Financial & Managerial Accounting: Information For Decisions

Financial & Managerial Accounting
Information for Decisions

Seventh Edition
Chapter 2
Accounting for
Business
Transactions
© McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No
reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.
Learning Objectives (1 of 2)
CONCEPTUAL
C1 Explain the steps in processing transactions and
the role of source documents.
C2 Describe an account and its use in recording
transactions.
C3 Describe a ledger and a chart of accounts.
C4 Define debits and credits and explain double-entry
accounting.
ANALYTICAL
A1 Analyze the impact of transactions on accounts and
financial statements.
A2 Compute the debt ratio and describe its use in
analyzing financial condition.
© McGraw-Hill Education. 2-2
Learning Objectives (2 of 2)
PROCEDURAL
P1 Record transactions in a journal and post
entries to a ledger.
P2 Prepare and explain the use of a trial balance.
P3 Prepare financial statements from business
transactions.

Learning Objective C1: Explain
the steps in processing
transactions and the role of source
documents.

System of Accounts
Learning Objective C1: Explain the steps in processing transactions
and the role of source documents.
• Business transactions and events are the starting

points of financial statements. Process from
transactions to financial statements is as follows:
– Identify each transaction and event from source
documents.
– Analyze each transaction and event using the
accounting equation.
– Record relevant transactions and events in a journal.
– Post journal information to ledger accounts.
– Prepare and analyze the trial balance and financial
statements.

Source Documents
Learning Objective C1: Explain the steps in processing transactions
and the role of source documents.
• Employee Earnings Records

• Checks
• Bills from Suppliers
• Purchase Orders
• Bank Statements
• Sales Tickets

Learning Objective C2:
Describe an account and its
use in recording transactions.

The Account and Its Analysis (1 of 3)
Learning Objective C2: Describe an account and its use in recording
transactions.
• An account is a record of increases and

decreases in a specific asset, liability, equity,
revenue, or expense.
• The general ledger is a record of all
accounts used by the company.

transactions.
Exhibit 2.1

transactions.
Revenues and common stock increases equity.

Expenses and dividends decrease equity.
Exhibit 2.2 Accounts Classified by the Expanded
Accounting Equation

Asset Accounts
transactions.
• Asset Accounts
– Cash
– Accounts Receivable
– Notes Receivable
– Prepaid Accounts
– Supplies
– Equipment
– Buildings
– Land

Liability Accounts
transactions.
• Liability Accounts
– Accounts Payable
– Notes Payable
– Unearned Revenue
– Accrued Liabilities

Equity Accounts
transactions.
• Equity Accounts
– + Common stock
– - Dividends
– - Expenses
– + Revenues

Learning Objective C3:
Describe a ledger and chart of
accounts.

Ledger and Chart of Accounts (1 of 2)
Learning Objective C3: Describe a ledger and chart of accounts.
• The ledger is a collection of all accounts for an

accounting system. A company’s size and
diversity of operations affect the number of
accounts needed.
• The chart of accounts is a list of all accounts
and includes an identifying number for each
account.

Ledger and Chart of Accounts (2 of 2)
Exhibit 2.4

NEED-TO-KNOW 2-1 (1 of 3)
Learning Objective C1: Explain the steps in processing
transactions and the role of source documents.
Learning Objective C2: Describe an account and its use in
recording transactions.
Classify each of the following as assets (A), liabilities

(L), or equity (EQ).
1) (A) Asset Prepaid Rent
2) (EQ) Equity Common stock
3) (A) Asset Note Receivable
4) (L) Liability Accounts Payable
5) (A) Asset Accounts Receivable
6) (A) Asset Equipment

7) (L) Liability Interest Payable

8) (L) Liability Unearned Revenue
9) (A) Asset Land
10) (A) Asset Prepaid Insurance
11) (L) Liability Wages Payable
12) (L) Liability Rent Payable

Key words to look for in account titles:

Prepaid Always an asset
Receivable Always an asset
Payable Always a liability
Unearned Always a liability

Learning Objective C4: Define
debits and credits and explain
double-entry accounting.

Debits and Credits
Learning Objective C4: Define debits and credits and explain double-
entry accounting.
A T-account represents a ledger account and is

used to depict the effects of one or more
transactions.
Exhibit 2.5

Double-Entry Accounting (1 of 3)
Learning Objective C4: Define debits and credits and explain
Assets = Liabilities + Equity

Exhibit 2.6

Here is the expanded accounting equation showing

the equity section.
Exhibit 2.7

An account balance is the difference between the

increases and decreases in an account. Notice the
T-Account.
Exhibit 2.8

Identify the normal balance (debit [Dr] or credit

[Cr]) for each of the following accounts.
1) Dr. Debit Prepaid Rent
2) Cr. Credit Common Stock
3) Dr. Debit Note Receivable
4) Cr.Credit Accounts Payable
5) Dr. Debit Accounts Receivable
6) Dr. Debit Equipment
7) Cr. Credit Interest Payable
8) Cr. Credit Unearned Revenue

9) Dr. Debit Land

10) Dr. Debit Prepaid Insurance
11) Dr. Debit Dividends
12) Dr. Debit Supplies


Learning Objective P1: Record
transactions in a journal and post

Exhibit 2.9 Journalizing and Posting
Transactions (1 of 4)
Learning Objective P1: Record transactions in a journal and post
Step 1: Identify transactions and source

documents.

Step 2: Analyze transactions using the accounting

equation.

Step 3: Record journal entry.

Step 4: Post entry to ledger.

Exhibit 2.10 Journalizing Transactions
(1 of 2)

Exhibit 2.10 Journalizing Transactions
(2 of 2)
a. Transaction Date
b. Titles of Affected Accounts
c. Dollar amount of debits and credits
d. Transaction explanation

Exhibit 2.11 Balance Account Column
T-accounts are useful illustrations, but balance

column ledger accounts are used in practice.

Exhibit 2.12 Posting Journal
Entries (1 of 2)
Learning Objective P1: Record transactions in a journal and post entries
to a ledger.

Exhibit 2.12 Posting Journal
Entries (2 of 2)
Key:
1) Identify debit account in ledger: enter date, journal
page, amount, and balance (in red).
2) Enter the debit account number from the ledger in
the PR column of the journal (in blue).
3) Identify credit account in ledger: enter date, journal
page, amount, and balance (in green).
4) Enter the credit account number from the ledger in
the PR column of the journal (in green).

Learning Objective A1: Analyze
the impact of transactions on
accounts and financial statements.

Processing Transactions (1 of 17)
Learning Objective A1: Analyze the impact of transactions on
Double-entry accounting is useful in analyzing and

processing transactions. Analysis of each transaction
follows these four steps.
Step 1: Identifying the transaction and any source
documents.
Step 2: Analyze the transaction using the accounting
equation.
Step 3: Record the transaction in journal entry form
applying double-entry accounting.
Step 4: Post the entry (for simplicity, we use T-accounts
to represent ledger accounts).

1. Receive Investment by Owner

1) Identify: FastForward receives $30,000 cash
from Chas Taylor in exchange for common stock.

2. Purchase Supplies for Cash

1) Identify: FastForward pays $2,500 cash for
supplies.

3. Purchase Equipment for Cash

equipment.

4. Purchase Supplies for Credit

1) Identify: FastForward purchases $7,100 of
supplies on credit from a supplier.

5. Provide Services for Cash

1) Identify: FastForward provides consulting
services and immediately collects $4,200 cash.

6. Payment of Expense in Cash

December rent.


1) Identify: FastForward pays $700 cash for
employee salary.

8. Provide Consulting and Rental Services on

Credit
1) Identify: FastForward provides consulting services of
$1,600 and rents its test facilities for $300. The
customer is billed $1,900 for these services.

9. Receipts of Cash on Account

1) Identify: FastForward receives $1,900 cash
from the client billed in transaction 8.

10.Partial Payments of Accounts Payable

1) Identify: FastForward pays CalTech Supply $900
cash toward the payable of transaction 4.

11.Payment of Cash Dividend

1) Identify: FastForward pays $200 cash for
dividends.

12. Receipts of Cash for Future Services

1) Identify: FastForward receives $3,000 cash in
advance of providing consulting services to customers.

13. Pay Cash for Future Insurance Coverage

1) Identify: FastForward pays $2,400 cash (insurance
premium) for a 24-month insurance policy. Coverage
begins on December 1.

14. Purchase Supplies for Cash

1) Identify: FastForward pays $120 cash for supplies.


1) Identify: FastForward pays $305 cash for December
utilities expense.


1) Identify: FastForward pays $700 cash in employee
salary for work performed in the latter part of
December.

Exhibit 2.13 Debit and Credit Rules

Learning Objective A1: Analyze the impact of transactions on accounts
and financial statements.
Assume Tata began operations on January 1 and completed

the following transactions during its first month of
operations.
Jan. 1 Jamsetji invested $4,000 cash in exchange for
common stock in the Tata company.
Jan. 5 The company purchased $2,000 of equipment on
credit.
Jan. 14 The company provided $540 of services for a client
on credit.
For each transaction, (a) analyze the transaction using the
accounting equation, (b) record the transaction in journal
entry form, and c) post the entry using T-accounts to
represent the general ledger accounts.
Jan. 1 Jamsetji invested $4,000 cash in the Tata

company.
a) Analyze
b) Record

c) Post

Jan. 5 The company purchased $2,000 of

equipment on credit.
a) Analyze
b) Record

c) Post

Jan. 14 The company provided $540 of services

for a client on credit.
a) Analyze
b) Record

c) Post

Learning Objective P2: Prepare
and explain the use of a trial
balance.

Preparing a Trial Balance
Learning Objective 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 the 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.

Trial Balance (1 of 2)
balance.
• After processing its remaining transactions for

December, FastForward’s Trial Balance is prepared.

Trial Balance (2 of 2)
balance.
• $45,300  The trial balance lists all ledger

accounts and their balances at a point in time. If
the books are in balance, the total debits will
equal the total credits.

Searching for Errors (1 of 2)
balance.
If the trial balance does not balance, the

error(s) must be found and corrected.
1. Make sure the trial balance columns are correctly
added.
2. Make sure account balances are correctly entered
from the ledger.
3. See if debit or credit accounts are mistakenly
placed on the trial balance.

Searching for Errors (2 of 2)
balance.
4. Re-compute each account balance in the ledger.

5. Verify that each journal entry is posted correctly.
6. Verify that each original journal entry has equal
debits and credits.

Learning Objective P3: Prepare
financial statements from business
transactions.

Exhibit 2.15 Financial Statements
Prepared from Trial Balance
Learning Objective P3: Prepare financial statements from business
transactions.

Financial Statements (1 of 2)
transactions.
The four financial statements and their purposes

are:
1. Income statement — reports revenues less
expenses along with the resulting net income or
loss over a period of time due to earnings
activities.
2. Statement of retained earnings— reports how
equity changes over the reporting period from net
income (or loss) and from any owner investments
and withdrawals over a period of time.

Financial Statements (2 of 2)
transactions.
3. Balance sheet — reports the financial position

(types and amounts of assets, liabilities, and
equity) at a point in time.
4. Statement of Cash Flows — The statement of
cash flows lists the cash inflows and cash outflows
for the period.
**For simplicity, we do not show the statement of
cash flows for FastForward in this chapter, but we do
return to this statement in the next chapter.**

Exhibit 2.16 Income Statement
transactions.

Exhibit 2.16 Statement of Retained
Earnings
transactions.

Exhibit 2.16 Balance Sheet
transactions.

Presentation Issues
transactions.
1. Dollar signs are not used in journals and ledgers.

2. Dollar signs appear 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.
3. When amounts are entered in the journal, ledger, or
trial balance, commas are optional to indicate
thousands, millions, and so forth.
4. Commas are always used in financial statements.
5. Companies commonly round amounts in reports to
the nearest dollar, or even to a higher level.

balance.
Prepare a trial balance for Apple using the following

condensed data from its fiscal year-ended Prepare a trial
balance for Apple using the following condensed data
from its fiscal year-ended
Common Stock $ 27,071 Dividends $48,262
Accounts payable 35,490 Investments and other assets 230,039
Other liabilities 135,634 Land and equipment 22,471
Cost of sales (expense) 140,089 Selling and other expense 40,232
Cash 21,120 Accounts receivable 16,849
Revenues 233,715 Retained earnings, beginning year 87,152

balance.

balance.

Learning Objective A2: Compute
the debt ratio and describe its use
in analyzing financial condition.

Debt Ratio
Learning Objective A2: Compute the debt ratio and describe its use
in analyzing financial condition.
Total Liabilitie s
Debt Ratio 
Total Assets
• Evaluates the level of debt risk.
• A higher ratio indicates that there is a greater
probability that a company will not be able to pay its
debt in the future.
Exhibit 2.18
$ millions 2015 2014 2013 2012 2011
Total liabilities………………………….. $672 $541 $429 $421 $389
Total assets……………………………… $2,047 $1,675 $1,409 $1,340 $1,282
Debt ratio………………………………… 0.33 0.32 0.30 0.31 0.30
Industry debt ratio…………………… 0.49 0.49 0.47 0.46 0.47

End of Presentation
© McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No
reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education. 2-83

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Financial & Managerial Accounting

Information for Decisions

© McGraw-Hill Education. 2-3

© McGraw-Hill Education. 2-4

• Business transactions and events are the starting

© McGraw-Hill Education. 2-5

• Employee Earnings Records

© McGraw-Hill Education. 2-6

© McGraw-Hill Education. 2-7

• An account is a record of increases and

© McGraw-Hill Education. 2-8

© McGraw-Hill Education. 2-9

Revenues and common stock increases equity.

© McGraw-Hill Education. 2-10

© McGraw-Hill Education. 2-11

© McGraw-Hill Education. 2-12

© McGraw-Hill Education. 2-13

© McGraw-Hill Education. 2-14

• The ledger is a collection of all accounts for an

© McGraw-Hill Education. 2-15

© McGraw-Hill Education. 2-16

Classify each of the following as assets (A), liabilities

© McGraw-Hill Education. 2-17

7) (L) Liability Interest Payable

© McGraw-Hill Education. 2-18

Key words to look for in account titles:

© McGraw-Hill Education. 2-19

© McGraw-Hill Education. 2-20

A T-account represents a ledger account and is

© McGraw-Hill Education. 2-21

Assets = Liabilities + Equity

© McGraw-Hill Education. 2-22

Here is the expanded accounting equation showing

© McGraw-Hill Education. 2-23

An account balance is the difference between the

© McGraw-Hill Education. 2-24

Identify the normal balance (debit [Dr] or credit

© McGraw-Hill Education. 2-25

9) Dr. Debit Land

© McGraw-Hill Education. 2-26

© McGraw-Hill Education. 2-27

© McGraw-Hill Education. 2-28

Step 1: Identify transactions and source

© McGraw-Hill Education. 2-29

Step 2: Analyze transactions using the accounting

© McGraw-Hill Education. 2-30

Step 3: Record journal entry.

© McGraw-Hill Education. 2-31

Step 4: Post entry to ledger.

© McGraw-Hill Education. 2-32

© McGraw-Hill Education. 2-33

© McGraw-Hill Education. 2-34

T-accounts are useful illustrations, but balance

© McGraw-Hill Education. 2-35

© McGraw-Hill Education. 2-36

© McGraw-Hill Education. 2-37

© McGraw-Hill Education. 2-38

Double-entry accounting is useful in analyzing and

© McGraw-Hill Education. 2-39