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©2008 Pearson Prentice Hall. All rights reserved. 2-1 Transaction Analysis Chapter 2.

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1 ©2008 Pearson Prentice Hall. All rights reserved. 2-1 Transaction Analysis Chapter 2

2 ©2008 Pearson Prentice Hall. All rights reserved. 2-2 Transactions Any event that impacts the financial position of a business Can be measured reliably Two sides:  Business gives something  Business receives something Accounting records both sides of a transaction

3 ©2008 Pearson Prentice Hall. All rights reserved. 2-3 The Account Record of all changes in a particular asset, liability or equity Remember the accounting equation  Assets = Liabilities + Owner’s Equity

4 ©2008 Pearson Prentice Hall. All rights reserved. 2-4 Common Asset Accounts Cash  Bank accounts, cash on hand Accounts Receivable  Customer promise to pay for goods or services provided  Represents future collection of cash Notes receivable  Written promise to pay  Bear interest

5 ©2008 Pearson Prentice Hall. All rights reserved. 2-5 Common Asset Accounts Inventory  Products held for sale Prepaid expenses  Expenses paid for in advance  Provide future benefit  Includes prepaid rent, prepaid insurance and supplies Land

6 ©2008 Pearson Prentice Hall. All rights reserved. 2-6 Common Asset Accounts Buildings Equipment Furniture and Fixtures

7 ©2008 Pearson Prentice Hall. All rights reserved. 2-7 Common Liability Accounts Accounts payable  Company’s promise to pay for goods or services received Notes payable  Signed agreements to pay  Include interest Accrued liabilities  Expenses that have not been paid  Include interest payable and salaries payable

8 ©2008 Pearson Prentice Hall. All rights reserved. 2-8 Equity Accounts Common stock  Shareholders’ investment in the company Retained earnings  Earnings kept by the company  Cumulative net income minus dividends paid to shareholders Revenues  Earned by providing goods or services Expenses  Costs of operating a business

9 ©2008 Pearson Prentice Hall. All rights reserved. 2-9 Learning Objective 1 Analyze Transactions

10 ©2008 Pearson Prentice Hall. All rights reserved. 2-10 Transaction Analysis Every transaction has at least two parts The accounting equation always balances before and after each transaction A common transaction for a new business is to issue stock to its owners How would this impact the accounting equation?

11 ©2008 Pearson Prentice Hall. All rights reserved. 2-11 Example Transaction (1) Three friends decide to start a salon They invest $40,000 to begin the business The business issues common stock to the owners

12 ©2008 Pearson Prentice Hall. All rights reserved. 2-12 AssetsLiabilities Stockholders’ Equity Type of Equity Transaction = + CashCommon stock +$50,000 Issued stock(1)

13 ©2008 Pearson Prentice Hall. All rights reserved. 2-13 Example Transaction (2) The salon purchases chairs and massage tables for $12,000

14 ©2008 Pearson Prentice Hall. All rights reserved. 2-14 AssetsLiabilities Stockholders’ Equity = + CashCommon stock + $50,000 (1) (2) - $12,000 Equip. + $12,000 SuppliesAccts PayRetained Earnings (2) $38,000$12,000$50,000 + =

15 ©2008 Pearson Prentice Hall. All rights reserved. 2-15 Example Transactions (3) The salon purchases hair styling and other supplies on account for $5,000

16 ©2008 Pearson Prentice Hall. All rights reserved. 2-16 AssetsLiabilities Stockholders’ Equity = + CashCommon stock + $50,000 (1) (2) - $12,000 Equip. + $12,000 SuppliesAccts Pay +$5,000 (3) Retained Earnings (2) $38,000$5,000$12,000$5,000$50,000 $55,000

17 ©2008 Pearson Prentice Hall. All rights reserved. 2-17 Example Transaction (4) The salon earns $6,000 from providing services to customers. The business collected cash.

18 ©2008 Pearson Prentice Hall. All rights reserved. 2-18 AssetsLiabilities Stockholders’ Equity = + CashCommon stock + $50,000 (1) (2) - $12,000 Equip. + $12,000 SuppliesAccts Pay +$5,000 (3) +$6,000 Retained Earnings (2) (4)+$6,000(4) Revenue $44,000$5,000$12,000$5,000$50,000$6,000 $61,000

19 ©2008 Pearson Prentice Hall. All rights reserved. 2-19 Example Transaction (5) The salon paid monthly rent of $4,000

20 ©2008 Pearson Prentice Hall. All rights reserved. 2-20 Assets Liabilities Stockholders’ Equity = + CashCommon stock + $50,000 (1) (2) - $12,000 Equip. + $12,000 SuppliesAccts Pay +$5,000 (3) +$6,000 Retained Earnings (2) (4) +$6,000(4) Revenue - $4,000 (5) Expense $40,000$5,000$12,000$5,000$50,000$2,000 $57,000

21 ©2008 Pearson Prentice Hall. All rights reserved. 2-21 Learning Objective 2 Understand how accounting works

22 ©2008 Pearson Prentice Hall. All rights reserved. 2-22 Double-entry Accounting Each transaction affects at least two accounts

23 ©2008 Pearson Prentice Hall. All rights reserved. 2-23 The T-account Account Title Debits on the left side Credits on the right side Every transaction has both a debit and a credit

24 ©2008 Pearson Prentice Hall. All rights reserved. 2-24 Debit and Credit Rules Debit and credit are neutral terms  Not good or bad Mean either a decrease or increase depending on the type of account

25 ©2008 Pearson Prentice Hall. All rights reserved. 2-25 Debits and Credits ASSETSLIABILITIES STOCKHOLDERS’ EQUITY = + Debit + Debit - Credit - Credit +

26 ©2008 Pearson Prentice Hall. All rights reserved. 2-26 Stockholders’ Equity Debit & Credits Common stock and Retained Earnings are increased by credits Dividends reduce Retained Earnings  Dividends are increased by debits Net income increases Retained Earnings  Net Income = Revenues minus Expenses Revenues are increased by credits Expenses are increased by debits

27 ©2008 Pearson Prentice Hall. All rights reserved. 2-27 Debits and Credits Debit to increase  Assets  Dividends  Expenses Credits to increase  Liabilities  Revenue  Common stock  Retained earnings Do NOT proceed until you learn these rules!

28 ©2008 Pearson Prentice Hall. All rights reserved. 2-28 Practicing Debits and Credits Increase cash  Debit Increase accounts payable  Credit Decrease accounts receivable  Credit Increase revenue  Credit

29 ©2008 Pearson Prentice Hall. All rights reserved. 2-29 Practicing Debits and Credits Increase rent expense  Debit Increase common stock  Credit Decrease notes payable  Debit Decrease cash  __________________________ What type of account is cash? How is it increased?

30 ©2008 Pearson Prentice Hall. All rights reserved. 2-30 Learning Objective 3 Record transactions in the journal

31 ©2008 Pearson Prentice Hall. All rights reserved. 2-31 The Journal Chronological record of transactions Three steps  Identify accounts impacted by transaction  Apply debit/credit rules for the increase or decrease in the accounts You should have at least one debit and one credit  Record transactions in journal

32 ©2008 Pearson Prentice Hall. All rights reserved. 2-32 Journal entry Write the account debited first and the amount in the left column Write (and indent) the account credited next and the amount in the right column Debits must equal credits

33 ©2008 Pearson Prentice Hall. All rights reserved. 2-33 E2-18 Apr 1 – Received $25,000 and issued common stock JOURNAL Date Accounts Debit Credit 1-Apr Cash $25,000 Common stock $25,000

34 ©2008 Pearson Prentice Hall. All rights reserved. 2-34 E2-18 April 2 - Purchased $800 of office supplies on account JOURNAL Date Accounts Debit Credit 2-Apr Supplies $800 Accounts payable $800

35 ©2008 Pearson Prentice Hall. All rights reserved. 2-35 E2-18 April 4 - Paid $20,000 cash for land to use as a building site JOURNAL Date Accounts Debit Credit 4-Apr Land $20,000 Cash $20,000

36 ©2008 Pearson Prentice Hall. All rights reserved. 2-36 E2-18 April 6 - Performed service for customers and received cash of $2,000 JOURNAL Date Accounts Debit Credit 6-Apr ______ $2,000 __________ $2,000

37 ©2008 Pearson Prentice Hall. All rights reserved. 2-37 E2-18 April 9Paid $100 on accounts payable JOURNAL Date Accounts Debit Credit 9-Apr Accounts payable $25,000 Cash $25,000

38 ©2008 Pearson Prentice Hall. All rights reserved. 2-38 E2-18 April 17 – Performed services for FedEx on account totaling $1,200 JOURNAL Date Accounts Debit Credit 17- Apr Accounts Receivable $1,200 ________________________ $1,200 What account is credited when services are performed?

39 ©2008 Pearson Prentice Hall. All rights reserved. 2-39 E2-18 Apr 23 – Collected $900 from FedEx on account JOURNAL Date Accounts Debit Credit 23- Apr Cash $900 Accounts Receivable $900

40 ©2008 Pearson Prentice Hall. All rights reserved. 2-40 E2-18 Apr 30 – Paid the following expense: salary, $1,000; rent, $500 JOURNAL Date Accounts Debit Credit 30- Apr Salary expense $1,000 Rent expense $500 Cash $1,500

41 ©2008 Pearson Prentice Hall. All rights reserved. 2-41 Posting Transferring information from the journal to the ledger  The collection of accounts and their balances

42 ©2008 Pearson Prentice Hall. All rights reserved. 2-42 Posting JOURNAL Date Accounts Debit Credit 6-Apr Cash $2,000 Service revenue $2,000 CASHSERVICE REVENUE $2,000

43 ©2008 Pearson Prentice Hall. All rights reserved. 2-43 Flow of Accounting Data Transaction occurs Transaction analyzed  Accounts identified  Debit/Credit rules applied Transaction recorded in the Journal Amounts posted to the Ledger

44 ©2008 Pearson Prentice Hall. All rights reserved. 2-44 Determining Account Balance After transactions are posted, the amount in each ledger account is computed The debit side and credit side are totaled The difference between the two sides is computed  If the debit side is larger, the account has a debit balance  If the credit side is larger, the account has a credit balance

45 ©2008 Pearson Prentice Hall. All rights reserved. 2-45 Determining Account Balance Cash $10,000 $15,000 $ 8,000 $12,000 $7,000 The debits total to $33,000 The credits total to $19,000 $14,000 Cash has a debit balance of $14,000 ($33,000 - $19,000)

46 ©2008 Pearson Prentice Hall. All rights reserved. 2-46 Learning Objective 4 Use a trial balance

47 ©2008 Pearson Prentice Hall. All rights reserved. 2-47 Trial Balance Lists all accounts with their balance  Debit amounts in the left column  Credit amounts in the right column Begins with assets, then liabilities and stockholders’ equity The columns are totaled and should equal each other  Shows if debits equal credits

48 ©2008 Pearson Prentice Hall. All rights reserved. 2-48 Correcting Errors Sometimes the trial balance columns don’t equal Steps to find the error:  Search for any missing accounts  Divide the out-of-balance amount by two This will help find a debit that was listed as a credit, and vice versa  Divide the out-of-balance amount by nine Slide – misstating an amount by omitting or adding a zero ($4000 as $400) Transposition – switching figures within a number ($1342 as $1423)

49 ©2008 Pearson Prentice Hall. All rights reserved. 2-49 Chart of Accounts Each account is assigned a number  Assets usually begin with 1 100s or 1000s  Liabilities usually begin with 2 200s and 200s  Stockholders’ Equity (Common Stock, Dividends and Retained Earnings) begin with 3  Revenues with a 4 and Expenses with a 5

50 ©2008 Pearson Prentice Hall. All rights reserved. 2-50 Normal Balance What increases the account (debit or credit) is the normal balance  Assets are increased by debits, so assets have a normal debit balance If the balance is not “normal”, it indicates a negative amount  If cash has a credit balance, it means the company has overdrawn its bank account

51 ©2008 Pearson Prentice Hall. All rights reserved. 2-51 Normal Balances DEBITS Assets Dividends Expenses CREDITS Liabilities Retained Earnings Common Stock Revenues

52 ©2008 Pearson Prentice Hall. All rights reserved. 2-52 Learning Objective 5 Analyze transactions using only T-Accounts

53 ©2008 Pearson Prentice Hall. All rights reserved. 2-53 T-Accounts A quick informal analysis Helps users of financial information make decisions

54 ©2008 Pearson Prentice Hall. All rights reserved. 2-54 E2-26 (a) Cash Feb. 28 Bal. Mar. 31 Bal. $10,000 $ 5,000 $80,000Cash Receipts ? Total cash paid

55 ©2008 Pearson Prentice Hall. All rights reserved. 2-55 E2-26 (a) Cash Feb. 28 Bal. Mar. 31 Bal. $10,000 $ 5,000 $80,000Cash Receipts ________ Total cash paid Add together the beginning balance and cash receipts. Subtract the ending balance from that amount

56 ©2008 Pearson Prentice Hall. All rights reserved. 2-56 E2-26 (b) Accounts Receivable Feb. 28 Bal. Mar. 31 Bal. $26,000 $ 24,000 $50,000Sales on account ? Cash collections from customers

57 ©2008 Pearson Prentice Hall. All rights reserved. 2-57 E2-26 (b) Accounts Receivable Feb. 28 Bal. Mar. 31 Bal. $26,000 $ 24,000 $50,000Sales on account $52,000 Cash collections from customers $26,000 + $50,000 = $76,000 $76,000 - $24,000 = $52,000

58 ©2008 Pearson Prentice Hall. All rights reserved. 2-58 E2-26 (c) Note Payable Feb. 28 Bal. Mar. 31 Bal. $13,000 $ 21,000 $80,000New Borrowing ? Cash paid on note

59 ©2008 Pearson Prentice Hall. All rights reserved. 2-59 E2-26 (c) Note Payable Feb. 28 Bal. Mar. 31 Bal. $13,000 $ 21,000 $80,000New Borrowing $72,000 Cash paid on note $13,000 + $80,000 = $93,000 $93,000 - $21,000 = $72,000

60 ©2008 Pearson Prentice Hall. All rights reserved. 2-60 End of Chapter Two


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