Ken Szulczyk's Lecture Notes for Accounting 1 - Recording Transactions

Lecture #2:  Recording Transactions

Accounting provides quantitative information about economic entities.
   

Two types of transactions

1.  Business transactions - These transactions occur between the entity and an outside party.

2.  Internal transactions - Transactions that affect the financial statements, but does not result from an outside party.
   

Business papers.

Printed documents that businesses use in the process of completing transactions.

F  These are evidence of business transactions and the basis for entry into the accounting records.

F  These are verifiable records between your business and another business.
   

Accounts

Business transactions must be recorded and stored in separate locations, so they can be sorted and combined when the financial reports are prepared.
   
 
 

Cash

 
Investment $9,000 Purchase of law books $2,500
Legal fees earned $2,200 Purchase of office equipment $5,600
Collection of account receivable $1,700 Rent payment $1,000
    Payment of salary $700
    Payment of account payable  $900
    Withdrawal by owner $1,100
Total increases: $12,900  Total decreases: $11,800
    Balance: $1,100
 
 

Accounts Commonly Used

A business uses a number of accounts to record and store the effects of its transactions.

1.  Asset Accounts.

  1. Cash:  Consists of money and any other medium of exchange.
  2. Notes Receivable:  A promissory note is an unconditional written promise to pay a definite sum of money on demand at some specific date in the future.
  3. Accounts Receivable:  Goods and services are commonly sold to customers on the basis of oral or implied promises of future payment.
  4. Prepaid Insurance:  Fire, liability, and other types of insurance protection are normally paid in advance.
  5. Office Supplies:  When stamps, stationary, paper, pencils, and other items are bought for the office, they are assets that are recorded here.  When these assets are used up, then they are transferred to expense accounts.
  6. Other Prepaid Expenses:  When payments are made for economic benefits that do not expire until some later time.
  7.  Equipment:  Physical assets are recorded here, such as computers, desks, chairs, and office machines.
  8.  Buildings:  Buildings used by a business in carrying on its operations, such as a store, garage, warehouse, or factory.
  9.  Land:  Increases and decreases of land owned by the business is recorded here.  Land and buildings are separated, because buildings deteriorate and depreciate over time, while land does not.

2.  Liability Accounts - They are present obligations to transfer assets or provide services to other entities in the future.

  1. Notes Payable:  A formal written promise to pay a definite sum of money at a fixed future date.
  2. Accounts Payable:  When purchases are made on the basis of oral or implied promises to pay.
  3. Unearned Revenue:  Revenue cannot be recognized until it is earned.  If a company collects money before its products are delivered, then this transaction must be recorded in an Unearned Revenue account.  When the products are delivered, then the amount earned would be transferred to the revenue accounts.
  4. Other Short-Term Payables:  Wages payable, taxes payable, and interest payable.  Each account requires their own separate account.

3.  Owner’s Equity Accounts - The owner’s equity is broken-down into three accounts.

  1. Capital Account.:  When a person invests in his own business, the investment is recorded in an account carrying the owner’s name and the word capital.  The capital account is used for any permanent additional increases or decreases in owner’s equity.
  2. Withdrawal Account:  When the business earns net income, the equity of the business increases.  The owner needs money for living expenses or for other personal uses, so he can withdraw some of the business’s assets, which reduces owner’s equity.
  3. Revenue and Expense Accounts:  To prepare an income statement for a business, you have to know the amount of each kind of revenue and each kind of expense.  Then you would have a number of expense and revenue accounts.
       

Debit and Credit

The T-account has a left side and a right side.  The left side is called the debit side, while the right is called a credit side.  The difference between total debits and total credits is called the account balance.
   

Transactions Illustrating the Rules of Debit and Credit.

We will be following the transactions for Jerry Dow’s law practice.

  1. On Dec. 1, Jerry Dow invested $9,000 in a new law practice.
       
  2. He purchased books for a law library, paying cash of $2,500.
       
  3. He purchased office equipment for cash $5,600.
       
  4. He purchased on credit from Equip-it Company law library items $380 and office equipment $1,280.
       
  5. He completed legal work for a client and immediately collected a $2,200.
       
  6. He paid the office rent for Dec. $1,000.
       
  7. He paid the secretary’s salary for the two weeks ended Dec. 12, $700.
       
  8. He completed legal work for a client and billed the client $1,700 for the services rendered.
       
  9.  The client paid the $1,700 legal fee billed in transaction 8.
     
  10. He paid Equip-it Company $900 of the $1,660 owed for the items purchased on credit in transaction 4.
       
  11.  Jerry Dow withdrew $1,100 from the law practice for personal use.
       
  12. He signed a contract with Chemical Supply to do its legal work on a fixed-fee basis for $500 per month.  He received the fee for the first six months in advance $3,000.
       
  13. He paid a $2,400 premium for liability insurance protection that lasts two years.
       
  14. He purchased office supplies for cash $120.
       
  15. He paid the Dec. utilities bill for electricity and water $230.
       
  16. He paid the secretary’s salary for the two weeks ended on Dec. 26, $700.
       

You can test this equality be constructing a trial balance.  To make one:

                1.  Determine the balance of each account in the ledger.

                2.  List the accounts with balances other than zero.
   
 
Jerry Dow, Attorney
Trial Balance
December 31, 1990
 
Cash $650  
Prepaid Insurance 2,400  
Office Supplies 120  
 Law Library 2,880  
Office Equipment  6,880  
Accounts Payable    $760
Unearned Legal Fees   3,000
Jerry Dow, Capital   9,000
Jerry Dow, Withdrawals 1,100  
Legal Fees Earned   3,900
Rent Expense 1,000  
Utilities Expense 230  
Salaries Expense 1,400  
Total $16,660  $16,660
 

We are using T-accounts to teach you accounting.  They are not used in the real world.  Businesses use accounts that is illustrated below.
 

 

Cash                                       Account No. 111
 

Date Explanation PR Debit Credit Balance
1990          
Dec 1 Invested in business G1 9,000   9,000
2 Purchased law books G1   2,500 6,500
3 Purchased office equip. G1   5,600 900
10 Client paid legal services  G1 2,200   3,100
 

Note:  Because of the equation:

Assets = Liabilities + Owner’s Equity

(Debit)                  (Credit)                   (Credit)


Account Classification The Normal Balance is:
Assets Debit
Liabilities Credit
Owner’s Equity Capital Credit (+)
Withdrawals Debit (-)
Revenue Credit (+)
Expense Debit (-)

         
 Transactions Should be First Recorded in a Journal

It is possible to record transactions by entering debits and credits directly in the accounts.  If you make an error, the error will be difficult to locate, using this method, because there is no link between the credit and debit items in the ledger books.

To correct this problem, all transactions are first recorded in a journal, called the General Journal.  From the journal, the information of the transactions is transferred to the accounts.  This procedure reduces the tendency to make errors.  If an error is made, then the General Journal makes it possible to locate the error.

The General Journal should contain the following information of each transaction.
   

  1. The transaction date.
  2. The names of the accounts involved.
  3. The amount of each debit and credit.
  4. An explanation of the transaction.
  5. A column in which to mark the identifying number of the account to which each debit or credit was copied.
       
     
 

General Journal                                                                     Page 1

 
Date Account Titles and Explanation PR Debit Credit
1990        
Dec 1 Cash   9,000  
       Jerry Dow, Capital     9,000
  Investment by owner      
         
2 Law Library   2,500  
       Cash     2,500
  Purchased law books for cash.      
         
3 Office Equipment   5,600  
       Cash     5,600
  Purchased office equipment for cash.      
         
6 Law Library   380  
  Office Equipment   1,280  
       Accounts Payable     1,660
  Purchased supplies and equipment on credit.      
 
   

Account Numbers

All companies should follow a systematic method of assigning numbers to their accounts.

For example.
 
Asset accounts: 111          through                  199
Liability accounts: 211          through                  299
Owner’s equity accounts: 311          through                  399
Revenue accounts: 411          through                  499
Operating expense accounts: 511          through                  699

Locating Errors

When a trial balance does not balance, then an error has been made.  To find the error:

  1. Recalculate the column totals in the trial balance.
  2. Check to see if the account balances were correctly copied from the ledger.
  3. Recalculate the account balances.
  4. Refer to the General Journal to see if transactions were correctly transferred from it to the ledger accounts.

When an error is discovered in either the journal or the ledger, it must be corrected.  Never erase the error, because this may indicate an effort to conceal something.

For example.

An amount was posted to the wrong account.
 

Oct.14

Office Furniture 160  
       Cash   160
  To record the purchase of office supplies.    

    You correct this error by using an entry in the journal.

 

Oct.17

Office Supplied 160  
       Office Furniture   160
  To correct the entry on Oct. 14, where an error was made.     

                                               

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