INTERMEDIATE ACCOUNTING
TENTH CANADIAN EDITION
Kieso • Weygandt • Warfield • Young • Wiecek • McConomy
CHAPTER 3
The Accounting
Information System
Prepared by:
Dragan Stojanovic, CA
Rotman School of Management,
University of Toronto
CHAPTER 3:
THE ACCOUNTING INFORMATION SYSTEM
After studying this chapter, you should be able to:
LEARNING
OBJECTIVES:
• Understand basic accounting
terminology.
• Explain double-entry rules.
• Explain how transactions affect the accounting equation.
• Identify the steps in the accounting cycle and the steps in the recording
process.
• Explain the reasons for and prepare adjusting entries.
• Explain how the type of ownership structure affects the financial statements.
• Prepare closing entries and consider other matters relating to the closing
process.
• Prepare a 10-column work sheet and financial statements.
After studying Appendix 3A, you should be able to:
• Identify adjusting entries that may be reversed.
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Canada, Ltd.
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The Accounting Information System
Accounting
Cycle and the
Recording
Process
• Basic
terminology • Identifying
and
• Debits and
recording
credits
transactions
• Accounting
and other
equation
events
Accounting
Information
System
Adjusting
Entries
Financial
Statements
and
• Adjusting
Ownership
entries for
prepayments Structure
Closing
Process
• Adjusting
entries for
accruals
• Reversing
entries
• Adjusting
entries for
estimated
• Journalizing
items
• Preparing
closing
entries
• The
accounting
cycle
summarized
• Posting
• Trial balance
Appendix 3AUsing
Reversing
• Adjustments
Entries
entered
Using a
Worksheet
• Work sheet
columns
• Preparing
financial
statements
from a work
sheet
• Accruals
• Prepayments
• Summary of
reversing
entries
• Closing
entries
• Monthly
statements,
yearly closing
• Adjusting
entries
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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)
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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 statement of
changes in shareholders equity.
• Temporary accounts are closed at year end
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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 entries)
• 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 ledger accounts
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Basic Terminology
Ledger
• Book (or 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)
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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)
• Typically prepared after end of period
adjustments (called Adjusted Trial Balance)
and possibly after closing entries (called Postclosing Trial Balance)
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Basic Terminology
Adjusting entries
•
•
•
Entries made at the end of an accounting period
Brings all accounts up to date on an accrual
accounting basis
Seven classifications of adjusting entries:
Prepayment
Accruals
Estimated Items
1. Prepaid Expenses
3. Accrued Revenues
5. Bad Debts
2. Unearned Revenues
4. Accrued Expenses
6. Unrealized Holding
Gain or Loss
7. Unrealized Holding
Gain or Loss - OCI
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Basic Terminology
Financial statements
• Final summaries of the accounting data for a
specific time period
• Four statements:
•
•
•
•
Statement of Financial Position (or Balance Sheet
under ASPE) - shows financial condition at a
specific date
Statement of Comprehensive Income (or Income
Statement under ASPE) - measures the results of
operations during a period of time
Statement of Cash Flows - shows sources and
uses of cash
Statement of Changes in Shareholders’ Equity
(Statement of Retained Earnings under ASPE)
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Debits and Credits
Credit (Cr.)
Debit (Dr.)
To record or enter an
To record or enter an
amount on the right side
amount on the left side
of a general ledger
of a general ledger
account
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”
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The Accounting Equation
Assets = Liabilities + Shareholders’ Equity*
*Shareholder’s Equity = Common Shares + Retained
Earnings – Dividends + Revenues - Expenses
Assets = Liabilities + Common Shares + Retained
Earnings – Dividends + Revenues - Expenses
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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
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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
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The Accounting Cycle: Steps
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
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)
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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
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Common Shares
3,000
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Preparation of Trial Balance
PIONEER ADVERTISING AGENCY INC. at October 31, 2014
Account
Cash
80,000
Notes Payable
50,000
Dividends
5,000
Revenue
100,000
Debit
Cash
80,000
Accounts Receivable
72,000
Advertising Supplies
25,000
Prepaid Insurance
6,000
Fair Value Investments
10,000
Office Equipment
50,000
Notes Payable
Accounts Payable
Unearned Service Revenue
Common Shares
Dividends
5,000
Service Revenue
Salaries Expense
40,000
Rent Expense
9,000
TOTALS
297,000
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Credit
50,000
35,000
12,000
100,000
100,000
297,000
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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.
2.
3.
4.
Transaction not journalized
Correct journal entry not posted
Journal entry posted twice
Incorrect accounts used in either the journal
entry or posting
5. Offsetting errors made during recording
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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
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Adjusting Entries for Prepayments
• Prepaid Expenses
– Prepayments made in cash and recorded as
assets before item is used
• Unearned Revenues
– Revenue received in cash and recorded as
liabilities before being earned
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Adjusting Entries for Prepayments
• 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
and debited Prepaid Insurance for $6,000.
• Adjust Prepaid Insurance on Dec. 31:
Dr Insurance Expense 1,500
Cr Prepaid Insurance 1,500
($6,000/12
* 3)
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Adjusting Entries for Prepayments
• 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
($12,000/4 * 3)
9,000
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Adjusting Entries for Accruals
• Accrued Revenues
– Revenues earned but not yet received in
cash and not recorded
• Accrued Expenses
– Expenses incurred but not yet paid in cash
and not recorded
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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
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Adjusting Entries for Estimated Items
•
Bad Debts
– Expenses relating to impaired accounts
receivable estimated in the period and relating
to revenue that has been earned
•
Investments – Fair Value Adjustments
– For certain categories of investments, an
unrealized gain or loss must be recorded in the
statement of comprehensive income
– Adjustment made either through:
•
•
Net Income, or
Other Comprehensive Income
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Financial Statements and Ownership
Structure
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Financial Statements and Ownership
Structure
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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
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Closing Entries
The following closing entries are made (assume net
income and other comprehensive income for the year):
1. Income Summary
$$$
Expense Accounts (individually)
$$$
2. Revenue Accounts (individually)
$$$
Income Summary
$$$
3. Income Summary
$$$
Retained Earnings
$$$
4. Retained Earnings
$$$
Dividends
$$$
5. OCI Accounts (individually)
$$$
Accumulated OCI
$$$
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Retained Earnings: Closing Entries
Ret. Earnings
Dividends
Income Summary
4
3
Expense
Revenue
1
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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
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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
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Periodic Inventory:
Closing Entry
First Step: Determine Cost of Goods Sold
Beginning Inventory
Purchases
$200,000
Less: Purchase returns $1,000
Purchase discounts 3,000
4,000
Net Purchases
196,000
Plus: Transportation-In
6,000
Cost of Goods Purchased
Cost of Goods Available for Sale
Less: Ending Inventory
Cost of Goods Sold
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$ 30,000
202,000
232,000
26,000
$206,000
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Periodic Inventory:
Closing Entry
Account
Cost of Goods Sold
Inventory (Ending)
Purchases Returns
Purchase Discounts
Dr.
Cr.
$ 206,000
$ 26,000
$ 1,000
$ 3,000
Purchases (Gross)
Transportation-in
Inventory (Beginning)
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$ 200,000
$ 6,000
$ 30,000
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