Chapter 3-1
An Accounting Information System (AIS)
collects and processes transaction data and
disseminates the information to interested parties.
Internal controls are a system of checks and balances within the AIS
designed to maintain good accounting records and prevent and detect fraud and errors.
Sarbanes Oxley act of 2002 requires large public Companies to have internal controls attested to by auditors.
Accounting Information SystemAccounting Information SystemAccounting Information SystemAccounting Information System
Chapter 3-2
The Accounting CycleThe Accounting CycleThe Accounting CycleThe Accounting Cycle
TransactionsTransactions
1. Journalization1. Journalization
6. Financial Statements6. Financial Statements
7. Closing entries7. Closing entries
8. Post-closing trail balance
8. Post-closing trail balance
9. Reversing entries9. Reversing entries
3. Trial balance3. Trial balance
2. Posting2. Posting
5. Adjusted trial balance5. Adjusted trial balance
4. Adjustments4. AdjustmentsWork SheetWork Sheet
Chapter 3-3
Transactions and EventsTransactions and EventsTransactions and EventsTransactions and Events
What to Record?What to Record?
FASB states, “transactions and other events and circumstances that affect a business enterprise.”
Types of Events:Types of Events:
External – between a business and its environment.
Internal – event occurring entirely within a business.
Chapter 3-4
General JournalGeneral Journal – a chronological record of transactions. Journal Entries are recorded in the journal.
Account Title Ref. Debit Credit
J an. 3 Cash 100 100,000
Common stock 300 100,000
10 Building 130 150,000
Note payable 220 150,000
Date
1. Journalizing1. Journalizing1. Journalizing1. Journalizing
General Journal
Chapter 3-5
Posting Posting – the process of transferring amounts from the journal to the ledger accounts.
Cash Acct. No. 100
Date Explanation Ref. Debit Credit Balance
General Ledger
Account Title Ref. Debit Credit
J an. 3 Cash 100,000
Common stock 100,000
Date
General Journal
Jan. 3 Sale of stock GJ1 100,000 100,000
100
GJ1
2. Posting2. Posting2. Posting2. Posting
Chapter 3-6
Posting Posting – the process of transferring amounts from the journal to the ledger accounts.
Common Stock Acct. No. 300
Date Explanation Ref. Debit Credit Balance
General Ledger
Account Title Ref. Debit Credit
J an. 3 Cash 100 100,000
Common stock 100,000
Date
General Journal
Jan. 3 Sale of stock GJ1 100,000 100,000
300
GJ1
2. Posting2. Posting2. Posting2. Posting
Chapter 3-7
Trial BalanceTrial Balance – a list of each account and its balance; used to prove equality of debit and credit balances.
Acct. No. Account Debit Credit
100 Cash 140,000$ 105 Accounts receivable 35,000 110 I nventory 30,000 130 Building 150,000 200 Accounts payable 60,000$ 220 Note payable 150,000 300 Common stock 100,000 330 Retained earnings400 Sales 75,000 500 Cost of goods sold 30,000
385,000$ 385,000$
3. Trial Balance3. Trial Balance3. Trial Balance3. Trial Balance
Chapter 3-8
4. Adjusting Entries4. Adjusting Entries4. Adjusting Entries4. Adjusting Entries
RevenuesRevenues - recorded in the period in which - recorded in the period in which they are earned and realizablethey are earned and realizable.
Expenses Expenses - recognized in the period in which - recognized in the period in which they are incurredthey are incurred.
Adjusting entriesAdjusting entries - needed to ensure that all - needed to ensure that all assets and liabilities that should be recorded assets and liabilities that should be recorded are recorded as of the end of the period are recorded as of the end of the period reported.reported.
revenue recognitionrevenue recognition and and expense expense recognition principlesrecognition principles are followed. are followed.
Chapter 3-9
Classes of Adjusting EntriesClasses of Adjusting EntriesClasses of Adjusting EntriesClasses of Adjusting Entries
Prepayments & DeferralsPrepayments & Deferrals
AccrualsAccruals
Revaluations & estimatesRevaluations & estimates
Chapter 3-10
Payment of cash that is recorded as an asset because Payment of cash that is recorded as an asset because service or benefit will be received in the future.service or benefit will be received in the future.
Adjusting Entries – “Prepaid Adjusting Entries – “Prepaid Expenses”Expenses”
Adjusting Entries – “Prepaid Adjusting Entries – “Prepaid Expenses”Expenses”
insuranceinsurance
suppliessupplies
advertisingadvertising
Cash PaymentCash Payment Expense RecordedExpense RecordedBEFORE
rentrent
maintenance on maintenance on equipmentequipment
fixed assetsfixed assets
Prepayments often occur in regard to:Prepayments often occur in regard to:
Chapter 3-11
Example:Example: On Jan. 1On Jan. 1stst, Phoenix Corp. paid $12,000 for , Phoenix Corp. paid $12,000 for 12 months of insurance coverage. Show the journal 12 months of insurance coverage. Show the journal entry to record the payment on Jan. 1entry to record the payment on Jan. 1stst. .
Adjusting Entries – “Prepaid Adjusting Entries – “Prepaid Expenses”Expenses”
Adjusting Entries – “Prepaid Adjusting Entries – “Prepaid Expenses”Expenses”
Cash 12,000
Prepaid insurance 12,000
Jan. 1
Debit Credit
Prepaid Insurance
12,00012,000 12,00012,000
Debit Credit
Cash
Chapter 3-12
Example:Example: On Jan. 1On Jan. 1stst, Phoenix Corp. paid $12,000 for , Phoenix Corp. paid $12,000 for 12 months of insurance coverage. Show the 12 months of insurance coverage. Show the adjusting adjusting journal entryjournal entry required at Jan. 31 required at Jan. 31stst. .
Adjusting Entries – “Prepaid Adjusting Entries – “Prepaid Expenses”Expenses”
Adjusting Entries – “Prepaid Adjusting Entries – “Prepaid Expenses”Expenses”
Prepaid insurance 1,000
Insurance expense 1,000Jan. 31
Debit Credit
Prepaid Insurance
12,00012,000 1,0001,000
Debit Credit
Insurance expense
1,0001,000
11,00011,000
Chapter 3-13
Receipt of cash that is recorded as a liability Receipt of cash that is recorded as a liability because the revenue has not been earned.because the revenue has not been earned.
Adjusting Entries – “Unearned Adjusting Entries – “Unearned Revenues”Revenues”
Adjusting Entries – “Unearned Adjusting Entries – “Unearned Revenues”Revenues”
rentrent
airline ticketsairline tickets
school tuitionschool tuition
Cash ReceiptCash Receipt Revenue RecordedRevenue RecordedBEFORE
magazine subscriptionsmagazine subscriptions
customer depositscustomer deposits
Unearned revenues often occur in regard to:Unearned revenues often occur in regard to:
Chapter 3-14
Example:Example: On Nov. 1On Nov. 1stst, Phoenix Corp. received $24,000 , Phoenix Corp. received $24,000 from Arcadia High School for 3 months rent in advance. from Arcadia High School for 3 months rent in advance. Show the journal entry to record the receipt on Nov. 1Show the journal entry to record the receipt on Nov. 1stst. .
Unearned rent revenue
24,000
Cash 24,000
Nov. 1
Debit Credit
Cash
24,00024,000 24,00024,000
Debit Credit
Unearned Rent Revenue
Adjusting Entries – “Unearned Adjusting Entries – “Unearned Revenues”Revenues”
Adjusting Entries – “Unearned Adjusting Entries – “Unearned Revenues”Revenues”
Chapter 3-15
Example:Example: On Nov. 1On Nov. 1stst, Phoenix Corp. received $24,000 , Phoenix Corp. received $24,000 from Arcadia High School for 3 months rent in advance. from Arcadia High School for 3 months rent in advance. Show the Show the adjusting journal entryadjusting journal entry required on Nov. 30 required on Nov. 30thth. .
Rent revenue 8,000
Unearned rent revenue 8,000Nov. 30
Debit Credit
Rent Revenue
8,0008,000 24,00024,000
Debit Credit
Unearned Rent Revenue
Adjusting Entries – “Unearned Adjusting Entries – “Unearned Revenues”Revenues”
Adjusting Entries – “Unearned Adjusting Entries – “Unearned Revenues”Revenues”
8,0008,000
16,00016,000
Chapter 3-16
Revenues earned but not yet received in cash or Revenues earned but not yet received in cash or recorded.recorded.
Adjusting Entries – “Accrued Adjusting Entries – “Accrued Revenues”Revenues”
Adjusting Entries – “Accrued Adjusting Entries – “Accrued Revenues”Revenues”
rentrent
interestinterest
services performedservices performed
BEFORE
Accrued revenues often occur in regard to:Accrued revenues often occur in regard to:
Cash ReceiptCash ReceiptRevenue RecordedRevenue Recorded
Adjusting entry results in:Adjusting entry results in:
Chapter 3-17
Example:Example: On July 1On July 1stst, Phoenix Corp. invested $300,000 , Phoenix Corp. invested $300,000 in securities that return 5% interest per year. Show the in securities that return 5% interest per year. Show the journal entry to record the investment on July 1journal entry to record the investment on July 1stst. .
Cash 300,000
Investments 300,000
July 1
Debit Credit
Investments
300,000300,000 300,000300,000
Debit Credit
Cash
Adjusting Entries – “Accrued Adjusting Entries – “Accrued Revenues”Revenues”
Adjusting Entries – “Accrued Adjusting Entries – “Accrued Revenues”Revenues”
Chapter 3-18
Example:Example: On July 1On July 1stst, Phoenix Corp. invested $300,000 , Phoenix Corp. invested $300,000 in securities that return 5% interest per year. Show the in securities that return 5% interest per year. Show the adjusting journal entryadjusting journal entry required on July 31 required on July 31stst. .
Interest revenue 1,250
Interest receivable 1,250July 31
Debit Credit
Interest Receivable
1,2501,250 1,2501,250
Debit Credit
Interest Revenue
Adjusting Entries – “Accrued Adjusting Entries – “Accrued Revenues”Revenues”
Adjusting Entries – “Accrued Adjusting Entries – “Accrued Revenues”Revenues”
Chapter 3-19
Expenses incurred but not yet paid in cash or Expenses incurred but not yet paid in cash or recorded.recorded.
Adjusting Entries – “Accrued Adjusting Entries – “Accrued Expenses”Expenses”
Adjusting Entries – “Accrued Adjusting Entries – “Accrued Expenses”Expenses”
rentrent
interestinterest
taxestaxes
BEFORE
Accrued expenses often occur in regard to:Accrued expenses often occur in regard to:
Cash PaymentCash PaymentExpense RecordedExpense Recorded
salariessalaries
Adjusting entry results in:Adjusting entry results in:
Chapter 3-20
Notes payable 200,000
Cash 200,000
Feb. 2
Debit Credit
Cash
200,000200,000 200,000200,000
Debit Credit
Notes Payable
Adjusting Entries – “Accrued Adjusting Entries – “Accrued Expenses”Expenses”
Adjusting Entries – “Accrued Adjusting Entries – “Accrued Expenses”Expenses”
Example:Example: On Feb. 2On Feb. 2ndnd, Phoenix Corp. borrowed $200,000 , Phoenix Corp. borrowed $200,000 at a rate of 9% per year. Interest is due on first of each at a rate of 9% per year. Interest is due on first of each month. Show the journal entry to record the borrowing on month. Show the journal entry to record the borrowing on Feb. 2Feb. 2ndnd..
Chapter 3-21
Example:Example: On Feb. 2On Feb. 2ndnd, Phoenix Corp. borrowed $200,000 , Phoenix Corp. borrowed $200,000 at a rate of 9% per year. Interest is due on first of each at a rate of 9% per year. Interest is due on first of each month. Show the month. Show the adjusting journal entryadjusting journal entry required on Feb. required on Feb. 2828thth..
Interest payable 1,500
Interest expense 1,500Feb. 28
Debit Credit
Interest Expense
1,5001,500 1,5001,500
Debit Credit
Interest Payable
Adjusting Entries – “Accrued Adjusting Entries – “Accrued Expenses”Expenses”
Adjusting Entries – “Accrued Adjusting Entries – “Accrued Expenses”Expenses”
Chapter 3-22
Revaluations of impaired assets and other Revaluations of impaired assets and other adjustments to fair market valueadjustments to fair market value
Marking Available for sale securities to marketMarking Available for sale securities to market
Good Will ImpairmentGood Will Impairment
Calculations of estimatesCalculations of estimates
Bad debt expenseBad debt expense
Adjust Entries –”Revaluation & Adjust Entries –”Revaluation & Estimates”Estimates”
Adjust Entries –”Revaluation & Adjust Entries –”Revaluation & Estimates”Estimates”
Chapter 3-23
Shows the balance of all accounts, after adjusting entries, at the end of the accounting period.
5. Adjusted Trial Balance5. Adjusted Trial Balance5. Adjusted Trial Balance5. Adjusted Trial Balance
Chapter 3-24
6. Preparing Financial Statements6. Preparing Financial Statements6. Preparing Financial Statements6. Preparing Financial Statements
Financial Statements are prepared directly from the Adjusted Trial Balance.
Financial Statements are prepared directly from the Adjusted Trial Balance.
Balance Sheet
Income Statemen
t
Statement of Cash
Flows
Statement of
Retained Earnings
Chapter 3-25
Adjusted Trial Balance Debit Credit
Cash 140,000$ Accounts receivable 35,000 Building 190,000 Note payable 150,000$ Common stock 100,000 Retained earnings 38,000 Dividends declared 10,000 Sales 185,000 I nterest income 17,000 Cost of goods sold 47,000 Salary expense 25,000 Depreciation expense 43,000
490,000$ 490,000$
I ncome Statement
Revenues:
Sales 185,000$ I nterest income 17,000
Total revenue 202,000 Expenses:
Cost of goods sold 47,000 Salary expense 25,000 Depreciation expense 43,000
Total expenses 115,000 Net income 87,000$
6. Preparing Financial Statements6. Preparing Financial Statements6. Preparing Financial Statements6. Preparing Financial Statements
Income Statement
Assume the following Adjusted Trial Balance
Chapter 3-26
Adjusted Trial Balance Debit Credit
Cash 140,000$ Accounts receivable 35,000 Building 190,000 Note payable 150,000$ Common stock 100,000 Retained earnings 38,000 Dividends declared 10,000 Sales 185,000 I nterest income 17,000 Cost of goods sold 47,000 Salary expense 25,000 Depreciation expense 43,000
490,000$ 490,000$
Statement of Retained Earnings
Beginning balance 38,000$ + Net income 87,000 - Dividends (10,000) Ending balance 115,000
6. Preparing Financial Statements6. Preparing Financial Statements6. Preparing Financial Statements6. Preparing Financial Statements
Statement of Retained Earnings
Assume the following Adjusted Trial Balance
Chapter 3-27
Adjusted Trial Balance Debit Credit
Cash 140,000$ Accounts receivable 35,000 Building 190,000 Note payable 150,000$ Common stock 100,000 Retained earnings 38,000 Dividends declared 10,000 Sales 185,000 I nterest income 17,000 Cost of goods sold 47,000 Salary expense 25,000 Depreciation expense 43,000
490,000$ 490,000$
Balance Sheet
Assets
Cash 140,000$ Accounts receivable 35,000 Building 190,000
Total assets 365,000$
Liabilities
Note payable 150,000 Stockholders' equity
Common stock 100,000 Retained earnings 115,000
Total liab. & equity 365,000$
6. Preparing Financial Statements6. Preparing Financial Statements6. Preparing Financial Statements6. Preparing Financial Statements
Balance SheetAssume the following Adjusted Trial Balance
Chapter 3-28
7. Closing Entries7. Closing Entries7. Closing Entries7. Closing Entries
To reduce the balance of the income To reduce the balance of the income statement (statement (revenuerevenue and and expenseexpense) accounts ) accounts to zero. to zero.
To transfer net income or net loss to owner’s To transfer net income or net loss to owner’s equity (through the Retained Earnings equity (through the Retained Earnings account).account).
Dividends are also closed directly to the Dividends are also closed directly to the Retained Earnings account.Retained Earnings account.
Balance sheet (Balance sheet (assetasset, , liabilityliability, and , and equityequity) ) accounts are not closed.accounts are not closed.
Chapter 3-29
7. Closing Entries7. Closing Entries7. Closing Entries7. Closing Entries
ExampleExample: Ex 3-16: Ex 3-16
Chapter 3-30
8. Post-Closing Trial Balance8. Post-Closing Trial Balance8. Post-Closing Trial Balance8. Post-Closing Trial Balance
LO 7 Prepare closing LO 7 Prepare closing entries.entries.
Example Example continued:continued:
Acct. No. Account Debit Credit
100 Cash 140,000$ 105 Accounts receivable 35,000 130 Building 190,000 220 Note payable 150,000$ 300 Common stock 100,000 330 Retained earnings 115,000 380 Dividends declared - 400 Sales - 430 I nterest income - 500 Cost of goods sold - 520 Salary expense - 550 Depreciation expense -
365,000$ 365,000$
Chapter 3-31
Most companies use accrual-basis accounting
recognize revenue when it is earned 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, and
record expenses only when they disperse cash.
Cash basis financial statements are not in conformity with GAAP.
Chapter 3-32
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.
Illustration 3A-1
Chapter 3-33
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.
Illustration 3A-2
Chapter 3-34
Conversion From Cash Basis To Accrual Conversion From Cash Basis To Accrual BasisBasisIllustration: Dr. Diane Windsor, like many small business owners, keeps her accounting records on a cash basis. In the year 2010, 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, 2010, she has accounts receivable, unearned service revenue, accrued liabilities, and prepaid expenses as shown in Illustration 3A-5. Illustration 3A-
5
Chapter 3-35
Conversion From Cash Basis To Accrual Conversion From Cash Basis To Accrual BasisBasisIllustration: Calculate service revenue on an accrual basis.
Illustration 3A-5
Illustration 3A-8
Chapter 3-36
Conversion From Cash Basis To Accrual Conversion From Cash Basis To Accrual BasisBasisIllustration: Calculate operating expenses on an accrual basis.
Illustration 3A-5
Illustration 3A-11