AC221 Financial Accounting
Transaction Analysis
(Ch. 2)
Double-Entry Accounting
A Simple Perfect System
The System is Based on Immutable Truths
1. A = L + E
So…you can’t just change one number
2. There are only 7 places to charge the effect of a transaction
Assets
Revenue
Liabilities
Expense
Gain
Equity
Loss
3. Assets + Expenses + Losses = Liabilities + Equity + Revenue + Gains
Sources of Capital
Uses of Capital
4. Earnings (profit, income) is part of Equity: Retained Earnings
So… Revenue/Gains  means Equity + , Expense/Losses  means Equity -
2
Double-Entry Accounting
A Simple Perfect System
Every event in the business can be tracked by:
Duality of Effects
A = L+ SE
Every transaction has at
least two effects on the
basic accounting equation.
The Universe MUST stay in
balance after we have tracked
the transaction
3
How to Analyze & Record Transactions:
Updated for Journalizing Process
• Step 1: Accounts and effects
 Identify accounts affected. MUST BE AT LEAST TWO ACCOUNTS
AFFECTED.
 Classify each account as:
 Asset, Liability, Equity, Revenue, Expense, Gain or Loss
 Determine the direction and amount of each effect (increase or
decrease)
• Step 2: Record the transaction in the journal using debits and
credits.
 Step 3: Verify that the accounting equation (A = L + SE)
remains in balance or that debits equal credits
 A = L + SE
 ∆A = ∆L + ∆SE
 Dr. = Cr.
4
Rhett Corp.: Transactions
1. On December 1, 20X1, Rhett issues common
stock in exchange for $20,000 of cash.
2. On Dec. 2, 20X1, Rhett purchases inventory for
$5,000 of cash.
3. On Dec. 3, 20X1, Rhett purchases $300 of office
supplies on account
4. On Dec. 4, 20X1, Rhett sold inventory to a
customer in exchange for $1,000 of cash. The
inventory sold originally cost $600.
5. On Dec. 5, 20X1, Rhett Corp.’s owner buys
$40,000 car with her personal funds.
5
Rhett Corp. Worksheet: Transactions 1-5
Assets
=
Liabilities
+
Equity
0
=
0
+
0
Beg.
Bal.
#1
Acct. Name and $
Acct. Name and $
Acct. Name and $
Acct. Name and $
=
+
#2
=
+
#3
=
+
#4
=
+
#5
=
+
End.
Bal.
=
+
Acct. Name and $
6
Accounting Language: “on account”
Purchase “on account”
To purchase without paying cash at the time of
purchase. Record an increase in accounts
payable (A/P or AP) liability instead of paying
cash. Pay the cash later.
Make a payment “on account”
Make a payment for a previous purchase on
account. Record a decrease in accounts payable
liability and a decrease in cash.
7
Accounting Language: “on account”
Sell “on account”
To sell without receiving cash at the time of sale.
Record an increase in an accounts receivable
(A/R or AR) asset instead of receiving cash.
Receive the cash later.
Receive a payment “on account”
To receive cash for a previous sale on account.
Record a decrease in an accounts receivable
asset and an increase in cash.
8
Recording Transactions
• All transactions change the balance sheet.
• However, recording all transactions directly in
a balance sheet format would be unwieldy.
• To make things more convenient, alternative
methods are used to record and track
transactions.
9
Recording Entries
• Ways that accountants record and summarize
transactions:
1. Journal entries: A listing of the accounts that are
impacted by each transaction, recorded in journal
format. The journal lists transactions in the order
they occur.
2. T-accounts: A graphic representation of the ledger
for each account, which shows how individual
transactions increase or decrease the account.
•
A group of T-accounts may be used to summarize the
impact of a transaction on multiple accounts.
10
What are debits and credits?
Debits and credits are accountants’ terms that
reflect a change in an account when recording
journal entries.
– Debit (dr.) means “left”
– Credit (cr.) means “right”
• Whether a Dr. or Cr. results in an increase or
decrease in an account depends on the type of
the account.
11
Journal Entries
• A journal entry is an entry into the accounting records that reflects
the analysis of the effects of a single transaction. It looks like this:
Dr.
Dr. [Name of Account Debited]
Cr. [Name of Account Credited]
Cr.
Amount
Amount
• Transactions will impact at least two accounts, but can impact more
than two accounts (compound entries). Follow the rule for each
transaction:
Total Debits (left column) = Total Credits (right column)
• Good Form:
• Debit entries come before credit entries
• Credit entries are indented
• Never write negative numbers!!
12
T-Accounts
• The T-Account is a graphic representation of an account that
tabulates the increases and decreases in each account
• T-Accounts have 4 parts:
• Large “T”
• The name of the account
Name of Account
Debit (Dr.)
Credit (Cr.)
• Debit side  Left side
• Credit side  Right side
13
Track Activity In Accounts and Show
Balance on Greater Side
Name of Account
Debits
Credits
Total, net: if Total, net: if
Dr. > Cr.
Cr. > Dr.
• Ending Balance Difference between total debits and
total credits (net balance)
• Debit Balance If the greater sum is on the left (Dr.)
• Credit Balance If the greater sum is on the right (Cr.)
14
Debit/Credit & T-Account Framework
Assets (A)
=
Liabilities (L)
Beg. Bal.
Stockholders’
Equity (SE)
Beg. Bal.
Increase
Decrease
Debit
(Dr.)
Credit
(Cr.)
Ending
Bal.1
+
Decrease Increase
Debit
(Dr.)
Credit
(Cr.)
Ending
Bal.1
Beg. Bal
Decrease
Increase
Debit
(Dr.)
Credit
(Cr.)
Ending
Bal.1
1Ending
Balance is the net of debits and credits with the net balance shown on the side that
was greater (e.g., if debits greater than credits, show ending net balance on the left). The
side that increases an account is the “normal” balance side for that type of account.
15
“Normal” (”Natural”) Balances1
A “normal” balance is the type of balance, Cr. or Dr., that
increases the balance of that account.
Assets have normal debit balances: This means that we increase
an asset balance by debiting the account (left side).
Liabilities and Equity have normal credit balances: This means
we increase liability and equity balances by crediting the
account (right side).
Contra Accounts2: “Contra” accounts have normal balances that
are the opposite of the primary account.
• For example, accumulated depreciation, contra account to a
non-current asset account, has a normal credit balance, the
opposite of a debit balance in the primary asset account.
1The
terms “normal” and “natural” mean the same thing in reference to credit or debit balances.
2Contra
Accounts are paired with and reduce a primary account. They will be discussed later in the course.
16
Rhett Corp.: Transactions
1.
2.
3.
4.
On Dec. 1, 20X1, Rhett issues common stock in exchange for $20,000 of cash.
On Dec. 2, 20X1, Rhett purchases a inventory for $5,000 of cash.
On Dec. 3, 20X1, Rhett purchases $300 of office supplies on account
On Dec. 4, 20X1, Rhett sold inventory to a customer in exchange for $1,000 of
cash. The inventory sold originally cost $600.
5. On Dec. 5, 20X1, Rhett owner buys $40,000 car with her personal funds.
6. On Dec. 6, 20X1, Rhett pays $100 to employees for work performed in the
current period (Dec.). A wage liability was not previously recorded.
7. On Dec. 7, 20X1, Rhett pays $200 for supplies previously purchased on Dec. 3,
20X1.
8. On Dec. 8, 20X1, Rhett sold inventory to a customer on account for $400. The
inventory sold originally cost $300.
9. On Dec. 9, 20X1, Rhett purchased two trucks for $9,000 each in exchange for a
$18,000 note (debt). The trucks are intended for use in business operations.
10. On Dec. 10, 20X1, Rhett collects $350 for sales made on account on Dec. 8, 20X1.
11. On Dec. 11, 20X1, Rhett sells one truck for $9,000 cash.
12. On Dec. 12, 20X1, Rhett declares and pays a $75 cash dividend.
17
Rhett JE Worksheet: Transactions 1-6
Journal Entries
Transaction #1
Account Name
Dr.
Dr.
Cr.
Cr.
Transaction #2
Account Name
Dr.
Dr.
Cr.
Cr.
Transaction #3
Account Name
Dr.
Dr.
Cr.
Cr.
$
$
$
$
$
$
Transaction #4
Account Name
Dr.
Dr.
Cr.
Cr.
Transaction #5
Account Name
Dr.
Dr.
Cr.
Cr.
Transaction #6
Account Name
Dr.
Dr.
Cr.
Cr.
$
$
$
$
$
$
18
Rhett JE Worksheet: Transactions 7-12
Journal Entries
Transaction #7
Account Name
Dr.
Dr.
Cr.
Cr.
Transaction #8
Account Name
Dr.
Dr.
Cr.
Cr.
Transaction #9
Account Name
Dr.
Dr.
Cr.
Cr.
$
$
$
$
$
$
Transaction #10
Account Name
Dr.
Dr.
Cr.
Cr.
Transaction #11
Account Name
Dr.
Dr.
Cr.
Cr.
Transaction #12
Account Name
Dr.
Dr.
Cr.
Cr.
$
$
$
$
$
$
19
Rhett Corp. : All 12 Transactions
20
Assets
=
Cash
Accounts
Receivable
Inventory
Supplie
s
Trucks
Beg
B/S
0
0
0
0
0
1
20,000
2
(5,000)
and dividends decrease equity.
Equity1
+
Accounts
Payable
Notes
Payable
Common
Stock
Revenue
COGS
Exp.
Wage
Expense
Dividends
0
0
0
0
0
0
0
1,000
(600)
20,000
5,000
3
4
=
Liabilities
1Expenses
300
1,000
300
(600)
5
(no entries)
6
(100)
7
(200)
8
(100)
(200)
400
(300)
400
9
18,000
10
350
11
9,000
12
(75)
End
B/S
24,975
(300)
18,000
(350)
(9,000)
(75)
50
4,100
300
9,000
100
18,000
20,000
1,400
(900)
(100)
(75)
Rhett Corp. : Trial Balance
All 12 Transactions
Assets
=
Cash
Accounts
Receivable
Inventory
Supplie
s
Trucks
Beg
B/S
0
0
0
0
End
B/S
24,975
50
4,100
300
Liabilities
+
Equity
Accounts
Payable
Notes
Payable
Common
Stock
Revenue
COGS
Exp.
Wage
Expense
Dividends
0
0
0
0
0
0
0
0
9,000
100
18,000
20,000
1,400
(900)
(100)
(75)
=
Trial Balance: A “Trial Balance Sheet” is a summary of all
account balances, including revenues, expenses, gains,
losses, and dividends.
• Can be prepared at any time
• Proves that assets = liabilities + equity
• Facilitates the preparation of the financial statements
21
Rhett Corp.: Trial Balance
12 Transactions in Dr./Cr. Format
Rhett Corp.
Trial Balance
Dec. 31, 20X1
Account
Cash
A/R
Inventory
Supplies
Trucks
Accounts Payable
Notes Payable
Common Stock
Revenue
Cost of Goods Sold
Wage Expense
Dividends
Totals
Dr. Bal.
$ 24,975
50
4,100
300
9,000
Cr. Bal.
$
100
18,000
20,000
1,400
900
100
75
$39,500
$39,500
22
The Order of Financial Statement
Preparation in a Period
23
Income Statement
What about transactions that impact the income
statement?
Income = Revenues – Expenses + Gains – Losses
24
Rhett Corp.: Transactions 1-12
Income Statement
Assets
=
Cash
Accounts
Receivable
Inventory
Supplie
s
Trucks
Beg
B/S
0
0
0
0
End
B/S
24,975
50
4,100
300
Liabilities
+
Equity
Accounts
Payable
Notes
Payable
Common
Stock
Revenue
COGS
Exp.
Wage
Expense
Dividends
0
0
0
0
0
0
0
0
9,000
100
18,000
20,000
1,400
(900)
(100)
(75)
=
25
Income Statement
Equity
 Retained Earnings, a component of equity, is all the net income
the company has ever made, minus what it gave back to
shareholders as dividends
 Retained Earnings = Cumulative Income – Cumulative Dividends
So...
 When Net Income goes up…
Retained Earnings goes up…
 When Retained Earnings goes up…
Equity goes up…
SO…
Changes to Income Statement
are also changes to Equity
26
Rhett Corp.: Transactions 1-12
Statement of Shareholders’ Equity
Assets
=
Cash
Accounts
Receivable
Inventory
Supplie
s
Trucks
Beg
B/S
0
0
0
0
End
B/S
24,975
50
4,100
300
Liabilities
+
Equity
Accounts
Payable
Notes
Payable
Common
Stock
Revenue
COGS
Exp.
Wage
Expense
Dividends
0
0
0
0
0
0
0
0
9,000
100
18,000
20,000
1,400
(900)
(100)
(75)
=
27
Rhett Corp.: Transactions 1-2
Balance Sheet
Assets
=
Cash
Accounts
Receivable
Inventory
Supplie
s
Trucks
Beg
B/S
0
0
0
0
End
B/S
24,975
50
4,100
300
Liabilities
+
Equity
Accounts
Payable
Notes
Payable
Common
Stock
Revenue
COGS
Exp.
Wage
Expense
Dividends
0
0
0
0
0
0
0
0
9,000
100
18,000
20,000
1,400
(900)
(100)
(75)
=
28
Rhett Corp.: Transactions 1-12
Statement of Cash Flows—Summary
Assets
=
Cash
Accounts
Receivable
Inventory
Supplie
s
Trucks
Beg
B/S
0
0
0
0
End
B/S
24,975
50
4,100
300
Liabilities
+
Equity
Accounts
Payable
Notes
Payable
Common
Stock
Revenue
COGS
Exp.
Wage
Expense
Dividends
0
0
0
0
0
0
0
0
9,000
100
18,000
20,000
1,400
(900)
(100)
(75)
=
29
Closing Entries
2 Types of Accounts:
• Permanent Accounts (also called “Balance Sheet Accounts”)
– Accounts that are carried forward to future periods, that is, the
ending balance in the current period becomes the beginning
balance in the next period.
– All accounts on a final “post-close” balance sheet are permanent
accounts.
• Temporary Accounts
– Accounts that are related to a specific accounting period only
and should be closed each period.
– You won’t see these accounts on a final “post close” balance
sheet
• not “balance sheet accounts” because they do not show up on the final BS
30
Temporary Accounts & Closing Accounts
• Temporary accounts measure activity in the account for a
single period (usually a year).
• At the end of each period, temporary accounts need to be
“closed” into retained earnings.
• This “closing” of the temporary accounts, updates
retained earning to the appropriate period end value.
• The “closing” also resets the value of these temporary
accounts to zero so they can start measuring activity in
the next period starting at zero.
31
Closing Entries
Closing Entries: Entries used to “close” temporary
accounts (i.e., make their balances zero) and
transfer their balances to retained earnings.
• All revenue, expense, gain, loss, and dividend
accounts are closed into retained earnings at the
end of a period (typically each year).
32
Closing Entries
Permanent Accounts
• Asset Accounts (including contra-asset accounts)
• Liability Accounts (including contra-liability accounts)
• Contributed Capital Accounts (Paid-in Capital)
– Common Stock (and Common Stock at Par Value)
– Additional Paid In Capital (APIC)
• Retained Earnings (RE)
Temporary Accounts  these accounts change RE
•
•
•
•
•
Revenues
Expenses
Gains
Losses
Dividends
Income Statement Accounts
33
Rhett Corp.: Closing Entries
Assets
End. B/S
PreClosing
=
Cash
Accounts
Receivable
Inventor
y
Supplie
s
Trucks
24,975
50
4,100
300
9,000
=
Liabilities
Equity1
+
Account
s
Payable
Notes
Payable
Comm.
Stock
Retained
Earnings
Revenue
COGS
Exp.
Wage
Expense
Dividends
100
18,000
20,000
0
1,400
(900)
(100)
(75)
Closing
Entries
End. B/S
PostClosing
Beg. B/S
Next
Period
Closing Entries:
• Updates the Retained Earnings account (balance sheet account) to the appropriate amount
shown in the Statement of Retained Earnings (or Statement of Shareholders’ Equity)
• Resets the revenues, expense, gain, loss & dividend accounts (temporary accounts) to zero to
beginning measuring activity for the next period.
Journal Entry – Closing Entries
1Expenses
and
dividends
decrease equity 34
“Close the Books” or “Closing Process”
• The phrases “Close the Books” and “Closing
Process” reference to the process of recording
all necessary adjusting entries and closing
entries at the end of the period and preparing
final financial statements for the period.
35
Closing Entries
Revenue/Gain and Expense/Loss T-Accounts
Dividends
Dividends
Cr. Dividends
Retained Earnings
Dr. Expenses or
Losses recognized
Dr. Dividends
Beg. Balance
Cr. Revenues or
Gains recognized
0
Ending Balance
Expense & Loss Accounts
Dr. Expenses or
Losses recognized
during period
0
Cr. Expenses or
Losses recognized
Revenue & Gain Accounts
Dr. Revenues or
Gains recognized
Cr.
Revenues or
Gains recognized
during period
0
36
Rhett Terrier Corp. Trial Balance
12 Transactions in Dr./Cr. Format
Rhett Terrier Corp.
Trial Balance
May 31, 20X1
Close
these
temporary
accounts
Account
Cash
A/R
Inventory
Supplies
Trucks
Accounts Payable
Notes Payable
Common Stock
Revenue
Cost of Goods Sold
Utilities Expense
Dividends
Totals
Dr. Bal.
$ 24,975
50
4,100
300
9,000
Cr. Bal.
$
The creation
of this trial
balance was
previously
discussed in
a prior class.
100
18,000
20,000
1,400
900
100
75
$39,500
$39,500
37
Examples of Closing Entries
Rhett Terrier Corp.
• Close revenue, expense & dividends accounts:
1RE
amount
shown is the net of
debits and credits
indicated in the Taccount below.
Cost of Goods Sold (Expense)
900 Pre-Close
900
Retained Earnings
0
900 COGS
100 Util. Exp.
Revenue
Beg. Bal.
1,400 Revenue
1,400 Pre-Close
1,400
75 Dividends
325 End. Bal.
0 End. Bal.
Utilities Expense
100 Pre-Close
Dividends
75 Pre-Close
75
100
0 End. Bal.
0 End. Bal.
0 End. Bal.
RE ending
balance
updated for
income and
dividends
All
temporary
accounts
balances
are zero
38
Rhett Corp.: Closing Entries
Assets
End. B/S
PreClosing
=
Cash
Accounts
Receivable
Inventor
y
Supplies
Trucks
24,975
50
4,100
300
9,000
=
Liabilities
+
Equity
Accounts
Payable
Notes
Payable
Comm.
Stock
Retained
Earnings
Revenue
COGS
Exp.
Wage
Expense
Dividends
100
18,000
20,000
0
1,400
(900)
(100)
(75)
325
(1,400)
900
100
75
Closing
Entries
End. B/S
PostClosing
24,975
50
4,100
300
9,000
100
18,000
20,000
325
0
0
0
0
Beg. B/S
Next
Period
24,975
50
4,100
300
9,000
100
18,000
20,000
325
0
0
0
0
Closing Entries:
• Updates the Retained Earnings account (balance sheet account) to the appropriate amount
shown in the Statement of Retained Earnings (or Statement of Shareholders’ Equity)
• Resets the revenues, expense, gain, loss & dividend accounts (temporary accounts) to zero to
beginning measuring activity for the next period.
Journal Entry – Closing Entries
39