Principles of financial accounting 12e by needles crosson chapter 02

CHAPTER

2

Analyzing and Recording
Business Transactions

Principles of
Accounting
12e
Needles
Powers
Crosson
© human/iStockphoto


Concepts Underlying Business Transactions
 Bus ine s s trans ac tio ns are economic
events that should be recorded in the
accounting records.
 The concepts of re cognition, valuation, and
clas s ification underlie all business
transactions.

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Concepts Underlying Business Transactions
 Re c o g nitio n refers to the decision as to whe n to
record a business transaction.
 Valuatio n is the process of assigning a monetary

amount to business transactions and the resulting
assets and liabilities. GAAP states that all business
transactions should be valued at fair value when they
occur.
– Fair value is the e xchange price of an actual or potential
business transaction between market participants.
– Recording transactions at the exchange price at the point of
recognition is called the c o s t princ iple .

 Clas s ific atio n is the process of assigning all the
transactions in which a business engages to
appropriate categories, or accounts.
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Double-Entry System and Accounts
 In the do uble -e ntry s ys te m, each
transaction must be recorded with at least
one debit and one credit, and the total
amount of the debits must equal the total
amount of the credits.
 Ac c o unts are the basic storage units for
accounting data and are used to accumulate
amounts from similar transactions.
– An accounting system has a separate account for
each asset, each liability, and each component of
owner’s equity, including revenues and expenses.
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Chart of Accounts
 In a manual accounting system, each account is kept
on a separate page or card. These pages or cards
are placed together in a book or file called the
g e ne ral le dg e r. In computerized systems,
accountants still refer to the group of accounts as the
ge ne ral le dge r, or simply the le dge r.
– A c hart o f ac c o unts is a table of contents for the
ledger. It lists the account titles and the numbers
that have been assigned to them. It usually lists
the accounts in the order in which they appear in
the ledger (the order in which they appear in the
financial statements).
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The T Account
(slide 1 of 2)

 The T ac c o unt is a tool used to analyze
transactions. It has three parts:
– a title, which identifies the asset, liability, or
owner’s equity account
– a left side, which is called the de bit side
(abbreviated Dr., from the Latin de be re )
– a right side, which is called the c re dit side
(abbreviated Cr., from the Latin cre de re )

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The T Account
(slide 2 of 2)

– For the Cash account, receipts are recorded on
the left (debit) side of a T account and payments
on the right (credit) side, as shown below.

– The totals in smaller, blue figures are simply
working totals, or fo o ting s .
– The difference between the total debit footing and
the total credit footing is called the ac c o unt
balanc e .
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Rules of Double-Entry Accounting
 The double-entry system follows two rules:
– Every transaction affects at least two accounts.
– Total debits must equal total credits.

 For every transaction:
– one or more accounts must be debited, or entered
on the left side of a T account.
– one or more accounts must be credited, or
entered on the right side of a T account.

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Rules of Double-Entry Accounting
 Keep the accounting equation in mind:
Assets =Liabilities +Owner’s Equity

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Rules of Double-Entry Accounting
 Withdrawals and expenses are deductions
from owner’s equity, so transactions that
incre as e withdrawals or expenses de cre as e
owner’s equity.

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Normal Balance
 The no rmal balanc e of an account is its
usual balance and is the side (debit or credit)
that increases the account.

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Business Transaction Analysis
 The details of business transactions are
supported by s o urc e do c ume nts —invoices,
receipts, checks, or contracts.
 A jo urnal e ntry is a notation that records a
single transaction in the chronological

accounting record known as a jo urnal. Each
entry must be in proper jo urnal fo rm.

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The Trial Balance
 The trial balanc e is a device used to ensure
that the total of debits and credits in the
accounts are equal.

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Finding Trial Balance Errors
 If the debits and credits in a trial balance are not
equal, look for one or more of these errors:
– A debit was entered in an account as a credit, or vice versa.
– The balance of an account was computed incorrectly.
– An error was made in carrying the account balance to the
trial balance.
 Recording an account as a credit when it usually carries a
debit balance, or vice versa, causes the trial balance to be out
of balance by an amount divisible by 2.
 Transposing two digits when transferring an amount to the trial
balance causes the trial balance to be out of balance by an
amount divisible by 9.

– The trial balance was summed incorrectly.

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Recording and Posting Transactions
 Although transactions can be entered directly into
the ledger accounts, identifying individual
transactions or finding errors is difficult because the
debit is recorded in one account and the credit in
another.
 The solution is to record all transactions
chronologically in a journal and then transfer the
debit and credit portions of each transaction to the
appropriate accounts in the ledger.
 The simplest and most flexible kind of journal is the
g e ne ral jo urnal.

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General Ledger
 While the ge ne ral journal is used to record the
details of each transaction, the ge ne ral le dge r is
used to update each account. Transferring
transactions from the journal to the ledger is called
po s ting .
 The le dg e r ac c o unt fo rm is a form of the account
that contains four columns for dollar amounts.

©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Ethical Financial Reporting and Business
Transactions
 R e cognition, valuation, and clas s ification, as
specified under generally accepted
accounting principles, are important factors in
ethical financial reporting.
 The re cognition issue can be particularly
difficult to resolve.
– The predetermined time at which a transaction
should be recorded is the re c o g nitio n po int.
– A purchase transaction should be recorded when
title to merchandise passes from the supplier to
the purchaser and creates an obligation to pay.
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Recognition
 Examples of economic events that should
and should not be recorded as business
transactions include:

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Cash Flows and the Timing of Transactions
 To avoid financial distress, a company must be able
to pay its bills on time. Consider the transactions of
Blue Design studio shown below. Blue must perform
a delicate balancing act with its cash flows to ensure

that it can remain profitable.

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