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chapter
3
THE ACCOUNTING
INFORMATION SYSTEM
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Scan Study Objectives
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Read Feature Story
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Read Text and Answer Do it!
p. 110
p. 116
p. 119
After studying this chapter, you should be able to:
p. 128
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Work Using the Decision Toolkit
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Review Summary of Study Objectives
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Work Comprehensive Do it! p. 133
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Answer Self-Test Questions
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100
study objectives
Read A Look at IFRS p. 159
1 Analyze the effect of business transactions on the basic
accounting equation.
2 Explain what an account is and how it helps in the recording
process.
3 Define debits and credits and explain how they are used to
record business transactions.
4 Identify the basic steps in the recording process.
5 Explain what a journal is and how it helps in the recording
process.
6 Explain what a ledger is and how it helps in the recording
process.
7 Explain what posting is and how it helps in the recording
process.
8 Explain the purposes of a trial balance.
9 Classify cash activities as operating, investing, or
financing.
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feature story
How organized are you financially? Take a short quiz.
sending us some money—now what did we do with
Answer yes or no to each question:
that?”
To ensure the accuracy of your balance and the
• Does your wallet contain so many cash machine
security of your funds, Fidelity Investments, like all
receipts that you’ve been declared a walking fire
other companies large and small, relies on a sophisti-
hazard?
cated accounting information system. That’s not to say
• Is your wallet such a mess that it is often faster to
that Fidelity or any other company is error-free. In fact,
fish for money in the crack of your car
seat than to dig around in your wallet?
• Was Steve Nash playing high school
basketball the last time you balanced
AC C I D E NTS
HAP P E N
your bank account?
if you’ve ever really messed up your
checkbook register, you may take some
comfort from one accountant’s mistake
at Fidelity Investments. The accountant
failed to include a minus sign while doing a calcula-
• Have you ever been tempted to burn down your
tion, making what was actually a $1.3 billion loss look
house so you don’t have to try to find all of the re-
like a $1.3 billion gain—yes, billion! Fortunately, like
ceipts and records that you need to fill out your tax
most accounting errors, it was detected before any
returns?
real harm was done.
No one expects that kind of mistake at a company
If you think it is hard to keep track of the many
like Fidelity, which has sophisticated computer sys-
transactions that make up your life, imagine what it is
tems and top investment managers. In explaining the
like for a major corporation like Fidelity Investments.
mistake to shareholders, a spokesperson wrote,
Fidelity is one of the largest mutual fund manage-
“Some people have asked how, in this age of technol-
ment firms in the world. If you had your life savings
ogy, such a mistake could be made. While many of
invested at Fidelity Investments, you might be just
our processes are computerized, accounting systems
slightly displeased if, when you called to find out
are complex and dictate that some steps must be han-
your balance, the representative said, “You know, I
dled manually by our managers and accountants, and
kind of remember someone with a name like yours
people can make mistakes.”
INSIDE CHAPTER 3 . . .
●
●
●
Why Accuracy Matters (p. 109)
Keeping Score (p. 115)
Boosting Microsoft’s Profits (p. 119)
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preview of chapter 3
As indicated in the Feature Story, a reliable information system is a necessity for any company. The purpose of
this chapter is to explain and illustrate the features of an accounting information system. The organization and
content of the chapter are as follows.
The Accounting Information System
Accounting
Transactions
• Analyzing
transactions
• Summary of
transactions
Steps in the
Recording Process
The Account
• Debits and credits
• Debit and credit
procedures
• Stockholders’ equity
relationships
• Summary of
debit /credit rules
•
•
•
•
The journal
The ledger
Chart of accounts
Posting
The Recording
Process Illustrated
• Summary illustration
of journalizing and
posting
The Trial Balance
• Limitations of a trial
balance
The Accounting Information System
The system of collecting and processing transaction data and communicating financial information to decision makers is known as the accounting information system. Factors that shape these systems include: the nature of the company’s business, the types of transactions, the size of the company, the volume
of data, and the information demands of management and others.
Most businesses use computerized accounting systems—sometimes referred
to as electronic data processing (EDP) systems. These systems handle all the
steps involved in the recording process, from initial data entry to preparation of
the financial statements. In order to remain competitive, companies continually
improve their accounting systems to provide accurate and timely data for decision making. For example, in a recent annual report, Tootsie Roll states, “We
also invested in additional processing and data storage hardware during the year.
We view information technology as a key strategic tool, and are committed to
deploying leading edge technology in this area.” In addition, many companies
have upgraded their accounting information systems in response to the requirements of Sarbanes-Oxley.
In this chapter, we focus on a manual accounting system because the accounting concepts and principles do not change whether a system is computerized or manual, and manual systems are easier to illustrate.
Accounting Transactions
To use an accounting information system, you need to know which economic
events to recognize (record). Not all events are recorded and reported in the financial statements. For example, suppose General Motors hired a new employee
or purchased a new computer. Are these events entered in its accounting records?
The first event would not be recorded, but the second event would. We call economic events that require recording in the financial statements accounting
transactions.
An accounting transaction occurs when assets, liabilities, or stockholders’
equity items change as a result of some economic event. The purchase of a
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Accounting Transactions
computer by General Motors, the payment of rent by Microsoft, and the sale of
a multi-day guided trip by Sierra Corporation are examples of events that change
a company’s assets, liabilities, or stockholders’ equity. Illustration 3-1 summarizes the decision process companies use to decide whether or not to record economic events.
103
Illustration 3-1
Transaction identification
process
Bank
Home
Accounting
Ballence
Events
DELL
Purchase computer
Criterion
Discuss guided trip options
with potential customer
Pay rent
Is the financial position (assets, liabilities, or stockholders’ equity) of the company changed?
Yes
No
Yes
Record
Don't
record
Record
Record/
Don’t Record
ANALYZING TRANSACTIONS
In Chapter 1, you learned the basic accounting equation:
Assets ⴝ Liabilities ⴙ Stockholders’ Equity
In this chapter, you will learn how to analyze transactions in terms of their effect on assets, liabilities, and stockholders’ equity. Transaction analysis is the
process of identifying the specific effects of economic events on the accounting
equation.
The accounting equation must always balance. Each transaction has a dual
(double-sided) effect on the equation. For example, if an individual asset is increased, there must be a corresponding:
Decrease in another asset, or
Increase in a specific liability, or
Increase in stockholders’ equity.
Two or more items could be affected when an asset is increased. For example, if a company purchases a computer for $10,000 by paying $6,000 in cash
and signing a note for $4,000, one asset (equipment) increases $10,000, another
asset (cash) decreases $6,000, and a liability (notes payable) increases $4,000.
study objective
1
Analyze the effect of
business transactions
on the basic accounting
equation.
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chapter 3 The Accounting Information System
The result is that the accounting equation remains in balance—assets increased
by a net $4,000 and liabilities increased by $4,000, as shown below.
ⴝ
Assets
Liabilities
$10,000
6,000
ⴙ
Stockholders’ Equity
$4,000
$ 4,000
$4,000
Chapter 1 presented the financial statements for Sierra Corporation for its
first month. You should review those financial statements (on page 17) at this
time. To illustrate how economic events affect the accounting equation, we will
examine events affecting Sierra Corporation during its first month.
In order to analyze the transactions for Sierra Corporation, we will expand
the basic accounting equation. This will allow us to better illustrate the impact
of transactions on stockholders’ equity. Recall from the balance sheets in Chapters 1 and 2 that stockholders’ equity is comprised of two parts: common stock
and retained earnings. Common stock is affected when the company issues new
shares of stock in exchange for cash. Retained earnings is affected when the company earns revenue, incurs expenses, or pays dividends. Illustration 3-2 shows
the expanded equation.
Illustration 3-2 Expanded
accounting equation
Assets
Liabilities
Stockholders' Equity
Common Stock
Retained Earnings
Revenues
Expenses
Dividends
If you are tempted to skip ahead after you’ve read a few of the following transaction analyses, don’t do it. Each has something unique to teach, something you’ll
need later. (We assure you that we’ve kept them to the minimum needed!)
EVENT (1). INVESTMENT OF CASH BY STOCKHOLDERS. On October 1, cash of
$10,000 is invested in the business by investors (primarily your friends and family) in exchange for $10,000 of common stock. This event is an accounting transaction because it results in an increase in both assets and stockholders’ equity.
Basic
Analysis
The asset Cash is increased $10,000, and stockholders’ equity (specifically
Common Stock) is increased $10,000.
Assets
Equation
Analysis
(1)
ⴝ
Liabilities
ⴙ
Stockholders’ Equity
Cash
Common
Stock
ⴙ$10,000
ⴝ
ⴙ$10,000
Issued stock
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Accounting Transactions
The equation is in balance after the issuance of common stock. Keeping track
of the source of each change in stockholders’ equity is essential for later accounting activities. In particular, items recorded in the revenue and expense columns
are used for the calculation of net income.
EVENT (2). NOTE ISSUED IN EXCHANGE FOR CASH. On October 1, Sierra borrowed
$5,000 from Castle Bank by signing a 3-month, 12%, $5,000 note payable. This
transaction results in an equal increase in assets and liabilities. The specific effect
of this transaction and the cumulative effect of the first two transactions are:
Equation
Analysis
The asset Cash is increased $5,000, and the liability Notes Payable
is increased $5,000.
(2)
Assets
ⴝ
Liabilities
ⴙ
Stockholders’ Equity
Cash
Notes
Payable
Common
Stock
$10,000
ⴙ5,000
$10,000
ⴙ$5,000
$15,000
$5,000
$10,000
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Basic
Analysis
$15,000
Total assets are now $15,000, and liabilities plus stockholders’ equity also total
$15,000.
EVENT (3). PURCHASE OF OFFICE EQUIPMENT FOR CASH. On October 2, Sierra
purchased equipment by paying $5,000 cash to Superior Equipment Sales Co.
This event is a transaction because an equal increase and decrease in Sierra’s assets occur.
The asset Equipment is increased $5,000; the asset Cash is decreased $5,000.
Cash
Equation
Analysis
(3)
Assets
ⴝ
Liabilities
ⴙ
Stockholders’ Equity
Notes
Payable
Common
Stock
$15,000
ⴚ5,000
$5,000
$10,000
ⴙ$5,000
$5,000
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$10,000
Equipment
$15,000
$5,000
$10,000
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Basic
Analysis
$15,000
The total assets are now $15,000, and liabilities plus stockholders’ equity also
total $15,000.
EVENT (4). RECEIPT OF CASH IN ADVANCE FROM CUSTOMER. On October 2, Sierra
received a $1,200 cash advance from R. Knox, a client. This event is a transaction because Sierra received cash (an asset) for guide services for multi-day trips
that are expected to be completed by Sierra in the future. Although Sierra received cash, it does not record revenue until it has performed the work. In
some industries, such as the magazine and airline industries, customers are
expected to prepay. These companies have a liability to the customer until they
deliver the magazines or provide the flight. When the company eventually provides
the product or service, it records the revenue.
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Since Sierra received cash prior to performance of the service, Sierra has a
liability for the work due.
The asset Cash is increased $1,200; the liability Unearned Service Revenue is increased $1,200 because
the service has not been provided yet. That is, when an advance payment is received, an unearned revenue
(a liability) should be recorded in order to recognize the obligation that exists.
Basic
Analysis
Equation
Analysis
ⴝ
Assets
Equipment
$10,000
ⴙ1,200
(4)
$5,000
Unearned Service
Revenue
Common
Stock
$5,000
$10,000
ⴙ$1,200
$5,000
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$11,200
Notes
Payable
Stockholders’ Equity
$5,000
$1,200
$10,000
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Cash
ⴙ
Liabilities
$16,200
$16,200
EVENT (5). SERVICES PROVIDED FOR CASH. On October 3, Sierra received $10,000
in cash from Copa Company for guide services performed for a corporate event.
This event is a transaction because Sierra received an asset (cash) in exchange
for services.
Guide service is the principal revenue-producing activity of Sierra. Revenue
increases stockholders’ equity. This transaction, then, increases both assets
and stockholders’ equity.
Basic
Analysis
The asset Cash is increased $10,000; the revenue Service Revenue is increased $10,000.
Equation
Analysis
ⴝ
Cash
$11,200
ⴙ10,000
$21,200
$5,000
$5,000
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(5)
Equipment
Notes
Pay.
$5,000
ⴙ
Liabilities
$5,000
Unearned
Serv. Rev.
$1,200
$1,200
Stockholders’ Equity
Common
Stock
$10,000
$10,000
Rev.
Retained Earnings
Exp. Div.
ⴙ$10,000
Service
Revenue
$10,000
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Assets
$26,200
$26,200
Often companies provide services “on account.” That is, they provide service for which they are paid at a later date. Revenue, however, is earned when
services are performed. Therefore, revenues would increase when services are
performed, even though cash has not been received. Instead of receiving cash,
the company receives a different type of asset, an account receivable. Accounts
receivable represent the right to receive payment at a later date. Suppose that
Sierra had provided these services on account rather than for cash. This event
would be reported using the accounting equation as:
Assets
ⴝ
Liabilities
ⴙ
Stockholders’ Equity
Accounts
Receivable
Revenues
ⴙ$10,000
ⴙ$10,000
Service Revenue
Later, when Sierra collects the $10,000 from the customer, Accounts Receivable
declines by $10,000, and Cash increases by $10,000.
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Accounting Transactions
ⴝ
Assets
Cash
Accounts
Receivable
ⴙ$10,000
ⴚ$10,000
Liabilities
ⴙ
Stockholders’ Equity
Note that in this case, revenues are not affected by the collection of cash. Instead
we record an exchange of one asset (Accounts Receivable) for a different asset (Cash).
EVENT (6). PAYMENT OF RENT. On October 3, Sierra Corporation paid its office
rent for the month of October in cash, $900. This rent payment is a transaction
because it results in a decrease in an asset, cash.
Rent is an expense incurred by Sierra Corporation in its effort to generate
revenues. Expenses decrease stockholders’ equity. Sierra records the rent payment by decreasing cash and increasing expenses to maintain the balance of the
accounting equation.
Basic
Analysis
The expense account Rent Expense is increased $900 because the payment pertains only to the current
month; the asset Cash is decreased $900.
Equation
Analysis
ⴝ
Assets
Equipment
$21,200
ⴚ900
(6)
$5,000
Notes
Pay.
$5,000
Unearned
Serv. Rev.
$1,200
Common
Stock
$10,000
Retained Earnings
Exp.
Rev.
Div.
$10,000
ⴚ$900
$5,000
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$20,300
Stockholders’ Equity
$5,000
$1,200
$10,000
$10,000
Rent
Expense
$900
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Cash
ⴙ
Liabilities
$25,300
$25,300
EVENT (7). PURCHASE OF INSURANCE POLICY FOR CASH. On October 4, Sierra
paid $600 for a one-year insurance policy that will expire next year on September 30. Payments of expenses that will benefit more than one accounting period
are identified as assets called prepaid expenses or prepayments.
Basic
Analysis
The asset Cash is decreased $600. The asset Prepaid Insurance is increased $600.
Equation
Analysis
ⴝ
Assets
Cash
(7)
$20,300
ⴚ600
Equipment
$5,000
Liabilities
Notes
Pay.
$5,000
Unearned
Serv. Rev.
ⴙ
$1,200
Stockholders’ Equity
Common
Stock
$10,000
Rev.
Retained Earnings
Exp.
$10,000
$900
ⴙ$600
$600
$5,000
$5,000
$1,200
$10,000
$10,000
$900
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$19,700
Prepaid
Insurance
$25,300
$25,300
The balance in total assets did not change; one asset account decreased by the
same amount that another increased.
Div.
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EVENT (8). PURCHASE OF SUPPLIES ON ACCOUNT. On October 5, Sierra purchased
supplies on account from Aero Supply for $2,500. In this case, “on account” means
that the company receives goods or services that it will pay for at a later date.
Basic
Analysis
The asset Supplies is increased $2,500; the liability Accounts Payable is increased $2,500.
Equation
Analysis
ⴝ
Assets
Cash
Supplies
Prepd.
Insur.
$19,700
$600
Equipment
$5,000
Notes
Pay.
Unearned
Serv. Rev.
$1,200
Stockholders’ Equity
Common
Stock
$10,000
Rev.
Retained Earnings
Exp.
$10,000
$900
$10,000
$900
Div.
ⴙ$2,500
$600
$5,000
$5,000
$2,500
$1,200
$10,000
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$19,700
Accounts
Payable
$5,000
ⴙ$2,500
(8)
ⴙ
Liabilities
$27,800
$27,800
EVENT (9). HIRING OF NEW EMPLOYEES. On October 9, Sierra hired four new employees to begin work on October 15. Each employee will receive a weekly salary
of $500 for a five-day work week, payable every two weeks. Employees will receive their first paychecks on October 26. On the date Sierra hires the employees, there is no effect on the accounting equation because the assets, liabilities,
and stockholders’ equity of the company have not changed.
Basic
Analysis
An accounting transaction has not occurred. There is only an agreement that the employees will begin
work on October 15. (See Event (11) for the first payment.)
EVENT (10). PAYMENT OF DIVIDEND. On October 20, Sierra paid a $500 dividend.
Dividends are a reduction of stockholders’ equity but not an expense. Dividends
are not included in the calculation of net income. Instead, a dividend is a distribution of the company’s assets to its stockholders.
Basic
Analysis
The dividends account is increased $500; the asset Cash is decreased $500.
Equation
Analysis
ⴝ
Assets
Cash
$19,700
ⴚ500
$2,500
$600
$5,000
Stockholders’ Equity
$5,000
$2,500
$1,200
$10,000
Retained Earnings
Rev. Exp. Div.
$10,000
$900
ⴚ $500
$27,300
$1,200
$10,000 $10,000 $900 $500
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$19,200 $2,500 $600 $5,000 $5,000 $2,500
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(10)
ⴙ
Liabilities
SupPrepd.
EquipNotes
Accts.
Unearned
Common
plies Insur. ment Pay. Pay. Serv. Rev. Stock
$27,300
EVENT (11). PAYMENT OF CASH FOR EMPLOYEE SALARIES. Employees have
worked two weeks, earning $4,000 in salaries, which were paid on October 26.
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109
Salaries Expense is an expense that reduces stockholders’ equity. This event is a
transaction because assets and stockholders’ equity are affected.
Basic
Analysis
The asset Cash is decreased $4,000; the expense account Salaries Expense is increased $4,000.
Equation
Analysis
ⴝ
Assets
Cash
$19,200
(11) ⴚ4,000
Supplies
$2,500
ⴙ
Liabilities
Stockholders’ Equity
Prepd.
EquipNotes
Accts.
Unearned
Common
Insur. ment Pay. Pay. Serv. Rev. Stock
$600
$5,000
$5,000
$2,500
$1,200
$10,000
Rev.
Retained Earnings
Exp. Div.
$10,000
ⴚ
$10,000 $10,000 $4,900 $500
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$1,200
$23,300
$23,300
Investor Insight
Why Accuracy Matters
While most companies record transactions very carefully, the reality is that
mistakes still happen. For example, bank regulators fined Bank One Corporation (now
Chase) $1.8 million because they felt that the unreliability of the bank’s accounting system caused it to violate regulatory requirements.
Also, in recent years Fannie Mae, the government-chartered mortgage association, announced a series of large accounting errors. These announcements caused alarm among
investors, regulators, and politicians because they fear that the errors may suggest larger,
undetected problems. This is important because the home-mortgage market depends on
Fannie Mae to buy hundreds of billions of dollars of mortgages each year from banks, thus
enabling the banks to issue new mortgages.
Finally, before a major overhaul of its accounting system, the financial records of Waste
Management Company were in such disarray that of the company’s 57,000 employees,
10,000 were receiving pay slips that were in error.
The Sarbanes-Oxley Act of 2002 was created to minimize the occurrence of errors like
these by increasing every employee’s responsibility for accurate financial reporting.
?
$500
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$15,200 $2,500 $600 $5,000 $5,000 $2,500
$ 900
4,000
In order for these companies to prepare and issue financial statements, their accounting equations (debits and credits) must have been in balance at year-end.
How could these errors or misstatements have occurred? (See page 158.)
SUMMARY OF TRANSACTIONS
Illustration 3-3 (page 110) summarizes the transactions of Sierra Corporation to
show their cumulative effect on the basic accounting equation. It includes the
transaction number in the first column on the left. The right-most column shows
the specific effect of any transaction that affects stockholders’ equity. Remember that Event (9) did not result in a transaction, so no entry is included for that
event. The illustration demonstrates three important points:
1. Each transaction is analyzed in terms of its effect on assets, liabilities, and
stockholders’ equity.
2. The two sides of the equation must always be equal.
3. The cause of each change in stockholders’ equity must be indicated.
Salaries
Expense
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Illustration 3-3 Summary
of transactions
ⴝ
Assets
Sup
Cash
plies
Prepd.
Equip-
(1) $10,000
(2)
5,000
(3)
5,000
(4)
1,200
Notes
Insur. ment
ⴙ
Liabilities
Pay.
Stockholders’ Equity
Accts.
Unearned
Common
Pay.
Serv. Rev.
Stock
Retained Earnings
900
(7)
600
500
(11)
4,000
Div.
Issued stock
$5,000
$5,000
$1,200
$10,000
Service Revenue
$ 900
Rent Expense
$600
$2,500
(8)
(10)
Exp.
$10,000
(5) 10,000
(6)
Rev.
$2,500
$500 Dividends
4,000
$600
$5,000
$5,000 $2,500
$1,200
$10,000
$10,000 $4,900
Salaries Expense
$500
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$2,500
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$15,200
$23,300
$23,300
DECISION TOOLKIT
DECISION CHECKPOINTS
INFO NEEDED FOR DECISION
Has an accounting transaction
occurred?
Details of the event
TOOL TO USE FOR DECISION
Accounting equation
HOW TO EVALUATE RESULTS
If the event affected assets,
liabilities, or stockholders’ equity,
then record as a transaction.
before you go on...
Do it!
TRANSACTION
ANALYSIS
A tabular analysis of the transactions made by Roberta Mendez & Co.,
a certified public accounting firm, for the month of August is shown below. Each increase
and decrease in stockholders’ equity is explained.
ⴝ Liabilities ⴙ
Assets
Equipment
Accounts
Payable
$7,000
$7,000
1. $25,000
2.
3. 8,000
4.
850
$7,000
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$32,150
$39,150
Action Plan
• Analyze the tabular analysis to
determine the nature and effect
of each transaction.
• Keep the accounting equation in
balance.
• Remember that a change in an
asset will require a change in
another asset, a liability, or in
stockholders’ equity.
$7,000
Common
Stock
Retained Earnings
Revenue Expenses
$25,000
Issued stock
$8,000
$25,000
$8,000
$850
Service Revenue
Rent Expense
$850
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Cash
Stockholders’ Equity
$39,150
Describe each transaction that occurred for the month.
Solution
1. The company issued shares of stock to stockholders for $25,000 cash.
2. The company purchased $7,000 of equipment on account.
3. The company received $8,000 of cash in exchange for services performed.
4. The company paid $850 for this month’s rent.
Related exercise material: BE3-1, BE3-2, BE3-3, Do it! 3-1, E3-1, E3-2, E3-3, and E3-4.
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The Account
111
study objective
2
The Account
Rather than using a tabular summary like the one in Illustration 3-3 for Sierra
Corporation, an accounting information system uses accounts. An account is an
individual accounting record of increases and decreases in a specific asset, liability, stockholders’ equity, revenue, or expense item. For example, Sierra Corporation has separate accounts for Cash, Accounts Receivable, Accounts Payable,
Service Revenue, Salaries Expense, and so on. (Note that whenever we are referring to a specific account, we capitalize the name.)
In its simplest form, an account consists of three parts: (1) the title of the
account, (2) a left or debit side, and (3) a right or credit side. Because the alignment of these parts of an account resembles the letter T, it is referred to as a
T account. The basic form of an account is shown in Illustration 3-4.
Dr.
Title of Account
Left or debit side
Cr.
Explain what an account is
and how it helps in the
recording process.
Illustration 3-4
form of account
Basic
Right or credit side
We use this form of account often throughout this book to explain basic accounting relationships.
DEBITS AND CREDITS
The term debit indicates the left side of an account, and credit indicates the
right side. They are commonly abbreviated as Dr. for debit and Cr. for credit.
They do not mean increase or decrease, as is commonly thought. We use the
terms debit and credit repeatedly in the recording process to describe where entries are made in accounts. For example, the act of entering an amount on the
left side of an account is called debiting the account. Making an entry on the
right side is crediting the account.
When comparing the totals of the two sides, an account shows a debit balance
if the total of the debit amounts exceeds the credits. An account shows a credit
balance if the credit amounts exceed the debits. Note the position of the debit side
and credit side in Illustration 3-4.
The procedure of recording debits and credits in an account is shown in
Illustration 3-5 for the transactions affecting the Cash account of Sierra Corporation. The data are taken from the Cash column of the tabular summary in
Illustration 3-3.
Tabular Summary
Cash
$10,000
5,000
–5,000
1,200
10,000
–900
–600
–500
–4,000
$15,200
Balance
(Debit)
Cash
10,000 (Credits)
5,000
1,200
10,000
15,200
3
Define debits and credits
and explain how they are
used to record business
transactions.
Illustration 3-5 Tabular
summary and account form
for Sierra Corporation’s
Cash account
Account Form
(Debits)
study objective
5,000
900
600
500
4,000
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chapter 3 The Accounting Information System
Every positive item in the tabular summary represents a receipt of cash; every
negative amount represents a payment of cash. Notice that in the account form
we record the increases in cash as debits, and the decreases in cash as credits. For example, the $10,000 receipt of cash (in red) is debited to Cash, and the
$5,000 payment of cash (in blue) is credited to Cash.
Having increases on one side and decreases on the other reduces recording
errors and helps in determining the totals of each side of the account as well as
the account balance. The balance is determined by netting the two sides (subtracting one amount from the other). The account balance, a debit of $15,200,
indicates that Sierra had $15,200 more increases than decreases in cash. That
is, since it started with a balance of zero, it has $15,200 in its Cash account.
International Note 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.
DEBIT AND CREDIT PROCEDURES
Each transaction must affect two or more accounts to keep the basic accounting equation in balance. In other words, for each transaction, debits must
equal credits. The equality of debits and credits provides the basis for the doubleentry accounting system.
Under the double-entry system, the two-sided effect of each transaction is
recorded in appropriate accounts. This system provides a logical method for recording transactions. The double-entry system also helps to ensure the accuracy of the
recorded amounts and helps to detect errors such as those at Fidelity Investments
as discussed in the Feature Story. If every transaction is recorded with equal debits
and credits, then the sum of all the debits to the accounts must equal the sum of all
the credits. The double-entry system for determining the equality of the accounting
equation is much more efficient than the plus/minus procedure used earlier.
Dr./Cr. Procedures for Assets and Liabilities
In Illustration 3-5 for Sierra Corporation, increases in Cash—an asset—were entered on the left side, and decreases in Cash were entered on the right side. We
know that both sides of the basic equation (Assets Liabilities Stockholders’
Equity) must be equal. It therefore follows that increases and decreases in liabilities will have to be recorded opposite from increases and decreases in assets. Thus,
increases in liabilities must be entered on the right or credit side, and decreases
in liabilities must be entered on the left or debit side. The effects that debits and
credits have on assets and liabilities are summarized in Illustration 3-6.
Illustration 3-6 Debit
and credit effects—assets
and liabilities
Debits
Credits
Increase assets
Decrease liabilities
Decrease assets
Increase liabilities
Asset accounts normally show debit balances. That is, debits to a specific
asset account should exceed credits to that account. Likewise, liability accounts
normally show credit balances. That is, credits to a liability account should
exceed debits to that account. The normal balances may be diagrammed as in
Illustration 3-7.
Illustration 3-7 Normal
balances—assets and
liabilities
Assets
Debit for Credit for
increase decrease
Normal
balance
Liabilities
Debit for Credit for
decrease increase
Normal
balance
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The Account
Knowing which is the normal balance in an account may help when you are
trying to identify errors. For example, a credit balance in an asset account, such
as Land, or a debit balance in a liability account, such as Salaries Payable, usually indicates errors in recording. Occasionally, however, an abnormal balance
may be correct. The Cash account, for example, will have a credit balance when
a company has overdrawn its bank balance (written a check that “bounced”). In
automated accounting systems, the computer is programmed to flag violations
of the normal balance and to print out error or exception reports. In manual systems, careful visual inspection of the accounts is required to detect normal balance problems.
113
Helpful Hint The normal balance
is the side where increases in the
account are recorded.
Dr./Cr. Procedures for Stockholders’ Equity
In Chapter 1, we indicated that stockholders’ equity is comprised of two parts:
common stock and retained earnings. In the transaction events earlier in this
chapter, you saw that revenues, expenses, and the payment of dividends affect
retained earnings. Therefore, the subdivisions of stockholders’ equity are: common stock, retained earnings, dividends, revenues, and expenses.
COMMON STOCK. Common stock is issued to investors in exchange for the stockholders’ investment. The common stock account is increased by credits and decreased by debits. For example, when cash is invested in the business, cash is
debited and common stock is credited. The effects of debits and credits on the
common stock account are shown in Illustration 3-8.
Debits
Credits
Decrease Common Stock
Increase Common Stock
Illustration 3-8 Debit
and credit effects—Common
Stock
The normal balance in the Common Stock account may be diagrammed as
in Illustration 3-9.
Illustration 3-9 Normal
balance—Common Stock
Common Stock
Debit for Credit for
decrease increase
Normal
balance
RETAINED EARNINGS. Retained earnings is net income that is retained in the
business. It represents the portion of stockholders’ equity that has been accumulated through the profitable operation of the company. Retained earnings is increased by credits (for example, by net income) and decreased by debits (for example, by a net loss), as shown in Illustration 3-10.
Debits
Credits
Decrease Retained Earnings
Increase Retained Earnings
Illustration 3-10 Debit
and credit effects—Retained
Earnings
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The normal balance for Retained Earnings may be diagrammed as in Illustration 3-11.
Illustration 3-11 Normal
balance—Retained Earnings
Retained Earnings
Debit for Credit for
decrease increase
Normal
balance
DIVIDENDS. A dividend is a distribution by a corporation to its stockholders. The
most common form of distribution is a cash dividend. Dividends result in a reduction of the stockholders’ claims on retained earnings. Because dividends reduce stockholders’ equity, increases in the Dividends account are recorded with
debits. As shown in Illustration 3-12, the Dividends account normally has a debit
balance.
Illustration 3-12 Normal
balance—Dividends
Dividends
Debit for Credit for
increase decrease
Normal
balance
REVENUES AND EXPENSES. When a company earns revenues, stockholders’ equity is increased. Revenue accounts are increased by credits and decreased by
debits.
Expenses decrease stockholders’ equity. Thus, expense accounts are increased by debits and decreased by credits. The effects of debits and credits on
revenues and expenses are shown in Illustration 3-13.
Illustration 3-13 Debit
and credit effects—revenues
and expenses
Debits
Credits
Decrease revenue
Increase expenses
Increase revenue
Decrease expenses
Credits to revenue accounts should exceed debits; debits to expense accounts
should exceed credits. Thus, revenue accounts normally show credit balances,
and expense accounts normally show debit balances. The normal balances
may be diagrammed as in Illustration 3-14.
Illustration 3-14 Normal
balances—revenues and
expenses
Expenses
Debit for Credit for
increase decrease
Normal
balance
Revenues
Debit for Credit for
decrease increase
Normal
balance
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The Account
Investor Insight
Keeping Score
The Chicago Cubs baseball team has these major revenue and expense
accounts:
Revenues
Admissions (ticket sales)
Concessions
Television and radio
Advertising
?
Expenses
Players’ salaries
Administrative salaries
Travel
Ballpark maintenance
Do you think that the Chicago Bears football team would be likely to have the
same major revenue and expense accounts as the Cubs? (See page 158.)
STOCKHOLDERS’ EQUITY RELATIONSHIPS
Companies report the subdivisions of stockholders’ equity in various places in
the financial statements:
•
•
•
Common stock and retained earnings: in the stockholders’ equity section of
the balance sheet.
Dividends: on the retained earnings statement.
Revenues and expenses: on the income statement.
Dividends, revenues, and expenses are eventually transferred to retained earnings at the end of the period. As a result, a change in any one of these three
items affects stockholders’ equity. Illustration 3-15 shows the relationships of the
accounts affecting stockholders’ equity.
Illustration 3-15
Stockholders’ equity
relationships
Balance Sheet
Assets
Liabilities
Stockholder’s equity
Common stock
Retained earnings
Income Statement
Revenues
Less: Expenses
Net income or net loss
Retained Earnings Statement
Begining retained earnings
Add: Net income
Less: Dividends
Ending retained earnings
Investments by stockholders
Net income retained in the business
115
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SUMMARY OF DEBIT/CREDIT RULES
Illustration 3-16 summarizes the debit/credit rules and effects on each type of
account. Study this diagram carefully. It will help you understand the fundamentals of the double-entry system. No matter what the transaction, total debits must equal total credits in order to keep the accounting equation in balance.
Illustration 3-16 Summary
of debit/credit rules
Assets
= Liabilities +
Stockholders’ Equity
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Basic
Equation
Expanded
Basic Equation
Debit / Credit
Rules
Assets
=
Dr. Cr.
+
–
Liabilities
Dr. Cr.
–
+
+
Common
+
Stock
Retained
Earnings
Dr. Cr.
+
–
Dr. Cr.
+
–
– Dividends + Revenues –
Dr.
+
Cr.
–
Dr.
–
Cr.
+
Expenses
Dr.
+
Cr.
–
before you go on...
DEBITS AND CREDITS
FOR BALANCE SHEET
ACCOUNTS
Action Plan
• First identify asset accounts for
each different type of asset
invested in the business.
• Then identify liability accounts
for debts incurred by the
business.
• Remember that Hair It Is Inc.
will need only one stockholders’
equity account for common stock
when it begins the business.
The other stockholders’ equity
accounts will be needed only
after the business is operating.
Do it!
Kate Browne, president of Hair It Is Inc., has just rented space in a shopping mall for the purpose of opening and operating a beauty salon. Long before opening
day and before purchasing equipment, hiring assistants, and remodeling the space, Kate
was strongly advised to set up a double-entry set of accounting records in which to record
all of her business transactions.
Identify the balance sheet accounts that Hair It Is Inc. will likely need to record the
transactions necessary to establish and open for business. Also, indicate whether the normal balance of each account is a debit or a credit.
Solution
Hair It Is Inc. would likely need the following accounts in which to record the transactions necessary to establish and ready the beauty salon for opening day: Cash (debit
balance); Equipment (debit balance); Supplies (debit balance); Accounts Payable (credit
balance); Notes Payable (credit balance), if the business borrows money; and Common
Stock (credit balance).
Related exercise material: BE3-4, BE3-5, Do it! 3-2, and E3-7.
Steps in the Recording Process
study objective
4
Identify the basic steps in
the recording process.
Although it is possible to enter transaction information directly into the accounts,
few businesses do so. Practically every business uses these basic steps in the
recording process:
1. Analyze each transaction in terms of its effect on the accounts.
2. Enter the transaction information in a journal.
3. Transfer the journal information to the appropriate accounts in the ledger.
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Steps in the Recording Process
117
The actual sequence of events begins with the transaction. Evidence of the
transaction comes in the form of a source document, such as a sales slip, a
check, a bill, or a cash register tape. This evidence is analyzed to determine the
effect of the transaction on specific accounts. The transaction is then entered
in the journal. Finally, the journal entry is transferred to the designated accounts in the ledger. The sequence of events in the recording process is shown
in Illustration 3-17.
Illustration 3-17 The
recording process
The Recording Process
JOURNAL
Invoice
LEDGER
JOURNAL
ASSETS
LIABILITIES
Stockholders’ Equity
Analyze each transaction
Enter transaction in a journal
Transfer journal information
to ledger accounts
THE JOURNAL
Transactions are initially recorded in chronological order in journals before they
are transferred to the accounts. For each transaction the journal shows the debit
and credit effects on specific accounts. (In a computerized system, journals are
kept as files, and accounts are recorded in computer databases.)
Companies may use various kinds of journals, but every company has at least
the most basic form of journal, a general journal. The journal makes three
significant contributions to the recording process:
1. It discloses in one place the complete effect of a transaction.
2. It provides a chronological record of transactions.
3. It helps to prevent or locate errors because the debit and credit amounts
for each entry can be readily compared.
Entering transaction data in the journal is known as journalizing. To illustrate the technique of journalizing, let’s look at the first three transactions of
Sierra Corporation in equation form.
On October 1, Sierra issued common stock in exchange for $10,000 cash:
Assets
Cash
$10,000
ⴝ
Liabilities ⴙ
Stockholders’ Equity
Common
Stock
$10,000 Issued stock
study objective
5
Explain what a journal is
and how it helps in the
recording process.
Ethics Note Business documents
provide evidence that transactions
actually occurred. International
Outsourcing Services, LLC, was
accused of submitting fraudulent
documents (store coupons) to
companies such as Kraft Foods
and PepsiCo for reimbursement of
as much as $250 million. Ensuring
that all recorded transactions are
backed up by proper business documents reduces the likelihood of
fraudulent activity.
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chapter 3 The Accounting Information System
On October 1, Sierra borrowed $5,000 by signing a note:
Assets
ⴝ
Cash
Liabilities ⴙ
$5,000
Stockholders’ Equity
Notes
Payable
$5,000
On October 2, Sierra purchased equipment for $5,000:
Assets
Cash
Equipment
$5,000
$5,000
ⴝ
Liabilities
ⴙ
Stockholders’ Equity
Sierra makes separate journal entries for each transaction. A complete entry consists of: (1) the date of the transaction, (2) the accounts and amounts to
be debited and credited, and (3) a brief explanation of the transaction. These
transactions are journalized in Illustration 3-18.
Illustration 3-18
Recording transactions in
journal form
GENERAL JOURNAL
Date
Account Titles and Explanation
Debit
Credit
2012
Oct.
1
1
2
Cash
Common Stock
(Issued stock for cash)
10,000
10,000
Cash
Notes Payable
(Issued 3-month, 12% note payable for cash)
5,000
Equipment
Cash
(Purchased equipment for cash)
5,000
5,000
5,000
Note the following features of the journal entries.
1. The date of the transaction is entered in the Date column.
2. The account to be debited is entered first at the left. The account to be credited is then entered on the next line, indented under the line above. The indentation differentiates debits from credits and decreases the possibility of
switching the debit and credit amounts.
3. The amounts for the debits are recorded in the Debit (left) column, and the
amounts for the credits are recorded in the Credit (right) column.
4. A brief explanation of the transaction is given.
It is important to use correct and specific account titles in journalizing.
Erroneous account titles lead to incorrect financial statements. Some flexibility
exists initially in selecting account titles. The main criterion is that each title
must appropriately describe the content of the account. For example, a company
could use any of these account titles for recording the cost of delivery trucks:
Equipment, Delivery Equipment, Delivery Trucks, or Trucks. Once the company
chooses the specific title to use, however, it should record under that account
title all subsequent transactions involving the account.
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Steps in the Recording Process
119
Accounting Across the Organization
Boosting Microsoft’s Profits
Bryan Lee is head of finance at Microsoft’s Home and Entertainment Division.
In recent years the division lost over $4 billion, mostly due to losses on the original Xbox
videogame player. With the Xbox 360 videogame player, Mr. Lee hoped the division would
become profitable. He set strict goals for sales, revenue, and profit. “A manager seeking
to spend more on a feature such as a disk drive has to find allies in the group to cut
spending elsewhere, or identify new revenue to offset the increase,” he explains.
For example, Microsoft originally designed the new Xbox to have 256 megabytes
of memory. But the design department said that amount of memory wouldn’t support
the best special effects. The purchasing department said that adding more memory
would cost $30—which was 10% of the estimated selling price of $300. But the marketing department “determined that adding the memory would let Microsoft reduce
marketing costs and attract more game developers, boosting royalty revenue. It would
also extend the life of the console, generating more sales.” Microsoft doubled the memory
to 512 megabytes.
Source: Robert A. Guth, “New Xbox Aim for Microsoft: Profitability,” Wall Street Journal (May 24, 2005), p. C1.
?
In what ways is this Microsoft division using accounting to assist in its effort to
become more profitable? (See page 158.)
before you go on...
Do it!
The following events occurred during the first month of business of Hair
It Is Inc., Kate Browne’s beauty salon:
JOURNAL ENTRIES
1. Issued common stock to shareholders in exchange for $20,000 cash.
2. Purchased $4,800 of equipment on account (to be paid in 30 days).
3. Interviewed three people for the position of beautician.
In what form (type of record) should the company record these three activities? Prepare
the entries to record the transactions.
Solution
Each transaction that is recorded is entered in the general journal. The three activities
are recorded as follows.
1. Cash
Common Stock
(Issued stock for cash)
2. Equipment
Accounts Payable
(Purchased equipment on account)
20,000
20,000
4,800
4,800
Action Plan
• Record the transactions in a
journal, which is a chronological
record of the transactions.
• Make sure to provide a
complete and accurate
representation of the
transactions’ effects on the
assets, liabilities, and
stockholders’ equity of the
business.
3. No entry because no transaction occurred.
Related exercise material: BE3-6, BE3-9, Do it! 3-3, E3-6, E3-8, and E3-9.
THE LEDGER
The entire group of accounts maintained by a company is referred to collectively
as the ledger. The ledger keeps in one place all the information about changes
in specific account balances.
Companies may use various kinds of ledgers, but every company has a general
ledger. A general ledger contains all the assets, liabilities, stockholders’ equity,
revenue, and expense accounts, as shown in Illustration 3-19 (page 120). Whenever
we use the term ledger in this textbook without additional specification, it will mean
the general ledger.
study objective
6
Explain what a ledger is
and how it helps in the
recording process.
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Illustration 3-19 The
general ledger
Individual
Asset
Accounts
Equipment
Land
Supplies
Cash
Individual
Liability
Accounts
Individual
Stockholders’ Equity
Accounts
Interest Payable
Salaries Payable
Accounts Payable
Notes Payable
Salaries Expense
Service Revenue
Dividends
Retained Earnings
Common Stock
Illustration 3-20 Chart
of accounts for Sierra
Corporation
CHART OF ACCOUNTS
The number and type of accounts used differ for each company, depending on the
size, complexity, and type of business. For example, the number of accounts depends on the amount of detail desired by management. The management of one
company may want one single account for all types of utility expense. Another may
keep separate expense accounts for each type of utility expenditure, such as gas,
electricity, and water. A small corporation like Sierra Corporation will not have
many accounts compared with a corporate giant like Ford Motor Company. Sierra
may be able to manage and report its activities in 20 to 30 accounts, whereas Ford
requires thousands of accounts to keep track of its worldwide activities.
Most companies list the accounts in a chart of accounts. They may create new
accounts as needed during the life of the business. Illustration 3-20 shows the chart
of accounts for Sierra Corporation in the order that they are typically listed (assets,
liabilities, stockholders’ equity, revenues, and expenses). Accounts shown in red
are used in this chapter; accounts shown in black are explained in later chapters.
SIERRA CORPORATION—CHART OF ACCOUNTS
Assets
Liabilities
Cash
Accounts Receivable
Supplies
Prepaid Insurance
Equipment
Accumulated Depreciation—
Equipment
Notes Payable
Accounts Payable
Interest Payable
Unearned
Service Revenue
Salaries Payable
study objective
Explain what posting is
and how it helps in the
recording process.
7
Stockholders’
Equity
Revenues
Expenses
Common Stock
Service Revenue Salaries Expense
Retained Earnings
Supplies Expense
Dividends
Rent Expense
Income Summary
Insurance Expense
Interest Expense
Depreciation Expense
POSTING
The procedure of transferring journal entry amounts to ledger accounts is called
posting. This phase of the recording process accumulates the effects of journalized transactions in the individual accounts. Posting involves these steps:
1. In the ledger, enter in the appropriate columns of the debited account(s) the
date and debit amount shown in the journal.
2. In the ledger, enter in the appropriate columns of the credited account(s) the
date and credit amount shown in the journal.
The Recording Process Illustrated
Illustrations 3-21 through 3-31 on the following pages show the basic steps in
the recording process using the October transactions of Sierra Corporation.
Sierra’s accounting period is a month. A basic analysis and a debit–credit analysis
precede the journalizing and posting of each transaction. Study these transaction
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The Recording Process Illustrated
121
analyses carefully. The purpose of transaction analysis is first to identify the
type of account involved and then to determine whether a debit or a credit
to the account is required. You should always perform this type of analysis before preparing a journal entry. Doing so will help you understand the journal entries discussed in this chapter as well as more complex journal entries to be described in later chapters.
Accounting Cycle Tutorial
The diagrams in Illustrations
3-21 to 3-31 review the
accounting cycle. If you
would like additional
practice, an Accounting
Cycle Tutorial is available
on WileyPLUS. The
illustration to the left is an
example of a screen from
the tutorial.
Event 1
On October 1, stockholders invest $10,000 cash in an outdoor
guide service company to be known as Sierra Corporation.
Basic
Analysis
The asset Cash is increased $10,000, and stockholders’ equity
(specifically Common Stock) is increased $10,000.
Equation
Analysis
(1)
Debit–Credit
Analysis
Journal
Entry
Assets
=
Cash
=
+$10,000
+
Stockholders’ Equity
Common
Stock
+$10,000 Issued stock
Debits increase assets: debit Cash $10,000.
Credits increase stockholders’ equity: credit Common Stock $10,000.
Oct. 1
Cash
Common Stock
(Issued stock for cash)
Cash
Posting
Liabilities
Oct. 1
10,000
10,000
10,000
Common Stock
Oct. 1
10,000
Illustration 3-21
Investment of cash
by stockholders
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Illustration 3-22
of note payable
Issue
Event 2
On October 1, Sierra borrows cash of $5,000 by signing
a 3-month, 12%, $5,000 note payable.
Basic
Analysis
The asset Cash is increased $5,000, and the liability Notes
Payable is increased $5,000.
Assets
=
Cash
=
Equation
Analysis
(2)
Debit–Credit
Analysis
Journal
Entry
+$5,000
Liabilities
Notes
Payable
+$5,000
+
Debits increase assets: debit Cash $5,000.
Credits increase liabilities: credit Notes Payable $5,000.
Oct. 1
Cash
Notes Payable
(Issued 3-month, 12% note
payable for cash)
Cash
Posting
Stockholders’ Equity
Oct. 1
1
5,000
5,000
Notes Payable
10,000
5,000
Oct. 1
5,000
Illustration 3-23
Purchase of equipment
Event 3
On October 2, Sierra used $5,000 cash to purchase equipment.
Basic
Analysis
The asset Equipment is increased $5,000; the asset Cash
is decreased $5,000.
= Liabilities
Assets
Equation
Analysis
Debit–Credit
Analysis
Cash
(3)
–$5,000
+
+
Stockholders’
Equity
Equipment
+$5,000
Debits increase assets: debit Equipment $5,000.
Credits decrease assets: credit Cash $5,000.
Journal
Entry
Oct. 2
Posting
Oct. 1
1
Equipment
Cash
(Purchased equipment
for cash)
Cash
10,000 Oct. 2
5,000
5,000
5,000
5,000
Oct. 2
Equipment
5,000
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The Recording Process Illustrated
Event 4
Basic
Analysis
On October 2, Sierra received a $1,200 cash advance from
R. Knox, a client, for guide services for multi-day trips that
are expected to be completed in the future.
The asset Cash is increased $1,200; the liability Unearned
Service Revenue is increased $1,200 because the service has
not been provided yet. That is, when an advance payment is
received, an unearned revenue (a liability) should be recorded
in order to recognize the obligation that exists.
Equation
Analysis
(4)
Debit–Credit
Analysis
Journal
Entry
Posting
Assets
=
Cash
=
+$1,200
+
Liabilities
Unearned
Serv. Rev.
+$1,200
Stockholders’ Equity
Oct. 2
Cash
Unearned Service Revenue
(Received advance from
R. Knox for future service)
Cash
10,000 Oct. 2
5,000
1,200
Oct. 1
1
2
1,200
Unearned Service Revenue
Oct. 2
1,200
5,000
Illustration 3-25
Services provided for cash
Basic
Analysis
The asset Cash is increased $10,000; the revenue Service
Revenue is increased $10,000.
Journal
Entry
(5)
Assets
=
Cash
=
Liabilities
+
Stockholders’ Equity
Revenues
+$10,000
+$10,000 Service Revenue
Debits increase assets: debit Cash $10,000.
Credits increase revenues: credit Service Revenue $10,000.
Oct. 3
Cash
Service Revenue
(Received cash for services
provided)
Cash
Posting
Helpful Hint Many liabilities have
the word “payable” in their title.
But, note that Unearned Service
Revenue is considered a liability
even though the word payable is
not used.
1,200
On October 3, Sierra received $10,000 in cash from
Copa Company for guide services provided in October.
Debit–Credit
Analysis
Illustration 3-24
Receipt of cash in advance
from customer
Debits increase assets: debit Cash $1,200.
Credits increase liabilities: credit Unearned Service
Revenue $1,200.
Event 5
Equation
Analysis
123
Oct. 1
1
2
3
10,000 Oct. 2
5,000
1,200
10,000
10,000
10,000
Service Revenue
5,000
Oct. 3
10,000
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Illustration 3-26
Payment of rent with cash
Event 6
On October 3, Sierra paid office rent for October in cash, $900.
Basic
Analysis
The expense account Rent Expense is increased $900 because
the payment pertains only to the current month; the asset
Cash is decreased $900.
Equation
Analysis
(6)
Debit–Credit
Analysis
Journal
Entry
Assets
=
Cash
=
+
Liabilities
Stockholders’ Equity
Expenses
–$900 Rent Expense
–$900
Debits increase expenses: debit Rent Expense $900.
Credits decrease assets: credit Cash $900.
Oct. 3
Rent Expense
Cash
(Paid cash for October office
rent)
900
900
Cash
Posting
Illustration 3-27
Purchase of insurance
policy with cash
Event 7
Basic
Analysis
Oct. 1
1
2
3
5,000
900
Oct. 3
Assets
Prepaid
Cash + Insurance
+$600
–$600
= Liabilities
+
Stockholders’
Equity
Debits increase assets: debit Prepaid Insurance $600.
Credits decrease assets: credit Cash $600.
Oct. 4
Prepaid Insurance
Cash
(Paid 1-year policy; effective
date October 1)
Oct. 1
1
2
3
10,000 Oct. 2
3
5,000
4
1,200
10,000
600
600
Prepaid Insurance
Cash
Posting
900
The asset Cash is decreased $600. Payments of expenses that
will benefit more than one accounting period are identified as
prepaid expenses or prepayments. When a payment is made,
an asset account is debited in order to show the service or
benefit that will be received in the future. Therefore, the
asset Prepaid Insurance is increased $600.
(7)
Journal
Entry
10,000 Oct. 2
3
5,000
1,200
10,000
On October 4, Sierra paid $600 for a 1-year insurance
policy that will expire next year on September 30.
Equation
Analysis
Debit–Credit
Analysis
Rent Expense
5,000
900
600
Oct. 4
600
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The Recording Process Illustrated
Illustration 3-28
Purchase of supplies on
account
Event 8
On October 5, Sierra purchased an estimated 3 months of
supplies on account from Aero Supply for $2,500.
Basic
Analysis
The asset Supplies is increased $2,500; the liability Accounts
Payable is increased $2,500.
Equation
Analysis
(8)
Debit–Credit
Analysis
Assets
=
Supplies
=
+$2,500
Liabilities
Accounts
Payable
+$2,500
+
125
Stockholders’ Equity
Debits increase assets: debit Supplies $2,500.
Credits increase liabilities: credit Accounts Payable $2,500.
Journal
Entry
Oct. 5
Posting
Oct. 5
Supplies
Accounts Payable
(Purchased supplies on
account from Aero Supply)
Supplies
2,500
2,500
2,500
Accounts Payable
Oct. 5
2,500
Illustration 3-29 Hiring
of new employees
Event 9
Basic
Analysis
On October 9, Sierra hired four employees to begin work on
October 15. Each employee will receive a weekly salary
of $500 for a 5-day work week, payable every 2 weeks—first
payment made on October 26.
An accounting transaction has not occurred. There is only an
agreement that the employees will begin work on October 15.
Thus, a debit–credit analysis is not needed because there is no
accounting entry. (See transaction of October 26 (Event II) for
first payment.)
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chapter 3 The Accounting Information System
Illustration 3-30
Payment of dividend
Event 10
Basic
Analysis
Equation
Analysis
Debit–Credit
Analysis
Journal
Entry
On October 20, Sierra paid a $500 cash dividend to stockholders.
The Dividends account is increased $500; the asset Cash is
decreased $500.
=
=
Assets
Cash
(10)
+
Liabilities
Stockholders’ Equity
Dividends
–$500
–$500
Debits increase dividends: debit Dividends $500.
Credits decrease assets: credit Cash $500.
Oct. 20
Dividends
Cash
(Declared and paid a cash
dividend)
500
500
Dividends
Cash
Posting
Illustration 3-31 Payment
of cash for employee
salaries
Oct. 1
1
2
3
10,000 Oct. 2
3
5,000
4
1,200
20
10,000
5,000
900
600
500
Oct. 20
500
Event 11
On October 26, Sierra paid employee salaries of $4,000 in cash.
(See October 9 event.)
Basic
Analysis
The expense account Salaries Expense is increased $4,000; the
asset Cash is decreased $4,000.
Assets
Equation
Analysis
Debit–Credit
Analysis
Journal
Entry
Cash
(11)
=
=
Liabilities
+
Stockholders’ Equity
Expenses
–$4,000
–$4,000 Salaries Expense
Debits increase expenses: debit Salaries Expense $4,000.
Credits decrease assets: credit Cash $4,000.
Oct. 26
Salaries Expense
Cash
(Paid salaries to date)
4,000
4,000
Cash
Posting
Oct. 1
1
2
3
10,000 Oct. 2
5,000
3
1,200
4
10,000
20
26
Salaries Expense
5,000
900
600
500
4,000
Oct. 26
4,000
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The Recording Process Illustrated
127
SUMMARY ILLUSTRATION OF
JOURNALIZING AND POSTING
The journal for Sierra Corporation for the month of October is summarized in
Illustration 3-32. The ledger is shown in Illustration 3-33 (on page 128) with all
balances highlighted in red.
Illustration 3-32 General
journal for Sierra Corporation
GENERAL JOURNAL
Date
Account Titles and Explanation
Debit
Credit
2012
Oct.
1
1
2
2
3
3
4
5
20
26
Cash
Common Stock
(Issued stock for cash)
10,000
10,000
Cash
Notes Payable
(Issued 3-month, 12% note payable for cash)
5,000
Equipment
Cash
(Purchased equipment for cash)
5,000
Cash
Unearned Service Revenue
(Received advance from R. Knox for future
service)
1,200
Cash
Service Revenue
(Received cash for services provided)
5,000
5,000
1,200
10,000
10,000
Rent Expense
Cash
(Paid cash for October office rent)
900
Prepaid Insurance
Cash
(Paid 1-year policy; effective date October 1)
600
Supplies
Accounts Payable
(Purchased supplies on account from Aero
Supply)
900
600
2,500
2,500
Dividends
Cash
(Paid a cash dividend)
500
Salaries Expense
Cash
(Paid salaries to date)
4,000
500
4,000
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Illustration 3-33 General
ledger for Sierra Corporation
GENERAL LEDGER
Cash
Oct. 1
1
2
3
10,000
5,000
1,200
10,000
Bal.
15,200
Oct.
Unearned Service Revenue
2
3
4
20
26
Oct.
5,000
900
600
500
4,000
Common Stock
Oct. 5
2,500
Oct.
Bal.
2,500
Bal.
Prepaid Insurance
1
10,000
10,000
Dividends
Oct. 4
600
Oct. 20
500
Bal.
600
Bal.
500
Equipment
Service Revenue
Oct. 2
5,000
Oct.
Bal.
5,000
Bal.
Notes Payable
3
10,000
10,000
Salaries Expense
1
Bal.
5,000
Oct. 26
4,000
5,000
Bal.
4,000
Accounts Payable
Oct.
1,200
1,200
Bal.
Supplies
Oct.
2
5
Bal.
Rent Expense
2,500
Oct.
2,500
Bal.
3
900
900
before you go on...
POSTING
Do it!
Selected transactions from the journal of Faital Inc. during its first
month of operations are presented below. Post these transactions to T accounts.
Date
Account Titles
July
1
9
24
Action Plan
• Journalize transactions to keep
track of financial activities
(receipts, payments, receivables,
payables, etc.).
• To make entries useful, classify
and summarize them by posting
the entries to specific ledger
accounts.
Debit
Cash
Common Stock
Accounts Receivable
Service Revenue
Cash
Accounts Receivable
Credit
30,000
30,000
6,000
6,000
4,000
4,000
Solution
Cash
July
1
24
Accounts Receivable
30,000
4,000
July
9
Common Stock
July
1
6,000
July 24
4,000
Service Revenue
30,000
Related exercise material: BE3-10, Do it! 3-4, and E3-11.
July
9
6,000
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The Trial Balance
129
The Trial Balance
A trial balance lists accounts and their balances at a given time. A company
usually prepares a trial balance at the end of an accounting period. The accounts
are listed in the order in which they appear in the ledger. Debit balances are
listed in the left column and credit balances in the right column. The totals of
the two columns must be equal.
The trial balance proves the mathematical equality of debits and credits after posting. Under the double-entry system this equality occurs when the
sum of the debit account balances equals the sum of the credit account balances.
A trial balance may also uncover errors in journalizing and posting. For example, a trial balance may well have detected the error at Fidelity Investments
discussed in the Feature Story. In addition, a trial balance is useful in the
preparation of financial statements.
These are the procedures for preparing a trial balance:
study objective
8
Explain the purposes of a
trial balance.
1. List the account titles and their balances.
2. Total the debit column and total the credit column.
3. Verify the equality of the two columns.
Illustration 3-34 presents the trial balance prepared from the ledger of Sierra
Corporation. Note that the total debits, $28,700, equal the total credits, $28,700.
Illustration 3-34 Sierra
Corporation trial balance
SIERRA CORPORATION
Trial Balance
October 31, 2012
Debit
Cash
Supplies
Prepaid Insurance
Equipment
Notes Payable
Accounts Payable
Unearned Service Revenue
Common Stock
Dividends
Service Revenue
Salaries Expense
Rent Expense
Credit
$15,200
2,500
600
5,000
$ 5,000
2,500
1,200
10,000
500
10,000
4,000
900
$28,700
Helpful Hint Note that the order
of presentation in the trial
balance is:
Assets
Liabilities
Stockholders’ equity
Revenues
Expenses
$28,700
LIMITATIONS OF A TRIAL BALANCE
A trial balance does not prove that all transactions have been recorded or that
the ledger is correct. Numerous errors may exist even though the trial balance
column totals agree. For example, the trial balance may balance even when any
of the following occurs: (1) a transaction is not journalized, (2) a correct journal
entry is not posted, (3) a journal entry is posted twice, (4) incorrect accounts are
used in journalizing or posting, or (5) offsetting errors are made in recording the
amount of a transaction. In other words, as long as equal debits and credits are
posted, even to the wrong account or in the wrong amount, the total debits will
equal the total credits. Nevertheless, despite these limitations, the trial balance is
a useful screen for finding errors and is frequently used in practice.
Ethics Note An error is the
result of an unintentional mistake;
it is neither ethical nor unethical.
An irregularity is an intentional
misstatement, which is viewed
as unethical.
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DECISION TOOLKIT
DECISION CHECKPOINTS
How do you determine that debits
equal credits?
KEEPING AN EYE
ON CASH
INFO NEEDED FOR DECISION
All account balances
Bal.
1
1
2
3
10,000
5,000
1,200
10,000
Oct.
15,200
study objective
Trial balance
HOW TO EVALUATE RESULTS
List the account titles and their
balances; total the debit and
credit columns; verify equality.
The Cash account shown below reflects all of the inflows and outflows of cash
that occurred during October. We have also provided a description of each transaction that affected the Cash account.
Cash
Oct.
TOOL TO USE FOR DECISION
9
Classify cash activities as
operating, investing, or
financing.
2
3
4
20
26
5,000
900
600
500
4,000
1. Oct. 1 Issued stock for $10,000 cash.
2. Oct. 1 Issued note payable for $5,000 cash.
3. Oct. 2 Purchased equipment for $5,000 cash.
4. Oct. 2 Received $1,200 cash in advance from customer.
5. Oct. 3 Received $10,000 cash for services provided.
6. Oct. 3 Paid $900 cash for October rent.
7. Oct. 4 Paid $600 cash for one-year insurance policy.
8. Oct. 20 Paid $500 cash dividend to stockholders.
9. Oct. 26 Paid $4,000 cash salaries.
The Cash account and the related cash transactions indicate why cash
changed during October. However, to make this information useful for analysis,
it is summarized in a statement of cash flows. The statement of cash flows classifies each transaction as an operating activity, an investing activity, or a financing activity. A user of this statement can then determine the amount of cash
provided by operations, the amount of cash used for investing purposes, and the
amount of cash provided by financing activities.
Operating activities are the types of activities the company performs to generate profits. Sierra Corporation is an outdoor guide business, so its operating
activities involve providing guide services. Activities 4, 5, 6, 7, and 9 relate to
cash received or spent to directly support its guide services.
Investing activities include the purchase or sale of long-lived assets used in
operating the business, or the purchase or sale of investment securities (stocks
and bonds of companies other than Sierra). Activity 3, the purchase of equipment, is an investment activity.
The primary types of financing activities are borrowing money, issuing shares
of stock, and paying dividends. The financing activities of Sierra Corporation
are activities 1, 2, and 8.
USING THE DECISION TOOLKIT
The Kansas Farmers’ Vertically Integrated Cooperative, Inc. (K-VIC) was formed by
over 200 northeast Kansas farmers in the late 1980s. Its purpose is to use raw materials, primarily grain and meat products grown by K-VIC’s members, to process
this material into end-user food products, and to distribute the products nationally.
Profits not needed for expansion or investment are returned to the members annually, on a pro-rata basis, according to the fair value of the grain and meat products
received from each farmer.
Assume that the following trial balance was prepared for K-VIC.
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Using the Decision Toolkit
KANSAS FARMERS’ VERTICALLY INTEGRATED COOPERATIVE, INC.
Trial Balance
December 31, 2012
(in thousands)
Debit
Accounts Receivable
Accounts Payable
Buildings
Cash
Cost of Goods Sold
Notes Payable (due in 2013)
Inventory
Land
Mortgage Payable
Equipment
Retained Earnings
Sales Revenue
Salaries and Wages Payable
Salaries and Wages Expense
Maintenance and Repairs Expense
Credit
$ 712,000
$ 673,000
365,000
32,000
2,384,000
12,000
1,291,000
110,000
873,000
63,000
822,000
3,741,000
62,000
651,000
500,000
$6,108,000
$6,183,000
Because the trial balance is not in balance, you have checked with various people
responsible for entering accounting data and have discovered the following.
1. The purchase of 35 new trucks, costing $7 million and paid for with cash, was
not recorded.
2. A data entry clerk accidentally deleted the account name for an account with a
credit balance of $472 million, so the amount was added to the Mortgage Payable
account in the trial balance.
3. December cash sales revenue of $75 million was credited to the Sales Revenue
account, but the other half of the entry was not made.
4. $50 million of salaries expenses were mistakenly charged to Maintenance and
Repairs Expense.
Instructions
Answer these questions.
(a) Which mistake(s) have caused the trial balance to be out of balance?
(b) Should all of the items be corrected? Explain.
(c) What is the name of the account the data entry clerk deleted?
(d) Make the necessary corrections and prepare a correct trial balance with accounts
listed in proper order.
(e) On your trial balance, write BAL beside the accounts that go on the balance sheet
and INC beside those that go on the income statement.
Solution
(a) Only mistake #3 has caused the trial balance to be out of balance.
(b) All of the items should be corrected. The misclassification error (mistake #4) on
the salaries expense would not affect bottom-line net income, but it does affect
the amounts reported in the two expense accounts.
(c) There is no Common Stock account, so that must be the account that was deleted
by the data entry clerk.
131
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chapter 3 The Accounting Information System
(d) and (e):
KANSAS FARMERS’ VERTICALLY INTEGRATED COOPERATIVE, INC.
Trial Balance
December 31, 2012
(in thousands)
Debit
Cash ($32,000 $7,000 $75,000)
Accounts Receivable
Inventory
Land
Equipment ($63,000 $7,000)
Buildings
Accounts Payable
Salaries and Wages Payable
Notes Payable (due in 2013)
Mortgage Payable ($873,000 $472,000)
Common Stock
Retained Earnings
Sales Revenue
Cost of Goods Sold
Salaries and Wages Expense
Maintenance and Repairs Expense
Credit
$ 100,000
712,000
1,291,000
110,000
70,000
365,000
$ 673,000
62,000
12,000
401,000
472,000
822,000
3,741,000
2,384,000
701,000
450,000
$6,183,000
BAL
BAL
BAL
BAL
BAL
BAL
BAL
BAL
BAL
BAL
BAL
BAL
INC
INC
INC
INC
$6,183,000
Summary of Study Objectives
1
Analyze the effect of business transactions on the basic
accounting equation. Each business transaction must
have a dual effect on the accounting equation. For
example, if an individual asset is increased, there must
be a corresponding (a) decrease in another asset, or
(b) increase in a specific liability, or (c) increase in
stockholders’ equity.
2
Explain what an account is and how it helps in the
recording process. An account is an individual accounting record of increases and decreases in specific
asset, liability, and stockholders’ equity items.
3
4
Define debits and credits and explain how they are used
to record business transactions. The terms debit and
credit are synonymous with left and right. Assets, dividends, and expenses are increased by debits and decreased by credits. Liabilities, common stock, retained
earnings, and revenues are increased by credits and
decreased by debits.
Identify the basic steps in the recording process. The
basic steps in the recording process are: (a) analyze
each transaction in terms of its effect on the accounts,
(b) enter the transaction information in a journal, and
(c) transfer the journal information to the appropriate accounts in the ledger.
5
Explain what a journal is and how it helps in the recording process. The initial accounting record of a transaction is entered in a journal before the data are
entered in the accounts. A journal (a) discloses in one
place the complete effect of a transaction, (b) provides
a chronological record of transactions, and (c) prevents or locates errors because the debit and credit
amounts for each entry can be readily compared.
6
Explain what a ledger is and how it helps in the recording process. The entire group of accounts maintained
by a company is referred to collectively as a ledger.
The ledger keeps in one place all the information
about changes in specific account balances.
7
Explain what posting is and how it helps in the recording process. Posting is the procedure of transferring
journal entries to the ledger accounts. This phase of
the recording process accumulates the effects of journalized transactions in the individual accounts.
8
Explain the purposes of a trial balance. A trial balance is
a list of accounts and their balances at a given time. The
primary purpose of the trial balance is to prove the mathematical equality of debits and credits after posting. A
trial balance also uncovers errors in journalizing and
posting and is useful in preparing financial statements.
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Comprehensive Do it!
9
Classify cash activities as operating, investing, or
financing. Operating activities are the types of activities the company uses to generate profits. Investing
activities relate to the purchase or sale of long-lived
assets used in operating the business, or to the pur-
DECISION TOOLKIT
DECISION CHECKPOINTS
133
chase or sale of investment securities (stock and bonds
of other companies). Financing activities are borrowing money, issuing
shares of stock, and paying dividends.
A SUMMARY
INFO NEEDED FOR DECISION
TOOL TO USE FOR DECISION
HOW TO EVALUATE RESULTS
Has an accounting transaction
occurred?
Details of the event
Accounting equation
If the event affected assets,
liabilities, or stockholders’ equity,
then record as a transaction.
How do you determine that
debits equal credits?
All account balances
Trial balance
List the account titles and their
balances; total the debit and
credit colums; verify equality.
Glossary
Account (p. 111) An individual accounting record of
increases and decreases in specific asset, liability, stockholders’ equity, revenue or expense items.
Accounting information system (p. 102) The system
of collecting and processing transaction data and communicating financial information to decision makers.
Accounting transactions (p. 102) Events that require
recording in the financial statements because they affect
assets, liabilities, or stockholders’ equity.
Chart of accounts (p. 120) A list of a company’s accounts.
Credit (p. 111) The right side of an account.
Debit (p. 111) The left side of an account.
Double-entry system (p. 112) A system that records the
two-sided effect of each transaction in appropriate accounts.
Comprehensive
General journal (p. 117) The most basic form of journal.
General ledger (p. 119) A ledger that contains all asset, liability, stockholders’ equity, revenue, and expense
accounts.
Journal (p. 117) An accounting record in which transactions are initially recorded in chronological order.
Journalizing (p. 117) The procedure of entering transaction data in the journal.
Ledger (p. 119) The group of accounts maintained by
a company.
Posting (p. 120) The procedure of transferring journal
entry amounts to the ledger accounts.
T account (p. 111) The basic form of an account.
Trial balance (p. 129) A list of accounts and their balances at a given time.
Do it!
Bob Sample and other student investors opened Campus Carpet Cleaning, Inc. on
September 1, 2012. During the first month of operations, the following transactions
occurred.
Sept. 1
2
3
4
10
15
20
30
Stockholders invested $20,000 cash in the business.
Paid $1,000 cash for store rent for the month of September.
Purchased industrial carpet-cleaning equipment for $25,000, paying $10,000
in cash and signing a $15,000 6-month, 12% note payable.
Paid $1,200 for 1-year accident insurance policy.
Received bill from the Daily News for advertising the opening of the cleaning
service, $200.
Performed services on account for $6,200.
Paid a $700 cash dividend to stockholders.
Received $5,000 from customers billed on September 15.
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chapter 3 The Accounting Information System
The chart of accounts for the company is the same as for Sierra Corporation except for
the following additional account: Advertising Expense.
Instructions
Action Plan
• Proceed through the accounting
cycle in the following sequence:
1. Make separate journal entries
for each transaction.
2. Note that all debits precede all
credit entries.
3. In journalizing, make sure
debits equal credits.
4. In journalizing, use specific
account titles taken from the
chart of accounts.
5. Provide an appropriate explanation of each journal entry.
6. Arrange ledger in statement
order, beginning with the
balance sheet accounts.
7. Post in chronological order.
8. Prepare a trial balance, which
lists accounts in the order in
which they appear in the
ledger.
9. List debit balances in the left
column and credit balances in
the right column.
(a) Journalize the September transactions.
(b) Open ledger accounts and post the September transactions.
(c) Prepare a trial balance at September 30, 2012.
Solution to Comprehensive
Do it!
(a)
GENERAL JOURNAL
Date
Account Titles and Explanation
2012
Sept. 1
2
3
4
10
15
20
30
Cash
Common Stock
(Issued stock for cash)
Rent Expense
Cash
(Paid September rent)
Equipment
Cash
Notes Payable
(Purchased cleaning equipment for cash
and 6-month, 12% note payable)
Prepaid Insurance
Cash
(Paid 1-year insurance policy)
Advertising Expense
Accounts Payable
(Received bill from Daily News for
advertising)
Accounts Receivable
Service Revenue
(Services performed on account)
Dividends
Cash
(Declared and paid a cash dividend)
Cash
Accounts Receivable
(Collection of accounts receivable)
(b)
Credit
20,000
20,000
1,000
1,000
25,000
10,000
15,000
1,200
1,200
200
200
6,200
6,200
700
700
5,000
5,000
GENERAL LEDGER
Common Stock
Cash
Sept.
Debit
1 20,000
30 5,000
Bal.
Sept. 2
3
4
20
1,000
10,000
1,200
700
Sept. 1
20,000
Bal.
20,000
12,100
Accounts Receivable
Sept. 15
6,200
Bal.
1,200
Sept. 30
Dividends
5,000
Sept. 20
700
Bal.
700
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Self-Test Questions
Service Revenue
Prepaid Insurance
Sept.
Bal.
4
1,200
Sept. 15
6,200
1,200
Bal.
6,200
Advertising Expense
Equipment
Sept.
Bal.
135
3 25,000
25,000
Sept. 10
200
Bal.
200
Rent Expense
Notes Payable
Sept. 3
15,000
Sept. 2 1,000
Bal.
15,000
Bal.
1,000
Accounts Payable
(c)
Sept. 10
200
Bal.
200
CAMPUS CARPET CLEANING, INC.
Trial Balance
September 30, 2012
Cash
Accounts Receivable
Prepaid Insurance
Equipment
Notes Payable
Accounts Payable
Common Stock
Dividends
Service Revenue
Advertising Expense
Rent Expense
Debit
$12,100
1,200
1,200
25,000
Credit
$15,000
200
20,000
700
6,200
200
1,000
$41,400
$41,400
Self-Test, Brief Exercises, Exercises, Problem Set A, and many
more resources are available for practice in WileyPLUS
Self-Test Questions
Answers are on page 159.
(SO 1)
1. The effects on the basic accounting equation of performing services for cash are to:
(a) increase assets and decrease stockholders’ equity.
(b) increase assets and increase stockholders’ equity.
(c) increase assets and increase liabilities.
(d) increase liabilities and increase stockholders’
equity.
2. Genesis Company buys a $900 machine on credit. (SO 1)
This transaction will affect the:
(a) income statement only.
(b) balance sheet only.
(c) income statement and retained earnings statement only.
(d) income statement, retained earnings statement,
and balance sheet.
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10. Which is not part of the recording process?
(a) Analyzing transactions.
(b) Preparing a trial balance.
(c) Entering transactions in a journal.
(d) Posting transactions.
(SO 1)
3. Which of the following events is not recorded in the
accounting records?
(a) Equipment is purchased on account.
(b) An employee is terminated.
(c) A cash investment is made into the business.
(d) Company pays dividend to stockholders.
(SO 1)
4. During 2012, Gibson Company assets decreased
$50,000 and its liabilities decreased $90,000. Its stockholders’ equity therefore:
(a) increased $40,000.
(b) decreased $140,000.
(c) decreased $40,000.
(d) increased $140,000.
(SO 2)
5. Which statement about an account is true?
(a) In its simplest form, an account consists of two
parts.
(b) An account is an individual accounting record of
increases and decreases in specific asset, liability,
and stockholders’ equity items.
(c) There are separate accounts for specific assets
and liabilities but only one account for stockholders’ equity items.
(d) The left side of an account is the credit or decrease side.
(SO 6)
12. A ledger:
(a) contains only asset and liability accounts.
(b) should show accounts in alphabetical order.
(c) is a collection of the entire group of accounts
maintained by a company.
(d) provides a chronological record of transactions.
(SO 3)
6. Debits:
(a) increase both assets and liabilities.
(b) decrease both assets and liabilities.
(c) increase assets and decrease liabilities.
(d) decrease assets and increase liabilities.
14.
(SO 3)
7. A revenue account:
(a) is increased by debits.
(b) is decreased by credits.
(c) has a normal balance of a debit.
(d) is increased by credits.
A trial balance:
(SO 8)
(a) is a list of accounts with their balances at a given
time.
(b) proves that proper account titles were used.
(c) will not balance if a correct journal entry is
posted twice.
(d) proves that all transactions have been recorded.
15.
(SO 8)
A trial balance will not balance if:
(a) a correct journal entry is posted twice.
(b) the purchase of supplies on account is debited to
Supplies and credited to Cash.
(c) a $100 cash dividend is debited to Dividends for
$1,000 and credited to Cash for $100.
(d) a $450 payment on account is debited to
Accounts Payable for $45 and credited to Cash
for $45.
(SO 3)
8. Which accounts normally have debit balances?
(a) Assets, expenses, and revenues.
(b) Assets, expenses, and retained earnings.
(c) Assets, liabilities, and dividends.
(d) Assets, dividends, and expenses.
(SO 3)
9. Paying an account payable with cash affects the components of the accounting equation in the following
way:
(a) Decreases stockholders’ equity and decreases
liabilities.
(b) Increases assets and decreases liabilities.
(c) Decreases assets and increases stockholders’ equity.
(d) Decreases assets and decreases liabilities.
11. Which of these statements about a journal is false? (SO 5)
(a) It contains only revenue and expense accounts.
(b) It provides a chronological record of transactions.
(c) It helps to locate errors because the debit and
credit amounts for each entry can be readily
compared.
(d) It discloses in one place the complete effect of a
transaction.
(SO 7)
13. Posting:
(a) normally occurs before journalizing.
(b) transfers ledger transaction data to the journal.
(c) is an optional step in the recording process.
(d) transfers journal entries to ledger accounts.
Go to the book’s companion website,
www.wiley.com/college/kimmel, to access
additional Self-Test Questions.
Questions
1. Describe the accounting information system.
2. Can a business enter into a transaction that affects
only the left side of the basic accounting equation?
If so, give an example.
3.
Are the following events recorded in the
accounting records? Explain your answer in each
case.
(SO 4)
(a)
(b)
(c)
(d)
A major stockholder of the company dies.
Supplies are purchased on account.
An employee is fired.
The company pays a cash dividend to its stockholders.
4. Indicate how each business transaction affects the
basic accounting equation.
(a) Paid cash for janitorial services.
(b) Purchased equipment for cash.
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Brief Exercises
(c) Issued common stock to investors in exchange
for cash.
(d) Paid an account payable in full.
(e) Salaries and Wages Expense.
(f ) Service Revenue.
14.
5. Why is an account referred to as a T account?
6. The terms debit and credit mean “increase” and “decrease,” respectively. Do you agree? Explain.
7. James Quest, a fellow student, contends that the
double-entry system means each transaction must
be recorded twice. Is James correct? Explain.
8. Gayle Weir, a beginning accounting student, believes
debit balances are favorable and credit balances are
unfavorable. Is Gayle correct? Discuss.
9. State the rules of debit and credit as applied to (a)
asset accounts, (b) liability accounts, and (c) the
common stock account.
137
What are the normal balances for the
following accounts of Tootsie Roll Industries? (a) Accounts Receivable, (b) Income Taxes Payable, (c) Sales,
and (d) Selling, Marketing, and Administrative
Expenses.
15. What are the basic steps in the recording process?
16. (a) When entering a transaction in the journal,
should the debit or credit be written first?
(b) Which should be indented, the debit or the credit?
17. (a) Should accounting transaction debits and credits
be recorded directly in the ledger accounts?
(b) What are the advantages of first recording transactions in the journal and then posting to the ledger?
10. What is the normal balance for each of these
accounts?
(a) Accounts Receivable.
(b) Cash.
(c) Dividends.
(d) Accounts Payable.
(e) Service Revenue.
(f ) Salaries and Wages Expense.
(g) Common Stock.
18. Journalize these accounting transactions.
(a) Stockholders invested $12,000 in the business in
exchange for common stock.
(b) Insurance of $800 is paid for the year.
(c) Supplies of $1,800 are purchased on account.
(d) Cash of $7,500 is received for services rendered.
11. Indicate whether each account is an asset, a liability, or a stockholders’ equity account, and whether
it would have a normal debit or credit balance.
(a) Accounts Receivable.
(d) Dividends.
(b) Accounts Payable.
(e) Supplies.
(c) Equipment.
21. Kevin Haden is confused about how accounting information flows through the accounting system. He
believes information flows in this order:
(a) Debits and credits are posted to the ledger.
(b) Accounting transaction occurs.
(c) Information is entered in the journal.
(d) Financial statements are prepared.
(e) Trial balance is prepared.
Indicate to Kevin the proper flow of the information.
12. For the following transactions, indicate the account
debited and the account credited.
(a) Supplies are purchased on account.
(b) Cash is received on signing a note payable.
(c) Employees are paid salaries in cash.
13. For each account listed here, indicate whether it
generally will have debit entries only, credit entries
only, or both debit and credit entries.
(a) Cash.
(b) Accounts Receivable.
(c) Dividends.
(d) Accounts Payable.
19. (a) What is a ledger?
(b) Why is a chart of accounts important?
20. What is a trial balance and what are its purposes?
22.
Two students are discussing the use of a
trial balance. They wonder whether the following
errors, each considered separately, would prevent
the trial balance from balancing. What would you
tell them?
(a) The bookkeeper debited Cash for $600 and credited Wages Expense for $600 for payment of wages.
(b) Cash collected on account was debited to Cash for
$800, and Service Revenue was credited for $80.
Brief Exercises
BE3-1 Presented below are three economic events. On a sheet of paper, list the letters
(a), (b), and (c) with columns for assets, liabilities, and stockholders’ equity. In each column, indicate whether the event increased (), decreased (), or had no effect (NE) on
assets, liabilities, and stockholders’ equity.
(a) Purchased supplies on account.
(b) Received cash for providing a service.
(c) Expenses paid in cash.
Determine effect of
transactions on basic
accounting equation.
BE3-2 During 2012, Gavin Corp. entered into the following transactions.
1. Borrowed $60,000 by issuing bonds.
2. Paid $9,000 cash dividend to stockholders.
3. Received $13,000 cash from a previously billed customer for services provided.
4. Purchased supplies on account for $3,100.
Determine effect of
transactions on basic
accounting equation.
(SO 1), C
(SO 1), AP
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Using the following tabular analysis, show the effect of each transaction on the accounting equation. Put explanations for changes to Stockholders’ Equity in the right-hand margin. For Retained Earnings, use separate columns for Revenues, Expenses, and Dividends
if necessary. Use Illustration 3-3 (page 110) as a model.
ⴝ
Assets
ⴙ Stockholders’ Equity
Liabilities
Accounts
Accounts
Bonds
Common
Retained
Cash Receivable Supplies Payable Payable
Stock Earnings
Determine effect of
transactions on basic
accounting equation.
(SO 1), AP
BE3-3 During 2012, Newberry Company entered into the following transactions.
1. Purchased equipment for $286,176 cash.
2. Issued common stock to investors for $137,590 cash.
3. Purchased inventory of $68,480 on account.
Using the following tabular analysis, show the effect of each transaction on the accounting equation. Put explanations for changes to Stockholders’ Equity in the right-hand margin. For Retained Earnings, use separate columns for Revenues, Expenses, and Dividends
if necessary. Use Illustration 3-3 (page 110) as a model.
ⴝ Liabilities ⴙ Stockholders’ Equity
Assets
Cash Inventory Equipment
Accounts
Payable
Common
Retained
Stock
Earnings
(SO 3), K
BE3-4 For each of the following accounts, indicate the effect of a debit or a credit on
the account and the normal balance.
(a) Accounts Payable.
(d) Accounts Receivable.
(b) Advertising Expense.
(e) Retained Earnings.
(c) Service Revenue.
(f ) Dividends.
Identify accounts to be
debited and credited.
BE3-5 Transactions for Marlin Company for the month of June are presented below.
Identify the accounts to be debited and credited for each transaction.
Indicate debit and credit
effects.
(SO 3), C
Journalize transactions.
(SO 5), AP
Identify steps in the
recording process.
(SO 4), C
Indicate basic debit–credit
analysis.
(SO 4), C
Journalize transactions.
June 1
2
3
12
BE3-6
Issues common stock to investors in exchange for $5,000 cash.
Buys equipment on account for $1,100.
Pays $740 to landlord for June rent.
Bills Matt Wilfer $700 for welding work done.
Use the data in BE3-5 and journalize the transactions. (You may omit explanations.)
BE3-7 Eugenie Steckler, a fellow student, is unclear about the basic steps in the recording process. Identify and briefly explain the steps in the order in which they occur.
BE3-8 Acker Corporation has the following transactions during August of the current
year. Indicate (a) the basic analysis and (b) the debit–credit analysis illustrated on
pages 121–126.
Aug. 1 Issues shares of common stock to investors in exchange for $10,000.
4 Pays insurance in advance for 3 months, $1,500.
16 Receives $900 from clients for services rendered.
27 Pays the secretary $620 salary.
(SO 5), AP
BE3-9
Use the data in BE3-8 and journalize the transactions. (You may omit explanations.)
Post journal entries to
T accounts.
BE3-10 Selected transactions for Rojas Company are presented below in journal form
(without explanations). Post the transactions to T accounts.
(SO 7), AP
Date
May 5
12
15
Account Title
Accounts Receivable
Service Revenue
Cash
Accounts Receivable
Cash
Service Revenue
Debit
Credit
3,800
3,800
1,600
1,600
2,000
2,000
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Do it! Review
BE3-11 From the ledger balances below, prepare a trial balance for Lyndon Company
at June 30, 2012. All account balances are normal.
Accounts Payable
Cash
Common Stock
Dividends
Equipment
$ 1,000
5,400
18,000
1,200
13,000
Service Revenue
Accounts Receivable
Salaries and Wages Expense
Rent Expense
139
Prepare a trial balance.
(SO 8), AP
$8,600
3,000
4,000
1,000
BE3-12 An inexperienced bookkeeper prepared the following trial balance that does not
balance. Prepare a correct trial balance, assuming all account balances are normal.
Prepare a corrected trial
balance.
(SO 8), AP
PELICAN COMPANY
Trial Balance
December 31, 2012
Debit
Cash
Prepaid Insurance
Accounts Payable
Unearned Service Revenue
Common Stock
Retained Earnings
Dividends
Service Revenue
Salaries and Wages Expense
Rent Expense
Credit
$20,800
$ 3,500
2,500
1,800
10,000
6,600
5,000
25,600
14,600
2,600
$37,200
$55,800
Do it! Review
Do it! 3-1 Transactions made by Leonardo Bloom Co. for the month of March are
shown below. Prepare a tabular analysis that shows the effects of these transactions on
the expanded accounting equation, similar to that shown in Illustration 3-3 (page 110).
Prepare tabular analysis.
(SO 1), C
1. The company provided $20,000 of services for customers on account.
2. The company received $20,000 in cash from customers who had been billed for services [in transaction (1)].
3. The company received a bill for $1,800 of advertising but will not pay it until a later date.
4. Leonardo Bloom Co. paid a cash dividend of $3,000.
Do it! 3-2 Phil Eubanks has just rented space in a strip mall. In this space, he will open
a photography studio, to be called Picture This! A friend has advised Phil to set up a doubleentry set of accounting records in which to record all of his business transactions.
Identify the balance sheet accounts that Phil will likely need to record the transactions needed to open his business (a corporation). Indicate whether the normal balance
of each account is a debit or credit.
Identify normal balances.
Do it! 3-3 Phil Eubanks engaged in the following activities in establishing his photography studio, Picture This!:
Record business activities.
1. Opened a bank account in the name of Picture This! and deposited $8,000 of his own
money into this account in exchange for common stock.
2. Purchased photography supplies at a total cost of $950. The business paid $400 in
cash, and t...