The Accounting Information System

Study Objectives 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.

Study Objectives 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.

Accounting Information System The system of collecting and processing transaction data and communicating financial information to interested parties. 5 5

Chapter Overview

Recall: must always balance! #1 Analyze the Effect of Business Transactions on the Basic Accounting Equation. Assets = Liabilities + Stockholders’ Equity Recall: must always balance!

Accounting Transactions Accounting Transactions: economic events that must be recorded in the financial statements. Event must affect assets, liabilities or stockholders’ equity

Accounting Transactions? Purchase computer Is the financial position (assets, liabilities or stockholders’ equity changed? YES!

Accounting Transactions? Discuss product design with customer Is the financial position (assets, liabilities or stockholders’ equity changed? NO!

Accounting Transactions? Pay rent Is the financial position (assets, liabilities or stockholders’ equity changed? YES!

Transaction Analysis Transaction Analysis: the process of identifying the specific effects of economic events on the accounting equation. Each transaction has a dual (double-sided) effect

Transaction Analysis If an individual asset is increased, there must be a corresponding: Decrease in another asset, or Increase in a specific liability, or Increase in stockholders’ equity

Transaction Analysis Two or more items can be affected Example: purchase computer for $10,000 by paying $6,000 in cash and signing a note for $4,000

Let’s practice transaction analysis with Sierra Corporation. . .

Event 1 – Investment of Cash by Stockholders Oct. 1 - Owner invested $10,000 Cash in business in exchange for $10,000 of Sierra Corporation Common Stock

Event 2 – Note Issued in Exchange for Cash Oct. 1 – Sierra issued a 3-month, 12%, $5,000 Note Payable to Castle Bank.

Event 3 – Purchase of Office Equipment for Cash Oct. 2 – Sierra acquired office equipment by paying $5,000 cash to Superior Sales Co.

Event 4 – Receipt of Cash in Advance from Customer Oct. 2 – Sierra received a $1,200 cash advance from R. Knox, a client.

Event 5 – Services Rendered for Cash Oct. 3 – Sierra received $10,000 in cash from Copa Co. for advertising services performed

Event 5 – Services Rendered, WHAT IF these were performed “on account”? Later, when $10,000 is collected from customer…

Event 6 – Payment of Rent Oct. 3 – Sierra paid its office rent for the month of October in cash, $900.

Event 7 – Purchase of Insurance Policy with Cash Oct. 4 – Sierra paid $600 for a one-year insurance policy that will expire next year on Sept. 30.

Event 8 – Purchase of Supplies on Credit Oct. 5 – Sierra purchases a three-month supply of advertising materials on account from Aero Supply for $2,500.

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

Event 10 – Payment of Dividend Oct. 20 – Sierra paid a $500 dividend.

Event 11 – Payment of Cash for Employee Salaries Oct. 26 – Paid employees working two weeks, who have earned $4,000 in salaries.

Summary of Transactions Assets = Liabilities + Equity

#2 Explain what an account is and how it helps in the recording process. Account: individual accounting record of increases and decreases in a specific Asset, Liability, or Stockholders’ Equity item.

Account Consists of three parts: Title of the account Left side, the debit side, Dr. Right side, the credit side, Cr. We call this the T - account

The T Account

#3 Define debits and credits and explain how they are used to record business transactions. Recall Debit means left thus, entry on left side is debiting Recall Credit means right thus, entry on right side is crediting

Examples

Total the Balances on T-Account Title of Account Debit Credit Total Debits > Credits, then you have a Debit Balance! 52 52

Total the Balances on T-Account Title of Account Debit Credit Total Credits > Debits, then you have a Credit Balance! 52 52

Normal Balances for Assets and Liabilities

Normal Balances for Stockholders’ Equity

Normal Balances for Expenses and Revenues

Debits Increase assets and expenses Decrease liabilities, common stock, revenues 52 52

Credits Decrease assets and expenses Increase liabilities, common stock, revenues 53 53

Expansion of Basic Equation

What is the normal balance for the following accounts? Let’s Review What is the normal balance for the following accounts? Cash? Debit Accounts Payable? Credit Accounts Receivable? Debit Service Revenue? Credit Common Stock? Credit Salaries Expense? Debit

What is the normal balance for the following accounts? Let’s Review What is the normal balance for the following accounts? Dividends? Debit Building? Debit Taxes Payable? Credit Service Revenue? Credit Prepaid Insurance? Debit Rent Expense? Debit More

Let’s Review Using Sierra’s Transactions Cash Common Stock 10,000 10,000 Oct. 1 - Owner invested $10,000 Cash in business in exchange for $10,000 of Sierra Corporation Common Stock 52 52

Let’s Review Using Sierra’s Transactions Cash Note Payable 5,000 5,000 Oct. 1 – Sierra issued a 3-month, 12%, $5,000 Note Payable to Castle Bank. 52 52

Let’s Review Using Sierra’s Transactions Office Equipment Cash 5,000 10,000 5,000 5,000 Oct. 2 – Sierra acquired office equipment by paying $5,000 cash to Superior Sales Co. 52 52

#4 Identify the Basic Steps in the Recording Process. Analyze Journalize Post

Recording Process Step 1 Analyze each transaction and effect on accounts

Recording Process Step 2 Enter transaction information in a journal, a process called journalizing

Recording Process Step 3 Transfer (post) the journal information to the appropriate accounts in the ledger

#5 Explain what a journal is and how it helps in the recording process. An accounting record where the transactions are initially recorded in chronological order. For each transaction journal shows the debit and credit

Journals Help Recording Process Discloses in one place the complete effect of a transaction Provides a chronological record of transactions Helps prevent or locate errors because debit and credit amounts can be readily compared 58 58

Computerized Systems Journals are kept as data files Accounts are recorded in computer database 58 58

Journalizing Example Complete entry consists of: Date of transaction Accounts titles and dollar amounts to be debited and credited Brief explanation Let’s use the first three Sierra transactions . . . Example

Account Titles and Explanations GENERAL JOURNAL Account Titles and Explanations 2005 Oct. 1 Cash 10,000 Common Stock 10,000 (Invested cash in business) Date Debit Credit 1 Cash 5,000 Notes Payable 5,000 (Issued 3-month, 12% note payable for cash) 2 Office Equipment 5,000 Cash 5,000 (Purchased office equipment for cash) 59

#6 Explain what a ledger is and how it helps in the recording process. Ledger is the entire group of accounts maintained by a company Ledger contains all the asset, liability, & stockholders’ equity accounts Keeps all the information about current account balances and changes in specific account balances

Most businesses computerize these files! General Ledger Most businesses computerize these files!

Chart of Accounts List of company accounts Number and type used depends upon size and complexity of business Small business might use 20 to 30 accounts Large business could use thousands worldwide Computerized systems assign number sequence to each unique account and group

Note: In the Sierra examples we used the red accounts Chart of Accounts Note: In the Sierra examples we used the red accounts

#7 Explain what posting is and how it helps in the recording process. Procedure of transferring journal entries to ledger is called posting

Recall: Basic Steps in the Recording Process. Analyze the transaction, identify the type of accounts involved? Journalize, debit or credit what? Post Let’s use some of Sierra’s data to demonstrate the recording process . . .

Posting in Data File or Paper Files GENERAL JOURNAL Account Titles and Explanations 2005 Oct. 1 Cash 10,000 Common Stock 10,000 Acct 1010 Account CASH Date Balance ref debit credit debit credit Oct 1 GJ 1 10,000 10,000 Account COMMON STOCK Acct 3010 Date Balance ref debit credit debit credit Oct 1 GJ 1 10,000 10,000 66

#8 Explain the purposes of a trial balance. Lists all the accounts and their balances at a given time. Proves mathematical equality of debits and credits after posting. Useful in the preparation of financial statements. Does not tell you ledger is correct!

Sierra Corporation Trial Balance October 31, 2005 Debit Credit Cash $15,200 Advertising Supplies 2,500 Prepaid Insurance 600 Office Equipment 5,000 Notes Payable $ 5,000 Accounts Payable 2,500 Unearned Service Revenue 1,200 Common Stock 10,000 Dividends 500 Service Revenue 10,000 Salaries Expense 4,000 Rent Expense 900 $28,700 $28,700 68