Analyze and Record Transactions PDF

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Analyze, Record, Summarize Transactions When a transaction occurs, the first place it is recorded is in the journal. The journal is a chronological record (in date order) of the transactions in a business. After each transaction is entered in the journal, it is posted to the ledger. The ledger is a collection of separate accounts (think of it as one page for Cash, one page for Accounts Receivable and so on). The ledger is in account order. Finally, a trial balance is prepared in order to prove that debits = credits. In terms of information management, we need a historical record of transactions, both by date (the journal) and by account (the ledger). These two orderings would allow us to find the answer to the question "what transactions happened on April 3?" by looking at the journal; or, we could ask the question "how much cash do we have?" by looking at the Cash account in the ledger. Under a manual system of accounting, there is a fair amount of work involved in getting the transactions sorted out these two different ways. You will get the impression that each transaction is recorded once in the journal, and then copied over into the ledger. That's essentially what happens. You might think that a mechanical process like copying the transactions from one place to another is a nonproductive activity for an accountant. You'd be right, which is why most people would spend their mental energy on the journalizing part of the process, and then let a computer system take care of the repetitive copying process. Debits and Credits In order to journalize and post, you will need to know about debits and credits. Every account has two sides, a debit side and a credit side:

Every account (asset, liability, owner's equity, revenue, expense) has a left side, or debit side, and a right side, or credit side. Debits and credits are used to denote increases and decreases in the accounts, but you must look carefully at the rules for how this is done. You must know 1) where each account lies in your chart of accounts, and 2) whether that account is being increased or decreased in a transaction. Once you have that information, you can refer to the rules for debit and credit, which are illustrated in the following diagram. For instance, an increase in an asset (Cash, Accounts Receivable, etc.) is recorded with a debit. But, an increase in liabilities or owner's equity is recorded with a credit.

I suggest that you print out the model presented above, or copy it down on a large piece of paper, and actively analyze the small set of transactions described below. Take some time with this and you will be rewarded. Your textbook uses debits and credits for processing the transactions, but in a larger sense, an understanding of debits and credits makes you more efficient at learning accounting. Once again, every single accounting transaction has a debit side and a credit side, and the two have to be equal. The word “side” here is crucial: in old-fashioned, traditional manual accounting systems (where each account looks like a T), all debits go on the left and all credits go on the right. Here's the tricky part. Some accounts are increased by debits; some are decreased. In the same way, some accounts are increased by credits, and others are decreased. Whether a debit acts like an addition or subtraction completely depends on the type of account you are working with. Here's a table summarizing the normal balances of the accounting elements, and the actions to increase or decrease them. Notice that the normal balance is the same as the action to increase the account.

Accounting Element

Normal Balance

To Increase To Decrease

1. Assets

Debit

Debit

Credit

2. Liabilities

Credit

Credit

Debit

3. Capital

Credit

Credit

Debit

4. Withdrawal

Debit

Debit

Credit

5. Income

Credit

Credit

Debit

6. Expense

Debit

Debit

Credit

Remember, you do not need to memorize the whole table. Just be familiar with the normal balance portion and you'll be okay. The normal balance is the same as the action to increase the account. The action to decrease the account is simply the opposite of that. Let us examine sample transactions from would be entered as debits and credits in the accounts shown above. Here are the transactions: 1. Owner invests $15,000 of personal assets in the business. 2. Company purchases $7000 of equipment for cash. 3. Purchase of supplies on account (account payable), $1600. 4. Providing services for cash, $1200. 5. Purchase of advertising on account, $250. 6. Services provided to a customer for cash ($1500) and $2000 on account (receivable). 7. Payment of expenses in cash (Rent $600, Salaries $900, Utilities $200). 8. Consuming of supplies, $400. Think of the expiration of the supplies as an expense. 9. Payment of an account payable ("payment on account"), $250. 10. Receipt of cash on account, $600. 11. Owner withdraws cash, $1300.

Transaction 1 In transaction 1, your thinking would be as follows: a. There was an increase in cash; b. Cash is an asset; c. Increases in assets are recorded with a debit; d. Therefore, debit Cash for $15,000. (Pencil it in on the left side of the Cash account). Transaction 1 has another effect: a. The Owner's Capital increased; b. Owner's Capital is an Owner's Equity account;

c. Increases in Owner's Equity are recorded with a credit; d. Therefore, credit Owner's Capital for $15,000. (Pencil it in, in the T-account). Note: for transaction 1, (and for all transactions) the debit amount and the credit amount must be equal. If they are not equal, the trial balance will not balance. Transaction 2: a. There was an increase in Equipment; b. Equipment is an Asset; c. Increases in Assets are recorded with a Debit; d. Therefore, debit Equipment for $7000. (Pencil it in.) Transaction 2 has another effect: a. There was a decrease in Cash; b. Cash is an Asset; c. Decreases in Assets are recorded with a credit; d. Therefore, credit Cash for $7000. Can you analyze transactions 3-11? Note: do not be tempted to abbreviate the step-by-step analysis illustrated above, until you become really proficient at it. Transaction 3: The purchase of supplies on account suggests an increase in Supplies and an increase in Accounts Payable. Debit Supplies and credit Accounts Payable. Transaction 4: We provided services for cash. Cash increases and a revenue was earned. Cash is debited; Service Revenue is credited. Note that Service Revenue, when earned, represents an increase in owner's equity. Therefore, Service Revenue is always a credit balance account. Transaction 5: We purchased advertising on account. You will find Advertising Expense in the owner's equity section of the ledger. When an expense is incurred, we record a decrease in owner's equity--so, debit Advertising Expense. Accounts Payable increases, so make a credit to Accounts Payable. Transaction 6: Services were provided to a customer in the amount of $3500, so revenue goes up by that amount--make a credit. Both Cash and Accounts Receivable are debited to reflect each of those assets increasing. Transaction 7:

In this transaction, we wrote three checks to pay monthly expenses. Therefore our Cash account balance decreased, so we must credit the Cash account and debit each expense account to increase their balances. Specifically, we debit Rent Expense for $600 and credit Cash for $600, we debit Salaries Expense for $900 and credit Cash for $900, and we debit Utilities Expense for $200 and credit Cash for $200. Transaction 8: This transaction is one in which an asset is consumed. Note that supplies were purchased in transaction 3, but that so of those supplies got used up. The using of an asset is considered an expense, in this case Supplies Expense. So we debit Supplies Expense and credit Supplies. In dollar terms, we originally purchased $1600 of Supplies, but $400 of supplies were used, leaving $1200 of supplies--which will be reported on the balance sheet. If someone asked you, "what is the difference between Supplies Expense and Supplies, how would you respond? Supplies Expense is the amount of supplies used up, and Supplies is the amount of supplies remaining. Transaction 9: We paid cash on account; debit Accounts Payable and credit Cash. Transaction 10: Received cash on account. Cash goes up and Accounts Receivable goes down. Debit Cash, credit Accounts Receivable. Transaction 11: The owner withdrew cash. Debit Drawing and credit Cash. OK, so much for the analysis. In practice, we do things in a certain order, called the Accounting Cycle. The first four steps in the accounting cycle are: 1. Analyze each transaction; 2. Journalize each transaction by recording it in the journal; 3. Post each transaction to the appropriate accounts in the ledger; 4. Prepare a trial balance to show the final total for each account. Once you've done the analysis, a transaction is first entered in the journal. Here is a sample journal entry for transaction 4, assuming that the revenue was earned on January 20:

Date

General Journal Accounts

Ref

Debit

Credit

Jan 20

Cash

1200

Service Revenue Provided services for cash.

1200

The debit account (in this case, Cash) is entered first; the credit account (Service Revenue) is indented. The date is shown out to the left. Here are transactions 5 and 6, assuming that they both happened on January 21:

General Journal Date Accounts Jan Advertising Expense 21 Accounts Payable Purchased advertising on account. Jan 21

Ref Debit Credit 250 250

Cash

1500

Accounts Receivable Service Revenue Provided services; cash received; remainder on account.

2000 3500

Notice that the columnar arrangement of the numbers in the journal allows you to verify that, at all times, the total debits always equals total credits. Also note that the Ref column has not been filled in. When the posting is made from journal to ledger, the account number to which the debit or credit is posted will be written in this Ref column. Here's an example of how to post.

General Journal Date Accounts Jan 20 Cash Service Revenue Provided services for cash.

Ref 101

Debit 1200

page 59 Credit 1200

We need to post a debit to Cash for $1200 to the ledger. Let's assume that the account number for Cash is 101. The ledger page for Cash appears as follows:

Cash

No. 101

Date Jan 20

Explanation

Ref Debit p. 59 1200

Credit

Balance 1200

Copy the date; in this case the transaction happened on January 20. Put the debit of 1200 in the ledger debit column. Update the account balance. In the ledger account, show the journal page number from which the posting came (in this case, page 59 of the journal). Then go back to the journal and put the account number for the posting (101) in the Ref column of the journal. For clarity, I have shown the posting references in red. The posting process is aptly illustrated in your text. Posting is equivalent to the "penciling in" that you did earlier to transfer journal entries to the appropriate side of each account. Every transaction that is journalized must be posted. After you have posted all transactions to the ledger accounts, you transfer the final balance of each account to the trial balance. For example, if Cash had debits of 10,000, 3,000 and 5,000 and credits of 3,000 and 1,000, the final balance would be $14,000.(Note that it would incorrect to say that Cash has 2 balances--a debit balance of $18,000 and a credit balance of $4,000. Perform a subtraction of credits from debits to arrive at the final total.) A trial balance involves computation of a final balance for each account. Then, each account is listed, along with its debit or credit balance. Logically, if all transactions have equal debit and credit entries, the trial balance should have equal debit and credit totals. But what happens if the trial balance doesn't balance? You will have to review your journal entries and postings to find the error. Here's a basic approach: 1) make sure each journal entry is balanced--especially with compound entries. Some accountants will compute the total debit side of the journal and compare it with the credit side--they should be equal; 2) review each posting to the ledger--it is easy to transpose digits or forget a zero in the posting; 3) scan your balance calculations in each account--Cash usually has more postings and balance calculations, so give that account a little more attention; 4) calculate the difference between the debit total and credit total in the trial balance--this is often a clue as to which transaction is faulty; 5) maintain your patience; 6) if you are trying to make something balance at 3:00 am, put it aside and try it again tomorrow. You'll probably find the error immediately....