MODULE 3
Recording Business Transactions
(part 1)
Chapter Overview
Chapter 2 introduces the account and the ledger then briefly describes specific asset, liability, and owner’s equity accounts. The concept of double-entry bookkeeping and the rules of debit and credit for assets, liabilities, and owner’s equity are described. The "T-account" is illustrated. The accounting equation is tied to the rules of debit and credit.
The journal is introduced and the process of recording transactions (journalizing) is illustrated. The four-step process, described for a manual system, is also completed in a computerized accounting system. The posting process is explained briefly. A series of entries are analyzed, journalized, and posted to T-accounts in the ledger. The trial balance is defined and prepared. The reason for preparing the trial balance is explained, and some accounting errors revealed by a trial balance are described. A mid-chapter summary problem reviews how to journalize, post, and prepare a trial balance.
Details of journals, ledgers, and the posting process are presented, including an illustration of a 4-column account with a running balance. A chart of accounts is illustrated, and the normal balances of accounts are explained. The rules of debit and credit are expanded to include specific types of owner’s equity accounts. An illustrative problem demonstrates the analyzing, journalizing, and posting of several revenue, expense, and withdrawal transactions, followed by the preparation of a trial balance.
Decision guidelines are presented that assist the student in analyzing and recording transactions. A journal entry may be quickly analyzed, without using a journal, by looking directly to the effect of that transaction on the ledger accounts. The chapter concludes with a summary problem that reviews opening accounts, journalizing, posting, preparing a trial balance, and computing net income or net loss.
Learning Objectives
After studying Chapter 2, your students should be able to:
1. Define and use key accounting terms
2. Apply the rules of debit and credit
3. Record transactions in the journal
4. Post from the journal to the ledger
5. Prepare and use a trial balance
6. Set up a chart of accounts for a business
7. Analyze transactions without a journal
Chapter Outline
Objective 1: Define and use key accounting terms
A. Account – a basic component of an accounting system. The account, a summary device, shows all the increases and decreases in a particular asset, liability, or owner’s equity account during a period. Accounts are grouped based on the accounting equation, A = L + O/E.
B. Ledger – a group of accounts. All the accounts of a business grouped together form a book called the ledger (or general ledger). Exhibit 2-1 shows how accounts are grouped in the ledger.
C. Assets – economic resources that will be used in the business, or will be of benefit to the business, in the future. Cash, notes and accounts receivable, prepaid expenses, land, building, furniture, and equipment are examples of assets.
D. Liabilities – debts or other obligations of the business that must be satisfied in the future.
Examples of liabilities are notes and accounts payable, and other accrued liabilities such as taxes payable, salary payable, and interest payable. Accrued liabilities are expenses that have not been paid.
E. Owner’s Equity – the owner’s claims to the assets owned by the business. Capital, withdrawals, revenues, and expenses are owner’s equity accounts.
2. Withdrawals – the owner’s withdrawals of cash or other assets from the business for personal use. Withdrawals decrease owner’s equity.
3. Revenues – increases in owner’s equity from performing services or selling products. Service revenue, interest revenue, and rent revenue are examples.
4. Expenses – costs incurred in operating a business. Expenses decrease owner’s equity. A business may have many different expenses, including salary, rent, interest, repairs, and so on.
F. Double-entry bookkeeping – records the dual effects of a business transaction. Each transaction affects at least two accounts. Each transaction has at least two effects on the entity.
G. The T-account is an abbreviated form of a ledger account, used to help illustrate the effect of transactions.
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Account Name |
|
|
Debit entries |
Credit entries |
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(left side) Dr |
(right side) Cr |
Objective 2: Apply the rules of debit and credit
A. The type of account determines the side on which increases and decreases are recorded; the rules of debit and credit keep the accounting equation in balance.
1. Increases in assets are recorded on the left (debit) side of the account. Decreases in assets are recorded on the right (credit) side.
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Asset |
|
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Debit entries |
Credit entries |
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(left side) Increases |
(right side) Decreases |
2. Rules for liabilities and owner’s equity accounts are the opposite of the rules for assets. Increases in liabilities and owner’s equity accounts are recorded on the right (credit) side of an account, and decreases are recorded on the left (debit) side.
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Liability and Owner’s Equity |
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Debit entries |
Credit entries |
|
(left side) Decreases |
(right side) Increases |
B. Summaries of the rules of debit and credit are found in Exhibits 2-2 and 2-13. Assets, liabilities, and owner’s equity are listed first in Exhibit 2-2, and then revenues, and expenses, and withdrawals are added in Exhibit 2-13.
C. Double-entry bookkeeping and the rules of debit and credit are based on the accounting equation, A = L + O/E. After each transaction is recorded, the equation must remain in balance, as illustrated in Exhibit 2-3. Additionally, total Dr amounts must equal total Cr amounts.
D. After increases and decreases in an account are recorded, the amount remaining in the account is its balance. Account balances are computed by adding the beginning balance and the increases, and subtracting the decreases. (The balance equals the difference between total debit entries and total credit entries.)
E. Create or open new accounts as needed when recording transactions.
Objective 3: Record transactions in the journal
A. Transactions are recorded first in the journal, a chronological listing of all the entity’s business transactions. (Refer to Exhibit 2-4 for an illustration of the journal.)
B. Analysis of each transaction involves these steps:
1. Identify the transaction from the source document, such as a sales invoice or check stub.
2. Identify the types of accounts affected by the transaction, such as asset or expense.
3. Determine which accounts increase and which decrease. (Some transactions may require only increases or only decreases.) Apply the rules of debit and credit.
4. Write the transaction in the journal, listing first the debit and then the credit. Include a brief explanation. Verify that total debits equal total credits.
C. The journal shows the complete effect of each transaction, not just one part of it. The journal provides more information than the ledger.
D. Personal transactions of the owners and transactions of other businesses are not included on the financial statements of a business.