Chapter 2: Recording Business Transactions
Types of Accounts, T-Accounts, Journals, Ledgers, Trial Balance
What is a Transaction?
Any event that has a financial impact on a business & can be measured reliably.
Describe Common Types of Accounts
What is an Account?
Each asset, liability & element of shareholders’ equity has its own account, which is used to record all the transactions affecting the related entity.
Common Asset Accounts
- Cash: Consists of bank account balances, paper currency & coins, undeposited cheques.
- Accounts Receivable: Represent the amounts owing from customers who have purchased products but not paid for them. They have purchased the products on account or on credit.
- Inventory: Consists of goods a company sells, including raw or intermediate goods.
- Prepaid Expenses: Expenses a company has paid for in advance of using the product.
- Land: Includes any land owned by a company.
- Buildings: Any office buildings, factories, etc., owned by a company.
- Equipment, Furniture, Fixtures: Include a variety of office, computer & manufacturing equipment, as well as furniture & fixtures owned by a company.
Common Liability Accounts
- Accounts Payable: Represent the amounts a company owes to suppliers.
- Accrued Liabilities: A liability for an expense that has not been billed for or paid. Includes interest owed on bank loans, salaries owed to employees, amounts owed to supplier who have not yet sent invoices.
- Loans Payable: Include funds a company has borrowed from banks & other creditors.
Common Shareholders’ Equity Accounts
- Share Capital: Includes the capital (usually cash) a company has received from its owners in exchange for shares of the company. Also known as Common Shares, which is the most basic element of equity.
- Retained Earnings: Shows the cumulative net income earned by the company over its lifetime, minus its cumulative net losses & dividends.
- Dividends: Includes dividends that have been declared during the current fiscal period. Dividends are payments to shareholders that represent the distribution of a portion of the company’s past earnings.
- Revenues: Revenues are a form of income that increase shareholders’ equity. Typically earned through sales.
- Expenses: Expenses decrease shareholders’ equity & consist mainly of costs to purchase goods to run the business. Common types include Salary Expense, Rent Expense, Advertising Expense & Utilities Expense.
- Gains & Losses: Gains & Losses also affect the shareholders’ equity via their impact on net income & retained earnings. Gains are another form of income, so they increase shareholders’ equity. Losses reduce it. For example, if a company sells a property for more than they purchased it, the difference would be a gain.
Analyze Business Transactions Using T-Accounts
What is a Double-Entry System?
A method where every transaction has two sides & affects 2+ accounts.
What is a Chart of Accounts?
It lists the name of every account & its unique account number, but it doesn’t provide the account balances. If an accountant is unsure about what account to use when recording a transaction, they can consult the chart of accounts to help them choose the most appropriate one, or add a new account.
What is the T-Account?
We can represent accounts in tables that look like a ‘T’. The vertical line divides the account into left (debit) & right (credit) sides, while the account title rests on the horizontal line. The debit side equals to the credit side.
The Rules of Debit & Credit
The rules of debit & credit vary by account type.
- Assets: Increase on the left, decrease on the right. This includes cash, for example.
- Liabilities & Shareholders’ Equity: Increase on the right, decrease on the left. This includes Payables.
The Expanded Accounting Equation
Record Transactions in Journal & Posting to Ledger
3 Steps in the Recording Process of Journals
When recording transactions, accountants use a chronological record called a journal.
- Specify each account affected by the transaction.
- Use rules of debit/credit to determine whether each account is increased/decreased by transaction.
- Record the transaction in the journal, including a brief explanation for the entry & the date of the transaction. Debit side is entered on the left margin & credit side is indented slightly to the right. This also known as recording the journal entry or journalizing the transaction.
Posting From the Journal to the Ledger
Ledger includes all of a company’s accounts, along with their balance as of the most recent posting date. A journal does not indicate balance.
Posting is a simple process of directly transferring information from the journal to the ledger.
Accounts After Posting to the Ledger
For each account, a horizontal line separates the transaction amounts from the account balance at the end of the month. If debit balance exceeds credit balance, then the account will have a debit balance (& vice versa).
Prepare & Use a Trial Balance
A trial balance lists all of a business’ ledger accounts & their balances. Asset accounts are listed first, followed by liability & then all accounts that affect shareholders’ equity. We add the debit & credit balances and place the totals at the bottom of the trial balances. They must equal each other.
Once the trial balance is prepared properly, the financial statements can be prepared.