ACCOUNTING FUNDAMENTALS Recording Business Transactions Learning Objectives: After studying this chapter, you should be able to: 1. List and explain in brief the sequential steps in the accounting cycle. 2. Identify the general journal as the book of original entry. 3. Outline the steps in analyzing transactions and state the role of source documents. Detail the standard contents of the general journal. Analyze the impact of transactions on the elements and the specific accounts. Apply the rules of debits and credits in analyzing business transactions. Journalize transactions ip proper form. Describe a general ledger and understand what purpose it serves. Distinguish between permanent and temporary accounts. 10. Develop a chart of accounts. 11. Post entries from the general journal to the general ledger. 12. Prepare and explain the use of a trial balance. 13. Perform steps in locating and correcting errors. oP Pena ACCOUNTING CYCLE ies of sequential steps or procedures performed to The accounting cycle refers to a seri the steps in the cycle and their aims follow: accomplish the accounting process. T! Step 1 _ Identification of Events to be Recorded ‘Aim: To gather information about transactions or events generally through the source documents. Duringthe step 2 Transactions are Recorded in the Journal serene Aim: To record the economic impact of transactions on the firm in a ane journal, whichis a form that facilitates transfer tothe accounts. Journal Entries are Posted to the Ledger ‘Aim: To transfer the information from the journal to the ledger for classification. Step3 109Step 4 Preparation of a Trial Balance ‘Aim: To provide a listing to veri in the ledger. . Step5 Preparation of the Worksheet including Adjusting Entries ‘Aim: To aid in the preparation of financial statements. Step6 Preparation of the Financial Statements iy the equality of debits and credits ‘Aim: To provide useful information to dectionsaers i i ized and Po Attheend Step? Adjusting Journal Entries are Journalize oe of the ‘aim: To record the accruals, expiration of deferrals, estimations and counted other events from the worksheet. period Step § Closing Journal Entries are Journalized and Posted and transfer profit to owner's ‘Aim: To close temporary accounts equity. Preparation of a Post-Closing Trial Balance 2 ‘im: To check the equality of debits and credits after the closing entries... Step 9 ‘Atthestart Step 10. Reversing Journal Entries are Journalized and Posted of the next Aim: To simplify the recor of certain regular transactions in the cad next accounting period. This cycle is repeated each accounting period. The first three steps in the accounting cycle are accomplished during the period. The fourth to the ninth steps generally occur at the end of the period. The last step is optional and occurs at the beginning of the next period. The discussion in this chapter will focus on the first four steps. Steps 5 to 10 will be taken up in Chapters 5 and 6. Refer to the following diagram for steps 2, 3 and 4. The General Journal Shows all the effects of a transaction in terms of debits and credits. (the book of original entry) Office Equipment xx Cash, mx Accounts Payable xx Posting Transferring the amounts from the general journal to appropriate accounts in the ledger. The Ledger A grouping of accounts. Office Used to classify and Equipment summarize transactions Accounts Payable and to prepare data for = basic financial statements. 10Trial Balance Listing of all ledger accounts, in a order, with their respective debit Liabilities or credit balances, Owner's Equity Revenues Expenses TRANSACTION ANALYSIS (Step 1) The analysis of transactions should follow these four basic steps: 1. Identify the transaction from source documents. 2. Indicate the accounts—either assets, liabilities, equity, income or expenses— affected by the transaction. 3. Ascertain whether each account is increased or decreased by the transaction. 4. Using the rules of debit and credit, determine whether to debit or credit the account to record its increase or decrease. Source Documents Transactions and events are the starting points in the accounting cycle. By relying on source documents, transactions and events can be analyzed as to how they will affect performance and financial position. Source documents identify and describe transactions and events entering the accounting process. These original written evidences contain information about the nature and the amounts of the transactions. These are the bases for the journal entries; some of the more common source documents are sales invoices, cash register tapes, official receipts, bank deposit slips, bank statements, checks, purchase orders, time cards and statements of account. TRANSACTIONS ARE JOURNALIZED (Step 2) After the transaction or event has been identified and measured, it is recorded in the journal. The process of recording @ transaction is called journalizing. The Journal The journal is a chronological record of the entity's transactions. A journal entry shows all the effects of a business transaction In terms of debits and credits. Each transaction is intially recorded in a journal rather than directly in the ledger. A journal is called the uiON book of original entry. The nature and volume of transactions of the busin, determine the number and type of journals needed. The general journal is the simpj_., journal. Format ‘The standard contents of the general journal are as follows: 1. Date. The year and month are not rewritten for every entry unless the year o, Month changes or a new page is needed. 2. Account Titles and Explanation. The account to be debited is entered at the extreme left of the first line while the account to be credited is entered slightiy indented on the next line. A brief description of the transaction is usually made on the line below the credit. Generally, skip a line after each entry. 3._P. R. (posting reference). This will be used when the entries are posted, that is, until the amounts are transferred to the related ledger accounts. The Posting Process will be described later. 4. Debit. The debit amount for each account is entered in this column, 5. Credit. The credit amount for each account is entered in this column. Assume that on Nov. 1, 2016, Galicano Del Mundo invests P450,000 to open his business, Del Mundo Landscape Specialist. The journal entry follows: Journal paged Date Account Titles and Explanation PR. Cash 450,000 Del Mundo, Capital 50,000 Initial investment. Simple and Compound Entry Ina simple entry, only two accounts are affected—one account is debited and the other account credited. An example of this is the entry to record the initial investment of De! Mundo. However, some transactions require the use Of more than two accounts. When three or more accounts are required in a journal entry, the entry is referred to.3S @ compound entry.we shall analyze the tmustration: To understand how to record a varlety of transactions, tain notes (in italics) business of Del Mundo Landscape Specialist. Some ions cont for clarification and guidance. transactions cor the letter A (for asset), L for better appreciation of the nature of the affected accounts, dddition, owner's equity (lability) or OE (owner's equity) is inserted after each entry. In a is further classified into OE:1 (income) and OE:E (expenses). Note that the rules of double-entry system are observed in each transaction: 1. Two or more accounts are affected by each transaction. 2. The sum of the debits for every transaction equals the sum of the credits. 3. The equality of the accounting equation is always maintained. ee Initial Investment Nov. 1 The owner of the Del Mundo Landscape Specialist, Galicano Del Mundo, invests P450,000 to open the business. Analysis Assets increased. Owner's equity increased. Increases in assets are recorded by debits. Increases in owner's equity are recorded by credits. Increase in assets is recorded by a debit to cash. Increase in Rules Entry owner's equity is recorded by a credit to Del Mundo, Capital Dr. Cr. Cash (A) 450,000 Del Mundo, Capital (OE) 450,000 Rent Paid in Advance Nov. 1 Rented office space and paid three months’ rent in advance, 21,000. Given the length of time, i.e., more than a month, that this contract is in effect, the matching principle requires that the contract's cost initially be recorded as an asset since it provides a future benefit. Analysis ‘Assets increased. Assets decreased. Rules increases in assets are recorded by debits. Decreases in assets are recorded by credits. Entry increase in assets is recorded by a debit to prepaid rent. Decrease in assets is recorded by a credit to cash. 113—————————————————— Dr. Cr. Prepaid Rent (A) 21,000 Cash (A) 21,000 Vehicle Acquired by Issuing a Note Nov. 2 Del Mundo purchases a P300,000 used truck by paying P200,000 in cash and signing a P100,000 note payable which is due in eighteen months. Analysis Assets increased. Assets decreased. Liabilities increased. Rules Increases in assets are recorded by debits. Decreases in assets are recorded by credits. Increases in liabilities are recorded by credits. , Entry Increase in assets is recorded by a debit to vehicles. Decrease in assets is recorded by a credit to cash. Increase in liabilities is recorded by a credit to notes payable. Dr. cr. Vehicles (A) 300,000 Cash (A) 200,000 Notes Payable (L) 100,000 Equipment Acquired for Cash Nov. 3 Del Mundo purchases mechanical lawn mowers for P54,000 in cash. Analysis Assets increased. Assets decreased, Rules Increases in assets are recorded by debits. Decreases by credits. Entry Increase in assets is recorded by a debit to equipment. Decrease in assets is recorded by a credit to cash. Dr. cr. Equipment (A) Cash (A) 114expenses Incurred and Paid aoe Del Mundo purchases 1,500 worth of gasoline. Analysis pose decreased. Owner's equity decreased. 4 fecre rule: ‘eases in assets are recorded by credits. Decreases in owner's ‘uity are recorded by debits EY Decrease in owner T's equity is recorded by a debit to gas expense. Decrease in assets is recorded by a credit to cash, Dr. Cr. Gas Expense (OE:£) . 5: 1,500 Cash (A) Aeon —_—,,, Insurance Premiums Paid Nov. 5 Del Mundo pays P24,000 for a one-year insurance contract that Protects his business from Nov. 1 until Oct. 31 of the following year. Analysis An asset increased. Another asset decreased. Rules Increases in assets are recorded by debits. Decreases in assets are recorded by credits. Entry Increase in assets is recorded by a debit to prepaid insurance. Decrease in assets is recorded by a credit to cash. Dr. cr. Prepaid Insurance (A) 24,000 Cash (A) 24,000 Supplies Purchased,on Account Del Mundo purchases P1,000 worth of office supplies, placing the purchase on his account with the store rather than paying cash. Supplies are a prepaid expense (an asset) until they are used and thereby become a cost of doing business (on expense). Accounts payable differ from notes payable. Accounts payable are amounts the entity owes based on the good credit of the entity or the whereas notes payable are amounts the entity owes under Nov. 8 owner, formal obligations. 115Analysis Assets increased. Liabilities increased. Rules Increases in assets are recorded by debits. Increases in liabilities are recorded by credits. , Entry Increase in assets is recorded by a debit to supplies. Increase in liabilities is recorded by a credit to accounts payable. Or. Cr. Supplies (A) 1,000 1,000 Accounts Payable (L) —— Revenues Earned and Cash Collected Nov. 14 The Del Mundo Landscape Specialist cuts grass for seven customers, receiving P2,500 from each. Analysis, Assets increased. Owner's equity increased. Rules Increases in assets are recorded by debits. Increases in owner's equity are recorded by credits. Entry Increase in assets is recorded by a debit to cash. Increase in owner's equity is recorded by a credit to lawn cutting revenues. Dr. cr. Cash (A) 17,500 Lawn Cutting Revenues (OE:!) 17,500 a Unearned Revenues Collected Nov. 20 Del Mundo receives P13,500 from a customer for six future maintenance visits. An advance deposit from a custamer is an obligation to perform work in the future. It is a liability until the work is performed, at which time it becomes revenue. Therefore the advance deposit is called unearned revenues. Analysis Assets increased. Liabilities increased. Rules Increases in assets are recorded by debits. Increases in liabilities are recorded by credits. Entry Increase in assets is recorded by a debit to cash. Increase in liabilities is recorded by a credit to unearned revenues. 116Or. Cr. Cash (A) "as00 Unearned Revenues (L) " 13,500 OO Revenues Earned on Account Nov. 22 Analysis Rules Entry Del Mundo Landscape Specialist cuts grass for eight customers, billing each one P2,500 but receiving no cash. In accordance with the revenue recognition principle, revenue is recognized upon the completion of a service or the delivery of a product, even if no cash changes hands at that time. Assets increased. Owner's equity increased. Increases in assets are recorded by debits. Increases in owner's equity are recorded by credits. Increase in assets is recorded by a debit to accounts receivable. Increase in owner's equity is recorded by a credit to lawn cutting revenues. Dr. Cr. Accounts Receivable (A) 20,000 Lawn Cutting Revenues (OE:!) 20,000 Salaries Paid Nov. 26 Analysis Rules Entry Del Mundo pays P4,000 in salaries to a part-time employee. Assets decreased. Owner's equity decreased. Decreases in assets are recorded by credits. Decreases in owner's equity are recorded by debits. Decrease in owner's equity is recorded by a debit to salaries expense. Decrease in assets is recorded by a credit to cash. Dr. Cr. salaries Expense (OE:E) 4,000 Cash (A) 4,900 ee EEEEEEEEEEEEEEEEEem 117Advertising Paid Nov. 28 Del Mundo pays P1,750 to print advertising fliers. Analysis Assets decreased. Owner's equity decreased. , Rules Decreases in assets are recorded by credits. Decreases In owner's equity are recorded by debits. Entry Decrease in owner's equity is recorded by a debit to advertising expense. Decrease in assets Is recorded by a credit to cash. Dr. Cr. Advertising Expense (OE:E) 1,750 Cash (A) 1,750 —S EE — Withdrawal of Cash by Owner Nov. 29 Del Mundo withdraws P5,000 for personal use. Analysis Assets decreased. Owner's equity decreased. Rules Decreases in assets are recorded by credits. Decreases in owner's equity are recorded by debits. Entry Decrease in owner's equity is recorded by a debit to Del Mundo, Withdrawals, Decrease in assets is recorded by a credit to cash. Dr. cr. Del Mundo, Withdrawals (OE) 5,000 Cash (A) 5,000 Accounts Receivable Partially Collected Nov.30 _ - Five of the eight customers billed last Nov. 22 each pay P2,500. Analysis An asset increased. Another asset decreased. Rules Increases in assets are recorded by debits. Decreases as credits. Entry Increase in assets is recorded by a debit to cash. Decrease in » assets is recorded by a credit to accounts receivable. Cash (A) ‘Accounts Receivable (A) 18THE LEDGER ts is referred to as a ledger. Although some firms may € certain detailed inf hi 1 . Ageneral ledger is the ", formation, all firms have a general tedger. AG lger is the "reference book" of the accounting system and is used to nd summarize i classify and su transactions, and to Prepare data for basic financial statements. are classified into two general groups: |. balance sheet 1 oF permanent accounts (assets, liabilities and owner's equity). . income stater 2. a ae or temporary accounts {income and expenses). Temporary Counts are used to gather information for a particular accounting Period. At the end of the period, the balances of these accounts are transferred to a permanent owner's equity account. Each account has its own record in the ledger. Every account in the ledger maintains the basic format of the T-account but offers more information (e.g. the account number at the upper right corner and the journal reference column). Compared to a journal, a ledger organizes information by account. CHART OF ACCOUNTS A listing of all the accounts and their account numbers in the ledger is known as the chart of accounts. The chart is arranged in the financial statement order, that is, assets first, followed by liabilities, owner's equity, income and expenses. The accounts should be numbered in a flexible manner to permit indexing and cross-referencing. When analyzing transactions, the accountant refers to the chart of accounts to identify the pertinent accounts to be increased or decreased. If an appropriate account title is not listed in the chart, an additional account may be added. Presented below is the chart of accounts for the illustration: ‘Del Mundo Landscape Specialist Chart of Accounts Balance Sheet Accounts Income Statement Accounts Assets income 110 Cash 410 Landscaping Revenues 120 Accounts Receivable 420 Lawn Cutting Revenues 130 Supplies 140 Prepaid Rent Expenses 150 Prepaid Insurance 510 Salaries Expense 520 Supplies Expense 530 Rent Expense 540 Insurance Expense 550 Gas Expense 560 Advertising Expense 160 Vehicles 165 Accumulated Depreciation-Vehicles 170 Equipment - 175 Accumulated Depreciation-Equipment 19abilities 570 Depreciation Expense. 210 Notes Payable Vehicles 220 Accounts Payable 580 Depreciation Expense. 230 Salaries Payable Equipment 240 Interest Payable 590 Interest Expense 250 Unearned Revenues ‘Owner's Equity 310 Del Mundo, Capital 320 Del Mundo, Withdrawals 330 Income Summary POSTING (Step 3) | | Posting means transferring the amounts from the journal to the appropriate accounts in the ledger. Debits in the journal are posted as debits in the ledger, and credits in the journal as credits in the ledger. The steps are illustrated on the next page: | 1. Transfer the date of the transaction from the journal to the ledger. 2. Transfer the page number from the journal to the journal reference (J.R.) column of the ledger. 3. Post the debit figure from the journal as a debit figure in the ledger and the credit figure from the journal as a credit figure in the ledger. 4. Enter the account number in the posting reference column of the journal once the figure has been posted to the ledger. | LEDGER ACCOUNTS AFTER POSTING At the end of an accounting period, the debit or credit balance of each account must be determined to enable us to come up with a trial balance. Each account balance is determined by footing (adding) all the debits and credits. If the sum of an account's debits is greater than the sum of its credits, that account has a debit balance. © ifthe sum of its credits is greater, that account has a credit balance. 120Account Titles and Explanation ze Nov. 1 | Cash Del Mundo, Capital Initial investment. ‘The Ledger Account: Cash Explanation > : Del Mundo, Capital Explanation 1 >2 Mlustration. The ledger accounts of Del Mundo Landscape Specialist after posting are shown below. The account numbers and journal reference columns are purposely omitted. The balance of each account has been determined. Notes Payable Nov. 2 __ 100,000 Balance — 100,000 Accounts Payable ; Nov. 8 1,000 Balance 1,000 Unearned Revenues Accounts Receivable Nov 22 20,000 | Nov. 30 ___12,500_ | Nov. 20 __13,500_ Balance 7,500 Balance 13,500 121. 311,250 Balance — 162,250Supplies Del Mundo, Capital Nov. 8 1,000 ‘Nov. 1 450,000 Balance 7,000 Balance 450,000" Prepaid Rent Del Mundo, Withdrawals ‘Nov. 1 21,000 ‘Nov. 29 5,000 Balance — 21,000 Balance — 5,000 Prepaid insurance Lawn Cutting Revenues ‘Nov. 5 24,000 Nov. 14 17,500 Balance — 24,000 22 __20,000 250 Balance 37,500 Vehicles Salaries Expense ‘Nov. 2 __300,000 Nov. 26 4,000 Balance ~ 300,000 Balance 4,000 Equipment_ Gas Expense Nov. 3 ‘54,000 Nov. 4 1,500 | Balance ‘$4,000 Balance 1,500 Advertsing Expense a Balance 1,750 The trial balance is a list of all accounts with their respective debit or credit balances. it is prepared to verify the equality of debits and credits in the ledger at the end of each accounting period or at any time the postings are updated. TRIAL BALANCE (Step 4) The procedures in the preparation of a trial balance follow: 1. List the account titles in numerical order. 2. Obtain the account balance of each account from the ledger and enter the debit balances in the debit column and the credit balances in the credit column. 3. Add the debit and credit columns. 4. Compare the totals. The trial balance is a control device that helps minimize accounting errors. When the totals are equal, the trial balance is in balance. This equality provides an interim proof of the accuracy of the records but it does not signify the absence of errors. For example, if the bookkeeper failed to record payment of rent, the trial balance columns are equal but in reality, the accounts are incorrect since rent expense is understated and cash overstated. The trial balance for the illustration follows: 122Del Mundo Landscape Specialist ‘Trial Balance Nov. 30, 2016 Cash Accounts Receivable arises Supplies pee Prepaid Rent cs Prepaid Insurance fate Vehicles i Equipment Focoen Notes Payable ‘ Accounts Payable Unearned Revenues Del Mundo, Capital Del Mundo, Withdrawals 5,000 Lawn Cutting Revenues Salaries Expense 4,000 Gas Expense 1,500 Advertising Expense 1,750 602,000 LOCATING ERRORS 100,000 1,000 13,500 450,000 37,500 602,000 An inequality in the totals of the debits and credits would automatically signal the presence of an error. These errors include: 1. Error in posting a transaction to the ledger: © an erroneous amount was posted to the account. 9 adebit entry was posted as a credit or vice versa. 0 adebit or credit posting was omitted. 2. Error in determining the account balances: © abalance was incorrectly computed. © abalance was entered in the wrong balance column. 3. Error in preparing the trial balance: % one of the columns of the trial balance was incorrectly added. 0 the amount of an account balance was incorrectly recorded on the trial balance. 0 Adebit balance was recorded on the trial balance as a credit or vice versa, or a balance was omitted entirely. What is the most efficient approach in locating an error? The following procedures when done in sequence may save considerable time and effort in locating errors: 123a 1. Prove the addition of the trial balance columns by adding these columns in the Opposite direction. balance is out of balance. The amount of the discrepancy is often a clue to the source of the error. If the discrepancy is divisible by 9, this suggests either transposition (reversing the order of numbers) error or a slide (moving of the decimal point). For example, assume that the cash account balance is P21,750, but in copying the balance into the trial balance the figures are transposed and written 28.P21,570. The resulting error amounted to P180 and is divisible by 9. Another common error is the slide, or incorrect placement of the decimal point, as when P21,750.00 is copied as P2,175.00. The resulting discrepancy in the trial balance wi, also be an amount divisible by 9. i 2. If the error does not lie in addition, determine the exact amount by which the tra | | Assume that the office equipment account has a debit balance of P42,000 but it is erroneously listed in the credit column of the trial balance. This will cause a discrepancy of two times P42,000 or P84,000 in the trial balance totals. Since such errors as recording a debit in a credit column are common, it is advisable, after determining the discrepancy in the trial balance totals, to scan the columns for an amount equal to exactly one-half of the discrepancy. It is also advisable to look over the transactions for an item of the exact amount of the discrepancy. An error may have been made by recording the debit side of the transaction and forgetting to enter the credit side. 3. Compare the accounts and amounts in the trial balance with that in the ledger. Be certain that no account is omitted. 4, Recompute the balance of each ledger account. 5. Trace all postings from the journal to the ledger accounts. As this is done, place a check mark in the journal and in the ledger after each figure is verified. When the operation is completed, look through the journal and the ledger for unchecked amounts. In tracing postings, be alert not only for errors in amount but also for debits entered as credits, or vice versa. Note that even when a trial balance is in balance, the accounting records may still contain errors. A balanced trial balance simply proves that, as recorded, debits equal credits. The following errors are not detected by a trial balance: | Failure to record or post a transaction. Recording the same transaction more than once. Recording an entry but with the same erroneous debit and credit amounts, Posting a part of a transaction correctly as a debit or credit but to the wrong account. AwNe 124 |