Chapter 2
Recording Business Transactions
Review Questions
1. The three categories of the accounting equation are assets, liabilities, and equity. Assets include
Cash, Accounts Receivable, Notes Receivable, Prepaid Expenses, Land, Building, Equipment,
Furniture, and Fixtures. Liabilities include Accounts Payable, Notes Payable, Accrued Liability, and
Unearned Revenue. Equity includes Common Stock, Dividends, Revenue, and Expenses.
2. Companies need a way to organize their accounts so they use a chart of accounts. Accounts starting
with 1 are usually Assets, 2 – Liabilities, 3 – Equity, 4 – Revenues, and 5 – Expenses. The second
and third digits in account numbers indicate where the account fits within the category.
3. A chart of accounts and a ledger are similar in that they both list the account names and account
numbers of the business. A ledger, though, provides more detail. It includes the increases and
decreases of each account for a specific period and the balance of each account at a specific point in
time.
4. With a double-entry you need to record the dual effects of each transaction. Every transaction affects
at least two accounts.
5. A T-account is a shortened form of each account in the ledger. The debit is on the left side, credit on
the right side, and the account name is shown on top.
6. Debits are increases for assets, dividends, and expenses. Debits are decreases for liabilities, common
stock, and revenue.
7. Credits are increases for liabilities, common stock, and revenue. Credits are decreases for assets,
dividends, and expenses.
8. Assets, dividends, and expenses have a normal debit balance. Liabilities, common stock, and
revenue have a normal credit balance.
9. Source documents provide the evidence and data for accounting transactions. Examples of source
documents a business would have are: bank deposit slips, purchase invoices, bank checks, and sales
invoices
10. Transactions are first recorded in a journal, which is the record of transactions in date order.
© 2018 Pearson Education, Inc. 2-1
,11. Step 1: Identify the accounts and the account type. You need this information before you can
complete the next step. Step 2: Decide if each account increases or decreases, then apply the rules of
debits and credits. Reviewing the rules of debits and credits, we use the accounting equation to help
determine debits and credits for each account. Step 3: Record transactions in the journal using
journal entries. Step 4: Post the journal entry to the ledger. When journal entries are posted from the
journal to the ledger, the dollar amount is transferred from the debit and credit columns to the
specific accounts in the ledger. The date on the journal entry should also be transferred to the
accounts in the ledger. Step 5: Determine whether the accounting equation is in balance. After each
entry the accounting equation should always be in balance.
12. Part 1: Date of the transaction. Part 2: Debit account name and dollar amount. Part 3: Credit account
name and dollar amount. The credit account name is indented. Part 4: Brief explanation.
13. When transactions are posted from the journal to the ledger, the dollar amount is transferred from the
debit and credit columns to the specific accounts in the ledger. The date of the journal entry is also
transferred to the accounts in the ledger. The posting reference columns in the journal and ledger are
also completed. In a computerized system, this step is completed automatically when the transaction
is recorded in the journal.
14. The trial balance is used to prove the equality of total debits and total credits of all accounts in the
ledger; it is also used to prepare the financial statements.
15. A trial balance verifies the equality of total debits and total credits of all accounts on the trial balance
and is an internal document used only by employees of the company. The balance sheet, on the other
hand, presents the business’s accounting equation and is a financial statement that can be used by
both internal and external users.
16. If total debits equal total credits on the trial balance, it does not mean that the trial balance is error-
free. An incorrect amount could have been used, an entry could have been completely missed, or the
wrong account title could have been debited or credited.
17. The debt ratio is calculated by dividing total liabilities by total assets and shows the proportion of
assets financed with debt. It can be used to evaluate a business’s ability to pay its debts.
© 2018 Pearson Education, Inc. 2-2
,Short Exercises
S2-1
a. Notes Receivable (A) f. Taxes Payable (L)
b. Common Stock (E) g. Rent Expense (E)
c. Prepaid Insurance (A) h. Furniture (A)
d. Notes Payable (L) i. Dividends (E)
e. Rent Revenue (E) j. Unearned Revenue (L)
S2-2
a. Increase to Accounts Receivable (DR) f. Decrease to Prepaid Rent (CR)
b. Decrease to Unearned Revenue (DR) g. Increase to Common Stock (CR)
c. Decrease to Cash (CR) h. Increase to Notes Receivable (DR)
d. Increase to Interest Expense (DR) i. Decrease to Accounts Payable (DR)
e. Increase to Salaries Payable (CR) j. Increase to Interest Revenue (CR)
S2-3
a. Notes Payable (CR) f. Common Stock (CR)
b. Dividends (DR) g. Utilities Expense (DR)
c. Service Revenue (CR) h. Office Supplies (DR)
d. Land (DR) i. Advertising Expense (DR)
e. Unearned Revenue (CR) j. Interest Payable (CR)
S2-4
Accounts Payable
May 2 6,000 21,000 May 1
May 22 11,500 500 May 5
8,500 May 15
500 May 23
13,000 Bal.
© 2018 Pearson Education, Inc. 2-3
, S2-5
Date Accounts and Explanation Debit Credit
Jan. 1 Cash 34,000
Common Stock 34,000
Received cash in exchange for common stock.
2 Medical Supplies 17,000
Accounts Payable 17,000
Purchased medical supplies on account.
4 Cash 1,600
Service Revenue 1,600
Performed services for patients.
12 Rent Expense 3,000
Cash 3,000
Paid rent with cash.
15 Accounts Receivable 7,000
Service Revenue 7,000
Performed services for patients on account.
© 2018 Pearson Education, Inc. 2-4
Recording Business Transactions
Review Questions
1. The three categories of the accounting equation are assets, liabilities, and equity. Assets include
Cash, Accounts Receivable, Notes Receivable, Prepaid Expenses, Land, Building, Equipment,
Furniture, and Fixtures. Liabilities include Accounts Payable, Notes Payable, Accrued Liability, and
Unearned Revenue. Equity includes Common Stock, Dividends, Revenue, and Expenses.
2. Companies need a way to organize their accounts so they use a chart of accounts. Accounts starting
with 1 are usually Assets, 2 – Liabilities, 3 – Equity, 4 – Revenues, and 5 – Expenses. The second
and third digits in account numbers indicate where the account fits within the category.
3. A chart of accounts and a ledger are similar in that they both list the account names and account
numbers of the business. A ledger, though, provides more detail. It includes the increases and
decreases of each account for a specific period and the balance of each account at a specific point in
time.
4. With a double-entry you need to record the dual effects of each transaction. Every transaction affects
at least two accounts.
5. A T-account is a shortened form of each account in the ledger. The debit is on the left side, credit on
the right side, and the account name is shown on top.
6. Debits are increases for assets, dividends, and expenses. Debits are decreases for liabilities, common
stock, and revenue.
7. Credits are increases for liabilities, common stock, and revenue. Credits are decreases for assets,
dividends, and expenses.
8. Assets, dividends, and expenses have a normal debit balance. Liabilities, common stock, and
revenue have a normal credit balance.
9. Source documents provide the evidence and data for accounting transactions. Examples of source
documents a business would have are: bank deposit slips, purchase invoices, bank checks, and sales
invoices
10. Transactions are first recorded in a journal, which is the record of transactions in date order.
© 2018 Pearson Education, Inc. 2-1
,11. Step 1: Identify the accounts and the account type. You need this information before you can
complete the next step. Step 2: Decide if each account increases or decreases, then apply the rules of
debits and credits. Reviewing the rules of debits and credits, we use the accounting equation to help
determine debits and credits for each account. Step 3: Record transactions in the journal using
journal entries. Step 4: Post the journal entry to the ledger. When journal entries are posted from the
journal to the ledger, the dollar amount is transferred from the debit and credit columns to the
specific accounts in the ledger. The date on the journal entry should also be transferred to the
accounts in the ledger. Step 5: Determine whether the accounting equation is in balance. After each
entry the accounting equation should always be in balance.
12. Part 1: Date of the transaction. Part 2: Debit account name and dollar amount. Part 3: Credit account
name and dollar amount. The credit account name is indented. Part 4: Brief explanation.
13. When transactions are posted from the journal to the ledger, the dollar amount is transferred from the
debit and credit columns to the specific accounts in the ledger. The date of the journal entry is also
transferred to the accounts in the ledger. The posting reference columns in the journal and ledger are
also completed. In a computerized system, this step is completed automatically when the transaction
is recorded in the journal.
14. The trial balance is used to prove the equality of total debits and total credits of all accounts in the
ledger; it is also used to prepare the financial statements.
15. A trial balance verifies the equality of total debits and total credits of all accounts on the trial balance
and is an internal document used only by employees of the company. The balance sheet, on the other
hand, presents the business’s accounting equation and is a financial statement that can be used by
both internal and external users.
16. If total debits equal total credits on the trial balance, it does not mean that the trial balance is error-
free. An incorrect amount could have been used, an entry could have been completely missed, or the
wrong account title could have been debited or credited.
17. The debt ratio is calculated by dividing total liabilities by total assets and shows the proportion of
assets financed with debt. It can be used to evaluate a business’s ability to pay its debts.
© 2018 Pearson Education, Inc. 2-2
,Short Exercises
S2-1
a. Notes Receivable (A) f. Taxes Payable (L)
b. Common Stock (E) g. Rent Expense (E)
c. Prepaid Insurance (A) h. Furniture (A)
d. Notes Payable (L) i. Dividends (E)
e. Rent Revenue (E) j. Unearned Revenue (L)
S2-2
a. Increase to Accounts Receivable (DR) f. Decrease to Prepaid Rent (CR)
b. Decrease to Unearned Revenue (DR) g. Increase to Common Stock (CR)
c. Decrease to Cash (CR) h. Increase to Notes Receivable (DR)
d. Increase to Interest Expense (DR) i. Decrease to Accounts Payable (DR)
e. Increase to Salaries Payable (CR) j. Increase to Interest Revenue (CR)
S2-3
a. Notes Payable (CR) f. Common Stock (CR)
b. Dividends (DR) g. Utilities Expense (DR)
c. Service Revenue (CR) h. Office Supplies (DR)
d. Land (DR) i. Advertising Expense (DR)
e. Unearned Revenue (CR) j. Interest Payable (CR)
S2-4
Accounts Payable
May 2 6,000 21,000 May 1
May 22 11,500 500 May 5
8,500 May 15
500 May 23
13,000 Bal.
© 2018 Pearson Education, Inc. 2-3
, S2-5
Date Accounts and Explanation Debit Credit
Jan. 1 Cash 34,000
Common Stock 34,000
Received cash in exchange for common stock.
2 Medical Supplies 17,000
Accounts Payable 17,000
Purchased medical supplies on account.
4 Cash 1,600
Service Revenue 1,600
Performed services for patients.
12 Rent Expense 3,000
Cash 3,000
Paid rent with cash.
15 Accounts Receivable 7,000
Service Revenue 7,000
Performed services for patients on account.
© 2018 Pearson Education, Inc. 2-4
