Bob Anderson, UCSB Financial Accounting: Tools for Business Decision Making, 4th Ed. Kimmel, Weygandt, Kieso CHAPTER 3

Bob Anderson, UCSB Chapter 3 The Accounting Information System Analyze the effect of business transactions on the basic accounting equation. Explain what an account is and how it helps in the recording process. Define debits and credits and explain how they are used to record business transactions. Identify the basic steps in the recording process.

Bob Anderson, UCSB Chapter 3 The Accounting Information System Explain what a journal is and how it helps in the recording process. Explain what a ledger is and how it helps in the recording process. Explain what posting is and how it helps in the recording process. Explain the purposes of a trial balance.

Bob Anderson, UCSB External and Internal Events External Event External Event – interaction between a business and its environment. Internal Event Internal Event – event occurring entirely within a business. Transaction Transaction – any event that is recognized in a set of financial statements. RECOGNIZED- An accounting entry is recorded… it becomes reflected in the financial statements. REALIZED- regardless of whether it results in an accounting entry, the business actually receives or gives something.

Bob Anderson, UCSB Exercise – Types of Events 1.A supplier of a company‘s raw material is paid an amount owed on account. External InternalNot Recorded 2.A customer pays its open account. 3.A new chief executive officer is hired. 4.The biweekly payroll is paid. 5.Raw materials are entered into production. 6.A new advertising agency is hired. 7.The accountant determines the federal income taxes owed based on the income earned. External Internal Not Recorded

Bob Anderson, UCSB Source Document Source Document – a piece of paper that is used as evidence to record a transaction. Sales invoice Payroll timecard Utility bill Stock certificate Promissory note (note payable) Source Documents Payment terms are 2/10, n/30 NOTE: Not all recordable events are supported by a standard source document.

Bob Anderson, UCSB Exercise – Source Documents 1.Utilities expense for the month is recorded. 2.A cash settlement is received from a pending lawsuit. 3.Owners contribute cash to start a new corporation. 4.The biweekly payroll is paid. 5.Cash sales for the day are recorded. 6.Equipment is acquired on a 30-day open account. 7.A sale is made on open account. 8.A building is acquired by signing an agreement to repay a stated amount plus interest in six months. Purchase invoice Sales invoice Cash register tape Time cards Promissory note Stock certificates Monthly utility statement Other/ or- No source document normally available

Bob Anderson, UCSB Assets = Liabilities + Equity Effect on the Accounting Equation Assets - Liabilities = Equity Assets - Liabilities = Net Assets Net Assets = Equity The accounting equation is made up of “Accounts.” An account is a record used to accumulate amounts for each individual asset, liability, equity, revenue, and expense.

Bob Anderson, UCSB Sara Lee Corp. – Assets Accounts LO 2Describe the qualitative characteristics of accounting information.

Bob Anderson, UCSB LO 3Analyze the effects of transactions on the accounting equation. Chart of Accounts

Bob Anderson, UCSB FINALLY- DEBITS AND CREDITS Rule number one: forget the concept of “credit” to your account that you are probably familiar with. If your bank charges you a late fee, you complain and they reverse it, you THINK that is a credit to your account. BUT, as you will see, on YOUR books, the adjustment is a DEBIT to your cash. CRUTCH: ASSETS & LIABILITIES: DEBIT GOOD, CREDIT BAD EQUITY & INCOME: OPPOSITE (DEBIT BAD, CREDIT GOOD) MORE: ASSETS AND EXPENSES ARE DEBITS LIABILITIES, EQUITY AND REVENUES ARE CREDITS OH YEAH, ONE OTHER THING: DEBITS ON THE LEFT, CREDITS ON THE RIGHT! REMEMBER FROM PRIOR CHAPTERS: “FOR EVERY ACTION THERE IS AN EQUAL AND OPPOSITE REACTION”… IN ACCOUNTING TERMS, FOR EVERY DEBIT, THERE IS A CREDIT.

Bob Anderson, UCSB Graphic debits and credits (GENERALLY) Balance Sheet Assets: Liabilities: Equity: Income Statement Revenues & Gains: Expenses & Losses: 2004 DEBITS CREDITS DEBITS CREDITS CREDITS

Bob Anderson, UCSB ANOTHER CRUTCH “Debit” Card- comes from your checking account, which is an ASSET. “Credit” Card- creates a LIABILITY. DEBIT- ASSET CREDIT- LIABILITY

Bob Anderson, UCSB Review What is the normal balance for the following accounts? Cash Service Revenue Accounts Receivable Accounts Payable Common Stock Salaries Expense Debit Credit Debit Credit Credit Debit

Bob Anderson, UCSB Review What is the normal balance for the following accounts? Dividends Unearned Revenus Taxes Payable Building Prepaid Insurance Rent Expense Debit Debit Credit Credit Debit Debit

Bob Anderson, UCSB Balance Sheet Income Stmt. Balance Sheet Income Stmt. = + = - Debits and Credits AssetLiab.EquityRev.Exp. Debit Credit

Bob Anderson, UCSB DEBITS AND CREDITS- POSTING We need to write a transaction in a format that can be communicated / input. We use a journal entry: DEBITS ON THE LEFT CREDITS ON THE RIGHT

Bob Anderson, UCSB ACCOUNTING EQUATION- JOURNAL ENTRIES On Jan. 3rd, sold common stock for $100,000 cash. What is the impact to common stock? INCREASE $100,000 What is the impact to cash? INCREASE $100,000 HOW IS THIS EXPRESSED IN A JOURNAL ENTRY? ACCOUNTDEBIT/ DR.CREDIT/ (CR) Cash$100,000 Common Stock $100,000

Bob Anderson, UCSB ACCOUNTING EQUATION- JOURNAL ENTRIES On Jan. 10th, purchased a building by signing a $150,000 note payable.. What is the impact to Building (Fixed assets)? INCREASE $150,000 What is the impact to Notes Payable? INCREASE $150,000 HOW IS THIS EXPRESSED IN A JOURNAL ENTRY? ACCOUNTDEBIT/ DR.CREDIT/ (CR) Building $150,000 Note payable $150,000

Bob Anderson, UCSB HOW TO LEARN DEBITS AND CREDITS There is no way to teach it and no way to learn it other than by: PRACTICE!!!!!

Bob Anderson, UCSB ACCOUNTING EQUATION- JOURNAL ENTRIES On Jan. 15th, purchased inventory on account for $60,000. What is the impact to Inventory? INCREASE $60,000 What is the impact to cash? NONE- PURCHASED ON ACCOUNT What is the impact to accounts payable? INCREASE $60,000 HOW IS THIS EXPRESSED IN A JOURNAL ENTRY? ACCOUNTDEBIT/ DR.CREDIT/ (CR) Inventory $60,000 Accounts payable $60,000

Bob Anderson, UCSB BY THE WAY WHAT IS THE DIFFERENCE BETWEEN THESE ENTRIES: ACCOUNTDEBIT/ DR.CREDIT/ (CR) Inventory $60,000 Accounts payable $60,000 AND ACCOUNTDEBIT/ DR.CREDIT/ (CR) Accounts payable $60,000 Inventory $60,000 ANSWER: NOTHING- IT IS ONLY A CONVENTION TO LIST THE DEBITS FIRST!

Bob Anderson, UCSB ACCOUNTING EQUATION- JOURNAL ENTRIES On Jan. 20th, sold inventory costing $30,000, for $75,000 on account. Did we “earn” the revenue? Yes- SALES INCREASE $75,000 Sold for cash or “on account” “ON ACCOUNT” ACCOUNTS RECEIVABLE INCREASE $75,000 What is the impact to Inventory? DECREASE $30,000 When we “Squeeze” Inventory from the Balance sheet to the income statement, where does it go (HAVE WE RECEIVED THE BENEFIT)? COGS $30,000 HOW IS THIS EXPRESSED IN A JOURNAL ENTRY? ACCOUNTDEBIT/ DR.CREDIT/ (CR) Accounts receivable$75,000 Sales$75,000 Cost of goods sold$30,000 Inventory$30,000

Bob Anderson, UCSB ACCOUNTING EQUATION- JOURNAL ENTRIES On Jan. 29th, received $40,000 cash from customers who purchased goods on account. SHOULD THIS IMPACT THE INCOME STATEMENT? NO! WE RECORDED THE SALE WHEN IT WAS EARNED, THIS ONLY REFLECTS A CHANGE FROM AN ACCOUNT RECEIVABLE TO CASH. What is the impact to sales? NONE What is the impact to accounts receivable? DECREASE $40,000 What is the impact to cash? INCREASE $40,000 HOW IS THIS EXPRESSED IN A JOURNAL ENTRY? ACCOUNTDEBIT/ DR.CREDIT/ (CR) Cash$40,000 Accounts receivable $40,000

Bob Anderson, UCSB Additional Terms General Ledger General Ledger – a file that contains the activity of all the accounts. T Account T Account – a format used to illustrate the increases, decreases and resulting total balance for each account.

Bob Anderson, UCSB Account Name Debit / Dr. Credit / Cr. (T Account illustration with excel)

Bob Anderson, UCSB Assets Debit / Dr. Credit / Cr. “NORMAL”- DEBIT

Bob Anderson, UCSB Liabilities Debit / Dr. Credit / Cr. “NORMAL”- CREDIT

Bob Anderson, UCSB Debit / Dr. Credit / Cr. Equity “NORMAL”- CREDIT

Bob Anderson, UCSB Debit / Dr. Credit / Cr. Revenue “NORMAL”- CREDIT

Bob Anderson, UCSB Debit / Dr. Credit / Cr. Expense “NORMAL”- DEBIT

Bob Anderson, UCSB REMEMBER THIS SLIDE FROM BEFORE? On Jan. 3rd, sold common stock for $100,000 cash. What is the impact to common stock? INCREASE $100,000 What is the impact to cash? INCREASE $100,000 HOW IS THIS EXPRESSED IN A JOURNAL ENTRY? ACCOUNTDEBIT/ DR.CREDIT/ (CR) Cash$100,000 Common Stock $100,000 WHAT WOULD THIS LOOK LIKE IN THE T-ACCOUNTS?

Bob Anderson, UCSB ENTRY POSTED TO T-ACCOUNTS $100,000 ACCOUNTDEBIT/ DR.CREDIT/ (CR) Cash$100,000 Common Stock $100,000

Bob Anderson, UCSB The Journal General Journal General Journal – a chronological record of transactions, also known as the book of original entry. What you record in the journal is known as a “Journal Entry.”

Bob Anderson, UCSB Posting Posting Posting – the process of transferring amounts from the journal to the ledger accounts. General Ledger General Journal GJ1

Bob Anderson, UCSB LO 7Explain the purposes of a trial balance. Trial Balance Trial Balance Trial Balance – a list of each account and its balance; used to prove equality of debits and credits.

Bob Anderson, UCSB Event 9 – Hiring of New Employees Oct. 9 – Sierra hired four new employees to begin work on Oct. 15. Accounting transaction has NOT occurred!

Bob Anderson, UCSB Basic Steps in the Recording Process. 1.Analyze 2.Journalize 3.Post 11 4