CH 03

Intermediate Accounting
Seventeenth Edition
Kieso ● Weygandt ● Warfield
Chapter 3
The Accounting
Information System
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Learning Objectives
After studying this chapter, you should be able to:
1. Describe the basic accounting information system.
2. Record and summarize basic transactions.
3. Identify and prepare adjusting entries.
4. Prepare financial statements from the adjusted trial
balance and prepare closing entries.
5. Prepare financial statements for a merchandising
company.
Copyright ©2019 John Wiley & Sons, Inc. 2

Preview of Chapter 3 (1 of 5)
The Accounting Information System
Accounting Information System
• Basic terminology
• Debits and credits
• Accounting equation
• Financial statements and ownership structure
• The accounting cycle
Copyright ©2016 John Wiley & Sons, Inc 3

Record and Summarize Basic Transactions
• Journalizing
• Posting
• Chart of accounts
• Recording process illustrated
• Trial balance

Adjusting Entries
• Types of adjusting entries
• Deferrals
• Accruals
• Adjusted trial balance

Preparing Financial Statements
• Closing
• Post-closing trial balance
• Reversing entries
• Summary

Financial Statements for Merchandisers
• Income statement
• Retained earnings statement
• Balance sheet
• Closing entries

Learning Objective 1
Describe the Basic Accounting
Information System

Accounting Information System (1 of 4)
Accounting information system
• Collects and processes transaction data
• Disseminates financial information to interested
parties
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Helps management answer such questions as:
• How much and what kind of debt is outstanding?
• Were sales higher this period than last?
• What assets do we have?
• What were our cash inflows and outflows?
• Did we make a profit last period?
• Are any of our product lines or divisions operating at a
loss?
• Can we safely increase our dividends to stockholders?
• Is our rate of return on net assets increasing?
Basic Terminology
• Event • Journal
• Transaction • Posting
• Account • Trial Balance
• Real Account • Adjusting Entries
• Nominal Account • Financial Statements
• Ledger • Closing Entries

Debits and Credits
• An account shows the effect of transactions on a
given asset, liability, equity, revenue, or expense
account
• Double-entry accounting system (two-sided effect)
• Recording done by debiting at least one account and
crediting another
• Debits must equal Credits

Debits and Credits (1 of 5)
The Account
• Record of increases and decreases in a specific asset,
liability, stockholders’ equity, revenue, or expense
item.
• Debit = “Left” Account Name
Debit Credit
• Credit = “Right”

An account can be
illustrated in a
T-account form.

If the sum of Debit entries are greater than the sum
of Credit entries, the account will have a debit
balance. Account Name
Debit Credit
Transaction #1 $10,000 $3,000 Transaction #2
Transaction #3 8,000

Balance $15,000

If the sum of Credit entries are greater than the sum
of Debit entries, the account will have a credit
balance. Account Name
Debit Credit
Transaction #1 $10,000 $3,000 Transaction #2
8,000 Transaction #3

Balance $1,000

Debits and Credits Normal Balance – Credit
Liability Accounts
(4 of 5)
Debit Credit
- (decrease) + (increase)
Normal Balance – Debit
Asset Accounts Stockholders’ Equity Accounts
Debit Credit Debit Credit
+ (increase) - (decrease) - (decrease) + (increase)
Expense Accounts Revenue Accounts

Debit Credit Debit Credit
+ (increase) - (decrease) - (decrease) + (increase)

Balance Sheet Income Statement
Asset = Liability + Equity + Revenue - Expense
Debit
Credit

The Accounting Equation
Relationship among the assets, liabilities and
stockholders’ equity accounts of a business:
The equation must be in balance after every transaction.

For every Debit there must be a Credit.

The Accounting Equation (1 of 4)
1. Owners invest $40,000 in exchange for common stock.
2. Disburse $600 cash for administrative wages.

3. Purchase office equipment priced at $5,200, giving a 10
percent promissory note in exchange.
4. Receive $4,000 cash for services performed.

5. Pay off a short-term liability of $7,000.
6. Declare a cash dividend of $5,000.

7. Convert a long-term liability of $80,000 into common stock.
8. Pay cash of $16,000 for a delivery van.

Financial Statements and Ownership
Structure
• Stockholders’ equity section of the balance sheet
reports common stock and retained earnings
• Income statement reports revenues and expenses
• Retained earnings statement reports net
income/loss and dividends
• Because dividends, revenues, and expenses are
transferred to retained earnings at the end of the
period, a change in any one of these three items
affects stockholders’ equity
Financial
Statements

Ownership Structure
Effects of Transactions Ownership Structure
on Equity Accounts Proprietorships and
Partnerships Corporations
Impact on
Transaction Affecting Owners’ or Nominal Real Nominal Real
Owners’ or Stockholders’ (Temporary) (Permanent) (Temporary) (Permanent)
Stockholders’ Equity Equity Accounts Accounts Accounts Accounts
Investment by owner(s) Increase Capital Common
Stock and
related
accounts
Revenues recognized Increase Revenue Revenue
Retained
Expenses incurred Decrease Expense Capital Expense
Withdrawal by owner(s) Decrease Drawings Dividends Earnings

The Accounting Cycle

Identify and Recording Transactions
and Other Events
What to Record?
The FASB uses the phrase “transactions and other events
and circumstances that affect a business enterprise.”
Types of Events:
• External – between an entity and its environment
• Internal – event occurring entirely within an entity

Record and Summarize Basic
Transactions

Journalizing
A company records in accounts those transactions and
events that affect assets, liabilities, equities, revenues,
and expenses.
General Ledger – contains all the asset, liability,
stockholders’ equity, revenue, and expense accounts.
General Journal – a chronological record of transactions.
Journal Entries are recorded in the journal.

Journalizing
Illustration: On September 1, stockholders invested $15,000
cash in the corporation in exchange for shares of stock and
purchased computer equipment for $7,000 cash.
GENERAL JOURNAL J1
Date Account Titles and Explanations Ref. Debit Credit
2020
Sept. 1 Cash 15,000
Common Stock 15,000
1 Equipment 7,000
Cash 7,000

Posting

Chart of Accounts (1 of 2)
The chart of accounts lists the accounts and account numbers
that identify their location in the ledger. The numbering
system that identifies the accounts usually starts with the
balance sheet accounts and follows with the income
statement accounts.

Chart of Accounts (2 of 2)
Assets Stockholders’ Equity
101 Cash 311 Common Stock
112 Accounts Receivable 320 Retained Earnings
113 Allowance for Doubtful Accounts 332 Dividends
126 Supplies 350 Income Summary
130 Prepaid Insurance
157 Equipment Revenues
158 Accumulated Depreciation—Equipment 400 Service Revenue
Liabilities Expenses
200 Notes Payable 631 Supplies Expense
201 Accounts Payable 711 Depreciation Expense
209 Unearned Service Revenue 722 Insurance Expense
212 Salaries and Wages Payable 726 Salaries and Wages Expense
230 Interest Payable 729 Rent Expense
732 Utilities Expense
905 Interest Expense
919 Bad Debt Expense

Recording Process Illustrated (1 of 11)
The following illustrations show the basic steps in the
recording process, using the October transactions of
Pioneer Advertising.
• Pioneer’s accounting period is a month
• A basic analysis and a debit-credit analysis precede
the journalizing and posting of each transaction
• We use the T-account form in the illustrations instead
of the standard account form

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Trial Balance (1 of 3)
• List of accounts and their balances at a given time
• Usually prepared at end of an accounting period
• Lists accounts in order they appear in ledger, with
debit balances listed in left column and credit
balances in right column
• Totals of the two columns must agree
• Proves mathematical equality of debits and credits
after posting
• Also uncovers errors in journalizing and posting
Trial
Balance
(2 of 3)

Trial Balance (3 of 3)
Does not prove that a company recorded all transactions
or that the ledger is correct. Trial balance may balance
even when a company:
1. Fails to journalize a transaction.
2. Omits posting a correct journal entry.
3. Posts a journal entry twice.
4. Uses incorrect accounts in journalizing or posting.
5. Makes offsetting errors in recording the amount of
a transaction.
Identify and Prepare Adjusting Entries

Adjusting Entries
Make it possible to:
• Report on balance sheet appropriate assets,
liabilities, and stockholders’ equity at statement date
• Report on income statement proper revenues and
expenses for the period
Are required every time a company prepares financial
statements

Types of Adjusting Entries
Deferrals:
1. Prepaid expenses: Expenses paid in cash before they are
used or consumed.
2. Unearned revenues: Cash received before services are
performed.
Accruals:
1. Accrued revenues: Revenues for services performed but
not yet received in cash or recorded.
2. Accrued expenses: Expenses incurred but not yet paid in
cash or recorded.
Adjusting
Entries for
Deferrals

Prepaid Expenses (1 of 8)
Prepaid Expenses. Assets paid for and recorded before a
company uses them.
Cash Payment Before Expense Recorded
Prepayments often occur in regard to:
• Insurance • Rent
• Supplies • Buildings and equipment
• Advertising

Supplies. Pioneer Advertising purchased advertising
supplies costing $25,000 on October 5. This account
shows a balance of $25,000 in the October 31 trial
balance. An inventory count at the close of business on
October 31 reveals that $10,000 of supplies are still on
hand. Thus, the cost of supplies used is $15,000 ($25,000
− $10,000).
The analysis and adjustment for advertising supplies is
summarized in the following illustration.


Insurance. On October 4, Pioneer Advertising paid $6,000
for a one-year fire insurance policy. Coverage began on
October 1. Pioneer debited the cost of the premium to
Prepaid Insurance at that time. This account still shows a
balance of $6,000 in the October 31 trial balance.
The analysis and adjustment for insurance is summarized
in the following illustration.


Depreciation. The process of allocating the cost of an
asset to expense over its useful life in a rational and
systematic manner.
Pioneer Advertising estimates depreciation on its office
equipment to be $4,800 a year (cost $50,000 less salvage
value $2,000 divided by useful life of 10 years), or $400
per month.
The analysis and adjustment for depreciation is


Depreciation Statement Presentation. Accumulated
Depreciation—Equipment is a contra asset account. A
contra asset account offsets an asset account on the
balance sheet.
Equipment $50,000
Less: Accumulated depreciation—equipment 400 $49,600
The book value of any depreciable asset is the difference

between its cost and its related accumulated
depreciation.

Unearned Revenues (1 of 3)
Receipt of cash before the services are performed is
recorded as a liability called unearned revenues.
Cash Receipt Before Revenue Recorded
Unearned revenues often occur in regard to:
• Rent • Magazine subscriptions
• Airline tickets • Customer deposits
• Tuition

Pioneer Advertising received $12,000 on October 2 from
R. Knox for advertising services expected to be completed
by December 31. Pioneer credited the payment to
Unearned Service Revenue. This liability account shows a
balance of $12,000 in the October 31 trial balance. Based
on an evaluation of the service Pioneer performed for
Knox during October, the company determines that it
should recognize $4,000 of revenue in October.
The analysis and adjustment for unearned revenue is


Adjusting
Entries
for
Accruals

Accrued Revenues (1 of 3)
Revenues recorded for services performed but cash has
yet to be received at the statement date.
Adjusting entry results in:
Revenue Recorded Before Cash Receipt
Accrued expenses often occur in regard to:
• Rent
• Interest
• Services performed

In October, Pioneer Advertising performed services worth
$2,000 that were not billed to clients on or before
October 31. Because these services are not billed, they
are not recorded. The accrual of unrecorded service
revenue increases an asset account, Accounts Receivable.
It also increases stockholders’ equity by increasing a
revenue account, Service Revenue.
The analysis and adjustment for accrued revenue is


Adjusting Entries for Accrued Expenses
Expenses incurred but not yet paid in cash or recorded.
Adjusting entry results in:
Expense Recorded Before Cash Payment
Accrued expenses often occur in regard to:
• Rent • Taxes
• Interest • Salaries

Accrued Expenses (1 of 8)
Accrued Interest. Pioneer Advertising signed a three-
month note payable in the amount of $50,000 on October
1. The note requires interest at an annual rate of 12
percent. Three factors determine the amount of the
interest accumulation:


Accrued Salaries and Wages. At October 31, the salaries
and wages for these days represent an accrued expense
and a related liability to Pioneer. The employees receive
total salaries of $10,000 for a five-day work week, or
$2,000 per day.

Accrued Salaries and Wages. There are 3 days in the
adjustment period from October 29 to 31. Thus, accrued
salaries and wages at October 31 are $6,000 ($2,000 × 3).
The analysis and adjustment process is summarized in the
following illustration.


Accrued Salaries and Wages. On November 23, Pioneer
will again pay total salaries and wages of $40,000.
Prepare the entry to record the payment of salaries on
November 23.
Salaries and Wages Payable 6,000

Salaries and Wages Expense 34,000
Cash 40,000

Bad Debts. Companies estimate uncollectible accounts at
the end of each period. This ensures that receivables are
reported on the balance sheet at their net realizable
value.
Assume that, based on past experience, Pioneer
Advertising reasonably estimates a bad debt expense for
the month of $1,600. The analysis and adjustment
process for bad debts is summarized in the following
illustration.
LO 3 Copyright ©2016 John Wiley & Sons, Inc 74


Adjusted
Trial
Balance
Shows the balance
of all accounts,
after adjusting
entries, at the end
of the accounting
period.

Prepare Financial Statements from the
Adjusted Trial Balance and Prepare
Closing Entries

Preparing Financial Statements (1 of 3)
Financial Statements are prepared directly from the
Adjusted Trial Balance.
• Income Statement
• Retained Earnings Statement
• Balance Sheet

Preparing Financial Statements (2 of 3)

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Closing
Closing Entries
• To reduce balance of nominal (temporary) accounts
to zero in order to prepare accounts for next period’s
transactions
• To transfer all income statement account balances to
the Retained Earnings account in stockholders’ equity
• Balance sheet (asset, liability, and equity) accounts
are not closed
• Dividends are closed directly to the Retained Earnings
account.
Closing
Entries

Posting
Closing
Entries

Post-
Closing
Trial
Balance

Accounting Cycle Summarized
1. Enter the transactions of the period in appropriate journals.
2. Post from the journals to the ledger (or ledgers).
3. Prepare an unadjusted trial balance (trial balance).
4. Prepare adjusting journal entries and post to the ledger(s).
5. Prepare a trial balance after adjusting (adjusted trial balance).
6. Prepare the financial statements from the adjusted trial
balance.
7. Prepare closing journal entries and post to the ledger(s).
8. Take a post-closing trial balance (optional).
9. Prepare reversing entries (optional) and post to the ledger(s).
Prepare Financial Statements for a
Merchandising Company

Statements of a
Merchandising
Company (1 of 3)

Statements of a Merchandising
Company (2 of 3)

Statements of a
Merchandising
Company (3 of 3)

Differentiate the Cash Basis of
Accounting from the Accrual Basis of
Accounting

Appendix 3A: Cash-Basis Accounting Versus
Accrual-Basis Accounting (1 of 3)
Most companies use accrual-basis accounting. They recognize
• revenue when the performance obligation is satisfied and
• expenses in the period incurred, without regard to the
time of receipt or payment of cash.
Under the strict cash-basis, companies
• record revenue only when they receive cash
• record expenses only when they disperse cash
Financial statements are not in conformity with GAAP.

Illustration: Quality Contractor signs an agreement to
construct a garage for $22,000. In January, Quality begins
construction, incurs costs of $18,000 on credit, and by the end
of January delivers a finished garage to the buyer. In February,
Quality collects $22,000 cash from the customer. In March,
Quality pays the $18,000 due the creditors.


Appendix 3A

Conversion from Cash Basis to Accrual Basis (1 of 4)
Illustration: Dr. Diane Windsor, like many small business owners,
keeps her accounting records on a cash basis. In the year 2020, Dr.
Windsor received $300,000 from her patients and paid $170,000
for operating expenses, resulting in an excess of cash receipts over
disbursements of $130,000 ($300,000 - $170,000). At January 1 and
December 31, 2020, she has accounts receivable, unearned service
revenue, accrued liabilities, and prepaid expenses as shown here.

Service Revenue Computation
Illustration: Calculate service revenue on an accrual basis.

Operating Expense Computation
Illustration: Calculate operating expenses on an accrual basis.


Accrual-Basis Accounting
Theoretical Weaknesses of the Cash Basis
Today’s economy is considerably more lubricated by
credit than by cash.
The accrual basis, not the cash basis, recognizes all
aspects of the credit phenomenon.
Investors, creditors, and other decision makers seek
timely information about a company’s future cash flows.

Identifying Adjusting Entries That May
Be Reversed

Appendix 3B: Using Reversing Entries (1 of 3)
Illustration of Reversing Entries—Accruals

Illustration of Reversing Entries—Deferrals

Summary of Reversing Entries
1. All accruals should be reversed.
2. All deferrals for which a company debited or credited
the original cash transaction to an expense or revenue
account should be reversed.
3. Adjusting entries for depreciation and bad debts are
not reversed.
Recognize that reversing entries do not have to be used.
Therefore, some accountants avoid them entirely.

Prepare a 10-Column Worksheet

Appendix 3C: Using a Worksheet: The
Accounting Cycle Revisited (1 of 4)
A company prepares a worksheet either
• on columnar paper or
• within a computer spreadsheet.
A company uses the worksheet to
• adjust account balances and
• prepare financial statements.

Worksheet Columns
• Trial Balance
• Adjustments
• Adjusted Trial Balance
• Income Statement
• Balance Sheet

Appendix 3C:
Using a
Worksheet: The
Accounting Cycle
Revisited (3 of 4)

Items (a) through (g) below serve as the basis for the adjusting entries made in
the worksheet for Uptown shown:
a. Depreciation of equipment at the rate of 10 percent per year based on
original cost of $67,000.
b. Estimated bad debts of $1,000, based on an aging of Accounts Receivable.
c. Insurance expired during the year $360.
d. Interest accrued on notes receivable as of December 31, $800.
e. The Rent Expense account contains $500 rent paid in advance, which is
applicable to next year.
f. Property taxes accrued December 31, $2,000.
g. Income taxes payable estimated $3,440.

Compare the Accounting Information
Systems Under GAAP and IFRS

IFRS Insights (1 of 4)
Relevant Facts
Similarities
• International companies use the same set of procedures and records to
keep track of transaction data. Thus, the material in this chapter
dealing with the account, general rules of debit and credit, and steps in
the recording process—the journal, ledger, and chart of accounts—is
the same under both GAAP and IFRS.
• Transaction analysis is the same under IFRS and GAAP but, as you will
see in later chapters, different standards sometimes impact how
transactions are recorded.
• Both the IASB and FASB go beyond the basic definitions provided in
this textbook for the key elements of financial statements, that is,
assets, liabilities, equity, revenues, and expenses.

Relevant Facts
Similarities
• A trial balance under IFRS follows the same format as shown in the
text. As shown in the text, dollar signs are typically used only in the
trial balance and the financial statements. The same practice is
followed under IFRS, using the currency of the country in which the
reporting company is headquartered.
Differences
• Rules for accounting for specific events sometimes differ across
countries. For example, European companies rely less on historical cost
and more on fair value than U.S. companies. Despite the differences,
the double-entry accounting system is the basis of accounting systems
worldwide.

Relevant Facts
Differences
• Internal controls are a system of checks and balances designed to
prevent and detect fraud and errors. While most companies have these
systems in place, many have never completely documented them nor
had an independent auditor attest to their effectiveness. Both of these
actions are required under SOX. Enhanced internal control standards
apply only to large public companies listed on U.S. exchanges.

On the Horizon
The basic recording process shown in this text is followed by companies
around the globe. It is unlikely to change in the future. The definitional
structure of assets, liabilities, equity, revenues, and expenses may change
over time as the IASB and FASB evaluate their overall conceptual
framework for establishing accounting standards. In addition, high-quality
international accounting requires both high-quality accounting standards
and high-quality auditing. Similar to the convergence of GAAP and IFRS,
there is a movement to improve international auditing standards. The
International Auditing and Assurance Standards Board (IAASB) functions
as an independent standard-setting body. It works to establish high-
quality auditing and assurance and quality-control standards throughout
the world. Whether the IAASB adopts internal control provisions similar
to those in SOX remains to be seen.

Copyright
Copyright © 2019 John Wiley & Sons, Inc.
All rights reserved. Reproduction or translation of this work beyond that permitted in
Section 117 of the 1976 United States Act without the express written permission of the
copyright owner is unlawful. Request for further information should be addressed to the
Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies
for his/her own use only and not for distribution or resale. The Publisher assumes no
responsibility for errors, omissions, or damages, caused by the use of these programs or
from the use of the information contained herein.

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Intermediate Accounting

Kieso ● Weygandt ● Warfield

Copyright ©2019 John Wiley & Sons, Inc. 2

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Expense Accounts Revenue Accounts

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The equation must be in balance after every transaction.

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2. Disburse $600 cash for administrative wages.

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4. Receive $4,000 cash for services performed.

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6. Declare a cash dividend of $5,000.

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8. Pay cash of $16,000 for a delivery van.

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The book value of any depreciable asset is the difference

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