Ch2 Analyzing Transactions

Analyzing Transactions
12e
PRINCIPLES OF FINANCIAL ACCOUNTING
24e
PRINCIPLES OF ACCOUNTING
2e
Chapter 2 ACCOUNTING PRINCIPLES

Using excel for Success
Prepared by: C. Douglas

Cloud
Prepared by: C. Douglas Cloud
Professor
ProfessorEmeritus
Emeritusof
of
Accounting
Accounting
PepperdineUniversity
Pepperdine University
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
© 2011 Cengage
permitted Learning.
in a license All Rights
distributed with aReserved. May not
certain product or be copied,
service scanned, or
or otherwise onduplicated, in whole or website
a password-protected in part, for
except for use use.
classroom as Reeve Warren Duchac
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Learning Objectives
1. Describe the characteristics of an account
and a chart of accounts.
2. Describe and illustrate journalizing
transactions using the double-entry
accounting system.
3. Describe and illustrate the journalizing and
posting of transactions to accounts.
4. Prepare an unadjusted trial balance and
explain how it can be used to discover
errors.
5. Describe and illustrate the use of horizontal
analysis in evaluating a company’s
performance and financial condition. 2
Learning Objective 1
 Describe the characteristics of an

account and a chart of accounts.
LO 1
Using Accounts to Record Transactions
 Accounting systems are designed to

show the increases and decreases in
each accounting equation element as
a separate record. This record is
called an account.
LO 1
Using Accounts to Record Transactions
5
LO 1
The T Account
Title
The T account
has a title.
LO 1
The T Account
Title
Debit
The left side of
the account is
called the debit
side.
LO 1
The T Account
Title
Debit Credit
The right side of
the account is
called the credit
side.
LO 1
The T Account
Cash
(a) 25,000 (b) 20,000
(d) 7,500 (e) 3,650 Credit
Debit
Side of (f) 950 Side of
Account
Account
(h) 2,000
Balance 5,900
Balance of the account
LO 1
Chart of Accounts
 A group of accounts for a business

entity is called a ledger.
 A list of the accounts in the ledger is
called a chart of accounts.
LO 1
Chart of Accounts
 Assets are resources owned by the

business. Some examples of assets
follow:
 Cash
 Supplies
 Accounts receivable
 Buildings
LO 1
Chart of Accounts
 Liabilities are debts owed to

outsiders (creditors). Some examples
of liabilities follow:
 Accounts payable
 Notes payable
 Wages payable
 Interest payable
LO 1
Chart of Accounts
 Owner’s equity is the owner’s right

to the assets of the business after all
liabilities have been paid. For a
proprietorship, the owner’s equity is
represented by the balance of the
owner’s capital account.
 A drawing account represents the
amount of withdrawals made by the
owner.
LO 1
Chart of Accounts
 Revenues are increases in owner’s

equity as a result of selling services
or products to customers. Some
examples of revenue accounts follow:
 Fees earned
 Commission revenue
 Rent revenue
LO 1
Chart of Accounts
 The using up of assets or consuming

services in the process of generating
revenues results in expenses. Some
examples of expenses follow:
 Wages expense
 Rent expense
 Miscellaneous expense
LO 1
Chart of Accounts
16
1. Describe the characteristics of an

accounting system.
LO 2
Double-Entry Accounting System
 All businesses use what is called the

double-entry accounting system.
This system is based on the
accounting equation and requires:
 Every business transaction to be
recorded in at least two accounts.
 The total debits recorded for each
transaction to be equal to the total
credits recorded.
Balance Sheet Accounts
 The debit and credit rules for balance

sheet accounts are as follows:
Income Statement Accounts
 The debit and credit rules for income

statement accounts are based on
their relationship with owner’s
equity.
Owner Withdrawals
LO 2
Normal Balances
 The sum of the increases in an

account is usually equal to or greater
than the sum of the decreases in the
account. Thus, the normal balance of
an account is either a debit or a credit
depending on whether increases in
the account are recorded as debits or
credits.
LO 2
Rules of Debit and Credit – Normal Balances of Accounts
LO 2
Normal Balances
Increases
(Normal Bal.) Decreases
Balance sheet accounts:
Asset Debit Credit
Liability Credit Debit
Owner’s Equity:
Capital Credit Debit
Drawing Debit Credit
Income statement accounts:
Revenue Credit Debit
Expense Debit Credit
EE 2-1
LO 2
Transaction A
On November 1, Chris Clark opens a new business

and deposits $25,000 in a bank account in the name
of NetSolutions.
LO 2
Transaction A
Step 2
Step 3
Step 1 Step 4 Step 5
Step 3
Accounting Equation Impact
Assets = Liabilities + Owner’s Equity (investment)
increase increase
LO 2
Journalizing
Journalizing requires the following
steps:
Step 1. The date of the transaction is
entered in the Date column.
Step 2. The title of the account to be
debited is recorded at the left-
hand margin under the
Description column, and the
amount to be debited is entered
in the Debit column.
(continued)
LO 2
Journalizing
Step 3. The title of the account to be

credited is listed below and to
the right of the debited account
title, and the amount to be
credited is entered in the Credit
column.
Step 4. A brief description may be
entered below the credited
account. (continued)
LO 2
Journalizing
Step 5. The Post. Ref. (Posting

Reference) column is left blank
when the journal entry is initially
recorded. This column is used
later when the journal entry
amounts are transferred to the
accounts in the ledger.
LO 2
Journalizing
 A transaction is initially entered in a

record called a journal.
LO 2
Journalizing

 The process of recording a
transaction in the journal is called
journalizing.
LO 2
Journalizing

 The process of recording a
transaction in the journal is called
journalizing.
 The entry in the journal is called a
journal entry.
LO 2
Transaction B
On November 5, NetSolutions paid $20,000 for the

purchase of land as a future building site.
LO 2
Transaction B

Assets = Liabilities + Owner’s Equity
increase
decrease
LO 2
Transaction C
On November 10, NetSolutions purchased supplies

on account for $1,350.
LO 2
Transaction C

increase increase
LO 2
Transaction D
On November 18, NetSolutions received cash of

$7,500 from customers for services provided.
LO 2
Transaction D

Assets = Liabilities + Owner’s Equity (Revenue)
increase increase
LO 2
Transaction E
On November 30, NetSolutions incurred the

following expenses: wages, $2,125; rent, $800;
utilities, $450; and miscellaneous, $275.
LO 2
Transaction E

Assets = Liabilities + Owner’s Equity (Expense)
All four
expense
decrease
accounts
increase
41
LO 2
Transaction F
On November 30, NetSolutions paid creditors on

account, $950.
LO 2
Transaction F

decrease decrease
LO 2
Transaction G
NetSolutions purchased $1,350 of supplies on

November 10. Chris Clark determined that the cost
of supplies on hand on November 30 was $550.
LO 2
Transaction G

decrease increase
LO 2
Transaction H
On November 30, Chris Clark withdrew $2,000 from

NetSolutions for personal use.
LO 2
Transaction H

Assets = Liabilities + Owner’s Equity (Drawing)
decrease increase
EE 2-2

accounting system.
3. Describe and illustrate the
journalizing and posting of
transactions to accounts.
LO 3
Posting Journal Entries to Accounts
 The process of transferring the

debits and credits from the journal
entries to the accounts is called
posting.
LO 3
On December 1, NetSolutions paid a premium of

$2,400 for an insurance policy for liability, theft, and
fire. The policy covers a one-year period.
LO 3

decrease
increase
LO 3
Exhibit 4 - Steps in Posting
Step 1. The date of the transaction is
entered in the Date column of
Prepaid Insurance.
Dec. 1 Prepaid Insurance 2,400

Cash 2,400
Paid premium on one-year policy.
Account Prepaid Insurance Account No. 15
Post..
Post. Balance
Date Item Ref. Debit Credit Debit Credit
2011
Dec. 1 53
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a certain product or service or otherwise on a password-protected website for classroom use.
LO 3
Step 2. The amount (2,400) is entered

in the Debit column of Prepaid
Insurance.

Cash 2,400
Post. Balance
2011
Dec. 2,400 2,400 54
LO 3
Step 3. The journal page number (2) is

entered in the account’s Post.
Ref. column.

Cash 2,400
Post. Balance
2011
Dec. 2 2,400 2,400 55
LO 3
Step 4. The account number (15) is

entered in the journal’s Post.
Ref. column.
Dec. 1 Prepaid Insurance 15 2,400

Cash 2,400
Post. Balance
2011
Dec. 2 2,400 2,400 56
LO 3
Recording and Posting of a Debit and a Credit
These
steps are
repeated
to post to
the Cash
account.
LO 3
December Transactions
On December 1, NetSolutions paid rent for

December, $800. The company from which
NetSolutions is renting its store space now requires
the payment of rent on the first of each month,
rather than at the end of the month.
LO 3

decrease increase
LO 3
 On December 1, NetSolutions received an offer

from a local retailer to rent the land purchased on
November 5. The retailer plans to use the land as a
parking lot for its employees and customers.
NetSolutions agreed to rent the land to the retailer
for three months, with the rent payable in
advance. NetSolutions received $360 for three
months’ rent beginning December 1.
 The liability created by receiving the cash in
advance of providing the service is called
unearned revenue.
LO 3

increase increase
LO 3
On December 4, NetSolutions purchased office

equipment on account from Executive Supply Co.
for $1,800.
LO 3

increase increase
LO 3
On December 6, NetSolutions paid $180 for a

newspaper advertisement.
LO 3

decrease increase
LO 3
On December 11, NetSolutions paid creditors $400.
LO 3

decrease decrease
LO 3
On December 13, NetSolutions paid a receptionist

and a part-time assistant $950 for two weeks’ wages.
LO 3

decrease
increase
LO 3
On December 16, NetSolutions received $3,100 from

fees earned for the first half of December.
LO 3

increase increase
LO 3
Fees earned on account totaled $1,750 for the first

half of December.
LO 3

increase increase
EE 2-3
LO 3
On December 20, NetSolutions paid $900 to

Executive Supply Co. on the $1,800 debt owed from
the December 4 transaction.
LO 3

decrease decrease
LO 3
On December 21, NetSolutions received $650 from

customers in payment of their accounts.
LO 3

increase
decrease
LO 3
On December 23, NetSolutions paid $1,450 for

supplies.
LO 3

decrease
increase
LO 3
On December 27, NetSolutions paid the receptionist

and the part-time assistant $1,200 for two weeks’
wages.
LO 3

decrease increase
LO 3
On December 31, NetSolutions paid its $310

telephone bill for the month.
LO 3

decrease increase
LO 3
On December 31, NetSolutions paid its $225 electric

bill for the month.
LO 3

decrease increase
LO 3
On December 31, NetSolutions received $2,870 from

fees earned for the second half of December.
LO 3

increase increase
88
LO 3
On December 31, fees earned on account totaled

$1,120 for the second half of December.
LO 3

increase increase
LO 3
On December 31, Chris Clark withdrew $2,000 for

personal use.
LO 3

Assets = Liabilities + Owner’s Equity (Drawing)
decrease increase
EE 2-4
EE 2-5
LO 3
Ledger NetSolutions
(continued)
95
LO 3
Ledger NetSolutions
96
(continued)
LO 3
Ledger NetSolutions

accounting system.
3. Describe and illustrate the
journalizing and posting of
transactions to accounts.
4. Prepare an unadjusted trial balance
and explain how it can be used to
discover errors.
LO 4
Trial Balance
 The equality of debits and credits in

the ledger should be proven at the
end of each accounting period by
preparing a trial balance.
LO 4
Unadjusted Trial Balance
LO 4
Trial Balance Errors - Transposition
 A transposition occurs when the

order of the digits is changed by
mistake, such as writing $542 as
$452 or $524.
LO 4
Trial Balance Errors - Slide
 In a slide, the entire number is

moved one or more spaces to the
right or the left by mistake, such as
writing $542.00 as $54.20 or $97.50
as $975.00.
EE 2-6
LO 4
Errors Not Affecting the Trial Balance
 If an error has already been

journalized and posted to the ledger,
a correcting journal entry is normally
prepared.
Errors Not Affecting the Trial Balance
 Another type of error is a posting

error.
 Assume that on May 5 a $12,500
purchase of office equipment on
account was incorrectly journalized
and posted as a debit to Supplies and
a credit to Accounts Payable for
$12,500.
 The entry to correct the error is:
105
EE 2-7

accounting system.
3. Describe and illustrate the journalizing
and posting of transactions to
accounts.
4. Prepare an unadjusted trial balance and
explain how it can be used to discover
errors.
5. Describe and illustrate the use of
LO 5
Horizontal Analysis
 In horizontal analysis, the amount of

each item on a current financial
statement is compared with the
same item on an earlier statement.
LO 5
Horizontal Analysis
 In horizontal analysis, the amount of

each item on a current financial
statement is compared with the
same item on an earlier statement.
 When two statements are being
compared, the earlier statement is
used as the base for computing the
amount and the percent of change.
LO 5
Horizontal Analysis
EE 2-8
Analyzing Transactions
The End
Prepared by: C. Douglas
Cloud
Professor Emeritus of
Accounting
Pepperdine University

Ch2 Analyzing Transactions

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Analyzing Transactions

PRINCIPLES OF FINANCIAL ACCOUNTING

Chapter 2 ACCOUNTING PRINCIPLES

Prepared by: C. Douglas

 Describe the characteristics of an

 Accounting systems are designed to

 A group of accounts for a business

 Assets are resources owned by the

 Liabilities are debts owed to

 Owner’s equity is the owner’s right

 Revenues are increases in owner’s

 The using up of assets or consuming

1. Describe the characteristics of an

 All businesses use what is called the

 The debit and credit rules for balance

 The debit and credit rules for income

 The sum of the increases in an

On November 1, Chris Clark opens a new business

Step 1 Step 4 Step 5

Step 3. The title of the account to be

Step 5. The Post. Ref. (Posting

 A transaction is initially entered in a

 A transaction is initially entered in a

 A transaction is initially entered in a

On November 5, NetSolutions paid $20,000 for the

Accounting Equation Impact

On November 10, NetSolutions purchased supplies

Accounting Equation Impact

On November 18, NetSolutions received cash of

Accounting Equation Impact

On November 30, NetSolutions incurred the

Accounting Equation Impact

On November 30, NetSolutions paid creditors on

Accounting Equation Impact

NetSolutions purchased $1,350 of supplies on

Accounting Equation Impact

On November 30, Chris Clark withdrew $2,000 from

Accounting Equation Impact

1. Describe the characteristics of an

 The process of transferring the

On December 1, NetSolutions paid a premium of

Accounting Equation Impact

Dec. 1 Prepaid Insurance 2,400

Account Prepaid Insurance Account No. 15

Step 2. The amount (2,400) is entered

Dec. 1 Prepaid Insurance 2,400

Account Prepaid Insurance Account No. 15

Step 3. The journal page number (2) is

Dec. 1 Prepaid Insurance 2,400

Account Prepaid Insurance Account No. 15

Step 4. The account number (15) is

Dec. 1 Prepaid Insurance 15 2,400

Account Prepaid Insurance Account No. 15

On December 1, NetSolutions paid rent for

Accounting Equation Impact

 On December 1, NetSolutions received an offer

Accounting Equation Impact

On December 4, NetSolutions purchased office

Accounting Equation Impact

On December 6, NetSolutions paid $180 for a

Accounting Equation Impact

On December 11, NetSolutions paid creditors $400.

Accounting Equation Impact