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

Study Objectives 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. Classify cash activities as operating, investing, or financing.

The Accounting Information System Accounting Transactions The Account Steps in the Recording Process The Recording Process Illustrated The Trial Balance Analyzing transactions Summary of transactions Debits and credits Debit and credit procedures Stockholders’ equity relationships Summary of debit/credit rules The journal The ledger Chart of accounts Posting Summary illustration of journalizing and posting Limitations of a trial balance

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.

Accounting Transactions Transactions are economic events 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.

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

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 = + SO 1 Analyze the effect of business transactions on the basic accounting equation.

Accounting Transactions Analyzing Transactions Illustration 3-2 Expanded accounting equation SO 1 Analyze the effect of business transactions on the basic accounting equation.

Accounting Transactions Illustration: 1. On October 1, cash of $10,000 is invested in Sierra Corporation by investors in exchange for $10,000 of common stock. 1. +10,000 +10,000 SO 1 Analyze the effect of business transactions on the basic accounting equation.

Accounting Transactions 2. On October 1, Sierra borrowed $5,000 from Castle Bank by signing a 3-month, 12%, $5,000 note payable. 1. +10,000 +10,000 2. +5,000 +5,000 SO 1 Analyze the effect of business transactions on the basic accounting equation.

Accounting Transactions 3. On October 2, Sierra purchased equipment by paying $5,000 cash to Superior Equipment Sales Co. 1. +10,000 +10,000 2. +5,000 +5,000 3. -5,000 +5,000 SO 1 Analyze the effect of business transactions on the basic accounting equation.

Accounting Transactions 4. On October 2, Sierra received a $1,200 cash advance from R. Knox, a client. 1. +10,000 +10,000 2. +5,000 +5,000 3. -5,000 +5,000 4. +1,200 +1,200 SO 1 Analyze the effect of business transactions on the basic accounting equation.

Accounting Transactions 5. On October 3, Sierra received $10,000 in cash from Copa Company for guide services performed. 1. +10,000 +10,000 2. +5,000 +5,000 3. -5,000 +5,000 4. +1,200 +1,200 5. +10,000 +10,000 SO 1 Analyze the effect of business transactions on the basic accounting equation.

Accounting Transactions 6. On October 3, Sierra Corporation paid its office rent for the month of October in cash, $900. 1. +10,000 +10,000 2. +5,000 +5,000 3. -5,000 +5,000 4. +1,200 +1,200 5. +10,000 +10,000 6. -900 -900 SO 1 Analyze the effect of business transactions on the basic accounting equation.

Accounting Transactions 7. On October 4, Sierra paid $600 for a one-year insurance policy that will expire next year on September 30. 1. +10,000 +10,000 2. +5,000 +5,000 3. -5,000 +5,000 4. +1,200 +1,200 5. +10,000 +10,000 6. -900 -900 7. -600 +600 SO 1 Analyze the effect of business transactions on the basic accounting equation.

Accounting Transactions 8. On October 5, Sierra purchased supplies on account from Aero Supply for $2,500. 1. +10,000 +10,000 2. +5,000 +5,000 3. -5,000 +5,000 4. +1,200 +1,200 5. +10,000 +10,000 6. -900 -900 7. -600 +600 8. +2,500 +2,500 SO 1 Analyze the effect of business transactions on the basic accounting equation.

Accounting Transactions 10. On October 20, Sierra paid a $500 dividend. 1. +10,000 +10,000 2. +5,000 +5,000 3. -5,000 +5,000 4. +1,200 +1,200 5. +10,000 +10,000 6. -900 -900 7. -600 +600 8. +2,500 +2,500 10. -500 -500 SO 1 Analyze the effect of business transactions on the basic accounting equation.

Accounting Transactions 11. Employees have worked two weeks, earning $4,000 in salaries, which were paid on October 26. 1. +10,000 +10,000 2. +5,000 +5,000 3. -5,000 +5,000 4. +1,200 +1,200 5. +10,000 +10,000 6. -900 -900 7. -600 +600 8. +2,500 +2,500 10. -500 -500 11. -4,000 -4,000

An Account can be illustrated in a T-Account form. The Account Record of increases and decreases in a specific asset, liability, equity, revenue, or expense item. Debit = “Left” Credit = “Right” Account An Account can be illustrated in a T-Account form. SO 2 Explain what an account is and how it helps in the recording process.

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. SO 3 Define debits and credits and explain their use in recording business transactions.

Debit and Credit Procedures If Debits are greater than Credits, the account will have a debit balance. Transaction #1 $10,000 $3,000 Transaction #2 Transaction #3 8,000 Balance $15,000 SO 3 Define debits and credits and explain their use in recording business transactions.

Debit and Credit Procedures If Credits are greater than Debits, the account will have a credit balance. Transaction #1 $10,000 $3,000 Transaction #2 8,000 Transaction #3 Balance $1,000 SO 3 Define debits and credits and explain their use in recording business transactions.

Dr./Cr. Procedures for Assets and Liabilities Assets - Debits should exceed credits. Liabilities – Credits should exceed debits. The normal balance is on the increase side. SO 3 Define debits and credits and explain their use in recording business transactions.

Dr./Cr. Procedures for Stockholders’ Equity Owner’s investments and revenues increase stockholders’ equity (credit). Dividends and expenses decrease stockholder’s equity (debit). SO 3 Define debits and credits and explain their use in recording business transactions.

Dr./Cr. Procedures for Revenue and Expense The purpose of earning revenues is to benefit the stockholders. The effect of debits and credits on revenue accounts is the same as their effect on stockholders’ equity. Expenses have the opposite effect: expenses decrease stockholders’ equity. SO 3 Define debits and credits and explain their use in recording business transactions.

Stockholders’ Equity Relationships Illustration 3-15 SO 3 Define debits and credits and explain their use in recording business transactions.

Summary of Debit/Credit Rules Normal Balance Debit Normal Balance Credit SO 3 Define debits and credits and explain their use in recording business transactions.

Summary of Debit/Credit Rules Balance Sheet Income Statement Asset = Liability + Equity Revenue - Expense = Debit Credit SO 3 Define debits and credits and explain their use in recording business transactions.

Summary of Debit/Credit Rules Relationship among the assets, liabilities and stockholders’ equity of a business: Illustration 3-16 Basic Equation Assets = Liabilities + Stockholders’ Equity Expanded Basic Equation The equation must be in balance after every transaction. For every Debit there must be a Credit. SO 3 Define debits and credits and explain their use in recording business transactions.

Summary of Debit/Credit Rules Review Question Debits: increase both assets and liabilities. decrease both assets and liabilities. increase assets and decrease liabilities. decrease assets and increase liabilities. SO 3 Define debits and credits and explain their use in recording business transactions.

Summary of Debit/Credit Rules Review Question Accounts that normally have debit balances are: assets, expenses, and revenues. assets, expenses, and equity. assets, liabilities, and dividends. assets, dividends, and expenses. SO 3 Define debits and credits and explain their use in recording business transactions.

Steps in the Recording Process Illustration 3-17 Transfer journal information to ledger accounts Analyze each transaction Enter transaction in a journal Source documents, such as a sales slip, a check, a bill, or a cash register tape, provide evidence of the transaction. SO 4 Identify the basic steps in the recording process.

Steps in the Recording Process The Journal Book of original entry. Transactions recorded in chronological order. Contributions to the recording process: Discloses the complete effects of a transaction. Provides a chronological record of transactions. Helps to prevent or locate errors because the debit and credit amounts can be easily compared. SO 5 Explain what a journal is and how it helps in the recording process.

The Journal Journalizing - Entering transaction data in the journal. Illustration: Presented below is information related to Sierra Corporation. Oct. 1 Sierra issued common stock in exchange for $10,000 cash. 1 Sierra borrowed $5,000 by signing a note. 2 Sierra purchased office equipment for $5,000. Instructions - Journalize these transactions. SO 5 Explain what a journal is and how it helps in the recording process.

Journalizing Oct. 1 Sierra issued common stock in exchange for $10,000 cash. General Journal Cash 10,000 Common stock 10,000 SO 5 Explain what a journal is and how it helps in the recording process.

Journalizing Oct. 1 Sierra borrowed $5,000 by signing a note. Cash General Journal Cash 5,000 Notes payable 5,000 SO 5 Explain what a journal is and how it helps in the recording process.

Journalizing Oct. 2 Sierra purchased equipment for $5,000. Equipment General Journal Equipment 5,000 Cash 5,000 SO 5 Explain what a journal is and how it helps in the recording process.

Steps in the Recording Process The Ledger contains the entire group of accounts maintained by a company. Illustration 3-19 SO 6 Explain what a ledger 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. SO 6 Explain what a ledger is and how it helps in the recording process.

Steps in the Recording Process Posting – the process of transferring amounts from the journal to the ledger accounts. General Journal J1 101 General Ledger Oct. 1 Owner investment J1 10,000 10,000 SO 7

Steps in the Recording Process Review Question Posting: normally occurs before journalizing. transfers ledger transaction data to the journal. is an optional step in the recording process. transfers journal entries to ledger accounts. SO 7 Explain what posting is and how it helps in the recording process.

The Recording Process Illustrated Follow these steps: 1. Determine what type of account is involved. 2. Determine what items increased or decreased and by how much. 3. Translate the increases and decreases into debits and credits. Illustration 3-21 SO 7 Explain what posting is and how it helps in the recording process.

The Recording Process Illustrated Follow these steps: 1. Determine what type of account is involved. 2. Determine what items increased or decreased and by how much. 3. Translate the increases and decreases into debits and credits. Illustration 3-22 SO 7 Explain what posting is and how it helps in the recording process.

The Recording Process Illustrated Follow these steps: 1. Determine what type of account is involved. 2. Determine what items increased or decreased and by how much. 3. Translate the increases and decreases into debits and credits. Illustration 3-23 SO 7 Explain what posting is and how it helps in the recording process.

The Recording Process Illustrated Additional Transactions Illustration 3-24 SO 7 Explain what posting is and how it helps in the recording process.

The Recording Process Illustrated Additional Transactions Illustration 3-25 SO 7 Explain what posting is and how it helps in the recording process.

The Recording Process Illustrated Additional Transactions Illustration 3-26 SO 7 Explain what posting is and how it helps in the recording process.

The Recording Process Illustrated Additional Transactions Illustration 3-27

The Recording Process Illustrated Additional Transactions Illustration 3-28 SO 7 Explain what posting is and how it helps in the recording process.

The Recording Process Illustrated Additional Transactions Illustration 3-29 SO 7 Explain what posting is and how it helps in the recording process.

The Recording Process Illustrated Additional Transactions Illustration 3-30 SO 7 Explain what posting is and how it helps in the recording process.

The Recording Process Illustrated Additional Transactions Illustration 3-31 SO 7

Summary Illustration of Journalizing SO 7 Explain what posting is and how it helps in the recording process.

Summary Illustration of Journalizing SO 7 Explain what posting is and how it helps in the recording process.

Summary Illustration of Posting SO 7 Explain what posting is and how it helps in the recording process.

The Trial Balance A list of accounts and their balances at a given time. Purpose is to prove that debits equal credits. Illustration 3-34

The Trial Balance Limitations of a Trial Balance The trial balance may balance even when a transaction is not journalized, a correct journal entry is not posted, a journal entry is posted twice, incorrect accounts are used in journalizing or posting, or offsetting errors are made in recording the amount of a transaction. SO 8 Explain the purposes of a trial balance.

The Trial Balance Review Question A trial balance will not balance if: a correct journal entry is posted twice. the purchase of supplies on account is debited to Supplies and credited to Cash. a $100 cash dividends is debited to the Dividends account for $1,000 and credited to Cash for $100. a $450 payment on account is debited to Accounts Payable for $45 and credited to Cash for $45. SO 8 Explain the purposes of a trial balance.

Key Points Transaction analysis is the same under IFRS and GAAP however different standards sometimes impact how transactions are recorded. European companies rely less on historical cost and more on fair value than U.S. companies. The double-entry system is the basis of accounting systems worldwide. Both the IASB and FASB go beyond the basic definitions provided in this textbook for the key elements of financial statements, that is, assets, liabilities, equity, revenues, and expenses.

Key Points A trial balance under IFRS follows the same format as shown in the textbook. As shown in the textbook, dollars signs are typically used only in the trial balance and the financial statements. The same practice is followed under IFRS, using the currency of the country that the reporting company is headquartered.

Key Points In deciding whether the United States should adopt IFRS, some of the issues the SEC said should be considered are: Whether IFRS is sufficiently developed and consistent in application. Whether the IASB is sufficiently independent. Whether IFRS is established for the benefit of investors.

Key Points Some of the issues the SEC said should be considered are: The issues involved in educating investors about IFRS. The impact of a switch to IFRS on U.S. laws and regulations. The impact on companies including changes to their accounting systems, contractual arrangements, corporate governance, and litigation. The issues involved in educating accountants, so they can prepare statements under IFRS.

Looking into the Future The basic recording process shown in this textbook is followed by companies across the globe. It is unlikely to change in the future. The definitional structure of assets, liabilities, equity, revenues, and expenses may change over time as the IASB and FASB evaluate their overall conceptual framework for establishing accounting standards.

Which statement is correct regarding IFRS? IFRS reverses the rules of debits and credits, that is, debits are on the right and credits are on the left. IFRS uses the same process for recording transactions as GAAP. The chart of accounts under IFRS is different because revenues follow assets. None of the above statements are correct.

A trial balance: is the same under IFRS and GAAP. proves that transactions are recorded correctly. proves that all transactions have been recorded. will not balance if a correct journal entry is posted twice.

One difference between IFRS and GAAP is that: GAAP uses accrual-accounting concepts and IFRS uses primarily the cash basis of accounting. IFRS uses a different posting process than GAAP. IFRS uses more fair value measurements than GAAP. the limitations of a trial balance are different between IFRS and GAAP.

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