Analyzing Transactions

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Kathlyn Hudson
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1 Question 1: What is the relationship between a transaction, a journal, a ledger, and a chart of accounts? A transaction is the record used to reflect the activity of a business. These transactions are posted to a journal in the order in which they occur. The journal is a historic record of the business activity. Periodically, the journal transactions are posted to the ledger. The ledger is a listing of accounts set up to record the different types of journal transactions. The accounts in the ledger are numbered and listed in the order in which they appear in the balance sheet and income statement. The accounts listed in the ledger make up the chart of accounts. Question 2: What is the normal balance of an asset account and a liability account and why? An account is made up of a minimum of three components. Each account must have a title, a place to record increases, and a place to record the 1

2 decreases. Thus, each account has a debit and a credit side. The normal balance of an asset account is a debit, and the normal balance of a liability is a credit. The reason for this is that they are on opposite sides of the accounting equation. Assets (debit normal balance) equal liabilities (credit normal balance) plus owner's equity (credit normal balance). This should look familiar as the accounting equation. Question 3: What accounts have a debit balance, and what accounts have a credit balance? Ms. Karen Smarts Esq. is a lawyer with her own legal practice. Ms. Smarts' account titles, numbers, and normal balances as of June 1 are as follows: Cash 10 $7,820 Accounts Receivable 14 $8,200 Supplies 16 $480 Prepaid Insurance 18 $300 Accounts Payable 23 $1,950 Smarts Capital 32 $14,850 Professional Fees 42 Salary Expense 53 Rent Expense 55 Utilities Expense 58 Miscellaneous Expense 59 The following is the ledger for each account for Ms. Smarts' as of June 1,

3 ACCOUNT Cash ACCOUNT NO Balance Start 7,820 ACCOUNT Accounts Receivable ACCOUNT NO Balance Start 8,200 ACCOUNT Supplies ACCOUNT NO Balance Start 480 ACCOUNT Prepaid Insurance ACCOUNT NO Balance Start 300 ACCOUNT Accounts Payable ACCOUNT NO Balance Start 1950 ACCOUNT Smarts Capital ACCOUNT NO. 32 Debit Credit Debit Credit 3

4 Ref. 1 Balance Start ACCOUNT Professional Fees ACCOUNT NO Balance Start ACCOUNT Salary Expense ACCOUNT NO Balance Start ACCOUNT Rent Expense ACCOUNT NO Balance Start ACCOUNT Utility Expense ACCOUNT NO Balance Start ACCOUNT Miscellaneous Expense ACCOUNT NO Balance Start 4

5 The following accounting equation would be used to verify that both sides of the ledger are equal (debits = credits). ASSETS - LIABILITIES = OWNER'S EQUITY Cash 7820 Account Pay Smarts Cap Account Rec Supplies 480 Prepaid Ins 300 Total = Question 4: What would the journal entries for Ms. Smarts' June activity look like? During June 2005, her law firm completed the following transactions. June 1 Paid cash for office rent for June $1, Purchased office supplies on account $ Paid cash to creditors on account $ Paid cash for renewal of 6 months practice insurance $1, Paid cash for miscellaneous expenses $ Recorded cash receipts from clients $8, Paid cash utility expenses for office $ Paid cash for salary to legal secretary $2, Recorded fees charged to clients for legal services $4, Recorded payment of cash for office supplies bought on account $300. Each of the transactions is posted to Ms. Smarts' journal. JOURNAL Date Description Post Ref. Debit Credit June 1 Rent Expense Cash Paid office rent for June 5 Supplies Accounts Payable

6 Purchased supplies on account 10 Accounts Payable Cash Paid creditors on account 15 Prepaid Insurance Cash Renewed 12 month insurance 18 Miscellaneous Expense Cash Cash Accounts Receivable Received cash on account 28 Utility Expense Cash Paid utilities 30 Salaries Cash Accounts Receivable Professional Fees Accounts Payable Cash Recorded June Payment to Creditors Question 5: What would the June ledger look like after posting the journal entries? Each journal entry for June has been posted to Ms. Smarts' ledger. 6

7 ACCOUNT Cash ACCOUNT NO Balance Start 7, / / / / / / / ACCOUNT Accounts Receivable ACCOUNT NO Balance Start 8,200 06/ / ACCOUNT Supplies ACCOUNT NO Balance Start ACCOUNT Prepaid Insurance ACCOUNT NO Balance Start /

8 ACCOUNT Accounts Payable ACCOUNT NO Balance Start / / ACCOUNT Smarts Capital ACCOUNT NO Balance Start ACCOUNT Professional Fees ACCOUNT NO Balance Start 06/ ACCOUNT Salary Expense ACCOUNT NO Balance Start 06/ ACCOUNT Rent Expense ACCOUNT NO Balance Start

9 ACCOUNT Utility Expense ACCOUNT NO Balance Start 06/ ACCOUNT Miscellaneous Expense ACCOUNT NO Balance Start 06/ Question 6: What would Ms. Smarts' trial balance for June 30, 2005, look like? All of the ledger account information has been posted to the trial balance. The trial balance proves that the total debits and credits are equal. Karen Smarts Esq. Trial Balance 30-Jun-05 Account Description Debits Credits Cash 9915 Accounts Receivable 4500 Supplies 960 Prepaid Insurance 1500 Accounts Payable 1650 Smarts Capital Professional Fees 4300 Salary Expense 2500 Rent Expense 1000 Utility Expense 250 Miscellaneous Expense 175 Total

10 Question 7: How would transposing a miscell expense as $715 instead of $175 affect trial balance? This would not have affected the trial balance. The purpose of the trial balance is to make sure that both sides of a transaction are posted with the same amount. If the supply side or cash side were posted with the transposed amount, then the trial balance would not have balanced. The only way to fix an error when both sides of the transaction are posted incorrectly would be to audit the journal. Question 8: What is the difference between the cash basis and the accrual basis of accounting when posting revenue and expenses? When a business uses the cash basis of accounting, all revenue and expense transactions are recorded when the cash is paid or received. When a business uses the accrual basis of accounting, all revenue and expense transactions are recorded when the activity takes place (when revenue is earned or an expense is created). Cash may or may not have been paid or received. Question 9: What accounts are revenue accounts, liability accounts, or owner's equity accounts? Accounts Payable Accounts Receivable Customer Revenue Office Supplies Utility Expense Supplies Expense Manufacturing Equipment Computers Wage Expense Earnings Retained in the business Liability Asset Revenue Asset Expense Expense Asset Asset Expense Owner s Equity Question 10: Which accounts are income statement accounts, and which ones are balance sheet accounts? Accounts Payable Accounts Receivable Customer Revenue Income Statement 10

11 Office Supplies Utility Expense Supplies Expense Manufacturing Equipment Computers Wage Expense Earnings Retained in the business Income Statement Income Statement Income Statement Balance sheet accounts include assets, liabilities, and owner's equity the components of the accounting equation. Income statement accounts include revenues and expenses accounts related to income. 11

Chapter 2 Analyzing Transactions

1 Chapter 2 Analyzing Transactions Chapter 2 Analyzing Transactions From Chapter 1: The Accounting Equation Assets = Liabilities + Owner's Equity Assets = Liabilities + Capital Drawing + Revenues - Expenses