Chapter 3: Analyzing Transactions PDF

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Jason Wang, online class. Chapter 3 which looks at Analyzing Transactions...

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Chapter 3

Analyzing Transactions o Accounting information system: used to collect and process transaction data and communicate financial information to decision makers o Accounting cycle: series of steps used to account for and report transactions First step in this cycle is to analyze transactions to determine their effect on the accounting equation o Accounting transaction: when an economic event results in a company’s financial position changing in a measurable way o The accounting equation (assets = liabilities + shareholders’ equity) can be used to

determine if an accounting transaction has occurred. Basic analysisequation analysis Unless you are told otherwise, you can assume in your assignments that goods or services purchased on account give rise to accounts payable (as opposed to another type of payable). Transactions o Investment of cash by shareholders = equivalent increase in assets and shareholders’ equity  no effect on statement of income o Taking out a bank loan = increase in assets and liabilities  no effect on statement of income o Purchasing equipment = one asset increasing & another decreasing  no effect on statement of income o Payment of rent = rent increases (shown as – number because expenses decrease retain earnings which decrease shareholders’ equity)  affects statement of income o Purchase of insurance policy for cash = prepaid expense  no effect on statement of income o Hiring of new employee = no equation analysis needed  assets, liabilities, shareholders equity has not changed o Purchase of supplies on account = assets & liabilities increased  no effect on statement of income

Unless you are told otherwise, you can assume in your assignments that goods or services provided on account give rise to accounts receivable (as opposed to another type of receivable). o Provision of services on account = company receives account receivable  service revenue on statement of income o Receipt of cash in advance from client = increased liability  no effect on statement of income o Partial payment of accounts payable = assets and liabilities decrease  no effect on statement of income o Payment of salaries = decrease in cash and expenses (shareholders equity)  salaries expense on statement of income o Declaration and payment of dividends = (dividends are not an expense and are not included in the company’s calculation of net income) decrease in cash and dividends o Partial collection of accounts receivable = cash increased and accounts receivable decreased o Payment of income tax = cash and expenses decreased  income tax expense on statement of income EQUATION ANALYSIS o Each transaction must be analyzed for its effect on the three primary components of the accounting equation (assets, liabilities, and shareholders’ equity), as well as the specific effects within shareholders’ equity items (revenues, expenses, and dividends) o The two sides of the equations must always be equal

Recording Transactions Account: individual accounting record of increases and decreases in a specific asset, liability, or shareholders’ equity item along with its opening and ending balances. T Accounts (general ledger account) o An account consists of 3 parts: o Title of the account o Left or debit side (dr) o Right of credit side (cr) The normal balance of an account can be determined if you know what side of the T account it is found

Assets  Left side of the accounting equation  If normal balance of an account Is always on its increase side, asset accounts normally have debit (left side) balances  Decreases In assets are entered on the right (credit) side  Increases in assets are recorded by debits and asset accounts normally have debit balances  Debit balance (debit > credit) vice versa  In the T account, increases in cash are debits and decreases are credits  Balance is determined by netting the 2 sides (subtracting one from the other) Liabilities  Normally have credit balances  Increases entered in right side and decreases in left  Normal credit balance  credits exceed debits Shareholders’ Equity  Retained earnings (revenues and expenses, dividends declared)  Increases in common shares, retained earnings and revenue accounts are recorded by credits, normally have credit balances  Increases in expense and dividends declared accounts are recorded by credits and these accounts normally have credit balances  Common shares/retained earnings = increase shareholders’ equity o Increased by credits and decreased by debits o Increased recorded by credits and have normal credit balances  Expenses/dividends decrease retained earnings o Expense accounts increased by debits and decreased by credits o Normal balance in these accounts is a debit balance Journalizing Transactions – step #2 General Journal – most basic form o Transaction info is recorded as a journal entry in a general journal. Recorded in chronological order 1. It discloses the complete effect of a transaction in one place, with an explanation and identification of the source document (if applies) 2. It provides a chronological record of transactions 3. It helps to prevent and locate errors, because the debit and credit amounts for each entry can be quickly compared o Journalizing: entering transaction data in the general journal o Compound entry: affects 3+ accounts o Simple entry: affects only 2 accounts o Total debit = total credit

Posting Transactions – step #3 General ledger: contains all the asset, liability, SE, dividends declared, revenue and expense accounts o Arranged in the order in which accounts are presented in the financial statements o Chart of accounts: lists the accounts and the account numbers that identify where the accounts are in the ledger o 1000-2999=Asset o 3000-3999=liability o 4000-4999=SE o 5000-6999=revenue o 7000-9999=expense Posting: procedure of transferring journal entries from the general journal to the general ledger accounts o Done in chronological order Preparing a Trial Balance – step #4 Trial Balance – a list of general ledger accounts and their balances at a specific time. (usually done monthly, quarterly or annually) A trial balance proves that the sum of accounts with debit balances is equal to the sum of accounts with credit balances Procedure 1. List the account titles and their balances in the same order as the general ledger. (financial statement order) 2. Enter debit balances in the left column and credit balances in the right column 3. Total the debit column and the credit column and ensure that the debit and credit totals are equal...