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I. Analyzing and Recording Process
A. Accounting process identifies business transactions and events, analyzes and records their effects, and summarizes and presents information in reports and financial statements. Steps in accounts process that focus on analyzing and recording transactions and events are: (1) record relevant transactions and events in a journal, (2) post journal information to ledger accounts, and (3) prepare and analyze the trial balance. Accounting records are informally referred as the accounting books, or simply the books. B. Source documents identify and describe transactions and events Source documents are sources of accounting information (hard copy or electronic form). Examples are sales tickets, checks, purchase orders, bills from suppliers, employee earnings records, and bank statements. Source documents provide objective and reliable evidence about transactions and events.
C. An account is a record of increases and decreases in a specific asset, liability, equity, revenue, or expense item. The general ledger, or ledger, is a record containing all accounts used by a company. D. Accounts are arranged in three basic categories based on the accounting equation. A separate accounts is kept for each of the following:
1. Asset Accounts—resources owned or controlled by a company that have expected future benefits; examples include Cash, Accounts Receivable, Note Receivable, Prepaid Accounts, Supplies, Equipment, Buildings, and Land. 2. Liability Accounts—claims by creditors against assets; obligations to transfer assets or provide products or service to other entities; examples include Accounts Payable, Note Payable, Unearned Revenue, and Accrued Liabilities. 3. *Equity Accounts*—owner’s residual interest in the assets of the business after deducting liabilities; examples include Common Stock, Dividends, Revenues and Expenses.
II. Analyzing and Processing Transactions
A. Ledger and Chart of Accounts 1. A ledger (or general ledger) is the sum of all the accounts a company uses. 2. The chart of accounts is a list of all the accounts in the ledger with their identification numbers.

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B. Debits and Credits
1. A T-account represents a ledger account and is used to understand the effects of one or more transactions. 2. The left side of an account is called the debit side. A debit is an entry on the left side of an account. 3. The right side of an account is called the credit side. A credit is an entry on the right side of an account.
4. Whether a debit or a credit is an increase or decrease depends on the account. 5. In an account where a debit is an increase, the credit is a decrease. In an account where a credit is an increase, the debit is a decrease. 6. The account balance is the difference between the total debits and the total credits recorded in an account.
C. Double-Entry Accounting
1. Total amount that is debited to accounts must equal the total amount credited to accounts for each transaction. Sum of debit account balances in the ledger must equal the sum of credit account balances. 2. Assets are on the left side of the equation; therefore, the left, or debit, side is the normal balance side for assets. 3. Liabilities and equities are on the right side; therefore, the right, or credit, side is the normal balance side for liabilities and equity. 4. Equity increases from revenues and stock issuances and it decreases from expenses and dividends. Increases (credits) to common stock and revenues increase equity; increases (debits) to dividends and expenses decrease equity.
5. The normal balance of each account (assets, liability, common stock, dividends, revenue, or expense) refers to the left or right (debit or credit) side where increases are recorded.
D. Journalizing and Posting Transactions 1. A journal gives a complete record of each transaction in one place; it shows the debits and credits for each transaction. The process of recording each transaction in a journal is called journalizing. The process of transferring journal entry information to the ledger is called posting. 2. The general journal can be used to record any type of transaction. Steps for recording entries in a general journal: a. Date the transaction; enter the year at the top of the first column and the month and day on the first line of each journal entry.

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b. Enter titles of accounts debited (account titles are taken from the chart of accounts and aligned with the left margin of the column), and then enter amounts in the Debit column on the same line. c. Enter titles of accounts credited (account titles are taken from the chart of accounts and indented from the left margin of the column to distinguish them from debited accounts), and then enter amounts in the Credit column on the same line. d. Enter a brief explanation of the transaction on the line below the entry. 3. A blank line is left between each journal entry for clarity. 4. When a transaction is first recorded, the posting reference (PR) column is left blank (in a manual system); later, when posting entries to the ledger, the identification numbers of the individual ledger accounts are entered in the PR column.
5. T-accounts are simple and direct means to show how the accounting process works; however, actual accounting systems need more structure and therefore use balance column accounts. The balance column account format is similar to a T-account in having columns for debits and credits; it is different in including date and explanation columns.
6. The heading of the Balance column does not show whether it is a debit or credit balance; instead, an account is assumed to have a normal balance (that is, the side where increases are recorded). Unusual events can temporarily give an account an abnormal balance (that is, the side where decreases are recorded). 7. To ensure the ledger is up-to-date, entries are posted as soon as possible using the following steps:
a. First, identify the ledger account that is debited in the entry; then, in the ledger, enter the date, the journal and page in its PR column, the debit amount, and the new balance of the ledger accounts. b. Second, enter the ledger account number in the PR column of the journal. c. Steps three and four repeat the first two steps for credit entries and amounts.

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E. Analyzing Transactions – An Illustration
The illustrations below follow the four steps in processing transactions. Each transaction is analyzed in terms of its effect on the accounting equation, double-entry accounting is used to record the transaction in journal entry form, and the financial statements affected by each transaction are identified. (The following abbreviations are used for the financial statements: IS for income statement, BLS for balance sheet, SCF for statement of cash flows, and SRE for statement of retained earning.) The first eleven transactions are from Chapter 1; five additional transactions are included.
Transaction 1: Investment by owner Analysis: + Assets (Cash) = + Equity (Common Stock) Double entry: Debit Cash and credit Common Stock Statements affected: BLS and SCF
Transaction 2: Purchase supplies for cash Analysis: +Assets (Supplies) = – Assets (Cash) Double entry: Debit Supplies and credit Cash Statements affected: BLS and SCF
Transaction 3: Purchase equipment for cash Analysis: + Assets (Equipment) = – Assets (Cash) Double entry: Debit Equipment and credit Cash Statements affected: BLS and SCF
Transaction 4: Purchase supplies on credit Analysis: +Assets (Supplies) = + Liability (Account Payable) Double entry: Debit Supplies and credit Accounts Payable Statements affected: BLS
Transaction 5: Provide services for cash Analysis: + Assets (Cash) = + Equity (Revenues) Double entry: Debit Cash and credit Revenue (type of revenue would be identified in account name) Statements affected: BLS, IS, SCF, and SRE

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Transactions 6 and 7: Payment of expenses in cash Analysis: - Assets (Cash) = – Equity (Expenses) Double entry: Debit Expenses (type of expense would be identified in account name) and credit Cash Statements affected: BLS, IS, SCF, and SRE
Transaction 8: Provide services and facilities for credit Analysis: + Assets (Accts Receivable) = + Equity (Revenues) Double entry: Debit Accounts Receivable and credit Revenue (type of revenue would be identified in account name) Statements affected: BLS, IS, SCF, and SRE
Transaction 9: Receipt of cash from accounts receivable Analysis: + Assets (Cash) = – Assets (Accounts Receivable) Double entry: Debit Cash and credit Accounts Receivable Statements affected: BLS and SCF
Transaction 10: Payment of accounts payable Analysis: – Assets (Cash) = – Liability (Accounts Payable) Double entry: Debit Accounts Payable and credit Cash Statements affected: BLS and SCF
Transaction 11: Payment of cash dividend Analysis: – Assets (Cash) = – Equity (Dividends) Double entry: Debit Dividends and credit Cash Statements affected: BLS, SCF, and SRE
Transaction 12: Receipts of cash from a customer for future services Analysis: + Assets (Cash) = + Liabilities (Unearned Revenue) Double entry: Debit Cash and credit Unearned Revenue (type of unearned revenue is often identified in account name) Statements affected: BLS and SCF

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Transaction 13: Pay cash for future insurance coverage Analysis: – Assets (Cash) = + Assets (Prepaid Insurance) Double entry: Debit Prepaid Insurance and credit Cash Statements affected: BLS and SCF
Transaction 14: Purchase supplies for cash Analysis: + Assets (Supplies) = + Assets (Supplies) Double entry: Debit Supplies and credit Cash Statements affected: BLS and SCF
Transactions 15 and 16: Payment of expenses in cash Analysis: – Assets (Cash) = – Equity (Expenses) Double entry: Debit Expense (type of expense would be identified in account name) and credit Cash Statements affected: BLS, IS, SCR, and SRE
III. Trial Balance
A. Preparing a Trial Balance 1. A trial balance is a list of accounts and their balances at a point in time. 2. The three steps to prepare a trial balance are as follows: a. List each account and its amount (from the ledger), b. Compute the total debit balances and the total credit balances, and c. Verify (prove) total debit balances equal total credit balances. B. Searching for and Correcting Errors 1. If a trial balance does not balance (the columns are not equal), the error(s) must be found and corrected. Find the errors by checking the following:
a. Verify that the trial balance columns are correctly added. b. Verify that the account balances are accurately entered from the ledger. c. See whether a debit (or credit) balance is mistakenly listed in the trial balance as a credit (or debit). d. Recompute each account balance in the ledger. e. Verify that each journal entry is properly posted. f. Verify that the original journal entry has equal debits and credits.

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2. If an error in a journal entry is discovered before the entry is posted, it can be corrected in a manual system by drawing a line through the incorrect information and writing in the correct information.

3. If an error in a journal entry is not discovered until after it is posted, a correcting entry that removes the amount from the wrong account and records it to the correct account should be journalized and posted.

C. Using a Trial Balance to Prepare Financial Statements

The statements prepared in this chapter are called unadjusted statements because further account adjustments need to be made (as described in chapter 3).

1. A balance sheet reports on an organization’s financial position at a point in time. The income statement, statement of retained earnings, and statement of cash flows report on financial performance over a period of time.

2. A one-year, or annual, reporting period is known as the accounting, or fiscal, year. A business whose accounting year begins on January 31 and ends on December 31 is known as a calendar-year company. A company that chooses a fiscal year ending on a date other than December 31 is known as a noncalendar-year company.

3. Income Statement—reports the revenues earned less the expenses incurred by a business over a period of time.

4. Statement of Retained Earnings—reports information about how retained earnings changes over the accounting period.

5. Balance Sheet—reports the financial position of a company at a point in time, usually at the end of a month, quarter, or year. The account form of the balance sheet reports assets on the left and liabilities and equity on the right. The report form of the balance sheet reports assets on the top and liabilities and equity on the bottom.

6. Presentation Issues:

a. Dollar signs are not used in journals and ledgers; they do appear in financial statements and other reports such as the trial balance. The usual practice is to put dollar signs beside only the first and last numbers in a column.

b. Companies commonly round amounts in reports to the nearest dollar, or even to a higher level.

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IV. Decision Analysis—Debt Ratio

A. A company that finances a relatively large portion of its assets with liabilities has a high degree of financial leverage. Higher financial leverage involves greater risk because liabilities must be repaid and often require regular interest payments (equity financing does not). The risk that a company might not be able to meet such required payments is higher if it has more liabilities (is more highly leveraged).

B. One way to assess the risk associated with a company’s use of liabilities is to compute the debt ratio.

1. It is calculated as total liabilities divided by total assets.

2. It tells us how much (what percentage) of the assets are financed by creditors (non-owners) or liability financing; the higher the debt ratio, the more risk a company faces from its financial leverage.