Chapter 2 RECORDING PROCESS

An account is an individual accounting record of increases and decreases in a specific

asset, liability, or owner’s equity item. For example, the company would have separate
accounts for Cash, Accounts Receivable, Accounts Payable, Service Revenue, Salaries and
Wages Expense, and so on. In its simplest form, an account consists of three parts: (1) a title,
(2) a left or debit side, and (3) a right or credit side. Because the format of an account
resembles the letter T, we refer to it as a T account.

Debits and Credits

The term debit indicates the left side of an account, and credit indicates the right side. They
are commonly abbreviated as Dr. for debit and Cr. for credit. They do not mean increase or
decrease, the act of entering an amount on the left side of an account is called debiting the
account. Making an entry on the right side is crediting the account. When comparing the
totals of the two sides, an account shows a debit balance if the total of the debit amounts
exceeds the credits. An account shows a credit balance if the credit amounts exceed the
debits.

DEBIT AND CREDIT PROCEDURE

Each transaction must affect two or more accounts to keep the basic accounting equation in
balance. In other words, for each transaction, debits must equal credits. The equality of
debits and credits provides the basis for the double-entry system of recording transactions.
Under the double-entry system, the dual (two-sided) effect of each transaction is recorded
in appropriate accounts.
DR./CR. PROCEDURES FOR ASSETS AND LIABILITIES
increases in Cash—an asset—were entered on the left side, and decreases in Cash were
entered on the right side. We know that both sides of the basic equation (Assets = Liabilities
+ Owner’s Equity) must be equal. It therefore follows that increases and decreases in
liabilities will have to be recorded opposite from increases and decreases in assets. Thus,
increases in liabilities must be entered on the right or credit side, and decreases in liabilities
must be entered on the left or debit side.

Asset accounts normally show debit balances. That is, debits to a specific asset account
should exceed credits to that account. Likewise, liability accounts normally show credit
balances. That is, credits to a liability account should exceed debits to that account. The
normal balance of an account is on the side where an increase in the account is recorded.

DR./CR. PROCEDURES FOR OWNER’S EQUITY

owner’s investments and revenues increase owner’s equity. Owner’s drawings and expenses
decrease owner’s equity. Investments by owners are credited to the Owner’s Capital
account. Credits increase this account, and debits decrease it. When an owner invests cash
in the business, the company debits (increases) Cash and credits (increases) Owner’s Capital.
When the owner’s investment in the business is reduced, Owner’s Capital is debited
(decreased).

Owner’s Drawings. An owner may withdraw cash or other assets for personal use.
Owner’s Drawings is increased by debits and decreased by credits. Normally, the drawings
account will have a debit balance. The Owner’s Drawings account decreases owner’s equity.
It is not an income statement account like revenues and expenses.

Revenues and Expenses. The purpose of earning revenues is to benefit the owner(s) of
the business. When a company earns revenues, owner’s equity increases. Therefore, the
effect of debits and credits on revenue accounts is the same as their effect on Owner’s
Capital. That is, revenue accounts are increased by credits and decreased by debits.

Summary of Debit/Credit Rules

Steps in the Recording Process

Practically every business uses three basic steps in the recording process:
1. Analyze each transaction for its effects on the accounts.
2. Enter the transaction information in a journal.
3. Transfer the journal information to the appropriate accounts in the ledger.
The Journal
Companies initially record transactions in chronological order (the order in which they
occur). Thus, the journal is referred to as the book of original entry. For each transaction the
journal shows the debit and credit effects on specific accounts. the most basic form of
journal is a general journal. Typically, a general journal has spaces for dates, account titles
and explanations, references, and two amount columns.
JOURNALIZING Entering transaction data in the journal is known as journalizing. Companies
make separate journal entries for each transaction. A complete entry consists of (1) the date
of the transaction, (2) the accounts and amounts to be debited and credited, and (3) a brief
explanation of the transaction.
1 The date of the transaction is entered in the Date column.
2 The debit account title (that is, the account to be debited) is entered first at the extreme left
margin of the column headed “Account Titles and Explanation,” and the amount of the debit is
recorded in the Debit column.
3 The credit account title (that is, the account to be credited) is indented and entered on the next
line in the column headed “Account Titles and Explanation,” and the amount of the credit is
recorded in the Credit column.
4 A brief explanation of the transaction appears on the line below the credit account title. A space is
left between journal entries. The blank space separates individual journal entries and makes the
entire journal easier to read.
5 The column titled Ref. (which stands for Reference) is left blank when the journal entry is made.
This column is used later when the journal entries are transferred to the ledger accounts.
The Ledger
The entire group of accounts maintained by a company is the ledger. The ledger keeps in one place
all the information about changes in specific account balances. Companies may use various kinds of
ledgers, but every company has a general ledger. A general ledger contains all the asset, liability, and
owner’s equity accounts, Companies arrange the ledger in the sequence in which they present the
accounts in the financial statements, beginning with the balance sheet accounts. First in order are
the asset accounts, followed by liability accounts, owner’s capital, owner’s drawings, revenues, and
expenses. Each account is numbered for easier identification. The ledger provides the balance in
each of the accounts.
POSTING
Transferring journal entries to the ledger accounts is called posting. This phase of the recording
process accumulates the effects of journalized transactions into the individual accounts. Posting
involves the following steps. 1. In the ledger, in the appropriate columns of the account(s) debited,
enter the date, journal page, and debit amount shown in the journal. 2. In the reference column of
the journal, write the account number to which the debit amount was posted. 3. In the ledger, in the
appropriate columns of the account(s) credited, enter the date, journal page, and credit amount
shown in the journal. 4. In the reference column of the journal, write the account number to which
the credit amount was posted.
A trial balance
A trial balance is a list of accounts and their balances at a given time. Customarily, companies
prepare a trial balance at the end of an accounting period. They list accounts in the order in which
they appear in the ledger. Debit balances appear in the left column and credit balances in the right
column. The trial balance proves the mathematical equality of debits and credits after posting.
Under the double-entry system, this equality occurs when the sum of the debit account balances
equals the sum of the credit account balances. A trial balance may also uncover errors in journalizing
and posting. For example, a trial balance may well have detected the error at Fidelity Investments
discussed in the Feature Story. The steps for preparing a trial balance are: 1. List the account titles
and their balances in the appropriate debit or credit column. 2. Total the debit and credit columns.
3. Prove the equality of the two columns.
Limitations of a Trial Balance A trial balance does not guarantee freedom from recording
errors, however. Numerous errors may exist even though the trial balance columns agree. For
example, the trial balance may balance even when: 1. a transaction is not journalized, 2. a correct
journal entry is not posted, 3. a journal entry is posted twice, 4. incorrect accounts are used in
journalizing or posting, or 5. offsetting errors are made in recording the amount of a transaction. As
long as equal debits and credits are posted, even to the wrong account or in the wrong amount, the
total debits will equal the total credits. The trial balance does not prove that the company has
recorded all transactions or that the ledger is correct.
Use of Dollar Signs
Note that dollar signs do not appear in journals or ledgers. Dollar signs are typically used only in the
trial balance and the financial statements. Generally, a dollar sign is shown only for the first item in
the column and for the total of that column. A single line is placed under the column of figures to be
added or subtracted. Total amounts are double-underlined to indicate they are final sums.
BE2-1 For each of the following accounts, indicate the effects of (a) a debit and (b) a credit
on the accounts and (c) the normal balance of the account. 1. Accounts Payable. 2.
Advertising Expense. 3. Service Revenue. 4. Accounts Receivable. 5. Owner’s Capital. 6.
Owner’s Drawings.
E2-1 Johan Aslata has prepared the following list of statements about accounts. 1. An
account is an accounting record of either a specific asset or a specific liability. 2. An account
shows only increases, not decreases, in the item it relates to. 3. Some items, such as Cash
and Accounts Receivable, are combined into one account. 4. An account has a left, or credit
side, and a right, or debit side. 5. A simple form of an account consisting of just the account
title, the left side, and the right side, is called a T account. Instructions Identify each
statement as true or false. If false, indicate how to correct the statement.
E2-2 Selected transactions for M. Anderson, an interior decorator, in her fi rst month of
business, are as follows. Jan. 2 Invested $10,000 cash in business. 3 Purchased used car for
$4,000 cash for use in business. 9 Purchased supplies on account for $500. 11 Billed
customers $2,100 for services performed. 16 Paid $350 cash for advertising. 20 Received
$700 cash from customers billed on January 11. 23 Paid creditor $300 cash on balance
owed. 28 Withdrew $1,000 cash for personal use by owner. Instructions For each
transaction, indicate the following. (a) The basic type of account debited and credited
(asset, liability, owner’s equity). (b) The specific account debited and credited (cash, rent
expense, service revenue, etc.). (c) Whether the specific account is increased or decreased.
(d) The normal balance of the specific account. Use the following format, in which the
January 2 transaction is given as an example.

P2-1A Frontier Park was started on April 1 by H. Hillenmeyer. The following selected events
and transactions occurred during April. Apr. 1 Hillenmeyer invested $35,000 cash in the
business. 4 Purchased land costing $27,000 for cash. 8 Incurred advertising expense of
$1,800 on account. 11 Paid salaries to employees $1,500. 12 Hired park manager at a salary
of $4,000 per month, effective May 1. 13 Paid $1,650 cash for a one-year insurance policy.
17 Withdrew $1,000 cash for personal use. 20 Received $6,800 in cash for admission fees.
25 S old 100 coupon books for $25 each. Each book contains 10 coupons that entitle the
holder to one admission to the park. 30 Received $8,900 in cash admission fees. 30 Paid
$900 on balance owed for advertising incurred on April 8. Hillenmeyer uses the following
accounts: Cash, Prepaid Insurance, Land, Accounts Payable, Unearned Service Revenue,
Owner’s Capital, Owner’s Drawings, Service Revenue, Advertising Expense, and Salaries and
Wages Expense. Instructions Journalize the April transactions.
P2-2A Desiree Clark is a licensed CPA. During the first month of operations of her business,
the following events and transactions occurred. May 1 Clark invested $20,000 cash in her
business. 2 Hired a secretary-receptionist at a salary of $2,000 per month. 3 Purchased
$2,500 of supplies on account from Read Supply Company. 7 Paid office rent of $900 cash
for the month. 11 Completed a tax assignment and billed client $3,200 for services provided.
12 Received $3,500 advance on a management consulting engagement. 17 Received cash of
$1,200 for services completed for C. Desmond Co. 31 Paid secretary-receptionist $2,000
salary for the month. 31 Paid 60% of balance due Read Supply Company. Instructions (a)
Journalize the transactions. (b) Post to the ledger accounts. (c) Prepare a trial balance on
May 31, 2012.
P2-5A The Chicago Theater is owned by Rashied Davis. All facilities were completed on
March 31. At this time, the ledger showed: No. 101 Cash $4,000, No. 140 Land $10,000, No.
145 Buildings (concession stand, projection room, ticket booth, and screen) $8,000, No. 157
Equipment $6,000, No. 201 Accounts Payable $2,000, No. 275 Mortgage Payable $8,000,
and No. 301 Owner’s Capital $18,000. During April, the following events and transactions
occurred. Apr. 2 Paid fi lm rental of $1,100 on first movie. 3 Ordered two additional films at
$1,000 each. 9 Received $2,800 cash from admissions. 10 Made $2,000 payment on
mortgage and $1,000 for accounts payable due. 11 Chicago Theater contracted with
Virginia McCaskey to operate the concession stand. McCaskey is to pay 17% of gross
concession receipts (payable monthly) for the rental of the concession stand. 12 Paid
advertising expenses $500. 20 Received one of the films ordered on April 3 and was billed
$1,000. The film will be shown in April. 25 Received $5,200 cash from admissions. 29 Paid
salaries $2,000. 30 Received statement from Virginia McCaskey showing gross concession
receipts of $1,000 and the balance due to The Chicago Theater of $170 ($1,000 3 17%) for
April. McCaskey paid one-half of the balance due and will remit the remainder on May 5. 30
Prepaid $1,200 rental on special fi lm to be run in May. In addition to the accounts identifi
ed above, the chart of accounts shows: No. 112 Accounts Receivable, No. 136 Prepaid Rent,
No. 400 Service Revenue, No. 429 Rent Revenue, No. 610 Advertising Expense, No. 726
Salaries and Wages Expense, and No. 729 Rent Expense. Instructions (a) Enter the beginning
balances in the ledger as of April 1. Insert a check mark (✓) in the reference column of the
ledger for the beginning balance. (b) Journalize the April transactions. Chicago records
admission revenue as service revenue, rental of the concession stand as rent revenue, and fi
lm rental expense as rent expense. (c) Post the April journal entries to the ledger. Assume
that all entries are posted from page 1 of the journal. (d) Prepare a trial balance on April 30,
2012.
CCC2 After researching the different forms of business organization. Natalie Koebel decides
to operate “Cookie Creations” as a proprietorship. She then starts the process of getting the
business running. In November 2011, the following activities take place. Nov. 8 Natalie
cashes her U.S. Savings Bonds and receives $520, which she deposits in her personal bank
account. 8 She opens a bank account under the name “Cookie Creations” and transfers $500
from her personal account to the new account. 11 Natalie pays $65 for advertising. 13 She
buys baking supplies, such as flour, sugar, butter, and chocolate chips, for $125 cash. (Hint:
Use Supplies account.) 14 Natalie starts to gather some baking equipment to take with her
when teaching the cookie classes. She has an excellent top-of-the-line food processor and
mixer that originally cost her $750. Natalie decides to start using it only in her new business.
She estimates that the equipment is currently worth $300. She invests the equipment in the
business. 16 Natalie realizes that her initial cash investment is not enough. Her grandmother
lends her $2,000 cash, for which Natalie signs a note payable in the name of the business.
Natalie deposits the money in the business bank account. (Hint: The note does not have to
be repaid for 24 months. As a result, the note payable should be reported in the accounts as
the last liability and also on the balance sheet as the last liability.) 17 She buys more baking
equipment for $900 cash. 20 She teaches her first class and collects $125 cash. 25 Natalie
books a second class for December 4 for $150. She receives $30 cash in advance as a down
payment. 30 Natalie pays $1,320 for a one-year insurance policy that will expire on
December 1, 2011.
Instructions (a) Prepare journal entries to record the November transactions. (b) Post the
journal entries to general ledger accounts. (c) Prepare a trial balance at November 30.