CH - 03 Recording Transactions

Recording Transactions
CHAPTER
2006 Prentice Hall Business Publishing
Introduction to Financial Accounting, 9/e
Horngren/Sundem/Elliott/Philbrick
Learning Objectives
After studying this chapter, you should be able to
1. 2. 3. 4. 5. Use double-entry accounting Analyze and journalize transactions Post journal entries to the ledgers Prepare and use a trial balance Close revenue and expense accounts and update retained earnings 6. Correct erroneous journal entries and describe how errors affect accounts 7. Explain how computers have transformed processing of accounting data
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The Double-Entry Accounting System

In the double-entry system, every transaction affects at least two accounts After each transaction, the balance sheet equation must always remain in balance
Assets = Liabilities + Stockholders Equity
This balance sheet format is too cumbersome for recording each and every transaction
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Ledger Accounts
The elements of transactions are organized into accounts that group similar items together In a double-entry system, a ledger contains the records for a group of related accounts A general ledger is the collection of accounts that accumulate the amounts reported in the financial statements
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Ledger Accounts
A T-account is a simplified version of accounts used in practice
Cash Left side (Increases in cash) Right side (Decreases in cash)
The vertical line in the T divides the account into left and right sides for recording increases and decreases The account title is on the horizontal line
2006 Prentice Hall Business Publishing Introduction to Financial Accounting, 9/e Horngren/Sundem/Elliott/Philbrick 5 of 40
Ledger Accounts
The T-accounts for the first three Biwheels Company transactions are as follows
Assets Cash = Liabilities + Stockholders Equity Note Payable Decreases Increases (2) 100,000
Increases (1) 400,000 (2) 100,000
Decreases (3) 150,000
Merchandise Inventory Increases Decreases (3) 150,000
Paid-in Capital Decreases Increases (1) 400,000
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Ledger Accounts
Each transaction affects at least two accounts The process of creating a new T-account in preparation for recording a transaction is called opening the account An account balance is the difference between the total left-side and right-side amounts at any particular time
Cash
10,000 Balance 4,000
6,000
Ledger Accounts
Asset accounts have left-side balances
Entries on the left side increase asset account balances Entries on the right side decrease them
Liabilities and owners equity accounts have right-side balances

Entries on the right side increase their balances Entries on the left side decrease them
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Debits and Credits

Accountants use the terms
Debit (abbreviated Dr.) to denote an entry on the left side of any account Credit (abbreviated Cr.) to denote an entry on the right side of any account
Some accountants use the word charge instead of debit

Cash Dr. Cr.
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The Recording Process

The sequence of five steps in recording and reporting transactions is as follows:
Transactions Documentation
Journal
Ledger
Trial Balance
Financial Statements
Source documents are the original records of any transaction

The Recording Process

The general journal is a formal chronological listing of each transaction and how it affects the balances in the accounts Transactions are entered into the ledger
The trial balance is a simple listing of the accounts in the general ledger together with their balances
Preparation of financial statements occurs at least once a quarter for publicly traded companies
Chart of Accounts
A chart of accounts is a numbered or coded list of all account titles Account numbers are used as references in the Post Ref. column of the journal
_______________________________________________________________ Account Account Account Account Number Title Number Title 100 Cash 202 Note payable 120 Accounts receivable 203 Accounts payable 130 Merchandise inventory 300 Paid-in capital 140 Prepaid rent 400 Retained earnings 170 Store equipment 500 Sales revenues 170A Accumulated 600 Cost of goods sold depreciation, 601 Rent expense store equipment 602 Depreciation expense _______________________________________________________________
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Journalizing Transactions
Journalizing is the process of entering transactions into the general journal A journal entry is an analysis of all the effects of a single transaction on the various accounts, usually accompanied by an explanation A compound entry means that a single transaction affects more than two accounts
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The following conventions are used for recording in the general journal
The title of the account or accounts to be debited are placed at the left margin The title of the account or accounts to be credited are indented in a consistent way
Date 20X1 12/31
Entry Post. No. Accounts and Explanation Ref. 1 Cash 100 Paid-in capital 300 Capital stock issued to Smith
Debit 400,000
Credit
400,00
12/31
Cash 100 100,000 Note Payable 202 Borrowed at 9% interest on a one year note
100,000
20X2 1/2
Merchandise Inventory 130 Cash 100 Acquired inventory for cash
150,000 150,000
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The journal entry is followed by the narrative explanation of the transaction The Post. Ref. column contains an identifying number that is assigned to each account and is used for cross-referencing to the ledger accounts
Date 20X1 12/31
Debit 400,000
Credit
400,00
12/31
100,000
20X2 1/2
150,000 150,000
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The debit and credit columns are for recording the dollar amounts that are debited or credited for each account
Date 20X1 12/31
Debit 400,000
Credit
400,00
12/31
100,000
20X2 1/2
150,000 150,000
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Posting Transactions to the Ledger

Posting is the transferring of amounts from the journal to the appropriate accounts in the ledger The following example shows
How the debit to merchandise inventory and the credit to cash are posted Columns for dates, explanations, journal references, and amounts in the ledger
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Date 20X1 12/31 Entry Post. No. Accounts and Explanation Ref. 1 Cash 100 Paid-in capital 300 Capital stock issued to Smith Debit 400,000 400,00 Credit
12/31
100,000
20X2 1/2
150,000 150,000
CASH Date 20X1 12/31 12/31 Explanation Journ. Ref. 1 2 Debit Date Expanation
Account No. 100 Journ. Ref. Credit 3 150,000
20X2 400,000 1/2 100,000
Date 20X2 1/2
Explanation
MERCHANDISE INVENTORY Journ. Ref. Debit Date Expanation 3 150,000
Account No. 130 Journ. Ref. Credit
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Cross-referencing is the process of using numbering, dating, and/or some other form of identification to relate each ledger posting to the appropriate journal entry
A single transaction from the journal might be posted to several different ledger accounts
Cross-referencing allows users to find all the components of the transactions in the ledger no matter where they start
Revenue and Expense Transactions

Ignoring dividends, T-accounts can be grouped as follows:
Assets + Debit Credit = Liabilities Debit + Credit + Paid-in Capital Debit + Credit + Retained Earnings Debit + Credit
Expenses + Debit
Revenues + Credit
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Revenue and expense information is accumulated separately to prepare a more meaningful income statement Expense and revenue accounts are part of Retained Earnings
A revenue account increases retained earnings An expense account decreases retained earnings
Although a debit entry increases expenses, it results in a decrease in retained earnings


Transaction: Sales on credit, $160,000 Analysis : The asset account Accounts Receivable increases The stockholders equity account Sales Revenues increases Journal Entry: Accounts receivable.160,000 Sales revenues 160,000 Posting: Accounts Receivable 160,000 Sales Revenues 160,000
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Transaction: Cost of merchandise sold, $100,000 Analysis : The asset Merchandise Inventory decreases Stockholders equity decreases because an expense account, Cost of Goods Sold (a negative stockholders account) increases Journal Entry: Cost of Goods Sold..100,000 Merchandise Inventory 100,000 Posting:
Merchandise Inventory 100,000
Cost of Goods Sold 100,000
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Prepaid Expenses and Depreciation Transactions

Transaction: Paid rent for 3 months in advance, $6,000 Analysis: The asset Cash decreases The asset Prepaid Rent increases Journal Entry: Prepaid rent..6,000 Cash 6,000 Posting: Cash 6,000 Prepaid Rent 6,000
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Transaction: Recognized expiration of rental services, $2,000 Analysis : The asset Prepaid Rent decreases The negative stockholders equity account Rent Expense increases Journal Entry: Rent expense..2,000 Prepaid Rent.. 2,000 Posting: Prepaid Rent 6,000 2,000 2,000 Rent Expense
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Transaction: Recognized depreciation, $100 Analysis : The asset reduction account Accumulated Depreciation, Store Equipment increases The negative stockholders equity account Depreciation Expense increases Journal Entry: Depreciation expense...100 Accumulated depreciation, store equipment.. 100 Posting: Accumulated Depreciation, Store Equipment 100
Depreciation Expense
100
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Asset: Contra Asset: Net asset: Store Equipment Accumulated depreciation, equipment Book value $14,000 100 $13,000
The book value or carrying value is the balance of an account minus the value of any contra accounts
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Preparing the Trial Balance

A trial balance is a list of all the accounts with their balances The purpose of the trial balance is twofold:
Proving whether the total debits equal the total credits in the ledger Summarizing the balances in the ledger accounts in preparation to construct the financial statements
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Cash Accounts receivable Merchandise Inventory Prepaid Rent Store equipment Accumulated depreciation, store equipment Note payable Accounts payable Paid-in capital Retained earnings Sales revenues Cost of goods sold Rent expense Depreciation expense Total Debits $ 336,700 160,300 59,200 4,000 14,000 Credits
100 100,000 16,200 400,000 0* 160,000
100,000 2,000 100 $ 676,300
$ 676,300
*Retained earnings in the trial balance does not yet reflect the income for the period
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The trial balance is prepared with the accounts in the following order:
Asset accounts Liability accounts Stockholders equity accounts Revenue accounts Expense accounts
The trial balance is the springboard for preparing the balance sheet and the income statement
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Deriving Financial Statements from the Trial Balance

Cash Accounts receivable Merchandise Inventory Prepaid Rent Store equipment Accumulated depreciation, store equipment Note payable Accounts payable Paid-in capital Retained earnings Sales revenues Cost of goods sold Rent expense Depreciation expense Total Debits $ 336,700 160,300 59,200 4,000 14,000 Credits
100 100,000 16,200 400,000 0 160,000
Balance Sheet
100,000 2,000 100 $ 676,300
Income Statement
$ 676,300
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Closing the Accounts

Closing the accounts has two purposes:
It transfers the balances of the temporary stockholders equity accounts (revenues and expenses) to the permanent stockholders equity account (retained earnings) It makes the revenues and expense accounts have a zero balance, which readies them for the next periods transactions
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Cost of Goods Sold
There are three closing entries:

Bal. 100,000 0 C2 100,000
C1: Close all revenue accounts
C2: Close all expense accounts

C3: Close the Income Summary account
Rent Expense Bal. 2,000 0 C2 2,000 C2
Income Summary 102,100 C1 160,000 0 C1
Sales 160,000 Bal. 160,000 0
C3
57,900
Depreciation Expense Bal. 100 0 C2 100
Retained Income Bal 0
C3
57,900
New bal. 57,900
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C1. Transaction: Clerical procedure of transferring the ending balances of revenue accounts to the Income Summary account Analysis : The stockholders' equity account Sales decreases to zero The stockholders equity account Income Summary increases Journal Entry: Sales160,000 Income Summary 160,000
C2. Transaction: Clerical procedure of transferring the ending balances of expense accounts to the Income Summary account Analysis : The negative stockholders equity (expense) accounts Cost of Goods Sold, Rent Expense, etc. decrease to zero The stockholders equity account Income Summary decreases Journal Entry: Income Summary102,100 Cost of goods sold. 100,000 Rent expense. 2,000 Depreciation expense 100
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C3. Transaction: Clerical procedure of transferring the ending balance of Income Summary account to the Retained Earnings account Analysis : The stockholders' equity account Income Summary decreases to zero The stockholders equity account Retained Earnings increases Journal Entry: Income summary57,000 Retained earnings 57,000
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Effects of Errors
If an error is detected after posting to the ledger accounts, a correcting entry must be made The following is an example of a correcting entry:
CORRECT ENTRY 12/27 Repair Expense Cash 12/27 Equipment Cash 12/31 Repair Expense Equipment 500 500 500 500 500 500
ERRONEOUS ENTRY
CORRECTING ENTRY
The correcting entry cancels or offsets the erroneous debit to Equipment

Some Errors are Temporary Errors Others Persist Until Corrected

Some errors in one period are automatically corrected in the next period Such errors misstate net income in both periods By the end of the second period the errors counterbalance or cancel each other out They affect the balance sheet of only the first periodnot the second Some errors will keep subsequent balance sheets in error until correcting entries are made
Data Processing and Accounting Systems

Data processing refers to the procedures used to record, analyze, store, and report on chosen activities In an accounting data processing system, a computer can automatically carry out steps such as ledger postings and financial statement preparation
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The cash register may be linked to a computer that also records a decrease in inventory It may also
Activate an order to a supplier Check a credit limit Update the accounts receivable Prepare monthly statements
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Computers also reduce the time it takes to close the books and prepare financial statements The most recent advance in data processing for financial reporting is the use of XBRL XBRL is an XML-based computer language that allows easy comparisons across companies
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Recording Transactions

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

The Double-Entry Accounting System

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

Increases (1) 400,000 (2) 100,000

Decreases (3) 150,000

Merchandise Inventory Increases Decreases (3) 150,000

Paid-in Capital Decreases Increases (1) 400,000

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

Liabilities and owners equity accounts have right-side balances

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

Debits and Credits

Some accountants use the word charge instead of debit

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

The Recording Process

Source documents are the original records of any transaction

The Recording Process

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

Merchandise Inventory 130 Cash 100 Acquired inventory for cash

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

Merchandise Inventory 130 Cash 100 Acquired inventory for cash

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

Merchandise Inventory 130 Cash 100 Acquired inventory for cash

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

Posting Transactions to the Ledger

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

Posting Transactions to the Ledger

Merchandise Inventory 130 Cash 100 Acquired inventory for cash

Account No. 100 Journ. Ref. Credit 3 150,000

20X2 400,000 1/2 100,000

Date 20X2 1/2

MERCHANDISE INVENTORY Journ. Ref. Debit Date Expanation 3 150,000

Account No. 130 Journ. Ref. Credit

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

Posting Transactions to the Ledger

Revenue and Expense Transactions

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

Revenue and Expense Transactions

Although a debit entry increases expenses, it results in a decrease in retained earnings

Revenue and Expense Transactions

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

Revenue and Expense Transactions

Merchandise Inventory 100,000

Cost of Goods Sold 100,000