Principles of financial accounting 12e by needles crosson chapter 02

Double-Entry System and Accounts In the double-entry system , each transaction must be recorded with at least one debit and one credit, and the total amount of the debits must equal t

Powers

Crosson

Principles of

Accounting

12e

Analyzing and Recording Business Transactions

2

C H A P T E R

Concepts Underlying Business Transactions

 Business transactions are economic events that should be recorded in the

accounting records

 The concepts of recognition, valuation, and classification underlie all business

transactions.

Concepts Underlying Business Transactions

 Recognition refers to the decision as to when to

record a business transaction.

 Valuation is the process of assigning a monetary amount to business transactions and the resulting assets and liabilities GAAP states that all business transactions should be valued at fair value when

they occur

– Fair value is the exchange price of an actual or potential

business transaction between market participants.

– Recording transactions at the exchange price at the point

of recognition is called the cost principle

 Classification is the process of assigning all the

transactions in which a business engages to

appropriate categories, or accounts.

Double-Entry System and Accounts

 In the double-entry system , each

transaction must be recorded with at least one debit and one credit, and the total

amount of the debits must equal the total

amount of the credits.

 Accounts are the basic storage units for

accounting data and are used to accumulate amounts from similar transactions.

– An accounting system has a separate account for each asset, each liability, and each component of owner’s equity, including revenues and expenses.

Chart of Accounts

 In a manual accounting system, each account is kept on a separate page or card These pages or cards are placed together in a book or file called the general ledger In computerized systems, accountants still refer to the group of accounts

as the general ledger, or simply the ledger.

– A chart of accounts is a table of contents for the ledger It lists the account titles and the

numbers that have been assigned to them It usually lists the accounts in the order in which they appear in the ledger (the order in which they appear in the financial statements).

The T Account

(slide 1 of 2)

 The T account is a tool used to analyze transactions It has three parts:

– a title, which identifies the asset, liability,

or owner’s equity account – a left side, which is called the debit side

(abbreviated Dr., from the Latin debere)

– a right side, which is called the credit side

(abbreviated Cr., from the Latin credere)

The T Account

(slide 2 of 2)

– For the Cash account, receipts are recorded on the left (debit) side of a T account and payments

on the right (credit) side, as shown below.

– The totals in smaller, blue figures are simply

working totals, or footings – The difference between the total debit footing

and the total credit footing is called the account balance

Rules of Double-Entry Accounting

 The double-entry system follows two

rules:

– Every transaction affects at least two

accounts.

– Total debits must equal total credits.

 For every transaction:

– one or more accounts must be debited, or entered on the left side of a T account.

– one or more accounts must be credited, or entered on the right side of a T account.

Rules of Double-Entry Accounting

 Keep the accounting equation in mind: Assets = Liabilities + Owner’s Equity

Rules of Double-Entry Accounting

 Withdrawals and expenses are

deductions from owner’s equity, so

transactions that increase withdrawals

or expenses decrease owner’s equity.

Normal Balance

 The normal balance of an account is its usual balance and is the side (debit

or credit) that increases the account.

Business Transaction Analysis

 The details of business transactions are supported by source documents —

invoices, receipts, checks, or contracts.

records a single transaction in the

chronological accounting record known

as a journal Each entry must be in

proper journal form

The Trial Balance

 The trial balance is a device used to ensure that the total of debits and

credits in the accounts are equal.

Finding Trial Balance Errors

 If the debits and credits in a trial balance are not equal, look for one or more of these errors:

– A debit was entered in an account 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.

debit balance, or vice versa, causes the trial balance to be

out of balance by an amount divisible by 2.

trial balance causes the trial balance to be out of balance by

an amount divisible by 9.

– The trial balance was summed incorrectly.

Recording and Posting Transactions

 Although transactions can be entered directly

into the ledger accounts, identifying individual transactions or finding errors is difficult because the debit is recorded in one account and the

credit in another.

 The solution is to record all transactions

chronologically in a journal and then transfer the debit and credit portions of each transaction to the appropriate accounts in the ledger.

 The simplest and most flexible kind of journal is the general journal

General Ledger

 While the general journal is used to record the details of each transaction, the general ledger

is used to update each account Transferring transactions from the journal to the ledger is called posting

 The ledger account form is a form of the

account that contains four columns for dollar amounts.

Ethical Financial Reporting and Business

Transactions

specified under generally accepted

accounting principles, are important factors

in ethical financial reporting.

difficult to resolve.

– The predetermined time at which a transaction should be recorded is the recognition point – A purchase transaction should be recorded when title to merchandise passes from the supplier to the purchaser and creates an obligation to pay.

 Examples of economic events that

should and should not be recorded as

business transactions include:

Cash Flows and the Timing of Transactions

 To avoid financial distress, a company must be able to pay its bills on time Consider the

transactions of Blue Design studio shown

below Blue must perform a delicate balancing act with its cash flows to ensure that it can

remain profitable.