Chapter 2 Notes Flashcards
Functions of Financial Accounting
(1) Measure business activities of the company. (2) Communicate measurements to external parties for decision making.
External Transactions
Transactions between the company and a separate company or individual.
Internal Transactions
Transactions that do not include an exchange with a separate economic entity.
Six Steps in Measuring External Transactions
- Use source documents to identify accounts affected by an external transaction. 2. Analyze the impact of the transaction on the accounting equation. 3. Assess whether the transaction results in a debit or credit to account balances. 4. Record the transaction in a journal using debits and credits. 5. Post the transaction to the general ledger. 6. Prepare a trial balance.
Account
Record of all transactions related to a particular item over a period of time.
Asset Accounts
Examples include Cash, Supplies, and Equipment.
Liability Accounts
Examples include Accounts Payable, Salaries Payable, Utilities Payable, and Taxes Payable.
Stockholders’ Equity Accounts
Examples include Common Stock and Retained Earnings.
Chart of Accounts
A list of all account names used to record transactions.
Dual Effect on the Basic Accounting Equation
Each transaction will have a dual effect on the basic accounting equation: Assets = Liabilities + Stockholders’ Equity.
Increase in Total Assets
If total assets increase, then liabilities or stockholders’ equity increases by the same amount.
Decrease in Total Assets
If total assets decrease, then liabilities or stockholders’ equity decreases by the same amount.
Basic Accounting Equation
Assets = Liabilities + Stockholders’ Equity (creditors’ claims) (owners’ claims).
Three Questions for Each Transaction
- What is one account affected by the transaction?
Learning Objective 1 (LO2-1)
Identify the basic steps in measuring external transactions.
Learning Objective 2 (LO2-2)
Analyze the impact of external transactions on the accounting equation.
Impact of Transactions
Analyze the effects of business transactions on the accounting equation.
Foundation of Financial Accounting
The six-step measurement process is the foundation of financial accounting.
Step 2 of Measurement Process
Analyze the effects of business transactions on the accounting equation.
Step 3 of Measurement Process
Begin the process of translating those effects into the accounting records.
Preparing Financial Statements
Communicate measurements to external parties for decision making.
Record Transactions
Record transactions in a journal using debits and credits.
Post Transactions
Post the transaction to the general ledger.
Prepare a Trial Balance
Prepare a trial balance after posting transactions.
Assess Transaction Impact
Assess whether the transaction results in a debit or credit to account balances.
Cash
Increase by $200,000
Common Stock
Increase by $200,000
Assets equal liabilities plus stockholders’ equity
Yes, assets increase by $200,000 and stockholders’ equity increases by $200,000
Borrow Cash from the Bank
Borrow $100,000 from the local bank and sign a note promising to repay the full amount of the debt in three years.
Notes Payable
Increase by $100,000
Total Assets after Transaction (2)
300000
Total Liabilities after Transaction (2)
100000
Total Stockholders’ Equity after Transaction (2)
200000
Transaction (1)
Sell shares of common stock for $200,000 to obtain the funds necessary to start the business.
Transaction (2)
Borrow $100,000 from the local bank and sign a note promising to repay the full amount of the debt in three years.
Transaction (3)
Purchase equipment necessary for giving soccer training for $120,000 cash.
Transaction (4)
Pay one year of rent in advance, $60,000 ($5,000 per month).
Transaction (5)
Purchase supplies on account for $23,000.
Transaction (6)
Provide soccer training to customers for cash, $43,000.
Transaction (7)
Provide soccer training to customers on account for $20,000.
Transaction (8)
Receive cash in advance for 12 soccer training sessions to be given.
Common Mistake
It’s sometimes tempting to decrease cash as a way of recording an investor’s initial investment.
Key Point
After each transaction, the accounting equation must always remain in balance.
Transaction (3): Purchase Equipment
Purchase equipment necessary for giving soccer training, $120,000 cash.
Total Assets Effect of Land Purchase
If a company purchased land for $200,000 cash, total assets would have zero effect.
Transaction (4): Pay for Rent in Advance
Pay one year of rent in advance, $60,000 ($5,000 per month).
Transaction (5): Purchase Supplies on Account
Purchase supplies on account, $23,000.
Expanded Accounting Equation
Assets = Liabilities + Stockholders’ Equity.
Basic Accounting Equation
The basic accounting equation is a foundational principle in accounting.
Key Point on Retained Earnings
The expanded accounting equation demonstrates that revenues increase retained earnings while expenses and dividends decrease retained earnings.
Transaction (6): Provide Services for Cash
Provide soccer training to customers for cash, $43,000.
Assets
Resources owned by a company that have economic value.
Liabilities
Obligations or debts that a company owes to outside parties.
Stockholders’ Equity
The residual interest in the assets of the entity after deducting liabilities.
Revenues
Income generated from normal business operations.
Expenses
Costs incurred in the process of earning revenues.
Dividends
Payments made to shareholders from a company’s earnings.
Prepaid Rent
Rent paid in advance for future periods.
Service Revenue
Income earned from providing services.
Common Stock
Equity ownership in a corporation, representing a claim on a portion of the company’s assets and earnings.
Retained Earnings
The cumulative amount of net income that has been retained in the company rather than paid out as dividends.
Notes Payable
Written promises to pay a certain amount of money at a future date.
Accounts Payable
Liabilities that a company owes to suppliers for goods and services purchased on credit.
Cash
The most liquid asset, consisting of currency and bank deposits.
Equipment
Tangible assets used in the operations of a business.
Supplies
Consumable items used in the course of business operations.
Transaction (7): Provide Services on Account
Provide soccer training to customers on account, $20,000.
Service Revenue
Income earned from providing services to customers.
Transaction (8): Receive Cash in Advance from Customers
Receive cash in advance for 12 soccer training sessions to be given in the future, $6,000.
Deferred Revenue
Liability account that represents revenue received but not yet earned.
Transaction (9): Pay Salaries to Employees
Pay salaries to employees, $28,000.
Salaries Expense
Cost incurred by a company for paying its employees.
Transaction (10): Pay Cash Dividends
Pay cash dividends of $4,000 to stockholders.
Common Mistake
Deferred revenue is not a revenue account; it indicates a liability for services yet to be provided.
Accounts Payable
Liability account that represents amounts owed to suppliers for goods and services purchased.
Accounts Receivable
Asset account that represents amounts owed to the company by customers for goods or services delivered.
Prepaid Expenses
Payments made for expenses that will be incurred in the future.
Retained Earnings
Cumulative amount of net income retained in the company after dividends are paid.
Common Stock
Equity security that represents ownership in a corporation.
Cash
Liquid asset used to conduct transactions.
Equipment
Tangible fixed assets used in the production of goods and services.
Rent
Payment made for the use of property or land.
Earnings
Profits generated from business operations.
Total Assets
$392,000 after transactions.
Total Liabilities
$392,000 after transactions.
Assets
Resources owned by a company.
Liabilities
Obligations or debts owed by a company.
Accounts Receivable
Money owed to a company by its customers for goods or services delivered.
Accounts Payable
Money a company owes to its suppliers for goods or services received.
Retained Earnings
The cumulative amount of net income that a company retains for reinvestment.
Common Stock
Equity ownership in a company, representing a claim on a portion of the company’s assets and earnings.
Deferred Revenue
Money received by a company for services not yet performed or goods not yet delivered.
Revenue
Income generated from normal business operations.
Earnings
The amount of profit a company makes after all expenses are deducted from revenue.
Cash
Liquid currency that a company has on hand.
Supplies
Items used in the course of business operations.
Equipment
Physical assets used in the production of goods and services.
Rent Payable
Obligation to pay rent for the use of property.
Common Mistake
The belief that payment of dividends increases stockholders’ equity.
Debit
An entry on the left side of an account that increases assets or decreases liabilities and equity.
Credit
An entry on the right side of an account that increases liabilities and equity or decreases assets.
Accounting Equation
The formula Assets = Liabilities + Stockholders’ Equity.
Impact of Dividends
Payment of dividends decreases both assets and equity.
Salaries Expense
Costs incurred for employee compensation.
External Transactions
Transactions that occur between a company and external parties.
Debit
The word debit means left side.
Credit
The word credit means right side.
Assets
Assets increase with debits.
Liabilities
Liabilities increase with credits and decrease with debits.
Stockholders’ Equity
Stockholders’ equity increases with credits and decreases with debits.
Retained Earnings
The Retained Earnings account is a stockholders’ equity account that normally has a credit balance.
Components of Retained Earnings
The Retained Earnings account has three components—revenues, expenses, and dividends.
Net Income
The difference between revenues (increased by credits) and expenses (increased by debits) equals net income.
Dividends
Dividends (increased by debits) decrease the balance of Retained Earnings.
Basic Accounting Equation
Assets = Liabilities + Stockholders’ Equity.
Journal Entry
Format for recording a business transaction, including date, debit, credit, account name, and amount.
Common Mistake
Many students forget to indent the credit account names.
Recording Transactions Example
On December 1, Eagle Soccer Academy sells shares of common stock to investors for cash of $200,000.
Debit to Cash
Debit to Cash for $200,000.
Credit to Common Stock
Credit to Common Stock for $200,000.
Illustration 2-6
Debit and Credit Effects on Accounts in the Expanded Accounting Equation.
Illustration 2-7
Debit and Credit Effects on Each Account Type.
Illustration 2-8
Format for Recording a Business Transaction, or Journal Entry.
Common Mistake in Journal Entries
For the account credited, be sure to indent both the account name and the amount.
Learning Objective 4
Record transactions in a journal using debits and credits.
Key Point on Debits and Credits
The effects of debits and credits on account balances are different depending on the type of account being used.
Increase and Decrease of Accounts
Sometimes a debit increases an account balance and sometimes it decreases an account balance.
Total Debits and Credits
For each transaction, total debits must equal total credits.
Common Mistake about Assets
Students sometimes hear the phrase ‘assets are the debit accounts’ and believe it indicates that assets can only be debited. This is incorrect! Assets, or any account, can be either debited or credited.
Debit Balance of Assets
Debiting the asset account will increase the balance and that an asset account normally will have a debit balance.
Common Mistake about Liabilities and Equity
The phrase ‘liabilities and stockholders’ equity are the credit accounts’ does not mean that these accounts cannot be debited. They will be debited when their balances decrease.
Credit Balance of Liabilities and Equity
Crediting the liabilities and stockholders’ equity accounts increases their balances, and they normally will have a credit balance.
Learning Objective 5
Post transactions to the general ledger.
Posting
Posting is the process of transferring the debit and credit information from the journal to individual general ledger accounts.
General Ledger
The general ledger provides, in a single collection, each account with its individual transactions and resulting account balance.
Transaction Example - Common Stock
On December 1, Eagle Soccer Academy sells shares of common stock to investors for cash of $200,000.
Debit for Cash from Common Stock
Debit Cash (+A) 200,000.
Credit for Common Stock
Credit Common Stock (+SE) 200,000.
Account Balance - Cash
Account: Cash; Beginning Balance 0; Debit 200,000; Credit 200,000.
Account Balance - Common Stock
Account: Common Stock; Beginning Balance 0; Debit 200,000; Credit 200,000.
Transaction Example - Borrowing Cash
On December 1, Eagle borrows cash from a bank, $100,000.
Debit for Cash from Borrowing
Debit Cash (+A) 100,000.
Credit for Notes Payable
Credit Notes Payable (+L) 100,000.
Account Balance - Cash After Borrowing
Account: Cash; Beginning balance 200,000; Debit 100,000; Total 300,000.
Account Balance - Notes Payable
Account: Notes Payable; Beginning balance 0; Debit 100,000.
T-account
A T-account includes the account title at the top, one side for recording debits, and one side for recording credits.
Debit Column in T-account
The left side of the T-account is the debit column.
Credit Column in T-account
The right side is the credit column.
Transaction Example - Equipment Purchase
On December 1, Eagle purchases equipment with cash, $120,000.
Equipment
Asset account representing the value of equipment purchased, recorded as +A.
Cash
Asset account representing cash transactions, recorded as +A or -A depending on the transaction.
Prepaid Rent
Asset account for rent paid in advance, recorded as +A.
Supplies
Asset account for supplies purchased, recorded as +A.
Accounts Payable
Liability account representing amounts owed to suppliers, recorded as +L.
Service Revenue
Revenue account for income earned from services provided, recorded as +R and +SE.
Accounts Receivable
Asset account for amounts owed by customers for services provided on account, recorded as +A.
Deferred Revenue
Liability account for cash received in advance for services to be provided in the future, recorded as +L.
Salaries Expense
Expense account for salaries paid to employees, recorded as +E and -SE.
T-account
A simplified version of a general ledger account with debits on the left and credits on the right.
Transaction Date
The date on which a financial transaction occurs, e.g., December 1, December 6.
Rent Payment
Payment of $60,000 for one year of rent in advance, at $5,000 per month.
Supplies Purchase
Purchase of supplies on account for $23,000.
Training Revenue
Revenue from providing soccer training for cash, totaling $43,000.
Training on Account
Revenue from providing soccer training on account, totaling $20,000.
Cash in Advance
Receipt of $6,000 in advance for future soccer training sessions.
Salaries Payment
Payment of $28,000 in salaries to employees.
Balance
The remaining amount in an account after transactions, e.g., Bal. 120,000.
Monthly Rent
The amount of rent paid each month, which is $5,000.
Total Revenue
Total income from services provided, including cash and on-account transactions.
Total Expenses
Total outflow of resources, including salaries and other expenses.
Liability
Obligation of the company, such as accounts payable and deferred revenue.
Asset
Resources owned by the company, such as cash, equipment, and prepaid rent.
Equity
The owner’s residual interest in the assets of the company after deducting liabilities.
Cash
A liquid asset used for transactions.
Posting
The process of transferring the debit and credit information from transactions recorded in the journal to individual accounts in the general ledger.
Common Stock
Equity ownership in a corporation, representing a claim on a portion of the company’s assets and earnings.
Notes Payable
A liability representing a written promise to pay a specified amount of money at a future date.
Equipment
Long-term tangible assets used in the production of goods and services.
Prepaid Rent
Advance payment for rent that provides future economic benefits.
Deferred Revenue
Liability representing cash received for services not yet performed.
Salaries Expense
The cost incurred by a company for employee wages.
Transaction Date
The date on which a financial transaction occurs.
Debit
An entry on the left side of an account, representing an increase in assets or expenses.
Credit
An entry on the right side of an account, representing an increase in liabilities, equity, or revenue.
Balance
The difference between the total debits and total credits in an account.
Accounts Payable
Liabilities representing amounts owed to suppliers for goods or services received.
Retained Earnings
The cumulative amount of net income retained in the company rather than distributed as dividends.
Cash Dividends
Cash payments made to shareholders as a distribution of profits.
General Ledger
A complete record of all financial transactions over the life of a company.
Liabilities
Obligations of a company that it is required to pay in the future.
Payable
An obligation to pay a specified amount.
Equipment
Physical assets used in the operation of a business.
Trial Balance
A list of all accounts and their balances at a particular date, showing that total debits equal total credits.
Prepaid Rent
An asset account representing rent paid in advance.
Common Stock
An equity account that represents ownership in a corporation.
Salaries Expense
The total amount of salaries paid to employees during a period.
Accounts Payable
Liabilities representing amounts owed to suppliers.
Deferred Revenue
Liabilities representing payments received before services are performed.
Notes Payable
Liabilities representing written promises to pay a certain amount.
Retained Earnings
The cumulative amount of net income retained in the company rather than paid out as dividends.
Accounts Receivable
Assets representing amounts owed to a company by its customers.
Cash
Liquid assets available for immediate use.
Supplies
Items used in the operation of a business that are not intended for resale.
Bal.
Abbreviation for balance, indicating the remaining amount in an account.
Total Debits
The sum of all debit entries in the accounts.
Total Credits
The sum of all credit entries in the accounts.
Chronological Record
A systematic record of transactions in the order they occur.
Economic Events
Transactions that have a financial impact on a business.
Adjusting Entries
Entries made at the end of an accounting period to update account balances.
Offsetting Errors
Errors that balance each other out, resulting in a trial balance that appears correct.
Equity Accounts
Accounts that represent the owner’s interest in the business.
Internal Purposes
Uses of financial information that are intended for management rather than external parties.
Financial Statements
Formal records of the financial activities of a business.
