Chapter 3

The Accounting Information

System

Prepared by:
Patricia Zima, CA
Mohawk College of Applied Arts and Technology
 The Accounting Information
System

Accounting Accounting Cycle Using a Appendix 3A-

Information Identifying and Worksheet Using
System recording Adjustments Reversing
Basic terminology Journalizing entered Entries
Debits and credits Posting Work sheet Accruals
columns
Accounting equation Trial balance Preparing financial Prepayments
Financial statements Adjusting entries statements from a Summary of
and ownership Adjusted trial balance work sheet
structure reversing entries
Closing entries
Closing
Monthly
Post-closing trial statements, yearly
balance closing
Reversing entries
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The accounting cycle
 Basic Terminology
Event: The cause of changes of assets,
liabilities, and equity

Transaction: A transfer or exchange between

two or more entities or parties

Account: Where transactions are recorded

A separate account is used for each asset,
liability, revenue, expense, gain, loss and
capital
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 Basic Terminology
Permanent accounts (or real accounts)
Asset, liability, and equity accounts
Appear on the balance sheet
Permanent accounts are not closed at year end
Temporary accounts (or nominal accounts)
Revenue, expense, and dividend accounts
Revenue and expenses are on the income
statement; dividends are on the equity statement
Temporary accounts are closed at year end

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 Basic Terminology
Journalizing and Posting
A Journal is a book of original entry for all
transactions
The General Journal is a chronological listing of
transactions expressed as debits and credits to
particular accounts (known as a journal entry)
Special Journals are used to summarize
transactions with common characteristics
(e.g. cash receipts, sales, purchases)
Posting: when the transaction information entered
in the journal is transferred to the general ledger
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 Basic Terminology
Ledger
Book (electronic database) containing all
accounts
Each account has a separate page
General ledger contains all asset, liability,
and all equity related accounts (capital,
revenue, and expenses)
Subsidiary ledger contains details related to
a specific general ledger account (example:
accounts receivable subsidiary ledger)
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 Basic Terminology
Trial balance
Listing of all accounts and their balances
from the general ledger at a given point in
time
Objective: prove the mathematical equality
of debits and credits after posting (i.e. to
ensure general ledger is in balance)
Prepared after end of period adjustments
(called Adjusted Trial Balance) and possibly
after closing entries (called Post-closing
Trial Balance)
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 Basic Terminology
Adjusting entries
Entries made at the end of an accounting period
Brings all accounts up to date on an accrual
accounting basis
Ensures that revenue recognition principle are
followed and that proper matching occurs
Four classifications of adjusting entries:
Prepayment Accruals
1. Prepaid expenses 2. Accrued revenues
3. Unearned revenues 4. Accrued expenses
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 Basic Terminology
Financial statements
Final summaries of the accounting data for a
specific time period
Four statements:
Balance Sheet-shows financial condition at
a specific date
Income Statement-measures the results of
operations during a period of time
Statement of Cash Flows-shows sources
and uses of cash
Statement of Retained Earnings
Optional: Statement of Comprehensive Income
(or as part of Income Statement) 9
 Debits and Credits
Debit (Dr.) Credit (Cr.)
To record or enter an To record or enter an
amount on the left side amount on the right side
of a general ledger of a general ledger
account account

This system of recording transactions is referred to as

the double-entry accounting system; the two-sided
effect of each transaction is recorded in appropriate
accounts
When a transaction is in balance, the debits equal the
credits
Debits and credits do not mean increases and
decreases 10
 The Accounting Equation

Assets = Liabilities + Shareholders Equity

Assets = Liabilities + Capital + Retained

Earnings*

*Retained Earnings = Revenues Expenses

Dividends

Assets = Liabilities + Capital + Revenues Expenses

Dividends

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 The Rules of Debit and
Credit
To increase the balance of any account,
record the amount in the normal balance
column
To decrease the balance of any account,
record the amount in the column opposite to
its normal balance
When any transaction is correctly recorded,
the accounting equation will remain in
balance

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 The Rules of Debit and
Credit
Account Debit Credit
Assets Increase Decrease

Liabilities Decrease Increase

Shareholders Equity Decrease Increase

Revenue Decrease Increase

Expenses Increase Decrease

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 Ownership Structure
Owners Dividends (for
investments corporation) or
(common shares for withdrawals (for
corporation) or proprietor or
capital (for partnership)
proprietor
or partnership)
Net Income Net Loss

+ -

Shareholders (or Owners) Equity

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 The Accounting Cycle: Steps
Analyse the transaction
Journalize the transaction
Post the transaction to general ledger (and
sub-ledgers) accounts
Prepare the (unadjusted) trial balance
Prepare necessary adjusting journal entries
Prepare the (adjusted) trial balance
Prepare financial statements
Prepare closing journal entries for the year
Prepare post-closing trial balance (optional)
Prepare reversing entries (optional) 15
 The Accounting Cycle
1 2
Identification and Record
measurement of transaction in
transactions journal 3
Post journal
7 entries to the
10 Prepare financial
Reversing entries ledgers
statements
4
6 Prepare trial
9 balance
Post-closing trial Adjusted trial
balance balance
5
8 Prepare adjusting
Close temporary Record adjusting journal entries
accounts journal entries to
worksheet (post to
the ledgers as well)
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 Recording a Transaction:
Shares are issued for $3,000
cash
Assets = Liabilities + Shareholders Equity

+ $3,000 + $3,000

To record this transaction as a journal entry (in

General Journal):
Dr. Cash $3,000
Cr. Common Shares $3,000
These amounts are then posted to the general
ledger
Cash Common
Shares
3,000 3,000
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 Preparation of Trial
Balance
PIONEER ADVERTISING AGENCY INC. at October 31, 2007
PIONEER ADVERTISING AGENCY INC. at October 31, 2007

Account Debit
Cash Credit
Cash 80,000
80,00 Accounts Receivable 72,000
0 Advertising Supplies 25,000
Notes Prepaid Insurance 6,000
Payable Office Equipment 50,000
50,00 Notes Payable 50,000
0 Accounts Payable
Dividen 25,000
ds Unearned Service Revenue
5,000
12,000
Revenu Common Shares
100,000
e
100,00 Dividends 5,000
0 Service Revenue
100,000
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Salaries Expense 40,000
 Preparation of Trial Balance
From the previous example, we can see that
the trial balance is in balance
However, the trial balance only proves the
mathematical accuracy of the ledger
Errors may still exist such as the following:
1. Transaction not recorded
2. Journal entry not posted
3. Journal entry posted twice
4. Incorrect accounts used in either the
journal or posting
5. Offsetting errors made during recording
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 Adjusting Journal Entries
Adjusting entries ensure that revenue
recognition and matching are followed within
the period
Reasons for adjusting entries include:
To record those events that are not
journalized daily
To record those costs, which expire with
time and are therefore not recorded
To record item previously unrecorded
Adjusting entries are required each time
financial statements are prepared 20
 Adjusting Entries

Prepayments Accruals

1. Prepayments made in
cash and recorded as 3. Revenues earned but not
assets before item is used yet received in cash and not
(Prepaid Expenses) recorded (Accrued Revenues)
2. Revenue received in 4. Expenses incurred but
cash and recorded as not yet paid in cash and not
liabilities before being recorded (Accrued Expenses)
earned (Unearned Revenue)
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 Adjusting Journal Entries
Prepaid expenses expire either with the
passage of time (e.g. rent and insurance) or by
being used and consumed (e.g. supplies)
Example: Company paid $6,000 for one year
insurance when coverage begins October 1
Adjust for Prepaid Insurance on Dec. 31 :
Dr Insurance Expense 1,500
Cr Prepaid Insurance 1,500
($6,000/12 * 3)

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 Adjusting Journal Entries
When payment is received from customers for
services (or goods) that will be provided in a future
accounting period, a liability (unearned revenue) is
recognized
e.g. Rent, magazine subscriptions, deposits
Example: Company received $12,000 for four
months advertising services that begins Oct. 1.
$12,000 was credited to unearned revenue
Adjustment required on December 31 :
Dr Unearned Revenue 9,000
Cr Service Revenue 9,000
($12,000/4 * 3)
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 Adjusting Journal Entries
Expenses must be accrued when they are
incurred; also revenues must be recorded as
earned
Accruals required: interest expense, salaries
expense, bad debts expense, interest earned
Example: assume on January 5, a company
pays $20,000 for salaries which includes
$10,000 of salaries for December
Adjustment required on December 31:
Dr Salaries Expense 10,000
Cr Salaries Payable 10,000
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 Closing Entries
Closing entries are made to close all nominal
accounts (revenue and expense accounts) for
the year
The balances in these accounts are
transferred to a clearing account (Income
Summary)
The balance in Income Summary represents
net income or net loss for the period
Real (or permanent) accounts are not closed
The Dividends account is closed to retained
earnings
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 Closing Entries
The following closing entries are made (assume
net income for the year):
1. Income Summary $$$
Expense Accounts (Individually) $$$
2. Revenue Accounts (Individually) $$$
Income Summary $$$
3. Income Summary $$$
Retained Earnings $$$
4. Retained Earnings $$$
Dividends $$$

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Scheme of Closing Entries

Ret. Earnings

Dividends Income Summary

4 3

Expense Revenue

1 2

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Closing Entries: Inventory

In a periodic inventory system, closing entries

are made to record cost of goods sold and
ending inventory
In a perpetual inventory system, such entries
are not required
See the following scheme of entries:

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 Closing Entry: Periodic
Inventory System
Dr Cr
To record Inventory
ending balance Inventory (ending) $ $
Purchases Returns
Purchases Returns $
$
Trans-In
Cost of Goods Sold $
$ Transportation-in $

Purchases
$ Purchases $ To remove
Inventory (Begin) $ beginning balance
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 Periodic Inventory:
Closing Entry
Collegiate Apparel Shop has the following
balances at year end. The company uses a
periodic inventory system.

Beginning Inventory $ 30,000

Purchases (gross) $200,000
Transportation-In $ 6,000
Purchases Returns $ 1,000
Purchase Discounts $ 3,000
Ending Inventory $ 26,000
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 Periodic Inventory:
Closing Entry
First Step: Determine Cost of Goods Sold
Beginning Inventory $ 30,000
Purchases $200,000
Less: Purchase returns $1,000
Purchase discounts 3,000 4,000
Net Purchases 196,000
Plus: Transportation-In 6,000
Cost of Goods Purchased 202,000
Cost of Goods Available for Sale 232,000
Less: Ending Inventory 26,000
Cost of Goods Sold $206,000
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 Periodic Inventory:
Closing Entry

Account Dr. Cr.

Cost of Goods Sold $ 206,000
Inventory (Ending) $ 26,000
Purchases Returns $ 1,000
Purchase Discounts $ 3,000

Purchases (Gross) $ 200,000

Transportation-in $ 6,000
Inventory (Beginning) $ 30,000

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 COPYRIGHT

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