Chapter 2: How do Companies keep track of account balances? Flashcards
What are the two basic recording tools used to determine the impact of business transactions on the statement of financial position?
The two basic recording tools used are journal entries and T-accounts.
Why is recording transaction effects and keeping track of account balances in the manner just presented impractical for most organizations?
For most organizations, this approach is impractical due to the multitude of daily transactions they generate.
What is the purpose of the accounting cycle, and what does it highlight?
The accounting cycle is a series of activities performed during the accounting period, highlighting primary activities related to financial transactions.
What do transaction effects impact, and why is it essential to represent them efficiently?
Transaction effects impact the balances of assets, liabilities, and shareholders’ equity accounts. It’s crucial to represent them efficiently to understand the direction of these effects.
How is each account represented in a transaction analysis model, and what are the key indicators for debit and credit?
Each account is represented as a “T.” Increases in asset accounts are on the left (debit) side, and increases in liability and shareholders’ equity accounts are on the right (credit) side. Debit (dr) refers to the left side, and credit (cr) refers to the right side.
What ensures that the accounting equation remains in balance during transaction analysis, and what is the significance of equality between debits and credits?
Identifying the correct accounts and effects in transaction analysis ensures that the accounting equation (A = L + SE) remains in balance.
The equality between the total monetary value of debits and credits is crucial to maintain balance.
Transaction Effects
Transaction effects in financial accounting refer to the changes in the balances of assets, liabilities, and shareholders’ equity accounts resulting from business transactions.
T-Account
A T-account is a graphical representation of an account with a “T” shape. It helps visualize and analyze the direction of transaction effects on accounts.
Debit (dr)
Debit (abbreviated as “dr”) represents the left side of a T-account. Increases in asset accounts are recorded on the debit side.
Credit (cr)
Credit (abbreviated as “cr”) represents the right side of a T-account.
Increases in liability and shareholders’ equity accounts are recorded on the credit side.
Debit Balances
Asset accounts typically have debit balances, meaning they increase on the left (debit) side of a T-account.
Credit Balances
Liability and shareholders’ equity accounts usually have credit balances, meaning they increase on the right (credit) side of a T-account.
Accounting Equation
The accounting equation (A = L + SE) represents the fundamental balance between assets, liabilities, and shareholders’ equity. It must always be in balance.
Equality Check
As a measure of accuracy, the total monetary value of all debits in a transaction should equal the total monetary value of all credits, ensuring that the accounting equation remains in balance.
Debits vs. Credits
Debits represent the left side, and credits represent the right side of a T-account. It’s important to understand that neither is inherently good or bad; they simply indicate direction.
T-Account Structure
T-accounts are structured with increases in asset accounts on the left (debit) side and increases in liability and shareholders’ equity accounts on the right (credit) side.
Journal Entry
A journal entry is an accounting method used to record the effects of a business transaction on various accounts, typically using debits and credits.
Debits and Credits (Journal Entry)
Debits represent what was received and are recorded on the top of a journal entry, while credits represent what was given and are recorded below the debits.
Transaction Analysis Model
The transaction analysis model is a structured approach to understanding and recording the effects of business transactions on accounts.
Compound Entry
A journal entry that affects more than two accounts is called a compound entry. Many transactions in accounting require compound entries.
Economic Substance vs. Legal Form
In financial accounting, transactions are recognized based on their economic substance rather than their legal form. This ensures relevant information is reported to financial statement users.
Formal Documents
Recording external transactions in the journal requires formal documents such as cash register receipts, checks, or invoices to initiate the procedure.
Account Classification
Clarifying accounts as assets (A), liabilities (L), or shareholders’ equity (SE) simplifies transaction analysis and journal entry writing.
Memorizing Transaction Analysis
It is important to memorize and use the transaction analysis model for all financial transactions, as it forms the basis of accurate recording.
Sequence of Transactions
Including a date and unique reference for each transaction helps in verifying transaction dates by auditors and maintains chronological order in the journal.
Posting transaction effects from Journal to Ledger
T-Account
A T-account is a simplified representation of a ledger account used to summarize transaction effects and determine account balances.
Posting
Posting is the process of transferring monetary values from journal entries to individual accounts in the general ledger.
General Ledger
The general ledger is a collection of all debited and credited amounts classified and reported by account, typically organized in computerized accounting systems.
Asset T-Account
In a T-account for assets like Cash, increases are recorded on the left side, while decreases are recorded on the right side.
Liability T-Account
For liabilities such as Long-term Debt, increases are recorded on the right side of the T-account, while decreases are on the left side.
Reference
Including a reference (e.g., journal entry identifier or date) next to each debit or credit in a T-account allows for easy tracing of transactions between journal entries and T-accounts.
Ending Balance
An ending balance is determined by adding or subtracting the effects of transactions to the beginning balance on the appropriate side of a T-account.
Debit and Credit Terminology
The terms “debit” and “credit” can be used as verbs, nouns, or adjectives to describe the left and right sides of T-accounts. For example, a debit (verb) increases an asset account on the left side, and an asset account is described as a debit account (adjective) when it has a normal positive balance.
Posting Process
The posting process involves transferring information from journal entries to T-accounts, helping determine the balances of individual accounts.
Manual vs. Computerized Accounting
While some small businesses still use handwritten T-accounts, computerized accounting systems automate the process, retaining the concept of T-accounts but not necessarily the format.
T-Accounts illistrated
