Chapter 3

Recording Transactions
 Learning Objectives
After studying this chapter, you should be able to:

• Use double-entry accounting.

• Analyze and journalize transactions.
• Post journal entries to the ledgers.
• Prepare and use a trial balance.
• Close revenue and expense accounts and update retained
income.
• Correct erroneous journal entries and describe how errors affect
accounts.
• Use T-accounts to analyze accounting relationships.
• Explain how computers have transformed processing of
accounting data.
 The Recording Process

 Sequence of five steps in recording and

reporting transactions

3-3
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 The Double-Entry
Accounting System
• Some businesses enter into thousands of
transactions daily or even hourly.
– Accountants must carefully keep track of and
record these transactions in a systematic manner.

• Double entry accounting system is the method usually

followed for recording transactions, whereby every
transaction affects at least two accounts.
 The Double-Entry
Accounting System
• Each transaction must be analyzed to determine -

• Which accounts are involved,

• Whether the accounts increase or decrease, and

• How much the balance will change.

• The balance sheet equation can be used for this

analysis, but with so many transactions, this is not
realistic.
 The Double-Entry Accounting
System
• Transactions are recorded in:
– General Journal: Chronological record of an
organization’s transactions and how each transaction
affects the balances in particular accounts.

– General Ledger: Collection of all ledger accounts

that supports an organization’s financial statements.

– Ledger account: Listing of all the increases and

decreases in a particular account
 General Ledger: T-Account
• Device used to portray individual ledger accounts in
the general ledger.

• Each T-account takes the form of the capital letter T

and represents an individual ledger account.

• Transactions affecting a particular ledger account are

accumulated here
 Ledger Accounts
• Ledger – contains the record for a group of related
accounts kept current in a systematic manner
– Think of a ledger as a book with one page for each
account.
– The ledger is a company’s “books.”

• General ledger - the collection of accounts that

accumulates the amounts reported in the major
financial statements
 Ledger Accounts
• A simplified version of a ledger account is called the
T-account- which takes the shape of the capital letter T.

– They allow us to capture the essence of the accounting

process without having to worry about too many details.

– The account is divided into two sides for recording

increases and decreases in the accounts.
Account Title

Left Side Right Side

 Ledger Accounts
• In practice, accounts are created as per the
need.

• The process of creating a new account is

called Opening the Account.

• Each T-Account summarizes the changes in

the particular accounts.

• T-Accounts show only the Amounts and NOT

the transaction description.
 Ledger Accounts
• Balance - difference between total left-side amounts and
total right-side amounts at any particular time

– Assets have left-side balances.

• Increased by entries to the left side
• Decreased by entries to the right side

– Liabilities and Owners’ Equity have right-side

balances.
• Decreased by entries to the left side
• Increased by entries to the right side
 Ledger Accounts
• T-accounts and the balance sheet
equation:

Assets = Liabilities + Owners’ Equity

Assets Liabilities
Increases Decreases Decreases Increases

Owners’ Equity
Decreases Increases
 Ledger Accounts
• Each transaction generates a right side
entry in one T- account and a left side entry
in another T- account, of the same amount
if there are only two accounts affected.

• Compound entries effect more than 2 T-

accounts with different amounts.
 Recording Transactions in T-
Accounts
1. Initial investment by owners, $400,000 cash
 Analysis
 The asset Cash increases
 The stockholders’ equity Paid-in Capital increases

Cash Paid-in Capital

(1) 400,000 (1) 400,000

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 Recording Transactions in T-
Accounts
2. Loan from bank, $100,000
 Analysis
 The asset Cash increases
 The liability Note Payable increases

Cash Note Payable

(1) 400,000 (2) 100,000
(2) 100,000

Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall.

 Recording Transactions in T-
Accounts
3. Acquired store equipment for cash,
$15,000
 Analysis
 The asset Cash decreases
 The asset Store Equipment increases
Cash Store Equipment
(1) 400,000 (3) 15,000 (3) 15,000
(2) 100,000

Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall.

 Debits and Credits
• Debit (dr.) – Denotes an entry on the
left side of an account

• Credit (cr.) – Denotes an entry on the

right side of an account

• Remember:
– Debit is always the left side!
– Credit is always the right side!
 The Recording Process
Step 1.
The process starts with source documents, which
are sales slips, purchase orders, receiving reports,
and cash receipt slips.
 The Recording Process
Step- 2
• In the second step, an analysis of the transaction is
placed in the book of original entry, which is a
chronological record of how the transactions affect
the balances of applicable accounts.
General Journal - a diary of all events
(transactions) in an entity’s life.
 The Recording Process
Step-3

• In the third step, transactions are entered into the

ledger.
– Remember that a transaction is not entered in just
one place; it must be entered in each account that
it affects.
– Depending on the nature of the organization,
analysis of the transactions could occur
continuously or periodically.
 The Recording Process
Step-4

The fourth step includes the preparation of the Trial

Balance, which is a simple listing of all accounts in
the general ledger with their balances.

– Aids in verifying accuracy and

in preparing the financial statements
– Prepared periodically as necessary
 The Recording Process
Step-5
• In the final step, the Financial Statements are
prepared.
– Financial statements are prepared each quarter of
the year for publicly traded companies.
– Other companies prepare
financial statements at December 2019
various other intervals to
meet the needs of their users.
 Journalizing Transactions
• Journalizing - the process of entering transactions
into the general journal.

• Journal entry - an analysis of the effects of a

transaction on the accounts, usually accompanied
by an explanation of the transaction

– This analysis identifies the accounts to be debited

and credited.
 Journalizing Transactions
• The conventional form for journal entries
includes the following:
– The date and identification number of the entry
– The accounts affected and an explanation of the
transaction
– The posting reference, which is the number
assigned to each account affected by the
transaction
– The amounts that the accounts are to be debited
and credited
 Journalizing Transactions
• The conventional form for recording in the
general journal:
Entry Post.
Date No. Accounts and Explanations Ref Debit Credit
2019
12/31 1 Cash 100 400,000
Paid-in capital 300 400,000
(Capital Stock issued)

12/31 2 Cash 100 100,000

Note payable 202 100,000
(Borrowed at 9% interest on a 1 yr note)

1/2 3 Merchandise inventory 130 150,000

Cash 100 150,000
(Acquired inventory for cash)
 Journalizing Transactions
• A journal entry for the following transaction will look
like this:
Purchased merchandise inventory for cash –
Rs.1,50,000 on Jan 1, 2023

Journal entry

2023 Debit Credit

Jan 1 Inventory……………….. 1,50,000
Cash………………... 1,50,000
(Purchased inventory for cash)
 Chart of Accounts
• Chart of accounts - a numbered or coded list
of all account titles used to record
transactions

Account Account Account Account

Number Title Number Title

100 Cash 202 Notes payable

120 Accounts receivable 203 Accounts payable
130 Merchandise inventory 300 Paid-in capital
140 Prepaid rent 400 Retained income
170 Store equipment 500 Sales revenue
170A Accumulated 600 Cost of goods sold
depreciation 601 Rent expense
602 Depreciation expense
 Posting Transactions
to the Ledger
• Posting – is the transferring of amounts from the
journal to the appropriate accounts in the ledger

– Dates, explanations, and journal references are

provided in detail on paper formatted with special
columns.
– Strictly a mechanical process and hence generally
done electronically
 Posting Transactions
to the Ledger
• Cross-referencing - the process of numbering or
otherwise specifically identifying each journal entry
and each posting

– Transactions are often posted to several different

accounts, but cross-referencing allows users to
find all components of a transaction in the ledger
no matter where they start.
– Cross-referencing also allows auditors to find and
correct errors.
 Analyzing, Journalizing, and
Posting Transactions
• Types of journal entries:
– Simple entry - an entry for a transaction that
affects only two accounts
– Compound entry - an entry for a transaction that
affects more than two accounts

• Remember: whether the entry is simple or

compound, the debits (left side) and credits (right
side) must always equal.
 Revenue and Expense
Transactions

Assets = Liabilities + Stockholder’s Equity

Assets = Liabilities + ( Paid-in Capital + Retained Earnings)
The T-accounts can be grouped in the following way:

Assets Liabilities Paid-in Capital Retained Earnings

= + +

Debit Credit Debit Credit Debit Credit Debit Credit

Expenses Revenues

Debit Credit

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Revenue and Expense Transactions
• Summary of revenue and expense
transactions:
– A credit to a revenue increases the revenue
and increases Retained Income.
– A debit to a revenue decreases the revenue
and decreases Retained Income.

– A credit to an expense decreases the

expense and increases Retained Income.
– A debit to an expense increases the
expense and decreases Retained Income.
 Revenue and Expense
Transactions
 Revenue and expense information is
accumulated separately to simplify the
preparation of the income statement.

 However, revenue and expense accounts

are part of retained earnings on the
balance sheet

Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall.

 Revenue and Expense Transactions
• Keeping revenues and expenses in separate
accounts makes the preparation of the
income statement easier.

– The income statement provides a detailed

explanation of how operations caused the balance
of Retained Income shown on the balance sheet
to change from the beginning of the
year to the end of the year.
 Prepaid Expense and Depreciation
Transactions
• Prepaid expenses relate to assets having
useful lives that will expire sometime in the
future.
– The expiration, or using up, of those assets is an expense.

• With depreciation, a new account,

Accumulated Depreciation, is introduced.
– the cumulative sum of all depreciation recognized
since the date of acquisition of a particular asset
 Prepaid Expense and Depreciation
Transactions
• Contra account :
An account such as Accumulated Depreciation is
called a contra account, which is a separate but
related account that offsets or is a deduction from a
companion account.

• Book value - the balance of an account, net of any

contra accounts (net book value, carrying amount, or
carrying value)

= Acquisition Cost - Accumulated Depreciation.

Why use accumulated depreciation? Why not just
reduce the asset account as it expires?