Chapter 2 - Accounting for Business Transactions

Process to get from Transactions/Events to Financial Statements (Step 1)

Identify each transaction/event from source docs

Process to get from Transactions/Events to Financial Statements (Step 2)

Analyze each transaction/event using Accounting Equation

Process to get from Transactions/Events to Financial Statements (Step 13

record relevant transactions/events in a journal

Process to get from Transactions/Events to Financial Statements (Step 4)

Post journal information to ledger account

Process to get from Transactions/Events to Financial Statements (Step 5)

Prepare/Analyze the trial balance and financial statements

Accounting Transactions

event involves transferring something between two entities

Examples of Accounting Transition

• Acquiring assets from owners

• Borrowing $ from Creditors

• Purchasing/Selling goods/services

Source Document

identify/describe transactions/events entering the accounting system (hard copy/elec.)

Examples of Source Documents

Sales Receipts, Purchase Orders, Employee Earning Recordings, Checks, Bills from suppliers, Bank Statements

Account

record of increase or decrease in specific asset/liability/equity/revenue/expense used by the business

General Ledger

record of all accounts used by a company and their balances

Asset Accounts

resources owned/controlled by a company and expected future benefit

Cash (type of account & definition)

Asset, shows company cash balance

Accounts Receivable(type of account & definition)

Asset, promises of payment from customer to seller

Note Receivable(type of account & definition)

Asset, PROMISORY NOTE, written promise of another entity to pay a specific sum of $ on a specified future date to the holder of the note, usually require intrest

Prepaid Accounts (type of account & definition)

Assets, also called pre-paid expenses, assets that represent prepayments of future expenses

• expenses incurred, the amounts in prepaid accounts are transferred to expense accounts

• expire with the passed of time

Examples of Prepaid Accounts

pre-paid insurance/ pre-paid rent/pre-paid services (club memberships)

Supplies(type of account & definition)

Asset, office and store (like inventory (what is for sell/merchandise)

Equipment(type of account & definition)

Asset, its cost is allocated over time to expense (DEPRECIATION)

Buildings(type of account & definition)

Asset,such as stores, offices, warehouses, and factories are assets. Cost of buildings is allocated over time to expense, called depreciation. When several buildings are owned, separate accounts are sometimes kept for each of them.

Land(type of account & definition)

Asset, The cost of any buildings located on the land is separately recorded in buildings account.

Liability Accounts

claims (by creditors) against assets

Creditors

individuals/organizations that have rights to receive payment from a company

Debitors

who owe money to creditors

Accounts Payable(type of account & definition)

Liability, promise to pay later

• also arise from purchases on credit or an account of supplies, equipment, and services

Notes Payable(type of account & definition)

Liability, FORMAL PROMISE, usually denoted by the signing of a promissory note, to pay a future amount, usually require intrest

Unearned revenue(type of account & definition)

Liability, recorded when customer pay in advance for producers/services

Examples of Unearned Revenue

• Magazines subscriptions collected in advance by a publisher

• Rent collected in advance by landlord

• Season tickets

Accrued Liabilities(type of account & definition)

Liability, amounts owed that are not yet paid

“bought on credit” “pay later”

Examples of Accrued Liabilities

• Wages Payable

• Taxes Payable

• Interest Payable

KEYWORDS to look for in an ASSET ACCOUNT

• Prepaid

• Receivable

KEYWORDS to look for in a LIABILITY ACCOUNT

• payable

• Unearned

Equity Accounts

owners residual interest in the assets of a business after deducting liabilities

Common Stock(type of account & definition)

Equity, owner investment

Dividends (type of account & definition)

Equity, not expenses of the business, they are simply the opposite of owner investment

Revenue(type of account & definition)

Equity, sale of products and services to customers

Examples of Revenue

• Revenue Rent

• Interest Revenue

• Professional Fees

• Commission Fees

• Sales

Expenses(type of account & definition)

Equity, costs of providing goods and services

Examples of Expenses

• Advertising Expense

• Salaries Expense

• Utilities Expense

• Rent Expense

• Insurance Expense

Chart of Accounts

listing of all ledger accounts used in a business, along with a pre-assigned number scheme

T-Accounts

visual representation of a ledger account and used to depict effects of transactions on that account

Account Balance

difference between total debits and total credits

Net increases/decreases on one side have equal net effects on the other side

*memorize

Double-Entry Accounting Requirements

1. Two accounts involved (at least one debit, one credit)

2. Total Amount debited=total amount credited

3. Accounting Equations must remain in BALANCE

Normal Balance: Assets*

Debit*

Normal Balance: Liabilities**

Credit**

Normal Balance: Equity***

Credit***

Normal Balance: Common Stock****

Credit****

Normal Balance: Dividends*****

Debit*****

Normal Balance: Revenues******

Credit******

Normal Balance: Expenses*******

Debit*******

Accounting Process (4 Steps)

1. Identify transactions and source documents

2. Analyze transactions using the Acct. Equation

3. Record Journal Entry

4. Post Entry to Ledger (also called Balance Column Accounts)

Journal

complete, chronological record of each business transaction in one place

Journal Entries

individual entries in journal

Compound Journal Entry

there is more than one debit/credit

1st Step: Journalizing Transactions

Date Transaction

2nd Step: Journalizing Transactions

Enter titles of accounts debited, and then enter amounts on debit column, same line

3rd Step: Journalizing Transactions

Enter titles of accounted credited, and then enter amounts on credit column, same line

• INDENTS MATTER!!!!!!

4th Step: Journalizing Transactions

Enter a brief explanation on the line below entry

Posting

transferring journal entry information to ledger

Balance Column Account

Accounts with debit/credit columns for recording entries and another column for showing the balance of the account after each entry

Trial Balance

list of ledger amounts and their balances (either debit or credit) at a point in time

• internal tool used in accounting process to prove that the TOAL DEBITS AND CREDITS posted during an accounting period are EQUAL

Step 1: Preparing a Trial Balance

List each account title and its amount (from the ledger) in the trial balance

Step 2: Preparing a Trial Balance

Compute the total of debit balances and total of credit balances

Step 3: Preparing a Trial Balance

Verify (prove) total debits balance = total credit balances

List of Trial Balance (in order)

1. Assets

2. Liabilities

3. Common Stock

4. Retained Earnings

5. Dividends

6. Revenue

7. Expenses

Step 1: Trial Balance - Searching for Errors

Ensure that debit/credit columns added correctly

Step 2: Trial Balance - Searching for Errors

Check Account Balances are accurately enter from the ledger also ensuring that a debit or credit balance is not mistakenly listed in a trail balance in the wrong column

Step 3: Trial Balance - Searching for Errors

Recomputing each account balance in the ledger

Step 4: Trial Balance - Searching for Errors

Verify that each journal entry is properly posted to the debit/credit columns of the ledger

Step 5: Trial Balance - Searching for Errors

Check each Journal Entry for equal debits and credits

How Financial Statements Link

Beg. Balance Sheet (Point in time) __________ {Income Statements/Statement of Retained Earnings/Statement of Cash Flows} (Period of time) _______________ End Balance Sheet (Point in time)

Ratio

reveal relations and trends that are difficult to detect by looking at numbers alone

Why do External and Internal Users use RATIO?

• External Users: lending, investment, and evaluating management

• Internal Users: improve company efficiency/effectiveness in providing goods/services

Intracompany (standard)

comparing company results across two or more periods

Intercompany (standard)

comparing results across competitors

Industry (standard)

comparing results to industry norms

Guidelines (standard)

comparing results to standards based on experience

Liquidity (Four Building Blocks of Analysis)

ability to meet SHORT-term obligation and generate REVENUE

Solvency(Four Building Blocks of Analysis)

ability to meet SHORT-term obligations and generate FUTURE REVENUE

Profitability(Four Building Blocks of Analysis)

ability to provide financial rewards to investors and attract and retain financing

Market Prospects(Four Building Blocks of Analysis)

ability to generate postive market expectations

Debt Ration Formula

Debt Ratio = Total Liabilities/Total Assets

Accounts Payable vs. Accrued Liabilities

Accrued liabilities are estimated costs recorded without an invoice, while accounts payable are exact amounts owed based on a received vendor bill. Both are short-term debts listed on a company's balance sheet, but they differ in timing, documentation, and certainty. (google explanation, not book)