1. Chapter 3 The Accounting Information System
Prepared by:
Patricia Zima, CA Mohawk College of Applied Arts and Technology

2. The Accounting Information System
Appendix 3A- Using Reversing Entries
Accruals
Prepayments
Summary of reversing entries
Accounting Information System
Basic terminology
Debits and credits
Accounting equation
Financial statements and ownership structure
Accounting Cycle
Identifying and recording
Journalizing
Posting
Trial balance
Adjusting entries
Adjusted trial balance
Closing
Post-closing trial balance
Reversing entries
The accounting cycle
Using a Worksheet
Adjustments entered
Work sheet columns
Preparing financial statements from a work sheet
Closing entries
Monthly statements, yearly closing

3. Basic Terminology
Event: The cause of changes of assets, liabilities, and equity
Transaction: A transfer or exchange between two or more entities or parties
Account: Where transactions are recorded
A separate account is used for each asset, liability, revenue, expense, gain, loss and capital

4. Basic Terminology Permanent accounts (or “real” accounts)
Asset, liability, and equity accounts
Appear on the balance sheet
Permanent accounts are not closed at year end
Temporary accounts (or “nominal” accounts)
Revenue, expense, and dividend accounts
Revenue and expenses are on the income statement; dividends are on the equity statement
Temporary accounts are closed at year end

5. Basic Terminology Journalizing and Posting
A Journal is a book of original entry for all transactions
The General Journal is a chronological listing of transactions expressed as debits and credits to particular accounts (known as a journal entry)
Special Journals are used to summarize transactions with common characteristics
(e.g. cash receipts, sales, purchases)
Posting: when the transaction information entered in the journal is transferred to the general ledger

6. Basic Terminology Ledger
Book (electronic database) containing all accounts
Each account has a separate page
General ledger contains all asset, liability, and all equity related accounts (capital, revenue, and expenses)
Subsidiary ledger contains details related to a specific general ledger account (example: accounts receivable subsidiary ledger)

7. Basic Terminology Trial balance
Listing of all accounts and their balances from the general ledger at a given point in time
Objective: prove the mathematical equality of debits and credits after posting (i.e. to ensure general ledger is in balance)
Prepared after end of period adjustments (called Adjusted Trial Balance) and possibly after closing entries (called Post-closing Trial Balance)

8. Basic Terminology Entries made at the end of an accounting period
Adjusting entries
Entries made at the end of an accounting period
Brings all accounts up to date on an accrual accounting basis
Ensures that revenue recognition principle are followed and that proper matching occurs
Four classifications of adjusting entries:
Prepayment Accruals
1. Prepaid expenses 2. Accrued revenues
3. Unearned revenues 4. Accrued expenses

9. Basic Terminology Financial statements
Final summaries of the accounting data for a specific time period
Four statements:
Balance Sheet-shows financial condition at a specific date
Income Statement-measures the results of operations during a period of time
Statement of Cash Flows-shows sources and uses of cash
Statement of Retained Earnings
Optional: Statement of Comprehensive Income
(or as part of Income Statement)

10. Debits and Credits To record or enter an amount on the left side
Debit (Dr.)
To record or enter an
amount on the left side
of a general ledger
account
Credit (Cr.)
To record or enter an
amount on the right side
of a general ledger
account
This system of recording transactions is referred to as the double-entry accounting system; the two-sided effect of each transaction is recorded in appropriate accounts
When a transaction is “in balance”, the debits equal the credits
Debits and credits do not mean “increases” and “decreases”

11. The Accounting Equation
Assets = Liabilities + Shareholders’ Equity
Assets = Liabilities + Capital + Retained Earnings*
*Retained Earnings = Revenues – Expenses – Dividends
Assets = Liabilities + Capital + Revenues – Expenses – Dividends

12. 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

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

14. Shareholders’ (or Owners’) Equity
Ownership Structure
Net Loss -
Dividends (for corporation) or
withdrawals (for proprietor or
partnership)
Net Income +
Owners’ investments (common shares for corporation) or
capital (for proprietor
or partnership)
Shareholders’ (or Owners’) Equity

15. 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)

16. The Accounting Cycle
Identification and measurement of transactions 1
Record transaction in journal 2
Post journal entries to the ledgers 3
Prepare financial statements 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

17. Recording a Transaction: Shares are issued for $3,000 cash
Assets = Liabilities + Shareholders’ Equity
+ $3,000
To record this transaction as a journal entry (in General Journal):
Dr. Cash $3,000
Cr. Common Shares $3,000
These amounts are then posted to the general ledger
Cash
Common Shares
3,000

18. Preparation of Trial Balance
PIONEER ADVERTISING AGENCY INC. at October 31, 2007
Account Debit Credit
Cash 80,000
Accounts Receivable 72,000
Advertising Supplies 25,000
Prepaid Insurance ,000
Office Equipment 50,000
Notes Payable ,000
Accounts Payable ,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 , ,000
Cash
80,000
Revenue
100,000
Dividends
5,000
Notes Payable
50,000

19. Preparation of Trial Balance
From the previous example, we can see that the trial balance is “in balance”
However, the trial balance only proves the mathematical accuracy of the ledger
Errors may still exist such as the following:
Transaction not recorded
Journal entry not posted
Journal entry posted twice
Incorrect accounts used in either the journal or posting
Offsetting errors made during recording

20. Adjusting Journal Entries
Adjusting entries ensure that revenue recognition and matching 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

21. Adjusting Entries Prepayments Accruals 1. Prepayments made in
cash and recorded as
assets before item is used
(Prepaid Expenses)
2. Revenue received in
liabilities before being
earned (Unearned Revenue)
3. Revenues earned but not
yet received in cash and not
recorded (Accrued Revenues)
4. Expenses incurred but
not yet paid in cash and not
recorded (Accrued Expenses)

22. Adjusting Journal Entries
Prepaid expenses expire either with the passage of time (e.g. rent and insurance) or by being used and consumed (e.g. supplies)
Example: Company paid $6,000 for one year insurance when coverage begins October 1
Adjust for Prepaid Insurance on Dec. 31 :
Dr Insurance Expense 1,500
Cr Prepaid Insurance 1,500
($6,000/12 * 3)

23. Adjusting Journal Entries
When payment is received from customers for services (or goods) that will be provided in a future accounting period, a liability (unearned revenue) is recognized
e.g. Rent, magazine subscriptions, deposits
Example: Company received $12,000 for four months’ advertising services that begins Oct $12,000 was credited to unearned revenue
Adjustment required on December 31 :
Dr Unearned Revenue 9,000
Cr Service Revenue 9,000
($12,000/4 * 3)

24. Adjusting Journal Entries
Expenses must be accrued when they are incurred; also revenues must be recorded as earned
Accruals required: interest expense, salaries expense, bad debts expense, interest earned
Example: assume on January 5, a company pays $20,000 for salaries which includes $10,000 of salaries for December
Adjustment required on December 31:
Dr Salaries Expense 10,000
Cr Salaries Payable ,000

25. Closing Entries
Closing entries are made to close all nominal accounts (revenue and expense accounts) for the year
The balances in these accounts are transferred to a clearing account (Income Summary)
The balance in Income Summary represents net income or net loss for the period
Real (or permanent) accounts are not closed
The Dividends account is closed to retained earnings

26. Closing Entries
$$$
Dividends
4. Retained Earnings
Retained Earnings
3. Income Summary
Income Summary
2. Revenue Accounts (Individually)
Expense Accounts (Individually)
1. Income Summary
The following closing entries are made (assume net income for the year):

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

28. 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 following scheme of entries:

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

30. Periodic Inventory: Closing Entry
Collegiate Apparel Shop has the following balances at year end. The company uses a periodic inventory system.
Beginning Inventory $ 30,000
Purchases (gross) $200,000
Transportation-In $ 6,000
Purchases Returns $ 1,000
Purchase Discounts $ 3,000 Ending Inventory $ 26,000

31. Periodic Inventory: Closing Entry
First Step: Determine Cost of Goods Sold
Beginning Inventory $ 30,000
Purchases $200,000
Less: Purchase returns $1,000
Purchase discounts 3, ,000
Net Purchases ,000
Plus: Transportation-In ,000
Cost of Goods Purchased ,000
Cost of Goods Available for Sale ,000
Less: Ending Inventory ,000
Cost of Goods Sold $206,000

32. Periodic Inventory: Closing Entry
Account
Dr.
Cr.
Cost of Goods Sold
Inventory (Ending) Purchases Returns
Purchase Discounts
$ 206,000
$ 26,000
$ 1,000
$ 3,000
$ 200,000
$ 6,000
$ 30,000
Purchases (Gross)
Transportation-in
Inventory (Beginning)

33. COPYRIGHT
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