Chapter 2
Analyzing and Recording
Business Transactions
McGraw-Hill/Irwin
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2-2
Conceptual Learning Objectives
C1: Explain the steps in processing
transactions
C2: Describe source documents and their
purpose
C3: Describe an account and its use in
recording transactions
C4: Describe a ledger and a chart of accounts
C5: Define debits and credits and explain their
role in double-entry accounting
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
2-3
Analytical Learning Objectives
A1: Analyze the impact of transactions on
accounts and financial statements
A2: Compute the debt ratio and describe
its use in analyzing financial
performance
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
2-4
Procedural Learning Objectives
P1: Record transactions in a journal and
post entries to a ledger
P2: Prepare and explain the use of a trial
balance
P3: Prepare financial statements from
business transactions
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
2-5
Analyzing and Recording
Process
C1
Exchanges of economic consideration
between two parties.
External Transactions
occur between the
organization and an
outside party.
McGraw-Hill/Irwin
Internal Transactions
occur within the
organization.
© The McGraw-Hill Companies, Inc., 2008
2-6
Analyzing and Recording
Process
C1
Analyze each transaction and
event from source documents
Prepare and analyze
the trial balance
McGraw-Hill/Irwin
Record relevant transactions
and events in a journal
Post journal
information
to ledger
accounts
© The McGraw-Hill Companies, Inc., 2008
2-7
Source Documents
C2
Checks
Employee
Earnings
Records
Bills from
Suppliers
Purchase
Orders
Bank
Statements
Sales
Tickets
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2-8
C3
The Account and its Analysis
An account is a
record of
increases and
decreases in a
specific asset,
liability, equity,
revenue, or
expense item.
McGraw-Hill/Irwin
The general
ledger is a record
containing all
accounts used by
the company.
© The McGraw-Hill Companies, Inc., 2008
2-9
C3
The Account and its Analysis
Assets
Assets
Assets
Accounts
Accounts
Accounts
McGraw-Hill/Irwin
=
Liability
Liability
Liability
Accounts
Accounts
Accounts
+
Equity
Equity
Equity
Accounts
Accounts
Accounts
© The McGraw-Hill Companies, Inc., 2008
2-10
Asset Accounts
C3
Cash
Land
Buildings
Asset
Accounts
Accounts
Receivable
Notes
Receivabl
e
Prepaid
Accounts
Equipment
Supplies
McGraw-Hill/Irwin
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2-11
Liability Accounts
C3
Accounts
Payable
Notes
Payable
Liability
Accounts
Accrued
Liabilities
McGraw-Hill/Irwin
Unearned
Revenue
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2-12
Equity Accounts
C3
Retained
Earnings
Common
Stock
Dividends
Equity
Accounts
Revenues
McGraw-Hill/Irwin
Expenses
© The McGraw-Hill Companies, Inc., 2008
2-13
C3
The Account and its Analysis
Assets
+
Common
Stock
McGraw-Hill/Irwin
=
Liabilities
–
Dividends
+
Equity
–
+
Revenues
Expenses
© The McGraw-Hill Companies, Inc., 2008
2-14
C4
Ledger and Chart of Accounts
The ledger is a collection of all accounts for an
information system. A company’s size and
diversity of operations affect the number
of accounts needed.
The chart of accounts is a list of all accounts and
includes an identifying number for each account.
101
106
126
128
167
201
236
Cash
Accounts receivable
Supplies
Prepaid insurance
Equipment
Accounts payable
Unearned revenue
319
403
406
622
637
640
652
307
Common stock
690
McGraw-Hill/Irwin
Dividends
Revenues
Rental revenue
Salaries expense
Insurance expense
Rent expense
Supplies expense
Utilities expense
© The McGraw-Hill Companies, Inc., 2008
2-15
Debits and Credits
C5
A T-account represents a ledger account
and is a tool used to understand the effects
of one or more transactions.
T- Account
(Left side)
(Right side)
Debit
Credit
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C5
Double-Entry Accounting
Assets
ASSETS
Debit
+
McGraw-Hill/Irwin
Credit
-
=
Liabilities
LIABILITIES
Debit
-
Credit
+
+
Equity
EQUITIES
Debit
-
Credit
+
© The McGraw-Hill Companies, Inc., 2008
2-17
Double-Entry Accounting
C5
Equity
Common
Stock
_
Dividends
+
Revenues
_
Expenses
Stock
Dividends
Revenues
Expenses
Debit Credit
Debit Credit
Debit Credit
Debit Credit
-
McGraw-Hill/Irwin
+
+
-
-
+
+
-
© The McGraw-Hill Companies, Inc., 2008
2-18
C5
Double-Entry Accounting
An account balance is the difference between the
increases and decreases in an account.
Notice the T-Account
Cash
Investment by owner for stock
Consulting services revenues earned
Collection of accounts receivable
Total increases
Balance
McGraw-Hill/Irwin
30,000 Purchase of supplies
4,200 Purchase of equipment
1,900 Payment of rent
Payment of salary
Payment of account payable
Payment of cash dividend
36,100 Total decreases
4,800
2,500
26,000
1,000
700
900
200
31,300
© The McGraw-Hill Companies, Inc., 2008
2-19
Journalizing &
Posting Transactions
P1
Assets
=
Liabilities
+
Equity
T- Account
(Left side)
(Right side)
Debit
Credit
Step 1: Analyze
transactions and source
documents.
ACCOUNT NAME:
Date
Step 2: Apply doubleentry accounting
GENERAL JOURNAL
ACCOUNT No.
Description
PR
Debit
Credit
Balance
Step 4: Post entry to ledger
McGraw-Hill/Irwin
Date
Description
Page
Post.
Ref.
Debit
123
Credit
Step 3: Record journal entry
© The McGraw-Hill Companies, Inc., 2008
2-20
P1
Journalizing Transactions
Transaction
Date
Titles of Affected
Accounts
GENERAL JOURNAL
Account Titles and Explanations PR
Date
2007
Dec. 1 Cash
Common stock
Investment by shareholders
Dec.
McGraw-Hill/Irwin
Transaction
2 Supplies
explanation
Cash
Page 1
Debit
Credit
30,000
30,000
Dollar amount of debits
2,500
and credits
2,500
© The McGraw-Hill Companies, Inc., 2008
2-21
P1
Balance Column Account
T-accounts are useful illustrations, but
balance column ledger accounts are used
in practice.
CASH
Date
ACCOUNT No. 101
Explanation
PR
Debit
Credit
Balance
2,500
26,000
30,000
27,500
1,500
5,700
2007
Dec. 1
Dec. 2
Dec. 3
Dec. 10
McGraw-Hill/Irwin
Initial investment
Purchased supplies
Purchased equipment
Collection from customer
30,000
4,200
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2-22
P1
Posting Journal Entries
GENERAL JOURNAL
Date
Account Titles and Explanation
2007
Dec. 1 Cash
Common stock
Investment by shareholders
Dec. 2 Supplies
Cash
1 Identify the
debit account
Purchased store supplies
for cash
Page 1
PR
Explanation
Credit
30,000
30,000
2,500
2,500
in ledger.
CASH
Date
Debit
ACCOUNT No.
PR
Debit
Credit
101
Balance
2007
McGraw-Hill/Irwin
Dec. 3
Purchased equipment
G1
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20,000.00
########
2-23
Posting Journal Entries
P1
GENERAL JOURNAL
Date
Account Titles and Explanation
2007
Dec. 1 Cash
Common stock
Investment by shareholders
Page 1
PR
Explanation
Credit
30,000
30,000
Dec. 2 Supplies
2
Enter
the date.
Cash
Purchased store supplies
CASH for cash
Date
Debit
2,500
2,500
ACCOUNT No.
PR
Debit
Credit
101
Balance
2007
Dec. 1
McGraw-Hill/Irwin
Dec. 3
Purchased equipment
G1
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20,000.00
########
2-24
Posting Journal Entries
P1
GENERAL JOURNAL
Page 1
Date
Account Titles & Elxplanations
PR
2007
Dec. 1 Cash
Common stock
Investment by shareholders
Dec. 2 Supplies
3 Enter the
amount and description.
Cash
Purchased store supplies
CASH for cash
Date
Explanation
PR
Debit
Credit
30,000
30,000
2,500
2,500
ACCOUNT No.
Debit
Credit
101
Balance
2007
30,000
Dec. 1
Dec. 3
McGraw-Hill/Irwin
Purchased equipment
G1
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Inc., 2008
20,000 Companies,
(20,000)
2-25
P1
Posting Journal Entries
GENERAL JOURNAL
Page 1
Date
Account Titles and Explanation
PR
2007
Dec. 1 Cash
Common stock
Investment by shareholders
Dec.
2 Supplies
the journal reference.
4 Enter
Cash
Purchased store supplies
CASH for cash
Date
Explanation
Debit
Credit
30,000
30,000
2,500
2,500
ACCOUNT No.
PR
Debit
G1
30,000
Credit
101
Balance
2007
Dec. 1
McGraw-Hill/Irwin
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2-26
Posting Journal Entries
P1
GENERAL JOURNAL
Date
Account Titles & Elxplanations
2007
Dec. 1 Cash
Common stock
Investment by shareholders
Page 1
PR
Debit
30,000
30,000
Dec.
5
2 Supplies
Compute the balance.
Cash
Purchased store supplies
CASH for cash
Date
Explanation
Credit
2,500
2,500
ACCOUNT No.
PR
Debit
G1
30,000
Credit
101
Balance
2007
Dec. 1
McGraw-Hill/Irwin
Dec. 3
Purchased equipment
G1
30,000
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20,000
(20,000)
2-27
P1
Posting Journal Entries
GENERAL JOURNAL
Date
Account Titles and Explanation
2007
Dec. 1 Cash
Common stock
Investment by shareholders
Page 1
PR
Debit
101
2 Enter
Supplies
the ledger reference.
Cash
Purchased store supplies
CASH for cash
Explanation
30,000
30,000
Dec.
6
Date
Credit
2,500
2,500
ACCOUNT No.
PR
Debit
G1
30,000
Credit
101
Balance
2007
Dec. 1
Purchased equipment
Dec. 3
McGraw-Hill/Irwin
G1
30,000
20,000
(20,000)
© The McGraw-Hill Companies, Inc., 2008
2-28
A1
Analyzing Transactions
Shareholders invested $30,000 in FastForward on
Dec. 1.
Transaction:
Analysis:
Assets
=
Liabilities
Cash
30,000
+
Equity
Common
Stock
30,000
Double entry:
(1)
Cash
101
301
Common stock
30,000
30,000
Posting:
(1)
McGraw-Hill/Irwin
Cash
30,000
101
Common Stock
(1)
301
30,000
© The McGraw-Hill Companies, Inc., 2008
2-29
Analyzing Transactions
A1
Transaction:
FastForward purchases supplies by paying $2,500
cash.
Analysis:
Cash
(2,500)
Assets
Supplies
=
Liabilities
+
Equity
Common
Stock
2,500
Double entry:
(2)
Supplies
Cash
126
101
2,500
2,500
Posting:
(2)
McGraw-Hill/Irwin
Supplies
2,500
126
(1)
Cash
30,000
101
(2)
2,500
© The McGraw-Hill Companies, Inc., 2008
2-30
Analyzing Transactions
A1
Transaction:
FastForward purchases equipment by paying $26,000
cash.
Analysis:
Assets
Cash Equipment
(26,000)
=
Liabilities
+
Equity
Common
Stock
26,000
Double entry:
(3)
Equipment
Cash
167
101
26,000
26,000
Posting:
(3)
McGraw-Hill/Irwin
Equipment
26,000
167
(1)
Cash
30,000
101
(2)
(3)
2,500
26,000
© The McGraw-Hill Companies, Inc., 2008
2-31
A1
Analyzing Transactions
Transaction:
FastForward purchases $7,100 of supplies on credit.
Analysis:
Assets
=
Supplies
+
Liabilities
Accounts Payable
7,100
Equity
Common
Stock
7,100
Double entry:
(4)
Supplies
Accounts payable
126
201
7,100
7,100
Posting:
(2)
(4)
McGraw-Hill/Irwin
Supplies
26,000
7,100
126
Accounts Payable
(4)
201
7,100
© The McGraw-Hill Companies, Inc., 2008
2-32
Analyzing Transactions
A1
Transaction:
FastForward provides consulting services and
immediately collects $4,200 cash.
Analysis:
Assets
=
+
Liabilities
Cash
4,200
Equity
Revenue
4,200
Double entry:
(5)
Cash
101
403
Consulting Revenue
4,200
4,200
Posting:
403
Consulting Revenue
(5)
4,200
McGraw-Hill/Irwin
(1)
(5)
Cash
30,000
4,200
101
(2)
(3)
2,500
26,000
© The McGraw-Hill Companies, Inc., 2008
2-33
After processing its remaining transactions for December,
FastForward’s Trial Balance is prepared.
A1
FastForwar
drial Balance
T
December 31, 2007
Cash
Accounts receivable
Supplies
Prepaid Insurance
Equipment
Accounts payable
Unearned consulting revenue
Common stock
Dividends
Consulting revenue
Rental revenue
Salaries expense
Rent expense
Utilities expense
Total
McGraw-Hill/Irwin
Debits
$ 4,350
9,720
2,400
26,000
Credits
$
6,200
3,000
30,000
200
The trial balance lists
all account balances
in the general ledger.
If the books are in
balance, the total
debits will equal the
total credits.
5,800
300
1,400
1,000
230
$ 45,300 $ 45,300
© The McGraw-Hill Companies, Inc., 2008
P2
Six Steps for Searching for and
Correcting Errors
2-34
If the trial balance does not balance, the
error(s) must be found and corrected.
Make sure the trial balance
columns are correctly added.
Recompute each account
balance in the ledger.
Make sure account
balances are correctly
entered from the ledger.
Verify that each journal
entry is posted correctly.
See if debit or credit
accounts are mistakenly
placed on the trial balance.
Verify that each original
journal entry has equal
debits and credits.
McGraw-Hill/Irwin
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2-35
P3
Using a Trial Balance to Prepare Financial
Statements
Point in
Time
Point in
Time
Period of Time
Income Statement
Statement of Retained Earnings
Beginning
Balance
Sheet
McGraw-Hill/Irwin
Statement of Cash
Flows
Ending
Balance
Sheet
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2-36
P3
Income Statement
FASTFORWARD
Income Statement
For the Month Ended December 31, 2007
Revenues:
Consulting revenue
$ 5,800
Rental revenue
300
Total revenues
$ 6,100
Expenses:
Rent expense
1,000
Salaries expense
1,400
Utilities expense
230
Total expenses
2,630
Net income
$ 3,470
McGraw-Hill/Irwin
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2-37
P3
Statement of Retained Earnings
FASTFORWARD
Statement of Retained Earnings
For the Month Ended December 31, 2007
Balance, 1/1/07
$
Net income for December
3,470
3,470
Less: Dividends
(200)
Balance, 12/31/07
$
3,270
FASTFORWARD
Income Statement
For the Month Ended December 31, 2007
Revenues:
Consulting revenue
$
5,800
Rental revenue
300
Total revenues
$
6,100
Expenses:
Rent expense
1,000
Salaries expense
1,400
Utilities expense
230
Total expenses
2,630
Net income
$
3,470
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
2-38
P3
Balance Sheet
FASTFORWARD
Balance Sheet
December 31, 2007
Assets
FASTFORWARD
Statement of Retained Earnings
For the Month Ended December 31, 2007
Balance, 1/1/07
$
-Cash
Net income for December
3,470
Supplies
3,470
Prepaid insurance
Less: Dividends
200
Equipment
Balance, 12/31/07
$
3,270
Total assets
Liabilities
Accounts payable
Unearned revenue
Total liabilities
Equity
Common stock
Retained earnings
Total equity
Total liabilities and equity
McGraw-Hill/Irwin
$ 4,350
9,720
2,400
26,000
$ 42,470
$ 6,200
3,000
9,200
30,000
3,270
33,270
$ 42,470
© The McGraw-Hill Companies, Inc., 2008
2-39
Debt Ratio
A2
o
Describes the relationship between the
amounts of the company’s liabilities
and assets.
Total Liabilities
Debt Ratio =
Total Assets
o
McGraw-Hill/Irwin
Helps to assess the risk that a
company will fail to pay its debts.
© The McGraw-Hill Companies, Inc., 2008
2-40
End of Chapter 2
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008