Gabriela H. Schneider, CMA; Grant MacEwan College INTERMEDIATE ACCOUNTING Sixth Canadian Edition KIESO, WEYGANDT, WARFIELD, IRVINE, SILVESTER, YOUNG, WIECEK Prepared by: Gabriela H. Schneider, CMA; Grant MacEwan College 2

The Accounting Information System C H A P T E R 3 The Accounting Information System

Learning Objectives 1. Understand basic accounting terminology. 2. Explain double-entry rules. 3. Identify steps in the accounting cycle. 4. Records transactions in journals, post to ledger accounts, and prepare a trial balance. 5. Explain the reasons for preparing adjusting entries.

Learning Objectives 6. Prepare closing entries. 7. Explain how inventory accounts are adjusted at year-end. 8. Prepare a 10-column work sheet.

The Accounting Information System Basic terminology Debits and credits Basic equation Financial statements and ownership structure The Accounting Cycle Identification and recording Journalizing Posting Trial Balance Adjusting entries Adjusted trial balance Closing Post-closing trial balance Reversing entries Using a Worksheet Adjustments entered Work sheet columns Preparing financial statements from a work sheet Closing entries Monthly statements, yearly closing

Basic Terminology Event Transaction Account The source/cause of a change in assets, liabilities and equity May be internal or external Transaction Transfer or exchange between two or more entities Account A summary of the transactions for each type of asset, liability and equity item

Basic Terminology Permanent account Temporary account Also known as a real account Asset, liability and equity accounts Appear on the balance sheet Permanent accounts are not closed at year-end Temporary account Also known as a nominal account Revenue and expense accounts Appear on the income statement Temporary accounts are closed at year-end

Basic Terminology Ledger Journal Posting Trial balance Book containing all accounts Each account has a separate page Journal Book of original entry for all transactions Posting Process of transferring transaction information from the journal to the ledger Trial balance Listing of all accounts and their balances from the general ledger Tool used to ensure that the general ledger is in balance

Basic Terminology Adjusting entries Record the effects of accrual accounting Ensure that revenue recognition and the matching principle are followed Five classifications of adjusting entries: Prepaid expenses Unearned revenues Accrued revenues Accrued expenses Amortization

Basic Terminology Financial statements Closing entries Final summaries of the accounting data for a specific period of time Four statements: Balance Sheet Income Statement Statement of Cash Flows Statement of Owners’ Equity Closing entries Process where all temporary accounts are reduced to zero Summary balance (= net income) transferred to owners’ equity account

Debits and Credits Debit (Dr.) Credit (Cr.) To record or enter an amount on the left side Credit (Cr.) To record or enter an amount on the right side This system of recording transactions is referred to as the double-entry system. When a transaction is ‘in balance’ the debits equal the credits.

The Accounting Equation Assets = Liabilities + Shareholders’ Equity Assets = Liabilities + Common Shares + Retained Earnings Retained Earnings = Revenues – Expenses - Dividends Assets = Liabilities + Common Shares + Revenue – Expenses - Dividends

The Rules of Debit and Credit To increase the balance of any account, record the amount in the normal balance column To decrease the balance of any account, record the amount in the column opposite to its normal balance When any transaction is correctly recorded, the accounting equation will remain in balance

The Rules of Debit and Credit Account Debit Credit Assets Increase Decrease Liabilities Shareholders’ Equity Revenue Expenses

Ownership Structure Owners’ Equity Net Income + Investments by Owners Common Shares–Corp. Capital – Proprietor or Partnership Net Loss - Dividends (Corp.) or Withdrawals (Proprietor or Partnership) Owners’ Equity

The Accounting Cycle: Steps Analyse the transaction Journalize the transaction Post the transaction to general ledger (and sub-ledgers) accounts Prepare the (unadjusted) trial balance Prepare necessary adjusting journal entries Prepare the (adjusted) trial balance Prepare financial statements Prepare closing journal entries for the year Prepare post-closing trial balance (optional) Prepare reversing entries (optional)

The Accounting Cycle Identification and Measurement of Transactions 1 Record Transaction in Journal 2 Post Journal Entries to the Ledgers 3 Prepare Financial Statement 7 Reversing Entries 10 Prepare Trial Balance 4 Post-Closing Trial Balance 9 Adjusted Trial Balance 6 Record Adjusting Journal Entries to Worksheet (post to the Ledgers as well) Prepare Adjusting Journal Entries 5 Close Temporary Accounts 8

Recording a Transaction From BE3-1 Assets = Liabilities + Common Shares + Revenue – Expenses - Dividends + $3,000 To record this transaction as a journal entry: Dr. Cash $3,000 Cr. Common Shares $3,000 These amounts are then posted to the general ledger Cash Common Shares 3,000

Recording a Transaction From the example we can see that: The accounting equation is in balance because: the debits = credits within our journal entry we have posted the debits and credits correctly to our general ledger accounts The system of double-entry bookkeeping facilitates this process Errors may still occur Double-entry simply ensures that the debits = the credits Incorrect amounts may still be recorded or posted to the incorrect account

Preparation of Trial Balance Trial Balance: list of accounts and their balances at a given point in time Objective: prove the mathematical equality of debits and credits after posting List the accounts in the order they appear in the ledger (do not include sub-ledger balances) All debit balances listed in the left column, credit balances in the right column Once all accounts listed, and totalled, the two column totals must agree

Preparation of Trial Balance Selected account balances for Pioneer Advertising Agency Inc. at Oct. 31, 2002 Account Debit Credit Cash 18,000 Accounts Receivable 72,000 Advertising Supplies 25,000 Prepaid Insurance 6,000 Office Equipment 50,000 Notes Payable 50,000 Accounts Payable 25,000 Unearned Service Revenue 12,000 Common Shares 100,000 Dividends 5,000 Service Revenue 100,000 Salaries Expense 40,000 Rent Expense 9,000 TOTALS 287,000 287,000 Cash 18,000 Notes Payable 50,000 Dividends 5,000 Revenue 100,000

Adjusting Journal Entries Adjusting entries ensure that: Revenue recognition and the matching principle are followed within the period Reasons for adjusting entries include: To record those events that are not journalized daily To record those costs, which expire with time and are therefore not recorded To record item previously unrecorded Adjusting entries are required each time financial statements are prepared

Adjusting Entries: Recognizing Revenue Unearned Revenue Recording Accrued Revenue Revenues received in cash and recorded as liabilities before being earned Revenues earned but not yet received in cash or recorded

Adjusting Entries: Matching Expenses Prepayments for Expenses Recording Accrued Expense Prepayments made in cash and recorded as assets Before item is used Expense incurred but not yet paid or recorded

Closing Entries Closing entries are made to close all nominal accounts (revenue and expense accounts) for the year Real (or Permanent) accounts are not closed Dividends account is closed to Retained Earnings account

Closing Entries The following closing entries are made: Income Summary Account $$$ Expense Accounts (Individually) $$$ Revenue Accounts (Individually) $$$ Income Summary Account $$$ Income Summary Account $$$ Retained Earnings $$$ Retained Earnings Account $$$ Dividends Account $$$

Scheme of Closing Entries Income Summary Ret. Earnings Dividends Expense Revenue 4 3 1 2

Closing Entries: Inventory In a periodic inventory system, closing entries are made to record cost of goods sold and ending inventory In a perpetual inventory system, such entries are not required See the scheme of entries (next slide)

Closing Entry: Periodic Inventory System Inventory (ending) $ Purchases Returns $ Cost of Goods Sold $ Freight-in $ Purchases $ Inventory (Begin) $ Dr Cr Inventory $ To record ending balance Purchases Returns $ Freight-In $ Purchases $ To remove beginning balance

Periodic Inventory: Closing Entry Intell Company has the following balances on December 31, 2000. The company uses a periodic inventory system. Purchases (gross) $400,000 Purchases Returns $ 27,000 Freight-in, $ 12,000 Opening Inventory $ 62,000 Inventory count on December 31, 2000 was $46,000.

Periodic Inventory: Closing Entry Account Dr Cr Cost of Goods Sold $ 369,000 Inventory (Ending balance) $ 62,000 Purchases Returns $ 27,000 Purchases (Gross) $ 400,000 Freight-in $ 12,000 Inventory (Beginning balance) $ 46,000

The Worksheet – An Example

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