Accounting Records and Systems 4 Accounting Records and Systems

Why learn basic record keeping procedures? Accounting is best learned by doing. Debit-credit mechanism provides an analytical framework.

The Account Device used for calculating net change Simplest form is T-account. Increases listed on one side; decreases listed on other side. Balanced periodically.

Permanent Accounts = real accounts = balance sheet accounts. Reported on balance sheet. Carried forward into next period: In this sense, they are permanent.

Temporary Accounts Revenue and expense accounts. Details of income statement and changes in retained earnings (RE). Helps summarize operating activity. Avoids cluttering RE account. At end of accounting period, amounts are totaled, combined and transferred to RE. Balances at beginning of each period are 0.

General Ledger General ledger contains all accounts. Some accounts may be in summary form. E.g. accounts receivable, inventory, fixed assets. Detail or subsidiary ledgers kept for above.

Chart of Accounts List of all accounts. Numbers assigned to accounts to make summaries for Balance Sheet and Income Statement easier. Minimum # is # of BS and IS lines. Usually many more. Management determines # of accounts based on information needs. May be several levels of detail. Can view as building blocks summarized in various ways.

Debit and Credit Left hand side (LHS) of an account arbitrarily called debit side. RHS is credit side. To debit or charge (credit) means to make an entry to LHS (RHS). For each transaction: dr. (debit) = cr. (credit) Assets = Liabilities + Owners’ Equity Thus double entry bookkeeping.

Rules for Dr. and Cr. Asset accounts: Liability and OE accounts: Increases on LHS (Dr.) Decreases on RHS (Cr.) Liability and OE accounts: Necessarily the opposite to maintain fundamental accounting equation: Increases on RHS (Cr.) Decreases on LHS (Dr.)

Rules for Dr. and Cr. (Continued) Revenue and expense accounts can be viewed as part of Retained Earnings or Owners’ Equity. Since revenues increase RE and expenses decrease RE: Revenue (& RE) accounts Increases on RHS (Cr.) Decreases on LHS (Dr.) Expense accounts Increases on LHS (Dr.) Decreases on RHS (Cr.)

Fundamental Accounting Equation = Owners’ Equity Assets Liabilities + Debit Credit Debit Credit Debit Credit - + + - - +

Summary of Accounting Process or Accounting Cycle Analysis of transactions. (Judgment) Journalize original entries . (Mechanical) Post from journal to ledger. (Mechanical) Make adjusting entries. (Judgment) Journalize and post closing entries. (Mechanical) Prepare financial statements (Judgment)

Transaction Analysis Assets = Liabilities + Owners’ Equity Dr. = Cr. Record which ever half of entry is more obvious. Example entry for Owner contributing $5,000 cash for stock: Cash 5,000 Paid-in-capital 5,000

Balancing Accounts & Trial Balance Original entries: Obvious: checks written, sales made, etc. Trial balance. List of all accounts & amounts; separate columns for dr. and cr. Shows equality of dr. and cr. Still could be errors. Convenient for making adjusting entries and preparing financial statements (BS & IS).

Owner invests $5,000 in Business Cash (1) 5,000 Paid-in-Capital (1) 5,000

Firm Pays $750 for Rent Cash (1) 5,000 (2) 750 Prepaid Expense (2) 750

Adjusting Entries Modifies account balances at end of period. Types: Recorded costs to be apportioned among 2 or more periods. Unrecorded expenses. Recorded revenues to be apportioned over 2 or more periods. Unrecorded revenues.

Adjusting Entries - Exercise #1 We purchased equipment for $20,000. The equipment has a life of 5 years. What are the depreciation entries for years 1 and 2? (Assume straight line) How much is the accumulated depreciation (contra asset) at the end of year 2? What is a contra asset account? What is the book value at the end of year 2 ? What is the fair (or market or current) value of the equipment at the end of year 2?

Adjusting Entries - Exercise #2 Prepare entries for the following: We purchase office supplies on 1/15 for $14,000. On hand at YE (12/31) are $3,000 of office supplies.

Adjusting Entries - Exercise #3 Prepare entries for the following: Credit sales for the year are $1,000,000. At year end, we estimate we will collect all but approximately 1.5% of our sales from customers due to customers that go bankrupt or disappear.

Closing Entries Temporary or IS accounts are closed out to the clearing account Income Summary (= Profit & Loss Summary = Expense and Revenue Summary). Close out = zero out = transfer balance to another account Income summary account is closed out to RE. Only Permanent Accounts remain open.

Journal All transactions are originally recorded or entered in a journal (hence book of original entry). Journal: Contains accounts and amounts to be debited and credited. Device for reclassifying and summarizing. Amounts are transferred or posted from the journal to the ledger (i.e. T account).

Accounting System Consists of: Journals. Ledgers. Rules for using them. Manual, computerized, or anything between. In a computerized system: Bookkeeping steps are done electronically.

Objectives of Accounting System To process information efficiently (low cost). To obtain reports quickly. To ensure a high degree of accuracy. To minimize possibility of theft or fraud.

Internal Accounting Controls Basic Principle: make it as difficult as is practical for people to be dishonest or careless. Activities that reduce possibility of theft, or intentional or unintentional mistakes.

Examples of Internal Controls Separation of duties: Record keeping. Custody of assets. Authorization of transactions. Reconciliations. Bank accounts. Detail ledgers to control accounts in general ledger.

What a Computer Based Accounting System Does Mechanical steps are bookkeeping. A computer based system performs some or all bookkeeping steps: Records and stores data. Performs arithmetic operations on data. Sorts and summarizes data. Prepares reports.

Inputs Data entry clerk using a keyboard. Point of origin: Factory time records, inventory counts, receiving records. Scanning device reading bar codes. Purchase orders from customer transmitted electronically.

Processing and Output Examples Only accept entries if debits equal credits. Assigning seat numbers for airline, or concert. Outputs Reports including tables and graphs. Routine or customized.

Modules Interconnected software programs. Examples: Order entry. Processes sales orders, records shipments, and related accounts receivable. Purchasing: Issues purchase orders. Personnel and Payroll: Keeps employee records and issues paychecks.

Opportunities and Problems with Computer Systems Efficiency over manual systems. Off the shelf systems available for small companies. Modifying to unique complexities of a company may be costly. Paper trail replaced by electronic records. Technological advances making systems obsolete. Challenge of educating users.

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