Chapter 2 – Analyzing and Recording Transactions

Last chapter we learned how to analyze transactions, and we are still doing that this chapter, but
they will appear in a different format. However, we are still working within the accounting
equation.
Assets = Liabilities + Owner’s Equity
Account – detailed record of all increases and decreases that have occurred in an individual
asset, liability or component of equity during a specified period.
Ledger – a record of all of accounts and their balances
Assets – resources of a business with a future economic benefit to the business
 Cash
 Accounts Receivable – customer’s promise to pay at a future date
 Notes Receivable – a written promise a customer will pay a fixed amount plus interest
(more formal than accounts receivable)
 Prepaid Expenses – a payment of expenses in advance (prepaid rent, prepaid insurance)
 Supplies
 Land
 Buildings
 Equipment

Liabilities – debt of the business. Represents a future economic sacrifice
 Accounts Payable
 Notes Payable – a written promise to pay a fixed amount plus interest (more formal than
accounts receivable)
 Accrued Liability – an amount owed but not paid (taxes payable, rent payable, salaries
payable)
 Unearned Revenue – occurs when a company receives payment from a customer for
services not yet provided (thus the revenue has not been earned and must be earned in the
future)
Equity – Owner’s claim to the assets after liabilities are paid (Capital, Withdrawals, Revenues,
Expenses)
Accounts can get confusing, but if you READ and think about the ACCOUNT TITLE you
should be able to figure it out – as I said, accountants are not that creative.
Example:
 Prepaid Rent – rent that was paid in advance. It is an ASSET -- resource, a future
economic benefit. You paid September’s rent already, so you won’t have to pay it on
September 1st.

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  Rent Payable – rent that is owed, but not paid. It is a LIABILITY – a debt, a future
economic sacrifice. Rent is due on the 1st, but not delinquent until the 15th. On the 1st, it
becomes a PAYABLE (rent owned). When you pay it, it becomes an expense.
 Rent Revenue – revenue that is earned by renting out a property or portion of a property.
It is a REVENUE (part of equity) – and inflow, money you have earned. The lease is in
your name, but you rent out a room to your friend. The entire amount of rent you pay is a
rent expense. The portion that your roommate owes to you is rent revenue.
 Rent Expense – the cost of renting the property. It is an EXPENSE (part of equity). The
amount you must pay to occupy the property.
Chart of accounts – Think table of contents. The way to organize a company’s accounts, varies
from business to business
Double entry accounting – what we have been doing. Every transaction recorded into at least
two accounts. We record the dual effect of each transaction.
T-Account – shortened form of an account. Looks like a “T” (see what I mean about
accountants not being creative). It has a left side (DEBIT) and a right side (CREDIT).
Debit – LEFT. It does NOT mean decrease or subtract. It just means LEFT.
Credit – RIGHT. It does not mean increase or add. It just means RIGHT.
*Whether an account increases or decreases with a debit depends purely upon what type of
account it is. Things that increase on the left, increases with a debit (and decrease with a
credit). Things that increase on the right, increase with a credit (and decrease with a debit).
Assets = Liabilities + Capital – Withdrawals (drawings or dividends) + Revenues –
Expenses
Put all the positive on one side.
Assets + Withdrawals (drawings or dividends) + Expenses = Liabilities + Capital +Revenue
So, let’s look at what is positive on the left (debit) side and the right (credit) side.
Debit Credit
Assets Liabilities
Withdrawals Capital
Expenses Revenue

AWE LCR = Awe, Liquor – what I say whenever I need to do accounting

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Normal Balance – is the side of the account (debit or credit) where an account increases. It is
where we expect the balance to be at the end of a period. Accounts can have a balance on the
other, non-normal side, but if they do it represents that the account is over-drawn or over paid.
Follow the AWE LCR rule to determine the normal balance.
To determine the balance of a T-Account, you add each side of the account separately, then
subtract the smaller number from the larger number. Reporting on the balance on the side of the
larger number.
QS2-3 & 204 modified, QS2-6, QS2-7
Source Documents – provide the evidence of the transaction/economic event. They are what we
work from.
Journalizing and Posting Transactions – instead of the big spread sheet, this is what we will
use. When we journalize, we record the transactions in the date order that they occur. When we
post transactions, we transfer the amount we have journalized to the ledger account (we will use
T-Accounts).
Step 1: Identify the accounts and account types for each transaction
Step 2: Decide whether each account increases or decreases, then apply the rules of debits or
credits
Step 3: Journalize the transaction (write a journal entry) Must have at least one debit and at least
one credit. Debits must equal credits
Compound Journal Entry – has multiple debits and/or multiple credits but the same rules apply
Step 4: Post the amount to the ledger/T-Account
Step 5: Determine if the accounting equation is still in balance. Use Trial Balance
Again – best demonstrated rather than lectured about.
Book Demo
Trial Balance – List of all the ledger accounts with their balances at a point in time. Frequently
used to prepare the financial statements. We are working with the Unadjusted Trial Balance in
this Chapter.
Book Demo
Correcting Trial Balance Errors
1. Verify everything is correctly added
2. Search for missing account
3. Divide the difference by 2. If divisible by 2, there is likely a debit/credit error (on the
wrong side)

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 4. Divide the difference by 9. If divisible by 9, it is likely a transposition error or a slide
error ($1,000 instead of $100).
P2-2A
Evaluating Business Performance
Debt Ratio = Total Liabilities/Total Assets
Calculates the portion of assets financed by debt. The higher the Debt Ratio, the greater risk of
default. Higher debt means higher financial leverage (assets are leaveraged).
QS2-19