Chapter 7 The Accounting Information System Diamond Chapter

Chapter 7 The Accounting Information System Diamond Chapter 7 1

The Accounting Cycle Diamond Chapter 7 2

The Accounting Cycle 1. Analyze transactions Diamond Chapter 7 3

The Accounting Cycle 1. Analyze transactions 2. Record the effect of transactions in a journal entry Diamond Chapter 7 4

The Accounting Cycle 1. Analyze transactions 2. Record the effect of transactions in a journal entry 3. Summarize the effects of transactions a. Post journal entries to the ledger b. Prepare a trial balance Diamond Chapter 7 5

The Accounting Cycle Diamond Chapter 7 1. Analyze transactions 2. Record the effect of transactions in a journal entry 3. Summarize the effects of transactions a. Post journal entries to the ledger b. Prepare a trial balance 4. Prepare reports a. Make adjusting entries b. Prepare financial statements c. Close the books 6

Transaction Analysis Using Debits and Credits Diamond Chapter 7 7

Transaction Analysis Using Debits and Credits The accounting equation Assets = Liabilities + Owners’ Equity The spreadsheet analysis format based on the accounting equation is not practical when a company has thousands of transactions Diamond Chapter 7 8

Transaction Analysis Using Debits and Credits All transactions relating to a specific item are recorded in an account The most simple form of an account is called a T- account Diamond Chapter 7 9

The T- Account ACCOUNT TITLE Diamond Chapter 7 DEBIT CREDIT (Left Side) (Right Side) 10

Debits and Credits: Balance Sheet Accounts Increase Assets Debit Liabilities Credit Right Equity Credit Right Diamond Chapter 7 Decrease Left 11

Debits and Credits: Balance Sheet Accounts Increase Decrease Assets Debit Liabilities Credit Right Debit Left Equity Credit Right Debit Left Diamond Chapter 7 Left Credit Right 12

Debits and Credits: Balance Sheet Accounts ASSET LIABILITY EQUITY DEBIT CREDIT DEBIT + - - + - Diamond Chapter 7 CREDIT + 13

Debits and Credits: Revenues, Expenses, and Dividends Increase Revenues Credit Expenses Debit Left Dividends Debit Left Diamond Chapter 7 Decrease Right 14

Debits and Credits: Revenues, Expenses, and Dividends Increase Decrease Revenues Credit Expenses Debit Left Credit Right Dividends Debit Left Credit Right Diamond Chapter 7 Right Debit Left 15

Debits and Credits: Revenues, Expenses, and Dividends REVENUE DEBIT CREDIT - Diamond Chapter 7 + EXPENSE DEBIT + CREDIT - DIVIDEND DEBIT + CREDIT - 16

Debits and Credits — All Accounts Assets Dr. Cr. + - = Liabilities Dr. - Owners’ Equity + Cr. + Dr. - Retained Earnings Paid-in Capital Dr. - Cr. + Dr. - Expenses Dr. + Cr. + Revenues Cr. - Dr. - Cr. + Dividends Diamond Chapter 7 Dr. + Cr. - 17

Recording Journal Entries Diamond Chapter 7 18

Recording the Effects of Transactions The journal is a book in which all transactions are recorded in chronological order Diamond Chapter 7 DR = CR Each journal entry has its debit amounts equal to its credit amounts to ensure that the accounting equation remains in balance 19

Recording the Effects of Transactions Journalizing involves a three-step process: 1. Identify which accounts are involved 2. For each account, determine if it is increased or decreased 3. For each account, determine by how much it changed Diamond Chapter 7 20

Recording the Effects of Transactions The account debited is always listed first, followed by the account credited The credit entry is indented Some selected transactions from Veda Landscape Solutions are presented next as examples… Diamond Chapter 7 21

Transaction 1 Investment of $700, 000 cash into the business. Diamond Chapter 7 22

Transaction 2 Borrowed $300, 000 cash from the bank. Diamond Chapter 7 23

Transaction 3 Purchased land costing $50, 000 and buildings costing $400, 000. Paid $100, 000 in cash and signed a mortgage for the balance. Diamond Chapter 7 24

Transaction 4 Purchased equipment for $650, 000 in cash. Diamond Chapter 7 25

Transaction 7 Purchased inventory costing $90, 000 for $10, 000 in cash and the remaining $80, 000 on account. Diamond Chapter 7 26

Transaction 8 Paid $15, 000 cash for an insurance policy. Diamond Chapter 7 27

Transaction 10 Sold inventory costing $800, 000 to customers for $1, 100, 000. The customers paid $200, 000 in cash and the remaining $900, 000 was put on the customers’ accounts. Diamond Chapter 7 28

Transaction 11 Performed landscaping consulting services and billed clients $200, 000 for these services. Diamond Chapter 7 29

Transaction 14 Collected $820, 000 cash from customers as payment on their accounts. Diamond Chapter 7 30

Transaction 15 Paid $1, 200, 000 in cash to suppliers as payment on account. Diamond Chapter 7 31

Transaction 18 Paid cash of $150, 000 for advertising, utilities, and office supplies. Diamond Chapter 7 32

Transaction 23 Paid cash dividends of $5, 000. Diamond Chapter 7 33

Posting and the Trial Balance Diamond Chapter 7 34

Posting involves transferring the debits and credits from the journal entries to the individual accounts Posting is purely mechanical in nature and requires no analysis The collection of all of a company’s accounts is called a ledger Diamond Chapter 7 35

Example: Posting Transaction 1 Cash 700, 000 Paid-in Capital Cash 700, 000 Diamond Chapter 7 700, 000 Paid-in Capital 700, 000 36

Trial Balance A trial balance is a listing of all of the ledger accounts and their balances The total of the debit balance accounts should equal the total of the credit balance accounts DR = CR The equality of the debits and credits provides some assurance that the posting process has been completed correctly Diamond Chapter 7 37

Diamond Chapter 7 38

Adjusting and Closing Entries Diamond Chapter 7 39

Adjusting Entries Adjusting entries are made at the end of the accounting period – to properly reflect the balances of all asset, liability, and owners’ equity accounts – to recognize all revenues and expenses on an accrual basis Diamond Chapter 7 40

Adjusting Entries Adjustments result from one of two sequences of events: New information requires an adjustment to a transaction that has already been recorded Diamond Chapter 7 A transaction has not yet been recorded even though a business event has occurred 41

An Event Already Recorded Assume a company purchases a oneyear insurance policy paying $1, 200 on October 1, 2006, resulting in the following journal entry Prepaid Insurance Cash Diamond Chapter 7 1, 200 42

An Event Already Recorded At December 31, 2006, the following adjusting journal entry is required: Insurance Expense 300 Prepaid Insurance 300 Diamond Chapter 7 43

An Event Not Yet Recorded Assume that a chemical spill during November 2006 at a factory will require a cleanup costing $23, 000. The cleanup will take place in 2007, and nothing yet has been recorded. The following adjustment is necessary at December 31, 2006: Chemical Cleanup Expense 23, 000 Chemical Cleanup Liability 23, 000 Diamond Chapter 7 44

Closing Entries Closing entries – Transfer the amounts in the revenue, expense, and dividend accounts to Retained Earnings – Zero-out these “temporary accounts” for the start of the next accounting period Diamond Chapter 7 45

Closing Entries Comprised of three journal entries: 1. Close the revenue accounts to Retained Earnings 2. Close the expense accounts to Retained Earnings 3. Close the dividends account to Retained Earnings Diamond Chapter 7 46

Closing Entries: Veda Landscape Solutions Diamond Chapter 7 47

Computers and Accounting The time spent performing routine tasks within the accounting cycle has been greatly reduced as a result of using computers Personal computers are being used for – financial analysis – accounting functions – word processing – database management – inventory control – credit analysis of customers Diamond Chapter 7 48

Computers and Accounting Through networking (Internet and intranet), personal computers are speeding up the exchange of information among users It is still important, however, to be familiar with the accounting cycle in order to understand the flow of information within an organization Diamond Chapter 7 49

In Summary. . . • The accounting cycle consists of analysis, recording, summarizing, and reporting financial transactions • Journal entries use debits and credits to describe and chronologically record business transactions • The trial balance lists all accounts of a business and their balances • Adjusting entries are used to (a) update information previously recorded and (b) record previously unrecognized transactions • Closing entries transfer the balances of revenues, expenses, and dividend accounts to Retained Earnings Diamond Chapter 7 50