Financial Accounting: Tools for Business Decision Making, 4th Ed. Chapter 3 The Accounting Information System. External and Internal Events

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1 Financial Accounting: Tools for Business Decision Making, 4th Ed. Kimmel, Weygandt, Kieso Chapter 3 The Accounting Information System CHAPTER 3 Analyze the effect of business transactions on the basic accounting equation. Explain what an account is, then apply debits and credits to those accounts (journal entries) External and Internal Events Exercise Types of Events External Event interaction between a business and its environment. Internal Event event occurring entirely within a business. Transaction any event that is recognized in a set of financial statements. RECOGNIZED- An accounting entry is recorded it becomes reflected in the financial statements. REALIZED- regardless of whether it results in an accounting entry, the business actually receives or gives something. External Internal 1. A supplier of a company s raw material is paid an amount owed on account. 2. A customer pays its open account. 3. A new chief executive officer is hired. 4. The biweekly payroll is paid. 5. Raw materials are entered into production. 6. A new advertising agency is hired. 7. The accountant determines the federal income taxes owed based on the income earned. Not Recorded External External Not Recorded External Internal Not Recorded Internal

2 Source Documents Source Document a piece of paper that is used as evidence to record a transaction. Sales invoice Payroll timecard Utility bill Stock certificate Promissory note (note payable) NOTE: Not all recordable events are supported by a standard source document. Payment terms are 2/10, n/30 Effect on the Accounting Equation Assets = Liabilities + Equity Assets - Liabilities = Equity Assets - Liabilities = Net Assets Net Assets = Equity The accounting equation is made up of Accounts. An account is a record used to accumulate amounts for each individual asset, liability, equity, revenue, and expense Sara Lee Corp. Assets Accounts Consolidated Balance Sheets Dollars in millions except share data July 3, June 28, June 29, Assets Cash and equivalents $ 638 $ 942 $ 298 Trade accounts receivable, less allowances of $184 in 2004, $181 in 2003 and $176 in ,929 1,857 1,768 Inventories 2,779 2,704 2,509 Other current assets Net assets held for sale Total current assets 5,746 5,882 4,923 Other noncurrent assets Deferred tax asset Property, plant, and equipment Land Buildings and improvements 2,052 1,915 1,744 Machinery and equipment 5,087 4,917 4,299 Construction in progress ,577 7,325 6,539 Accumulated depreciation 4,306 3,975 3,384 Property, net 3,271 3,350 3,155 Trademarks and other identifiable intangibles, net 2,024 2,110 2,106 Goodwill 3,414 3,387 3,314 Total assets $ 14,883 $ 15,450 $ 13,694 LO 2 Describe the qualitative characteristics of accounting information. 3-7 Chart of Accounts LO 3 Chart of Accounts Acct. No. Account 100 Cash 105 Accounts receivable 110 Inventory 130 Building 200 Accounts payable 220 Note payable 300 Common stock 330 Retained earnings 400 Sales 500 Cost of goods sold Analyze the effects of transactions on the accounting equation. 3-8

3 FINALLY- DEBITS AND CREDITS Rule number one: forget the concept of credit to your account that you are probably familiar with. If your bank charges you a late fee, you complain and they reverse it, you THINK that is a credit to your account. BUT, as you will see, on YOUR books, the adjustment is a DEBIT to your cash. CRUTCH: ASSETS & LIABILITIES: DEBIT GOOD, CREDIT BAD EQUITY & INCOME: OPPOSITE (DEBIT BAD, CREDIT GOOD) MORE: ASSETS AND EXPENSES ARE DEBITS LIABILITIES, EQUITY AND REVENUES ARE CREDITS OH YEAH, ONE OTHER THING: DEBITS ON THE LEFT, CREDITS ON THE RIGHT! REMEMBER FROM PRIOR CHAPTERS: FOR EVERY ACTION THERE IS AN EQUAL AND OPPOSITE REACTION IN ACCOUNTING TERMS, FOR EVERY DEBIT, THERE IS A CREDIT. 3-9 Graphic debits and credits (GENERALLY) Assets: Liabilities: Equity: Balance Sheet DEBITS CREDITS CREDITS Income Statement Revenues & Gains: Expenses & Losses: CREDITS DEBITS 3-10 ANOTHER CRUTCH Debit Card- comes from your checking account, which is an ASSET. Credit Card- creates a LIABILITY. DEBIT- ASSET CREDIT- LIABILITY Review What is the normal balance for the following accounts? Cash Debit Accounts Payable Credit Accounts Receivable Debit Service Revenue Credit Common Stock Credit Salaries Expense Debit

4 Review What is the normal balance for the following accounts? Dividends Debit Building Debit Taxes Payable Credit Unearned Revenus Credit Prepaid Insurance Debit Rent Expense Debit Debits and Credits Balance Sheet Income Stmt. Asset = Liab. + Equity Rev. - Exp. = Debit Credit DEBITS AND CREDITS- POSTING ACCOUNTING EQUATION- JOURNAL ENTRIES We need to write a transaction in a format that can be communicated / input. We use a journal entry: DEBITS ON THE LEFT CREDITS ON THE RIGHT On Jan. 3rd, sold common stock for $100,000 cash. What is the impact to common stock? INCREASE $100,000 What is the impact to cash? INCREASE $100,000 Cash $100,000 Common Stock $100,

5 ACCOUNTING EQUATION- JOURNAL ENTRIES On Jan. 10th, purchased a building by signing a $150,000 note payable.. What is the impact to Building (Fixed assets)? INCREASE $150,000 What is the impact to Notes Payable? INCREASE $150,000 Building $150,000 Note payable $150, HOW TO LEARN DEBITS AND CREDITS There is no way to teach it and no way to learn it other than by: PRACTICE!!!!! PRACTICE!!!!! PRACTICE!!!!! PRACTICE!!!!! 3-18 ACCOUNTING EQUATION- JOURNAL ENTRIES On Jan. 15th, purchased inventory on account for $60,000. What is the impact to Inventory? INCREASE $60,000 What is the impact to cash? NONE- PURCHASED ON ACCOUNT What is the impact to accounts payable? INCREASE $60,000 Inventory $60,000 Accounts payable $60,000 BY THE WAY WHAT IS THE DIFFERENCE BETWEEN THESE ENTRIES: Inventory $60,000 Accounts payable $60,000 AND Accounts payable $60,000 Inventory $60,000 ANSWER: NOTHING- IT IS ONLY A CONVENTION TO LIST THE DEBITS FIRST!

6 ACCOUNTING EQUATION- JOURNAL ENTRIES On Jan. 20th, sold inventory costing $30,000, for $75,000 on account. Did we earn the revenue? Yes- SALES INCREASE $75,000 Sold for cash or on account ON ACCOUNT ACCOUNTS RECEIVABLE INCREASE $75,000 What is the impact to Inventory? DECREASE $30,000 When we Squeeze Inventory from the Balance sheet to the income statement, where does it go (HAVE WE RECEIVED THE BENEFIT)? COGS $30,000 Accounts receivable $75,000 Sales $75,000 Cost of goods sold $30,000 Inventory $30, ACCOUNTING EQUATION- JOURNAL ENTRIES On Jan. 29th, received $40,000 cash from customers who purchased goods on account. SHOULD THIS IMPACT THE INCOME STATEMENT? NO! WE RECORDED THE SALE WHEN IT WAS EARNED, THIS ONLY REFLECTS A CHANGE FROM AN ACCOUNT RECEIVABLE TO CASH. What is the impact to sales? NONE What is the impact to accounts receivable? DECREASE $40,000 What is the impact to cash? INCREASE $40,000 Cash $40,000 Accounts receivable $40, Additional Terms General Ledger a file that contains the activity of all the accounts. Account Name T Account a format used to illustrate the increases, decreases and resulting total balance for each account. Account Name Slide JE-4 Copyright 2003 by Coby Harmon (T Account illustration with excel)

7 Assets Liabilities NORMAL - DEBIT NORMAL - CREDIT Equity Revenue NORMAL - CREDIT NORMAL - CREDIT

8 Expense REMEMBER THIS SLIDE FROM BEFORE? On Jan. 3rd, sold common stock for $100,000 cash. What is the impact to common stock? INCREASE $100,000 What is the impact to cash? INCREASE $100,000 NORMAL - DEBIT Cash $100,000 Common Stock $100,000 WHAT WOULD THIS LOOK LIKE IN THE T-ACCOUNTS? ENTRY POSTED TO T-ACCOUNTS The Journal Cash $100,000 Common Stock $100,000 General Journal a chronological record of transactions, also known as the book of original entry. What you record in the journal is known as a Journal Entry. CASH DEBIT CREDIT $100,000 $100,000 COMMON STOCK DEBIT CREDIT $100,000 $100,000 Date Account Title Ref. Debit Credit Jan. 3 Cash ,000 Common stock , Building ,000 Note payable ,

9 Posting Posting the process of transferring amounts from the journal to the ledger accounts. General Journal GJ1 Date Account Title Ref. Debit Credit Jan. 3 Cash 100,000 Common stock 100,000 General Ledger Cash Acct. No. 100 Date Explanation Ref. Debit Credit Balance Trial Balance Trial Balance a list of each account and its balance; used to prove equality of debits and credits. Acct. No. Account Debit Credit 100 Cash 140, Accounts receivable 35, Inventory 30, Building 150, Accounts payable 60, Note payable 150, Common stock 100, Retained earnings 400 Sales 75, Cost of goods sold 30, , , LO 7 Explain the purposes of a trial balance Event 9 Hiring of New Employees Oct. 9 Sierra hired four new employees to begin work on Oct. 15. Accounting transaction has NOT occurred! 411 Basic Steps in the Recording Process. 1.Analyze 2.Journalize 3.Post

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