Principal accounting - Ch02 analyzing transaction

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Warren Reeve Fess …

Warren Reeve Fess
Principal Accounting
Chapter 02
Analyzing Transaction

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  • 1. Chapter 2 Analyzing Transactions Accounting, 21st Edition Warren Reeve Fess
  • 2. 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:
  • 3. 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
  • 4. Each financial statement item, called an account, is included in the ledger.
  • 5. A group of accounts for a business entity is called a ledger.
  • 6. A list of the accounts in a ledger is called a chart of accounts.
  • 7. 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
  • 8. Major Account Classifications 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.
  • 9. 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 Major Account Classifications
  • 10. To assist you in learning, an account can be drawn to resemble the letter T.
  • 11. The T-Account The T-account has a title. Cash
  • 12. The T-Account The left side of the account is the debit side. Cash Left side debit
  • 13. The T-Account The right side of the account is the credit side. Cash Left side debit Right side credit
  • 14. The T-Account Cash 3,750 4,300 2,900 850 1,400 700 2,900 Typical entries
  • 15. Balancing a T-Account
  • 16. Cash 3,750 4,300 2,900 850 1,400 700 2,90010,950 First, foot the debit side.
  • 17. 850 1,400 700 2,900 Cash 3,750 4,300 2,900 10,950 5,850 Next, foot the credit side.
  • 18. 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
  • 19. Transactions and Balance Sheet Accounts
  • 20. 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.
  • 21. (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
  • 22. 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.
  • 23. Effects of this entry in the Ledger 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.
  • 24. 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.
  • 25. (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
  • 26. 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.
  • 27. Cash Nov. 1 25,000 Nov. 525,000 18 7,500 30 3,650 Effects of this entry in the Ledger Accounts Payable Nov. 10 1,350Nov. 30 950 30 950 (F) On November 30, NetSolutions paid creditors on account, $950.
  • 28. Debits Credits Asset accounts………. Increase (+) Decrease (-) Liability accounts…… Decrease (-) Increase (+) Owner’s equity (capital) accounts…. Decrease (-) Increase (+) Rules of Debit / Credit Balance Sheet Accounts
  • 29. 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
  • 30. (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
  • 31. Effects of this entry in the Ledger 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 .
  • 32. (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
  • 33. Effects of this entry in the Ledger 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 .
  • 34. In every entry the sum of the debits always equal the sum of the credits.
  • 35. (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
  • 36. Effects of this entry in the Ledger 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.
  • 37. 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
  • 38. Credit for increases (+) Credit for decreases (-) Debit for increases (+) Debit for decreases (-) Expense Accounts Revenue Accounts Rules of Debit / Credit Income Statement Accounts
  • 39. Debits Credits Revenue accounts…… Decrease (-) Increase (+) Expense accounts…… Increase (+) Decrease (-) Income Statement Accounts
  • 40. Withdrawals by the Owner
  • 41. Post. Ref. JOURNAL Date Description Debit Credit 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.
  • 42. 30 950 30 2,000 Cash Nov. 1 25,000 Nov. 525,000 18 7,500 30 3,650 Effects of this entry in the Ledger 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.
  • 43. 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
  • 44. Flow of Business Transactions 1 Transaction authorized 2 Transaction takes place 3 Document prepared 4 Entry recorded in journal 5 Entry posted to ledger
  • 45. 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
  • 46. Journalizing and Posting
  • 47. Post. Ref. JOURNAL Date Description Debit Credit 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.
  • 48. Post. Ref. JOURNAL Date Description Debit Credit Page 2 1 2 3 4 Dec. 1 2005 Prepaid Insurance 2 400 00 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 Paid premium on two-year policy.
  • 49. Post. Ref. JOURNAL Date Description Debit Credit Page 2 1 2 3 4 Dec. 1 2005 Prepaid Insurance 2 400 00 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 2 15 Paid premium on two-year policy.
  • 50. Post. Ref. JOURNAL Date Description Debit Credit Page 2 1 2 3 4 Dec. 1 2005 Prepaid Insurance 2 400 00 Cash 2 400 00 Paid premium on two-year policy. 15 ACCOUNT Cash ACCOUNT NO. 11 Balance Debit CreditDate Debit CreditItem Post. Ref. 2 000 00 5 900 00Nov. 30 2005 2 Dec. 1 2 400 00 3 500 00
  • 51. Post. Ref. JOURNAL Date Description Debit Credit Page 2 1 2 3 4 Dec. 1 2005 Prepaid Insurance 2 400 00 Cash 2 400 00 Paid premium on two-year policy. 15 ACCOUNT Cash ACCOUNT NO. 11 Balance Debit CreditDate Debit CreditItem Post. Ref. 2 000 00 5 900 00Nov. 30 2005 2 2 400 00 3 500 00Dec. 1 11 2
  • 52. 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.
  • 53. 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.
  • 54. 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.
  • 55. 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.
  • 56. Dec. 11 NetSolutions paid creditors $400. 24 25 26 27 11 Accounts Payable 21 400 00 Cash 11 400 00 Paid creditors on account.
  • 57. Dec. 13 NetSolutions paid a receptionist and part-time assistant $950 for two weeks’ wages. Post. Ref. JOURNAL Date Description Debit Credit Page 3 1 2 3 4 Dec. 13 2005 Wages Expense 51 950 00 Cash 11 950 00 Paid two week’s wages.
  • 58. 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 Received fees from customers.
  • 59. 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 Fees Earned 41 1 750 00 Received fees from customers.
  • 60. 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.
  • 61. 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.
  • 62. 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.
  • 63. 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.
  • 64. 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.
  • 65. Dec. 31 NetSolutions paid its $225 electric bill for the month. Post. Ref. JOURNAL Date Description Debit Credit Page 4 1 2 3 4 Dec. 31 2005 Utilities Expense 54 225 00 Cash 11 225 00 Paid utility bill.
  • 66. 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 Fees Earned 41 2 870 00 Received fees from customers.
  • 67. 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 Fees Earned 41 1 120 00 Recorded fees earned on account.
  • 68. 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.
  • 69. Trial Balance
  • 70. 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 Chris Clark, Capital 25 000 00 Chris Clark, Drawing 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
  • 71. 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 Chris Clark, Capital 25 000 00 Chris Clark, Drawing 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 Balance Sheet Items
  • 72. 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 Chris Clark, Capital 25 000 00 Chris Clark, Drawing 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 Statement of Owner’s Equity Item
  • 73. 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 Chris Clark, Capital 25 000 00 Chris Clark, Drawing 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 Income Statement Items
  • 74. 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:
  • 75. Error Correction Procedure 1. Journal entry is incorrect Draw a line through the error but not posted. and insert correct title or amount. Error Correction Procedure Correction of Errors
  • 76. Error Correction Procedure 1. Journal entry is incorrect Draw a line through the error but not posted. and insert correct title or amount. Error Correction Procedure 2. Journal entry is correct Draw a line through the but posted incorrectly. posted error and post correctly. Correction of Errors
  • 77. Error Correction ProcedureError Correction Procedure 3. Journal entry is incorrect Journalize and post a and posted correcting entry. Correction of Errors
  • 78. 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. Date Description Debit Credit May 5 Supplies 12,500 Accounts Payable 12,500
  • 79. 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. Date Description Debit Credit May 5 Supplies 12,500 Accounts Payable 12,500 Date Description Debit Credit May 5 Office Equipment 12,500
  • 80. Date Description Debit Credit May 5 Office Equipment 12,500 Supplies 12,500 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. Date Description Debit Credit May 5 Supplies 12,500 Accounts Payable 12,500
  • 81. Financial Analysis and Interpretation Comparing an item in a current statement with the same item in prior statements is called horizontal analysis.
  • 82. 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%
  • 83. The End Chapter 2