Principles of Accounting

Chapter 2

RECORDING FINANCIAL
TRANSACTIONS
Content

• Financial Transactions
• Definition of Account
•Types of Account
•The Impact of Financial Transactions on Accounts
•Recording Transactions in The Books
•Construct and Use a Trial Balance

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 Financial Transaction

A transaction is any event that has a financial impact on the

business and can be measured reliably.
• Provides objective information about the financial impact on an
exchange
– Gives something
– Receives something
• Accounting records both sides of the transaction

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 Financial Transaction
• Transactions may be identified as either external or internal
transactions.
• External transactions are realized between the company
and a third party (an outside enterprise). Sale of goods to
customers is an example of external transaction.
• Internal transactions refer financial transactions which
occur entirely within one company. The use or consume of
raw materials for the production is an example of internal
transaction.

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 Financial Transaction
• Each transaction has two aspects and both of them will affect the
statement of financial position
• Each transaction has a dual effect on the accounting equation
• Dual effect means that at least two items must be affected by a
transaction and accounting equation has to remain in balance
after making the changes in accounting equation
• Accordingly, if an asset item is increased, there must be a
corresponding decrease in another asset item, or increase in a
liability item, or increase in owner’s equity item in the same
amount.

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Financial Transaction
• For example,
• A company collect $100,000 in account receivables. In this
transaction the cash which is an asset item is increased by
$100,000 while the accounts receivable which is another asset
item is decreased by $100,000. In the end, the accounting
equation remains in balance

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Account
The accounting equation expresses the basic relationship of
accounting.

Assets  Liabilities  Stockholder's  owner's  Equity

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 Account
• An account is the record of all the changes in a particular
asset, liability, or shareholders’ equity during a period.
– Basic summary device.

• An account is an individual accounting tool that shows the

increases and decreases in a specific asset, liability, or owner’s
equity item during a specified period.

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Different Types of Accounts
Assets: economic resources that provide a future benefit.
• Cash
– Money including bank account balances, paper currency, coins,
certificates of deposits and checks.
• Accounts Receivable (arises from credit sales)
– Promise for future cash payments for goods or service sold on
credit
• Notes Receivable (more formal form of A/R)
– Promissory note, specifying an interest rate, signed by a customer
to pay on a certain day. (includes interest)
• Inventory
– Goods the company sells customers.

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Different Types of Accounts

• Prepaid expenses
– Expenses paid in advance, as insurance or rent.
• Property, plant and equipment (PPE)
– Cost of the land, buildings and equipment owned by a
company.

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Different Types of Accounts
Liabilities: a debt or payable.
• Accounts payable
– Promise to pay debt.
• Notes payable
– Signed notes promising to pay a future amount.
• Accrued liabilities
– Liability for an expense you have not yet paid.

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Different Types of Accounts
Equity: the owner’s claims to the assets of the company
• Share capital
– Owner’s investment in the corporation through shares.
• Retained earnings
– Cumulative net income minus net losses and dividends
over the company’s life.
• Dividends
– Distribution of the company’s earnings to its
shareholders.

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Different Types of Accounts

• Income
– Increase in shareholder’s equity from delivering goods
or services to customers.
• Expenses
– Decrease in shareholder’s equity due to the cost of
operating a business.

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Analyze the Impact of Business
Transactions on the Accounting Equation
Example: RedLotus Travel, Inc.

To illustrate the accounting for transactions, we will

consider 11 transactions and analyze each in terms of
its effect on RedLotus Travel.

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Transaction 1
On, April 1, Starr Williams and a few friends invest $50,000
to open RedLotus Travel, Inc., and the business issues
common stock to the stockholders.

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Transaction 2
RedLotus purchases land for a new location and pays cash
of $40,000.

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Transaction 3
The business buys supplies on account, agreeing to pay
$3,700 within 30 days.

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Transaction 4
RedLotus earns $7,000 of service revenue by providing
services for customers.

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Transaction 5
RedLotus performs services on account, which means that
RedLotus lets some customers pay later.

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Transaction 6
During the month, RedLotus Travel, Inc., pays $2,700 for the
following expenses: rent $1,100; employee salaries, $1,200;
and utilities, $400.

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Transaction 7
RedLotus pays $1,900 on account, which means to make a
payment toward an account payable.

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Transaction 8
Starr Williams, the major stockholder of RedLotus Travel,
paid $30,000 out of his personal bank account to remodel
his home.

No Entry

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Transaction 9
In transaction 5, RedLotus performed services for UPS on
account. The business now collects $1,000 from UPS.

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Transaction 10
RedLotus sells some land for $22,000, which is the same
amount RedLotus paid for the land and makes a $2,000
gain.

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Transaction 11
RedLotus Travel, Inc., declares a dividend and pays the
stockholders $2,100 cash.

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Transaction Analysis: RedLotus Travel, Inc.

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Transaction Analysis: RedLotus Travel, Inc.

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Transaction Analysis: RedLotus Travel, Inc.

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Analyze the Impact of Business
Transactions on Accounts
Accounting:
• Double-entry system
• Records dual effects of each transaction
– At least two accounts in each transaction

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 Analyze the Impact of Business
Transactions on Accounts
Double- entry System:
• The equality of debits and credits provides the basis for the
double-entry system of recording transactions.
• In a double-entry system, equal debits and credits are made
in the accounts for each transaction.
• Under double-entry system, debit and credit procedure is
used to keep the accounting equation in balance by using
appropriate accounts instead of using plus and minus
procedure.
• Equality between the sum of all the debits and the sum of all
the credits maintains the balance of accounting equation.
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Analyze the Impact of Business
Transactions on Accounts
The T-Account
• Record of increases and decreases in a specific
asset, liability, equity, revenue, or expense
• Left side = “Debit”
• Right side = “Credit”

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Accounting Equation and the Rules
of Debit and Credit

The type of account determines how to record increases and

decreases.

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Final Form of the Rules of Debit and Credit

income and revenue shows credist balnace

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 Final Form of the Rules of Debit and Credit
• Dr./Cr. Rules for Assets: Assets increase on left side by debiting while
decrease on right side by crediting and normally show debit balance.
• Dr./Cr. Rules for Liabilities: Liabilities increase on right side by crediting
while decrease on left side by debiting and normally show credit balance.
• Dr./Cr. Rules for Contributions (Owner’s capital): Contributions increase
on right side by crediting while decrease on left side by debiting and
normally show credit balance.
• Dr./Cr. Rules for Distributions (Owner’s withdrawals): Distributions
increase on left side by debiting while decrease on right side by crediting
and normally show debit balance.
• Dr./Cr. Rules for Revenues: Revenues increase on right side by crediting
while decrease on left side by debiting and normally show credit balance.
• Dr./Cr. Rules for Expenses: Expenses increase on left side by debiting
while decrease on right side by crediting and normally show debit balance.
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Final Form of the Rules of Debit and Credit

• The total amount of debits must be equal to the total amount of

credıts.
• Assets, owner’s withdrawals, and expenses increase by
debiting (on left side) and normally show debit balance.
• Liabilities, owner’s capital, and revenues increase by crediting
(on right side) and normally show credit balance.

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Flow of Accounting Data

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Record (Journalize and Post)
Transactions in the Books
Journal and Journalizing
• 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

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Journal and Journalizing

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Record Transactions in the Journal Book
Steps to journalize the first transaction of RedLotus Travel, Inc.
Step 1 Business receives $50,000 cash and issues stock
Step 2 Both Cash and Common Stock increase
Step 3 Journalize the transaction:

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Journal and Journalizing

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The Ledger (Asset, Liability, and
Shareholders’ Equity Accounts)

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Journal Entry and Posting to the Accounts

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Transaction 1 Analysis
(1) Received $50,000 cash and issued stock to the owners

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Transaction 2 Analysis
(2) Paid $40,000 cash for land

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Transaction 3 Analysis
(3) Purchased supplies for $3,700 on account

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Transaction 4 Analysis
(4) Performed services and received cash of $7,000

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Transaction 5 Analysis
(5) Performed services for UPS on account, $3,000

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Transaction 6 Analysis
(6) Paid cash expenses: rent, $1,100; employee salary,
$1,200; utilities, $400

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Transaction 7 Analysis
(7) Paid $1,900 on the payable created in transaction 3

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Transaction 8 Analysis
(8) Stockholder of RedLotus remodeled her home with
personal funds

No Entry

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Transaction 9 Analysis
(9) Received $1,000 on account

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Transaction 10 Analysis
(10) Sold land for cash at the land’s cost of $22,000 and a
gain of $2,000 is recognized

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Transaction 11 Analysis
(11) Declared and paid a dividend of $2,100 to shareholders

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Alladin Travel, Inc.’s, Ledger Accounts
after Posting

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Trial Balance
Trial Balance
• Lists all accounts with their balances
• Assets listed first, then liabilities and shareholders’
equity
• Shows that debits equal credits
• Usually prepared at the end of the period
• Facilitates preparation of the financial statements

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Trial Balance

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Chart of Accounts—RedLotus Travel, Inc.

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Normal Balances of the Accounts

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