Topic 3.

The Bookkeeping Process and

Transaction Analysis
The Balance Sheet Equation

Assets = Liabilities + Stockholders’ Equity

The basic accounting equation can be expanded to

include the beginning balances of retained earnings,
revenues, and expenses.
Another principal element of stockholders’ equity is the
amount of capital invested by the owners/stockholders—the
PIC (paid-in capital)

A = L + PIC + RE + R - E BEG
The Balance Sheet Equation

The balance sheet equation is written as A (assets) equals L

(liabilities) plus SE (stockholders' equity). This basic accounting
equation can be expanded to include the beginning balances of
retained earnings, revenues, and expenses. There are two major
components of stockholders' equity, PIC (paid-in capital, which
represents investments by stockholders) and RE (retained earnings,
which represent the accumulated earnings (net income) of the
company less dividends paid). NI (net income) equals R (revenue)
minus E (expenses).
The Balance Sheet Equation
Transactions
1. Investors organized the firm and invested $30, thus becoming the initial
group of stockholders.
2. Equipment costing $25 was purchased for cash.
3. The firm borrowed $15 from a bank.
4. Merchandise costing $20 was purchased for inventory; $10 cash was
paid, and $10 of the cost was charged on account.
5. Equipment that cost $7 was sold for $7; $2 was received in cash, and $5
will be received later.
6. The $5 account receivable from the sale of equipment was collected.
7. The firm sold merchandise inventory that had cost $12 for a selling price
of $20; the sale was made on account (i.e., on credit), and the customer
will pay later.
8. Wages of $3 earned by the firm’s employees are accrued.
The Balance Sheet Equation
The Balance Sheet Equation
Statement of Changes in
Income Statement Retained Earnings
Revenues $ 20 Beginning Balance $ -
Expenses 15 Add: Net Income 5
Less: Dividends -
Net Income $ 5 Ending Balance $ 5

Assets Liabilities
Cash $ 17 Notes Payable $ 15
Accounts Receivable 20 Accounts payable 13
Merchandise inventory 8 Total liabilities $ 28
Total current assets $ 45 Stockholders' Equity
Equipment $ 18 Paid-in Capital 30
Retained Earnings 5

Total Stockholders'
Equity $ 35

Total liabilities and

Total Assets $ 63 stockholders’ equity $ 63
Bookkeeping

Transactions are initially recorded in

a journal.

Then, transactions are recorded in

or posted to individual accounts in a
ledger.

Accounts are used to organize or to

group transactions to facilitate
financial statement preparation.
Bookkeeping
Bookkeeping is one part of the accounting process.
Transactions are initially recorded in a journal. Transactions are
then recorded or posted to individual accounts in a ledger.
Accounts are used to organize or to group transactions to
facilitate financial statement preparation.
A chart of accounts serves as an index to the ledger, and each
account is numbered to facilitate the frequent written
references that are made to it.
T-Account

A T-account is a tool used to represent

an account.
Account Name

Left Right
side side
T-Account

The left side of the The right side of the

T-account is always the T-account is always the
debit side. credit side.

Account Name
Left Right
side side
Debit Credit
Debits and Credits

Debits and credits affect the accounting

equation as follows:

A = L + SE
Debits and Credits

A = L + SE

Includes:

Remember that stockholders'

equity includes paid-in capital and Paid-in Retained
retained earnings. capital earnings
Revenue and Expenses

Increases in Increases with

stockholders' credit entries
equity

Decreases in Increase with

stockholders' debit entries
equity
Debits and Credits

A = L + SE
Journal Entry Format

A general journal is the book of original entry for

recording a transaction. The typical journal has columns
for date, description, debit amounts, and credit amounts.

Dr. Account Name . . . . . Amount

Date Cr. Account Name. . . . .
Amount
Journal Entry Format
The name (or names) of the account(s) to be debited are
always listed first and shown to the left, while the name (or
names) of the account(s) to be credited are indented and
shown on the right. Likewise, the debit amount(s) are shown
on the left of the credit amount(s). Remember, debit means left
and credit means right.
The abbreviations Dr. and Cr. are used for debit and credit,
respectively. These identifiers are frequently omitted from the
journal entry to reduce writing time and because the indenting
practice is universally followed and understood.
Journal Entry Format

Provide a reference
date for each transaction. Debits are recorded first.

Credits are indented and Total debits must equal

recorded after debits. total credits.

A brief description of the transaction to explain the entry

Journal Entry Format
The rules for journal entries are as follows: 1) journal entries
must provide a reference date for each transaction; 2) debits
are recorded first; 3) credits are indented and recorded after
debits; 4) total debits must equal total credits; and 5) a brief
description of the transaction to explain the entry must be
provided.
The Bookkeeping Process
Understanding the Effects of Transactions
on the Financial Statements
• The horizontal model is as follows:

• The journal entry below records the investment of

$30 in the firm by the stockholders
Understanding the Effects of Transactions on
the Financial Statements
• To further illustrate the model’s use, assume a
transaction in which the firm paid $12 for
advertising.

• The journal entry would be as follows:

Understanding the Effects of Transactions
on the Financial Statements
• A transaction can affect two accounts in a single
balance sheet or income statement category.
– For example, assume a transaction in which a firm collects
$40 that was owed to it by a customer for services
performed in a prior period.

• The journal entry would be as follows:

Understanding the Effects of Transactions
on the Financial Statements
• A transaction to affect more than two accounts
– For example, assume a transaction in which a firm provided $60 worth
of services to a client, $45 of which was collected when the services
were provided and $15 of which will be collected later.

• The journal entry would be as follows:

Adjustments/Adjusting Entries

After the end of the accounting period,

bookkeepers normally have to record an
adjustment to certain account balances to
reflect accrual accounting in the financial
statements.
Two Types of Adjusting Entries

Accruals Deferrals

Transactions for which

cash has NOT yet been The initial recording of a
received or paid, but the transaction does not
effect of which must be result in appropriate
recorded in the accounts in assigning of revenues to
order to accomplish a the period in which they
matching of revenues and were earned or expenses
expenses and accurate to the period in which
financial statements. they were incurred.
Two Types of Adjusting Entries
We record two types of adjusting entries, accruals and
deferrals. Accruals are transactions for which cash has NOT yet
been received or paid, but the effect of which must be
recorded in the accounts in order to accomplish a matching of
revenues and expenses and accurate financial statements.
Deferrals are necessary because the initial recording of a
transaction does not result in assigning of revenues to the
period in which they were earned or expenses to the period in
which they were incurred. As a result, an amount must be
reclassified from one account to another (at the end of the
accounting period) to reflect the appropriate balance in each
account.
Adjustments/Adjusting Entries

Adjusting entries (accruals and

deferrals) occur at the end of the
accounting period.

Adjusting entries are Every adjusting entry

needed whenever revenue or involves a change in either a
expenses affect more than one revenue or an expense AND an
accounting period. asset or a liability.
Adjustments: Accrual of Wages
• To illustrate accrual of wages, assume that employees earned
$60 in March, which will be paid to them in April. Using the
horizontal model, the accrued wages adjustment has the
following effect on the financial statements:

• The journal entry would be as follows:

Adjustments: Accrual of Interest Income

• The effect on the financial statements, using the horizontal

model, of accruing $50 of interest income that has been
earned but not yet received is shown as follows:

• The journal entry would be as follows:

Adjustments: Adjustment for Supplies

• Assuming that supplies costing $35 were used during

February, the reclassification adjustment would be reflected
in the horizontal model as follows:

• The journal entry would be as follows:

Deferred Adjustment for Supplies
• The reclassification adjustment for the $65 of
supplies still on hand at the end of February would
be reflected in the horizontal model as follows:

• The journal entry would be as follows:

Reclassifying Assets to Expenses

End of month adjusting entries

Assets Expenses

Adjusting entries
Prepaid insurance Insurance expense
Supplies Supplies expense
Transaction Analysis Methodology

Answer Five Questions:

1. What’s going on?
2. What accounts are affected?
3. How are they affected?
4. Does the balance sheet balance? (Do the debits
equal the credits?)
5. Does my analysis make sense?
Closing the Books
The closing process simply transfers the year-end balances
of all income statement accounts (e.g., revenues, expenses,
gains, and losses) to the Retained Earnings account.
Closing Entries

Expenses, losses, and Revenues and gains

dividends decrease increase retained earnings.
retained earnings.