CHAPTER TWO – ANALYZING AND RECORDING TRANSACTIONS

 The accounting process identifies business transactions and events,

analyzes and records their effects, and summarizes and presents
information in reports and financial statements.

The Accounting Cycle

 The accounting cycle refers to the series of steps required to prepare a

set of financial statements for users. These steps referred to as a cycle
because they are repeated each time financial statements are prepared
for that company, also known as a reporting period.
ACCOUNTING CYCLE

Prepare post-closing Analyse transactions - Source Documents

Trial Balance
Journalize - Recording in a Journal

Close

Post - Transferring to an Account or Ledger

Prepare Fin Statements

Prepare unadjusted - Proof equality of debits & credits

Trial balance

Prepare adjusted
Trial balance Adjustments

The Account

 An Account is a detailed record of increases and decreases in a specific

asset, liability, or equity item. Information is taken from counts, analyzed,
summarized and presented in useful reports and financial statements for
users.
 A Ledger is the term used to describe a record containing all individual
accounts used by a business. In other words, a ledger is a group of Accounts

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 Cash Acc no. 101
Date Description PR* Debit Credit Balance
Jan 1, Investment by the owner GJ1 10000 10000
2019

 *Post Reference
Mrs. X Capital/Equity Acc no. 301

Date Description PR* Debit Credit Balance

Jan 1, Investment by the owner GJ1 10000 10000
2019

Asset Accounts

 The transaction to acquire the asset has occurred

 The company has control over the assets ( owns/has title to the asset)
 A future benefit exists for the company as it is used in operations

Current Assets: includes such as Cash, Accounts Receivable, Inventory, supplies,

Prepayments and so on.

Fixed Assets/PPE/Non-current Assets: includes like Equipment, Building,

Machinery, Furniture, Vehicles etc

PPE = Property, Plant & Equipment

Liability Accounts

 They are present obligation as result of past event

 The company has an outstanding obligation to pay via a transfer of assets or
provision of services in the future.

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Current Liabilities: include accounts like Accounts Payable, Notes Payable, Taxes
Payable, Unearned Revenue and so on

Long-term Liabilities/Non-current Liabilities: Includes such as Long-term bank

loans, Bonds, Debentures etc

Equity/Capital Accounts

 Investments by the owner

 Withdrawals by the owner
 Revenues (Transferred through Profit or Loss)
 Expenses (Transferred through Profit or Loss)

However, Revenue and Expense Accounts have their own categories in Income
Statement, though at the end of the day (the bottom-line) is transferred to the
Balance Sheet and this in turn either increases the Owners Equity or Decreases it.

T-Accounts

A T- account is a helpful learning tool that prepares an account in the ledger. It

shows the effects of individual transactions on specific accounts.

 An account balance is the difference between the increases and decreases

recorded in an account.
 The left side of a T-account is always called the Debit Side (Dr)
 The right side of a T-account is always called the Credit Side (Cr)

Dr Cash 101 CR

Debit (Dr) is defined to as the left hand side of an account, while Credit (Cr) is
referred to as the right hand side of an account.

Double-Entry Accounting

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Double-entry accounting means every transaction affects and is recorded in at least
two accounts. For the accounting records to be accurate, every time a transaction is
recorded the total amount debited must equal the total amount credited

DEBITS = CREDITS

Debits and Credits Effects for Accounts A = L + C/E

Accounts Asset Liability Equity

Debit Increase Decrease Decrease
Credit Decrease Increase Increase

Accounts that Affect the Equity Account

Accounts Additional Owners Revenues / Expenses

Investment Withdrawal Sales
Debit Decrease Increase Decrease Increase
Credit Increase Decrease Increase Decrease

 The green ones happened very rarely when you want to adjust some entries

Normal Balances

Assets – Debit Side

Liabilities = Credit Side
Equity/Capital – Credit Side
Revenue/ Income – Credit Side
Expenses – Debit Side

Chart of Accounts

The chart of accounts is a list of all accounts used in the ledger by a company. It
includes an identification number assigned to each account.

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101 - 199 – Asset Accounts (1)
201 – 299 – Liability Accounts (2)
301 – 399 – Equity Accounts (3)
401 – 499 – Revenue Accounts (4)
501 – 599 – Cost of sales accounts (Cost of Goods Sold) ( 5)
601 – 699 – Expense Accounts (6)

Exercise 1

Indicate whether the normal balance of each of the following accounts is Debit
or Credit and indicate also whether they are Assets, Liabilities, Equity,
Revenue or Expense.

- Equipment ( Asset – Debit), Land( Asset – Debit), Mr. X withdrawal

(Equity – Debit) , Rent expense ( Expenses – Debit), Interest income
( Revenue/Income – Credit), Prepaid Rent ( Asset – Debit) , Accounts
Receivable ( Asset – Debit), Office Supplies (Asset – Debit), Notes
Receivable (Asset – Debit), Notes Payable (Liability – Credit), Mr. X,
Equity/Capital ( Equity – Credit), Rent Revenue (Revenue – Credit),
Rent Payable (Liability – Credit), Interest expense (Expense- Debit) ,
Interest Payable (Liability – Credit)

Exercise 2

The following accounts are from XYZ Company. For each account, complete the
following:

1) The basic account category (Asset, Liability, Equity, Withdrawal, Revenue,

Expense)
2) The financial statement the account is recorded ( Income Statement,
Statement of change in Equity, or Balance sheet)
3) The Normal Balance (Debit or Credit)
4) The effect of a debit to the account ( Increase or Decrease)
5) The effect of a credit (Increase or Decrease)

Cash, Supplies, Accounts Payable, XYZ, Capital, XYZ, withdrawals, Revenue,

Salaries expense, Accounts receivable, Notes payable, Prepaid insurance

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 Basic Financial Normal Effect of Effect of
account (1) Statement(2) Balance a Debit a Credit
(3) (4) (5)
Cash Asset Bal. sheet Debit Increase Decrease
Supplies Asset Bal. sheet Debit Increase Decrease
Accounts Liability Balance Credit Decreases Increase
Payable sheet
XYZ Equity/Capital Balance Credit Decrease Increase
Capital sheet or *
XYZ Equity/Capital Balance Debit Increase Decrease
Withdrawal Sheet or *
Revenue Revenue Income Credit Decrease Increase
statement
Salary Expense Income Debit Increase Decrease
expense statement
Accounts Asset Balance Debit Increase Decrease
receivable sheet
Notes Liability Balance Credit Decrease Increase
Payable sheet
Prepaid Asset Balance Debit Increase Decrease
Insurance sheet
*Statement of change in Equity

Recording and Posting Transactions

The first four steps of the accounting cycle:

 The first step in accounting cycle is to identify a business transaction

 The second step is to record journal entries
 The third step is to transfer the account – posting to the ledger
 The last step here is preparing the Trial Balance

Journal Entry Analysis

 A journal is a record where journal entries are posted in chronological order.

 A journal entry refers to an individual transaction that has been entered in
the journal, and provides information regarding the date the transaction is
entered, as debit & credit.
 The process of recording transactions in a journal is called Journalising.

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  A transaction affecting two accounts – Single Journal entry
 A transactions affecting three or more – Compound Journal entry

General Journal Page no. 1

Date Account Titles & explanation PR Debit Credit

Jan 1, Cash 101 10000
2019 Mrs. X Capital 301 10000
Investment by the owner
Ja1, Supplies 2500
2019 Cash 2500
Purchase of supplies

Every transaction is recorded in a General Journal then it will be posted or

transferred to the Ledger/Account.

Recording Entry Positing to ledgers preparing Trial Balance

Accounting Transactions in Action

1. Investment by Owner – Mrs. X to open a business invested $10000 cash -
Jan 1,2019
Debit Credit
Jan 1, 2019 Cash 10000
Mrs. X Capital 10000
Investment by the owner

2. Purchase of supplies for cash $2500. – Jan 1, 2019

Debit Credit
Jan1, 2019 Supplies 2500
Cash 2500
To purchase supplies

3. Purchase of Equipment and Supplies on Credit (loan) – Supplies for $1100

& Equipment for $ 6000 ( signed a promissory note) – Jan 4

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 Debit Credit
Jan 4, 2019 Supplies 1100
Equipment 6000
Accounts payable 1100
Notes Payable 6000
Purchase of supplies &
Equipment on credit

4. Service rendered for cash: Jan 10 – Sales of $2200 for cash

Debit Credit
Jan 10, 2019 Cash 2200
Food income 2200
Sales of food on cash

5. Payment of expenses in cash – Jan 10, $1000 cash for rent of the month

Debit Credit
Jan 10, 2019 Rent expense 1000
Cash 1000
Rent of the month

6. Payment of expense in cash – Jan 10, - Paid $700 cash for employee’s salary

Debit Credit
Jan10, 2019 Salary expense 700
Cash 700
Payment of salary

7. Services contract signed for February. – Jan 11, signed a contract to provide
for next month food worth of $2700
No recording

8. Services and training fees on credit (loan). Jan 17, training fees - $300 and
food catering $1600 on account

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 Debit Credit
Jan 17, 2019 Accounts Receivable 1900
Food income 1600
Training income 300
Income from Food catering
& training on account

9. Receipt of cash on account (loan). Jan 27, - $1900 received from our
customer in transaction no. 8
Debit Credit
Cash 1900
Accounts Receivable 1900
Collection of cash from our
Customer

10.Partial payment of accounts payable – Jan 27, - $900 is paid to our supplier
of transaction no. 3 towards the accounts payable

Debit Credit
Jan 27, 2019 Accounts Payable 900
Cash 900
Partial payment to our supplier

11.Withdrawal of cash by Owner. Jan 28, - $600 withdrawal by owner

Debit Credit
Jan 28, 2019 Mrs. X withdrawal 600
Cash 600
Withdrawal of cash by
the owner

12.Receipt of cash for future services. Jan 29, - $3000 for food catering to be
provided for next month
Debit Credit
Jan 29, 2019 Cash 3000
Unearned food service revenue 3000 (Liability)
Collection of cash in advance

13.Payments of cash for future insurance coverage. Jan 30, - $2400 premium
for a two years insurance policy.
Debit Credit
Jan 30, 2019 Prepaid Insurance 2400
Cash 2400
Insurance premium of
2 years paid in advance

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 14.Payment of expense in Cash. Jan 31, - $230 for internet/ phone etc
Debit Credit
Jan 31, 2019 Communication expense 230
Cash 230
Payment of internet/phone fees

15.Payment of expense in Cash. Jan 31, - $700 paid for salary of the employee

Debit Credit
Jan 31, 2019 Salary expense 700
Cash 700
Payment of salary

NB. Check the Posting of these transactions and the Trial Balance in the Excel
sheets renamed as Chapter 2 & Chapter 2.1 respectively

LEDGERS

 A General Ledger (Controlling account) summarizes each financial

statement account, providing a total balance in each account used in the
Organization’s chart of accounts.
 Detailed information on account activity is required to be maintained in
subsidiary ledgers (Sub account) ; the account in the general ledger contains
the total balance for each account.
 Once journal entries are recorded in the appropriate journal, transactions
details need to be posted to the appropriate ledger. Ledgers contain financial
statement activity for each specific account.

TRIAL BALANCE

 A Trial Balance is a list of accounts and their balances at a point in time.

Account balances are reported in the debit or credit column of the trial
balance.
 Another use of the trial balance is as an internal report for preparing
financial statements. Preparing statements is easier when we can take
account balances from a trial balance instead of searching the ledger.
 The sum of debit account balances must always equal the sum of credit
account balances.
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  Trial Balance can be defined as the form that shows as proof of debits and
credits balance

MID – CHAPTER DEMONSTRATION PROBLEM

Kara Morris founded her dream business, called Kara’s Kiteboarding Adventures.
The following transactions occurred during June 2020, her first month of
operations.

a) Kara invested $15000 cash into the business on June 1

b) Kara’s Kiteboarding paid $400 to cover insurance for the month of June.
c) June 3, Kara’s Kiteboarding purchased $12,000 worth of Kiteboarding
equipment on credit.
d) June 6, the business rented additional Kiteboarding equipment for $1,500 on
account
e) June 9, the business provided lessons to a group of clients for $3,500 on
account
f) June 14, the business collected $2,000 from its credit customers
g) The Kiteboarding equipment purchased June 3, on credit was paid for June
28

Required:

1. Open the following T-accounts: Cash, Accounts Receivable, Equipment,

Accounts Payable, Kara Morris, Capital; Teaching Revenue, Insurance
Expense, Equipment Rental Expense.
2. Post the June entries directly into the T-accounts

Analysis Component:

Using your answer in Part 2, prove that the accounting equation balances at the end
of June.

NB. Check the answers in the Excel sheet - demonstration Problem

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Questions

1. Explain the accounting cycle

Possible answer: The accounting cycle represents the steps followed in each
reporting period for the purpose of preparing financial statements

2. What is the normal balance of assets, liabilities, revenue, expenses,

withdrawals, and capital accounts?

Possible Answer: Normal balance of Assets, Withdrawals and Expenses is Debit

side; while normal balance of Liabilities, Revenue, and Capital is Credit side

3. Why are posing reference numbers entered in the journal when entries are
posted to accounts?

Possible Answer: Posting reference is entered; first, as a control over the posting
process. Second, they provide cross-reference to trace debits & credits for other
people who check the financial statements

4. Does Debit always mean increase and credit always mean decrease

Possible Answer: No. Debit and credit both can mean increase or decrease. The
particular meaning depends on the type of the account.

5. What kinds of transactions increase equity? What kinds decrease equity?

Possible Answer: Investment and revenue increases Equity while withdrawals and
expenses decrease equity.

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QS 2-13 – Preparing Journal Entries

January 3 Stan Adams opened a landscaping business by investing $60,000 cash

and equipment having a $40,000 fair value

4 Purchased office supplies on credit for $340

6 Received $5,200 for providing landscaping services to a customer

15 Paid $200 regarding the office supplies purchase of January 4

16 Purchased $700 of office supplies on account

30 Paid the balance owing of the office supplies purchase of January 4

a) Prepare journal entries for the following transactions that occurred during
January2020:
Debit Credit
Jan 3 Cash 60000
Equipment 40000
Stan Adams, Capital 100000
To record Stan Adams Capital

Jan4 Office Supplies 340

Accounts payable 340
Purchase of supplies
On credit

Jan6 Cash 5200

Landscaping service Revenue 5200
To record income from
services rendered

Jan 15 Accounts Payable 200

Cash 200

Jan 16 Office Supplies 700

Accounts payable 700

Jan 30 Accounts Payable 140

Cash 140

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b) Set up the following ledger accounts using a T-account

Cash (101), Office Supplies (124), Equipment (163), Accounts Payable (201), Stan
Adams, Capital (301), Landscaping Services Revenue (403)
Cash 101 Office Supplies 124 Equipment 163

60000 200 340 40000

5200 140 700
Bal 64860 Bal 1040

Accounts payable 201 Stan A, Cap 301 Landscaping S. Revenue 403

200 340 100000 5200

140 700
Bal 700
c) Post the journal entries from the above to the general ledger accounts

Assets = 64860 + 1040 + 40000 = $105,900

Liabilities = $700

Capital = $ 100000 + 5200 = 105200

Liabilities + Capital = 700 + 105200 = $105,900

Exercise 2-9 – Journalizing, Posting, Trial Balance, and Financial Statements

Check Figures: Total Debits = $25,470 (no 4); Total assets $17,530 (no. 5)

Manny Gill is an entrepreneur who started West Secure, a business that provides a
number of security guard services. West secure incurred the following transactions
during July 2020, its first month of operations:

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July1 The owner, Many Gill invested $5,200 cash
Debit Credit
July 1 Cash 5200
Manny G. Capital 5200

Investment by the owner

July 10 Purchased $2,700 worth of security equipment on credit

July 10 Equipment 2700
Accounts payable 2700

Purchase of equipment
On account
July 12 Performed security services for a sold-out concert and received
$12,000 cash from the client

July 12 Cash 12000

Security service revenue 12000

Recording income for cash

14 Paid for expenses; $3,700

July 14 Various expenses 3700
Cash 3700
Payment of expenses

15 Completed security services for graduation event and sent the client a bill
for $1,600

July 15 Accounts Receivable 1600

Security service revenue 1600
To record revenue on account

31 The owner withdrew $270 cash for personal use

July 31 Withdrawals 270

Cash 270

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 To record personal withdrawal
By the owner

Required:
1. Set up the following general ledger accounts using either the T-account
format or the balance column format: Cash, 101; Accounts Receivable, 106;
Equipment, 150; Accounts Payable, 201; Manny Gill, capital, 301; Manny
Gill, Withdrawals, 302; Revenue, 401; Expenses, 501.
2. Record the journal entries for the month of July
3. Post the July journal entries into your general ledger accounts. Include the
date next to each number posted. Determine the balances.
4. Prepare the trial balance using the balances in your general ledger accounts
5. Prepare an income statement, statement of changes in equity, and the
balance sheet based on your trial balance. (don’t do this question)

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