“I 2

want everything done . . . like, yesterday”—Tanya York Analyzing and Recording Transactions

A Look Back Chapter 1 considered the role of account- ing in the information age and introduced financial statements.We described different forms of organizations and identified users and uses of accounting.We explained the accounting equation and applied it to trans- action analysis.

Larson−Wild−Chiappetta: Fundamental Accounting Principles, Seventeenth Edition

2. Analyzing and Recording Transactions

A Look at This Chapter This chapter focuses on the accounting process.We describe transactions and source documents as inputs for analysis. We explain the analysis and recording of transactions.The accounting equation, T-account, general ledger, trial balance, and debits and credits are shown as useful tools in the accounting process.

Text © The McGraw−Hill

Companies, 2004

A Look Ahead Chapter 3 extends our focus on processing information.We explain the importance of adjusting accounts and the procedures in preparing financial statements.


2. Larson−Wild−Chiappetta:

Analyzing and Recording Fundamental Accounting

Transactions Principles, Seventeenth Edition

Text © The McGraw−Hill

Companies, 2004

Learning Objectives

CAP

Conceptual

Explain the steps in processing transactions. (p. 48)

Describe source documents and their purpose. (p. 49)

Describe an account and its use in recording transactions. (p. 49)

Describe a ledger and a chart of accounts. (p. 52)

Define debits and credits and explain their role in double-entry accounting. (p. 53)

Decision Feature

Analytical

Analyze the impact of transactions on accounts and financial statements. (p. 57)

Compute the debt ratio and describe its use in analyzing company performance. (p. 67)

Procedural C1

Record transactions in a journal and post entries to a ledger. (p. 55) C2

Prepare and explain the use of a trial balance. (p. 64) C3

Prepare financial statements from business transactions. (p. 65) C4 C5

A1

A2

P1 P2 P3

Against Long Odds

LOS ANGELES—Tanya York produced her first film at 19. Since then she has produced hundreds of films with her company York Entertainment (YorkEntertainment.com). York’s company has become an urban powerhouse and distributes its titles under the York Urban,York Latino, and York En Espanol labels. Says York, “I’m Jamaican myself, so I can kind of relate to being a minority in a world where so much is aimed at the majority, so, in that way I’m happy to be able to offer films with an urban appeal.”

York insists that the business and accounting side of production is as important as the artistic side.“With producing you’re involved in all aspects of the entertainment industry,” she says,“the creative side as well as the business side.” York knows that attention to fi- nancial statements and know-how of the accounting system of deb- its and credits is crucial to success.An understanding of the ac- counting details enabled York to assess and enhance her company’s profitability and financial position.

York relies on the financial numbers in devising strategies to enhance income.At the same time, she does not lose sight of giving the public what they want.Adds York,“I don’t see my job as chang- ing the public [demands].” Instead she fulfills them.This includes fill- ing her movies with stars like Ice T, Kurupt, Destiny’s Child, Kool Mo Dee, and Mac 10.

York continues to grow her company.With revenues near $20 million, she shows a keen understanding of accounting information in making good business decisions. Still, she insists anyone can use such information in a business to achieve similar success.“I came to America and through hard work built a company.”

Without a doubt,Tanya York has not only tasted success but is living it.Adds York,“I like to always have new challenges in front of me.”

[Sources: York Entertainment Website, January 2004; Cinescape, 2002; Rolling Out Urban Style, January 2002; Entrepreneur, November 2002; Los Angeles Daily News, February 2003.]


2. Larson−Wild−Chiappetta:

Analyzing and Recording Fundamental Accounting

Transactions Principles, Seventeenth Edition

Text © The McGraw−Hill

Companies, 2004

Chapter Preview

Financial statements report on the financial performance and condition of an organization. Knowledge of their preparation, organization, and analysis is important.A main goal of this chapter is to illustrate how transactions are recorded, how

Explain the steps in processing transactions.

they are reflected in financial statements, and how they impact analysis of financial statements. Debits and credits are introduced and identified as a tool in helping understand and process transactions.

Analyzing and Recording Transactions

Analyzing and Recording Process

• Source documents

• The account and its analysis

• Types of accounts

Analyzing and Processing Transactions

Trial Balance

• General ledger

• Trial balance

• Double-entry accounting

preparation

• Journalizing and posting

• Search for and

• Illustration

correction of errors

• Trial balance use

Analyzing and Recording Process

The accounting process identifies business transactions and events, analyzes and records their effects, and summarizes and presents information in reports and financial statements. These reports and statements are used for making investing, lending, and other business Exhibit 2.1

The Analyzing and Recording

decisions. The steps in the accounting process that focus on analyzing and recording trans- actions and events are shown in Exhibit 2.1.

Process

Services Contract

Supplies TOTAL

Business transactions and events are the starting points. Relying on source documents, trans- actions and events are analyzed using the accounting equation to understand how they af- fect company performance and financial position. These effects are recorded in accounting records, informally referred to as the accounting books, or simply the books. Additional steps such as posting and then preparing a trial balance help summarize and classify the ef- fects of transactions and events. Ultimately, the accounting process provides information in useful reports or financial statements to decision makers.

Journal Client Billing Note Payable

Purchase Ticket Bank Statement

2,500 Deposit 30,000

2,500

30,000

Journal

Journal

Dec.1 Cash

30,000 Taylor, Capital

30,000

Dec.1

Cash

Dec.1

30,000 Taylor, Capital

30,000 30,000

30,000

Cash Dec.2

Dec.2

2,500

Cash 2,500

Supplies

Record relevant transactions and events in a journal

Dec.1 Cash

Taylor, Capital

2,500

2,500

Dec.2

Supplies Cash

Ledger

1

Dec.2

Supplies Ledger

no.101

Cash

Cash

no.101

no.126

Supplies

no.126

Prepaid insurance Equipment Co Cash

Trial Date

Balance Name

no.126 1,500

$ Debit 3,950

Credit

Supplies

9,720 Prepaid insurance

2,400 26,000

Analyze each

Post journal

Prepare and transaction

information

analyze the and event from

to ledger

trial balance source documents

accounts

C1


2. Larson−Wild−Chiappetta:

Analyzing and Recording Fundamental Accounting

Transactions Principles, Seventeenth Edition

Text © The McGraw−Hill

Companies, 2004

Chapter 2 Analyzing and Recording Transactions 49

Source Documents Source documents identify and describe transactions and events entering the accounting process. They are the sources of accounting information and can be in either hard copy or electronic form. Examples are sales tickets, checks, purchase orders, bills from suppliers, employee earnings records, and bank statements. To illustrate, when an item is purchased on credit, the seller usually prepares at least two copies of a sales invoice. One copy is given to the buyer. Another copy, often sent electronically, results in an entry in the seller’s in- formation system to record the sale. Sellers use invoices for recording sales and for control; buyers use them for recording purchases and for monitoring purchasing activity. Note that many cash registers record information for each sale on a tape or electronic file locked inside the register. This record can be used as a source document for recording sales in the accounting records. Source documents, especially if ob- tained from outside the organization, provide objective and reliable evidence about transac- tions and events and their amounts.

The Account and Its Analysis An account is a record of increases and decreases in a specific asset, liability, equity, rev- enue, or expense item. Information from an account is analyzed, summarized, and presented in reports and financial statements. The general ledger, or simply ledger, is a record con- taining all accounts used by a company. The ledger is often in electronic form. While most companies’ ledgers contain similar accounts, a company may use one or more unique ac- counts because of its type of operations. Accounts are arranged into three general categories (based on the accounting equation), as shown in Exhibit 2.2.

Asset Accounts Assets are resources owned or controlled by a company and that have expected future benefits. Most accounting systems include (at a minimum) separate accounts for the assets described here.

A Cash account reflects a company’s cash balance. All increases and decreases in cash are recorded in the Cash account. It includes money and any medium of exchange that a bank accepts for deposit (coins, checks, money orders, and checking account balances).

Accounts receivable are held by a seller and refer to promises of payment from cus- tomers to sellers. These transactions are often called credit sales or sales on account (or on credit). Accounts receivable are increased by credit sales and are decreased by cus- tomer payments. A company needs a separate record for each customer, but for now, we use the simpler practice of recording all increases and decreases in receivables in a sin- gle account called Accounts Receivable.

A note receivable, or promissory note, is a written promise of another entity to pay a definite sum of money on a specified future date to the holder of the note. A company hold- ing a promissory note signed by another entity has an asset that is recorded in a Note (or Notes) Receivable account.

Prepaid accounts (also called prepaid expenses) are assets that represent prepayments of future expenses (not current expenses). When the expenses are later incurred, the amounts in prepaid accounts are transferred to expense accounts. Common examples of prepaid

C2

Describe documents source

and their purpose.

Point: To ensure that all sales are rung up on the register, most sellers require customers to have their receipts to exchange or return purchased items.

Decision Ethics

Cashier Your manager requires that you, as cashier, immediately enter each sale. Recently, lunch hour traffic has increased and the assistant manager asks you to avoid delays by taking customers’ cash and making change without entering sales.The assistant manager says she will add up cash and enter sales after lunch. She says that, in this way, the register will always match the cash amount when the manager arrives at three o’clock.What do you do?

Answer—p. 72

Describe an account and its use in recording transactions.

= +

C3

Asset Accounts

Exhibit 2.2 Accounts Organized by the Accounting Equation

Point: Customers and others who owe a company are called its debtors.

Point: A college parking fee is a prepaid account from the student’s standpoint.At the beginning of the term, it represents an asset that entitles a student to park on or near campus. The benefits of the parking fee expire as the term progresses.At term-end, prepaid parking (asset) equals zero as it has been entirely recorded as parking expense. Liability Accounts

Equity Accounts


2. Larson−Wild−Chiappetta:

Analyzing and Recording Fundamental Accounting

Transactions Principles, Seventeenth Edition

Text © The McGraw−Hill

Companies, 2004

50 Chapter 2 Analyzing and Recording Transactions

Point: Prepaid accounts that apply to

accounts include prepaid insurance, prepaid rent, and prepaid services (such as club mem- current and future periods are assets. These assets are adjusted at the end of each period to reflect only those amounts that have not yet expired and to record as expenses those amounts

berships). Prepaid accounts expire with the passage of time (such as with rent) or through use (such as with prepaid meal tickets). When financial statements are prepared, prepaid accounts are adjusted so that (1) all expired and used prepaid accounts are recorded as regular expenses and (2) all unexpired and unused prepaid accounts are recorded as as- that have expired.

sets (reflecting future use in future periods). To illustrate, when an insurance fee, called a premium, is paid in advance, the cost is typically recorded in the asset account Prepaid Insurance. Over time, the expiring portion of the insurance cost is removed from this asset account and reported in expenses on the income statement. Any unexpired portion remains in Prepaid Insurance and is reported on the balance sheet as an asset. (An exception exists for prepaid accounts that will expire or be used before the end of the current accounting pe- riod when financial statements are prepared. In this case, the prepayments can be recorded immediately as expenses.)

Supplies are assets until they are used. When they are used up, their costs are reported as expenses. The costs of unused supplies are recorded in a Supplies asset account. Supplies are often grouped by purpose—for example office supplies and store supplies. Office sup- plies include stationery, paper, toner, and pens. Store supplies include packaging materials, plastic and paper bags, gift boxes and cartons, and cleaning materials. The costs of these unused supplies can be recorded in an Office Supplies or a Store Supplies asset account. When supplies are used, their costs are transferred from the asset accounts to expense accounts. Point: Some assets are described as

Equipment is an asset. When equipment is used and gets worn down its cost is gradually intangible because they do not have

reported as an expense (called depreciation). Equipment is often grouped by its purpose— physical existence or their benefits are highly uncertain. A recent balance sheet for Coca-Cola Company shows nearly $3.5 billion in intangible assets.

for example, office equipment and store equipment. Office equipment includes computers, printers, desks, chairs, shelves, and other office equipment. Costs incurred for these items are recorded in an Office Equipment asset account. The Store Equipment account includes the costs of assets used in a store such as counters, showcases, ladders, hoists, and cash registers.

Buildings such as stores, offices, ware- houses, and factories are assets because they provide expected future benefits to those who Decision Insight

control or own them. Their costs are recorded

Boss-Aid Entrepreneurs were asked whom they would want—if they could have anyone—to help run their businesses for a week. Bill Gates led, with 24%, followed by Donald Trump and Warren Buffet—see selected survey results.

in a Buildings asset account. When several buildings are owned, separate accounts are sometimes kept for each of them.

The cost of land owned by a business is recorded in a Land account. The cost of build- ings located on the land is separately recorded in one or more building accounts.

Liability Accounts Liabilities are claims (by creditors) against assets, which means they are obligations to transfer assets or provide products or services to other entities. Creditors are individuals and organizations that own the right to receive payments from a company. If a company fails to pay its obligations, the law gives creditors a right to force the sale of that company’s assets to obtain the money to meet creditors’ claims. When as- sets are sold under these conditions, creditors are paid first, but only up to the amount of their claims. Any remaining money, the residual, goes to the owners of the company. Creditors often use a balance sheet to help decide whether to loan money to a company. A loan is less risky if the borrower’s liabilities are small in comparison to assets because there are more resources than claims on resources. The more common liability accounts are described here.

Accounts payable refer to oral or implied promises to pay later, which commonly arise from purchases of merchandise. Payables can also arise from purchases of supplies, equip-

Point: Accounts Payable are also called Trade Payables.

Bill Gates 24% Donald Trump 6.8 Warren Buffet 5.8 Lee Iacocca 5.2 Ross Perot 3.1 Hillary Clinton 1.4

ment, and services. Accounting systems keep separate records about each creditor. We describe these individual records in Chapter 4.


2. Larson−Wild−Chiappetta:

Analyzing and Recording Fundamental Accounting

Transactions Principles, Seventeenth Edition

Text © The McGraw−Hill

Companies, 2004

Chapter 2 Analyzing and Recording Transactions 51

A note payable refers to a formal promise, usually denoted by the signing of a promis- sory note, to pay a future amount. It is recorded in either a Short-Term Note Payable account or a Long-Term Note Payable account, depending on when it must be repaid. We explain details of short- and long-term classification in Chapter 4.

Unearned Revenue refers to a liability that is settled in the future when a company delivers its products or services. When customers pay in advance for products or services (before revenue is earned), the revenue recognition principle requires that the seller consider this payment as unearned revenue. Examples of un- earned revenue include magazine subscriptions collected in advance by a publisher, sales of gift certificates by stores, and season ticket sales by sports teams. The seller would record these in liability accounts such as Unearned Subscriptions, Unearned Store Sales, and Unearned Ticket Revenue. When products and services are later delivered, the earned portion of the unearned revenue is transferred to rev- enue accounts such as Subscription Fees, Store Sales, and Ticket Sales.1

Accrued liabilities are amounts owed that are not yet paid. Examples are wages payable, taxes payable, and interest payable. These are often recorded in separate liabil- ity accounts by the same title. If they are not large in amount, one or more ledger accounts can be added and reported as a single amount on the balance sheet. (Financial statements often have amounts reported that are a summation of several ledger accounts.)

Equity Accounts The owner’s claim on a company’s assets is called equity or owner’s equity. Equity is the owners’ residual interest in the assets of a business after deducting liabilities. There are four subcategories of equity: owner’s capital, owner’s withdrawals, revenues, and expenses. We show this visually in Exhibit 2.3 by expanding the accounting equation.

Decision Insight

Cash Spread The Green Bay Packers have Unearned Revenues of nearly $40 million in advance ticket sales.When the team plays its regular season home games, it settles this liability to its ticket holders and transfers the amount earned to Ticket Revenues.

Point: If a subscription is cancelled the publisher should refund the unused portion to the subscriber.

Point: Equity is also called net assets.

Asset Accounts

= Liability

Accounts

+

Equity Accounts

Exhibit 2.3

Expanded Accounting Equation

+ Owner’s

Capital

− Owner’s

Withdrawals

+ − Expenses

When an owner invests in a company, the invested amount is recorded in an account titled Owner, Capital (where the owner’s name is inserted in place of “owner”). An ac- count called C. Taylor, Capital is used for FastForward. Any further investments are recorded in this account. When the owner withdraws assets for personal use the with- drawal decreases both the company’s assets and its total equity. (Owners of proprietor- ships cannot receive salaries because they are not legally separate from their companies and cannot enter into salary, or any other, contracts with themselves.) Withdrawals are

1 In practice, account titles vary. As one example, Subscription Fees is sometimes called Subscription Fees Revenue, Subscription Fees Earned, or Earned Subscription Fees. As another example, Rent Earned is sometimes called Rent Revenue, Rental Revenue, or Earned Rent Revenue. We must use good judgment when reading financial statements because titles can differ even within the same industry. For example, product sales are called revenues at Krispy Kreme, but net sales at Tastykake. Generally, the term revenues or fees is more commonly used with service businesses, and net sales or sales with product businesses.

Revenues

Point: The Owner’s Withdrawals account (also called Drawing or Personal account) is sometimes referred to as a contra equity account because it reduces the normal balance of equity.


2. Larson−Wild−Chiappetta:

Analyzing and Recording Fundamental Accounting

Transactions Principles, Seventeenth Edition

Text © The McGraw−Hill

Companies, 2004

52 Chapter 2 Analyzing and Recording Transactions

Point: The withdrawal of assets by

not expenses of the business. They are simply the opposite of owner investments. the owners of a corporation is called a dividend.

An Owner, Withdrawals account is used in recording withdrawals by the owner. An account called C. Taylor, Withdrawals, is used to record Taylor’s withdrawals from FastForward.

Revenues and expenses are the final two Decision Insight

categories of equity. Examples of revenue ac- counts are Sales, Commissions Earned, Profess- Sports Accounts The Boston Celtics report

ional Fees Earned, Rent Earned, and Interest the following major revenue and expense accounts:

Revenue. Revenues increase equity and result

Revenues Expenses

Basketball ticket sales Team salaries TV & radio broadcast fees Game costs Advertising revenues NBA franchise costs Basketball playoff receipts Promotional costs

from products or services provided to cus- tomers. Examples of expense accounts are Advertising Expense, Store Supplies Expense, Office Salaries Expense, Office Supplies Expense, Rent Expense, Utilities Expense, and Insurance Expense. Expenses decrease equity and result from assets or services used in a com- pany’s operations. The variety of revenues and expenses can be seen by looking at the chart of accounts that follows the index at the back of this book. (Different companies sometimes use different account titles than those in this book’s chart of accounts. For example, some might use Interest Revenue instead of Interest Earned, or Rental Expense instead of Rent Expense. It is important only that an account title describe the item it represents.)

Analyzing and Processing Transactions

This section explains several crucial tools and processes that comprise an accounting sys- tem. These include a ledger, T-accounts, debits and credits, double-entry accounting, jour- nalizing, and posting.

Ledger and Chart of Accounts C4

Describe a ledger and a chart of accounts.

The collection of all accounts for an information system is called a ledger (or general ledger). If accounts are in files on a hard drive, the sum of those files is the ledger. If the accounts are pages in a file, that file is the ledger. A company’s size and diversity of operations af-

Decision Insight

fect the number of accounts needed. A small company can get by with as few as 20 or 30

Accoun-tech Using technology, Sears shrank its annual financial plan from 100 flowcharts with more than 300 steps to just one sheet of paper with 25 steps! Technology also allows Sears execs to analyze budgets and financial plans on their PCs. Sears says it slashed $100 million in recordkeeping costs.

accounts; a large company can require several thousand. The chart of accounts is a list of all accounts a company uses and includes an iden- tification number assigned to each account. A small business might use the following num- bering system for its accounts:

101–199 Asset accounts 201–299 Liability accounts 301–399 Equity accounts 401–499 Revenue accounts 501–699 Expense accounts

These numbers provide a three-digit code that is useful in recordkeeping. In this case, the first digit assigned to asset accounts is a 1, the first digit assigned to liability accounts is a 2, and so on. The second and third digits relate to the accounts’ subcategories. Exhibit 2.4 shows a partial chart of accounts for FastForward.


Chapter 2 Analyzing and Recording Transactions 53

Account Number Account Name

101 Cash 106 Accounts receivable 126 Supplies 128 Prepaid insurance 167 Equipment 201 Accounts payable 236 Unearned consulting

revenue

Debits and Credits A T-account represents a ledger account and is a tool used to understand the effects of one or more transactions. Its name comes from its shape like the letter T. The layout of a T-account (shown in Exhibit 2.5) is (1) the account title on top, (2) a left, or debit side, and (3) a right, or credit, side.

The left side of an account is called the debit side, often abbreviated Dr. The right side is called the credit side, abbreviated Cr.2 To enter amounts on the left side of an account is to debit the account. To enter amounts on the right side is to credit the account. Do not make the error of thinking that the terms debit and credit mean increase or decrease. Whether a debit or a credit is an increase or decrease depends on the account. In an account where a debit is an increase, the credit is a decrease; in an account where a debit is a decrease, the credit is an increase. The difference between total debits and total credits for an account, including any beginning balance, is the account balance. When the sum of debits exceeds the sum of credits, the account has a debit balance. It has a credit balance when the sum of credits exceeds the sum of debits. When the sum of debits equals the sum of credits, the account has a zero balance.

Double-Entry Accounting Double-entry accounting requires that each transaction affect, and be recorded in, at least two accounts. It also means the total amount debited must equal the total amount credited for each transaction. Thus, the sum of the debits for all entries must equal the sum of the credits for all entries, and the sum of debit account balances in the ledger must equal the sum of credit account balances.

The system for recording debits and credits follows from the usual accounting equation— see Exhibit 2.6. Two points are important here. First, like any simple mathematical relation, net increases or decreases on one side have equal net effects on the other side. For exam- ple, a net increase in assets must be accompanied by an identical net increase on the liabilities

C5

Point: Think of debit and credit as accounting directions for left and right.

2 These abbreviations are remnants of 18th-century English recordkeeping practices where the terms debitor and creditor were used instead of debit and credit. The abbreviations use the first and last letters of these terms, just as we still do for Saint (St.) and Doctor (Dr.).

Define debits and credits and explain their role in double-entry accounting.

Account Title

Exhibit 2.5 (Left side) (Right side)

The T-Account Debit Credit

Assets

Debit for Credit for increases decreases

Larson−Wild−Chiappetta: Fundamental Accounting Principles, Seventeenth Edition

Text © The McGraw−Hill

Companies, 2004

Account Number Account Name

Exhibit 2.4

301 302 C. Taylor, Capital

C.Taylor,Withdrawals

Partial Chart of Accounts for FastForward

403 Consulting revenue 406 Rental revenue 622 Salaries expense 637 Insurance expense 640 Rent expense 652 Supplies expense 690 Utilities expense

“Total debits equal total credits for each entry.”

Liabilities Equity

Exhibit 2.6 Debits and Credits in the Accounting Equation Debit for decreases

Credit for

Debit for increases

decreases 2. Analyzing and Recording Transactions

Credit for increases


2. Larson−Wild−Chiappetta:

Analyzing and Recording

Text © The McGraw−Hill Fundamental Accounting

Transactions

Companies, 2004 Principles, Seventeenth Edition

54 Chapter 2 Analyzing and Recording Transactions

Point: Debits and credits do not

and equity side. Recall that some transactions affect only one side of the equation, mean- mean favorable or unfavorable. A debit to an asset increases it, as does a debit to an expense. A credit to a liability increases it, as does a credit to a revenue.

Answers—pp. 72–73

ing that two or more accounts on one side are affected, but their net effect on this one side is zero. Second, the left side is the normal balance side for assets, and the right side is the normal balance side for liabilities and equity. This matches their layout in the accounting equation where assets are on the left side of this equation, and liabilities and equity are on the right.

Equity increases from revenues and owner investments and it decreases from expenses and owner withdrawals. These important equity relations are conveyed by expanding the Exhibit 2.7 Debit and Credit Effects for

accounting equation to include debits and credits in double-entry form as shown in Exhibit 2.7.

Component Accounts

Assets

Dr. for Cr. for increases decreases

Increases (credits) to capital and revenues increase equity; increases (debits) to withdrawals and expenses decrease equity. The normal balance of each account (asset, liability, capital, withdrawals, revenue, or expense) refers to the left or right (debit or credit) side where increases are recorded. Understanding these diagrams and rules is required to prepare, analyze, and interpret financial statements.

The T-account for FastForward’s Cash account, reflecting its first 11 transactions (from Exhibit 1.9), is shown in Exhibit 2.8. The total increases in its Cash account are $36,100, the total decreases are $31,700, and the account’s debit balance is $4,400.

Point: The ending balance is on the side with the largest dollar amount.

1. Identify examples of accounting source documents. 2. Explain the importance of source documents. 3. Identify each of the following as either an asset, a liability, or equity: (a) Prepaid Rent,

(b) Unearned Fees, (c) Building, (d) Wages Payable, and (e) Office Supplies. 4. What is an account? What is a ledger? 5. What determines the number and types of accounts a company uses? 6. Does debit always mean increase and credit always mean decrease? 7. Describe a chart of accounts.

Equity

Liabilities

Owner, Capital

Owner, Withdrawals Revenues

Dr. for Cr. for

Cr. for

Dr. for Cr. for decreases increases

decreases

decreases increases

Expenses

Dr. for Cr. for increases decreases

Normal Normal

Dr. for Cr. for

Dr. for decreases increases

increases

Normal Normal

Normal Normal

Exhibit 2.8

Computing the Balance for a T-Account

Cash

Investment by owner 30,000 Purchase of supplies 2,500 Consulting services revenue earned 4,200 Purchase of equipment 26,000 Collection of account receivable 1,900 Payment of rent 1,000 Payment of salary 700 Payment of account payable 900 Withdrawal by owner 600

Balance 4,400

Quick Check


Chapter 2 Analyzing and Recording Transactions 55

Journalizing and Posting Transactions Processing transactions is a crucial part of accounting. The four usual steps of this process are depicted in Exhibit 2.9. Steps 1 and 2—involving transaction analysis and double-entry accounting—were introduced in prior sections. This section extends that discussion and fo- cuses on steps 3 and 4 of the accounting process. Step 3 is to record each transaction in a journal. A journal gives a complete record of each transaction in one place. It also shows debits and credits for each transaction. The process of recording transactions in a journal is called journalizing. Step 4 is to transfer (or post) entries from the journal to the ledger. The process of transferring journal entry information to the ledger is called posting.

P1

General Journal

Record transactions in a journal and post entries to a ledger.

Step 1: Analyze transactions and

source documents.

Deposit

TOTAL

Step 2: Apply double-entry accounting.

Services Contract

Client Billing Note Payable Purchase Ticket Bank Statement 1

30,000 C

ash

Assets =Liability+Equity

Step 3: Record journal entry.

Step 4: Post entry to ledger.

Dec. 1 Cash

30,000

General Journal

Taylor, Capital

30,000

Ledger Dec. 2

Supplies 2,500

Cash

2,500

Journalizing Transactions The process of journalizing transactions requires an un- derstanding of a journal. While companies can use various journals, every company uses a general journal. It can be used to record any transaction and includes the following infor- mation about each transaction: (1) date of transaction, (2) titles of affected accounts, (3) dol- lar amount of each debit and credit, and (4) explanation of the transaction. Exhibit 2.10 shows how the first two transactions of FastForward are recorded in a general journal. This process is similar for manual and computerized systems. Computerized journals are often designed to look like a manual journal page, and also include error-checking routines that ensure debits equal credits for each entry. Shortcuts allow recordkeepers to select account names and numbers from pull-down menus.

To record entries in a general journal, apply these steps; refer to the entries in Exhibit 2.10 when reviewing these steps. 1 Date the transaction: Enter the year at the top of the first column and the month and day on the first line of each journal entry. 2 Enter titles

Exhibit 2.10

Partial General Journal for FastForward

Larson−Wild−Chiappetta: Fundamental Accounting Principles, Seventeenth Edition

Debit Date Account Titles and Explanation PR

2004 Dec. 1

Cash

30,000 C. Taylor, Capital Investment by owner.

Dec. 2

Supplies

2,500 Cash Purchased supplies for cash.

2. Analyzing and Recording Transactions

Text © The McGraw−Hill

Companies, 2004

Page 1 Credit

30,000

2,500

Exhibit 2.9

Steps in Processing Transactions


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Analyzing and Recording Fundamental Accounting

Transactions Principles, Seventeenth Edition

Text © The McGraw−Hill

Companies, 2004

56 Chapter 2 Analyzing and Recording Transactions

Exhibit 2.11 Cash Account in Balance Column Format

of accounts debited and then enter amounts in the Debit column on the same line. Account titles are taken from the chart of accounts and are aligned with the left margin of the Account Titles and Explanation column. 3 Enter titles of accounts credited and then en- ter amounts in the Credit column on the same line. Account titles are from the chart of accounts and are indented from the left margin of the Account Titles and Explanation column to distinguish them from debited accounts. 4 Enter a brief explanation of the transaction on the line below the entry (it often references a source document). This ex- planation is indented about half as far as the credited account titles to avoid confusing it with accounts, and it is italicized.

A blank line is left between each journal entry for clarity. When a transaction is first recorded, the posting reference (PR) column blank is left blank (in a manual system). Later, when posting entries to the ledger, the identification numbers of the individual ledger ac- counts are entered in the PR column.

Balance Column Account T-accounts are simple and direct means to show how the accounting process works. However, actual accounting systems need more structure and therefore use balance column accounts, as in Exhibit 2.11.

Point: A journal is often referred to as the book of original entry. The ledger is referred to as the book of final entry because financial statements are pre- pared from it.

The balance column account format is similar to a T-account in having columns for deb- its and credits. It is different in including transaction date and explanation columns. It also has a column with the balance of the account after each entry is recorded. To illustrate, FastForward’s Cash account in Exhibit 2.11 is debited on December 1 for the $30,000 owner investment, yielding a $30,000 debit balance. The account is credited on December 2 for $2,500, yielding a $27,500 debit balance. On December 3, it is credited again, this time for $26,000, and its debit balance is reduced to $1,500. The Cash account is debited for $4,200 on December 10, and its debit balance increases to $5,700; and so on.

The heading of the Balance column does not show whether it is a debit or credit balance. Instead, an account is assumed to have a normal balance. Unusual events can sometimes tem- porarily give an account an abnormal balance. An abnormal balance refers to a balance on the side where decreases are recorded. For example, a customer might mistakenly overpay a

Point: There are no exact rules for writing journal entry explanations. An explanation should be short yet describe why an entry is made.

bill. This gives that customer’s account receivable an abnormal (credit) balance. An abnor- mal balance is often identified by circling it or by entering it in red or some other unusual color. A zero balance for an account is usually shown by writing zeros or a dash in the Balance column to avoid confusion between a zero balance and one omitted in error.

Posting Journal Entries Step 4 of processing transactions is to post journal entries Point: Computerized systems often

to ledger accounts (see Exhibit 2.9). To ensure that the ledger is up-to-date, entries are posted provide a code beside a balance such as dr. or cr. to identify its balance.

as soon as possible. This might be daily, weekly, or when time permits. All entries must be posted to the ledger before financial statements are prepared to ensure that account balances are up-to-date. When entries are posted to the ledger, the debits in journal entries are trans- ferred into ledger accounts as debits, and credits are transferred into ledger accounts as cred- its. Exhibit 2.12 shows the four steps to post a journal entry. First, identify the ledger account that is debited in the entry; then, in the ledger, enter the entry date, the journal and page in its PR column, the debit amount, and the new balance of the ledger account. (The letter G Point: Posting is automatic and immediate with accounting software.

shows it came from the General Journal. Other journals are discussed in Chapter 7.) Second, enter the ledger account number in the PR column of the journal. Steps three and four re- peat the first two steps for credit entries and amounts. The posting process creates a link

2004 Dec. 1

G1 Dec. 2

G1 Dec. 3

G1 Dec. 10

G1

Cash

Account No. 101 Date Explanation

PR

Debit Credit

Balance

30,000

4,200

2,500 26,000

30,000 27,500 1,500 5,700


1

Point: The fundamental concepts of a manual (pencil-and-paper) system are identical to those of a computerized information system.

between the ledger and the journal entry. This link is a useful cross-reference for tracing an amount from one record to another.

Analyzing Transactions—An Illustration We return to the activities of FastForward to show how double-entry accounting is useful in analyzing and processing transactions. Analysis of each transaction follows the four steps

A1

of Exhibit 2.9. First, we review the transaction and any source documents. Second, we ana- lyze the transaction using the accounting equation. Third, we use double-entry accounting to record the transaction in journal entry form. Fourth, the entry is posted (for simplicity, we use T-accounts to represent ledger accounts). We also identify the financial statements affected by each transaction. Study each transaction thoroughly before proceeding to the next transac- tion. The first 11 transactions are from Chapter 1, and we analyze five additional December transactions of FastForward (numbered 12 through 16) that were omitted earlier. Topic Tackler 2-1

3 We use abbreviations for the statements: income statement (IS), balance sheet (BLS), statement of cash flows (SCF), and statement of owner’s equity (SOE).

Analyze the impact of transactions on accounts and financial statements.

1. Investment by Owner

Cash 101

(1) 30,000

C.Taylor, Capital 301

(1) 30,000

2004 Dec. 1

101

4

2004 Dec. 1

Cash

30,000 C. Taylor, Capital

301

30,000 Investment by owner

2

2004 Dec. 1

G1 30,000

30,000

G1

30,000

30,000

Key: 1

Identify debit account in Ledger: enter date, journal page, amount, and balance.

2

Enter the debit account number from the Ledger in the PR column of the journal.

3

Identify credit account in Ledger: enter date, journal page, amount, and balance.

4

Enter the credit account number from the Ledger in the PR column of the journal.

Larson−Wild−Chiappetta: Fundamental Accounting Principles, Seventeenth Edition

2. Analyzing and Recording Transactions

Transaction: Chuck Taylor invests $30,000 cash in FastForward. Analysis: Assets Liabilities Equity

Cash Capital 30,000 0 30,000 Double entry: (1) Cash 101 30,000

C.Taylor, Capital 301 30,000 Statements affected:3 BLS and SCF

Text © The McGraw−Hill

Companies, 2004

Chapter 2 Analyzing and Recording Transactions 57

Exhibit 2.12 Posting an Entry to the Ledger

3

Point: Explanations are typically included in ledger accounts only for unusual transactions or events.

FAST

Forward


2. Larson−Wild−Chiappetta:

Analyzing and Recording Fundamental Accounting

Transactions Principles, Seventeenth Edition

Text © The McGraw−Hill

Companies, 2004

58 Chapter 2 Analyzing and Recording Transactions

2. Purchase Supplies for Cash

Supplies 126

Transaction: FastForward pays $2,500 cash for supplies.

(2) 2,500

Analysis: Assets Liabilities Equity

Cash Supplies

2,500 2,500 0 0 Cash 101

Changes the composition of assets but not the total. (1) 30,000 (2) 2,500

Double entry: (2) Supplies 126 2,500

Cash 101 2,500 Statements affected: BLS and SCF

3. Purchase Equipment for Cash

Equipment 167

Transaction: FastForward pays $26,000 cash for equipment.

(3) 26,000

Analysis: Assets Liabilities Equity

Cash Equipment 26,000 26,000 0 0 Cash 101

Changes the composition of assets but not the total. (1) 30,000 (2) 2,500

Double entry: (3) Equipment 167 26,000 (3) 26,000

Cash 101 26,000 Statements affected: BLS and SCF

4. Purchase Supplies on Credit

Supplies (2) 2,500 (4) 7,100

126

Transaction: FastForward purchases $7,100 of supplies on

credit from a supplier. Analysis: Assets Liabilities Equity

Accounts Supplies Payable Accounts Payable 201

7,100 7,100 0

(4) 7,100

Double entry: (4) Supplies 126 7,100

Accounts Payable 201 7,100 Statements affected: BLS

5. Provide Services for Cash

Cash (1) 30,000 (2) (5) 4,200 (3) 101 2,500 26,000

Transaction: FastForward provides consulting services and

immediately collects $4,200 cash. Analysis: Assets Liabilities Equity

Consulting Cash Revenue Consulting Revenue 403

4,200 0 4,200

(5) 4,200

Double entry: (5) Cash 101 4,200

Consulting Revenue 403 4,200 Statements affected: BLS, IS, SCF, and SOE


2. Larson−Wild−Chiappetta:

Analyzing and Recording Fundamental Accounting

Transactions Principles, Seventeenth Edition

Text © The McGraw−Hill

Companies, 2004

Chapter 2 Analyzing and Recording Transactions 59

6. Payment of Expense in Cash

Rent Expense 640

Transaction: FastForward pays $1,000 cash for December rent.

(6) 1,000

Analysis: Assets Liabilities Equity

Cash Rent Expense

Cash 101

1,000 0 Double entry: (6) Rent Expense 1,000

640 1,000 (1) 30,000 (2) 2,500

Cash 101 1,000 (5) 4,200 (3) 26,000

Statements affected: BLS, IS, SCF, and SOE (6) 1,000

7. Payment of Expense in Cash

Salaries Expense 622 Transaction: FastForward (7) 700 Analysis: Assets Cash (1) 30,000 (2) 2,500 (5) 4,200 (3) 26,000 (6) 1,000 (7) 700

pays $700 cash for employee salary.

Point: Salary usually refers to

Liabilities Equity

Salaries Expense

compensation for an employee who receives a fixed amount for a given time period, whereas wages usually refers to

Cash 101

700 0 Double entry: (7) Salaries Expense 700

compensation based on time worked. 622 700 Cash 101 700 Statements affected: BLS, IS, SCF, and SOE

8. Provide Consulting and Rental Services on Credit

Accounts Receivable 106

(8) 1,900

Transaction: FastForward provides consulting services of

$1,600 and rents its test facilities for $300. The customer is billed $1,900 for these services. Analysis: Assets Liabilities Equity Consulting Revenue 403

Accounts Consulting Rental (5) 4,200

Receivable Revenue Revenue

(8) 1,600

1,900 0 1,600 300 Double entry: (8) Accounts Receivable 106 1,900

Rental Revenue 406

Consulting Revenue 403 1,600 Rental Revenue 406 300 Statements affected: BLS, IS, and SOE

(1) 30,000 (2) 2,500 (5) 4,200 (3) 26,000 (9) 1,900 (6) 1,000 (7) 700

Point: Transaction 8 is a compound

(8) 300

journal entry, which affects three or more accounts.

9. Receipt of Cash on Account

Transaction: FastForward receives $1,900 cash from the client

billed in transaction 8. Analysis: Assets Liabilities Equity

Accounts Cash Receivable

1,900 1,900 0 0 Double entry: (9) Cash 101 1,900

Accounts Receivable 106 1,900 Statements affected: BLS and SCF Cash 101

Point: The revenue recognition principle requires revenue to be recognized when earned, which is when the company provides products or services to a customer.This is not necessarily the same time that the customer pays. A customer can pay before or after products or services are provided. Accounts Receivable 106

(8) 1,900 (9) 1,900


2. Larson−Wild−Chiappetta:

Analyzing and Recording Fundamental Accounting

Transactions Principles, Seventeenth Edition

Text © The McGraw−Hill

Companies, 2004

60 Chapter 2 Analyzing and Recording Transactions

Point: Luca Pacioli is considered a pioneer in accounting and the first to devise double-entry accounting.

10. Partial Payment of Accounts Payable

Accounts Payable (10) 900 (4) 201 7,100

Transaction: FastForward pays CalTech Supply $900 cash

toward the payable of transaction 4. Analysis: Assets Liabilities Equity

Cash 101

Cash Accounts Payable

900 900 0 (1) 30,000 (2) 2,500

Double entry: (10) Accounts Payable 201 900 (5) 4,200 (3) 26,000

Cash 101 900 (9) 1,900 (6) 1,000

Statements affected: BLS and SCF (7) 700 (10) 900

11. Withdrawal of Cash by Owner

C.Taylor,Withdrawals (11) 600

302

Transaction: Chuck Taylor withdraws $600 cash from

FastForward for personal use. Analysis: Assets Liabilities Equity

Cash 101

Cash Withdrawals

600 0 600 (1) 30,000 (2) 2,500

Double entry: (11) C.Taylor, Withdrawals 302 600 (5) 4,200 (3) 26,000

Cash 101 600 (9) 1,900 (6) 1,000

Statements affected: BLS, SCF, and SOE (7) 700 (10) 900 (11) 600

12. Receipt of Cash for Future Services

Cash (1) 30,000 (2) (5) 4,200 (3) (9) 1,900 (6) (12) 3,000 (7) 101 2,500 26,000 1,000 700

Transaction: FastForward receives $3,000 cash in advance of

providing consulting services to a customer. Analysis: Assets Liabilities Equity

Unearned Cash Consulting Revenue

3,000 3,000 0 (10) 900 (11) 600

Accepting $3,000 cash obligates FastForward to perform future services and is a liability. No revenue is earned until services are provided. Unearned Consulting

Double entry: (12) Cash 101 3,000 Revenue 236

Unearned Consulting

Revenue 236 3,000 Statements affected: BLS and SCF

(13) 2,400

(12) 3,000

13. Pay Cash for Future Insurance Coverage

Prepaid Insurance 128

Transaction: FastForward pays $2,400 cash (insurance premium)

for a 24-month insurance policy. Coverage begins on December 1. Analysis: Assets Liabilities Equity Cash 101

Prepaid (1) 30,000 (2) 2,500

Cash Insurance

(5) 4,200 (3) 26,000 (9) 1,900 (6) 1,000 (12) 3,000 (7) 700 (10) 900

2,400 2,400 0 0 Changes the composition of assets from cash to prepaid insurance. Expense is incurred as insur- ance coverage expires.

(11) 600 (13) 2,400

Double entry: (13) Prepaid Insurance Cash Statements affected: BLS and SCF

128 2,400 101 2,400


2. Larson−Wild−Chiappetta:

Analyzing and Recording Fundamental Accounting

Transactions Principles, Seventeenth Edition

Text © The McGraw−Hill

Companies, 2004

Chapter 2 Analyzing and Recording Transactions 61

14. Purchase Supplies for Cash

Supplies 126

Transaction: FastForward pays $120 cash for supplies.

(2) 2,500

Analysis: Assets Liabilities Equity

(4) 7,100

Cash Supplies (14) 120

120 120 0 0 Double entry: (14) Supplies 126 120 Cash 101

Cash 101 120

(1) 30,000 (2) 2,500

Statements affected: BLS and SCF

(5) 4,200 (3) 26,000 (9) 1,900 (6) 1,000 (12) 3,000 (7) 700 (10) 900 (11) 600 (13) 2,400 (14) 120

15. Payment of Expense in Cash

Utilities Expense 690 Transaction: (15) 230

Analysis: FastForward expense.

Assets pays $230 cash for December utilities

Liabilities Equity

Cash 101

Cash Utilities Expense (1) 30,000 (2) 2,500

230 0 230

(5) 4,200 (3) 26,000

Double entry: (15) Utilities Expense 690 230 (9) 1,900 (6) 1,000

Cash 101 230

(12) 3,000 (7) 700

Statements affected: BLS, IS, SCF, and SOE

(10) 900 (11) 600 (13) 2,400 (14) 120 (15) 230

16. Payment of Expense in Cash

Transaction: FastForward pays $700 cash in employee salary

(7) 700 (16) 700

for work performed in the latter part of December. Analysis: Assets Liabilities Equity

Salaries Cash Expense 700 0 700 Double entry: (16) Salaries Expense 622 700

Cash 101 700 Statements affected: BLS, IS, SCF, and SOE Salaries Expense 622

Point: We could merge transactions 15 and 16 into one compound entry.

Cash 101

(1) 30,000 (2) 2,500 (5) 4,200 (3) 26,000 (9) 1,900 (6) 1,000 (12) 3,000 (7) 700 (10) 900 (11) 600 (13) 2,400 (14) 120 (15) 230 (16) 700


2. Larson−Wild−Chiappetta:

Analyzing and Recording Fundamental Accounting

Transactions Principles, Seventeenth Edition

Text © The McGraw−Hill

Companies, 2004

62 Chapter 2 Analyzing and Recording Transactions

Accounting Equation Analysis

Summary of debit and credit rules:

Exhibit 2.13 shows the accounts (in T-account form) of FastForward after all 16 transactions

Increase

are recorded, posted and the balances computed. The accounts are grouped into three ma- Accounts (normal bal.) Decrease

jor columns corresponding to the accounting equation: assets, liabilities, and equity. Note

Asset Liability Debit Credit Credit

Debit

several important points. First, as with each transaction, the totals for the three columns must obey the accounting equation. Specifically, assets equal Capital Credit Debit Withdrawals Debit Credit liabilities equal Revenue Credit Debit

$42,070 1$3,950 $0 $9,720 $2,400 $26,0002;

$9,200 1$6,200 $3,0002; and equity equals $32,870 1$30,000 $600 $5,800 $300 $1,400 $1,000 $2302

. These numbers prove Expense Debit Credit

the accounting equation: Assets of $42,070 Liabilities of $9,200

Equity of $32,870.

Point: Technology does not provide the judgment required to analyze most business transactions.Analysis requires

Second, the capital, withdrawals, revenue, and expense accounts reflect the transactions that change equity. Their balances underlie the statement of owner’s equity. Third, the revenue and expense account balances will be summarized and reported in the income statement. the expertise of skilled and ethical

Fourth, increases and decreases in the cash account make up the elements reported in the professionals.

statement of cash flows.

Exhibit 2.13 Ledger for FastForward (in T-Account Form)

Assets Liabilities Equity

Cash 101

Accounts Payable 201

C.Taylor, Capital 301

(1) 30,000 (2) 2,500

(10) 900 (4) 7,100

(1) 30,000 (5) 4,200 (3) 26,000

Balance 6,200 (9) 1,900 (6) 1,000

C.Taylor,Withdrawals 302 (12) 3,000 (7) (10) (11) 700 900 600

Unearned Consulting Revenue 236

(11) (12) 3,000

600

(13) 2,400

Consulting Revenue 403

(14) 120

(5) 4,200 (15) 230

(8) 1,600 (16) 700

Balance 5,800 Balance 3,950

Rental Revenue 406 Accounts Receivable 106

(8) 300 (8) 1,900 (9) 1,900 Balance 0

Salaries Expense 622

(7) 700 Supplies 126

(16) 700 (2) 2,500

Balance 1,400 (4) 7,100 (14) 120

Rent Expense 640 Balance 9,720

(6) 1,000

Prepaid Insurance 128

Utilities Expense 690 (13) 2,400

(15) 230

Equipment 167

(3) 26,000

Accounts in this white area reflect those reported on the income statement.

$42,070 $9,200 $32,870


Text © The McGraw−Hill

Companies, 2004

Chapter 2 Analyzing and Recording Transactions 63

Trial Balance

Double-entry accounting requires the sum of debit account balances to equal the sum of credit account balances. A trial balance is used to verify this. A trial balance is a list of ac- counts and their balances at a point in time. Account balances are reported in the appropri- ate debit or credit column of a trial balance. Exhibit 2.14 shows the trial balance for FastForward after its 16 entries have been posted to the ledger. (This is an unadjusted trial balance—Chapter 3 will explain the necessary adjustments.)

Exhibit 2.14 Trial Balance (unadjusted)

Quick Check

8. What types of transactions increase equity? What types decrease equity? 9. Why are accounting systems called double entry? 10. For each transaction, double-entry accounting requires which of the following: (a) Debits to asset accounts must create credits to liability or equity accounts, (b) a debit to a liability account must create a credit to an asset account, or (c) total debits must equal total credits. 11. An owner invests $15,000 cash along with equipment having a market value of $23,000 in a

proprietorship. Prepare the necessary journal entry. 12. Explain what a compound journal entry is. 13. Why are posting reference numbers entered in the journal when entries are posted to

ledger accounts?

Point: Knowing how financial statements are prepared improves our analysis of them.

Larson−Wild−Chiappetta: Fundamental Accounting Principles, Seventeenth Edition

FASTFORWARD Trial Balance December 31, 2004

Debit Credit

Cash

$

3,950 Accounts receivable

0 Supplies

9,720 Prepaid insurance

2,400 Equipment

26,000 Accounts payable

$

6,200 Unearned consulting revenue

3,000 C. Taylor, Capital

30,000 C. Taylor, Withdrawals

600 Consulting revenue

5,800 Rental revenue

300 Salaries expense

1,400 Rent expense

1,000 Utilities expense

230

Totals

$

45,300 $

45,300

2. Analyzing and Recording Transactions

Answers—p. 73


2. Larson−Wild−Chiappetta:

Analyzing and Recording Fundamental Accounting

Transactions Principles, Seventeenth Edition

Text © The McGraw−Hill

Companies, 2004

64 Chapter 2 Analyzing and Recording Transactions

Preparing a Trial Balance P2

Prepare and explain the use of a trial balance.

Preparing a trial balance involves three steps:

1. List each account title and its amount (from ledger) in the trial balance. If an account has a zero balance, list it with a zero in its normal balance column (or omit it entirely). 2. Compute the total of debit balances and the total of credit balances. 3. Verify (prove) total debit balances equal total credit balances.

Point: The ordering of accounts in

The total of debit balances equals the total of credit balances for the trial balance in Exhibit a trial balance typically follows their identification number from the chart of accounts.

2.14. Note that equality of these two totals does not guarantee that no errors were made. For example, the column totals still will be equal when a debit or credit of a correct amount is made to a wrong account. Another error that does not cause unequal column totals is when Point: A trial balance is not a financial statement but a mechanism for checking

equal debits and credits of an incorrect amount are entered.

equality of debits and credits in the ledger. Financial statements do not have debit and credit columns.

Searching for and Correcting Errors If the trial balance does not balance (when its columns are not equal), the error (or errors) must be found and corrected. An efficient way to search for an error is to check the journalizing, posting, and trial balance preparation in reverse order. Step 1 is to verify that the trial balance columns are correctly added. If Example: If a credit to Unearned

step 1 fails to find the error, step 2 is to verify that account balances are accurately entered Revenue were incorrectly posted from the journal as a credit to the Revenue ledger account, would the ledger still balance? Would the financial statements be correct? Answers: The ledger would

from the ledger. Step 3 is to see whether a debit (or credit) balance is mistakenly listed in the trial balance as a credit (or debit). A clue to this error is when the difference between total debits and total credits equals twice the amount of the incorrect account balance. If the error is still undiscovered, Step 4 is to recompute each account balance in the ledger. balance, but liabilities would be under-

Step 5 is to verify that each journal entry is properly posted. Step 6 is to verify that the stated, equity would be overstated, and income would be overstated (all be- cause of overstated revenues).

original journal entry has equal debits and credits. At this point, any errors should be uncovered.4

If an error in a journal entry is discovered before the error is posted, it can be corrected in a manual system by drawing a line through the incorrect information. The correct infor- mation is written above it to create a record of Decision Insight

change for the auditor. Many computerized sys- tems allow the operator to replace the incorrect Gorge’em Disgorgement is one of the government’s

information directly. strongest weapons for going after shady executives.

If an error in a journal entry is not discov- When the SEC wins a court order or settles a case

ered until after it is posted, do not strike against executives, it can require them to give back

through both erroneous entries in the journal their salaries, including stock gains.

and ledger. Instead, correct this error by creat- ing a correcting entry that removes the amount from the wrong account and records it to the correct account. As an example, suppose a $100 purchase of supplies is journalized with an incorrect debit to Equipment, and then this incorrect entry is posted to the ledger. The Supplies ledger account balance is understated by $100, and the Equipment ledger account

Point: The IRS requires companies to keep records that can be audited.

balance is overstated by $100. The correcting entry is: debit Supplies and credit Equipment (both for $100).

4 Transposition occurs when two digits are switched, or transposed, within a number. If transposition is the only error, it yields a difference between the two trial balance totals that is evenly divisible by 9. For example, assume that a $691 debit in an entry is incorrectly posted to the ledger as $619. Total credits in the trial balance are then larger than total debits by $72 1$691 $6192.

The $72 error is evenly divisible by 9 172 9 82. The first digit of the quotient (in our example it is 8) equals the difference between the digits of the two transposed numbers (the 9 and the 1). The number of digits in the quotient also tells the location of the transposition, starting from the right. The quotient in our example had only one digit (8), so it tells us the transposition is in the first digit. Consider another example where a transposition error involves posting $961 instead of the correct $691. The dif- ference in these numbers is $270, and its quotient is 30 1270 92.

The quotient has two digits, so it tells us to check the second digit from the right for a transposition of two numbers that have a difference of 3.


2. Larson−Wild−Chiappetta:

Analyzing and Recording Fundamental Accounting

Transactions Principles, Seventeenth Edition

Text © The McGraw−Hill

Companies, 2004

Chapter 2 Analyzing and Recording Transactions 65

Using a Trial Balance to Prepare Financial Statements This section shows how to prepare financial statements from the trial balance in Exhibit 2.14 and information on the December transactions of FastForward. The statements differ from those in Chapter 1 because of several additional transactions. These statements are also more precisely called unadjusted statements because we need to make some further ac- counting adjustments (described in Chapter 3).

How financial statements are linked in time is illustrated in Exhibit 2.15. A balance sheet reports on an organization’s financial position at a point in time. The income statement, statement of owner’s equity, and statement of cash flows report on fi- nancial performance over a period of time. The three statements in the middle column of Exhibit 2.15 link balance sheets from the beginning to the end of a reporting period. They explain how financial position changes from one point to another.

Preparers and users (including reg- ulatory agencies) determine the length of the reporting period. A one-year, or annual, reporting period is common, as are semiannual, quarterly, and monthly periods. The one-year reporting period is known as the accounting, or fiscal, year. Businesses whose accounting year begins on January 1 and ends on December 31 are known as calendar-year companies. Many com- panies choose a fiscal year ending on a date other than December 31. Krispy Kreme is a noncalendar-year company as reflected in the headings of its February 2 year-end financial statements in Appendix A near the end of the book.

Income Statement An income statement reports the revenues earned less the expenses incurred by a business over a period of time. FastForward’s in- come statement for December is shown at the top of Exhibit 2.16. Information about revenues and expenses is conveniently taken from the trial balance in Exhibit 2.14. Net income of $3,470 is reported at the bottom of the statement. Owner investments and withdrawals are not part of income.

Statement of Owner’s Equity The statement of owner’s equity reports information about how equity changes over the reporting period. FastForward’s statement of owner’s equity is the second report in Exhibit 2.16. It shows the $30,000 owner investment plus the $3,470 of net income earned during the month. It also reports the $600 withdrawal and the $32,870 end-of-month eq- uity (capital) balance. (The beginning capital balance in the statement of owner’s equity is rarely zero. An exception is for the first period of a company’s oper- ations. The beginning capital balance in January 2005 is $32,870, which is December’s ending balance.)

Balance Sheet The balance sheet reports the financial position of a company at a point in time, usually at the end of a month, quarter, or year. FastForward’s balance sheet is the third report in Exhibit 2.16. This statement refers to FastForward’s financial condition at the close of business on December 31. The left side of the balance sheet lists its assets: cash, supplies, prepaid insurance, and equipment. The upper right side of the balance sheet shows that it owes $6,200 to creditors and $3,000 in services to customers who paid in advance.

Exhibit 2.15

Income

Links between Financial statement

Statements Across Time

Beginning balance sheet

Statement of

Ending owner's

balance equity

sheet

Statement of cash flows

Point in time Period of time

Point in time Topic Tackler 2-2

Point: A statement’s heading lists the 3 W’s: Who—name of organization, What—name of statement, When— statement’s point in time or period of time.

Point: An income statement is also called an earnings statement, a statement of operations, or a P&L (profit and loss) statement.A balance sheet is also called a statement of financial position.

P3

Prepare financial statements from business transactions.


2. Larson−Wild−Chiappetta:

Analyzing and Recording Fundamental Accounting

Transactions Principles, Seventeenth Edition

Text © The McGraw−Hill

Companies, 2004

66 Chapter 2 Analyzing and Recording Transactions

Decision Maker

The equity section shows an ending capital bal- ance of $32,870. Note the link between the end- Entrepreneur You open a wholesale business selling entertainment

ing balance of the statement of owner’s equity equipment to retail outlets.You find that most of your customers demand to

and the capital balance here. (Recall that this buy on credit. How can you use the balance sheets of these customers to

presentation of the balance sheet is called the decide which ones to extend credit to?

account form: assets on the left and liabilities

Answer—p. 72

and equity on the right. Another presentation is the report form: assets on top, followed by liabilities and then equity. Either presentation is acceptable.) Point: While revenues increase equity and expenses decrease equity, the amounts are not reported in detail in the statement of owner’s equity. Instead, their effects are reflected through net income.

Presentation Issues Dollar signs are not used in journals and ledgers. They do ap- pear in financial statements and other reports such as trial balances. The usual practice is to put dollar signs beside only the first and last numbers in a column. Krispy Kreme’s

Exhibit 2.16

FASTFORWARD Financial Statements and Their Links

Income Statement For Month Ended December 31, 2004

Revenues

Consulting revenue ($4,200 $1,600) . . . . . . . $ 5,800 Rental revenue . . . . . . . . . . . . . . . . . . . . . . . . . 300 Total revenues . . . . . . . . . . . . . . . . . . . . . . . . . $ 6,100 Expenses

Rent expense . . . . . . . . . . . . . . . . . . . . . . . . . . 1,000 Salaries expense . . . . . . . . . . . . . . . . . . . . . . . . 1,400 Utilities expense . . . . . . . . . . . . . . . . . . . . . . . 230 Total expenses . . . . . . . . . . . . . . . . . . . . . . . . . 2,630 Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 3,470

Point: Arrow lines show how the statements are linked.

FASTFORWARD Statement of Owner’s Equity For Month Ended December 31, 2004

C.Taylor, Capital, December 1, 2004 . . . . . . . . . . . $ 0 Plus: Investments by owner . . . . . . . . . . . . . . . . $30,000

Net income . . . . . . . . . . . . . . . . . . . . . . . 3,470 33,470 33,470 Less: Withdrawals by owner . . . . . . . . . . . . . . . . 600 C.Taylor, Capital, December 31, 2004 . . . . . . . . . . $32,870

FASTFORWARD Balance Sheet December 31, 2004

Assets Liabilities Cash . . . . . . . . . . . $ 3,950 Accounts payable . . . . . . . $ 6,200 Supplies . . . . . . . . . 9,720 Unearned revenue . . . . . . 3,000 Prepaid insurance . . 2,400 Total liabilities . . . . . . . . . 9,200 Equipment . . . . . . . 26,000

Equity C.Taylor, Capital . . . . . . . . 32,870 Point: To foot a column of numbers is

Total assets . . . . . . $42,070 Total liabilities and equity . $ 42,070 to add them.


2. Larson−Wild−Chiappetta:

Analyzing and Recording Fundamental Accounting

Transactions Principles, Seventeenth Edition

Text © The McGraw−Hill

Companies, 2004

Chapter 2 Analyzing and Recording Transactions 67

financial statements in Appendix A show this. When amounts are entered in a journal,

Example: How would the balance ledger, or trial balance, commas are optional to indicate thousands, millions, and so forth. However, commas are always used in financial statements. Companies also commonly round amounts in reports to the nearest dollar, or even to a higher level. Krispy Kreme is typical of many companies in that it rounds its financial statement amounts to the nearest

sheet in Exhibit 2.16 change if FastForward pays $2,000 of its payable on December 31 using its Cash ac- count? What would be the new amount of total assets? Would the balance sheet thousand. This decision is based on the perceived impact of rounding for users’ business

still balance? Answers: Cash would be decisions.

$1,950, accounts payable would be $4,200, total assets (and liabilities plus equity) would be $40,070, and the bal- ance sheet would still balance.

Quick Check

14. Where are dollar signs typically entered in financial statements? 15. If a $4,000 debit to Equipment in a journal entry is incorrectly posted to the ledger as a

$4,000 credit, and the ledger account has a resulting debit balance of $20,000, what is the effect of this error on the Trial Balance column totals? 16. Describe the link between the income statement and the statement of owner’s equity. 17. Explain the link between the balance sheet and the statement of owner’s equity. 18. Define and describe revenues and expenses. 19. Define and describe assets, liabilities, and equity.

Answers—p. 73

Debt Ratio

Decision Analysis

An important business objective is gathering information to help assess a company’s risk of fail- ing to pay its debts. Companies finance their assets with either liabilities or equity. A company that

A2

Compute the debt ratio and describe its use in finances a relatively large portion of its assets with liabilities is said to have a high degree of finan-

analyzing company performance. cial leverage. Higher financial leverage involves greater risk because liabilities must be repaid and often require regular interest payments (equity financing does not). The risk that a company might not be able to meet such required payments is higher if it has more liabilities (is more highly lever- aged). One way to assess the risk associated with a company’s use of liabilities is to compute the debt ratio as in Exhibit 2.17.

Debt ratio

Total Total liabilities

assets

Exhibit 2.17

Debt Ratio

To see how to apply the debt ratio, let’s look at Stride Rite’s liabilities and assets. Stride Rite makes Keds, Pro-Keds, and other footwear. Exhibit 2.18 computes and reports its debt ratio at the end of each year from 1998 to 2002.

Stride Rite’s debt ratio ranges from a low of 0.24 to a high of 0.31. Its ratio is low compared with

Point: Compare the equity amount to the industry ratio. Stride Rite reports that it carries no long-term debt, which is unusual. This analy- sis implies a low risk from its financial leverage. Is this good or bad? To answer that question we

the liability amount to assess the extent of owner versus nonowner financing.

2002 2001 2000 1999 1998

Exhibit 2.18

Total liabilities (in mil.) . . . . . . . $ 82 Total assets (in mil.) . . . . . . . . . $335 $100 $110 $101 $362 $359 $351 $102 $347

Computation and Analysis of Debt Ratio

Debt ratio . . . . . . . . . . . . . . . 0.24 0.28 0.31 0.29 0.29 Industry debt ratio . . . . . . . . . . 0.45 0.49 0.48 0.46 0.52


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Transactions Principles, Seventeenth Edition

Text © The McGraw−Hill

Companies, 2004

68 Chapter 2 Analyzing and Recording Transactions

Decision Maker

need to compare the company’s return on the bor- rowed money to the rate it is paying creditors. If the Investor You consider buying stock in Converse.As part of your

company’s return is higher, it is successfully bor- analysis, you compute its debt ratio for 2001, 2002, and 2003 as: 0.35, 0.74,

rowing money to make more money. Be aware and 0.94, respectively. Based on the debt ratio, is Converse a low-risk invest-

that a company’s success with making money ment? Has the risk of buying Converse stock changed over this period? (Note: The industry ratio averages 0.40.)

from borrowed money can quickly turn unprofitable if its own return drops below the rate it is paying creditors. Answer—p. 72

Demonstration Problem

(Note: This problem extends the demonstration problem of Chapter 1.) After several months of plan- ning, Sylvia Workman started a haircutting business called Expressions. The following events oc- curred during its first month:

a. On August 1, Workman invested $3,000 cash and $15,000 of equipment in Expressions. b. On August 2, Expressions paid $600 cash for furniture for the shop. c. On August 3, Expressions paid $500 cash to rent space in a strip mall for August. d. On August 4, it purchased $1,200 of equipment on credit for the shop (using a long-term note payable). e. On August 5, Expressions opened for business. Cash received from services provided in the first

week and a half of business (ended August 15) is $825. f. On August 15, it provided $100 of haircutting services on account. g. On August 17, it received a $100 check for services previously rendered on account. h. On August 17, it paid $125 to an assistant for working during the grand opening. i. Cash received from services provided during the second half of August is $930. j. On August 31, it paid a $400 installment toward principal on the note payable entered into on August 4. k. On August 31, Workman made a $900 cash withdrawal for personal use.

Required 1. Open the following ledger accounts in balance column format (account numbers are in parentheses): Cash (101); Accounts Receivable (102); Furniture (161); Store Equipment (165); Note Payable (240); S. Workman, Capital (301); S. Workman, Withdrawals (302); Haircutting Services Revenue (403); Wages Expense (623); and Rent Expense (640). Prepare general journal entries for the transactions. 2. Post the journal entries from (1) to the ledger accounts. 3. Prepare a trial balance as of August 31. 4. Prepare an income statement for August. 5. Prepare a statement of owner’s equity for August. 6. Prepare a balance sheet as of August 31. 7. Determine the debt ratio as of August 31.

Extended Analysis 8. In the coming months, Expressions will experience a greater variety of business transactions. Identify which accounts are debited and which are credited for the following transactions. (Hint: You need to use some accounts not opened in part 1.) a. Purchase supplies with cash. b. Pay cash for future insurance coverage. c. Receive cash for services to be provided in the future. d. Purchase supplies on account.


Text © The McGraw−Hill

Companies, 2004

Chapter 2 Analyzing and Recording Transactions 69

Planning the Solution

Analyze each transaction and use the debit and credit rules to prepare a journal entry for each.

Post each debit and each credit from journal entries to their ledger accounts and cross-reference each amount in the posting reference (PR) columns of the journal and ledger.

Calculate each account balance and list the accounts with their balances on a trial balance.

Verify that total debits in the trial balance equal total credits.

To prepare the income statement, identify revenues and expenses. List those items on the state- ment, compute the difference, and label the result as net income or net loss.

Use information in the ledger to prepare the statement of owner’s equity.

Use information in the ledger to prepare the balance sheet.

Calculate the debt ratio by dividing total liabilities by total assets.

Analyze the future transactions to identify the accounts affected and apply debit and credit rules.

Solution to Demonstration Problem 1. General journal entries:

Aug. 1 Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101 3,000 Store Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 165 15,000

S.Workman, Capital . . . . . . . . . . . . . . . . . . . . . . . . . . 301 18,000 Owner’s investment. 2 Furniture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 161 600

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101 600 Purchased furniture for cash. 3 Rent Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 640 500

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101 500 Paid rent for August. 4 Store Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 165 1,200

Note Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 240 1,200 Purchased additional equipment on credit. 15 Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101 825

Haircutting Services Revenue . . . . . . . . . . . . . . . . . . . 403 825 Cash receipts from 10 days of operations. 15 Accounts Receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102 100

Haircutting Services Revenue . . . . . . . . . . . . . . . . . . . 403 100 To record revenue for services provided on account. 17 Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101 100

Accounts Receivable . . . . . . . . . . . . . . . . . . . . . . . . . 102 100 To record cash received as payment on account. 17 Wages Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 623 125

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101 125 Paid wages to assistant. 31 Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101 930

Haircutting Services Revenue . . . . . . . . . . . . . . . . . . . 403 930 Cash receipts from second half of August. 31 Note Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 240 400

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101 400 Paid an installment on the note payable. 31 S.Workman,Withdrawals . . . . . . . . . . . . . . . . . . . . . . . . . 302 900

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101 900 Cash withdrawal by owner.

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70 Chapter 2 Analyzing and Recording Transactions

2. Post journal entries from (part 1) to the ledger accounts:

Cash Account No. 101

Date PR Debit Credit Balance

Aug. 1 G1 3,000 3,000 2 G1 600 2,400 3 G1 500 1,900 15 G1 825 2,725 17 G1 100 2,825 17 G1 125 2,700 31 G1 930 3,630 31 G1 400 3,230 31 G1 900 2,330

Accounts Receivable Account No. 102

Date PR Debit Credit Balance

Aug. 15 G1 100 100 17 G1 100 0

Furniture Account No. 161

Date PR Debit Credit Balance

Aug. 2 G1 600 600

Store Equipment Account No. 165

Date PR Debit Credit Balance

Aug. 1 G1 15,000 15,000 4 G1 1,200 16,200

Note Payable Account No. 240

Date PR Debit Credit Balance

Aug. 4 G1 1,200 1,200 31 G1 400 800

S.Workman, Capital Account No. 301

Date PR Debit Credit Balance

Aug. 1 G1 18,000 18,000

S.Workman,Withdrawals Account No. 302

Date PR Debit Credit Balance

Aug. 31 G1 900 900

Haircutting Services Revenue Account No. 403

Date PR Debit Credit Balance

Aug. 15 G1 825 825 15 G1 100 925 31 G1 930 1,855

Wages Expense Account No. 623

Date PR Debit Credit Balance

Aug. 17 G1 125 125

Rent Expense Account No. 640

Date PR Debit Credit Balance

Aug. 3 G1 500 500

Larson−Wild−Chiappetta: Fundamental Accounting Principles, Seventeenth Edition

Text 2. Analyzing and Recording

© The McGraw−Hill Transactions

Companies, 2004

General Ledger

3. Prepare a trial balance from the ledger:

EXPRESSIONS Trial Balance August 31

Debit Credit Cash . . . . . . . . . . . . . . . . . . . . . . . . $ 2,330 Accounts receivable . . . . . . . . . . . . . . 0 Furniture . . . . . . . . . . . . . . . . . . . . . 600 Store equipment . . . . . . . . . . . . . . . . 16,200 Note payable . . . . . . . . . . . . . . . . . . $ 800 S.Workman, Capital . . . . . . . . . . . . . . 18,000 S.Workman,Withdrawals . . . . . . . . . . 900 Haircutting services revenue . . . . . . . 1,855 Wages expense . . . . . . . . . . . . . . . . . 125 Rent expense . . . . . . . . . . . . . . . . . . 500 Totals . . . . . . . . . . . . . . . . . . . . . . . . $20,655 $20,655


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Transactions Principles, Seventeenth Edition

Text © The McGraw−Hill

Companies, 2004

Chapter 2 Analyzing and Recording Transactions 71

4.

EXPRESSIONS Income Statement For Month Ended August 31

Revenues

Haircutting services revenue . . . . . . . $1,855 Operating expenses

Rent expense . . . . . . . . . . . . . . . . . . $500 Wages expense . . . . . . . . . . . . . . . . . 125 Total operating expenses . . . . . . . . . . 625 Net Income . . . . . . . . . . . . . . . . . . . . . $1,230

5.

EXPRESSIONS Statement of Owner’s Equity For Month Ended August 31

S.Workman, Capital,August 1 . . . . . . . . $ 0 Plus: Investments by owner . . . . . . . . . $18,000

Net income . . . . . . . . . . . . . . . . 1,230 19,230 19,230 Less: Withdrawals by owner . . . . . . . . 900 S.Workman, Capital,August 31 . . . . . . . $18,330

6.

EXPRESSIONS Balance Sheet August 31

Assets Liabilities Cash . . . . . . . . . . . . . . . . $ 2,330 Note payable . . . . . . . . . . . . . . . . $ 800 Furniture . . . . . . . . . . . . . 600 Equity Store equipment . . . . . . . 16,200 S.Workman, Capital . . . . . . . . . . . 18,330 Total assets . . . . . . . . . . . $19,130 Total liabilities and equity . . . . . . . $19,130

7.

Debt ratio

Total liabilities Total assets

$800 $19,130

4.18%

8a. Supplies debited 8c. Cash debited

Cash credited Unearned Services Revenue credited 8b. Prepaid Insurance debited 8d. Supplies debited

Cash credited Accounts Payable credited

Summary

C1 Explain counting the process steps identifies in processing business transactions. transactions The and ac-

events,

are the starting points in the accounting process. Source docu- ments help in their analysis. The effects of transactions and analyzes and records their effects, and summarizes and prepares

events are recorded in journals. Posting along with a trial balance information useful in making decisions. Transactions and events

helps summarize and classify these effects.


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Analyzing and Recording Fundamental Accounting

Transactions Principles, Seventeenth Edition

Text © The McGraw−Hill

Companies, 2004

72 Chapter 2 Analyzing and Recording Transactions

C2

Describe documents source identify documents and describe and transactions their purpose. and Source events. Examples are sales tickets, checks, purchase orders, bills, and bank statements. Source documents provide objective and reliable evidence, making information more useful. C3

Describe an account and its use in recording transac- tions. An account is a detailed record of increases and de- creases in a specific asset, liability, equity, revenue, or expense. Information from accounts is analyzed, summarized, and pre- sented in reports and financial statements for decision makers. C4

Describe a ledger and a chart of accounts. The ledger (or general ledger) is a record containing all accounts used by a company and their balances. It is referred to as the books. The chart of accounts is a list of all accounts and usually includes an identification number assigned to each account. C5

Define debits and credits and explain their role in double- entry accounting. Debit refers to left, and credit refers to right. Debits increase assets, expenses, and withdrawals while cred- its decrease them. Credits increase liabilities, owner capital, and rev- enues; debits decrease them. Double-entry accounting means each transaction affects at least two accounts and has at least one debit and one credit. The system for recording debits and credits follows from the accounting equation. The left side of an account is the nor- mal balance for assets, withdrawals, and expenses, and the right side is the normal balance for liabilities, capital, and revenues. A1

Analyze nancial statements. the impact We of transactions analyze transactions on accounts using and concepts

fi-

of double-entry accounting. This analysis is performed by deter- mining a transaction’s effects on accounts. These effects are recorded in journals and posted to ledgers. A2

Compute the debt ratio and describe its use in analyzing company performance. A company’s debt ratio is com- puted as total liabilities divided by total assets. It reveals how much of the assets are financed by creditor (nonowner) financing. The higher this ratio, the more risk a company faces because lia- bilities must be repaid at specific dates.

Record transactions in a journal and post entries to a ledger. Transactions are recorded in a journal. Each entry in a journal is posted to the accounts in the ledger. This provides in- formation that is used to produce financial statements. Balance column accounts are widely used and include columns for debits, credits, and the account balance.

Prepare and explain the use of a trial balance. A trial balance is a list of accounts from the ledger showing their debit or credit balances in separate columns. The trial balance is a summary of the ledger’s contents and is useful in preparing finan- cial statements and in revealing recordkeeping errors.

Prepare financial statements from business transac- tions. The balance sheet, the statement of owner’s equity, the income statement, and the statement of cash flows use data from the trial balance (and other financial statements) for their preparation.

Cashier The advantages to the process proposed by the assis- tant manager include improved customer service, fewer delays, and less work for you. However, you should have serious concerns about internal control and the potential for fraud. In particular, the assistant manager could steal cash and simply enter fewer sales to match the remaining cash. You should reject her suggestion with- out the manager’s approval. Moreover, you should have an ethi- cal concern about the assistant manager’s suggestion to ignore store policy.

Entrepreneur We can use the accounting equation (Assets Liabilities Equity) to help us identify risky customers to whom

P1

P2

P3

Guidance Answers to Decision Maker and Decision Ethics

1. Examples of source documents are sales tickets, checks, pur- chase orders, charges to customers, bills from suppliers, em- ployee earnings records, and bank statements. 2. Source documents serve many purposes, including record- keeping and internal control. Source documents, especially if obtained from outside the organization, provide objective and reliable evidence about transactions and their amounts.

we would likely not want to extend credit. A balance sheet provides amounts for each of these key components. The lower a customer’s equity is relative to liabilities, the less likely you would extend credit. A low equity means the business has little value that does not already have creditor claims to it.

Investor The debt ratio suggests the stock of Converse is of higher risk than normal and that this risk is rising. The average in- dustry ratio of 0.40 further supports this conclusion. The 2003 debt ratio for Converse is twice the industry norm. Also, a debt ratio ap- proaching 1.0 indicates little to no equity.

Guidance Answers to Quick Checks

3.

Assets a,c,e

Equity Liabilities b,d

— 4. An account is a record in an accounting system that records and stores the increases and decreases in a specific asset, lia- bility, equity, revenue, or expense. The ledger is a collection of all the accounts of a company.


2. Larson−Wild−Chiappetta:

Analyzing and Recording

Text © The McGraw−Hill Fundamental Accounting

Transactions

Companies, 2004 Principles, Seventeenth Edition

Chapter 2 Analyzing and Recording Transactions 73

5. A company’s size and diversity affect the number of accounts in its accounting system. The types of accounts depend on in- formation the company needs to both effectively operate and report its activities in financial statements. 6. No. Debit and credit both can mean increase or decrease. The particular meaning in a circumstance depends on the type of account. For example, a debit increases the balance of asset, withdrawals, and expense accounts, but it decreases the bal- ance of liability, capital, and revenue accounts. 7. A chart of accounts is a list of all of a company’s accounts

and their identification numbers. 8. Equity is increased by revenues and by owner investments. Equity is decreased by expenses and owner withdrawals. 9. The name double entry is used because all transactions affect at least two accounts. There must be at least one debit in one account and at least one credit in another account. 10. Answer is (c). 11.

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15,000 Equipment . . . . . . . . . . . . . . . . . . . . . . . . 23,000

Owner, Capital . . . . . . . . . . . . . . . . . . 38,000 Investment by owner of cash and equipment.

12. A compound journal entry affects three or more accounts. 13. Posting reference numbers are entered in the journal when posting to the ledger as a cross-reference that allows the record- keeper or auditor to trace debits and credits from one record to another.

14. At a minimum, dollar signs are placed beside the first and last numbers in a column. It is also common to place dollar signs beside any amount that appears after a ruled line to indicate that an addition or subtraction has occurred. 15. The Equipment account balance is incorrectly reported at $20,000—it should be $28,000. The effect of this error un- derstates the trial balance’s Debit column total by $8,000. This results in an $8,000 difference between the column totals. 16. An income statement reports a company’s revenues and ex- penses along with the resulting net income or loss. A state- ment of owner’s equity reports changes in equity, including that from net income or loss. Both statements report transac- tions occurring over a period of time. 17. The balance sheet describes a company’s financial position (as- sets, liabilities, and equity) at a point in time. The capital ac- count in the balance sheet is obtained from the statement of owner’s equity. 18. Revenues are inflows of assets in exchange for products or services provided to customers as part of the main opera- tions of a business. Expenses are outflows or the using up of assets that result from providing products or services to customers. 19. Assets are the resources a business owns or controls that carry expected future benefits. Liabilities are the obligations of a business, representing the claims of others against the assets of a business. Equity reflects the owner’s claims on the assets of the business after deducting liabilities.

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Key Terms

Key Terms are available at the book’s Website for learning and testing in an online Flashcard Format.

Account (p. 49)

Owner, capital (p. 51) Account balance (p. 53)

Posting (p. 55) Balance column account (p. 56)

Posting reference (PR) column (p. 56) Chart of accounts (p. 52)

Source documents (p. 49) Compound journal entry (p. 59)

T-account (p. 53) Credit (p. 53)

Trial balance (p. 63) Creditors (p. 50)

Unearned revenue (p. 51)

Personal Interactive Quizzes A and B are available at the book’s Website to reinforce and assess your learning.

1. Provide the names of two (a) asset accounts, (b) liability

accounts, and (c) equity accounts. 2. What is the difference between a note payable and an account

payable?

Debit (p. 53) Debt ratio (p. 67) Double-entry accounting (p. 53) General journal (p. 55) Journal (p. 55) Journalizing (p. 55) Ledger (p. 49)

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Personal Interactive Quiz

Discussion Questions

3. Discuss the steps in processing business transactions. 4. What kinds of transactions can be recorded in a general journal? 5. Are debits or credits typically listed first in general journal

entries? Are the debits or the credits indented?


2. Larson−Wild−Chiappetta:

Analyzing and Recording Fundamental Accounting

Transactions Principles, Seventeenth Edition

Text © The McGraw−Hill

Companies, 2004

74 Chapter 2 Analyzing and Recording Transactions

6. If assets are valuable resources and asset accounts have debit balances, why do expense accounts have debit balances? 7. Should a transaction be recorded first in a journal or the

ledger? Why? 8. Why does the recordkeeper prepare a trial balance? 9. If a wrong amount is journalized and posted to the accounts,

how should the error be corrected? 10. Identify the four financial statements of a business. 11. What information is reported in an income statement? 12. Why does the user of an income statement need to know the

time period that it covers? 13. What information is reported in a balance sheet?

QS 2-2 Identifying financial statement items C3 P3

14. Define (a) assets, (b) liabilities, (c) equity, and (d) net assets. 15. Which financial statement is sometimes called the statement

of financial position? 16. Review the Krispy Kreme balance sheet in Appendix A. Identify three accounts on its balance sheet that carry debit balances and three accounts on its balance sheet that carry credit balances. 17. Review the Tastykake balance sheet in Appen- dix A. Identify two different liability accounts that include the word payable in the account title. 18. Locate Harley-Davidson’s income statement in Appendix A. What is the title of its revenue account?

Red numbers denote Discussion Questions that involve decision-making.

Davidson Harley-

Homework Manager repeats all Quick Study assignments on the book’s Website with new numbers each time they are worked. It can be used in practice, homework, or exam mode.

QUICK STUDY

QS 2-1 Identifying source documents C2

Identify the items from the following list that are likely to serve as source documents: a. Bank statement d. Trial balance g. Company revenue account b. Sales ticket e. Telephone bill h. Balance sheet c. Income statement f. Invoice from supplier i. Prepaid insurance

QS 2-4 Analyzing debit or credit by account C5 A1

Identify the financial statement(s) where each of the following items appears. Use I for income state- ment, E for statement of owner’s equity, and B for balance sheet: a. Service fees earned d. Accounts payable g. Office supplies b. Owner cash withdrawal e. Cash h. Prepaid rent c. Office equipment f. Utilities expenses i. Unearned fees

QS 2-3 Linking debit or credit with normal balance C5

Indicate whether a debit or credit decreases the normal balance of each of the following accounts: a. Office Supplies e. Salaries Expense i. Interest Revenue b. Repair Services Revenue f. Owner Capital j. Owner Withdrawals c. Interest Payable g. Prepaid Insurance k. Unearned Revenue d. Accounts Receivable h. Buildings l. Accounts Payable

Identify whether a debit or credit yields the indicated change for each of the following accounts: a. To increase Store Equipment f. To decrease Unearned Revenue b. To increase Owner Withdrawals g. To decrease Prepaid Insurance c. To decrease Cash h. To increase Notes Payable d. To increase Utilities Expense i. To decrease Accounts Receivable e. To increase Fees Earned j. To increase Owner Capital

QS 2-5 Identifying normal balance C5

Identify whether the normal balances (in parentheses) assigned to the following accounts are correct or incorrect. a. Office supplies (Debit) d. Wages Expense (Credit) g. Wages Payable b. Owner Withdrawals (Credit) e. Cash (Debit) (Credit) c. Fees Earned (Debit) f. Prepaid Insurance (Credit) h. Building (Debit)


Prepare journal entries for each of the following selected transactions: a. On January 13, Chico Chavez opens a landscaping business called Showcase Yards by investing

$70,000 cash along with equipment having a $30,000 value. b. On January 21, Showcase Yards purchases office supplies on credit for $280. c. On January 29, Showcase Yards receives $7,800 cash for performing landscaping services. d. On January 30, Showcase Yards receives $1,000 cash in advance of providing landscaping ser-

vices to a customer.

A trial balance has total debits of $20,000 and total credits of $24,500. Which one of the following errors would create this imbalance? Explain. a. A $2,250 debit to Rent Expense in a journal entry is incorrectly posted to the ledger as a $2,250

credit, leaving the Rent Expense account with a $3,000 debit balance. b. A $4,500 debit to Salaries Expense in a journal entry is incorrectly posted to the ledger as a $4,500

credit, leaving the Salaries Expense account with a $750 debit balance. c. A $2,250 credit to Consulting Fees Earned in a journal entry is incorrectly posted to the ledger as a $2,250 debit, leaving the Consulting Fees Earned account with a $6,300 credit balance.

Indicate the financial statement on which each of the following items appears. Use I for income state- ment, E for statement of owner’s equity, and B for balance sheet: a. Office Supplies e. Salaries Expense h. Buildings b. Services Revenue f. Equipment i. Interest Revenue c. Interest Payable g. Prepaid Insurance j. Withdrawals d. Accounts Receivable

Homework Manager repeats all Exercises on the book’s Website with new numbers each time they are worked. It can be used in practice, homework, or exam mode.

For each of the following (1) identify the type of account as an asset, liability, equity, revenue, or ex- pense, (2) enter debit (Dr.) or credit (Cr.) to identify the kind of entry that would increase the account

EXERCISES

balance, and (3) identify the normal balance of the account. a. Unearned Revenue e. Land i. Cash

Exercise 2-1 Identifying type and normal b. Accounts Payable f. Owner Capital j. Equipment

balances of accounts c. Postage Expense g. Accounts Receivable k. Fees Earned

C3 C5 d. Prepaid Insurance h. Owner Withdrawals l. Wages Expense

Tavon Co. recently notified a client that it must pay a $48,000 fee for services provided. Tavon agreed

Exercise 2-2 to accept the following three items in full payment: (1) $7,500 cash, (2) computer equipment worth

Analyzing effects of $75,000, and (3) assume responsibility for a $34,500 note payable related to the computer equipment.

transactions on accounts The entry Tavon makes to record this transaction includes which one or more of the following? a. $34,500 increase in a liability account d. $48,000 increase in an asset account

A1

b. $7,500 increase in the Cash account e. $48,000 increase in a revenue account c. $7,500 increase in a revenue account

Larson−Wild−Chiappetta: Fundamental Accounting Principles, Seventeenth Edition

2. Analyzing and Recording Transactions

Text © The McGraw−Hill

Companies, 2004

Chapter 2 Analyzing and Recording Transactions 75

QS 2-6 Preparing journal entries P1

QS 2-7 Identifying a posting error P2

QS 2-8 Classifying accounts in financial statements P3


2. Larson−Wild−Chiappetta:

Analyzing and Recording Fundamental Accounting

Transactions Principles, Seventeenth Edition

Text © The McGraw−Hill

Companies, 2004

76 Chapter 2 Analyzing and Recording Transactions

Exercise 2-3 Analyzing account entries and balances A1

Exercise 2-7 Preparing a trial balance P2

Use the information in each of the following separate cases to calculate the unknown amount: a. During October, Shandra Company had $97,500 of cash receipts and $101,250 of cash disburse- ments. The October 31 Cash balance was $16,800. Determine how much cash the company had at the close of business on September 30. b. On September 30, Li Ming Co. had a $97,500 balance in Accounts Receivable. During October, the company collected $88,950 from its credit customers. The October 31 balance in Accounts Receivable was $100,500. Determine the amount of sales on account that occurred in October. c. Nasser Co. had $147,000 of accounts payable on September 30 and $136,500 on October 31. Total purchases on account during October were $270,000. Determine how much cash was paid on accounts payable during October.

Exercise 2-4 Preparing general journal entries A1 P1

Prepare general journal entries for the following transactions of a new business called Pose for Pics.

Aug. 1 Hashim Paris, the owner, invested $7,500 cash and $32,500 of photography equipment in

the business. 1 Paid $3,000 cash for an insurance policy covering the next 24 months. 5 Purchased office supplies for $1,400 cash. 20 Received $2,650 cash in photography fees earned. 31 Paid $875 cash for August utilities.

Exercise 2-5 Preparing T-accounts and a trial balance C3 P2

Check Cash ending balance, $6,425

Use the information in Exercise 2-4 to prepare an August 31 trial balance for Pose-for-Pics. Open these T-accounts: Cash; Office Supplies; Prepaid Insurance; Photography Equipment; H. Paris, Capital; Photography Fees Earned; and Utilities Expense. Post the general journal entries to these T-accounts (which will serve as the ledger), and prepare a trial balance.

Exercise 2-6 Recording effects of transactions in T-accounts C5 A1

Record the transactions below for Dejonge Company by recording the debit and credit entries di- rectly in the following T-accounts: Cash; Accounts Receivable; Office Supplies; Office Equipment; Accounts Payable; Dejonge, Capital; Dejonge, Withdrawals; Fees Earned; and Rent Expense. Use the letters beside each transaction to identify entries. Determine the ending balance of each T-account. a. Robert Dejonge invested $12,750 cash in the business. b. Purchased office supplies for $375 cash. c. Purchased $7,050 of office equipment on credit. d. Received $1,500 cash as fees for services provided to a customer. e. Paid $7,050 cash to settle the payable for the office equipment purchased in transaction c. f. Billed a customer $2,700 as fees for services provided. g. Paid the monthly rent with $525 cash. h. Collected $1,125 cash toward the account receivable created in transaction f.

i. Dejonge withdrew $1,000 cash for personal use.

After recording the transactions of Exercise 2-6 in T-accounts and calculating the balance of each account, prepare a trial balance. Use May 31, 2005, as its report date.


Examine the following transactions and identify those that create revenues for Jade Services, a com- pany owned by Mia Jade. Prepare general journal entries to record those transactions and explain why the other transactions did not create revenues. a. Mia Jade invests $38,250 cash in the business. b. Provided $1,350 of services on credit. c. Provided services to a client and received $1,575 cash. d. Received $9,150 cash from a client in payment for services to be provided next year. e. Received $4,500 cash from a client in partial payment of an account receivable. f. Borrowed $150,000 cash from the bank by signing a promissory note.

Examine the following transactions and identify those that create expenses for Jade Services. Prepare

Exercise 2-9 general journal entries to record those transactions and explain why the other transactions did not

Analyzing and journalizing create expenses.

expense transactions a. Paid $14,100 cash for office supplies that were purchased more than 1 year ago.

A1 P1 b. Paid $1,125 cash for the two-week salary of the receptionist. c. Paid $45,000 cash for equipment. d. Paid $930 cash for monthly utilities. e. Owner withdrew $5,000 cash for personal use.

On October 1, Ming Lue organized a new consulting firm called Tech Today. On October 31, the

Exercise 2-10 company’s records show the following items and amounts. Use this information to prepare an October

Preparing an income income statement for the business.

statement C4 P3 Cash . . . . . . . . . . . . . . . . . . . . $ 8,360 M. Lue,Withdrawals . . . . . . . . . . $ 3,000 Accounts receivable . . . . . . . . . 17,000 Consulting fees earned . . . . . . . . 17,000 Office supplies . . . . . . . . . . . . . 3,250 Rent expense . . . . . . . . . . . . . . 4,550 Patents . . . . . . . . . . . . . . . . . . . 46,000 Salaries expense . . . . . . . . . . . . 8,000 Office equipment . . . . . . . . . . . 18,000 Telephone expense . . . . . . . . . . 560 Accounts payable . . . . . . . . . . . 8,000 Miscellaneous expenses . . . . . . . 280 M. Lue, Capital . . . . . . . . . . . . . 84,000

Exercise 2-12 Preparing a balance sheet P3

Assets Liabilities

Beginning of the year . . . . . . . . $ 70,000 $30,000 End of the year . . . . . . . . . . . . 115,000 46,000

Check Net income, $3,610

Use the information in Exercise 2-10 to prepare an October statement of owner’s equity for Tech

Exercise 2-11 Today.

Preparing a statement of owner’s equity P3

Use the information in Exercise 2-10 (if completed, you can also use your solution to Exercise 2-11) to prepare an October 31 balance sheet for Tech Today.

A sole proprietorship had the following assets and liabilities at the beginning and end of a recent year:

Exercise 2-13 Computing net income A1 P3

Larson−Wild−Chiappetta: Fundamental Accounting Principles, Seventeenth Edition

2. Analyzing and Recording Transactions

Text © The McGraw−Hill

Companies, 2004

Chapter 2 Analyzing and Recording Transactions 77

Exercise 2-8 Analyzing and journalizing revenue transactions A1 P1


2. Larson−Wild−Chiappetta:

Analyzing and Recording Fundamental Accounting

Transactions Principles, Seventeenth Edition

Text © The McGraw−Hill

Companies, 2004

78 Chapter 2 Analyzing and Recording Transactions

Exercise 2-17 Identifying effects of posting errors on the trial balance A1 P2

Determine the net income earned or net loss incurred by the business during the year for each of the following separate cases: a. Owner made no investments in the business and withdrew no assets during the year. b. Owner made no investments in the business but withdrew $1,250 per month for personal use. c. Owner withdrew no assets during the year but invested an additional $45,000 cash. d. Owner withdrew $1,250 per month for personal use and invested an additional $25,000 cash.

Exercise 2-14 Analyzing changes in a company’s equity C5 P3

Compute the missing amount in each of the following separate companies a through d:

Exercise 2-15 Interpreting and describing transactions from T-accounts C1 A1

Assume the following T-accounts reflect Joy Co.’s general ledger and that seven transactions a through g are posted to them. Provide a short description of each transaction. Include the amounts in your descriptions.

Cash

Automobiles

(a) 7,000

(b) 3,600

(a) 11,000 (e) 2,500

(c) 600 (f) 2,400 (g) 700

(c) 600 (d) 200

Accounts Payable

(b) 3,600

(f) 2,400 (d) 9,600

Office Supplies

D. Joy, Capital

(a) 5,600 (d) 9,400

(a) 23,600

Delivery Services Revenue Prepaid Insurance

(g) 700

(e) 2,500

Gas and Oil Expense Equipment

Exercise 2-16 Preparing general journal entries A1 P1

Use information from the T-accounts in Exercise 2-15 to prepare general journal entries for each of the seven transaction a through g.

Posting errors are identified in the following table. In column (1), enter the amount of the difference between the two (debit and credit) trial balance columns due to the error. In column (2), identify the trial balance column (debit or credit) with the larger amount if they are not equal. In column (3), iden- tify the account(s) affected by the error. In column (4), indicate the amount by which the account(s) in column (3) is (are) under- or overstated. Answers for the first error are given.


Text © The McGraw−Hill

Companies, 2004

Chapter 2 Analyzing and Recording Transactions 79

(1) (2) (3) (4) Difference between Column with Identify Amount that Debit and Credit the Larger Account(s) Account(s) is Description of Posting Error Columns Total Incorrectly Over- or

Stated Understated

a. $2,400 debit to Rent Expense is $810 Credit Rent Expense Rent Expense

posted as a $1,590 debit. understated $810 b. $4,050 credit to Cash is posted

twice as two credits to Cash. c. $9,900 debit to the owner’s withdrawals

account is debited to owner’s capital. d. $2,250 debit to Prepaid Insurance

is posted as a debit to Insurance Expense. e. $42,000 debit to Machinery is

posted as a debit to Accounts Payable. f. $4,950 credit to Services Revenue

is posted as a $495 credit. g. $1,440 debit to Store Supplies is

not posted.

a. Calculate the debt ratio and the return on assets using the year-end information for each of the

following six separate companies ($ in thousands):

b. Of the six companies, which business relies most heavily on creditor financing? c. Of the six companies, which business relies most heavily on equity financing? d. Which two companies indicate the greatest risk? e. Which two companies earn the highest return on assets? f. Which one company would investors likely prefer based on the risk-return relation? You are told the column totals in a trial balance are not equal. After careful analysis, you discover

Exercise 2-18 only one error. Specifically, a correctly journalized credit purchase of a computer for $16,950 is posted

Analyzing a trial from the journal to the ledger with a $16,950 debit to Office Equipment and another $16,950 debit

balance error to Accounts Payable. The balance of the Office Equipment account has a debit balance of $40,100 on the trial balance. Answer each of the following questions and compute the dollar amount of any

A1 P2

misstatement: a. Is the debit column total of the trial balance overstated, understated, or correctly stated? b. Is the credit column total of the trial balance overstated, understated, or correctly stated? c. Is the balance of the Office Equipment account overstated, understated, or correctly stated in the

trial balance? d. Is the balance of the Accounts Payable account overstated, understated, or correctly stated in the

trial balance? e. If the debit column total of the trial balance is $360,000 before correcting the error, what is the

total of the credit column before correction?

Exercise 2-19 Interpreting the debt ratio and return on assets A2

Larson−Wild−Chiappetta: Fundamental Accounting Principles, Seventeenth Edition

Case Company 1 Company 2 Company 3 Company 4 Company 5 Company 6

A B C D E

$ 90,500 64,000 32,500 147,000 92,000 104,500

Assets Liabilities Average Assets Net Income

2. Analyzing and Recording Transactions

12,000 $ 47,000 26,500 56,000 31,000 51,500

100,000 $ 40,000 50,000 200,000 40,000 70,000

20,000 $ 3,800 660 21,000 7,500 12,000


Text © The McGraw−Hill

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80 Chapter 2 Analyzing and Recording Transactions

PROBLEM SET A

Roberto Ricci opens a computer consulting business called Viva Consultants and completes the following transactions in its first month of operations: Problem 2-1A

April 1 Ricci invests $100,000 cash along with office equipment valued at $24,000 in the business. Preparing and posting general

2 Prepaid $7,200 cash for twelve months’ rent for office space. (Hint: Debit Prepaid Rent journal entries; preparing a

for $7,200.) trial balance

3 Made credit purchases for $12,000 in office equipment and $2,400 in office supplies. C4 C5 A1 P1 P2

Payment is due within 10 days. 6 Completed services for a client and immediately received $2,000 cash. 9 Completed an $8,000 project for a client, who must pay within 30 days. 13 Paid $14,400 cash to settle the account payable created on April 3. 19 Paid $6,000 cash for the premium on a 12-month insurance policy. (Hint: Debit Prepaid

Insurance for $6,000.) 22 Received $6,400 cash as partial payment for the work completed on April 9. 25 Completed work for another client for $2,640 on credit. 28 Ricci withdrew $6,200 cash for personal use. 29 Purchased $800 of additional office supplies on credit. 30 Paid $700 cash for this month’s utility bill.

Required 1. Prepare general journal entries to record these transactions (use account titles listed in part 2).

Check (2) Ending balances: Cash,

2. Open the following ledger accounts—their account numbers are in parentheses (use the balance $73,900; Accounts Receivable, $4,240;

column format): Cash (101); Accounts Receivable (106); Office Supplies (124); Prepaid Insurance Accounts Payable, $800

(128); Prepaid Rent (131); Office Equipment (163); Accounts Payable (201); R. Ricci, Capital (301); R. Ricci, Withdrawals (302); Services Revenue (403); and Utilities Expense (690). Post journal entries from part 1 to the ledger accounts and enter the balance after each posting.

(3) Total debits, $137,440

3. Prepare a trial balance as of the end of this month’s operations.

Problem 2-2A Preparing and posting journal entries; preparing a trial balance C4 C5 A1 P1 P2

Shelton Engineering completed the following transactions in the month of June.

a. Shania Shelton, the owner, invested $105,000 cash, office equipment with a value of $6,000, and

$45,000 of drafting equipment to launch the business. b. Purchased land worth $54,000 for an office by paying $5,400 cash and signing a long-term note

payable for $48,600. c. Purchased a portable building with $75,000 cash and moved it onto the land acquired in b. d. Paid $6,000 cash for the premium on an 18-month insurance policy. e. Completed and delivered a set of plans for a client and collected $5,700 cash. f. Purchased $22,500 of additional drafting equipment by paying $10,500 cash and signing a long-

term note payable for $12,000. g. Completed $12,000 of engineering services for a client. This amount is to be received in 30 days. h. Purchased $2,250 of additional office equipment on credit.

i. Completed engineering services for $18,000 on credit. j. Received a bill for rent of equipment that was used on a recently completed job. The $1,200 rent

must be paid within 30 days. k. Collected $7,200 cash in partial payment from the client described in transaction g.

l. Paid $1,500 cash for wages to a drafting assistant. m. Paid $2,250 cash to settle the account payable created in transaction h.

n. Paid $675 cash for minor repairs to the drafting equipment. o. Shelton withdrew $9,360 cash for personal use. p. Paid $1,500 cash for wages to a drafting assistant. q. Paid $3,000 cash for advertisements in the local newspaper during June.

Larson−Wild−Chiappetta: Fundamental Accounting Principles, Seventeenth Edition

2. Analyzing and Recording Transactions


Required 1. Prepare general journal entries to record these transactions (use the account titles listed in

part 2). 2. Open the following accounts—their account numbers are in parentheses (use the balance column format): Cash (101); Accounts Receivable (106); Prepaid Insurance (108); Office Equipment (163); Drafting Equipment (164); Building (170); Land (172); Accounts Payable (201); Notes Payable (250); S. Shelton, Capital (301); S. Shelton, Withdrawals (302); Engineering Fees Earned (402); Wages Expense (601); Equipment Rental Expense (602); Advertising Expense (603); and Repairs Expense (604). Post the journal entries from part 1 to the accounts and enter the balance after each posting. 3. Prepare a trial balance as of the end of this month’s operations.

Santo Birch opens a Web consulting business called Show-Me-the-Money Consultants and completes the following transactions in March:

March 1 Birch invested $150,000 cash along with $22,000 of office equipment in the business.

2 Prepaid $6,000 cash for six months’ rent for an office. (Hint: Debit Prepaid Rent for

$6,000.) 3 Made credit purchases of office equipment for $3,000 and office supplies for $1,200.

Payment is due within 10 days.

e cel 6 Completed services for a client and immediately received $4,000 cash. 9 Completed a $7,500 project for a client, who must pay within 30 days. 10 Paid $4,200 cash to settle the account payable created on March 3. 19 Paid $5,000 cash for the premium on a 12-month insurance policy. 22 Received $3,500 cash as partial payment for the work completed on March 9. 25 Completed work for another client for $3,820 on credit. 29 Birch withdrew $5,100 cash for personal use. 30 Purchased $600 of additional office supplies on credit. 31 Paid $200 cash for this month’s utility bill.

Required 1. Prepare general journal entries to record these transactions (use the account titles listed in part 2). 2. Open the following accounts—their account numbers are in parentheses (use the balance column format): Cash (101); Accounts Receivable (106); Office Supplies (124); Prepaid Insurance (128); Prepaid Rent (131); Office Equipment (163); Accounts Payable (201); S. Birch, Capital (301); S. Birch, Withdrawals (302); Services Revenue (403); and Utilities Expense (690). Post the jour- nal entries from part 1 to the accounts and enter the balance after each posting. 3. Prepare a trial balance as of the end of this month’s operations.

x mhhe.com/larson

Check (2) Ending balances: Cash, $137,000; Accounts Receivable, $7,820; Accounts Payable, $600

(3) Total debits, $187,920

The accounting records of Crist Crate Services show the following assets and liabilities as of December

Problem 2-4A 31, 2004, and 2005:

Computing net income from equity analysis, preparing a December 31

balance sheet, and calculating the debt ratio 2004 2005 Cash . . . . . . . . . . . . . . . . . . $ 52,500 $ 18,750

C3 A1 A2 P3

Accounts receivable . . . . . . . 28,500 22,350

e cel Office supplies . . . . . . . . . . . 4,500 3,300 Office equipment . . . . . . . . . 138,000 147,000 Trucks . . . . . . . . . . . . . . . . . 54,000 54,000 Building . . . . . . . . . . . . . . . . 0 180,000 Land . . . . . . . . . . . . . . . . . . . 0 45,000 Accounts payable . . . . . . . . . 7,500 37,500 Note payable . . . . . . . . . . . . 0 105,000

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Larson−Wild−Chiappetta: Fundamental Accounting Principles, Seventeenth Edition

2. Analyzing and Recording Transactions

Text © The McGraw−Hill

Companies, 2004

Chapter 2 Analyzing and Recording Transactions 81

Check (2) Ending balances: Cash, $2,715; Accounts Receivable, $22,800; Accounts Payable, $1,200

(3) Trial balance totals, $253,500

Problem 2-3A Preparing and posting general journal entries; preparing a trial balance C4 C5 A1 P1 P2


2. Larson−Wild−Chiappetta:

Analyzing and Recording Fundamental Accounting

Transactions Principles, Seventeenth Edition

Text © The McGraw−Hill

Companies, 2004

82 Chapter 2 Analyzing and Recording Transactions

Late in December 2005, the business purchased a small office building and land for $225,000. The business paid $120,000 cash toward the purchase and a $105,000 note payable was signed for the bal- ance. Crist had to invest $35,000 cash in the business to enable it to pay the $120,000 cash. Crist also withdraws $3,000 cash per month from the business for personal use.

Required 1. Prepare balance sheets for the business as of December 31, 2004, and 2005. (Remember that total

equity equals the difference between assets and liabilities.)

Check (2) Net income, $58,900

2. By comparing equity amounts from the balance sheets and using the additional information pre- sented in this problem, prepare a calculation to show how much net income was earned by the business during 2005.

(3) Debt ratio, 30.29%

3. Compute the 2005 year-end debt ratio for the business.

Problem 2-5A

Carlos Beltran started an engineering firm called Beltran Engineering. He began operations and com- Analyzing account balances

pleted seven transactions in May, which included his initial investment of $17,000 cash. After these and reconstructing

transactions, the ledger included the following accounts with normal balances: transactions C1 C4 A1 P2

Cash . . . . . . . . . . . . . . . . . . . . . $26,660 Office supplies . . . . . . . . . . . . . . 660 Prepaid insurance . . . . . . . . . . . . 3,200 Office equipment . . . . . . . . . . . . 16,500 Accounts payable . . . . . . . . . . . . 16,500 C. Beltran, Capital . . . . . . . . . . . . 17,000 C. Beltran,Withdrawals . . . . . . . . 3,740 Engineering fees earned . . . . . . . 24,000 Rent expense . . . . . . . . . . . . . . . 6,740

Required

Check (1) Trial balance totals,

1. Prepare a trial balance for this business at the end of May. $57,500

Analysis Components 2. Analyze the accounts and their balances and prepare a list that describes each of the seven most

likely transactions and their amounts.

(3) Cash paid, $14,340

3. Prepare a report of cash received and cash paid showing how the seven transactions in part 2 yield

the $26,660 ending Cash balance.

Problem 2-6A Recording transactions; posting to ledger; preparing a trial balance C4 A1 P1 P2

Business transactions completed by Eric Piburn during the month of September are as follows:

a. Piburn invested $23,000 cash along with office equipment valued at $12,000 in a new sole pro-

prietorship named EP Consulting. b. Purchased land valued at $8,000 and a building valued at $33,000. The purchase is paid with

$15,000 cash and a long-term note payable for $26,000. c. Purchased $600 of office supplies on credit. d. Piburn invested his personal automobile in the business. The automobile has a value of $7,000

and is to be used exclusively in the business. e. Purchased $1,100 of additional office equipment on credit. f. Paid $800 cash salary to an assistant. g. Provided services to a client and collected $2,700 cash. h. Paid $430 cash for this month’s utilities.

i. Paid $600 cash to settle the account payable created in transaction c. j. Purchased $4,000 of new office equipment by paying $2,400 cash and trading in old equipment with a recorded net cost and value of $1,600. (Hint: Credit Office Equipment (old) for $1,600.)


k. Completed $2,400 of services for a client, who must pay within 30 days.

l. Paid $800 cash salary to an assistant. m. Received $1,000 cash on the receivable created in transaction k.

n. Piburn withdrew $1,050 cash from the business for personal use.

Required 1. Prepare general journal entries to record these transactions (use the account titles listed in

part 2). 2. Open the following accounts—their account numbers are in parentheses (use the balance column format): Cash (101); Accounts Receivable (106); Office Supplies (108); Office Equipment (163); Automobiles (164); Building (170); Land (172); Accounts Payable (201); Notes Payable (250); E. Piburn, Capital (301); E. Piburn, Withdrawals (302); Fees Earned (402); Salaries Expense (601); and Utilities Expense (602). Post the journal entries from part 1 to the accounts and enter the bal- ance after each posting. 3. Prepare a trial balance as of the end of this month’s operations.

Lummus Management Services opens for business and completes these transactions in September:

PROBLEM SET B Sept. 1 Rhonda Lummus, the owner, invests $28,000 cash along with office equipment valued at

$25,000 in the business. 2 Prepaid $10,500 cash for twelve months’ rent for office space. (Hint: Debit Prepaid Rent

for $10,500.) 4 Made credit purchases for $9,000 in office equipment and $1,200 in office supplies. Payment

Problem 2-1B Preparing and posting general journal entries; preparing a trial balance is due within 10 days. 8 Completed work for a client and immediately received $2,600 cash.

C4 C5 A1 P1 P2

12 Completed a $13,400 project for a client, who must pay within 20 days. 13 Paid $10,200 cash to settle the account payable created on September 4. 19 Paid $5,200 cash for the premium on an 18-month insurance policy. (Hint: Debit Prepaid

Insurance for $5,200.) 22 Received $7,800 cash as partial payment for the work completed on September 12. 24 Completed work for another client for $1,900 on credit. 28 Lummus withdrew $5,300 cash for personal use. 29 Purchased $1,700 of additional office supplies on credit. 30 Paid $460 cash for this month’s utility bill.

Required 1. Prepare general journal entries to record these transactions (use account titles listed in part 2). 2. Open the following ledger accounts—their account numbers are in parentheses (use the bal- ance column format): Cash (101); Accounts Receivable (106); Office Supplies (124); Prepaid Insurance (128); Prepaid Rent (131); Office Equipment (163); Accounts Payable (201); R. Lummus, Capital (301); R. Lummus, Withdrawals (302); Service Fees Earned (401); and Utilities Expense (690). Post journal entries from part 1 to the ledger accounts and enter the balance after each posting. 3. Prepare a trial balance as of the end of this month’s operations.

Check (2) Ending balances: Cash, $6,740; Accounts Receivable, $7,500; Accounts Payable, $1,700

(3) Total debits, $72,600

At the beginning of April, Brooke Grechus launched a custom computer programming company called

Problem 2-2B Softways. The company had the following transactions during April:

Preparing and posting journal a. Brooke Grechus invested $45,000 cash, office equipment with a value of $4,500, and $28,000 of

entries; preparing a trial balance computer equipment in the company.

C4 C5 A1 P1 P2 b. Purchased land worth $24,000 for an office by paying $4,800 cash and signing a long-term note

payable for $19,200. c. Purchased a portable building with $21,000 cash and moved it onto the land acquired in b.

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2. Analyzing and Recording Transactions

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Chapter 2 Analyzing and Recording Transactions 83

Check (2) Ending balances: Cash, $5,620; Office Equipment, $15,500

(3) Trial balance totals, $74,200


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Transactions Principles, Seventeenth Edition

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Companies, 2004

84 Chapter 2 Analyzing and Recording Transactions

d. Paid $6,600 cash for the premium on a two-year insurance policy. e. Provided services to a client and collected $3,200 cash. f. Purchased $3,500 of additional computer equipment by paying $700 cash and signing a long-

term note payable for $2,800. g. Completed $3,750 of services for a client. This amount is to be received within 30 days. h. Purchased $750 of additional office equipment on credit.

i. Completed client services for $9,200 on credit. j. Received a bill for rent of a computer testing device that was used on a recently completed job.

The $320 rent must be paid within 30 days. k. Collected $4,600 cash from the client described in transaction i.

l. Paid $1,600 cash for wages to an assistant. m. Paid $750 cash to settle the account payable created in transaction h.

n. Paid $425 cash for minor repairs to the computer equipment. o. Grechus withdrew $3,875 cash for personal use. p. Paid $1,600 cash for wages to an assistant. q. Paid $800 cash for advertisements in the local newspaper during April.

Required 1. Prepare general journal entries to record these transactions (use the account titles listed in

part 2). Check (2) Ending balances: Cash,

2. Open the following accounts—their account numbers are in parentheses (use the balance column $10,650; Accounts Receivable, $8,350;

format): Cash (101); Accounts Receivable (106); Prepaid Insurance (108); Office Equipment (163); Accounts Payable, $320

Computer Equipment (164); Building (170); Land (172); Accounts Payable (201); Notes Payable (250); B. Grechus, Capital (301); B. Grechus, Withdrawals (302); Fees Earned (402); Wages Expense (601); Computer Rental Expense (602); Advertising Expense (603); and Repairs Expense

(3) Trial balance totals,

(604). Post the journal entries from part 1 to the accounts and enter the balance after each posting. $115,970

3. Prepare a trial balance as of the end of this month’s operations.

Problem 2-3B Preparing and posting general journal entries; preparing a trial balance C4 C5 A1 P1 P2

Shaw Management Services opens for business and completes these transactions in November:

Nov. 1 Kita Shaw, the owner, invested $30,000 cash along with $15,000 of office equipment in the

business. 2 Prepaid $4,500 cash for six months’ rent for an office. (Hint: Debit Prepaid Rent for

$4,500.) 4 Made credit purchases of office equipment for $2,500 and of office supplies for $600.

Payment is due within 10 days. 8 Completed work for a client and immediately received $3,400 cash. 12 Completed a $10,200 project for a client, who must pay within 30 days. 13 Paid $3,100 cash to settle the account payable created on November 4. 19 Paid $1,800 cash for the premium on a 24-month insurance policy. 22 Received $5,200 cash as partial payment for the work completed on November 12. 24 Completed work for another client for $1,750 on credit. 28 Shaw withdrew $5,300 cash for personal use. 29 Purchased $249 of additional office supplies on credit. 30 Paid $531 cash for this month’s utility bill.

Required 1. Prepare general journal entries to record these transactions (use account titles listed in part 2).

Check (2) Ending balances: Cash,

2. Open the following accounts—their account numbers are in parentheses (use the balance column $23,369; Accounts Receivable, $6,750;

format): Cash (101); Accounts Receivable (106); Office Supplies (124); Prepaid Insurance (128); Accounts Payable, $249

Prepaid Rent (131); Office Equipment (163); Accounts Payable (201); K. Shaw, Capital (301); K. Shaw, Withdrawals (302); Services Revenue (403); and Utilities Expense (690). Post the jour- nal entries from part 1 to the accounts and enter the balance after each posting.

(3) Total debits, $60,599

3. Prepare a trial balance as of the end of this month’s operations.


The accounting records of Schmit Co. show the following assets and liabilities as of December 31, 2004, and 2005:

Late in December 2005, the business purchased a small office building and land for $325,000. The business paid $65,000 cash toward the purchase and a $260,000 note payable was signed for the bal- ance. Schmit had to invest an additional $25,000 cash to enable it to pay the $65,000 cash. Schmit also withdraws $1,000 cash per month from the business for personal use.

Required 1. Prepare balance sheets for the business as of December 31, 2004, and 2005. (Remember that total

equity equals the difference between assets and liabilities.) 2. By comparing equity amounts from the balance sheets and using the additional information pre- sented in the problem, prepare a calculation to show how much net income was earned by the business during 2005. 3. Calculate the December 31, 2005, debt ratio for the business.

Miguel Gould started a Web consulting firm called Gould Solutions. He began operations and completed seven transactions in April that resulted in the following accounts, which all have normal balances:

Required 1. Prepare a trial balance for this business at the end of April.

Analysis Component 2. Analyze the accounts and their balances and prepare a list that describes each of the seven most

likely transactions and their amounts. 3. Present a report that shows how the seven transactions in part 2 yield the $12,485 Cash balance.

Czekai Consulting completed the following transactions during June:

a. Chris Czekai, the sole proprietor, invested $80,000 cash along with office equipment valued at

$30,000 in the new business. b. Purchased land valued at $30,000 and a building valued at $170,000. The purchase is paid with

$40,000 cash and a long-term note payable for $160,000.

Larson−Wild−Chiappetta: Fundamental Accounting Principles, Seventeenth Edition

December 31

2004 2005 Cash . . . . . . . . . . . . . . . . . . $14,000 $ 10,000 Accounts receivable . . . . . . . 25,000 30,000 Office supplies . . . . . . . . . . . 10,000 12,500 Office equipment . . . . . . . . . 60,000 60,000 Machinery . . . . . . . . . . . . . . . 30,500 30,500 Building . . . . . . . . . . . . . . . . 0 260,000 Land . . . . . . . . . . . . . . . . . . . 0 65,000 Accounts payable . . . . . . . . . 5,000 15,000 Note payable . . . . . . . . . . . . 0 260,000

Cash . . . . . . . . . . . . . . . . . . . . . $12,485 Office supplies . . . . . . . . . . . . . . 560 Prepaid rent . . . . . . . . . . . . . . . 1,500 Office equipment . . . . . . . . . . . . 11,450 Accounts payable . . . . . . . . . . . . 11,450 M. Gould, Capital . . . . . . . . . . . . 10,000 M. Gould,Withdrawals . . . . . . . . 6,200 Consulting fees earned . . . . . . . . 16,400 Operating expenses . . . . . . . . . . 5,655

(3) Cash paid, $13,915

Problem 2-6B Recording transactions; posting to ledger; preparing a trial balance C4 A1 P1 P2

2. Analyzing and Recording Transactions

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Chapter 2 Analyzing and Recording Transactions 85

Problem 2-4B Computing net income from equity analysis, preparing a balance sheet, and computing the debt ratio C3 A1 A2 P3

Check (2) Net income, $45,500

(3) Debt ratio, 58.76%

Problem 2-5B Analyzing account balances and reconstructing transactions C1 C4 A1 P2

Check (1) Trial balance total, $37,850


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86 Chapter 2 Analyzing and Recording Transactions

c. Purchased $2,400 of office supplies on credit. d. Czekai invested her personal automobile in the business. The automobile has a value of $18,000

and is to be used exclusively in the business. e. Purchased $6,000 of additional office equipment on credit. f. Paid $1,500 cash salary to an assistant. g. Provided services to a client and collected $6,000 cash. h. Paid $800 cash for this month’s utilities.

i. Paid $2,400 cash to settle the account payable created in transaction c. j. Purchased $20,000 of new office equipment by paying $18,600 cash and trading in old equip- ment with a recorded net cost and value of $1,400. (Hint: Credit Office Equipment (old) for $1,400.) k. Completed $5,200 of services for a client, who must pay within 30 days.

l. Paid $1,500 cash salary to an assistant. m. Received $3,800 cash on the receivable created in transaction k.

n. Czekai withdrew $6,400 cash from the business for personal use.

Required 1. Prepare general journal entries to record these transactions (use the account titles listed in

part 2).

Check (2) Ending balances: Cash,

2. Open the following accounts—their account numbers are in parentheses (use the balance column $18,600; Office Equipment, $54,600

format): Cash (101); Accounts Receivable (106); Office Supplies (108); Office Equipment (163); Automobiles (164); Building (170); Land (172); Accounts Payable (201); Notes Payable (250); C. Czekai, Capital (301); C. Czekai, Withdrawals (302); Fees Earned (402); Salaries Expense (601); and Utilities Expense (602). Post the journal entries from part 1 to the accounts and enter

(3) Trial balance totals,

the balance after each posting.

$305,200

3. Prepare a trial balance as of the end of this month’s operations.

PROBLEM SET C

m o c /

. l a

e h r s

h o

m n

Problem Set C is available at the book’s Website to further reinforce and assess your learning.

SERIAL PROBLEM

(This serial problem started in Chapter 1 and continues through most of the book. If the Chapter 1 segment was not completed, the problem can begin at this point. It is helpful, but not necessary, to

Success Systems

use the Working Papers that accompany this book.)

On October 1, 2004, Kay Breeze launched a computer services company called Success Systems, which is organized as a sole proprietorship and provides consulting services, computer system in- stallations, and custom program development. Breeze adopts the calendar year for reporting purposes and expects to prepare the company’s first set of financial statements on December 31, 2004. The company’s initial chart of accounts follows:

Account No. Account No.

Cash . . . . . . . . . . . . . . . . . . . . 101 K. Breeze, Capital . . . . . . . . . . . . . . . . 301 Accounts Receivable . . . . . . . . 106 K. Breeze,Withdrawals . . . . . . . . . . . . 302 Computer Supplies . . . . . . . . . 126 Computer Services Revenue . . . . . . . . 403 Prepaid Insurance . . . . . . . . . . 128 Wages Expense . . . . . . . . . . . . . . . . . 623 Prepaid Rent . . . . . . . . . . . . . . 131 Advertising Expense . . . . . . . . . . . . . . 655 Office Equipment . . . . . . . . . . . 163 Mileage Expense . . . . . . . . . . . . . . . . . 676 Computer Equipment . . . . . . . 167 Miscellaneous Expenses . . . . . . . . . . . . 677 Accounts Payable . . . . . . . . . . . 201 Repairs Expense—Computer . . . . . . . 684


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Transactions Principles, Seventeenth Edition

Text © The McGraw−Hill

Companies, 2004

Chapter 2 Analyzing and Recording Transactions 87

Required 1. Prepare journal entries to record each of the following transactions for Success Systems.

Oct. 1 Breeze invested $55,000 cash, a $20,000 computer system, and $8,000 of office equipment

in the business. 2 Paid $3,300 cash for four months’ rent. (Hint: Debit Prepaid Rent for $3,300.) 3 Purchased $1,420 of computer supplies on credit from Cain Office Products. 5 Paid $2,220 cash for one year’s premium on a property and liability insurance policy. (Hint:

Debit Prepaid Insurance for $2,220.) 6 Billed Easy Leasing $4,800 for services performed in installing a new Web server. 8 Paid $1,420 cash for the computer supplies purchased from Cain Office Products on

October 3. 10 Hired Sherry Adams as a part-time assistant for $125 per day, as needed. 12 Billed Easy Leasing another $1,400 for services performed. 15 Received $4,800 cash from Easy Leasing on its account. 17 Paid $805 cash to repair computer equipment damaged when moving it. 20 Paid $1,940 cash for an advertisement in the local newspaper. 22 Received $1,400 cash from Easy Leasing on its account. 28 Billed Clark Company $5,208 for services performed. 31 Paid $875 cash for Sherry Adams’s wages for seven days’ work. 31 Breeze withdrew $3,600 cash for personal use. Nov. 1 Reimbursed Breeze in cash for business automobile mileage allowance (Breeze logged 1,000

miles at $0.32 per mile). 2 Received $4,633 cash from Chang Corporation for computer services performed. 5 Purchased computer supplies for $1,125 cash from Cain Office Products. 8 Billed Gomez Co. $5,668 for services performed. 13 Received notification from Alex’s Engineering Co. that Success Systems’ bid of $3,950 for

an upcoming project is accepted. 18 Received $2,208 cash from Clark Company as partial payment of the October 28 bill. 22 Donated $250 cash to the United Way in the company’s name. 24 Completed work for Alex’s Engineering Co. and sent it a bill for $3,950. 25 Sent another bill to Clark Company for the past-due amount of $3,000. 28 Reimbursed Breeze in cash for business automobile mileage (1,200 miles at $0.32 per mile). 30 Paid $1,750 cash for Sherry Adams’s wages for 14 days’ work. 30 Breeze withdrew $2,000 cash for personal use.

2. Open ledger accounts (in balance column format) and post the journal entries from part 1 to them. 3. Prepare a trial balance as of the end of November.

BTN 2-1 Refer to Krispy Kreme’s financial statements in Appendix A for the following questions.

Required 1. What amount of total liabilities does it report for each of the fiscal years ended 2002 and 2003? 2. What amount of total assets does it report for each of the fiscal years ended 2002 and 2003? 3. Calculate its debt ratio for each of the fiscal years ended 2002 and 2003. 4. In which fiscal year did it employ more financial leverage (2002 or 2003)? Explain.

Roll On 5. Access its financial statements (10-K report) for a fiscal year ending after February 2, 2003,

from its Website (KrispyKreme.com) or the SEC’s EDGAR database (www.

SEC

BEYOND THE NUMBERS

REPORTING IN ACTION

A1 A2

.gov). Recompute its debt ratio for any subsequent year’s data and compare it with the February 2, 2003, debt ratio.


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88 Chapter 2 Analyzing and Recording Transactions

COMPARATIVE

BTN 2-2 Key comparative figures ($ thousands) for both Krispy Kreme and Tastykake follow: ANALYSIS A1 A2

1. What is the debt ratio for Krispy Kreme in the current year and the prior year? 2. What is the debt ratio for Tastykake in the current year and the prior year? 3. Which of the two companies has a higher degree of financial leverage? What does this

imply?

ETHICS CHALLENGE C1 C2

TEAMWORK IN ACTION C1 C3 C5 A1

BTN 2-3 Review the Decision Ethics case from the first part of this chapter involving the cashier. The guidance answer suggests that you should not comply with the assistant manager’s request.

Required Propose and evaluate two other courses of action you might consider, and explain why.

COMMUNICATING

BTN 2-4 Amy Renkmeyer is an aspiring entrepreneur and your friend. She is having difficulty IN PRACTICE

understanding the purposes of financial statements and how they fit together across time.

C1 C3 A1 P3

Required Write a one-page memorandum to Renkmeyer explaining the purposes of the four financial state- ments and how they are linked across time.

TAKING IT TO

BTN 2-5 Access EDGAR online (www.

SEC THE NET A1

.gov) and locate the 10-K report of Amazon.com (ticker AMZN) filed on January 24, 2002. Review its financial statements reported for fiscal years ended 1999, 2000, and 2001 to answer the following questions:

Required 1. What are the amounts of its net losses reported for each of these three years? 2. Does Amazon’s operations provide cash or use cash for each of these three years? 3. If Amazon has a 2000 net loss and a net use of cash in operations in 2000, how is it possible that its cash balance at December 31, 2000, shows an increase relative to its balance at January 1, 2000?

BTN 2-6 The expanded accounting equation consists of assets, liabilities, capital, withdrawals, revenues, and expenses. It can be used to reveal insights into changes in a company’s financial position.

Required 1. Form learning teams of six (or more) members. Each team member must select one of the six com- ponents and each team must have at least one expert on each component: (a) assets, (b) liabili- ties, (c) capital, (d) withdrawals, (e) revenues, and ( f ) expenses. 2. Form expert teams of individuals who selected the same component in part 1. Expert teams are to draft a report that each expert will present to his or her learning team addressing the following: a. Identify for its component the (i) increase and decrease side of the account and (ii) normal

balance side of the account. b. Describe a transaction, with amounts, that increases its component.

Larson−Wild−Chiappetta: Fundamental Accounting Principles, Seventeenth Edition

2. Analyzing and Recording Transactions

Krispy Kreme Tastykake

Current Prior Current Prior Key Figures Year Year Year Year

Total liabilities . . . . . . . $131,942 $ 65,218 $ 69,035 $ 61,072 Total assets . . . . . . . . . 410,487 255,376 116,560 116,137


c. Using the transaction and amounts in (b), verify the equality of the accounting equation and

then explain any effects on the income statement and statement of cash flows. d. Describe a transaction, with amounts, that decreases its component. e. Using the transaction and amounts in (d), verify the equality of the accounting equation and

then explain any effects on the income statement and statement of cash flows. 3. Each expert should return to his/her learning team. In rotation, each member presents his/her ex-

pert team’s report to the learning team. Team discussion is encouraged.

BTN 2-7 Read the article “Leveraged for Success” in the April 18, 2002, issue of Business Week.

Required 1. Explain why debt financing can be a less expensive alternative than equity financing. 2. What can happen if a company takes on too much debt? 3. Name five companies cited by the article that are using a high degree of leverage but still main-

taining top credit ratings.

BTN 2-8 Liang Lu is a young entrepreneur who operates Lu Music Services, offering singing les- sons and instruction on musical instruments. Lu wishes to expand but needs a loan. The bank requests Lu to prepare a balance sheet and key financial ratios. Lu has not kept formal records but is able to provide the following accounts and their amounts as of December 31, 2005:

Required 1. Prepare a balance sheet as of December 31, 2005, for Lu Music Services. 2. Compute Lu’s debt ratio and its return on assets (from Chapter 1). Assume average assets equal

its ending balance. 3. Do you think the prospects of a $15,000 bank loan are good? Why or why not?

BTN 2-9 Assume that Tanya York of York Entertainment wants to grow company revenues by 10% each year for the next five years. York has determined that achieving that revenue growth will require additional financing. Accordingly, the company has sought and been offered a $5 million line of credit by a Los Angeles bank to help fund current operations and new movie projects. York is not required to use the line of credit, but it does have preapproval to use the line of credit as needed. If the line of credit is used, an annual interest rate of 8% will be charged on the money borrowed.

Required 1. What will York’s annual revenues be in five years if the revenue growth target rate is achieved? 2. If York decides to borrow against the line of credit, what must it do to successfully employ fi-

nancial leverage?

BTN 2-10 Obtain a recent copy of the most prominent newspaper distributed in your area. Research the classified section and prepare a report answering the following questions (attach relevant classified clippings to your report). Alternatively, you may want to search the Web for the re- quired information. One suitable Website is America’s Job Bank (www.AJB.org). For documenta- tion, you should print copies of Websites accessed.

BUSINESS WEEK ACTIVITY A2

Cash . . . . . . . . . . . . . $ 1,800 Accounts Receivable . . . . . $4,800 Prepaid Insurance . . $ 750 Prepaid Rent . . . . . . . 4,700 Store Supplies . . . . . . . . . . 3,300 Equipment . . . . . . . . 25,000 Accounts Payable . . . 1,100 Unearned Lesson Fees . . . . 7,800 Total Equity* . . . . . . 31,450 Annual net income . . 20,000

* The total equity amount reflects all owner investments, owner withdrawals, revenues, and expenses as of December 31, 2005.

HITTING THE ROAD C1

Larson−Wild−Chiappetta: Fundamental Accounting Principles, Seventeenth Edition

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Text © The McGraw−Hill

Companies, 2004

Chapter 2 Analyzing and Recording Transactions 89

ENTREPRENEURIAL DECISION A1 A2 P3

A1 A2 P3


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90 Chapter 2 Analyzing and Recording Transactions

GLOBAL DECISION

A2

Key Figure Grupo Bimbo Krispy Kreme Tastykake

Return on assets . . . . . . . . 3.6% 10.1% 1.7% Debt ratio . . . . . . . . . . . . 56.0% 32.1% 59.2%

Larson−Wild−Chiappetta: Fundamental Accounting Principles, Seventeenth Edition

2. Analyzing and Recording Transactions

1. Identify the number of listings for accounting positions and the various accounting job titles. 2. Identify the number of listings for other job titles, with examples, that require or prefer account-

ing knowledge/experience but are not specifically accounting positions. 3. Specify the salary range for the accounting and accounting-related positions if provided. 4. Indicate the job that appeals to you, the reason for its appeal, and its requirements.

BTN 2-11 Grupo Bimbo (GrupoBimbo.com) competes with several companies, including Krispy Kreme and Tastykake. Key financial ratios for the current fiscal year follow:

Required 1. Which company is most profitable according to return on assets? 2. Which company is most risky according to the debt ratio? 3. Which company deserves increased investment based on a joint analysis of return on assets and

the debt ratio?