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Chapter 2

Analyzing Transactions
Accounting, 21st 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. Task Force Image Gallery clip art included in this electronic presentation is used with the permission of NVTech Inc.

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 equity is the owners right to the assets of the business.
Chris Clark, Capital Chris Clark, Drawing Revenues are increases in owners 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 2,900 850 1,400 700 2,900

Typical entries

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

5,100

4,300 2,900 10,950

Subtract total credits Cash from total debits to obtain the account 3,750 850 balance.

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.
JOURNAL
Date Description Post. Ref. Debit
2005

Page 1
Credit

1 Nov. 1 Cash 2 Chris Clark, Capital

25 000 00 25 000 00

3
4

Invested cash in 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

Chris Clark, Capital


Nov. 1 25,000

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


4 5 6 7 8 9 5 Land 20 000 00

Cash
Purchased land for building site.

20 000 00

10

(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 20,000 Nov. 5

Land
20,000

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


10 11 12 13 14 15 16 10 Supplies 1 350 00

Accounts Payable
Purchased supplies on account.

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 30 Accounts Payable 950 00

Cash
Paid creditors on account.

950 00

36

(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 Nov. 30 7,500 30 3,650 30 950

Accounts Payable
950 Nov. 10 1,350

Rules of Debit / Credit Balance Sheet Accounts


Debits Asset accounts. Increase (+) Liability accounts Decrease (-) Owners equity (capital) accounts. Decrease (-) Credits Decrease (-) Increase (+) Increase (+)

Balance Sheet Accounts


ASSETS
Asset Accounts
Debit for increases (+) Credit for decreases (-)

LIABILITIES
Liability Accounts
Debit for decreases (-) Credit for increases (+)

OWNERS EQUITY
Owners 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 18 Cash 7 500 00

Fees Earned
Received fees from customers.

7 500 00

20

(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 25,000

Fees Earned
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 20 21 22 23 30 Wages Expense Rent Expense Utilities Expense Miscellaneous Expense 2 125 00 800 00 450 00 275 00

Cash
Paid expenses.

3 650 00

24

(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 25,000 Nov. 525,000 Nov. 30 7,500 30 3,650

Wages Expense
2,125

Rent Expense
Nov. 30 800 Nov. 30

Utilities Expense
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 27 28 29 30 30 Supplies Expense 800 00

Supplies
Supplies used during November.

800 00

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
Nov. 10 1,350 Nov. 30 800 Nov. 30

Supplies Expense
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 Receive DEBIT Receive DEBIT Give CREDIT Right Side Give CREDIT

Luca Pacioli Developer of Double-Entry Accounting

Rules of Debit / Credit Income Statement Accounts


Expense Accounts
Debit for increases (+) Credit for decreases (-)

Revenue Accounts
Debit for decreases (-) Credit for increases (+)

Income Statement Accounts


Debits Revenue accounts Decrease (-) Expense accounts Increase (+) Credits Increase (+) Decrease (-)

Withdrawals by the Owner

(H) On November 30, Chris Clark withdrew $2,000 in cash from NetSolutions for personal use.
JOURNAL
Date
2005

Page 2
Post. Ref. Debit Credit

Description

1 Nov. 30 Chris Clark, Drawing 2 Cash

2 000 00 2 000 00

3
4

Chris Clark withdrew cash for


personal use.

(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

Chris Clark, Drawing


2,000 Nov. 10 1,350

25,000 Nov. 525,000 Nov. 30 7,500 30 3,650 30 950 30 2,000

Normal Balances of Accounts


Increase (Normal Balances) Balance sheet accounts: Asset Liability Owners Equity: Capital Drawing Income statement accounts: Revenue Expense Debit Credit Credit Debit Decreases

Credit Debit Debit Credit

Credit Debit

Debit Credit

Flow of Business Transactions 1


Transaction authorized

Transaction takes place

Document prepared

Entry recorded in journal

Entry posted to ledger

System to Analyze Transactions


1. Determine whether an asset, a liability, owners 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
Date
2005

Page 2
Post. Ref. Debit Credit

Description

1 Dec. 31 Prepaid Insurance 2 Cash

2 400 00 2 400 00

3
4

Paid premium on two-year


policy.

JOURNAL
Date
2005

Page 2
Post. Ref. Debit Credit

Description

1 Dec. 1 Prepaid Insurance 2 3 4 Cash Paid premium on two-year policy.

2 400 00 2 400 00

ACCOUNT Prepaid Insurance

ACCOUNT NO. 15
Balance Debit Credit Debit Credit

Date
2005

Item

Post. Ref.

Dec. 1

2 400 00

2 400 00

JOURNAL
Date
2005

Page 2
Post. Ref. Debit Credit

Description

1 Dec. 1 Prepaid Insurance 2 3 4 Cash Paid premium on two-year policy.

15

2 400 00 2 400 00

ACCOUNT Prepaid Insurance

ACCOUNT NO. 15
Balance Debit Credit Debit Credit

Date
2005

Item

Post. Ref.

Dec. 1

2 400 00

2 400 00

JOURNAL
Date
2005

Page 2
Post. Ref. Debit Credit

Description

1 Dec. 1 Prepaid Insurance 2 3 4 Cash Paid premium on two-year policy.

15

2 400 00 2 400 00

ACCOUNT Cash

ACCOUNT NO. 11
Post. Ref.
Balance Debit Credit Debit Credit

Date
2005

Item

Nov. 30 Dec. 1

2 000 00 2 400 00

5 900 00 3 500 00

JOURNAL
Date
2005

Page 2
Post. Ref. Debit Credit

Description

1 Dec. 1 Prepaid Insurance 2 3 4 Cash Paid premium on two-year policy.

15 11

2 400 00 2 400 00

ACCOUNT Cash

ACCOUNT NO. 11
Post. Ref.
Balance Debit Credit Debit Credit

Date
2005

Item

Nov. 30 Dec. 1

2 2

2 000 00 2 400 00

5 900 00 3 500 00

Dec. 1 NetSolutions paid rent for December, $800.

14
15 16 17

1 Rent Expense Cash Paid rent for December.

52 11

800 00 800 00

Dec. 1 NetSolutions receives $360 for three months rent beginning December 1.

14
15 16 17

1 Cash Unearned Rent Received advanced payment For three months rent of land.

14 23

360 00 360 00

Dec. 4 NetSolutions purchased office equipment on account from Executive Supply Co. for $1,800.

18
19 20 21

4 Office Equipment Accounts Payable Purchased office equipment on 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.
JOURNAL
Date
2005

Page 3
Post. Ref. Debit Credit

Description

1 Dec. 13 Wages Expense 2 Cash

51 11

950 00 950 00

3
4

Paid two weeks wages.

Dec. 16 NetSolutions received $3,100 from fees earned for the first half of December.

5
6 7 8

16 Cash Fees Earned Received fees from customers.

11 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 15 16

20 Accounts Payable Cash Paid part of amount owed to Executive Supply Co.

21 11

900 00 900 00

Dec. 21 NetSolutions received $650 from customers in payment of their accounts.


18
19 20 21

21 Cash Accounts Receivable Received cash from customer on account.

11 12

650 00 650 00

Dec. 23 NetSolutions paid $1,450 for supplies.

22
23 24 25

23 Supplies Cash Purchased supplies.

14 11

1 450 00 1 450 00

Dec. 27 NetSolutions paid the receptionist and part-time assistant $1,200 for two weeks wages.

27
28 29 30

27 Wages Expense Cash Paid two weeks wages.

51 11

1 200 00 1 200 00

Dec. 31 NetSolutions paid its $310 telephone bill for the month.

31
32 33 34

31 Utilities Expense Cash Paid telephone bill.

54 11

310 00 310 00

Dec. 31 NetSolutions paid its $225 electric bill for the month.
Page 4
Post. Ref. Debit Credit

JOURNAL
Date
2005

Description

1 Dec. 31 Utilities Expense 2 Cash

54 11

225 00 225 00

3
4

Paid utility bill.

Dec. 31 NetSolutions received $2,870 from fees earned for the second half of December.

5
6 7 8

31 Cash Fees Earned Received fees from customers.

11 41

2 870 00 2 870 00

Dec. 31 NetSolutions earned $1,120 on account for the second half of December.

9
10 11 12

31 Accounts Receivable Fees Earned Recorded fees earned on account.

12 41

1 120 00 1 120 00

Dec. 31 Chris Clark withdrew $2,000 for personal use.

14
15 16 17

31 Chris Clark, Drawing Cash Chris Clark withdrew cash for personal use.

32 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 Chris Clark, Capital Chris Clark, Drawing 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 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 Chris Clark, Capital Chris Clark, Drawing 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 4 275 00 1 600 00 985 00 800 00 455 00 42 600 00 42 600 00

Balance Sheet Items

NetSolutions Trial Balance December 31, 2005 Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Chris Clark, Capital Chris Clark, Drawing 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 Owners Equity 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 Chris Clark, Capital Chris Clark, Drawing 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

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

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

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