Chapter 2 - Accounting for Business Transactions

Trial balance

List of all ledger accounts and balances at a point in time and used to verify debits = credits. Exhibit 2.14. Not a financial statement, but a tool for checking equality and debits and credits in ledger. Lists every account from general ledger with its balance, either debit or credit. Accounts are listed in financial order.

Note Receivable

Promissory note, written promise of another entity to pay specific sum or money on a specified future date to holder of note; holder has asset recorded in a Note (or Notes) Receivable Accounts.

General Ledger or ledger

Record of all accounts used by a company. Electronic form. The collection of all accounts and with their activity and balances that exist in business.

Journalizing

Recording transactions in a journal

Prepaid Accounts

(prepaid expenses) assets from prepayments of future expenses (expenses expected to be incurred in future accounting periods). If expenses are later incurred, amounts in prepaid accounts are transferred to expense account. Ex. prepaid accounts are prepaid insurance, prepaid rent, and prepaid services.

Steps in processing transactions

1. Identify transactions and source documents. 2. Analyze transactions using accounting equation. 3. Record journal entry. 4. Post entry to ledger.

Supplies

Assets until they're used. When they're used up, costs are reported as expenses. Unused supplies are recorded in supplies asset account.

Searching for errors in a trial balance:

Check journalizing, posting, and trial balance preparation in reverse order. 1. verify trial balance columns are correctly added. 2. verify account balances are accurately entered from ledger. 3. Debit (or credit) balance is mistakenly listed in trial balance as credit or debit. 4. Recompute each account balance in ledger. 5. Verify each journal entry is properly posted. 6. Verify original journal entry has equal debits and credits.

Classified balance sheet

Groups accounts into classifications and reports current assets before noncurrent assets and current liabilities before noncurrent liabilities.

Accounts Receivable

Held by seller and are promises of payment from customers to sellers. Increase by credit sales or sales on accounts (or on credit). Increase by customer payments. Records all increase or decrease in receivables in Accounts Receivable account. Multiple customers, separate records for kept for each,titled Accounts Receivable - 'Customer Name.'

Debit balance

When total debits exceed total credits.

Note Payable

Written promissory note to pay future amount. Recorded as short or long term.

Chart of Accounts

a list of all ledger accounts and includes an identification number assigned to each account. Exhibit 2.4

Creditors

individuals and organizations that have rights to receive payments from a company.

Account balance

the difference between the increases and decreases in an account (between total debits and total credits, including beginning balance).

Accrued Liabilities

amounts owed that are not yet paid. Examples are wages payable, taxes payable, and interest payable. Often recorded in separate liability accounts by same title.

Credit balance

when total credits exceed total debits.

Balance column account in a ledger

1. A zero balance for an account is usually shown by writing zeros or a dash in the balance column. 2. Immediately after posting transaction, balance of account is written in balance column. 3.An abnormal balance is identified by circling it, writing it in red or setting it in brackets. 4. Balance column only contains final balance after each transaction is entered.

Summarizing transactions in a ledger

1. totals for three columns obey the accounting equation. 2. common stock, dividends, revenue, expense accounts reflect transactions that change equity 3. Revenue and expense account balances are reported in income statement.

Process to go from transactions and events to financial statements include:

1. Identify each transaction and event from source documents. 2. Analyze each transaction and event using accounting equation. 3. Record relevant transactions and events in a journal. 4. Post journal info to ledger accounts. 5. Prepare and analyze the trial balance and financial statements.

Journal

A book of original entry that includes a chronological record of all transactions that have occurred within a business during a period occurred. Complete record of each transaction in one place. Shows debits and credits for each transaction. Transactions are generally entered in chronological order; in a journal, both debit and credit side of transaction can be seen, journal is used to record business transactions.

Total debits = total credits

Account has zero balance

Balance column account

Actual accounting systems need more structure and use balance column. Similar to T-accounts in having columns for debits and credits. Different in including transaction date and explanation columns. Also has a column with the balance of the account after each entry is recorded. Heading doesn't show whether it is a debit or credit balance. Account is assumed to have a normal balance. Exhibit 2.11

Revenue accounts

Amounts received from sales of products and services to customers, which increase equity. Ex. sales, commissions earned, professional fees earned, rent revenue, and interest revenue.

Expense accounts

Amounts used for costs of providing products and services, decrease equity. Ex. advertising expense, salaries expense, rent expense, utilities expense, and insurance expense. Expenses decrease equity.

Buildings

Assets, provide future benefits. When a building is used and wears down it's reported as an expense.

Abnormal balance

Balance on side where decreases are recorded. Abnormal balance identified by setting it in brackets or entering it in red. Zero balance is shown by writing a zero or a dash in the balance column.

Unearned revenue

Liability that's settled in future when company delivers products or services. When customers pay in advance for products/services, seller records as unearned revenue. Ex. magazine subscriptions, rent, season ticket sales. Earned portion of unearned revenue transferred to revenue accounts.

Owner investments

Owner invests in company, increase assets and equity. Increase to equity is recorded in account titled common stock. Owner investments doesn't equal revenues.

Accounts payable

Promises to pay later. Record increases or decreases in payables in Accounts Payable account. Multiple suppliers, title accounts payable - 'supplier name.'

Account

Record of increasing and decreasing in a specific asset, liability, equity, revenue or expense.

Asset accounts

Resources owned or controlled by a company. Resources have expected future benefits.

Equity

Stockholders' equity or shareholders' equity. Owner's claim on a company's assets. Owner's residual interest in assets of a business after subtracting liabilities. Impacted by four accounts: common stock, dividends, revenues, and expenses.

Revenue Recognition Principle

The principle that companies recognize revenue in the accounting period in which the performance obligation is satisfied. Revenue is recognized when it's earned, regardless of when cash is received. Recognized when product or service is provided.

Posting a journal entry

a. identify debit amount in ledger: enter date, journal page, amount, and balance. b. enter debit account number from ledger in PR column of journal. c. identify credit account in ledger: enter date, journal page, amount, and balance. d. Enter credit account number from ledger in PR column of journal Exhibit 2.12

Posting Process (journal entries)

a. posting process doesn't require detailed explanations in ledger. b. Posting process creates a link between ledger and journal. c. Entries are posted as soon as possible. d. entries must be posted to ledger before financial statements are prepared. e. Posting takes place as soon as possible after journalizing process.

cash

account shows a company's cash balance. All increases or decreases are recorded. Includes money and any funds bank accepts for deposit (coins, checks, money orders, and checking account balances).

Equipment Accounts

an asset. When equipment is used and wears down, it's reported as an expense (deprecation).

Unclassified Balance Sheet

broadly groups accounts into assets, liabilities, and equity

Double-entry accounting

demands the accounting equation remain in balance: 1. at least two accounts are involved, with at least one debit and one credit. 2. total amount debited must equal total amount credited. Total debits must equal total credits for all entries. Total debit account balances in ledger must equal total credit account balances. Net increases or decreases on one side have equal net effects on the other side. The left side is the normal balance side for assets; right side is normal balance for equity and liability. Equity increases from revenues and owner investments (stock issuance), and decreases from expenses and dividends. Exhibit 2.6

Source documents

identify and describe transactions and events entering the accounting system. Hard or electronic form. Ex. sales receipts, checks, purchase orders, bills from suppliers, payroll records, and bank statements. Objective and reliable evidence about transactions and events and amounts.

Debt ratio

total liabilities/total assets

Posting

transferring information from a journal entry to a ledger account. A posting reference in a ledger includes page numbers of account debited or credited in journal and serves as a link to cross-reference transaction from one record to another.

Prepare financial statements from trial balance

1. Income statement - reports revenues earned minus expenses incurred over a period of time. Info about revenues and expenses is taken from trial balance on left side. Owner investments and dividends aren't part of income. 2. Statement of retained earnings - Reports how retained earnings changes over reporting period. Revenues and expenses aren't reported in detail in statement of retained earnings. Effects are reflected through net income. 3. Balance sheet - reports financial position of company at a point in time. Account form - assets on left and liabilities and equity on right. Report form - assets on top, followed by liabilities then equity.

Preparing a trial balance

1. List each account title and its amount (from ledger) in trial balance. If account has a zero balance, list it with a zero in its normal balance column (or omit it). 2. Compute total of debit balances and total of credit balances. 3. Verify (prove) total debit balances equal total credit balances.

To record entries in a general journal...

1. date transaction, enter year at top of first column and month and day on the first line of each journal entry. 2. enter titles of accounts debited and then enter amounts in debit column on same line. Account titles are taken from chart of accounts and are aligned with left margin of Account Titles and Explanation column. 3. Enter titles of accounts credited and then enter amounts in credit column on same line. Account titles are from chart of accounts and are indented from left margin of Account Titles and Explanation column to separate them from debited accounts. 4. Enter brief explanation of transaction on line below entry (often references a source document). Indented and italicized. Exhibit 2.10

Financial statements across time

Balance sheet reports organization's financial position at point in time. Income statement, statement of retained earnings, and statement of cash flows report financial performance over period of time. One year reporting period = accounting, fiscal year. Calendar-year companies = businesses whose accounting year begins on January 1st and ends on December 31st.

Analyzing the accounting equation at the end of the month will reveal...

assets = liabilities + equity revenues and expenses will change the equity account

T-account

represents a ledger account and is a tool used to understand the effects of one or more transactions. Left side is called the debit side and ride side is called the credit side. To enter amounts on the left side is to debit the account, to enter amounts on the right side is to credit the account. Exhibit 2.5

Owner distributions

when a corporation distributes assets to its owner it decreases both company assets and total equity. Decrease equity is recorded in an account called dividends. Dividends are not expenses of business; opposite of owner investments.