tenth canadian edition intermediate accounting prepared by: dragan stojanovic, ca rotman school of...
TRANSCRIPT
TENTH CANADIAN EDITION
INTERMEDIATE ACCOUNTING
Prepared by:
Dragan Stojanovic, CARotman School of Management,
University of Toronto
CHAPTER 3The Accounting
Information System
Kieso • Weygandt • Warfield • Young • Wiecek • McConomy
CHAPTER
LEARNING OBJECTIVES:
3:
After studying this chapter, you should be able to:• Understand basic accounting terminology.• Explain double-entry rules.• Explain how transactions affect the accounting equation.• Identify the steps in the accounting cycle and the steps in the recording
process.• Explain the reasons for and prepare adjusting entries.• Explain how the type of ownership structure affects the financial statements.• Prepare closing entries and consider other matters relating to the closing
process.• Prepare a 10-column work sheet and financial statements.
After studying Appendix 3A, you should be able to:• Identify adjusting entries that may be reversed.
Copyright © John Wiley & Sons Canada, Ltd.
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THE ACCOUNTING INFORMATION SYSTEM
The Accounting Information System
3
Accounting Information System
• Basic terminology
• Debits and credits
• Accounting equation
Using a Worksheet
• Adjustments entered
• Work sheet columns
• Preparing financial statements from a work sheet
• Closing entries
• Monthly statements, yearly closing
Accounting Cycle and the Recording Process• Identifying
and recording transactions and other events
• Journalizing
• Posting
• Trial balance
• Adjusting entries
Appendix 3A-Using Reversing Entries
• Accruals
• Prepayments
• Summary of reversing entries
Copyright © John Wiley & Sons Canada, Ltd.
Adjusting Entries
• Adjusting entries for prepayments
• Adjusting entries for accruals
• Adjusting entries for estimated items
Financial Statements and Ownership Structure
Closing Process
• Preparing closing entries
• Reversing entries
• The accounting cycle summarized
Basic Terminology
• Event: The cause of changes of assets, liabilities, and equity
• Transaction: A transfer or exchange between two or more entities or parties
• Account: Where transactions are recorded– A separate account is used for each asset,
liability, revenue, expense, gain, loss and capital (owner’s equity)
4Copyright © John Wiley & Sons Canada, Ltd.
Basic Terminology
Permanent accounts (or “real” accounts)• Asset, liability, and equity accounts• Appear on the balance sheet• Permanent accounts are not closed at year end
Temporary accounts (or “nominal” accounts)• Revenue, expense, and dividend accounts• Revenue and expenses are on the income
statement; dividends are on the statement of changes in shareholders equity.
• Temporary accounts are closed at year end
5Copyright © John Wiley & Sons Canada, Ltd.
Basic Terminology
Journalizing and Posting• A Journal is a book of original entry for all
transactions• The General Journal is a chronological listing of
transactions expressed as debits and credits to particular accounts (known as a journal entries)
• Special Journals are used to summarize transactions with common characteristics (e.g. cash receipts, sales, purchases)
• Posting: when the transaction information entered in the journal is transferred to the ledger accounts
6Copyright © John Wiley & Sons Canada, Ltd.
Basic Terminology
Ledger• Book (or electronic database) containing all
accounts• Each account has a separate page• General ledger contains all asset, liability, and
all equity related accounts (capital, revenue, and expenses)
• Subsidiary ledger contains details related to a specific general ledger account (example: accounts receivable subsidiary ledger)
7Copyright © John Wiley & Sons Canada, Ltd.
Basic Terminology
Trial balance• Listing of all accounts and their balances from
the general ledger at a given point in time• Objective: prove the mathematical equality of
debits and credits after posting (i.e. to ensure general ledger is in balance)
• Typically prepared after end of period adjustments (called Adjusted Trial Balance) and possibly after closing entries (called Post-closing Trial Balance)
8Copyright © John Wiley & Sons Canada, Ltd.
Basic Terminology
Adjusting entries• Entries made at the end of an accounting period• Brings all accounts up to date on an accrual
accounting basis• Seven classifications of adjusting entries:
Prepayment AccrualsEstimated Items
1. Prepaid Expenses 3. Accrued Revenues 5. Bad Debts
2. Unearned Revenues 4. Accrued Expenses 6. Unrealized Holding
Gain or Loss
7. Unrealized Holding
Gain or Loss - OCI
9Copyright © John Wiley & Sons Canada, Ltd.
Basic Terminology
Financial statements• Final summaries of the accounting data for a
specific time period• Four statements:
• Statement of Financial Position (or Balance Sheet under ASPE) - shows financial condition at a specific date
• Statement of Comprehensive Income (or Income Statement under ASPE) - measures the results of operations during a period of time
• Statement of Cash Flows - shows sources and uses of cash
• Statement of Changes in Shareholders’ Equity (Statement of Retained Earnings under ASPE) 10Copyright © John Wiley & Sons Canada,
Ltd.
Debits and Credits
Debit (Dr.)To record or enter anamount on the left sideof a general ledgeraccount
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Credit (Cr.)To record or enter anamount on the right sideof a general ledgeraccount
• This system of recording transactions is referred to as the double-entry accounting system; the two-sided effect of each transaction is recorded in appropriate accounts
• When a transaction is “in balance”, the debits equal the credits
• Debits and credits do not mean “increases” and “decreases” Copyright © John Wiley & Sons Canada,
Ltd.
The Accounting Equation
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Assets = Liabilities + Shareholders’ Equity*
*Shareholder’s Equity = Common Shares + Retained Earnings – Dividends + Revenues -
Expenses
Assets = Liabilities + Common Shares + Retained Earnings – Dividends + Revenues - Expenses
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The Rules of Debit and Credit
• To increase the balance of any account, record the amount in the normal balance column
• To decrease the balance of any account, record the amount in the column opposite to its normal balance
• When any transaction is correctly recorded, the accounting equation will remain in balance
13Copyright © John Wiley & Sons Canada, Ltd.
The Rules of Debit and Credit
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DecreaseIncreaseExpenses
IncreaseDecreaseRevenue
IncreaseDecreaseShareholders’ Equity
IncreaseDecreaseLiabilities
DecreaseIncreaseAssets
CreditDebitAccount
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The Accounting Cycle: Steps
1. Analyse the transaction2. Journalize the transaction3. Post the transaction to general ledger (and sub-
ledgers) accounts4. Prepare the (unadjusted) trial balance5. Prepare necessary adjusting journal entries6. Prepare the (adjusted) trial balance7. Prepare financial statements8. Prepare closing journal entries for the year9. Prepare post-closing trial balance (optional)10. Prepare reversing entries (optional)
15Copyright © John Wiley & Sons Canada, Ltd.
Recording a Transaction:Shares are issued for $3,000 cash
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Assets = Liabilities + Shareholders’ Equity
+ $3,000 + $3,000
To record this transaction as a journal entry (in General Journal):
Dr. Cash $3,000
Cr. Common Shares $3,000
These amounts are then posted to the general ledger
Cash Common Shares
3,000 3,000
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Copyright © John Wiley & Sons Canada, Ltd.
Preparation of Trial Balance
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PIONEER ADVERTISING AGENCY INC. at October 31, 2014
Cash
80,000
Revenue
100,000
Dividends
5,000
Notes Payable
50,000
Account DebitCredit
Cash 80,000Accounts Receivable 72,000Advertising Supplies 25,000Prepaid Insurance 6,000Fair Value Investments 10,000Office Equipment 50,000Notes Payable 50,000Accounts Payable 35,000Unearned Service Revenue 12,000Common Shares 100,000Dividends 5,000Service Revenue 100,000Salaries Expense 40,000Rent Expense 9,000TOTALS 297,000 297,000
Preparation of Trial Balance
• From the previous example, we can see that the trial balance is “in balance”
• However, the trial balance only proves the mathematical accuracy of the ledger
• Errors may still exist such as the following:1. Transaction not journalized2. Correct journal entry not posted3. Journal entry posted twice4. Incorrect accounts used in either the journal
entry or posting5. Offsetting errors made during recording
18Copyright © John Wiley & Sons Canada, Ltd.
Adjusting Journal Entries
• Adjusting entries ensure that revenue recognition and matching are followed within the period
• Reasons for adjusting entries include:– To record those events that are not journalized
daily
– To record those costs, which expire with time and are therefore not recorded
– To record item previously unrecorded
• Adjusting entries are required each time financial statements are prepared
19Copyright © John Wiley & Sons Canada, Ltd.
Adjusting Entries for Prepayments
• Prepaid Expenses– Prepayments made in cash and recorded as
assets before item is used
• Unearned Revenues– Revenue received in cash and recorded as
liabilities before being earned
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20
Adjusting Entries for Prepayments
• Prepaid expenses expire either with the passage of time (e.g. rent and insurance) or by being used and consumed (e.g. supplies)
• Example: Company paid $6,000 for one year insurance when coverage begins October 1 and debited Prepaid Insurance for $6,000.
• Adjust Prepaid Insurance on Dec. 31:Dr Insurance Expense 1,500
Cr Prepaid Insurance 1,500
($6,000/12 * 3)21Copyright © John Wiley & Sons Canada,
Ltd.
Adjusting Entries for Prepayments
• When payment is received from customers for services (or goods) that will be provided in a future accounting period, a liability (unearned revenue) is recognized
• e.g. Rent, magazine subscriptions, deposits
• Example: Company received $12,000 for four months’ advertising services that begins Oct. 1. $12,000 was credited to unearned revenue
• Adjustment required on December 31:
Dr Unearned Revenue 9,000
Cr Service Revenue 9,000
($12,000/4 * 3)
22Copyright © John Wiley & Sons Canada, Ltd.
Adjusting Entries for Accruals
• Accrued Revenues– Revenues earned but not yet received in
cash and not recorded
• Accrued Expenses– Expenses incurred but not yet paid in cash
and not recorded
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23
Adjusting Journal Entries
• Expenses must be accrued when they are incurred; also revenues must be recorded as earned
• Accruals required: interest expense, salaries expense, bad debts expense, interest earned
• Example: assume on January 5, a company pays $20,000 for salaries which includes $10,000 of salaries for December
• Adjustment required on December 31: Dr Salaries Expense 10,000
Cr Salaries Payable 10,00024Copyright © John Wiley & Sons Canada,
Ltd.
Adjusting Entries for Estimated Items
• Bad Debts– Expenses relating to impaired accounts receivable
estimated in the period and relating to revenue that has been earned
• Investments – Fair Value Adjustments– For certain categories of investments, an
unrealized gain or loss must be recorded in the statement of comprehensive income
– Adjustment made either through: • Net Income, or• Other Comprehensive Income
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25
Financial Statements and Ownership Structure
26Copyright © John Wiley & Sons Canada, Ltd.
Financial Statements and Ownership Structure
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27
Closing Entries
• Closing entries are made to close all nominal accounts (revenue and expense accounts) for the year
• The balances in these accounts are transferred to a clearing account (Income Summary)
• The balance in Income Summary represents net income or net loss for the period
• Real (or permanent) accounts are not closed• The Dividends account is closed to retained
earnings28Copyright © John Wiley & Sons Canada,
Ltd.
Closing Entries
The following closing entries are made (assume net income and other comprehensive income for the year):
1. Income Summary $$$
Expense Accounts (individually) $$$
2. Revenue Accounts (individually) $$$
Income Summary $$$
3. Income Summary $$$
Retained Earnings $$$
4. Retained Earnings $$$
Dividends $$$
5. OCI Accounts (individually) $$$
Accumulated OCI $$$
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Retained Earnings: Closing Entries
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4 3
1 2
Income Summary
Ret. Earnings
Dividends
Expense Revenue
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Closing Entries: Inventory
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• In a periodic inventory system, closing entries are made to record cost of goods sold and ending inventory
• In a perpetual inventory system, such entries are not required
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Periodic Inventory: Closing Entry
Collegiate Apparel Shop has the following balances at year end. The company uses a periodic inventory system.
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Beginning Inventory $ 30,000
Purchases (gross) $200,000
Transportation-In $ 6,000
Purchases Returns $ 1,000
Purchase Discounts $ 3,000
Ending Inventory $ 26,000
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Periodic Inventory: Closing Entry
First Step: Determine Cost of Goods Sold
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Beginning Inventory $ 30,000
Purchases $200,000
Less: Purchase returns $1,000
Purchase discounts 3,000 4,000
Net Purchases 196,000
Plus: Transportation-In 6,000
Cost of Goods Purchased 202,000
Cost of Goods Available for Sale 232,000
Less: Ending Inventory 26,000
Cost of Goods Sold $206,000Copyright © John Wiley & Sons Canada,
Ltd.
Periodic Inventory: Closing Entry
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Cost of Goods SoldInventory (Ending) Purchases ReturnsPurchase Discounts
$ 206,000$ 26,000$ 1,000$ 3,000
Purchases (Gross) Transportation-in Inventory (Beginning)
$ 200,000$ 6,000$ 30,000
Account Dr. Cr.
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COPYRIGHT
Copyright © 2013 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by Access Copyright (The Canadian Copyright Licensing Agency) is unlawful. Requests for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his or her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages caused by the use of these programs or from the use of the information contained herein.
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