HANDHOLD 3.

2
Processing Transactions

Salma sets up FreeHand Company, a creative writing school. Let us take the company’s first two transactions to illustrate the four
steps in processing transactions: (1) analysis; (2) rules; (3) entry; (4) accounts. Italics signify change. We have the following four
steps for each transaction4:

Step 1 ANALYSIS Study the changes in asset, liability and equity items.
Step 2 RULES State the debit and credit rules relevant to the transaction.
Step 3 ENTRY Record the transaction showing the accounts to debit and credit.
Step 4 ACCOUNTS Present the related accounts after recording the transaction.

The balance is the result of recording more increase than decrease. We debit asset,
expense, drawing, and dividend accounts to record increase, and credit to record
decrease in those accounts. As a result, asset and expense accounts usually have
debit balances. Since we credit liability, share capital and revenue accounts to record
increase and debit to record decrease, these accounts usually have credit balances.
The usual type of balance for an account is its normal balance. Figure 3.3
summarizes the normal balances for the various types of accounts.

QUICK QUESTION
Cash account balance

Can the cash account have a credit balance?

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TEST YOUR UNDERSTANDING 3.3
Normal Balances

Indicate the normal balance of the accounts in Test Your Understanding 3.1.

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DISCUSSION
We don’t need to learn double-entry accounting when we can use accounting software. Do QUESTION 3.2
you agree?
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COMPREHENSIVE ILLUSTRATION: VOGUE COMPANY

To illustrate the procedure for recording transactions, let us set up

Vogue Company, a business that supplies new designs for dresses. In this illustration,
you will learn how to record a transaction in terms of debits and credits.
June 5 Signed an agreement with EthnicWear for developing a special design. The agreement provided for payment of a fee
of `2,000 by EthnicWear on completion of the work.

Signing an agreement with a customer is not a transaction since it does not create any asset or revenue. Vogue will
ANALYSIS
earn the revenue when it completes the design.