Financial Accounting and Accounting Standards

3-1
THE ACCOUNTING
INFORMATION
SYSTEM
3-2
Financial Accounting, Seventh Edition
Learning Objectives
After studying this chapter, you should be able to:
3-3
1.
Analyze the effect of business transactions on the basic accounting
equation.
2.
Explain what an account is and how it helps in the recording process.
3.
Define debits and credits and explain how they are used to record
business transactions.
4.
Identify the basic steps in the recording process.
5.
Explain what a journal is and how it helps in the recording process.
6.
Explain what a ledger is and how it helps in the recording process.
7.
Explain what posting is and how it helps in the recording process.
8.
Explain the purposes of a trial balance.
9.
Classify cash activities as operating, investing, or financing.
Preview of Chapter 3
Financial Accounting
Seventh Edition
Kimmel Weygandt Kieso
3-4
The Accounting Information System
Accounting Information System
System of
►
collecting and
►
processing transaction data and
►
communicating financial information to decision makers.
Most businesses use computerized accounting (EDP) systems.
3-5
LO 1 Analyze the effect of business transactions on the basic accounting equation.
Accounting Transactions
Transactions are economic events that require recording
in the financial statements.
3-6

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.
LO 1 Analyze the effect of business transactions on the basic accounting equation.
Accounting Transactions
Question: Are the following events recorded in the
accounting records?
Illustration 3-1
Purchase
computer.
Event
Criterion
Discuss guided trip
options with potential
customer.
Pay rent.
Is the financial position (assets, liabilities, or
stockholders’ equity) of the company changed?
Record/ Don’t
Record
3-7
LO 1 Analyze the effect of business transactions on the basic accounting equation.
Accounting Transactions
Analyzing Transactions
The process of identifying the specific effects of economic
events on the accounting equation.
Basic Accounting Equation
Assets
3-8
=
Liabilities
+
Stockholders’
Equity
LO 1 Analyze the effect of business transactions on the basic accounting equation.
Accounting Transactions
Analyzing Transactions
Illustration 3-2
Expanded accounting equation
3-9
LO 1 Analyze the effect of business transactions on the basic accounting equation.
Accounting Transactions
Event (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
3-10
+10,000
LO 1 Analyze the effect of business transactions on the basic accounting equation.
Accounting Transactions
Event (2). On October 1, Sierra borrowed $5,000 from Castle Bank by signing
a 3-month, 12%, $5,000 note payable.
1. +10,000
2. +5,000
3-11
+10,000
+5,000
LO 1 Analyze the effect of business transactions on the basic accounting equation.
Accounting Transactions
Event (3). On October 2, Sierra purchased equipment by paying $5,000 cash
to Superior Equipment Sales Co.
1. +10,000
2. +5,000
3. -5,000
3-12
+10,000
+5,000
+5,000
LO 1 Analyze the effect of business transactions on the basic accounting equation.
Accounting Transactions
Event (4). On October 2, Sierra received a $1,200 cash advance from R. Knox,
a client.
1. +10,000
2. +5,000
3. -5,000
4. +1,200
3-13
+10,000
+5,000
+5,000
+1,200
LO 1 Analyze the effect of business transactions on the basic accounting equation.
Accounting Transactions
Event (5). On October 3, Sierra received $10,000 in cash from Copa Company
for guide services performed.
1. +10,000
2. +5,000
3. -5,000
4. +1,200
5. +10,000
3-14
+10,000
+5,000
+5,000
+1,200
+10,000
LO 1 Analyze the effect of business transactions on the basic accounting equation.
Accounting Transactions
Event (6). On October 3, Sierra Corporation paid its office rent for the month of
October in cash, $900.
1. +10,000
2. +5,000
3. -5,000
4. +1,200
5. +10,000
6.
3-15
-900
+10,000
+5,000
+5,000
+1,200
+10,000
-900
LO 1 Analyze the effect of business transactions on the basic accounting equation.
Accounting Transactions
Event (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
3. -5,000
+5,000
+5,000
4. +1,200
+1,200
5. +10,000
6.
-900
7.
-600
3-16
+10,000
-900
+600
LO 1 Analyze the effect of business transactions on the basic accounting equation.
Accounting Transactions
Event (8). On October 5, Sierra purchased an estimated three months of
supplies on account from Aero Supply for $2,500.
1. +10,000
+10,000
2. +5,000
3. -5,000
+5,000
+5,000
4. +1,200
+1,200
5. +10,000
6.
-900
7.
-600
+10,000
-900
+600
8.
+2,500
+2,500
3-17
LO 1 Analyze the effect of business transactions on the basic accounting equation.
Accounting Transactions
Event (9). On October 9, Sierra hired four new employees to begin work on
October 15.
1. +10,000
+10,000
2. +5,000
3. -5,000
+5,000
+5,000
4. +1,200
+1,200
5. +10,000
6.
-900
7.
-600
8.
+10,000
-900
+600
+2,500
+2,500
An accounting transaction has not occurred.
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LO 1 Analyze the effect of business transactions on the basic accounting equation.
Accounting Transactions
Event (10). On October 20, Sierra paid a $500 dividend.
1. +10,000
+10,000
2. +5,000
3. -5,000
+5,000
+5,000
4. +1,200
+1,200
5. +10,000
6.
-900
7.
-600
8.
10.
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+10,000
-900
+600
+2,500
-500
+2,500
-500
LO 1 Analyze the effect of business transactions on the basic accounting equation.
Accounting Transactions
Event (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
3. -5,000
+5,000
+5,000
4. +1,200
+1,200
5. +10,000
6.
-900
7.
-600
8.
10. -500
11. -4,000
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+10,000
-900
+600
+2,500
+2,500
-500
-4,000
3-21
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.
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Account Name
Debit / Dr.
Credit / Cr.
LO 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.

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DEBITS must equal CREDITS.
LO 3 Define debits and credits and explain they are used to record business transactions.
Debit and Credit Procedures
If Debits are greater than Credits, the account will have
a debit balance.
Account Name
Debit / Dr.
Credit / Cr.
Transaction #1
$10,000
$3,000
Transaction #3
8,000
Balance
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Transaction #2
$15,000
LO 3 Define debits and credits and explain they are used to record business transactions.
Debit and Credit Procedures
If Credits are greater than Debits, the account will have
a credit balance.
Account Name
Transaction #1
Balance
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Debit / Dr.
Credit / Cr.
$10,000
$3,000
Transaction #2
8,000
Transaction #3
$1,000
LO 3 Define debits and credits and explain they are used to record business transactions.
Procedures for Assets and Liabilities
Assets
Debit / Dr.
Credit / Cr.
Normal Balance
Chapter
3-23

Assets - Debits should
exceed credits.

Liabilities – Credits should
exceed debits.
Liabilities
Debit / Dr.
Credit / Cr.
Normal Balance
Chapter
3-24
3-26
LO 3 Define debits and credits and explain they are used to record business transactions.
Procedures for Stockholders’ Equity
Stockholders’ Equity

Investments by stockholders and
revenues increase stockholders’
equity (credit).

Dividends and expenses decrease
stockholder’s equity (debit).
Credit / Cr.
Debit / Dr.
Normal Balance
Chapter
3-25
Common Stock
Debit / Dr.
Retained Earnings
Credit / Cr.
Debit / Dr.
Normal Balance
Chapter
3-25
3-27
Chapter
3-25
Dividends
Credit / Cr.
Debit / Dr.
Normal Balance
Normal Balance
Credit / Cr.
Chapter
3-23
LO 3 Define debits and credits and explain they are used to record business transactions.
Procedures for Revenue and Expense
Revenue
Debit / Dr.

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.
Credit / Cr.
Normal Balance
Chapter
3-26
Expense
Debit / Dr.
Normal Balance
Credit / Cr.
Chapter
3-27
3-28
LO 3 Define debits and credits and explain they are used to record business transactions.
Stockholders’ Equity Relationships
Illustration 3-15
3-29
LO 3 Define debits and credits and explain they are used to record business transactions.
Summary of Debit/Credit Rules
Liabilities
Normal
Balance
Debit
Assets
Credit / Cr.
Normal Balance
Chapter
3-24
Stockholders’ Equity
Credit / Cr.
Debit / Dr.
Debit / Dr.
Normal
Balance
Credit
Debit / Dr.
Credit / Cr.
Normal Balance
Normal Balance
Chapter
3-23
Expense
Debit / Dr.
Chapter
3-25
Revenue
Credit / Cr.
Debit / Dr.
Normal Balance
Chapter
3-27
3-30
Credit / Cr.
Normal Balance
Chapter
3-26
LO 3 Define debits and credits and explain they are used to record business transactions.
Summary of Debit/Credit Rules
Balance Sheet
Asset = Liability + Equity
Income Statement
Revenue - Expense =
Debit
Credit
3-31
LO 3 Define debits and credits and explain they are used to record 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.
3-32
LO 3 Define debits and credits and explain they are used to record business transactions.
Summary of Debit/Credit Rules
Review Question
Debits:
a. increase both assets and liabilities.
b. decrease both assets and liabilities.
c. increase assets and decrease liabilities.
d. decrease assets and increase liabilities.
3-33
LO 3 Define debits and credits and explain they are used to record business transactions.
Summary of Debit/Credit Rules
Review Question
Accounts that normally have debit balances are:
a. assets, expenses, and revenues.
b. assets, expenses, and equity.
c. assets, liabilities, and dividends.
d. assets, dividends, and expenses.
3-34
LO 3 Define debits and credits and explain they are used to record business transactions.
3-35
Steps in the Recording Process
Illustration 3-17
Analyze each transaction
Enter transaction in a journal
Transfer journal information to
ledger accounts
Source documents, such as a sales slip, a check, a bill, or a
cash register tape, provide evidence of the transaction.
3-36
LO 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:
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.
3-37
LO 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 equipment for $5,000.
Instructions - Journalize these transactions.
3-38
LO 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
Date
Oct. 1
3-39
Account Title
Cash
Common stock
Ref.
Debit
Credit
10,000
10,000
LO 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.
General Journal
Date
Oct. 1
3-40
Account Title
Cash
Notes payable
Ref.
Debit
Credit
5,000
5,000
LO 5 Explain what a journal is and how it helps in the recording process.
Journalizing
Oct. 2
Sierra purchased equipment for $5,000.
General Journal
Date
Oct. 2
3-41
Account Title
Equipment
Cash
Ref.
Debit
Credit
5,000
5,000
LO 5 Explain what a journal is and how it helps in the recording process.
3-42
Steps in the Recording Process
The Ledger is comprised of the entire group of accounts
maintained by a company.
Illustration 3-19
3-43
LO 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.
Illustration 3-20
3-44
LO 6 Explain what a ledger is and how it helps in the recording process.
Steps in the Recording Process
Posting – the process of transferring journal entry
amounts to ledger accounts.
J1
General Journal
Date
Oct. 1
Account Title
Ref.
Debit
101
10,000
Cash
Common stock
Credit
10,000
General Ledger
Cash
Date
Oct. 1
3-45
Explanation
Stock issued
Acct. No. 101
Ref.
Debit
J1
10,000
Credit
Balance
10,000
LO 7
Steps in the Recording Process
Review Question
Posting:
a. normally occurs before journalizing.
b. transfers ledger transaction data to the journal.
c. is an optional step in the recording process.
d. transfers journal entries to ledger accounts.
3-46
LO 7 Explain what posting is and how it helps in the recording process.
3-47
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
3-48
LO 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
3-49
LO 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
3-50
LO 7 Explain what posting is and how it helps in the recording process.
The
Recording
Process
Illustrated
Additional
Transactions
Illustration 3-24
3-51
LO 7 Explain what posting is and how it helps in the recording process.
The
Recording
Process
Illustrated
Additional
Transactions
Illustration 3-25
3-52
LO 7 Explain what posting is and how it helps in the recording process.
The
Recording
Process
Illustrated
Additional
Transactions
Illustration 3-26
3-53
LO 7 Explain what posting is and how it helps in the recording process.
The
Recording
Process
Illustrated
Additional
Transactions
Illustration 3-27
3-54
The
Recording
Process
Illustrated
Additional
Transactions
Illustration 3-28
3-55
LO 7 Explain what posting is and how it helps in the recording process.
The Recording Process Illustrated
Additional Transactions
Illustration 3-29
3-56
LO 7 Explain what posting is and how it helps in the recording process.
The
Recording
Process
Illustrated
Additional
Transactions
Illustration 3-30
3-57
LO 7 Explain what posting is and how it helps in the recording process.
The
Recording
Process
Illustrated
Additional
Transactions
Illustration 3-31
3-58
LO 7
Summary Illustration of Journalizing
Illustration 3-32
3-59
LO 7
Summary Illustration of Journalizing
Illustration 3-32
3-60
LO 7
Summary
Illustration
of Posting
Illustration 3-33
3-61
LO 7 Explain what posting is and how it helps in the recording process.
Selected transactions from the journal of Faital Inc. during its first
month of operations are presented below. Post these transactions to T-accounts.
3-62
LO 7 Explain what posting is and how it helps in the recording process.
The Trial Balance
Trial Balance

A list of accounts and their balances at a given time.

Accounts are listed in the order in which they appear
in the ledger.

Purpose is to prove that debits
equal credits.

May also uncover errors in
journalizing and posting.

Useful in the preparation of
financial statements.
3-63
LO 8 Explain the purposes of a trial balance.
The Trial Balance
Illustration 3-34
Equal
3-64
LO 8
The Trial Balance
Limitations of a Trial Balance
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
Ethics Note An error is
the result of an
unintentional mistake. It
is neither ethical nor
unethical. An irregularity
is an intentional
misstatement, which
is viewed as unethical.
5. offsetting errors are made in recording
the amount of a transaction.
3-65
LO 8 Explain the purposes of a trial balance.
The Trial Balance
Review Question
A trial balance will not balance if:
3-66
a.
a correct journal entry is posted twice.
b.
the purchase of supplies on account is debited to
Supplies and credited to Cash.
c.
a $100 cash dividends is debited to the Dividends
account for $1,000 and credited to Cash for $100.
d.
a $450 payment on account is debited to Accounts
Payable for $45 and credited to Cash for $45.
LO 8 Explain the purposes of a trial balance.
The Cash account and the related cash
transactions indicate why cash changed
during October. To make this information useful for analysis it is
summarized in a statement of cash flows. The statement of cash flows
classifies each transaction as an operating activity, an investing
activity, or a financing activity.
Sierra Corporation’s:
3-67

Operating activities involve providing guide services.

Investing activities include the purchase or sale of long-lived
assets used in operating the business, or the purchase or sale
of investment securities.

Financing activities are borrowing money, issuing shares of
stock, and paying dividends.
LO 9 Classify cash activities as operating, investing, or financing.
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.
3-68
LO 10 Compare the procedures for the recording process under GAAP and IFRS.
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 in which
the reporting company is headquartered.
3-69
LO 10 Compare the procedures for the recording process under GAAP and IFRS.
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.
3-70
►
Whether the IASB is sufficiently independent.
►
Whether IFRS is established for the benefit of investors.
LO 10 Compare the procedures for the recording process under GAAP and IFRS.
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.
►
3-71
The issues involved in educating accountants, so they can
prepare statements under IFRS.
LO 10 Compare the procedures for the recording process under GAAP and IFRS.
Looking to 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.
3-72
LO 10 Compare the procedures for the recording process under GAAP and IFRS.
IFRS Practice
Which statement is correct regarding IFRS?
a) IFRS reverses the rules of debits and credits, that is, debits
are on the right and credits are on the left.
b) IFRS uses the same process for recording transactions as
GAAP.
c) The chart of accounts under IFRS is different because
revenues follow assets.
d) None of the above statements are correct.
3-73
LO 10 Compare the procedures for the recording process under GAAP and IFRS.
IFRS Practice
A trial balance:
a) is the same under IFRS and GAAP.
b) proves that transactions are recorded correctly.
c) proves that all transactions have been recorded.
d) will not balance if a correct journal entry is posted twice.
3-74
LO 10 Compare the procedures for the recording process under GAAP and IFRS.
IFRS Practice
One difference between IFRS and GAAP is that:
a) GAAP uses accrual-accounting concepts and IFRS uses
primarily the cash basis of accounting.
b) IFRS uses a different posting process than GAAP.
c) IFRS uses more fair value measurements than GAAP.
d) the limitations of a trial balance are different between IFRS
and GAAP.
3-75
LO 10 Compare the procedures for the recording process under GAAP and IFRS.
Copyright
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