Chapter 2

6 steps in measuring external transactions (a)

1. Use source documents to identify accounts affected by an external transaction 

2. Analyze the impact of the transaction on the accounting equation 

3. Assess whether the transaction results in a debit or credit to account balances 

6 steps in measuring external transactions (b)

4. Record the transaction in a journal using debts and credits 

5. Post the transaction to the general ledger 

6. Prepare a trial balance  

Transaction #1 Issue Common Stock  

Company receives 200k cash from investors who in turn become owners of company receiving shares of common stock  

Transaction #2 Borrow cash from the bank  

Eagle borrows 100k from bank 

• Signs a note to repay the loan amount in 3 years  

Transaction #3 Purchase Equipment  

Eagle purchases 120k in equipment  

• Causes one asset (equipment) to increase and another asset (cash) to decrease  

Transaction #4 Pay for rent in advance  

Eagle pays 1 year of rent in advance, 60k (5k/month) 

• Bc rent paid is occupying space in future its listed as a resource (prepaid rent) 

Asset cash decreases and asset prepaid rent increases  

Types of prepaid things

prepaid insurance, prepaid advertising, prepaid rent and other prepaid services  

Transaction #5 Purchase supplies on account  

Company purchases 23k of supplies on account 

• Supplies are an asset and the liability is accounts payable 

On account

means that company does not pay cash immediately but promises to pay cash in the future  

• keeps record of companies u will may in future

• is like paying w a credit card

Accounts payable vs Notes payable

• accounts is paid in 30 days

• notes payable may take more than 12 months to pay

Basic accounting equation and expanded accounting equation

• If revenue goes up so does net income, then retained earnings, this makes SE go up  

• If expense goes up, net income, retained earnings, and SE go down  

• If dividends go up, retained earnings and SE goes down  

Transaction #6 Provide Services for Cash  

Eagle provides 43k of services  

• Cash asset increases 43k and stockholders' equity increases 43k through 43k increase in retained earnings  

Revenue recognition principle

companies recognize revenue at the time they provide goods and services to customers  

• Amount of revenue to recognize equals the amount of the company is entitled to receive from customers 

Transaction #7 Provide Services on Account  

Customers receive services but don’t pay at time of service, instead pay 20k cash at some other point in time  

• 20k increase in accounts receivable (assets) and 20k increase in stockholders' equity (retained earnings – listed as service revenue) 

Transaction #8 Receive Cash In Advance From Customers  

Receive 6k of cash from customers in advance for soccer training to be provided later 

• Receiving cash in advance causes asset (cash) and liability (referred revenue) to increase  

Deferred revenue

eventually will be revenue but until service is provided it’s a liability 

Transaction #9 Pay Salaries to Employees

Salary expense during current month is 28k  

• Asset (cash) decreases and stockholders' equity decreases (salary expense in retained earnings decreases)  

Transaction #10 Paying Cash Dividends  

Payment of 4k cash dividend to stockholders 

• 4k cash is lost in assets and 4k is lost in stockholders' equity (retained earnings through dividends) 

Effects of credit and debit on account balances (DEALOR)

What can be listed as Assets

• Cash

• Accounts Receivable

• Supplies

• Prepaid Rent

• Equipment

What can be listed as Liabilities

• Accounts Payable

• Deferred Revenue

• Notes Payable

Format for recording transactions in a Journal  

First 5 transactions in the Journal  

Last 5 transactions in the Journal

Posting to the General Ledger  

One side is credit side and Debits on one side  

Trial balance

Splits up Debits and Credits