1. Processing Accounting Information
Chapter 3
Processing Accounting
Information

2. Learning Objectives
LO1 Explain the difference between external and internal events. LO2 Explain the role of source documents in an accounting system. LO3 Analyze the effects of transactions on the accounting equation and understand how these transactions affect the balance sheet and the income statement. LO4 Define the concept of a general ledger and understand the use of the T account as a method for analyzing transactions. LO5 Explain the rules of debits and credits. LO6 Explain the purposes of a journal and the posting process. LO7 Explain the purpose of a trial balance.

3. Module 1 Transactions and the Accounting Equation
Source documents are used as the necessary evidence to record transactions
Transactions affect the accounting equation and the financial statements
Module 1

4. External and Internal Events
External event: interaction between an entity and its environment
Internal event: occurs entirely within an entity
Transaction: any event that is recognized in a set of financial statements
Module 1: LO 1

5. The Role of Source Documents in Recording Transactions
Used as evidence to record a transaction
Documents need not be in hard copy form and can come from parties that are either internal or external to the company
Different forms:
Purchase invoice
Sales invoice
Cash register tape
Time cards
Module 1: LO 2

6. Analyzing the Effects of Transactions on the Accounting Equation
The accounting equation illustrates the relationship between assets, liabilities, and stockholders’ equity accounts
Understanding these relationships helps to see the logic behind the double-entry system in recording transactions
Module 1: LO 3

7. The Accounting Equation
As transactions are recorded, the accounting equation must remain in balance:
Assets = Liabilities + Stockholders’ Equity
The equation can be expanded to show the linkage between the balance sheet and the income statement through the Retained Earnings account:
Assets = Liabilities + Capital Stock + Retained Earnings
Module 1: LO 3

8. Example 3-1—Analyzing the Effects of Transactions on the Accounting Equation
Following is a series of transactions for a hypothetical corporation, Glengarry Health Club
The transactions are for January 2016, the first month of operations for the new business
Module 1: LO 3

9. Issuance of Capital Stock
Glengarry Health Club is started when Karen Bradley and Kathy Drake file articles of incorporation with the state to obtain a charter
Each invests $50,000 in the business
In return, each receives 5,000 shares of capital stock
Module 1: LO 3

10. Acquisition of Property in Exchange for a Note
Company buys a piece of property for $200,000
The seller agrees to accept a five-year promissory note
The property consists of land valued at $50,000 and a newly constructed building valued at $150,000
Module 1: LO 3

11. Acquisition of Equipment on an Open Account
Karen and Kathy contact an equipment supplier and buy $20,000 of exercise equipment: treadmills, barbells, and stationary bicycles
The supplier agrees to accept payment in full in 30 days
Module 1: LO 3

12. Sale of Monthly Memberships on Account
During January, the owners sell 300 monthly club memberships for $50 each, or a total of $15,000
The members have until the 10th of the following month to pay
Module 1: LO 3

13. Sale of Court Time for Cash
In addition to memberships, Glengarry sells court time
Court fees are paid at the time of use and amount to $5,000 for the first month
Module 1: LO 3

14. Payment of Wages and Salaries
Wages and salaries for the first month amount to $10,000
Module 1: LO 3

15. Payment of Utilities Cost of utilities for the first month is $3,000
Glengarry pays this amount in cash
Module 1: LO 3

16. Collection of Accounts Receivable
Amount received from members in payment of their accounts is $4,000
Module 1: LO 3

17. Payment of Dividends
Karen and Kathy, acting on behalf of Glengarry Health Club, decide to pay a dividend of $1,000 on the shares of stock that each of them owns, or $2,000 in total
Module 1: LO 3

18. The Cost Principle
Record an asset at the cost to acquire it and continue to show this amount on all balance sheets until the asset is disposed
Module 1: LO 3

19. Exhibit 3-1—Transactions
Module 1: LO 3

20. Exhibit 3-2—Balance Sheet
Module 1: LO 3

21. Exhibit 3-3—Income Statement
Module 1: LO 3

22. Module 2 Ledger Accounts and Debits and Credits
The double-entry system of accounting is used in the recording process
Debits increase asset accounts and credits increase liability and equity accounts
The double-entry system requires that total debits equal total credits for any transaction recorded in the accounting system
Module 2

23. Account and Chart of Accounts
Account: record used to accumulate amounts for each individual asset, liability, revenue, expense, and component of stockholders’ equity
Chart of accounts: numerical list of all accounts used by a company
Module 2: LO 4

24. Exhibit 3-4—Chart of Accounts
Module 2: LO 4

25. Ledger Accounts
General ledger: a book, a file, a hard drive, or another device containing all of the accounts
Double-entry system: system of accounting
For every transaction recorded, total debits must equal total credits
Accounting equation must always be in balance
T Account: format for showing amounts coming into and leaving an account
Module 2: LO 4

26. Example 3-2—Using a T Account
Module 2: LO 4

27. Debits and Credits Tools to record increases and decreases in accounts
Debits increase asset accounts, and credits increase liability and stockholders’ equity accounts
Additionally, debits increase expense accounts, and credits increase revenue accounts
Module 2: LO 5

28. Summary of the Rules for Increasing and Decreasing Accounts
Module 2: LO 5

29. Example 3-3—Determining Normal Account Balances
Module 2: LO 5

30. Debits and Credits Applied to Transactions
(1) Issuance of capital stock
Cash
Capital Stock
(1)
100,000
100,000
(1)
Module 2: LO 5

31. Debits and Credits Applied to Transactions
(2) Acquisition of property in exchange for a note
Building
Notes Payable
(2)
150,000
200,000
(2)
Land
(2)
50,000
Module 2: LO 5

32. Debits and Credits Applied to Transactions
(3) Acquisition of equipment on an open account
Equipment
Accounts Payable
(3)
20,000
20,000
(3)
Module 2: LO 5

33. Debits and Credits Applied to Transactions
(4) Sale of monthly memberships on account
Accounts Receivable
Membership Revenue
(4)
15,000
15,000
(4)
Module 2: LO 5

34. Debits and Credits Applied to Transactions
(5) Sale of court time for cash
Cash
Court Fee Revenue
(1)
100,000
5,000
(5)
(5)
5,000
T Accounts reflect
current and previous
postings to the account
for each period
Module 2: LO 5

35. Debits and Credits Applied to Transactions
(6) Payment of wages and salaries
Cash
Wage & Salary Expense
(1)
100,000
10,000
(6)
(6)
10,000
(5)
5,000
Module 2: LO 5

36. Debits and Credits Applied to Transactions
(7) Payment of utilities
Cash
Utilities Expense
(1)
100,000
10,000
(6)
(7)
3,000
(5)
5,000
3,000
(7)
Module 2: LO 5

37. Debits and Credits Applied to Transactions
(8) Collection of accounts receivable
Cash
Accounts Receivable
(1)
100,000
10,000
(6)
(4)
15,000
4,000
(8)
(5)
5,000
3,000
(7)
(8)
4,000
Module 2: LO 5

38. Debits and Credits Applied to Transactions
(9) Payment of dividends
Cash
Dividends
(1)
100,000
10,000
(6)
(9)
2,000
(5)
5,000
3,000
(7)
(8)
4,000
2,000
(9)
Module 2: LO 5

39. Module 3 Journal Entries and Trial Balance
Accountants use tools to effectively and efficiently process the information that appears on financial statements
A journal documents the details of transactions by date
A trial balance lists all of the accounts in the general ledger along with their debit or credit balances
Module 3

40. Journal Entries and Trial Balances
Journal: chronological record of a company’s transactions
Book of original entry
Transactions are periodically posted from the journal to ledger accounts
Journalizing: act of recording journal entries
Module 3: LO 6

41. Posting
Process of transferring amounts from a journal to the ledger accounts
Module 3: LO 6

42. Example 3-6—Posting from the Journal to the Ledger
Module 3: LO 6

43. Trial Balance
List of each account and its balance at a specific point in time
Used to prove the equality of debits and credits
Normally prepared at the end of the accounting period
Basis for preparation of financial statements
Module 3: LO 7

44. Example 3-7—Preparing a Trial Balance
Module 3: LO 7

45. Review
LO1 Explain the difference between external and internal events.
Both of these different types of events affect an entity and are usually recorded in the accounting system as a transaction.
External events are interactions between an entity and its environment.
Internal events are interactions entirely within an entity.
LO2 Explain the role of source documents in an accounting system.
Source documents provide the evidence needed to begin the procedures for recording and processing a transaction.
These documents need not be in hard copy form and can come from parties that are either internal or external to the company.

46. Review
LO3 Analyze the effects of transactions on the accounting equation and understand how these transactions affect the balance sheet and the income statement.
The accounting equation illustrates the relationship between assets, liabilities, and stockholders’ equity accounts. Understanding these relationships helps to see the logic behind the double-entry system in recording transactions.
The accounting equation: Assets = Liabilities + Stockholders’ Equity
This equality must always be maintained. The equation can be expanded to show the linkage between the balance sheet and the income statement through the Retained Earnings account:
Assets = Liabilities + Capital Stock + Retained Earnings

47. Review
LO4 Define the concept of a general ledger and understand the use of the T account as a method for analyzing transactions.
The general ledger is a crucial part of the accounting system that lists all accounts and their balances. Financial statements may be prepared from current account balances in the general ledger.
T accounts are a convenient way to analyze the activity in any particular account. One side of the account is used to record increases; the other side, decreases.

48. Review LO5 Explain the rules of debits and credits .
Debits and credits represent the left and right sides of a T account, respectively. They take on meaning only when associated with the recording of transactions involving asset, liability, and equity accounts.
In general, debits increase asset accounts and credits increase liability and equity accounts.
The double-entry system requires that total debits equal total credits for any transaction recorded in the accounting system.

49. Review LO6 Explain the purposes of a journal and the posting process.
A journal documents the details of transactions by date. Entries are made to a journal every time a transaction occurs.
Similar transactions that occur regularly may be recorded in special journals.
Ultimately, information is posted from the journal to the ledger for each individual account.
LO7 Explain the purpose of a trial balance.
At the end of a period, a trial balance may be prepared that lists all of the accounts in the general ledger along with their debit or credit balances.
The purpose of the trial balance is to see whether total debits equal total credits. This provides some assurance that the accounting equation was adhered to in the processing of transactions but is no guarantee that transactions have been recorded properly.

50. End of Chapter 3