intermediate accounting, ninth edition

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Intermediate Accounting, Ninth EditionIntermediate Accounting, Ninth Edition

Kieso and WeygandtKieso and Weygandt

Prepared byPrepared by

Catherine Katagiri, CPACatherine Katagiri, CPA

The College of Saint RoseThe College of Saint Rose

Albany, New YorkAlbany, New York

John Wiley & Sons, IncJohn Wiley & Sons, Inc..

K & W

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Chapter 3:Chapter 3:The Accounting Information SystemThe Accounting Information System

After studying this chapter you should be able to:After studying this chapter you should be able to:• Understand basic accounting terminology.

• Explain double-entry rules.

• Identify steps in the accounting cycle.

• Record transactions in journals, post to ledger accounts, and prepare a

trial balance.

• Explain the reasons for preparing adjusting entries.

• Explain how inventory accounts are adjusted at year-end.

• Prepare closing entries.

• Identify adjusting entries that may be reversed.

• Prepare a 10-column worksheet.

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Basic TerminologyBasic Terminology

• The following is a brief summary of selected terms.

Please review page 69, our text as well.

– Event: A happening of consequence. May be external or

internal. Generally triggers a change in assets, liabilities or

equity.

– Transaction: An external event involving a transfer or

exchange between two or more entities.

– Account: A systematic recording of transactions or events

that affect assets, liabilities, equity, revenue and expense

areas. An account represents an area of similar economic

interest.

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– Real Accounts: Balance

sheet accounts--Asset,

liability and equity accounts

(except dividends). Exist

from one period to the next

(not closed).

–Nominal Accounts: Income

statement accounts--Revenue and

expense as well as the dividends

account. They do not exist from one

period to the next (they are closed).

Exist in name only!

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– Ledger: The book (manual or computer) of “T” accounts.

» General ledger (GL) is the book of control or general

accounts.

» Subsidiary ledger contains the detail of a specific

control or general account (e.g., Accounts Receivable).

– Journal: The book of original entry. Transactions are

recorded in journal entry form in their entirety. Posted to the

GL.

– Posting: The carrying of the essential facts from the journal

to the general ledger.

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– Trial Balance: A list of all open accounts in the GL and their

balances. Done to prove the equality of debits and credits.

» Unadjusted--taken after routine entries are posted.

» Adjusted--taken after adjusting entries are posted.

» Post-closing--taken after closing entries are posted.

– Adjusting Entries: Done to bring the books up to date in

anticipation of the preparation of the financial statements.

– Financial Statements: The primary reporting vehicles for

accounting information. They are the result of the collection,

tabulation and summation of accounting data. The following

four statements comprise a complete set of financial

statements (“taken as a whole”):

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» Balance sheet--Financial condition (position) of an

enterprise at the end of the period.

» Income statement--Shows the results of operations for the

period.

» Statement of cash flows--Reports cash activity for the

period by operating, investing and financing flows.

» Statement of retained earnings--Reconciles the beginning

and ending balances in the owner equity account.

– Closing entries: Done to zero the nominal accounts, formally

calculate income or loss and update retained earnings.

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– Debits and credits:

» Debit means entering an amount on the left-hand side of

an account. It does not mean increase or decrease.

» Credit means entering an amount on the right-hand side of

an account. It does not mean increase or decrease.

Account Name

Debit Credit

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– Double Entry System of Accounting. A logical method

for recording transactions. It recognizes that there

are at least two events or changes for each

transaction. Debit (or sum of the debits) will

always equal the credit (or the sum of the credits).

• Balance Sheet Equation: Balance Sheet Equation:

Assets = Liabilities + Owner EquityAssets = Liabilities + Owner Equity

Assets will always equal the sources of those

assets. That is, assets belong to either the

creditors or the owners.

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Accounting CycleAccounting Cycle

• Accounting Cycle:

– Identify, analyze and record relevant business

transactions.

» Please see Chapter Two--Elements of financial

statements.

» Both internal and external events.

– Journalizing

» Record of transactions in the journal in formal

journal entry form. Transactions are recorded

all in one place in chronological order.

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» Formal journal entry form: (If more than one debit and/or

more than one credit it is called a compound entry.)

Date Account name XX

Account name XX

Account name

XX

Explanation

– Posting: Routine function of carrying the entries from

the journal to the ledger.

– Trial balance: Listing of accounts and their balances

in general ledger order (A,L, OE, R, E). Done to prove

the equality of the debits and credits.

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– Adjusting Journal Entries (AJE): Done to bring the books up to date

so financial statements can be prepared.


Types of AJEs:

Deferrals

Accruals

Cost Allocation

– Please review the common characteristics of AJEs

» Dated last day of period.

» Always change at least one balance sheet account

and one income statement account.

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Adjusting EntriesAdjusting Entries

• Let’s review examples of selected AJEs:Let’s review examples of selected AJEs:

– Deferral of an expense (prepaids)

– Deferral of a revenue (unearned revenues)

– Accrual of an expense

– Accrual of a revenue

– Cost allocation

» Depreciation

» Bad Debts

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– Deferral Type of AJE is characterized by a previous transaction

which must be adjusted because it is now the end of the period

(time period assumption). The transaction is not yet complete at

the end of the period.

– Example: Deferral of an expense.Deferral of an expense.

Information: You are a tenant renting office space for $2,000 per

month. On November 1, 19X1, you prepay six months of rent or

$12,000 to your landlord. The original entry may have been:

11/1 Rent expense 12,000

Cash 12,000

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– Suppose it is now December 31, 19X1, two months later. The previous

entry must be adjusted. The adjusting entry would be:

To adjust:

12/31 Prepaid Rent 8,000

Rent Expense 8,000

Note: You had to refer back to the original entry to prepare the correct adjusting entry.

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– This properly reflects, at the end of the period,

four months of asset remaining and two

months of expense matched to the period.

– But what if the original entry had been:But what if the original entry had been:

11/1 Prepaid Rent 12,000

Cash 12,000

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– Then the appropriate adjusting entry would be:

To adjust:

12/31 Rent Expense 4,000

Prepaid Rent 4,000

Note: You had to refer back to

the original entry to prepare the

correct adjusting entry.

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– Example: Deferral of an revenue.Deferral of an revenue.

Information: You are a publisher selling magazines. You collect

on 9/1/X1, a total of $18,000 for the next six months of

publications (earned evenly). The original entry may have been:

12/31 Cash 18,000

Earned Revenue 18,000

– It is now 12/31/X1 and the above entry is no

longer wholly correct. It must be adjusted to

reflect you have services still to perform.

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To adjust:

12/31 Earned Revenues 6,000

Unearned (Deferred) Revenues 6,000

But what if the original entry had been:But what if the original entry had been:

To adjust:

12/31 Cash 18,000

Unearned (Deferred) Revenues

18,000

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– It is now 12/31/X1 and the above entry is no longer wholly

correct. It must be adjusted to reflect you have services

still to perform. The adjusting entry at 12/31/X1 would be:

To adjust:

12/31 Unearned Revenues 12,000

Earned Revenues 12,000

– The adjusting entry was prepared with the original entry in

mind. You arrive at $12,000 of earned revenue and $6,000

of a liability, deferred revenues, at the end of the period.

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Accrual typeAccrual type of adjusting journal entries:

– Done to record an as yet unrecorded transaction. To accrue or

record for the first time.

– No prior transaction to refer back to or update.

– Example: Accrual of a revenue:Accrual of a revenue:

Information: You have performed accounting services for a

client on December 30, 19X1. The services are valued at $300

but you have not recorded this yet nor sent a bill. To adjust:

12/31 Accounts Receivable 300

Service Revenue (Earned) 300

Note: There will always be a pairing between a receivable Note: There will always be a pairing between a receivable (balance sheet) and a revenue (income statement) (balance sheet) and a revenue (income statement)

account.account.

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– Example: Accrual of an expenseAccrual of an expense

Information: You had some emergency repair work done on 12/31/X1.

The plumber states the bill will be approximately $3,400. To adjust:

12/31

Repair Expense 3,400

Accounts Payable 3,400

Note: There will always be a pairing between Note: There will always be a pairing between an expense (income an expense (income statement) and a payable statement) and a payable (balance sheet) account.(balance sheet) account.

The final accrual done will be the tax accrual.The final accrual done will be the tax accrual.

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Cost allocation typeCost allocation type of adjusting journal entry:

– To follow matching and divide up cost to current and future

periods benefited.

– Depreciation, bad debt expense.

Example: You consume the usefulness of your building at the

rate of $12,000 per year. To recognize that the cost has now

been consumed (now an expense) you depreciate:

12/31

Depreciation Expense (I/S) 12,000

Accumulated Depreciation (B/S) 12,000

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• After all the adjusting entries have been recorded and After all the adjusting entries have been recorded and

posted an adjusted trial balance is taken. posted an adjusted trial balance is taken.

– This will not detect omissions or errors where

debits = credits. It only determines, after

adjusting, that total debits = credits.

– Financial statements may then be prepared from

the adjusted balances.

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• Inventory Methods:Inventory Methods:

– Periodic:Periodic:

» Use of the purchases and contra accounts, Freight-in.

» Adjust inventory at end of period within the context of

closing.

» Cost of Goods Sold (CGS) is a calculated figure

» Closing involves purchases, sales, contras, Freight-in.

– Perpetual:Perpetual:

» Inventory is kept up-to-date--Debited when bought,

credited when sold-Returns & Allowances, discounts flow

through the inventory account.

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Closing EntriesClosing Entries

» Cost of Goods Sold is a known figure.

» No purchase contras to close.

• Closing--Please review the mechanics of closing, Closing--Please review the mechanics of closing, pages 88-90, our text.pages 88-90, our text.

– Closing done to ready the nominal (I/S, dividends) accounts for the next period.

– Under a periodic system the inventory account is adjusted during closing.

– Closing done to formally calculate net income or loss.

– Closing done to update RE

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Closing EntriesClosing Entries

• Closing to capital:Closing to capital:

– In a corporation capital is divided into amounts for shares (stock) and amounts earned by the corporation (Retained Earnings-RE). Income is closed to RE.

• After closing completed:After closing completed:

– Only real (balance sheet accounts) remain.

– A post-closing trial balance is prepared to check

the equality of debits and credits and is a starting

point for the next period.

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• Please review the preparation of the worksheet Please review the preparation of the worksheet

(pages 93-96, our text). (pages 93-96, our text).

– Done to coordinate and substantiate work done.

– Financial statements and tax returns prepared

directly from the worksheet.

– When satisfied your work is complete the records

are then updated permanently and closing occurs.

– Note the treatment of the inventory. There is more

than one method to adjust inventory-it gets to the

same place eventually!

Worksheet PreparationWorksheet Preparation

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Reversing EntriesReversing Entries

• Reversing entries-done to ease subsequent Reversing entries-done to ease subsequent

recording.recording.

– Optional

– Accruals are usually reversed.

– Deferrals may be reversed.

– Cost Allocation type AJE would not logically be a candidate

for reversal .

– For example: You accrue your $8,900 payroll on Wednesday,

12/31/X1, the end of the period. The full weekly payroll is

normally $15,000. To accrue:12/31/X1 Wage Expense (I/S) 8,900

Wages Payable (B/S) . 8,900

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– As the adjusting entries tend to be difficult, the AJE was

prepared by you, the accountant, instead of the usual clerical

personnel. They are unaware the accrual was done and so on

Friday, January 2, 19X2, they record the entire week’s payroll

($15,000) like they usually do:

1/2/X2

Wage Expense (I/S) 15,000

Cash (B/S) 15,000

– This would be incorrect because the first three days of

the pay period were already expensed and matched to

the year X1. There is also a liability outstanding that

must be removed when the payroll is paid. The correct

entry would be:

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1/2/X2


Wage Payable (B/S) 8,900

Cash (B/S) 15,000

– To avoid these types of errors or to be able to “ignore”

AJEs a reversing entry may be done. Suppose after the

original AJE was done and CLOSING occurred, the

following reversing entry was done on 1/1/X2:

1/1/X2

Wage Payable (B/S) 8,900


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– This reversing entry would get rid of the payable and record

a CREDIT balance in the wage expense account. When the

routine payroll entry was done:

1/2/X2


Cash (B/S) 15,000

– The accounts would now be correct: The payable would

be gone, the expense for 19X2 would be $6,100.

– Reversing entries should simplify the subsequent

recording of routine transactions.

intermediate accounting, ninth edition

Documents

ledger accounts

general accounts

equity accounts

nominal accounts

basic terminologyreal

accounts receivable

open accounts

inventory accounts