Chapter 2 Analyzing Business Transactions Skyline College.

Chapter 2

Analyzing Business Transactions

Skyline College

Copyright © Houghton Mifflin Company. All rights reserved. 2–2

Measuring Transactions

Economic Event

Affects the financial position of an entity

When to record?

Recognition Valuation

What value to record?

Classification

How to categorize?


When is a Recognized?

Recognition of a transaction refers to when it should be recorded

Point of recognition is important because it affects the financial statements

For Products

Recognize when title of property transfers

For Services

Recognize when services are performed

If services are performed over a long period of time, bill at key points


At What Value Should a Transaction Be Recorded?

GAAP state that original cost (historical cost) be used to assign value

The cost principle is used because the exchange price can be verified by documentation (a cancelled check or an invoice)

Check 334: Intelligent Designs

$1,500 for computer

Record at cost = $1,500

© Royalty Free C Squared Studios/ Getty Images


How Should a Transaction Be Classified?

Classification refers to assigning transactions to the proper accounts

Requires maintaining a system of accounts

Able Co. purchases tools used for repairing manufacturing equipment.

Classify as an expense OR

Classify as equipment

Affects net income

(stockholders’ equity)

Affects assets

©Comstock Klips


Ethics and Measurement Issues

In the News – Violations of Measurement Guidelines

WorldCom misclassifies expenditures: Understates expenses by more than

$10 billion

Xerox overstates revenues: Records lease revenues when leases signed rather than over lease term

Enron overvalues assets: Investors and employees lose

billions

© Royalty-Free/Corbis


Discussion: Ethics on the Job

Curt Winthrop, CFO for Tralcom Industries, decided to classify a purchase of small tools as an asset rather than an expense. In the past, such purchases have been classified as expenses, but the company needs the income statement to look strong for an upcoming loan application.

Q. What do you think of Winthrop’s decision?


One Debit

The Backbone of Accounting

Based on the principle of duality – Every economic event has two aspects…

In the double-entry accounting system,

every transaction is recorded with at least…

Effort AND Reward

Sacrifice AND Benefit

One Credit

Debit totals must equal credit totals

AND


Sacrifice Versus BenefitIf you were to purchase a HD DVD player for $300, what is your sacrifice? What is your benefit?

Sacrifice = $300

Benefit = DVD player



AccountsBasic storage units for accounting data Used to accumulate amounts from similar

transactions

Categories of Accounts

Assets Liabilities Stockholders’

Equity

• Common Stock• Retained Earnings

+ Revenues - Expenses- Dividends


The T AccountThe T account is a visual representation of an accountUsed to analyze transactions

Title of Account

Debit(left) side

Credit(right) side

Identifies the asset, liability, or

stockholders’ equity account



The Rules of Double-Entry Accounting

Stockholders’Assets = Liabilities + Equity

Debitfor

Increases(+)

Creditfor

Decreases(–)

Remember that every transaction affects at least two accounts.

At least one account is debited and one account is credited. One on the left and one on the right.

Debitfor

Decreases(–)

Creditfor

Increases(+)

Creditfor

Increases(+)

Debitfor

Decreases(–)


Stockholders’ Equity Accounts

Retained Earnings

Revenues

Common Stock

Dividends

Expenses

Increases to these accounts increase stockholders’ equity:

These accounts are deductions from stockholders’ equity:

– +

+ –

+ – + –

– +



Normal Balance of AccountThe usual balance of an account

Normal balance of asset, dividend, and expense accounts

Normal balance of liability, common stock, retained earnings, and revenue accounts

Account

Account

Debit side

Credit side

The side (debit or credit) that increases an account


Accounts and the Accounting Equation Illustrated


If a debit increases assets by $100, then a credit must increase stockholders’ equity or liabilities by $100 for the

accounting equation to stay in balance.

700 200

800 = 300 + 500

500 100 100

+ + +_ _ _


Analyzing and Recording Transactions

1. Analyze the transaction to determine which accounts are affected.

2. Show the transaction in journal form.

3. Use T accounts to show how the transaction affects the accounting equation.



Next: Record the entry in journal form

Transaction: Owner’s Investment

July 1: Pricilla Treadle invests $40,000 in Treadle Website Design, Inc. in exchange for 40,000 shares of $1 par value common stock.

Cash Common Stock


+ + + 40,000

+ 40,000


Transaction: Journal Form

2. Debit account and debit amount recorded on first line

Cash 40,000

1. Date recorded on first line

July 1

Recording the transaction in journal form:

Cr. Dr.

3. Indent, credit account and credit amount recorded on second line

Common Stock 40,000



+3,200

Transaction: Prepayment of Rent

July 3: Payment of 2 months rent in advance, $3,200

Cash

Prepaid Rent


+ 40,000

-3,200

This transaction simply trades one asset for

another. The amount of total assets is not changed.-


Transaction: Journal Form

Recording the transaction in journal form:

3,200 Cash

3,200Prepaid Rent July 3 Cr. Dr.

© Royalty Free PhotoDisc Collection/ Getty Images


Transaction: Purchase of Supplies on Credit

July 5: Receipt of office supplies ordered on July 2 and an invoice for $5,200.

Office Supplies Accounts Payable


+ 5,200

July 5 Office Supplies 5,200

Accounts Payable 5,200

+ 5,200

- -


+9,600

Transaction: Service Revenue July 15: Performs design services; bill now but to be received later, $9,600

Accounts Receivable Design Revenue


+ 9,600

July 15 Accounts Receivable 9,600

Design Revenue 9,600

- -


Preparing the Trial Balance To ensure that total debits equal total credits,

prepare a trial balance Usually prepared on the last day of month

1. List accounts in the order in which they appear on the financial statements.

2. Put debit balances in the left column and credit balances in the right column

3. Add each column.

4. Compare the totals of the columns.


Trial BalanceTreadle Website Design, Inc.

Trial Balance July 31, 20xx

Cash $22,480

Accounts Receivable 4,600 Office Supplies 5,200 Prepaid Rent 3,200 Office Equipment 16,320 Accounts Payable $ 6,280 Unearned Design Revenue 1,400 Common Stock 40,000 Dividends 2,800 Design Revenue 12,400 Wages Expense 4,800 Utilities Expense 680 $60,080 $60,080

Record debit balances in left

column

Record credit balances in right

columnTotal each column


Finding Trial Balance ErrorsIf the debit and credit totals are not equal, look for one or more of these errors:

A debit was entered as a credit, or vice versa

The balance of an account was computed incorrectly

An error was made in carrying the account balance to the trial balance

The trial balance was summed incorrectly

[photo]



What Are the Most Common Trial Balance Errors?

Recording a debit as a credit or vice versa

Transposing two digits when transferring an amount to the trial balance

Hint: The trial balance will be out of balance by an amount divisible by 2

Hint: The trial balance will be out of balance by an amount divisible by 9



Limitations of the Trial Balance Does not prove that

transactions were analyzed correctly

Does not determine whether amounts were recorded in the proper accounts

[Photo]

Does not detect whether transactions have been omitted

© Royalty Free PhotoDisc Collection/ Getty Images


Cash Flows: Treadle Website Design, Inc.

Cash

Inv. by owner 40,000 3,200 Prepayment of rent13,320 Purchase of equipment2,600 Payment of liability

Revenue 2,800Advance revenue 1,400Collection of A/R 5,000 4,800 Payment of wages

2,800 Payment of dividends

Treadle must ensure that it has adequate cash on hand at all times to pay its debts and maintain ongoing

operations.

Bal. 22,480

+_


Accounting System

General Ledger

100 Account

101 Account

300 Account

301 Account

400 Account200 AccountChart of Accounts

List of accounts and identifying

numbers

System of accounts grouped together manually or

electronically © Royalty Free C Squared Studios/ Getty Images


Sample Chart of AccountsAssets Revenues

100 Cash 401 Service A

102 Accounts Receivable 402 Service B

105 Office Supplies 403 Service C

106 Prepaid Rent

110 Land

Liabilities Expenses

200 Accounts Payable 501 Wages Expense

201 Notes Payable 502 Utilities Expense

204 Wages Payable 503 Rent Expense

504 Office Supplies Expense

Stockholders’ Equity 505 Income Taxes Expense

301 Common Stock

305 Retained Earnings

313 Dividends

314 Income Summary

The first digit in each account

number signifies its

classification

Assets Revenues

Liabilities Expenses

Stockholders’ Equity


The General Journal Journalizing is the process of recording all

transactions chronologically in a journal

General Journal: Most flexible and simple

General Journal Page 1

Date

Description Post. Ref.

Debit

Credit


Journalizing a Transaction

General Journal Page 1

Date

Description Post. Ref.

Debit

Credit

20xx July 6

Cleaning Supplies 1,800 Office Supplies 800 Accounts Payable 2,600 Purchased supplies on credit

1. The date2. Names of accounts debited and dollar amounts on same

line in debit column3. Names of accounts credited (indented) and dollar

amounts on same line in credit column

4. Explanation of transaction

5. Account identification numbers, if applicable

July 6 Purchased cleaning supplies and office supplies on account

Record:


The General Ledger Used to record the

details of each transaction

Used to update each account

In practice, the ledger account form is used

General Ledger

Account Name Account No. Balance

Date

Item Post. Ref.

Debit

Credit Debit Credit



Ledger Account Form

General Ledger

Accounts Payable Account No. 212

Balance Date

Item

Post. Ref.

Debit

Credit Debit Credit

Account title and number appear at top of account form

The date appears in the first two columns (as in the journal)Item column is rarely used because explanations already appear

in the journalPost. Ref. column used to note the journal page on which the original

entry for the transaction can be foundDollar amount is entered in appropriate Debit or Credit columnNew account balance computed in the last two columns opposite each entry


PostingTransferring…

Journal entry information transferred from the journal

to the ledger

Posting can be done daily, or less frequently depending on the number of transactions


Posting a Transaction General Journal Page 2

Date

Description

Post. Ref.

Debit

Credit

20xx July 30 Telephone Expense 140 Accounts Payable 140 Received bill from telephone company

General Ledger Accounts Payable Account No. 212

Balance Date

Item

Post. Ref.

Debit

Credit Debit Credit

20xx July 5 J1 1,500 1,500

6 J1 2,600 4,100 9 J1 1,000 3,100

General Ledger Telephone Expense Account No. 513

Balance Date

Item

Post. Ref.

Debit

Credit Debit Credit

1. Locate debit account in the ledger

2. Enter date of transaction and journal page number in Post. Ref. column

3. Enter in Debit column amount of debit from journal

4. Calculate account balance and enter in appropriate Balance column

5. In journal Post. Ref. Column, enter account number to which amount was posted

6. Repeat for credit entry

20xx July 30 J2

140

140

513

30 J2 140 3,240

Chapter 2 Analyzing Business Transactions Skyline College.

Documents

Transcript of Chapter 2 Analyzing Business Transactions Skyline College.