A business may engage in thousands of transactions during a year. Can you imagine preparing a transaction analysis, like we did in the previous unit, for all of those transactions? It would take a lot of time and the spreadsheet would be large! There has to be a better way to classify and summarize the data in these transactions to create useful information. We will learn the first part of the accounting cycle:
|1. Analyze Transactions|
|2. Prepare Journal Entries|
|3. Post journal Entries|
|4. Prepare Unadjusted Trial Balance|
Let’s review what we have learned. An account is a part of the accounting system used to classify and summarize the increases, decreases, and balances of each asset, liability, stockholders’ equity item, dividend, revenue, and expense. Firms set up accounts for each different business element, such as cash, accounts receivable, and accounts payable. Every business has a Cash account in its accounting system because knowledge of the amount of cash on hand is useful information.
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Accountants may differ on the account title (or name) they give the same item. For example, one accountant might name an account Notes Payable and another might call it Loans Payable. Both account titles refer to the amounts borrowed by the company. The account title should be logical to help the accountant group similar transactions into the same account. Once you give an account a title, you must use that same title throughout the accounting records.
The following video introduces the journal, ledger, and trial balance, which we will discuss next.
A journal is a chronological (arranged in order of time) record of business transactions. A journal entry is the recording of a business transaction in the journal. A journal entry shows all the effects of a business transaction as expressed in debit(s) and credit(s) and may include an explanation of the transaction. A transaction is entered in a journal before it is entered in ledger accounts. Because each transaction is initially recorded in a journal rather than directly in the ledger, a journal is called a book of original entry.
A ledger (general ledger) is the complete collection of all the accounts and transactions of a company. The ledger may be in loose-leaf form, in a bound volume, or in computer memory. The chart of accounts is a listing of the titles and numbers of all the accounts in the ledger. The chart of accounts can be compared to a table of contents. The groups of accounts usually appear in this order: assets, liabilities, equity, dividends, revenues, and expenses. Think of the chart of accounts as a table of contents of a textbook. It provides direction as to what exactly will be found in the financial statement preparation.
Individual accounts are in order within the ledger. Each account typically has an identification number and a title to help locate accounts when recording data. For example, a company might number asset accounts, 100-199; liability accounts, 200-299; equity accounts, 300-399; revenue accounts, 400-499; and expense accounts, 500-599. We use this numbering system in this text. The uniform chart of accounts used in the first 11 chapters appears in a separate file at the end of the text. You should print that file and keep it handy for working certain problems and exercises. Companies may use other numbering systems. For instance, sometimes a company numbers its accounts in sequence starting with 1, 2, and so on. The important idea is that companies use some numbering system.
A trial balance is a listing of all accounts (in this order: asset, liability, equity, revenue, expense) with the ending account balance. It is called a trial balance because the information on the form must balance. We will illustrate this later in the chapter.
Steps in recording business transactions
Source documents, such as bills received from suppliers for goods or services received, bills sent to customers for goods sold or services performed, and cash register tapes provide the evidence that a business transaction occurred. After recognizing a business event as a business transaction, we analyze it to determine its increase or decrease effects on the assets, liabilities, equity, dividends, revenues, or expenses of the business. Then we translate these increase or decrease effects into debits and credits.
The information in the source document serves as the basis for preparing a journal entry. Then a firm posts (transfers) that information to accounts in the ledger.
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However, before you can record the journal entry, you must understand the rules of debit and credit. You will learn this concept and journal entries in the next section.
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