Book PP Ch. 2

Learning Objectives

• Obj. 1: Describe characteristics of an account and chart of accounts.

• Obj. 2: Illustrate journalizing transactions using the double-entry accounting system.

• Obj. 3: Journalizing and posting transactions to accounts.

• Obj. 4: Prepare an unadjusted trial balance and its use in discovering errors.

• ADM: Describe horizontal analysis for evaluating a company’s performance.

Accounting Basics

Accounts and Transactions

• Accounting systems track increases and decreases in accounting elements through separate records called accounts.

The T Account Structure

Definition

• A T account includes:

  • Title: Name of the accounting element.

Recording Increases

• Debits: Increases in assets are recorded on the left side (debit side) of the T account.

Recording Decreases

• Credits: Decreases in assets are recorded on the right side (credit side).

Chart of Accounts

• Ledger: A group of accounts for a business entity.

• Chart of Accounts: A list of accounts in the ledger, arranged for reference:

  • Balance Sheet Accounts: Listed first (assets, liabilities, and stockholders’ equity).

  • Income Statement Accounts: Listed next (revenues and expenses).

Types of Accounts

Assets

• Definition: Resources owned by the business.

• Examples:

  • Cash

  • Supplies

  • Accounts receivable

  • Buildings

  • Equipment

Liabilities

• Definition: Debts owed to creditors.

• Examples:

  • Accounts payable

  • Notes payable

  • Unearned revenues

Stockholders’ Equity

• Definition: Stockholders’ right to the assets of the business.

• Components: Common stock and retained earnings.

Revenues

• Definition: Increases in assets and stockholders’ equity from selling services/products.

• Examples: Fees earned, commissions revenue, rental income.

Expenses

• Definition: Costs incurred to generate revenue.

• Examples: Wages, rent, utilities, miscellaneous expenses.

The Double-Entry Accounting System

• Principles:

  • Record every transaction in at least two accounts.

  • Total debits must equal total credits.

• Accounting Equation: Assets = Liabilities + Stockholders’ Equity.

Normal Balances of Accounts

• Balance of accounts typically reflects an increase being recorded as either a debit or a credit.

Trial Balance Preparation

Steps to Prepare

1. List company name, title, and date of trial balance.

2. List accounts from the ledger with their balances.

3. Total Debit and Credit columns.

4. Check equality of debit and credit totals.

Common Errors Affecting Trial Balance

• Transposition Error: Incorrect digit order (e.g., recording $542 as $452).

• Slide Error: Entire number copied wrong across spaces.

Horizontal Analysis

• Definition: Comparing items from two financial statements.

• Purpose: To measure the increase/decrease in amounts and compute the percentage change.

• Base Statement: Earlier statement for reference in the analysis.