1. 1 Chapter 2 Analyzing Transactions Financial and Managerial Accounting 8th 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.

2. 2 1.Explain why accounts are used to record and summarize the effects of transactions on financial statements. 2.Describe the characteristics of an account. 3.List the rules of debit and credit and the normal balances of accounts. 4. Analyze and summarize the financial statement effects of transactions. 5. Prepare a trial balance and explain how it can be used to discover errors. 6.Discover errors in recording transactions and correct them. 7.Use horizontal analysis to compare financial statements from different periods. ObjectivesObjectives

3. 3 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.

4. 4 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 Liabilities are often identified on the balance sheet by titles that include “payable” Liabilities are often identified on the balance sheet by titles that include “payable”

5. 5 Owners’ (stockholders’) 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. Capital Stock Retained Earnings Dividends Fees Earned Fares Earned Commission Revenue Expenses are the using up of assets or consuming of services to generate revenue. Rent Expense Salary Expense Utilities Expense Major Account Classifications

6. 6 The T-Account Cash Left side debit Right side credit

7. 7 The T-Account Cash 3,750 4,300 2,900 850 1,400 700 2,900 Typical entries

8. 8 Cash 3,750 4,300 2,900 850 1,400 700 2,900 10,950 First, foot the debit side. Balancing a T-Account

9. 9 850 1,400 700 2,900 Cash 3,750 4,300 2,900 10,950 5,850 Next, foot the credit side. Next, foot the credit side.

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

11. 11 Transactions and Balance Sheet Accounts

12. 12 Post. Ref. JOURNAL DateDescriptionDebitCredit Page 1 12341234 Nov.1 2005 Cash25 000 00 Capital Stock25 000 00 Issued capital stock for cash. (A)On November 1, Chris Clark deposits $25,000 in a bank account in the name of NetSolutions in exchange for capital stock.

13. 13 Effects of this entry in the Ledger Cash Nov. 125,000 Capital Stock (A)On November 1, Chris Clark deposits $25,000 in a bank account in the name of NetSolutions in exchange for capital stock.

14. 14 4 5 6 7 8 9 10 5Land20 000 00 Cash20 000 00 Purchased land for building site. (B)On November 5, NetSolutions bought land for $20,000, paying cash.

15. 15 Effects of this entry in the Ledger Cash Nov. 125,000Nov. 520,000 Land Nov. 520,000 (B)On November 5, NetSolutions bought land for $20,000, paying cash.

16. 16 10 11 12 13 14 15 16 10Supplies1 350 00 Accounts Payable1 350 00 Purchased supplies on account. (C)On November 10, NetSolutions purchased supplies on account for $1,350.

17. 17 (C)On November 10, NetSolutions purchased supplies on account for $1,350. Effects of this entry in the Ledger Supplies Nov. 101,350 Accounts Payable Nov. 101,350

18. 18 30 Accounts Payable950 00 Cash950 00 Paid creditors on account. 30 31 32 33 34 35 36 (F)On November 30, NetSolutions paid creditors on account, $950.

19. 19 Cash Nov. 125,000Nov. 525,000 187,500 303,650 Effects of this entry in the Ledger Accounts Payable Nov. 101,350Nov. 30950 30950 (F)On November 30, NetSolutions paid creditors on account, $950.

20. 20 Debits Credits Asset accounts……….Increase (+)Decrease (-) Liability accounts……Decrease (-)Increase (+) Owner’s equity (capital) accounts….Decrease (-)Increase (+) Rules of Debit / Credit Balance Sheet Accounts

21. 21 Credit for increases (+) Credit for decreases (–) Debit for increases (+) Debit for decreases (–) ASSETS Asset Accounts LIABILITIES Liability Accounts Balance Sheet Accounts Debit for decreases (–) Credit for increases (+) Stockholders’ Equity Accounts OWNERS’ EQUITY

22. 22 (D)On November 18, NetSolutions received fees of $7,500 from customers for services provided. 18Cash7 500 00 Fees Earned7 500 00 Received fees from customers. 14 15 16 17 18 19 20

23. 23 Effects of this entry in the Ledger Cash Nov. 125,000Nov. 525,000 Fees Earned Nov. 187,500 187,500 (D)On November 18, NetSolutions received fees of $7,500 from customers for services provided.

24. 24 (E)Throughout the month, NetSolutions incurred the following expenses: wages, $2,125; rent, $800; utilities, $450; and miscellaneous, $275. 30 Wages Expense2 125 00 Rent Expense800 00 Utilities Expense450 00 Miscellaneous Expense275 00 Cash3 650 00 Paid expenses. 18 19 20 21 22 23 24 In every entry the sum of the debits always equal the sum of the credits.

25. 25 Effects of this entry in the Ledger Cash Nov. 125,000Nov. 525,000 Wages Expense Nov. 302,125 187,500 Rent Expense Nov. 30800 Utilities Expense Nov. 30450 Miscellaneous Expense Nov. 30275 303,650 (E)Throughout the month, NetSolutions incurred the following expenses: wages, $2,125; rent, $800; utilities, $450; and miscellaneous, $275. In every entry the sum of the debits always equal the sum of the credits.

26. 26 (G)On November 30, a count revealed that $800 of the supplies inventory had been used. 30 Supplies Expense800 00 Supplies800 00 Supplies used during November. 25 26 27 28 29 30 31

27. 27 Effects of this entry in the Ledger Supplies Nov. 101,350 Supplies Expense Nov. 30 800 (G)On November 30, a count revealed that $800 of the supplies inventory had been used.

28. 28 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.” Luca Pacioli Developer of Double-Entry Accounting Scale or Balance Receive DEBIT Give CREDIT T account Left Side Receive DEBIT Right Side Give CREDIT

29. 29 Credit for increases (+) Credit for decreases (-) Debit for increases (+) Debit for decreases (-) Expense AccountsRevenue Accounts Rules of Debit / Credit Income Statement Accounts Debits Credits Revenue accounts……Decrease (-)Increase (+) Expense accounts……Increase (+)Decrease (-) Income Statement Accounts

30. 30 Post. Ref. JOURNAL DateDescriptionDebitCredit Page 2 12341234 Nov.30 2005 Dividends2 000 00 Cash2 000 00 Paid dividends to stockholders. (H)On November 30, Net Solutions paid dividends of $2,000. Payment of dividends

31. 31 30950 302,000 Cash Nov. 125,000Nov. 525,000 187,500 303,650 Effects of this entry in the Ledger Dividends Nov. 302,000 (H)On November 30, Chris Clark withdrew $2,000 in cash from NetSolutions for personal use.

32. 32 Increase (Normal Balances) Decreases Balance sheet accounts: AssetDebitCredit LiabilityCreditDebit Owners’ (Stockholders’) Equity: Capital StockCreditDebit Retained EarningsCreditDebit Income statement accounts: RevenueCreditDebit ExpenseDebitCredit Dividend accounts: DividendsDebitCredit Normal Balances of Accounts

33. 33 Flow of Business Transactions 1 Transaction authorized 2 Transaction takes place 4 Entry recorded in journal 5 Entry posted to ledger

34. 34 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.

35. 35 Journalizing and Posting

36. 36 Post. Ref. JOURNAL DateDescriptionDebitCredit Page 2 12341234 Dec.31 2005 Prepaid Insurance2 400 00 Cash2 400 00 Paid premium on two-year policy. Dec. 1NetSolutions paid a premium of $2,400 for a comprehensive insurance policy covering two years.

37. 37 Post. Ref. JOURNAL DateDescriptionDebitCredit Page 2 12341234 Dec.1 2005 Prepaid Insurance2 400 00 Cash2 400 00 ACCOUNT Prepaid Insurance ACCOUNT NO. 15 Balance Debit Credit Date Debit Credit Item Post. Ref. 2 400 00 Dec.1 2005 Paid premium on two-year policy.

38. 38 Post. Ref. JOURNAL DateDescriptionDebitCredit Page 2 12341234 Dec.1 2005 Prepaid Insurance2 400 00 Cash2 400 00 ACCOUNT Prepaid Insurance ACCOUNT NO. 15 Balance Debit Credit Date Debit Credit Item Post. Ref. 2 400 00 Dec.1 2005 2 15 Paid premium on two-year policy.

39. 39 Post. Ref. JOURNAL DateDescriptionDebitCredit Page 2 12341234 Dec.1 2005 Prepaid Insurance2 400 00 Cash2 400 00 Paid premium on two-year policy. 15 ACCOUNT Cash ACCOUNT NO. 11 Balance Debit Credit Date Debit Credit Item Post. Ref. 2 000 00 5 900 00 Nov.30 2005 2 Dec. 1 2 400 003 500 00

40. 40 Post. Ref. JOURNAL DateDescriptionDebitCredit Page 2 12341234 Dec.1 2005 Prepaid Insurance2 400 00 Cash2 400 00 Paid premium on two-year policy. 15 ACCOUNT Cash ACCOUNT NO. 11 Balance Debit Credit Date Debit Credit Item Post. Ref. 2 000 00 5 900 00 Nov.30 2005 2 2 400 003 500 00 Dec. 1 11 2

41. 41 14 15 16 17 1 Rent Expense52800 00 Cash11800 00 Paid rent Dec. 1NetSolutions paid rent for December, $800.

42. 42 14 15 16 17 1 Cash11360 00 Unearned Rent23360 00 Received advanced payment For three months’ rent of land. Dec. 1NetSolutions receives $360 for three month’s rent for land beginning December 1.

43. 43 Dec. 4NetSolutions purchased office equipment on account from Executive Supply Co. for $1,800. 18 19 20 21 4 Office Equipment181 800 00 Accounts Payable211 800 00 Purchased office equipment on account.

44. 44 Dec. 6NetSolutions paid $180 for a newspaper advertisement. 21 22 23 24 6 Miscellaneous Expense59180 00 Cash11180 00 Paid for newspaper ad.

45. 45 Dec. 11NetSolutions paid creditors $400. 24 25 26 27 11 Accounts Payable21400 00 Cash11400 00 Paid creditors on account.

46. 46 Dec. 13NetSolutions paid a receptionist and part-time assistant $950 for two weeks’ wages. Post. Ref. JOURNAL DateDescriptionDebitCredit Page 3 12341234 Dec.13 2005 Wages Expense51950 00 Cash11950 00 Paid two week’s wages.

47. 47 Dec. 16NetSolutions received $3,100 from fees earned for the first half of December. 56785678 16 Cash113 100 00 Fees Earned413 100 00 Received fees from customers.

48. 48 Dec. 16Fees earned on account totaled $1,750 for the first half of December. 9 10 11 12 16 Accounts Receivable121 750 00 Fees Earned411 750 00 Received fees from customers.

49. 49 Dec. 20NetSolutions paid $900 to Executive Supply Co. on the $1,800 debt owed from the December 4 transaction. 13 14 15 16 20 Accounts Payable21900 00 Cash11900 00 Paid part of amount owed to Executive Supply Co.

50. 50 Dec. 21NetSolutions received $650 from customers in payment of their accounts. 18 19 20 21 Cash11650 00 Accounts Receivable12650 00 Received cash from customer on account.

51. 51 Dec. 23NetSolutions paid $1,450 for supplies. 22 23 24 25 23 Supplies141 450 00 Cash111 450 00 Purchased supplies.

52. 52 Dec. 27NetSolutions paid the receptionist and part-time assistant $1,200 for two weeks’ wages. 27 28 29 30 27 Wages Expense511 200 00 Cash111 200 00 Paid two weeks’ wages.

53. 53 Dec. 31NetSolutions paid its $310 telephone bill for the month. 31 32 33 34 31 Utilities Expense54310 00 Cash11310 00 Paid telephone bill.

54. 54 Dec. 31NetSolutions paid its $225 electric bill for the month. Post. Ref. JOURNAL DateDescriptionDebitCredit Page 4 12341234 Dec.31 2005 Utilities Expense54225 00 Cash11225 00 Paid utility bill.

55. 55 Dec. 31NetSolutions received $2,870 from fees earned for the second half of December. 56785678 31 Cash112 870 00 Fees Earned412 870 00 Received fees from customers.

56. 56 Dec. 31NetSolutions earned $1,120 on account for the second half of December. 9 10 11 12 31 Accounts Receivable121 120 00 Fees Earned411 120 00 Recorded fees earned on account.

57. 57 Dec. 31 NetSolutions paid dividends of $2,000 to stockholders. 14 15 16 17 31 Dividends332 000 00 Cash112 000 00 Paid dividends to stockholders.

58. 58 Trial Balance

59. 59 NetSolutions Trial Balance December 31, 2005 Cash2 065 00 Accounts Receivable2 220 00 Supplies2 000 00 Prepaid Insurance2 400 00 Land20 000 00 Office Equipment1 800 00 Accounts Payable900 00 Unearned Rent360 00 Capital Stock25 000 00 Dividends Fees Earned16 340 00 Wages Expense4 275 00 Rent Expense1 600 00 Utilities Expense985 00 Supplies Expense800 00 Miscellaneous Expense455 0042 600 00

60. 60 NetSolutions Trial Balance December 31, 2005 Cash2 065 00 Accounts Receivable2 220 00 Supplies2 000 00 Prepaid Insurance2 400 00 Land20 000 00 Office Equipment1 800 00 Accounts Payable900 00 Unearned Rent360 00 Capital Stock25 000 00 Dividends4 000 00 Fees Earned16 340 00 Wages Expense4 275 00 Rent Expense1 600 00 Utilities Expense985 00 Supplies Expense800 00 Miscellaneous Expense455 0042 600 00 Balance Sheet Items

61. 61 NetSolutions Trial Balance December 31, 2005 Cash2 065 00 Accounts Receivable2 220 00 Supplies2 000 00 Prepaid Insurance2 400 00 Land20 000 00 Office Equipment1 800 00 Accounts Payable900 00 Unearned Rent360 00 Capital Stock25 000 00 Dividends4 000 00 Fees Earned16 340 00 Wages Expense4 275 00 Rent Expense1 600 00 Utilities Expense985 00 Supplies Expense800 00 Miscellaneous Expense455 0042 600 00 Statement of Retained Earnings Item

62. 62 NetSolutions Trial Balance December 31, 2005 Cash2 065 00 Accounts Receivable2 220 00 Supplies2 000 00 Prepaid Insurance2 400 00 Land20 000 00 Office Equipment1 800 00 Accounts Payable900 00 Unearned Rent360 00 Capital Stock25 000 00 Dividends4 000 00 Fees Earned16 340 00 Wages Expense4 275 00 Rent Expense1 600 00 Utilities Expense985 00 Supplies Expense800 00 Miscellaneous Expense455 00 42 600 00 Income Statement Items

63. 63 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. Errors that will not cause the trial balance to be unequal:

64. 64 Error Correction Procedure 1.Journal entry is incorrectDraw a line through the error but not posted.and insert correct title or amount. Error Correction Procedure Correction of Errors

65. 65 Error Correction Procedure 1.Journal entry is incorrectDraw a line through the error but not posted.and insert correct title or amount. Error Correction Procedure 2.Journal entry is correctDraw a line through the but posted incorrectly.posted error and post correctly. Correction of Errors

66. 66 Error Correction Procedure 3.Journal entry is incorrectJournalize and post a and postedcorrecting entry. Correction of Errors

67. 67 What would be the necessary correcting entry? What would be the necessary correcting entry? Journal – As recorded and posted Correcting Errors – An Example On May 5, a purchase of office equipment on account was incorrectly journalized and posted as shown. DateDescriptionDebitCredit May 5Supplies 12,500 Accounts Payable 12,500

68. 68 Journal – As recorded and posted Correcting Errors – An Example On May 5, a purchase of office equipment on account was incorrectly journalized and posted as shown. DateDescriptionDebitCredit May 5Supplies 12,500 Accounts Payable 12,500 DateDescriptionDebitCredit May 5Office Equipment12,500

69. 69 DateDescriptionDebitCredit May 5Office Equipment12,500 Supplies12,500 Journal – As recorded and posted Correcting Errors – An Example On May 5, a purchase of office equipment on account was incorrectly journalized and posted as shown. DateDescriptionDebitCredit May 5Supplies 12,500 Accounts Payable 12,500

70. 70 Financial Analysis and Interpretation Comparing an item in a current statement with the same item in prior statements is called horizontal analysis.

71. 71 J Holmes, Attorney-at-Law, P.C. Income Statement For the Year Ended December 31, 2005 and 2006 Increase (Decrease) 2006 2005 Amount Percent Fees earned$187,500$150,000$37,50025.0% Operating expenses: Wages expense$ 60,000$ 45,000$15,00033.3% Rent expense15,00012,0003,00025.0% Utilities expense12,5009,0003,50038.9% Supplies expense2,7003,000(300)(10.0)% Misc. expense 2,300 1,800 50027.8% Total operating expenses$ 92,500$ 70,800$21,70030.6% Net income$ 95,000$ 79,200$15,80019.9%