keep the accounting equation in balance. 2-8Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall

What Is a T-Account? A T-account is a shortened visual form of the more formal general ledger account format. Increases are shown on one side of the T-account and decreases on the other side. The T-account is balanced at the end of each period. 2-9Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall

What Are Debits and Credits? Debits and Credits are used to record the increases and decreases in T-accounts. –Debit means “left” –Credit means “right” Any time we put a debit in one account, we have to put an equal credit in another account. 2-10Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall

What Are Debits and Credits? An account with more debits than credits will have a “debit” balance. An account with more credits than debits will have a “credit” balance. Some accounts will be increased with debits, and some accounts will be increased with credits. 2-11Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall

What Are Debits and Credits? We can explain the balancing impact of transactions using T-accounts and debits and credits. The account category governs the increase side or decrease side 2-12Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall

What Are Debits and Credits? When Smart Touch purchases land, we use debits to increase the Land account, and credits to decrease the Cash account. 2-13Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall

Increases in company’s contributions or distributions will be reflected in the changing Common Stock and Dividends accounts, respectively. What Are Debits and Credits? 2-14Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall

When revenues exceed expenses, net income increases Retained Earnings. What Are Debits and Credits? 2-15Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall

Normal Balance of an Account The balance that appears on the increase side of an account 16

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How Do You Record Transactions? The next step in the process is to formally record the transaction in the General Journal. 2-18Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall

How Do You Record Transactions? Transactions are first recorded using a “journal entry." The account to be debited is usually written first. 2-19Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall

How Do You Record Transactions? In Transaction #1, Smart Touch Learning sold $30,000 worth of Common Stock. Cash should be debited for $30,000 and Common Stock should be credited for $30,000. Next, each amount should be “posted” to the appropriate T-account. NOTWithout this step, the trial balance will NOT balance. 2-20Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall

How Do You Record Transactions? 2-21Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall

How Do You Record Transactions? In Transaction #2, Smart Touch purchased Land for $20,000 cash. Land should be debited for $20,000 and Cash should be credited for $20,000. Next, each amount should be “posted” to the appropriate T-account. NOTWithout this step, the trial balance will NOT balance. 2-22Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall

How Do You Record Transactions? 2-23Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall

How Do You Record Transactions? In Transaction #3, Smart Touch purchased Office Supplies on account for $500 cash. Office Supplies should be debited for $500 and Accounts Payable should be credited for $500. Next, each amount should be “posted” to the appropriate T-account. 2-24Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall

How Do You Record Transactions? 2-25Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall

Transactions 4 & 5 Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall2-26 Service Revenue for cash $5.500 Service Revenue on Account $3,000

Transactions 6 & 7 Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall2-27 Cash payment for expenses Payment on Account Payable $300

Transactions 8 & 9 Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall2-28 Collection on Account Receivable $2,000 Cash Dividend Paid $5,000

Transactions 10 Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall2-29 Prepays three month’s office rent ($1000 per month x 3 months)

Transactions 11 Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall2-30 Paid employee salaries of $1,200

Transactions 12 & 13 Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall2-31 Building purchase signing a Note payable $60,000 Stockholder contribution of Furniture $18,000

Transactions 14 Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall2-32 Phone bill received and will be paid next month $100

Transactions 15 Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall2-33 Paid employee salaries of $1,200

Transactions 16 Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall2-34 Receive $600 payment in advance for services to be provided in future

Transactions 17 Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall2-35 Service Revenue for cash $8.000

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Trial Balance The primary purpose of the trial balance is to prove the mathematical equality of debits and credits after posting. The amounts come from the individual account balances in the General Ledger. Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall2-37

First, we prepare the Income Statement. Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall2-38

The information for the Statement of Retained Earnings comes from the trial balance AND from the Income Statement. Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall2-39

The information for the Statement of Owner’s Equity comes from the trial balance AND from the Income Statement. Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall2-40

The Debt Ratio The debt ratio shows the proportion of assets financed with debt. It can be used to evaluate a business’s ability to pay its debts and to determine if the company has too much debt to be considered financially “healthy.” Evaluate long term solvency Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall2-41

Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall2-42 = $60,900 / $114,700 = 53%