©2008 Pearson Prentice Hall. All rights reserved. 2-1 Transaction Analysis Chapter 2

©2008 Pearson Prentice Hall. All rights reserved.2-1

Transaction Analysis

Chapter 2


Transactions

• Any event that impacts the financial position of a business

• Can be measured reliably

• Two sides: Business gives something Business receives something

• Accounting records both sides of a transaction


The Account

• Record of all changes in a particular asset, liability or equity

• Remember the accounting equation Assets = Liabilities + Owner’s Equity


Common Asset Accounts

• Cash Bank accounts, cash on hand

• Accounts Receivable Customer promise to pay for goods or

services provided Represents future collection of cash

• Notes receivable Written promise to pay Bear interest



• Inventory Products held for sale

• Prepaid expenses Expenses paid for in advance Provide future benefit Includes prepaid rent, prepaid insurance and

supplies

• Land



• Buildings

• Equipment

• Furniture and Fixtures


Common Liability Accounts

• Accounts payable Company’s promise to pay for goods or

services received

• Notes payable Signed agreements to pay Include interest

• Accrued liabilities Expenses that have not been paid Include interest payable and salaries payable


Equity Accounts

• Common stock Shareholders’ investment in the company

• Retained earnings Earnings kept by the company Cumulative net income minus dividends paid to

shareholders

• Revenues Earned by providing goods or services

• Expenses Costs of operating a business


Learning Objective 1

Analyze Transactions


Transaction Analysis

• Every transaction has at least two parts

• The accounting equation always balances before and after each transaction

• A common transaction for a new business is to issue stock to its owners

• How would this impact the accounting equation?


Example Transaction (1)

• Three friends decide to start a salon

• They invest $40,000 to begin the business

• The business issues common stock to the owners


Assets Liabilities

Stockholders’ Equity

Type of Equity Transaction= +

Cash Common stock

+$50,000 +$50,000 Issued stock(1) (1)



• The salon purchases chairs and massage tables for $12,000


Assets LiabilitiesStockholders’

Equity= +

Cash Common stock

+ $50,000 +$50,000(1) (1)

(2) - $12,000

Equip.

+ $12,000

Supplies Accts Pay Retained Earnings

(2)

$38,000 $12,000 $50,000 + =


Example Transactions (3)

• The salon purchases hair styling and other supplies on account for $5,000



Equity= +

Cash Common stock

+ $50,000 +$50,000(1) (1)

(2) - $12,000

Equip.

+ $12,000

Supplies Accts Pay

+$5,000 +$5,000(3) (3)

Retained Earnings

(2)

$38,000 $5,000 $12,000 $5,000 $50,000

$55,000 $55,000



The salon earns $6,000 from providing services to customers. The business collected cash.



Equity= +

Cash Common stock

+ $50,000 +$50,000(1) (1)

(2) - $12,000

Equip.

+ $12,000

Supplies Accts Pay

+$5,000 +$5,000(3) (3)

+$6,000

Retained Earnings

(2)

(4) +$6,000(4)Revenue

$44,000 $5,000 $12,000 $5,000 $50,000 $6,000

$61,000 $61,000



• The salon paid monthly rent of $4,000


AssetsLiabilities

Stockholders’ Equity= +

Cash Common stock

+ $50,000 +$50,000(1) (1)

(2) - $12,000

Equip.

+ $12,000

Supplies Accts Pay

+$5,000 +$5,000(3) (3)

+$6,000

Retained Earnings

(2)

(4) +$6,000(4)

Revenue

- $4,000 - $4,000(5) (5)

Expense

$40,000 $5,000 $12,000 $5,000 $50,000 $2,000

$57,000 $57,000



Understand how accounting works


Double-entry Accounting

• Each transaction affects at least two accounts


The T-account

Account Title

Debits on the left side

Credits on the right side

Every transaction has both a debit

and a credit


Debit and Credit Rules

• Debit and credit are neutral terms Not good or bad

• Mean either a decrease or increase depending on the type of account


Debits and Credits

ASSETS LIABILITIESSTOCKHOLDERS’

EQUITY= +

Debit +

Debit -

Debit -

Credit -

Credit +

Credit +


Stockholders’ Equity Debit & Credits

• Common stock and Retained Earnings are increased by credits

• Dividends reduce Retained Earnings Dividends are increased by debits

• Net income increases Retained Earnings Net Income = Revenues minus Expenses

• Revenues are increased by credits• Expenses are increased by debits


Debits and Credits

Debit to increase Assets Dividends Expenses

Credits to increase Liabilities Revenue Common stock Retained earnings

Do NOT proceed until you learn these rules!


Practicing Debits and Credits

• Increase cash Debit

• Increase accounts payable Credit

• Decrease accounts receivable Credit

• Increase revenue Credit


Practicing Debits and Credits

• Increase rent expense Debit

• Increase common stock Credit

• Decrease notes payable Debit

• Decrease cash __________________________

What type of account is

cash? How is it increased?



Record transactions in the journal


The Journal

• Chronological record of transactions

• Three steps Identify accounts impacted by transaction Apply debit/credit rules for the increase or

decrease in the accounts• You should have at least one debit and one credit

Record transactions in journal


Journal entry

• Write the account debited first and the amount in the left column

• Write (and indent) the account credited next and the amount in the right column

• Debits must equal credits


E2-18

• Apr 1 – Received $25,000 and issued common stock

JOURNAL

Date Accounts Debit Credit

1-Apr Cash $25,000

Common stock $25,000


E2-18

• April 2 - Purchased $800 of office supplies on account

JOURNAL


2-Apr Supplies $800

Accounts payable $800


E2-18

• April 4 - Paid $20,000 cash for land to use as a building site

JOURNAL


4-Apr Land $20,000

Cash $20,000


E2-18

• April 6 - Performed service for customers and received cash of $2,000

JOURNAL


6-Apr ______ $2,000

__________ $2,000


E2-18

• April 9 Paid $100 on accounts payable

JOURNAL


9-Apr Accounts payable $25,000

Cash $25,000


E2-18

• April 17 – Performed services for FedEx on account totaling $1,200

JOURNAL


17-Apr Accounts Receivable $1,200

________________________ $1,200

What account is credited when services are performed?


E2-18

• Apr 23 – Collected $900 from FedEx on account

JOURNAL


23-Apr Cash $900

Accounts Receivable $900


E2-18

• Apr 30 – Paid the following expense: salary, $1,000; rent, $500

JOURNAL


30-Apr Salary expense $1,000

Rent expense $500

Cash $1,500


Posting

• Transferring information from the journal to the ledger The collection of accounts and their balances


Posting

JOURNAL


6-Apr Cash $2,000

Service revenue $2,000

CASH SERVICE REVENUE

$2,000 $2,000


Flow of Accounting Data

• Transaction occurs

• Transaction analyzed Accounts identified Debit/Credit rules applied

• Transaction recorded in the Journal

• Amounts posted to the Ledger


Determining Account Balance

• After transactions are posted, the amount in each ledger account is computed

• The debit side and credit side are totaled• The difference between the two sides is

computed If the debit side is larger, the account has a

debit balance If the credit side is larger, the account has a

credit balance


Determining Account Balance

Cash

$10,000

$15,000

$ 8,000

$12,000

$7,000

The debits total to $33,000

The credits total to $19,000

$14,000Cash has a debit balance of $14,000

($33,000 - $19,000)



Use a trial balance


Trial Balance

• Lists all accounts with their balance Debit amounts in the left column Credit amounts in the right column

• Begins with assets, then liabilities and stockholders’ equity

• The columns are totaled and should equal each other Shows if debits equal credits


Correcting Errors

• Sometimes the trial balance columns don’t equal• Steps to find the error:

Search for any missing accounts Divide the out-of-balance amount by two

• This will help find a debit that was listed as a credit, and vice versa

Divide the out-of-balance amount by nine• Slide – misstating an amount by omitting or adding a zero

($4000 as $400)• Transposition – switching figures within a number ($1342 as

$1423)


Chart of Accounts

• Each account is assigned a number Assets usually begin with 1

• 100s or 1000s

Liabilities usually begin with 2• 200s and 200s

Stockholders’ Equity (Common Stock, Dividends and Retained Earnings) begin with 3

Revenues with a 4 and Expenses with a 5


Normal Balance

• What increases the account (debit or credit) is the normal balance Assets are increased by debits, so assets

have a normal debit balance

• If the balance is not “normal”, it indicates a negative amount If cash has a credit balance, it means the

company has overdrawn its bank account


Normal Balances

DEBITS• Assets• Dividends• Expenses

CREDITS• Liabilities• Retained Earnings• Common Stock• Revenues



Analyze transactions using only T-Accounts


T-Accounts

• A quick informal analysis

• Helps users of financial information make decisions


E2-26(a)

Cash

Feb. 28 Bal.

Mar. 31 Bal.

$10,000

$ 5,000

$80,000Cash Receipts ? Total cash paid


E2-26(a)

Cash

Feb. 28 Bal.

Mar. 31 Bal.

$10,000

$ 5,000

$80,000Cash Receipts ________Total cash paid

Add together the beginning balance and cash receipts. Subtract

the ending balance from that amount


E2-26(b)

Accounts Receivable

Feb. 28 Bal.

Mar. 31 Bal.

$26,000

$ 24,000

$50,000Sales on account ? Cash collections

from customers


E2-26(b)

Accounts Receivable

Feb. 28 Bal.

Mar. 31 Bal.

$26,000

$ 24,000

$50,000Sales on account $52,000Cash collections from customers

$26,000 + $50,000 = $76,000

$76,000 - $24,000 = $52,000


E2-26(c)

Note Payable

Feb. 28 Bal.

Mar. 31 Bal.

$13,000

$ 21,000

$80,000 New Borrowing ?

Cash paid on note


E2-26(c)

Note Payable

Feb. 28 Bal.

Mar. 31 Bal.

$13,000

$ 21,000

$80,000 New Borrowing$72,000

Cash paid on note

$13,000 + $80,000 = $93,000

$93,000 - $21,000 = $72,000


End of Chapter Two

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©2008 Pearson Prentice Hall. All rights reserved. 2-1 Transaction Analysis Chapter 2