Recording Transactions

Learning Objectives
After studying this chapter, you should be able to
1. 2. 3. 4. 5. Use double-entry accounting Analyze and journalize transactions Post journal entries to the ledgers Prepare and use a trial balance Close revenue and expense accounts and update retained earnings 6. Correct erroneous journal entries and describe how errors affect accounts 7. Explain how computers have transformed processing of accounting data
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The Double-Entry Accounting System
• In the double-entry system, every transaction affects at least two accounts • After each transaction, the balance sheet equation must always remain in balance
Assets = Liabilities + Stockholders’ Equity

• This balance sheet format is too cumbersome for recording each and every transaction
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Ledger Accounts
• The elements of transactions are organized into accounts that group similar items together • In a double-entry system, a ledger contains the records for a group of related accounts • A general ledger is the collection of accounts that accumulate the amounts reported in the financial statements

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Ledger Accounts
• A T-account is a simplified version of accounts used in practice
Cash Left side (Increases in cash) Right side (Decreases in cash)

• The vertical line in the T divides the account into left and right sides for recording increases and decreases • The account title is on the horizontal line
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Ledger Accounts
• The T-accounts for the first three Biwheels Company transactions are as follows
Assets Cash Increases Decreases (1) 400,000 (3) 150,000 (2) 100,000 = Liabilities + Stockholders’ Equity Note Payable Decreases Increases (2) 100,000

Merchandise Inventory Increases Decreases (3) 150,000

Paid-in Capital Decreases Increases (1) 400,000

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Ledger Accounts
• Each transaction affects at least two accounts • The process of creating a new T-account in preparation for recording a transaction is called opening the account • An account balance is the difference between the total left-side and right-side amounts at any particular time
Cash 10,000 Balance 4,000
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6,000

Ledger Accounts
• Asset accounts have left-side balances
– Entries on the left side increase asset account balances – Entries on the right side decrease them

• Liabilities and owners’ equity accounts have right-side balances
– Entries on the right side increase their balances – Entries on the left side decrease them

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Debits and Credits
• Accountants use the terms
– Debit (abbreviated Dr.) to denote an entry on the left side of any account – Credit (abbreviated Cr.) to denote an entry on the right side of any account

• Some accountants use the word “charge” instead of debit
Cash Dr. Cr.

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The Recording Process
• The sequence of five steps in recording and reporting transactions is as follows:

Transactions Documentation

Journal

Ledger

Trial Balance

Financial Statements

• Source documents are the original records of any transaction
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The Recording Process
• The general journal is a formal chronological listing of each transaction and how it affects the balances in the accounts • Transactions are entered into the ledger • The trial balance is a simple listing of the accounts in the general ledger together with their balances • Preparation of financial statements occurs at least once a quarter for publicly traded companies
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Chart of Accounts
• A chart of accounts is a numbered or coded list of all account titles • Account numbers are used as references in the Post Ref. column of the journal

_______________________________________________________________ Account Account Account Account Number Title Number Title 100 Cash 202 Note payable 120 Accounts receivable 203 Accounts payable 130 Merchandise inventory 300 Paid-in capital 140 Prepaid rent 400 Retained earnings 170 Store equipment 500 Sales revenues 170A Accumulated 600 Cost of goods sold depreciation, 601 Rent expense store equipment 602 Depreciation expense _______________________________________________________________

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Journalizing Transactions
• Journalizing is the process of entering transactions into the general journal • A journal entry is an analysis of all the effects of a single transaction on the various accounts, usually accompanied by an explanation • A compound entry means that a single transaction affects more than two accounts

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Journalizing Transactions
• The following conventions are used for recording in the general journal
– The title of the account or accounts to be debited are placed at the left margin – The title of the account or accounts to be credited are indented in a consistent way

Entry Post. Date No. Accounts and Explanation Ref. 20X1 12/31 1 Cash 100 Paid-in capital 300 Capital stock issued to Smith

Debit 400,000

Credit

400,00

12/31

2

Cash 100 100,000 Note Payable 202 Borrowed at 9% interest on a one year note

100,000

20X2 1/2

3

Merchandise Inventory 130 Cash 100 Acquired inventory for cash

150,000 150,000

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Journalizing Transactions
• The following conventions are used for recording in the general journal
– The journal entry is followed by the narrative explanation of the transaction – The Post. Ref. column contains an identifying number that is assigned to each account and is used for cross-referencing to the ledger accounts
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Entry Post. Date No. Accounts and Explanation Ref. 20X1 12/31 1 Cash 100 Paid-in capital 300 Capital stock issued to Smith

Debit 400,000

Credit

400,00

12/31

2

Cash 100 100,000 Note Payable 202 Borrowed at 9% interest on a one year note

100,000

20X2 1/2

3

Merchandise Inventory 130 Cash 100 Acquired inventory for cash

150,000 150,000

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Journalizing Transactions
• The following conventions are used for recording in the general journal
– The debit and credit columns are for recording the dollar amounts that are debited or credited for each account

Entry Post. Date No. Accounts and Explanation Ref. 20X1 12/31 1 Cash 100 Paid-in capital 300 Capital stock issued to Smith

Debit 400,000

Credit

400,00

12/31

2

Cash 100 100,000 Note Payable 202 Borrowed at 9% interest on a one year note

100,000

20X2 1/2

3

Merchandise Inventory 130 Cash 100 Acquired inventory for cash

150,000 150,000

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Posting Transactions to the Ledger
• Posting is the transferring of amounts from the journal to the appropriate accounts in the ledger • The following example shows
– How the debit to merchandise inventory and the credit to cash are posted – Columns for dates, explanations, journal references, and amounts in the ledger

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Posting Transactions to the Ledger
Date 20X1 12/31 Entry Post. No. Accounts and Explanation Ref. 1 Cash 100 Paid-in capital 300 Capital stock issued to Smith Debit 400,000 400,00 Credit

12/31

2

Cash 100 100,000 Note Payable 202 Borrowed at 9% interest on a one year note

100,000

20X2 1/2

3

Merchandise Inventory 130 Cash 100 Acquired inventory for cash
CASH

150,000 150,000

Date 20X1 12/31 12/31

Explanation

Journ. Ref. 1 2

Debit

Date

Expanation

Account No. 100 Journ. Ref. Credit 3 150,000

20X2 400,000 1/2 100,000

Date 20X2 1/2

Explanation

MERCHANDISE INVENTORY Journ. Ref. Debit Date Expanation 3 150,000

Account No. 130 Journ. Ref. Credit

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Posting Transactions to the Ledger
• Cross-referencing is the process of using numbering, dating, and/or some other form of identification to relate each ledger posting to the appropriate journal entry • A single transaction from the journal might be posted to several different ledger accounts • Cross-referencing allows users to find all the components of the transactions in the ledger no matter where they start
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Revenue and Expense Transactions
• Ignoring dividends, T-accounts can be grouped as follows:
Assets + Debit Credit = Liabilities Debit + Credit + Paid-in Capital Debit + Credit + Retained Earnings Debit + Credit

Expenses + Debit

Revenues + Credit

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Revenue and Expense Transactions
• Revenue and expense information is accumulated separately to prepare a more meaningful income statement • Expense and revenue accounts are part of Retained Earnings
– A revenue account increases retained earnings – An expense account decreases retained earnings

• Although a debit entry increases expenses, it results in a decrease in retained earnings
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Revenue and Expense Transactions
Transaction: Sales on credit, $160,000 Analysis : The asset account Accounts Receivable increases The stockholders’ equity account Sales Revenues increases Journal Entry: Accounts receivable……….160,000 Sales revenues………… 160,000 Posting: Accounts Receivable 160,000 Sales Revenues 160,000

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Revenue and Expense Transactions
Transaction: Cost of merchandise sold, $100,000 Analysis : The asset Merchandise Inventory decreases Stockholders’ equity decreases because an expense account, Cost of Goods Sold (a negative stockholders’ account) increases Journal Entry: Cost of Goods Sold………………..100,000 Merchandise Inventory………… 100,000 Posting:

Merchandise Inventory 100,000

Cost of Goods Sold 100,000

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Prepaid Expenses and Depreciation Transactions
Transaction: Paid rent for 3 months in advance, $6,000 Analysis: The asset Cash decreases The asset Prepaid Rent increases Journal Entry: Prepaid rent………………..6,000 Cash…………………… 6,000 Posting: Cash 6,000 Prepaid Rent 6,000

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Prepaid Expenses and Depreciation Transactions
Transaction: Recognized expiration of rental services, $2,000 Analysis : The asset Prepaid Rent decreases The negative stockholders’ equity account Rent Expense increases Journal Entry: Rent expense………………..2,000 Prepaid Rent…………….. 2,000 Posting: Prepaid Rent 6,000 2,000 2,000 Rent Expense

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Prepaid Expenses and Depreciation Transactions
Transaction: Recognized depreciation, $100 Analysis : The asset reduction account Accumulated Depreciation, Store Equipment increases The negative stockholders’ equity account Depreciation Expense increases Journal Entry: Depreciation expense…………………………………………...100 Accumulated depreciation, store equipment…………….. 100 Posting: Accumulated Depreciation, Store Equipment 100

Depreciation Expense 100

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Prepaid Expenses and Depreciation Transactions
Asset: Contra Asset: Net asset: Store Equipment Accumulated depreciation, equipment Book value $14,000 100 $13,000

• The book value or carrying value is the balance of an account minus the value of any contra accounts

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Preparing the Trial Balance
• A trial balance is a list of all the accounts with their balances • The purpose of the trial balance is twofold:
– Proving whether the total debits equal the total credits in the ledger – Summarizing the balances in the ledger accounts in preparation to construct the financial statements

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Preparing the Trial Balance
Cash Accounts receivable Merchandise Inventory Prepaid Rent Store equipment Accumulated depreciation, store equipment Note payable Accounts payable Paid-in capital Retained earnings Sales revenues Cost of goods sold Rent expense Depreciation expense Total Debits $ 336,700 160,300 59,200 4,000 14,000 Credits

$

100 100,000 16,200 400,000 0* 160,000

100,000 2,000 100 $ 676,300

$ 676,300

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Preparing the Trial Balance
• The trial balance is prepared with the accounts in the following order:
– – – – – Asset accounts Liability accounts Stockholders’ equity accounts Revenue accounts Expense accounts

• The trial balance is the springboard for preparing the balance sheet and the income statement
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Deriving Financial Statements from the Trial Balance
Cash Accounts receivable Merchandise Inventory Prepaid Rent Store equipment Accumulated depreciation, store equipment Note payable Accounts payable Paid-in capital Retained earnings Sales revenues Cost of goods sold Rent expense Depreciation expense Total Debits $ 336,700 160,300 59,200 4,000 14,000 Credits

$

100 100,000 16,200 400,000 0 160,000

Balance Sheet

100,000 2,000 100 $ 676,300

Income Statement

$ 676,300

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Closing the Accounts
• Closing the accounts has two purposes:
– It transfers the balances of the “temporary” stockholders’ equity accounts (revenues and expenses) to the “permanent” stockholders’ equity account (retained earnings) – It makes the revenues and expense accounts have a zero balance, which readies them for the next period’s transactions

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Closing the Accounts
Cost of Goods Sold

There are three closing entries:
Bal. 100,000 0 C2 100,000

C1: Close all revenue accounts C2: Close all expense accounts C3: Close the Income Summary account

Rent Expense Bal. 2,000 0 C2 2,000 C2

Income Summary 102,100 C1 160,000 0 C1

Sales 160,000 Bal. 160,000 0

C3

57,900

Depreciation Expense Bal. 100 0 C2 100

Retained Income Bal 0

C3

57,900

New bal. 57,900

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Closing the Accounts
C1. Transaction: Clerical procedure of transferring the ending balances of revenue accounts to the Income Summary account Analysis : The stockholders' equity account Sales decreases to zero The stockholders’ equity account Income Summary increases Journal Entry: Sales………………………160,000 Income Summary…… 160,000

C2. Transaction: Clerical procedure of transferring the ending balances of expense accounts to the Income Summary account Analysis : The negative stockholders’ equity (expense) accounts Cost of Goods Sold, Rent Expense, etc. decrease to zero The stockholders’ equity account Income Summary decreases Journal Entry: Income Summary……………102,100 Cost of goods sold………. 100,000 Rent expense……………. 2,000 Depreciation expense…… 100

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Closing the Accounts
C3. Transaction: Clerical procedure of transferring the ending balance of Income Summary account to the Retained Earnings account Analysis : The stockholders' equity account Income Summary decreases to zero The stockholders’ equity account Retained Earnings increases Journal Entry: Income summary…………57,000 Retained earnings…… 57,000

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Effects of Errors
• If an error is detected after posting to the ledger accounts, a correcting entry must be made • The following is an example of a correcting entry:
CORRECT ENTRY ERRONEOUS ENTRY CORRECTING ENTRY 12/27 Repair Expense Cash 12/27 Equipment Cash 12/31 Repair Expense Equipment 500 500 500 500 500 500

• The correcting entry cancels or offsets the erroneous debit to Equipment
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Some Errors are Temporary Errors— Others Persist Until Corrected
• Some errors in one period are automatically corrected in the next period • Such errors misstate net income in both periods • By the end of the second period the errors counterbalance or cancel each other out • They affect the balance sheet of only the first period—not the second • Some errors will keep subsequent balance sheets in error until correcting entries are made
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Data Processing and Accounting Systems
• Data processing refers to the procedures used to record, analyze, store, and report on chosen activities • In an accounting data processing system, a computer can automatically carry out steps such as ledger postings and financial statement preparation

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Data Processing and Accounting Systems
• The cash register may be linked to a computer that also records a decrease in inventory • It may also
– – – – Activate an order to a supplier Check a credit limit Update the accounts receivable Prepare monthly statements

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Data Processing and Accounting Systems
• Computers also reduce the time it takes to close the books and prepare financial statements • The most recent advance in data processing for financial reporting is the use of XBRL • XBRL is an XML-based computer language that allows easy comparisons across companies

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