Are the following events recorded in the accounting records

The Accounting Information System

Kimmel ● Weygandt ● Kieso

Financial Accounting, Eighth Edition

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Explain how accounts, debits, and credits are used to record business transactions.

CHAPTER OUTLINE

Analyze the effect of business transactions on the basic accounting equation.

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2

LEARNING OBJECTIVES

Indicate how a journal is used in the recording process.

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Explain how a ledger and posting help in the recording process.

4

Prepare a trial balance.

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Accounting Information System

System of

collecting and

processing transaction data and

communicating financial information to decision-makers.

LEARNING OBJECTIVE

Analyze the effect of business transactions on the basic accounting equation.

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Accounting information systems rely on a process referred to as the accounting cycle.

Accounting Information System

Analyze business transactions

Journalize

Post

Trial Balance

Adjusting Entries

Adjusted Trial Balance

Financial Statements

Closing Entries

Post-Closing Trial Balance

Most businesses use computerized accounting systems.

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Transactions are economic events that require recording in the financial statements.

Not all activities represent transactions.

Assets, liabilities, or stockholders’ equity items change as a result of some economic event.

Dual effect on the accounting equation.

ACCOUNTING TRANSACTIONS

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Question: Are the following events recorded in the accounting records?

Event

Purchase computer

Criterion

Pay rent

Record/ Don’t Record

Discuss guided trip options with potential customer

Illustration 3-1

Transaction identification process

ACCOUNTING TRANSACTIONS

Is the financial position (assets, liabilities, or stockholders’ equity) of the company changed?

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Assets

Liabilities

Stockholders’ Equity

=

+

Basic Accounting Equation

The process of identifying the specific effects of economic events on the accounting equation.

ANALYZING TRANSACTIONS

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Illustration 3-2

Expanded accounting equation

ANALYZING TRANSACTIONS

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Event (1). On October 1, cash of $10,000 is invested in Sierra Corporation by investors in exchange for $10,000 of common stock.

1. +10,000 +10,000

ANALYZING TRANSACTIONS

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Event (2). On October 1, Sierra borrowed $5,000 from Castle Bank by signing a 3-month, 12%, $5,000 note payable.

1. +10,000 +10,000

2. +5,000 +5,000

ANALYZING TRANSACTIONS

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Event (3). On October 2, Sierra purchased equipment by paying $5,000 cash to Superior Equipment Sales Co.

3. -5,000 +5,000

1. +10,000 +10,000

2. +5,000 +5,000

ANALYZING TRANSACTIONS

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Event (4). On October 2, Sierra received a $1,200 cash advance from R. Knox, a client.

4. +1,200 +1,200

3. -5,000 +5,000

1. +10,000 +10,000

2. +5,000 +5,000

ANALYZING TRANSACTIONS

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Event (5). On October 3, Sierra received $10,000 in cash from Copa Company for guide services performed.

4. +1,200 +1,200

5. +10,000 +10,000

3. -5,000 +5,000

1. +10,000 +10,000

2. +5,000 +5,000

ANALYZING TRANSACTIONS

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Event (6). On October 3, Sierra Corporation paid its office rent for the month of October in cash, $900.

4. +1,200 +1,200

5. +10,000 +10,000

6. -900 -900

3. -5,000 +5,000

1. +10,000 +10,000

2. +5,000 +5,000

ANALYZING TRANSACTIONS

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Event (7). On October 4, Sierra paid $600 for a one-year insurance policy that will expire next year on September 30.

4. +1,200 +1,200

5. +10,000 +10,000

6. -900 -900

7. -600 +600

3. -5,000 +5,000

1. +10,000 +10,000

2. +5,000 +5,000

ANALYZING TRANSACTIONS

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Event (8). On October 5, Sierra purchased an estimated three months of supplies on account from Aero Supply for $2,500.

4. +1,200 +1,200

5. +10,000 +10,000

6. -900 -900

7. -600 +600

8. +2,500 +2,500

3. -5,000 +5,000

1. +10,000 +10,000

2. +5,000 +5,000

ANALYZING TRANSACTIONS

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Event (9). On October 9, Sierra hired four new employees to begin work on October 15.

4. +1,200 +1,200

5. +10,000 +10,000

6. -900 -900

7. -600 +600

8. +2,500 +2,500

3. -5,000 +5,000

1. +10,000 +10,000

2. +5,000 +5,000

An accounting transaction has not occurred.

ANALYZING TRANSACTIONS

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Event (10). On October 20, Sierra paid a $500 dividend.

4. +1,200 +1,200

5. +10,000 +10,000

6. -900 -900

7. -600 +600

8. +2,500 +2,500

10. -500 -500

3. -5,000 +5,000

1. +10,000 +10,000

2. +5,000 +5,000

ANALYZING TRANSACTIONS

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Event (11). Employees have worked two weeks, earning $4,000 in salaries, which were paid on October 26.

4. +1,200 +1,200

5. +10,000 +10,000

6. -900 -900

7. -600 +600

8. +2,500 +2,500

10. -500 -500

11. -4,000 -4,000

3. -5,000 +5,000

1. +10,000 +10,000

2. +5,000 +5,000

ANALYZING TRANSACTIONS

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INVESTOR INSIGHT

Why Accuracy Matters

While most companies record transactions very carefully, the reality is that mistakes still happen. For example, bank regulators fi ned Bank One Corporation (now JPMorgan 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 feared that the errors might suggest larger, undetected problems. This was 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 was created to minimize the occurrence of errors like these by increasing every employee’s responsibility for accurate financial reporting.

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Transaction Analysis

A tabular analysis of the transactions for the month of August is shown below. Describe each transaction.

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1. Company issued shares of stock for $25,000 cash.

2. Company purchased $7,000 of equipment on account.

3. Company received $8,000 cash in exchange for services performed.

4. Company paid $850 for this month’s rent.

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Double-entry system

Each transaction must affect two or more accounts to keep the basic accounting equation in balance.

Recording done by debiting at least one account and crediting another.

DEBITS must equal CREDITS.

Debit and Credit Procedures

LEARNING OBJECTIVE

Explain how accounts, debits, and credits are used to record business transactions.

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If Debits are greater than Credits, the account will have a debit balance.

$10,000

Transaction #2

$3,000

$15,000

8,000

Transaction #3

Balance

Transaction #1

DEBIT AND CREDIT PROCEDURES

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$10,000

Transaction #2

$3,000

Balance

Transaction #1

$1,000

8,000

Transaction #3

DEBIT AND CREDIT PROCEDURES

If Credits are greater than Debits, the account will have a credit balance.

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Assets - Debits should exceed credits.

Liabilities – Credits should exceed debits.

Procedures for Assets and Liabilities

▼ HELPFUL HINT

The normal balance is the side where increases in the account are recorded.

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Investments by stockholders and revenues increase stockholders’ equity (credit).

Dividends and expenses decrease stockholder’s equity (debit).

Procedures for Stockholders’ Equity

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Revenues increase stockholder’s equity.

Expenses have the opposite effect: expenses decrease stockholders’ equity.

The effect of debits and credits on revenue and expense accounts is the same as their effect on stockholders’ equity.

Procedures for Stockholders’ Equity

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INVESTOR INSIGHT

Keeping Score

The Chicago Cubs baseball team has these major revenue and expense accounts:

Revenues Expenses

Admissions (ticket sales) Players’ salaries

Concessions Administrative salaries

Television and radio Travel

Advertising Ballpark maintenance

Chicago Cubs

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STOCKHOLDERS’ EQUITY RELATIONSHIPS

ILLUSTRATION 3-15

Stockholders’ equity

relationships

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Normal Balance Credit

Normal Balance Debit

DEBIT/CREDIT RULES

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Balance Sheet Income Statement

=

+

=

-

Asset

Liability

Equity

Revenue

Expense

Debit

Credit

SUMMARY OF DEBIT/CREDIT RULES

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Relationship among the assets, liabilities and stockholders’ equity of a business:

The equation must be in balance after every transaction. For every Debit there must be a Credit.

ILLUSTRATION 3-16

Assets

Liabilities

=

Stockholders’ Equity

Basic Equation

Expanded Basic Equation

+

SUMMARY OF DEBIT/CREDIT RULES

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SUMMARY OF DEBIT/CREDIT RULES

Review Question

Debits:

increase both assets and liabilities.

decrease both assets and liabilities.

increase assets and decrease liabilities.

decrease assets and increase liabilities.

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SUMMARY OF DEBIT/CREDIT RULES

Review Question

Accounts that normally have debit balances are:

assets, expenses, and revenues.

assets, expenses, and equity.

assets, liabilities, and dividends.

assets, dividends, and expenses.

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The Recording Process

LEARNING OBJECTIVE

Indicate how a journal is used in the recording process.

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Analyze business transactions

Journalize the transaction

Post to ledger accounts

Analyze each transaction in terms of its effect on the accounts.

Enter the transaction information in a journal.

Transfer the journal information to the appropriate accounts in the ledger.

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THE RECORDING PROCESS

Analyze business transactions

Journalize the transaction

Post to ledger accounts

Analyze transaction

Enter

transaction

Transfer from journal to ledger

ILLUSTRATION 3-17

The recording process

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Transactions recorded in chronological order in a journal before they are transferred to the accounts.

Contributions to the recording process:

Discloses the complete effects of a transaction.

Provides a chronological record of transactions.

Helps to prevent or locate errors because the debit and credit amounts can be easily compared.

THE JOURNAL

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Journalizing - Entering transaction data in the journal.

Illustration: Presented below is information related to Sierra Corporation.

Oct. 1 Sierra issued common stock in exchange for $10,000 cash.

1 Sierra borrowed $5,000 by signing a note.

2 Sierra purchased equipment for $5,000.

Instructions - Journalize these transactions.

THE JOURNAL

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THE JOURNAL

Oct. 1 Sierra issued common stock in exchange for $10,000 cash.

General Journal

Cash

Common Stock

10,000

10,000

Oct. 1

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THE JOURNAL

Oct. 1 Sierra borrowed $5,000 by signing a note.

General Journal

Cash

Notes Payable

5,000

5,000

Oct. 1

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THE JOURNAL

Oct. 2 Sierra purchased equipment for $5,000.

General Journal

Equipment

Cash

5,000

5,000

Oct. 2

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THE JOURNAL

ILLUSTRATION 3-18

Recording transactions in

journal form

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ACCOUNTING ACROSS THE ORGANIZATION

Boosting Profits

Microsoft originally designed the Xbox 360 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. The marketing department, however, “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.” As a result of these changes, Xbox enjoyed great success. But, it does have competitors. Its newest video game console, Xbox One, is now in a battle with Sony’s Playstation4 for market share. How to compete? First, Microsoft bundled the critically acclaimed Titan fall with its Xbox One. By including the game most Xbox One buyers were going to purchase anyway, Microsoft was making its console more attractive. In addition, retailers are also discounting the Xbox, which should get the momentum going for increased sales. What Microsoft is doing is making sure that Xbox One is the center of the home entertainment system in the long run.

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Journal Entries

The following events occurred during the first month of business of Hair It Is Inc., Kate Browne’s beauty salon:

Issued common stock to shareholders in exchange for $20,000 cash.

Purchased $4,800 of equipment on account (to be paid in 30 days).

Interviewed three people for the position of stylist.

The three activities are recorded as follows:

DO IT!

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1. Cash 20,000

Common Stock 20,000

2. Equipment 4,800

Accounts Payable 4,800

3. No entry because no transaction occurred.

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The Accounting Cycle

LEARNING OBJECTIVE

Explain how a ledger and posting help in the recording process.

4

LO 4

Analyze business transactions

Post to ledger accounts

Journalize the transaction

Trial Balance

Adjusting Entries

Adjusted Trial Balance

Financial Statements

Closing Entries

Post-Closing Trial Balance

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The Ledger is comprised of the entire group of accounts maintained by a company.

THE LEDGER

ILLUSTRATION 3-19

The general ledger

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Listing of accounts used by a company to record transactions.

CHART OF ACCOUNTS

ILLUSTRATION 3-20

Chart of accounts for Sierra

Corporation

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General Ledger

J1

The process of transferring journal entry amounts to ledger accounts.

POSTING

General Journal

Cash

Common Stock

10,000

10,000

Oct. 1

J1

Oct. 1

Stock issued

10,000

10,000

101

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POSTING

Review Question

Posting:

normally occurs before journalizing.

transfers ledger transaction data to the journal.

is an optional step in the recording process.

transfers journal entries to ledger accounts.

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ETHICS INSIGHT

A Convenient Overstatement

Sometimes a company’s investment securities suffer a permanent decline in value below their original cost. When this occurs, the company is supposed to reduce the recorded value of the securities on its balance sheet (“write them down” in common financial lingo) and record a loss. It appears, however, that during the financial crisis of 2008, employees at some financial institutions chose to look the other way as the value of their investments skidded. A number of Wall Street traders that worked for the investment bank Credit Suisse Group were charged with intentionally overstating the value of securities that had suffered declines of approximately $2.85 billion. One reason that they may have been reluctant to record the losses is out of fear that the company’s shareholders and clients would panic if they saw the magnitude of the losses. However, personal self-interest might have been equally to blame—the bonuses of the traders were tied to the value of the investment securities.

Source: S. Pulliam, J. Eaglesham, and M. Siconolfi , “U.S. Plans Changes on Bond Fraud,” Wall Street Journal Online (February 1, 2012).

Credit Suisse Group

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Follow these steps:

1. Determine what type of account is involved.

2. Determine what items increased or decreased and by how much.

3. Translate the increases and decreases into debits and credits.

RECORDING PROCESS ILLUSTRATED

ILLUSTRATION 3-21

Investment of cash by

stockholders

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ILLUSTRATION 3-22

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ILLUSTRATION 3-23

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ILLUSTRATION 3-24

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ILLUSTRATION 3-25

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ILLUSTRATION 3-26

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ILLUSTRATION 3-27

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ILLUSTRATION 3-28

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ILLUSTRATION 3-29

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ILLUSTRATION 3-30

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ILLUSTRATION 3-31

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JOURNALIZING SUMMARY

ILLUSTRATION 3-32

General journal for Sierra Corporation

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Illustration 3-32

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ILLUSTRATION 3-33

General ledger for Sierra Corporation

POSTING SUMMARY

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Selected transactions from the journal of Faital Inc. during its first month of operations are presented below. Post these transactions to T-accounts.

Posting

DO IT!

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The Accounting Cycle

LEARNING OBJECTIVE

Prepare a trial balance.

5

LO 5

Analyze business transactions

Post to ledger accounts

Journalize the transaction

Prepare a Trial Balance

Adjusting Entries

Adjusted Trial Balance

Financial Statements

Closing Entries

Post-Closing Trial Balance

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A list of accounts and their balances at a given time.

Accounts are listed in the order in which they appear in the ledger.

Purpose is to prove that debits equal credits.

May also uncover errors in journalizing and posting.

Useful in the preparation of financial statements.