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