Chapter 3 recording transtion

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Chapter 3

Recording

Transactions

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Learning Objectives

After studying this chapter, you should be able to:

update retained income.

Learning Objectives

After studying this chapter, you should be able to:

 Correct erroneous journal entries and describe how errors affect accounts.

 Use T-accounts to analyze accounting relationships.

 Explain how computers have transformed processing of accounting data.

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The Double-Entry

Accounting System

 Some businesses enter into thousands of transactions daily or even hourly.

 Accountants must carefully keep track of and record these transactions in a systematic manner

 Accountants use a double-entry accounting system in which at least two accounts are always affected by each transaction.

The Double-Entry

Accounting System

 Each transaction must still be analyzed to determine which accounts are involved, whether the accounts increase or decrease, and how much the balance will change.

 The balance sheet equation can be used for this analysis, but with so many transactions, this is not realistic.

 In practice, accountants use ledgers

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 The ledger is a company’s “books.”

 General ledger - the collection of accounts that

accumulates the amounts reported in the major financial statements

Ledger Accounts

the T-account

 They allow us to capture the essence of the accounting process

without having to worry about too many details

 The account is divided into two sides for recording increases and

decreases in the accounts

Account Title

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Ledger Accounts

 Balance - difference between total left-side

amounts and total right-side amounts at any

particular time

 Assets have left-side balances

 Increased by entries to the left side

 Decreased by entries to the right side

 Liabilities and Owners’ Equity have right-side balances

 Decreased by entries to the left side

 Increased by entries to the right side

Ledger Accounts

 T-accounts and the balance sheet equation:

Assets = Liabilities + Owners’ Equity

Owners’ Equity

Decreases Increases

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Debits and Credits

 Debit (dr.) - an entry or balance on the left side of an account

 Credit (cr.) - an entry or balance on the right side of an account

 Remember:

 Debit is always the left side!

 Credit is always the right side!

The Recording Process

 The sequence of steps in recording transactions:

Transactions Documentation Journal

Financial

Statements

TrialBalance Ledger

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The Recording Process

 The process starts with source documents , which are the supporting original records of any transaction.

 Examples are sales slips or invoices, check stubs, purchase orders, receiving reports, and cash receipt slips

The Recording Process

 In the second step, an analysis of the transaction is placed in the book of original entry , which is a chronological record of how the transactions affect the balances of applicable accounts.

 The most common example is the general journal -

a diary of all events (transactions) in an entity’s life

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The Recording Process

 In the third step, transactions are entered into the ledger.

 Remember that a transaction is not entered in just one place; it must be entered in each account that it affects

 Depending on the nature of the organization, analysis of the

transactions could occur continuously or periodically

The Recording Process

 The fourth step includes the preparation of the trial balance , which is a simple listing of all accounts in the general ledger with

their balances.

 Aids in verifying accuracy and in preparing

the financial statements

 Prepared periodically as necessary

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The Recording Process

 In the final step, the financial statements are prepared.

 Financial statements are prepared each quarter of the year for

publicly traded companies

 Other companies prepare financial statements at various other

intervals to meet the needs of

their users

Journalizing Transactions

 Journalizing - the process of entering transactions into the journal

 Journal entry - an analysis of the effects of a transaction on the accounts, usually accompanied by an explanation of the

transaction

 This analysis identifies the accounts to be debited and credited

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Journalizing Transactions

 The conventional form for journal entries includes the

following:

 The date and identification number of the entry

 The accounts affected and an explanation of the

transaction

 The posting reference, which is the number assigned

to each account affected by the transaction

 The amounts that the accounts are to be debited and credited

Journalizing Transactions

2/1 3 Merchandise inventory 150,000

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Chart of Accounts

account titles used to record transactions

Account Account Account Account

Number Title Number Title

111 Cash 311 Notes payable

131 Accounts receivable 331 Accounts payable

156 Inventory 411 Paid-in capital

142 Prepaid rent 421 Retained income

211 Equipment 511 Revenue

214 Accumulated 632 Cost of goods sold

depreciation 641 Rent expense

642 Depreciation expense

Posting Transactions

to the Ledger

 Posting - transferring of amounts from the journal to the appropriate accounts in the ledger

 Dates, explanations, and journal references are provided in detail on paper formatted with special columns

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Posting Transactions

to the Ledger

 Cross-referencing - the process of numbering or

otherwise specifically identifying each journal entry and each posting

 Transactions are often posted to several different

accounts, but cross-referencing allows users to find all components of a transaction in the ledger no

matter where they start.

 Cross-referencing also allows auditors to find and

correct errors.

Running Balance Column

your checkbook and provides columns for:

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Running Balance Column

account at a glance at any given point in time.

CASH Account No 111

Journal Date Explanation Ref Debit Credit Balance

Analyzing, Journalizing, and

Posting Transactions

 Types of journal entries:

 Simple entry - an entry for a transaction that affects only two accounts

 Compound entry - an entry for a transaction that affects more than two accounts

 Remember: whether the entry is simple or compound, the debits (left side) and credits (right side) must always equal.

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Revenue and Expense

Transactions

less expenses, but we cannot just increase or

decrease the Retained Income account directly.

 This would make preparing the income statement very difficult

separately, a more meaningful income statement can be easily prepared.

Revenue and Expense

CreditIncrease

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Revenue and Expense Transactions

 Summary of revenue and expense transactions:

 A credit to a revenue increases the revenue and

increases Retained Income.

 A debit to a revenue decreases the revenue and

decreases Retained Income.

 A credit to an expense decreases the expense and

increases Retained Income.

 A debit to an expense increases the expense and

decreases Retained Income.

Revenue and Expense

Transactions

 Keeping revenues and expenses in separate accounts makes the preparation of the income statement easier.

 The income statement provides a detailed explanation of how

operations caused the balance of Retained Income shown on the

balance sheet to change from the beginning of the year to the end of the year

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Prepaid Expense and

Depreciation Transactions

lives that will expire sometime in the future.

 The expiration, or using up, of those assets is an expense

Depreciation, is introduced.

 Accumulated depreciation - the cumulative sum of all depreciation

recognized since the date of acquisition of a particular asset

Prepaid Expense and

Depreciation Transactions

related account that offsets or is a deduction from

a companion account.

 Book value - the balance of an account, net of any contra accounts (a.k.a net book value, carrying

amount, or carrying value)

 The book value of an asset is its acquisition cost minus accumulated

depreciation

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A Note on Accumulated

Depreciation

reduce the asset account as it expires?

 Accountants want the acquisition cost to remain on the books, so the asset must be “reduced” in some manner

 Also, the acquisition cost of the asset is a reliable and objective number, whereas accumulated depreciation is an estimate of the allocation of the cost of that asset over the period that it benefits

Transactions in the Journal and Ledger

 Some details to remember:

 Do not use dollar signs in either the journal or the ledger

 Do not use negative numbers The effect on the account is conveyed by the side (debit or credit) on which the number appears

 For ledgers that do not have a running balance (such as T-accounts), the balances may be updated from time to time

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Preparing the Trial Balance

 Once all transactions have been posted to the ledger, a trial balance is prepared.

 Trial balance - a list of all of the accounts with their balances

 It is prepared as a test or check before continuing the

recording process

Preparing the Trial Balance

 The purposes of the trial balance:

 To help check on accuracy of posting by proving whether

the total debits equal the total credits

 To establish a convenient summary of balances in all

accounts for the preparation of formal financial statements

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Preparing the Trial Balance

balance sheet accounts first, followed by the income statement accounts.

Deriving Financial Statements from the Trial Balance

preparation of the balance sheet and the income

statement.

account called Net Income, which becomes part of

Retained Income in the Balance sheet.

 The trial balance shows the beginning balance in Retained Income because no changes have actually been made to the account during the year.

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 A transaction may be recorded as different amounts

in two different accounts.

 A transaction may be recorded in a wrong account.

 In both situations, the total debits will still equal total

credits on the trial balance.

Closing the Accounts

accounts must be prepared to record the next period’s transactions This process is called closing the books

 The balances in all “temporary” stockholders’ equity accounts are transferred to a “permanent”

stockholders’ equity account.

 The revenue and expense accounts are “reset” to

zero and the current net income is transferred to

Retained Income.

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Closing the Accounts

 The revenue accounts are closed to Income

Summary in the first entry.

 The expense accounts are closed to Income

Summary in the second entry.

 The amount of Net Income (revenues -

expenses) is then transferred from Income

Summary to Retained Income.

References: