1. Analyzing Transactions
Chapter 2

2. Learning Objectives
Describe the characteristics of an account and a chart of accounts.
Describe and illustrate journalizing transactions using the double-entry accounting system.
Describe and illustrate the journalizing and posting of transactions to accounts.
Prepare an unadjusted trial balance and explain how it can be used to discover errors.
Describe and illustrate the use of horizontal analysis in evaluating a company’s performance and financial condition.

3. Learning Objective 1
Describe the characteristics of an account and a chart of accounts.

4. LO 1
Using Accounts to Record Transactions
Accounting systems are designed to show the increases and decreases in each accounting equation element as a separate record. This record is called an account.

5. Using Accounts to Record Transactions
LO 1
Using Accounts to Record Transactions

6. The T account has a title.
LO 1
The T Account
Title
The T account has a title.

7. The left side of the account is called the debit side.
LO 1
The T Account
Title
Debit
The left side of the account is called the debit side.

8. The right side of the account is called the credit side.
LO 1
The T Account
Title
Debit
Credit
The right side of the account is called the credit side.

9. Cash (a) 25,000 (b) 20,000 (d) 7,500 (e) 3,650 (f) 950 (h) 2,000
LO 1
The T Account
Cash
(a) 25,000 (b) 20,000
(d) 7,500 (e) 3,650
Credit Side of Account
Debit Side of Account
(f) 950
(h) 2,000
Balance 5,900
Balance of the account

10. A group of accounts for a business entity is called a ledger.
LO 1
Chart of Accounts
A group of accounts for a business entity is called a ledger.
A list of the accounts in the ledger is called a chart of accounts.

11. LO 1
Chart of Accounts
Assets are resources owned by the business. Some examples of assets follow:
Cash
Supplies
Accounts receivable
Buildings

12. LO 1
Chart of Accounts
Liabilities are debts owed to outsiders (creditors). Some examples of liabilities follow:
Accounts payable
Notes payable
Wages payable
Interest payable

13. LO 1
Chart of Accounts
Owner’s equity is the owner’s right to the assets of the business after all liabilities have been paid. For a proprietorship, the owner’s equity is represented by the balance of the owner’s capital account.
A drawing account represents the amount of withdrawals made by the owner.

14. LO 1
Chart of Accounts
Revenues are increases in owner’s equity as a result of selling services or products to customers. Some examples of revenue accounts follow:
Fees earned
Commission revenue
Rent revenue

15. Miscellaneous expense
LO 1
Chart of Accounts
The using up of assets or consuming services in the process of generating revenues results in expenses. Some examples of expenses follow:
Wages expense
Rent expense
Miscellaneous expense

16. LO 1
Chart of Accounts

17. Learning Objective 2
Describe the characteristics of an account and a chart of accounts.
Describe and illustrate journalizing transactions using the double-entry accounting system.

18. Double-Entry Accounting System
LO 2
Double-Entry Accounting System
All businesses use what is called the double-entry accounting system. This system is based on the accounting equation and requires:
Every business transaction to be recorded in at least two accounts.
The total debits recorded for each transaction to be equal to the total credits recorded.

19. Balance Sheet Accounts
The debit and credit rules for balance sheet accounts are as follows:

20. Income Statement Accounts
The debit and credit rules for income statement accounts are based on their relationship with owner’s equity.

21. Owner Withdrawals

22. LO 2
Normal Balances
The sum of the increases in an account is usually equal to or greater than the sum of the decreases in the account. Thus, the normal balance of an account is either a debit or a credit depending on whether increases in the account are recorded as debits or credits.

23. Rules of Debit and Credit – Normal Balances of Accounts
LO 2
Rules of Debit and Credit – Normal Balances of Accounts

24. Normal Balances LO 2 Increases (Normal Bal.) 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

25. EE 2-1

26. LO 2
Transaction A
On November 1, Chris Clark opens a new business and deposits $25,000 in a bank account in the name of NetSolutions.

27. Accounting Equation Impact
LO 2
Transaction A
Step 2
Step 3
Step 1
Step 4
Step 5
Step 3
Assets = Liabilities Owner’s Equity (investment)
Accounting Equation Impact
increase
increase

28. Journalizing requires the following steps:
Step 1. The date of the transaction is entered in the Date column.
Step 2. The title of the account to be debited is recorded at the left-hand margin under the Description column, and the amount to be debited is entered in the Debit column.
(continued)

29. Step 4. A brief description may be entered below the credited account.
Journalizing
Step 3. The title of the account to be credited is listed below and to the right of the debited account title, and the amount to be credited is entered in the Credit column.
Step 4. A brief description may be entered below the credited account.
(continued)

30. LO 2
Journalizing
Step 5. The Post. Ref. (Posting Reference) column is left blank when the journal entry is initially recorded. This column is used later when the journal entry amounts are transferred to the accounts in the ledger.

31. A transaction is initially entered in a record called a journal.
LO 2
Journalizing
A transaction is initially entered in a record called a journal.

32. A transaction is initially entered in a record called a journal.
LO 2
Journalizing
A transaction is initially entered in a record called a journal.
The process of recording a transaction in the journal is called journalizing.

33. A transaction is initially entered in a record called a journal.
LO 2
Journalizing
A transaction is initially entered in a record called a journal.
The process of recording a transaction in the journal is called journalizing.
The entry in the journal is called a journal entry.

34. LO 2
Transaction B
On November 5, NetSolutions paid $20,000 for the purchase of land as a future building site.

35. Accounting Equation Impact
LO 2
Transaction B
Accounting Equation Impact
Assets = Liabilities Owner’s Equity
increase
decrease

36. On November 10, NetSolutions purchased supplies on account for $1,350.
LO 2
Transaction C
On November 10, NetSolutions purchased supplies on account for $1,350.

37. Accounting Equation Impact
LO 2
Transaction C
Accounting Equation Impact
Assets = Liabilities Owner’s Equity
increase
increase

38. LO 2
Transaction D
On November 18, NetSolutions received cash of $7,500 from customers for services provided.

39. Accounting Equation Impact
LO 2
Transaction D
Accounting Equation Impact
Assets = Liabilities Owner’s Equity (Revenue)
increase
increase

40. LO 2
Transaction E
On November 30, NetSolutions incurred the following expenses: wages, $2,125; rent, $800; utilities, $450; and miscellaneous, $275.

41. Accounting Equation Impact
LO 2
Transaction E
Accounting Equation Impact
Assets = Liabilities Owner’s Equity (Expense)
All four expense accounts increase
decrease

42. On November 30, NetSolutions paid creditors on account, $950.
LO 2
Transaction F
On November 30, NetSolutions paid creditors on account, $950.

43. Accounting Equation Impact
LO 2
Transaction F
Accounting Equation Impact
Assets = Liabilities Owner’s Equity
decrease
decrease

44. LO 2
Transaction G
NetSolutions purchased $1,350 of supplies on November 10. Chris Clark determined that the cost of supplies on hand on November 30 was $550.

45. Accounting Equation Impact
LO 2
Transaction G
Accounting Equation Impact
Assets = Liabilities Owner’s Equity (Expense)
decrease
increase

46. LO 2
Transaction H
On November 30, Chris Clark withdrew $2,000 from NetSolutions for personal use.

47. Accounting Equation Impact
LO 2
Transaction H
Accounting Equation Impact
Assets = Liabilities Owner’s Equity (Drawing)
decrease
increase

48. EE 2-2

49. Learning Objective 3
Describe the characteristics of an account and a chart of accounts.
Describe and illustrate journalizing transactions using the double-entry accounting system.
Describe and illustrate the journalizing and posting of transactions to accounts.

50. Posting Journal Entries to Accounts
LO 3
Posting Journal Entries to Accounts
The process of transferring the debits and credits from the journal entries to the accounts is called posting.

51. Posting Journal Entries to Accounts
LO 3
Posting Journal Entries to Accounts
On December 1, NetSolutions paid a premium of $2,400 for an insurance policy for liability, theft, and fire. The policy covers a one-year period.

52. Accounting Equation Impact
LO 3
Posting Journal Entries to Accounts
Accounting Equation Impact
Assets = Liabilities Owner’s Equity
decrease
increase

53. Exhibit 4 - Steps in Posting
LO 3
Exhibit 4 - Steps in Posting
Step 1. The date of the transaction is entered in the Date column of Prepaid Insurance.
Dec. 1 Prepaid Insurance 2,400
Cash 2,400
Paid premium on one-year policy.
Dec. 1 Prepaid Insurance 2,400
Cash 2,400
Paid premium on one-year policy.
Account Prepaid Insurance Account No. 15
Date Item Ref. Debit Credit Debit Credit
Post.
Balance
Account Prepaid Insurance Account No. 15
Date Item Ref. Debit Credit Debit Credit
Post..
Balance
Dec. 1
2011
2011
Dec. 1

54. Exhibit 4 - Steps in Posting
LO 3
Exhibit 4 - Steps in Posting
Step 2. The amount (2,400) is entered in the Debit column of Prepaid Insurance.
Dec. 1 Prepaid Insurance 2,400
Cash 2,400
Paid premium on one-year policy.
Account Prepaid Insurance Account No. 15
Date Item Ref. Debit Credit Debit Credit
Post.
Balance
2011
Dec. 1
2,400
2,400

55. Exhibit 4 - Steps in Posting
LO 3
Exhibit 4 - Steps in Posting
Step 3. The journal page number (2) is entered in the account’s Post. Ref. column.
Dec. 1 Prepaid Insurance 2,400
Cash 2,400
Paid premium on one-year policy.
Account Prepaid Insurance Account No. 15
Date Item Ref. Debit Credit Debit Credit
Post.
Balance
2011
Dec. 1 2
2,400
2,400

56. Exhibit 4 - Steps in Posting
LO 3
Exhibit 4 - Steps in Posting
Step 4. The account number (15) is entered in the journal’s Post. Ref. column.
Dec. 1 Prepaid Insurance 2,400
Cash 2,400
Paid premium on one-year policy. 15
Account Prepaid Insurance Account No. 15
Date Item Ref. Debit Credit Debit Credit
Post.
Balance
2011
Dec. 1 2
2,400
2,400

57. Recording and Posting of a Debit and a Credit
LO 3
Recording and Posting of a Debit and a Credit
These steps are repeated to post to the Cash account.

58. December Transactions
LO 3
December Transactions
On December 1, NetSolutions paid rent for December, $800. The company from which NetSolutions is renting its store space now requires the payment of rent on the first of each month, rather than at the end of the month.

59. December Transactions
LO 3
December Transactions
Accounting Equation Impact
Assets = Liabilities Owner’s Equity (Expense)
decrease
increase

60. December Transactions
LO 3
December Transactions
On December 1, NetSolutions received an offer from a local retailer to rent the land purchased on November 5. The retailer plans to use the land as a parking lot for its employees and customers. NetSolutions agreed to rent the land to the retailer for three months, with the rent payable in advance. NetSolutions received $360 for three months’ rent beginning December 1.
The liability created by receiving the cash in advance of providing the service is called unearned revenue.

61. December Transactions
LO 3
December Transactions
Accounting Equation Impact
Assets = Liabilities Owner’s Equity
increase
increase

62. December Transactions
LO 3
LO 3
December Transactions
On December 4, NetSolutions purchased office equipment on account from Executive Supply Co. for $1,800.

63. Accounting Equation Impact
LO 3
LO 3
December Transactions
Accounting Equation Impact
Assets = Liabilities Owner’s Equity
increase
increase

64. December Transactions
LO 3
December Transactions
On December 6, NetSolutions paid $180 for a newspaper advertisement.

65. Accounting Equation Impact
LO 3
December Transactions
Accounting Equation Impact
Assets = Liabilities Owner’s Equity (Expense)
decrease
increase

66. December Transactions
LO 3
December Transactions
On December 11, NetSolutions paid creditors $400.

67. Accounting Equation Impact
LO 3
December Transactions
Accounting Equation Impact
Assets = Liabilities Owner’s Equity
decrease
decrease

68. December Transactions
LO 3
December Transactions
On December 13, NetSolutions paid a receptionist and a part-time assistant $950 for two weeks’ wages.

69. Accounting Equation Impact
LO 3
December Transactions
Accounting Equation Impact
Assets = Liabilities Owner’s Equity (Expense)
decrease
increase

70. December Transactions
LO 3
December Transactions
On December 16, NetSolutions received $3,100 from fees earned for the first half of December.

71. December Transactions
LO 3
December Transactions
Accounting Equation Impact
Assets = Liabilities Owner’s Equity (Revenue)
increase
increase

72. December Transactions
LO 3
December Transactions
Fees earned on account totaled $1,750 for the first half of December.

73. Accounting Equation Impact
LO 3
December Transactions
Accounting Equation Impact
Assets = Liabilities Owner’s Equity (Revenue)
increase
increase

74. EE 2-3
EE 2-3

75. December Transactions
LO 3
December Transactions
On December 20, NetSolutions paid $900 to Executive Supply Co. on the $1,800 debt owed from the December 4 transaction.

76. December Transactions
LO 3
December Transactions
Accounting Equation Impact
Assets = Liabilities Owner’s Equity
decrease
decrease

77. December Transactions
LO 3
December Transactions
On December 21, NetSolutions received $650 from customers in payment of their accounts.

78. December Transactions
LO 3
December Transactions
Accounting Equation Impact
Assets = Liabilities Owner’s Equity
increase
decrease

79. December Transactions
LO 3
December Transactions
On December 23, NetSolutions paid $1,450 for supplies.

80. Accounting Equation Impact
LO 3
December Transactions
Accounting Equation Impact
Assets = Liabilities Owner’s Equity
decrease
increase

81. December Transactions
LO 3
December Transactions
On December 27, NetSolutions paid the receptionist and the part-time assistant $1,200 for two weeks’ wages.

82. Accounting Equation Impact
LO 3
December Transactions
Accounting Equation Impact
Assets = Liabilities Owner’s Equity (Expense)
decrease
increase

83. December Transactions
LO 3
December Transactions
On December 31, NetSolutions paid its $310 telephone bill for the month.

84. December Transactions
LO 3
December Transactions
Accounting Equation Impact
Assets = Liabilities Owner’s Equity (Expense)
decrease
increase

85. December Transactions
LO 3
December Transactions
On December 31, NetSolutions paid its $225 electric bill for the month.

86. Accounting Equation Impact
LO 3
December Transactions
Accounting Equation Impact
Assets = Liabilities Owner’s Equity (Expense)
decrease
increase

87. December Transactions
LO 3
December Transactions
On December 31, NetSolutions received $2,870 from fees earned for the second half of December.

88. Accounting Equation Impact
LO 3
LO 3
December Transactions
Accounting Equation Impact
Assets = Liabilities Owner’s Equity (Revenue)
increase
increase

89. December Transactions
LO 3
December Transactions
On December 31, fees earned on account totaled $1,120 for the second half of December.

90. December Transactions
LO 3
December Transactions
Accounting Equation Impact
Assets = Liabilities Owner’s Equity (Revenue)
increase
increase

91. December Transactions
LO 3
December Transactions
On December 31, Chris Clark withdrew $2,000 for personal use.

92. Accounting Equation Impact
LO 3
December Transactions
Accounting Equation Impact
Assets = Liabilities Owner’s Equity (Drawing)
decrease
increase

93. EE 2-4

94. EE 2-5

95. LO 3
Ledger NetSolutions
(continued)

96. LO 3
Ledger NetSolutions
(continued)

97. LO 3
Ledger NetSolutions

98. Learning Objective 4
Describe the characteristics of an account and a chart of accounts.
Describe and illustrate journalizing transactions using the double-entry accounting system.
Describe and illustrate the journalizing and posting of transactions to accounts.
Prepare an unadjusted trial balance and explain how it can be used to discover errors.

99. LO 4
Trial Balance
The equality of debits and credits in the ledger should be proven at the end of each accounting period by preparing a trial balance.

100. Unadjusted Trial Balance
LO 4
Unadjusted Trial Balance

101. Trial Balance Errors - Transposition
LO 4
Trial Balance Errors - Transposition
A transposition occurs when the order of the digits is changed by mistake, such as writing $542 as $452 or $524.

102. Trial Balance Errors - Slide
LO 4
Trial Balance Errors - Slide
In a slide, the entire number is moved one or more spaces to the right or the left by mistake, such as writing $ as $54.20 or $97.50 as $

103. EE 2-6

104. Errors Not Affecting the Trial Balance
LO 4
Errors Not Affecting the Trial Balance
If an error has already been journalized and posted to the ledger, a correcting journal entry is normally prepared.

105. Errors Not Affecting the Trial Balance
Another type of error is a posting error.
Assume that on May 5 a $12,500 purchase of office equipment on account was incorrectly journalized and posted as a debit to Supplies and a credit to Accounts Payable for $12,500.
The entry to correct the error is:

106. EE 2-7

107. Learning Objective 5
Describe the characteristics of an account and a chart of accounts.
Describe and illustrate journalizing transactions using the double-entry accounting system.
Describe and illustrate the journalizing and posting of transactions to accounts.
Prepare an unadjusted trial balance and explain how it can be used to discover errors.
Describe and illustrate the use of horizontal analysis in evaluating a company’s performance and financial condition.

108. LO 5
Horizontal Analysis
In horizontal analysis, the amount of each item on a current financial statement is compared with the same item on an earlier statement.

109. LO 5
Horizontal Analysis
In horizontal analysis, the amount of each item on a current financial statement is compared with the same item on an earlier statement.
When two statements are being compared, the earlier statement is used as the base for computing the amount and the percent of change.

110. LO 5
Horizontal Analysis

111. EE 2-8

112. Analyzing Transactions
The End