Recording Transactions

CHAPTER 
3
Learning Objectives
After studying this chapter, you should be able to
•	Use double-entry accounting
•	Analyze and journalize transactions
•	Post journal entries to the ledgers
•	Prepare and use a trial balance
•	Close revenue and expense accounts and update retained earnings
•	Correct erroneous journal entries and describe how errors affect accounts
•	Explain how computers have transformed processing of accounting data
The Double-Entry Accounting System
•	In the double-entry system, every transaction affects at least two accounts
•	After each transaction, the balance sheet equation must always remain in balance

•	This balance sheet format is too cumbersome for recording each and every transaction 
Ledger Accounts
•	The elements of transactions are organized into accounts that group similar items together
•	In a double-entry system, a ledger contains the records for a group of related accounts
•	A general ledger is the collection of accounts that accumulate the amounts reported in the financial statements

Ledger Accounts
•	A T-account is a simplified version of accounts used in practice

•	The vertical line in the T divides the account into left and right sides for recording increases and decreases
•	The account title is on the horizontal line
Ledger Accounts
•	The T-accounts for the first three Biwheels Company transactions are as follows
Ledger Accounts
•	Each transaction affects at least two accounts
•	The process of creating a new T-account in preparation for recording a transaction is called opening the account
•	An account balance is the difference between the total left-side and right-side amounts at any particular time
Ledger Accounts
•	Asset accounts have left-side balances
–	Entries on the left side increase asset account balances 
–	Entries on the right side decrease them
•	Liabilities and owners’ equity accounts have right-side balances
–	Entries on the right side increase their balances 
–	Entries on the left side decrease them
Debits and Credits
•	Accountants use the terms
–	Debit (abbreviated Dr.) to denote an entry on the left side of any account
–	Credit (abbreviated Cr.) to denote an entry on the right side of any account
•	Some accountants use the word “charge” instead of debit
The Recording Process
•	The sequence of five steps in recording and reporting transactions is as follows:

•	Source documents are the original records of any transaction

The Recording Process
•	The general journal is a formal chronological listing of each transaction and how it affects the balances in the accounts
•	Transactions are entered into the ledger
•	The trial balance is a simple listing of the accounts in the general ledger together with their balances
•	Preparation of financial statements occurs at least once a quarter for publicly traded companies
Chart of Accounts
•	A chart of accounts is a numbered or coded list of all account titles
•	Account numbers are used as references in the Post Ref. column of the journal

Journalizing Transactions
•	Journalizing is the process of entering transactions into the general journal
•	A journal entry is an analysis of all the effects of a single transaction on the various accounts, usually accompanied by an explanation
•	A compound entry means that a single transaction affects more than two accounts

Journalizing Transactions
•	The following conventions are used for recording in the general journal
–	The title of the account or accounts to be debited are placed at the left margin
–	The title of the account or accounts to be credited are indented in a consistent way
Journalizing Transactions
•	The following conventions are used for recording in the general journal
–	The journal entry is followed by the narrative explanation of the transaction
–	The Post. Ref. column contains an identifying number that is assigned to each account and is used for cross-referencing to the ledger accounts

Journalizing Transactions
•	The following conventions are used for recording in the general journal
–	The debit and credit columns are for recording the dollar amounts that are debited or credited for each account
Posting Transactions to the Ledger
•	Posting is the transferring of amounts from the journal to the appropriate accounts in the ledger
•	The following example shows
–	How the debit to merchandise inventory and the credit to cash are posted
–	Columns for dates, explanations, journal references, and amounts in the ledger

Posting Transactions to the Ledger
Posting Transactions to the Ledger
•	Cross-referencing is the process of using numbering, dating, and/or some other form of identification to relate each ledger posting to the appropriate journal entry
•	A single transaction from the journal might be posted to several different ledger accounts
•	Cross-referencing allows users to find all the components of the transactions in the ledger no matter where they start
Revenue and Expense Transactions
•	Ignoring dividends, T-accounts can be grouped as follows:

Revenue and Expense Transactions
•	Revenue and expense information is accumulated separately to prepare a more meaningful income statement
•	Expense and revenue accounts are part of Retained Earnings
–	A revenue account increases retained earnings
–	An expense account decreases retained earnings
•	Although a debit entry increases expenses, it results in a decrease in retained earnings
Revenue and Expense Transactions
Revenue and Expense Transactions
Prepaid Expenses and 
Depreciation Transactions
Prepaid Expenses and 
Depreciation Transactions
Prepaid Expenses and 
Depreciation Transactions
Prepaid Expenses and 
Depreciation Transactions
Preparing the Trial Balance
•	A trial balance is a list of all the accounts with their balances
•	The purpose of the trial balance is twofold:
–	Proving whether the total debits equal the total credits in the ledger
–	Summarizing  the balances in the ledger accounts in preparation to construct the financial statements
Preparing the Trial Balance
Preparing the Trial Balance
•	The trial balance is prepared with the accounts in the following order:
–	Asset accounts
–	Liability accounts
–	Stockholders’ equity accounts
–	Revenue accounts
–	Expense accounts
•	The trial balance is the springboard for preparing the balance sheet and the income statement
Deriving Financial Statements 
from the Trial Balance
Closing the Accounts
•	Closing the accounts has two purposes:
–	It transfers the balances of the “temporary” stockholders’ equity accounts (revenues and expenses) to the “permanent” stockholders’ equity account (retained earnings) 
–	It makes the revenues and expense accounts have a zero balance, which readies them for the next period’s transactions
Closing the Accounts
Closing the Accounts
Closing the Accounts
Effects of Errors
•	If an error is detected after posting to the ledger accounts, a correcting entry must be made
•	The following is an example of a correcting entry:

•	The correcting entry cancels or offsets the erroneous debit to Equipment
Some Errors are Temporary Errors—Others Persist Until Corrected
•	Some errors in one period are automatically corrected in the next period
•	Such errors misstate net income in both periods
•	By the end of the second period the errors counterbalance or cancel each other out
•	They affect the balance sheet of only the first period—not the second
•	Some errors will keep subsequent balance sheets in error until correcting entries are made
Data Processing and 
Accounting Systems
•	Data processing refers to the procedures used to record, analyze, store, and report on chosen activities
•	In an accounting data processing system, a computer can automatically carry out steps such as ledger postings and financial statement preparation
Data Processing and 
Accounting Systems
•	The cash register may be linked to a computer that also records a decrease in inventory
•	It may also
–	Activate an order to a supplier
–	Check a credit limit
–	Update the accounts receivable
–	Prepare monthly statements

Data Processing and 
Accounting Systems
•	Computers also reduce the time it takes to close the books and prepare financial statements
•	The most recent advance in data processing for financial reporting is the use of XBRL
•	XBRL is an XML-based computer language that allows easy comparisons across companies