Accounting, Fifth Edition 3 THE ACCOUNTING INFORMATION SYSTEM Accounting, Fifth Edition

Learning Objectives After studying this chapter, you should be able to: Analyze the effect of business transactions on the basic accounting equation. Explain what an account is and how it helps in the recording process. Define debits and credits and explain how they are used to record business transactions. Identify the basic steps in the recording process. Explain what a journal is and how it helps in the recording process. Explain what a ledger is and how it helps in the recording process. Explain what posting is and how it helps in the recording process. Explain the purposes of a trial balance.

Tell a story The Accounting Information System System of collecting and processing transaction data and communicating financial information to decision makers. Most businesses use computerized accounting (EDP) systems. Tell a story LO 1 Analyze the effect of business transactions on the basic accounting equation.

Accounting Transactions Transactions are economic events/exchanges that require recording in the financial statements. Not all activities represent transactions. Assets, liabilities, or stockholders’ equity items change as a result of some economic event. Dual effect on the accounting equation. LO 1 Analyze the effect of business transactions on the basic accounting equation.

Accounting Transactions Question: Are the following events recorded in the accounting records? Illustration 3-1 Discuss guided trip options with potential customer. Purchase computer. Pay rent. Event Is the financial position (assets, liabilities, or stockholders’ equity) of the company changed? Criterion Record/ Don’t Record LO 1 Analyze the effect of business transactions on the basic accounting equation.

Accounting Transactions Analyzing Transactions The process of identifying the specific effects of economic events on the accounting equation. Basic Accounting Equation Assets Liabilities Stockholders’ Equity = + Assets Liabs & Equity LO 1 Analyze the effect of business transactions on the basic accounting equation.

Accounting Equation Practice Problem BE3-2, p 138 Write out the accounting equation. Indicate the TWO accounts involved, then identify each account as an Asset, Liability, Common Stock, Dividends, Revenue or Expense. For each account, indicate if that account increases in value or decreases. Check to see that the accounting equation remains in balance.

Accounting Equation & Fin’l Statements Analyzing Transactions Illustration 3-2 Expanded accounting equation Income Statement LO 1 Analyze the effect of business transactions on the basic accounting equation.

Accounting Equation & Fin’l Statements Analyzing Transactions Illustration 3-2 Expanded accounting equation Stmt of Retained Earnings Net Income/Income Statement LO 1 Analyze the effect of business transactions on the basic accounting equation.

Accounting Equation & Fin’l Statements Analyzing Transactions Balance Sheet Illustration 3-2 Expanded accounting equation Stmt of Retained Earnings Net Income/Income Statement LO 1 Analyze the effect of business transactions on the basic accounting equation.

Analyzing & Recording Business Transactions Analyze each transaction and event from source documents Record relevant transactions & events in a general journal Post journal information to the general ledger (t-accounts) We begin the accounting process by analyzing source documents. For example, you usually receive a receipt when you pay cash for something. Think about the last time you went to a fast food restaurant. When you received your order you were given a receipt, a source document. If you wanted a company to reimburse you for the meal because you were traveling on company business, you must present evidence of your expenditure. This evidence takes the form of a source document, the receipt. Once we identify a business transaction, we record it in a journal. A journal is arranged in chronological order. Transactions are recorded by date of occurrence. At the end of the accounting period, usually a month, transactions in the journal are posted to a ledger account. Posting is the systematic process of transferring information from the journal to the ledger. The ledger groups transactions by the accounts impacted. For example, we will have a ledger account for cash. All transactions that result in increases or decreases in the cash account will be posted to the cash ledger account. Once all transactions have been posted, we prepare a trial balance. The purpose of the trial balance is to make sure that all information has been transferred properly. The trial balance is a listing of all account balances. Prepare and analyze the trial balance 2-11

Steps in the Recording Process The General Journal Chronological list of all business transactions. It is the book of original entry. It records the increase or decrease in a specific asset, liability, equity, revenue, or expense account. Helps to prevent or locate errors because the debit and credit amounts can be easily compared. LO 5 Explain what a journal is and how it helps in the recording process.

Steps in the Recording Process Chart of Accounts – listing of accounts used by a company to record transactions in the journal and general ledger. Illustration 3-20 LO 6 Explain what a ledger is and how it helps in the recording process.

Steps in the Recording Process The General Ledger is comprised of the entire group of accounts maintained by a company (like sorting coins). Illustration 3-19 LO 6 Explain what a ledger is and how it helps in the recording process.

Assets = Liabilities + Owners’ Equity Advantage of T Accounts (aka Posting) “T” accounts provide a better visual trail for an individual account. They are often useful in helping one find where an “Out of Balance” exists. Assets = Liabilities + Owners’ Equity

A T-account represents a general ledger account. Recording Transactions using T Accts A T-account represents a general ledger account. Accountants often use a T-account to represent a general ledger account. It is a quick way to analyze transaction before we enter the information in the journal. The left side of a T-account is always called the debit side, and the right side is always called the credit side. This terminology comes from the time when the first double-entry system was first developed. We still use the terms as a convention. The words do not have any significant meaning other than that they stand for the left and right side of a ledger. 2-16

The Account Debit and Credit Procedures Double-entry system Each transaction must affect two or more accounts to keep the basic accounting equation in balance. Recording done by debiting at least one account and crediting another. DEBITS must equal CREDITS. LO 3 Define debits and credits and explain they are used to record business transactions.

Double-Entry Accounting Debit and Credit Procedures Liabilities Equity Assets = + Debit Credit ASSETS + - LIABILITIES - + EQUITIES After we decide on the terms to use for the left and right side of a ledger account, we must establish the mathematics of the double-entry system. Liabilities and equity have the opposite sign of assets. If we were to move the liabilities to the left side of the equation, it would read assets minus liabilities equal equity. As a convention of double-entry accounting we have decided that a debit, or left side, to an asset account will represent an increase in the asset account balance. Once this decision is made all the remaining math is determined. Because liabilities and equity have the opposite sign of assets, a debit to a liability or equity account must mean a decrease and a credit means an increase. Instead of using the terms increase and decrease we use the terms debit and credit. It is important to remember whether we are talking about an asset, liability or equity account for the meaning of a debit or a credit. It will take you a short while to become accustomed to using the terms debit and credit, but with practice you will master the concept easily. 2-18

Equity _ + - + + - Debit and Credit Procedures Revenues Expenses Common Stock Dividends _ + Debit Credit Stock - + Dividends + - Expenses Revenues Here is the expanded accounting equation showing the equity section. Because revenues increase equity, a revenue account must be recorded just like the common stock account. A credit is an increase in revenues and a debit is an increase in expenses. The common stock and revenue accounts are both increased with a credit and decreased with a debit. Dividends and expenses have an opposite sign, so these accounts are increased with a debit and decreased with a credit. 2-19

T-Account Summary – Normal Balances Debit Credit Assets Dividends Expenses Liabilities Capital/Equity Revenue

Assets = Liabilities + Owners’ Equity Journalizing Transactions Read the transaction. Decide which accounts are involved. Look first to see if cash is involved. Classify the accounts involved (asset, liability, capital, revenue or expense). Decide if the accounts increase or decrease in value. Properly allocate the transaction as debit(s) and credit(s). Check to see the debits for that transaction equal the credits and that the fundamental equation still works: Assets = Liabilities + Owners’ Equity

Journalizing & Posting Sierra issued common stock in exchange for $10,000 cash. Oct. 1 General Journal Cash 10,000 Common stock 10,000 10,000 + Debit (Dr) Credit (Cr) - - Debit (Dr) Credit (Cr) + A - Cash E – Common Stock Posting: LO 5 Explain what a journal is and how it helps in the recording process.

Journalizing & Posting Sierra borrowed $5,000 by signing a note. Oct. 1 General Journal Cash Notes payable 5,000 + Debit (Dr) Credit (Cr) - - Debit (Dr) Credit (Cr) + A - Cash L – Notes Payable Posting: 5,000 LO 5 Explain what a journal is and how it helps in the recording process.

Journalizing & Posting Sierra purchased equipment for $5,000. Oct. 2 General Journal Equipment Cash 5,000 + Debit (Dr) Credit (Cr) - A - Cash 5,000 A - Equipment Posting: + Debit (Dr) Credit (Cr) - 5,000 LO 5 Explain what a journal is and how it helps in the recording process.

Journalizing Business Transactions Practice Problem P3-6B, p 151 Set up a “T” account for each account listed in the Trial Balance and each additional account listed in part (a). For each “T” account, indicate whether that account is an Asset, Liability, Common Stock, Dividends, Revenues or Expense account. For each “T”, mark the + and – side, using Slides 18-20. Now proceed to solve for (b) and (c). You can also solve for (c) then (b), if preferred. Calculate the ending balance for each T account, then create the trial balance.

The Trial Balance Trial Balance A list of accounts and their balances at a given time. Accounts are listed in the order in which they appear in the ledger. Purpose is to prove that debits equal credits. May also uncover errors in journalizing and posting. Useful in the preparation of financial statements. LO 8 Explain the purposes of a trial balance.

The Trial Balance Illustration 3-34 Equal LO 8