Recording Business Transactions

Introduction

In this topic, we will examine how to identify business transactions and how to record the transactions in the financial records of your business.

The raw data of accounting are the business transactions. We learned how to record the transactions in Unit One, based on the increases or decreases in the assets, liabilities, and owners' equity items of the accounting equation. This procedure illustrated how various transactions affect the accounting equation. When working through the sample transactions, you should have noted that listing all transactions as increases or decreases in the balance sheet would be too cumbersome in practice. Most businesses, even small ones, enter into many transactions every day. Unit Two will demonstrate how to actually record business transactions in the accounting process.

We will learn how to post the information from the journal to the ledgers. The ledger will then be balanced and a Trial Balance extracted.

Objectives

Upon completion of this topic you should be able to:

1. Identify business transactions.
2. Record transactions in a double entry set of books.
3. Define an account.
4. State the steps in the recording business transactions.
5. Identify the effects of business transactions.
6. Identify the information to transfer to the different ledgers.
7. Record merchandising transactions in the ledgers.
8. Record accounts receivable and accounts payable transactions.
9. Record transactions for assets, liabilities and owners’ equity.

Business Transactions

To explain the dual procedure of recording business transactions with debits and credits, you need to understand how to use the following new tools: the T-account, the journal, and the ledger. Using these tools, you can follow your business through its various business transactions. Like accountants, you can use a trial balance to check the equality of your recorded debits and credits. Understanding this system enables you to better understand the content of financial statements so you can use the information provided to make informed business decisions.

The Account and Rules of Debit and Credit
A business may engage in thousands of transactions during a year. An accountant classifies and summarizes the data in these transactions to create useful information. Business transactions are measurable events that affect the financial condition of a business.

Illustration 2.1 – The Steps in Recording and Posting the Effects of a Business Transaction

Illustration 2.1

Look at illustration 2.1 and observe the steps in recording and posting the effects of a business transaction. Note that source documents provide the evidence that a business transaction occurred. These source documents include such items as bills received from suppliers for goods or services received, bills sent to customers for goods sold or services performed and cash register tapes. 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. You can see from the illustration that after you prepare the journal entry, you post it to the accounts in the ledger.

However, before you can record a journal entry, you must understand the rules of debit and credit. To understand these rules, you must first understand the nature of an account.

Most business transactions are repetitive. This makes the task of accountants somewhat easier because they can classify the transactions into groups having common characteristics. For example, a business may have thousands of receipts or payments of cash during a year. Part of every cash transaction must be recorded and summarized in a single place called an account.

An Account

An account is a part of the accounting system used to classify and summarize the increases, decreases, and balances of each asset, liability, owners' equity, revenue, and expense items. Businesses 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.

Accountants may differ on the account title (or name) they give the same item. For example, one might name an account Notes Payable and another might call it Loans Payable. Both account titles refer to the amounts borrowed by the business. 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 number of accounts in a business's accounting system depends on the information needs by those interested in the business. The main requirement is that each account provides information useful in making decisions. Thus, one account may be set up for all cash rather than having a separate account for each form of cash (coins on hand, currency on hand, and deposits in banks). The amount of cash is useful information; the form of cash often is not.

To illustrate recording the increases and decreases in an account, texts use the T-account, which looks like a capital letter T. The name of the account, such as Cash, appears across the top of the T. We record increases on one side of the vertical line of the T and decreases on the other side. A T-account appears as follows:

• o Date - day, month, year.
• o Details – account titles are written here.
• o Folio - this is a reference column showing the journal page to which each entry is transferred from.
• o Amount - the monetary amount is shown.

Accountants use the term debit instead of saying, "Place an entry on the left side of the T-account". They use the term credit for "Place an entry on the right side of the T-account". Debit (abbreviated Dr) simply means left side; credit (abbreviated Cr) means right side. Thus, for all accounts a debit entry is an entry on the left side, while a credit entry is an entry on the right side.

After recognizing a business event as a business transaction, you must analyse it to determine if it is an increase or decrease effect on the assets, liabilities owners’ equity items, revenues, or expenses of the business. Then you must translate these increase or decrease effects into debits and credits.

The accounting requirement that each transaction be recorded by an entry that has equal debits and credits is called double-entry procedure, or duality. This double-entry procedure keeps the accounting equation in balance.

The dual recording process produces two sets of accounts—those with debit balances and those with credit balances. The totals of these two groups of accounts must be equal. Then, some assurance exists that the arithmetic part of the transaction recording process has been properly carried out. Below is an example of how to record business transactions in T-accounts using debits and credits.

While recording business transactions, remember that the foundation of the accounting process is the following basic accounting equation:
Assets = Liabilities + Owners’ Equity

Take some time to review the handout on the 

Rules for Double Entry.docx

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Let’s now record a list of transactions for ORE Retail for the month of February 2011 in their various accounts.

1 Feb - Started business with $15, 000 in cash

• o Debit Cash Account
• o Credit Owners’ Equity Account (Capital Account)

Dr	Cash						CR
Date	Details	Folio	Amount	Date	Details	Folio	Amount
2011			$	2011			$
Feb 1	Owners’ Equity	GL	15, 000

Dr	Owners’ Equity						CR
Date	Details	Folio	Amount	Date	Details	Folio	Amount
2011			$	2011			$
				Feb 1	Cash	CB	15, 000

The money invested to start a business is recorded in the Owners’ Equity Account. This will need an increase in that account and also an increase in the cash account. To increase the Cash (which is an asset account) you debit that account as illustrated above. To increase the owners’ equity account you credit that account.
Feb 4 Bought a Motor Vehicle paying by cash $2,000

• o Debit Motor Vehicle Account
• o Credit Cash Account

Dr	Motor Vehicle						CR
Date	Details	Folio	Amount	Date	Details	Folio	Amount
2011			$	2011			$
Feb 4	Cash	CB	2, 000
Dr	Cash						CR
Date	Details	Folio	Amount	Date	Details	Folio	Amount
2011			$	2011			$
Feb 1	Owners’ Equity	GL	15, 000	Feb 4	Motor Vehicle	GL	2,000

Because you have taken $2,000 out of your cash account to pay for the Motor Vehicle your cash amount has decreased. This is indicated by a credit entry in your cash account. By purchasing that motor vehicle you have increase your motor vehicle account. This is done by a debit entry in the Motor Vehicle accounts. Both the motor vehicle and the cash accounts are asset accounts.

Feb 8 Deposited $5, 000 of the cash into a bank account

• o Debit Cash at Bank Account
• o Credit Cash Account

Dr	Cash at Bank						CR
Date	Details	Folio	Amount	Date	Details	Folio	Amount
2011			$	2011			$
Feb 8	Cash	CB	5, 000
Dr	Cash						CR
Date	Details	Folio	Amount	Date	Details	Folio	Amount
2011			$	2011			$
Feb 1	Owners’ Equity	GL	15, 000	Feb 4	Motor Vehicle	GL	2,000
				Feb 8	Cash at Bank	CB	5,000

Your Cash Account is being further reduced by taking some of the cash in that account and depositing it into the cash at bank account, which is now being increased.

Feb 12 He paid his supplier Bargain Wholesale owed $1200 by cheque.

• o Debit Bargain Wholesale Account
• o Credit Cash at Bank Account

Dr	Cash at Bank								CR
Date	Details	Folio	Amount	Date	Details			Folio	Amount
2011			$	2011					$
Feb 8	Cash	CB	5, 000	Feb 12	Bargain Wholesale			PL	1,200
Dr	Bargain Wholesale								CR
Date	Details	Folio	Amount	Date		Details	Folio		Amount
2011			$	2011					$
Feb 12	Cash at Bank	CB	1,200

Bargain wholesale is a supplier that you owed money that makes it a liability to you. Because you are paying them the liability is decreasing, therefore, a debit entry is needed in bargain wholesale account and a credit entry in the cash at bank account to reflect the payment being made from your cash at bank account by cheque.
Feb 15 Paid rent $500 by cash

• o Debit Rent Account
• o Credit Cash Account

Dr	Rent						CR
Date	Details	Folio	Amount	Date	Details	Folio	Amount
2011			$	2011			$
Feb 15	Cash	CB	500
Dr	Cash						CR
Date	Details	Folio	Amount	Date	Details	Folio	Amount
2011			$	2011			$
Feb 1	Owners’ Equity	GL	15, 000	Feb 4	Motor Vehicle	GL	2,000
				Feb 8	Cash at Bank	CB	5,000
				Feb 15	Rent	GL	500

Rent is an expense account, which should be debited to indicate that the expense has been paid. Your cash account is credited to indicate that funds were taken from the cash account to pay the rent.

Feb 20 Received $150 interest on you cash at bank account

• o Debit Cash at Bank Account
• o Credit Interest Received Account

Dr	Cash at Bank								CR
Date	Details	Folio	Amount	Date	Details			Folio	Amount
2011			$	2011					$
Feb 8	Cash	CB	5, 000	Feb 12	Bargain Wholesale			PL	1,200
Feb 20	Interest Received	GL	150
Dr	Interest Received								CR
Date	Details	Folio	Amount	Date		Details	Folio		Amount
2011			$	2011					$
Feb 12	Cash at Bank	CB	1,200	Feb 20		Cash at Bank	CB		150

Interest Received is additional revenue received from your bank as an incentive for doing business with them. This account should be credited to indicate the receipt of the additional amount. Your cash at bank account is also increased by an additional $150 indicated by the entry in the account.