Chapter 2 Flashcards

Accounting Cycle

The multi-step process for measuring external transactions, which involves recording and posting them, and is the focus of Chapter 2.

External Transactions

Transactions that occur between a company and a separate legal entity, which are recorded and posted by the company.

Source Documents

Documents used in the first step of measuring external transactions to identify which accounts are affected.

Account

A dedicated place to record the impacts of a transaction, detailing increases and decreases, and is often depicted in the shape of a T.

Chart of Accounts

A comprehensive listing of all the various accounts a specific business utilizes to record its transactions, commonly organized with a numbering system (e.g., 1s for assets, 2s for liabilities).

Accounting Equation

A fundamental concept that helps in understanding how T accounts function and how transactions lead to increases or decreases in account balances.

T Account

A visual representation of an account, characterized by three parts: a title, a left side, and a right side.

Debit

Refers to the left side of a T account; the word literally means 'left' and does not intrinsically mean an increase, decrease, good, or bad.

Credit

Refers to the right side of a T account; the word literally means 'right' and does not intrinsically mean an increase, decrease, good, or bad.

Assets

Located on the left side of the accounting equation and the debit side of the T-account. They increase with a debit, decrease with a credit, and have a normal debit balance.

Cash

An example of an asset; it increases with a debit and decreases with a credit.

Normal Balance (Asset)

A debit balance.

Accounts Payable

An example of a liability; it increases with a credit and decreases with a debit.

Liabilities

Located on the right side of the accounting equation and the credit side of the T-account. They increase with a credit, decrease with a debit, and have a normal credit balance.

Normal Balance (Liability)

A credit balance.

Stockholders' Equity

Located on the right side of the accounting equation and the credit side of the T-account. Items that increase it are credited with normal credit balances, and items that decrease it are debited with normal debit balances.

Common Stock

A component of stockholders' equity that increases it, recorded with a credit when shares are issued, and has a normal credit balance.

Revenues

Increase stockholders' equity, are recorded with a credit, and have a normal credit balance.

Expenses

Decrease stockholders' equity, are recorded with a debit, and have a normal debit balance.

Dividends

Decrease stockholders' equity and are recorded with a debit.

AD (Acronym)

A mnemonic to remember normal debit balance accounts: Assets, Dividends, and Expenses.

Journalizing

The step in accounting where transactions are recorded in a journal using debits and credits.

Double Entry Accounting

An accounting system, invented by Luca Pacioli in 1494, where every transaction affects at least two accounts, ensuring debits equal credits.

Luca Pacioli

The individual credited with inventing double-entry accounting in 1494.

Journal Entry

A record of a financial transaction that shows which accounts are debited and which are credited, ensuring debits always equal credits.

Debited Accounts

Accounts that are listed first in a journal entry, typically representing an increase in assets or expenses, or a decrease in liabilities, equity, or revenue.

Credited Accounts

Accounts that are listed after debited accounts and are typically indented in a journal entry, representing a decrease in assets or expenses, or an increase in liabilities, equity, or revenue.

Journal Entry Balancing

The fundamental rule in double-entry accounting that states total debits must always be equal to total credits for every transaction.

Compound Journal Entry

A journal entry that involves more than one debited account or more than one credited account.

Transaction Analysis - Step 1

Identify the accounts and account types involved in a transaction (e.g., Cash as an asset account).

Transaction Analysis - Step 2

Determine if the accounts involved increase or decrease and apply the rules of debits and credits (e.g., assets increase with debits, decrease with credits).

Transaction Analysis - Step 3

Record the journal entry, ensuring at least one account is debited, at least one account is credited, and the entry balances.

"Paid" (in accounting context)

A keyword that signals cash is decreasing for the business, meaning cash should be credited.

Advertising Expense

An expense account that decreases stockholders' equity, typically recorded with a debit.

Purchase equipment for cash

Equipment (asset) is debited for an increase; Cash (asset) is credited for a decrease.

Pay a cash dividend

Dividends (decrease stockholders' equity) are debited; Cash (asset) is credited for a decrease.

Pay rent in advance for 3 months

Prepaid Rent (asset) is debited for an increase; Cash (asset) is credited for a decrease.

Provide services to customers on account

Accounts Receivable (asset) is debited for an increase; Service Revenue (increases stockholders' equity) is credited.

Purchase office supplies on account

Office Supplies (asset) are debited for an increase; Accounts Payable (liability) is credited for an increase.

Pay salaries for the current month

Salaries Expense (decreases stockholders' equity) is debited; Cash (asset) is credited for a decrease.

Issue common stock in exchange for cash

Cash (asset) is debited for an increase; Common Stock (increases stockholders' equity) is credited.

Collect cash from customers for services previously provided on account

Cash (asset) is debited for an increase; Accounts Receivable (asset) is credited for a decrease.

Borrow cash from the bank and sign a note

Cash (asset) is debited for an increase; Notes Payable (liability) is credited for an increase.

Pay for the current month's utilities

Utilities Expense (decreases stockholders' equity) is debited; Cash (asset) is credited for a decrease.

Pay for office supplies previously purchased on account

Accounts Payable (liability) is debited for a decrease; Cash (asset) is credited for a decrease.

Posting

The process of transferring transactions from journal entries to the general ledger.

General Ledger

The main record where a business's financial accounts are kept.

Debit side

The side of an account used to record increases in asset accounts such as supplies, inventory, and cash.

Credit side

The side of an account used to record increases in liability accounts such as accounts payable.

Cash T account

A visual representation of the cash account with debits on the left and credits on the right, used to track cash transactions.

Normal Debit Balance

The expected balance for an asset account like cash, indicating that its balance is typically on the debit side.

Receiving cash

A transaction that increases the cash asset, which is recorded on the debit side of the cash account.

Paying cash

A transaction that decreases the cash asset, which is recorded on the credit side of the cash account.

Account Balance

The difference between the total debit amounts and total credit amounts in any account, carried by the side with the larger total.

Trial Balance

A listing of all accounts and their account balances, used to ensure that total debits equal total credits.

Unadjusted Trial Balance

The first of three types of trial balances prepared, used to prepare adjusting journal entries.

Normal Balance (Accounts)

The expected balance type for a specific account (e.g., assets normally have debit balances, liabilities normally have credit balances).

Assets

Economic resources owned by a business, normally having a debit balance, and listed on a trial balance in order of liquidity.

Order of Liquidity

The arrangement of assets on a trial balance or balance sheet based on how quickly they can be converted into cash.

Liabilities

Obligations of a company to outside parties, normally having a credit balance.

Stockholders' Equity

The owners' claim to the assets of the business, typically including common stock and retained earnings, and normally having a credit balance.

Revenues

The income earned by a business from its primary operations, normally having a credit balance.

Expenses

The costs incurred by a business in its efforts to generate revenue, normally having a debit balance.

Common Stock Issuance (Cash)

A transaction where cash is received in exchange for issuing common stock, increasing cash (debit) and common stock (credit).

Equipment Purchase (Note Payable)

A transaction to acquire equipment by signing a note with a bank, increasing equipment (debit) and note payable (credit).

Legal Fees Expense

An expense incurred for legal services related to current operations, recorded by crediting cash and debiting legal fees expense.

Non-Transaction Event

An event like a customer placing an order without payment or service completion, which does not require a journal entry because no revenue was earned and no money was collected.

Purchase Supplies on Account

A transaction to acquire supplies on credit, increasing supplies (debit) and accounts payable (credit).

Service Revenue (Cash Received)

Revenue earned when services are delivered to a customer and immediate payment is received, increasing cash (debit) and service revenue (credit).

Deferred Revenue (Unearned Revenue)

A liability recorded when cash is received in advance for services not yet rendered, increasing cash (debit) and establishing a liability (credit deferred revenue).

Earning Deferred Revenue

The act of rendering services for which payment was previously received and recorded as deferred revenue, decreasing the deferred revenue liability (debit) and increasing service revenue (credit).

Utilities Expense

An expense incurred for utilities for the current period, recorded by crediting cash and debiting utilities expense.

Dividends Payment

A distribution of cash to stockholders, recorded by crediting cash and debiting dividends to decrease stockholders' equity.

T-Account Posting

The process of transferring journal entry amounts to their respective T-accounts, with debits on the left side and credits on the right side.

Calculating T-Account Balance

Determining the final balance of an account after all postings; for accounts with multiple entries, it's the difference between total debits and total credits, carried on the side with the larger amount.

Normal Balance Side

The side (debit or credit) of an account where increases are recorded; for a liability like deferred revenue, it is the credit side, even if the final balance is zero.

Trial Balance Order

The standard sequence for listing accounts on a trial balance: assets, liabilities, stockholders' equity, revenues, and then expenses.