Unit 2: Recording Business Transactions

2a. Illustrate the rules of debits and credits, and which accounts they increase or decrease 

  • What do the terms debit and credit represent?
  • What accounts increase or decrease with a debit or a credit?

The term debit means the left side of the t-account, while credit refers to the right side of the t-account. The American accounting system is a double-entry system, where every entry must have equal debits and credits. Debits and credits are the building blocks of our accounting system. Assets increase by debits and decrease by credits. Liabilities and stockholders' equity decrease by debits and increase by credits. Revenues increase with a credit and decrease with a debit. Expenses increase by debits and decrease by credits. Debits must always equal credits for every transaction.
 
To review, see Recording Business Transactions and More on the Rules of Debits and Credits.
 

2b. Explain the steps in the accounting cycle 

  • What are the eight steps in the accounting cycle?
  • What is the goal of the accounting cycle?

The accounting cycle is the series of steps performed during every accounting period. The eight steps in the accounting cycle are:

  1. Analyze transactions by examining source documents.
  2. Journalize transactions in the journal.
  3. Post journal entries to the accounts in the ledger.
  4. Prepare a trial balance of the accounts and complete the worksheet (includes adjusting entries).
  5. Prepare financial statements.
  6. Journalize and post adjusting entries.
  7. Journalize and post closing entries.
  8. Prepare a post-closing trial balance.

The goal of the accounting cycle is to produce financial statements for the company.
 
To review, see The Accounting Cycle.
 

2c. Perform double entry accounting for basic business transactions 

  • What is the double entry system for analyzing business transactions?
  • How does the basic accounting equation help you understand and apply the rules of double entry accounting?
  • How is a t-account used to analyze transactions?

The double entry system is the backbone of financial accounting. Double entry accounting requires that every business transaction be recorded with at least one debit and one credit, and the sum of the debits must equal the sum of the credits. The transaction must always balance. How the balancing occurs can be understood by looking back at the basic balance sheet equation. Since Assets = Liabilities + Owner's Equity, the transaction must be recorded in a manner that continues to balance. Since a debit increases an asset, a credit must increase a liability or equity account since they are on opposite sides of the basic accounting equation.
 
Knowing which side of the equation the account falls on allows you to know if they are increased or decreased with a debit or a credit. T-accounts help you apply the double-entry system. Entries on the left are debits, and entries on the right are credits. By utilizing t-accounts to analyze business transactions, you can more easily see what account should be debited and what account should be credited, and easily check that debits=credits and your accounting equation remains in balance.
 
To review, see Recording Business Transactions.
 

2d. Prepare a trial balance 

  • What is the purpose of a trial balance?
  • What are the steps required to prepare a trial balance?

A trial balance is usually prepared once all of the business transactions are recorded for the period. The purpose of the trial balance is to test if the total debits equal the total credits for all the transactions recorded. The accounting manager is checking their work by completing a trial balance. To prepare a trial balance, you first list all the accounts with a balance and enter debit balances in the left column and credit balances on the right. The left and right columns are then summed, and the totals are compared to check for equality. If the totals are not equal, the manager goes back and re-checks that the balances were entered correctly, that the math was correct, and that nothing was left off the statement.
 
The trial balance is useful for finding some errors but will not show if a transaction is completely left off or if errors of the same amount are made on both the debit and credit sides. The trial balance is an important check before moving on to adjusting entries and financial statement preparation.
 
To review, see Accounting Cycle Step 4: Unadjusted Trial Balance.
 

Unit 2 Vocabulary

This vocabulary list includes terms you will need to know to successfully complete the final exam.

  • accounting cycle
  • credit
  • debit
  • double-entry system
  • t-account
  • trial balance