Fundamentals of accounting

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Published on February 27, 2014

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Transaction Analysis and the Accounting Equation

Transaction Analysis and the Accounting Equation

HAPTER2 STUDY OBJECTIVES: 1)Explain what an account is and helps in recording process. 2) Define debit and credit. 3) Explain journal and journalizing process The Recording Process

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ecord of increases and decreases in a specific asset, liability, equity, revenue, or expense item. Dt Cr

 The accounts can be classified as: 1. 2. 3. Assets. Liabilities. Owner’s Equity.

 Resources a business owns  Can be divided into : 1. 2. Current Assets. Long term Assets.

 Assets that can be converted to cash or used to pay current liabilities within 12 months.  Examples : 1. Cash 2. Account Receivables.

 known as a non-current asset which cannot easily be converted into cash.  Examples: 1. Land. 2. Building. 3. Machinery.

 Creditor claims on total assets  Can be divided into: 1. 2. Current Liabilities. Long Term Liabilities.

 current liabilities are all liabilities of the business that are to be settled in cash within the fiscal year or the operating cycle* of a given firm, whichever period is longer.  Examples: 1. Account Payable. 2. Rent Payable, Salary Payable. * An operating cycle for a firm is the average time that is required to go from cash to cash in producing revenues

 all liabilities of the business that are to be settled in cash more than one year  Examples: 1. 2. Debenture. Bank Loan.

 The ownership claim on total assets.  Divided into: 1. 2. 3. 4. Capital. Drawing. Revenue. Expense.

Scale or Balance DEBIT Luca Pacioli Founder of Double Entry System CREDIT

Cash An account must have a title An account must have a title

The Account An Account can be illustrated in a TAccount form. Account Name Debit / Dr. Credit / Cr. SO 1 Explain what an account is and how it helps in the recording process.

Cash Left debit Left side of an account is called Left side of an account is called debit side. debit side.

Cash Left debit Right credit Right side of an account is called as Right side of an account is called as credit side. credit side.

The Account Debit and Credit Procedures Double-entry system ► Each transaction must affect two or more accounts to keep the basic accounting equation in balance. ► Recording done by debiting at least one account and crediting another. ► DEBITS must equal CREDITS. SO 2 Define debits and credits and explain their use in recording business transactions.

Debits and Credits If Debits are greater than Credits, the account will have a debit balance. Account Name Debit / Dr. Credit / Cr. Transaction #1 $10,000 $3,000 Transaction #3 8,000 Balance Transaction #2 $15,000 SO 2 Define debits and credits and explain their use in recording business transactions.

Debits and Credits If Debits are less than Credits, the account will have a credit balance. Account Name Debit / Dr. Balance $10,000 $3,000 Transaction #2 8,000 Transaction #1 Credit / Cr. Transaction #3 $1,000 SO 2 Define debits and credits and explain their use in recording business transactions.

Debits and Credits Assets - Debits should exceed credits. Liabilities – Credits should exceed debits.  Debit / Dr.   Assets Normal balance is on the increase side. Credit / Cr. Normal Balance Chapter 3-23 Liabilities Debit / Dr. Credit / Cr. Normal Balance Chapter 3-24 SO 2 Define debits and credits and explain their use in recording business transactions.

Debits and Credits Debit / Dr.  Owner’s investments and revenues increase owner’s equity (credit).  Owner’s Equity Owner’ Owner’s drawings and expenses decrease owner’s equity (debit). Credit / Cr. Normal Balance Chapter 3-25 Owner’s Capital Owner’ Owner’s Drawing Owner’ Chapter 3-25 Credit / Cr. Debit / Dr. Normal Balance Debit / Dr. Credit / Cr. Normal Balance Chapter 3-23 SO 2 Define debits and credits and explain their use in recording business transactions.

Debits and Credits Purpose of earning revenues is to benefit the owner(s). Effect of debits and credits on revenue accounts is the same as their effect on Owner’s Capital.  Debit / Dr.   Revenue Expenses have the opposite effect: expenses decrease owner’s equity. Credit / Cr. Normal Balance Chapter 3-26 Expense Debit / Dr. Credit / Cr. Normal Balance Chapter 3-27 SO 2 Define debits and credits and explain their use in recording business transactions.

Debits/Credits Rules Liabilities Normal Normal Balance Balance Debit Debit Normal Normal Balance Balance Credit Credit Assets Credit / Cr. Normal Balance Chapter 3-24 Owners’ Equity Owners’ Credit / Cr. Debit / Dr. Debit / Dr. Debit / Dr. Credit / Cr. Normal Balance Normal Balance Chapter 3-23 Expense Debit / Dr. Chapter 3-25 Revenue Credit / Cr. Debit / Dr. Normal Balance Chapter 3-27 Credit / Cr. Normal Balance Chapter 3-26 SO 2

ASSETS = LIABILITIES + O/EQUITY Dt. Cr. Asset + - Liability - + Owner’s equity - +

Debits/Credits Rules Balance Sheet Asset = Income Statement Liability + Equity Revenue - Expense = Debit Credit SO 2 Define debits and credits and explain their use in recording business transactions.

Debits/Credits Rules Question Debits: a. increase both assets and liabilities. b. decrease both assets and liabilities. c. increase assets and decrease liabilities. d. decrease assets and increase liabilities. SO 2 Define debits and credits and explain their use in recording business transactions.

Debits/Credits Rules Question Accounts that normally have debit balances are: a. assets, expenses, and revenues. b. assets, expenses, and owner’s capital. c. assets, liabilities, and owner’s drawings. d. assets, owner’s drawings, and expenses. SO 2 Define debits and credits and explain their use in recording business transactions.

Summary of Debits/Credits Rules Relationship among the assets, liabilities and owner’s equity of a business: Basic Equation Illustration 2-11 Assets = Liabilities + Owner’s Equity Expanded Basic Equation The equation must be in balance after every transaction. For every Debit there must be a Credit. SO 2 Define debits and credits and explain their use in recording business transactions.

Steps in the Recording Process Illustration 2-12 Analyze each transaction Enter transaction in a journal Transfer journal information to ledger accounts Source documents, such as a sales slip, a check, a bill, or a cash register tape, provide evidence of the transaction. SO 3 Identify the basic steps in the recording process.

Steps in the Recording Process The Journal  Book of original entry.  Transactions recorded in chronological order.  Contributions to the recording process: 1. Discloses the complete effects of a transaction. 2. Provides a chronological record of transactions. 3. Helps to prevent or locate errors because the debit and credit amounts can be easily compared. SO 4 Explain what a journal is and how it helps in the recording process.

nter the transaction date in the date column. General Journal Date 2011 Oct. 1 Account Titles and Explanation J1 Ref. Debit Credit

he debit account title is entered first at the extreme left margin in the “account titles and explanation column and the amount is recorded in the DEBIT column . General Journal Date Account Titles and Explanation J1 Ref. Debit 2011 Oct. 1 Cash 15,000 Credit

he credit account title is indented and entered at the next line in the “account titles and explanation column and the amount is recoded in the CREDIT column . General Journal Date Account Titles and Explanation J1 Ref. Debit Credit 2011 Oct. 1 Cash Owner’s Capital 15,000 15,000

brief explanation of the transaction appears on the line below the credit title. General Journal Date Account Titles and Explanation J1 Ref. Debit Credit 2011 Oct. 1 Cash Owner’s Capital (Owner’s investment of cash in the business.) 15,000 15,000

he column titled Ref. Is left blank when the journal entry is made. This column is used later when journal entry is transferred to the accounts. General Journal Date Account Titles and Explanation J1 Ref. Debit Credit 2011 Oct. 1 Cash Owner’s Capital (Owner’s investment of cash in the business.) 15,000 15,000

f an entry involves only two accounts, one debit and one credit, it is considered a simple entry. hen three or more accounts are required in one journal entry, the entry is referred to as a compound entry.

Steps in the Recording Process Journalizing - Entering transaction data in the journal. Illustration: On September 1, Ray Neal invested $15,000 cash in the business, and Softbyte purchased computer equipment for $7,000 cash. Illustration 2-13 General Journal Date Account Title Sept. 1 Cash Ref. Debit 15,000 Owner’s, Capital Equipment Cash Credit 15,000 7,000 7,000 SO 4 Explain what a journal is and how it helps in the recording process.

Steps in the Recording Process Simple and Compound Entries Illustration: On July 1, Butler Company purchases a delivery truck costing $14,000. It pays $8,000 cash now and agrees to pay the remaining $6,000 on account. Illustration 2-14 General Journal Date July 1 Account Title Equipment Ref. Debit Credit 14,000 Cash 8,000 Accounts payable 6,000 SO 4 Explain what a journal is and how it helps in the recording process.

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