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Recording Business Transactions: Accounts, Debits & Credits, and the Accounting Cycle

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Chapter 2: Recording Business Transactions

Learning Objectives

  • Explain accounts as they relate to the accounting equation and describe common accounts

  • Define debits, credits, and normal account balances using double-entry accounting and T-accounts

  • Record transactions in a journal and post journal entries to the ledger

  • Prepare the unadjusted trial balance

  • Describe the Accounting Cycle

  • Use the debt ratio to evaluate business performance

Accounts and the Accounting Equation

What Is an Account?

The accounting equation is the foundation of financial accounting and is expressed as:

Assets = Liabilities + Equity

Each category in the equation contains multiple accounts. An account is a detailed record of all increases and decreases that have occurred in a specific asset, liability, or equity item during a period.

Types of Accounts

Accounts are classified into three main categories: Assets, Liabilities, and Equity. Each category contains several common accounts, as described below.

Asset Accounts

Account Name

Explanation

Cash

A business's money, including bank balances, bills, coins, and checks.

Accounts Receivable

A customer's promise to pay in the future for services or goods received. Often described as "On Account."

Notes Receivable

A written promise that a customer will pay a fixed amount of money (principal) and interest by a certain date in the future. More formal than Accounts Receivable.

Prepaid Expense

A payment of an expense in advance. Considered an asset because the prepayment provides a future benefit. Examples: Prepaid Rent, Prepaid Insurance, Office Supplies.

Land

The cost of land a business uses in operations.

Building

The cost of an office building, store, or warehouse.

Equipment, Furniture, and Fixtures

The cost of equipment, furniture, and fixtures (such as light fixtures and shelving). Each has a separate asset account.

Liability Accounts

Account Name

Explanation

Accounts Payable

A promise made by the business to pay a debt in the future. Arises from a credit purchase.

Notes Payable

A written promise made by the business to pay a debt, usually involving interest, in the future.

Accrued Liability

An amount owed but not yet paid. Specific types include Taxes Payable, Rent Payable, and Salaries Payable.

Unearned Revenue

Occurs when a company receives cash from a customer but has not yet provided the product or service. The company promises to provide services or deliver goods in the future.

Equity Accounts

Account Name

Explanation

Common Stock

Represents the net contributions of the stockholders in the business. Increases equity.

Dividends

Distributions of cash or other assets to the stockholders. Decreases equity.

Revenues

Earnings from delivering goods or services to customers. Increases equity. Examples: Service Revenue, Rent Revenue.

Expenses

The cost of selling goods or services. Decreases equity. Examples: Rent Expense, Salaries Expense, Utilities Expense.

Example: If a company receives cash from a customer for services to be performed in the future, it records an increase in Cash (Asset) and an increase in Unearned Revenue (Liability).

Additional info:

  • Each account tracks the changes in a specific item over time, allowing for detailed financial analysis and reporting.

  • Asset accounts generally have a debit balance, while liability and equity accounts generally have a credit balance.

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