Principal accounting - Ch02 analyzing transaction

Chapter 2Analyzing Transactions

Accounting, 21st Edition

Warren Reeve Fess

1. Explain why accounts are used to record and summarize the effects of transactions on financial statements.

2. Describe the characteristics of an account.

3. List the rules of debit and credit and the normal balances of accounts.

4. Analyze and summarize the financial statement effects of transactions.

ObjectivesObjectives

After studying this chapter, you should

be able to:

After studying this chapter, you should

be able to:

5. Prepare a trial balance and explain how it can be used to discover errors.

6. Discover errors in recording transactions and correct them.

7. Use horizontal analysis to compare financial statements from different periods.

ObjectivesObjectives

Each financial statement item, called an account, is

included in the ledger.

Each financial statement item, called an account, is

included in the ledger.

A group of accounts for a

business entity is called a ledger.

A group of accounts for a

business entity is called a ledger.

A list of the accounts in a ledger is called a chart of

accounts.

A list of the accounts in a ledger is called a chart of

accounts.

Major Account Classifications

Assets are resources owned by the business.


Liabilities are debts owed to outsiders

(creditors).


(creditors).

CashSuppliesBuildingAccounts

receivable

Accounts payable

Notes payableWages payable



(creditors).


(creditors).

CashSuppliesBuildingAccounts

receivable

Accounts payable

Notes payableWages payable



Liabilities are often identified on the balance sheet by titles

that include payable.

Liabilities are often identified on the balance sheet by titles

that include payable.

Owner’s equity is the owner’s

right to the assets of the

business.

Owner’s equity is the owner’s

right to the assets of the

business.

Revenues are increases in

owner’s equity as a result of selling

services or products.

Revenues are increases in

owner’s equity as a result of selling

services or products.Chris Clark,

CapitalChris Clark,

Drawing

Fees EarnedFares EarnedCommission

Revenue

Expenses are the using up of assets or consuming of

services to generate revenue.

Expenses are the using up of assets or consuming of

services to generate revenue.

Rent ExpenseSalary ExpenseUtilities

Expense


To assist you in learning, an account can be drawn to resemble the letter T.

To assist you in learning, an account can be drawn to resemble the letter T.

The T-AccountThe T-Account

The T-account has a title.The T-account has a title.

Cash


The left side of the account is the debit side.The left side of the account is the debit side.

Cash

Left side debit


The right side of the account is the credit side.The right side of the account is the credit side.

Cash

Left side debit

Right side credit


Cash3,7504,3002,900

8501,400

7002,900

Typical entries

Balancing a T-AccountBalancing a T-Account

Cash3,7504,3002,900

8501,400

7002,90010,950

First, foot the debit

side.

First, foot the debit

side.

8501,400

7002,900

Cash3,7504,3002,900

10,9505,850

Next, foot thecredit side.

Next, foot thecredit side.

8501,400

7002,900

Cash3,7504,3002,900

10,9505,850

Subtract total credits from total debits to obtain the account

balance.

Subtract total credits from total debits to obtain the account

balance.

5,100

Transactions and Balance Sheet Accounts

Post. Ref.

JOURNAL

Date Description Debit Credit

Page 1

1

2

3

4

Nov. 12005

Cash 25 000 00

Chris Clark, Capital 25 000 00

Invested cash in NetSolutions.

(A) On November 1, Chris Clark deposits $25,000 in a bank account in the name of NetSolutions.




Effects of this entry in the Ledger

CashNov. 1 25,000 Nov. 1 25,000

Chris Clark, Capital

4

5

6

7

8

9

10

5 Land 20 000 00

Cash 20 000 00

Purchased land for building

site.

(B) On November 5, NetSolutions bought land for $20,000, paying cash.



CashNov. 1 25,000 Nov. 5 20,000

LandNov. 5 20,000



10

11

12

13

14

15

16

10 Supplies 1 350 00

Accounts Payable 1 350 00

Purchased supplies on account.

(C) On November 10, NetSolutions purchased supplies on account for $1,350.





SuppliesNov. 10

1,350

Accounts PayableNov. 10

1,350

30 Accounts Payable 950 00

Cash 950 00

Paid creditors on account.

30

31

32

33

34

35

36

(F) On November 30, NetSolutions paid creditors on account, $950.


CashNov. 1 25,000 Nov. 5 25,00018

7,50030

3,650

Effects of this entry in the LedgerAccounts Payable

Nov. 101,350

Nov. 30950

30950



Debits Credits

Asset accounts………. Increase (+) Decrease (-)

Liability accounts…… Decrease (-) Increase (+)

Owner’s equity (capital) accounts…. Decrease (-) Increase (+)

Rules of Debit / Credit Balance Sheet Accounts

Credit for increases

(+)


(+)

Credit for decreases

(-)

Debit for increases

(+)

Debit for decreases

(-)

Debit for decreases

(-)

ASSETSAsset Accounts

LIABILITIESLiability Accounts

Owner’s Equity AccountsOWNER’S EQUITY

Balance Sheet Accounts

(D) On November 18, NetSolutions received fees of $7,500 from customers for services provided .


18 Cash 7 500 00

Fees Earned 7 500 00

Received fees from customers.

14

15

16

17

18

19

20


CashNov. 1 25,000 Nov. 5 25,000

Fees EarnedNov. 18

7,500187,500



(E) Throughout the month, NetSolutions incurred the following expenses: wages, $2,125; rent, $800; utilities, $450; and miscellaneous, $275 .


30 Wages Expense 2 125 00

Rent Expense 800 00

Utilities Expense 450 00

Miscellaneous Expense 275 00

Cash 3 650 00

Paid expenses.

18

19

20

21

22

23

24

Effects of this entry in the LedgerCash

Nov. 1 25,000 Nov. 5 25,000Wages Expense

Nov. 302,12518

7,500

Rent ExpenseNov. 30

800

Utilities ExpenseNov. 30

450

Miscellaneous ExpenseNov. 30

275

303,650



In every entry the sum of the debits always equal the sum of the credits.

In every entry the sum of the debits always equal the sum of the credits.

(G) On November 30, a count revealed that $800 of the supplies inventory had been used.


30 Supplies Expense 800 00

Supplies 800 00

Supplies used during

November.

25

26

27

28

29

30

31


SuppliesNov. 10

1,350

Supplies ExpenseNov. 30

800Nov. 30

800



Double-Entry AccountingDouble-Entry Accounting

“ Double-entry accounting is based on a simple concept: each party in a business transaction will receive something and give something in return. In bookkeeping terms, what is received is a debit and what is given is a credit. The T account is a representation of a scale or balance.”

Luca PacioliDeveloper ofDouble-EntryAccounting

Scale or Balance

ReceiveDEBIT

GiveCREDIT

T account

Left SideReceiveDEBIT

Right SideGive

CREDIT


(+)

Credit for decreases

(-)

Debit for increases

(+)

Debit for decreases

(-)

Expense Accounts Revenue Accounts

Rules of Debit / Credit Income Statement Accounts

Debits Credits

Revenue accounts…… Decrease (-) Increase (+)

Expense accounts…… Increase (+) Decrease (-)

Income Statement Accounts

Withdrawals by the Owner

Withdrawals by the Owner

Post. Ref.

JOURNAL


Page 2

1

2

3

4

Nov. 302005

Chris Clark, Drawing 2 000 00

Cash 2 000 00

Chris Clark withdrew cash for

personal use.

(H) On November 30, Chris Clark withdrew $2,000 in cash from NetSolutions for personal use.


30950 302,000

CashNov. 1 25,000 Nov. 5 25,00018

7,50030

3,650

Effects of this entry in the LedgerChris Clark, Drawing

Nov. 101,350

Nov. 302,000



Increase(Normal Balances) Decreases

Balance sheet accounts:Asset Debit CreditLiability Credit DebitOwner’s Equity:

Capital Credit DebitDrawing Debit Credit

Income statement accounts:Revenue Credit DebitExpense Debit Credit

Normal Balances of Accounts

Flow of Business TransactionsFlow of Business Transactions

1 Transaction authorized 2 Transaction

takes place 3 Document prepared

4Entry recorded in journal 5

Entry posted to ledger

1. Determine whether an asset, a liability, owner’s equity, revenue, or expense account is affected by the transaction.

2. For each account affected by the transaction, determine whether the account increases or decreases.

3. Determine whether each increase or decrease should be recorded as a debit or a credit.

System to Analyze TransactionsSystem to Analyze Transactions

Journalizing and Posting

Post. Ref.

JOURNAL


Page 2

1

2

3

4

Dec. 12005

Prepaid Insurance 2 400 00

Cash 2 400 00

Paid premium on two-year

policy.

Dec. 1 NetSolutions paid a premium of $2,400 for a comprehensive insurance policy covering two years.

Dec. 1 NetSolutions paid a premium of $2,400 for a comprehensive insurance policy covering two years.

Post. Ref.

JOURNAL


Page 2

1

2

3

4

Dec. 12005


Cash 2 400 00

ACCOUNT Prepaid Insurance ACCOUNT NO. 15

Balance

Debit CreditDate Debit CreditItemPost. Ref.

2 400 00 2 400 00Dec. 12005


policy.

Post. Ref.

JOURNAL


Page 2

1

2

3

4

Dec. 12005


Cash 2 400 00

ACCOUNT Prepaid Insurance ACCOUNT NO. 15

Balance


2 400 00 2 400 00Dec. 12005

2

15


policy.

Post. Ref.

JOURNAL


Page 2

1

2

3

4

Dec. 12005


Cash 2 400 00


policy.

15

ACCOUNT Cash ACCOUNT NO. 11

Balance


2 000 00 5 900 00Nov. 302005

2

Dec. 1 2 400 00 3 500 00

Post. Ref.

JOURNAL


Page 2

1

2

3

4

Dec. 12005


Cash 2 400 00


policy.

15

ACCOUNT Cash ACCOUNT NO. 11

Balance


2 000 00 5 900 00Nov. 302005

2

2 400 00 3 500 00Dec. 1

11

2

14

15

16

17

1 Rent Expense 52 800 00

Cash 11 800 00

Paid rent for December.

Dec. 1 NetSolutions paid rent for December, $800.

Dec. 1 NetSolutions paid rent for December, $800.

14

15

16

17

1 Cash 14 360 00

Unearned Rent 23 360 00

Received advanced payment

For three months’ rent of land.

Dec. 1 NetSolutions receives $360 for three month’s rent beginning December 1.

Dec. 1 NetSolutions receives $360 for three month’s rent beginning December 1.

Dec. 4 NetSolutions purchased office equipment on account from Executive Supply Co. for $1,800.

Dec. 4 NetSolutions purchased office equipment on account from Executive Supply Co. for $1,800.

18

19

20

21

4 Office Equipment 18 1 800 00

Accounts Payable 21 1 800 00

Purchased office equipment on

account.

Dec. 6 NetSolutions paid $180 for a newspaper advertisement.

Dec. 6 NetSolutions paid $180 for a newspaper advertisement.

21

22

23

24

6 Miscellaneous Expense 59 180 00

Cash 11 180 00

Paid for newspaper ad.

Dec. 11 NetSolutions paid creditors $400.Dec. 11 NetSolutions paid creditors $400.

24

25

26

27

11 Accounts Payable 21 400 00

Cash 11 400 00

Paid creditors on account.

Dec. 13 NetSolutions paid a receptionist and part-time assistant $950 for two weeks’ wages.

Dec. 13 NetSolutions paid a receptionist and part-time assistant $950 for two weeks’ wages.

Post. Ref.

JOURNAL


Page 3

1

2

3

4

Dec. 132005

Wages Expense 51 950 00

Cash 11 950 00

Paid two week’s wages.

Dec. 16 NetSolutions received $3,100 from fees earned for the first half of December.

Dec. 16 NetSolutions received $3,100 from fees earned for the first half of December.

5

6

7

8

16 Cash 11 3 100 00

Fees Earned 41 3 100 00


Dec. 16 Fees earned on account totaled $1,750 for the first half of December.

Dec. 16 Fees earned on account totaled $1,750 for the first half of December.

9

10

11

12

16 Accounts Receivable 12 1 750 00



Dec. 20 NetSolutions paid $900 to Executive Supply Co. on the $1,800 debt owed from the December 4 transaction.

Dec. 20 NetSolutions paid $900 to Executive Supply Co. on the $1,800 debt owed from the December 4 transaction.

13

14

15

16

20 Accounts Payable 21 900 00

Cash 11 900 00

Paid part of amount owed to

Executive Supply Co.

Dec. 21 NetSolutions received $650 from customers in payment of their accounts.

Dec. 21 NetSolutions received $650 from customers in payment of their accounts.

18

19

20

21

21 Cash 11 650 00

Accounts Receivable 12 650 00

Received cash from customer

on account.

Dec. 23 NetSolutions paid $1,450 for supplies.

Dec. 23 NetSolutions paid $1,450 for supplies.

22

23

24

25

23 Supplies 14 1 450 00

Cash 11 1 450 00

Purchased supplies.

Dec. 27 NetSolutions paid the receptionist and part-time assistant $1,200 for two weeks’ wages.

Dec. 27 NetSolutions paid the receptionist and part-time assistant $1,200 for two weeks’ wages.

27

28

29

30

27 Wages Expense 51 1 200 00

Cash 11 1 200 00

Paid two weeks’ wages.

Dec. 31 NetSolutions paid its $310 telephone bill for the month.

Dec. 31 NetSolutions paid its $310 telephone bill for the month.

31

32

33

34

31 Utilities Expense 54 310 00

Cash 11 310 00

Paid telephone bill.

Dec. 31 NetSolutions paid its $225 electric bill for the month.

Dec. 31 NetSolutions paid its $225 electric bill for the month.

Post. Ref.

JOURNAL


Page 4

1

2

3

4

Dec. 312005

Utilities Expense 54 225 00

Cash 11 225 00

Paid utility bill.

Dec. 31 NetSolutions received $2,870 from fees earned for the second half of December.

Dec. 31 NetSolutions received $2,870 from fees earned for the second half of December.

5

6

7

8

31 Cash 11 2 870 00



Dec. 31 NetSolutions earned $1,120 on account for the second half of December.

Dec. 31 NetSolutions earned $1,120 on account for the second half of December.

9

10

11

12

31 Accounts Receivable 12 1 120 00


Recorded fees earned on

account.

Dec. 31 Chris Clark withdrew $2,000 for personal use.

Dec. 31 Chris Clark withdrew $2,000 for personal use.

14

15

16

17

31 Chris Clark, Drawing 32 2 000 00

Cash 11 2 000 00

Chris Clark withdrew cash

for personal use.

Trial Balance

NetSolutionsTrial Balance

December 31, 2005

Cash2 065 00Accounts Receivable 2 220 00Supplies 2 000 00Prepaid Insurance 2 400 00Land 20 000 00Office Equipment 1 800 00Accounts Payable 900 00Unearned Rent 360 00Chris Clark, Capital 25 000 00Chris Clark, Drawing4 000 00Fees Earned 16 340 00Wages Expense 4 275 00Rent Expense 1 600 00Utilities Expense 985 00Supplies Expense 800 00Miscellaneous Expense 455 00

42 600 00 42 600 00


December 31, 2005


42 600 00 42 600 00

Balance Sheet Items


December 31, 2005


42 600 00 42 600 00

Statement of Owner’s

Equity Item


December 31, 2005


42 600 00 42 600 00

Income Statement

Items

1. Failure to record a transaction or to post a transaction.

2. Recording the same erroneous amount for both the debit and the credit parts of a transaction.

3. Recording the same transaction more than once.

4. Posting a part of a transaction correctly as a debit or credit but to the wrong account.

Errors that will not cause the trial balance to be unequal:

Error Correction Procedure

1. Journal entry is incorrect Draw a line through the errorbut not posted. and insert correct title or

amount.


Correction of Errors


1. Journal entry is incorrect Draw a line through the errorbut not posted. and insert correct title or

amount.


2. Journal entry is correct Draw a line through thebut posted incorrectly. posted error and post

correctly.


Error Correction Procedure Error Correction Procedure

3. Journal entry is incorrect Journalize and post a and posted correcting entry.


What would be the necessary correcting entry?

What would be the necessary correcting entry?

Journal – As recorded and posted

Correcting Errors – An ExampleCorrecting Errors – An Example

On May 5, a purchase of office equipment on account was incorrectly journalized and posted as shown.


May 5Supplies 12,500 Accounts Payable 12,500






Date Description Debit CreditMay 5Office Equipment 12,500

Date Description Debit CreditMay 5Office Equipment 12,500

Supplies 12,500






Financial Analysis and Interpretation

Financial Analysis and Interpretation

Comparing an item in a current statement with the same item in prior statements is called

horizontal analysis.

Comparing an item in a current statement with the same item in prior statements is called

horizontal analysis.

J Holmes, Attorney-at-LawIncome Statement

For the Year Ended December 31, 2005 and 2006Increase (Decrease)

2006 2005 Amount Percent

Fees earned $187,500 $150,000 $37,500 25.0%Operating expenses:

Wages expense $ 60,000 $ 45,000 $15,000 33.3%Rent expense 15,000 12,000 3,000 25.0%Utilities expense 12,500 9,000 3,500 38.9%Supplies expense 2,700 3,000 (300) (10.0)%Misc. expense 2,300 1,800 500 27.8% Total operating expenses $ 92,500 $ 70,800 $21,700 30.6%

Net income $ 95,000 $ 79,200 $15,800 19.9%

The EndThe End

Chapter 2

Education

Principal accounting - Ch02 analyzing transaction