Measuring and Recording Business Transactions
To measure a business transaction, the accountant must determine when the transaction occurred (the recognition issue), what value should be placed on the transaction (the valuation issue), and how the components of the transaction should be categorized (the classification issue). In general, recognition occurs when title passes, and a transaction is valued at the exchange price, the cost at the time the transactions is recognized. Classification refers to the categorizing of transactions according to a system of accounts.
An account is a device for storing data from transactions. There is one account for each asset, liability, and component of owner’s equity, including revenues and expenses. The general ledger is a book or file consisting of all of a company’s accounts arranged according to a chart of accounts.
Commonly used asset accounts are Cash, Notes Receivable, Accounts Receivable, Prepaid Expenses, Land, Buildings, and Equipment. Common liability accounts are Notes Payable, Accounts Payable, Wages Payable, and Mortgages Payable. Common owner’s equity accounts are Capital, Withdrawals, and revenue and expense accounts.
In the double-entry system, each transaction must be recorded with at least one debit and one credit so that the total dollar amount of the debits equals the total dollar amount of the credits. The rules for debit and credit are (1) increases in assets are debited to assets accounts, decreases in assets are credited to assets accounts; and (2) increases in liabilities and owner’s equity are credited to those accounts; decreases in liabilities aMonday, July 30, 2007 1:30 PM
The procedure for analyzing transactions is (1) analyze the effect of the transaction on assets, liabilities, and owner’s equity; (2) apply the appropriate double-entry rule; and (3) make the entry.
The general journal is a chronological record of all transactions. That record contains the date of each transaction, the names of the accounts and the dollar amounts debited and credited, and explanation of each entry, and the account numbers to which postings have been made.
After transactions have been entered in the general journal, they are posted to the general ledger. Posting is done by transferring each amount in the Debit column of the general ledger to the Debit column of the appropriate account in the general ledger, and transferring each amount in the Credit column of the general ledger the Credit column of the Credit column of the appropriate account in the general ledger. After each entry is posted, a new balance is entered in the appropriate Balance column.
A trial balance is used to check that the debit and credit balances in the ledger are equal. It is prepared by listing each account with its balance in the Debit or Credit column. Then, the two columns are added and compared to test their balances. The major limitation of the trial balance is that even if debit and credit balances are equal, this does not necessarily mean that the transaction were analyzed correctly or recorded in the proper accounts.