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Intermediate Accounting
IFRS Edition
Kieso, Weygandt, Warfield
Fourth Edition
Chapter 3
The Accounting Information System
Prepared by
Coby Harmon
University of California, Santa Barbara
Westmont College
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Copyright ©2020 John Wiley & Sons, Inc.
Learning Objectives
After studying this chapter, you should be able to:

LO 1 Describe the basic accounting information system.
LO 2 Record and summarize basic transactions.
LO 3 Identify and prepare adjusting entries.
LO 4 Prepare financial statements from the adjusted trial
balance and prepare closing entries.
LO 5 Prepare financial statements for a merchandising
company.
Copyright ©2020 John Wiley & Sons, Inc. 2

PREVIEW OF CHAPTER 3

Learning Objective 1
Describe the basic accounting
information system.
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Accounting Information System (1 of 3)
• Collects and processes transaction data.
• Disseminate financial information to interested parties.
• Varies widely from business to business – tailored made.
• Factors to shape the systems
o Nature of business
o Type of transactions
o Size of business
o Volume of data to be handled
o Informational requirements

A good accounting information system helps management answer
such questions as:
• How much and what kind of debt is outstanding?
• Were our 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 shareholders?
• Is our rate of return on net assets increasing?

Ledger Transaction Account Real Account Event
Nominal
Basic Terminology Account
 The happening of consequence which is the source or cause of changes in
assets, liabilities, and equity.
 An external event involving a transfer or exchange between two or more
entities.
 A systematic arrangement that shows the effect of transactions and other
events on a specific element.
 Asset, liability, and equity accounts
 Revenue, expense, and dividend accounts; except for dividends
 “Book of original entry”

Adjusting Financial Closing
Trial Balance Journal
Entries Statements Entries
Posting
Basic Terminology
 The “book of original entry” where the company initially records
transactions and the selected other events.
 The process of transferring the essential facts and figures from the journals
to the ledger accounts.
 The list of all open accounts in the ledger and their balances.
 Entries made at the end of an accounting period to bring all accounts up to
date.
 The collection, tabulation, and final summarization of the accounting data.
 The formal process to reduce all nominal accounts to zero and determine
and transfer the net income/loss to an equity account.
Debits and Credits
• The terms debit and credit have Latin roots. The term debit
comes from the word debitum, meaning "what is due," and
credit comes from creditum, defined as "something entrusted
to another or a loan.“
• However, the terms debit (Dr.) and credit (Cr.) also mean left
and right, respectively.
• Double-entry accounting system (two-sided effect).
• Recording done by debiting at least one account and crediting
another.
• DEBITS must equal CREDITS.
Source: https://egrove.olemiss.edu/cgi/viewcontent.cgi?article=1225&context=aah_journal

Double Entry (Debit and Credit) Accounting
System
ILLUSTRATION 3.1

The Basic Accounting Equation
ILLUSTRATION 3.2

The Expanded Accounting Equation
ILLUSTRATION 3.3
The equation must be in balance after every transaction. For
every Debit there must be a Credit.

Transactions for Perez Inc.
Transaction 1

Transaction 2

Transaction 3

Transaction 4

Transaction 5

Transaction 6

Transaction 7

Transaction 8
Note that the accounting equation equality is maintained after recording each
transaction.

Financial Statements and Ownership Structure
Ownership structure dictates the types of accounts that are part of the
equity section.
Proprietorship or Partnership Corporation
• Owner’s Capital • Share capital
• Owner’s Drawing • Share premium
• Dividends
• Retained Earnings

Income Statement and Equity Relationships
ILLUSTRATION 3.4

Effects of Transactions on Equity Accounts
ILLUSTRATION 3.5

The Accounting Cycle
ILLUSTRATION 3.6

The Accounting Cycle
Identify and Recording Transactions and Other Events
An item should be recognized in the financial statements

provided that the item meets the definition of one of the
elements of financial statements and if such recognition
provides users of financial statements with
a) relevant information about the asset or the liability
and about any income, expenses, or changes in equity
and
b) a faithful representation of the asset or the liability
and of any income, expenses, or changes in equity.

Record and summarize basic
transactions.

Technique of Journalizing
Recording transactions and events that effect particular asset, liability, equity,
revenue, and expense accounts.
September 1: Shareholders invested ₺15,000 cash in the corporation in exchange
for ordinary shares.
September 1: Purchase computer equipment for ₺7,000 cash.
ILLUSTRATION 3.7

Posting a Journal Entry
Posting – The process of transferring amounts from the journal to

the ledger accounts.
ILLUSTRATION 3.8

Chart of Accounts (CoAs)
Chart of accounts lists the accounts and the account numbers

that identify their location in the ledger.
The numbering system that identifies the accounts usually
starts with the statement of financial position accounts and
follows with the income statement accounts.

Chart of Accounts Illustration
ILLUSTRATION 3.9

The Recording Process Illustrated
The next ten slides show the basic steps in the recording process,
using the October transactions of Yazici Advertising A.Ş. Yazici’s
accounting period is a month.
A basic analysis and a debit-credit analysis precede the journalizing
and posting of each transaction.
For simplicity, we use the T-account form in the illustrations instead
of the standard account form.

Investment of Cash by Shareholders
ILLUSTRATION 3.10

Purchase of Office Equipment
ILLUSTRATION 3.11

Receipt of Cash for Future Service
ILLUSTRATION 3.12

Payment of Monthly Rent
ILLUSTRATION 3.13

Payment for Insurance
ILLUSTRATION 3.14

Purchase of Supplies on Credit
ILLUSTRATION 3.15

Signing a Contract
ILLUSTRATION 3.16
Declaration and Payment of Dividend
ILLUSTRATION 3.17

Payment of Salaries
ILLUSTRATION 3.18

Receipt of Cash for Services Provided
ILLUSTRATION 3.19

Trial Balance
A Trial Balance
• List of each account and its balance at a given time in the
order in which they appear in the ledger.
• Debit balances listed in the left column and credit balance
in the right column.
• Used to prove the mathematical equality of debit and
credit balances.
• Uncovers errors in journalizing and posting.

Trial Balance (Unadjusted)
ILLUSTRATION 3.20
Identify and prepare adjusting entries.

Identify and Prepare Adjusting Entries
Makes it possible to:

• Report on the statement of financial position the
appropriate assets, liabilities, and equity at the statement
date.
• Report on the income statement the proper revenues and
expenses for the period.
• Adjusting entries are required every time a company,
prepares financial statements.
• Companies date the entries as of the statement of
financial position date.
Categories of Adjusting Entries
ILLUSTRATION 3.21

Deferrals
Deferrals are expenses or revenues that are recognized at a date

later than the point when cash was originally exchanged.
Two types of deferrals
• Prepaid expenses
• Unearned revenues
If a company does not make an adjustment for these deferrals,
• the asset and liability are overstated, and
• the related expense and revenue are understated.

Adjusting Entries for Deferrals
ILLUSTRATION 3.22

Adjustment for Supplies
ILLUSTRATION 3.23

Supplies
Statement Presentation:
Supplies identifies that portion of
the asset’s cost that will provide
future economic benefit.
ILLUSTRATION 3.37

Supplies Expense
Supplies expense shows a balance
of ₺15,000, which equals the cost
of supplies used in October.
ILLUSTRATION 3.36

Adjustment for Insurance
ILLUSTRATION 3.24

Prepaid Insurance
Prepaid Insurance represents the
unexpired cost for the remaining
11 months of coverage.
ILLUSTRATION 3.37

Insurance Expense
Insurance expense identifies
that portion of the asset’s cost
that expired in October.
ILLUSTRATION 3.36

Adjustment for Depreciation
ILLUSTRATION 3.25

Accumulated Depreciation
Accumulated Depreciation is a
contra asset account.
ILLUSTRATION 3.37

Depreciation Expense
Depreciation expense identifies
that portion of the asset’s cost
that expired in October.
ILLUSTRATION 3.36

Adjustment for Unearned Service Revenue
ILLUSTRATION 3.27

Unearned Service Revenue
Unearned service revenue
represents the remaining
advertising services expected to
be performed in the future.
ILLUSTRATION 3.37

Service Revenue
Service revenue shows total
revenue recognized in October.
*The Service revenue balance is
after posting an adjusting entry
for accrued revenue shown in
Slide 62.
ILLUSTRATION 3.36

Adjusting Entries for Accruals
Accruals are made to record

• revenues for services performed and
• expenses incurred in the current accounting period.
Without an accrual adjustment, the
• revenue account (and the related asset account) or the
• expense account (and the related liability account) are
understated.

ILLUSTRATION 3.28

Adjustment for Receivable and Revenue
Accounts
ILLUSTRATION 3.29

Accounts Receivable
Accounts Receivable shows total
amount owed by customers on
October 31, 2022.
ILLUSTRATION 3.37

Service Revenue
Service revenue shows total
revenue recognized in October.
ILLUSTRATION 3.36

Formula for Computing Interest
Accrued Interest. Yazici 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:
ILLUSTRATION 3.30

Adjustment for Interest
ILLUSTRATION 3.31

Interest Payable
Interest Payable shows the
interest owed by Yazici
Advertising on October 31,
2022.
ILLUSTRATION 3.37

Interest Expense
Interest Expense shows total
interest recognized in October.
ILLUSTRATION 3.36

Adjustment for Salaries and Wages Expense
ILLUSTRATION 3.32

Adjustment for Salaries and Wages Expense
ILLUSTRATION 3.33

Salaries and Wages Payable
Salaries and Wages Payable
shows the salaries and wages
owed by Yazici Advertising on
October 31, 2022.
ILLUSTRATION 3.37

Salaries and Wages Expense
Salaries and Wages Expense
shows total salaries and wages
recognized in October.
ILLUSTRATION 3.36

Adjustment for Bad Debt
ILLUSTRATION 3.34

Allowance for Doubtful Accounts
Allowance for Doubtful
Accounts is a contra asset
account.
ILLUSTRATION 3.37

Bad Debt Expense
Bad Debt Expense is a non-cash
expense.
ILLUSTRATION 3.36

Adjusted Trial Balance
Shows the balance of all

accounts, after adjusting
entries, at the end of the
accounting period.
Proves the equality of the
total debit and credit
balances
ILLUSTRATION 3.35

Prepare financial statements from the
adjusted trial balance and prepare closing
entries.

Preparing Financial Statements
Income Statement and Retained Earnings Statement
ILLUSTRATION 3.36

Preparing Financial Statements
Statement of Financial Position
ILLUSTRATION 3.37

Closing
Closing Process
• Reduce the balance of nominal (temporary) accounts to zero in
preparation for the next period’s transactions.
• Transfer all revenue and expense account balances (income
statement accounts) to an account called Income Summary.
• Income Summary balance is then transferred to Retained
Earnings.
• Statement of financial position (asset, liability, and equity)
accounts are not closed.
• Dividends are closed directly to Retained Earnings.

Closing Entries Journalized
ILLUSTRATION 3.38

Posting of Closing Entries
ILLUSTRATION 3.39

Post-Closing Trial Balance
ILLUSTRATION 3.40

The 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 trial balance after closing (post-closing trial balance).
9. Prepare reversing entries (optional) and post to the ledger(s).
Prepare financial statements for a
merchandising company.

Financial Statements for a Merchandising
Company
The income statement for Ciner Cabinets is shown in
Illustration 3.41.
The income statement classifies amounts into such categories
as gross profit on sales, income from operations, income
before income taxes, and net income.
Earnings per share information is required to be shown on the
face of the income statement for a company, although we
omit this item here.

Income Statement for a Merchandising
Company
ILLUSTRATION 3.41
Retained Earnings Statement for a
Merchandising Co.
ILLUSTRATION 3.42

Statement of Financial Position for a
Merchandising Company
ILLUSTRATION 3.43

Differentiate the cash basis of
accounting from the accrual basis of
accounting.

Cash-Basis vs. Accrual-Basis Accounting
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 Cash basis financial
• statements are not
record revenue only when they receive cash, and
in conformity with
• record expenses only when they disperse cash. IFRS.

Cash-Basis Accounting
Income Statement
Illustration: Eser Contractor signs an agreement to construct a garage for
₺22,000. In January, Eser begins construction, incurs costs of ₺18,000 on
credit, and by the end of January delivers a finished garage to the buyer.
In February, Eser collects ₺22,000 cash from the customer. In March, Eser
pays the ₺18,000 due the creditors.
ILLUSTRATION 3A.1

Cash-Basis Accounting
ILLUSTRATION 3A.3

Accrual-Basis Accounting
Income Statement
ILLUSTRATION 3A.2

Accrual-Basis Accounting
ILLUSTRATION 3A.4

Conversion from Cash to Accrual Basis
Illustration: Dr. L. Liwan, like many small business owners, keeps her accounting
records on a cash basis. In the year 2022, Dr. Liwan 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, 2022, she has accounts receivable, unearned service revenue,
accrued liabilities, and prepaid expenses as shown below.
ILLUSTRATION 3A.5

Service Revenue Computation
To convert the amount of cash received from patients to service revenue on an accrual
basis, we must consider changes in accounts receivable and unearned service revenue
during the year.
ILLUSTRATION 3A.6
ILLUSTRATION 3A.7
ILLUSTRATION 3A.8
Operating Expense Computation
To convert cash paid for operating expenses during the year to operating expenses on an
accrual basis, we must consider changes in prepaid expenses and accrued liabilities.
ILLUSTRATION 3A.9
ILLUSTRATION 3A.10
ILLUSTRATION 3A.11
Conversion Worksheet
ILLUSTRATION 3A.12

Theoretical Weakness 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.

Identify adjusting entries that may be
reversed.

Using Reversing Entries for Accruals
A company most often uses reversing entries to reverse two

types of adjusting entries:
1. accrued revenues and
2. accrued expenses.

January February
Report deadline Invoices received 105 Baht

6 February 20X1 8 February 20X1
Expenses incurred
End of month
What should we do with the expenses? 31 January 20X1
1) Wait for invoices and submit late 3) Send report on 6th with fake numbers
2) Send report on 6th without expenses 4) None is correct.

January February
Dec’s Expenses were
100 Baht Report deadline Invoices received 105 Baht
6 February 20X1 8 February 20X1
It is calculable at 103
Baht
Expenses incurred
End of month
How much should we record the expenses? 31 January 20X1
1) 100 Baht 3) 103 Baht
2) 105 Baht 4) None is correct.

Comparison of Entries for Accruals, With
and Without Reversing Entries
ILLUSTRATION 3B.1

Using Reversing Entries for Deferrals
Up to this point, we assumed the recording of all deferrals as

prepaid expense or unearned revenue. In some cases, though, a
company records deferrals directly in expense or revenue accounts.
When this occurs, a company may also reverse deferrals.
To illustrate the use of reversing entries for prepaid expenses, we
use the following transaction and adjustment data.
1. December 10 (initial entry): Purchased 20,000 of supplies with
cash.
2. December 31 (adjusting entry): Determined that 5,000 of
supplies are on hand.

Comparison of Entries for Deferrals, With
and Without Reversing Entries
ILLUSTRATION 3B.2

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.
Reversing entries are optional to be used.

Prepare a 10-column worksheet.

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

Worksheet Columns
Worksheet Columns
• Trial Balance Columns
• Adjustment Columns
• Adjusted Trial Balance
• Income Statement
• Statement of Financial Position

Use of a Worksheet
ILLUSTRATION 3C.1

Preparing Financial Statements from a
Worksheet
Preparing Financial Statements from a Worksheet
The Worksheet:
• provides information needed for preparation of the
financial statements.
• Sorts data into appropriate columns, which facilitates the
preparation of the statements.

Compare the accounting information
systems under IFRS and U.S. GAAP.

Global Accounting Insights
As indicated in this chapter, companies must have an effective

accounting system. In the wake of accounting scandals at U.S.
companies like Sunbeam, Rite-Aid, Xerox, and WorldCom,
U.S. lawmakers demanded higher assurance on the quality of
accounting reports. Since the passage of the Sarbanes-Oxley
Act (SOX), companies that trade on U.S. exchanges are
required to place renewed focus on their accounting systems
to ensure accurate reporting.

Similarities
• International companies use the same set of procedures and records
to keep track of transaction data. Thus, the material in Chapter 3
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 U.S. GAAP and IFRS.
• Transaction analysis is the same under U.S. GAAP and IFRS but, as you
will see in later chapters, different standards sometimes impact how
transactions are recorded.

More Similarities
• Both the FASB and IASB go beyond the basic definitions
provided in this textbook for the key elements of financial
statements, that is, assets, liabilities, equity, revenues, and
expenses.
• A trial balance under U.S. GAAP follows the same format as
shown in the textbook. As shown in the textbook, currency
signs are typically used only in the trial balance and the
financial statements. The same practice is followed under U.S.
GAAP.

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

On the Horizon
High-quality international accounting requires both high-quality
accounting standards and high-quality auditing. Similar to the
convergence of U.S. 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 S OX
remains to be seen. You can follow developments in the international
audit arena at http:// www.ifac.org/iaasb/.

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Copyright © 2020 John Wiley & Sons, Inc.
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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

After studying this chapter, you should be able to:

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An item should be recognized in the financial statements

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Posting – The process of transferring amounts from the journal to

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Chart of accounts lists the accounts and the account numbers

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Makes it possible to:

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Deferrals are expenses or revenues that are recognized at a date

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Accruals are made to record