CAT Level 1

Module 1 Recording Business Transactions

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Accounting: How to Record Business Transactions
Account: basic summary device of accounting.
An account is the detailed record of all the
changes that occurred in an individual asset,
liability or equity during a time period
Journal: chronological record of transactions.
Where transactions are first recorded
Ledger: book of accounts. Where transactions
from a journal are posted/copied
Trial Balance: List of all ledger accounts and
their balances
Record Transactions in journal copy to
ledger - prepare trial balance

Accounts are grouped in 3 categories:

Assets- something a business owns that has value
Cash
Accounts Receivable
Notes Receivable
Prepaid expenses- rent and insurance
Land
Building
Equipment, Furniture and Fixtures
Liabilities- something owed
Accounts Payable
Notes Payable
Accrued Liabilities- taxes, interest, salary
Stockholders equity- owners claim to assets of business
Common stock
Retained Earnings- net income
Dividends
Revenues
Expenses

Chart of Accounts: contains a list of account names you might use to record a
transaction to (pg66)
Ledger contains accounts grouped under:
Assets, liabilities, equity
Revenues and Expenses
Assets usually are numbered beginning with 1
Liabilities numbered beginning with 2

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Module 1 Recording Business Transactions
Equity beginning with 3
Revenues 4
Expenses 5

Debits, Credits and Double-Entry Accounting:

Receiving side and giving side
Example: Business received cash of 10,000 dollars. Business issues 10,000 dollars of
stock
Double Entry System: Dual effects of each transaction are recorded. Every transaction
has at least 2 accounts
T Account: shortened form of general ledger
Takes shape of T
Left side is debit
Right side is credit

HOW TO RECORD BUSINESS

TRANSACTIONS
Increases and Decreases in Accounts:
Assets: Debits = increase to assets, credits = decrease to assets
Liabilities and Equity: Debits = decrease to liabilities, credits = increase to liabilities
Balance: amount remaining in an account
Steps in Recording Process:
Step 1: Transactions recorded in the journal
1. Identify each account affected and its type
2. Determine whether each account increased or decreased (credit/debit)
3. Record each transaction in journa, including brief explanation, credit indented
4.
Date Account and Explanation Debit Credit
Debit listed first
Credit indented
Brief explanation

Step 2: Posting from Journal to Ledger

Take info from debit and credit columns of journal and make T Accounts
Revenues are increasing in equity that result from providing goods and services

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Module 1 Recording Business Transactions
Expenses are decreases in equity

Assets = liabilities + equity (revenues and expenses)

Normal Balance: appears on the side where recorded increases occur
Assets: Debit-balance accounts
Liabilities and equity: Credit-Balance accounts (usually equity varies)
If items that should have a debit balance has a credit balance, that means there is a
negative amount

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Accounting Tutorials and Notes
Financial accounting external
Managerial Accounting internal
Private vs. public
Public Accounting : CPA for public, public company
(stocks)
Private accounting: working for a company, private
company(no public stocks)

Accounting Rules:
GAAP (General Accepted Accounting Principals) Written by
FASB- Financial Accounting Standards Board
IFRS (International Financial Reporting Standards) Written by IASB- International
Accounting Standards Board
Sasanes Oxley created PCAOB Public Companies Accounting Oversight Board
Sole proprietorship 1 person owning business. Person liable
Partnership- 2 people operating business: They have liability
Corporation: business is liable. Separate entity
Assets = Liabilities + Equity
Assets: owned, can derive future benefits - Most assets are held on books at historical
costs (what the original price was)
Liabilities: Obligations
Equity: Ownership of company - contributed capital (owners gave) (stock)
- retained earnings- earnings kept from net income.
Net income minus dividends
4 Basic Financial Statements:

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Module 1 Recording Business Transactions

Balance sheet: Assets, liabilities and equity and a point in time

Income Statement: results of operations
revenue minus expenses = net income
Equity Statement: Contributed capital selling stock
Retained earnings: beginning balance+
net income dividends = ending balance
-changes in equity during a period
Cash Flow Statement: Shows sources and uses of
cash
- operating: operations
-investing: investing in the future,
buying/selling assets
-financing: borrowing money / pay back/ equity
transactions
total change in cash

HOW TO READ A BALANCE SHEET

All statements interrelated

Accounts: Basic Summary Device
Transactions: Events requiring accounting recognition
Journal: Chronological list of transactions
Ledger: ledger of accounts Listing of all the accounts, shows transactions on account
Chart of accounts: List of accounts used
o Double Entry Bookkeeping
Left Right
Debit Credit
o Prepare tax return
Deliver return to customer, get check for $1000
Debit Credit
cash 1000
Revenue: 1000
o Records transaction in journal
Pay employee $200
debit credit
Payroll expense 200
Cash 200
Assets = liability + equity
Debit balance : + debit | Credit balance: + credit
: credit | : debit

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Module 1 Recording Business Transactions

Revenues are credits, expenses are debits

o Purchase computer equipment for $1,000
Debit credit
Computer Equipment 1,000
Cash 1,000
o Purchase equipment for $2,000. Pay $500 cash. Sign note for the rest of it
Debit credit
Equipment 2000
Cash 500
Note Payable 1500

Payable liability
Accounts Payable vendors that are owed money
Receivable- Asset Accounts Receivable
Accrual Accounting(use this) vs. Cash Accounting
Record when events occur vs. Record events when cash moves

o Perform service for $2,000 on account (no cash received yet)

Debit Credit
Accounts Receivable 2000
Revenue 2000
o Sell stock to owners for $5,000
Debit Credit
Cash 5,000
Stock $5,000

Ledger example:
Account Name
Date Description Debit Credit Total

T accounts Ledger
Make one for each account --- account receivable, cash, stock, revenue, computer
equipment, note payable, equipment
Assets- liabilities- common stock = retained
Trial Balance- list of accounts at a point in time
Revenues are credits, expenses are debits
Debit Credit
Accounts Receivable 2000

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Module 1 Recording Business Transactions

Cash 3500
Computer equipment 1000
Equipment 2000
Note payable 1500
Stock 5000
Revenue 2000
8500 8500
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Types of Financial Statements in Accounting
Accounting information system that measures business activity , processes the data into reports,
communicates the results to decision makers
Financial Statements- report on a business in monetary terms
Accounting can be divided into 2 fields: Financial and Managerial
Financial Accounting-provides information for external decision makers
Managerial Accounting provides information for internal decision makers

Governing Organizations:
FASB Financial Accounting Standards Board
PCAOB Public Companies Accounting Oversight Board
AICPA American Institute of Certified Public Accountants
GAAP Generally Accepted Accounting Principals
Sarbanes Oxley Act - in response to Enron, it made it a criminal offense to falsify financial
statements. It also created PCAOB

Types of Business Organizations:

Proprietorship- single owner

Partnership- 2 owners
Corporation- legal entity
Limited Liability Partnership- each member is responsible for own actions
Not for profit approved by IRS

Fiduciary Responsibility legal responsibility to perform duties in a trustworthy

manner

o Corporations:

Separate Legal Entity

Business entity formed under state law
Granted charter which acts as articles of incorporation
Authorization is granted by state to form a corporation
Charter specifies how much stock can be sold

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Module 1 Recording Business Transactions

Continuous Life
No Mutual Agency
Limited Liability of Stockholders
Separation of Ownership and Management
Corporate Taxation
Annual Franchise Tax
Income taxes
Government Regulation
Organization
Stockholders
Board of directors
Chairperson of the board
President
VPs and Secretary

Accounting Concepts and Principals

Entity Concept- refers to one business separate from the owners

Faithful Representation- data is correctly represented
Cost Principals- Historical Cost
Going Concern Concept- Entity will remain in operation in future
Stable Monetary Unit Concept- stable currency buying power is assumed

Accounting Equation:

Assets- something the business owns that has value

Assets = Liabilities + equity
Liabilities- something a business owes
Liabilities = Assets equity
Equity- The owners claims to assets of a business
Equity = assets liabilities
Equity: Equity of a corporation is called shareholders equity ; Equity consists of paid in capital and
retained earnings

Paid in Capital (contributed capital)- stock

Retained Earnings- Revenues and expenses

Net income retained earnings before dividends are paid out

Review: Assets (what is owned) = liabilities (what you owe) + equity

(net worth)

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Module 1 Recording Business Transactions
Types of Financial Statements:
Income statement- net income reported
Statement of Retained Earnings- what was done with retained earnings (dividends?)
Balance Sheet- shows assets and what is owed
Statement of Cash Flows- shows whether cash receipts increased or decreased

Financial Statement Headings:

Name of Business
Name of Type of Financial Statement
Date reported

Statement Preparation

1. Income Statement
2. Retained Earnings
3. Balance Sheet
4. Cash Flow
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The Accounting Cycle: 9-Step Accounting Process
The accounting cycle, also commonly referred to as accounting process, is a series
of procedures in the collection, processing, and communication of financial
information.
As defined in earlier lessons, accounting involves recording, classifying,
summarizing, and interpreting financial information.
Financial information is presented in reports called financial statements. But before
they can be prepared, accountants need to gather information about business
transactions, record and collate them to come up with the values to be presented in
the reports.
The cycle does not end with the presentation of financial statements. Several steps
are needed to be done to prepare the accounting system for the next cycle.
Accounting Cycle Diagram
Accounting Cycle Steps
1. Identifying and Analyzing Business Transactions
The accounting process starts with identifying and analyzing business transactions
and events. Not all transactions and events are entered into the accounting system.
Only those that pertain to the business entity are included in the process.

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Module 1 Recording Business Transactions
For example, a personal loan made by the owner that does not have anything to do
with the business entity is not accounted for.
The transactions identified are then analyzed to determine the accounts affected and
the amounts to be recorded.
The first step includes the preparation of business documents, or source documents.
A business document serves as basis for recording a transaction.
2. Recording in the Journals
A journal is a book paper or electronic in which transactions are recorded.
Business transactions are recorded using the double-entry bookkeeping system.
They are recorded in journal entries containing at least two accounts (one debited
and one credited).
To simplify the recording process, special journals are often used for transactions
that recur frequently such as sales, purchases, cash receipts, and cash
disbursements. A general journal is used to record those that cannot be entered in
the special books.
Transactions are recorded in chronological order and as they occur.
Journals are also known as Books of Original Entry.
3. Posting to the Ledger
Also known as Books of Final Entry, the ledger is a collection of accounts that shows
the changes made to each account as a result of past transactions, and their current
balances.
After the posting all transactions to the ledger, the balances of each account can
now be determined.
For example, all journal entry debits and credits made to Cash would be transferred
into the Cash account in the ledger. We will be able to calculate the increases and
decreases in cash; thus, the ending balance of Cash can be determined.
4. Unadjusted Trial Balance
A trial balance is prepared to test the equality of the debits and credits. All account
balances are extracted from the ledger and arranged in one report. Afterwards, all
debit balances are added. All credit balances are also added. Total debits should be
equal to total credits.
When errors are discovered, correcting entries are made to rectify them or reverse
their effect. Take note however that the purpose of a trial balance is only test the
equality of total debits and total credits and not to determine the correctness of
accounting records.

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Some errors could exist even if debits are equal to credits, such as double posting or
failure to record a transaction.
5. Adjusting Entries
Adjusting entries are prepared as an application of the accrual basis of accounting.
At the end of the accounting period, some expenses may have been incurred but not
yet recorded in the journals. Some income may have been earned but not entered in
the books.
Adjusting entries are prepared to update the accounts before they are summarized
in the financial statements.
Adjusting entries are made for accrual of income, accrual of expenses, deferrals
(income method or liability method), prepayments (asset method or expense
method), depreciation, and allowances.
6. Adjusted Trial Balance
An adjusted trial balance may be prepared after adjusting entries are made and
before the financial statements are prepared. This is to test if the debits are equal to
credits after adjusting entries are made.
7. Financial Statements
When the accounts are already up-to-date and equality between the debits and
credits have been tested, the financial statements can now be prepared. The
financial statements are the end-products of an accounting system.
A complete set of financial statements is made up of: (1) Statement of
Comprehensive Income (Income Statement and Other Comprehensive Income), (2)
Statement of Changes in Equity, (3) Statement of Financial Position or Balance
Sheet, (4) Statement of Cash Flows, and (5) Notes to Financial Statements.
8. Closing Entries
Temporary or nominal accounts, i.e. income statement accounts, are closed to
prepare the system for the next accounting period. Temporary accounts include
income, expense, and withdrawal accounts. These items are measured periodically.
The accounts are closed to a summary account (usually, Income Summary) and
then closed further to the appropriate capital account. Take note that closing entries
are made only for temporary accounts. Real or permanent accounts, i.e. balance
sheet accounts, are not closed.
9. Post-Closing Trial Balance
In the accounting cycle, the last step is to prepare a post-closing trial balance. It is
prepared to test the equality of debits and credits after closing entries are made.

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Module 1 Recording Business Transactions
Since temporary accounts are already closed at this point, the post-closing trial
balance contains real accounts only.
*10. Reversing Entries: Optional step at the beginning of the new accounting
period
Reversing entries are optional. They are prepared at the beginning of the new
accounting period to facilitate a smoother and more consistent recording process.
In this step, the adjusting entries made for accrual of income, accrual of expenses,
deferrals under the income method, and prepayments under the expense method
are simply reversed.
Author's Notes: So there you have the nine steps in the accounting cycle. This is just
an overview of the accounting process. Each step will be illustrated one by one in
later chapters.

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