7 The System Learning Objectives Unit 7 Explain the accounting process as an information system Explain the use of Special Journals and Subsidiary Ledgers in the accounting process Identify the components of an Income Statement, Balance Sheet and Statement of Changes in Owner’s Equity Analysis: Calculate and explain the current ratio and working capital from a Classified Balance Sheet Unit 7

Objective 7.1: Accounting as an Information System The accounting process is an excellent example of a modern information system. The system process is characterized by: O7.1

Inputs – Processing - Outputs INPUTS -The controlled collection of information (example is journalizing); PROCESSING -The reorganization and storage of this information (example is posting and updating account balances) and; OUTPUTS -The production of new information (examples are the financial statements output from the process). O7.1

Feedback from the Outputs is used to improve the system TRANSACTIONS ADJUSMENTS CLOSING ENTRIES Feedback from the Outputs is used to improve the system INPUTS JOURNAL Controls must be adequate to insure the quality of the outputs. OUTPUTS Financial Statements Balance Sheet Income Statement Statement of Changes in Owner’s Equity Cash Flow PROCESSING ACCOUNT LEDGERS O-7.1

System Controls -Goals Protect assets against loss due to waste or theft Provide reliable financial reports from accurate data Encourage efficient operations Comply with management’s goals Achieve compliance with laws and regulations. O-7.1

System Controls –Issues Segregation of duties Clear definitions of authority and responsibility Safeguards to protect the firm’s assets Written policies Periodic quality reviews Maintenance of a review (audit) trail Access limitations Management philosophy consistent with good control

System Controls -Issues AUTHORIZATION RECORDING CUSTODY OF ASSETS Keep in mind the goal of always separating these duties:

Objective 7.2: Special Journals & Subsidiary Ledgers Special Journals bring efficiencies to the accounting process by providing books of original entry designed to handle large numbers of similar transactions. O7.2

Special Journals Sales Journal –All sales from regular operations on credit Purchases Journal –All inventory* purchases on credit Cash Receipts Journal –All cash received Cash Payments Journal –All cash paid * Often expanded to include other purchases on credit such as supplies and equipment

different paths can lead to the GL Special Journals TRANSACTIONS JOURNALIZING SALES JOURNAL PURCHASES JOURNAL CASH RECEIPTS JOURNAL CASH PAYMENTS JOURNAL GENERAL JOURNAL Many different paths can lead to the GL POSTING ACCOUNT LEDGERS (General Ledger) Some accounts will be Control Ledgers

Objective 7.2: Special Journals & Subsidiary Ledgers Subsidiary ledgers are used to maintain sub accounts within a main or control account. O7.2

Example- Subsidiary Ledger An example is customer accounts receivable. Each customer’s balances must be maintained and all customers must reconcile with the total accounts receivable reported. O7.2

The Subsidiary Ledgers must add up to the Control Ledger Accounts Receivable Balance Subsidiary Ledgers AR Customer A O7.2

Which Journal? Does the transaction. . . 1. Involve Cash? CASH RECEIPTS JOURNAL CASH PAYMENTS JOURNAL 2. Involve sales & purchases “On Account”? SALES JOURNAL PURCHASES JOURNAL 3. Remaining transactions go to the General Journal GENERAL JOURNAL O7.2

Sales Journal For Sales on Credit Only (P) Indicates subsidiary account posting Indicates that the total $3,750 has been posted to both the Accounts Receivable and to the Sales Ledgers. Notice the totals under each column are posted to the account ledgers, rather than posting each individual transaction. O7.2

Posting O7.2

Dual Posting From Sales Journal O5.2

Notice the Other Debit all purpose column Purchases Journal Notice the Other Debit all purpose column O7.2

Dual Posting From Purchases Journal O5.2 O-5.2

Dedicated columns are totaled and posted Cash Receipts Journal Dedicated columns are totaled and posted O7.2

The Other account column is used for the Owner Investment transaction Cash Receipts Journal The Other account column is used for the Owner Investment transaction O7.2

Cash Receipts Journal Remember to maintain Subsidiary Ledgers O7.2

Cash Payments Journal O7.2 Cash is reduced with each transaction in this journal The Other account column is used for the Salaries Expense O7.2

Cash Payments Journal Remember to maintain Subsidiary Ledgers O7.2

General Journal These transactions don’t fit in the other journals –they must go in the general journal. O7.2

Remember that we are using a Perpetual Inventory System General Journal Remember that we are using a Perpetual Inventory System O7.2

Objective 7.3: Identify the components of an Income Statement, Balance Sheet and Statement of Changes in Owner’s Equity O7.3

Service Firm Income Statement Multi-step No cost of goods sold and gross profit section. Separate sections for operating expenses and nonoperating expenses. Further separation of operating expenses into selling and administrative expenses. The other income and expense area segregates nonoperating revenue and expenses O7.3

Merchandising Income Statement The cost of goods sold and gross profit section is a distinguishing feature A single step statement would simply summarize the operating expenses to a single amount.. O7.3

Current Asset & Liabilities Current assets - assets that are expected to be converted to cash or provide a benefit (consumed) within one year or the firm’s fiscal period whichever is longer. Examples are Cash, Accounts Receivable, Inventory, Supplies, Prepaid Insurance.  Current liabilities- liabilities that are due and payable within the longer of one year or the firm’s fiscal period. Examples are trade accounts payable, taxes and wages payable, credit lines and notes due within the firm’s fiscal period

Classified Balance Sheet Separate both assets and liabilities into current and noncurrent. O7.3

Classified Balance Sheet More liquid Earlier Payment Dates Current assets are listed in order of their liquidity or convertibility to cash. Liabilities are listed in order of their scheduled due dates. O7.3

Statement of Changes in Owner’s Equity Notice the beginning of the fiscal period Owner’s Capital, less the Owner draws during the fiscal period and finally the period’s income or loss. The total ending equity is the same number that appears on the Balance Sheet of the same date. O7.3

Objective 7.4: Analysis: Calculate and explain the current ratio and working capital from a Classified Balance Sheet Current Assets Current Ratio Current Liabilities Working Capital Current Assets Current Liabilities O7.4

Liquidity Liquidity –The current ratio and working capital are often called liquidity measures. The term “liquidity” refers the relative cash nature of a particular balance sheet. O7.4

Liquidity For example, a highly liquid balance sheet would have a large amount of cash and other current assets, with limited current liabilities that would require the use of that cash (liquidity). O7.4

Liquidity More Liquid Less Liquid Balance Sheet Balance Sheet Current Liabilities Current Liabilities Current Assets Current Assets More Liquid Less Liquid Equity Assets Equity More current asset dollars to pay each current liability dollar Fewer current asset dollars to pay each current liability dollar O4.3

Current ratio The current ratio answers the following question: How many dollars of current assets are available to pay each dollar of current liabilities scheduled? The higher the number, the more dollars of current assets are available and therefore the more liquid is the particular balance sheet being studied. Current Assets Current Ratio Current Liabilities O7.4

Working capital Working capital answers the following question: How many dollars of current assets would remain if all current liabilities were paid using current assets? The resulting answer is expressed in dollars. The higher the number, the more liquidity is displayed by the balance sheet. Working Capital Current Assets Current Liabilities O7.4

Current Ratio Example 1.10 ? O7.4 $1.10 of current assets are available to pay each dollar of current liabilities 1.10 ? O7.4

Working Capital Example $16,900 of current assets would remain if current assets were used to pay all current liabilities $16,900 ? O7.4

End Unit 7