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Chapter 2
Analyzing Transactions
Financial and Managerial Accounting
8th Edition
Warren Reeve Fess
PowerPoint Presentation by Douglas Cloud
Professor Emeritus of Accounting
Pepperdine University
© Copyright 2004 South-Western, a division
of Thomson Learning. All rights reserved.
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Objectives
1. Explain why
accounts
are
used
to
record
After studying this
and summarize
the
effects
chapter,
you
shouldof transactions
on financial statements.
be able to:
2. Describe the characteristics of an
account.
3. List the rules of debit and credit and the
normal balances of accounts.
4. Analyze and summarize the financial
statement effects of transactions.
Objectives
5. Prepare a trial balance and explain how
it can be used to discover errors.
6. Discover errors in recording
transactions and correct them.
7. Use horizontal analysis to compare
financial statements from different
periods.
Each financial statement
item, called an account, is
included in the ledger.
A group of
accounts for a
business entity is
called a ledger.
A list of the
accounts in a ledger
is called a chart of
accounts.
Major Account Classifications
Assets are
resources owned
by the business.
Cash
Supplies
Building
Accounts
receivable
Liabilities are debts
owed to outsiders
(creditors).
Accounts
payable
Notes payable
Wages payable
Major Account Classifications
Liabilities are often identified
sheetare
by debts
titles
Assets are on the balance
Liabilities
.
resources owned that include
owed payable
to outsiders
by the business.
(creditors).
Cash
Supplies
Building
Accounts
receivable
Accounts
payable
Notes payable
Wages payable
Major Account Classifications
Owners’
(stockholders’)
equity is the
owner’s right to
the assets of the
business.
Capital Stock
Retained
Earnings
Dividends
Revenues are
increases in
owner’s equity as
a result of selling
services or
products.
Fees Earned
Fares Earned
Commission
Revenue
Expenses are the
using up of assets
or consuming of
services to
generate revenue.
Rent Expense
Salary Expense
Utilities
Expense
To assist you in learning,
an account can be drawn
to resemble the letter T.
The T-Account
Cash
The T-account has a title.
The T-Account
Cash
Left side
debit
The left side of the account is the debit side.
The T-Account
Cash
Left side
debit
Right side
credit
The right side of the account is the credit side.
The T-Account
Cash
3,750
4,300
2,900
Typical entries
850
1,400
700
2,900
Balancing a T-Account
First, foot
the debit
side.
Cash
3,750
4,300
2,900
10,950
850
1,400
700
2,900
Cash
3,750
4,300foot the
Next,
2,900
credit side.
10,950
850
1,400
700
2,900
5,850
Subtract total credits
Cash from total debits to
obtain the account
3,750
850
balance.
5,100
4,300
2,900
10,950
1,400
700
2,900
5,850
Transactions and
Balance Sheet Accounts
(A) On November 1, Chris Clark
deposits $25,000 in a bank account in
the name of NetSolutions in
exchange for capital stock.
Page 1
JOURNAL
Date
Description
Post.
Ref.
Debit
Credit
2005
1 Nov. 1 Cash
2
3
4
25 000 00
Capital Stock
Issued capital stock for cash.
25 000 00
(A) On November 1, Chris Clark
deposits $25,000 in a bank account in
the name of NetSolutions in
exchange for capital stock.
Effects of this entry in the Ledger
Cash
Nov. 1
25,000
Capital Stock
Nov. 1
25,000
(B) On November 5,
NetSolutions bought land
for $20,000, paying cash.
4
5
6
5 Land
20 000 00
Cash
7
Purchased land for building
8
site.
9
10
20 000 00
(B) On November 5,
NetSolutions bought land
for $20,000, paying cash.
Effects of this entry in the Ledger
Cash
Nov. 1
25,000 Nov. 5
Land
20,000 Nov. 5
20,000
(C) On November 10, NetSolutions
purchased supplies on account
for $1,350.
10
11
12
13
14
15
16
10 Supplies
Accounts Payable
Purchased supplies on account.
1 350 00
1 350 00
(C) On November 10, NetSolutions
purchased supplies on account
for $1,350.
Effects of this entry in the Ledger
Supplies
Nov. 10
1,350
Accounts Payable
Nov. 10
1,350
(F) On November 30, NetSolutions
paid creditors on account, $950.
30
31
32
33
34
35
36
30 Accounts Payable
Cash
Paid creditors on account.
950 00
950 00
(F) On November 30, NetSolutions
paid creditors on account, $950.
Effects of this entry in the Ledger
Cash
Nov. 1
18
25,000 Nov. 525,000
7,500
30
3,650
30
950
Accounts Payable
Nov. 30
950 Nov. 10
1,350
Rules of Debit / Credit Balance
Sheet Accounts
Debits
Asset accounts………. Increase (+)
Liability accounts…… Decrease (-)
Owner’s equity
(capital) accounts…. Decrease (-)
Credits
Decrease (-)
Increase (+)
Increase (+)
Balance Sheet Accounts
ASSETS
LIABILITIES
Asset Accounts
Liability Accounts
Debit for
increases
(+)
Credit for
decreases
(–)
Debit for
decreases
(–)
Credit for
increases
(+)
OWNERS’ EQUITY
Stockholders’ Equity
Accounts
Debit for
decreases
(–)
Credit for
increases
(+)
(D) On November 18, NetSolutions
received fees of $7,500 from
customers for services provided .
14
15
16
17
18
19
20
18 Cash
7 500 00
Fees Earned
Received fees from customers.
7 500 00
(D) On November 18, NetSolutions
received fees of $7,500 from
customers for services provided .
Effects of this entry in the Ledger
Cash
Nov. 1
18
25,000 Nov. 5
7,500
Fees Earned
25,000
Nov. 18
7,500
(E) Throughout the month, NetSolutions
incurred the following expenses:
wages, $2,125; rent, $800; utilities,
$450; and miscellaneous, $275 .
18
19
30 Wages Expense
2 125 00
20
Rent Expense
800 00
21
Utilities Expense
450 00
22
Miscellaneous Expense
275 00
23
24
Cash
Paid expenses.
3 650 00
(E) Throughout the month, NetSolutions
incurred the following expenses:
wages, $2,125; rent, $800; utilities,
$450; and miscellaneous, $275 .
Effects of this entry in the Ledger
Cash
Nov. 1
18
Wages Expense
25,000 Nov. 525,000
Nov. 30
7,500
30
3,650
Rent Expense
Nov. 30
2,125
Utilities Expense
800
Nov. 30
Miscellaneous Expense
Nov. 30
275
450
In every entry the sum of
the debits always equal
the sum of the credits.
(G) On November 30, a count revealed
that $800 of the supplies inventory
had been used.
25
26
27
30 Supplies Expense
Supplies
28
Supplies used during
29
November.
30
31
800 00
800 00
(G) On November 30, a count revealed
that $800 of the supplies inventory
had been used.
Effects of this entry in the Ledger
Supplies
Nov. 10
1,350 Nov. 30
Supplies Expense
800 Nov. 30
800
Double-Entry Accounting
“ Double-entry accounting is based on a simple
concept: each party in a business transaction
will receive something and give something in
return. In bookkeeping terms, what is received
is a debit and what is given is a credit. The T
account is a representation of a scale or
balance.”
Scale or Balance
Luca Pacioli
Developer of
Double-Entry
Accounting
T account
Left Side
Receive
DEBIT
Receive
DEBIT
Give
CREDIT
Right Side
Give
CREDIT
Rules of Debit / Credit Income
Statement Accounts
Expense Accounts
Revenue Accounts
Debit for
increases
(+)
Debit for
decreases
(-)
Credit for
decreases
(-)
Credit for
increases
(+)
Income Statement Accounts
Debits
Revenue accounts…… Decrease (-)
Expense accounts…… Increase (+)
Credits
Increase (+)
Decrease (-)
Payment of
dividends
(H) On November 30, Net Solutions paid
dividends of $2,000.
Page 2
JOURNAL
Date
Description
Post.
Ref.
Debit
Credit
2005
1 Nov. 30 Dividends
2
3
4
Cash
Paid dividends to stockholders.
2 000 00
2 000 00
(H) On November 30, Chris Clark
withdrew $2,000 in cash from
NetSolutions for personal use.
Effects of this entry in the Ledger
Cash
Nov. 1
18
25,000 Nov. 525,000
Nov. 30
7,500
30
3,650
30
950
30
2,000
Dividends
2,000
Normal Balances of Accounts
Increase
(Normal Balances)
Balance sheet accounts:
Asset
Debit
Liability
Credit
Owners’ (Stockholders’) Equity:
Capital Stock
Credit
Retained Earnings
Credit
Income statement accounts:
Revenue
Credit
Expense
Debit
Dividend accounts:
Dividends
Debit
Decreases
Credit
Debit
Debit
Debit
Debit
Credit
Credit
Flow of Business Transactions
1
Transaction
authorized
4
2
Entry recorded
in journal
Transaction
takes place
5
3
Document
prepared
Entry posted to
ledger
System to Analyze Transactions
1. Determine whether an asset, a liability,
owner’s equity, revenue, or expense account
is affected by the transaction.
2. For each account affected by the transaction,
determine whether the account increases or
decreases.
3. Determine whether each increase or decrease
should be recorded as a debit or a credit.
Journalizing
and Posting
Dec. 1 NetSolutions paid a premium of
$2,400 for a comprehensive insurance
policy covering two years.
Page 2
JOURNAL
Date
Description
Post.
Ref.
Debit
Credit
2005
1 Dec. 31 Prepaid Insurance
2
Cash
3
Paid premium on two-year
4
policy.
2 400 00
2 400 00
Page 2
JOURNAL
Date
Description
Post.
Ref.
Debit
Credit
2005
1 Dec. 1 Prepaid Insurance
2
2 400 00
Cash
2 400 00
3
Paid premium on two-year
4
policy.
ACCOUNT NO. 15
ACCOUNT Prepaid Insurance
Date
Item
Post.
Ref.
Balance
Debit
Credit
Debit
2005
Dec. 1
2 400 00
2 400 00
Credit
Page 2
JOURNAL
Date
Description
Post.
Ref.
Debit
15
2 400 00
Credit
2005
1 Dec. 1 Prepaid Insurance
2
Cash
2 400 00
3
Paid premium on two-year
4
policy.
ACCOUNT NO. 15
ACCOUNT Prepaid Insurance
Date
Item
Post.
Ref.
Balance
Debit
Credit
Debit
2005
Dec. 1
2
2 400 00
2 400 00
Credit
Page 2
JOURNAL
Date
Description
Post.
Ref.
Debit
15
2 400 00
Credit
2005
1 Dec. 1 Prepaid Insurance
2
Cash
2 400 00
3
Paid premium on two-year
4
policy.
ACCOUNT Cash
Date
Item
ACCOUNT NO. 11
Post.
Ref.
Balance
Debit
Credit
Debit
2005
Nov. 30
Dec. 1
2
2 000 00
5 900 00
2 400 00
3 500 00
Credit
Page 2
JOURNAL
Post.
Ref.
Debit
1 Dec. 1 Prepaid Insurance
15
2 400 00
2
11
Date
Description
Credit
2005
Cash
3
Paid premium on two-year
4
policy.
ACCOUNT Cash
Date
Item
2 400 00
ACCOUNT NO. 11
Post.
Ref.
Balance
Debit
Credit
Debit
2005
Nov. 30
2
2 000 00
5 900 00
Dec. 1
2
2 400 00
3 500 00
Credit
Dec. 1 NetSolutions paid rent for December,
$800.
14
15
16
17
1 Rent Expense
Unearned Rent
Paid rent for December.
52
11
800 00
800 00
Dec. 1 NetSolutions receives $360 for three
month’s rent for land beginning
December 1.
14
15
1 Cash
11
Unearned Rent
16
Received advanced payment
17
For three months’ rent of land.
23
360 00
360 00
Dec. 4 NetSolutions purchased office
equipment on account from Executive
Supply Co. for $1,800.
18
19
4 Office Equipment
Accounts Payable
20
Purchased office equipment on
21
account.
18
21
1 800 00
1 800 00
Dec. 6 NetSolutions paid $180 for a
newspaper advertisement.
21
22
23
24
6 Miscellaneous Expense
Cash
Paid for newspaper ad.
59
11
180 00
180 00
Dec. 11 NetSolutions paid creditors $400.
24
25
26
27
11 Accounts Payable
Cash
Paid creditors on account.
21
11
400 00
400 00
Dec. 13 NetSolutions paid a receptionist and
part-time assistant $950 for two
weeks’ wages.
Page 3
JOURNAL
Date
Description
Post.
Ref.
Debit
Credit
2005
1 Dec. 13 Wages Expense
51
2
11
3
4
Cash
Paid two week’s wages.
950 00
950 00
Dec. 16 NetSolutions received $3,100 from
fees earned for the first half of
December.
5
6
7
8
16 Cash
11
Fees Earned
Received fees from customers.
41
3 100 00
3 100 00
Dec. 16 Fees earned on account totaled
$1,750 for the first half of
December.
9
10
11
12
16 Accounts Receivable
Fees Earned
Received fees from customers.
12
41
1 750 00
1 750 00
Dec. 20 NetSolutions paid $900 to Executive
Supply Co. on the $1,800 debt owed
from the December 4 transaction.
13
14
20 Accounts Payable
Cash
15
Paid part of amount owed to
16
Executive Supply Co.
21
11
900 00
900 00
Dec. 21 NetSolutions received $650 from
customers in payment of their
accounts.
18
19
21 Cash
11
Accounts Receivable
20
Received cash from customer
21
on account.
12
650 00
650 00
Dec. 23 NetSolutions paid $1,450 for
supplies.
22
23 Supplies
14
23
Cash
11
24
25
Purchased supplies.
1 450 00
1 450 00
Dec. 27 NetSolutions paid the receptionist
and part-time assistant $1,200 for
two weeks’ wages.
27
27 Wages Expense
51
28
Cash
11
29
30
Paid two weeks’ wages.
1 200 00
1 200 00
Dec. 31 NetSolutions paid its $310 telephone
bill for the month.
31
31 Utilities Expense
54
32
Cash
11
33
34
Paid telephone bill.
310 00
310 00
Dec. 31 NetSolutions paid its $225 electric
bill for the month.
Page 4
JOURNAL
Date
Description
Post.
Ref.
Debit
Credit
2005
1 Dec. 31 Utilities Expense
54
2
11
3
4
Cash
Paid utility bill.
225 00
225 00
Dec. 31 NetSolutions received $2,870 from
fees earned for the second half of
December.
5
6
7
8
31 Cash
11
Fees Earned
Received fees from customers.
41
2 870 00
2 870 00
Dec. 31 NetSolutions earned $1,120 on
account for the second half of
December.
9
10
31 Accounts Receivable
Fees Earned
11
Recorded fees earned on
12
account.
12
41
1 120 00
1 120 00
Dec. 31 NetSolutions paid dividends of
$2,000 to stockholders.
14
15
16
17
31 Dividends
Cash
Paid dividends to stockholders.
33
11
2 000 00
2 000 00
Trial Balance
NetSolutions
Trial Balance
December 31, 2005
Cash
Accounts Receivable
Supplies
Prepaid Insurance
Land
Office Equipment
Accounts Payable
Unearned Rent
Capital Stock
Dividends
Fees Earned
Wages Expense
Rent Expense
Utilities Expense
Supplies Expense
Miscellaneous Expense
2
2
2
2
20
1
065
220
000
400
000
800
00
00
00
00
00
00
900 00
360 00
25 000 00
16 340 00
4 275 00
1 600 00
985 00
800 00
455 00
42 600 00 42 600 00
NetSolutions
Trial Balance
December 31, 2005
Cash
Accounts Receivable
Supplies
Prepaid Insurance
Land
Office Equipment
Accounts Payable
Unearned Rent
Capital Stock
Dividends
Fees Earned
Wages Expense
Rent Expense
Utilities Expense
Supplies Expense
Miscellaneous Expense
Balance
Sheet
Items
2
2
2
2
20
1
065
220
000
400
000
800
00
00
00
00
00
00
900 00
360 00
25 000 00
4 000 00
16 340 00
4 275 00
1 600 00
985 00
800 00
455 00
42 600 00 42 600 00
NetSolutions
Trial Balance
December 31, 2005
Cash
Accounts Receivable
Supplies
Prepaid Insurance
Land
Office Equipment
Accounts Payable
Unearned Rent
Capital Stock
Dividends
Fees Earned
Wages Expense
Rent Expense
Utilities Expense
Supplies Expense
Miscellaneous Expense
2
2
2
2
20
1
065
220
000
400
000
800
00
00
00
00
00
00
900 00
360 00
25 000 00
4 000 00
Statement
of
Retained
Earnings
Item
16 340 00
4 275 00
1 600 00
985 00
800 00
455 00
42 600 00 42 600 00
NetSolutions
Trial Balance
December 31, 2005
Cash
Accounts Receivable
Supplies
Prepaid Insurance
Land
Office Equipment
Accounts Payable
Unearned Rent
Capital Stock
Dividends
Fees Earned
Wages Expense
Rent Expense
Utilities Expense
Supplies Expense
Miscellaneous Expense
2
2
2
2
20
1
065
220
000
400
000
800
00
00
00
00
00
00
900 00
360 00
25 000 00
4 000 00
16 340 00
Income
Statement
Items
4 275 00
1 600 00
985 00
800 00
455 00
42 600 00 42 600 00
Errors that will not cause the
trial balance to be unequal:
1. Failure to record a transaction or to post a
transaction.
2. Recording the same erroneous amount
for both the debit and the credit parts of a
transaction.
3. Recording the same transaction more
than once.
4. Posting a part of a transaction correctly
as a debit or credit but to the wrong
account.
Correction
of Errors
Error
1. Journal entry is incorrect
but not posted.
Correction Procedure
Draw a line through the error
and insert correct title or
amount.
Correction
of Errors
Error
1. Journal entry is correct
incorrect
2.
not posted.
but posted
incorrectly.
Correction Procedure
Draw a line through the error
and insert
correct
title or
posted
error
and post
amount.
correctly.
Correction
of Errors
Error
Correction Procedure
3. Journal entry is incorrect Journalize and post a
and posted
correcting entry.
Correcting Errors – An Example
On May 5, a purchase of office equipment on
account was incorrectly journalized and posted
as shown.
Journal – As recorded and posted
Date
Description
May 5 Supplies
Accounts Payable
Debit
Credit
12,500
12,500
What would be the necessary
correcting entry?
Correcting Errors – An Example
On May 5, a purchase of office equipment on
account was incorrectly journalized and posted
as shown.
Journal – As recorded and posted
Date
Description
May 5 Supplies
Debit
12,500
Accounts Payable
Date
Description
May 5 Office Equipment
Credit
12,500
Debit
12,500
Credit
Correcting Errors – An Example
On May 5, a purchase of office equipment on
account was incorrectly journalized and posted
as shown.
Journal – As recorded and posted
Date
Description
May 5 Supplies
Debit
12,500
Accounts Payable
Date
Description
May 5 Office Equipment
Supplies
Credit
12,500
Debit
Credit
12,500
12,500
Financial Analysis and
Interpretation
Comparing an item in a current
statement with the same item in
prior statements is called
horizontal analysis.
J Holmes, Attorney-at-Law, P.C.
Income Statement
For the Year Ended December 31, 2005 and 2006
2006
Fees earned
Operating expenses:
Wages expense
Rent expense
Utilities expense
Supplies expense
Misc. expense
Total operating
expenses
Net income
2005
Increase (Decrease)
Amount Percent
$187,500 $150,000 $37,500 25.0%
$ 60,000 $ 45,000 $15,000 33.3%
15,000
12,000
3,000 25.0%
12,500
9,000
3,500 38.9%
2,700
3,000
(300) (10.0)%
2,300
1,800
500 27.8%
$ 92,500 $ 70,800 $21,700 30.6%
$ 95,000 $ 79,200 $15,800 19.9%
Chapter 2
The End