CHAPTER Analyzing and Recording Business Transactions Principles of Accounting 12e Needles Powers Crosson © human/iStockphoto Concepts Underlying Business Transactions Bus ine s s trans ac tio ns are economic events that should be recorded in the accounting records The concepts of re cognition, valuation, and clas s ification underlie all business transactions ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Concepts Underlying Business Transactions Re c o g nitio n refers to the decision as to whe n to record a business transaction Valuatio n is the process of assigning a monetary amount to business transactions and the resulting assets and liabilities GAAP states that all business transactions should be valued at fair value when they occur – Fair value is the e xchange price of an actual or potential business transaction between market participants – Recording transactions at the exchange price at the point of recognition is called the c o s t princ iple Clas s ific atio n is the process of assigning all the transactions in which a business engages to appropriate categories, or accounts ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Double-Entry System and Accounts In the uble -e ntry s ys te m, each transaction must be recorded with at least one debit and one credit, and the total amount of the debits must equal the total amount of the credits Ac c o unts are the basic storage units for accounting data and are used to accumulate amounts from similar transactions – An accounting system has a separate account for each asset, each liability, and each component of owner’s equity, including revenues and expenses ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Chart of Accounts In a manual accounting system, each account is kept on a separate page or card These pages or cards are placed together in a book or file called the g e ne ral le dg e r In computerized systems, accountants still refer to the group of accounts as the ge ne ral le dge r, or simply the le dge r – A c hart o f ac c o unts is a table of contents for the ledger It lists the account titles and the numbers that have been assigned to them It usually lists the accounts in the order in which they appear in the ledger (the order in which they appear in the financial statements) ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part The T Account (slide of 2) The T ac c o unt is a tool used to analyze transactions It has three parts: – a title, which identifies the asset, liability, or owner’s equity account – a left side, which is called the de bit side (abbreviated Dr., from the Latin de be re ) – a right side, which is called the c re dit side (abbreviated Cr., from the Latin cre de re ) ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part The T Account (slide of 2) – For the Cash account, receipts are recorded on the left (debit) side of a T account and payments on the right (credit) side, as shown below – The totals in smaller, blue figures are simply working totals, or fo o ting s – The difference between the total debit footing and the total credit footing is called the ac c o unt balanc e ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Rules of Double-Entry Accounting The double-entry system follows two rules: – Every transaction affects at least two accounts – Total debits must equal total credits For every transaction: – one or more accounts must be debited, or entered on the left side of a T account – one or more accounts must be credited, or entered on the right side of a T account ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Rules of Double-Entry Accounting Keep the accounting equation in mind: Assets =Liabilities +Owner’s Equity ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Rules of Double-Entry Accounting Withdrawals and expenses are deductions from owner’s equity, so transactions that incre as e withdrawals or expenses de cre as e owner’s equity ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Normal Balance The no rmal balanc e of an account is its usual balance and is the side (debit or credit) that increases the account ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Business Transaction Analysis The details of business transactions are supported by s o urc e c ume nts —invoices, receipts, checks, or contracts A jo urnal e ntry is a notation that records a single transaction in the chronological accounting record known as a jo urnal Each entry must be in proper jo urnal fo rm ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part The Trial Balance The trial balanc e is a device used to ensure that the total of debits and credits in the accounts are equal ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Finding Trial Balance Errors If the debits and credits in a trial balance are not equal, look for one or more of these errors: – A debit was entered in an account as a credit, or vice versa – The balance of an account was computed incorrectly – An error was made in carrying the account balance to the trial balance Recording an account as a credit when it usually carries a debit balance, or vice versa, causes the trial balance to be out of balance by an amount divisible by Transposing two digits when transferring an amount to the trial balance causes the trial balance to be out of balance by an amount divisible by – The trial balance was summed incorrectly ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Recording and Posting Transactions Although transactions can be entered directly into the ledger accounts, identifying individual transactions or finding errors is difficult because the debit is recorded in one account and the credit in another The solution is to record all transactions chronologically in a journal and then transfer the debit and credit portions of each transaction to the appropriate accounts in the ledger The simplest and most flexible kind of journal is the g e ne ral jo urnal ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part General Ledger While the ge ne ral journal is used to record the details of each transaction, the ge ne ral le dge r is used to update each account Transferring transactions from the journal to the ledger is called po s ting The le dg e r ac c o unt fo rm is a form of the account that contains four columns for dollar amounts ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Ethical Financial Reporting and Business Transactions R e cognition, valuation, and clas s ification, as specified under generally accepted accounting principles, are important factors in ethical financial reporting The re cognition issue can be particularly difficult to resolve – The predetermined time at which a transaction should be recorded is the re c o g nitio n po int – A purchase transaction should be recorded when title to merchandise passes from the supplier to the purchaser and creates an obligation to pay ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Recognition Examples of economic events that should and should not be recorded as business transactions include: ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Cash Flows and the Timing of Transactions To avoid financial distress, a company must be able to pay its bills on time Consider the transactions of Blue Design studio shown below Blue must perform a delicate balancing act with its cash flows to ensure that it can remain profitable ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part ... be out of balance by an amount divisible by Transposing two digits when transferring an amount to the trial balance causes the trial balance to be out of balance by an amount divisible by – The... amount of the debits must equal the total amount of the credits Ac c o unts are the basic storage units for accounting data and are used to accumulate amounts from similar transactions – An accounting. .. Financial Reporting and Business Transactions R e cognition, valuation, and clas s ification, as specified under generally accepted accounting principles, are important factors in ethical financial