Chapter 3
The Accounting Information System
Prepared by:
Dragan Stojanovic, CA
Rotman School of Management, University of Toronto
The Accounting Information
System
Accounting Cycle
Accounting
Information System •Identifying and
recording
•Basic terminology
•Debits and credits
•Journalizing
•Accounting equation •Posting
•Financial statements •Trial balance
and ownership
•Adjusting entries
structure
•Adjusted trial balance
•Closing
•Post-closing trial
balance
Using a
Worksheet
•Adjustments
entered
•Work sheet
columns
•Preparing financial
statements from a
work sheet
•Closing entries
Appendix 3AUsing
Reversing
Entries
•Accruals
•Prepayments
•Summary of
reversing entries
•Monthly
statements, yearly
closing
•Reversing entries
•The accounting cycle
2
The Accounting Information
System
Accounting Cycle
Accounting
Information System •Identifying and
recording
•Basic terminology
•Debits and credits
•Journalizing
•Accounting equation •Posting
•Financial statements •Trial balance
and ownership
•Adjusting entries
structure
•Adjusted trial balance
•Closing
•Post-closing trial
balance
Using a
Worksheet
•Adjustments
entered
•Work sheet
columns
•Preparing financial
statements from a
work sheet
•Closing entries
Appendix 3AUsing
Reversing
Entries
•Accruals
•Prepayments
•Summary of
reversing entries
•Monthly
statements, yearly
closing
•Reversing entries
•The accounting cycle
3
Basic Terminology
• Event: The cause of changes of assets,
liabilities, and equity
• Transaction: A transfer or exchange between
two or more entities or parties
• Account: Where transactions are recorded
– A separate account is used for each asset,
liability, revenue, expense, gain, loss and
capital (owner’s equity)
4
Basic Terminology
Permanent accounts (or “real” accounts)
• Asset, liability, and equity accounts
• Appear on the balance sheet
• Permanent accounts are not closed at year end
Temporary accounts (or “nominal” accounts)
• Revenue, expense, and dividend accounts
• Revenue and expenses are on the income
statement; dividends are on the equity statement
• Temporary accounts are closed at year end
5
Basic Terminology
Journalizing and Posting
• A Journal is a book of original entry for all
transactions
• The General Journal is a chronological listing of
transactions expressed as debits and credits to
particular accounts (known as a journal entry)
• Special Journals are used to summarize
transactions with common characteristics
(e.g. cash receipts, sales, purchases)
• Posting: when the transaction information entered
in the journal is transferred to the general ledger
6
Basic Terminology
Ledger
• Book (electronic database) containing all
accounts
• Each account has a separate page
• General ledger contains all asset, liability,
and all equity related accounts (capital,
revenue, and expenses)
• Subsidiary ledger contains details related to
a specific general ledger account (example:
accounts receivable subsidiary ledger)
7
Basic Terminology
Trial balance
• Listing of all accounts and their balances
from the general ledger at a given point in
time
• Objective: prove the mathematical equality
of debits and credits after posting (i.e. to
ensure general ledger is in balance)
• Prepared after end of period adjustments
(called Adjusted Trial Balance) and possibly
after closing entries (called Post-closing
Trial Balance)
8
Basic Terminology
Adjusting entries
• Entries made at the end of an accounting period
• Brings all accounts up to date on an accrual
accounting basis
• Ensures that revenue recognition principle are
followed and that proper matching occurs
• Four classifications of adjusting entries:
Prepayment
Accruals
1. Prepaid expenses
2. Accrued revenues
3. Unearned revenues 4. Accrued expenses
9
Basic Terminology
Financial statements
•
•
Final summaries of the accounting data for a specific
time period
Four statements:
• Balance Sheet - shows financial condition at a
specific date
• Income Statement - measures the results of
operations during a period of time
• Statement of Cash Flows - shows sources and
uses of cash
• Statement of Retained Earnings
Optional: Statement of Comprehensive Income
(or as part of Income Statement)
10
Debits and Credits
Debit (Dr.)
To record or enter an
amount on the left side
of a general ledger
account
•
•
•
Credit (Cr.)
To record or enter an
amount on the right side
of a general ledger
account
This system of recording transactions is referred to as
the double-entry accounting system; the two-sided
effect of each transaction is recorded in appropriate
accounts
When a transaction is “in balance”, the debits equal
the credits
Debits and credits do not mean “increases” and
“decreases”
11
The Accounting Equation
Assets = Liabilities + Shareholders’ Equity
Assets = Liabilities + Capital + Retained Earnings*
*Retained Earnings = Revenues – Expenses – Dividends
Assets = Liabilities + Capital + Revenues – Expenses – Dividends
12
The Rules of Debit and Credit
• To increase the balance of any account,
record the amount in the normal balance
column
• To decrease the balance of any account,
record the amount in the column opposite to
its normal balance
• When any transaction is correctly recorded,
the accounting equation will remain in
balance
13
The Rules of Debit and Credit
Account
Debit
Credit
Assets
Increase
Decrease
Liabilities
Decrease
Increase
Shareholders’ Equity
Decrease
Increase
Revenue
Decrease
Increase
Expenses
Increase
Decrease
14
Financial Statements and
Ownership Structure
15
The Accounting Information
System
Accounting Cycle
Accounting
Information System •Identifying and
recording
•Basic terminology
•Debits and credits
•Journalizing
•Accounting equation •Posting
•Financial statements •Trial balance
and ownership
•Adjusting entries
structure
•Adjusted trial balance
•Closing
•Post-closing trial
balance
Using a
Worksheet
•Adjustments
entered
•Work sheet
columns
•Preparing financial
statements from a
work sheet
•Closing entries
Appendix 3AUsing
Reversing
Entries
•Accruals
•Prepayments
•Summary of
reversing entries
•Monthly
statements, yearly
closing
•Reversing entries
•The accounting cycle
16
The Accounting Cycle: Steps
•
•
•
•
•
•
•
•
•
•
Analyse the transaction
Journalize the transaction
Post the transaction to general ledger (and subledgers) accounts
Prepare the (unadjusted) trial balance
Prepare necessary adjusting journal entries
Prepare the (adjusted) trial balance
Prepare financial statements
Prepare closing journal entries for the year
Prepare post-closing trial balance (optional)
Prepare reversing entries (optional)
17
Recording a Transaction:
Shares are issued for $3,000 cash
Assets = Liabilities + Shareholders’ Equity
+ $3,000
+ $3,000
To record this transaction as a journal entry (in General
Journal):
Dr. Cash
Cr.
$3,000
Common Shares
$3,000
These amounts are then posted to the general ledger
Cash
3,000
Common Shares
3,000
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Preparation of Trial Balance
PIONEER ADVERTISING AGENCY INC. at October 31, 2010
Account
Cash
80,000
Notes Payable
50,000
Dividends
5,000
Revenue
100,000
Debit
Credit
Cash
80,000
Accounts Receivable
72,000
Advertising Supplies
25,000
Prepaid Insurance
6,000
Office Equipment
50,000
Notes Payable
50,000
Accounts Payable
25,000
Unearned Service Revenue
12,000
Common Shares
100,000
Dividends
5,000
Service Revenue
100,000
Salaries Expense
40,000
Rent Expense
9,000
TOTALS
287,000 287,000
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Preparation of Trial Balance
•
From the previous example, we can see that
the trial balance is “in balance”
• However, the trial balance only proves the
mathematical accuracy of the ledger
• Errors may still exist such as the following:
1. Transaction not recorded
2. Journal entry not posted
3. Journal entry posted twice
4. Incorrect accounts used in either the
journal or posting
5. Offsetting errors made during recording
20
Adjusting Journal Entries
•
•
•
Adjusting entries ensure that revenue
recognition and matching are followed within
the period
Reasons for adjusting entries include:
– To record those events that are not
journalized daily
– To record those costs, which expire with
time and are therefore not recorded
– To record item previously unrecorded
Adjusting entries are required each time
financial statements are prepared
21
Adjusting Entries
Prepayments
1. Prepayments made in
cash and recorded as
assets before item is used
(Prepaid Expenses)
2. Revenue received in
cash and recorded as
liabilities before being
earned (Unearned Revenue)
Accruals
3. Revenues earned but not
yet received in cash and not
recorded (Accrued Revenues)
4. Expenses incurred but
not yet paid in cash and not
recorded (Accrued Expenses)
22
Adjusting Journal Entries
• Prepaid expenses expire either with the
passage of time (e.g. rent and insurance) or by
being used and consumed (e.g. supplies)
• Example: Company paid $6,000 for one year
insurance when coverage begins October 1
• Adjust for Prepaid Insurance on Dec. 31:
Dr Insurance Expense 1,500
Cr Prepaid Insurance 1,500
($6,000/12 * 3)
23
Adjusting Journal Entries
• When payment is received from customers for
services (or goods) that will be provided in a future
accounting period, a liability (unearned revenue) is
recognized
• e.g. Rent, magazine subscriptions, deposits
• Example: Company received $12,000 for four
months’ advertising services that begins Oct. 1.
$12,000 was credited to unearned revenue
• Adjustment required on December 31:
Dr Unearned Revenue 9,000
Cr Service Revenue
9,000
($12,000/4 * 3)
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Adjusting Journal Entries
• Expenses must be accrued when they are
incurred; also revenues must be recorded as
earned
• Accruals required: interest expense, salaries
expense, bad debts expense, interest earned
• Example: assume on January 5, a company
pays $20,000 for salaries which includes
$10,000 of salaries for December
• Adjustment required on December 31:
Dr Salaries Expense 10,000
Cr Salaries Payable 10,000
25
Closing Entries
• Closing entries are made to close all nominal
accounts (revenue and expense accounts) for
the year
• The balances in these accounts are
transferred to a clearing account (Income
Summary)
• The balance in Income Summary represents
net income or net loss for the period
• Real (or permanent) accounts are not closed
• The Dividends account is closed to retained
earnings
26
Closing Entries
The following closing entries are made (assume
net income for the year):
1. Income Summary
$$$
Expense Accounts (Individually)
2. Revenue Accounts (Individually)
$$$
$$$
Income Summary
3. Income Summary
$$$
$$$
Retained Earnings
4. Retained Earnings
Dividends
$$$
$$$
$$$
27
Scheme of Closing Entries
Ret. Earnings
Dividends
Income Summary
4
3
Expense
Revenue
1
2
28
Closing Entries: Inventory
• In a periodic inventory system, closing entries
are made to record cost of goods sold and
ending inventory
• In a perpetual inventory system, such entries
are not required
29
Periodic Inventory:
Closing Entry
Collegiate Apparel Shop has the following
balances at year end. The company uses a
periodic inventory system.
Beginning Inventory
Purchases (gross)
Transportation-In
Purchases Returns
Purchase Discounts
Ending Inventory
$ 30,000
$200,000
$ 6,000
$
$
1,000
3,000
$ 26,000
30
Periodic Inventory:
Closing Entry
First Step: Determine Cost of Goods Sold
Beginning Inventory
Purchases
$200,000
Less: Purchase returns $1,000
Purchase discounts 3,000
4,000
Net Purchases
196,000
Plus: Transportation-In
6,000
Cost of Goods Purchased
Cost of Goods Available for Sale
Less: Ending Inventory
Cost of Goods Sold
$ 30,000
202,000
232,000
26,000
$206,000
31
Periodic Inventory:
Closing Entry
Account
Cost of Goods Sold
Inventory (Ending)
Purchases Returns
Purchase Discounts
Purchases (Gross)
Transportation-in
Inventory (Beginning)
Dr.
Cr.
$ 206,000
$ 26,000
$ 1,000
$ 3,000
$ 200,000
$ 6,000
$ 30,000
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