PAMANTASAN NG LUNGSOD NG VALENZUELA STEP 1: TRANSACTION ANALYSIS

College of Accountancy
FINANCIAL ACCOUNTING AND REPORTING (FAR1)
Lecture 03: Accounting Cycle (Steps 1-4)
The analysis of transactions should follow these four basic steps:
1. Identify the transaction from source documents.
2. Indicate the accounts – either assets, liabilities, equity, income or expenses – affected by
the transaction.
3. Ascertain whether each account is increased or decreased by the transaction.
4. Using the rule of debit and credit, determine whether to debit or credit the account to
record its increase or decrease.

Source Documents
Source document identify and describe transactions and events entering the accounting
process. These original written evidences contain information about the nature and the
amounts of the transaction. These are the bases for the journal entries; some of the more
common documents are sales invoices, cash register tapes, official receipts, bank deposit
slips, bank statements, checks, purchase orders, time cards and statements of account.

Rule of Debit and Credit

To debit an account means to enter an amount to the left side of the account and to credit
an account means to enter an amount to the right side. The abbreviations for debit and
credit are Dr. (from the Latin debere) and Cr. (from the Latin credere).

Normal Balance of an Account

The normal balance of an account refers to the side of the account – debit or credit –
where increases are recorded. The following are the normal balance of each element of
financial statement:

Normal Balance
Account Category
Debit Credit
Asset 
Liabilities 
Owner’s Equity:
Owner’s Capital 
Withdrawals 
Income 
Expenses 

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STEP 2: TRANSACTIONS ARE JOURNALIZED
After the transaction or event has been identified and measured, it is recorded in the journal. The steps in preparing journal entries are as follows:
The process of recording a transaction is called journalizing. 1. Put the date of the transaction in the corresponding column. Remember that the year
and month are not written for every entry unless the year or month changes or a new
The Journal
page is needed.
The journal is a chronological record of the entity’s transactions. A journal entry shows
2. Analyze the transaction and determine the account titles that will be affected by the
all the effects of a business transaction in terms of debits and credits. Each transaction is
transaction. Determine also the effect (increase or decrease) of the transaction in
initially recorded in a journal rather than directly in the ledger. A journal is called the
respective account titles.
book of original entry. The nature and volume of transactions of the business determine
3. Apply the rules of debit and credit to know which account title is to be debited and
the number and type of journals needed.
credited respectively.
4. Record first the account title to be debited in the left most part of the Account Titles
Format
and Explanation column and write its corresponding amount in the Debit column (use
The standard contents of the general journal are as follows:
properly the money column). Record next the account title to be credited with slight
1. Date. The year and month are not written for every entry unless the year or month
indention in the Account Titles and Explanation column and write its corresponding
changes or a new page is needed.
amount in the Credit column (use properly the money column).
2. Account Titles and Explanation. The account to be debited Is entered at the
5. Write a brief explanation in the line after the last account title credited with slight
extreme left of the first line while the account to be credited is entered slightly
indention as well.
indented on the next line. A brief description of the transaction is usually made on the
6. A line is left blank before entering another transaction in the journal.
line below the credit. Generally, skip a line after each entry.
3. P.R. (posting reference). This will be used when the entries are posted, that is, until
Note that the rules of double-entry system are observed in each transaction:
the amounts are transferred to the related edger accounts. The posting process will be
1. Two or more accounts are affected by each transaction.
described later.
2. The sum of the debits for every transaction equals the sum of the credits.
4. Debit. The debit amount for each account is entered in this column.
3. The equality of the accounting equation is always maintained.
5. Credit. The credit amount of each account is entered in this column.

STEP 3: POSTING
Posting means transferring the amounts from the journal to the appropriate accounts in the
ledger. Debits in the journal are posted as debits in the ledger, and credits in the journal as
credits in the ledger. The steps for posting journal entries to ledger are as follows:
1. Transfer the date of the transaction from the journal to the ledger.
2. Transfer the page number from the journal to the journal reference (J.R.) column of
the ledger.
Simple and Compound Entry 3. Post the debit figure from the journal as the debit figure in the ledger and the credit
In a simple entry, only two accounts are affected – one account is debited and the other figure from the journal as a credit figure in the ledger.
account is credited. When three or more accounts are required in a journal entry, the entry 4. Enter the account number in the posting reference (P.R.) column of the journal once
is referred to as a compound entry. the figure has been posted to the ledger.
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 The Ledger
A grouping of the entity’s accounts is referred to as a ledger. Although some firms may
use various ledgers to accumulate certain detailed information, all firms have a general
ledger. A general ledger is the “reference book” of the accounting system and is used to
classify and summarize transactions, and to prepare data for basic financial statements.

The accounts in the general ledger are classified into two general groups:
1. Balance sheet or permanent accounts (assets, liabilities and owner’s equity)
2. Income statement or temporary accounts (income and expenses). Temporary or
nominal accounts are used to gather information for a particular accounting period.
At the end of the period, the balances of these accounts are transferred to permanent
owner’s equity account.
Chart of Accounts
It contains the listing of all the accounts and their account numbers in the ledger. The
chart is arranged in the financial statement order, that is, assets first, followed by
liabilities, equity, income and expenses. The accounts should be numbered in a flexible
manner to permit indexing and cross-referencing.

Each account has its own record in the ledger. Every account in the ledger maintains the When analyzing transactions, the accountant refers to the chart of accounts to identify the
basic format of the T-account but offers more information (e.g. the account number at the pertinent accounts to be increase or decreased. If an appropriate account title is not listed
upper right corner and the journal reference column). Compared to a journal, a ledger in the chart, an additional account may be added.
organizes information by account.

Two-Column Ledger (T-Account Ledger)

Three-Column Ledger (Running Balance Ledger)

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STEP 4: TRIAL BALANCE
The trial balance is a list of all accounts with their respective debit or credit balances. It is
prepared to verify the equality of debits and credits in the ledger at the end of each
accounting period or at any time the postings are updated.
The procedures in the preparation of a trial balance follow:
1. List the account title in numerical order.
2. Obtain the account balance of each account from the ledger and enter the debit balance in
the debit column and the credit balances in the credit column.
3. Add the debit and credit.
4. Compare the totals.
The trial balance is a control device that helps minimize accounting errors. When the totals
are equal, the trial balance is in balance. This equality provides an interim proof of the
accuracy of the records but it does not signify the absence of errors. For example, if the
bookkeeper failed to record payment of rent, the trial balance columns are equal but in reality,
the accounts are incorrect since expense is understated and cash is overstated.
Locating Errors
An inequality in the totals of the debits and credits would automatically signal the presence of
an error. These errors include:
1. Error in posting a transaction in the ledger:
 An erroneous amount was posted to the account.
 A debit entry was posted as a credit or vice versa.
 A debit or credit posting was omitted.
2. Error in determining the account balances:
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 A balance was incorrectly computed.
 A balance was entered in the wrong balance column.
3. Error in preparing the trial balance:
 One of the columns of the trial balance was incorrectly added.
 The amount of an account balance was incorrectly recorded on the trial balance.
 A debit balance was recorded on the trial balance as a credit or vice versa, or a
balance was omitted entirely.
What is the most efficient approach in locating an error? The following procedure when done
in sequence may save considerable time and effort in locating errors:
1. Prove the addition of the trial balance by adding these columns in the opposite direction.
2. If the error does not lie in addition, determine the exact amount by which the trial balance
is out of balance. The amount of the discrepancy is often a clue to the source of error. If
the discrepancy is divisible by 9, this suggests either a transposition (reversing the order
of numbers) error or a side (moving of the decimal point). You can also get the half of the
amount of discrepancy in the columns of debit or credit which may suggest that you put
the amount in the wrong side of the trial balance (e.g. debit balance is written in the credit
column).
3. Compare the accounts and amounts in the trial balance with that in the ledger. Be certain
that no account is omitted.
4. Recompute the balance of each ledger account.
5. Trace all postings from the journal ledger accounts. As this is done, place a check mark
in the journal and in the ledger after each figure is verified. When the operation is
completed, look through the journal and ledger for unchecked amounts. In tracing
posting, be alert not only for errors in amount but also for debits entered as credits, vice
versa.
Errors not Detected by a Trial Balance
1. Failure to record or post a transaction.
2. Recording the same transaction more than once.
3. Recording the entry but with the same erroneous debit and credit amounts.
4. Posting a part of a transaction correctly as a debit or credit but to the wrong account.
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