The Accounting Information System: Learning Objectives

3 The Accounting
Information System
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1. Understand basic accounting 6. Prepare financial statements from the

terminology. adjusted trial balance.
2. Explain double-entry rules. 7. Prepare closing entries.
3. Identify steps in the accounting cycle. 8. Prepare financial statements for a
4. Record transactions in journals, post to merchandising company.
ledger accounts, and prepare a trial
balance.
5. Explain the reasons for preparing
adjusting entries and identify major types
of adjusting entries.
3-1
Accounting Information System
Accounting information system

 Collects and processes transaction data.
 Disseminates the financial information to interested
parties.
3-2 LO 1 Understand basic accounting terminology.

Helps management answer such questions as:

 How much and what kind of debt is outstanding?
 Were sales higher this period than last?
 What assets do we have?
 What were our cash inflows and outflows?
 Did we make a profit last period?
 Are any of our product lines or divisions operating at a loss?
 Can we safely increase our dividends to stockholders?
 Is our rate of return on net assets increasing?

Basic Terminology
 Event  Journal
 Transaction  Posting
 Account  Trial Balance
 Real Account  Adjusting Entries
 Nominal Account  Financial Statements
 Ledger  Closing Entries

3 The Accounting
Information System
LEARNING OBJECTIVES

balance.
3-5
Debits and Credits

 An account shows the effect of transactions on a given
asset, liability, equity, revenue, or expense account.
 Double-entry accounting system (two-sided effect).
 Recording done by debiting at least one account and
crediting another.
 DEBITS must equal CREDITS.
3-6 LO 2 Explain double-entry rules.

Debits and Credits
 An arrangement that shows the

Account
effect of transactions on an
account.
 Debit = “Left”
 Credit = “Right”
An Account can Account Name

be illustrated in a Debit / Dr. Credit / Cr.
T-Account form.

Debits and Credits
If the sum of Debit entries are greater than the sum of

Credit entries, the account will have a debit balance.
Account Name
Debit / Dr. Credit / Cr.
Transaction #1 $10,000 $3,000 Transaction #2

Transaction #3 8,000
Balance $15,000

Debits and Credits
If the sum of Credit entries are greater than the sum of

Debit entries, the account will have a credit balance.
Account Name
Transaction #1 $10,000 $3,000 Transaction #2

8,000 Transaction #3
Balance $1,000

Debits and Credits Summary
Liabilities
Normal
Normal Normal
Normal
Balance
Balance Balance
Balance
Debit
Debit Credit
Credit Normal Balance
Chapter
3-24
Assets Stockholders’ Equity

Debit / Dr. Credit / Cr. Debit / Dr. Credit / Cr.
Normal Balance Normal Balance
Chapter Chapter
3-23 3-25
Revenue
Expense
Normal Balance
Normal Balance
Chapter
Chapter 3-26
3-27

Debits and Credits Summary
Balance Sheet Income Statement
Asset = Liability + Equity Revenue - Expense
Debit
Credit

The Accounting Equation
Relationship among the assets, liabilities and stockholders’

equity accounts of a business:
Illustration 3-3
The equation must be in balance after every transaction. For

every Debit there must be a Credit.

Double-Entry System Illustration
1. Owners invest $40,000 in exchange for common

stock.
Stockholders’
Assets = Liabilities +
Equity
+ 40,000 + 40,000

2. Disburse $600 cash for secretarial wages.
Stockholders’
Equity
- 600 - 600
(expense)

3. Purchase office equipment priced at $5,200, giving a

10 percent promissory note in exchange.
Stockholders’
Equity
+ 5,200 + 5,200

4. Received $4,000 cash for services performed.
Stockholders’
Equity
+ 4,000 + 4,000
(revenue)

5. Pay off a short-term liability of $7,000.
Stockholders’
Equity
- 7,000 - 7,000

6. Declared a cash dividend of $5,000.
Stockholders’
Equity
+ 5,000 - 5,000

7. Convert a long-term liability of $80,000 into common

stock.
Stockholders’
Equity
- 80,000 + 80,000

8. Pay cash of $16,000 for a delivery van.
Stockholders’
Equity
- 16,000
+ 16,000
Note
Notethat
thatthe
theaccounting
accountingequation
equationequality
equalityisis
maintained
maintainedafter
afterrecording
recordingeach
eachtransaction.
transaction.

Financial Statements and Ownership Structure
Ownership structure dictates the types of accounts that are

part of or affect the equity section.
Proprietorship
Proprietorship or
or Corporation
Corporation
Partnership
Partnership
 Owner’s Capital  Common Stock

 Owner’s Drawing  Paid-in Capital in
Excess of Par
 Dividends
 Retained Earnings

Financial Statements and Ownership Structure
Illustration 3-4
Balance Sheet
Stockholders’ Equity
Equity
Common
Common Stock
Stock Retained Earnings
(investments
(investments by
by stockholders)
stockholders) (net
(net income
income retained
retained in
in business)
business)
Net
Net income
income or
or Net
Net loss
loss
Dividends (revenues
(revenues less
less expenses)
expenses)
Income
Income Statement
Statement
Statement of Retained Earnings

3 The Accounting
Information System
LEARNING OBJECTIVES

balance.
3-23
The Accounting Cycle
Illustration 3-6
Transactions
Transactions
Reversing
Reversing entries
entries Journalization
Journalization
Post-closing
Post-closing trail
trail balance
balance Posting
Posting
Closing
Closing Trial
Trial balance
balance
Work
Work
Statement
Statement preparation
preparation Sheet
Sheet
Adjustments
Adjustments
Adjusted
Adjusted trial
trial balance
balance
3-24 LO 3 Identify steps in the accounting cycle.

Identify and Recording Transactions
What to Record?
The FASB used the phrase “transactions and other events
and circumstances that affect a business enterprise.”
Types of Events:
 External – between an entity and its environment.
 Internal – event occurring entirely within an entity.
3-25 LO 3 Identify steps in the accounting cycle.

3 The Accounting
Information System
LEARNING OBJECTIVES

balance.
3-26
Journalizing
General Journal – a chronological record of transactions.

Journal Entries are recorded in the journal.
September 1: Stockholders invested $15,000 cash in the corporation

in exchange for shares of stock. Purchased computer equipment for
$7,000 cash.
Illustration 3-7
3-27 LO 4
Posting
Posting – Transferring amounts from journal to ledger.
Illustration 3-8
3-28
LO 4
Posting
An Expanded Example
The purpose of transaction analysis is
(1) to identify the type of account involved, and
(2) to determine whether a debit or a credit is required.
Keep in mind that every journal entry affects one or more of the
following items: assets, liabilities, stockholders’ equity,
revenues, or expenses.
LO 4 Record transactions in journals, post to ledger

3-29
accounts, and prepare a trial balance.
Posting
1. October 1: Stockholders invest $100,000 cash in an

advertising venture to be known as Pioneer Advertising
Agency Inc.
Oct. 1 Cash 100,000

Common Stock 100,000
Cash Common Stock

Debit Credit Debit Credit
100,000 100,000

3-30
Posting
2. October 1: Pioneer Advertising purchases office equipment

costing $50,000 by signing a 3-month, 12%, $50,000 note
payable.
Oct. 1 Equipment 50,000

Notes Payable 50,000
Equipment Notes Payable

50,000 50,000

3-31
Posting
3. October 2: Pioneer Advertising receives a $12,000 cash

advance from KC, a client, for advertising services that are
expected to be completed by December 31.
Oct. 2 Cash 12,000

Unearned Service Revenue 12,000
Cash Unearned Service Revenue

100,000 12,000
12,000

3-32
Posting
4. October 3: Pioneer Advertising pays $9,000 office rent, in

cash, for October.
Oct. 3 Rent Expense 9,000

Cash 9,000
Cash Rent Expense

100,000 9,000 9,000
12,000

3-33
Posting
5. October 4: Pioneer Advertising pays $6,000 for a one-year

insurance policy that will expire next year on September 30.
Oct. 4 Prepaid Insurance 6,000

Cash 6,000
Cash Prepaid Insurance

100,000 9,000 6,000
12,000 6,000

3-34
Posting
6. October 5: Pioneer Advertising purchases, for $25,000 on

account, an estimated 3-month supply of advertising materials
from Aero Supply.
Oct. 5 Supplies 25,000

Accounts Payable 25,000
Supplies Accounts Payable

25,000 25,000

3-35
Posting
7. October 9: Pioneer Advertising signs a contract with a local

newspaper for advertising inserts (flyers) to be distributed
starting the last Sunday in November. Pioneer will start work
on the content of the flyers in November. Payment of $7,000 is
due following delivery of the Sunday papers containing the
flyers.
A business transaction has not occurred. There is only an

agreement between Pioneer Advertising and the newspaper for
the services to be performed in November. Therefore, no journal
entry is necessary in October.

3-36
Posting
8. October 20: Pioneer Advertising’s board of directors declares

and pays a $5,000 cash dividend to stockholders.
Oct. 20 Dividends 5,000

Cash 5,000
Cash Dividends
100,000 9,000 5,000
12,000 6,000
5,000

3-37
Posting
9. October 26: Employees are paid every four weeks. The total
payroll is $2,000 per day. The pay period ended on Friday,
October 26, with salaries and wages of $40,000 being paid.
Oct. 26 Salaries and Wages Expense 40,000

Cash 40,000
Cash Salaries and Wages Expense

100,000 9,000 40,000
12,000 6,000
5,000
40,000
3-38 LO 4
Posting
10. October 31: Pioneer Advertising receives $28,000 in cash and
bills Copa Company $72,000 for advertising services of
$100,000 performed in October.
Oct. 31 Cash 28,000
Accounts Receivable 72,000
Service Revenue 100,000
Cash Accounts Receivable Service Revenue

Debit Credit Debit Credit Debit Credit
100,000 9,000 72,000 100,000
12,000 6,000
28,000 5,000
40,000
80,000
3-39
Trial Balance
Illustration 3-19
Trial Balance –
A list of each
account and its
balance; used to
prove equality of
debit and credit
balances.
3-40
LO 4
3 The Accounting
Information System
LEARNING OBJECTIVES

balance.
3-41
Adjusting Entries
Makes it possible to:

 Report on the balance sheet the appropriate assets,
liabilities, and owner’s equity at the statement date.
 Report on the income statement the proper revenues
and expenses for the period.
► Revenues are recorded in the period in which services
are performed.
► Expenses are recognized in the period in which they are
incurred.
LO 5 Explain the reasons for preparing adjusting entries

3-42 and identify major types of adjusting entries.
Types of Adjusting Entries
Illustration 3-20
Deferrals Accruals
1. Prepaid Expenses. 3. Accrued Revenues.

Expenses paid in cash Revenues for services
before they are used or performed but not yet
consumed. received in cash or
recorded.
2. Unearned Revenues. 4. Accrued Expenses.
Cash received before Expenses incurred but not
services are performed. yet paid in cash or
recorded.

Adjusting Entries for Deferrals
Deferrals are
either
 prepaid
expenses
or
 unearned
revenues.
Illustration 3-21
3-44 LO 5
Adjusting Entries for Prepaid Expenses
Prepaid Expenses. Assets paid for and recorded before a

company uses them.
Cash Payment BEFORE Expense Recorded
Prepayments often occur in regard to:

 insurance  rent
 supplies  buildings and equipment
 advertising

Supplies. Pioneer Advertising purchased advertising supplies

costing $25,000 on October 5. Prepare the journal entry to
record the purchase of the supplies.
Oct. 5 Supplies 25,000

Cash 25,000
Supplies Cash
25,000 25,000
3-46 LO 5
Supplies. An inventory count at the close of business on

October 31 reveals that $10,000 of the advertising supplies are
still on hand.
Oct. 31 Supplies Expense 15,000
Supplies 15,000
Supplies Supplies Expense

25,000 15,000 15,000
10,000
3-47 LO 5
PIONEER ADVERTISING AGENCY INC.
Adjusting Entries for Balance Sheet
October 31, 2014
Prepaid Expenses
Illustration 3-35
Statement
Presentation:
Supplies identifies that
portion of the asset’s
cost that will provide
future economic benefit.
3-48 Illustration 3-35

Illustration 3-35
Statement PIONEER ADVERTISING AGENCY INC.
Presentation: Income Statement
For the Month Ended October 31, 2014
Supplies expense
identifies that portion of
the asset’s cost that
expired in October.

Insurance. On Oct. 4th, Pioneer Advertising paid $6,000 for a

one-year fire insurance policy, coverage beginning October 1.
Prepare the entry to record the purchase of the insurance.
Oct. 4 Prepaid Insurance 6,000

Cash 6,000
Prepaid Insurance Cash

6,000 6,000
3-50 LO 5
Insurance. An analysis of the policy reveals that $500

($6,000 ÷ 12) of insurance expires each month. Prepare the
entry to record the insurance cost expired in October.
Oct. 31 Insurance Expense 500

Prepaid Insurance 500
Prepaid Insurance Insurance Expense

6,000 500 500
5,500
3-51 LO 5
October 31, 2014
Prepaid Expenses
Illustration 3-35
Statement
Presentation:
Prepaid insurance
the asset’s cost that will
provide future economic
benefit.

Illustration 3-35

Insurance expense
expired in October.

Depreciation. Pioneer Advertising estimates depreciation on its

office equipment to be $400 per month. Prepare the entry to
record depreciation for the month of October.
Oct. 31 Depreciation Expense 400

Accumulated Depreciation 400
Depreciation Expense Accumulated Depreciation

400 400
3-54 LO 5
October 31, 2014
Prepaid Expenses
Illustration 3-35
Statement
Presentation:
Accumulated
Depreciation is a contra
asset account.

Illustration 3-35
Depreciation expense
expired in October.

Adjusting Entries for Unearned Revenues
Receipt of cash before the services are performed is

recorded as a liability called unearned revenues.
Cash Receipt BEFORE Revenue Recorded
Unearned revenues often occur in regard to:
 rent  magazine subscriptions

 airline tickets  customer deposits
 tuition

Unearned Revenue. Pioneer Advertising received $12,000 on

October 2nd from KC for advertising services expected to be
completed by December 31. Prepare the journal entry to
record the receipt on October 2nd.
Oct. 2 Cash 12,000
Unearned Service Revenue 12,000
Cash Unearned Service Revenue

12,000 12,000
3-58 LO 5
Unearned Revenues. Analysis reveals that Pioneer Advertising

earned $4,000 of the advertising services in October. Prepare
the entry to record the revenue for services performed.
Oct. 31 Unearned Service Revenue 4,000

Service Revenue Unearned Service Revenue

100,000 4,000 12,000
4,000
104,000 8,000
3-59 LO 5
Adjusting Entries PIONEER ADVERTISING AGENCY INC.
Balance Sheet
for Unearned October 31, 2014
Revenues Illustration 3-35
Statement
Presentation:
Unearned service
revenue identifies that
portion of the liability for
which services have not
been performed.

Illustration 3-35
Service Revenue
includes the portion of
unearned service
revenue for which
services were
performed in October.

Adjusting Entries for Accruals
Accruals are
either
 accrued
revenues or
 accrued
expenses.
Illustration 3-27
3-62 LO 5
Adjusting Entries for Accrued Revenues
Revenues recorded for services performed but cash has yet

to be received at the statement date are accrued revenues.
Adjusting entry results in:
Revenue Recorded BEFORE Cash Receipt
Accrued revenues often occur in regard to:

 rent
 interest
 services performed

Adjusting Entries for Accrued Revenues
Accrued Revenues. In October Pioneer Advertising performed

services worth $2,000 that were not billed clients before Oct. 31.
Prepare the entry to revenues for services performed.
Oct. 31 Accounts Receivable 2,000
Accounts Receivable Service Revenue

72,000 100,000
2,000 4,000
2,000
74,000 106,000
3-64 LO 5
Balance Sheet
for Accrued October 31, 2014
Revenues Illustration 3-35
Illustration 3-35

Income Statement
3-65 LO 5
Adjusting Entries for Accrued Expenses
Expenses incurred but not yet paid in cash or recorded.
Adjusting entry results in:
Expense Recorded BEFORE Cash Payment
Accrued expenses often occur in regard to:
 rent  taxes
 interest  salaries

Accrued Interest. Pioneer Advertising signed a three-month

note payable in the amount of $50,000 on October 1. The note
requires interest at an annual rate of 12 percent. Three factors
determine the amount of the interest accumulation:
1 2 3 Illustration 3-29

Accrued Interest. Pioneer signed a three-month, 12%, note

payable in the amount of $50,000 on October 1. Prepare the
adjusting entry on Oct. 31 to record the accrual of interest.
Oct. 31 Interest Expense 500

Interest Payable 500
Interest Expense Interest Payable

500 500
3-68 LO 5
Balance Sheet
Expenses Illustration 3-35
Illustration 3-35

Income Statement
3-69 LO 5
Accrued Salaries and Wages. At October 31, the salaries and

wages for these days represent an accrued expense and a
related liability to Pioneer. The employees receive total salaries of
$10,000 for a five-day work week, or $2,000 per day.
3-70 LO 5
Accrued Salaries. Employees receive total salaries and wages

of $10,000 for a five-day work week, or $2,000 per day. Prepare
the adjusting entry on Oct. 31 to record accrual for salaries.
Oct. 31 Salaries and Wages Expense 6,000

Salaries and Wages Payable 6,000
Salaries and Wages Expense Salaries and Wages Payable

40,000 6,000
6,000
46,000
3-71 LO 5
Accrued Salaries. On November 23, Pioneer will again pay

total salaries and wages of $40,000. Prepare the entry to
record the payment of salaries on November 23.
Nov. 23 Salaries and Wages Payable 6,000

Salaries and Wages Expense 34,000
Cash 40,000
Salaries and Wages Expense Salaries and Wages Payable

34,000 6,000 6,000
3-72 LO 5
Balance Sheet
Illustration 3-35

Income Statement
3-73 LO 5
Bad Debts. Pioneer Advertising reasonably estimates a bad

debt expense for the month of $1,600. Prepare the entry to
record the bad debts for the month of October.
Oct. 31 Bad Debt Expense 1,600

Allowance for Doubtful Accounts 1,600
Illustration 3-32
3-74 LO 5
Balance Sheet
Illustration 3-35

Income Statement
3-75 LO 5
Adjusted Trial Balance
Shows the October 31, 2014
balance of all
accounts, after
adjusting entries,
at the end of the
accounting
period.
Illustration 3-33
3-76
3 The Accounting
Information System
LEARNING OBJECTIVES

balance.
3-77
Preparing Financial Statements
Financial
FinancialStatements
Statementsare
areprepared
prepareddirectly
directlyfrom
fromthe
the
Adjusted
AdjustedTrial
TrialBalance.
Balance.
Retained
Income Balance
Earnings
Statement Sheet
Statement
3-78 LO 6 Prepare financial statement from the adjusted trial balance.

Illustration 3-34
3-79 LO 6
Illustration 3-35
3-80 LO 6
3 The Accounting
Information System
LEARNING OBJECTIVES

balance.
3-81
Closing Entries
Basic Process
 To reduce the balance of the nominal (temporary) accounts
to zero in order to prepare the accounts for the next
period’s transactions.
 To transfer all income statement account balances to the
Retained Earnings account in owner’s equity.
 Balance sheet (asset, liability, and equity) accounts are
not closed.
 Dividends are closed directly to the Retained Earnings
account.
3-82 LO 7 Prepare closing entries.

Closing Entries
PIONEER ADVERTISING AGENCY INC. Illustration 3-33
October 31, 2014
Closing Journal Entries:
Retained Earnings 5,000

Dividends 5,000
Salaries & Wages Expense
46,000
Supplies Expense 15,000
Rent Expense 9,000
Insurance Expense 500
Interest Expense 500
Depreciation Expense 400
Bad Debt Expense 1,600
Retained Earnings 33,000

Post-Closing Trial Balance Illustration 3-38

Post-Closing Trial Balance
October 31, 2014
3-84 LO 7
Accounting Cycle Summarized
1. Enter the transactions of the period in appropriate journals.

2. Post from the journals to the ledger (or ledgers).
3. Take an unadjusted trial balance (trial balance).
4. Prepare adjusting journal entries and post to the ledger(s).
5. Take a trial balance after adjusting (adjusted trial balance).
6. Prepare the financial statements from the second trial balance.
7. Prepare closing journal entries and post to the ledger(s).
8. Take a post-closing trial balance (optional).
9. Prepare reversing entries (optional) and post to the ledger(s).
Reversing entries are

covered in Appendix 3B.
3 The Accounting
Information System
LEARNING OBJECTIVES

balance.
3-86
Financial Statements of a Merchandising Company
UPTOWN CABINET CORP.
Income Statement
Illustration 3-39
For the Year Ended December 31, 2014
3-87 LO 8
Financial Statements of a Merchandising Company
Illustration 3-40
UPTOWN CABINET CORP.

Statement of Retained Earnings
For the Year Ended December 31, 2014
3-88 LO 8 Prepare financial statements for a merchandising company.

Financial UPTOWN CABINET CORP.
Balance Sheet
As of December 31, 2014
Statements of a
Merchandising
Company
Illustration 3-41
3-89 LO 8

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3 The Accounting

1. Understand basic accounting 6. Prepare financial statements from the

Accounting information system

3-2 LO 1 Understand basic accounting terminology.

Helps management answer such questions as:

3-3 LO 1 Understand basic accounting terminology.

3-4 LO 1 Understand basic accounting terminology.

1. Understand basic accounting 6. Prepare financial statements from the

Debits and Credits

3-6 LO 2 Explain double-entry rules.

 An arrangement that shows the

An Account can Account Name

3-7 LO 2 Explain double-entry rules.

If the sum of Debit entries are greater than the sum of

Transaction #1 $10,000 $3,000 Transaction #2

3-8 LO 2 Explain double-entry rules.

If the sum of Credit entries are greater than the sum of

Transaction #1 $10,000 $3,000 Transaction #2

3-9 LO 2 Explain double-entry rules.

Assets Stockholders’ Equity

Normal Balance Normal Balance

3-10 LO 2 Explain double-entry rules.

Balance Sheet Income Statement

Asset = Liability + Equity Revenue - Expense

3-11 LO 2 Explain double-entry rules.

Relationship among the assets, liabilities and stockholders’

The equation must be in balance after every transaction. For

3-12 LO 2 Explain double-entry rules.

1. Owners invest $40,000 in exchange for common

3-13 LO 2 Explain double-entry rules.

2. Disburse $600 cash for secretarial wages.

3-14 LO 2 Explain double-entry rules.

3. Purchase office equipment priced at $5,200, giving a

3-15 LO 2 Explain double-entry rules.

4. Received $4,000 cash for services performed.

3-16 LO 2 Explain double-entry rules.

5. Pay off a short-term liability of $7,000.

3-17 LO 2 Explain double-entry rules.

6. Declared a cash dividend of $5,000.

3-18 LO 2 Explain double-entry rules.

7. Convert a long-term liability of $80,000 into common

3-19 LO 2 Explain double-entry rules.

8. Pay cash of $16,000 for a delivery van.

3-20 LO 2 Explain double-entry rules.

Ownership structure dictates the types of accounts that are

 Owner’s Capital  Common Stock

3-21 LO 2 Explain double-entry rules.

Statement of Retained Earnings

3-22 LO 2 Explain double-entry rules.

1. Understand basic accounting 6. Prepare financial statements from the

3-24 LO 3 Identify steps in the accounting cycle.

3-25 LO 3 Identify steps in the accounting cycle.

1. Understand basic accounting 6. Prepare financial statements from the

General Journal – a chronological record of transactions.

September 1: Stockholders invested $15,000 cash in the corporation

Posting – Transferring amounts from journal to ledger.

LO 4 Record transactions in journals, post to ledger

1. October 1: Stockholders invest $100,000 cash in an

Oct. 1 Cash 100,000