Learning objectives

Lecture 3
Business Transactions – Chapter 2
Adapted by SHARRON O’NEILL | Lecturer
©2009 John Wiley & Sons Australia, Ltd
INTRODUCTORY ACCOUNTING
This week we aim to:
¾ Identify source documents and business transactions
¾ Analyse the effect of accounting transactions
¾ Explain the role of a general journal and use it to record
accounting transactions and prepare journal entries
¾ Explain the role of debits and credits in recording business
transactions
¾ Explain the role of a general ledger and use it to record
accounting information
¾ Appreciate the role of a trial balance, prepare and analyse a
trial balance

Recall the Definition of Accounting

THE ACCOUNTING CYCLE

Accounting is the process of Steps in the accounting cycle Accounting Records

1. Identify & analyse transactions Source documents
identifying, measuring, recording,
summarising and communicating
2. Journalise transactions General journal
economic information
to interested stakeholders
so they can make informed 3. Post to ledger accounts General ledger

resource allocation decisions

4. Prepare trial balance of GL Trial balance

This describes the “accounting cycle”

5. Prepare financial statements Financial statements

Step 1. Chart of Accounts

Identify & analyse transactions What are Accounts?
What do we need to know? A/c # Account name
¾ An account is the basic summary devise
a) Has a transaction occurred ? of accounting 101 Cash at Bank

¾ Check source documents. They provide documentary evidence that 111 Accounts receivable
¾ Each account provides a record of the
a transaction occurred and internal control over the firm’s resources 141 Equipment
increases and decreases in the specific
item indicated by the account name. 181 Building
b) If so, is the transaction a business transaction ?
¾ External business transactions: exchange of economic resources ¾ Accounts can be grouped into five 201 Accounts Payable
and / or obligations involving an external party categories: 221 Loan Payable
¾ Internal business transactions: changes in economic resources and Assets, Liabilities, Owners Equity, 301 Share Capital
/ or obligations that do not involve an external party Revenues, Expenses
311 Retained Profits
¾ Non-business transactions: Private (personal) transactions, or ¾ The complete set of accounts is called a
transactions relating to a different business or events which result in general ledger 321 Dividends
no exchange of economic resources / value
401 Service revenue
¾ A list of all the accounts, and each
c) How does the transaction affect the accounting equation? corresponding account number, is called 501 Supplies expense
the “Chart of Accounts” 511 Wages expense
d) What specific accounts are affected by the transaction?
 Examples of Accounts
Individual Individual Individual
ASSET LIABILITY EQUITY
accounts accounts accounts
Account Type Account Name (examples include)
Land Interest Payable Salaries Expense
Assets Current Assets: Cash, A/c receivable, Inventory, Supplies Equipment Salaries Payable Service Revenue
Non-current Assets: Furniture, Motor vehicles, Building Supplies Accounts Payable Retained Profits
Cash Bank Loan Share Capital
Liabilities Current Liabilities: A/c payable, Rent payable
Non-current Liabilities: Bank Loan, Mortgage
Owners equity Share capital, Retained earnings, Dividends (for a
company) OR… › Remember: Following the principles of double entry book-keeping…
Capital and Drawings (for a sole trader or partnership) every business transaction
Revenue Sales revenue, Service revenue, Interest revenue, Rental - WILL cause CHANGES in at least two INDIVIDUAL accounts, but
revenue, Advertising revenue… etc - WILL NOT CHANGE the fundamental EQUALITY of the accounting equation
Expense Wages expense, Electricity expense, Supplies expense, -
Rent expense, Bank charges, Fuel expense, Telephone › The accounting equation must ALWAYS balance.
expense… etc
ONWER’S
This is not an exhaustive list but simply provides some examples of accounts that may be
affected by business transactions
ASSETS = LIABILITIES + EQUITY 8

Exercise:
Exercise: Identifying business transactions Analysing the effect of business transactions
Events for Bob the Builder
Events for Bob the Builder
1. Bob the builder purchased timber on account
1. Bob the builder purchased timber on account Assets = Liability O/Equity

2. Bob received $10,000 from a customer Ç Timber = Ç A/c payable -

3. Bob paid wages to his carpenters 2. Bob received $10,000 from a customer

4. Bob went to the movies Ç Cash = - -

È A/c receivable
5. Bob paid the phone bill
3. Bob paid wages to his carpenters
6. Bob used the timber (purchased above) to build a
È Cash = È OE
home for a customer
because
Ç Wages expense

EXPLORING OWNER’S EQUITY Recall: the Accounting Cycle

Steps in the accounting cycle Accounting Records

Share Retained
1. Identify & analyse transactions Source documents
Capital Earnings Revenue

2. Journalise transactions General journal

Assets = Liabilities + Owners Equity
Dividends Expenses 3. Post to ledger accounts General ledger
Permanent accounts – Statement of financial position
Temporary accounts – income statement & changes in equity
4. Prepare trial balance of GL Trial balance
Note: for a sole trader or partnership
- the Share Capital and Retained Earnings accounts are replaced by a single
account for each owner called Capital-Owners Name 5. Prepare financial statements Financial statements
- the Dividends account is replaced by a Drawings account
 Step 2.
Recording Transactions in a Journal (Journalising)

↑ Dr ↑ Cr
¾ The effect of business transactions on assets, liabilities, equities,
revenues and expenses are first recorded in a general journal Capital Revenue
¾ The journal entries:
Assets = Liabilities + Owners Equity
¾Are prepared in chronological order (ie date order, oldest first)
¾Show the “debit” or “credit” entry to be made to the accounts Drawings Expenses
È Cr È Dr
So, what is a Debit? What is a Credit? ¾ Accounts on the LEFT side of the basic accounting equation are
¾Debit means LEFT hand side (of the basic accounting equation) Debits and so are increased by making a Debit entry
¾Credit means RIGHT hand side (of the basic accounting equation) ¾ Accounts on the RIGHT side of the basic accounting equation are
Credits and so are increased by making a Credit entry
Debit Credit
Asset = Liabilities + Owner’s Equity
To decrease any account – just do the opposite!

ASSETS LIABILITIES OWNER’S EQUITY The General Journal (Continued)

Debit to Credit to Debit to Credit to Debit to Credit to
Increase Decrease Decrease Increase Decrease Increase Each general journal entry must contain the following information:
Normal Normal Normal
balance
• The date that the business transaction occurred
balance balance
• Details of the accounts to be debited (Name, a/c number and amount)
• Details of the accounts to be credited (Name, a/c number and amount)
• A narration or description of the transaction

Share Capital Dividends (or Drawings) (each) Revenue Assume: Ted purchased $2,000 stationery on account from
Debit to Credit to Debit to Credit to Debit to Credit to Officeworks on the 12th January 2010.
decrease increase increase decrease decrease increase This transaction is recorded in the journal as follows:
Date Details A/c Debit Credit
Retained Earnings (each) Expense
12/1/10 Stationery 130 2,000
Debit to Credit to Debit to Credit to
decrease increase Normal balance increase decrease Accounts Payable 210 2,000
shown in bold
Purchased stationery from Officeworks

Transaction Analysis and Journals The transaction 1 would be represented as follows:

Asset ↑ = Debit Owners Equity ↑ = Credit

Situation 1
Assets = Liabilities + Owners Equity
Stuart Lang decided to start a cleaning business on 1st
January 2010. He contributed $20,000 from his own Cash ↑ = Capital ↑
1 20,000 = 0 + 20,000
bank account to open a new business bank account
called Lang Cleaning.
Note: debit entries are always recorded in the journal first.
Source document?
› So the journal entry to record the transaction is…
Bank deposit slip
Business transaction? Date Details A/c Debit Credit

Yes 1 Jan 10 Cash at Bank 101 20,000

Analysis? Capital – S. Lang 300 20,000

(S. Lang contributed cash)
 Situation 2 Transaction 2 would be represented as follows:

Assets = Liabilities + Owners Equity

Stuart purchased a motor vehicle (a van) to use for his Cash ↓ Vehicles↑ = Loan ↑
business on January 2nd. The van cost $40,000. He paid a 2 (5,000) + 40,000 = 35,000 + 0
deposit of $5,000 and borrowed the difference from the bank.
Credit Debit Credit
Source document(s)
Receipt • So the journal entry to record the transaction is…
Bank loan contract Date Details A/c Debit Credit
2 Jan 10 Motor Vehicles 151 40,000
Business transaction?
Loan payable 211 35,000
Yes
Cash at Bank 101 5,000
Analysis?
(purchased car-rego ABC123)

NB. This transaction affects more than 2 accounts – it is called a compound entry

Situation 3 Transaction 3 would be represented as follows:

Assets = Liabilities + Owners

Stuart purchased some cleaning supplies worth $750 on Equity
3rd January. He opened an account with the supplier rather 3 Cleaning supplies = A/c Payable
than paying cash. The credit terms set by the supplier are ↑ ↑
2/10, n30. 750 = 750 + 0
Source document Debit Credit
Invoice So the journal entry to be recorded is…
Business transaction?
Date Details A/c Debit Credit
Yes
3 Jan 10 Cleaning supplies 131 750
Analysis?
Accounts Payable 201 750
(purchased cleaning supplies on credit)

Situation 4 Transaction 4 would be represented as follows:

Assets = Liabilities + Owners Equity

Stuart needed some spending money for drinks with his
friends Friday night and wrote a “cash” cheque for $300 4 Cash ↓ = Drawings ↑
on Friday 4th January. ∴ Owners Equity ↓
(300) = 0 + (300)
Source document
Credit Debit
Cheque (or cheque stub)
So the journal entry to be recorded is…
Business transaction? Date Details A/c Debit Credit
Yes
4 Jan 10 Drawings 311 300

Analysis? Cash at Bank 101 300

(withdrew cash for personal use)
 Situation 5

On Monday 7th January, Stuart gave Trevor, the owner of a Assets = Liabilities + Owners Equity
local shop, a written quote to clean the shop once per week.
- - -
Trevor was happy with the price quoted and said Stuart
should start cleaning the store next Friday. The agreed price
was $350 per week.
Source document
Quotation
Date Details A/c Debit Credit
Business transaction?
No
Analysis?

Transaction 6 would be represented as follows:

Situation 6

Next Friday, Stuart cleaned Trevor’s shop. Trevor did not Assets = Liabilities + Owners Equity
pay on that day but was given an invoice and promised Accounts receivable = Revenue ↑
to pay on the following Monday. ↑ ∴ Owners equity ↑
Source document 350 = 0 + 350
Invoice (prepared by Stuart and given to Trevor) Debit Credit
Business transaction? So the journal entry to be recorded is…
Yes
Date Details A/c Debit Credit
10 Jan 10 Accounts receivable 111 350
Analysis?
Cleaning Revenue 401 350
(cleaned Trevor’s shop, invoice #1)

Transaction 7 would be represented as follows:

Situation 7

Assets = Liabilities + Owners Equity

When Stuart cleaned Trevor’s corner store he used $35 Cleaning Supplies ↓ = Supplies expense ↑
worth of the cleaning supplies he had purchased ∴ Owners Equity ↓
previously. (35) = 0 + (35)
Source document Credit Debit
Stores Requisition (an internal document)
So the journal entry to be recorded is…
Business transaction?
Yes Date Details A/c Debit Credit
10 Jan 10 Cleaning supplies expense 521 35
Analysis?
Cleaning supplies 131 35
(supplies used to clean Trevor’s shop)
 General Journal page 1

Date Details A/c Debit Credit Step 3:

1 Jan 10 Cash at Bank 101 20,000 POSTING JOURNALS TO THE LEDGER

THE COMPLETED GENERAL JOURNAL

Capital – S. Lang 301 20,000
(S. Lang contributed cash)

2 Jan 10 Motor Vehicle 151 40,000

› Posting is the procedure where information is
Cash at Bank 101 5,000
transferred from the general journal entries to the
Loan payable 221 35,000
general ledger accounts
(Purchased new van)
› Steps in the process:
3 Jan 10 Cleaning Supplies 131 750
Accounts Payable 201 750
1. Find the account to be debited
(Purchased supplies on credit) 2. Enter the transaction date in the account
4 Jan 10 Drawings 311 300
3. Enter name of account that will be credited
Cash at Bank 101 300
(Withdrew cash for personal use) 4. Enter amount of the debit
10 Jan 10 Accounts Receivable 111 350 5. Go back to the journal and tick the account number
Cleaning Revenue 401 350 to show that part of the entry has been posted
(Provided services on credit)

10 Jan 10 Cleaning Supplies Expense 521 35 6. Repeat steps 1-5 for the account to be credited
Cleaning Supplies 131 35 32

(Used cleaning supplies) 61 435 61 435

Accounts: T-Account versus Running Balance Posting from a Journal to a Ledger

Cash at Bank 100 The general journal

Date Explanation Ref Debit Date Explanation Ref Credit Date Details A/c Debit Credit
2010 2010 1 Jan Cash at Bank 101 20,000
1/1 Opening Balance 30 000 21/1 Phone Expense 510 1 000 9
10/1 A/c Receivable 120 10 000 31/1 Closing Balance 39 000 Capital – S. Lang 301 20,000
40 000 40 000 (J Smith contributed cash)
1/2 Opening Balance 39 000

The general ledger

ACCOUNT: Cash at Bank Account No.: 100 Account Name: # 101
Cash at Bank
Date Explanation Post Ref. Debit Credit Balance
Date Details Ref Debit Credit Balance
2010
Jan 1 Opening balance 30 000 Dr 1 Jan Capital – S.Lang GJ1 20,000 20,000 Dr
10 Account receivable GJ1 10 000 40 000 Dr
21 Phone expense GJ5 1 000 39 000 Dr

Now, let’s post the journals from above

General Journal page 1

General Journal page 2
Date Details A/c Debit Credit Date Details A/c Debit Credit
1 Jan 10 Cash at Bank 101 20,000 9 4 Jan 10 Drawings 311 300
Capital – S. Lang 301 20,000
Cash at Bank 101 300
(S. Lang contributed cash)
(Withdrew cash for personal use)
2 Jan 10 Motor Vehicle 151 40,000
10 Jan 10 Accounts Receivable 111 350
Cash at Bank 101 5,000
Cleaning Revenue 401 350
Loan payable 221 35,000
(Provided services on credit)
(Purchased new van)

3 Jan 10 Cleaning Supplies 131 750 10 Jan 10 Cleaning Supplies Expense 501 35

Accounts Payable 201 750 Cleaning Supplies 131 35

(Purchased supplies on credit) (Used cleaning supplies)

60,750 60,750 685 685

 The General Ledger General Ledger continued

Account Name: Accounts Receivable # 111

Account Name: Cash at Bank # 101

Date Details Ref Debit Credit Balance

Date Details Ref Debit Credit Balance
1 Jan Capital – S. Lang GJ1 20,000 20,000 Dr 10/1 Cleaning revenue GJ2 350 350 Dr

2 Jan Motor Vehicle GJ1 5,000 15,000 Dr

4 Jan Drawings GJ2 300 14,700 Dr Account Name: Cleaning Supplies # 131
Date Details Ref Debit Credit Balance

3/1 Accounts Payable GJ1 750 750 Dr

10/1 Supplies expense GJ2 35 715 Dr

Final Cash at Bank balance

Account Name: Motor Vehicle # 151

Date Details Ref Debit Credit Balance Account Name: Capital – S. Lang # 301

2/1 Cash / Loan Payable GJ1 40,000 40,000 Dr Date Details Ref Debit Credit Balance
1/1 Cash at Bank GJ1 20,000 20,000 Cr
Account Name: Accounts Payable # 201

Date Details Ref Debit Credit Balance

3/1 Cleaning Supplies GJ1 750 750 Cr
Account Name: Drawings – S. Lang # 311

Account Name: Loan Payable # 221 Date Details Ref Debit Credit Balance

Date Details Ref Debit Credit Balance 4/1 Cash at bank GJ1 300 300 Dr

2/1 Motor Vehicle GJ1 35,000 35,000 Cr

THE TRIAL BALANCE

› After posting journals to the ledger a trial balance is prepared to check

Account Name: Cleaning Revenue # 401 that the GL “balances”
ie. to check that: DR = CR
Date Details Ref Debit Credit Balance
› Steps to prepare a trial balance
10/1 A/c receivable GJ2 350 350 Cr 1. List account numbers, titles and balances
2. Calculate totals for debit and credit columns
3. Verify debit total equals credit total
Account Name: Cleaning Supplies Expense # 501
› The trial balance…
Date Details Ref Debit Credit Balance - is a report (so it needs a heading)
10/1 Cleaning Supplies GJ2 35 35 Dr - can be prepared as often as you like
- must show totals to prove that total DR balances of accounts in the GL
equals total CR balances of accounts in the GL
- can help identify some types of posting errors
 S. Lang Cleaning
Trial Balance If the trial balance – doesn’t balance!
As at 15th January, 2010

A/c Account name Debit Credit › Check that you have not omitted the balance of an account by
mistake
101 Cash at Bank 14,700
Dr bal – Cr bal = Missing value
111 Accounts receivable 350
131 Cleaning Supplies 715
› Check that you have not recorded an amount on the wrong side
151 Motor Vehicle 40,000 (eg recorded a debit instead of a credit)
201 Accounts Payable 750 (Dr bal – Cr bal)/2 = Amount on wrong side
221 Loan Payable 35,000
301 Capital – S. Lang 20,000 › Check that you have not made a transposition error (eg recording
311 Drawings 300 210 as 120 or 78 as 87)
401 Cleaning revenue 350 (Dr bal – Cr bal)/9 = a whole number
501 Cleaning Supplies expense 35
Total 56,100 56,100 › If these steps can not identify the error then you may have more than
one mistake and so will need to go back and recheck all your entries

Finding Errors – example 1 Finding Errors – example 2

S. Lang Cleaning S. Lang Cleaning

Trial Balance Dr – Cr Trial Balance (Dr – Cr) / 2

As at 15th January, 2010 As at 15th January, 2010
Have we forgotten to put Did we put one account
A/c Account name Debit Credit one account in the trial A/c Account name Debit Credit balance on the wrong side
balance? If so, the amount 101 Cash at Bank 14,700 of the trial balance? If so,
101 Cash at Bank 14,700
we left out will equal the the error will = half the
111 Accounts receivable 350 111 Accounts receivable 350
difference between total difference between total
131 Cleaning Supplies 715 Debits and total Credits. 131 Cleaning Supplies 715 Debits and total Credits
151 Motor Vehicle 40,000 151 Motor Vehicle 40,000
55,800 – 56,100 = $300. (56,450-55,750) / 2 = $350.
201 Accounts Payable 750 201 Accounts Payable 750
We need to check whether We need to check whether
221 Loan Payable 35,000 221 Loan Payable 35,000
there is a GL account that there is a GL account that
301 Capital – S. Lang 20,000 has a balance of $300 that 301 Capital – S. Lang 20,000 has a balance of $350 that
401 Cleaning revenue 350 we have omitted from the 311 Drawings 300 we have put on the wrong
Trial Balance? 401 Cleaning revenue 350
side of the Trial Balance?
501 Cleaning supplies 35
expense 501 Cleaning supplies expense 35 There is – we accidentally
There is – it seems we
Total 55,800 56,100 forgot to put “Drawings” in put “Cleaning Revenue” on
Total 56,450 55,750
this Trial Balance ! the wrong side of this Trial
Balance !

Finding Errors – example 3 Remember,

if there is more than 1 error
S. Lang Cleaning
Trial Balance (Dr – Cr) / 9
As at 15th January, 2010
Did we make a transposition
A/c Account name Debit Credit ¾ If there is more than one error in the trial balance, then the
error? If we did, the difference
101 Cash at Bank 14,700 between total Debits and total difference between the total debits and total credits will be a
111 Accounts receivable 350 Credits will be exactly
divisible by 9. combination of both errors
131 Cleaning Supplies 751
151 Motor Vehicle 40,000 (56,136 – 56,100) = 36
201 Accounts Payable 750 36 / 9 = exactly 4.0
221 Loan Payable 35,000 ¾ The methods on the previous three pages will not be able to
This means there could be a
301 Capital – S. Lang 20,000 transposition error in this identify combinations of errors. Instead you will need to go
311 Drawings 300
Trial Balance.
back and double-check your work to find each of the mistakes.
401 Cleaning revenue 350 There is – we accidentally
501 Cleaning supplies 35 made a transposition error in
expense the “Cleaning Supplies”
Total 56,136 56,100
account balance! (it should have
been $ 715 not $ 751 ).
 Limitations of a Trial Balance

Errors that a trial balance will not detect :

› A missing transaction (not journalised) The end – see you next week !
› Posting of an incorrect journal entry
› A journal entry posted twice
› An incorrect account used in the journal
› Offsetting errors made in recording the amount of a
transaction

49