Accounting 1

Fundamentals
of Accounting
Lesson 1a

Uses of Accounting Information

and the Financial Statements

Introduction
Accounting is widely defined as the art of
recording, classifying, and summarizing in a
significant manner and in terms of money,
transactions and events which are, in part at
least, of financial character, then analyzing and
interpreting the results thereof.
Accounting is a set of concepts and techniques
that are used to measure and report financial
information about an economic unit.
It has been used for thousand years now with the
earliest accounting records dating back more
than 7,000 years, were found in Mesopotamia
(Assyrians).

Introduction
The people of that time relied on primitive
accounting methods to record the growth of
crops and herds.
In 1494, Luca Pacioli, a Renaissance era monk,
developed a method for tracking the success or
failure of trading ventures in his book, Summa
de Arithmetica, Geometria, Proportioni et
Proportionalita.
The foundation of that method became the
principle behind the double-entry bookkeeping
system and continues to serve the modern
business world.
He is now referred to as the Father of

Introduction
Today, accounting is called "the language of
business" because it is the vehicle for reporting
financial information about a business entity to
many different groups of people.
It is also considered as the framework of
Management (Brain/
business.
Mental System)
Marketing

(Sensory/
Nerve System)

Finance &
Investments

(Blood/Circulatory)

Human Resource
(Heart/Cardiology)

Accounting &
Information System

(Anatomy/Physiology)

Operations & Production

(Limbs/Motor System)

Accounting as Information System

Accounting an information system that
measures, processes, and communicates financial
information about an economic entity.
Economic entity a unit that exists
independently, such as a business, a hospital, or a
governmental body.
Accountants focus on the needs of decision
makers who use financial information, whether
those decision makers are inside or outside a
business or other economic entity.
Accountants provide a vital service by supplying
the information decision makers need to make
reasoned choices among alternative uses of

Goals, Activities & Measures

A business is an economic unit that aims to sell
goods and services to customers at prices that
will provide an adequate return to its owners.
The two major goals of all businesses are
profitability and liquidity.
1. Profitability is the ability to earn enough
income to attract and hold investment capital.
2. Liquidity is the ability to have enough cash to
pay debts when they are due.

Goals, Activities & Measures

All businesses pursue their goals by engaging in
operating, investing, and financing activities.
Operating activities include selling goods and
services to customers, employing managers
and workers, buying and producing goods and
services, and paying taxes.
Investing activities involve spending the
capital a company receives in productive ways
that will help it achieve its objectives, such as
buying land, buildings, equipment, and other
resources that are needed to operate the
business and selling them when they are no
longer needed.

Goals, Activities & Measures

Financing activities involve obtaining
adequate funds, or capital from creditors, such
as banks and suppliers, and from owners, to
begin operations and to continue operating;
and may also include repaying creditors and
paying a return to the owners.
An important function of accounting is to
provide performance measures, which indicate
whether managers are achieving their business
goals and whether the business activities are well
managed.
The evaluation and interpretation of financial
statements and related performance measures is

Financial & Management Acctg

Accountings role of assisting decision makers
by measuring, processing, and communicating
financial information is usually divided into the
categories of management accounting and
financial accounting.
Although the functions of management
accounting and financial accounting overlap, the
two can be distinguished by the principal users
of the information they provide.
Management accounting provides internal
decision makers, who are charged with achieving
the goals of profitability and liquidity, with
information about operating, investing, and

Financial & Management Acctg

Managers and employees who conduct the
activities of the business need information that
tells them how they have done in the past and
what they can expect in the future.
Financial accounting generates reports
(financial statements) and communicates them to
external decision makers so they can evaluate
how well the business has achieved its goals.
Financial statements report directly on the goals
of profitability and liquidity and are used
extensively both inside and outside a business to
evaluate the businesss success.
It is important for every person involved with a

Users of Accounting Information

The basic management functions are:
Financing the business: obtaining funds so that
a company can begin and continue operating
Investing resources: investing assets in
productive ways that support a companys
goals
Producing goods and services: managing the
production of goods and services
Marketing goods and services: overseeing how
goods or services are advertised, sold, and
distributed
Managing employees: overseeing the hiring,

Users of Accounting Information

Providing information to decision makers:

gathering data about all aspects of a
companys operations, organizing the data
into usable information, and providing reports
to manager

Accounting 1

Fundamentals
of Accounting
Lesson 1b

Uses of Accounting Information

and the Financial Statements

Accounting Measurement
To make an accounting measurement, the
accountant must answer four basic questions:
1. What is measured?
2. When should the measurement be made?
3. What value should be placed on what is
measured?
4. How should what is measured be classified?
Every system must define what it measures, and
accounting is no exception.
Basically, financial accounting uses money to
gauge the impact of business transactions on
separate business entities.

Accounting Measurement
Business transactions are economic events that
affect a businesss financial position and are the
raw material of accounting reports.
A transaction can be an exchange of value (a
purchase, sale, payment, collection, or loan)
between two or more parties.
A transaction also can be an economic event that
has the same effect as an exchange transaction
but that does not involve an exchange.
Some examples of non-exchange transactions
are losses from fire, flood, explosion, and theft;
physical wear and tear on machinery and
equipment; and the day-by-day accumulation of

Accounting Measurement
Money Measure is a concept in which all
business transactions are recorded in terms of
money.
Money is the only factor common to all business
transactions, and thus it is the only unit of
measure capable of producing financial data that
can be compared.
The monetary unit a business uses depends on
the country in which the business resides.
In international transactions, exchange rates
must be used to translate from one currency to
another.

Accounting Measurement
For accounting purposes, a business is a
separate entity, distinct not only from its
creditors and customers but also from its owners.
It should have its own set of financial records,
and its records and reports should refer only to
its own affairs.

Forms of Business Organization

1. A sole proprietorship is a business owned by
one person.
The owner takes all the profits or losses of the
business and is liable for all its obligations.
2. A partnership is like a sole proprietorship in
most ways, but it has two or more owners.
The partners share the profits and losses of the
business according to a prearranged formula.
Generally, any partner can obligate the business
to another party, and the personal resources of
each partner can be called on to pay the
obligations.

Forms of Business Organization

A partnership must be dissolved if the ownership
changes, as when a partner leaves or dies.
If the business is to continue as a partnership
after this occurs, a new partnership must be
formed.
Both the sole proprietorship and the partnership
are convenient ways of separating the owners
commercial activities from their personal
activities.
Legally, however, there is no economic
separation between the owners and the
businesses.

Forms of Business Organization

3. A corporation, on the other hand, is a business
unit chartered by the state and legally separate
from its owners (the stockholders).
The stockholders, whose ownership is
represented by shares of stock, do not directly
control the corporations operations.
Instead, they elect a board of directors to run the
corporation for their benefit.
In exchange for their limited involvement in the
corporations operations, stockholders enjoy
limited liability; that is, their risk of loss is
limited to the amount they paid for their shares.

Financial Position
Financial position refers to a companys
economic resources, such as cash, inventory, and
buildings, and the claims (or equities) against
those resources at a particular time.
Every company has two types of equities
(sources): creditors equities, such as bank loans,
and owners equity.
The sum of these equities (sources) equals a
companys resources:
Economic Resources = Creditors Equities +
Owners Equity
In accounting terminology, economic resources
are called assets and creditors equities are called

Accounting Elements
Assets are the economic resources of a company
that are expected to benefit the companys future
operations.
Certain kinds of assets for example, cash and
money that customers owe to the company
(called accounts receivable) are monetary
items.
Other assets inventories (goods held for sale),
land, buildings, and equipment are nonmonetary, physical items.
Still other assets the rights granted by patents,
trademarks, and copyrights are non-physical.
Assets are presumed to entail probable future

Accounting Elements
Liabilities are a businesss present obligations to
pay cash, transfer assets, or provide services to
other entities in the future.
Among these obligations are amounts owed to
suppliers for goods or services bought on credit
(called accounts payable), borrowed money (e.g.,
money owed on bank loans), salaries and wages
owed to employees, taxes owed to the
government, and services to be performed.
As debts, liabilities are claims recognized by law.
That is, the law gives creditors the right to force
the sale of a companys assets if the company
fails to pay its debts.

Accounting Elements
Creditors have rights over owners and must be
paid in full before the owners receive anything,
even if payment of the debt uses up all the assets
of the business.
Owners equity represents the claims by the
owner of a business to the assets of the business.
Theoretically, owners equity is what would be
left if all liabilities were paid, and it is sometimes
said to equal net assets.
By rearranging the accounting equation, we can
define owners equity this way:
Owners Equity = Assets Liabilities

Accounting Elements
Owners equity is affected by the owners
investments in and withdrawals from the
business and by the businesss revenues and
expenses.
Owners investments are assets that the owner
puts into the business (e.g., by transferring cash
from a personal bank account to the businesss
bank account).
In this case, the assets (cash) of the business
increase, and the owners equity in those assets
also increases.

Accounting Elements
Owners withdrawals are assets that the owner
takes out of the business (e.g., by transferring
cash from the businesss bank account to a
personal bank account).
In this case, the assets of the business decrease,
as does the owners equity in the business.
Simply stated, revenues and expenses are the
increases and decreases in owners equity that
result from operating a business.
Generally, a company is successful if its
revenues exceed its expenses.

Accounting Elements
When revenues exceed expenses, the difference
is called net income.
When expenses exceed revenues, the difference
is called net loss.
This gives rise to another accounting equation:
Revenue Expenses = Net Income (Net Loss)
It is important not to confuse expenses and
withdrawals, both of which reduce owners
equity.
In summary, owners equity is the accumulated
net income (revenues expenses) less
withdrawals over the life of the business.

Accounting Elements
To summarize the accounting elements based on
the expanded accounting equation:
Assets = Liabilities + Owners Equity + Revenue
Expenses
ELEMENTS
A

Assets

CREDIT

Liabilities

OE Owners Equity

DEBIT

Revenue

Expenses

+ = to increase or to add

Financial Statements
Financial statements are the primary means of
communicating important accounting
information about a business to those who have
an interest in the business.
These statements are models of the business
enterprise in that they show the business in
financial terms.
As is true of all models, however, financial
statements are not perfect pictures of the real
thing.
Rather, they are the accountants best effort to
represent what is real.

Financial Statements
Four major financial statements are used to
communicate accounting information about a
business:
1. Income Statement
The income statement summarizes the
revenues earned and expenses incurred by a
business over an accounting period.
This is also called Statement of Results
from Operation or Financial Performance.
Many people consider it the most important
financial report because it shows whether a
business achieved its profitability goal
that is, whether it earned an acceptable

Financial Statements
2.

3.

Statement of Owners Equity

The statement of owners equity shows the
changes in owners equity over an
accounting period.
Balance Sheet
The purpose of a balance sheet is to show
the financial position of a business on a
certain date, usually the end of the month
or year.
For this reason, it is often called the
Statement of Financial Position and is
dated as of a specific date.

Financial Statements
The balance sheet presents a view of the
business as the holder of resources, or
assets, that are equal to the claims against
those assets.
The claims consist of the companys
liabilities and the owners equity in the
company.
Statement of Cash Flows
Cash flows are the inflows and outflows of
cash into and out of a business.
Net cash flows are the difference between
the inflows and outflows.

4.

Financial Statements

The statement of cash flows is organized

according to the three major business
activities we have described earlier.
a. Cash flows from operating activities:
shows the cash produced or spent by
business operations.
b. Cash flows from investing activities:
shows the cash used for purchases or
replacements of fixed assets, expansion,
renovation, and placements in financial
securities.
c. Cash flows from financing activities:
shows the cash obtained from the owner

Characteristics of Accounting
Relevance
Accounting information must have the ability to
influence decisions in a timely manner.
It may be relevant to the prediction of future
events (for example, in predicting how much
profit is likely to be earned next year) or relevant
in helping to confirm past events (for example,
in establishing how much profit was earned last
year).
The role of accounting in confirming past events
is important because users often wish to check
the accuracy of earlier predictions that they have
made which in turn may them to judge the

Characteristics of Accounting
Reliability
Accounting should be free from significant error
or bias.
It should be capable of being relied upon by
managers to represent what it is supposed to
represent.
Though both relevance and reliability are very
important, the problem that we often face in
accounting is that information that is highly
relevant may not be very reliable, and that which
is reliable may not be very relevant.

Characteristics of Accounting
Comparability
This quality will enable users to identify changes
in the business over time (for example, the trend
in sales revenue over the past five years).
It will also help them to evaluate the
performance of the business in relation to similar
businesses.
Comparability is achieved by treating items that
are basically the same in the same manner for
accounting purposes.
Comparability may also be enhanced by making
clear the policies that have been adopted in
measuring and presenting the information.

Characteristics of Accounting
Understandability
Accounting reports should be expressed as clearly
as possible and should be understood by those at
whom the information is aimed.
Materiality
We also have to consider whether the information
and amounts involved is material, or significant,
meaning that whether its omission or
misrepresentation in the accounting reports would
really alter the decisions that users make.
If the information is not regarded as material, it
should not be included within the reports as it will
merely clutter them up and, perhaps, interfere with

Characteristics of Accounting
Cost & Benefits
In theory, a particular item of accounting
information should only be produced if the costs
of providing it are less than the benefits, or
value, to be derived from its use.
The provision of accounting information can be
very costly; however, the costs are often difficult
to quantify.
The direct, out-of-pocket, costs such as salaries
of accounting staff are not really a problem to
identify, but these are only part of the total costs
involved.

Characteristics of Accounting
There are also less direct costs such as the cost
of the users time spent on analyzing and
interpreting the information contained in reports.
The economic benefit of having accounting
information is even harder to assess.
No one would seriously advocate that the typical
business should produce no accounting
information.
At the same time, no one would advocate that
every item of information that could be seen as
possessing one or more of the key characteristics
should be produced, irrespective of the cost of
producing it.

Characteristics of Accounting

Assignment
Below are independent sets of financial statements
with several amounts missing:
Set X
Income Statement
Revenues
P1,100
Expenses
a
Net Income
b
Statement of Owners
Equity
Beginning balance P2,900
Net Income
c
Less Withdrawals
200
Ending balance
P3,000

Balance Sheet
Total Assets
Liabilities
Owners Equity:
Owners Capital
Total Liab. & OE

d
P1,600
e
f

Assignment
Set Y
Income Statement
Revenues
P
g
Expenses
5,200
Net Income
P
h
Statement of Owners Equity
Beginning balance P24,400
Net Income
1,600
Less Withdrawals
i
Ending balance
P
j

Balance Sheet
Total Assets
Liabilities
Owners Equity:
Owners Capital
Total Liab. & OE

P31,000
P 5,000
k
l

Assignment
Set Z
Income Statement
Revenues
P
Expenses
Net Income
P

240
m
80

Statement of Owners Equity

Beginning balance P 240
Net Income
n
Less Withdrawals
o
Ending balance
P
p

Balance Sheet
Total Assets
Liabilities
Owners Equity:
Owners Capital
Total Liab. & OE

P
P

q
r

280
580

Assignment
Required:
1. Complete each set of financial statements by
determining the amounts that correspond to the
letters.
2. In what order is it necessary to prepare the
financial statements and why?

Assignment
Below are independent sets of financial statements
with several amounts missing:
Set X
Income Statement
Revenues
P1,100
Expenses
a
Net Income
b
Statement of Owners
Equity
Beginning balance P2,900
Net Income
c
Less Withdrawals
200
Ending balance
P3,000

Balance Sheet
Total Assets
Liabilities
Owners Equity:
Owners Capital
Total Liab. & OE

d
P1,600
e
f

Assignment
Set Y
Income Statement
Revenues
P
g
Expenses
5,200
Net Income
P
h
Statement of Owners Equity
Beginning balance P24,400
Net Income
1,600
Less Withdrawals
i
Ending balance
P
j

Balance Sheet
Total Assets
Liabilities
Owners Equity:
Owners Capital
Total Liab. & OE

P31,000
P 5,000
k
l

Assignment
Set Z
Income Statement
Revenues
P
Expenses
Net Income
P

240
m
80

Statement of Owners Equity

Beginning balance P 240
Net Income
n
Less Withdrawals
o
Ending balance
P
p

Balance Sheet
Total Assets
Liabilities
Owners Equity:
Owners Capital
Total Liab. & OE

P
P

q
r

280
580

Assignment Solutions
1.
.Set X
Income Statement
Revenues
P1,100
Expenses
800
Net Income
300
Statement of Owners
Equity
Beginning balance P2,900
Net Income
300
Less Withdrawals
200
Ending balance
P3,000

Balance Sheet
Total Assets
Liabilities
Owners Equity:
Owners Capital
Total Liab. & OE

P4,600
P1,600
3,000
P4,600

Assignment Solutions
Set Y
Income Statement
Revenues
P 6,800
Expenses
5,200
Net Income
P 1,600
Statement of Owners Equity
Beginning balance P24,400
Net Income
1,600
Less Withdrawals
0
Ending balance
P26,000

Balance Sheet
Total Assets
Liabilities
Owners Equity:
Owners Capital
Total Liab. & OE

P31,000
P 5,000
26,000
P31,000

Assignment Solutions
Set Z
Income Statement
Revenues
P
Expenses
Net Income
P

240
160
80

Statement of Owners Equity

Beginning balance P 240
Net Income
80
Less Withdrawals
40
Ending balance
P 280

Balance Sheet
Total Assets
Liabilities
Owners Equity:
Owners Capital
Total Liab. & OE

P
P

580
300

280
580

Assignment Solutions
2. In what order is it necessary to prepare the
financial statements and why?
1) Income statement
2) Statement of changes in equity
3) Cash flow statement
4) Balance sheet
The interdependence of each statement requires
that the following should be computed
chronologically:
5) Net income
6) Ending balance of equity
7) Ending balance of cash
8) Total assets & the total liabilities &

Accounting 1

Fundamentals
of Accounting
Lesson 2a

Analyzing Business Transactions

Measurement Issues
Business transactions are economic events that
affect a companys financial position.
To measure a business transaction, you must
decide:
When the transaction occurred (the
recognition issue)?
What value to place on the transaction (the
valuation issue)? and
How the components of the transaction should
be categorized (the classification issue)?

Measurement Issues
These three issues recognition, valuation, and
classification underlie almost every major
decision in financial accounting today.
They are at the heart of accounting for pension
plans, mergers of giant companies, and
international transactions.
In discussing these issues, we follow generally
accepted accounting principles and use an
approach that promotes an understanding of
basic accounting concepts.

Measurement Issues
Recognition
The recognition issue refers to the difficulty of
deciding when a business transaction should be
recorded.
The resolution of this issue is important because
the date on which a transaction is recorded
affects amounts in the financial statements.
To illustrate some of the factors involved in the
recognition issue, suppose a company wants to
purchase an office desk.
The following events take place:
1. An employee sends a purchase requisition for

Measurement Issues
Valuation
The valuation issue focuses on assigning a
monetary value to a business transaction and
accounting for the assets and liabilities that
result from the business transactions.
Generally accepted accounting principles state
that all business transactions should be valued at
fair value when they occur.
Fair value is defined as the exchange price of an
actual or potential business transaction between
market participants.

Measurement Issues
This practice of recording transactions at
exchange price at the point of recognition is
commonly referred to as the cost principle.
It is used because the cost, or exchange price, is
verifiable.
Normally, the value of an asset is held at its
initial fair value or cost until the asset is sold,
expires, or is consumed.
However, if there is evidence that the fair value
of the asset or liability has changed, an
adjustment to the initial value may be required.
There are different rules for the application of
fair value to different classes of assets.

Measurement Issues
For example, a building or equipment remains at
cost unless there is convincing evidence that the
fair value is less than cost.
In this case, a loss should be recorded to reduce
the value from its cost to fair value.
Investments, on the other hand, are often
accounted for at fair value, regardless of whether
fair value is greater or less than cost.
Because these investments are available for sale,
the fair value is the best measure of the potential
benefit to the company.

Measurement Issues
Classification
The classification issue has to do with assigning
all the transactions in which a business engages
to appropriate categories, or accounts.
Classification of debts can affect a companys
ability to borrow money, and classification of
purchases can affect its income.
One of the most important classification issues
in accounting is the difference between an
expense and an asset, both represented by debits
in the accounts.

Double-Entry System
The double-entry system is the backbone of
accounting.
The system is based on the principle of duality,
which means that every economic event has two
aspects effort and reward, sacrifice and
benefit, source and use that offset, or balance,
each other.
In the double-entry system, each transaction
must be recorded with at least one debit and one
credit, and the total amount of the debits must
equal the total amount of the credits.
Because of the way it is designed, the whole
system is always in balance.

Double-Entry System
All accounting systems, no matter how
sophisticated, are based on the principle of
duality.
Accounts are the basic storage units for
accounting data and are used to accumulate
amounts from similar transactions.
An accounting system has a separate account for
each asset, each liability, and each component of
owners equity, including revenues and
expenses.
Whether a company keeps records by hand or by
computer, managers must be able to refer to
accounts so that they can study their companys

Double-Entry System
A very small company may need only a few
dozen accounts; a multinational corporation may
need thousands.
An account title should describe what is
recorded in the account.
The following are examples of titles for longterm assets:
Fixed Assets,
Plant and Equipment,
Capital Assets, and
Long-Lived Assets
Many account titles change over time as
preferences and practices change.

Double-Entry System
When you come across an account title that you
dont recognize, examine the context of the
name whether it is classified in the financial
statements as an asset, liability, or component of
owners equity and look for the kind of
transaction that gave rise to the account.
T-account is a good place to begin the study of
the double-entry system.
Such an account has three parts:
a title, which identifies the asset, liability, or
owners equity account;
a left side, which is called the debit side; and

Double-Entry System
The T-account, so called because it resembles the
letter T, is used to analyze transactions and is not
part of the accounting records.

Any entry made on the left side of the account is a

debit, and any entry made on the right side is a
credit.
The two rules of the double-entry system are that
every transaction affects at least two accounts and
that total debits must equal total credits.

Sample Chart of Accounts

Sample Chart of Accounts

Sample Chart of Accounts

Assignment
You are given the following list of accounts with
dollar amounts:
J. Morgan, Withdrawals
75
Accounts Payable
200
Wages Expense
150
Cash
625
J. Morgan, Capital
400
Fees Revenue
250
Insert the account title at the top of the
corresponding T-accounts that follows and enter
the dollar amount as a normal balance in the
account.
Then show that the accounting equation is in

Assignment

Accounting 1

Fundamentals
of Accounting
Lesson 2b

Analyzing Business Transactions

Business Transaction Analysis

Analyzing and Processing Transactions

Business Transaction Analysis

Source documents invoices, receipts, checks,
or contracts usually support the details of a
transaction.
For each transaction, we follow these steps:
1. State the transaction.
2. Analyze the transaction to determine which
accounts are affected.
3. Apply the rules of double-entry accounting by
using T-accounts to show how the transaction
affects the accounting equation. It is important
to note that this step is not part of the
accounting records but is undertaken before
recording a transaction in order to understand

Business Transaction Analysis

4.

Show the transaction in journal form.

The journal form is a way of recording a
transaction with the date, debit account, and
debit amount shown on one line, and the
credit account (indented) and credit amount
on the next line.
The amounts are shown in their respective
debit and credit columns.
This step represents the initial recording of a
transaction in the records and takes the
following form:

Business Transaction Analysis

5.

A series of transactions in this form results in

a chronological record of the transactions
called a general journal (book of original
entry).
Periodically, each debit and credit in an entry
is transferred to its appropriate account in a
list of accounts called the general ledger
(book of final entry).
Provide a short description of each journal
entry that will help explain the nature of the
transaction.
Presently, this practice has become optional
for experienced accountants.

Business Transaction Analysis

Sample:
Economic events for the first month operation of
a small firm named Miller Design Studio.
July 1: Joan Miller invests $40,000 in cash to
form Miller Design Studio.
July 2: Orders office supplies, $5,200.
July 3: Rents an office; pays two months rent in
advance, $3,200.
July 5: Receives office supplies ordered on July
2 and an invoice for $5,200.
July 6: Purchases office equipment, $16,320;
pays $13,320 in cash and agrees to pay

Business Transaction Analysis

July 9: Makes a partial payment of the amount
owed for the office supplies received on
July 5, $2,600.
July 10: Performs a service for an investment
advisor by designing a series of
brochures and collects a fee in cash,
$2,800.
July 15: Performs a service for a department
store by designing a TV commercial;
bills for the fee now but will collect the
fee later, $9,600.
July 19: Accepts an advance fee as a deposit on
a series of brochures to be designed,

Business Transaction Analysis

July 22: Receives cash from customer previously
billed on July 15, $5,000.
July 26: Pays employees four weeks wages,
$4,800.
July 30: Receives, but does not pay, the utility
bill that is due next month, $680.
July 31: Withdraws $2,800 in cash.

Owners Investment in the Business

July 1: Joan Miller invests $40,000 in cash to
form Miller Design Studio.
Analysis:
An owners investment in the business increases
the asset account Cash with a debit and increases
the owners equity account J. Miller, Capital with
a credit.

Owners Investment in the Business

To record owners initial investment.

Note:
If Joan Miller had invested assets other than cash
in the business, the appropriate asset accounts
would be increased with a debit.

Economic Event but Non-Business

July 2: Orders office supplies, $5,200.
Analysis:
When an economic event does not constitute a
business transaction, no entry is made.
In this case, there is no confirmation that the
supplies have been shipped or that title has
passed.

Prepayment of Expenses in Cash

July 3: Rents an office; pays two months rent in
advance, $3,200.
Analysis: The prepayment of office rent in cash
increases the asset account Prepaid Rent with a
debit and decreases the asset account Cash with
a credit.

To record prepayment of office rental fees.

Prepayment of Expenses in Cash

Note:
A prepaid expense is an asset because the
expenditure will benefit future operations.
This transaction does not affect the totals of
assets or liabilities and owners equity because it
simply trades one asset for another asset.
If the company had paid only Julys rent, the
owners equity account Rent Expense would be
debited because the total benefit of the
expenditure would be used up in the current
month.

Purchase of an Asset on Credit

July 5: Receives office supplies ordered on July
2 and an invoice for $5,200.
Analysis:
The purchase of office supplies on credit
increases the asset account Office Supplies with
a debit and increases the liability account
Accounts Payable with a credit.

Purchase of an Asset on Credit

To record purchase of office supplies on credit.

Note:
Office supplies are considered an asset (prepaid
expense) because they will not be used up in the
current month and thus will benefit future periods.
Accounts Payable is used when there is a delay
between the time of the purchase and the time of

Purchase of Asset w/Partial

Payment
July 6: Purchases office equipment, $16,320;
pays $13,320 in cash and agrees to pay the rest
next month.
Analysis:
The purchase of office equipment in cash and on
credit increases the asset account Office
Equipment with a debit, decreases the asset
account Cash with a credit, and increases the
liability account Accounts Payable with a credit.

Purchase of Asset w/Partial

Payment

To record purchase of office equipment.

Note: As this transaction illustrates, assets may

be paid for partly in cash and partly on credit.
When more than two accounts are involved in a
journal entry, as they are in this one, it is called a

Payment of a Liability
July 9: Makes a partial payment of the amount
owed for the office supplies received on July 5,
$2,600.
Analysis:
A payment of a liability decreases the liability
account Accounts Payable with a debit and
decreases the asset account Cash with a credit.

Payment of a Liability

To record partial payment of account for the office supplies.

Note:
The office supplies were recorded when they
were purchased on July 5.

Revenue in Cash
July 10: Performs a service for an investment
advisor by designing a series of brochures and
collects a fee in cash, $2,800.
Analysis:
Revenue received in cash increases the asset
account Cash with a debit and increases the
owners equity account Design Revenue with a
credit.

Revenue in Cash

To record cash received for services rendered.

Note:
For this transaction, revenue is recognized when
the service is provided and the cash is received.

Revenue on Credit
July 15: Performs a service for a department
store by designing a TV commercial; bills for the
fee now but will collect the fee later, $9,600.
Analysis:
A revenue billed to a customer increases the
asset account Accounts Receivable with a debit
and increases the owners equity account Design
Revenue with a credit.
Accounts Receivable is used to indicate the
companys right to collect the money in the
future.

Revenue on Credit

To record billing to customer for services rendered.

Note: In this case, there is a delay between the

time revenue is earned and the time the cash is
received. Revenues are recorded at the time they
are earned and billed regardless of when cash is
received.

Revenue Collected in Advance

July 19: Accepts an advance fee as a deposit on a
series of brochures to be designed, $1,400.
Analysis:
Revenue received in advance increases the asset
account Cash with a debit and increases the
liability account Unearned Design Revenue with
a credit.

Revenue Collected in Advance

To record cash received as advance payment for

services to be rendered.

Note:
In this case, cash is received before the fees are
earned. Unearned Design Revenue is a liability
because the firm must provide the service or

Collection on Account
July 22: Receives cash from customer previously
billed on July 15, $5,000.
Analysis:
Collection of an account receivable from a
customer previously billed increases the asset
account Cash with a debit and decreases the
asset account Accounts Receivable with a credit.

Collection on Account

To record collection from customer.

Note:
The revenue related to this transaction was
recorded on July 15. Thus, no revenue is
recorded at this time.

Expense Paid in Cash

July 26: Pays employees four weeks wages,
$4,800.
Analysis:
This cash expense increases the owners equity
account Wages Expense with a debit and
decreases the asset account Cash with a credit.

Expense Paid in Cash

To record payment of wages.

Note:
The increase in Wages Expense will decrease
owners equity.

Expense to be Paid Later

July 30: Receives, but does not pay, the utility
bill that is due next month, $680.
Analysis:
This cash expense increases the owners equity
account Utilities Expense with a debit and
increases the liability account Accounts Payable
with a credit.

Expense to be Paid Later

To record billing for utility due next month.

Note:
The expense is recorded if the benefit has been
received and the amount is owed, even if the cash
is not to be paid until later. Note that the increase
in Utilities Expense will decrease owners equity.

Withdrawals
July 31: Withdraws $2,800 in cash.
Analysis:
A cash withdrawal increases the owners equity
account Withdrawals with a debit and decreases
the asset account Cash with a credit.

Withdrawals

To record withdrawals made by the owner.

Note:
The increase in Withdrawals will decrease
owners equity.

Summary

Assignment
The following accounts are applicable to Leonas
Nail Salon, a company that provides manicures
and pedicures:
1. Cash
2. Accounts Receivable
3. Supplies
4. Equipment
5. Accounts Payable
6. Services Revenue
7. Wages Expense
8. Rent Expense

Assignment
For Leonas Nail Salon, enter the number
corresponding to the proper account for each
debit and credit for the following transactions:
Debit
a) Made a rent payment for the
current month.
b) Received cash from customers for
current services.
c) Agreed to accept payment next
month from a client for current
services.
d) Purchased supplies on credit.
e) Purchased a new chair and table
for cash.
f) Made a payment on accounts
payable.

Credit

Assignment Solutions
a) Made a rent payment for the
current month.
b) Received cash from customers for
current services.
c) Agreed to accept payment next
month from a client for current
services.
d) Purchased supplies on credit.
e) Purchased a new chair and table
for cash.
f) Made a payment on accounts
payable.

Debit

Credit

Accounting 1

Fundamentals
of Accounting
Lesson 2c

Analyzing Business Transactions

Preparation of Trial Balance

For every amount debited, an equal amount must
be credited.
This means that the total of debits and credits in
the T-accounts must be equal.
To test this, the accountant periodically prepares
a trial balance.
Although a trial balance may be prepared at any
time, it is usually prepared on the last day of the
accounting period.

Preparation of Trial Balance

This is the Trial Balance of Miller Design Studio.

Preparation of Trial Balance

Steps in the preparation of trial balance:
1. List each account that has a balance, with
debit balances in the left column and credit
balances in the right column.
Accounts are listed in the order in which they
appear in the financial statements.
2. Add each column.
3. Compare the totals of the columns.
Once in a while, a transaction leaves an account
with a balance that isnt normal.
For example, when a company overdraws its
bank account, its Cash account (an asset) will
show a credit balance instead of a debit balance.

Preparation of Trial Balance

The abnormal balance should be copied into
the trial balance columns as it stands, as a debit
or a credit.
The trial balance proves whether the accounts
are in balance.
In balance means that the total of all debits
recorded equals the total of all credits recorded.
But the trial balance does not prove that the
transactions were analyzed correctly or recorded
in the proper accounts.
For example, there is no way of determining
from the trial balance that a debit should have
been made in the Office Supplies account rather

Finding Trial Balance Errors

If the debit and credit balances in a trial balance
are not equal, look for one or more of the
following errors:
1. A debit was entered in an account as a credit,
or vice versa.
2. The balance of an account was computed
incorrectly.
3. An error was made in carrying the account
balance to the trial balance.
4. The trial balance was summed incorrectly.

Finding Trial Balance Errors

Other than simply adding the columns
incorrectly, the two most common mistakes in
preparing a trial balance are
1. Recording an account as a credit when it
usually carries a debit balance, or vice versa.
This mistake causes the trial balance to be out
of balance by an amount divisible by 2.
2. Transposing two digits when transferring an
amount to the trial balance (for example,
entering $23,459 as $23,549). This error
causes the trial balance to be out of balance
by an amount divisible by 9.

Finding Trial Balance Errors

So, if a trial balance is out of balance and the
addition of the columns is correct, determine the
amount by which the trial balance is out of
balance and divide it first by 2 and then by 9.
If the amount is divisible by 2, look in the trial
balance for an amount that is equal to the
quotient.
If you find such an amount, chances are its in
the wrong column.
If the amount is divisible by 9, trace each amount
back to the T-account balance, checking carefully
for a transposition error.

Finding Trial Balance Errors

If neither of these techniques is successful in
identifying the error, first recompute the balance
of each T-account.
Then, if you still have not found the error, retrace
each posting to the journal or the T-account.

Practice
Prepare a trial balance from the following list of
accounts (in alphabetical order) of the Jasoni
Company as of March 31, 2011.
Compute the balance of cash.
Accounts Payable $ 9
Accounts Receivable 5
Building 10
Cash ?
Jasoni, Capital 16
Equipment 2
Land 1
Inventory 3

Practice Solution

Cash Flows & Timing of Transactions

To avoid financial distress, a company must be
able to pay its bills on time.
Because the timing of cash flows is critical to
maintaining adequate liquidity to pay bills,
managers and other users of financial
information must understand the difference
between transactions that generate immediate
cash and those that do not.
Lets consider the transactions of Miller Design
Studio.
Most of them involve either an inflow or outflow
of cash.

Sample Chart of Accounts

Sample Chart of Accounts

Sample Chart of Accounts

Recording & Posting Transactions

General Journal

Assignment
A. Prepare the journal entries for the following
transactions:
06/01 - Tony Ornega opened Ornega Repair
Service by investing $4,300 in cash and
$1,600 in repair equipment.
06/03 - Paid $800 for the current months rent.
06/05 - Purchased repair supplies on credit,
$1,100.
06/06 - Purchased additional repair equipment
for cash, $600.
06/10 - Paid salary to a helper, $900.
06/17 - Paid $400 of amount purchased on

Assignment
06/25 - Accepted cash for repairs completed,
$3,720.
06/28 - Withdrew $1,000 in cash.
B. Record the transactions in A in the following Taccounts:
Cash; Repair Supplies; Repair Equipment;
Accounts Payable; T. Ornega, Capital;
Withdrawals; Repair Fees Earned; Salaries
Expense; and Rent Expense.
Determine the balance in each account.
C. Prepare the Trial Balance as of June 30 of the
above transactions of Omega Repair Service.

Assignment Solutions
A. Journal Entries: 17 + 3 (20 points)
06/01 Cash
4,300
Repair Equipment 1,600
T. Ornega, Capital
5,900
To record owners initial investment
06/03 Rent Expense 800
Cash
800
To record payment of rent
06/05 Repair Supplies1,100
Accounts Payable
1,100
To record purchase of repair supplies
on credit
06/06 Repair Equipment 600

Assignment Solutions
06/10 Salaries Expense 900
Cash
900
To record salary paid to a helper.
06/17 Accounts Payable 400
Cash
400
To record payment of account.
06/25 Cash
3,720
Repair Fees Earned
3,720
To record receipts for repairs
completed.
06/28 T. Ornega, Withdrawals 1,000
Cash
1,000

Assignment Solutions
B. T-accounts: 20 points
Cash

Repair Supplies

06/01

4,300 06/03

800

06/25

3,720 06/06

600

06/10

900

06/17

400

06/28

1,000

8,020

3,700

4,320

06/05

1,100

Repair Equipment
06/01

1,600

06/06

600
2,200

Accounts Payable
06/17

400 06/05

T. Ornega, Capital
1,100
700

06/01

5,900

Assignment Solutions
T. Ornega, Withdrawals
06/28

Repair Fees Earned

1,000

06/25

Salaries Expense
06/10

900

Rent Expense
06/03

800

3,720

Assignment Solutions
C.

Omega Repair Service

Trial Balance
June 30
Cash

4,320

Repair Supplies

1,100

Repair Equipment

2,200

Accounts Payable

700

T. Ornega, Capital
T. Ornega, Withdrawals

5,900
1,000

Repair Fees Earned

3,720

Salaries Expense

900

Rent Expense

800
10,320

10 points

10,320