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Prepared by

Coby Harmon
2-1 University of California, Santa Barbara
Copyright ©2015 Pearson Education Inc. All rights reserved.
Westmont College
Learning Objective

1. Explain what a transaction is

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EXPLAIN WHAT A TRANSACTION IS

Transaction
 Any event that has a financial impact on the business
 Can be measured reliably
 Provides information about an exchange
► Something given
► Something received

 Accounting records both sides of a transaction

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LO 1
EXPLAIN WHAT A TRANSACTION IS

Transaction Examples

Whole Foods Market, Inc.

Purchase
Sell product
fresh produce

Borrow money Repay a loan

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LO 1
Learning Objective

2. Define “account,” and list and differentiate


between different types of accounts

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DEFINE “ACCOUNT,” AND LIST AND
DIFFERENTIATE BETWEEN DIFFERENT
TYPES OF ACCOUNTS

Stockholders’
Assets = Liabilities + Equity

Account
 Record of all changes in a particular asset, liability, or
stockholders’ equity during a period
 Basic summary device

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LO 2
Assets
Economic resources that provide a future benefit

Money including bank account balances,


Cash paper currency, coins, certificates of
deposit, and checks

Accounts Promise for future collection of cash from


Receivable the sale of goods or providing services

 Promise for future collection of cash


Notes
Receivable  Customer signed note
 Interest rate

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LO 2
Assets
Economic resources that provide a future benefit

Inventory Goods the company sells to customers

Prepaid Expenses paid in advance, such as


Expenses insurance and rent

Land Cost of land used in operations

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LO 2
Assets
Economic resources that provide a future benefit

Building Cost of buildings used in operations

 Cost of furniture, fixture, and equipment


Equipment,
used in operations
Furniture, and
Fixtures  Includes heating and air conditioning,
computers, and office furniture
 Depreciated

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LO 2
Liabilities
A liability is a debt

Accounts
Promise to pay a debt
Payable

Signed notes promising to pay a future


Notes Payable
amount

Accrued Liability for an expense not yet paid


Liabilities

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LO 2
Stockholders’ (Owners’) Equity
Owners’ claims to the assets of a corporation

Common Owners’ investment in the corporation


Stock through the ownership of stock

Retained Net income (loss) earned over the


Earnings company’s lifetime, minus dividends

 Distribution to stockholders
Dividends
 Declared by board of directors

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LO 2
Stockholders’ (Owners’) Equity
Owners’ claims to the assets of a corporation

Increase in stockholders’ equity from


Revenues
delivering goods or services to customers

Decrease in stockholders’ equity due to


Expenses
the cost of operating the business

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LO 2
Name two things that (1) increase Whole Foods Market,
Inc.’s stockholders’ equity and (2) decrease Whole Foods
Market, Inc.’s stockholders’ equity.

Answer:
(1) Increases in stockholders’ equity: Sale of stock and net
income (revenue greater than expenses).

(2) Decreases in stockholders’ equity: Dividends and net


loss (expenses greater than revenue).

2-13 Advance slide in presentation mode to reveal answers. LO 2


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Learning Objective

3. Show the impact of business transactions on the


accounting equation

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SHOW THE IMPACT OF BUSINESS
TRANSACTIONS ON THE ACCOUNTING
EQUATION
Example: Freddy’s Auto Service, Inc.
To illustrate the accounting for transactions, let’s assume
Freddy Kish opened Freddy’s Auto Service, Inc., in April 2014.

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LO 3
Transaction 1. On April 1, Freddy Kish and a few friends invest $50,000 to
open Freddy’s Auto Service, Inc., in return for common stock.

1. +50,000 +50,000

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LO 3
Transaction 2. Freddy’s purchases land for a new location and pays cash
of $40,000.

1. +50,000 +50,000
2. -40,000 +40,000

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LO 3
Transaction 3. The business buys supplies on account, agreeing to pay
$3,700 within 30 days.

1. +50,000 +50,000
2. -40,000 +40,000
3. +3,700 +3,700

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LO 3
Transaction 4. Freddy’s received $7,000 cash by providing services for
customers.

1. +50,000 +50,000
2. -40,000 +40,000
3. +3,700 +3,700
4. +7,000 Service revenue +7,000

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LO 3
Transaction 5. Freddy’s repairs a fleet of UPS delivery trucks, and UPS
promises to pay Freddy’s $3,000 within one month.

1. +50,000 +50,000
2. -40,000 +40,000
3. +3,700 +3,700
4. +7,000 +7,000
5. +3,000 Service revenue +3,000

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LO 3
Transaction 6. Freddy’s Auto Service, Inc., pays $2,700 for the following
expenses: rent, $1,100; employee salaries, $1,200; and utilities, $400.

1. +50,000 +50,000
2. -40,000 +40,000
3. +3,700 +3,700
4. +7,000 +7,000
5. +3,000 +3,000
6. -2,700 Rent expense - 1,100
Salary expense - 1,200
Utilities expense - 400

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LO 3
Transaction 7. Freddy’s pays $1,900 on account, which means to make a
payment toward an account payable.

1. +50,000 +50,000
2. -40,000 +40,000
3. +3,700 +3,700
4. +7,000 +7,000
5. +3,000 +3,000
6. -2,700 - 2,700
7. -1,900 -1,900

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LO 3
Transaction 8. Freddy Kish, the major stockholder of Freddy’s Auto
Service, paid $30,000 from his personal bank account to remodel his home.

1. +50,000 +50,000
2. -40,000 +40,000
3. +3,700 +3,700
4. +7,000 +7,000
5. +3,000 +3,000
6. -2,700 -2,700
7. -1,900 -1,900

No Entry

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LO 3
Transaction 9. In transaction 5, Freddy’s performed services for UPS on
account. The business now collects $1,000 from UPS.

1. +50,000 +50,000
2. -40,000 +40,000
3. +3,700 +3,700
4. +7,000 +7,000
5. +3,000 +3,000
6. -2,700 -2,700
7. -1,900 -1,900
9. +1,000 -1,000

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LO 3
Transaction 10. Freddy’s receives $22,000 from the sale of land, which is
the same amount that Freddy’s paid for the land.

1. +50,000 +50,000
2. -40,000 +40,000
3. +3,700 +3,700
4. +7,000 +7,000
5. +3,000 +3,000
6. -2,700 -2,700
7. -1,900 -1,900
9. +1,000 -1,000
10. +22,000 -22,000

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LO 3
Transaction 11. Freddy’s Auto Service, Inc., declares a dividend and pays
the stockholders $2,100 cash.

1. +50,000 +50,000
2. -40,000 +40,000
3. +3,700 +3,700
4. +7,000 +7,000
5. +3,000 +3,000
6. -2,700 -2,700
7. -1,900 -1,900
9. +1,000 -1,000
10. +22,000 -22,000
11. -2,100 Dividends -2,100

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LO 3
Financial Statements
Exhibit 2-2 | Financial Statements of Freddy’s Auto Service, Inc.

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LO 3
Financial Statements
Exhibit 2-2 | Financial Statements of Freddy’s Auto Service, Inc.

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LO 3
Financial Statements
Exhibit 2-2 | Financial Statements of Freddy’s Auto Service, Inc.

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LO 3
Illustration
Dr. Luke opened a medical practice specializing in physical
therapy. During the first month of operation (February), the
business, titled Dr. Luke, Professional Corporation (P.C.),
experienced several events.

Requirement
Analyze the effects of the following events on the accounting
equation of the medical practice of Dr. Luke, P.C.

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LO 3
Feb. 1 Dr. Luke invested $100,000 in the business in return for
common stock.

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Feb. 5 The business borrowed $50,000, signing a note payable to
the bank.

2-32 LO 3
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Feb. 8 The business paid cash for land costing $105,000. Luke
plans to build an office building on the land.

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LO 3
Feb. 11 The business purchased medical supplies for $1,700 on
account.

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LO 3
Feb. 12 Dr. Luke, P.C., officially opened for business.

No Entry

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LO 3
Feb. 14 Dr. Luke treated patients and earned service revenue of
$5,600, receiving cash for half the revenue earned.

Service Revenue

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LO 3
Feb. 16 The business paid employee salaries of $2,300 for the first
half of the month.

Salaries Expense

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LO 3
Feb. 25 Dr. Luke treated patients and received $1,500 cash at the
time of service.

Service Revenue

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LO 3
Feb. 28 The business paid office rent of $1,000.

Rent Expense

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LO 3
Feb. 28 The business paid $500 on account.

$155,500 $155,500

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LO 3
Illustration
Requirements
Using the data from the transaction analysis of the medical practice
of Dr. Luke, P.C., answer the following questions.
a. How much are total assets?
b. How much does the business expect to collect from patients?
c. How much does the business owe in total?
d. How much of the business’s assets does Luke really own?
e. How much net income or net loss did the business
experience during its first month of operations?

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LO 3
a. How much are total assets?

$ 155,000

$155,000 $155,000

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LO 3
b. How much does the business expect to collect from
patients?

$ 2,800

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LO 3
c. How much does the business owe in total?

$ 51,200

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LO 3
d. How much of the business’s assets does Luke
really own?

$ 103,800

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LO 3
e. How much net income or net loss did the business
experience during its first month of operations?

$ 3,800

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LO 3
Learning Objective

4. Analyze the impact of business transactions on


accounts

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ANALYZE THE IMPACT OF BUSINESS
TRANSACTIONS ON ACCOUNTS

Accounting
 Double-entry system
 Each transaction affects at least two accounts

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LO 4
The T-Account
 Record of increases and decreases in
a specific asset, liability, equity,
Account
revenue, or expense element
 Debit = “Left”
 Credit = “Right”

An Account can
be illustrated in a
T-Account form

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LO 4
Increases and Decreases in the Accounts:
The Rules of Debit and Credit
Exhibit 2-3 | Accounting Equation and the Rules of Debit and Credit

The type of account determines how to record


increases and decreases.

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LO 4
Increases and Decreases in the Accounts:
The Rules of Debit and Credit
To illustrate, Freddy’s Auto Service, Inc., received $50,000 and
issued (gave) stock. What is the effect on the accounts?

Cash Common Stock


Debit for Credit for
increase, increase,
50,000 50,000

Exhibit 2-4 | The Accounting


Equation after Freddy’s Auto
Service’s First Transaction

2-51 LO 4
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Freddy’s’ second transaction is a $40,000 cash purchase of
land. What is the effect on the accounts?

Cash Common Stock


Bal 50,000 Credit for Bal 50,000
decrease,
40,000
Bal 10,000

Exhibit 2-5 | The Accounting


Equation after Freddy’s Auto
Land Service’s First Two Transactions

Debit for
increase,
40,000
Bal 40,000

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LO 4
Additional Stockholders’ Equity Accounts:
Revenues and Expenses

Two categories of income statement accounts

Increase in stockholders’ equity from


Revenues
delivering goods or services to customers

Decrease in stockholders’ equity due to


Expenses
the cost of operating the business

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LO 4
Additional Stockholders’ Equity Accounts:
Revenues and Expenses

Exhibit 2-6 | Expansion of the Accounting Equation


+
Common Stock
Assets Liabilities
+
Retained Earnings

-
Dividends
Stockholders’
Equity +
Revenues

-
Expenses

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LO 4
Final Form of the Rules of Debit and Credit

Exhibit 2-7

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LO 4
Final Form of the Rules of Debit and Credit

Exhibit 2-7

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LO 4
Learning Objective

5. Record (journalize and post) transactions in the


books

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RECORD (JOURNALIZE AND POST)
TRANSACTIONS IN THE BOOKS

Journal
 Chronological record of transactions
 Three steps
1. Specify each account affected by the transaction and
classify by type

2. Determine if each account is increased or decreased


(debit or credit)

3. Record in the journal

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LO 5
RECORD (JOURNALIZE AND POST)
TRANSACTIONS IN THE BOOKS
Steps to journalize the first transaction of Freddy’s Auto Service
Step 1 Business receives $50,000 cash and issues stock

Step 2 Both Cash and Common Stock increase

Step 3 Journalize the transaction:

A B C D
1 Date Accounts and Explanations Debit Credit
2 Apr 1 Cash 50,000
3 Common Stock 50,000
4 Issued common stock.

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LO 5
Individual
asset
accounts

Individual
liability
accounts

Individual
equity
accounts

Exhibit 2-8 | The Ledger (Asset, Liability, and


Stockholders’ Equity Accounts)
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LO 5
Copying Information (Posting) from the
Journal to the Ledger Exhibit 2-9 | Journal Entry
and Posting to the Accounts

A B C D
1 Date Accounts and Explanations Debit Credit
2 Apr 1 Cash 50,000
3 Common Stock 50,000
4 Issued common stock.

Cash Common Stock


Posting
to the
Accounts
50,000 50,000

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LO 5
The Flow of Accounting Data

Transaction Occurs

Transaction Analyzed

Transaction Entered in the Journal

Amounts Posted to the Ledger


Accounts

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LO 5
Transactions from Freddy’s Auto Service
(1) Received $50,000 cash and issued stock to the owners

Accounting Assets = Liabilities + Stockholders’ Equity


Equation
+ 50,000 + 50,000

Journal A B C
Entry 1 Cash 50,000
2 Common Stock 50,000

Ledger Cash Common Stock


Accounts
(1) 50,000 (1) 50,000

2-63 Advance slide in presentation mode to reveal answers LO 5


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Transactions from Freddy’s Auto Service
(2) Paid $40,000 cash for land

Accounting Assets = Liabilities + Stockholders’ Equity


Equation
+ 40,000
- 40,000

Journal A B C
Entry 1 Land 40,000
2 Cash 40,000

Ledger Cash Land


Accounts
(1) 50,000 (2) 40,000 (2) 40,000

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LO 5
Transactions from Freddy’s Auto Service
(3) Purchased supplies for $3,700 on account

Accounting Assets = Liabilities + Stockholders’ Equity


Equation
+ 3,700 + 3,700

Journal A B C
Entry 1 Supplies 3,700
2 Accounts Payable 3,700

Ledger Supplies Accounts Payable


Accounts
(3) 3,700 (3) 3,700

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LO 5
Transactions from Freddy’s Auto Service
(4) Performed services for clients and received cash of $7,000

Accounting Assets = Liabilities + Stockholders’ Equity + Revenues


Equation
+ 7,000 + 7,000

Journal A B C
Entry 1 Cash 7,000
2 Service Revenue 7,000

Ledger Cash Service Revenue


Accounts
(1) 50,000 (2) 40,000 (4) 7,000
(4) 7,000
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LO 5
Transactions from Freddy’s Auto Service
(5) Performed services for a customer on account, $3,000

Accounting Assets = Liabilities + Stockholders’ Equity + Revenues


Equation
+ 3,000 + 3,000

Journal A B C
Entry 1 Accounts Receivable 3,000
2 Service Revenue 3,000

Ledger Accounts Receivable Service Revenue


Accounts
(5) 3,000 (4) 7,000
(5) 3,000
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LO 5
Transactions from Freddy’s Auto Service
(6) Paid cash expenses: rent, $1,100; employee salary, $1,200;
utilities, $400

Accounting Assets = Liabilities + Stockholders’ Equity - Expenses


Equation
- 2,700 - 2,700

Journal A B C
Entry 1 Rent Expense 1,100
2 Salary Expense 1,200
3 Utilities Expense 400
4 Cash 2,700

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LO 5
Transactions from Freddy’s Auto Service
(6) Paid cash expenses: rent, $1,100; employee salary, $1,200;
utilities, $400

Journal A B C
Entry 1 Rent Expense 1,100
2 Salary Expense 1,200
3 Utilities Expense 400
4 Cash 2,700

Rent Salary Utilities


Cash Expense Expense Expense
(1) 50,000 (2) 40,000 (6) (6) (6)
(4) 7,000 (6) 2,700
1,100 1,200 400
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LO 5
Transactions from Freddy’s Auto Service
(7) Paid $1,900 on the account payable created in transaction 3

Accounting Assets = Liabilities + Stockholders’ Equity


Equation
- 1,900 - 1,900

Journal A B C
Entry 1 Accounts Payable 1,900
2 Cash 1,900

Ledger Cash Accounts Payable


Accounts
(1) 50,000 (2) 40,000 (7) 1,900 (3) 3,700
(4) 7,000 (6) 2,700
(7) 1,900
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LO 5
Transactions from Freddy’s Auto Service
(9) Received $1,000 on account

Accounting Assets = Liabilities + Stockholders’ Equity


Equation + 1,000
- 1,000

Journal A B C
Entry 1 Cash 1,000
2 Accounts Receivable 1,000

Ledger Cash Accounts Receivable


Accounts
(1) 50,000 (2) 40,000 (5) 3,000 (9) 1,000
(4) 7,000 (6) 2,700
(9) 1,000 (7) 1,900
2-71 LO 5
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Transactions from Freddy’s Auto Service
(10) Sold land for cash at the land’s cost of $22,000

Accounting Assets = Liabilities + Stockholders’ Equity


Equation + 22,000
- 22,000

Journal A B C
Entry 1 Cash 22,000
2 Land 22,000

Ledger Cash Land


Accounts
(1) 50,000 (2) 40,000 (2) 40,000 (10) 22,000
(4) 7,000 (6) 2,700
(9) 1,000 (7) 1,900
(10) 22,000
2-72 LO 5
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Transactions from Freddy’s Auto Service
(11) Declared and paid a dividend of $2,100 to the stockholders

Accounting Assets = Liabilities + Stockholders’ Equity - Dividends


Equation
- 2,100 - 2,100

Journal A B C
Entry 1 Dividends 2,100
2 Cash 2,100

Ledger Cash Dividends


Accounts
(1) 50,000 (2) 40,000 (11) 2,100
(4) 7,000 (6) 2,700
(9) 1,000 (7) 1,900
(10) 22,000 (11) 2,100
2-73 LO 5
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Accounts after Posting to the Ledger
Exhibit 2-11 | Freddy’s Auto Service, Inc.’s Ledger Accounts after Posting

2-74 LO 5
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Accounts
after
Posting to
the Ledger

Exhibit 2-11 | Freddy’s


Auto Service, Inc.’s
Ledger Accounts after
Posting (partial)

2-75
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Accounts
after
Posting to
the Ledger

Exhibit 2-11 | Freddy’s


Auto Service, Inc.’s
Ledger Accounts after
Posting (partial)

2-76
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Illustration
Architect Wendy Lim purchased supplies on account for $5,000.
Later Wendy paid $1,400 on account. Journalize the two
transactions on the books of Wendy Lim, architect.

Account Debit Credit


Supplies 5,000
Accounts Payable 5,000

Accounts Payable 1,400


Cash 1,400

2-77 LO 5
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Post the journal entries to
Illustration T-accounts

Account Debit Credit


Journal Supplies 5,000
Entries Accounts Payable 5,000

Accounts Payable 1,400


Cash 1,400

Cash Supplies Accounts Payable

1,400 5,000 1,400 5,000

2-78 LO 5
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Illustration

Account Debit Credit


Journal Supplies 5,000
Entries Accounts Payable 5,000

Accounts Payable 1,400


Cash 1,400

Cash Supplies Accounts Payable

1,400 5,000 1,400 5,000


Bal 3,600

How much does the business owe?


2-79 LO 5
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Learning Objective

6. Construct and use a trial balance

2-80
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CONSTRUCT AND USE A TRIAL BALANCE
Trial Balance
 Lists all accounts with their balances
 Assets listed first, then liabilities and stockholders’
equity
 Shows that debits equal credits
 Usually prepared at the end of the period
 Facilitates preparation of the financial statements

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LO 6
Analyzing Accounts
Suppose Freddy’s Auto Service began May with cash of
$1,000. During May, Freddy’s received cash of $8,000 and
ended the month with a cash balance of $3,000.

You can compute total cash payments by analyzing Freddy’s


Cash account:
Cash
Beginning balance
Cash receipts Cash payments *
1,000
Ending balance
8,000 6,000

3,000
* 1,000 + 8,000 - 3,000 = 6,000
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LO 6
Analyzing Accounts
You can compute either sales on account or cash collections
on account by analyzing the Accounts Receivable account
(using assumed amounts):

Accounts Receivable
Beginning balance
Sales on account Collections on account *
6,000
Ending balance
10,000 11,000

5,000
* 6,000 + 10,000 - 5,000 = 11,000

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LO 6
Analyzing Accounts
You can determine how much you paid on account by
analyzing Accounts Payable (using assumed amounts):

Accounts Payable
Beginning balance
Payments on account * Purchases on account
9,000
4,000 Ending balance
6,000

11,000
* 9,000 + 6,000 - 11,000 = 4,000

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LO 6
Correcting Accounting Errors

• Trace each account from journal to


Missing account
ledger

Divide out-of- • Reversing debits and credits doubles


balance amount
by 2 the error

Divide out-of- • If an integer (no decimals), error may be


balance amount
by 9 a slide or transposition

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LO 6
Chart of Accounts
Exhibit 2-13 | Chart of Accounts—Freddy’s Auto Service, Inc.

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LO 6
The Normal Balance of an Account
Exhibit 2-14 | Normal Balances of the Accounts

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LO 6
Account Formats
Two Formats:
 T-account
 Four column
Exhibit 2-15 | Account in Four-Column Format

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LO 6
Analyzing Transactions Using Only
T-Accounts
 Decisions often are made without a complete
accounting system
 T-accounts allow managers to analyze transactions
quickly

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LO 6
Analyzing Transactions Using T-Accounts
For example, the managers of Whole Foods Market, Inc.,
may consider borrowing $100,000 to buy equipment. To see
how the two transactions affect Whole Foods Market, Inc., the
manager can go directly to T-accounts.

(a) Borrow Cash

(b) Buy Equipment (a) 100,000 (b) 100,000

Equipment Note Payable


(b) 100,000 (a) 100,000

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LO 6
Copyright

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