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Chapter 2 Lecture Notes

Chapters 1 and 2 are extremely important. Everything that is done in accounting is based
on the concepts in these two chapters. Be sure you read and understand them!
The T account form:

T-Account: an account format that is shaped like the letter T.


T-Accounts are used for illustration purposes, classroom work, and accountants personal
work records. They are not for the formal accounting records.
Look on page 50 at the comparison of the column format versus the T account format. Look
at the illustration of the Cash account and the T account form.
There are two sides to the T account form. One side is used for increases (+) in an account,
and the other side is used for decreases () in an account.
Footings: the totals of the amounts listed on both sides of a T account. These are the
subtotals of the account.
Balance: The balance of an account is determined after a group of transactions has been
recorded over a period of time. Subtract the smaller footing on one side from the larger
footing on the other side. Record the balance on the side having the larger footing.
Normal Balance: the increase or positive (+) side of any T account.

Recording transactions using the concepts of debit and credit

The T account for each of the classifications of accounts has an increase (+) and a decrease
() side.
The left side of an account is called the debit (Dr) and the right side is called the credit (Cr).
The normal balance of an account can be either a debit or credit. It all depends on the
accounts classification.
Every business transaction affects at least two accounts. The credits and debits must equal
for the accounts to be balanced.
The other important thing to remember is that the amount placed in one account on the debit
side MUST also be placed on the credit side in another account. This is the double-entry
accounting that we discussed in the last chapter!
Look at Debits and Credits not as Negatives and Positives, but rather as Increase and
Decreases!

The table below lists the normal balances of each classification of accounts. To use
Debits and Credits you must know: the Normal Balance of the accounts and what
increases and decreases the account. It is extremely important that you learn this! I am
not into a lot of memorization BUT this is something that you need to MEMORIZE!

Rules of Debits and Credits


Account Category
Assets
Liabilities
Owners Equity
Capital
Withdrawals
Revenues
Expenses

Increase (Normal Balance)

Decrease

Debit
Credit

Credit
Debit

Credit
Debit
Credit
Debit

Debit
Credit
Debit
Credit

The Key to Adding and Subtracting Debits and Credits (Important to Remember)
Debit + Debit
Credit + Credit
Debit - Credit
****Add like items, subtract unlike items!

Steps for recording business transactions in T accounts


1. What accounts are involved?
2. What are the classifications of the accounts involved (ie. asset, liability, etc.)?
3. Does the transaction increase or decrease each account?
4. Write the transaction as a debit to one account (or accounts) and a credit to another account (or
accounts).
5. Is the equation in balance after the transaction has been recorded? Are the debits and credits
balanced in the accounts?
Read through the various transactions on pages 63-73. Be sure you understand the thought
process of the transaction and then the recording to each account.

Compound Entry: this is a business transaction that involves more than one credit or more
than one debit. Look at the example on page 71.

The Trial Balance

The Trial Balance is used as a check to ensure that in recording transactions, the total of the
amounts placed on the debit sides of T accounts equals the total of the amounts placed on the
credit sides of T accounts.
List/record the accounts as they are listed in the chart of accounts and their balances.
You only have to list the accounts that have a balance, or you can list all of the accounts
regardless of whether they have a balance or not.
Sometimes the account numbers of each account will be listed to the left of the accounts. In
this case the accounts are listed in numerical order which should be the same as the chart of
accounts.
Review the key points (in red) of the Trial Balance in Figure 2 on page 75.
Always have a Heading on the Trial Balance.
Single underlining numbers means you are totaling the numbers.
Double underlining means that the column of numbers has been totaled and that the two
columns are balanced.

Major Financial Statements

Financial statements summarize the financial affairs of a business.


The financial statements are generally prepared by the accountants of the business.
They are used by management and owners for making business decision. They are also used
by external stakeholders such as the government, creditors, etc. to determine the financial
position of the business.
You must know how to do the financial statements in correct format. The correct
format includes the heading and body. They also should balance.
All major financial statements start with a heading. This is extremely important so that the
multiple statements and companies can be distinguished from each other.
Each statement heading consist of three parts: Line 1) Name of the Company, Line 2) Title of
the Financial Statement, and Line 3) Period of time covered by the statement or its exact
date.
Dollar signs are only placed at the beginning and end of each column.
Columns on a financial statement: The column to the far right is the total column and each
column as you go to the left represents a subtotal.
The Income Statement is always the first financial statement prepared.
It shows the results of operations for a period of time. By results of operations it means a loss
or gain in income.
The Income Statement is for the period of a month, quarter, or year. At the end of each
accounting year the figures in these accounts become zero and start over again. Sort of like
your personal tax return --- youre W2 (income) and expenses start over every year.
The Statement of Owners Equity is the second financial statement prepared.
This is the summary of the changes in the owners investment in the company.
The Net Income/Loss from the Income Statement is required to complete the Statement of
Owners Equity.
3

Again the Statement of Owners Equity is for the period of a month, quarter, or year. At the
end of each accounting year the figures in these accounts become zero and start over again.
The Balance Sheet is the third financial statement prepared.
It shows the condition or financial position of the business at a point in time.
It is a list of the assets, liabilities, and owners equity of the company. It is based on the
accounting equation.
The date is always as of the date the statement is prepared. It is considered to be continuous
since the assets and liabilities of the company do not go away each year.
The ending capital amount is carried over from the Statement of Owners Equity to the
Balance Sheet.

Errors exposed by the trial balance


Types of Errors
Arithmetic errors
Recording only part of the transaction (omitting recording either the debit or credit)
Recording the transaction all as credits or debits instead of balancing it with one of
each
Recording the amounts incorrectly
Locating and correcting errors
Transpositions: The switching around or changing around of the numbers; writing $565
as $556.
Slides: the entire number is moved one or more spaces; writing $542.00 as $5420.00.
Divide the difference between two trial balance totals by 2 to see if the result matches a
transaction amount.
Errors divisible by 9: If an error exists and the amount of difference between the totals
of the trial balance is evenly divisible by 9, the error consists of either a transposition or a
slide or both.

Errors need to identified and corrected.


Some errors will not cause the Trial Balance to be out of balance.
Generally you will reverse the incorrect transaction to fix the error and then do another
transaction for the correct entry.
Materiality Concept: GAAP guideline that states that you need to correct errors that are
significant and to correct them in the easiest way possible.

Answers to Quiz Yourself on page 93-94


1.
2.
3.
4.

B
C
C
D

6.
7.
8.
9.

B
C
D
D
4

5. A