Analyzing Business Transactions

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Analyzing Business Transactions

Business Transaction Analysis

Analyzing and Processing Transactions


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Source documentsinvoices, receipts, checks, or contracts usually support the

details of a transaction.

For each transaction, we follow these steps:

1. State the transaction.

2.

Analyze the transaction to determine which accounts are affected.

3.

Apply the rules of double-entry accounting by using T-accounts to show how the

transaction affects the accounting equation. It is important to note that this step

is not part of the accounting records but is undertaken beforerecording a

transaction in order to understand the effects of the transaction on the

accounts.


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4.

Show the transaction injournal form.

Thejournal formis a way of recording a transaction with the date, debit account, and debit

amount shown on one line, and the credit account (indented) and credit amount on the next

line.

The amounts are shown in their respective debit and credit columns.

This step represents the initial recording of a transaction in the records and takes the followingform:

A series of transactions in this form results in a chronological record of the transactions called a

general journal (book of original entry).

Periodically, each debit and credit in an entry is transferred to its appropriate account in a list of

accounts called the general ledger (book of final entry).

5. Provide a short description of each journal entry that will help explain the nature

of the transaction.

Presently, this practice has become optional for experienced accountants.

Sample:

Economic events for the first month operation of a small firm named Miller Design Studio.

July 1:Joan Miller invests $40,000 in cash to form Miller Design Studio.

July 2: Orders office supplies, $5,200.

July 3: Rents an office; pays two months rent in advance, $3,200.

July 5: Receives office supplies ordered on July 2 and an invoice for $5,200.

July 6: Purchases office equipment, $16,320; pays $13,320 in cash and agrees to pay the rest

next month.

July 9: Makes a partial payment of the amount owed for the office supplies received on July 5,

$2,600.

July 10: Performs a service for an investment advisor by designing a series of brochures and

collects a fee in cash, $2,800.


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July 15: Performs a service for a department store by designing a TV commercial; bills for the

fee now but will collect the fee later, $9,600.

July 19: Accepts an advance fee as a deposit on a series of brochures to be designed, $1,400.

July 22: Receives cash from customer previously billed on July 15, $5,000.

July 26: Pays employees four weeks wages, $4,800.

July 30: Receives, but does not pay, the utility bill that is due next month, $680.

July 31: Withdraws $2,800 in cash.

Solution:

July 1:Joan Miller invests $40,000 in cash to form Miller Design Studio.

Analysis:

An owners investment in the business increasesthe asset account Cash with a debit and

increasesthe owners equity account J. Miller, Capital with a credit.

July 2: Orders office supplies, $5,200.

Analysis:

When an economic event does not constitute a business transaction, no entry is made.

In this case, there is no confirmation that the supplies have been shipped or that title has passed.

July 3: Rents an office; pays two months rent in advance, $3,200.

Analysis: The prepayment of office rent in cash increasesthe asset account Prepaid Rent

with a debit and decreasesthe asset account Cash with a credit.


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Note:

A prepaid expense is an asset because the expenditure will benefit future operations.

This transaction does not affect the totals of assets or liabilities and owners equity because it simply

trades one asset for another asset.

If the company had paid only Julys rent, the owners equity account Rent Expense woul d be debited

because the total benefit of the expenditure would be used up in the current month.

July 5: Receives office supplies ordered on July 2 and an invoice for $5,200.

Analysis:

The purchase of office supplies on credit increasesthe asset account Office Supplies with a

debit and increasesthe liability account Accounts Payable with a credit.

Note:

Office suppliesare considered an asset (prepaid expense) because they will not be used up in the

current month and thus will benefit future periods.

Accounts Payableis used when there is a delay between the time of the purchase and the time of

payment.


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July 6: Purchases office equipment, $16,320; pays $13,320 in cash and agrees to pay the

rest next month.

Analysis:

The purchase of office equipment in cash and on credit increasesthe asset account Office

Equipment with a debit, decreasesthe asset account Cash with a credit, and increasesthe

liability account Accounts Payable with a credit.

Note: As this transaction illustrates, assets may be paid for partly in cash and partly on

credit. When more than two accounts are involved in a journal entry, as they are in this

one, it is called a compound entry.

July 9: Makes a partial payment of the amount owed for the office supplies received on

July 5, $2,600.

Analysis:

A payment of a liability decreasesthe liability account Accounts Payable with a debit and

decreasesthe asset account Cash with a credit.

Note:The office supplies were recorded when they were purchased on July 5.


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July 10: Performs a service for an investment advisor by designing a series of brochures

and collects a fee in cash, $2,800.

Analysis:

Revenue received in cash increasesthe asset account Cash with a debit and increasesthe

owners equity account Design Revenue with a credit.

Note:

For this transaction, revenue is recognized when the service is provided and the cash is received.

July 15: Performs a service for a department store by designing a TV commercial; bills

for the fee now but will collect the fee later, $9,600.

Analysis:

A revenue billed to a customer increasesthe asset account Accounts Receivable with a debit

and increasesthe owners equity account Design Revenue with a credit.

Accounts Receivable is used to indicate the companys right to collect the money in the future.


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Note: In this case, there is a delay between the time revenue is earned and the time the

cash is received. Revenues are recorded at the time they are earned and billed

regardless of when cash is received.

July 19: Accepts an advance fee as a deposit on a series of brochures to be designed,

$1,400.

Analysis:

Revenue received in advance increasesthe asset account Cash with a debit and increasesthe

liability account Unearned Design Revenue with a credit.

July 22: Receives cash from customer previously billed on July 15, $5,000.

Analysis:

Collection of an account receivable from a customer previously billed increasesthe asset

account Cash with a debit and decreasesthe asset account Accounts Receivable with a credit.


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Note:

The revenue related to this transaction was recorded on July 15. Thus, no revenue is recorded

at this time.

July 26: Pays employees four weeks wages, $4,800.

Analysis:

This cash expense increasesthe owners equity account Wages Expense with a debit and

decreasesthe asset account Cash with a credit.

July 30: Receives, but does not pay, the utility bill that is due next month, $680.

Analysis:

This cash expense increasesthe owners equity account Utilities Expense with a debit and

increasesthe liability account Accounts Payable with a credit.


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Note: The expense is recorded if the benefit has been received and the amount is owed,

even if the cash is not to be paid until later. Note that the increase in Utilities Expense

will decrease owners equity.

July 31: Withdraws $2,800 in cash.

Analysis:

A cash withdrawal increasesthe owners equity account Withdrawals with a debit anddecreasesthe asset account Cash with a credit.

T-ACCOUNT


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Analyzing Business Transactions

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