Chapter 2: The recording

process
Learning Objective 1: Describe how
accounts, debits, and credits are used to
record business transactions
Accounts, Debits, and Credits
The Account
An account is an individual accounting record of increases and decreases
in a specific asset, liability, or equity item.

In its simplest form, an account consists of three parts: (1) a title, (2) a left
or debit side (Dr.), and (3) a right or credit side (Cr.).

Note: Whenever we are referring to a specific account, we capitalize the name.

Debits and Credits

Tabular Summary (Chapter 1) and Account Form (this chapter)

Chapter 2: The recording process 1

 Dr./Cr. Procedures for Assets and Liabilities

Both sides of the basic equation (Assets = Liabilities + Equity) must be equal.

Increases and decreases in liabilities have to be recorded opposite from

increases and decreases in assets.

Thus, increases in liabilities are entered on the right or credit side, and
decreases in liabilities are entered on the left or debit side.

Asset accounts normally show debit balances.

→ That is, debits to a specific asset account should exceed credits to that
account.

Liability accounts normally show credit balances.

→ That is, credits to a liability account should exceed debits to that account.

Dr./Cr. Procedures for Equity

Share Capital—Ordinary

Chapter 2: The recording process 2

 Companies issue share capital—ordinary in exchange for the owners’
investment paid in to the company.

Credits increase the Share Capital—Ordinary account, and debits decrease

it.

Knowing the normal balance in an account may help you trace errors.

Occasionally, though, an abnormal balance may be correct.

Retained Earnings.

Share capital—ordinary, retained earnings and liabilities:

Same rules apply for debit and credit and the normal balances.

Retained earnings is net income that is kept (retained) in the business. It

represents the portion of equity that the company has accumulated through
the profitable operation of the business.

Credits (net income) increase the Retained Earnings account, and debits
(dividends or net losses) decrease it

Dividends.

Chapter 2: The recording process 3

 A company’s distribution to its shareholders.

The most common form of a distribution is a cash dividend.

Dividends reduce the shareholders’ claims on retained earnings.

Debits increase the Dividends account, and credits decrease it.

Revenues and Expenses.

The purpose of earning revenues is to benefit the shareholders of the

business. When a company recognizes revenues, equity increases.

The effect of debits and credits on revenue accounts is the same as their
effect on Retained Earnings.

Expenses have the opposite effect. Expenses decrease equity.

Revenue accounts are increased by credits and decreased by debits.

Expense accounts are increased by debits and decreased by credits.

Because revenues increase equity, a revenue account has the same

debit/credit rules as the Retained Earnings account. Expenses have the
opposite effect.

Chapter 2: The recording process 4

 Equity Relationships

Summary of Debit/Credit Rules

Learning Objective 2: Indicate how a

journal is used in the recording process
The Journal

Chapter 2: The recording process 5

 Companies initially record transactions in chronological order.

Thus, the journal is referred to as the book of original entry.

The journal makes several significant contributions to the recording

process:

1. It discloses in one place the complete effects of a transaction.

2. It provides a chronological record of transactions.

3. It helps to prevent or locate errors because the debit and credit

amounts for each entry can be easily compared.

Journalizing:
Assume: On September 1, Softbyte SA shareholders invested €15,000 cash in
the corporation in exchange for ordinary shares, and Softbyte purchased
computer equipment for €7,000 cash.

Demonstrate: How do you enter the transaction data in the journal?

Chapter 2: The recording process 6

 Simple and Compound Entries
Simple entry: Involves one debit and one credit account.

Compound entry: An entry that requires three or more accounts. The

standard format requires that all debits be listed before the credits.

***Question: Why is it important for companies to record financial

transactions completely and accurately?

Learning Objective 3: Explain how a

ledger and posting help in the recording
process
The Ledger and Posting:

Chapter 2: The recording process 7

 Ledger: The entire group of accounts maintained by a company.

Provides the balance in each of the accounts as well as keeps track of

changes in these balances.

Companies may use various kinds of ledgers, but every company

has a
general ledger.

The Ledger
The General Ledger

***Question: What incentives might employees have had to overstate the value
of these investment securities on the company’s financial statements?

Standard Form of Account

Chapter 2: The recording process 8

 —> This format is called the three-column form of account. It has three money
columns - debit, credit, and balance

Posting

Chart of Accounts

Lists the accounts and the account numbers that identify their location in
the ledger.

Numbering system: Usually starts with the statement of financial

position accounts and follows with the income statement accounts.

Chapter 2: The recording process 9

 Number of accounts: Depends on the amount of detail management
desires.

Companies leave gaps to permit the insertion of new accounts as

needed during the life of the business.

The Recording Process Illustrated

October transactions of Yazici Advertising A.Ş.
Accounting period: One month

HELPFUL HINT: Follow these steps:\

1 - Determine what type of account is involved.

2 - Determine what items increased or decreased and by how much.

3 - Translate the increases and decreases into debits and credits.

Chapter 2: The recording process 10

Chapter 2: The recording process 11
Chapter 2: The recording process 12
Chapter 2: The recording process 13
Chapter 2: The recording process 14
 Summary Illustration of Journalizing and Posting

Chapter 2: The recording process 15

 Learning Objective 4: Prepare a trial
balance
The Trial Balance

A list of accounts and their balances at a given time.

Proves the mathematical equality of debits and credits after posting.

Three steps of preparation:

1. List the account titles and their balances in the appropriate debit or
credit column.

2. Total the debit and credit columns.

3. Verify the equality of the two columns.

Chapter 2: The recording process 16

 Limitations of a Trial Balance
A trial balance may balance even when:

1. Transaction not journalized.

2. Correct journal entry not posted.

3. Journal entry posted twice.

4. Incorrect accounts used in journalizing or posting.

5. Offsetting errors made in recording the amount of a transaction.

Error:

The result of an unintentional mistake

Neither ethical nor unethical

Irregularity:

An intentional misstatement

Viewed as unethical

Trial Balance - Locating Errors

Determine the amount of the difference between the two columns of the
trial balance.

Take one of the commonly useful steps as follows:

Chapter 2: The recording process 17

 Currency Signs and Underlining
Currency Signs

Do not appear in journals or ledgers.

Typically used only in the trial balance and the financial statements.

Shown only for the first item and the total in the column.

Underlining

A single line is placed under the column of figures to be added or

subtracted.

Totals are double-underlined.

Chapter 2: The recording process 18