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chapter
2
Analyzing Transactions
______________________________________________
OPENING COMMENTS
Chapter 2 is the most important chapter in the text. It introduces students to the rules of debit and credit,
chart of accounts, two-column journals, four-column ledgers, T accounts, and the trial balance. Quite
frankly, if students fail to grasp the concepts in this chapter, the first seeds of destruction will be sown for
those students who will ultimately withdraw from or fail the course.
Emphasize that Chapter 2 builds the foundation for all that will be learned about accounting principles.
Unlike many other college courses, it is impossible to understand Chapter 3 and beyond if the principles of
Chapter 2 are not mastered. You need to dispel the false belief that “maybe I’ll get the next chapter—even
though I’m totally lost now.”
Also encourage your students to seek help immediately if they begin to struggle with course content. Make
them aware of the resources available at your institution: tutorial services, peer assistance, your office hours,
2. Describe and illustrate journalizing transactions using the double-entry accounting system.
4. Prepare an unadjusted trial balance and explain how it can be used to discover errors.
5. Describe and illustrate the use of horizontal analysis in evaluating a company’s performance and
financial condition.
KEY TERMS
account
account receivable
assets
balance of the account
chart of accounts
correcting journal entry
common stock
credit
debit
dividends
double-entry accounting system
expenses
horizontal analysis
journal
STUDENT FAQS
• Why does Cash have a debit balance instead of a credit? My bank tells me they are crediting my
account when I put money in. This question has to be answered several times until the student realizes
that to the bank it is a liability, and they are telling the student what they are doing to their books.
• Why is the abbreviation for a debit “Dr” when there is no “r” in the spelling?
• Why can’t the normal balances of all the accounts be opposite what they are?
• Who dreamed this accounting system up?
• Who uses these statements, and what do they do with the information?
Chapter 2 Analyzing Transactions 25
• What is the difference between journalizing and posting?
• What is the difference between an expense and a liability?
• Aren’t assets and revenue the same? If a business works for someone and gets paid, aren’t Cash and
Revenue exactly the same thing?
• Aren’t expenses and liabilities the same? If a business gets a utility bill and hasn’t paid it yet, aren’t
Utility Expense and Utility Payable exactly the same account?
• Why do they call it a credit card? Who is crediting what?
• “I work in a bank and we use debits and credits, but you have them all reversed in the book. The bank
where I work does everything exactly the opposite.”
• Why can’t we just record the transactions directly into the ledger?
and subtract from their bank account?
OBJECTIVE 1
Describe the characteristics of an account and a chart of accounts.
SYNOPSIS
In the previous chapter, transactions were recorded using the accounting equation format. Exhibit 1 presents
a summary of the transactions we analyzed in the previous chapter for NetSolutions. This chapter
demonstrates how to record transactions using accounts. Accounts make it easy to track increases and
decreases in a company’s assets, liabilities, stockholders’ equity, revenues, expenses, and dividends. For
example, NetSolutions will need 12 accounts, one for each of the financial statement items shown in Exhibit
1. Basically, accounts have two sides, a left side and a right side. Because the letter “T” has a left side and
a right side, the term “T account” is often used to refer to accounts. Debits are recorded on the left side of
the T, and credits are recorded on the right side of the T. The balance of the account is the amount of the
difference between the debits and the credits that have been entered into an account. All the accounts used
in a business are grouped together in a ledger. A list of the accounts maintained in the ledger is known as a
26 Chapter 2 Analyzing Transactions
Key Terms and Definitions
• Account - An accounting form that is used to record the increases and decreases in each
financial statement item.
• Assets - The resources owned by a business.
• Balance of the Account - The amount of the difference between the debits and the credits
that have been entered into an account.
• Revenues - Increases in assets and stockholders’ equity as a result of selling services or
products to customers.
• Stockholders’ Equity - The owners’ equity in a corporation.
• T account - The simplest form of an account.
Relevant Example Exercises and Exhibits
• Exhibit 1 – NetSolutions’ November Transaction
• Exhibit 2 – Chart of Accounts for NetSolutions
SUGGESTED APPROACH
Remind students that accounts are used to record business transactions. An account is simply a record of
all the increases and decreases in a financial statement item (such as cash, supplies, and accounts payable).
A group of accounts is called a ledger.
Point out that only a very small enterprise with very few transactions (such as a lawn-mowing service run
by students) could use the accounting system illustrated in Chapter 1. For most businesses, this system
Chapter 2 Analyzing Transactions 27
TM 2-2 presents information related to the business transactions of Larry Sharp, M.D. Divide students into
small groups and ask them to use the information to develop a chart of accounts for Dr. Sharp. Also ask
them to assign a number to each account.
TM 2-3 presents a suggested chart of accounts that you may want to share with the class after they have
completed their group work. Remind them that the chart of accounts is different for every company,
reflecting each company’s typical business transactions.
You will notice that the suggested solution in TM 2-3 does not include insurance expense or depreciation
expense accounts. These accounts, although necessary for preparing adjusting entries, have been omitted
since that step in the accounting cycle will not be introduced until Chapter 3.
28 Chapter 2 Analyzing Transactions
INTERNET ACTIVITY—Chart of Accounts
There are organizations that post recommended charts of accounts on the Internet, so your students can see
some real-world examples. A standard chart of accounts is provided by Small Business Notes. The Web
address is:
http://www.smallbusinessnotes.com/operating/finmgmt/financialstmts/cofa.html
You might also want to encourage your students to search for other suggested charts of accounts.
OBJECTIVE 2
Describe and illustrate journalizing transactions using the double-entry accounting system.
SYNOPSIS
Businesses use the double-entry accounting system for recording transactions, based on recording increases
and decreases in accounts so that debits equal credits. In this system, the rules of debit and credit specify
record in which the effects of a transaction are recorded. The process of entering a transaction is called
journaling. Each such record is known as a journal entry. Exhibit 4 summarizes terminology that is often
used to describe common transactions along with the specific accounts that would be debited and credited.
The transaction is recorded using the following steps: the date of the transaction is recorded in the date
column, the title of the account to be debited is entered first in the description column, and the amount to
be debited is entered in the debit column. The title of the account to be credited is listed under the account
Key Terms and Definitions
• Double-Entry Accounting System - A system of accounting for recording transactions, based on
recording increases and decreases in accounts so that debits equal credits.
• Journal - The initial record in which the effects of a transaction are recorded.
• Journal Entry - The form of recording a transaction in a journal.
• Journalizing - The process of recording a transaction in the journal.
• Normal Balance of an Account - The normal balance of an account can be either a debit or a
credit depending on whether increases in the account are recorded as debits or credits.
• Rules of Debit and Credit - In the double-entry accounting system, specific rules for recording
debits and credits based on the type of account.
Chapter 2 Analyzing Transactions 29
Relevant Example Exercises and Exhibits
• Example Exercise 2-1 – Rules of Debit and Credit and Normal Balances
SUGGESTED APPROACH
Learning the rules of debit and credit is one of the first major hurdles for students in accounting principles.
Remind students that debit and credit simply represent the left and right sides of an account. The trick is
remembering which accounts are increased with debits and which are increased with credits.
LECTURE AID—Rules of Debit and Credit
Three approaches to explain the rules of debit and credit follow. You may want to present all methods to
your class and encourage each student to use the approach that he or she understands best.
“Mirror Image” Approach: One way to explain the rules of debit and credit is to draw the following equation
on the board.
Assets = Liabilities + Stockholders’ Equity
+ – – + – +
Point out that the rules for increasing and decreasing liabilities and stockholders’ equity accounts are the
mirror image of the rules for assets. Therefore, if students can remember the rules for assets, they can
deduce the rules for the remaining accounts. This method requires that the student understand that the
30 Chapter 2 Analyzing Transactions
Here’s how it works.
After Eating Dinner, Let’s Relax and Snooze
Accounts increased Accounts increased
“ALSIE” Approach: The rules of debit and credit can also be explained using the acronym “ALSIE.”
List the types of classifications of accounts:
A = Assets
L = Liabilities
S = Stockholders’ Equity
I = Income (Revenue)
E = Expense
Arrange the letters to read “ALSIE.” Then list normal balances by the side of each.
A
=
Dr.
L
=
Cr.
S
=
Cr.
I
=
Cr.
E
=
Dr.
Note that ALSIE begins and ends with normal Dr. balance accounts, while the three middle classifications
are normal Cr. balance accounts. The dividends account is not included in this explanation, so the student
must memorize the proper treatment of this account.
No matter which approach the student uses to learn the rules, you will need to reinforce the categories and
the proper treatment of increases and decreases over and over. Start by emphasizing that half of the accounts
Chapter 2 Analyzing Transactions 31
GROUP LEARNING ACTIVITY—Rules of Debit and Credit
After explaining the rules of debit and credit, it is important to reinforce those concepts with an example.
Ask your students to draw the following T accounts on a sheet of paper:
Cash Retained Earnings
Accounts Receivable Dividends
Supplies Fees Earned
Stereo Equipment Wages Expense
Accounts Payable Advertising Expense
Common Stock
TM 2-4 lists several business transactions. Illustrate the process by recording the first two or three
transactions in a journal format and by posting them to the appropriate T account. As you work these
examples, emphasize that there is a three-step process in analyzing each entry: (1) determine which accounts
are affected, (2) decide whether each account should be increased or decreased, and (3) translate the increase
or decrease into a debit or a credit.
LECTURE AID—Double-Entry Accounting
To help the student understand the effect of double-entry accounting, it can be helpful to illustrate examples
of some of the more common transactions, such as the ones below, as you lecture.
TRANSACTION
AFFECTED ACCOUNTS
Cash
Common Stock
Dr.
Cr.
Dr.
Cr.
Increase
Increase
Issued stock for cash
32 Chapter 2 Analyzing Transactions
Cash
Fees Earned
Dr.
Cr.
Dr.
Cr.
Received cash for services rendered
Increase
Increase
Cash
Accounts Receivable
Dr.
Cr.
Dr.
Cr.
Received cash on account
Increase
Decrease
Cash
Accounts Payable
Dr.
Cr.
Dr.
Cr.
Paid on account
Decrease
Decrease
Supplies
Accounts Payable
Dr.
Cr.
Dr.
Cr.
Purchased on account
Increase
Increase
Cash
Dividends
Dr.
Cr.
Dr.
Cr.
Paid cash dividends
Decrease
Increase
LECTURE AID—Journalizing
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TM 2-6 shows a series of transactions recorded in a two-column journal. Use this exhibit to review the two-
column journal format with your students. You may want to stress the following format issues:
1. Dates: The year is entered only at the top of the date column. The month is entered on the first line of
3. Proper journalizing always has at least one debit and one credit, and total debits must always equal total
credits. Proper journalizing will keep the accounting equation in balance.
4. Explanations: A brief description of the transaction should be written below the debit and credit account
5. Blank Lines: A blank line should separate all transactions in a manual journal to make them easier to
read. Computerized systems are normally designed to separate journal entries without special input.
34 Chapter 2 Analyzing Transactions
OBJECTIVE 3
Describe and illustrate the journalizing and posting of transactions to accounts.
SYNOPSIS
This objective continues with journalizing and also demonstrates how to post the journal entries to the
ledger. Posting is the process of transferring the debits and credits from the journal entries to the accounts
in the ledger. Exhibit 5 illustrates this process. Using the company NetSolutions, the chapter shows the
journalizing of a transaction in a standard account form and then demonstrates how to record each entry in
the ledger. The debits and credits from each entry are transferred to the ledger in the order in which they
occurred. The ledger account is located for the first line of the entry, the date is transferred first, then the
amount of the debit is entered in the debit column, the journal page is entered in the Post Reference (Post.
Ref.) column of the ledger, and the account number is entered in the Post. Ref. column in the journal. The
ledger account is located for the second line of the entry, the date is transferred first, then the amount of the
credit is entered in the credit column, the journal page is entered in the Post. Ref. column of the ledger, and
the account number is entered in the Post. Ref. column in the journal. Thus, the Post. Ref. notations serve
to link the journal and ledger and provide an easy way to trace transactions from the journal to the ledger
or vice versa.
Key Terms and Definitions
• Account Receivable - A claim against the customer created by selling merchandise or services
on credit.
• Posting - The process of transferring the debits and credits from the journal entries to the
accounts in the ledger.
• Unearned Revenue - The liability created by receiving revenue in advance.
Relevant Example Exercises and Exhibits
• Example Exercise 2-3 – Journal Entry for Fees Earned
• Example Exercise 2-4 – Journal Entry for Dividends
Chapter 2 Analyzing Transactions 35
SUGGESTED APPROACH
Remind students that journalizing transactions is a sequential record of business dealings and posting is the
updating of individual account balances. Getting the journal entry correct is the bigger challenge; the
posting is a merely a process of transferring the information from the journal to the proper ledger accounts.
Although posting can be a tedious process, it is critical that the student follow the process and not resort to
shortcuts; otherwise, information may be omitted, resulting in incorrect account balances.
DEMONSTRATION PROBLEM—The Ledger
TM 2-7 is a series of four-column ledger accounts. Use these blank accounts to demonstrate posting of the
WRITING EXERCISE—The Journal and the Ledger
It is important for students to understand the reason that business transactions are recorded in a journal as
the book of original entry and later posted to a ledger. To check their understanding of these concepts, ask
them to write a response to the following questions. These questions are also found on TM 2-8.
1. Why are business transactions initially recorded in a journal?
2. Why are business transactions posted from the journal to a ledger?
Question 1 possible response: The journal is used to record transactions in the order in which they occur.
Question 2 possible response: The ledger tracks the balance of the individual accounts. Without posting
transaction to the ledger, the accountant would have to go back and track every individual transaction to
find those that impact the account in question and track the increases and decreases over the accounting
period to determine the balance in the account.
GROUP LEARNING ACTIVITY—The Journal and the Ledger
This activity presents another method to emphasize the purpose of the journal and the ledger in the
accounting process. TM 2-9 lists questions a business owner might ask that can be answered by examining
the company’s accounting records. Your students’ task is to determine which accounting record holds the
36 Chapter 2 Analyzing Transactions
OBJECTIVE 4
Prepare an unadjusted trial balance and explain how it can be used to discover errors.
SYNOPSIS
This objective explains the purpose and the steps in the preparation of the trial balance. The trial balance is
a summary listing of the titles and balances of accounts in the ledger, and it verifies the equality of the
debits and the credits which double-entry accounting requires. The first step in preparing a trial balance is
to create the heading. This includes the company name, the title of the document, and the date it is prepared.
Next, list all the accounts from the ledger, in order, and enter their debit or credit balances. Total the debit
and credit columns and verify the totals match. The trial balance shown in Exhibit 7 is an unadjusted trial
balance, which distinguishes it from other trial balances that will be introduced later. An unadjusted trial
balance is a summary listing of the titles and balances of accounts in the ledger prior to the posting of
adjusting entries.
Key Terms and Definitions
• Correcting Journal Entry - An entry that is prepared when an error has already been journalized
and posted.
• Slide - An error in which the entire number is moved one or more spaces to the right or the left,
such as writing $542.00 as $54.20 or $5,420.00.
Relevant Example Exercises and Exhibits
• Example Exercise 2-6 – Trial Balance Errors
• Example Exercise 2-7 – Correcting Entries
• Exhibit 7 – Trial Balance
Chapter 2 Analyzing Transactions 37
SUGGESTED APPROACH
Remind students that a trial balance is simply a listing of accounts and their balances. It is used to check
the accuracy of posting by testing to see that total debits equal total credits. At this point, students have
learned two controls over recording entries in a double-entry accounting system: (1) Debits = Credits and
(2) Assets = Liabilities + Stockholders’ Equity.
You may point out at this time that this is the first of three times in the accounting cycle that the trial balance
will be completed.
DEMONSTRATION PROBLEM—Preparing a Trial Balance
GROUP LEARNING ACTIVITY—Errors in a Trial Balance
The goal of this activity is to demonstrate the use of a trial balance in detecting errors made while recording
journal entries, posting, and computing account balances. TM 2-12 presents journal entries, T accounts, and
a trial balance. Several errors have been made in posting the journal entries, and as a result, the trial balance
does not balance. Ask your students to work in small groups to uncover the errors and correct the trial
balance. TM 2-13 shows the corrected trial balance.
You may want to give your students the following hints to help them detect the errors:
2. Look for accounts with abnormal balances on the trial balance. This usually points to an error.
4. Re-compute the balance of each account to check for math errors. Again, this usually doesn’t happen
with a computerized program.
5. Trace each posting back to the journal entry to make sure the proper amount was posted. Watch for
2. Recording the same erroneous amount for both the debit and the credit parts of a transaction.
4. Posting part of a transaction correctly as a debit or credit but to the wrong account.
As an example, ask your class the following question: Would recording an $800 sale on account as a debit
to Cash and a credit to Fees Earned cause the columns of a trial balance to be unequal? Answer: No.
OBJECTIVE 5
Describe and illustrate the use of horizontal analysis in evaluating a company’s
performance and financial condition.
SYNOPSIS
It is useful in business to compare a company’s performance with its past performance. Financial analysis
that compares an item in a current statement with the same item in prior statements is called horizontal
analysis. The financial statements being compared are arranged next to each other to facilitate the
Key Terms and Definitions
• Horizontal Analysis - Financial analysis that compares an item in a current statement with the
same item in prior statements.
Relevant Example Exercises and Exhibits
• Example Exercise 2-8 – Horizontal Analysis
SUGGESTED APPROACH
This objective introduces the value of horizontal analysis as a tool to indicate trends in a company’s
performance. Remind students that financial statements are a “snapshot” in time without any means of
comparison to other time periods. The horizontal analysis indicates changes (increase or decrease) in both
amounts and percentages.
TM 2-14 shows an example of what a horizontal analysis of income statements for Music Express using
figures from TM 2-11 might look like. Note that while the June expenditures were greater than those in
May so, too, were the fees earned—enough to show increases in the amount and percentage of net income
for Music Express.
Type Item Description LO(s) Difficulty Time Est BUSPROG AICPA ACBSP - APC Bloom's EE Excel GL SMH FAI Service Real World Writing Ethics Internet Group
DQ 1 2 Easy 5 min. Analytic FN - Measurement GAAP Knowledge
DQ 2 1 Easy 5 min. Analytic FN - Measurement GAAP Knowledge
DQ 3 2 Easy 5 min. Analytic FN - Measurement Recording Transactions Knowledge
DQ 4 1 Easy 5 min. Analytic FN - Measurement Recording Transactions Knowledge
DQ 5 3 Easy 5 min. Analytic FN - Measurement Recording Transactions Knowledge
DQ 6 4 Easy 5 min. Analytic FN - Measurement Recording Transactions Knowledge
DQ 7 4 Easy 5 min. Analytic FN - Measurement Recording Transactions Knowledge
DQ 8 4 Easy 5 min. Analytic FN - Measurement Recording Transactions Knowledge
DQ 9 4 Easy 5 min. Analytic FN - Measurement Recording Transactions Knowledge
DQ 10 1 Easy 5 min. Analytic FN - Measurement Recording Transactions Knowledge
PE 1A Rules of debit and credit and normal balances 2 Easy 5 min. Analytic FN - Measurement Recording Transactions Knowledge
PE 1B Rules of debit and credit and normal balances 2 Easy 5 min. Analytic FN - Measurement Recording Transactions Knowledge
PE 7B Correcting entries 4 Easy 5 min. Analytic FN - Measurement Recording Transactions Application
PE 8A Horizontal analysis 5 Moderate 10 min. Analytic FN - Measurement Recording Transactions Application x
PE 8B Horizontal analysis 5 Moderate 10 min. Analytic FN - Measurement Recording Transactions Application x
EX 1 Chart of accounts 1 Easy 5 min. Analytic FN - Measurement GAAP Knowledge x
EX 13 Identifying transactinos 1,2 Easy 10 min. Analytic FN - Measurement Recording Transactions Application
EX 14 Journal entries 1,2 Easy 10 min. Analytic FN - Measurement Recording Transactions Application x
EX 15 Trial balance 4 Easy 5 min. Analytic FN - Measurement Recording Transactions Application x x
EX 16 Trial balance 4 Moderate 10 min. Analytic FN - Measurement Recording Transactions Application x
PR 4A Journal entries and trial balance 1,2,3,4 Moderate 2 hours Analytic FN - Measurement Recording Transactions Application x
PR 5A Corrected trial balance 4 Challenging 1.5 hours Analytic FN - Measurement Recording Transactions Application x
PR 1B Entries into T accounts and trial balance 1,2,3,4 Moderate 1.5 hours Analytic FN - Measurement Recording Transactions Application
PR 2B Journal entries and trial balance 1,2,3,4 Moderate 1.5 hours Analytic FN - Measurement Recording Transactions Application x x x
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