Analyzing Business Transactions
0REVIEWING THE CHAPTER
Objective 1: Explain how the concepts of recognition, valuation, and classification apply to
business transactions and why they are important factors in ethical financial reporting.
Before recording a business transaction, the accountant must determine three things:0
When the transaction should be recorded (the
What value, or dollar amount, to place on the transaction (the
How the components of the transaction should be categorized (the
Normally, a sale is recognized (entered into the accounting records) when title to the
merchandise passes from the supplier to the purchaser, regardless of when payment is made
or received. This point of sale is referred to as the
Some business events, such as the hiring of a new employee, are
Other business events, such as payment to an employee for work performed,
states that business transactions should be recognized at their original
cost (also called
). In this case,
refers to a transaction’s
—a verifiable measure based on the agreement between the buyer and the seller—at the
point of recognition. Generally, any change in value that occurs after the original transaction
is not reflected in the accounting records.
Ethical financial reporting requires that accountants apply generally accepted accounting
principles when dealing with recognition, valuation, and classification issues. For example,
when a company overstates its revenue, it has violated the guideline of recognition. When
an asset is reported at an inflated dollar amount, for example, the guideline of valuation has
been violated. And when expenses, for example, are treated as assets, the guideline of
classification has been violated. Significant, intentional violations are viewed as fraudulent.
Objective 2: Explain the double-entry system and the usefulness of T accounts in analyzing
Every business transaction is classified in a filing system consisting of accounts. An
is the basic storage unit for accounting data. Each asset, liability, and component of
owner’s equity, including revenues and expenses, has a separate account.
of accounting requires that one or more accounts be debited and
one or more accounts be credited for each transaction and that total dollar amounts of debits
equal total dollar amounts of credits.
shows an account in its simplest form. It has three parts:0
A title that expresses the name of the asset, liability, or owner’s equity account