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Financial Accounting: Tools for Business Decision Making, 4th Ed. Kimmel, Weygandt, Kieso CHAPTER 3 Chapter 3 The Accounting Information System Analyze the effect of business transactions on the basic accounting equation. Explain what an account is and how it helps in the recording process.

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Financial Accounting:Tools for Business Decision Making, 4th Ed.

Kimmel, Weygandt, Kieso

CHAPTER 3


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Chapter 3The Accounting Information System

  • 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.


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Chapter 3The Accounting Information System

  • 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.


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External and Internal Events

External Event – interaction between a business and its environment.

Internal Event – event occurring entirely within a business.

Transaction– any event that is recognized in a set of financial statements.

RECOGNIZED- An accounting entry is recorded… it becomes reflected in the financial statements.

REALIZED- regardless of whether it results in an accounting entry, the business actually receives or gives something.


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Exercise – Types of Events

Internal

Not Recorded

External

  • A supplier of a company‘s raw material is paid an amount owed on account.

External

External

2. A customer pays its open account.

Not Recorded

3. A new chief executive officer is hired.

External

4. The biweekly payroll is paid.

Internal

5. Raw materials are entered into production.

Not Recorded

6. A new advertising agency is hired.

7. The accountant determines the federal income taxes owed based on the income earned.

Internal


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Source Documents

  • Source Document – a piece of paper that is used as evidence to record a transaction.

    Sales invoice

    • Payroll timecard

    • Utility bill

    • Stock certificate

    • Promissory note (note payable)

Payment terms are 2/10, n/30

NOTE: Not all recordable events are supported by a standard source document.


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Exercise – Source Documents

  • Utilities expense for the month is recorded.

Purchase invoice

Sales invoice

2. A cash settlement is received from a pending lawsuit.

Cash register tape

3. Owners contribute cash to start a new corporation.

Time cards

4. The biweekly payroll is paid.

Promissory note

5. Cash sales for the day are recorded.

Stock certificates

6. Equipment is acquired on a 30-day open account.

Monthly utility statement

7. A sale is made on open account.

8. A building is acquired by signing an agreement to repay a stated amount plus interest in six months.

Other/ or- No source document normally available


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Effect on the Accounting Equation

Assets = Liabilities + Equity

Assets - Liabilities = Equity

Assets - Liabilities = Net Assets

Net Assets = Equity

The accounting equation is made up of “Accounts.”

An account is a record used to accumulate amounts for each individual asset, liability, equity, revenue, and expense.


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Sara Lee Corp. – Assets Accounts

LO 2

Describe the qualitative characteristics of accounting information.


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Chart of Accounts

LO 3

Analyze the effects of transactions on the accounting equation.


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FINALLY- DEBITS AND CREDITS

Rule number one: forget the concept of “credit” to your account that you are probably familiar with. If your bank charges you a late fee, you complain and they reverse it, you THINK that is a credit to your account. BUT, as you will see, on YOUR books, the adjustment is a DEBIT to your cash.

CRUTCH:

ASSETS & LIABILITIES: DEBIT GOOD, CREDIT BAD

EQUITY & INCOME: OPPOSITE (DEBIT BAD, CREDIT GOOD)

MORE: ASSETS AND EXPENSES ARE DEBITS

LIABILITIES, EQUITY AND REVENUES ARE CREDITS

OH YEAH, ONE OTHER THING: DEBITS ON THE LEFT, CREDITS ON THE RIGHT!

REMEMBER FROM PRIOR CHAPTERS: “FOR EVERY ACTION THERE IS AN EQUAL AND OPPOSITE REACTION”… IN ACCOUNTING TERMS, FOR EVERY DEBIT, THERE IS A CREDIT.


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Graphic debits and credits (GENERALLY)

Balance Sheet

Income Statement

2004

2004

Assets:

Revenues & Gains:

DEBITS

CREDITS

Liabilities:

CREDITS

Expenses & Losses:

Equity:

DEBITS

CREDITS


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ANOTHER CRUTCH

“Debit” Card- comes from your checking account, which is an ASSET.

“Credit” Card- creates a LIABILITY.

DEBIT- ASSET

CREDIT- LIABILITY


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Review

What is the normal balance for the following accounts?

Cash

Debit

Credit

Accounts Payable

Accounts Receivable

Debit

Service Revenue

Credit

Common Stock

Credit

Salaries Expense

Debit


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Review

What is the normal balance for the following accounts?

Dividends

Debit

Debit

Building

Taxes Payable

Credit

Unearned Revenus

Credit

Prepaid Insurance

Debit

Rent Expense

Debit


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Debits and Credits

Balance Sheet Income Stmt.

-

=

+

=

Asset

Liab.

Equity

Rev.

Exp.

Debit

Credit


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DEBITS AND CREDITS- POSTING

We need to write a transaction in a format that can be communicated / input. We use a journal entry:

DEBITS ON THE LEFT

CREDITS ON THE RIGHT


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ACCOUNTING EQUATION- JOURNAL ENTRIES

On Jan. 3rd, sold common stock for $100,000 cash.

What is the impact to common stock?

INCREASE $100,000

What is the impact to cash?

INCREASE $100,000

HOW IS THIS EXPRESSED IN A JOURNAL ENTRY?

ACCOUNTDEBIT/ DR.CREDIT/ (CR)

Cash $100,000

Common Stock $100,000


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ACCOUNTING EQUATION- JOURNAL ENTRIES

On Jan. 10th, purchased a building by signing a $150,000 note payable..

What is the impact to Building (Fixed assets)?

INCREASE $150,000

What is the impact to Notes Payable?

INCREASE $150,000

HOW IS THIS EXPRESSED IN A JOURNAL ENTRY?

ACCOUNTDEBIT/ DR.CREDIT/ (CR)

Building $150,000

Note payable $150,000


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HOW TO LEARN DEBITS AND CREDITS

There is no way to teach it and no way to learn it other than by:

PRACTICE!!!!!

PRACTICE!!!!!

PRACTICE!!!!!

PRACTICE!!!!!


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ACCOUNTING EQUATION- JOURNAL ENTRIES

On Jan. 15th, purchased inventory on account for $60,000.

What is the impact to Inventory?

INCREASE $60,000

What is the impact to cash?

NONE- PURCHASED ON ACCOUNT

What is the impact to accounts payable?

INCREASE $60,000

HOW IS THIS EXPRESSED IN A JOURNAL ENTRY?

ACCOUNTDEBIT/ DR.CREDIT/ (CR)

Inventory $60,000

Accounts payable $60,000


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BY THE WAY

WHAT IS THE DIFFERENCE BETWEEN THESE ENTRIES:

ACCOUNTDEBIT/ DR.CREDIT/ (CR)

Inventory $60,000

Accounts payable $60,000

AND

ACCOUNTDEBIT/ DR.CREDIT/ (CR)

Accounts payable $60,000

Inventory $60,000

ANSWER:

NOTHING- IT IS ONLY A CONVENTION TO LIST THE DEBITS FIRST!


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ACCOUNTING EQUATION- JOURNAL ENTRIES

On Jan. 20th, sold inventory costing $30,000, for $75,000 on account.

Did we “earn” the revenue?

Yes- SALES INCREASE $75,000

Sold for cash or “on account”

“ON ACCOUNT” ACCOUNTS RECEIVABLE INCREASE $75,000

What is the impact to Inventory?

DECREASE $30,000

When we “Squeeze” Inventory from the Balance sheet to the income statement, where does it go (HAVE WE RECEIVED THE BENEFIT)?

COGS $30,000

HOW IS THIS EXPRESSED IN A JOURNAL ENTRY?

ACCOUNTDEBIT/ DR.CREDIT/ (CR)

Accounts receivable $75,000

Sales $75,000

Cost of goods sold $30,000

Inventory $30,000


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ACCOUNTING EQUATION- JOURNAL ENTRIES

On Jan. 29th, received $40,000 cash from customers who purchased goods on account.

SHOULD THIS IMPACT THE INCOME STATEMENT?

NO! WE RECORDED THE SALE WHEN IT WAS EARNED, THIS ONLY REFLECTS A CHANGE FROM AN ACCOUNT RECEIVABLE TO CASH.

What is the impact to sales?

NONE

What is the impact to accounts receivable?

DECREASE $40,000

What is the impact to cash?

INCREASE $40,000

HOW IS THIS EXPRESSED IN A JOURNAL ENTRY?

ACCOUNTDEBIT/ DR.CREDIT/ (CR)

Cash $40,000

Accounts receivable $40,000


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Additional Terms

General Ledger – a file that contains the activity of all the accounts.

T Account – a format used to illustrate the increases, decreases and resulting total balance for each account.


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Account Name

Credit / Cr.

Debit / Dr.

(T Account illustration with excel)


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Assets

Credit / Cr.

Debit / Dr.

“NORMAL”- DEBIT


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Liabilities

Credit / Cr.

Debit / Dr.

“NORMAL”- CREDIT


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Equity

Credit / Cr.

Debit / Dr.

“NORMAL”- CREDIT


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Revenue

Credit / Cr.

Debit / Dr.

“NORMAL”- CREDIT


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Expense

Credit / Cr.

Debit / Dr.

“NORMAL”- DEBIT


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REMEMBER THIS SLIDE FROM BEFORE?

On Jan. 3rd, sold common stock for $100,000 cash.

What is the impact to common stock?

INCREASE $100,000

What is the impact to cash?

INCREASE $100,000

HOW IS THIS EXPRESSED IN A JOURNAL ENTRY?

ACCOUNTDEBIT/ DR.CREDIT/ (CR)

Cash $100,000

Common Stock $100,000

WHAT WOULD THIS LOOK LIKE IN THE T-ACCOUNTS?


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ENTRY POSTED TO T-ACCOUNTS

ACCOUNTDEBIT/ DR.CREDIT/ (CR)

Cash $100,000

Common Stock $100,000

$100,000

$100,000

$100,000

$100,000


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The Journal

General Journal – a chronological record of transactions, also known as the book of original entry. What you record in the journal is known as a “Journal Entry.”


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Posting

Posting – the process of transferring amounts from the journal to the ledger accounts.

General Journal

GJ1

General Ledger


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Trial Balance

Trial Balance – a list of each account and its balance; used to prove equality of debits and credits.

LO 7

Explain the purposes of a trial balance.


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Event 9 – Hiring of New Employees

Oct. 9 – Sierra hired four new employees to begin work on Oct. 15.

Accounting transaction has NOT occurred!


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11

4

Basic Steps in the Recording Process.

  • Analyze

  • Journalize

  • Post


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