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Chapter 2: Analyzing and Recording Business Transactions

Discussion Questions: Key Points

1. Assets are listed in order of liquidity, or closeness to cash. Discuss the steps that the business would have to go through in order to convert each asset to cash in the normal course of business.

2. When the company pays for something in advance that won’t be used up in this accounting period, it would record a prepaid asset. In a sense, plant assets are a type of prepaid asset, although it would not be classified as such. All prepaid assets would be used up, eventually. That is, they all become expenses over time or with use.

3. Revenue increases retained earnings. By definition, when revenue is increased as assets are acquired (or liabilities reduced) as a result of activities relating to the company’s line of business, the owners have a claim on those assets that are acquired. This ownership interest is reflected in the retained earnings account.

4. Not all events are transactions. A transaction is an event that has a financial impact on a company. Journal entries are recorded for all transactions.

5. The normal balance of an account is the side that increases the account.

a. Debit

b. Debit

c. Credit

d. Credit

e. Debit

6. The bank is keeping its own books, not yours. When you give the bank cash or deposit your paycheck, the bank needs to keep track of its liability to you. It is increasing its liability account with a credit (the debit that it makes is to its own cash account).

7. A credit balance in the cash account would indicate a negative cash balance. Negative cash does not make sense. If a company overdraws its cash account, it now has a liability to the bank. Rather than showing a credit balance in its cash account, it should show a credit balance in a liability account.

8. Journalizing is the process of recording a transaction in the journal. Posting is the process of transferring the information from...