acct550 ch 3 summary for students

8/10/2019 ACCT550 Ch 3 Summary for Students

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CHAPTER 3

The Accounting Information System

LEARNING OBJECTIVES

1. Understand basic accounting terminology.

2. Explain double-entry rules.

3. Identify steps in the accounting cycle.

4. Record transactions in journals, post to ledger accounts, and prepare a trial balance.

5. Explain the reasons for preparing adjusting entries and identify major types of adjus

entries.

6. Prepare financial statements from the adjusted trial balance.

7. Prepare closing entries.

8. Prepare financial statements for a merchandising company.

*9. Differentiate the cash basis of accounting from the accrual basis of accounting.

*10. Identify adjusting entries that may be reversed.

*11. Prepare a 10-column worksheet.

*12. Compare the accounting information systems under GAAP and IFRS.

Copyright 2013 John Wiley & Sons, Inc. Ki eso, Intermediate Accounting,15/e Instructors Manual ( For Instructor Use Only)


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CHAPTER REVIEW

*Note: All asterisked (*) items relate to material contained in the Appendices to the chapter.

1. Chapter 3 presents a concise yet thorough review of the accounting process. The basicelements of the accounting process are identified and explained, and the way in whichthese elements are combined in completing the accounting cycle is described.

Accounting Information System

2. (L.O. 1) The accounting information system collects and processes transaction data andthen disseminates the financial information to interested parties. To understand theaccounting process, one must be aware of the basic terminology employed in theprocess. The basic terminology includes: event, transaction, account, real accounts,nominal accounts, ledger, journal, posting, trial balance, adjusting entries, financialstatements, andclosing entries.These terms refer to the various activities that makeup the accounting cycle.

Double-Entry Rules

3. (L.O. 2)Double-entry accounting refers to the process used in recording transactions.The terms debit and credit are used in the accounting process to indicate the effecta transaction has on account balances. The debit side of any account is the left side; theright side is the credit side. Assets and expenses are increased by debits and decreasedby credits. Liabilities, stockholders equity, and revenues are decreased by debits andincreased by credits.

4. In a double-entry system, for every debit there must be a credit and vice-versa. This leadsus to the basic accounting equation: Assets = Liabilities + Stockholders Equity.

The Accounting Cycle

5. (L.O. 3) The first step in the accounting cycle is analysis of transactions and selectedother events. The purpose of this analysis is to determine which events representtransactions that should be recorded.

6. Events can be classified as external or internal.External events are those between anentity and its environment, whereas internal events relate to transactions totally within anentity.

Journalizing

7. (L.O. 4) Transactions are initially recorded in a journal, sometimes referred to as thebook of original entry.A general journal is merely a chronological listing of transactionsexpressed in terms of debits and credits to particular accounts. No distinction is made ina general journal concerning the type of transaction involved. In addition to a general

journal, specialized journals are used to accumulate transactions possessing commoncharacteristics.

3-2 Copyright 2013 John Wiley & Sons, Inc. Ki eso, Intermediate Accounting,15/e Instructors Manual ( For Instructor Use Only)


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Posting

8. The next step in the accounting cycle involves transferring amounts entered in the jouto the general ledger.The ledger is a book that usually contains a separate page for eaccount. Transferring amounts from a journal to the ledger is called posting.Transactrecorded in a general journal must be posted individually, whereas entries madespecialized journals are generally posted by columnar total.

Trial Balance

9. The next step in the accounting cycle is the preparation of a trial balance. A trial balanca list of accounts and their balances at a given time. An entity may prepare a trial balaat any time in the accounting cycle. A trial balance prepared after posting has becompleted serves to check the mechanical accuracy of the posting process and provia listing of accounts to be used in preparing financial statements.

Adjusting Entries

10. (L.O. 5) Preparation of adjusting journal entries is the next step in the accounting cy

Adjusting entries are entries made at the end of accounting period to bring all accouup to date on an accrual accounting basis so that correct financial statements canprepared. Adjusting entries are necessary to achieve a proper matching of revenues expenses in the determination of net income for the current period and to achieveaccurate statement of the assets and equities existing at the end of the period. Ocommon characteristic of adjusting entries is that they affect at least one real acco(asset or liability account) and one nominal account (revenue or expense accouAdjusting entries can be classified as: (1) deferrals (prepaid expenses, unearrevenues), or(2) accruals (accrued revenues, accrued expenses).

11. Prepaid expenses and unearned revenues refer to situations where cash has been por received but the corresponding expense or revenue will not be recognized until a futperiod. Accrued revenues and accrued expenses are revenues and expenses recogniin the current period for which the corresponding payment or receipt of cash is to occua future period.

Adjusted Trial Balance

12. After adjusting entries are recorded and posted, an adjusted trial balance is prepareshows the balance of all accounts at the end of the accounting period.

Financial Statements

13. (L.O. 6) From the adjusted trial balance, a company can directly prepare its finanstatements.



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Closing Process

14. (L.O. 7) After financial statements have been prepared, nominal (revenue and expense)accounts should be reduced to zero in preparation for recording the transactions of the nextperiod. This closing processrequires recording and posting of closing entries. All nominalaccounts are reduced to zero by closing them through the Income Summaryaccount. Thenet balance in the Income Summary account is equal to net income or net loss for theperiod. The net income or net loss for the period is transferred to an owners equity account

by closing the Income Summary account to Retained Earnings.

Post-Closing Trial Balance

15. A third trial balance may be prepared after the closing entries are recorded and posted.This post-closing trial balance shows that equal debits and credits have been postedproperly to the Income Summary account.

Reversing Entries

6. Reversing entries are made at the beginning of an accounting period to remove the

effects of some adjusting entries. They are optional.

Accounting Cycle Summarized

17. In summary, the steps in the accounting cycle performed every fiscal period are as follows:

a. Enter the transactions of the period in appropriate journals.

b. Post from the journals to the ledger (or ledgers).

c. Take an unadjusted trial balance (trial balance).

d. Prepare adjusting journal entries and post to the ledger(s).

e. Take a trial balance after adjusting (adjusted trial balance).

f. Prepare the financial statements from the adjusted trial balance.

g. Prepare closing journal entries and post to the ledger(s).

h. Take a trial balance after closing (post-closing trial balance).

i. Prepare reversing entries (optional) and post to the ledger(s).



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Financial Statements for a Merchandising Company

18. The income statement classifies amounts into such categories as gross profit, incofrom operations, income before taxes, and net income. The statement of retaiearnings shows the changes in retained earnings during the period. A classified balasheet classifies assets and liabilities into current and noncurrent.

19. Closing entries of a merchandising company require that the Cost of Goods Sold acco

be closed along with the other expense accounts.

*Cash Versus Accrual-Basis Accounting

*20. (L.O. 8)Cash-Basis Accounting Versus Accrual-Basis Accounting is presenteAppendix A of Chapter 3 for the purpose of demonstrating the difference between cbasis and accrual-basis accounting. Under the strict cash basis of accounting, revenis recognized only when cash is received, and expenses are recorded only when caspaid. The accrual basis of accounting recognizes revenue when it is earned and expenwhen incurred without regard to the time of receipt or payment of cash.

*Reversing Entries

*21. (L.O. 9) Appendix B covers preparation and posting of reversing entries, the final stethe accounting cycle. A reversing entry is made at the beginning of the next accountperiod and is the exact opposite of the adjusting entry made in the previous period. Trecording of reversing entries is an optional step in the accounting cycle that mayperformed at the beginning of the next accounting period. The entries subject to reveare the adjusting entries for accrued revenues and accrued expenses recorded at close of the previous accounting period.

*Worksheet

*22. (L.O. 10) Appendix C covers the use of a 10-column worksheet, whichserves as an aithe accountant in adjusting the account balances and preparing the financial statemeThe worksheet provides an orderly format for the accumulation of information necessarypreparation of financial statements. Use of a worksheet does not replace any finanstatements, nor does it alter any of the steps in the accounting cycle.

*H. (L.O. 12) IFRS Insights

1. As indicated in this chapter, companies must have an effective accounting systemthe wake of accounting scandals at U.S. companies like Sunbeam, Rite-Aid, Xerand WorldCom, U.S. lawmakers demanded higher assurance on the qualityaccounting reports. Since the passage of the Sarbanes-Oxley Act of 2002 (SOcompanies that trade on U.S. exchanges are required to place renewed focus on taccounting systems to ensure accurate reporting.



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2. Relevant facts

a. Similarities

(1) International companies use the same set of procedures and records to keeptrack of transaction data. Thus, the material in Chapter 3 dealing with theaccount, general rules of debit and credit, and steps in the recording process

the journal, ledger, and chart of accountsis the same under both GAAP

and IFRS.

(2) Transaction analysis is the same under IFRS and GAAP, but, as you will seein later chapters, different standards sometimes impact how transactions arerecorded.

(3) Both the IASB and FASB go beyond the basic definitions provided in thistextbook for the key elements of financial statements, that is, assets,liabilities, equity, revenues, and expenses.

(4) A trial balance under IFRS follows the same format as shown in the textbook.

As shown in the textbook, dollar signs are typically used only in the trialbalance and the financial statements. The same practice is followed underIFRS, using the currency of the country in which the reporting company isheadquartered.

b. Differences

(1) Rules for accounting for specific events sometimes differ across countries.For example, European companies rely less on historical cost and more onfair value than U.S. companies. Despite the differences, the double-entryaccounting system is the basis of accounting systems worldwide.

(2) Internal controls are a system of checks and balances designed to preventand detect fraud and errors. While most companies have these systems inplace, many have never completely documented them nor had anindependent auditor attest to their effectiveness. Both of these actions arerequired under SOX. Enhanced internal control standards apply only to largepublic companies listed on U.S. exchanges.

3. First-time adoption of IFRS.

a. IFRS 1 requires that information in a companys first IFRS statements (1) be

transparent, (2) provide a suitable starting point, and (3) have a cost that does notexceed the benefits. As a result, many companies will be going through a substantialconversion process to switch from their reporting standards to IFRS.

b. The overriding principle in converting to IFRS is full retrospective application ofIFRS. Retrospective applicationrecasting prior financial statements on the basisof IFRSprovides financial statement users with comparable information.



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LLUSTRATION 3-2TRANSACTIONS AFFECTING OWNERS EQUITY ACCOUNTS



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ILLUSTRATION 3-5CONVERSION FROM CASH BASIS TO ACCRUAL BASIS



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LLUSTRATION 3-6REVERSING ENTRIES


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