Chapter 3
Accounting Information System
The Basics of Financial Accounting
Accounting Information System
Collects and processes transaction data.
Disseminates information to interested
parties.
Terminology: event; transaction (external
event with a transfer or exchange between
entities); real (assets, liabilities & equity)
and nominal (income statement + dividends)
accounts.
Accounting Process
Journal (book of original entry, record of
transactions)
Posting to ledger (book of all accounts)
Trial Balance
Adjusting Entries (entries at the end of the period
to bring all accounts up-to-date)
Financial Statements
Closing Entries (close nominal accounts to equity)
Reversing Entries
Double Entry Bookkeeping
• The use of double entry bookkeeping invented by
Medieval Italian merchants by 1200; described by Luca
Pacioli’s Summa in 1494.
• Double entry was essential to business success (and
ultimately the Renaissance) in Italy, then the success of
the Industrial Revolution in Britain and Northern
Europe.
• Charles Sprague invents the Algebra of Accounts in
1880: Debits = Credits; Assets = Liabilities+ Equity;
Revenues – Expenses = Earnings; ultimately: Assets –
Liabilities + Common Stock + Retained Earnings –
Dividends + Revenue – Expenses.
Ownership Structure of a Corporation
Common
Stock
Additional
Dividends
Paid-in Capital
Declared (negative)
Retained
Earnings
Treasury
Stock (negative)
Accounting Cycle
• Transaction
Journal Entry
Post to Ledger
Prepare Trial Balance
Adjustments
Adjusted Trial
Balance
Financial Statements
Closing Entries
Post-closing Trial
Balance
Reversing Entries
Journalizing
• General Journal – a chronological
record of transactions. Journal Entries
are recorded in the journal.
Date
Jan.
3
Account Title
Cash
Common stock
10
Building
Note payable
Ref.
100
Debit
100,000
300
130
220
Credit
100,000
150,000
150,000
Posting to Ledger
• Posting – the process of transferring
amounts from the journal to the ledger
accounts.
Cash
Date Explanation Debit Credit Balance
Jan. 3 Sale of Stock 100,000
100,000
Trial Balance
Acct. No.
100
105
110
130
200
220
300
330
400
500
Account
Cash
Accounts receivable
Inventory
Building
Accounts payable
Note payable
Common stock
Retained earnings
Sales
Cost of goods sold
Debit
Credit
$ 140,000
35,000
30,000
150,000
$
60,000
150,000
100,000
75,000
30,000
$ 385,000
$ 385,000
Adjusting Entries
Revenues - recorded in the period in which
they are earned.
Expenses - recognized in the period in
which they are incurred or (and/or
matched to revenues).
Adjusting entries - needed to ensure that
the revenue recognition and matching
principles are followed.
Types of Adjusting Entries
• Prepayments:
Prepaid Expense (expenses paid but not
yet used)
Unearned Revenue (cash received but
revenue not yet earned)
Accruals:
Accrued Revenue (earned but cash not
yet received)
Accrued Expense (incurred but not yet paid)
Adjustments: Prepaid Expenses
• Payment of cash that is recorded as an
asset because service or benefit will be
received in the future.
Prepayments often occur in regard to:
Insurance
Rent
Supplies
Maintenance on Equipment
Advertising Fixed Assets
Adjustments: Prepaid Expenses
• Example: On Jan. 1st, Phoenix Corp. paid
$12,000 for 12 months of insurance
coverage. Show the journal entry to
record the payment on Jan. 1st.
Jan. 1 Prepaid Insurance 12,000
Cash
12,000
Adjustments: Prepaid Expenses
• Show the adjusting journal entry
required at Jan. 31st.
Jan. 31 Insurance Expense 1,000
Prepaid Insurance
1,000
Adjustments: Unearned Revenue
• Receipt of cash that is recorded as a
liability because the revenue has not
been earned.
• Unearned revenues often occur in
regard to:
Rent
Magazine Subscriptions
Airline Tickets Customer Deposits
School Tuition Prepaid Software
Adjustments: Accrued Revenue
• Revenues earned but not yet received in
cash or recorded.
• Examples:
Rent
Interest
Services Performed
Adjustments: Accrued Expenses
• Expenses incurred but not yet paid in
cash or recorded.
• Examples:
Rent
Salaries
Interest
Bad Debts
Taxes
Trial Balance and Financial Statements
• Adjusted Trial Balance: Shows the
balance of all accounts, after adjusting
entries, at the end of the accounting
period.
• Financial Statements are prepared
directly from the Adjusted Trial
Balance: Balance Sheet; Income
Statement; Cash Flow Statement;
Statement of Stockholders’ Equity
Closing Entries
To reduce the balance of the income statement (revenue
and expense) accounts to zero. [Income statement items
are nominal (temporary) accounts that are eliminated at
the end of the accounting period.]
To transfer net income or net loss to owner’s equity.
Balance sheet (asset, liability, and equity—permanent
accounts) accounts are not closed.
Dividends are closed directly to the Retained Earnings
account.
Perpetual Inventory System
Inventory account increased with each purchase.
Inventory account reduced and Cost of Goods Sold
account increased with each sale.
Balance in Inventory account should equal
inventory amount on hand.
No Adjusting Entries should be needed.
Physical inventory performed to confirm balance in
Inventory account.
Periodic Inventory System
Inventory account remains unchanged during
period.
Purchases account increased with each
purchase.
•
At end of accounting period:
Purchases account closed.
Inventory account adjusted to physical count.
Reversing Entries
• Reversing entries is an optional step
that a company may perform at the
beginning of the next accounting period.