FA I Ch 2 Notes PDF

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Notes taken from the Financial Accounting textbook....

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Financial Accounting I Chapter 2 Notes: Recording Business Transactions Recording Business Transactions ● ACCOUNT ○ An ACCOUNT is a detailed record of all increases/decreases that have occured in an individual asset, liability, or equity during a specific period. ■ Recall: Assets are economic resources expected to benefit business in the future - something the business owns or has control of that has value. ■ Recall: Liabilities are debts that businesses owe ■ Recall: Equity is the stockholders’ claim to assets of the business ○ Common asset accounts: ■ Cash ■ Accounts Receivable ■ Notes Receivable ■ Taxes Payable ■ Salaries Payable ■ Unearned revenue ○ Common equity accounts: ■ Common stock ■ Dividends ■ Revenues ■ Expenses

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2  ○ A CHART OF ACCOUNTS lists a company’s accounts along with account numbers. ○ A LEDGER holds the record of all the accounts (more detailed) ; shows the increases/decreases in each account along with their balances. ● DOUBLE-ENTRY ACCOUNTING ○ DOUBLE-ENTRY ACCOUNTING requires transactions to be recorded into at least two accounts ○ The T-ACCOUNT (shortened form of the ledger) is shaped like a capital T with debits posted to the left side of the vertical line and credits posted to the right of the vertical line ■ Debit (DR) = Left ■ Credit (CR) = Right ■ “Don’t Leave  Cars Running”  ○ Debit INCREASES, Credit DECREASES: ■ Assets ■ Dividends ■ Expenses ○ Debit DECREASES, Credit INCREASES: ■ Liabilities ■ Common Stock ■ Revenues ○ The NORMAL BALANCE of an account is the increase side of an account. In other words, it is the balance that appears on the increase side of an account. ○ RULES OF DEBIT AND CREDIT ■ Assets ■ Expenses ■ Dividends ■ Liabilities ■ Revenues ■ Common Stock ● “All Elderly Don’t Like Revving Cars” ○ Expense accounts increase debit ○ Cash, normally having a debit balance, decreases credit ○ Cash increases with a debit entry 

3  ○ Accounts payable increases with credit entries ○ Payable accounts decrease debit ○ Liabilities normally have credit balances ○ Accounts receivable is an asset ○ Equity includes dividends ● RECORDING TRANSACTIONS ○ SOURCE DOCUMENTS provide evidence and data for transactions ○ Transactions recorded in journal, then journal entries are posted (transferred) to the ledger ■ SOURCE DOCUMENTS include: ● Purchase invoices ● Bank checks ● Sales invoices ○ A JOURNAL is the record of transactions in date order ■ POSTING is transferring data from the journal to the ledger ■ COMPOUND JOURNAL ENTRIES have more than two accounts ; are characterized by multiple debits or multiple credits ○ Transactions are journalized and posted using the five steps: 1. Identify the accounts and account type (Asset, liability, or equity) 2. Decide whether each account increases or decreases, then apply rules of debit and credits (“All elderly don’t like revving cars”) 3. Record transaction in journal 4. Post journal entry to ledger 5. Determine whether accounting equation is in balance ● TRIAL BALANCE ○ The TRIAL BALANCE summarizes the ledger by listing all the accounts in the ledger with their balances at one point in time ○ Assets are listed first, followed by liabilities, and then equity ○ The trial balance ensures that debits = credits and is used to prepare the financial statement ○ Actions for correcting trial balance errors: 1. Search the trial balance for a missing account 2. Divide the difference between total debits and total credits by 2 3. Divide the out-of-balance amount by 9 ● DEBT RATIO FOR EVALUATING BUSINESS PERFORMANCE 

4  ○ The DEBT RATIO can be used to evaluate a business’s ability to pay its debts

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