Chapter 3: The Accounting Information System Flashcards
Modified Cash Basis
Mixture of Cash and Accrual basis accounting.
Mostly cash basis but with modifications
- capitalizing and depreciating plat assets
- recording inventory
NRV
Net Realizable Value
Unearned Revenues
Liability account
Receipt of payment creates performance obligation
Prepaid Expenses
An asset account (benefit received in the future)
expire either with passage of time or through use and consumption
Daily entries are impractical
Entry when paid for:
Debit Asset Account (prepaid expense)
Credit Cash
Deferrals
Type of adjusting entry
- prepaid expenses (asset that expires to become an expense)
- unearned revenue (liability that expires to become an asset)
- supplies as they are used up
Recognized after the cash is received
Accruals
Type of Adjusting Entry
- Accrued Revenues (services performed but cash not yet received)
- Accrued expenses (expenses incurred but not yet paid for)
If not adjusted then the revenue (asset) or expense (liability) account are understated.
Accrual adjusting entries increase balance sheet and income statement account
Adjusting Entries
Must be done EVERY time financial statements are prepared
Enables revenues to be recorded in the period in which performance obligations are satisfied and expenses to be matched
- not always efficient to record all events daily (salary accruals)
- costs expire/ occur as time passes
- Billings that are in arrears
Each account must be analyzed and brought up to date
Special Journals
Summarize transactions possessing a common characteristics
- cash receipts
- cash sales
- purchases
- cash payments
Posting
Transfer date, journal page, explaination and amount debited in account debited
- write account number in journal reference column
- repeat for credits
Three Column Account Form
An account format in the general ledger with three columns for money: Debit, credit and balance
Chart of Accounts
List of accounts and account numbers and their position in the ledger
Usually statement of financial system (balance sheet) account and then income statement accounts
Credit
CR right
Credit balance if credits exceed debits
Debit
DR Left
Debit balance if debits exceed credits
Financial Statements
Reflect the collection, tabulation and financial summarization of accounting data
Subsidiary Ledger
Contains details related to a given general ledger account
Account
Systematic arrangement showing the effect of transactions or other events on a specific element (asset, liability etc..)
Event
A happening of consequence
The source or cause of changes in assets liabilities and equity
May be internal or external
U.S. Foreign Corrupt Practices Act
Requires companies to make and keep books, records and accounts which, in reasonable detail, accurately and fairly reflect the transactions and deposition of assets.
ICFR
Internal control over financial reporting
Continuous Accounting
New Technologies enabling:
- agility
- intelligent analysis
- data driven decision making
24/7 accounting
- closes books on a daily basis
- issues with unaudited data
Reversing entry for accruals adjustments
Reverses the adjusting entry for an accrual so that when the expense is paid or revenue is received the entry isn’t split between payables and expense (receivables and revenues)
Eliminates payables / receivables balance
- all expenses debited to expense
- all revenues credited to revenue
Reversing entry for deferrals adjustment
Unnecessary if deferred expenses not originally debited to expense account, but rather a real account
IF deferred expenses debited to expense account & then adjusted
Permanent accounts at the end of a period
single line under current period entries
account balance entered below single underline and carried forward to the next period
Closing temporary accounts
Total
Balance
Double Underlines
Accounts now at 0
Contra-asset account
Decreases the value of an asset account so can see both the historical cost of equipment and the current value
Debit Decrease Credit Increase
(Credit NB)
Ownership on Balance Sheet
Stockholders equity section on balance sheet
Common stock = investments by stockholders
Retained earnings = net income not distributed as dividends
Ownership structure dictates types of accounts in this section
Revenue Conversion Cash Basis to Accrual Basis
Cash Receipts from Customers - Beginning Accounts Receivable \+ Ending Accounts Receivable \+ Beginning unearned revenue - Ending unearned revenue = Revenue on accrual basis
Operating Expenses: Conversion cash basis to accrual basis
Cash paid for operating expenses \+ Beginning prepaid expenses - Ending prepaid expenses - Beginning Accrued liabilities \+ Ending accrued liabilities = Expenses on an accrual basis
Add depreciation or amortization as necessary
Sarbanes Oxley Act
- Determines internal control standards for U.S. publicly traded companies. Protects investors from fraudulent financial reporting by corporations
- 2002
- criminal penalties for officers who knowingly sign off on false reports
- created Public Company Accounting Oversight Board (PCAOB) to monitor auditors
Statement of Cash Flows
- Covers a specific period of time and shows:
- where cash came from
- what cash was used for
- total change in cash balance
cash provided and used by operating, investing and financing activities during the period
Balance Sheet
Shows financial position
- snapshot of a single point in time
- shows that accounting equation balances (A=L+OE)
- shows current balance of all accounts in general ledger (assets and liabilities accounts)
Statement of Retained Earnings
Aka: Retained earnings statement
Retained Earnings (start of period)
+ Net income (or - Net loss)
- dividends
= Retained Earnings (end of period)
Balance of retained earnings account from the beginning to the end of the period
- income statement
- retained earnings, dividends accounts
Income Statement
AKA: profit and loss, statement of earnings
Income (revenue)
less expenses
= net income or loss
Done for a specific period
Results of operation for a period (revenue and expense accounts)
Basic Accounting Equation
Assets = Liabilities + Owners Equity
aka
What a business has and those who have claim to those assets
MUST always balance
Double Entry Accounting
- each transaction effects two or more accounts
- keeps accounting equation in balance (A=L+OE)
- Debits must equal credits in each transaction
- can prove accuracy of the accounts
Journal
“Book of original entry”
- chronological record of all transactions
- Debits always recorded first
- $ not always used
- Select events/ transactions journalized and then posted to the ledger
General Ledger
Tracking of transactions sorted by account
arranged in trial balance order
”$” not used
collection of all accounts
Transaction
EXTERNAL EVENTS
Transaction is an event that affects the financial position of the company
AND
can be measured with faithful representation
“an external event involving a transfer of exchange between two or more entities”
Transaction steps
- Identify accounts affected and account type
- decide if each account increases or decreases
- record transaction in journal
- post journal entries to general ledger accounts
- Assure accounting equation is still in balance
Accounts that Decrease Owner’s Equity
- owners drawings (dividends)
- Business expenses
Accounts that increase owners equity
- owner investments (capital, stock)
- revenue
Revenue
Debit Decrease Credit Increase
Credit Normal Balance
Temporary account - closed at the end of each cycle
Owner’s Equity
Equity/ stocks/ capital
Debit Decrease Credit Increase
Credit Normal balance
On a classified balance sheet:
- proprietorship = one capital account
- partnership = one account per partner
- corporation = capital stock account + retained earnings account
Permanent accounts
Liabilities
Debit decrease Credit increase
Credit Normal Blaance
Permanent account
Owners Drawing
Debit increase Credit Decrease
Debit Normal Balance
Temporary account - closed at the end of the cycle
Expenses
Debit Increase Credit Decrease
Debit normal blance
Temporary account - closed at the end of each cycle
Assets
Debit increase Credit Decrease
Normal balance
Something that provides future benefit for the company
permanent account
Normal Balance
Always on the increase side of the account
Trial balance
- list of account balances at a given time
- in order of general ledger accounts
- proves only that debit balances = credit balances
- ”$” on 1st item in the column and on column totals
Trial Balance Error checks
Does the credit vs debit difference:
- evenly divisible by 2: something probably in the wrong column
- evenly divisible by 9: transposition error or missing account
HOWEVER. many potential errors are not visible on a trial balance
Expanded Accounting Equation
Assets = Liabilities + Owners capital - Owner’s drawing + revenues - expenses
Retained earnings = revenue - expenses - owner drawings
Owner’s capital = common stock + retained earnings
Adjusting Entries
- ensure that revenue recognition and matching principles are followed (expense recognition)
- required every time financial statements are prepared - bring all accounts up to date on an accrual basis
- will ALWAYS include one income statement and one balance sheet account
Depreciation
The process of allocating the cost of an asset to expense over its useful life
Accumulated depreciation = contra asset account
NOT an attempt to report accurate change in fair market value. About allocation, not valuation
Contra Account
Account paired with and listed immediately after its related account in the chart of accounts and in financial statements
Normal balance is opposite of normal balance of its related account
Residual value
Expected value of a depreciable asset at the end of its natural life
Book Value
The difference between the cost of an asset and its accumulated depreciation (remaining value)
Worksheet
An internal document that helps summarize data for the preparation of financial statements
- generally done in excel
Sections:
1) account names
2) unadjusted trial balance
3) adjustments
4) adjusted trial balance
5) income statement
6) balance sheet
7) net income or loss
Cash-Basis accounting
Opposite of accrual accounting
Revenue increases when cash is received
Expenses increase when cash is paid
NOT in accordance with GAAP
- ignores existence of credit
- removes much of forcasting ability
Accrual Accounting
Revenues increase when company performs work (not when receive payment)
Expenses increase when company incurs expenses, not when paid
Transactions recorded when events occur (not when their paid for)
In accordance with GAAP and IFRS
If Accrued Expenses not adjusted
Expenses understated
Liabilities understated
Income statement: expenses understated, net income overstated
Balance sheet: liabilities understated, equity overstated
Adjusting Entry, Accrued Expenses
Debit (increase) expense account
Credit (increase) liability account
If not adjusted - expenses understated, liabilities understated
expenses incurred but not paid for
Accrued Expenses
Expenses accrued but not yet paid
liability account
payables, accrued interest
permanent account
If Accrued revenues are not adjusted
Assets understated
Revenue understated
Income statement: revenues understated, net income understated
Balance Sheet: Assets understated, equity understated
Adjusting Entry, Accrued Revenue
Debit (increase) asset account
Credit (increase) revenue account
If not adjusted: assets understated, revenue understated
revenues earned but not yet received payment for
Accrued Revenues
Revenue earned (obligation fulfilled) but not yet received
Asset account
Receivables (including interest receivable that accrues with passage of time)
Debit (increase) asset account
Credit (increase) service revenue account
Permanent account
If unearned revenue NOT adjusted
Liabilities overstated
Revenues understated
Income statement: revenues understated, net income overstated
balance sheet: liabilities overstated, equity understated
Adjusting entry, unearned revenues
Debit (decrease) liability account
Credit (increase) revenue account
Once revenue has been earned (time passed, subscription fulfilled, services provided)
If not adjusted - liabilities overstated, revenues understated
Adjusting Entry, Accumulated Depreciation
contra asset account - always appears after the account it offsets on the balance sheet
Debit (increase) Depreciation expense
Credit (increase) accumulated depreciation
If skipped assets/ equity/ income all overstated
Property, plant & equipment
Fixed assets, plat assets
Assets with long useful lives that are currently used for business operations
depreciation allocates cost over useful years
Accumulated depreciation - depreciation thus far expensed, listed as a single amount after listed PPE assets
LAND IS NOT DEPRECIATED
If prepaid expenses not adjusted
Assets overstated
Expenses understated
income statement effect: expenses understated, net income overstated
Balance sheet effect: assets overstated, equity overstate
Adjusting Entry, prepaid expenses
Debit (increase) expense account
Credit (decrease) asset (prepaid expense) account
via use of asset or passage of time
accounts like supplies are adjusted by inventory
If not adjusted assets overstated, expenses understated
Unearned Revenue
Aka deferred Revenue
- considered a liability (deferral)
Payment collected in advance of services
Debit (increase) cash
Credit (increase) liability (unearned revenue)
Permanent account
Prepaid expense
Aka: deferred expenses (recognition is deferred)
Considered an asset
Payments of expenses that will benefit more than one accounting period
Debit (increase) asset account (prepaid expense)
Credit cash or a/p
Permanent account
adjusted Trial balance
Primary basis for preparation of financial basis
Second trial balance prepared after adjusting entries are journalized/ posted
proves that debits = credits
balance sheet, income statement, owner’s equity statement prepared from adjusted trial balance
Depreciation on balance sheet
Under assets section
Asset
less accumulated depreciation
= net asset
Straight-line method of depreciation
Depreciation formula
Straight line depreciation = (cost - residual value) / useful life
Usually measured in years
Interest
Amount of interest = principle x rate x time
Time is expressed as a fraction of a year (in months or days)
rate always expressed as annual
Closing Process
At the end of a period. journalizing and posting the closing entries to set the balance of temporary (nominal) accounts (revenues, expenses, income summary & dividends) to zero
Accounting Cycle
Process to produce financial statements for a period: 1) analyze business transactions 2) journalize transactions 3) post to ledger accounts 4) prepare trial balance 5) journalize and post adjusting entries 6) Prepare an adjusted trial balance 7) Prepare financial statements 8) journalize and post closing entries 9) Prepare a post closing trial balance (optional 10: reversing entries) start new period at 1
Reversing Entry
Optional step of the accounting cycle
Switches the debit and credit of a previous entry
makes the next period’s accounting easier
entries to reverse:
- all accruals
- deferrals debited/ credited to an expense or revenue account (instead of an asset or liability account)
- bad debt and depreciation are NOT reversed
Income Summary Account
Only used at closing
Account used to close out expenses & revenue at the end of the accounting period
Debit decrease Credit increase
Credit normal balance
Closed to retained earnings
Closing the books: Revenues & Expenses
Debit (decrease) revenue to 0
Credit (increase) income summary
Debit income (decrease) income summary
Credit (decrease) expenses to 0
Debit Income Summary to 0
Credit owner’s capital/ retained earnings
(this assumes all accounts on normal balance side - net gain for period. If net loss will Debit Owners capital, credit income summary
Closing the books: Owners Drawing
Debit Owner’s Capital/ Retained Earnings
Credit Owner’s Drawing down to 0
Do NOT close dividends through income summary, they are not an expense!
Closing Entries
Net Income (loss) + Drawings closed to owner’s capital
Fiscal year-end adjusting journal entries
Formally recognizes the transfer of net income (or loss) and owner’s drawings to owners capital (or retained earnings) or stockholders equity. Sets all nominal accounts to 0
Temporary vs Permanent Accounts
Temporary (aka Nominal) accounts:
- income statement accounts
- closed at the end of the fiscal year/ period
- account only relates to a specific accounting period
- Revenue and Expense accounts
- owner’s drawing account
Permanent (aka real accounts):
- Balance sheet accounts
- not closed at the end of the period
- Asset and Liability accounts
- Owner’s Capital (stock) accounts
Post Closing Trial balance
Proves the debt vs credit equality of permanet account balances after temporary accounts are closed (after closing entries are posted)
Does not prove that all transactions were necessarily recorded correctly
Classified balance sheet
Merchandising company balance sheet
- snapshot of the company position at a single point in time
- similar assets/ similar liabilities grouped together
- still in Assets = Liabilities + Owners’ Equity form
Assets:
- current assets
- long term investments
- property, plant & equipment
- intangible assets
Liabilities
- current liabilities
- long term liabilities
Owner’s/ Stockholders Equity
Balance Sheet Accounts
All assets, liabilities & stockholders’ equity
- assets + contra assets
- liabilities (payables)
- Equity/ common stock
all permanent accounts
Merchandising company income formula
Sales revenue less cost of goods sold = gross profit less operating expenses = net income
Multi-step income statement
Distinguishes between operating and non-operating activities (sometimes also between selling and admin expenses)
Sales less contra-revenue accounts = net sales less COGS = Gross Profits less Operating expenses = income from operations plus other revenue/gains less other expenses/ loss let income tax expenses = net income
Percentage of receivables method of estimating allowance for doubtful accounts
- focuses on accurate valuation of receivables on the balance sheet
- often uses A/R aging schedule (sometimes just a total % of all A/R)
- existing balance in allowance for doubtful accounts is considered (since all outstanding a/r considered)
- if ADA credit balance: subtract balance from target balance to get adjustment
- if ADA debt balance: add balance to target to get adjustment
Uncollectable Accounts Receivable
Accrual accounting
Debit (increase) Bad Debt Expense
Credit Allowance for Doubtful Accounts
Direct write off method not acceptable for under GAAP, must use allowance method
Recording Payroll
To Accrue:
Debit Salaries/ Wages Expense
Credit Deduction payables
Credit salaries/ wages payables
use payrolll register as source document
when paid:
Debit Salaries/Wages payable
Credit Cash
