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Chapter 2
Analyzing transactions
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Learning objectives
1. Explain the steps in the accounting cycle and
each step’s supporting documentation
2. Explain the purpose of source documents
3. Describe an account and its purpose
4. Describe a chart of accounts
5. Define debits, credits and account balance
6. Explain the rules of debits and credits in doubleentry accounting and the normal balance of an
account
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Learning objectives
7. Transaction analysis – debits and credits
8. Prepare a trial balance and explain its purpose in
the accounting cycle
9. Prepare financial statements from the trial
balance
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Learning objective 1
Explain the steps in the
accounting cycle and each step’s
supporting documentation
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The accounting cycle
▪ Steps and procedures that accountants follow when
recording accounting information
▪ Performing the same steps each cycle helps
minimize errors when recording transactions
Step in the accounting cycle
Documentation
1. Analyze transactions
Source documents
2. Journalize transactions
General journal
3. Post transactions from the journal to the ledger
General ledger
4. Prepare a trial balance
Trial balance
5. Prepare the financial statements
Financial statements
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Learning objective 2
Explain the purpose of
source documents
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Source documents
▪ Step one in the accounting cycle is to analyze
transactions from source documents
▪ A source document is a record that provides
written evidence that a transaction has occurred
▪ Used to record the transaction
Examples:
– Invoice
– Bank statement
– Purchase order
– Cash register tape
– Checks
– Employee records
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Learning objective 3
Describe an account
and its purpose
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The account
▪ After analyzing the transaction from the source
document we record it in the accounting records
▪ But what are these accounting records?
▪ Accounts!
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The account
▪ An account is a record that documents increases
and decreases in specific items
▪ These items are classified as:
– Assets
– Liabilities
– Equity
– Revenues
– Expenses
▪ Accounts are used because they are an efficient
way to record information
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The account
▪ Chapter 1 introduced us to some specific accounts:
– Cash
– Accounts Payable
– Accounts Receivable
– Capital
▪ New accounts introduced in this chapter:
– Prepaid Expenses
(Asset account)
– Unearned Revenue
(Liability account)
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Learning objective 4
Describe a
chart of accounts
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Chart of accounts
▪ How do we know what accounts are used by a
business?
Chart of accounts:
– List of all of the accounts used by the business
– Displays account name and account number for each
account
– Used to keep track of the accounts held by the business
▪ What does a chart of accounts look like?
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Chart of accounts - example
Account No. Account Name
100 Cash
110 Accounts Receivable
130 Supplies
160 Equipment
210 Accounts Payable
230 Unearned Revenue
250 Loan Payable
300 Capital
350 Withdrawals
400 Revenues
541 Advertising Expense
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Learning objective 5
Define debits, credits
and account balance
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Debits and credits
▪ We know that transactions are recorded in accounts
▪ But how they are recorded in the accounts?
▪ Transactions are recorded using debits and credits
▪ But what does debit and credit mean?
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Debits and credits
Debit = Left
Credit = Right
▪ Debits and credits do not mean:
– Good or bad
– Favorable or unfavorable
– Increase or decrease
• Whether debits or credits refer to an increase or decrease depends
on the classification of each account
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T-account
▪ We can see debits and credits using the T-account:
Account Title
Debit
Credit
Dr
Cr
Left side
Right side
▪ To debit an account is to record an entry on the left
▪ To credit an account is to record an entry on the right
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Account balance
▪ As well as a debit and a credit side, an account has
an account balance
▪ An account balance is the difference between total
debits and total credits recorded in that account
– Debit balance: Dr > Cr
– Credit balance: Dr < Cr
▪ How do we calculate the account balance?
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Calculating an account balance
Example using a simple T-account:
Cash
(debits)
3,000 (credits)
No. 100
1,000
5,000
Balance
7,000
▪ The Cash account has a debit balance of $7,000
▪ There are other formats an account may take
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Account formats: T-account
An example of a more detailed T-account:
Cash
Dec.
No.100
1 Capital
2,000 Dec.
2 Supplies
700
5 Loan Payable
5,000
4 Accounts Payable
600
6 Revenues
3,300
9 Expenses
150
8 Accounts Receivable
Balance
800
10 Withdrawals
250
9,400
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Account formats: Running balance format
The same account - running balance format:
Cash
No. 100
Date
Description
Ref.
Debit
Credit
Balance
2011
Dec.
1 Balance
1 Cash investment by owner
0
2,000
2,000
Dr
2 Purchase stationery with cash
700
1,300
Dr
4 Partial payment for credit purchase
600
700
Dr
5 Received bank loan
5,000
5,700
Dr
6 Performed services for cash
3,300
9,000
Dr
800
9,800
Dr
150
9,650
Dr
250
9,400
Dr
8 Received cash from Accounts Receivable
9 Paid expense with cash
10 Owner withdrawal of cash
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Learning objective 6
Explain the rules of debits and
credits in double-entry accounting
and the
normal balance of an account
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Double-entry accounting
▪ We use debits and credits in double-entry
accounting to record transactions
▪ The rules of double-entry accounting are:
– Each transaction affects at least two accounts
– Each transaction has at least one debit and one credit
– Total debits must equal total credits
– The accounting equation must always remain in balance
Assets = Liabilities + Equity
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Rules of debits and credits
▪ This leads us to the general rules of debits and
credits used in double-entry accounting
– Assets are increased by debits (decreased by credits)
– Liabilities and equity are increased by credits (decreased
by debits)
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Rules of debits and credits
▪ These general rules are extended to the
components of the expanded accounting equation:
– Capital is increased by credits (decreased by debits)
– Withdrawals is increased by debits (decreased by credits)
– Revenues are increased by credits (decreased by debits)
– Expenses are increased by debits (decreased by credits)
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Normal balance of an account
▪ To help us remember the rules of debits and credits,
we can think of the normal balance of an account:
– the debit or credit side of the account to which increases
are recorded
Account classification:
Normal balance:
Asset
Debit
Liabilities
Credit
Capital
Credit
Withdrawals
Debit
Revenues
Credit
Expenses
Debit
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Learning objective 7
Transaction analysis –
debits and credits
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Transaction analysis - debits and credits
▪ Recall the first step in the accounting cycle was to
analyze transactions from source documents
▪ We can now use debits and credits to perform the
second step, journalize transactions
Step in the accounting cycle
Documentation
1. Analyze transactions
Source documents
2. Journalize transactions
General journal
▪ But what does journalize transactions mean?
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Journalizing transactions
Journalizing:
▪ the process of recording a transaction in a journal
Journal:
▪ A record in which the transactions of the business
are entered (or journalized)
– Like a diary that records the transactions in chronological
order
▪ Once a transaction has been journalized, the
individual transaction is known as a journal entry
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General journal
▪ Transactions are recorded in the general journal:
General journal
GJ-1
Date
Account and explanation
Post
Ref.
Debit
Credit
2011
Dec.
1
Cash
Capital
(Cash investment by owner.)
▪ For each transaction, we record the:
– Date
– Accounts debited and credited
– Value of the transaction
– Short explanation of the transaction
2,000
2,000
Posting to the ledger
▪ Once transactions have been journalized, the next
step in the accounting cycle is to post them to the
general ledger
Step in the accounting cycle
Documentation
1. Analyze transactions
Source documents
2. Journalize transactions
General journal
3. Post transactions from the journal to the ledger
General ledger
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Posting to the ledger
General ledger:
▪ A record that contains all accounts of the business
Posting:
▪ The process of transferring information from
journals to ledger accounts
▪ Let’s look at an illustration of how this is done
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Posting from the journal to the ledger
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Illustration of transaction analysis
▪ Now we know how to journalize transactions in the
general journal and post them to the ledger, we can
look at how to record specific transactions
▪ The general steps for recording all transactions are:
– Recognize the transaction to be recorded
– Analyze the transaction using the accounting equation
– Determine which accounts are to be debited and credited
– Journalize the transaction
– Post the transaction to the ledger
A. Cash investment by owner
A. Owner invests $2,000 cash into the business
Journal entry:
Date
Post
Ref.
Account and explanation
Debit
Credit
2011
Dec.
1 Cash
100
Capital
2,000
300
2,000
(Cash investment by owner.)
Ledger posting (T-accounts):
Cash
(A)
2,000
No. 100
Capital
No. 300
(A)
2,000
B. Purchased an asset with cash
B. Purchased supplies for $700 cash
Journal entry:
Date
Post
Ref.
Account and explanation
Debit
Credit
2011
Dec.
2 Supplies
130
Cash
100
700
700
(Purchased supplies with cash.)
Ledger posting (T-accounts):
Cash
No. 100
(B)
700
Supplies
(B)
700
No. 130
C. Purchased an asset on credit
C. Purchased a laptop computer on credit for $2,400
Journal entry:
Date
Account and explanation
Post
Ref.
Debit
Credit
2011
Dec.
3 Equipment
160
Accounts Payable
2,400
210
2,400
(Purchased computer on credit.)
Ledger posting (T-accounts):
Equipment
(C)
2,400
No. 160
Accounts Payable
(C)
No. 210
2,400
D. Paid for an asset purchased on credit
D. Paid $600 cash toward previous credit purchase
Journal entry:
Date
Post
Ref.
Account and explanation
Debit
Credit
2011
Dec.
4 Accounts Payable
210
Cash
100
600
600
(Partial payment for asset purchased on credit.)
Ledger posting (T-accounts):
Cash
No. 100
(D)
600
Accounts Payable
(D)
600
No. 210
E. Received loan
E. Received a loan of $5,000 from the bank
Journal entry:
Date
Account and explanation
Post
Ref.
Debit
Credit
2011
Dec.
5 Cash
100
Loan Payable
5,000
250
5,000
(Received cash loan from bank.)
Ledger posting (T-accounts):
Cash
(E)
5,000
No. 100
Loan Payable
(E)
No. 250
5,000
F. Performed services for cash
F. Performed tutoring services for $3,300 cash
Journal entry:
Date
Account and explanation
Post
Ref.
Debit
Credit
2011
Dec.
6 Cash
100
Revenues
3,300
400
3,300
(Received cash for services performed.)
Ledger posting (T-accounts):
Cash
(F)
3,300
No. 100
Revenues
No. 400
(F)
3,300
G. Performed services on credit
G. Performed $4,400 worth of services on credit
Journal entry:
Date
Account and explanation
Post
Ref.
Debit
Credit
2011
Dec.
7 Accounts Receivable
110
Revenues
400
4,400
4,400
(Performed services on credit.)
Ledger posting (T-accounts):
Accounts Receivable
(G)
4,400
No. 110
Revenues
No. 400
(G)
4,400
H. Received cash from Accounts Receivable
H. Received $800 cash from credit customers
Journal entry:
Date
Account and explanation
Post
Ref.
Debit
Credit
2011
Dec.
8 Cash
100
Accounts Receivable
800
110
800
(Received cash from credit customers.)
Ledger posting (T-accounts):
Cash
(H)
800
No. 100
Accounts Receivable
(H)
No. 110
800
I. Paid expense with cash
I. Paid $150 cash for advertising campaign
Journal entry:
Date
Post
Ref.
Account and explanation
Debit
Credit
2011
Dec.
9 Advertising Expense
541
Cash
150
100
(Paid cash for advertising expense.)
Ledger posting (T-accounts):
Cash
No. 100
(I)
150
Advertising Expense No. 541
(I)
150
150
J. Owner withdraws cash from business
J. Owner withdraws $250 cash from the business
Journal entry:
Date
Post
Ref.
Account and explanation
Debit
Credit
2011
Dec.
10 Withdrawals
350
Cash
250
100
250
(Cash withdrawal by owner.)
Ledger posting (T-accounts):
Cash
No. 100
(J)
250
Withdrawals
(J)
250
No. 350
K. Non business transaction
K. Signing an employment agreement
Journal entry:
▪ No journal entry required because there is no change to the
value of the assets, liabilities, equity, revenues or expenses
of the business
L. Prepaid expense
L. Paid $360 for a 3 year insurance premium
Journal entry:
Date
Post
Ref.
Account and explanation
Debit
Credit
2011
Dec.
12 Prepaid Insurance
142
Cash
100
360
360
(Paid for 36 month insurance policy for the computer.)
Ledger posting (T-accounts):
Cash
No. 100
(L)
360
Prepaid Insurance
(L)
360
No. 142
M. Repayment of loan
M. Made a loan repayment of $500
Journal entry:
Date
Post
Ref.
Account and explanation
Debit
Credit
2011
Dec.
13 Loan Payable
250
Cash
500
100
500
(Repaid part of the principal of the bank loan.)
Ledger posting (T-accounts):
Cash
No. 100
(M)
500
Loan Payable
(M)
500
No. 250
N. Unearned revenue
N. Received $900 cash in advance for tutoring
Journal entry:
Date
Account and explanation
Post
Ref.
Debit
Credit
2011
Dec.
14 Cash
100
Unearned Revenue
900
230
900
(Received revenue in advance.)
Ledger posting (T-accounts):
Cash
(N)
900
No. 100
Unearned Revenue
No. 230
(N)
900
O. Compound journal entry
O. Performed $2,000 worth of tutoring services.
$450 was received in cash with the remaining
$1,550 to be received on credit
Journal entry:
Date
Account and explanation
Post
Ref.
Debit
Credit
2011
Dec.
15 Cash
Accounts Receivable
Revenues
100
450
110
1,550
400
2,000
(Performed services for cash and credit.)
▪ Post to each of the 3 accounts in this journal entry
Learning objective 8
Prepare a trial balance and
explain its purpose in the
accounting cycle
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Trial balance
▪ After journalizing transactions and posting them to
the ledger, the next stage in the accounting cycle is
to prepare a trial balance
Step in the accounting cycle
Documentation
1. Analyze transactions
Source documents
2. Journalize transactions
General journal
3. Post transactions from the journal to the ledger
General ledger
4. Prepare a trial balance
Trial balance
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Trial balance
▪ The trial balance is a list of all general ledger
accounts held by the business and their balances at
a specific point in time
▪ Purpose is to verify that total debits equals total
credits in the accounts
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Trial balance - example
Running Latte
Trial Balance
December 31, 2011
Debit
$
Credit
$
No.
Account
100
Cash
9,890
110
Accounts Receivable
5,150
130
Supplies
700
142
Prepaid Insurance
360
160
Equipment
210
Accounts Payable
230
Unearned Revenue
250
Loan Payable
4,500
300
Capital
2,000
350
Withdrawals
400
Revenues
541
Advertising Expense
Totals
2,400
1,800
900
250
9,700
150
18,900
18,900
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Preparing a trial balance
▪ Use the general ledger to construct the trial balance
– List account numbers and account names
– Transfer debit and credit balances into corresponding
column
– Calculate total debits and credits
– Verify total debits equals total credits
▪ The trial balance is said to be balanced when total
debits equals total credits
▪ But what if the trial balance does not balance?
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Trial balance errors
▪ Add up the columns again and check:
▪ Is an account missing?
– Look for difference between debits and credits in the ledger
▪ Debits or credits recorded in wrong column?
– Difference ÷ 2
▪ Transposition or slide error?
– Difference ÷ 9
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Correcting errors in the accounts
▪ There are 2 main ways to correct an error in the
accounts
▪ Rule a line through the entry and enter the correct
information for:
– Incorrect journal entry that has not been posted
– Posting an incorrect amount to the correct ledger account
▪ Journalize a correcting entry for:
– Incorrect journal entry that has been posted
– Journal entry posted to the wrong account
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Limitations of the trial balance
▪ A balanced trial balance can not guarantee the
accounts are free from errors
▪ The following errors may still exist in the accounts:
– Missing transactions that were not journalized or posted
– Duplicate transactions where journal entries were
recorded or posted more than once
– Incorrect accounts that have been used in journalizing or
posting
– Incorrect dollar amounts that have been journalized or
posted to the correct account
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Learning objective 9
Prepare financial statements
from the trial balance
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Financial statements
▪ Once the trial balance is balanced, we can use it to
help prepare the financial statements
Step in the accounting cycle
Documentation
1. Analyze transactions
Source documents
2. Journalize transactions
General journal
3. Post transactions from the journal to the ledger
General ledger
4. Prepare a trial balance
Trial balance
5. Prepare the financial statements
Financial statements
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Financial statements
▪ The trial balance can be used to help construct the
financial statements
▪ The order of the accounts in the trial balance is
generally the order in which they appear in the
financial statements
– balance sheet accounts are at the top of the trial balance
– income statement accounts are at the bottom of the trial
balance
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