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Chapter 2

Analyzing Transactions

Financial and Managerial Accounting


8th Edition
Warren Reeve Fess
© Copyright 2004 South-Western, a division
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Professor Emeritus of Accounting
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Objectives
1. Explain why accounts are used
After studying this to record
and summarize the
chapter, effects
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 Liabilities are debts


resources owned owed to outsiders
by the business. (creditors).
Cash Accounts
Supplies payable
Building Notes payable
Accounts Wages payable
receivable
Major Account Classifications
Liabilities are often identified
Assets are on the balance sheetare
Liabilities by debts
titles
owed payable
resources owned that include .
to outsiders
by the business. (creditors).
Cash Accounts
Supplies payable
Building Notes payable
Accounts Wages payable
receivable
Major Account Classifications
Owners’
Revenues are Expenses are the
(stockholders’)
increases in using up of assets
equity is the
owner’s equity as or consuming of
owner’s right to
a result of selling services to
the assets of the
services or generate revenue.
business.
products. Rent Expense
Capital Stock
Fees Earned Salary Expense
Retained
Fares Earned Utilities
Earnings
Commission Expense
Dividends
Revenue
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 Right side
debit credit

The right side of the account is the credit side.


The T-Account
Cash
3,750 850
4,300 1,400
2,900 700
2,900

Typical entries
Balancing a T-Account
Cash
First, foot
the debit 3,750 850
side. 4,300 1,400
2,900 700
10,950 2,900
Cash
3,750 850
4,300foot the
Next, 1,400
2,900
credit side. 700
10,950 2,900
5,850
Subtract total credits
Cash from total debits to
obtain the account
3,750 balance.
850
4,300 1,400
2,900 700
5,100 10,950 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.

JOURNAL Page 1
Post.
Date Description Ref. Debit Credit
2005
1 Nov. 1 Cash 25 000 00
2 Capital Stock 25 000 00
3 Issued capital stock for cash.
4
(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 Capital Stock


Nov. 1 25,000 Nov. 1 25,000
(B) On November 5,
NetSolutions bought land
for $20,000, paying cash.

4
5 5 Land 20 000 00
6 Cash 20 000 00
7 Purchased land for building
8 site.
9
10
(B) On November 5,
NetSolutions bought land
for $20,000, paying cash.

Effects of this entry in the Ledger


Cash Land
Nov. 1 25,000 Nov. 5 20,000 Nov. 5 20,000
(C) On November 10, NetSolutions
purchased supplies on account
for $1,350.

10
11 10 Supplies 1 350 00
12 Accounts Payable 1 350 00
13 Purchased supplies on account.
14
15
16
(C) On November 10, NetSolutions
purchased supplies on account
for $1,350.

Effects of this entry in the Ledger


Supplies Accounts Payable
Nov. 10 1,350 Nov. 10 1,350
(F) On November 30, NetSolutions
paid creditors on account, $950.

30
31 30 Accounts Payable 950 00
32 Cash 950 00
33 Paid creditors on account.
34
35
36
(F) On November 30, NetSolutions
paid creditors on account, $950.

Effects of this entry in the Ledger


Cash Accounts Payable
Nov. 1 25,000 Nov. 525,000 Nov. 30 950 Nov. 10 1,350
18 7,500 30 3,650
30 950
Rules of Debit / Credit Balance
Sheet Accounts
Debits Credits
Asset accounts………. Increase (+) Decrease (-)
Liability accounts…… Decrease (-) Increase (+)
Owner’s equity
(capital) accounts…. Decrease (-) Increase (+)
Balance Sheet Accounts
ASSETS LIABILITIES
Asset Accounts Liability Accounts
Debit for Credit for Debit for Credit for
increases decreases decreases increases
(+) (–) (–) (+)

OWNERS’ EQUITY
Stockholders’ Equity
Accounts
Debit for Credit for
decreases increases
(–) (+)
(D) On November 18, NetSolutions
received fees of $7,500 from
customers for services provided .

14
15 18 Cash 7 500 00
16 Fees Earned 7 500 00
17 Received fees from customers.
18
19
20
(D) On November 18, NetSolutions
received fees of $7,500 from
customers for services provided .

Effects of this entry in the Ledger


Cash Fees Earned
Nov. 1 25,000 Nov. 5 25,000 Nov. 18 7,500
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 Cash 3 650 00
24 Paid expenses.
(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 Wages Expense
Nov. 1 25,000 Nov. 525,000 Nov. 30 2,125
18 7,500 30 3,650

Rent Expense Utilities Expense


Nov. 30 800 Nov. 30 450

Miscellaneous Expense
Nov. 30 275
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 30 Supplies Expense 800 00
27 Supplies 800 00
28 Supplies used during
29 November.
30
31
(G) On November 30, a count revealed
that $800 of the supplies inventory
had been used.

Effects of this entry in the Ledger


Supplies Supplies Expense
Nov. 10 1,350 Nov. 30 800 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 T account

Left Side Right Side


Receive Give
Luca Pacioli DEBIT CREDIT
Developer of
Double-Entry Receive Give
Accounting DEBIT CREDIT
Rules of Debit / Credit Income
Statement Accounts
Expense Accounts Revenue Accounts
Debit for Credit for Debit for Credit for
increases decreases decreases increases
(+) (-) (-) (+)
Income Statement Accounts
Debits Credits
Revenue accounts…… Decrease (-) Increase (+)
Expense accounts…… Increase (+) Decrease (-)
Payment of
dividends
(H) On November 30, Net Solutions paid
dividends of $2,000.

JOURNAL Page 2
Post.
Date Description Ref. Debit Credit
2005
1 Nov. 30 Dividends 2 000 00
2 Cash 2 000 00
3 Paid dividends to stockholders.
4
(H) On November 30, Chris Clark
withdrew $2,000 in cash from
NetSolutions for personal use.

Effects of this entry in the Ledger


Cash Dividends
Nov. 1 25,000 Nov. 525,000 Nov. 30 2,000
18 7,500 30 3,650
30 950
30 2,000
Normal Balances of Accounts
Increase
(Normal Balances) Decreases

Balance sheet accounts:


Asset Debit Credit
Liability Credit Debit
Owners’ (Stockholders’) Equity:
Capital Stock Credit Debit
Retained Earnings Credit Debit
Income statement accounts:
Revenue Credit Debit
Expense Debit Credit
Dividend accounts:
Dividends Debit Credit
Flow of Business Transactions
Transaction Transaction Document
1 authorized 2 takes place 3 prepared

Entry recorded Entry posted to


4 in journal 5 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.

JOURNAL Page 2
Post.
Date Description Ref. Debit Credit
2005
1 Dec. 31 Prepaid Insurance 2 400 00
2 Cash 2 400 00
3 Paid premium on two-year
4 policy.
JOURNAL Page 2
Post.
Date Description Ref. Debit Credit
2005
1 Dec. 1 Prepaid Insurance 2 400 00
2 Cash 2 400 00
3 Paid premium on two-year
4 policy.

ACCOUNT Prepaid Insurance ACCOUNT NO. 15


Balance
Post.
Date Item Ref. Debit Credit Debit Credit
2005
Dec. 1 2 400 00 2 400 00
JOURNAL Page 2
Post.
Date Description Ref. Debit Credit
2005
1 Dec. 1 Prepaid Insurance 15 2 400 00
2 Cash 2 400 00
3 Paid premium on two-year
4 policy.

ACCOUNT Prepaid Insurance ACCOUNT NO. 15


Balance
Post.
Date Item Ref. Debit Credit Debit Credit
2005
Dec. 1 2 2 400 00 2 400 00
JOURNAL Page 2
Post.
Date Description Ref. Debit Credit
2005
1 Dec. 1 Prepaid Insurance 15 2 400 00
2 Cash 2 400 00
3 Paid premium on two-year
4 policy.

ACCOUNT Cash ACCOUNT NO. 11


Balance
Post.
Date Item Ref. Debit Credit Debit Credit
2005
Nov. 30 2 2 000 00 5 900 00
Dec. 1 2 400 00 3 500 00
JOURNAL Page 2
Post.
Date Description Ref. Debit Credit
2005
1 Dec. 1 Prepaid Insurance 15 2 400 00
2 Cash 11 2 400 00
3 Paid premium on two-year
4 policy.

ACCOUNT Cash ACCOUNT NO. 11


Balance
Post.
Date Item Ref. Debit Credit Debit Credit
2005
Nov. 30 2 2 000 00 5 900 00
Dec. 1 2 2 400 00 3 500 00
Dec. 1 NetSolutions paid rent for December,
$800.

14 1 Rent Expense 52 800 00


15 Unearned Rent 11 800 00
16 Paid rent for December.
17
Dec. 1 NetSolutions receives $360 for three
month’s rent for land beginning
December 1.

14 1 Cash 11 360 00
15 Unearned Rent 23 360 00
16 Received advanced payment
17 For three months’ rent of land.
Dec. 4 NetSolutions purchased office
equipment on account from Executive
Supply Co. for $1,800.

18 4 Office Equipment 18 1 800 00


19 Accounts Payable 21 1 800 00
20 Purchased office equipment on
21 account.
Dec. 6 NetSolutions paid $180 for a
newspaper advertisement.

21 6 Miscellaneous Expense 59 180 00


22 Cash 11 180 00
23 Paid for newspaper ad.
24
Dec. 11 NetSolutions paid creditors $400.

24 11 Accounts Payable 21 400 00


25 Cash 11 400 00
26 Paid creditors on account.
27
Dec. 13 NetSolutions paid a receptionist and
part-time assistant $950 for two
weeks’ wages.

JOURNAL Page 3
Post.
Date Description Ref. Debit Credit
2005
1 Dec. 13 Wages Expense 51 950 00
2 Cash 11 950 00
3 Paid two week’s wages.
4
Dec. 16 NetSolutions received $3,100 from
fees earned for the first half of
December.

5 16 Cash 11 3 100 00
6 Fees Earned 41 3 100 00
7 Received fees from customers.
8
Dec. 16 Fees earned on account totaled
$1,750 for the first half of
December.

9 16 Accounts Receivable 12 1 750 00


10 Fees Earned 41 1 750 00
11 Received fees from customers.
12
Dec. 20 NetSolutions paid $900 to Executive
Supply Co. on the $1,800 debt owed
from the December 4 transaction.

13 20 Accounts Payable 21 900 00


14 Cash 11 900 00
15 Paid part of amount owed to
16 Executive Supply Co.
Dec. 21 NetSolutions received $650 from
customers in payment of their
accounts.

18 21 Cash 11 650 00
19 Accounts Receivable 12 650 00
20 Received cash from customer
21 on account.
Dec. 23 NetSolutions paid $1,450 for
supplies.

22 23 Supplies 14 1 450 00
23 Cash 11 1 450 00
24 Purchased supplies.
25
Dec. 27 NetSolutions paid the receptionist
and part-time assistant $1,200 for
two weeks’ wages.

27 27 Wages Expense 51 1 200 00


28 Cash 11 1 200 00
29 Paid two weeks’ wages.
30
Dec. 31 NetSolutions paid its $310 telephone
bill for the month.

31 31 Utilities Expense 54 310 00


32 Cash 11 310 00
33 Paid telephone bill.
34
Dec. 31 NetSolutions paid its $225 electric
bill for the month.

JOURNAL Page 4
Post.
Date Description Ref. Debit Credit
2005
1 Dec. 31 Utilities Expense 54 225 00
2 Cash 11 225 00
3 Paid utility bill.
4
Dec. 31 NetSolutions received $2,870 from
fees earned for the second half of
December.

5 31 Cash 11 2 870 00
6 Fees Earned 41 2 870 00
7 Received fees from customers.
8
Dec. 31 NetSolutions earned $1,120 on
account for the second half of
December.

9 31 Accounts Receivable 12 1 120 00


10 Fees Earned 41 1 120 00
11 Recorded fees earned on
12 account.
Dec. 31 NetSolutions paid dividends of
$2,000 to stockholders.

14 31 Dividends 33 2 000 00
15 Cash 11 2 000 00
16 Paid dividends to stockholders.
17
Trial Balance
NetSolutions
Trial Balance
December 31, 2005
Cash 2 065 00
Accounts Receivable 2 220 00
Supplies 2 000 00
Prepaid Insurance 2 400 00
Land 20 000 00
Office Equipment 1 800 00
Accounts Payable 900 00
Unearned Rent 360 00
Capital Stock 25 000 00
Dividends
Fees Earned 16 340 00
Wages Expense 4 275 00
Rent Expense 1 600 00
Utilities Expense 985 00
Supplies Expense 800 00
Miscellaneous Expense 455 00
42 600 00 42 600 00
NetSolutions
Trial Balance
December 31, 2005
Cash 2 065 00
Accounts Receivable 2 220 00
Supplies 2 000 00
Prepaid Insurance Balance 2 400 00
Land Sheet 20 000 00
Office Equipment 1 800 00
Accounts Payable Items 900 00
Unearned Rent 360 00
Capital Stock 25 000 00
Dividends 4 000 00
Fees Earned 16 340 00
Wages Expense 4 275 00
Rent Expense 1 600 00
Utilities Expense 985 00
Supplies Expense 800 00
Miscellaneous Expense 455 00
42 600 00 42 600 00
NetSolutions
Trial Balance
December 31, 2005
Cash 2 065 00
Accounts Receivable 2 220 00
Supplies 2 000 00
Prepaid Insurance 2 400 00
Land 20 000 00
Office Equipment 1 800 00
Accounts Payable 900 00
Unearned Rent 360 00
Capital Stock 25 000 00
Dividends 4 000 00
Fees Earned Statement 16 340 00
Wages Expense 4 275 00
Rent Expense
of 1 600 00
Utilities Expense Retained 985 00
Supplies Expense Earnings 800 00
Miscellaneous Expense 455 00
Item 42 600 00 42 600 00
NetSolutions
Trial Balance
December 31, 2005
Cash 2 065 00
Accounts Receivable 2 220 00
Supplies 2 000 00
Prepaid Insurance 2 400 00
Land 20 000 00
Office Equipment 1 800 00
Accounts Payable 900 00
Unearned Rent 360 00
Capital Stock 25 000 00
Dividends 4 000 00
Fees Earned 16 340 00
Wages Expense Income 4 275 00
Rent Expense 1 600 00
Utilities Expense
Statement 985 00
Supplies Expense Items 800 00
Miscellaneous Expense 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 Correction Procedure


1. Journal entry is incorrect Draw a line through the error
but not posted. and insert correct title or
amount.
Correction
of Errors

Error Correction Procedure


1. Journal entry is correct
2. incorrect Draw a line through the error
not posted.
but posted incorrectly. and insert
posted correct
error title or
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 Debit Credit
May 5 Supplies 12,500
Accounts Payable 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 Debit Credit
May 5 Supplies 12,500
Accounts Payable 12,500

Date Description Debit Credit


May 5 Office Equipment 12,500
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 Debit Credit
May 5 Supplies 12,500
Accounts Payable 12,500

Date Description Debit Credit


May 5 Office Equipment 12,500
Supplies 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
Increase (Decrease)
2006 2005 Amount Percent
Fees earned $187,500 $150,000 $37,500 25.0%
Operating expenses:
Wages expense $ 60,000 $ 45,000 $15,000 33.3%
Rent expense 15,000 12,000 3,000 25.0%
Utilities expense 12,500 9,000 3,500 38.9%
Supplies expense 2,700 3,000 (300) (10.0)%
Misc. expense 2,300 1,800 500 27.8%
Total operating
expenses $ 92,500 $ 70,800 $21,700 30.6%
Net income $ 95,000 $ 79,200 $15,800 19.9%
Chapter 2

The End