Chapter 2

Learning Objective
1. Explain what a transaction is
2-1
Copyright 2015 Pearson Education Inc. All rights reserved.
EXPLAIN WHAT A TRANSACTION IS

Transaction
Any event that has a financial impact on the business
Can be measured reliably
Provides information about an exchange
2-2
Something given
Something received
Accounting records both sides of a transaction
LO 1
EXPLAIN WHAT A TRANSACTION IS

Transaction Examples
Whole Foods Market, Inc.
2-3
Purchase
fresh produce
Sell product
Borrow money
Repay a loan
LO 1
Learning Objective
2. Define account, and list and differentiate
between different types of accounts
2-4
DEFINE ACCOUNT, AND LIST AND

DIFFERENTIATE BETWEEN DIFFERENT
TYPES OF ACCOUNTS
Assets
Liabilities
Stockholders
Equity
Account
2-5
Record of all changes in a particular asset, liability, or

stockholders equity during a period
Basic summary device
LO 2
Assets
Economic resources that provide a future benefit
Cash
Money including bank account balances,

paper currency, coins, certificates of
deposit, and checks
Accounts
Receivable
Promise for future collection of cash from

the sale of goods or providing services
Notes
Receivable
2-6
Promise for future collection of cash
Customer signed note
Interest rate
LO 2
Assets
Inventory
Goods the company sells to customers
Prepaid
Expenses
Expenses paid in advance, such as

insurance and rent
Land
2-7
Cost of land used in operations
LO 2
Assets
Cost of buildings used in operations
Building
Equipment,
Furniture, and
Fixtures
2-8
Cost of furniture, fixture, and equipment

used in operations
Includes heating and air conditioning,

computers, and office furniture
Depreciated
LO 2
Liabilities
A liability is a debt
Accounts
Payable
Promise to pay a debt
Notes Payable
Accrued
Liabilities
2-9
Signed notes promising to pay a future

amount
Liability for an expense not yet paid
LO 2
Stockholders (Owners) Equity

Owners claims to the assets of a corporation
Common
Stock
Owners investment in the corporation

through the ownership of stock
Retained
Earnings
Net income (loss) earned over the

companys lifetime, minus dividends
Dividends
2-10
Distribution to stockholders
Declared by board of directors
LO 2
Stockholders (Owners) Equity

Owners claims to the assets of a corporation
2-11
Revenues
Increase in stockholders equity from

delivering goods or services to customers
Expenses
Decrease in stockholders equity due to

the cost of operating the business
LO 2
Learning Objective
3. Show the impact of business transactions on the
accounting equation
2-12
SHOW THE IMPACT OF BUSINESS

TRANSACTIONS ON THE ACCOUNTING
EQUATION
Example: Freddys Auto Service, Inc.
To illustrate the accounting for transactions, lets assume
Freddy Kish opened Freddys Auto Service, Inc., in April 2014.
2-13
LO 3
Transaction 1. On April 1, Freddy Kish and a few friends invest $50,000 to

open Freddys Auto Service, Inc., in return for common stock.
1. +50,000
2-14
+50,000
LO 3
Transaction 2. Freddys purchases land for a new location and pays cash
of $40,000.
1. +50,000
2. -40,000
2-15
+50,000
+40,000
LO 3
Transaction 3. The business buys supplies on account, agreeing to pay

$3,700 within 30 days.
1. +50,000
2. -40,000
3.
2-16
+50,000
+40,000
+3,700
+3,700
LO 3
Transaction 4. Freddys received $7,000 cash by providing services for

customers.
1. +50,000
2. -40,000
3.
+50,000
+40,000
+3,700
+3,700
4. +7,000
2-17
Service revenue
+7,000
LO 3
Transaction 5. Freddys repairs a fleet of UPS delivery trucks, and UPS

promises to pay Freddys $3,000 within one month.
1. +50,000
+50,000
2. -40,000
3.
+40,000
+3,700
+3,700
4. +7,000
5.
2-18
+7,000
+3,000
Service revenue
+3,000
LO 3
Transaction 6. Freddys Auto Service, Inc., pays $2,700 for the following
expenses: rent, $1,100; employee salaries, $1,200; and utilities, $400.
1. +50,000
+50,000
2. -40,000
3.
+40,000
+3,700
+3,700
4. +7,000
5.
6.
2-19
+7,000
+3,000
+3,000
-2,700
Rent expense
- 1,100
Salary expense
- 1,200
Utilities expense
- 400
LO 3
Transaction 7. Freddys pays $1,900 on account, which means to make a

payment toward an account payable.
1. +50,000
+50,000
2. -40,000
3.
+40,000
+3,700
+3,700
4. +7,000
5.
+3,000
6.
-2,700
7.
-1,900
2-20
+7,000
+3,000
- 2,700
-1,900
LO 3
Transaction 8. Freddy Kish, the major stockholder of Freddys Auto

Service, paid $30,000 from his personal bank account to remodel his home.
1. +50,000
+50,000
2. -40,000
3.
+40,000
+3,700
+3,700
4. +7,000
5.
+7,000
+3,000
6.
-2,700
7.
-1,900
+3,000
-2,700
-1,900
No Entry
2-21
LO 3
Transaction 9. In transaction 5, Freddys performed services for UPS on

account. The business now collects $1,000 from UPS.
1. +50,000
+50,000
2. -40,000
3.
+40,000
+3,700
+3,700
4. +7,000
5.
+3,000
6.
-2,700
7.
-1,900
9. +1,000
2-22
+7,000
+3,000
-2,700
-1,900
-1,000
LO 3
Transaction 10. Freddys receives $22,000 from the sale of land, which is
the same amount that Freddys paid for the land.
1. +50,000
+50,000
2. -40,000
3.
+40,000
+3,700
+3,700
4. +7,000
5.
+3,000
6.
-2,700
7.
-1,900
9. +1,000
10. +22,000
2-23
+7,000
+3,000
-2,700
-1,900
-1,000
-22,000
LO 3
Transaction 11. Freddys Auto Service, Inc., declares a dividend and pays
the stockholders $2,100 cash.
1. +50,000
+50,000
2. -40,000
3.
+40,000
+3,700
+3,700
4. +7,000
5.
+7,000
+3,000
6.
-2,700
7.
-1,900
9. +1,000
10. +22,000
+3,000
-2,700
-1,900
-1,000
-22,000
11. -2,100
2-24
Dividends
-2,100
LO 3
Financial Statements
Exhibit 2-2 | Financial Statements of Freddys Auto Service, Inc.
2-25
LO 3
2-26
LO 3
2-27
LO 3
Illustration
Dr. Luke opened a medical practice specializing in physical
therapy. During the first month of operation (February), the
business, titled Dr. Luke, Professional Corporation (P.C.),
experienced several events.
Requirement
Analyze the effects of the following events on the accounting
equation of the medical practice of Dr. Luke, P.C.
2-28
LO 3
Feb. 1 Dr. Luke invested $100,000 in the business in return for

common stock.
2-29
Advance slide in presentation mode to reveal answer

LO 3
Feb. 5 The business borrowed $50,000, signing a note payable to

the bank.
2-30
LO 3
Feb. 8 The business paid cash for land costing $105,000. Luke
plans to build an office building on the land.
2-31
LO 3
Feb. 11 The business purchased medical supplies for $1,700 on

account.
2-32
LO 3
Feb. 12 Dr. Luke, P.C., officially opened for business.
No Entry
2-33
LO 3
Feb. 14 Dr. Luke treated patients and earned service revenue of

$5,600, receiving cash for half the revenue earned.
Service Revenue
2-34
LO 3
Feb. 16 The business paid employee salaries of $2,300 for the first
half of the month.
Salaries Expense
2-35
LO 3
Feb. 25 Dr. Luke treated patients and received $1,500 cash at the
time of service.
Service Revenue
2-36
LO 3
Feb. 28 The business paid office rent of $1,000.
Rent Expense
2-37
LO 3
Feb. 28 The business paid $500 on account.
$155,500
2-38
$155,500
LO 3
Illustration
Requirements
Using the data from the transaction analysis of the medical practice
of Dr. Luke, P.C., answer the following questions.
a. How much are total assets?
b. How much does the business expect to collect from patients?
c. How much does the business owe in total?
d. How much of the businesss assets does Luke really own?
e. How much net income or net loss did the business
experience during its first month of operations?
2-39
LO 3
a. How much are total assets?
$ 155,000
$155,000
2-40
$155,000
LO 3
b. How much does the business expect to collect from

patients?
$ 2,800
2-41
LO 3
c. How much does the business owe in total?
$ 51,200
2-42
LO 3
d. How much of the businesss assets does Luke

really own?
$ 103,800
2-43
LO 3
e. How much net income or net loss did the business

experience during its first month of operations?
$ 3,800
2-44
LO 3
Learning Objective
4. Analyze the impact of business transactions on
accounts
2-45
ANALYZE THE IMPACT OF BUSINESS

TRANSACTIONS ON ACCOUNTS
Accounting
2-46
Double-entry system
Each transaction affects at least two accounts
LO 4
The T-Account
Record of increases and decreases in

a specific asset, liability, equity,
revenue, or expense element
Debit = Left
Credit = Right
Account
An Account can
be illustrated in a
T-Account form
2-47
LO 4
Increases and Decreases in the Accounts:

The Rules of Debit and Credit
Exhibit 2-3 | Accounting Equation and the Rules of Debit and Credit
The type of account determines how to record

increases and decreases.
2-48
LO 4
Increases and Decreases in the Accounts:

The Rules of Debit and Credit
To illustrate, Freddys Auto Service, Inc., received $50,000 and
issued (gave) stock. What is the effect on the accounts?
Cash
Debit for
increase,
50,000
Common Stock
Credit for
increase,
50,000
Exhibit 2-4 | The Accounting

Equation after Freddys Auto
Services First Transaction
2-49
LO 4
Freddys second transaction is a $40,000 cash purchase of

land. What is the effect on the accounts?
Cash
Bal
50,000
Bal
10,000
Common Stock
Credit for
decrease,
40,000
Land
Bal
50,000
Exhibit 2-5 | The Accounting

Equation after Freddys Auto
Services First Two Transactions
Debit for
increase,
40,000
Bal
2-50
40,000
LO 4
Additional Stockholders Equity Accounts:

Revenues and Expenses
Two categories of income statement accounts
2-51
Revenues
Increase in stockholders equity from

delivering goods or services to customers
Expenses
Decrease in stockholders equity due to

the cost of operating the business
LO 4
Additional Stockholders Equity Accounts:

Revenues and Expenses
Exhibit 2-6 | Expansion of the Accounting Equation
+
Common Stock
Assets
Liabilities
Stockholders
Equity
+
Retained Earnings
Dividends
+
Revenues
Expenses
2-52
LO 4
Final Form of the Rules of Debit and Credit
Exhibit 2-7
2-53
LO 4
Final Form of the Rules of Debit and Credit
Exhibit 2-7
2-54
LO 4
Learning Objective
5. Record (journalize and post) transactions in the
books
2-55
RECORD (JOURNALIZE AND POST)

TRANSACTIONS IN THE BOOKS
Journal
Chronological record of transactions
Three steps
1. Specify each account affected by the transaction and
classify by type
2. Determine if each account is increased or decreased
(debit or credit)
3. Record in the journal
2-56
LO 5
RECORD (JOURNALIZE AND POST)

TRANSACTIONS IN THE BOOKS
Steps to journalize the first transaction of Freddys Auto Service
Business receives $50,000 cash and issues stock
Step 2
Both Cash and Common Stock increase
Step 3
Journalize the transaction:
Date
Accounts and Explanations
Debit
Credit
Apr 1
3
4
2-57
Step 1
Cash
Common Stock
50,000
50,000
Issued common stock.

LO 5
Individual
asset
accounts
Individual
liability
accounts
Individual
equity
accounts
2-58
Exhibit 2-8 | The Ledger (Asset, Liability, and

Stockholders Equity Accounts)
LO 5
Copying Information (Posting) from the

Journal to the Ledger
Exhibit 2-9 | Journal Entry
and Posting to the Accounts
Date
Accounts and Explanations
Debit
Credit
Apr 1
3
4
Posting
to the
Accounts
2-59
Cash
50,000
Common Stock
50,000
Issued common stock.
Cash
50,000
Common Stock
50,000
LO 5
The Flow of Accounting Data

Transaction Occurs
Transaction Analyzed
Transaction Entered in the Journal
Amounts Posted to the Ledger
Accounts
2-60
LO 5
Transactions from Freddys Auto Service

(1) Received $50,000 cash and issued stock to the owners
Accounting
Equation
Assets
Liabilities
+ 50,000
1
2
Ledger
Accounts
50,000
Cash
Common Stock
Cash
(1)
Stockholders Equity
+ 50,000
Journal
Entry
2-61
50,000
Common Stock
50,000
Advance slide in presentation mode to reveal answers

(1)
50,000
LO 5

(2) Paid $40,000 cash for land
Accounting
Equation
Journal
Entry
Assets
2-62
Liabilities
Stockholders Equity
+ 40,000
- 40,000
A
1
2
Ledger
Accounts
B
40,000
Land
Cash
40,000
Cash
(1)
Land
50,000
(2)
40,000
(2)
40,000
LO 5

(3) Purchased supplies for $3,700 on account
Accounting
Equation
Journal
Entry
Assets
+ 3,700
Supplies
2-63
Stockholders Equity
3,700
Accounts Payable
Supplies
(3)
+ 3,700
Ledger
Accounts
Liabilities
3,700
3,700
Accounts Payable
(3)
3,700
LO 5

(4) Performed services for clients and received cash of $7,000
Accounting
Equation
Journal
Entry
Assets = Liabilities + Stockholders Equity + Revenues

+ 7,000
1
2
Ledger
Accounts
2-64
+ 7,000
7,000
Cash
Service Revenue
Cash
7,000
Service Revenue
(1)
50,000
(4)
7,000
(2)
40,000
(4)
7,000
LO 5

(5) Performed services for a customer on account, $3,000
Accounting
Equation
Journal
Entry
Ledger
Accounts
2-65
Assets = Liabilities + Stockholders Equity + Revenues

+ 3,000
+ 3,000
Accounts Receivable
Service Revenue
Accounts Receivable
(5)
3,000
3,000
3,000
Service Revenue
(4)
(5)
7,000
3,000
LO 5

(6) Paid cash expenses: rent, $1,100; employee salary, $1,200;
utilities, $400
Accounting
Equation
Journal
Entry
Assets = Liabilities + Stockholders Equity - Expenses

- 2,700
Rent Expense
1,100
Salary Expense
1,200
3
4
2-66
- 2,700
Utilities Expense
Cash
400
2,700
LO 5

(6) Paid cash expenses: rent, $1,100; employee salary, $1,200;
utilities, $400
A
Journal
Entry
Rent Expense
1,100
Salary Expense
1,200
400
Utilities Expense
Cash
2,700
Rent
Expense
Cash
(1) 50,000
(2) 40,000 (6)
(4)
(6)
2-67
1
3
7,000
2,700
1,100
Salary
Expense
Utilities
Expense
(6)
(6)
1,200
400
LO 5

(7) Paid $1,900 on the account payable created in transaction 3
Accounting
Equation
Journal
Entry
Assets
2-68
Liabilities
- 1,900
1,900
Accounts Payable
Cash
1,900
Cash
(1)
(4)
Stockholders Equity
- 1,900
2
Ledger
Accounts
Accounts Payable
50,000
7,000
(2)
(6)
(7)
40,000
2,700
1,900
(7)
1,900
(3)
3,700
LO 5

(9) Received $1,000 on account
Accounting
Equation
Journal
Entry
Assets
Liabilities
Stockholders Equity
+ 1,000
- 1,000
A
1
2
Ledger
Accounts
B
1,000
Cash
Accounts Receivable
1,000
Cash
(1)
(4)
(9)
Accounts Receivable
50,000
7,000
1,000
(2)
(6)
(7)
40,000
2,700
1,900
2-69
(5)
3,000
(9)
1,000
LO 5

(10) Sold land for cash at the lands cost of $22,000
Accounting
Equation
Journal
Entry
Assets
2-70
Liabilities
Stockholders Equity
+ 22,000
- 22,000
A
1
2
Ledger
Accounts
B
22,000
Cash
Land
22,000
Cash
(1)
(4)
(9)
(10)
Land
50,000
7,000
1,000
22,000
(2)
(6)
(7)
40,000
2,700
1,900
(2)
40,000
(10)
22,000
LO 5

(11) Declared and paid a dividend of $2,100 to the stockholders
Accounting
Equation
Journal
Entry
Ledger
Accounts
2-71
Assets = Liabilities + Stockholders Equity - Dividends

- 2,100
- 2,100
Dividends
Cash
B
2,100
2,100
Cash
(1)
(4)
(9)
(10)
Dividends
50,000
7,000
1,000
22,000
(2)
(6)
(7)
(11)
40,000
2,700
1,900
2,100
(11)
2,100
LO 5
Accounts after Posting to the Ledger

Exhibit 2-11 | Freddys Auto Service, Inc.s Ledger Accounts after Posting
2-72
LO 5
Accounts
after
Posting to
the Ledger
Exhibit 2-11 | Freddys

Auto Service, Inc.s
Ledger Accounts after
Posting (partial)
2-73
Accounts
after
Posting to
the Ledger
Exhibit 2-11 | Freddys

Auto Service, Inc.s
Ledger Accounts after
Posting (partial)
2-74
Learning Objective
6. Construct and use a trial balance
2-75
CONSTRUCT AND USE A TRIAL BALANCE

Trial Balance
2-76
Lists all accounts with their balances
Assets listed first, then liabilities and stockholders

equity
Shows that debits equal credits
Usually prepared at the end of the period
Facilitates preparation of the financial statements
LO 6
Analyzing Accounts
Suppose Freddys Auto Service began May with cash of
$1,000. During May, Freddys received cash of $8,000 and
ended the month with a cash balance of $3,000.
You can compute total cash payments by analyzing Freddys
Cash account:
Cash
Beginning balance
Cash receipts
1,000
Cash payments
Ending balance
8,000
6,000
3,000
* 1,000 + 8,000 - 3,000 = 6,000
2-77
LO 6
Analyzing Accounts
You can compute either sales on account or cash collections
on account by analyzing the Accounts Receivable account
(using assumed amounts):
Accounts Receivable
Beginning balance
Sales on account
6,000
Collections on account
Ending balance
10,000
11,000
5,000
* 6,000 + 10,000 - 5,000 = 11,000
2-78
LO 6
Analyzing Accounts
You can determine how much you paid on account by
analyzing Accounts Payable (using assumed amounts):
Accounts Payable
Beginning balance
Payments on account
4,000
Ending balance
6,000
* 9,000 + 6,000 - 11,000 = 4,000
2-79
* Purchases on account
9,000
11,000
LO 6
Correcting Accounting Errors
2-80
Missing account
Trace each account from journal to

ledger
Divide out-ofbalance amount

by 2
Reversing debits and credits doubles

the error
Divide out-ofbalance amount

by 9
If an integer (no decimals), error may be

a slide or transposition
LO 6
Chart of Accounts
Exhibit 2-13 | Chart of AccountsFreddys Auto Service, Inc.
2-81
LO 6
The Normal Balance of an Account

Exhibit 2-14 | Normal Balances of the Accounts
2-82
LO 6
Account Formats
Two Formats:
T-account
Four column
Exhibit 2-15 | Account in Four-Column Format
2-83
LO 6
Analyzing Transactions Using Only

T-Accounts
2-84
Decisions often are made without a complete

accounting system
T-accounts allow managers to analyze transactions

quickly
LO 6
Analyzing Transactions Using T-Accounts

For example, the managers of Whole Foods Market, Inc.,
may consider borrowing $100,000 to buy equipment. To see
how the two transactions affect Whole Foods Market, Inc., the
manager can go directly to T-accounts.
(a) Borrow
(b) Buy Equipment
(a)
Equipment
Note Payable
(b)
2-85
Cash
100,000
100,000
(b)
100,000
(a)
100,000
LO 6
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Learning Objective

1. Explain what a transaction is

Copyright 2015 Pearson Education Inc. All rights reserved.

EXPLAIN WHAT A TRANSACTION IS

Any event that has a financial impact on the business

Can be measured reliably

Provides information about an exchange

Accounting records both sides of a transaction

Copyright 2015 Pearson Education Inc. All rights reserved.

EXPLAIN WHAT A TRANSACTION IS

Copyright 2015 Pearson Education Inc. All rights reserved.

Copyright 2015 Pearson Education Inc. All rights reserved.

DEFINE ACCOUNT, AND LIST AND

Record of all changes in a particular asset, liability, or

Basic summary device

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Money including bank account balances,

Promise for future collection of cash from

Promise for future collection of cash

Customer signed note

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Goods the company sells to customers

Expenses paid in advance, such as

Cost of land used in operations

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Cost of furniture, fixture, and equipment

Includes heating and air conditioning,

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Promise to pay a debt

Signed notes promising to pay a future

Liability for an expense not yet paid

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Stockholders (Owners) Equity

Owners investment in the corporation

Net income (loss) earned over the

Declared by board of directors

Copyright 2015 Pearson Education Inc. All rights reserved.

Stockholders (Owners) Equity

Increase in stockholders equity from

Decrease in stockholders equity due to

Copyright 2015 Pearson Education Inc. All rights reserved.

Copyright 2015 Pearson Education Inc. All rights reserved.

SHOW THE IMPACT OF BUSINESS

Copyright 2015 Pearson Education Inc. All rights reserved.

Transaction 1. On April 1, Freddy Kish and a few friends invest $50,000 to

Copyright 2015 Pearson Education Inc. All rights reserved.

Copyright 2015 Pearson Education Inc. All rights reserved.

Transaction 3. The business buys supplies on account, agreeing to pay

Copyright 2015 Pearson Education Inc. All rights reserved.

Transaction 4. Freddys received $7,000 cash by providing services for

Copyright 2015 Pearson Education Inc. All rights reserved.

Transaction 5. Freddys repairs a fleet of UPS delivery trucks, and UPS

Copyright 2015 Pearson Education Inc. All rights reserved.

Copyright 2015 Pearson Education Inc. All rights reserved.

Transaction 7. Freddys pays $1,900 on account, which means to make a

Copyright 2015 Pearson Education Inc. All rights reserved.

Transaction 8. Freddy Kish, the major stockholder of Freddys Auto

Copyright 2015 Pearson Education Inc. All rights reserved.

Transaction 9. In transaction 5, Freddys performed services for UPS on

Copyright 2015 Pearson Education Inc. All rights reserved.

Copyright 2015 Pearson Education Inc. All rights reserved.

Copyright 2015 Pearson Education Inc. All rights reserved.

Copyright 2015 Pearson Education Inc. All rights reserved.