Chapter 3:
The Accounting
Information System
1
Transaction Analysis
The first step in the accounting process is
transaction analysis.
 This process examines relevant, objectively
measurable economic events through their
effect on the accounting equation:
Assets = Liabilities + Equity

2
Transaction Analysis
All business transactions will have an effect
on at least 2 items in the accounting
equation.
 For example, if you buy a car with cash, you
decrease one asset (cash) and increase
another asset (auto).
 If you purchased a car by signing a note, you
would increase an asset (auto), and increase
a liability (notes payable).

3
The Accounting Process



Once the direction of the effect on the specific
accounts is determined, the second step is the
recording of transactions and events (journal
entries).
Journal entries are recorded using debits and
credits.
The effect of a debit or credit depends on the
type of account being affected.
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Double Entry Accounting
Debit (dr) - means an entry to the left
hand side of an account.
 Credit (cr) - means an entry to the right
hand side of an account.
 Note that a debit or credit, per se, does not
indicate increase or decrease.
 To decide the effect of a debit or credit,
the type of account must be considered.

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Effect of Debits and Credits
Based on the accounting equation, we can
increase or decrease various accounts
depending on their classification:
Assets = Liabilities + Equity
Increase
DR =
CR
CR
Decrease CR =
DR
DR
 Note that we use debits and credits
instead of plusses and minuses.
 Note, also, that bank terminology is
reversed from the customer perspective.

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Effect of Debits and Credits
Expanded rules for debits and credits based
on financial statement relationships:
Assets = Liabilities
+
Stockholders’ Equity
Retained
Earnings
Common
Stock
Net Income Dividends
Revenues Expenses
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The following rules can be derived from
the basic formula:





Assets have normal debit balances and are
increased with a debit.
Liabilities and equities have normal credit
balances and are increased with a credit.
Revenues (a part of equity) have normal credit
balances and are increased with a credit.
Expenses (which decrease equity) have normal
debit balances and are increased with a debit.
Dividends (which decrease equity) have a
normal debit balance and are increased with a
debit.
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The Format of a Journal Entry
To initially record transactions, we use a journal
entry to represent the debits and credits.
For example, if investors contribute $20,000 into the
company, and receive common stock, the
transaction is recorded as follows:
Debit Credit
Cash
20,000
Common Stock
20,000
This transaction INCREASES cash with a DEBIT,
and INCREASES common stock with a CREDIT.
Note that the debit is to the left and the credit is to
the right. First we list the account (left hand entry
on top), then the amount.
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Additional Entries
Purchase $20,000 of equipment with
the payment of $8,000 cash, and
finance the balance with a Notes
Payable:
10
Additional Entries
Perform services for customer on
account, and bill the customer $5,000:
Collect $4,000 on accounts receivable:
Pay current month’s rent of $1,000:
11
The Accounting Cycle
Components of the basic accounting cycle:
A. Preparation of Journal
-Post to the General Ledger
-Unadjusted Trial Balance
B. Preparation of Adjusting Journal Entries
-Post to the General Ledger (or spreadsheet)
-Adjusted Trial Balance
C. Financial Statements (more in Ch. 4 and 5)
D. Closing Journal Entries
-Post ClosingTrial Balance
Note: reversing journal entries may be prepared
at the beginning of the next accounting cycle. 12
A. General Journal Entries (GJEs)





The first step in the accounting process.
Prepared for daily activity.
Usually journalized in special journals for
efficiency, but we will record in “General Journal”
format.
Identified through a document flow:
– cash receipt, record a cash sale
– charge receipt, record a sale on account
– bank note, record a notes payable
– employee time card, record wages
The Journal Entries on Slides 9-11 are GJEs.
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The General Ledger (G/L)
The G/L serves as a place to “total”
amounts by account titles.
 After GJEs (and later – adjusting journal
entries) are recorded, they are posted (by
account) to the G/L. See page 92.
 Accounting systems perform the posting
and totaling electronically.
 For illustration and understanding of the
flow through, we will do the posting by
hand in class.
 We will use “T” accounts to represent G/L
accounts where needed.

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Back to Class Problem: Posting to G/L
Now post transactions (for Cash) to “T” account:
Cash
15
Unadjusted Trial Balance




Trial balances are prepared throughout the
accounting cycle.
The Unadjusted Trial Balance represents G/L
totals (by account) at a particular point in time.
The Unadjusted Trial Balance is a preliminary
total, and is a starting point for the Adjusting
Journal Entries (discussed later in the
chapter).
Example on page 96.
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1. Accrual of Expenses

Probably the most common type of AJE.
Ex: accrue interest at the end of the period:
Interest Expense
xx
Interest Payable
xx
 Note: this is a “skeletal” journal entry, where the
“xx” simply indicates values to be calculated
later. The focus here is on the account and
direction.
 Other examples of expense/payable include
wages, rent, taxes, insurance.
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1. Accrual of Expenses - Example 1
Raider Company borrowed $10,000 on October
1, 2012. The note included a 5 percent annual
interest rate, payable each September 30,
starting Sept. 30, 2013. How much interest must
Raider accrue at Dec. 31, 2012 before financial
statements are prepared?
Calc: Principal x rate x time
P
x R x T
AJE:
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2. Accrual of Revenues
For revenues that have not yet been
recorded at the end of the period.
 Ex: accrue interest revenue:
Interest Receivable
xx
Interest Revenue
xx
 Another example of receivable/revenue
accruals relates to rent revenue, where
the rental payment has not yet been
received.

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2. Accrual of Revenues - Example 2
Raider Company leases out part of its
office building to Baylor Company for
$2,000 per month. At the end of the
year, Baylor owes Raider for December’s
rent. Prepare the AJE for Raider
Company:
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3.Prepaid (Deferred) Expenses

This category of AJE relates to the concept of
asset capitalization and the matching principle.
 Asset capitalization occurs when a cost (with
future economic benefit) is incurred. An asset is
recognized at that time. Examples include
supplies, prepaid Insurance, inventory.
 As the asset is “used up” in the generation of
revenue, the related cost is recognized as an
expense (matching).
 Some expenses are deferred for a short period of
time (supplies expense), and some expenses are
deferred and allocated over many years
(depreciation expense – treated in a separate
category).
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3. Prepaid Expenses

Example: Purchase 1-year insurance policy.
General JE at time of purchase, assumes
original debit to an asset account:
Prepaid Insurance
xx
Cash
xx
AJE at end of the period (for the portion that
has been used):
Insurance Expense
xx
Prepaid Insurance
xx
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3.Prepaid Expenses - Example 3
Raider Company purchased a 1-year insurance
policy on April 1, 2012 at a cost of $2,400
General JE at time of purchase (to asset):
Prepaid Insurance
2,400
Cash
2,400
Calculation for AJE at December 31 to
recognize the portion that has been used up:
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3.Prepaid Expenses – Example 4
Raider Company purchased a 1-year insurance
policy on April 1, 2012 at a cost of $2,400
General JE at time of purchase (to expense):
Insurance Expense
2,400
Cash
2,400
Calculation for AJE at December 31 to create
asset for the portion that was not used up:
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4.Unearned (Deferred) Revenues

Cash is received from customer before
goods/services are delivered (before revenue
can be recognized).
Ex: Received subscription in advance (other
examples include rent received in advance, and
advance collections for gift cards).
General JE at time cash received (credit to
liability):
Cash
xx
Unearned Revenues
xx
AJE at end of the period (for portion earned):
Unearned Revenues
xx
Subscription Revenues
xx
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4.Unearned Revenues – Example 5
Raider Company received $6,000 on November
30, 2012 for subscriptions to be delivered over
the next 12 months, starting in December of
2012.
General JE at time cash received (credit to
liability):
Cash
6,000
Unearned Revenues
6,000
AJE at end of the period (for portion earned):
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4.Unearned Revenues – Example 6
Raider Company received $6,000 on November
30, 2012 for subscriptions to be delivered over
the next 12 months, starting in December of
2012.
General JE at time cash received (credit to
revenue):
Cash
6,000
Subscription Revenues
6,000
AJE at end of the period (for portion earned):
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5. Other AJEs


Example: purchase of equipment.
General JE at time of purchase:
Equipment
xx
Cash
xx
AJE at end of the period (for the portion that
has been used):
Depreciation Expense
xx
Accumulated Depreciation
xx
Note: Accumulated Depreciation is a contra
asset account and is presented as an offset
to Equipment on the balance sheet (expanded
coverage in Chapter 11).
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5. Depreciation Exp. – Example 7
Raider Company purchased equipment in 2010
at a cost of $30,000. The equipment has a
useful life of 10 years and no salvage value.
Calculation for AJE at December 31, 2012 for
the current year’s depreciation.
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Financial Statements




Financial Statements prepared from the
adjusted trial balance.
Income Statement (page 109) – basic single
step: Revenues – Expenses = Net Income.
Net Income carries to the Statement of
Retained Earnings (or the Statement of
Stockholders’ Equity in later chapters), page
109.
Ending Retained Earnings carries to the
Balance Sheet (page 110).
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Closing Journal Entries

Closing journal entries are prepared at the end
of the year, after the financial statements have
been prepared.
 Only the nominal (temporary) accounts are
closed. These accounts include revenues,
expenses and dividends. These accounts are
closed to Retained Earnings.
 The temporary accounts will start the new year
with zero balances.
 The real (permanent) balance sheet accounts,
including Retained Earnings, are not closed at
the end of the year.
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Exercise 3-16 Closing JEs
Close revenues and expenses to Retained Earn.:
Sales Revenue
410,000
Sales Discounts
15,000
Sales Returns & Allowances 12,000
COGS
225,700
Selling Expenses
16,000*
Administrative Expenses
38,000*
Income Tax Expense
30,000
Close dividends to Retained Earnings:
Dividends
18,000
Ending RE?
*Note: close individual account titles.
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Reversing Journal Entries


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Reversing journal entries are not required, but
can significantly simply subsequent postings,
especially for payments relating to accrual
adjusting journal entries.
If used, reversing journal entries are created at
the beginning of the period for all accrual
adjusting journal entries.
They may also be used for deferral adjusting
journal entries, where the original activity was
posted to a revenue or expense.
Reversing journal entries are never done for
special AJES for depreciation and bad debt
expense.
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Example of Reversing JEs
Annual interest expense of $4,000 is due on a
note payable is due March 31, 2013. At
December 31, 2012 the accountant accrued
9/12 of the interest in an AJE:
Interest Expense
Interest Payable
3,000
3,000
If NO reversing journal entries are used, the
journal entry to pay the interest on March 31,
2013 would be:
Interest Payable
3,000
Interest Expense
1,000
Cash
4,000
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Example of Reversing JEs
If a reversing journal entry IS posted at the
beginning of 2013, the entry would be:
Interest Payable
3,000
Interest Expense
3,000
Note: this eliminates the liability, and leaves a
temporary credit balance in interest expense.
The journal entry to pay the interest on March 31,
2013 would now be:
Interest Expense
4,000
Cash
4,000
The RJE simplifies subsequent postings,
particularly for accruals. The accountant does
not need to research, for every payment (or
receipt) which portion relates to the current year,
and which portion relates to the prior year.
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Worksheets

Worksheets are not required to complete the
accounting cycle.
 They are a useful tool, particularly when
preparing to do adjusting journal entries.
 They are often used by auditors who construct
adjusting (correcting) journal entries during the
audit, and in consolidation activities.
 Tax accountants use worksheets to convert
financial accounting balances to correspond
with tax regulations.
 The process for a financial statement
worksheet is shown on page 128. We will use
a slightly modified spreadsheet for Ch. 3 HW.
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