Intermediate: Accounting

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

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”
• 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.

If the sum of Credit entries are greater than the sum of
Debit entries, the account will have a credit balance.



The Accounting Equation (1 of 5)
Relationship among the asset, liability and stockholders’
equity accounts of a business:
The equation must be in balance after every transaction.

For every Debit there must be a Credit.
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 on Equity Accounts

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 (1 of 2)
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 (2 of 2)
Illustration: On September 1, Softbyte Inc.'s shareholders
invested $15,000 cash in the corporation in exchange for shares of
stock. On the same date, Softbyte Inc. 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)
Pioneer Advertising
Chart of Accounts
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
158 Accumulated Depreciation— Revenues
Equipment 400 Service Revenue
Expenses
Liabilities 631 Supplies Expense
200 Notes Payable 711 Depreciation Expense
201 Accounts Payable 722 Insurance Expense
209 Unearned Service Revenue 726 Salaries and Wages Expense
212 Salaries and Wages Payable 729 Rent Expense
230 Interest Payable 732 Utilities Expense
905 Interest Expense
910 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











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

Pioneer Advertising
Trial Balance
October 31, 2020
Debit Credit
Cash $ 80,000
Accounts Receivable 72,000
Supplies 25,000
Prepaid Insurance 6,000
Equipment 50,000
Notes Payable $ 50,000
Accounts Payable 25,000
Unearned Service Revenue 12,000
Common Stock 100,000
Dividends 5,000
Service Revenue 100,000
Salaries and Wages Expense 40,000
Rent Expense 9,000 .
$287,000 $287,000

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
Adjusting entries 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 revenues 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:
Face Value Annual Time
of Note × Interest × in Terms of = Interest
Rate One Year
$50,000 × 12% × 1 / 12 = $500


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
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.


Adjusted Trial Balance (1 of 2)
Shows the balance of all accounts, after adjusting entries, at the
end of the accounting period.
Pioneer Advertising
Adjusted Trial Balance
October 31, 2020
Debit Credit
Cash $ 80,000
Accounts Receivable 74,000
Allowance for Doubtful Accounts $ 1,600
Supplies 10,000
Equipment 50,000
Accumulated Depreciation—Equipment 400
Notes Payable 50,000

Adjusted Trial Balance (2 of 2)
Debit Credit
Interest Payable 500
Dividends 5,000
Service Revenue 106,000
Supplies Expense 15,000
Rent Expense 9,000
Insurance Expense 500
Interest Expense 500
Depreciation Expense 400
Bad Debt Expense 1,600 .
$297,500 $297,500

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



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
Pioneer Advertising Account Debit Credit
Post-Closing Trial Balance Cash $ 80,000
October 31, 2020 Accounts Receivable 74,000
Allowance for Doubtful Accounts $ 1,600
Supplies 10,000
Equipment 50,000
Accumulated Depreciation—Equipment 400
Notes Payable 50,000
Interest Payable 500
Retained Earnings 28,000
$219,500 $219,500

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. Prepare 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)
Uptown Cabinet corp.
Retained Earnings Statement
For the Year Ended December 31, 2020
Retained earnings, January 1 $16,200
Add: Net income 12,200
28,400
Less: Dividends 2,000
Retained earnings, December 31 $26,400

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
• 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.
January 1, 2020 December 31, 2020
Accounts receivable $12,000 $9,000
Unearned service revenue -0- 4,000
Accrued liabilities 2,000 5,500
Prepaid expenses 1,800 2,700

Service Revenue Computation
Illustration: Calculate service revenue on an accrual basis.
Cash receipts from customers $300,000
− Beginning accounts receivable $(12,000)
+ Ending accounts receivable 9,000
+ Beginning unearned service revenue -0-
− Ending unearned service revenue (4,000) (7,000)
Service revenue (accrual) $293, 000


Operating Expense Computation
Illustration: Calculate operating expenses on an accrual basis.
Cash paid for operating expenses $170,000
+ Beginning prepaid expense $ 1,800
− Ending prepaid expense (2,700)
− Beginning accrued liabilities (2,000)
+ Ending accrued liabilities 5,500 2,600
Operating expenses (accrual) $172, 600



Versus 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

(2 of 3)
Illustration of Reversing Entries—Deferrals

(3 of 3)
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 on the previous slide:
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 G AAP and IFRS.
• Transaction analysis is the same under I FRS 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 text for
the key elements of financial statements, that is, assets, liabilities, equity,
revenues, and expenses.

Relevant Facts
Similarities
• A trial balance under I FRS 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 (I AASB) 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

The Accounting Information

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The equation must be in balance after every transaction.

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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Assets Stockholders’ Equity

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Adjusting entries are required every time a company

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