Financial Accounting

Eleventh Edition
Global Edition

Chapter 2
Recording
Business
Transactions

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Learning Objectives
2.1 Explain what a business transaction is
2.2 Keep track of financial statement items
2.3 Analyze the impact of business transactions on accounts
2.4 Record (journalize and post) transactions in the books
2.5 Construct and use a trial balance

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Learning Objective 2.1
Explain what a transaction is

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Explain What a Transaction Is
A transaction is any event that has a financial impact
on the business and can be measured reliably.
• Provides objective information about the financial
impact on an exchange
– Gives something
– Receives something
• Accounting records both sides of the transaction

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Learning Objective 2.2
Keep track of financial statement items.

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Define Account (1 of 2)
The accounting equation expresses the basic relationship of
accounting.

Assets = Liabilities + Owners’ (Shareholders’) Equity

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Define Account (2 of 2)
• An account is the record of all the changes in a particular
asset, liability, or shareholders’ equity during a period.
– Basic summary device.

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List and Differentiate Between
Different Types of Accounts (1 of 5)
Assets: economic resources that provide a future benefit.
• Cash
– Money including bank account balances, paper currency, coins,
certificates of deposits and checks.
• Accounts Receivable
– Promise for future cash for goods or service.
• Notes Receivable
– Promissory note, specifying an interest rate, signed by a customer
to pay on a certain day.
• Inventory
– Goods the company sells customers.

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List and Differentiate Between
Different Types of Accounts (2 of 5)
Assets: economic resources that provide a future benefit.
• Prepaid expenses
– Expenses paid in advance, as insurance or rent.
• Property, plant and equipment (PPE)
– Cost of the land, buildings and equipment owner by a
company.

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List and Differentiate Between
Different Types of Accounts (3 of 5)
Liabilities: a debt or payable.
• Accounts payable
– Promise to pay debt.
• Notes payable
– Signed notes promising to pay a future amount.
• Accrued liabilities
– Liability for an expense you have not yet paid.

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List and Differentiate Between
Different Types of Accounts (4 of 5)
Equity: the owner’s claims to the assets of the company
• Share capital
– Owner’s investment in the corporation through shares.
• Retained earnings
– Cumulative net income minus net losses and dividends
over the company’s life.
• Dividends
– Distribution of the company’s earnings to its
shareholders.

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List and Differentiate Between
Different Types of Accounts (6 of 6)
Stockholders’ Equity: the stockholders’ claims to the
assets of the company.
• Income
– Increase in shareholder’s equity from delivering goods
or services to customers.
• Expenses
– Decrease in shareholder’s equity due to the cost of
operating a business.

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Learning Objective 2.3
Analyze the impact of business transactions on the
accounting equation

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Analyze the Impact of Business
Transactions on the Accounting Equation
Example: RedLotus Travel, Inc.

To illustrate the accounting for transactions, we will

consider 11 transactions and analyze each in terms of
its effect on RedLotus Travel.

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Transaction 1
On, April 1, Starr Williams and a few friends invest $50,000
to open RedLotus Travel, Inc., and the business issues
common stock to the stockholders.

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Transaction 2
RedLotus purchases land for a new location and pays cash
of $40,000.

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Transaction 3
The business buys supplies on account, agreeing to pay
$3,700 within 30 days.

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Transaction 4
RedLotus earns $7,000 of service revenue by providing
services for customers.

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Transaction 5
RedLotus performs services on account, which means that
RedLotus lets some customers pay later.

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Transaction 6
During the month, RedLotus Travel, Inc., pays $2,700 for the
following expenses: rent $1,100; employee salaries, $1,200;
and utilities, $400.

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Transaction 7
RedLotus pays $1,900 on account, which means to make a
payment toward an account payable.

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Transaction 8
Starr Williams, the major stockholder of RedLotus Travel,
paid $30,000 out of his personal bank account to remodel
his home.

No Entry

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Transaction 9
In transaction 5, RedLotus performed services for UPS on
account. The business now collects $1,000 from UPS.

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Transaction 10
RedLotus sells some land for $22,000, which is the same
amount RedLotus paid for the land and makes a $2,000
gain.

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Transaction 11
RedLotus Travel, Inc., declares a dividend and pays the
stockholders $2,100 cash.

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Exhibit 2-1 Transaction Analysis:
RedLotus Travel, Inc.

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Exhibit 2-2 Financial Statements of
RedLotus Travel, Inc. (1 of 2)

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Exhibit 2-2 Financial Statements of
RedLotus Travel, Inc. (2 of 2)

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Analyze the Impact of Business
Transactions on Accounts (1 of 2)
Accounting:
• Double-entry system
• Records dual effects of each transaction
– At least two accounts in each transaction

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Analyze the Impact of Business
Transactions on Accounts (2 of 2)
The T-Account
• Record of increases and decreases in a specific
asset, liability, equity, revenue, or expense
• Left side = “Debit”
• Right side = “Credit”

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Exhibit 2-3 Accounting Equation and
the Rules of Debit and Credit

The type of account determines how to record increases and

decreases.

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Exhibit 2-4 The Accounting Equation after
RedLotus Travel, Inc.'s, First Transaction

To illustrate, RedLotus Travel, Inc., received $50,000 and

issued (gave) share. What is the effect on the accounts?

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Exhibit 2-5 The Accounting Equation after
RedLotus Travel, Inc.’s, First Two Transactions

RedLotus’ second transaction is a $40,000 cash purchase of

land. What is the effect on the accounts?
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Additional Shareholders’ Equity
Accounts: Income and Expenses
Two categories of income statement accounts:
• Income  increase shareholders’ equity
 result from delivering goods/services
• Expenses  decrease shareholders equity
 cost of operating the business

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Exhibit 2-6 Expansion of the
Accounting Equation

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Exhibit 2-7 Final Form of the Rules of
Debit and Credit

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Learning Objective 2.4
Record (journalize and post) transactions in the books

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Record (Journalize and Post)
Transactions in the Books (1 of 2)
Journal
• Chronological record of transactions
• Three steps:
1. Specify each account affected by the transaction and
classify by type
2. Determine if each account is increased or decreased
(debit or credit)
3. Record in the journal

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 Record (Journalize and Post)
Transactions in the Books (2 of 2)
Steps to journalize the first transaction of RedLotus Travel, Inc.
Step 1 Business receives $50,000 cash and issues stock
Step 2 Both Cash and Common Stock increase
Step 3 Journalize the transaction:

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Exhibit 2-8 The Ledger (Asset, Liability,
and Shareholders’ Equity Accounts)

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Exhibit 2-9 Journal Entry and Posting
to the Accounts

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Exhibit 2-10 Flow of Accounting Data

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Transaction 1 Analysis
(1) Received $50,000 cash and issued stock to the owners

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Transaction 2 Analysis
(2) Paid $40,000 cash for land

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Transaction 3 Analysis
(3) Purchased supplies for $3,700 on account

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Transaction 4 Analysis
(4) Performed services and received cash of $7,000

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Transaction 5 Analysis
(5) Performed services for UPS on account, $3,000

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Transaction 6 Analysis
(6) Paid cash expenses: rent, $1,100; employee salary,
$1,200; utilities, $400

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Transaction 7 Analysis
(7) Paid $1,900 on the payable created in transaction 3

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Transaction 8 Analysis
(8) Stockholder of RedLotus remodeled her home with
personal funds

No Entry

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Transaction 9 Analysis
(9) Received $1,000 on account

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Transaction 10 Analysis
(10) Sold land for cash at the land’s cost of $22,000 and a
gain of $2,000 is recognized

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Transaction 11 Analysis
(11) Declared and paid a dividend of $2,100 to shareholders

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Exhibit 2-11 Alladin Travel, Inc.’s,
Ledger Accounts after Posting

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Learning Objective 2.5
Construct and use a trial balance

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Construct and Use a Trial Balance
Trial Balance
• Lists all accounts with their balances
• Assets listed first, then liabilities and shareholders’
equity
• Shows that debits equal credits
• Usually prepared at the end of the period
• Facilitates preparation of the financial statements

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Exhibit 2-12 Trial Balance

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Analyzing Accounts (1 of 3)
Suppose RedLotus’ began May with cash of $33,000. During
May, RedLotus’ received cash of $8,000 and ended the
month with a cash balance of $35,000.
You can compute total cash payments by analyzing
RedLotus’ Cash account:

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Analyzing Accounts (2 of 3)
You can compute either sales on account or cash collections
on account by analyzing the Accounts Receivable account
(using assumed amounts):

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Analyzing Accounts (3 of 3)
You can determine how much you paid on account by
analyzing Accounts Payable (using assumed amounts):

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Correcting Accounting Errors
First compute the difference between debits and
credits in the trial balance.
• Search for missing accounts
• Divide the out-of-balance amount by 2
• Divide the out-of-balance amount by 9
– Slide
– Transposition

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Exhibit 2-13 Chart of Accounts—
RedLotus Travel, Inc.

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Exhibit 2-14 Normal Balances of the
Accounts

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Exhibit 2-15 Account in Four-Column
Format

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