CHAPTER 3 THE ACCOUNTING INFORMATION SYSTEM Overview Chapter 1 explained that the primary means of conveying financial information to investors creditors and other external users is through financial statements and related notes The purpose of this chapter is to review the fundamental accounting process used to produce the financial statements This review establishes a framework for the study of the concepts covered in intermediate accounting Actual accounting systems differ significantly from company to company This chapter focuses on the many features that tend to be common to any accounting system Learning Objectives 1 Analyze routine economic events transactions and record their effects on a company s financial position using the accounting equation format 2 Record transactions using the general journal format 3 Post the effects of journal entries to general ledger accounts and prepare an unadjusted trial balance 4 Identify and describe the different types of adjusting journal entries 5 Record adjusting journal entries in general journal format post entries and prepare an adjusted trial balance 6 Describe the four basic financial statements 7 Explain the closing process 8 Convert from cash basis net income to accrual basis net income 3 1 TRANSACTION ANALYSIS Each transaction is analyzed to determine its effect on the equation and on the specific financial position elements 1 An attorney invested 50 000 to open a law office An investment by the owner causes both assets and owners equity to increase Assets 50 000 cash Liabilities Owners Equity 50 000 investment by owner 2 40 000 was borrowed from a bank and a note payable was signed This transaction causes assets and liabilities to increase A bank loan increases cash and creates an obligation to repay it Assets 40 000 cash Liabilities Owners Equity 40 000 note payable 3 Supplies costing 3 000 were purchased on account Buying supplies on credit also increases both assets and liabilities Assets 3 000 supplies Liabilities Owners Equity 3 000 accounts payable TRANSACTION ANALYSIS continued 3 2 4 Services were performed on account for 10 000 Transactions 4 5 and 6 are revenue and expense transactions Revenues and expenses and gains and losses are events that cause owners equity to change Revenues and gains describe inflows of assets causing owners equity to increase Expenses and losses describe outflows of assets or increases in liabilities causing owners equity to decrease Assets Liabilities 10 000 receivables Owners Equity 10 000 revenue 5 Salaries of 5 000 were paid to employees Assets 5 000 cash Liabilities Owners Equity 5 000 expense 6 500 of supplies were used Assets 500 supplies Liabilities Owners Equity 500 expense 7 1 000 was paid on account to the supplies vendor This transaction causes assets and liabilities to decrease Assets 1 000 cash Liabilities Owners Equity 1 000 accounts payable ACCOUNTING EQUATION FOR A CORPORATION Owners equity for a corporation called shareholders equity is classified as either paid in capital or retained earnings Assets Liabilities Shareholders Equity 3 3 Paid in Capital Retained Earnings Revenues Gains 3 4 Expenses Losses Dividends ACCOUNTING EQUATION DEBITS AND CREDITS INCREASES AND DECREASES Assets Debit Credit Liabilities Paid in Capital Debit Debit Credit Retained Earnings Credit Debit Credit Expenses and Losses Revenues and Gains Debit 3 5 Credit Debit Credit JOURNAL ENTRIES July 1 Two individuals each invested 30 000 in the corporation Each investor was issued 3 000 shares of common stock July 1 Borrowed 40 000 from a local bank and signed two notes The first note for 10 000 requires payment of principal and 10 interest in six months The second note for 30 000 requires the payment of principal in two years Interest at 10 is payable each year on July 1 2012 and July 1 2013 July 1 Paid 24 000 in advance for one year s rent on the store building July 1 Purchased furniture and fixtures from Acme Furniture for 12 000 cash July 3 Purchased 60 000 of clothing inventory on account from the Birdwell Wholesale Clothing Company July 6 Purchased 2 000 of supplies for cash July 4 31 During the month sold merchandise costing 20 000 for 35 000 cash July 9 Sold clothing on account to St Jude s School for Girls for 3 500 The clothing cost 2 000 July 16 Subleased a portion of the building to a jewelry store Received 1 000 in advance for the first two months rent beginning on July 16 July 20 Paid Birdwell Wholesale Clothing 25 000 on account July 20 Paid salaries to employees for the first half of the month 5 000 July 25 Received 1 500 on account from St Jude s July 30 The corporation paid its shareholders a cash dividend of 1 000 3 6 GENERAL JOURNAL 3 7 GENERAL JOURNAL Date Account Title and Explanation PAGE 1 Post Ref Debit Cash Common stock To record the issuance of common stock 100 300 60 000 Cash Notes payable To record the borrowing of cash and the signing of notes payable 100 220 40 000 Prepaid rent Cash To record the payment of one year s rent in advance 130 100 24 000 Furniture and fixtures Cash To record the purchase of furniture and fixtures 150 100 12 000 Inventory Accounts payable To record the purchase of merchandise inventory 140 210 60 000 Credit 2011 July 1 July 1 July 1 July 1 July 3 3 8 60 000 40 000 24 000 12 000 60 000 July 6 July 4 31 July 4 31 July 9 July 9 July 16 July 20 Supplies Cash To record the purchase of supplies 125 100 2 000 Cash Sales revenue To record cash sales for the month 100 400 35 000 Cost of goods sold Inventory To record the cost of cash sales 500 140 20 000 Accounts receivable Sales revenue To record credit sale 110 400 3 500 Cost of goods sold Inventory To record the cost of a credit sale 500 140 2 000 Cash Unearned rent revenue To record the receipt of rent in advance 100 230 1 000 Accounts payable Cash To record the payment of accounts payable 210 100 25 000 3 9 2 000 35 000 20 000 3 500 2 000 1 000 25 000 July 20 July 25 July 30 Salaries expense Cash To record the payment of salaries for the first half of the month 510 100 5 000 Cash Accounts receivable To record the receipt of cash on account 100 110 1 500 Retained earnings Cash To record the payment of a cash dividend 310 100 1 000 3 10 5 000 1 500 1 000 GENERAL LEDGER Cash GJ 1 GJ 1 60 000 40 000 24 000 100 GJ 1 Prepaid Rent 130 GJ 1 Note Payable 220 40 000 24 000 Common Stock 300 GJ 1 60 000 3 11 GJ 1 UNADJUSTED TRIAL BALANCE DRESS RIGHT CLOTHING CORPORATION Unadjusted Trial Balance July 31 2011 Account