Chapter 2
Analyzing Transactions
Accounting, 21st Edition
Warren Reeve Fess
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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.
Objectives
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.
Objectives
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 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).
Cash
Supplies
Building
Accounts receivable
Accounts payable
Notes payable
Wages payable
Major Account Classifications
Liabilities are debts owed to outsiders (creditors).
Cash
Supplies
Building
Accounts receivable
Accounts payable
Notes payable
Wages payable
Assets are resources owned by the business.
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.
Revenues are increases in owner’s equity as a result of selling services or products.
Chris Clark, Capital
Chris Clark, Drawing
Fees Earned
Fares Earned
Commission Revenue
Expenses are the using up of assets or consuming of services to generate revenue.
Rent Expense
Salary Expense
Utilities Expense
Major Account Classifications
To assist you in learning, an account can be drawn to resemble the letter T.
The T-Account
The T-account has a title.
Cash
The T-Account
The left side of the account is the debit side.
Cash
Left side debit
The T-Account
The right side of the account is the credit side.
Cash
Left side debit
Right side credit
The T-Account
Cash
3,750
4,300
2,900
850
1,400
700
2,900
Typical entries
Balancing a T-Account
Cash
3,750
4,300
2,900
850
1,400
700
2,900
10,950
First, foot the debit side.
850
1,400
700
2,900
Cash
3,750
4,300
2,900
10,950
5,850
Next, foot the
credit side.
850
1,400
700
2,900
Cash
3,750
4,300
2,900
10,950
5,850
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. 1
2005
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.
(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
Cash
Nov. 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.
Effects of this entry in the Ledger
Cash
Nov. 1 25,000
Nov. 5 20,000
Land
Nov. 5 20,000
(B) On November 5, NetSolutions bought land for $20,000, paying cash.
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.
(C) On November 10, NetSolutions purchased supplies on account for $1,350.
Effects of this entry in the Ledger
Supplies
Nov. 10 1,350
Accounts Payable
Nov. 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.
Cash
Nov. 1 25,000
Nov. 5 25,000
18 7,500
30 3,650
Effects of this entry in the Ledger
Accounts Payable
Nov. 10 1,350
Nov. 30 950
30 950
(F) On November 30, NetSolutions paid creditors on account, $950.
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 increases (+)
Credit for decreases (-)
Debit for increases (+)
Debit for decreases (-)
Debit for decreases (-)
ASSETS
Asset Accounts
LIABILITIES
Liability Accounts
Owner’s Equity Accounts
OWNER’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
Effects of this entry in the Ledger
Cash
Nov. 1 25,000
Nov. 5 25,000
Fees Earned
Nov. 18 7,500
18 7,500
(D) On November 18, NetSolutions received fees of $7,500 from customers for services provided .
(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 Ledger
Cash
Nov. 1 25,000
Nov. 5 25,000
Wages Expense
Nov. 30 2,125
18 7,500
Rent Expense
Nov. 30 800
Utilities Expense
Nov. 30 450
Miscellaneous Expense
Nov. 30 275
30 3,650
(E) Throughout the month, NetSolutions incurred the following expenses: wages, $2,125; rent, $800; utilities, $450; and miscellaneous, $275 .
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
Effects of this entry in the Ledger
Supplies
Nov. 10 1,350
Supplies Expense
Nov. 30 800
Nov. 30 800
(G) On November 30, a count revealed that $800 of the supplies inventory had been used.
Double-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 Pacioli
Developer of
Double-Entry
Accounting
Scale or Balance
Receive
DEBIT
Give
CREDIT
T account
Left Side
Receive
DEBIT
Right Side
Give
CREDIT
Credit for increases (+)
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
Post. Ref.
JOURNAL
Date
Description
Debit
Credit
Page 2
1
2
3
4
Nov. 30
2005
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.
30 950
30 2,000
Cash
Nov. 1 25,000
Nov. 5 25,000
18 7,500
30 3,650
Effects of this entry in the Ledger
Chris Clark, Drawing
Nov. 10 1,350
Nov. 30 2,000
(H) On November 30, Chris Clark withdrew $2,000 in cash from NetSolutions for personal use.
Increase
(Normal Balances)
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
Normal Balances of Accounts
Flow of Business Transactions
1
Transaction authorized
2
Transaction takes place
3
Document prepared
4
Entry 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 Transactions
Journalizing and Posting
Post. Ref.
JOURNAL
Date
Description
Debit
Credit
Page 2
1
2
3
4
Dec. 31
2005
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.
Post. Ref.
JOURNAL
Date
Description
Debit
Credit
Page 2
1
2
3
4
Dec. 1
2005
Prepaid Insurance 2 400 00
Cash 2 400 00
ACCOUNT
Prepaid Insurance
ACCOUNT NO. 15
Balance
Debit
Credit
Date
Debit
Credit
Item
Post. Ref.
2 400 00
2 400 00
Dec. 1
2005
Paid premium on two-year
policy.
Post. Ref.
JOURNAL
Date
Description
Debit
Credit
Page 2
1
2
3
4
Dec. 1
2005
Prepaid Insurance 2 400 00
Cash 2 400 00
ACCOUNT
Prepaid Insurance
ACCOUNT NO. 15
Balance
Debit
Credit
Date
Debit
Credit
Item
Post. Ref.
2 400 00
2 400 00
Dec. 1
2005
2
15
Paid premium on two-year
policy.
Post. Ref.
JOURNAL
Date
Description
Debit
Credit
Page 2
1
2
3
4
Dec. 1
2005
Prepaid Insurance 2 400 00
Cash 2 400 00
Paid premium on two-year
policy.
15
ACCOUNT
Cash
ACCOUNT NO. 11
Balance
Debit
Credit
Date
Debit
Credit
Item
Post. Ref.
2 000 00
5 900 00
Nov. 30
2005
2
Dec. 1
2 400 00
3 500 00
Post. Ref.
JOURNAL
Date
Description
Debit
Credit
Page 2
1
2
3
4
Dec. 1
2005
Prepaid Insurance 2 400 00
Cash 2 400 00
Paid premium on two-year
policy.
15
ACCOUNT
Cash
ACCOUNT NO. 11
Balance
Debit
Credit
Date
Debit
Credit
Item
Post. Ref.
2 000 00
5 900 00
Nov. 30
2005
2
2 400 00
3 500 00
Dec. 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.
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. 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.
21
22
23
24
6
Miscellaneous Expense 59 180 00
Cash 11 180 00
Paid for newspaper ad.
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.
Post. Ref.
JOURNAL
Date
Description
Debit
Credit
Page 3
1
2
3
4
Dec. 13
2005
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.
5
6
7
8
16
Cash 11 3 100 00
Fees Earned 41 3 100 00
Received fees from customers.
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
Fees Earned 41 1 750 00
Received fees from customers.
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.
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.
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.
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.
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.
Post. Ref.
JOURNAL
Date
Description
Debit
Credit
Page 4
1
2
3
4
Dec. 31
2005
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.
5
6
7
8
31
Cash 11 2 870 00
Fees Earned 41 2 870 00
Received fees from customers.
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
Fees Earned 41 1 120 00
Recorded fees earned on
account.
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
NetSolutions
Trial Balance
December 31, 2005
Cash 2 065 00
Accounts Receivable 2 220 00
Supplies 2 000 00
Prepaid Insurance 2 400 00
Land 20 000 00
Office Equipment 1 800 00
Accounts Payable 900 00
Unearned Rent 360 00
Chris Clark, Capital 25 000 00
Chris Clark, Drawing 4 000 00
Fees Earned 16 340 00
Wages Expense 4 275 00
Rent Expense 1 600 00
Utilities Expense 985 00
Supplies Expense 800 00
Miscellaneous Expense 455 00
42 600 00 42 600 00
NetSolutions
Trial Balance
December 31, 2005
Cash 2 065 00
Accounts Receivable 2 220 00
Supplies 2 000 00
Prepaid Insurance 2 400 00
Land 20 000 00
Office Equipment 1 800 00
Accounts Payable 900 00
Unearned Rent 360 00
Chris Clark, Capital 25 000 00
Chris Clark, Drawing 4 000 00
Fees Earned 16 340 00
Wages Expense 4 275 00
Rent Expense 1 600 00
Utilities Expense 985 00
Supplies Expense 800 00
Miscellaneous Expense 455 00
42 600 00 42 600 00
Balance Sheet Items
NetSolutions
Trial Balance
December 31, 2005
Cash 2 065 00
Accounts Receivable 2 220 00
Supplies 2 000 00
Prepaid Insurance 2 400 00
Land 20 000 00
Office Equipment 1 800 00
Accounts Payable 900 00
Unearned Rent 360 00
Chris Clark, Capital 25 000 00
Chris Clark, Drawing 4 000 00
Fees Earned 16 340 00
Wages Expense 4 275 00
Rent Expense 1 600 00
Utilities Expense 985 00
Supplies Expense 800 00
Miscellaneous Expense 455 00
42 600 00 42 600 00
Statement of Owner’s Equity Item
NetSolutions
Trial Balance
December 31, 2005
Cash 2 065 00
Accounts Receivable 2 220 00
Supplies 2 000 00
Prepaid Insurance 2 400 00
Land 20 000 00
Office Equipment 1 800 00
Accounts Payable 900 00
Unearned Rent 360 00
Chris Clark, Capital 25 000 00
Chris Clark, Drawing 4 000 00
Fees Earned 16 340 00
Wages Expense 4 275 00
Rent Expense 1 600 00
Utilities Expense 985 00
Supplies Expense 800 00
Miscellaneous Expense 455 00
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 error
but not posted. and insert correct title or
amount.
Error Correction Procedure
Correction of Errors
Error Correction Procedure
1. Journal entry is incorrect Draw a line through the error
but not posted. and insert correct title or
amount.
Error Correction Procedure
2. Journal entry is correct Draw a line through the
but posted incorrectly. posted error and post correctly.
Correction of Errors
Error Correction Procedure
Error Correction Procedure
Journal entry is incorrect Journalize and post a
and posted correcting entry.
Correction of Errors
What would be the necessary correcting entry?
Journal – As recorded and posted
Correcting Errors – An Example
On May 5, a purchase of office equipment on account was incorrectly journalized and posted as shown.
Date Description Debit Credit
May 5 Supplies 12,500
Accounts Payable 12,500
Journal – As recorded and posted
Correcting Errors – An Example
On May 5, a purchase of office equipment on account was incorrectly journalized and posted as shown.
Date Description Debit Credit
May 5 Supplies 12,500
Accounts Payable 12,500
Date Description Debit Credit
May 5 Office Equipment 12,500
Date Description Debit Credit
May 5 Office Equipment 12,500
Supplies 12,500
Journal – As recorded and posted
Correcting Errors – An Example
On May 5, a purchase of office equipment on account was incorrectly journalized and posted as shown.
Date Description Debit Credit
May 5 Supplies 12,500
Accounts Payable 12,500
Financial Analysis and Interpretation
Comparing an item in a current statement with the same item in prior statements is called horizontal analysis.
J Holmes, Attorney-at-Law
Income Statement
For the Year Ended December 31, 2005 and 2006
Increase (Decrease)
2006 2005 Amount Percent
Fees earned $187,500 $150,000 $37,500 %
Operating expenses:
Wages expense $ 60,000 $ 45,000 $15,000 %
Rent expense 15,000 12,000 3,000 %
Utilities expense 12,500 9,000 3,500 %
Supplies expense 2,700 3,000 (300) ()%
Misc. expense 2,300 1,800 500 %
Total operating
expenses $ 92,500 $ 70,800 $21,700 %
Net income $ 95,000 $ 79,200 $15,800 %
The End
Chapter 2
