Lesson 3
Analyzing and Recording Transactions
Task team of
Fundamental Accounting
School of Business, Sun Yat-sen University
Outline
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•
•
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Accounts
Detailed Description of Various
Accounts
T-Accounts
Rules of Debits and Credits
Double-entry Accounting
Illustrated Application of Rules
2
Opening Story
• Do you have any idea about how your parents
keep an “account” of how much the family
spends?
• What a good family accountant!
3
Opening Story
• A global demand for accountants – where can the
“Big Four” find accountants with talent and virtues?
– Mr.Land, E&Y British president (indirect quote)
In the recent 18 months, the shortage of accounting talents
has been scarcely satisfied. The most valuable in the 21st
century is accountants to special accounting firms like us.
（2005－7－21）
4
The Account
Accounting’s main summary device
is the account, the record of changes.
Accounts are grouped in 3 broad categories,
according to the accounting equation:
5
The Assets Account
Assets are the economic resources that
benefit the business now and in the future
Cash
Accounts receivable
Inventory
Notes receivable
Prepaid expenses
Supplies
Properties
Buildings
Equipment
6
The Liabilities Account
Liabilities are the debts of the company.
Notes payable
Accounts payable
Accrued liabilities
(for expenses incurred but not paid)
Long-term liabilities (bonds)
7
The Equity Account
Stockholders’ (owners’) equity is the
owners’ claims to the assets of a corporation.
A proprietorship uses a single account.
A partnership uses separate accounts for each
owner’s capital balance and withdrawals.
A corporation uses separate capital
accounts for each source of capital.
8
Details of Equity Account
Common Stock
Dividends
Retained Earnings
Revenues
Expenses
9
The T-Account
Account Title
Debit
LEFT SIDE
Credit
RIGHT SIDE
10
Increases and Decreases
in the Accounts
Accounting
Equation:
Rules of
Debit and
Credit:
Assets
Debit Credit
+
–
=
Liabilities
Debit Credit
–
+
Stockholders’
+
Equity
Debit Credit
–
+
11
Rules of Debit and Credit
Air & Sea received $50,000 and issued stock.
Assets
Cash
Debit
for
Increase,
50,000
=
Liabilities
+
Stockholders’
Equity
Common Stock
Credit
for
Increase,
50,000
12
Rules of Debit and Credit
Air & Sea purchased land for $40,000 cash.
Assets
=
Cash
Bal. 50,000 Credit
for
Decrease,
40,000
Liabilities
Stockholders’
+
Equity
Common Stock
Bal. 50,000
Land
Debit
for
Increase,
40,000
13
Expansion of the
Accounting Equation
Liabilities
Assets
Stockholders’
Equity
+
Common Stock
+
Retained Earnings
–
Dividends
+
Revenues
–
Expenses
14
Recording Transactions
• Record transactions first in the journal
(analyses)
• Ledger
• Posting
• Trial balance
15
Analysis of each transaction
• Identify the transaction from the source document,
such as a sales invoice or check stub
• Determine which accounts increase and which
decrease
• Apply the rules of debit and credit
• Enter the transaction in the journal, listing first the
debit and then the credit
• Verify that total debits equal total credits
16
A journal entry
• A journal entry would appear as follows:
Account Name XX (debit amount)
Account Name XX (credit amount)
Brief explanation of the transaction.
17
Ledger
• A group of accounts.
• All the accounts of a business grouped
together form a book called the ledger (or
general ledger).
18
Posting
• The process of copying (transferring) data from the
journal to accounts in the ledger.
– Debits in the journal are posted as debits to the
appropriate accounts; credits in the journal are posted as
credits to the appropriate accounts.
– All transactions must be keyed by date or number to
provide a link between the journal and the ledger.
– Ledger accounts appear after a series of transactions have
been posted and account balances calculated.
19
Trial balance
• The trial balance is a listing, in general ledger
order (assets, liabilities, then stockholders’
equity), of the debit or credit balance in each
account
20
Transactions, Accounts and Rules of Debits
& Credits
1. Owners’ investment of cash increases both assets
and stockholders’ equity.
2. Purchase of an asset for cash increases assets and
decreases assets (no effect on total assets).
3. Purchase of an asset on credit (on account)
increases both assets and liabilities.
4. Receipt of cash for service revenue increases both
assets and stockholders’ equity.
5. Performance of services on account increases both
assets and stockholders’ equity.
6. Cash payment of expenses decreases both assets
and stockholders’ equity.
21
Transactions, Accounts and Rules of
Debits & Credits (cont)
7. Payment on account decreases both assets and
liabilities.
8. Personal transactions of the owner do not affect the
business, per the entity concept.
9. Collection of cash on account increases assets and
decreases assets.
10. Sale of an asset at a price equal to its cost increases
assets and decreases assets.
11. Declaration and payment of cash dividends
decreases both assets and stockholders’ equity.
22
An Practical Illustration
• Do you still remember the example of Beauty
Photo Store? We are using it again here!
• Remember always:
The accounting equation must remain in
balance after each transaction has been
recorded.
23
An Practical Illustration (cont)
• Wang Fang invests $30,000 cash to start her
business of Beauty Photo Store.
The accounts involved are:
(1)Cash (asset)
(2)Owner’s Equity (equity)
24
An Practical Illustration (cont)
Wang Fang invests $30,000 cash to
start her business.
Assets
Cash
(1) $ 30,000
=
Supplies equipment
$ 30,000 $
-
$ 30,000
$
-
Liabilities
Accounts
Notes
Payable Payable
$
=
-
$
-
Owner's
+
Equity
Owner's
Capital
$ 30,000
$ 30,000
$ 30,000
25
An Practical Illustration (cont)
• Purchased supplies paying $2,500 cash.
The accounts involved are:
(1) Cash (asset)
(2) Supplies (asset)
26
An Practical Illustration (cont)
Purchased supplies paying $2,500 cash.
Assets
=
Cash
Supplies equipment
(1) $ 30,000
(2)
(2,500) $ 2,500
$ 27,500 $
2,500 $
$ 30,000
-
Liabilities
Accounts Notes
Payable Payable
$
=
-
$
-
Owner's
+ Equity
Owner's
Capital
$ 30,000
$ 30,000
$ 30,000
27
An Practical Illustration (cont)
• Purchased camera and producing equipment
for the store for $20,000 cash.
The accounts involved are:
(1) Cash (asset)
(2) equipment (asset)
28
An Practical Illustration (cont)
Purchased equipment for the store for $20,000 cash.
Assets
=
Cash
Supplies equipment
(1) $ 30,000
(2)
(2,500) $ 2,500
(3)
(20,000)
$ 20,000
$
7,500 $
2,500 $
$ 30,000
20,000
Liabilities
Accounts
Notes
Payable Payable
$
=
-
$
-
Owner's
+ Equity
Owner's
Capital
$ 30,000
$ 30,000
$ 30,000
29
An Practical Illustration (cont)
• Purchased supplies of $1,100 on account and
equipment of $6,000 by signing a note.
The accounts involved are:
(1) Supplies (asset)
(2) Equipment (asset)
(3) Accounts payable (liability)
(4) Notes payable (liability)
30
An Practical Illustration (cont)
Purchased supplies of $1,100 on account and
equipment of $6,000 by signing a note.
Assets
=
Cash
Supplies equipment
(1) $ 30,000
(2)
(2,500) $ 2,500
(3)
(20,000)
$ 20,000
(4)
1,100
6,000
$ 7,500 $ 3,600 $ 26,000
$ 37,100
Liabilities
Accounts
Notes
Payable Payable
$ 1,100
$ 1,100 $
=
6,000
6,000
Owner's
+ Equity
Owner's
Capital
$ 30,000
$ 30,000
$ 37,100
31
An Practical Illustration (cont)
Now let’s look at transactions involving
revenues and expenses.
Supplies equipment
Cash
Bal. $ 7,500 $ 3,600 $ 26,000
$
7,500 $
3,600 $
$ 37,100
Liabilities
=
Assets
Notes
Accounts
Payable Payable
6000
$ 1,100
Owner's
Capital
$ 30,000
6,000
$ 30,000
$
26,000
=
+
Owner's
Equity
1,100 $
$ 37,100
32
An Practical Illustration (cont)
• Performed wedding-photo and graduation ceremony
photo-taking services, receiving $2,200 cash.
The accounts involved are:
(1) Cash (asset)
(2) Owner’s capital (equity)
33
An Practical Illustration (cont)
Performed wedding photo-taking services, receiving
$2,200 cash.
Assets
=
Cash
Supplies equipment
Bal. $ 7,500 $ 3,600 $ 26,000
(5)
2,200
$ 9,700 $
3,600 $
$ 39,300
26,000
=
Liabilities
+
Owner's
Equity
Accounts Notes
Payable Payable
$ 1,100 $ 6,000
Owner's
Capital
$ 30,000
2,200
$ 1,100 $
$ 32,200
6,000
$ 39,300
34
An Practical Illustration (cont)
• Paid rent for January, $1,000 and salaries to the
store’s employees, $700 cash.
The accounts involved are:
(1) Cash (asset)
(2) Owner’s capital (equity)
(Rent expense)
(3) Owner’s capital (equity)
(Salaries expense )
35
An Practical Illustration (cont)
Paid rent for the month, $1,000 and salary to
employees, $700 cash.
Assets
=
Accounts
Notes
Payable Payable
$ 1,100
6000
Cash
Supplies equipment
Bal. $ 7,500 $ 3,600 $ 26,000
(5)
2,200
(6)
(1,000)
(7)
(700)
$ 8,000 $ 3,600 $ 26,000
$ 37,600
Liabilities
$ 1,100 $
=
6,000
+
Owner's
Equity
Owner's
Capital
$ 30,000
2,200
(1,000)
$
(700)
$ 30,500
$ 37,600
36
An Practical Illustration (cont)
• Provided wedding photo services of $1,600
and rented equipment for $300 to another
store.
The accounts involved are:
(1) Cash (asset)
(2) Owner’s capital (equity)
(Sales revenue)
(3) Owner’s capital (equity)
(Rental revenue)
37
An Practical Illustration (cont)
Provided photo-taking services of $1,600 and rented
equipment for $300 to another store.
Cash
Assets
Account
Receivable Supplies
equipment
Liabilities
Accounts Notes
payable Payable
$ 3,600
$ 26,000
$ 1,100
Bal. $ 8,000
(8)
=
$ 6,000
1,900
$ 8,000
$
1,900
+
Owner's
Equity
Owner's
capital
$ 30,500
1,900
$ 3,600
$ 39,500
$ 26,000
$ 1,100
=
$ 6,000
$ 32,400
$ 39,500
38
An Practical Illustration (cont)
Received $1,900 cash on account.
The accounts involved are:
(1) Cash (asset)
(2) Account receivable (asset)
39
An Practical Illustration (cont)
Received cash of $1,900 on account.
40
An Practical Illustration (cont)
Paid $900 on account.
The accounts involved are:
(1) Cash (asset)
(2) Account payable (liability)
41
An Practical Illustration (cont)
Paid $900 cash on account.
42
An Practical Illustration (cont)
• Wang Fang withdrew $600 cash for
personal living expenses.
The accounts involved are:
(1) Cash (asset)
(2) Owner’s capital (equity)
Withdrawals
43
An Practical Illustration (cont)
Wang Fang withdrew $600 for personal living expenses.
Cash
Assets
Account
Receivable Supplies
equipment
Liabilities
+
Accounts Notes
payable Payable
$ 3,600
$ 26,000
$ 1,100
Bal. $ 8,000
(8)
(9)
=
$ 6,000
1,900
1,900
(10)
(900)
(11)
(600)
$ 8,400
Owner's
Equity
Owner's
capital
$ 30,500
1,900
(1,900)
(900)
(600)
$
-
$ 3,600
$ 38,000
$ 26,000
$
=
200
$ 6,000
$ 31,800
$ 38,000
44
Summary
• Accounts are used to appropriately categorize transactions.
• T-accounts are a simplified version used in practice.
• The type of account determines the side on which increases
and decreases are recorded; the rules of debit and credit keep
the accounting equation in balance
• In the double-entry accounting system, at least two accounts
are always affected by a transaction. After a transaction is
recorded, the accounting equation must remain in balance.
• Economic transactions of a business will impact various asset,
liability, and/or equity accounts; but, they will not disturb the
equality of the accounting equation.
45
Case for Discussion
• In order for all accounts to look the same, and to simultaneously make
sure that the accounting equation stays in balance with double-entry
bookkeeping, the debit and credit system was devised. Luca Pacioli first
described it in 1494, and the basic system is so sound and efficient, we
still use it today. Tradition aside, we would not still be using this ancient
system if it did not work extremely well and efficiently. One could set up
a system with pluses and minuses, but it would not be as efficient at
generating the data needed for financial statements while making sure
that the accounting equation was still in balance. One is more likely to
make mistakes in entering data with plus and minus signs, although this is
a secondary concern to the
issues of uniformity and efficiency.
• Why use debits and credits rather than pluses and
minuses?
46
The End of Lesson 3