Analyzing Transactions

Chapter 2
Analyzing Transactions
Accounting, 21st Edition

Warren Reeve Fess
Copyright 2004 South-Western, a division

PowerPoint Presentation by Douglas Cloud of Thomson Learning. All rights reserved.
Professor Emeritus of Accounting
Pepperdine University Task Force Image Gallery clip art included in this
electronic presentation is used with the permission of
NVTech Inc.
Some
Some ofof the
the action
action has
has been
been automated,
automated, soso
click
click the
the mouse
mouse when
whenyouyou see
see this
this
lightning
lightning bolt
bolt in
in the
the lower
lower right-hand
right-hand
corner
corner ofof the
the screen.
screen. YouYou can
can point
point and
and
click
click anywhere
anywhere on on the
the screen.
screen.
Objectives
Objectives
1. Explain why accounts
After
After studying
studyingare used to record
this
this
and summarize the
chapter, effects
you should
chapter, you should of transactions
on financial statements.
be
be able
able to:
to:
2. Describe the characteristics of an account.
3. List the rules of debit and credit and the
normal balances of accounts.
4. Analyze and summarize the financial
statement effects of transactions.
Objectives
Objectives
5. Prepare a trial balance and explain how
it can be used to discover errors.
6. Discover errors in recording
transactions and correct them.
7. Use horizontal analysis to compare
financial statements from different
periods.
Each
Each financial
financial statement
statement
item,
item, called
called an
an account,
account, isis
included
included in
in the
the ledger.
ledger.
AAgroup
group of of
accounts
accounts forfor aa
business
business entity
entity isis
called
called aa ledger.
ledger.
AAlist
list of
of the
the
accounts
accounts in in aa ledger
ledger
isis called
called aa chart
chart ofof
accounts.
accounts.
Major Account Classifications
Assets
Assets are
are Liabilities
Liabilities are
are debts
debts
resources
resources owned
owned owed
owed toto outsiders
outsiders
by
by the
the business.
business. (creditors).
(creditors).
Cash Accounts
Supplies payable
Building Notes payable
Accounts Wages payable
receivable
Liabilities
Liabilities are
are often
often identified
identified
Assets are on
on the
the balance
balance sheet
sheet
Liabilities by
by
are titles
titles
debts
Assets are Liabilities are debts
resources owned
resources owned that
that include
include
owed payable
payable
to ..
outsiders
owed to outsiders
by
by the
the business.
business. (creditors).
(creditors).
Cash Accounts
Supplies payable
Building Notes payable
Accounts Wages payable
receivable
Owners
Ownersequity equity Revenues
Revenues are are Expenses
Expenses are are the
the
isis the
the owners
owners increases
increases inin using
using upup of
of assets
assets
right
right to
to the
the owners
ownersequity
equity asas or
or consuming
consuming of of
assets
assets of of the
the aa result
result of
of selling
selling services
services to
to
business.
business. services
services or
or generate
generate revenue.
revenue.
Chris Clark, products.
products. Rent Expense
Capital Fees Earned Salary Expense
Chris Clark, Fares Earned Utilities
Drawing Commission Expense
Revenue
To
Toassist
assist you
you in
in learning,
learning,
an
an account
account can
can be
be drawn
drawn
to
to resemble
resemble the
the letter
letter T.
T.
The
The T-Account
T-Account
Cash
The
TheT-account
T-account has
has aa title.
title.
The
The T-Account
T-Account
Cash
Left side
debit
The
The left
left side
side of
of the
the account
account isis the
the debit
debit side.
side.
The
The T-Account
T-Account
Cash
Left side Right side
debit credit
The
The right
right side
side of
of the
the account
account isis the
the credit
credit side.
side.
The
The T-Account
T-Account
Cash
3,750 850
4,300 1,400
2,900 700
2,900
Typical entries
Balancing
Balancing aa T-Account
T-Account
Cash
First,
First, foot
foot
the 3,750 850
the debit
debit
side.
side. 4,300 1,400
2,900 700
10,950 2,900
Cash
3,750 850
4,300 1,400
Next,
Next, foot
foot the
the
2,900
credit
credit side.
side.
700
10,950 2,900
5,850
Subtract
Subtract total
total credits
credits
Cash from
from total
total debits
debits to
to
obtain
obtain the
the account
account
3,750 balance.
850
balance.
4,300 1,400
2,900 700
5,100 10,950 2,900
5,850
Transactions and Balance
Sheet Accounts
(A) On
(A) On November
November 1,1, Chris
Chris Clark
Clark
deposits $25,000
deposits $25,000 in
in aa bank
bank account
account
in the
in the name
name of
of NetSolutions.
NetSolutions.
JOURNAL Page 1
Post.
Date Description Debit Credit
2005 Ref.
1 Nov. 1 Cash 25 000 00
2 Chris Clark, Capital 25 000 00
3 Invested cash in NetSolutions.
4
(A) On
(A) On November
November 1,1, Chris
Chris Clark
Clark
deposits $25,000
deposits $25,000 in
in aa bank
bank account
account
in the
in the name
name of
of NetSolutions.
NetSolutions.
Effects of this entry in the Ledger
Cash Chris Clark, Capital

Nov. 1 25,000 Nov. 1 25,000
(B) On
(B) On November
November 5,5,
NetSolutions bought
NetSolutions bought land
land
for $20,000,
for $20,000, paying
paying cash.
cash.
4
5 5 Land 20 000 00
6 Cash 20 000 00
7 Purchased land for building
8 site.
9
10
(B) On
(B) On November
November 5,5,
NetSolutions bought
NetSolutions bought land
land
for $20,000,
for $20,000, paying
paying cash.
cash.

Cash Land
Nov. 1 25,000 Nov. 5 20,000 Nov. 5 20,000
(C) On
(C) On November
November 10,
10, NetSolutions
NetSolutions
purchased supplies
purchased supplies on
on account
account
for $1,350.
for $1,350.
10
11 10 Supplies 1 350 00
12 Accounts Payable 1 350 00
13 Purchased supplies on account.
14
15
16
(C) On
(C) On November
November 10,
10, NetSolutions
NetSolutions
purchased supplies
purchased supplies on
on account
account
for $1,350.
for $1,350.

Supplies Accounts Payable
Nov. 10 1,350 Nov. 10 1,350
(F) On
(F) On November
November 30,30, NetSolutions
NetSolutions
paid creditors
paid creditors on
on account,
account, $950.
$950.
30
31 30 Accounts Payable 950 00
32 Cash 950 00
33 Paid creditors on account.
34
35
36
(F) On
(F) On November
November 30,30, NetSolutions
NetSolutions
paid creditors
paid creditors on
on account,
account, $950.
$950.

Cash Accounts Payable
Nov. 1 25,000 Nov. 525,000 Nov. 30 950 Nov. 10 1,350
18 7,500 30 3,650
30 950
Rules of Debit / Credit Balance
Sheet Accounts
Debits Credits
Asset accounts. Increase (+) Decrease (-)
Liability accounts Decrease (-) Increase (+)
Owners equity
(capital) accounts. Decrease (-) Increase (+)
Balance Sheet Accounts
ASSETS LIABILITIES
Asset Accounts Liability Accounts
Debit for Credit for Debit for Credit for
increases decreases decreases increases
(+) (-) (-) (+)
OWNERS EQUITY
Owners Equity Accounts
Debit for Credit for
decreases increases
(-) (+)
(D) On
(D) On November
November 18, 18, NetSolutions
NetSolutions
received fees
received fees of
of $7,500
$7,500 from
from
customers for
customers for services
services provided
provided ..
14
15 18 Cash 7 500 00
16 Fees Earned 7 500 00
17 Received fees from customers.
18
19
20
(D) On
(D) On November
November 18, 18, NetSolutions
NetSolutions
received fees
received fees of
of $7,500
$7,500 from
from
customers for
customers for services
services provided
provided ..

Cash Fees Earned
Nov. 1 25,000 Nov. 5 25,000 Nov. 18 7,500
18 7,500
(E) Throughout
(E) Throughout thethe month,
month, NetSolutions
NetSolutions
incurred the
incurred the following
following expenses:
expenses:
wages, $2,125;
wages, $2,125; rent,
rent, $800;
$800; utilities,
utilities,
$450; and
$450; and miscellaneous,
miscellaneous, $275
$275 ..
18
19 30 Wages Expense 2 125 00
20 Rent Expense 800 00
21 Utilities Expense 450 00
22 Miscellaneous Expense 275 00
23 Cash 3 650 00
24 Paid expenses.
(E) Throughout
(E) Throughout thethe month,
month, NetSolutions
NetSolutions
incurred the
incurred the following
following expenses:
expenses:
wages, $2,125;
wages, $2,125; rent,
rent, $800;
$800; utilities,
utilities,
$450; and
$450; and miscellaneous,
miscellaneous, $275
$275 ..
Cash Wages Expense
Nov. 1 25,000 Nov. 525,000 Nov. 30 2,125
18 7,500 30 3,650
Rent Expense Utilities Expense

Nov. 30 800 Nov. 30 450
Miscellaneous Expense
Nov. 30 275
In
In every
every entry
entry the
the sum
sum ofof
the
the debits
debits always
always equal
equal
the
the sum
sum of
of the
the credits.
credits.
(G) On
(G) On November
November 30, 30, aa count
count revealed
revealed
that $800
that $800 of
of the
the supplies
supplies inventory
inventory
had been
had been used.
used.
25
26 30 Supplies Expense 800 00
27 Supplies 800 00
28 Supplies used during
29 November.
30
31
(G) On
(G) On November
November 30, 30, aa count
count revealed
revealed
that $800
that $800 of
of the
the supplies
supplies inventory
inventory
had been
had been used.
used.

Supplies Supplies Expense
Nov. 10 1,350 Nov. 30 800 Nov. 30 800
Double-Entry
Double-Entry Accounting
Accounting
Double-entry accounting is based on a simple
concept: each party in a business transaction
will receive something and give something in
return. In bookkeeping terms, what is received
is a debit and what is given is a credit. The T
account is a representation of a scale or
balance.
Scale or Balance T account
Left Side Right Side

Receive Give
Luca Pacioli DEBIT CREDIT
Developer of
Double-Entry Receive Give
Accounting DEBIT CREDIT
Rules of Debit / Credit Income
Statement Accounts
Expense Accounts Revenue Accounts
Debit for Credit for Debit for Credit for
increases decreases decreases increases
(+) (-) (-) (+)
Income Statement Accounts
Debits Credits
Revenue accounts Decrease (-) Increase (+)
Expense accounts Increase (+) Decrease (-)
Withdrawals
Withdrawals
by
by the
the
Owner
Owner
(H) On
(H) On November
November 30,
30, Chris
Chris Clark
Clark
withdrew $2,000
withdrew $2,000 inin cash
cash from
from
NetSolutions for
NetSolutions for personal
personal use.
use.
JOURNAL Page 2
Post.
2005 Ref.
1 Nov. 30 Chris Clark, Drawing 2 000 00
2 Cash 2 000 00
3 Chris Clark withdrew cash for
4 personal use.
(H) On
(H) On November
November 30,
30, Chris
Chris Clark
Clark
withdrew $2,000
withdrew $2,000 inin cash
cash from
from
NetSolutions for
NetSolutions for personal
personal use.
use.

Cash Chris Clark, Drawing
Nov. 1 25,000 Nov. 525,000 Nov. 30 2,000 Nov. 10 1,350
18 7,500 30 3,650
30 950
30 2,000
Normal Balances of Accounts
Increase
(Normal Balances) Decreases
Balance sheet accounts:

Asset Debit Credit
Liability Credit Debit
Owners Equity:
Capital Credit Debit
Drawing Debit Credit
Income statement accounts:
Revenue Credit Debit
Expense Debit Credit
Flow
Flow of
of Business
Business Transactions
Transactions
Transaction Transaction Document
1 authorized 2 takes place 3 prepared
Entry recorded Entry posted to

4 in journal 5 ledger
System
System to
to Analyze
Analyze Transactions
Transactions
1. Determine whether an asset, a liability,
owners equity, revenue, or expense account
is affected by the transaction.
2. For each account affected by the transaction,
determine whether the account increases or
decreases.
3. Determine whether each increase or decrease
should be recorded as a debit or a credit.
Journalizing
and Posting
Dec. 11 NetSolutions
Dec. NetSolutions paid
paid aa premium
premium ofof
$2,400 for
$2,400 for aa comprehensive
comprehensive insurance
insurance
policy covering
policy covering two
two years.
years.
JOURNAL Page 2
Post.
2005 Ref.
1 Dec. 31 Prepaid Insurance 2 400 00
2 Cash 2 400 00
3 Paid premium on two-year
4 policy.
JOURNAL Page 2
Post.
2005 Ref.
1 Dec. 1 Prepaid Insurance 2 400 00
2 Cash 2 400 00
4 policy.
ACCOUNT Prepaid Insurance ACCOUNT NO. 15

Balance
Post.
Date Item Ref. Debit Credit Debit Credit
2005
Dec. 1 2 400 00 2 400 00
JOURNAL Page 2
Post.
2005 Ref.
1 Dec. 1 Prepaid Insurance 15 2 400 00
2 Cash 2 400 00
4 policy.
ACCOUNT Prepaid Insurance ACCOUNT NO. 15

Balance
Post.
2005
Dec. 1 2 2 400 00 2 400 00
JOURNAL Page 2
Post.
2005 Ref.
2 Cash 2 400 00
4 policy.
ACCOUNT Cash ACCOUNT NO. 11

Balance
Post.
2005
Nov. 30 2 2 000 00 5 900 00
Dec. 1 2 400 00 3 500 00
JOURNAL Page 2
Post.
2005 Ref.
2 Cash 11 2 400 00
4 policy.
ACCOUNT Cash ACCOUNT NO. 11

Balance
Post.
2005
Nov. 30 2 2 000 00 5 900 00
Dec. 1 2 2 400 00 3 500 00
paid rent
rent for
for December,
December,
$800.
$800.
14 1 Rent Expense 52 800 00

15 Cash 11 800 00
16 Paid rent for December.
17
Dec. NetSolutions receives
receives $360
$360 for
for three
three
months rent
months rent beginning
beginning December
December 1. 1.
14 1 Cash 14 360 00
15 Unearned Rent 23 360 00
16 Received advanced payment
17 For three months rent of land.
Dec. NetSolutions purchased
purchased office
office
equipment on
equipment on account
account from
from Executive
Executive
Supply Co.
Supply Co. for
for $1,800.
$1,800.
18 4 Office Equipment 18 1 800 00

19 Accounts Payable 21 1 800 00
20 Purchased office equipment on
21 account.
paid $180
$180 for
for aa
newspaper advertisement.
newspaper advertisement.
21 6 Miscellaneous Expense 59 180 00

22 Cash 11 180 00
23 Paid for newspaper ad.
24
Dec. 11
NetSolutions paid
paid creditors
creditors $400.
$400.
24 11 Accounts Payable 21 400 00

25 Cash 11 400 00
26 Paid creditors on account.
27
Dec. 13
NetSolutions paid
paid aa receptionist
receptionist and
and
part-time assistant
part-time assistant $950
$950 for
for two
two
weekswages.
weeks wages.
JOURNAL Page 3
Post.
2005 Ref.
1 Dec. 13 Wages Expense 51 950 00
2 Cash 11 950 00
3 Paid two weeks wages.
4
Dec. 16
NetSolutions received
received $3,100
$3,100 from
from
fees earned
fees earned for
for the
the first
first half
half of
of
December.
December.
5 16 Cash 11 3 100 00
6 Fees Earned 41 3 100 00
8
Dec. 16
Dec. 16 Fees
Fees earned
earned on on account
account totaled
totaled
$1,750 for
$1,750 for the
the first
first half
half of
of
December.
December.
9 16 Accounts Receivable 12 1 750 00

10 Fees Earned 41 1 750 00
12
Dec. 20
NetSolutions paid
paid $900
$900 to
to Executive
Executive
Supply Co.
Supply Co. on
on the
the $1,800
$1,800 debt
debt owed
owed
from the
from the December
December 44 transaction.
transaction.
13 20 Accounts Payable 21 900 00

14 Cash 11 900 00
15 Paid part of amount owed to
16 Executive Supply Co.
Dec. 21
received $650
$650 from
from
customers in
customers in payment
payment ofof their
their
accounts.
accounts.
18 21 Cash 11 650 00
19 Accounts Receivable 12 650 00
20 Received cash from customer
21 on account.
Dec. 23
NetSolutions paid
paid $1,450
$1,450 for
for
supplies.
supplies.
22 23 Supplies 14 1 450 00
23 Cash 11 1 450 00
24 Purchased supplies.
25
Dec. 27
NetSolutions paid
paid the
the receptionist
receptionist
and part-time
and part-time assistant
assistant $1,200
$1,200 for
for
two weeks
two weekswages.
wages.
27 27 Wages Expense 51 1 200 00

28 Cash 11 1 200 00
29 Paid two weeks wages.
30
Dec. 31
NetSolutions paidpaid its
its $310
$310 telephone
telephone
bill for
bill for the
the month.
month.
31 31 Utilities Expense 54 310 00

32 Cash 11 310 00
33 Paid telephone bill.
34
Dec. 31
NetSolutions paidpaid its
its $225
$225 electric
electric
bill for
bill for the
the month.
month.
JOURNAL Page 4
Post.
2005 Ref.
1 Dec. 31 Utilities Expense 54 225 00
2 Cash 11 225 00
3 Paid utility bill.
4
Dec. 31
received $2,870
$2,870 from
from
fees earned
fees earned for
for the
the second
second half
half of
of
December.
December.
5 31 Cash 11 2 870 00
6 Fees Earned 41 2 870 00
8
Dec. 31
NetSolutions earned
earned $1,120
$1,120 on
on
account for
account for the
the second
second half
half of
of
December.
December.
9 31 Accounts Receivable 12 1 120 00

10 Fees Earned 41 1 120 00
11 Recorded fees earned on
12 account.
Dec. 31
Dec. 31 Chris
Chris Clark
Clark withdrew
withdrew $2,000
$2,000 for
for
personal use.
personal use.
14 31 Chris Clark, Drawing 32 2 000 00

15 Cash 11 2 000 00
16 Chris Clark withdrew cash
17 for personal use.
Trial Balance
NetSolutions
Trial Balance
December 31, 2005
Cash 2 065 00
Accounts Receivable 2 220 00
Supplies 2 000 00
Prepaid Insurance 2 400 00
Land 20 000 00
Office Equipment 1 800 00
Accounts Payable 900 00
Unearned Rent 360 00
Chris Clark, Capital 25 000 00
Chris Clark, Drawing 4 000 00
Fees Earned 16 340 00
Wages Expense 4 275 00
Rent Expense 1 600 00
Utilities Expense 985 00
Supplies Expense 800 00
Miscellaneous Expense 455 00
42 600 00 42 600 00
NetSolutions
Trial Balance
December 31, 2005
Cash 2 065 00
Supplies 2 000 00
Prepaid Insurance Balance 2 400 00
Land Sheet 20 000 00
Accounts Payable Items 900 00
Utilities Expense 985 00
Supplies Expense 800 00
42 600 00 42 600 00
NetSolutions
Trial Balance
December 31, 2005
Cash 2 065 00
Supplies 2 000 00
Land 20 000 00
Fees Earned Statement 16 340 00
Rent Expense
of Owners 1 600 00
Utilities Expense Equity 985 00
Supplies Expense Item 800 00
42 600 00 42 600 00
NetSolutions
Trial Balance
December 31, 2005
Cash 2 065 00
Supplies 2 000 00
Land 20 000 00
Wages Expense Income 4 275 00
Utilities Expense
Statement 985 00
Supplies Expense Items 800 00
42 600 00 42 600 00
Errors that will not cause the
trial balance to be unequal:
1. Failure to record a transaction or to post a
transaction.
2. Recording the same erroneous amount for
both the debit and the credit parts of a
transaction.
3. Recording the same transaction more
than once.
4. Posting a part of a transaction correctly as
a debit or credit but to the wrong account.
Correction of
Errors
Error Correction Procedure

1. Journal entry is incorrect Draw a line through the error
but not posted. and insert correct title or
amount.
Correction of
Errors

1. Journal entry is correct
2. incorrect Draw a line through the error
not posted.
but posted incorrectly. and insert
posted correct
error title or
and post
amount.
correctly.
Correction of
Errors

3. Journal entry is incorrect Journalize and post a
and posted correcting entry.
Correcting
Correcting Errors
Errors An
An Example
Example
On May 5, a purchase of office equipment on

account was incorrectly journalized and posted
as shown.
Journal As recorded and posted

May 5 Supplies 12,500

Accounts Payable 12,500
What
What would
would be
be the
the necessary
necessary
correcting
correcting entry?
entry?
Correcting
Correcting Errors
Errors An
An Example
Example

as shown.



May 5 Office Equipment 12,500
Correcting
Correcting Errors
Errors An
An Example
Example

as shown.



May 5 Office Equipment 12,500
Supplies 12,500
Financial
Financial Analysis
Analysis and
and
Interpretation
Interpretation
Comparing
Comparing an an item
item in
in aa
current
current statement
statement withwith the
the
same
same itemitem in
in prior
prior statements
statements
isis called
called horizontal
horizontal analysis.
analysis.
J Holmes, Attorney-at-Law
Income Statement
For the Year Ended December 31, 2005 and 2006
Increase (Decrease)
2006 2005 Amount Percent
Fees earned $187,500 $150,000 $37,500 25.0%
Operating expenses:
Wages expense $ 60,000 $ 45,000 $15,000 33.3%
Rent expense 15,000 12,000 3,000 25.0%
Utilities expense 12,500 9,000 3,500 38.9%
Supplies expense 2,700 3,000 (300) (10.0)%
Misc. expense 2,300 1,800 500 27.8%
Total operating
expenses $ 92,500 $ 70,800 $21,700 30.6%
Net income $ 95,000 $ 79,200 $15,800 19.9%
Chapter 2
The
The End
End

Analyzing Transactions

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Analyzing Transactions

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Chapter 2

Accounting, 21st Edition

Copyright 2004 South-Western, a division

Effects of this entry in the Ledger

Cash Chris Clark, Capital

Effects of this entry in the Ledger

Effects of this entry in the Ledger

Effects of this entry in the Ledger

Effects of this entry in the Ledger

Rent Expense Utilities Expense

Effects of this entry in the Ledger

Scale or Balance T account

Left Side Right Side

Effects of this entry in the Ledger

Balance sheet accounts:

Entry recorded Entry posted to

ACCOUNT Prepaid Insurance ACCOUNT NO. 15

ACCOUNT Prepaid Insurance ACCOUNT NO. 15

ACCOUNT Cash ACCOUNT NO. 11

ACCOUNT Cash ACCOUNT NO. 11

14 1 Rent Expense 52 800 00

18 4 Office Equipment 18 1 800 00

21 6 Miscellaneous Expense 59 180 00

24 11 Accounts Payable 21 400 00

9 16 Accounts Receivable 12 1 750 00

13 20 Accounts Payable 21 900 00

27 27 Wages Expense 51 1 200 00

31 31 Utilities Expense 54 310 00

9 31 Accounts Receivable 12 1 120 00

14 31 Chris Clark, Drawing 32 2 000 00

Error Correction Procedure

Error Correction Procedure

Error Correction Procedure

On May 5, a purchase of office equipment on

Journal As recorded and posted

May 5 Supplies 12,500

On May 5, a purchase of office equipment on

Journal As recorded and posted

May 5 Supplies 12,500

Date Description Debit Credit

On May 5, a purchase of office equipment on

Journal As recorded and posted

May 5 Supplies 12,500

Date Description Debit Credit

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