Chapter 2

2-1
CHAPTER 2
Recording Business Transactions
2-2
The Body of Accounting Knowledge
Chapter 1
2-3
Tools of The Recording Process
Debits and Credits Journal Entries
Ledger Accounts
2-4
First, however, lets look at...
The Accounting Cycle
2-5
Steps in The Accounting Cycle
Analyze source documents.
Journalize transactions in the general journal.
Post entries to the accounts in the general ledger.
Prepare a trial balance.
Prepare financial statements.
Lets start with The General Ledger Account

A ledger account is a tool used for classifying and summarizing information about increases, decreases, and balances of financial statements items.
2-6
Think of it as a storage container like a bucket.
Dollars, which are used to measure economic transactions, are poured into and out of the container.
2-7
General Ledger
Was not a Civil War Hero
2-8
Two General Ledger Account Formats

Three-Amount Column Format (Debit, Credit, Balance)
Used in general ledgers in the business world Used primarily for teaching and analysis of complex transactions
T-Account Format
2-9
General Ledger Account

Three-Amount Column Format
ACCOUNT NAME:
Date Description PR
ACCOUNT No. 1 2 3
Debit Credit Balance
2-10
General Ledger Account

T-Account Format
For the sake of simplicity, we often use this format in teaching accounting even though it is no longer used in practice.
Account Name
Debit Credit
2-11
The T-Account
Increases to the T-account are recorded on one side of the T-account, and decreases are recorded on the other side.
Account Name
Debit Credit
2-12
The T-Account
The side which increases and the side which decreases is determined by the type of account.
Account Name
Debit Credit
2-13
What Are Debits and Credits?
Tools used for recording transactions

Debit (DR) Credit (CR)
Debit refers to the LEFT and Credit to the RIGHT side of the T-Account. Debit and Credit are neutral terms and do not connote value judgments. Neither is good or bad!
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[Baltimore Sun, September 23, 1998]
2-15

Debit refers to the LEFT and Credit to the RIGHT side of the T-Account
Account Name
LEFT
RIGHT
2-16

Account Name
LEFT
RIGHT
Used as Adjectives:
DEBIT SIDE
CREDIT SIDE
2-17

Account Name
LEFT
RIGHT
Used as Verbs:
DEBIT
CREDIT
Synonym for Debit?
2-18
Common Business Terminology
2-19
Names of Ledger Accounts
There are no magic names for many accounts
e.g., either Heat, Light & Power or Utilities Expense could be used for an account name.
Other accounts have names which must be used
e.g., Cash, Accounts Receivable and Accounts Payable.
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Types of Ledger Accounts
Lets see how debits and credits affect the different types of accounts.
Account Name
Debit Credit
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Types of Ledger Accounts

Assets
Liabilities Stockholders Equity Revenues
Expenses
2-22
Using Debits and Credits
Again, debits and credits are used to increase or decrease account balances. Determining whether to use a debit or credit to record an increase or decrease depends on the type of account in question. The Balance Sheet equation is the basis for the determination.
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Balance Sheet Model (Revisited)
A = L + SE
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Assign a T-Account to each element of the Balance Sheet Model
A = L + SE
Account Name Account Name Account Name
Debit
Credit
Debit
Credit
Debit
Credit
2-25

Debits and credits affect the Balance Sheet Model as follows:
A = L + SE
Account Name Account Name Account Name
Debit
Credit
Debit
Credit
Debit
Credit
2-26

A = L + SE
ASSETS Debit Credit for for Increase Decrease Account Name Account Name
Debit
Credit
Debit
Credit
2-27

A = L + SE
ASSETS Debit Credit for for Increase Decrease LIABILITIES Debit Credit for for Decrease Increase Account Name
Debit
Credit
2-28

A = L + SE
ASSETS Debit Credit for for Increase Decrease LIABILITIES Debit Credit for for Decrease Increase EQUITIES Debit Credit for for Decrease Increase
Stockholders Equity
A Closer Look
Recall that Stockholders Equity consists of the following components:
2-29
Capital Stock + Retained Earnings
C/S + R/E
Stockholders Equity
A Closer Look
Therefore, the Capital Stock and Retained Earnings accounts are affected in the following manner by debits and credits because they are part of Stockholders Equity:
CAPITAL STOCK Debit Credit for for Decrease Increase RET. EARNINGS Debit Credit for for Decrease Increase
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Stockholders Equity
A Closer Look
Also, because Revenue accounts increase Stockholders Equity, they are affected by debits and credits as follows:
2-31
REVENUES Debit Credit for for Decrease Increase
Stockholders Equity
A Closer Look
And because Expense accounts decrease Stockholders Equity, they are affected by debits and credits as follows:
2-32
EXPENSES Debit Credit for for Increase Decrease
2-33
Normal Balances
Each of the 5 account types also has a normal balance side. It is always the side which is used to record increases in the account.
2-34
Normal Balances
The normal balances for each of the FIVE types of accounts are as follows: Account Name
Debit Balance Credit Balance
Assets Expenses
Liabilities Stockholders Equity Revenues
2-35
Three Alternative Approaches For Learning Debits and Credits
Alternative #1
The textbook approach on p. 59
Alternative #2
Expanded Accounting Equation This is Rices preferred approach
Alternative #3
A L O R E acronym
2-36
Alternative Approach #1
Textbook Approach
59
Check it out at top of page!
2-37
Alternative Approach #2
Expanded Accounting Equation
ASSETS + EXP. = LIAB. + S/H EQUITY + REV.
A + E = L + S/E + R
Dr. Cr. Dr. Cr.
+
Bal.
+
Bal.
2-38
Alternative Approach #3 A L O R E Acronym

Debit Credit
A (ssets) L (iabilities)
+ -
+ + + -
O (wners' equity) R (evenues) E (xpenses)
2-39
Debits and Credits

Question 1
Which of the following accounts would normally be expected to have a debit (or left-side) balance?
a. b. c. d.
Accounts Payable Buildings Interest Revenue Capital Stock
2-40
Debits and Credits

Solution 1
Which of the following accounts would normally be expected to have a debit (or left-side) balance?
a. b. c. d.
Accounts Payable Buildings Interest Revenue Capital Stock
BUILDINGS is an asset account and normally has a DEBIT balance. The other three accounts normally have CREDIT balances.
2-41
Debits and Credits

Question 2
Which of the following accounts would normally be expected to have a credit (or right-side) balance?
a. b. c. d.
Accounts Receivable Salary Expense Salary Payable Land
2-42
Debits and Credits

Solution 2
a. b. c. d.
Accounts Receivable Salary Expense Salary Payable Land
2-43
Debits and Credits

Solution 2
a. b. c. Salary Payable d. Land
SALARY PAYABLE is a liability account and Accounts Receivable normally has a CREDIT Salary Expense balance. The other three accounts normally have DEBIT balances.
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Debits and Credits

Example
If the balance in Accounts Receivable (an asset) is $750 (debit side balance),
Accounts Receivable
750
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Debits and Credits

Example
Accounts Receivable
750
What would we do to increase the account by $200?
2-46
Debits and Credits

Example
Accounts Receivable
750 200
What would we do to increase the account by $200?
2-47
Debits and Credits

Example
Accounts Receivable
750 200
What would we do to increase the account by $200? What would we do to decrease the account by $350?
2-48
Debits and Credits

Example
Accounts Receivable
750 200
350
What would we do to increase the account by $200? What would we do to decrease the account by $350?
2-49
Debits and Credits

Example
Accounts Receivable
750 200
350
Note the lack of $. It is understood that the yardstick is dollars. It is not money!
2-50
Balancing The T-Account

To get the balance of the T-Account . . .
Accounts Receivable
750 200
350
. . . net the totals on the two sides against each other. Place the residual amount on the appropriate side.
2-51

Accounts Receivable
750 200
600
350
. . . net the totals on the two sides against each other. Place the residual amount on the appropriate side.
2-52

Accounts Receivable
750 200
600
350
(Can use the either the approach above to show the balance, the texts approach or Rices approach)
2-53
Three Alternative Approaches to Balancing The T-Account

Using the example at the bottom of p. 57
Approach on Previous slide
Cash
Text Approach
Cash
Rices Approach
Cash
(1) 10,000 (4) 600 (1) 10,000 (4) 600 (1) 10,000 (4) 600 (2) 5,000 (5) 2,000 (2) 5,000 (5) 2,000 (2) 5,000 (5) 2,000 (3) 1,000 (3) 1,000 (3) 1,000 16,000 2,600
13,400
bal 13,400
13,400
ALL 3 are O.K.!
Debits and Credits

Question 3
The Cash account has three entries: a debit for $1,200, a credit for $300, and another credit for $400. What is the balance in the Cash account? a. b. c. d. $ 1,900 Debit. $ 500 Credit. $ 700 Credit. $ 500 Debit.
2-54
Debits and Credits

Question 3
The Cash account has three entries: a debit for $1,200, a credit for $300, and another credit for $400. What is the balance in the Cash account? a. b. c. d. $ 1,900 Debit. $ 500 Credit. $ 700 Credit. $ 500 Debit.
Cash
2-55
$1,200 $ 500
$ 300 $ 400
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Implications Of Debits And Credits

Debits and Credits are used to indicate that something happened to an account.
Interpreting the implications requires an analysis of the entire journal entry.
2-57
Implications Question 1
If the company made a Credit entry to Notes Payable, would the account increase or decrease?
2-58
If the company made a Credit entry to Notes Payable, would the account increase or decrease?
ANSWER:
Notes Payable would increase.
2-59
Notes Payable is the account where we record long-term borrowings. What event would cause us to record an increase in our long-term borrowings?
2-60
Notes Payable is the account where we record long-term borrowings. What event would cause us to record an increase in our long-term borrowings?
ANSWER:
Such an increase could imply that the company borrowed money.
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If the company borrowed money, which account would also be affected and in what way?
2-62
If the company borrowed money, which account would also be affected and in what way?
ANSWER:
There would also be an equal-sized increase in the Cash account.
2-63
Suppose instead of an increase to Cash, you find an increase to the Land account. How do you interpret the increase in Notes Payable?
2-64
Suppose instead of an increase to Cash, you find an increase to the Land account. How do you interpret the increase in Notes Payable?
ANSWER:
The company acquired land and gave a note that promised to pay for the land in the future.
2-65
Recording Transactions
Initially, all transactions are recorded in the General Journal.
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Recording Transactions
Initially, all transactions are recorded in the General Journal. Each transaction always affects at least two different accounts.
One account has a debit effect. The second account has a credit effect.
This methodology was named double entry accounting by whom? Pacioli
2-67
General Journal Page

GENERAL JOURNAL
Page:
Date
Description
PR
Debit
Credit
2-68
Journal Entries
Example 1
On January 1, 19X7, Caldwell Company borrows $10,000 from the bank. Prepare the appropriate general journal entry for the above transaction.
2-69
Journal Entries
Solution 1
Two accounts are affected:

Cash is increased by $10,000. Notes Payable is increased by $10,000.
2-70
Journal Entries
Solution 1

GENERAL JOURNAL
Page:
1
Credit
Date
Description
PR
Debit
2-71
Journal Entries
Solution 1

GENERAL JOURNAL
Page:
1
Credit
Date
Description
PR
Debit
1-Jan Cash Notes Payable to record loan from bank
100 201
10,000 10,000
2-72
Journal Entries
Solution 1
Typically, accounts are Two accounts are affected: Cash is increased numbered. The by $10,000. Notes Payable is increased by $10,000. account numbers are used as references for GENERAL JOURNAL posting to the General Page: 1 Date Description PR Debit Credit Ledger. More on 1-Jan Cash 100 10,000 account numbers will Notes Payable 201 10,000 come later. to record loan from bank
2-73
Journal Entries
Example 2
On January 15, 19X7, Caldwell Company purchases a truck for $19,500 cash. Prepare the appropriate journal entry for the above transaction.
2-74
Journal Entries
Solution 2

Trucks is increased by $19,500. Cash is decreased by $19,500.
2-75
Journal Entries
Solution 2

GENERAL JOURNAL
Page:
1
Credit
Date
Description
PR
Debit
2-76
Journal Entries
Solution 2

GENERAL JOURNAL
Page:
1
Credit
Date
Description
PR
Debit
15-Jan Trucks Cash to record purchase of truck
150 100
19,500 19,500
2-77
Journal Entries
Example 3
On January 20, 19X7, Caldwell Co. pays the $400 electric bill for January. Prepare the appropriate journal entry for the above transaction.
2-78
Journal Entries
Solution 3

Utility Expense is increased by $400. Cash is decreased by $400.
2-79
Journal Entries
Solution 3

GENERAL JOURNAL
Page:
1
Credit
Date
Description
PR
Debit
2-80
Journal Entries
Solution 3

GENERAL JOURNAL
Page:
1
Credit
Date
Description
PR
Debit
20-Jan Utility Expense Cash to record payment of January electric bill
511 100
400 400
2-81
More About The General Ledger
It is a complete collection of all the accounts of a company Accounts are individually numbered for easy reference It is used to collect the information about all of the transactions affecting a specific account A cumulative, running balance is maintained when using the 3-column type
2-82
Categories of General Ledger Accounts

The five types of accounts fall into one of two categories Real Accounts Nominal Accounts
2-83
Real Accounts
This category includes Assets, Liabilities, and Stockholders Equities (i.e., Balance Sheet accounts)
Accounts are permanent.

Account balances are carried forward from one fiscal year to the next.
2-84
Nominal Accounts
Nominal accounts include revenues and expenses. Nominal accounts are temporary. Nominal account balances are closed out to zero at the end of the fiscal year.
Closing Entries will be discussed in Chapter 4.
2-85
Numbering Accounts
The listing of all accounts and their account numbers is called the chart of accounts.
2-86
Numbering Accounts
The listing of all accounts and their account numbers is called the chart of accounts. A typical account numbering scheme might appear as follows:
Assets 100-199 Liabilities 200-299 Equities 300-399 Revenues 400-499 Expenses 500-599
(See page 63 and inside back cover)
Posting to the GL
Example
GENERAL JOURNAL
Page:
2-87
1 Credit
Date
Description
PR
Debit
10,000 10,000
Start with the journal entry from the General Journal.
Posting to the GL
Example
Date
Page: page Next, find the appropriate Description PR forDebit in the General Ledger Cash. Credit
2-88
GENERAL JOURNAL
1-Jan Cash Notes Payable to record loan from bank ACCOUNT NAME: CASH
Date Description
10,000
10,000
ACCOUNT No.
PR Debit Credit
100
Balance
Beginning Balance
Posting to the GL
Example
GENERAL JOURNAL Post the account reference number. Page: Date Description PR Debit Credit 1
2-89
Date Description PR
100
10,000 10,000
ACCOUNT No.
Debit Credit
100
Balance
Beginning Balance
Posting to the GL
Example
GENERAL JOURNAL
Page:
2-90
1 Credit
Date
Description
PR
Debit
Date Description PR
100
10,000 10,000
ACCOUNT No.
Debit Credit
100
Balance
Beginning Balance 1-Jan Loan
G1
0 10,000
Post the transaction info to the GL.
Posting to the GL
Example
GENERAL JOURNAL
Page:
2-91
1 Credit
Date
Description
PR
Debit
Date Description PR
100
10,000 10,000
ACCOUNT No.
Debit Credit
100
Balance
G1
0 10,000
0 10,000
Update the General Ledger balance.
Posting to the GL
Example
Date
Page: Next, find the Notes Payable PR Ledger. Debit pageDescription in the General
2-92
GENERAL JOURNAL
1 Credit
100
10,000
10,000
ACCOUNT NAME: Notes Payable

Date Description PR
ACCOUNT No.
Debit Credit
201
Balance
Beginning Balance
Posting to the GL
Example
GENERAL JOURNAL Post the account reference number. Page: Date Description PR Debit Credit 1
2-93
1-Jan Cash Notes Payable to record loan from bank ACCOUNT NAME: Notes Payable
Date Description PR
100 201
10,000 10,000
ACCOUNT No.
Debit Credit
201
Balance
Beginning Balance
Posting to the GL
Example
GENERAL JOURNAL
Page:
2-94
1 Credit
Date
Description
PR
Debit
Date Description PR
100 201
10,000 10,000
ACCOUNT No.
Debit Credit
201
Balance
G1
0 10,000
Post the transaction info to the GL.
Posting to the GL
Example
GENERAL JOURNAL
Page:
2-95
1 Credit
Date
Description
PR
Debit
Date Description PR
100 201
10,000 10,000
ACCOUNT No.
Debit Credit
201
Balance
G1
0 10,000
0 10,000
Posting to the GL
Example
Examine the next journal entry. Page:
Date Description PR Debit Credit
GENERAL JOURNAL 1
2-96
15-Jan Trucks Cash to record purchase of truck ACCOUNT NAME: CASH

Date Description PR
9,500 9,500
ACCOUNT No.
Debit Credit
100
Balance
Beginning Balance 1-Jan Loan from bank
G1
0 10,000
0 10,000
Posting to the GL
Example
Record the account reference. Page:
Date Description PR Debit Credit
GENERAL JOURNAL 1
2-97

Date Description PR
9,500 100 9,500
ACCOUNT No.
Debit Credit
100
Balance
Beginning Balance 1-Jan Loan from bank
G1
0 10,000
0 10,000
Posting to the GL
Example
GENERAL JOURNAL
Page:
2-98
Date
Description
PR
Debit
Credit

Date Description PR
9,500 100 9,500
ACCOUNT No.
Debit Credit
100
Balance
Beginning Balance 1-Jan Loan from bank 15-Jan Purchase of truck
G1 G3
0 10,000 9,500
0 10,000
Post the entry to the GL.
Posting to the GL
Example
GENERAL JOURNAL
Page:
2-99
Date
Description
PR
Debit
Credit

Date Description PR
9,500 100 9,500
ACCOUNT No.
Debit Credit
100
Balance
Beginning Balance 1-Jan Loan from bank 15-Jan Purchase of truck
G1 G3
0 10,000 9,500
0 10,000 500
2-100
TRIAL BALANCE
Used to periodically test whether the General Ledger is in balance. Consists of a listing of each account with its balance as of a specific date.
All Debit balances are in one column. All Credit balances are in another column.
2-101
Trial Balance Illustration

(Text example is on p. 79)
First Company Trial Balance 12/31/X8 Debits $ 500 1,200 3,800 Credits
Cash Accounts Receivable Equipment Accounts Payable Notes Payable Capital Stock Retained Earnings - 1/1/X8 Dividends Revenues Salary Expense Utility Expense Rent Expense
700 1,450 3,000 11,000
250 5,000 3,000 2,400 $ 16,150
$ 16,150
2-102
Trial Balance Illustration

(Text example is on p. 79)
First Company Trial Balance 12/31/X8
Notice that Total Cash Accounts Receivable Debits are equal Equipment Accounts Payable to Total Credits. Notes Payable
Capital Stock Retained Earnings - 1/1/X8 Dividends Revenues Salary Expense Utility Expense Rent Expense
Debits $ 500 1,200 3,800
Credits
700 1,450 3,000 11,000
250 5,000 3,000 2,400 $ 16,150
$ 16,150
2-103
Trial Balance Errors
Click picture to view video
2-104
Loose Ends
Questions on the 15 transactions on pp. 64-71?
2-105
Loose Ends
Questions on the 15 transactions on pp. 64-71? Dont read the chapter!
First full par. on p. 75
2-106
Loose Ends
Skip Analyzing and Using the Financial Results
p. 81
2-107
Loose Ends
Skip Analyzing and Using the Financial Results
p. 81
The Dividends account is not a primary type of account as implied on pp. 58-59!
2-108
Dividends Account
The Dividends account is a contra account to Retained Earnings. Therefore, it is affected by debits and credits as follows:
DIVIDENDS Debit Credit for for Increase Decrease
2-109
Have you ever had that Ivejust-been-runover-by-atrain feeling?

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2-1

Recording Business Transactions

The Body of Accounting Knowledge

Tools of The Recording Process

Debits and Credits Journal Entries

First, however, lets look at...

The Accounting Cycle

Steps in The Accounting Cycle

Analyze source documents.

Journalize transactions in the general journal.

Post entries to the accounts in the general ledger.

Prepare a trial balance.

Prepare financial statements.

Lets start with The General Ledger Account

Think of it as a storage container like a bucket.

Two General Ledger Account Formats

General Ledger Account

General Ledger Account

What Are Debits and Credits?

Tools used for recording transactions

[Baltimore Sun, September 23, 1998]

What Are Debits and Credits?

Tools used for recording transactions

What Are Debits and Credits?

Tools used for recording transactions

What Are Debits and Credits?

Tools used for recording transactions

Synonym for Debit?

Common Business Terminology

Names of Ledger Accounts

There are no magic names for many accounts

Other accounts have names which must be used

e.g., Cash, Accounts Receivable and Accounts Payable.

Types of Ledger Accounts

Types of Ledger Accounts

Using Debits and Credits

Balance Sheet Model (Revisited)

Balance Sheet Model (Revisited)

Balance Sheet Model (Revisited)

Balance Sheet Model (Revisited)

Balance Sheet Model (Revisited)

Balance Sheet Model (Revisited)

Capital Stock + Retained Earnings

REVENUES Debit Credit for for Decrease Increase

EXPENSES Debit Credit for for Increase Decrease

Liabilities Stockholders Equity Revenues

Three Alternative Approaches For Learning Debits and Credits

The textbook approach on p. 59

Alternative Approach #3 A L O R E Acronym

O (wners' equity) R (evenues) E (xpenses)

Debits and Credits

Accounts Payable Buildings Interest Revenue Capital Stock

Debits and Credits

Accounts Payable Buildings Interest Revenue Capital Stock

Debits and Credits

Accounts Receivable Salary Expense Salary Payable Land

Debits and Credits

Accounts Receivable Salary Expense Salary Payable Land

Debits and Credits

a. b. c. Salary Payable d. Land

Debits and Credits

Debits and Credits

What would we do to increase the account by $200?