Chapter 2

Learning Objective One

Recording Business
Transactions

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 Chapter 2’s Learning Objectives

1. Describe common types of accounts

2. Illustrate the impact of business transactions on the
accounting equation
3. Analyze business transactions using T-accounts
4. Record business transactions in the journal and post them
to the ledger
5. Prepare and use a trial balance

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 Learning Objective One
Learning Objective One
Describe common types of accounts

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 4

Business Transactions

• Accounting focuses on events that have an economic impact on

the entity.
– Transactions are such events that have a financial impact
on a business and that can be reliably measured (i.e., must
be able to reliably assign a $ value).
– E.g., When you purchase an iPad from Apple store for $500:
i. has a financial impact on Apple, and
ii. Apple can reliably assign a $ value ($500)
 Apple will record this sale (transaction) in its
accounting records.

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 Accounts

• An Account is a record of each asset, liability and elements of

shareholders’ equity.

• The accounts listed on the financial statements are aggregation

of a number of specific accounts.
– E.g., Apple keeps separate accounts for its different products,
but combines these accounts as Inventories on Balance Sheet.

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 Common Types of Accounts

• Recall the Accounting Equation:

A = L + SE
• Each asset (A), liability (L), and shareholders’ equity (SE) has its
own account used to record transactions affecting related A, L,
SE during an accounting period.

• Let’s look at common types of accounts before learning how to

record transactions.

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 Common Account Titles – Balance Sheet
• Assets: Economic resources that provide future benefit.
• Liabilities: debts/other obligations of the business that must be satisfied
in the future.
• Shareholders’ Equity: Owners’ claims on company’s assets.
Assets (A) Liabilities (L)
Cash Trade Payable
Short-Term Investment Accrued Liabilities(expense
Trade Receivables incurrer, but not occured yet.)
Notes Receivable（not day Notes Payable
to day） Taxes Payable
Inventory(raw, complete, Deferred Revenue (customer
uncomplete) pay cash, rervice not
Prepaid Expenses provided yet, get cash when
Long-Term Investments provide services)
Equipment Bonds Payable Shareholders’ Equity (SE)
Buildings Contributed Capital 7
Land(property, plant) Retained Earnings
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Receivables & Payables

Receivables - always an asset because it represents an amount

that will be received in the future.
• Receivables are often related to customers.

Payables - always a liability because it represents an amount that

will be paid in the future.
• Payables are often related to vendors/suppliers.

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 Shareholders’ Equity Accounts
Assets = Liabilities + SE
Assets = Liabilities + (Capital + RE)
Assets = Liabilities + (Capital + Beginning RE + Net Income - Dividends)
Expanded Accounting Equation SE

Assets = Liabilities + (Capital + Beg RE + Rev +Gains – Exp - Losses – Div)

Share capital Owners’ investment in the company

Retained earnings Cumulative net income (loss) less dividends
Dividends Distributions to owners
Revenues Income from providing goods and services
Gains Income outside the company’ s normal operations
Expenses Costs of operating a business
Losses Expenses outside the company’ s normal operations
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Common Account Titles – Income Statement

1. Revenue: Income earned from ordinary business activities. Revenues

increase net income and RE, thus increase SE.
2. Gains: Another form of income earned from peripheral activities. Gains
increase net income and RE, thus increase SE. (investment, sell equips)
3. Expense: Costs incurred the course of ordinary business activities.
Expenses decrease net income and RE, thus decrease SE.
4. Losses: Another form of expense incurred in the course of peripheral
activities. Losses decrease net income and RE, thus decrease SE.

Expenses
Cost of Sales
Revenues
Wages Expense
Sales Revenue
Rent Expense
Fee Revenue
Interest Expense
Interest Revenue
Depreciation Expense
Rent Revenue
Insurance Expense
Income Tax Expense 10
 Learning Objective Two
Learning Objective One
Illustrate the impact of business
transactions on the accounting equation

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 Accounting for Business Transactions

• A transaction is an event that:

1. affects the financial position of the business entity, and
2. can be reliably recorded.
• Transactions are analyzed according to their effect on the accounting
equation (elements of the statement of financial position).
For every transaction, the net amount on the left side of the
equation must equal the net amount on the right side.

A = L + SE
– i.e., The accounting equation must BALANCE after each
transaction is recorded.
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Two Principles of Transaction Analysis

1. Every transaction affects at least two accounts (duality of effects).

– e.g., Tara Inc. issued common shares for $50K in cash:

 Cash (increase in an asset)

 Share Capital (increase in an SE)

2. The accounting equation must remain in balance after each

transaction.

A = L + SE
$50K Balance  $50K
 Accounting for Business Transactions

• Let’s analyze and record 11 transactions of Tara Inc (page 59-64).

• Exhibit 2-1 (page 65) illustrates how these 11 transactions affect
the accounting equation.

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 Accounting for Business Transactions

Transaction 1:
Booth, Savard and several fellow engineers invest $50,000
to begin Tara Inc., and the business
issues share capital.
TYPE OF
SHAREHOLDERS’ SHAREHOLDERS’
ASSETS LIABILITIES + EQUITY EQUITY TRANSACTION
Cash = Share Capital
(1) + 50,000 +50,000 Issued common shares

Left = Right 

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 Accounting for Business Transactions

Transaction 2:
Tara Inc. purchases land and
pays $40,000 in cash.

SHAREHOLDERS’
ASSETS LIABILITIES + EQUITY
Cash + Land Share Capital
Balance 50,000 = 50,000
(2) −40,000 + 40,000
Bal. 10,000 40,000 50,000

50,000 50,000

Left = Right 

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 Accounting for Business Transactions

Transaction 3:
The business buys stationery and other office
supplies on account agreeing to pay $3700 within 30 days.

SHAREHOLDERS’
ASSETS LIABILITIES + EQUITY
Cash + Office + Land Accounts Payable + Share Capital
Supplies
Bal. 10,000 40,000 = 50,000
(3) +3700 +3,700
Bal. 10,000 3,700 40,000 3,700 50,000

53,700 53,700

Left = Right 

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 Accounting for Business Transactions

Transaction 4:
Tara Inc. earns service revenue of
$7,000 and collects this amount in cash.

SHAREHOLDERS’
ASSETS LIABILITIES + EQUITY
Cash + Office + Land Accounts Share Retained
+ +
Supplies Payable Capital Earnings
Bal. 10,000 3,700 40,000 3,700 50,000

(4) + 7,000 = 7,000

Bal. 17,000 3,700 40,000 3,700 50,000 7,000

60,700 60,700

Left = Right 
Credit Revenue, and Revenue on the Income statements goes into Net
Income, which goes to Retained Earning, which goes to Balance sheet18
Owner's Equity.
 Accounting for Business Transactions

Transaction 5:
Tara Inc., performs service
and earns $3,000 on account.

ASSETS LIABILITIES + SHAREHOLDERS’ EQUITY

Cash + Accounts + Office + Land Accounts Share Retained
+ +
Receivable Supplies Payable Capital Earnings
Bal. 17,000 3,700 40,000 = 3,700 50,000 7,000
(5) + 3,000 +3,000
Bal. 17,000 3,000 3,700 40,000 3,700 50,000 10,000

63,700 63,700

Left = Right 

On account: On credit.
Because the services is provided right away, so credit revenue rather than cred
recrrued revenue. 19
 Accounting for Business Transactions

Transaction 6:
Tara Inc. pays $2,700 for the following expenses:
office rent $1,100, employee salary $1,200
and utilities $400
ASSETS LIABILITIES + SHAREHOLDERS’ EQUITY
Accounts Office Land Accounts Share Retained
Cash + + + + +
Receivable Supplies Payable Capital Earnings
Bal. 17,000 3,000 3,700 40,000 3,700 50,000 10,000
(6) –1,100 = –1,100
–1,200 –1,200
– 400 – 400
Bal. 14,300 3,000 3,700 40,000 3,700 50,000 7,300

61,000 61,000

Left = Right 
Expenses----Net loss/income-----Retained Earning----Balance Sheet-SE
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 Accounting for Business Transactions

Transaction 7:
Tara pays $1,900 on account for supplies purchased
in Transaction 3.

ASSETS LIABILITIES + SHAREHOLDERS’ EQUITY

Accounts Office Land Accounts Share Retained
Cash + + + + +
Receivable Supplies Payable Capital Earnings
Bal. 14,300 3,000 3,700 40,000 = 3,700 50,000 7,300
(7) –1,900 –1,900
Bal. 12,400 3,000 3,700 40,000 1,800 50,000 7,300

59,100 59,100

Left = Right 

on account----on credit
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Accounting for Business Transactions

Transaction 8:
The owner pays for the re-modeling of
his home at a cost of $30,000.

This event is a transaction of the

personal entity, not the business entity.
No transaction is recorded for Tara Inc.

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 Accounting for Business Transactions

Transaction 9:
The business collects $1,000
from a customer on account.

ASSETS LIABILITIES + SHAREHOLDERS’ EQUITY

Accounts Office Land Accounts Share Retained
Cash + + + + +
Receivable Supplies Payable Capital Earnings
Bal. 12,400 3,000 3,700 40,000 = 1,800 50,000 7,300
(9) +1,000 –1,000
Bal. 13,400 2,000 3,700 40,000 1,800 50,000 7,300

59,100 59,100

Left = Right 

收走了以前没收的钱-----recive on account
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 Accounting for Business Transactions

Transaction 10:
Tara Inc. sells part of the land purchased in
Transaction 2 for $22,000 in cash.

ASSETS LIABILITIES + SHAREHOLDERS’ EQUITY

Accounts Office Land Accounts Share Retained
Cash + + + + +
Receivable Supplies Payable Capital Earnings
Bal. 13,400 2,000 3,700 40,000 = 1,800 50,000 7,300
(10) +22,000 –22,000
Bal. 35,400 2,000 3,700 18,000 1,800 50,000 7,300

59,100 59,100

Left = Right 

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 Accounting for Business Transactions

Transaction 11:
The corporation declares a dividend and pays
$2,100 cash to the shareholders.

ASSETS LIABILITIES + SHAREHOLDERS’ EQUITY

Cash + Accounts + Office + Land Accounts + Share + Retained
Receivable Supplies Payable Capital Earnings
Bal. 35,400 2,000 3,700 18,000 = 1,800 50,000 7,300
(11) –2,100 –2,100
Bal. 33,300 2,000 3,700 18,000 1,800 50,000 5,200

57,000 57,000

Left = Right 

dividend paid from Share Holders' Equity

debit dividend, cr Cash, but since no dividend acn here, so debit RE 25

 Accounting for Business Transactions
Summary of Tara Inc.’s 11 transactions at the month end.

Assets = Liabilities + Shareholders’ Equity

Trans Cash AR Supplies Land AP C Shares RE
1 50,000 50,000
2 (40,000) 40,000
3 3,700 3,700
4 7,000 7,000
5 3,000 3,000
6 (2,700) (1,100)
(1,200)
(400)
7 (1,900) (1,900)
9 1,000 (1,000)
10 22,000 (22,000)
11 (2,100) (2,100)
Bal 33,300 2,000 3,700 18,000 1,800 50,000 5,200
Totals 57,000 57,000
Note: Accounting Eq’n.balances  26
 Transactions and Financial Statements

• Exhibit 2-1 (page 65) shows the data needed for the financial
statements:

Income Statement data appear as revenues and expenses

under Retained Earnings. The revenues increase
retained earnings; the expenses decrease retained earnings.

Statement of Retained Earnings adds net income

(or net loss) from the income statement. Dividends are
subtracted. Ending retained earnings is the final result.

Balance Sheet data are composed of the ending balances

of the assets, liabilities, and shareholders’ equity

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 Financial Statements

• Income statement
Revenues – Expenses = Net Income

• Statement of Retained Earnings

Beg. Balance RE = Net Income – Dividends =
End. Balance RE

Note: End. RE is
• Balance Sheet included in SE
Assets = Liabilities + Shareholders’ Equity

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 Income Statement

Tara Inc.
Income Statement
Month Ended April 30, 2017
Revenues

Service revenue ($7,000 + $3,000) $ 10,000

Expenses

Salary expense $ 1,200

Rent expense 1,100

Utilities expense 400

Total expenses 2,700

Net income $ 7,300

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 Statement of Retained Earnings

Tara Inc.
Statement of Retained Earnings
Month Ended April 30, 2017
Retained earnings, April 1, 2017 $ 0

Add: Net income for the month 7,300

Subtotal 7,300

Less: Dividends declared (2,100)

Retained earnings, April 30, 2017 $5,200

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 Balance Sheet

Tara Inc.
Balance Sheet
April 30, 2017
Assets Liabilities
Cash $ 33,300 Accounts payable $ 1,800
Accounts receivable 2,000 Shareholders’ Equity
Office supplies 3,700 Common shares 50,000
Land 18,000 Retained earnings 5,200
Total shareholders’ equity 55,200
Total assets $ 57,000 Total liabilities and shareholders’ equity $ 57,000

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 What “on account” means?

• There are four ways “on account” is used in transactions:

1. Performed services on account  means A/R increases

2. Collected on account means  A/R decreases

3. Purchased on account means  A/P increases

4. Paid on account means  A/P decreases

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 Learning Objective Three
Learning Objective One
Analyze business transactions using T-
accounts

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 Chart of Accounts
• Chart of accounts lists all the accounts and their account numbers.
Accounts are numbered beginning with assets, then labilities, shareholders’
equity, revenues, and finally expenses (Exhibit 2-3 p 69)
BALANCE SHEET ACCOUNTS
Assets Liabilities Shareholders’ Equity
101 Cash 201 Accounts Payable 301 Share Capital
111 Accounts Receivable 231 Notes Payable 311 Dividends
141 Office Supplies 312 Retained Earnings
151 Office Furniture
191 Land
INCOME STATEMENT ACCOUNTS
(PART OF SHAREHOLDERS’ EQUITY)
Revenues Expenses
401 Service Revenue 501 Rent Expense
502 Salary Expense
503 Utilities Expense
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 Double-Entry Accounting

Double-entry system of accounting.

– It’s called double-system because every transaction has two

sides and affects at least two accounts.

Assets = Liabilities + Shareholders' Equity

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 The T-Account

Account Title
LEFT SIDE RIGHT SIDE
Debit Credit

• “T-account” is a simple tool to represent an account.

– It has a left side  called the debit side, and

– It has a right side  called the credit side.

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 The Rule of Debit & Credit

Assets = Liabilities + SE

Debit balance accounts Credit balance accounts

• Left is Debit and Right is Credit, Thus T-Account

debit credit

 Assets on the left  Increases on the left (debit) side

 Liabilities on the right  Increase on the right (credit) side

 SE on the right  Increase on the right (credit) side

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 Increases and Decreases in the Accounts
Exhibit 2-4 (page 70)

• Increase in asset accounts are recorded on the left (debit) side

• Increases in liability and SE accounts are recorded on the right (credit) side
– Expenses and dividends are the exceptions. Because they decrease
shareholders’ equity. Hence, increases in these accounts are recorded
on the left (debit) side.
– Refer to expanded Accounting Equation (see next slide)
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 Increases and Decreases in the Accounts

Expanded Accounting Equation

A = L + (Share Capital + Beg RE + Rev + Gains – Expenses
– Losses – Dividends)
Rearrange:
A + Expenses + Losses + Dividends = L+ Capital + Beg RE
+ Rev + Gains
 Assets, expenses, losses, and dividends increase the debit
side.
 All other account types increase the credit side.

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 Rules of Debit and Credit

Exhibit 2-8 (page 72)

Assets = Liabilities + Shareholders’ Equity

Assets Liabilities Share Capital Retained Earnings
Debit Credit Debit Credit Debit Credit Debit Credit
+ − − + − + − +

Revenue
Debit Credit
− +
Dividends Expenses
Debit Credit Debit Credit
+ − + −

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 Normal Balances of Accounts

Assets Debit
Liabilities Credit
Shareholders’ Equity—overall Credit
Share capital Credit
Retained earnings Credit
Dividends Debit
Revenues Credit
Expenses Debit

Normal Balances

Assets Liabilities
Expenses Revenues
Dividends Common Shares
Retained Earnings

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 Rules of Debit and Credit - Example

Transaction 1

Tara Inc. received $50,000 and issued shares.

Assets = Liabilities + Shareholders’ Equity

Cash (A) Share Capital (SE)

Debit Credit for
for Increase,
Increase, 50,000
50,000

Net Income is not

an account
Transaction: 1. a least 2 accounts
2. Equation must balance 42
 Rules of Debit and Credit – Example 2

Transaction 2
Tara Inc. purchases land for $40,000 cash.

Assets = Liabilities + Shareholders’ Equity

Cash (A) Share Capital (SE)
Bal. 50,000 Credit
for Bal. 50,000
Decrease,
40,000

Land (A)
Debit
Paid on account: pay account payable
for Collect on Account: collect from account re
Increase,
40,000

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 Learning Objective Four
Learning Objective One
Record business transactions in the
journal and post them to the ledger

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 The Journal

• Accountants use a chronological record of transactions called a journal.

• The journalizing process follows three steps (Exhibit 2-9 on page 73):

1. Specify the accounts affected by the transaction and their type

(asset, liability, shareholders’ equity).
2. Determine if each account is increased or decreased.
 Use debit credit rules: Is it a Dr. or Cr. given account type and
whether it increases/decreases?
 Remember: the amounts of debits must equal the amount of the
credits.
3. Record in journal (journalizing the transaction)
 Debited accounts are written first (on top) and entered on the left
margin.
 Credited accounts are written below the debits and indented to
the right.
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 Journal Entry - Example

Transaction 1: Tara Inc. received $50,000 and issued shares.

JOURNAL
Date Accounts and explanation Debit Credit
Apr. 2 Cash 50,000
Share Capital 50,000
Issued common share

Reference: Account Titles: Amounts:

Letter, Debited accounts on top. Debited amounts on left.
number, or Credited accounts on bottom Credited amounts on right.
date. usually indented.
Description of transaction
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 Copying Information (Posting) from the Journal
to the Ledger
• Ledger is a book that contains all of the company’s accounts.
 Each account has a debit and a credit side (like T-Account).
• After journal entries are prepared, the accountant posts
(transfers) the dollar amounts to each account affected by the
transaction to determine new account balances – a process
called posting.

JOURNAL
Date Accounts and explanation Debit Credit Ledger
Apr. 2 Cash 50K
Post
Share Capital 50K

Issued common share

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 Copying Information (Posting) from the Journal
to the Ledger

JOURNAL
Date Accounts and explanation Debit Credit Ledger
Apr. 2 Cash 50K
Post
Share Capital 50K

Issued common share

Posting
Cash Share Capital
50,000 50,000

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 The Ledger

Cash

Ledger
Individual
asset Share
accounts Capital

Individual
equity
accounts
Accounts
Payable Individual
liability
accounts

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 Flow of Accounting Data

• Exhibit 2-10 (page 74) shows the flow of accounting data from
business transaction to the ledger.

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 Accounts After Posting
Exhibit 2-11 (page 78)
Assets = Liabilities + Shareholders’ Equity
Cash Accounts Payable Dividends
(1) 50,000 (2) 40,000 (11) 2,100
(7) 1,900 (3) 3,700
(4) 7,000 (6) 2,700 Bal. 2,100
(9) 1,000 (7) 1,900 Bal. 1,800
(10) 22,000 (11) 2,100
EXPENSES
Bal. 33,300 Share Capital Rent Expense
Accounts Receivable (1) 50,000 (6) 1,100
(5) 3,000 (9) 1,000 Bal. 50,000 Bal. 1,100
Bal. 2,000
REVENUE Salary Expense
Office Supplies Service Revenue (6) 1,200
(3) 3,700 (4) 7,000 Bal. 1,200
Bal. 3,700 (5) 3,000
Utilities Expense
Land Bal.
(6) 400
10,000
(2) 40,000 (10) 22,000 Bal. 400
Bal. 18,000

Debit Balance $57K = Credit Balance $57K  51

 Why Journal and Ledger?

• Businesses need both:

– Journal: A chronological record of transactions (the journal),
and
– Ledger: A record of each account's activity and its balance.
 Therefore, both are necessary to ensure that data are reported
accurately.
Note: The journal gives more information than a ledger account
because it shows a complete effect of each transaction, not just
one side of it.

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 Learning Objective Five
Learning Objective One
Prepare and use a trial balance

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 unadjusted, adjusted
Trial Balance post-closed.

• A trial balance lists all ledger accounts with their balances.

– Facilitates preparation of the financial statements.
• usually prepared at the end of the accounting period
• lists assets first, then liabilities, and shareholders’ equity
• Essentially has three columns: (1) account name; (2) debit; and (3)
credit
• reports total debit balance and total credit balance at the bottom
• Total debits must equal total credits.
• Once debits and credits balance, we can prepare the financial
statements using the account balances.

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 Trial Balance
• Note the following:
1. Trial balance is NOT one of our four financial statements.
2. Types of errors detected by a trial balance (i.e., whether Total
Dr. = Total Cr.) are the kinds of errors made by humans but
not computers.
3. Equal trial balance totals proves only that debits posted to
accounts equal credits posted to accounts.
 It does NOT prove that the trial balance does not have
errors and that it is correct.
 In other words, errors in transactions that have equal
debits and credits will NOT be revealed by unequal totals!

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 Trial Balance – Tara Inc.
Use Tara’s ledger accounts to prepare the Trial Balance
– Exhibit 2-12 (page 79)
Tara Inc.
Trial Balance
April 30, 2017
Balance
Account Title Debit Credit
Cash $33,300
Accounts receivable 2,000
Supplies
Assets 3,700
Land 18,000
Accounts payable Liability $1,800
Common shares 50,000
Dividends 2,100
Service revenue Shareholders’ 10,000
Rent expense Equity 1,100
Salary expense 1,200
Utilities expense 400
Total $61,800 = $61,80056