Essentials of Managerial Finance

1
Chapter 2 Recording Business Transactions
2
The Accounting Process
Record transactions in the journal
Copy (post) to the ledger
Prepare the trial balance
3
The Account

• Basic summary device
• Detailed record of all changes that have occurred
  in a particular asset, liability, or
  stockholders equity
• Covers a specific period of time
• Grouped in three broad categories
• Assets
• Liabilities
• Stockholders Equity

4
The Journal and The Ledger

• Journal
• Chronological record of transactions
• Organized by date
• Ledger
• The book holding all the accounts and their
  balances
• Organized by account

5
Trial Balance

• Listing of all accounts and their balances

6
Assets

• Economic resources that will benefit the business
  in the future
• Cash
• Accounts receivable
• Notes receivable
• Prepaid expenses
• Land
• Building
• Equipment, Furniture, Fixtures

7
Liabilities

• A debt (something owed)
• Accounts payable
• Notes payable
• Accrued liabilities

8
Stockholders Equity

• Owners claim to the assets
• Common stock
• Retained earnings
• Dividends
• Revenues
• Expenses

9
Ledger

• Asset, Liability, and Stockholders equity
  Accounts

10
Double Entry System

• Record dual effects of each transaction
• Each transaction has a
• Receiving side
• Giving side
• Examples
• Company purchases supplies (receiving) with cash
  (giving)
• Company issues stock (giving) and receives cash
  (receiving)

11
T-Account

• Tool for analyzing and determining the balance in
  a given account

Dr Debit
Cr Credit
12
Increases and Decreases in Accounts

• Whether an account is increased by debit or a
  credit is determined by the account type
• Asset, liability, or equity
• Debits are not good or bad
• Neither are credits

13
Rules of Debit and Credit

• The account category governs the increase side or
  decrease side
• Increases are recorded on one side
• Decreases are recorded on the opposite side
• Rules of debits and credits

14
Illustrate Debits and Credits

• The first transaction involves receiving 30,000
  cash and issuing common stock
• The second transaction is a 20,000 purchase of
  land for cash

15
S2-2 EXPLAINING ACCOUNTS AND THE RULES OF DEBITS
AND CREDITS

• Margaret Alves is tutoring Timothy Johnson, who
  is taking introductory accounting. Margaret
  explains to Timothy that debits are used to
  record increases in accounts and credits record
  decreases. Timothy is confused and seeks your
  advice.
• When are debits increases?
• When are debits decreases?
• 2. When are credits increases?
• When are credits decreases?

Debits are increases in the Assets, Dividends,
and Expenses.
Debits are decreases in the Liabilities,
Stockholders equity, Retained earnings and
Revenues.
Credits are increases in the Liabilities,
Stockholders equity, Retained earnings and
revenues.
Credits are decreases in the Assets, Dividends,
and Expenses.
16
Steps in the Transaction Recording Process
Use the rules of debit and credit
17
Illustrating a Journal Entry

• Journalize the first transaction of Smart
  Touchthe receipt of 30,000 cash and issuance of
  common stock
• Step 1 The accounts affected are Cash and Common
  stock. Cash is an asset. Common stock is equity.
• Both accounts increase by 30,000. Assets
  increase with debits. Equity increases with
  credits.

18
Illustrating a Journal Entry (continued)

• Four parts
• Date of transaction
• Title of account debited with dollar amount
• Title of account credited with dollar amount
• Brief explanation of transaction

19
S2-5 JOURNALIZING TRANSACTIONS

• Ned Brown opened a medical practice in San Diego,
  California.
• 1. Record the preceding transactions in the
  journal of Ned Brown, M.D., P.C. Include an
  explanation.

Jan 1 The business received 29,000 cash and issued common stock.
2 Purchased medical supplies on account, 14,000.
2 Paid monthly office rent of 2,600.
3 Recorded 8,000 revenue for service rendered to patients on account.
20
S2-5 JOURNALIZING TRANSACTIONS

• Jan 1 The business received 29,000 cash and
  issued common stock
• Cash received indicates cash increases
• Cash is an Asset Assets increase with debits
• Issued common stock indicates equity is
  increasing
• Increase equity with credits

GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL
DATE DATE DESCRIPTION REF DEBIT CREDIT



Jan 1 Cash
29,000
Common Stock
29,000 Issued stock.
21
S2-5 JOURNALIZING TRANSACTIONS

• Jan. 2 Purchased medical supplies on account,
  14,000
• Medical Supplies, an asset, is increasing
• Assets increase with debits
• On account, increases accounts payable, a
  liability
• Increase liabilities with credits

GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL
DATE DATE DESCRIPTION REF DEBIT CREDIT



Jan 2 Medical supplies
14,000
Accounts payable
14,000 Purchased supplies on
account.
22
S2-5 JOURNALIZING TRANSACTIONS

• Jan. 2 Paid monthly office rent of 2,600
• Paid rent, an expense, expense is increasing
• Expenses increase with debits
• Paid cash, cash is an asset
• Increase assets with debits

GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL
DATE DATE DESCRIPTION REF DEBIT CREDIT



Jan 2 Rent Expense
2,600
Cash
2,600 Paid office
rent.
23
S2-5 JOURNALIZING TRANSACTIONS

• Jan. 3 Recorded 8,000 revenue for service
  rendered to patients on account
• On account indicates Accounts receivable increase
• Accounts receivable is an Asset, Assets increase
  with debits
• Rendered services, services are revenues,
  indicates revenues are increasing
• Increase revenues with credits

GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL
DATE DATE DESCRIPTION REF DEBIT CREDIT



Jan 3 Accounts receivable
8,000
Service revenue
8,000 Performed service on
account.
24
Posting from the Journal to the Ledger

• Copying amounts from the journal to the ledger

25
Expanding Debit/Credit Rules to Include Revenues
and Expenses
26
Complete Rules of Debit and Credit
27
Normal Balance of an Account
28
Flow of Accounting Data from the Journal to the
Ledger
29
Source Documents

• Origin of accounting transactions
• Examples
• Bank deposit tickets
• Invoices
• Checks
• Stock certificates

30
Practice Journalizing and Posting Transaction 1
30,000
30,000
GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL
DATE DATE DESCRIPTION REF DEBIT CREDIT
Cash 30,000
Common stock 30,000
Issued stock.
31
Practice Journalizing and Posting Transaction 2
Land
30,000
20,000
30,000
20,000
10,000
GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL
DATE DATE DESCRIPTION REF DEBIT CREDIT
Land 20,000
Cash 20,000
Received payment on account.
32
Practice Journalizing and Posting Transaction 3
Office supplies
30,000
20,000
30,000
20,000
500
500
10,000
GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL
DATE DATE DESCRIPTION REF DEBIT CREDIT
Office supplies 500
Accounts payable 500
Received payment on account.
33
Practice Journalizing and Posting Transaction 4
30,000
20,000
30,000
20,000
5,500
5,500
GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL
DATE DATE DESCRIPTION REF DEBIT CREDIT
Cash 5,500
Service revenue 5,500
Received payment on account.
34
The Ledger Accounts After Posting
35
S2-10 PREPARING A TRIAL BALANCE

• Oakland Floor Coverings, Inc. reported the
  following summarized data at December 31, 2012.
  Accounts appear in no particular order.

Revenues 34,000 Other liabilities 18,000
Equipment 45,000 Cash 12,000
Accounts payable 2,000 Expenses 19,000
Common stock 22,000
36
S2-10 PREPARING A TRIAL BALANCE
Oakland Floor Coverings, Inc.
Trial Balance
December 31, 2012
Cash
Equipment
Accounts Payable
Other Liabilities
Common Stock
Revenues
Expenses

12,000 45,000
2,000 18,000
22,000
34,000 19,000 76,000 76,000
37
S2-9 POSTING, BALANCING T-ACCOUNTS, AND
PREPARING A TRIAL BALANCE

• Use the January transaction data for Ned Brown,
  M.D., P.C. given in Short Exercise 2-5.
• 2. After making the journal entries in Short
  Exercise 2-5, post to the T-accounts. No dates or
  posting references are required. Compute the
  balance of each account, and denote it as Bal

Jan 1 The business received 29,000 cash and issued common stock.
2 Purchased medical supplies on account, 14,000.
2 Paid monthly office rent of 2,600.
3 Recorded 8,000 revenue for service rendered to patients on account.
38
S2-5 JOURNALIZING TRANSACTIONS
GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL
DATE DATE DESCRIPTION REF DEBIT CREDIT



Jan 1 Cash
29,000
Common Stock
29,000 Issued stock.
29,000
29,000
39
S2-5 JOURNALIZING TRANSACTIONS
GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL
DATE DATE DESCRIPTION REF DEBIT CREDIT



Jan 1 Medical supplies
14,000
Accounts payable
14,000 Purchased supplies on
account.
14,000
14,000
40
S2-5 JOURNALIZING TRANSACTIONS
GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL
DATE DATE DESCRIPTION REF DEBIT CREDIT



Jan 2 Rent Expense
2,600
Cash
2,600 Paid office
rent.
29,000
2,600
2,600
41
S2-5 JOURNALIZING TRANSACTIONS
GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL GENERAL JOURNAL
DATE DATE DESCRIPTION REF DEBIT CREDIT



Jan 3 Accounts receivable
8,000
Service revenue
8,000 Performed service
on account.
8,000
8,000
42
S2-9 COMPUTE THE BALANCE OF EACH ACCOUNT,
AND DENOTE IT AS Bal
Bal 14,000
Bal 29,000
Bal 26,400
Bal 8,000
Bal 8,000
Bal 14,000
Bal 2,600
43
S2-9 PREPARE THE TRIAL BALANCE
3. Prepare the trial balance, complete with a
proper heading, at January 3, 2012.
Ned Brown, M.D., P.C.
Trial Balance
January 3, 2012
Cash
Accounts receivable
Medical supplies
Accounts payable
Common stock
Service revenue
Rent expense
Total
26,400 8,000 14,000
14,000
29,000 8,000
2,600 51,000 51,000
44
Trial Balance

• Summary of the ledger
• Lists all accounts with their balances
• Accuracy check
• Debits should equal credits
• NOT a balance sheet

45
Trial Balance
46
Detecting Trial Balance Errors

• Search for missing account
• Divide the difference between total debits and
  total credits by two
• Is there a debit/credit balance for this amount
  posted in the wrong column?
• Divide out-of-balance amount by nine
• SlideAdding or dropping a zero (100 instead of
  1,000)
• TranspositionReversing two digits (2,100
  instead of 1,200)

47
Details of the Journal
48
Four-Column Account