Chapter 3: Processing accounting information Flashcards
What are the two types of events that affect an entity? Describe each.
Both external and internal events affect an entity. An external event involves interaction with someone outside of the entity. For example, the purchase of land is an external event. An internal event takes place entirely within the entity. The transfer of raw materials into production is an internal event.
What is the significance of source documents to the recording process? Give two examples of source documents.
Source documents are the basis for recording transactions. They provide the evidence, or documentation, needed to recognize an event for accounting purposes. Purchase invoices, time cards, and cash register tapes are all examples of source documents.
Provide three examples of source documents and the event for which each would provide the evidence to record.
Purchase invoice: acquisition of goods or services from a supplier
Sales invoice: sale of goods or services to a customer
Cash register tape: cash sale of goods or services to a customer
Time cards: payment of periodic payroll
Promissory note: borrowing money in return for promise to repay in the future with interest
What do accountants mean when they refer to the double-entry system of accounting?
The term double-entry system of accounting means that every transaction is entered in at least two accounts on opposite sides of T accounts. In this system, every transaction is recorded in such a way that the equality of debits and credits is maintained, and in the process, the accounting equation is kept in balance.
A friend comes to you with the following plight: “I’m confused. An asset is something positive, and it is increased with a debit. However, an expense is something negative, and it is also increased with a debit. I don’t get it.” How can you “straighten out” your friend?
Assets are positive in that they represent future economic benefits. It is merely a matter of convention that an asset is increased with a debit. An expense is negative in the sense that it reduces net income, which in turn reduces retained earnings, one of the two elements of owners’ equity. Because owners’ equity is on the opposite side of the accounting equation from assets, it is increased with a credit. Therefore, any item that reduces owners’ equity, like an expense, is itself increased with a debit.
The payment of dividends reduces cash. If the Cash account is reduced with a credit, why is the Dividends account debited when dividends are paid?
There are two sides to every transaction. The two sides of the transaction when a dividend is paid are the decrease in cash and the decrease in retained earnings. Assets are increased with debits and decreased with credits. Cash is an asset and is therefore decreased with a credit. Retained Earnings is on the opposite side of the accounting equation from assets and is therefore increased with a credit. Retained Earnings is decreased with a debit. Because dividends are a decrease in retained earnings, they are increased with a debit.
If Cash is increased with a debit, why does the bank credit your account when you make a deposit?
When you deposit money in your account, the bank has a liability. The entry on the bank’s books consists of a debit to Cash and a credit to some type of liability account, such as Customers’ Deposits. Therefore, when you make a deposit, the bank “credits” your account; that is, it increases its liability.
Your friend presents the following criticism of the accounting system: “Accounting involves so much duplication of effort. First, entries are recorded in a journal; then the same information is recorded in a ledger. No wonder accountants work such long hours!” Do you agree with this criticism? Explain.
A business actually saves time by first recording transactions in a journal and then posting them to the ledger. Because of the sheer volume of transactions, it would be impractical to prepare financial statements directly from the journal. The journal serves as a book of original entry; the ledger accounts are the basis for preparing a trial balance, which in turn is used to prepare the financial statements.
What is the benefit of using a cross-referencing system between a ledger and a journal?
At the time of posting, the Posting Reference column of the account in the ledger is filled in with the page number of the journal entry. At the same time, the account number is placed in the Posting Reference column of the journal. This cross-referencing system used in posting allows the accountant to trace an entry made in the journal to the account it was posted to, or, conversely, to trace from an account back to the entry in the journal.
What is the purpose of a trial balance?
A trial balance proves the equality of debits and credits. It does not prove that the correct accounts were debited and credited or that the correct amounts were necessarily recorded. It simply ensures that the balance of all of the debits in the ledger accounts is equal to the balance of all the credits at any point in time.
