Recording the Effect of Transactions

Introduction
In this module:

You'll look at:

• The theories and processes involved in recording transactions.

You'll be introduced to:

• The General Journal, the General Ledger and will continue to work with financial statements.

Learning Outcomes
Upon successful completion of Module 2 you will be able to:
1. Understand accounts and their purpose in recording transactions, including "T" accounts.
2. Explain the role of debits and credits in the recording process, and their effect on the following
types of accounts: Asset, Liability, Owner Equity, Owner Withdrawal, Revenue, and Expense.
3. Describe and use the General Journal and General ledger to record and summarize transactions.
4. Describe and use the process of posting from the General Journal to the General Ledger.
5. Explain the purpose of and prepare a Trial Balance.
6. From a Trial Balance, prepare: Income Statement, Statement of Owner Equity, Balance Sheet.

Pre-Test
Instructions: You're going to test your accounting knowledge before you begin the module content by
answering the following multiple choice.

1. A transaction is any type of event that affects a business.

a) True
b) False
2. A chart of accounts is:
a) A list of all of a company’s bank accounts
b) A list of all of the accounts in the general ledger
c) Both of the above
d) None of the above
3. Debits refers to:
a) Money that is lost
b) Money received as a loan
c) An accounting entry that decreases assets
d) An accounting entry made to left of an account
4. The general ledger is a group of accounts, which shows the accumulated effect of all
transactions related to those accounts.
a) True
b) False
5. The general journal is prepared from the financial statements.
a) True
 b) False
6. The trial balance is used to verify a company’s bank statements.
a) True
b) False
7. The purpose of analyzing transactions is to determine whether a company made good
business decisions.
a) True
b) False
8. A credit is an entry to the right side of the account.
a) True
b) False
9. A trial balance will uncover all errors in the recording of transactions.
a) True
b) False
10. “Double entry system” means that transactions are recorded in both the general journal and
the general ledger.
a)True
b) False

Answers:
1. b). False
2. b). a list of all of the accounts in the general ledger
3. d) an accounting entry made to the left side of an account
4. a). True
5. b). False
6. b). False
7. b). False
8. a). True
9. b). False
10. b). False

The Recording Process

As you learned in Module 1, the recording process begins with an economic event (transaction).
Remember, too, that only those events which have a verifiable economic impact on the business will be
recorded for accounting purposes.

The evidence of the transaction is usually found on a document, such as a cash register tape, a bill of
sale, or a cheque.

Examples:

• Purchase of a car.
• Sale of a product (such as a computer).
• Payment of salaries.

The Accounting Process

Economic Process: Analyze transactions
Record: Enter in General Journal

Summarize: Post to General Ledger

Prepare Financial Reports: Prepare Trial Balance Statements

For each verifiable transaction, we must:

1. Identify and analyze transactions
2. Record transactions in a journal
3. Post (copy) from the journal to the accounts in the ledger
4. Prepare the trial balance
5. Journalize and post adjusting entries
6. Prepare the financial statements
7. Journalize and post the closing entries
8. Prepare the post-closing trial balance

What is an Account?
Many transactions are similar in nature and affect logical categories within each part of the Basic
Accounting Equation. These categories are known as accounts.

For example, all transactions that affect the company's cash are listed in the Cash account.

Organizations develop a Chart of Accounts and use those accounts throughout the recording process.
Their balances are reported on the financial statements.

Each account is associated with one of the three parts of the Basic Accounting Equation.

Chart of Accounts: A list of agreed account names to be used in the accounting records.

What is an Account?
Let us look at the accounts for Louie's Landscaping.
Assets:

• Cash
• Accounts Receivable
• Office Equipment

Liabilities:

• Accounts Payable
• Unpaid Utilities
• Bank Loan

Owner’s Equity:

• Louie Lindross, Capital

What is an Account?
The next step in analyzing the transaction is to understand the type of effect it had on the accounts.
Let's see how some transactions increase or decrease Louie's accounts.

What is a T Account?
Notice how the Basic Accounting Equation takes the form of a T, with distinct left and right sides.

Remember: A = L + E stands for Assets = Liabilities + Owner Equity

What is a T Account?
Within the asset, liability, and owner equity sides of the Basic Accounting Equation appear the
specific accounts (cash, accounts payable and owner equity) associated with that part of the
equation.

Each of these accounts has a left and right side, too.

Only one side of each T account will be affected by a transaction. To determine which side, we'll need to
understand debits and credits.

What are Debits and Credits?

Most people learn about debits and credits through their banking information. Sometimes, people find
it confusing to understand the difference between them. For accountants, though, Debits (DR) and
Credits (CR) are really quite straightforward.

The balance sheet, (which looks similar to a large "T" account), has a left (asset), and a right (liability and
owner equity) side, just as the Basic Accounting Equation does.

Individual accounts such as Cash, Accounts Payable and Owner Equity will also have a left (debit) and
right (credit) side.

The left (asset) side of the Balance Sheet is normally associated with debits.

So, a debt (DR) entry affects the left side of the Balance Sheet, or the left side of an account.

The right (liability and owner equity) side is normally associated with credits.

So, a credit (CR) entry affects the right side of the Balance Sheet, or the right side of an account.

Once we know whether a transaction increased or decreased an account, we can determine whether to
record a debit entry or a credit entry to that account.
Recording Transactions
What is Double Entry Accounting?

The final aspect of analyzing a transaction is to make sure we have analyzed all of the accounts that are
affected.

Whenever you entered a transaction into the basic accounting equation in Module 1, there were always
at least two entries (e.g. if you increased assets by $100 you also increased either liabilities or owner
equity by $100). This ensured that the equation was always in balance.

The same concept holds true when dealing with debits and credits. To keep the Basic Accounting
Equation and the financial statements in balance, the debits must equal the credits for each transaction
you record. This is double entry accounting.

• If you debit an account you must also credit another account for the same amount.
• The debits must always equal the credits and the Basic Accounting Equation must always be in
balance.

Now let's take a closer look at the effect of typical transactions on specific types of accounts.

Recording Assets
Asset accounts are on the left side (debit side) of the Basic Accounting Equation and the balance sheet,
so they will normally (normally, if the business is doing well, assets should be increasing.) have debit
balances.

Record transactions that:

• Increase an asset account, on the debit side of the “T” account.
 • Decrease an asset account, on the credit side of “T” account.

Example:

Mary Smith purchased office equipment (an asset) worth $5,000 for her law office, agreeing to pay for it
in 30 days.

The first line of the entry for this transaction is a debit (increase) to the office equipment account.

To complete the recording of this transaction, we need an entry to the right side of the Balance sheet.

Recording Liabilities and Owners' Equity

Liability and equity accounts are on the right (credit) side of the Basic Accounting Equation and the
Balance Sheet. They normally have credit balances. (Normally, if the business is doing well, liabilities
should be decreasing and owner’s equity should be increasing.)

Record transactions that:

• Increase a liability or owner equity account on the credit side of the “T” account.
• Decrease a liability or owner equity account on the debit side of the “T” account.

Example:

Mary Smith purchased office equipment (an asset) worth $5,000 for her law office agreeing to pay for it
in 30 days.

The second line of entry is a credit (increase) to the accounts payable account.
Recording Revenue, Expenses and Personal Withdrawals
While revenue, expense, and draw accounts do not appear on the balance sheet they do impact the
balance sheet through the owner equity account.

Revenue: Remember that revenue increases equity. Since increases to equity are recorded on the credit
side:

Record transactions that:

• Increase a revenue account on the credit side of the “T” account.

• Decrease a revenue account on the debit side of the “T” account.

Expense and Draw:

On the other hand, expenses decrease equity. Draws are not expenses, but they do decrease equity so
the recording of these transactions is handled the same way as expenses. Since decrease to equity are
recorded on the debit side.

Record transactions that:

• Increase an expense or draw account on the debit side of the “T” account.
• Decrease an expense or draw account on the credit side of the “T” account.

Recording Revenue, Expenses and Personal Withdrawals

Louie Lindross invested $1,000 cash into his new landscaping business.

The first line of the entry is a debit (increase) to the cash account. The second line of the entry is a credit
(increase) to the owner equity account.

Louie paid rent expense for the month $700.

The first line of the entry is a debit (increase) to the rent expense account. The second line of the entry
is a credit (decrease) to the cash account.

Louie earned revenue of $1,200 and received the cash.

The first line of the entry is a debit (increase) to cash. The second line of the entry is a credit (increase)
to the revenue account.
To Recap:

Check your Understanding

With the following transactions, describe the effect by writing in the appropriate options for each
transaction.

Hint: Record debits first, as accountants do; each transaction requires two lines to complete the entry.

1. Invested $20,000 cash in your new business.

2. Paid $1, 000 rent expense for the month.
3. Purchased a computer worth $3, 000 which you will pay for in 15 days.
4. Sold your services worth $250. The cash was collected at the time of the sale.
5. Billed a client for services worth $600. The cash will be collected in 20 days.

Answers:

1. Asset- Cash – Increase- Debit

Equity- Owner’s Equity- Increase- Credit
2. Expense- Rent Expense- Increase- Debit
Asset- Cash- Decrease- Credit
3. Asset- Office Equipment- Increase- Debit
Liability- Accounts Payable- Increase- Credit
4. Asset- Cash- Increase- Debit
Revenue- Sales Revenue- Increase- Credit
5. Asset- Accounts Receivable- Increase- Debit
Revenue- Sales Revenue- Increase- Credit
Journalizing
After a transaction is analyzed, it is recorded in the general journal (journalizing). Each entry identifies
the specific accounts affected by the transaction, and the amount of the debits and credits to each
account.
• Transactions are usually recorded in the order in which they happened.
• Debits are always entered on the first line.
• Credits are always indented and entered on the second line.

Simple and Compound Entries

The entries in all of the previous examples were simple entries. One account was debited and one
account was credited.

Sometimes, though, more than two accounts are needed. Debits or credits may need to be split among
two or more accounts.

Example: George's Electronics sold a cellphone worth $100 on account. GST is calculated at 7% and PST
is calculated at 8%.

The sale will be recorded as follows:

Accounts Receivable 115
Revenue 100
GST Payable (100 * 7%) 7
PST Payable (100 * 8%) 8

Notice that debits still equal credits. Therefore, the general ledger is in balance.

Case Study #1
Instructions:

• Journalize the following 5 transaction, by writing in the correct accounts, and entering the debits
and credits.
 • Remember that each entry will require at least two lines.

1. May 1- Owner invested $2, 000 cash in the business.

2. May 10- Paid salary expense $500 cash.
3. May 12- Performed a service and collected $1,000 revenue in cash.
4. May 14- Withdrew $300 for personal use.
5. May 15- Purchased office equipment (asset) for $4,000 paying $1,000 cash and agreeing to pay
the balance in 30 days.

Answer:
Summarizing the Transactions
What is the General Ledger?

In the general journal, transactions are recorded by date.

The general ledger summarizes all of the general journal entries, organized by account name. It houses
all assets, liability, owner equity, revenue, expense and owner draw accounts.

To maintain accurate records, every general journal entry must be posted (copied) to the appropriate
account in the general ledger.

Let's post Louie's journal entries into the general ledger.

Remember? A debit entry is recorded on the left or debit side of the "T" account, and a credit entry is
recorded on the right or credit side of the "T" account):
Notice how the total of all the debit columns equals the total of all the credit columns. The general
ledger is in balance.

Check Your Understanding

With the following General Journal create trial balance so that we can prepare the financial statements.
Answer:
Financial Reports
What is a Trial Balance?

The trial balance summarizes all of the account balance from the general ledger.

The amounts on the trial balance are taken from the account balance column in the general ledger.

Here’s the trial balance prepared from Louie’s Landscaping’s general ledger.

Example:
Usually, (but not always) this proves that the general ledger is in balance.

What if the trial balance doesn't balance?

If the trial balance doesn't balance, you must stop and retrace your steps through the recording process.
Errors must be found and corrected before any financial statements are prepared. However, the trial
balance is not a perfect test of the general ledger's accuracy.

Let's look at what errors the trial balance will detect.

Yes:

• A missing debit or credit part of an entry

• Mathematical errors
• Transcription errors (reversed digits)

No:
• Missing journal entries
• Incorrect dollar amounts
• Entries to incorrect accounts

So it's important to verify the accuracy of the accounting records at every stage of the recording
process.
Check Your Understanding
With the following general ledger, create fill in the trial balance:

Answer:
Check Your Understanding
Once we’re sure that our records are accurate, we can use the trial balance to prepare financial
statements.
CHECK BOXES

Check Your Understanding

Using trial balance fill in the financial statements.
Post-Test
Answer the following multiple choice.

1. An account can be used to record the effect of both financial and non-financial transaction.
a) True
b) False
2. “T” accounts have a left side (debit) and right side (credit).
a) True
b) False
3. An entry on the left side (debit) of a “T” account will always result in an increase to the
balance of that account.
a) True
b) False
4. All asset accounts are increased by Debit and decreased by a Credit.
a) True
b) False
5. All liability and owner equity account are increased by a Credit and decreased by a Debit.
a) True
b) False
6. Revenue is normally recorded as:
a) Debits
b) Credits
7. Expenses are normally recorded as:
a) Debits
b) Credits
8. As transactions recorded in the General Ledger must be posted to the General Journal.
a) True
b) False
9. A Trial Balance is prepared from the General Journal.
a) True
b) False
10. Financial Statements should be completed prior to the posting of entries from the general
journal to the general ledger.
a) True
b) False

Answers:

1. False
2. True
3. False
4. True
5. True
6. Credits
7. Debits
 8. False
9. False
10. False

Case Study #2
Instructions: Now, you have a chance to practice everything you've learned in this module, by
handling 20 transactions.

How to move through this case:

1. June 1- Invested $10, 000 cash and $ 4, 000 worth of computer equipment.
2. June 1- Hired an office assistant agreeing to pay them $500 at the middle and end of each
month.
3. June 2- Purchased office furniture for $6,000 paying $1, 000 down as a deposit and agreeing to
pay the remaining $5,000 in 30 days.
4. June 2- Paid rent for the month of June. $2,000
5. June 3- Purchased general office supplies paying cash of $600
6. June 5- Purchased advertising on the local radio station at a cost of $1,200 which is payable in
30 days.
7. June 8 -Consulted with a potential client to discuss the possibility of providing future financial
advice.
8. June 10-Completed work for above client and received $1,800 cash.
9. June 12- Completed work for a client and billed them $1,200.
10. June 15- Paid office assistant $500 salary.
11. June 16- Received full payment from client billed on June 12. $1,200.
12. June 16- Completed work for a client and billed them $1,500.
13. June 18- Completed work for a client and received $400 cash.
14. June 20- Received $1,000 from client billed on June 16.
15. June 22- Placed advertisement in local newspaper at a cost of $500, paid cash.
16. June 24- Paid $2,000 off the amount owing from the office furniture purchased June 2.
17. June 25- Completed work for a client and billed them $700. The client immediately paid $400
and agreed to pay the remaining $300 by the middle of July.
18. June 27- Received a utility bill for the month of June for $200. Allen plans to pay this bill in July.
19. June 29- Allen withdraws $1,500 from the company bank account to pay personal living
expenses.
20. June 30- Paid office assistant $500 salary.

Answers:
 You have completed Recording the Effect of Transactions

Remember to check the timeline before you proceed to the next module to ensure you have completed
any assignments as required. Check with your instructor if you have any questions.