Chapter 3 Processing Accounting Information

External and Internal Events  Event: a happening of consequence to an entity  External event: interaction between an entity and its environment  Internal event: occurs entirely within an entity  Transaction: any event, external or internal, that is recognized in a set of financial statements LO 1

Role of Source Documents in an Accounting System  Source document: used as evidence to record a transaction  Different Forms:  Purchase Invoice  Sales Invoice  Cash register tape  Time cards LO 2

Analyze the Effects of Transactions on the Accounting Equation  Accounting equation: Assets =Liabilities + Stockholders’ Equity

Issuance of Capital Stock  Glengarry Health Club is started when Karen Bradley and Kathy Drake file articles of incorporation with the state to obtain a charter. Each invests $50,000 in the business. In return, each receives 5,000 shares of capital stock

Acquisition of Property in Exchange for a Note  Company buys a piece of property for $200,000. The seller agrees to accept a five-year promissory note. The property consists of land valued at $50,000 and a newly constructed building valued at $150,000

Acquisition of Equipment on an Open Account  Karen and Kathy contact an equipment supplier and buy $20,000 of exercise equipment: treadmills, barbells, and stationary bicycles. The supplier agrees to accept payment in full in 30 days

Sale of Monthly Memberships on Account  During January, the owners sell 300 monthly club memberships for $50 each, or a total of $15,000. The members have until the 10th of the following month to pay

Sale of Court Time for Cash  In addition to memberships, Glengarry sells court time. Court fees are paid at the time of use and amount to $5,000 for the first month

Payment of Wages and Salaries  Wages and salaries for the first month amount to $10,000

Payment of Utilities  Cost of utilities for the first month is $3,000. Glengarry pays this amount in cash

Collection of Accounts Receivable  Amount received from members in payment of their accounts is $4,000

Payment of Dividends  Karen and Kathy, acting on behalf of Glengarry Health Club, decide to pay a dividend of $1,000 on the shares of stock that each of them owns, or $2,000 in total

Cost Principle  Requires assets such as equipment to be recorded at cost to acquire and continue to report this amount on all balance sheets until the asset is disposed  These assets are not carried at market value, but at original cost (with few exceptions)

Accounts  Account: record used to accumulate monetary amounts for each asset, liability, revenue, expense, and component of stockholders’ equity  Chart of Accounts: numerical list of all of the accounts an entity uses LO 4

The General Ledger  A book, a file, a hard drive, or another device containing all of the accounts

Identify and Analyze  The accounting equation is the basis for financial statements  For every transaction, three questions must be answered: 1. What type of activity did the transaction reflect? 2. What accounts are affected by the transaction, and are they increased or decreased? 3. Which financial statements are affected by the transaction?

Identify and Analyze  Wages and salaries for the first month amount to $10,000 for Glengarry

T account  T Account: format for showing amounts coming into and leaving an account

Example 3.2—Using a T Account

Debits and Credits  Tools to record increases and decreases in accounts  Debits increase asset accounts, and credits increase liability and stockholders’ equity accounts  Additionally, debits increase expense accounts, and credits increase revenue accounts LO 5

Summary of the Rules for Increasing and Decreasing Accounts

Example 3.3—Determining Normal Account Balances

Debits and Credits Applied to Transactions Cash 100,000(1) Capital Stock 100,000(1)

Debits and Credits Applied to Transactions (2) Acquisition of property in exchange for a note 150,000(2)200,000(2) BuildingNotes Payable 50,000(2) Land

Debits and Credits Applied to Transactions (3) Acquisition of equipment on an open account 20,000(3)20,000(3) EquipmentAccounts Payable

Debits and Credits Applied to Transactions (4) Sale of monthly memberships on account 15,000(4)15,000(4) Accounts ReceivableMembership Revenue

Debits and Credits Applied to Transactions T Accounts reflect current and previous postings to the account for each period (5) Sale of court time for cash 100,000 5,000 (1) (5) 5,000(5) CashCourt Fee Revenue

Debits and Credits Applied to Transactions (6) Payment of wages and salaries 100,000 5,000 (1) (5) CashWage & Salary Expense 10,000(6)10,000(6)

Debits and Credits Applied to Transactions (7) Payment of utilities 100,000 5,000 (1) (5) Cash Utilities Expense 3,000(7)10,000(6) 3,000(7)

Debits and Credits Applied to Transactions (8) Collection of accounts receivable Cash 100,000 5,000 10,000 3,000 4,000 (6) (7) (1) (5) (8) Accounts Receivable 15,0004,000(8)(4)

Debits and Credits Applied to Transactions Cash 100,000 5,000 10,000 3,000 4,000 2,000 (9) Payment of dividends (6) (7) (9) (1) (5) (8) Dividends 2,000(9)

Journal  Chronological record of a company’s transactions  Book of original entry  Transactions are periodically posted from the journal to ledger accounts  Journalizing: act of recording journal entries LO 6

Posting  Process of transferring amounts from a journal to the ledger accounts

Example 3.6—Posting from the Journal to the Ledger

Trial Balance  List of each account and its balance at a specific point in time  Used to prove the equality of debits and credits  Normally prepared at the end of the accounting period  Basis for preparation of financial statements LO 7

Example 3.7—Preparing a Trial Balance

End of Chapter 3