Guided Readings for Financial Accounting, Lesson 4.3 – Mastery Level
SUGGESTION: Read the fourth section of Chapter Four (“Recording Transactions Using Journal Entries”). This section merges transaction analysis (What balances are affected in a transaction? Do they go up or down?) with the rules of debits and credits. How is the effect of a transaction actually recorded using double-entry bookkeeping?
(4Q29) – What is the purpose of a journal entry?
(4A29) – A journal entry is a mechanical method to record the changes in account balances caused by one transaction. It accomplishes this goal by showing either a debit or credit for each affected account. All journal entries are recorded in a company’s journal. Thus, the journal serves as a historical record of the changes caused by every transaction.
(4Q30) – In recording the journal entry for a transaction, how many accounts are affected? Why do the debits and credits always have to be equal in every journal entry?
(4A30) – Every transaction affects at least two accounts. More than two accounts can be changed by a transaction but at least two accounts are always involved.
Debits must equal credits in each journal entry because there must be a cause for every effect. If cash goes up, there has to be a cause. If inventory goes down, there has to be a cause. Debits always equal credits in every journal entry to mirror both the cause and the effect of the account changes.
SUGGESTION: Work the first Test Yourself question in Section 4.4 of Chapter Four (“An accountant looks at a journal entry …”). This question was included to show how debits and credits can be used to communicate information about a transaction. The notes payable account is debited here and cash is credited. What went up and what went down? What transaction does that imply? Read the answer carefully.
(4Q31) – What is the purpose of a trial balance like the one presented in Table 4.14?
(4A31) – At any point in time, company officials may want to know the various account balances for internal decision-making. The balance for each T-account is determined (the debit total and the credit total are netted) and listed individually to create a trial balance. The trial balance is merely a listing of every account in the ledger along with its current balance. The balances are included in separate debit and credit columns to ensure that the debit and credit totals are the same. This agreement reduces the chance that mechanical errors are made at some point in the process.
(4Q32) – An investor pays $34,000 in cash to a company for shares of its capital stock. What journal entry does the company make to report the effect of this transaction?
(4Q33) – What are the journal entries for the following transactions:
a – Buy $20,000 in inventory on account.
b – Pay $9,000 of the above debt.
c – Pay $7,000 in rent for the past three months, an amount that has not been previously recorded.
(4Q34) – What journal entries are created to record the following transactions.
a – Inventory costing $20,000 is sold to a customer on account for $31,000
b - The above customer pays the first $12,000 in cash.
SUGGESTION: Work the second Test Yourself question in Section 4.4 of Chapter Four (“Which of the following statements…”). Accrual accounting is an essential concept in financial accounting. This question helps you better define that term.
(4Q35) – The D’antan Corporation sells a car to a customer who signs the contract and drives the car away on December 10. D’antan does not collect the money until January 15 of the next year. When is the revenue recognized? Is it at the time of sale or when the cash is collected?
(4A35) – US GAAP follows the revenue recognition principle. In simple terms, this rule holds that revenue is recognized when the seller has satisfied its performance obligation as established between the two parties. The performance obligation is what the seller is required to do. In this case, the performance obligation is giving the car to the customer. The revenue is recognized on December 10. Accounts receivable is debited and sales revenue is credited on that date.
(4Q36) – A cost is reported as an asset if it provides a company with future economic benefit. If the cost does not provide future economic benefit, then it must be reported as an expense. What is the matching principle?
(4A36) – Whenever accountants have difficulty determining whether a cost should be reported as an asset or an expense, they look for the revenue that is most likely to be generated by that cost. The expense is then recorded in the same time period as that revenue. That is known as the matching principle.
(4Q37) – This chapter talks about four steps to financial reporting: analyze, record, adjust, and report. How would you explain those steps to a friend who was not taking financial accounting?
(4A37) – A financial event happens that affects account balances. That is a transaction. The financial accountant ANALYZES that event to determine what accounts are affected—either as an increase or as a decrease. The accountant RECORDS those effects in a journal entry and T-accounts using an ancient system of debits and credits known as double-entry bookkeeping. When financial statements are to be prepared, the accountant ADJUSTS (or updates) the balances so they are presented fairly. The resulting figures are used to REPORT financial statements. Organizations throughout the world follow this pattern.
SUGGESTION: Read the fifth section of Chapter Four (“Connecting the Journal to the Ledger”). This section provides additional practice in using debits and credits to make journal entries. The process is carried further as the journal entries are posted to T-accounts. Next, a trial balance is created as a preparatory step in creating financial statements.
(4Q38) – After a journal entry is recorded (in the journal), what happens next in a company’s accounting system?
(4A38) – A journal entry is prepared to identify the debits and credits created by a transaction. Next, those same amounts are posted to (or entered on) the appropriate side of the corresponding T-account. The journal entry records the transaction and the T-accounts are then updated so that all account balances remain current. Journal entries are posted to the appropriate T-accounts found in the ledger.
(4Q39) – What journal entries are prepared to record the following transactions?
a – Land is bought by a donut shop for $100,000 by signing a note payable.
b – The above note is paid off for $105,000. The extra amount is interest on the loan.
c – The above land is sold to another party for $160,000 with $20,000 paid immediately and a note signed for the rest.
(4Q40) – What journal entries should be created for the following transactions?
a – $3,000 is paid for an advertisement that will appear next month in a magazine.
b – $7,000 is collected as an advance payment for work to be done next year.
c – $5,000 is paid to employees for work previously provided (and already recorded by the company)
Note that the more you practice journal entries like those in the previous few cards, the better you will come to understand them. Table 4.1 provides basic transactions. Then, in Chapter Four, the accounts that are affected by those transactions are first determined. Each of those increases and decreases is recorded by the company in the journal entries shown throughout the chapter. Simply learning those examples is a great start.
(4Q41) – A company has recorded journal entries for all transactions and the various debits and credits have been posted into the appropriate T-accounts. Balances have been determined for each T-account and transcribed into a trial balance. The debit total is equal to the credit total. All account balances are judged to be presented fairly according to U.S. GAAP. What does the financial accountant do next?
(4A41) – After all account balances are listed in a trial balance and each amount is judged to be presented fairly according to U.S. GAAP, the company’s financial accountant uses those balances to produce financial statements. The income statement is prepared first followed by the statement of retained earnings, and then the balance sheet and finally the statement of cash flows.
SUGGESTION: Walk through this process (a few times):
In Table 4.14, a trial balance is presented as of 12/29. All accounts are listed with a current debit or credit balance.
In Table 4.34, the 14 basic journal entries discussed in this chapter (after 12/29) are shown with proper debits and credits.
T-accounts are presented in Table 4.35 with opening debit or credit balances (from Table 4.14).
Each entry in Table 4.34 is posted to the proper T-account (in Table 4.35) and a new total determined.
All account balances are listed on an updated trial balance (Table 4.36) to be used in financial statements.