Chapter 3
Analyzing and Recording
Transactions
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
The Accounting Cycle
• These are the steps followed in
preparing financial statements
• It is called a cycle since it repeats
itself in every accounting period
• Chapter 3 covers the white boxes
and Chapters 4 and 5 cover the
purple boxes
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Accounts
• An account is a detailed record of increases and decreases
in a specific asset, liability, equity, revenue or expense
item
• Separate accounts are kept for each type of asset, liability,
equity, revenue or expense item.
• Balance Sheet accounts (like cash, AR, AP, etc) are “As
at” accounts, showing the status of these items at the end
of a period
• Income Statement accounts are “flow through” accounts,
measuring the amount of revenue and expense occurring
through a period
• A Chart of Accounts or Ledger is a list of all the accounts
used by a company, often showing an account number
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Assets
• Assets are resources available and controlled by the
organization for current or future benefit
• Assets
– Cash, the most liquid of all assets
– Accounts Receivable: amounts owed to the company for goods or
services provided through operations
– Prepaid Expenses, advanced payments made for expenses. Prepaid
expenses are assets until the asset is consumed (insurance, rent)
– Equipment, are assets not sold in the course of operations, but used
to deliver products or services (computers, desks, machinery) over
the course of several accounting periods
– Buildings and Land are assets because they provide a location in
which to operate the business
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Liabilities
• Liabilities are obligations to transfer assets or provide
services to other entities.
• Liabilities
– Accounts Payable: Money owed to suppliers for products or
services bought on credit
– Unearned Revenue, when customers pay in advance for products
or services.
– Wages, amounts owed to employees for services provided, but for
which they have not yet been paid
– Taxes payable, amounts owed to governments for sales tax or
income taxes accumulated but not yet paid.
– Mortgages or loans, money owed to lending institutions or
individuals for money they have loaned to the organization
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Equity Accounts
• There are 4 types of accounts affecting Owner’s Equity:
– Owner Capital: records owner investment
– Owner Withdrawals: records their withdrawals from investment
– Revenues and Expenses
• Incurred over a defined period of time
• The difference between revenue and expenses defines net income
which is either paid out as dividends (after taxes are applied) or rolled
back into the organization (often called Retained Earnings)
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
T-Account
• We have been using these in our sample problems so far
• It is a helpful tool to help illustrate how the various
business transactions affect the various accounts and how
they relate to each other
• The left side is always labeled debit and the right, credit
• Depending on which side of the balance sheet the account
in question is on, entries on either the right or left could be
increases or decreases for that account.
Account Title
Debit side
Credit Side
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Double Entry Accounting
• The most common way to keep accounting records
• Means that for every business transaction, there is an affect and a
record written into at least 2 accounts to always ensure that the
accounting equation is in balance
• Rules to remember:
– Increases to assets are debited (entered on left side) of asset accounts.
Decreases are credited (entered on right side)
– Increases in liabilities are credited (entered on right side) to liability
accounts. Decreases are debited (entered on left)
– Increases in owner’s equity are credited (right side) and decreases are
debited left side)
– Revenues (or increases in revenues) are credited to revenue accounts,
expenses (or increases) are debited to expense accounts
• Illustrate: A sale is made for cash, hydro expense paid, cash is used to
buy inventory
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Organizing Accounts
• A ledger is a collection of all accounts on the books
• A Chart of Accounts is a numeric list of accounts
• Some accounting systems and accountants are familiar
with an account numbering system
• In general the first digit provides a clue to the type of
account with subsequent digits providing further detail
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Analyzing Transactions
• Analyzing Transactions is Step 1 in the Accounting Cycle
• Lets review the first 15 activities of Vertically Inclined
– Review each transaction for their effects on the accounts
– Lets see if we can build the Ledger outlined in Exhibit 3.9 (without
looking…..hey, no peeking…. Yes, that means you in the red)
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Journal Entries
• We have already been doing these, this is Step 2 in the
Accounting Cycle
• Consists the following info:
–
–
–
–
Date of transaction
Titles of the affected accounts
Dollar amount of each debit or credit
Transaction explanation for future reference
• Double entry accounting requires that every transaction will
affect at least 2 accounts.
– Those that affect 3 or more accounts are called Compound Journal
Entries
• Note that the accounts involved do not need to be on opposite
sides of the balance sheet
– Ex: A cash purchase of furniture vs. purchase of furniture on credit
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Journal Entries
Date
Account Titles and explanation
Jan 1 Cash
D. Ludwick, Capital
Jan 3 Furniture
101
10000
600
1200
1200
125
2000
101
1000
500
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Credit
10000
101
Jan 7 Accounts Receivable
Revenue
Debit
150
Cash
Cash
PR
3000
Journal Entries
• Date column: the transaction date
• Account title and explanation: the names of the accounts
affected by the transaction. Some journal entries place a
short, plain-english, description of the transaction so the
record keeper remembers the event
• PR: Posting Reference column: a place to enter the account
number if accounting number is being applied to the books
• Debit and Credit columns: Places to enter the amounts
affecting the specific account for the transaction
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Posting Journal Entries
• Step 3 in the Accounting Cycle
• The process of posting or transferring entries from the
journal to the ledger
• Exhibit 3.13 shows a sample posting
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Trial Balance
• Step 4 in the Accounting Cycle
• A trial balance is run to simply check whether debits and
credits balances
• It is a useful summary for understanding how the business
transactions affected accounts during the period
• Also makes the creation of the Balance Sheet, Income
Statement and Statement of Owner’s Equity easier
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Trial Balance
• 5 Steps to a care-free trial balance
– Identify account balances either from the ledgers or from the Taccounts
– List each account, in the same order of as the Chart of Accounts
(usually asset accounts come first, followed by liability accounts,
then Owner’s Equity accounts), and their debit or credit sums
– Add up all the debits
– Add up all the credits
– Make sure they equal
• Now for the moment you’ve all been waiting for…….
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Demonstration Problem
• Lets try the Demonstration Problem. Lets create a
–
–
–
–
Balance Sheet,
Income Statement,
Statement of Owner’s Equity and
Cash Flow Statement
• Along the way,
– journalize all the transactions
– Summarize them into T-account entries
– Create a trial balance
• This is a representative question for the Mid-term exam
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Onward….
• Good sample problems to try are:
– Problems 3-2A, 3-3A, 3-6A, 3-11A
• Chapter 4
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD