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3-2 THE ACCOUNTING INFORMATION SYSTEM Accounting, Fifth Edition 3

3-3 After studying this chapter, you should be able to: 1. 1.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 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 Classify cash activities as operating, investing, or financing. Learning Objectives

3-4 Preview of Chapter 3 Accounting Fifth Edition Kimmel Weygandt Kieso

3-5 Accounting Information System System of ► collecting and ► processing transaction data and ► communicating financial information to decision makers. Most businesses use computerized accounting (EDP) systems. The Accounting Information System LO 1 Analyze the effect of business transactions on the basic accounting equation.

3-6 Transactions are economic events that require recording in the financial statements.  Not all activities represent transactions.  Assets, liabilities, or stockholders’ equity items change as a result of some economic event.  Dual effect on the accounting equation. Accounting Transactions LO 1 Analyze the effect of business transactions on the basic accounting equation.

3-7 Question: Are the following events recorded in the accounting records? Event Purchase computer. Criterion Is the financial position (assets, liabilities, or stockholders’ equity) of the company changed? Pay rent. Record/ Don’t Record Accounting Transactions Discuss guided trip options with potential customer. Illustration 3-1 LO 1 Analyze the effect of business transactions on the basic accounting equation.

3-8 AssetsAssetsLiabilitiesLiabilities Stockholders’ Equity = + Analyzing Transactions LO 1 Analyze the effect of business transactions on the basic accounting equation. Basic Accounting Equation Accounting Transactions The process of identifying the specific effects of economic events on the accounting equation.

3-9 LO 1 Analyze the effect of business transactions on the basic accounting equation. Accounting Transactions Illustration 3-2 Expanded accounting equation Analyzing Transactions

3-10 Event (1). On October 1, cash of $10,000 is invested in Sierra Corporation by investors in exchange for $10,000 of common stock. Accounting Transactions 1.+10,000+10,000 LO 1 Analyze the effect of business transactions on the basic accounting equation.

3-11 Event (2). On October 1, Sierra borrowed $5,000 from Castle Bank by signing a 3-month, 12%, $5,000 note payable. Accounting Transactions 1.+10,000+10, ,000+5,000 LO 1 Analyze the effect of business transactions on the basic accounting equation.

3-12 Event (3). On October 2, Sierra purchased equipment by paying $5,000 cash to Superior Equipment Sales Co. Accounting Transactions 3.-5,000+5, ,000+10, ,000+5,000 LO 1 Analyze the effect of business transactions on the basic accounting equation.

3-13 Event (4). On October 2, Sierra received a $1,200 cash advance from R. Knox, a client. Accounting Transactions 4.+1,200+1, ,000+5, ,000+10, ,000+5,000 LO 1 Analyze the effect of business transactions on the basic accounting equation.

3-14 Event (5). On October 3, Sierra received $10,000 in cash from Copa Company for guide services performed. Accounting Transactions 4.+1,200+1, ,000+10, ,000+5, ,000+10, ,000+5,000 LO 1 Analyze the effect of business transactions on the basic accounting equation.

3-15 Event (6). On October 3, Sierra Corporation paid its office rent for the month of October in cash, $900. Accounting Transactions 4.+1,200+1, ,000+10, ,000+5, ,000+10, ,000+5,000 LO 1 Analyze the effect of business transactions on the basic accounting equation.

3-16 Event (7). On October 4, Sierra paid $600 for a one-year insurance policy that will expire next year on September 30. Accounting Transactions 4.+1,200+1, ,000+10, ,000+5, ,000+10, ,000+5,000 LO 1 Analyze the effect of business transactions on the basic accounting equation.

3-17 Event (8). On October 5, Sierra purchased an estimated three months of supplies on account from Aero Supply for $2,500. Accounting Transactions 4.+1,200+1, ,000+10, ,500+2, ,000+5, ,000+10, ,000+5,000 LO 1 Analyze the effect of business transactions on the basic accounting equation.

3-18 Event (9). On October 9, Sierra hired four new employees to begin work on October 15. Accounting Transactions 4.+1,200+1, ,000+10, ,500+2, ,000+5, ,000+10, ,000+5,000 LO 1 Analyze the effect of business transactions on the basic accounting equation. An accounting transaction has not occurred.

3-19 Event (10). On October 20, Sierra paid a $500 dividend. Accounting Transactions 4.+1,200+1, ,000+10, ,500+2, ,000+5, ,000+10, ,000+5,000 LO 1 Analyze the effect of business transactions on the basic accounting equation.

3-20 Event (11). Employees have worked two weeks, earning $4,000 in salaries, which were paid on October 26. Accounting Transactions 4.+1,200+1, ,000+10, ,500+2, ,000-4, ,000+5, ,000+10, ,000+5,000

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3-22  Record of increases and decreases in a specific asset, liability, equity, revenue, or expense item.  Debit = “Left”  Credit = “Right” Account An Account can be illustrated in a T-Account form. LO 2 Explain what an account is and how it helps in the recording process. The Account

3-23 Double-entry Double-entry system  Each transaction must affect two or more accounts to keep the basic accounting equation in balance.  Recording done by debiting at least one account and crediting another. must equal  DEBITS must equal CREDITS. LO 3 Define debits and credits and explain they are used to record business transactions. Debit and Credit Procedures The Account

3-24 greater than If Debits are greater than Credits, the account will have a debit balance. $10,000Transaction #2$3,000 $15,000 8,000Transaction #3 Balance Transaction #1 Debit and Credit Procedures LO 3 Define debits and credits and explain they are used to record business transactions.

3-25 $10,000Transaction #2$3,000 Balance Transaction #1 $1,000 8,000Transaction #3 Debit and Credit Procedures If Credits are greater than Debits, the account will have a credit balance. LO 3 Define debits and credits and explain they are used to record business transactions.

3-26  Assets - Debits should exceed credits.  Liabilities – Credits should exceed debits. Procedures for Assets and Liabilities LO 3 Define debits and credits and explain they are used to record business transactions.

3-27  Investments by stockholders and revenues increase stockholders’ equity (credit).  Dividends and expenses decrease stockholder’s equity (debit). Procedures for Stockholders’ Equity LO 3 Define debits and credits and explain they are used to record business transactions.

3-28  The purpose of earning revenues is to benefit the stockholders.  The effect of debits and credits on revenue accounts is the same as their effect on stockholders’ equity.  Expenses have the opposite effect: expenses decrease stockholders’ equity. Procedures for Revenue and Expense LO 3 Define debits and credits and explain they are used to record business transactions.

3-29 Stockholders’ Equity Relationships Illustration 3-15 LO 3 Define debits and credits and explain they are used to record business transactions.

3-30 Normal Balance Credit Normal Balance Debit Summary of Debit/Credit Rules LO 3 Define debits and credits and explain they are used to record business transactions.

3-31 Balance Sheet Income Statement = + = - AssetLiabilityEquityRevenueExpense Debit Credit Summary of Debit/Credit Rules LO 3 Define debits and credits and explain they are used to record business transactions.

3-32 Summary of Debit/Credit Rules Relationship among the assets, liabilities and stockholders’ equity of a business: The equation must be in balance after every transaction. For every Debit there must be a Credit. Illustration 3-16 AssetsLiabilities = Stockholders’ Equity Basic Equation Expanded Basic Equation + LO 3 Define debits and credits and explain they are used to record business transactions.

3-33 Debits: a. increase both assets and liabilities. b. decrease both assets and liabilities. c. increase assets and decrease liabilities. d. decrease assets and increase liabilities. Review Question Summary of Debit/Credit Rules LO 3 Define debits and credits and explain they are used to record business transactions.

3-34 Accounts that normally have debit balances are: a. assets, expenses, and revenues. b. assets, expenses, and equity. c. assets, liabilities, and dividends. d. assets, dividends, and expenses. Review Question Summary of Debit/Credit Rules LO 3 Define debits and credits and explain they are used to record business transactions.

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3-36 Source documents, such as a sales slip, a check, a bill, or a cash register tape, provide evidence of the transaction. Steps in the Recording Process LO 4 Identify the basic steps in the recording process. Illustration 3-17 Analyze each transaction Enter transaction in a journal Transfer journal information to ledger accounts

3-37  Book of original entry.  Transactions recorded in chronological order.  Contributions to the recording process: 1.Discloses the complete effects of a transaction. 2.Provides a chronological record of transactions. 3.Helps to prevent or locate errors because the debit and credit amounts can be easily compared. LO 5 Explain what a journal is and how it helps in the recording process. Steps in the Recording Process The Journal

3-38 Journalizing - Entering transaction data in the journal. Illustration: Presented below is information related to Sierra Corporation. Sierra issued common stock in exchange for $10,000 cash. Oct. 1 Sierra borrowed $5,000 by signing a note.1 Sierra purchased equipment for $5,000.2 Instructions - Journalize these transactions. The Journal LO 5 Explain what a journal is and how it helps in the recording process.

3-39 JournalizingJournalizing General Journal LO 5 Explain what a journal is and how it helps in the recording process. Cash Common stock 10,000 Sierra issued common stock in exchange for $10,000 cash. Oct. 1

3-40 JournalizingJournalizing General Journal LO 5 Explain what a journal is and how it helps in the recording process. Sierra borrowed $5,000 by signing a note.Oct. 1 Cash Notes payable 5,000

3-41 JournalizingJournalizing General Journal LO 5 Explain what a journal is and how it helps in the recording process. Sierra purchased equipment for $5,000.Oct. 2 Equipment Cash 5,000

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3-43 The Ledger is comprised of the entire group of accounts maintained by a company. LO 6 Explain what a ledger is and how it helps in the recording process. Illustration 3-19 Steps in the Recording Process

3-44 Steps in the Recording Process LO 6 Explain what a ledger is and how it helps in the recording process. Chart of Accounts – listing of accounts used by a company to record transactions. Illustration 3-20

3-45 General Ledger General Journal Oct. 1Stock issuedJ110, J1 Steps in the Recording Process LO 7 Posting – the process of transferring journal entry amounts to ledger accounts.

3-46 Posting: a. normally occurs before journalizing. b. transfers ledger transaction data to the journal. c. is an optional step in the recording process. d. transfers journal entries to ledger accounts. Review Question LO 7 Explain what posting is and how it helps in the recording process. Steps in the Recording Process

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3-48 The Recording Process Illustrated Follow these steps: 1. Determine what type of account is involved. 2. Determine what items increased or decreased and by how much. 3. Translate the increases and decreases into debits and credits. LO 7 Explain what posting is and how it helps in the recording process. Illustration 3-21

3-49 The Recording Process Illustrated LO 7 Explain what posting is and how it helps in the recording process. Follow these steps: 1. Determine what type of account is involved. 2. Determine what items increased or decreased and by how much. 3. Translate the increases and decreases into debits and credits. Illustration 3-22

3-50 The Recording Process Illustrated LO 7 Explain what posting is and how it helps in the recording process. Follow these steps: 1. Determine what type of account is involved. 2. Determine what items increased or decreased and by how much. 3. Translate the increases and decreases into debits and credits. Illustration 3-23

3-51 LO 7 Explain what posting is and how it helps in the recording process. Additional Transactions The Recording Process Illustrated Illustration 3-24

3-52 LO 7 Explain what posting is and how it helps in the recording process. Additional Transactions The Recording Process Illustrated Illustration 3-25

3-53 LO 7 Explain what posting is and how it helps in the recording process. Additional Transactions The Recording Process Illustrated Illustration 3-26

3-54 Additional Transactions The Recording Process Illustrated Illustration 3-27

3-55 LO 7 Explain what posting is and how it helps in the recording process. Additional Transactions The Recording Process Illustrated Illustration 3-28

3-56 LO 7 Explain what posting is and how it helps in the recording process. The Recording Process Illustrated Additional Transactions Illustration 3-29

3-57 LO 7 Explain what posting is and how it helps in the recording process. Additional Transactions The Recording Process Illustrated Illustration 3-30

3-58 LO 7 Additional Transactions The Recording Process Illustrated Illustration 3-31

3-59 Summary Illustration of Journalizing Illustration 3-32 LO 7

3-60 Summary Illustration of Journalizing Illustration 3-32 LO 7

3-61 Summary Illustration of Posting Illustration 3-33 LO 7 Explain what posting is and how it helps in the recording process.

3-62 Selected transactions from the journal of Faital Inc. during its first month of operations are presented below. Post these transactions to T-accounts. LO 7 Explain what posting is and how it helps in the recording process.

3-63 Trial Balance  A list of accounts and their balances at a given time.  Accounts are listed in the order in which they appear in the ledger. The Trial Balance LO 8 Explain the purposes of a trial balance.  Purpose is to prove that debits equal credits.  May also uncover errors in journalizing and posting.  Useful in the preparation of financial statements.

3-64 The Trial Balance Illustration 3-34 Equal LO 8

3-65 The trial balance may balance even when 1.a transaction is not journalized, 2.a correct journal entry is not posted, 3.a journal entry is posted twice, 4.incorrect accounts are used in journalizing or posting, or 5.offsetting errors are made in recording the amount of a transaction. The Trial Balance LO 8 Explain the purposes of a trial balance. Limitations of a Trial Balance Ethics Note An error is the result of an unintentional mistake. It is neither ethical nor unethical. An irregularity is an intentional misstatement, which is viewed as unethical.

3-66 A trial balance will not balance if: a. a correct journal entry is posted twice. b. the purchase of supplies on account is debited to Supplies and credited to Cash. c. a $100 cash dividends is debited to the Dividends account for $1,000 and credited to Cash for $100. d. a $450 payment on account is debited to Accounts Payable for $45 and credited to Cash for $45. Review Question The Trial Balance LO 8 Explain the purposes of a trial balance.

3-67 The Cash account and the related cash transactions indicate why cash changed during October. To make this information useful for analysis it is summarized in a statement of cash flows. The statement of cash flows classifies each transaction as an operating activity, an investing activity, or a financing activity. Sierra Corporation’s:  Operating activities involve providing guide services.  Investing activities include the purchase or sale of long-lived assets used in operating the business, or the purchase or sale of investment securities.  Financing activities are borrowing money, issuing shares of stock, and paying dividends. LO 9 Classify cash activities as operating, investing, or financing.

3-68  Transaction analysis is the same under IFRS and GAAP however different standards sometimes impact how transactions are recorded.  European companies rely less on historical cost and more on fair value than U.S. companies. The double-entry system is the basis of accounting systems worldwide.  Both the IASB and FASB go beyond the basic definitions provided in this textbook for the key elements of financial statements, that is, assets, liabilities, equity, revenues, and expenses. Key Points LO 10 Compare the procedures for the recording process under GAAP and IFRS.

3-69  A trial balance under IFRS follows the same format as shown in the textbook.  As shown in the textbook, dollars signs are typically used only in the trial balance and the financial statements. The same practice is followed under IFRS, using the currency of the country in which the reporting company is headquartered. Key Points LO 10 Compare the procedures for the recording process under GAAP and IFRS.

3-70  In deciding whether the United States should adopt IFRS, some of the issues the SEC said should be considered are: ► Whether IFRS is sufficiently developed and consistent in application. ► Whether the IASB is sufficiently independent. ► Whether IFRS is established for the benefit of investors. Key Points LO 10 Compare the procedures for the recording process under GAAP and IFRS.

3-71  Some of the issues the SEC said should be considered are: ► The issues involved in educating investors about IFRS. ► The impact of a switch to IFRS on U.S. laws and regulations. ► The impact on companies including changes to their accounting systems, contractual arrangements, corporate governance, and litigation. ► The issues involved in educating accountants, so they can prepare statements under IFRS. Key Points LO 10 Compare the procedures for the recording process under GAAP and IFRS.

3-72 The basic recording process shown in this textbook is followed by companies across the globe. It is unlikely to change in the future. The definitional structure of assets, liabilities, equity, revenues, and expenses may change over time as the IASB and FASB evaluate their overall conceptual framework for establishing accounting standards. Looking to the Future LO 10 Compare the procedures for the recording process under GAAP and IFRS.

3-73 Which statement is correct regarding IFRS? a)IFRS reverses the rules of debits and credits, that is, debits are on the right and credits are on the left. b)IFRS uses the same process for recording transactions as GAAP. c)The chart of accounts under IFRS is different because revenues follow assets. d)None of the above statements are correct. IFRS Practice LO 10 Compare the procedures for the recording process under GAAP and IFRS.

3-74 A trial balance: a)is the same under IFRS and GAAP. b)proves that transactions are recorded correctly. c)proves that all transactions have been recorded. d)will not balance if a correct journal entry is posted twice. IFRS Practice LO 10 Compare the procedures for the recording process under GAAP and IFRS.

3-75 One difference between IFRS and GAAP is that: a)GAAP uses accrual-accounting concepts and IFRS uses primarily the cash basis of accounting. b)IFRS uses a different posting process than GAAP. c)IFRS uses more fair value measurements than GAAP. d)the limitations of a trial balance are different between IFRS and GAAP. IFRS Practice LO 10 Compare the procedures for the recording process under GAAP and IFRS.

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