FINANCIAL ACCOUNTING AND REPORTING CHAPTER 2
Information System
• Collection of people, procedures, software,
hardware, and data which works together
to provide information essential to
running an organization.
People
• competent end users working to increase
their productivity. End users use hardware
and software to solve information-related or
decision-making problems.
Procedures
• manuals and guidelines that instruct end
users on how to use the software and
hardware.
Software
• another name for programs -instructions
that tell the computer how to process data.
There are basically two kinds of software:
System and Application Software
System Software
• background software that helps a computer
manage its internal resources.
• Ex. Operating system such as Windows
and Linux
Application Software
• performs useful work on general-purpose
problems.
• Two types: basic applications and
advanced applications
Basic Applications
• Browsers – navigate, explore, find
information on the internet.
• Word Processor – prepare written
documents.
• Spreadsheet – analyze and summarize
numerical data.
• Database management system –
organize and manage data and information.
• Presentation graphics – communicate a
message or persuade other people.
Advanced Applications
• Multimedia – integrate video, music, voice,
and graphics to create interactive
presentations.
• Web publishers – create interactive multi-
media Web pages.
• Graphics programs – create professional
publications, draw, edit, and modify images.
• Virtual reality – create realistic three-
dimensional virtual or simulated
environments.
• Artificial intelligence – simulated human
thought processes and actions.
• Project managers – plan projects,
schedule, people, and control resources.
Hardware
• consists of input devices, the system unit,
secondary storage, output devices, and
communication devices.
Input Devices
• translate data and programs that humans
can understand into a form the computer
can process.
• Ex. Keyboard, mouse, scanner, digital
camera, and microphone
The System Unit
• Electronic circuitry consisting of:
• Central Processing Unit (controls and
manipulates data to produce information)
• Memory (primary storage) - -temporarily
holds data, program instructions, and
processed data.
Secondary Storage
• stores data and programs.
• Three most common are: flash drive, hard
disk, and optical disk.
Output Devices
• processed information from the CPU.
• Monitor and Printer
Communications Devices
• send and receive data and programs from
one computer to another.
Modem
• device that connects a microcomputer to a
telephone
Data
• raw material for data processing.
• Consists of numbers, letters, and symbols
that relates to facts, events, and
transactions.
• Typically stored electronically in a file
Accounting Information System
• Will generate reliable financial information
needed by the decision-makers in a timely
manner.
 FINANCIAL ACCOUNTING AND REPORTING CHAPTER 2
• Design and operation of a system must
consider the anticipated users of the
information and the types of decisions they
are expected to make.
• A combination of personnel, records and
procedures that a business uses to meet its
need for financial information.
Accounting manual
• Specifies the policies and procedures to be
followed in accumulating information within
the accounting information system.
• Details what events are to be recorded in
the accounts, and when and how the
information is to be classified and
Stages of Data Processing
Elements of Financial Statements
Asset
accumulated.
Objectives of an Effective Accounting Information
System
1. Cost-benefit principle - To process the
information efficiently at the least cost.
2. Control principle - To protect entity's
assets, to ensure that data are reliable, and
to minimize wastes and the possibility of
theft or fraud.
3. Compatibility principle - To be in harmony
with the entity's organizational and human
factors.
4. Flexibility principle - To be able to
accommodate growth in the volume of
transactions and for organizational
changes.
Types of Accounting Information Systems
• All of these systems are designed to
capture information regarding accounting
events to prepare financial statements.
1. Manual Systems
• rely on human processing so they are labor
intensive and may be inefficient in today's
complex business environment.
• Prone to error
2. Computer-based Transaction Systems
• systems replace paper records with
computer records.
• maintains accounting data separately from
other operating data.
3. Database Systems
• Capture data, both financial and non-
financial, and stores that information in a
data warehouse.
• Reduce inefficiencies and redundancies
that often exist in transaction-based
systems.
• input-processing-output
1. Assets, Liabilities, and Equity
• relate to a reporting entity's financial
position.
2. Income and Expenses
• relate to a reporting entity's financial
performance.
• present economic resource controlled
by the entity because of past events.
• An economic resource is a right that has
the potential to produce economic
benefits.
• Right, Potential to Produce Economic
Benefits, and Control.
Rights of an Asset
a. Rights that correspond to an obligation of
another party
• rights to receive cash.
• rights to receive goods or services.
• rights to exchange economic resources
with another.
• rights to benefit from an obligation of
another party.
b. Rights that do not correspond to an
obligation of another party.
• rights over physical objects, such as
property, plant and equipment or
inventories.
• rights to use intellectual property.
 FINANCIAL ACCOUNTING AND REPORTING CHAPTER 2
COULD PRODUCE ECONOMIC BENEFITS
a. receive contractual cash flows or another
economic resource.
b. exchange economic resources with another
party.
c. produce cash inflows or avoid cash
outflows.
d. receive cash or other economic resources
by selling the economic resource.
e. extinguish liabilities by transferring the
economic resource.
CONTROLS
• if it has the present ability to direct the use
of the economic resource and obtain the
economic benefits that may flow from it.
• present ability to prevent other parties from
directing the use of the economic resource
and from obtaining the economic benefits
that may flow from it.
• if one party controls an economic
resource, no other part, controls that
resource.
Liability
• present obligation of the entity to transfer
an economic resource because of past
events.
• Three criteria: the entity has an obligation;
the obligation is to transfer an economic
resource; and the obligation is a present
obligation that exists because of past
events.
Obligation
• duty or responsibility that an entity has no
practical ability to avoid.
• always owed to another party.
TRANSFER AN ECONOMIC RESOURCE
a. obligations to pay cash.
b. obligations to deliver goods or provide
services.
c. obligations to exchange economic
resources with another party.
d. obligations to transfer an economic
resource.
e. obligations to issue a financial instrument if
that financial instrument will oblige the
entity to transfer an economic resource.
RESULT OF PAST EVENTS
a. the entity has already obtained economic
benefits or taken an action.
b. Consequently, the entity will or may have to
transfer an economic resource that it would
not otherwise have had to transfer.
Equity
• The residual interest in the assets of the
entity after deducting all its liabilities.
• In sole proprietorship, there is only one
owner's equity account because there is
only one owner.
• In a partnership, an owner's equity
account exists for each partner.
• In a corporation, owners' equity or
stockholders' equity consists of share
capital, retained earnings and reserves
representing appropriations of retained
earnings among others.
Income
• Increases in assets, or decreases in
liabilities, that result in increases in equity,
other than those relating to contributions
from holders of equity claims.
Expenses
• Decreases in assets, or increases in
liabilities, that result in decreases in equity,
other than those relating to distributions to
holders of equity claims.
Account
• basic summary device of accounting.
• maintained for each element that appears
in the balance sheet (assets, liabilities, and
owner’s equity) and in the income
statement (income and expenses).
T-account
The Accounting Equation
• presents the resources controlled by the
enterprise, the present obligations of the
enterprise and the residual interest in the
assets.
• Assets = Liabilities + Owner’s Equity
• Equality must be maintained.
Double-entry system
• Dual effects of a business transaction are
recorded.
• For every debit, there should be a credit.
 FINANCIAL ACCOUNTING AND REPORTING CHAPTER 2
• Each transaction affects at least two 2. Exchange of Assets (EA)
accounts. • One asset account increases and another
asset account decreases.
Debit • Ex. Acquired equipment for cash.
• Goes in.
• Left side. 3. Use of Assets (UA)
• Increases in assets. • asset account decreases and a
• Decreases in liabilities and owner’s equity. corresponding claims (liabilities or equity)
• Decreases in income. account decreases.
• Increases in expenses. • Ex. Settled accounts payable and Paid
salaries of employees.
Credit
• Goes out. 4. Exchange of Claims (EC)
• Right side. • One claims (liabilities or owner's equity)
• Decreases in assets. account increases and another claims
• Increases in liabilities and owner’s equity. (liabilities or owner's equity) account
• Increases in income. decreases.
• Decreases in expenses. • Ex. Received utilities bill but did not pay.

NORMAL BALANCE OF AN ACCOUNT TYPES OF TRANSACTIONS

Normal Balance/Increase Assets Liabilities/Equity
Assets DEBIT Source of Assets + +
Liabilities CREDIT Exchange of +- 0
Assets
Owner’s Equity:
Use of Assets - -
Owner’s Capital CREDIT
Exchange of 0 +-
Withdrawals DEBIT
Claims
Income CREDIT
Expenses DEBIT
Assets
• should be classified only into two: current
Accounting Event
assets and non-current assets.
• Economic occurrence that causes changes
in an enterprise's assets, liabilities, and/or
Current Assets
equity.
• realize the asset, or intends to sell or
• Events may be internal actions, such as
consume it, in its normal operating cycle.
the use of equipment to produce goods or
• holds the asset primarily for the purpose of
services.
trading.
• It can also be an external event, such as
• realize the asset within twelve months.
the purchase of raw materials from a
supplier. • cash or a cash equivalent.

Transaction Operating Cycle

• involves the transfer of something of value
between two entities.
• Examples include acquiring assets from
owner(s), borrowing funds from creditors,
and purchasing or selling goods and
services.
TYPES OF TRANSACTIONS
1. Source of Assets (SA)
• asset account increases and a
corresponding claims (liabilities or
owner's equity) account increases.
• Examples: Purchase of supplies on account
and Sold goods on cash on delivery basis.
• Time between the acquisition of assets
for processing and their realization in
cash or cash equivalents.
• Usually 12 months.
Current Assets Examples
• Cash - any medium of exchange that a
bank will accept for deposit at face value.
Examples are coins, currency, checks, and
etc.
• Cash Equivalents – short term, highly
liquid investments that are readily
convertible to known amounts of cash.
• Notes Receivable - note receivable is a
written pledge that the customer will pay
 FINANCIAL ACCOUNTING AND REPORTING CHAPTER 2
the business a fixed amount of money on a
certain date.
• Accounts Receivable - claims against
customers arising from sale of service or
goods on credit. Offers less security.
• Inventories - held for sale in the ordinary
course of business, in the process of
production for such sale, in the form of
materials or supplies to be consumed in
the production process or in the rendering
of services.
• Prepaid Expenses - expenses paid for by
the business in advance.
Non-Current Assets
• Property, Plant, and Equipment -
tangible assets that are held by an
enterprise for use in the production or
supply of goods or services, or for rental
to others, or for administrative purposes
and which are expected to be used during
more than one period. Examples are land,
building, machinery, and equipment.
• Accumulated Depreciation - contra
account that contains the sum of the
periodic depreciation charges.
• Intangible Assets - identifiable,
nonmonetary assets without physical
substance. Examples are goodwill,
patents, copyrights, licenses, trademarks
and etc.
Current Liabilities
• it expects to settle the liability in its
normal operating cycle, it holds the liability
primarily for the purpose of trading, the
liability is due to be settled within twelve
months after the reporting period; or the
entity does not have an unconditional
right to defer settlement of the liability for at
least twelve months after the reporting
period.
Current Liabilities Examples
• Accounts Payable - represents the
reverse relationship of the accounts
receivable. Pay for them soon.
• Notes Payable - note receivable but in a
reverse sense. Promises to pay the other
party a specified amount of money on a
specified future date.
• Accrued Liabilities - Amounts owed to
others for unpaid expenses. This includes
salaries payable, utilities payable, interest
payable and taxes payable.
• Unearned Revenues - the business entity
receives payment before providing its
customers with goods or services, the
amounts received are recorded in the
unearned revenue account (liability
method). When the goods or services are
provided to the customer, the unearned
revenue is reduced, and income is
recognized.
• Current Portion of Long-Term Debt -
These are portions of mortgage notes,
bonds and other long-term indebtedness
which are to be paid within one year from
the balance sheet date.
Non-Current Liabilities Examples
• Mortgage Payable - records long-term
debt of the business entity for which the
business entity has pledged certain assets
as security to the creditor.
• Bonds Payable - obtain substantial sums
of money from lenders to finance the
acquisition of equipment and other needed
assets. They obtain these funds by issuing
bonds.
Owner’s Equity Examples
• Capital – (“property” in Latin”) used to
record the original and additional
investments of the owner. Increased by
profit and decrease by loss.
• Withdrawals - When the owner of a
business entity withdraws cash or other
assets, such are recorded in the drawing or
withdrawal account rather than directly
reducing the owner's equity account.
• Income Summary - temporary account
used at the end of the accounting period to
close income and expenses. Shows the
profit or loss for the period before closing
the capital account.
Income Examples
• Service Income - revenues earned by
performing services for a customer or
client.
• Sales - Revenues earned because of sale
of merchandise.
Expenses Examples
• Cost of Sales - The cost incurred to
purchase or to produce the products
sold to customers during the period; also
called cost of goods sold.
• Salaries or Wages Expense - Includes all
payments as a result of an employer-
employee relationship such as salaries or
 FINANCIAL ACCOUNTING AND REPORTING CHAPTER 2
wages, 13th month pay, cost of living
allowances and other related benefits.
• Telecommunications, Electricity, Fuel
and Water Expenses - use of
telecommunications facilities, consumption
of electricity, fuel and water.
• Rent Expense - Expense for space,
equipment or other asset rentals.
• Supplies Expense – Expense of using
supplies in the daily business operations.
• Insurance Expense – Portions of
premiums paid on insurance coverage.
• Depreciation Expense – portion of the
cost of a tangible asset
• Uncollectible Accounts Expense -
amount of receivables estimated to be
doubtful of collection and charged as
expense during an accounting period.
• Interest Expense - An expense related to
use of borrowed funds.
Business Transaction
• occurrence of an event or a condition that
affects financial position and can be reliably
recorded.
Accounting Cycle
• A series of sequential steps or procedures
performed to accomplish the accounting
process.
Steps in the Accounting Cycle
1. Identification of Events to be Recorded –
To gather information about financial
transactions or events generally through
the source documents.
2. Transaction are Recorded in the Journal
- record the economic impact of
transactions on the firm in a journal, which
is a form that facilitates transfer to the
accounts.
3. Journal Entries are Posted to the Ledger
- To transfer the information from the journal
to the ledger for classification.
4. Preparation of a Trial Balance - To
provide a listing to verify the equality of
debits and credits in the ledger.
5. Preparation of Worksheet including
Adjusting Entries - To provide a listing to
verify the equality of debits and credits in
the ledger.
6. Preparation of Financial Statements - To
aid in the preparation of financial
statements.
7. Adjusting Journal Entries are
Journalized and Posted - To record the
accruals, expiration of deferrals,
estimations, and other events from the
worksheet.
8. Closing Journal Entries are Journalized
and Posted - To close temporary accounts
and transfer profit to owner's equity.
9. Preparation of a Post-Closing Trial
Balance - To check the equality of debits
and credits after the closing entries.
10. Reversing Journal Entries are
Journalized and Posted - To simplify the
recording of certain regular transactions
period in the next accounting period.
NOTES:
• First three steps are accomplished during
the period.
• Fourth to ninth steps generally occur at the
end of the period.
• Last step is optional and occurs at the
beginning of the next period.
Transaction Analysis (Step 1)
1. Identify the transaction from source
documents.
2. Indicate the accounts-either assets,
liabilities, equity, income, or expenses
affected by the transaction.
3. Ascertain whether each account is
increased or decreased by the transaction.
4. Determine whether to debit or credit the
account to record its increase or decrease.
Source Documents
• Through this, transactions and events can
be analyzed as to how they will affect
performance and financial position.
• Examples are sales invoice, cash register
tapes, receipts, bank deposit slips, and etc.
The General Journal
• The book of original entry
• Chronological record of the entity's
transactions.
• Shows all the effects of a transaction in
terms of debits and credits. Includes date,
account titles and explanation, posting
reference, debit, and credit.
Ledger or T-account
• “Reference book”
• Two groups: balance sheet or permanent
account (ALO) and income statement or
temporary account (RE).
 FINANCIAL ACCOUNTING AND REPORTING CHAPTER 2
• A grouping of accounts used to classify
and summarize transactions and to
prepare data for basic financial statements.

Chart of Accounts
• A listing of all accounts and their account
numbers
• 100 for Assets
• 200 for Liabilities
• 300 for Owner’s Equity
• 400 for Income
• 500 for Expenses

Posting
• means transferring the amounts from the
journal to the appropriate accounts in the
ledger.
• Transfer the date, then page number, then
debit and credit, then PR

Footing
• Adding all the debits and credits.
• Which side has the greatest sum is the
balance.

Trial Balance
• Listing of all ledger accounts, in order, with
their respective debit or credit balances.
(ALORE)
• Debit and credit must be balanced.
• control device that helps minimize
accounting errors.

Procedures in Trial Balance

1. List the account titles in numerical order.
2. Obtain the account balance of each
account from the ledger and enter the debit
balances in the debit column and the credit
balances in the credit column.
3. Add the debit and credit columns.
4. Compare the totals.

Locating Errors
1. Errors in posting a transaction to the ledger.
2. Error in determining the account balances.
3. Error in preparing trial balance.