Chapter 2: The Accounting Cycle During the Period

Objectives of this chapter:

1. Identify the basic steps in measuring external transactions.
2. Analyze the impact of external transactions on the accounting
equation.
3. Assess whether the impact of external transactions results in a debit
or credit to an account balance.
4. Record transactions using debits and credits.
5. Post transactions to T-accounts in the general ledger.
6. Prepare a trial balance.

Trial Balance and Overview of Accounting Cycle

At the end of Chapter 1, we prepared financial statements from a list of accounts
and their balances at the end of the accounting period---this list is called a trial
balance.
1. Record
The 7-step accounting cycle is the
process external
used to generate the four financial
transactions in journal entry
statements:
form (Chapter 2)

2. Post the journal entries to the ledger

(Chapter 2)

3. Prepare a trial balance

(Chapter 2)

4. Record and post adjusting

journal entries (Chapter 3)

5. Prepare an adjusted trial

balance
(Chapter 3)

6. Prepare the financial

statements
(Chapter 3)

7. Close temporary accounts

and prepare a post-closing
trial balance
(Chapter 3)

Financial Accounting: What is Measured and

Communicated?

Recall from Chapter 1 that the two primary goals of financial accounting are to:
Measure the companys business activities (i.e., transactions).
Communicate those measurements to the companys external users.
Two types of transactions

External transactions:
Events that affect
financial statement
accounts of the company,
and involve an exchange
with a separate party
Examples:
1. Sale of service to
customer
2. Purchase of equipment
from supplier
3. Issuance of common
stock to stockholders

Internal transactions:
Events that affect
financial statement
accounts of the company,
but do not involve an
exchange with a separate
party
Examples:
1. Using equipment in
operations
2. Using supplies already
purchased from vendor

The Accounting Cycle

The accounting cycle is a way to keep track of all transactions that affect the
financial statement accounts.
The main output of the cycle is the set of financial statements.
We will take one company (Dischord Records) through the entire cycle for its
first month of operations.
Chapter 2 of this course covers steps 1 3 of the cycle; Chapter 3 covers
steps 4 7.
Note:

Most business enterprises use a computerized accounting

system to carry out the accounting cycle.

That said: working through the accounting cycle manually is

the best way to gain an understanding of the processes that
underlie the computerized programs.

Transaction Analysis
Prior to learning journal entries, you need to become adept at
analyzing transactions.
That is, determining which financial statement accounts have been
affected by that particular transaction.
Exercise #1

Recording Transactions using Journal Entries

To actually record a transaction into a companys books, we need make
a journal entry.
A journal entry is used to record the dollar amount change in each
account that is affected by the transaction.
In a journal entry, the financial statement accounts that are affected by
the transaction are either debited or credited for the amount they are
impacted by:
Debit
Credit
Land
$X
Equipment
$Y
Cash
$Z
There may be multiple accounts debited and/or credited in a journal
entry. But, the total dollar amount of debits must equal the total dollar
amount of credits (i.e., $X + $Y = $Z).
The debit and credit rules tell us how to increase (or decrease)

Recording Transactions: Rules for Debits and Credits

Debit and credit rules:
Type of Account

Debit

Credit

Asset

Increase

Decrease

Liability

Decrease

Increase

Stockholders Equity

Decrease

Increase

Revenues

Increase

Expenses

Decrease
Increase

Dividends

Increase

Decrease
Decrease

Given that assets increase with a debit and decrease with a credit,
the rest of the rules follow directly from the accounting equation.

Debits arent bad and credits arent good

Normal Account Balances

Whichever increases the accounts balance (a debit or a credit) is
that accounts normal balance:
Type of Account

Normal Balance

Asset

Debit

Liability

Credit

Stockholders Equity

Credit

Revenue

Credit

Expense

Debit

Dividends

Debit

Recording Transactions: Preparing Journal Entries

Follow these two steps to prepare a journal entry:

1. Analyze the transaction - decide the accounts that the
transactions has increased or decreased (by how much).
2. Prepare the journal entry by applying the rules of debits and
credits.

Pay close attention to the wording of the transaction!

On Nov. 30, a firm
receives $500 from
clients for services
provided:
Cash $500

Vs.

Service Rev.
$500

Firm billed clients back here.

At this point, it made the
following
JE:
Accts.
Rec.
$500

Service Rev.
$500

On Nov. 15, a firm

receives $500 from
clients for services
provided.
The clients
Cash $500
were previously billed:
Accts Rec.
$500

Firm receives Cash.

Makes the following
JE:
Cash $500
Accts Rec.
$500

Pay close attention to the wording of the transaction!

(Continued)
On Nov. 30, a firm pays
its $200 monthly utility
bill:

Vs.

Utilities Exp. $200

Cash $200

Firm received and recorded

bill back here. At this point,
it made the following JE:
Utilities Exp.
$200 Accts. Pay.

$200

On Nov. 30, a firm pays

its $200 monthly utility
bill. The bill was
previously
Accts. Pay.received
$200 and
recorded:
Cash $200

Firm pays bill.

Makes the following
JE:
Accts. Pay. $200
Cash $200

Posting Journal Entries: Ledgers and T-Accounts

Throughout the accounting period, the same account may be debited and/or
credited thousands of times via different journal entries.
Ledger accounts are used to summarize the effects of all transactions on the
different accounts.
A T-account is a simplified form of a general ledger account with space at the
top for the account title and two sides: one for recording debits, and one side
Cash credits:
Accounts Payable
Service Revenue
for recording

The left side of the T-account is used for the debits and the right side
is used for the credits.
Each account has its own T-account.

Posting Journal Entries to Ledger Accounts

In order for the ledger accounts to reflect a journal entry, that journal
entry must be posted to the ledger.
Posting is the process of transferring a journal entry to the ledger
accounts:
Debit
Credit
Sept.
$120,000
1 Cash
Common Stock
$120,000
Common Stock
Cash
$120,000

$120,00
0

Dischords Cash T-Account

Cash
(1)
$120,000
(5)
$9,000
(7)
$12,000
(11)
$6,000
9/30 Bal.
$37,600

$100,000
(2)
$1,200
(4)
$1,200
(8)
$5,000
(9)
$2,000
(12)

Preparing a Trial Balance

After all the entries are posted, the balances in the T-accounts can be used to
prepare a trial balance.
Common Stock
Service Revenue
Cash
$10,00
$2,000
0
$8,000

$10,00
0
$3,000

$13,00
0
XYZ Corp.
Trial Balance
XX/XX/XX
Debits
Credits
Cash
$8,000
Accounts Receivable
XXX
Common Stock
$100,000
Service Revenue
$13,000
Salaries Expense
XXX

$100,0
00
$100,0
00

Trial Balance
The trial balance provides a convenient summary of account balances for
preparing adjusting entries related to internal transactions (will be
discussed in Chapter 3).
It is not a published financial statement provided to external parties.
The trial balance is used for internal purposes only and provides a check
on the equality of the debits and credits. This allows for the detection of
certain errors:
Incorrect computation of an account balance in the T-account;
Incorrect posting of a debit as a credit (or vice versa); and
Omission of part of a journal entry in the posting process.