CHAPTER 2 LECTURE NOTES

Recording Business Transactions

Learning Objectives [LO]

1. Identify the five major steps in the accounting cycle.
2. Analyze and record transactions using the accounting equation.
3. Describe the system of debits and credits and its use in recording transactions.
4. Explain the process of journalizing and posting transactions.
5. Describe the trial balance.
LO 1 - Identify the Five Major Steps in the Accounting Cycle

Chapter 2

Chapter 3

Chapter 4

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To illustrate the accounting cycle, I will use Sierra Corporation as an example. Sierra Corporation provides
guide services in the Lake Tahoe area of the Sierra Nevada Mountains.

LO 2 - Analyze and Record Transactions using the Accounting Equation

• Accounting Transactions
o Definition: (1) are _____________________ that require recording in the financial
statements; (2) can be expressed in _________________
o Criterion for recording events in the accounting system: has any of the elements of the
accounting equation – _______________________________________– of the company
changed?
o Examples of accounting transactions: purchase inventory, payment of rent, payment of
salaries and wages, cost of buildings and equipment used or depreciated, collect cash from
customers
 Question: Is hiring an employee an accounting transaction?

• Analyzing Transactions – Transaction analysis – the process of identifying the specific effects
of economic events on the accounting equation
o Each transaction has a _______________on the equation. That is, affects at least
________ elements of the accounting equation.
o The accounting equation must always balance at any point in time!
 Question: If an asset account such as cash is increased by $5,000, which one of
the following financial events must also occur to keep the accounting equation in
balance?
A. Another asset, such as Accounts Receivable, must decrease by $5,000
B. A liability, such as Accounts Payable, must increase by $5,000
C. Stockholders’ equity, such as Common Stock, must increase by $5,000
D. Each of the above is correct
o Double-entry accounting
o Basic accounting equation
Assets = Liabilities + Stockholders’ Equity
What company owns = what company owes + owners’ interest
o Expanded accounting equation

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• Explain the Nature, Format, and Purpose of the Account
o Account – an individual accounting record of increases and decreases in a specific asset,
liability, stockholders’ equity, revenue or expense item.
 For example, Sierra Corporation has separate accounts for Cash, Accounts
Receivable, Accounts Payable, Service Revenue, Salaries and Wages Expense
o Chart of Accounts – a list of accounts used by a company. They are typically listed in
the following order:

Example of Analyzing Transactions – keeping the accounting equation in balance

Note: Supplies are recorded as an asset because they are available for future use.
Supplies expense occurs when the supplies are used up in business operations
On account: purchase or sell on credit. Purchase on account results in accounts payable, and sell
on account results in accounts receivable.
Summary of analyzing transactions
 Each transaction is analyzed in terms of its effect on assets, liabilities, and stockholders’
equity
 The two sides of the equation must always be equal
 The cause of each change in stockholders’ equity must be indicated

Event (1) Issued Stock. On October 1, cash of $10,000 is invested in Sierra Corporation by
investors in exchange for $10,000 of common stock.
Event (2) Signed Bank Note in Exchange for Cash. On October 1, Sierra borrowed $5,000
from Castle Bank by signing a 3-month, 12%, $5,000 note payable.
Event (3) Purchased Equipment with Cash. On October 2, Sierra purchased equipment by
paying $5,000 cash to Superior Equipment Sales Co.
Event (4) Received Customer Prepayment. On October 2, Sierra received a $1,200 cash
advance from R. Knox, a client.
Event (5) Provided Services to Customers for Cash. On October 3, Sierra received $10,000 in
cash from Copa Company for guide services performed.
Event (6) Payment of Rent. On October 3, Sierra Corporation paid its office rent for the month
of October in cash, $900.
Event (7) Paid Insurance Policy in Advance. On October 4, Sierra paid $600 for a one-year
insurance policy that will expire next year on September 30.

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Event (8) Purchased Supplies on Account. On October 5, Sierra purchased an estimated three
months of supplies on account from Aero Supply for $2,500.
Event (9) Hired an Employee. On October 9, Sierra hired four new employees to begin work on
October 15.
Event (10) Paid Cash Dividend. On October 20, Sierra paid a $500 dividend
Event (11) Paid Employee Salaries. Employees have worked two weeks, earning $4,000 in
salaries, which were paid on October 26.

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 Asset = Liabilities + Stockholders' Equity
Retained Earnings
Unearned
Event Prepaid Notes Accounts Service Common
# Cash + Supplies + Insurance + Equipment = Payable + Payable + Revenue + Stock + Revenue - Expense - Dividends
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Sum + + + = + + + + - -
=

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LO 3 – Describe the System of Debits and Credits and its Use in Recording Transactions.

• T-account: a simplified form of an account; resemble the letter “T”.

o Consists of three parts: (1)_______________________ ,
(2)___________________________, and (3)___________________________
Account Name
Debit / Dr. Credit / Cr.

o Use proper account titles in journal entries and for T accounts. Should not use phrases
such as “paid cash”, “bought supplies”, “performed services” as account titles
o Debit is abbreviated Dr. and credit is abbreviated Cr.
o Debiting: the act of entering an amount on the left side of an account. Crediting: making
an entry on the right side of an account

• Debit balance: When the totals of the two sides are compared, if the left side (Dr. side) is greater
than the right side (Cr. side). Credit balance: if the right side (Cr. side) is greater than the left
side (Dr. side).
Example:
Cash Accounts Payable
Dr. Cr. Dr. Cr.

• Debit and Credit Procedures: Double-Entry System

o Each transaction must affect two or more accounts to keep the basic accounting
equation in balance
o For each individual transaction, ________________________________________
o The two-sided effect of each transaction is recorded in ______________________
o This system provides a logical method for recording transactions, which helps to ensure
the accuracy of the recorded amounts and helps to detect error

• Dr./Cr. Rules
o Think of the accounting equation:
Basic: Assets = Liabilities + Stockholders’ Equity

Expanded: Assets = Liabilities + Common Stock + Retained Earnings + Revenues - Expenses -

Dividends

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 Rearranged: Assets + Expenses + Dividends = Liabilities + Common Stock + Retained Earnings +
Revenues
Common Retained
Assets Expense Dividends Liabilities Stock Earnings Revenues
Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.

A debit or a left hand side entry, increases accounts on the left of the equation. A
credit, or a right hand side entry, increases accounts on the right of the equation.
Therefore,
 Assets are increased by _____________entries.
 Liabilities are increased by _________________entries.
 Stockholders’ equity is increased by ________________entries.
 Now, think of the elements in Stockholders’ Equity. Three of these
elements: Common Stock, Retained Earnings, and Revenue, increase
stockholders’ equity. Therefore, these three accounts are increased by
______________entries and decreased by _________________entries.
 The fourth and fifth elements – Expenses and Dividends, decrease
stockholders’ equity. Therefore, Expenses and Dividends are increased
by _____________entries and decreased by _______________entries.
 In summary, “DEAD” = Debits Increase Expenses Assets Dividends.

o The normal balance for an account is on its increase side

 The normal balance for Assets, Dividends, and Expenses is a _________ balance.
 The normal balance for Liabilities, Common Stock, Retained Earnings, and
Revenues is a _______________ balance.

Question: For each of the following accounts, identify whether the account’s normal balance is a
debit or credit.
a. Cash b. Common stock
c. Wage expense d. Notes payable
e. Dividends f. Sales revenue
g. Inventory h. Accounts receivable

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LO 4 – Explain the Process of Journalizing and Posting
• Step 1: Analyze each transaction in terms of its effect on the accounts.
o A source document, such as a sales slip, a check, a bill, or a cash register document
provides evidence of the transaction.
(In an audit, auditors are required to “trace to the source”. These source documents
should support the data recorded in the accounting journals and the general ledger by
providing an indisputable audit trail from source documents to journals to general ledger
to trial balance to financial statement).
• Step 2: Journalize the transaction information in a journal (book of original entry)
• Step 3: Post the journal information to the appropriate accounts in the ledger (book of accounts)

• The Journal / General Journal

o Book of original entry
o Shows _________________________ on specific accounts for each transaction
o Transactions recorded in __________________________
o Think of the journal as a diary that has a chronological listing of the financial transactions
of a business
• Contributions to the recording process:
o Discloses the complete effects of a transaction.
o Provides a chronological record of transactions.
o Helps to prevent or locate errors because the debit and credit amounts can be easily
compared.
• Journalizing: Entering transaction data in the journal
• Journal entry: an entry in a journal

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Examples of proper journal entries: using the information for Sierra that was entered in the extended
balance sheet equation
• Features of the journal entries
o Date of the transaction
o Pick out account titles – stick with it for all subsequent transactions involving the account
o ________________________________ (both for accounts and amounts)
o Every transaction will be recorded in at least two accounts – “double entry” system
o A brief explanation of the transaction

General Journal
Date Account Titles and Explanation Debit Credit
2017

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• The Ledger / General Ledger – The entire group of accounts maintained by a company
o Contributions to the recording process:
 Journal, alone, is of limited use. Accounts facilitate the classification of
financial information. For example, all of the transactions pertaining to
cash maybe found in the cash account.
 The Ledger provides management with the balances and changes in
balances in various accounts
o The general ledger contains all the assets, liabilities, stockholders’ equity,
revenue, and expense accounts.

• Posting – the process of transferring journal entries to the ledger accounts

o Accumulates the effects of journalized transactions in the individual ledger
accounts

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Examples of posting: using the General Journal of Sierra Corporation

Asset = Liabilities + Stockholders' Equity

Cash Notes Payable Common Stock

Accounts Payable Service Revenue

Equipment Unearned Ser. Rev. Rent Expense

Prepaid Insurance Salaries and Wage Exp.

Supplies Dividends

Asset = Liabilities + Stockholders' Equity

= +

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LO 5 – Describe the Trial Balance
• Trial Balance – a list of all accounts in the general ledger and their balances
• Purposes:
o Prove that ________________________
o Catch some obvious errors in journalizing and posting
 The trial balance will NOT catch errors when: (1) a transaction is not
journalized, (2) a correct journal entry is not posted, (3) a journal entry is
posted twice, (4) journal entries being posted to the wrong account, or (5)
journal entries are being posted in the wrong amount
o Useful in the preparation of financial statements

Example of Trial Balance: using the General Ledger of Sierra Corporation to prepare an
Unadjusted Trial Balance

Sierra Corporation Unadjusted Trial Balance

October 31, 2017

Debit Credit
Cash
Supplies
Assets
Prepaid Insurance
Equipment
Notes Payable
Liabilities Accounts Payable
Unearned Service Revenue
Common Stock
Dividends
Stockholders'
Equity Service Revenue
Salaries and Wages Expense
Rent Expense

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