1. Recording Transactions
CHAPTER 3

2. Learning Objectives (LO)
After studying this chapter, you should be able to
Use double-entry accounting
Describe the five steps in the recording process
Analyze and journalize transactions and post journal entries to the ledgers
Prepare and use a trial balance
Close revenue and expense accounts and update retained earnings
Correct erroneous journal entries and describe how errors affect accounts
Explain how computers have transformed the processing of accounting data

3. LO 1 – Double-Entry System
Basic accounting equation + specific accounts (Act.)
ASSETS = LIABILITIES + OWNERS’ EQUITY
Cash Accounts Payable Paid in Capital
Accounts Receivable Notes Payable Retained Earnings
Prepaid items Revenue
Equipment Expenses
Building Gains (later)
Land Losses (later)
Distributions to owners
Dividends
At least two entries required to maintain equality
NET
INCOME

4. LO 1 – Double-Entry System
Analyze transactions, events, circumstances – looking for three things
Which accounts are affected?
What amounts are involved?
In which direction did the accounts change?
Up = +; Down = “–” Debits and credits
Analogy – check register for cash (the account)
Date
Reference Description
Deposit
Withdrawal
Balance
Beginning balance
1,000
6/20/20X2
6/22/20X2
Paycheck
Groceries
200 32
1,200
1.168

5. LO 1 – Double-Entry System
T-account = visualization of every account
EVERY ACCOUNT
Left side
DEBIT
Increase (+) or decrease (–)?
Right side
CREDIT
Increase (+) or Decrease (–)?
Assets
Liabilities
Owners’ Equity = + D C D C
Paid in Capital
Retained Earnings D C
Revenue
(Expense)
(Dividend) D C D C D C

6. LO 1 – Double-Entry System
T-account = visualization of every account
EVERY ACCOUNT
Left side
DEBIT
Increase (+) or decrease (–)?
Right side
CREDIT
Increase (+) or Decrease (–)?
Assets
Liabilities
Owners’ Equity = + D + C – D – C +
Paid in Capital
Retained Earnings D – C +
Revenue
(Expense)
(Dividend) D – C + D – C + D – C +

7. LO 1 – Double-Entry System
Usage as a verb
Debit
Credit
Assets
Increase
Decrease
Liabilities
Owners’ Equity
Paid-in Capital
Retained Earnings
Revenues
(Expenses)
(Dividends)
Debits increase
these accounts
but they also
reduce owners’
equity
At least two entries are required to keep the
accounting equation in balance

8. LO 2 – Recording Process
Transaction Documentation - original records underlying transactions, events, circumstances are analyzed to determine the amounts, accounts, and direction (up/down) each caused
Journal – chronological listing of events (diary)
Ledger – grouping like events into one record, e.g. cash in minus cash out = cash balance
Trial Balance – ledger acts. collectively balance
Transactions
Documentation
Journal
Ledger
Trial
Balance
Financial
Statements

9. LO 2 – Recording Process Analyze each transaction to find
Accounts – Chart of accounts used in the business
Amounts – given/obvious or have to back into
Beg.(10) + Purchase (5) less Used (?) = End (4)
Direction - Debit Assets Liabilities/owners’ equity
- Credit Assets Liabilities/owners’ equity

10. LO 3 –Posting to Ledger Accounts
Posting = copying amounts from the journal to the ledger
At least two postings per transaction
For complex events, could involve many accounts (called compound journal entries)
Cross-referencing - using numbering, dating, and/or some other identification in the ledger to trace it back to the appropriate journal entry or vice versa

11. LO 3 –Posting to Ledger Accounts
Ledger formats may differ

12. LO 3 – Journal/Ledger Examples
Sale of merchandise on credit (Part 1)
Transaction: Customer charged purchase $180,000; paid later in full
Analysis: Accounts Receivable and ultimately Cash increase
Stockholders’ equity increases because Revenue was earned at the time of sale
Journal Entry: Accounts Receivable ,000
Revenue ,000
Cash ,000
Accounts Receivable ,000
Posting:
Cash Accounts Receivable Revenue
180,000
180,000
180,000
180,000

13. LO 3 – Journal/Ledger Examples
Sale of merchandise on credit (Part 2)
Transaction: Cost of merchandise sold, $100,000
Analysis: Merchandise Inventory decreases
Stockholders’ equity decreases because an expense account Cost of Goods Sold (a negative stockholders’ account) increases
Journal Entry: Cost of Goods Sold ,000
Merchandise Inventory ,000
Posting:
Merchandise Inventory Cost of Goods Sold
100,000
100,000

14. LO 3 – Journal/Ledger Examples
Sale of merchandise on credit (Part 3)
Transaction: Customer pays for charged purchase $180,000
Analysis: Accounts Receivable decreases and Cash increases
Journal Entry: Cash ,000
Accounts Receivable ,000
Cash Accounts Receivable Revenue
Posting:
180,000
180,000
180,000
180,000

15. LO 3 – Journal/Ledger Examples
Cash is received before it is earned
Transaction: Customer paid $5,000 in advance, service later performed
Analysis: Cash increases
Unearned Revenue (liability) increases then decreases
Stockholders’ equity increases when Revenue is earned
Journal Entry: Cash 5,000
Unearned Revenue 5,000
Unearned Revenue 5,000
Revenue 5,000
Posting:
Cash Unearned Revenue Revenue
5,000
5,000
5,000
5,000

16. LO 3 – Journal/Ledger Examples
Purchased an asset before consuming 1/3 of it
Transaction: Cost of assets acquired = $6,000; consumed = $2,000
Analysis: Prepaid Rent increases then decreases when consumed
Cash decreases
Stockholders’ equity decreases because an expense account Rent Expense (a negative stockholders’ account) increases
Journal Entry: Prepaid Rent ,000
Cash ,000
Rent Expense 2,000
Prepaid Rent 2,000
Posting:
Cash Prepaid Rent Rent Expense
6,000
6,000
2,000
2,000

17. LO 3 – Journal/Ledger Examples
Purchase an asset and depreciate it (Part 1)
“Matching” suggests expenses include only those costs that contribute to the production of revenue
To deduct total cost of multi-year asset in first year is poor matching
Alternative approach – deduct some each year
Cost ($1,000) less its salvage value ($0) = amount allocated
Estimated useful life (10 years) each year ($100)

18. LO 3 – Journal/Ledger Examples
Purchase an asset and depreciate it (Part 2)
Transaction: Buy equipment $10,000; 10 year life; zero salvage value
Analysis: Cash decrease, Equipment increases then decreases
Stockholders’ equity decreases because an expense account Depreciation Expense (a negative stockholders’ account) increases
Journal Entry: Equipment ,000
Cash ,000
Depreciation Expense * 1,000
Equipment ,000
* {10,000 – 0) / 10 year life = 1,000 / year}
Posting:
Cash Equipment Depreciation Exp.
10,000
10,000
1,000
1,000

19. LO 3 – Journal/Ledger Examples
Purchase an asset and depreciate it (Part 3)
Transaction: Buy equipment $10,000; 10 year life; zero salvage value
Analysis: If reduce Equipment account directly, lose track of initial
Cost. Better to split amounts into two accounts
1) original cost, and 2) amount of cost allocated
Accumulated Depreciation (contra asset account)
Journal Entry: Depreciation Expense * 1,000
Accumulated Depreciation 1,000
* {10,000 – 0) / 10 year life = 1,000 / year}
Posting:
Equipment Accumulated Depreciation
Depreciation Expense
10,000
1,000
1,000

20. LO 3 – Journal/Ledger Examples
Purchase an asset and depreciate it (Part 4)
Equipment ,000
Less Accumulated Depreciation (1,000)
Book Value (appears in the statements) 9,000

21. LO 4 – Trial Balance
Trial Balance – list of all general ledger accounts
and their balances

22. LO 4 – Trial Balance (TB)
Taken anytime – but three times are important
Unadjusted TB - before making adjustments (Ch. 3)
Adjusted TB - after making adjustments (Ch. 4)
Could use TBs to prepare the financial statements
Post-closing TB – after closing entries (Ch. 3)
Accounts’ debit balances equal credit balances?
Yes – proceed but errors can still exist – see Learning Objective 6
No – go back and find/fix the error

23. LO 5 – Closing Accounts Closing the accounts - background
Adjustments (Ch. 4) must be made before closing
Balance sheet accounts are “permanent”
So long as a balance exists, they will be used from year to year, i.e. have a running balance so they are not closed
Income statement accounts {Revenue, Expenses, (Gains, Losses – later)} and Dividends are “temporary” accounts
Beginning of year - all have a zero balance
End of year – if activity occurred, have balances

24. LO 5 – Closing Accounts
Closing the accounts – the concept is to take all temporary accounts and
Transfer all income statement account balances to a “collecting” account called Income Summary
Transfer the Income Summary balance and Dividends balance to Retained Earnings which is a “permanent” stockholders’ equity account
Balance remaining in temporary accounts should equal zero and thus be ready for the next accounting period’s transactions

25. LO 5 – Closing Accounts Cost of Goods Sold Bal. 100,000 Rent Expense
Three Expense and one Revenue accounts need closing to get the ending balance to zero. WHAT NEEDS TO BE DONE?
Cost of Goods Sold
Bal ,000
Rent Expense
Income Summary
Sales Revenue
Bal ,000
Bal. 160,000
Depreciation Expense
Retained Income
Bal 0
Bal

26. LO 5 – Closing Accounts
Three Expense and one Revenue accounts need closing to get the ending balance to zero) WHAT NEEDS TO BE DONE?
Credit the Expense accounts; Debit Income Summary act
Debit the Revenue account; Credit Income Summary account
Determine the balance in the Income Summary account
Close the Income Summary balance to Retained Earnings
Cost of Goods Sold
Bal ,000
Rent Expense
Income Summary
Sales Revenue
Bal ,000
Bal. 160,000
Depreciation Expense
Retained Income
Bal
Bal

27. LO 5 – Closing Accounts Journal entries always precede entries to the
ledger accounts
Journal Entry: C1 Revenue 160,000
Income Summary 160,000
C2 Income Summary 102,100
Cost of goods sold 100,000
Rent expense ,000
Depreciation expense

28. LO 5 – Closing Accounts Cost of Goods Sold Bal. 100,000 C2 100,000
Rent Expense
Income Summary
Sales Revenue
Bal ,000 C ,000
C ,100 C ,000
C ,000 Bal. 160,000
Depreciation Expense
Retained Income
Bal
Bal C

29. LO 5 – Closing Accounts Journal entries always precede entries to the
ledger accounts
Journal Entry: C3 Income Summary 57,900
Retained Earnings 57,900

30. LO 5 – Closing Accounts Cost of Goods Sold Bal. 100,000 C2 100,000
Rent Expense
Income Summary
Sales Revenue
Bal , C ,000
C ,100 C1 160,000
C1 160,000 Bal. 160,000
C ,900
Depreciation Expense
Retained Income
Bal
Bal C
C ,900
New bal. 57,900

31. LO 5 – Closing Accounts Close Dividends directly to Retained Earnings
(Dividends are not part of income)
C4 Retained Earnings 50
Dividends 50
Retained Earnings
Dividends
C ,100 C1 160,000
Bal. 50
C ,900 C
C4 50
Bal ,850
After closing, four financial statements are prepared
- As frequently as management desires
- SEC – quarterly and annual reports

32. LO 6 - Errors Errors are multi-dimensional
No entry is made when one should have been made
If erroneous entry is made, could be
Correct amounts to incorrect accounts
Incorrect amounts to correct accounts
Transaction omitted
GAAP is misapplied
Types of accounts involved
Permanent – always open so correct anytime
Temporary
If accounts not closed, simple correction
If accounts are closed, use Retained Earnings or just wait (self correcting after 2 years)

33. LO 6 - Errors Approach to correcting errors – an example
What was recorded?
Rent Expense 100
Cash 100
What should have been recorded?
Prepaid Rent 100
Cash 100
Correcting entry depends on where we are in time?
Made and discovered in same fiscal year
Made in one fiscal year, discovered next fiscal year

34. LO 6 - Errors
Made and discovered in same fiscal year, the temporary account Rent Expense is still open (not been closed to Retained Earnings)
Prepaid Rent 100
Rent Expense 100
Made last year, discovered this year
(Rent Expense was closed to Retained Earnings
- Do nothing – after 2nd year, will be correct, or
Prepaid Rent 100
Retained Earnings 100
- Then later, debit Rent Expense and credit Prepaid Rent

35. LO 6 - Errors Ledger (“T”) accounts – an analytical tool
Information available (black); unavailable (purple)
Accounts Receivable
Cash
Sales Revenue
4,000
Sales ?
6,000
280,000
280,000
Sales Revenue?
- Assuming all sales were on credit, what was
Sales Revenue?
4,000 + Sales Revenue – 280,000 = 6,000
Sales Revenue =282,000

36. LO 7 – Computers’ effect on Accounting
Data Processing – hardware and software used to record, analyze, store, and report on activities
In general, computers
Increase
Speed of processing data
Accuracy of data/reports
Reduce
Processing costs (perhaps)
Errors

37. LO 7 – Computers’ effect on Accounting
Specific to accounting, computers
Capture cost of goods sold and inventory changes
Activate an order to a supplier
Check credit limits and update accounts receivable
Prepare invoices/statements to buyers
Process journal entries and post to ledger accounts
Prepare trial balances and financial statements
Extensible Business Reporting Language (XBRL)
Facilitate reporting and analyzing financial data