Recording

Business
Transactions

Chapter 2

© 2015 Pearson Education, Limited. 2-1

Learning Objectives
1. Explain accounts as they relate
to the accounting equation and
describe common accounts
2. Define debits, credits, and
normal account balances using
double-entry accounting and T-
accounts
3. Record transactions in a journal
and post journal entries to the
ledger
© 2015 Pearson Education, Limited. 2-2
Learning Objectives
4. Prepare the trial balance and
illustrate how to use the trial
balance to prepare financial
statements
5. Use the debt ratio to evaluate
business performance

© 2015 Pearson Education, Limited. 2-3

Learning Objective 1

Explain accounts as
they relate to the
accounting equation
and describe common
accounts

© 2015 Pearson Education, Limited. 2-4

 What Is an Account?

Assets = Liabilities + Equity

• Each element of the Accounting Equation

contains smaller elements called accounts.
• Account—the
Account detailed record of all increases
and decreases that have occurred in an
individual asset, liability, equity, revenue or
expense during a specified period.
© 2015 Pearson Education, Limited. 2-5
 Chart of Accounts
• Companies typically
maintain a listing of all of Large companies can
the accounts that they have thousands of
use in their accounting different accounts that
system, called the Chart are used in their
of Accounts.
Accounts accounting system.
• Often accounts are
numbered. It is easier to reference
– The numbers will usually a specific account if
be grouped by account there is a number
type. assigned to it.

© 2015 Pearson Education, Limited. 2-6

 Chart of Accounts
Exhibit 2-4 Chart of Accounts—Smart Touch Learning

Balance Sheet Accounts

Assets Liabilities Equity

101 Cash 201 Accounts Payable 301 Bright, Capital
111 Accounts Receivable 211 Salaries Payable 311 Bright, Withdrawals
121 Notes Receivable 221 Interest Payable
141 Offi ce Supplies 231 Unearned Revenue
151 Furniture 241 Notes Payable
171 Building
191 Land

Income Statement Accounts (Part of Equity)

Revenues Expenses
401 Service Revenue 501 Rent Expense
411 Interest Revenue 511 Salaries Expense
521 Utilities Expense
531 Advertising Expense

© 2015 Pearson Education, Limited. 2-7

Learning Objective 2

Define debits, credits,

and normal account
balances using double-
entry accounting and
T-accounts

© 2015 Pearson Education, Limited. 2-8

What Is Double-Entry Accounting?
• Transactions always have two impacts on
the accounting equation.
– When Smart Touch
bought land, the
Land account
increased, but the
Cash account
decreased by the same amount.
– These “double” entries help keep the
accounting equation in balance.
© 2015 Pearson Education, Limited. 2-9
 What Is a T-Account?
• A T-account is a shortened visual form of
the more formal general ledger account
format.
Account Name
• Increases are shown
+/- +/-
on one side of the
T-account and decreases
on the other side.
• The T-account is balanced at the end of
each period.
© 2015 Pearson Education, Limited. 2-10
 What Are Debits and Credits?
• Debits and Credits are used to record the
increases and decreases in T-accounts.
– Debit means “left”
Account Name
– Credit means “right”
Debit (DR) Credit (CR)
• Any time we put a debit
in one account, we have
to put an equal credit in
another account.

© 2015 Pearson Education, Limited. 2-11

 What Are Debits and Credits?
• An account with more debits than credits
will have a “debit” balance.
• An account with more
Account Name
credits than debits will Debit (DR) Credit (CR)
have a “credit” balance.
• Some accounts will be
increased with debits, and
some accounts will be increased with
credits.
© 2015 Pearson Education, Limited. 2-12
 What Are Debits and Credits?
• We can explain the balancing impact of
transactions using T-accounts and debits
and credits.

© 2015 Pearson Education, Limited. 2-13

 What Are Debits and Credits?
• When Smart Touch purchases land, we
use debits to increase the Land account,
and credits to decrease the Cash account.

Land Cash
20,000 20,000

© 2015 Pearson Education, Limited. 2-14

 What Are Debits and Credits?
Increases in owner’s
Owner's Capital contributions or owner’s
Debit for Credit for withdrawals will be reflected
in the changing owner’s
Decreases Increases
capital balance.

Withdrawals
Debit for
Increases

© 2015 Pearson Education, Limited. 2-15

 What Are Debits and Credits?
When revenues exceed
Owner's Capital expenses, net income
Debit for Credit for increases Owner’s
Decreases Increases Capital.

Revenues Expenses
Credit for Debit for
Increases Increases

© 2015 Pearson Education, Limited. 2-16

Learning Objective3

Record transactions in
a journal and post
journal entries to the
ledger

© 2015 Pearson Education, Limited. 2-17

How Do You Record Transactions?

The next step in the process is to formally

record the transaction in the General Journal.

© 2015 Pearson Education, Limited. 2-18

How Do You Record Transactions?

• Transactions are first recorded using a

“journal entry."
• The account to be debited is usually
written first.
© 2015 Pearson Education, Limited. 2-19
How Do You Record Transactions?

• In Transaction #1, Bright contributed

$30,000 to Smart Touch.
• Cash should be debited for $30,000 and
Bright, Capital should be credited for
$30,000.
© 2015 Pearson Education, Limited. 2-20
How Do You Record Transactions?

• In Transaction #1, Bright contributed

$30,000 to Smart Touch.
• Cash should be debited for $30,000 and
Bright, Capital should be credited for
$30,000.
© 2015 Pearson Education, Limited. 2-21
How Do You Record Transactions?

• Next, each amount should be “posted”

to the appropriate T-account.
• Without this step, the trial balance will
NOT balance.
© 2015 Pearson Education, Limited. 2-22
How Do You Record Transactions?

Cash Bright, Capital

30,000 30,000

© 2015 Pearson Education, Limited. 2-23

How Do You Record Transactions?

• In Transaction #2, Smart Touch

purchased Land for $20,000 cash.
• Land should be debited for $20,000 and
Cash should be credited for $20,000.
© 2015 Pearson Education, Limited. 2-24
How Do You Record Transactions?

• In Transaction #2, Smart Touch

purchased Land for $20,000 cash.
• Land should be debited for $20,000 and
Cash should be credited for $20,000.
© 2015 Pearson Education, Limited. 2-25
How Do You Record Transactions?

• Next, each amount should be “posted”

to the appropriate T-account.
• Without this step, the trial balance will
NOT balance.
© 2015 Pearson Education, Limited. 2-26
How Do You Record Transactions?

Land Cash
20,000 30,000 20,000

© 2015 Pearson Education, Limited. 2-27

How Do You Record Transactions?

• In Transaction #3, Smart Touch purchased

Office Supplies on account for $500 cash.
• Office Supplies should be debited for $500
and Accounts Payable should be credited
for $500.
© 2015 Pearson Education, Limited. 2-28
How Do You Record Transactions?

• In Transaction #3, Smart Touch purchased

Office Supplies on account for $500 cash.
• Office Supplies should be debited for $500
and Accounts Payable should be credited
for $500.
© 2015 Pearson Education, Limited. 2-29
How Do You Record Transactions?

• Next, each amount should be “posted”

to the appropriate T-account.
• Without this step, the trial balance will
NOT balance.
© 2015 Pearson Education, Limited. 2-30
How Do You Record Transactions?

Office Supplies Accounts Payable

500 500

© 2015 Pearson Education, Limited. 2-31

Learning Objective 4

Prepare the trial

balance and illustrate
how to use the trial
balance to prepare
financial statements

© 2015 Pearson Education, Limited. 2-32

 Trial Balance
The primary purpose of
the trial balance is to
prove the mathematical
equality of debits and
credits after posting.

The amounts come

from the individual
account balances in the
General Ledger.

© 2015 Pearson Education, Limited. 2-33

 First, we prepare the
Income Statement.

SMART
SMARTTT OUCH
OUCHLEARNING
LEARNING
Income Statement
Income Statement
TTwo
wo MonthsEnded
Months EndedDecember
December31,
31,2014
2014
Revenues
Revenues
Service
ServiceRevenue
Revenue $$ 16,500
16,500
Expenses
Expenses
Salaries
SalariesExpense
Expense $$ 3,600
3,600
Rent
Rentexpense
expense 2,000
2,000
Utilities Expense
Utilities Expense 100
100
Total expenses
Total expenses 5,700
5,700
Net income
Net income $ 10,800
$ 10,800

© 2015 Pearson Education, Limited. 2-34

 SMART
SMARTTT OUCH
OUCHLEARNING
LEARNING The information for
Income Statement
TTwo Months
Income Statement
wo MonthsEnded
EndedDecember
December31,
31,2014
2014
the Statement of
Revenues
Revenues
Service
ServiceRevenue
Revenue $$ 16,500
16,500
Owner’s Equity comes
Expenses
Expenses
Salaries
from the trial balance
SalariesExpense
Expense $$ 3,600
3,600
Rent expense
Rent expense
Utilities Expense
2,000
2,000
100
AND from the Income
Utilities Expense 100
Total expenses
Total expenses 5,700
5,700 Statement.
Net income
Net income $ 10,800
$ 10,800

SMART
SMARTTT OUCH
OUCHLEARNING
LEARNING
Statement
Statement of Owner'sEquity
of Owner's Equity
TT
wo
wo Months Ended December31,
Months Ended December 31,2014
2014
Bright,
Bright,Capital,
Capital,11/1/14
11/1/14 $$ --
Owner
OwnerContribution
Contribution 48,000
48,000
Net Income for 2 Months
Net Income for 2 Months 10,800
10,800
58,800
58,800
Owner Withdrawal
Owner Withdrawal (5,000)
(5,000)
Bright, Capital, 12/31/14
Bright, Capital, 12/31/14 $ 53,800
$ 53,800

© 2015 Pearson Education, Limited. 2-35

 Smart
SmartTT
ouch
ouchLearning
Learning
The information for
Balance Sheet
Balance Sheet
31-Dec-14
31-Dec-14
Assets
Assetsthe Statement of
Cash
Cash $$ 12,200
12,200
Owner’s
Accounts Equity comes
Receivable
Accounts Receivable 1,000
1,000
Office Supplies 500
from
Prepaid
PrepaidRent
the
Office Supplies
Rent
trial balance 500
3,000
3,000
AND
Furniture from the Income
Furniture
Building
Building
18,000
18,000
60,000
60,000
Land
Land
Total Assets
Statement. 20,000
20,000
$ 114,700
Total Assets $ 114,700

Liabilities
Liabilities
Accounts
AccountsPayable
Payable $$ 200
200
Utilities Payable
Utilities Payable 100
100
Unearned
UnearnedRevenue
Revenue 600
600
Notes Payable
Notes Payable 60,000
60,000
Total
TotalLiabilities
Liabilities 60,900
60,900

Owner's
Owner'sEquity
Equity
Bright
Bright Capital,12/31/14
Capital, 12/31/14 53,800
53,800
Total
TotalLiabilities
Liabilities&&Owner's
Owner'sEquity
Equity $$ 114,700
114,700

© 2015 Pearson Education, Limited. 2-36

Learning Objective 5

Use the debt ratio to

evaluate business
performance

© 2015 Pearson Education, Limited. 2-37

 The Debt Ratio
• The debt ratio shows the proportion of
assets financed with debt.
• It can be used to evaluate a business’s
ability to pay its debts and to determine if
the company has too much debt to be
considered financially “healthy.”

© 2015 Pearson Education, Limited. 2-38

End of Chapter 2

© 2015 Pearson Education, Limited. 2-39