College of Business at Illinois

Department of Accountancy

Formal Financial
Accounting
Module 1: Introduction to Financial
Accounting Terminology
Dr. Oktay Urcan
Module 1 Lesson 1

Transaction and
Transaction Worksheet
Transaction

A transaction

Has financial effect on the firm

Is reliably estimated

In general, a transaction involves firms receiving

something and giving something else in return

Example: A firm purchases inventory of $1,000

on account
Account
Fundamental accounting equation:

Assets = Liabilities + Shareholders’ Equity

An account is any particular element of assets,

liabilities, or shareholders’ equity

Example: Cash, Accounts payable, Common stock

Financial transactions are recorded and

summarized in accounts

Example revisited: A firm purchases inventory of

$1,000 on account
Recording a Transaction
Recording is showing the impact of a transaction
on accounts

Fundamental accounting equation:

Assets = Liabilities + Shareholders’ equity

Thus, we have for over any period of time:

∆ Assets = ∆ Liabilities + ∆ Shareholders’ equity

This equation constitutes the foundation of

recording financial transactions
Transaction Worksheets
We learned how to use transaction worksheets
to record a transaction in the Financial
Accounting: Foundations course

Assets = Liabilities + Shareholders’ equity

Inventory
Transaction Worksheet
We learned how to use transaction worksheet to
record a transaction in “Financial Accounting:
Foundations” course

A firm purchases inventory of $1,000 on account

Assets = Liabilities + Shareholders’ equity

Purchase $1,000 $1,000

inventory

Inventory Accounts
payable
Transaction Worksheet
We learned how to use transaction worksheet to
record a transaction in “Financial Accounting:
Foundations” course

A firm purchases inventory of $1,000 on account

Assets = Liabilities + Shareholders’ equity

Purchase $1,000 $1,000

inventory

∆Assets = ∆Liabilities = ∆SHE =

$1,000 $1,000 $0
Transaction Worksheet
We learned how to use transaction worksheet to
record a transaction in “Financial Accounting:
Foundations” course

A firm purchases inventory of $1,000 on account

Assets = Liabilities + Shareholders’ equity

Purchase $1,000 $1,000

inventory

∆Assets = ∆Liabilities = ∆SHE =

$1,000 $1,000 $0

√ Fundamental accounting equation holds

Module 1 Lesson 2

T-Accounts, Debit,
and Credit
Double Entry System

Business transactions involve firms receiving

something and giving something in return

Thus, each transaction impacts at least two

accounts

This is called double-entry system

Example revisited: A firm purchases inventory of

$1,000 on account
T-Account

We record transactions on accounts

through T-accounts in formal accounting
Account Name

Debit Credit

Left side Right side

Rules of Recording in
Formal Accounting (1)
Please think about the balance sheet
as a huge T-account:

Balance Sheet

Assets Liabilities
Debit Credit
Shareholders’ equity
Rules of Recording in
Formal Accounting (2)
Assets

Debit (+) Credit (-)

Liabilities

Debit (-) Credit (+)

Shareholders’ Equity

Debit (-) Credit (+)

Rules of Recording in
Formal Accounting (3)
Dividends
Dividends
decrease
retained earnings
Debit (+) Credit (-)

Revenues Revenues
increase retained
Debit (-) Credit (+) earnings

Expenses
Expenses
Debit (+) Credit (-) decrease
retained earnings
Rules of Recording in
Formal Accounting (4)

Final rule:
Make sure that total amount of
debits is equal to total amount of
credits for each transaction
Example 1

A firm purchases inventory of $1,000 on account

Inventory

$1,000

Accounts payable

$1,000
Example 1

A firm purchases inventory of $1,000 on account

Inventory

$1,000
Total
Debits
=
Accounts payable Total
Credits
$1,000
Example 2
A firm performs services worth $5,000 for a client.
The client will make the payment next month

Accounts receivable

$5,000

Revenues

$5,000
Example 3

A firm declares but does not pay

dividends of $2,500

Dividends payable

$2,500

Retained earnings

$2,500
Module 1 Lesson 3

Journal Entry, Ledger,

Trial Balance
Journalizing and Journal Entry

A journal is the list of transactions in

chronological order
Each transaction in the journal is called
a journal entry
Example 4
A firm purchases land by paying $10,000
on Jan 2, 2017

JOURNAL
Date Accounts and explanation Debit Credit
Jan 2 Land $10,000
Cash $10,000
Purchase of land
Example 4
A firm purchases a land by paying $10,000 on
Jan 2, 2017
JOURNAL
Date Accounts and explanation Debit Credit
Jan 2 Land $10,000
Cash $10,000
Purchase of land

Note:

The account debited is entered on the left

The account credited is entered on the right
Ledger

The Ledger is the group of all T-

accounts with balances
Journal entries need to be copied to
account in the ledger to calculate
individual accounts’ balances. This
process is called posting
Flow of Accounting Information

Transaction occurs
Transaction is journalized (i.e., a journal
entry is created for the transaction)
Journal entry is posted to individual
ledger accounts (using T-accounts)
Example 5
Illini Travel pays the water bill of $500 on Mar 2, 2017

JOURNAL
Date Accounts and explanation Debit Credit
Mar 2 Water expense $500
Cash $500
Water bill payment

LEDGER ACCOUNTS

Water expense Cash

$500 $500
Example 6
A customer makes an advance payment of $750 on May 7, 2017

JOURNAL
Date Accounts and explanation Debit Credit
May 7 Cash $750
Unearned revenue $750
Customer advance payment

LEDGER ACCOUNTS

Water expense Cash Unearned revenue

$500 $500
$750 $750
Example 6
A customer makes an advance payment of $750 on May 7, 2017

JOURNAL
Date Accounts and explanation Debit Credit
May 7 Cash $750
Unearned revenue $750
Customer advance payment

LEDGER ACCOUNTS
Water expense Cash Unearned revenue

$500 $500
$750 $750
Cash balance $250
Trial Balance
A trial balance shows all accounts with their balance
up to trial balance date

Trial balance is very useful to prepare financial

statements
Illini Travel
Trial Balance
Dec 31, 2017
Balance
Account Title Debit Credit
Cash $250
Unearned Revenue $750
Water Expense $500
Total $750 $750
Summary

In this module, we learned about financial

accounting terminology

We focused especially on how to journalize

financial transactions and how to post journal
entries on the ledger

Next module, we will go through examples

which will require journalizing and posting
transactions about assets