3-1 THE ACCOUNTING INFORMATION SYSTEM Accounting, Fifth Edition 3 Fall 2015

3-2 Accounting Transactions Expanding The Basic Accounting Equation B/S = Balance Sheet I/S = Income Statement R/E = Retained Earnings Inv = Investing Activities Fin = Financing Activities Op = Operating Activities B/S Inv B/S Fin B/S Fin I/S Op I/S Op R/E Fin B/S Fin B/S Fin

3-3 Accounting Transactions Applying The Basic Accounting Equation Assume the B/S below is from Jan 1. The Revenues, Expenses and Dividends represent what happened over the course of the year. So, what are the B/S amounts at the end of the year? 12 = 4 + 8! 104 ?

3-4 The Accounting Information System: a system of collecting and processing transactions, then communicating financial information to decision makers. Most businesses use computerized systems. Transactions are $ economic $ events recorded in the F/S  Not all activities represent transactions (hiring an employee). They must be able to be expressed in monetary terms.  Assets, liabilities, or stockholders’ equity items change as a result of $ economic $ events - if they can be expressed in monetary terms.  The Dual effect: At least two or more accounts will always be affected with a transaction. If I spend cash to purchase 4 other assets then 5 accounts will be affected! Accounting Transactions

3-5 Event (1). On October 1, cash of $10,000 is invested in Sierra Corporation by investors in exchange for $10,000 of common stock. Accounting Transactions 1.+10,000+10,000 Note how every transaction from this point on maintains the balance: Assets = Liabilities and Equity

3-6 Event (2). On October 1, Sierra borrowed $5,000 from Castle Bank by signing a 3-month, 12%, $5,000 note payable. Accounting Transactions 1.+10,000+10, ,000+5,000

3-7 Event (3). On October 2, Sierra purchased equipment by paying $5,000 cash to Superior Equipment Sales Co. Accounting Transactions 3.-5,000+5, ,000+10, ,000+5,000 Note the Assets total of $15,000 hasn’t changed, only the composition. Cash went down $5,000 and Equipment went up $5,000. The Balance Sheet is still in balance!

3-8 Event (4). On October 2, Sierra received a $1,200 cash advance from R. Knox, a client. Accounting Transactions 4.+1,200+1, ,000+5, ,000+10, ,000+5,000 Unearned Revenue is recorded when you receive payment before you perform the service. You’ve been given a $1,200 cash advance and now have an obligation (a liability) to perform the service at a later date or have to give the cash back! This is just like receiving a deposit in advance of the job.

3-9 Event (5). On October 3, Sierra received $10,000 in cash from Copa Company for guide services performed. Accounting Transactions 4.+1,200+1, ,000+10, ,000+5, ,000+10, ,000+5,000

3-10 Event (6). On October 3, Sierra Corporation paid its office rent for the month of October in cash, $900. Accounting Transactions 4.+1,200+1, ,000+10, ,000+5, ,000+10, ,000+5,000

3-11 Event (7). On October 4, Sierra paid $600 for a one-year insurance policy that will expire next year on September 30. Accounting Transactions 4.+1,200+1, ,000+10, ,000+5, ,000+10, ,000+5,000 In some cases, like insurance, you have to pre-pay the fee in advance. This has value and is considered an asset. Over time it will turn into an expense as each month passes ($600 / 12 months = $50 per month)

3-12 Event (8). On October 5, Sierra purchased an estimated three months of supplies on account from Aero Supply for $2,500. Accounting Transactions 4.+1,200+1, ,000+10, ,500+2, ,000+5, ,000+10, ,000+5,000 Any time you purchase something on account, this means you did not pay at the time of the purchase and you owe them the money.

3-13 Event (9). On October 9, Sierra hired four new employees to begin work on October 15. Accounting Transactions 4.+1,200+1, ,000+10, ,500+2, ,000+5, ,000+10, ,000+5,000 NOTE: An accounting transaction has not occurred!

3-14 Event (10). On October 20, Sierra paid a $500 dividend. Accounting Transactions 4.+1,200+1, ,000+10, ,500+2, ,000+5, ,000+10, ,000+5,000 Remember dividend payments are not considered to be an expense, simply reductions of stockholder’s equity.

3-15 Event (11). Employees have worked two weeks, earning $4,000 in salaries, which were paid on October 26. Accounting Transactions 4.+1,200+1, ,000+10, ,500+2, ,000-4, ,000+5, ,000+10, ,000+5,000

3-16  Record of increases and decreases in a specific asset, liability, equity, revenue, or expense item.  Debit = “Left” (debits go on the left)  Credit = “Right” (credits go on the right) Account An Account can be illustrated in a T-Account form. The Account

3-17 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 at least one other. ► DEBITS must equal CREDITS no matter how many accounts are affected in a transaction. Debit and Credit Procedures The Account

3-18 greater than If Debits are greater than Credits, the account will have a debit balance. $10,000Transaction #2$3,000 $15,000 8,000Transaction #3 Balance Transaction #1 Debit and Credit Procedures

3-19 $10,000Transaction #2$3,000 Balance Transaction #1 $1,000 8,000Transaction #3 Debit and Credit Procedures If Credits are greater than Debits, the account will have a credit balance.

3-20  Assets - Debits should exceed credits.  Liabilities – Credits should exceed debits. Procedures for Assets and Liabilities

3-21  Investments by stockholders and revenues increase stockholders’ equity (credit).  Dividends and expenses decrease stockholder’s equity (debit). Procedures for Stockholders’ Equity

3-22  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. Procedures for Revenue and Expense

3-23 Normal Balances Credits Normal Balances Debits Summary of Debit/Credit Rules Equity includes Common Stk. & R/E Normal Balance Debit Normal Balance Credit Normal Balances Debits Normal Balances Credits DEAD = Debits increase Expenses, Assets, and Dividends CLEaR = Credits increase Liabilities, Equity (Common Stock & Retained Earnings) and Revenues

3-24 The Debit Credit Summary = + Assets, Expenses & Dividends all go up with Debits Liabilities, Owners Equity (Common Stock & Retained Earnings) & Revenues all go up with Credits DEAD = Debits increase Expenses, Assets, and Dividends CLEaR = Credits increase Liabilities, Equity (Common Stock & Retained Earnings) and Revenues

3-25 Source documents, such as a sales slip, a check, a bill, or a cash register tape, provide evidence of the transaction. Steps in the Recording Process Analyze each transactionEnter transaction in a journal Transfer journal information to ledger accounts

3-26  Book of original entry (like a diary of the transactions).  Transactions are recorded in chronological order.  Contributions to the recording process: 1.Discloses the complete effects of a transaction. 2.Provides a chronological record of transactions. 3.Helps to prevent or locate errors because the debit and credit amounts can be easily compared. Steps in the Recording Process The Journal

3-27 Journalizing - Entering transaction data in the journal. Presented below is information related to Sierra Corporation. Sierra issued common stock for $10,000 cash. Oct. 1 Sierra borrowed $5,000 by signing a note.1 Sierra purchased equipment for $5,000.2 How do we journalize these transactions? The Journal

3-28 JournalizingJournalizing General Journal Cash Common stock 10,000 Sierra issued common stock in exchange for $10,000 cash. Oct. 1 Note: all the debits are listed first. The credits are next and are always indented. In this example there’s only one debit and one credit.

3-29 JournalizingJournalizing General Journal Sierra borrowed $5,000 by signing a note.Oct. 1 Cash Notes payable 5,000

3-30 JournalizingJournalizing General Journal Sierra purchased equipment for $5,000.Oct. 2 Equipment Cash 5,000

3-31 The Ledger is comprised of the entire group of accounts maintained by a company. Illustration 3-19 Steps in the Recording Process

3-32 Steps in the Recording Process Chart of Accounts – lists only the accounts used by a given company to record transactions.

3-33 General Ledger General Journal Oct. 1Stock issuedJ110, J1 Steps in the Recording Process Posting – is the process of transferring journal entry amounts to the Ledger accounts. The ledger summarizes all the transactions (all the debits and credits) for each account and provides a running balance.

3-34 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.

3-35 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.

3-36 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.

3-37 LO 7 Explain what posting is and how it helps in the recording process. Additional Transactions The Recording Process Illustrated Illustration 3-24

3-38 LO 7 Explain what posting is and how it helps in the recording process. Additional Transactions The Recording Process Illustrated Illustration 3-25

3-39 Additional Transactions The Recording Process Illustrated Illustration 3-26

3-40 Additional Transactions The Recording Process Illustrated Illustration 3-27

3-41 Additional Transactions The Recording Process Illustrated Illustration 3-28

3-42 The Recording Process Illustrated Additional Transactions An accounting transaction has not occurred!

3-43 Additional Transactions The Recording Process Illustrated Illustration 3-30

3-44 LO 7 Additional Transactions The Recording Process Illustrated Illustration 3-31

3-45 Summary Illustration of Journalizing

3-46 Summary Illustration of Journalizing

3-47 Summary Illustration of Posting

3-48 Once again, the Debit Credit Summary = + Assets, Expenses & Dividends all go up with Debits Liabilities, Owners Equity (Common Stock & Retained Earnings) & Revenues all go up with Credits DEAD = Debits increase Expenses, Assets, and Dividends CLEaR = Credits increase Liabilities, Equity (Common Stock & Retained Earnings) and Revenues

3-49 How The Accounting Process Works After we set up a beginning B/S for the very first time in Jan. of year 1, we start our operations. At year end, the I/S is then calculated, followed by R/E. At the end of year 1 on Dec 31, we adjust the B/S by adding income or subtracting losses. We then subtract any dividends. The ending B/S of year 1 turns into the beginning B/S of year 2 and we start the process over.

3-50 The Trial Balance Illustration 3-34 Equal

3-51 The trial balance may balance even when 1.a transaction is not journalized, 2.a correct journal entry is not posted, 3.a journal entry is posted twice, 4.incorrect accounts are used in journalizing or posting, or 5.offsetting errors are made in recording the amount of a transaction. In other words the total debits may actually equal the total credits but… something is incorrect because of one or more reasons. The Trial Balance Limitations of a Trial Balance

3-52 Selected transactions from the journal of Faital Inc. during its first month of operations are presented below. Post these transactions to T-accounts.