Principal accounting - Ch02 analyzing transaction

Chapter 2
Analyzing Transactions
Accounting, 21st Edition
Warren Reeve Fess

1. Explain why accounts are used to record
and summarize the effects of transactions
on financial statements.
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
After studying this
chapter, you should
be able to:

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.
Objectives

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.
Liabilities are debts
owed to outsiders
(creditors).
Cash
Supplies
Building
Accounts
receivable
Accounts
payable
Notes payable
Wages payable

Liabilities are debts
owed to outsiders
(creditors).
Cash
Supplies
Building
Accounts
receivable
Accounts
payable
Notes payable
Wages payable
Assets are
resources owned
by the business.
Liabilities are often identified
on the balance sheet by titles
that include payable.

Owner’s
equity is the
owner’s right to
the assets of the
business.
Revenues are
increases in
owner’s equity as
a result of selling
services or
products.Chris Clark,
Capital
Chris Clark,
Drawing
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
The T-account has a title.
Cash

The T-Account
The left side of the account is the debit side.
Cash
Left side
debit

The T-Account
The right side of the account is the credit side.
Cash
Left side
debit
Right side
credit

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

Cash
3,750
4,300
2,900
850
1,400
700
2,90010,950
First, foot
the debit
side.

850
1,400
700
2,900
Cash
3,750
4,300
2,900
10,950
5,850
Next, foot the
credit side.

850
1,400
700
2,900
Cash
3,750
4,300
2,900
10,950
5,850
Subtract total credits
from total debits to
obtain the account
balance.
5,100

Transactions and Balance
Sheet Accounts

Post.
Ref.
JOURNAL
Date Description Debit Credit
Page 1
1
2
3
4
Nov. 1
2005
Cash 25 000 00
Chris Clark, Capital 25 000 00
Invested cash in NetSolutions.
(A) On November 1, Chris Clark
deposits $25,000 in a bank account in
the name of NetSolutions.

(A) On November 1, Chris Clark
deposits $25,000 in a bank account in
the name of NetSolutions.
Effects of this entry in the Ledger
Cash
Nov. 1 25,000 Nov. 1 25,000
Chris Clark, Capital

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

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

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

(C) On November 10, NetSolutions
purchased supplies on account
for $1,350.
Supplies
Nov. 10 1,350
Accounts Payable
Nov. 10 1,350

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

Cash
Nov. 1 25,000 Nov. 525,000
18 7,500 30 3,650
Accounts Payable
Nov. 10 1,350Nov. 30 950
30 950
(F) On November 30, NetSolutions
paid creditors on account, $950.

Debits Credits
Asset accounts………. Increase (+) Decrease (-)
Liability accounts…… Decrease (-) Increase (+)
Owner’s equity
(capital) accounts…. Decrease (-) Increase (+)
Rules of Debit / Credit Balance
Sheet Accounts

Credit for
increases
(+)
Credit for
increases
(+)
Credit for
decreases
(-)
Debit for
increases
(+)
Debit for
decreases
(-)
Debit for
decreases
(-)
ASSETS
Asset Accounts
LIABILITIES
Liability Accounts
Owner’s Equity Accounts
OWNER’S EQUITY
Balance Sheet Accounts

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

Cash
Nov. 1 25,000 Nov. 5 25,000
Fees Earned
Nov. 18 7,500
18 7,500
(D) On November 18, NetSolutions
received fees of $7,500 from
customers for services provided .

(E) Throughout the month, NetSolutions
incurred the following expenses:
wages, $2,125; rent, $800; utilities,
$450; and miscellaneous, $275 .
30 Wages Expense 2 125 00
Rent Expense 800 00
Utilities Expense 450 00
Miscellaneous Expense 275 00
Cash 3 650 00
Paid expenses.
18
19
20
21
22
23
24

Cash
Nov. 1 25,000 Nov. 525,000
Wages Expense
Nov. 30 2,125
18 7,500
Rent Expense
Nov. 30 800
Utilities Expense
Nov. 30 450
Miscellaneous Expense
Nov. 30 275
30 3,650
(E) Throughout the month, NetSolutions
incurred the following expenses:
wages, $2,125; rent, $800; utilities,
$450; and miscellaneous, $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.
30 Supplies Expense 800 00
Supplies 800 00
Supplies used during
November.
25
26
27
28
29
30
31

Supplies
Nov. 10 1,350
Supplies Expense
Nov. 30 800Nov. 30 800
(G) On November 30, a count revealed
that $800 of the supplies inventory
had been used.

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.”
Luca Pacioli
Developer of
Double-Entry
Accounting
Scale or Balance
Receive
DEBIT
Give
CREDIT
T account
Left Side
Receive
DEBIT
Right Side
Give
CREDIT

Credit for
increases
(+)
Credit for
decreases
(-)
Debit for
increases
(+)
Debit for
decreases
(-)
Expense Accounts Revenue Accounts
Rules of Debit / Credit Income
Statement Accounts

Debits Credits
Revenue accounts…… Decrease (-) Increase (+)
Expense accounts…… Increase (+) Decrease (-)
Income Statement Accounts

Post.
Ref.
JOURNAL
Page 2
1
2
3
4
Nov. 30
2005
Chris Clark, Drawing 2 000 00
Cash 2 000 00
Chris Clark withdrew cash for
personal use.
(H) On November 30, Chris Clark
withdrew $2,000 in cash from
NetSolutions for personal use.

30 950
30 2,000
Cash
Nov. 1 25,000 Nov. 525,000
18 7,500 30 3,650
Chris Clark, Drawing
Nov. 10 1,350Nov. 30 2,000
(H) On November 30, Chris Clark
withdrew $2,000 in cash from
NetSolutions for personal use.

Increase
(Normal Balances) Decreases
Balance sheet accounts:
Asset Debit Credit
Liability Credit Debit
Owner’s Equity:
Capital Credit Debit
Drawing Debit Credit
Income statement accounts:
Revenue Credit Debit
Expense Debit Credit
Normal Balances of Accounts

Flow of Business Transactions
1 Transaction
authorized 2 Transaction
takes place 3 Document
prepared
4
Entry recorded
in journal 5
Entry posted to
ledger

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.
System to Analyze Transactions

Post.
Ref.
JOURNAL
Page 2
1
2
3
4
Dec. 1
2005
Prepaid Insurance 2 400 00
Cash 2 400 00
Paid premium on two-year
policy.
Dec. 1 NetSolutions paid a premium of
$2,400 for a comprehensive insurance
policy covering two years.

Post.
Ref.
JOURNAL
Page 2
1
2
3
4
Dec. 1
2005
Cash 2 400 00
ACCOUNT Prepaid Insurance ACCOUNT NO. 15
Balance
Debit CreditDate Debit CreditItem
Post.
Ref.
2 400 00 2 400 00Dec. 1
2005
policy.

Post.
Ref.
JOURNAL
Page 2
1
2
3
4
Dec. 1
2005
Cash 2 400 00
ACCOUNT Prepaid Insurance ACCOUNT NO. 15
Balance
Post.
Ref.
2 400 00 2 400 00Dec. 1
2005
2
15
policy.

Post.
Ref.
JOURNAL
Page 2
1
2
3
4
Dec. 1
2005
Cash 2 400 00
policy.
15
ACCOUNT Cash ACCOUNT NO. 11
Balance
Post.
Ref.
2 000 00 5 900 00Nov. 30
2005
2
Dec. 1 2 400 00 3 500 00

Post.
Ref.
JOURNAL
Page 2
1
2
3
4
Dec. 1
2005
Cash 2 400 00
policy.
15
ACCOUNT Cash ACCOUNT NO. 11
Balance
Post.
Ref.
2 000 00 5 900 00Nov. 30
2005
2
2 400 00 3 500 00Dec. 1
11
2

14
15
16
17
1 Rent Expense 52 800 00
Cash 11 800 00
Paid rent for December.
Dec. 1 NetSolutions paid rent for December,
$800.

14
15
16
17
1 Cash 14 360 00
Unearned Rent 23 360 00
Received advanced payment
For three months’ rent of land.
Dec. 1 NetSolutions receives $360 for three
month’s rent beginning December 1.

Dec. 4 NetSolutions purchased office
equipment on account from Executive
Supply Co. for $1,800.
18
19
20
21
4 Office Equipment 18 1 800 00
Accounts Payable 21 1 800 00
Purchased office equipment on
account.

Dec. 6 NetSolutions paid $180 for a
newspaper advertisement.
21
22
23
24
6 Miscellaneous Expense 59 180 00
Cash 11 180 00
Paid for newspaper ad.

Dec. 11 NetSolutions paid creditors $400.
24
25
26
27
11 Accounts Payable 21 400 00
Cash 11 400 00
Paid creditors on account.

Dec. 13 NetSolutions paid a receptionist and
part-time assistant $950 for two
weeks’ wages.
Post.
Ref.
JOURNAL
Page 3
1
2
3
4
Dec. 13
2005
Wages Expense 51 950 00
Cash 11 950 00
Paid two week’s wages.

Dec. 16 NetSolutions received $3,100 from
fees earned for the first half of
December.
5
6
7
8
16 Cash 11 3 100 00
Fees Earned 41 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 12 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
15
16
20 Accounts Payable 21 900 00
Cash 11 900 00
Paid part of amount owed to
Executive Supply Co.

Dec. 21 NetSolutions received $650 from
customers in payment of their
accounts.
18
19
20
21
21 Cash 11 650 00
Accounts Receivable 12 650 00
Received cash from customer
on account.

Dec. 23 NetSolutions paid $1,450 for
supplies.
22
23
24
25
23 Supplies 14 1 450 00
Cash 11 1 450 00
Purchased supplies.

Dec. 27 NetSolutions paid the receptionist
and part-time assistant $1,200 for
two weeks’ wages.
27
28
29
30
27 Wages Expense 51 1 200 00
Cash 11 1 200 00
Paid two weeks’ wages.

Dec. 31 NetSolutions paid its $310 telephone
bill for the month.
31
32
33
34
31 Utilities Expense 54 310 00
Cash 11 310 00
Paid telephone bill.

Dec. 31 NetSolutions paid its $225 electric
bill for the month.
Post.
Ref.
JOURNAL
Page 4
1
2
3
4
Dec. 31
2005
Utilities Expense 54 225 00
Cash 11 225 00
Paid utility bill.

Dec. 31 NetSolutions received $2,870 from
fees earned for the second half of
December.
5
6
7
8
31 Cash 11 2 870 00

Dec. 31 NetSolutions earned $1,120 on
account for the second half of
December.
9
10
11
12
31 Accounts Receivable 12 1 120 00
Recorded fees earned on
account.

Dec. 31 Chris Clark withdrew $2,000 for
personal use.
14
15
16
17
31 Chris Clark, Drawing 32 2 000 00
Cash 11 2 000 00
Chris Clark withdrew cash
for personal use.

NetSolutions
Trial Balance
December 31, 2005
Cash 2 065 00
Supplies 2 000 00
Land 20 000 00
Office Equipment 1 800 00
Accounts Payable 900 00
Unearned Rent 360 00
Rent Expense 1 600 00
Supplies Expense 800 00
42 600 00 42 600 00

NetSolutions
Trial Balance
December 31, 2005
Cash 2 065 00
Supplies 2 000 00
Land 20 000 00
42 600 00 42 600 00
Balance
Sheet
Items

NetSolutions
Trial Balance
December 31, 2005
Cash 2 065 00
Supplies 2 000 00
Land 20 000 00
42 600 00 42 600 00
Statement
of Owner’s
Equity
Item

NetSolutions
Trial Balance
December 31, 2005
Cash 2 065 00
Supplies 2 000 00
Land 20 000 00
42 600 00 42 600 00
Income
Statement
Items

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.
Errors that will not cause the
trial balance to be unequal:

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

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

Error Correction ProcedureError Correction Procedure
3. Journal entry is incorrect Journalize and post a
and posted correcting entry.
Correction
of Errors

What would be the necessary
correcting entry?
Journal – As recorded and posted
Correcting Errors – An Example
On May 5, a purchase of office equipment on
account was incorrectly journalized and posted
as shown.
May 5 Supplies 12,500
Accounts Payable 12,500

as shown.
May 5 Office Equipment 12,500

May 5 Office Equipment 12,500
Supplies 12,500
as shown.

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
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%

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