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CHAPTER

3
The Accounting Information System

The Accounting Information System
Accounting Information System
Basic terminology Debits and credits

The Accounting Cycle
Identification and recording Journalizing

Posting Basic equation Financial statements Trial balance and ownership Adjusting entries structure Adjusted trial balance Closing Post-closing trial balance Reversing entries

The Accounting Equation
Assets = Liabilities+ Shareholders’ Equity Assets= Liabilities Common Shares + Retained + Earnings Retained Earnings: revenues that made AND retained in business. Earnings by Year End (Method 1) Retained = Revenues (all years)–expenses (all years)–dividends (all
years) = Net income (all years)-dividends (all years) Retained Earnings by Year End (Method 2) = Beginning Retained Earnings + Net income– dividends

The Accounting Equation
• Retained Earnings (R/E): revenues that made AND retained in the business. 1 2 3 4 5 Net income 100 110 120 130 140 Dividend (20) (20) (20) (20) (20) Year-end R/E 80 ? ? ? ? R/E by year 2 (M1): 100+110-40=170 R/E by year 2 (M2): 80+110-20=170 R/E by year 3 (M1): 100+110+120-60=270 R/E by year 3 (M2): 170+120-20=270 The second way to calculate R/E is the popular way used in real world business.

Basic Terminology
Event
• The source/cause of a change in assets, liabilities and equity

Account
• A summary of the transactions for each type of asset, liability and equity item

Basic Terminology
Ledger
• • • • Book containing all accounts Each account has a separate page Book of original entry for all transactions Process of transferring transaction information from the journal to the ledger
Listing of all accounts and their balances from the general ledger Tool used to ensure that the general ledger is in balance

Journal Posting Trial balance
• •

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

The Accounting Cycle
1
Identification and Measurement of Transactions

2 7

Record Transaction in Journal

3

10 9

Reversing Entries

Prepare Financial Statement Adjusted Trial Balance

6

4

Post Journal Entries to the Ledgers Prepare Trial Balance Prepare Adjusting Journal Entries

Post-Closing Trial Balance Close Temporary Accounts

8

5
Record Adjusting Journal Entries to Worksheet (post to the Ledgers as well)

Basic Terminology (Step 5)
Adjusting entries
• • • Record the effects of accrual accounting Ensure that revenue recognition and the matching principle are followed Five classifications of year-end adjusting entries:
1. 2. 3. 4. 5. Prepaid expenses Unearned revenues Accrued revenues Accrued expenses Depreciations/Amortization

Adjusting Entries: Recognizing Revenue
Adjusting Unearned Revenue Revenues received in cash and recorded as liabilities before being earned Recording Accrued Revenue

Revenues earned but not yet received in cash or recorded

E3-6 Text page 109:
Karen Pain started dental practice on Jan 1, 2005. The following transactions occurred during the first month.

3. At Jan 31, $1,750 services was earned but not billed to insurance companies (customers are on dental insurance plan). 4. Utility expense incurred but not paid by Jan 31 totaled $1,520. 5. On Jan 1, purchase dental equipment for $80,000, paying $20,000 in cash and signing a $60,000, 3 year note payable. The equipment amortization is $400 per month. Interest is $500 per month. 6. Purchased a one-year malpractice insurance policy on Jan 1 for $13,000. 7. Purchased $2,600 of dental supplies. On Jan 31 determined that $500 of supplies were on hand.

E3-6 Text page 109 Solution
1. Accounts Receivable 1,750 Service Revenue 1,750 2. Utilities Expense 1,520 Utilities Payable 1,520 3. Amortization Expense 400 Accumulated Amortization–Equipment 400 Interest Expense 500 Interest Payable 500 4. Insurance Expense 1,083 Prepaid Insurance 1,083($13,000 / 12) 5. Supplies Expense 2,100 Supplies 2,100($2,600 $500)

Basic Terminology (Step 8)
Permanent account
• • • Also known as a real account Permanent accounts are not closed at year-end. The balances of these accounts will be carried over to the next year. All balance sheet accounts are permanent accounts excepts distribution accounts (e.g. Dividend account is a temporary account) Also known as a nominal account Temporary accounts are closed at year-end to Retained Earnings All income statement accounts are temporary accounts

Temporary account
• • •

Homework assignment
– E3-8, E3-17, P3-3