Chapter 2 – The Accounting Information System

Accounting Information System (AIS)

→ A system that collects, processes, and communicates financial information to users
→ Can be manual or computerized

Purpose of AIS

• Collect transaction data

• Process data into useful information

• Disseminate financial information to interested parties

Accounting Terminology: Event

→ Any happening of consequence to an entity

Accounting Terminology: Transaction

An event involving a transfer of value that can be measured reliably

Accounting Terminology: Account

A record of increases and decreases in a specific asset, liability, equity, revenue, or expense

Accounting Terminology: Real (Permanent) Accounts

→ Balance sheet accounts
→ Assets, Liabilities, Equity
→ Carry forward to next period

Accounting Terminology: Nominal (Temporary) Accounts

→ Income statement accounts
→ Revenues, Expenses, Dividends
→ Closed each period

Accounting Terminology: Journal

→ Chronological record of transactions

Accounting Terminology: Ledger

Collection of all accounts

Accounting Terminology: Posting

Transferring journal entries to ledger accounts

Accounting Terminology: Trial Balance

→ List of accounts and balances at a specific date
→ Debits must equal credits

Accounting Terminology: Adjusting Entries

→ Entries made at period end to ensure proper revenue and expense recognition

Accounting Terminology: Financial Statements

→ Income Statement
→ Retained Earnings Statement
→ Balance Sheet

Accounting Terminology: Closing Entries

→ Entries that reset temporary accounts to zero

Double-Entry Accounting System

• Every transaction affects at least two accounts

• Total debits = total credits

Debit (Dr)

→ Left side of an account

Credit (Cr)

→ Right side of an account

T-Account

• Left side = Debit

• Right side = Credit

Debit Balance

→ Total debits > total credits

Credit Balance

→ Total credits > total debits

Basic Accounting Equation

Assets = Liabilities + Stockholders’ Equity

Expanded Accounting Equation

• Equity includes:

  • Common Stock

  • Retained Earnings

  • Revenues (+)

  • Expenses (−)

  • Dividends (−)

Income Statement

• Reports revenues and expenses

• Determines net income or loss

Retained Earnings Statement

• Begins with beginning RE

• Net Income

• − Dividends

Balance Sheet

Reports assets, liabilities, and equity at a point in time

Financial Statement Articulation

→ Net income flows from:
Income Statement → Retained Earnings → Balance Sheet

Accounting Cycle

• Analyze transactions

• Journalize transactions

• Post to ledger

• Prepare trial balance

• Journalize & post adjusting entries

• Prepare adjusted trial balance

• Prepare financial statements

• Journalize & post closing entries

• Prepare post-closing trial balance

External Events

→ Between company and outside parties

Internal Events

Occur entirely within the company

General Journal

Chronological record of transactions

General Ledger

→ Contains all asset, liability, equity, revenue, and expense accounts

Chart of Accounts

→ Listing of all accounts and their account numbers

Chart of Accounts: Typical Order

• Assets

• Liabilities

• Equity

• Revenues

• Expenses

Trial Balance

• Prepared at end of period

• Lists all accounts and balances

• Debit balances on left, credit balances on right

• Totals must match

Trial Balance: Purpose

• Checks mathematical accuracy

• Helps uncover posting/journalizing errors

Trial Balance: Limitations

A trial balance may still balance if:

• Transactions are omitted

• Entries are posted twice

• Wrong accounts are used

• Offsetting errors occur

Purpose of Adjusting Entries

• Match revenues and expenses to correct period

• Required whenever financial statements are prepared

Deferrals: Prepaid Expenses

• Cash paid before expense is incurred

• Recorded as an asset

• Examples:

  • Insurance

  • Supplies

  • Rent

  • Equipment

Deferrals: Adjustment

• Debit Expense

• Credit Prepaid Asset

Depreciation

• Allocation of asset cost over useful life

• Not valuation

• Uses Accumulated Depreciation (contra asset)

Book Value

→ Cost − Accumulated Depreciation

Unearned Revenues

• Cash received before revenue is earned

• Recorded as a liability

Unearned Revenues: Adjustment

• Debit Unearned Revenue

• Credit Revenue

Accrued Revenues

• Revenue earned but not yet billed or collected

• Creates an asset (Accounts Receivable)

Accruals: Adjustment

• Debit Accounts Receivable

• Credit Revenue

Accrued Expenses

• Expense incurred but not yet paid

• Creates a liability

Common Accrued Expenses

• Salaries

• Interest

• Taxes

Accrued Expenses/Common Accrued Expenses; Adjustment

• Debit Expense

• Credit Liability

Bad Debts

• Estimated uncollectible receivables

• Ensures receivables are reported at net realizable value

Bad Debts: Adjustment

• Debit Bad Debt Expense

• Credit Allowance for Doubtful Accounts

Adjusted Trial Balance

→ Trial balance prepared after adjusting entries
→ Used to prepare financial statements

Preparing Financial Statements

Prepared directly from the Adjusted Trial Balance:

1. Income Statement

2. Retained Earnings Statement

3. Balance Sheet

Closing Entries: Purpose

• Reset temporary accounts to zero

• Transfer net income to Retained Earnings

Closing Entries: Closed Accounts

• Revenues

• Expenses

• Income Summary

• Dividends

Closing Entries: Not Closed

• Assets

• Liabilities

• Equity accounts (except dividends)

Post-Closing Trial Balance

• Contains only permanent accounts

• Verifies debits = credits after closing

Merchandising Company Statements: Key Difference

→ Includes Cost of Goods Sold (COGS)

Merchandising Company Statements: Statements

• Merchandising Income Statement

• Retained Earnings Statement

• Balance Sheet

Accrual Basis (GAAP)

• Revenue recognized when earned

• Expenses recognized when incurred

• Used by most companies

Cash Basis

• Revenue recognized when cash received

• Expenses recognized when cash paid

• Not GAAP

Converting Cash to Accrual : Accrual Revenue Formula

Cash receipts
− Beginning A/R

• Ending A/R

• Beginning Unearned Revenue
  − Ending Unearned Revenue

Converting Cash to Accrual: Accrual Expense Formula

Cash paid

• Beginning Prepaids
  − Ending Prepaids
  − Beginning Accrued Liabilities

• Ending Accrued Liabilities

Reversing Entries

→ Optional entries made at beginning of next period

Reversing Entries: Rules

• Reverse all accruals

• Reverse deferrals recorded as revenues or expenses

• Do NOT reverse

  • Depreciation

  • Bad debts

Worksheet (10-Column Worksheet): Purpose

• Organize adjusting entries

• Prepare financial statements

Worksheet (10-Column Worksheet): Columns

• Trial Balance

• Adjustments

• Adjusted Trial Balance

• Income Statement

• Balance Sheet

GAAP vs IFRS: Similarities

• Same double-entry system

• Same journal, ledger, trial balance structure

• Same transaction analysis

GAAP vs IFRS: Differences

• IFRS relies more on fair value

• GAAP emphasizes historical cost

• SOX internal control requirements apply mainly to U.S. public companies