Financial Accounting:Tools for Business Decision Making, 4th Ed. Kimmel, Weygandt, Kieso CHAPTER 3
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.
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.
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.
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
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.
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
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.
Sara Lee Corp. – Assets Accounts LO 2 Describe the qualitative characteristics of accounting information.
Chart of Accounts LO 3 Analyze the effects of transactions on the accounting equation.
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.
Graphic debits and credits (GENERALLY) Balance Sheet Income Statement 2004 2004 Assets: Revenues & Gains: DEBITS CREDITS Liabilities: CREDITS Expenses & Losses: Equity: DEBITS CREDITS
ANOTHER CRUTCH “Debit” Card- comes from your checking account, which is an ASSET. “Credit” Card- creates a LIABILITY. DEBIT- ASSET CREDIT- LIABILITY
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
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
Debits and Credits Balance Sheet Income Stmt. - = + = Asset Liab. Equity Rev. Exp. Debit Credit
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
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
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
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!!!!!
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
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!
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
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
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.
Account Name Credit / Cr. Debit / Dr. (T Account illustration with excel)
Assets Credit / Cr. Debit / Dr. “NORMAL”- DEBIT
Liabilities Credit / Cr. Debit / Dr. “NORMAL”- CREDIT
Equity Credit / Cr. Debit / Dr. “NORMAL”- CREDIT
Revenue Credit / Cr. Debit / Dr. “NORMAL”- CREDIT
Expense Credit / Cr. Debit / Dr. “NORMAL”- DEBIT
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?
ENTRY POSTED TO T-ACCOUNTS ACCOUNTDEBIT/ DR.CREDIT/ (CR) Cash $100,000 Common Stock $100,000 $100,000 $100,000 $100,000 $100,000
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.”
Posting Posting – the process of transferring amounts from the journal to the ledger accounts. General Journal GJ1 General Ledger
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.
Event 9 – Hiring of New Employees Oct. 9 – Sierra hired four new employees to begin work on Oct. 15. Accounting transaction has NOT occurred!
11 4 Basic Steps in the Recording Process. • Analyze • Journalize • Post