CHAPTER

3
The Accounting Information
System
 The Accounting
Information System

Accounting The Accounting

Information Cycle
System Identification and
Basic terminology recording
Debits and credits Journalizing
Basic equation Posting
Financial statements Trial balance
and ownership Adjusting entries
structure
Adjusted trial balance
Closing
Post-closing trial
balance
Reversing entries
 The Accounting Equation

Assets = Liabilities+ Shareholders’ Equity

Assets= Liabilities+ Common Shares + Retained

Earnings
Retained Earnings: revenues that made AND retained in
business.
Retained Earnings by Year End (Method 1)

= Revenues (all years)–expenses (all years)–dividends (all

years)
= Net income (all years)-dividends (all years)
Retained Earnings by Year End (Method 2)

= Beginning Retained Earnings + Net income– dividends

 The Accounting Equation
• Retained Earnings (R/E): revenues that
made AND retained in the business.
1 2 3 4 5
Net income 100 110 120 130 140
Dividend (20) (20) (20) (20) (20)
Year-end R/E 80 ? ? ? ?

R/E by year 2 (M1): 100+110-40=170

R/E by year 2 (M2): 80+110-20=170
R/E by year 3 (M1): 100+110+120-60=270

R/E by year 3 (M2): 170+120-20=270

The second way to calculate R/E is the
popular way used in real world business.
 Basic Terminology

Event
• The source/cause of a change in
assets, liabilities and equity
Account
• A summary of the transactions for
each type of asset, liability and
equity item
 Basic Terminology
Ledger
• Book containing all accounts
• Each account has a separate page
Journal
• Book of original entry for all transactions
Posting
• Process of transferring transaction information
from the journal to the ledger
Trial balance
• Listing of all accounts and their balances from the
general ledger
• Tool used to ensure that the general ledger is in
balance
 The Rules of Debit and
Credit
Account Debit Credit
Assets Increase Decrease
Liabilities Decrease Increase
Shareholders’ Decrease Increase
Equity
Revenue Decrease Increase
Expenses Increase Decrease
 The Accounting Cycle
1
Identification and
2
Record
Measurement of Transaction in
Transactions Journal 3
7 Post Journal
10 Prepare Financial Entries to the
Reversing Entries Statement Ledgers
4
6 Prepare Trial
9 Adjusted Trial Balance
Post-Closing Trial
Balance
Balance
5
8 Prepare Adjusting
Record Adjusting Journal Entries
Close Temporary
Journal Entries to
Accounts
Worksheet (post to
the Ledgers as well)
 Basic Terminology (Step
5)
Adjusting entries
• Record the effects of accrual accounting
• Ensure that revenue recognition and the
matching principle are followed
• Five classifications of year-end adjusting
entries:
1. Prepaid expenses
2. Unearned revenues
3. Accrued revenues
4. Accrued expenses
5. Depreciations/Amortization
 Adjusting Entries:
Recognizing Revenue

Adjusting Recording
Unearned Revenue Accrued Revenue

Revenues received
Revenues earned
in cash
but not yet
and
received in cash
recorded as liabilities
or recorded
before being earned
E3-6 Text page 109:
Karen Pain started dental practice on Jan 1, 2005. The
following transactions occurred during the first month.
3. At Jan 31, $1,750 services was earned but not
billed to insurance companies (customers are
on dental insurance plan).
4. Utility expense incurred but not paid by Jan 31
totaled $1,520.
5. On Jan 1, purchase dental equipment for
$80,000, paying $20,000 in cash and signing
a $60,000, 3 year note payable. The
equipment amortization is $400 per month.
Interest is $500 per month.
6. Purchased a one-year malpractice insurance
policy on Jan 1 for $13,000.
7. Purchased $2,600 of dental supplies. On Jan
31 determined that $500 of supplies were on
hand.
E3-6 Text page 109 Solution
1. Accounts Receivable 1,750
Service Revenue 1,750
2. Utilities Expense 1,520
Utilities Payable 1,520
3. Amortization Expense 400
Accumulated Amortization–Equipment 400
Interest Expense 500
Interest Payable 500
4. Insurance Expense 1,083
Prepaid Insurance 1,083($13,000 /
12)
5. Supplies Expense 2,100
Supplies 2,100($2,600 -
$500)
 Basic Terminology (Step
8)
Permanent account
• Also known as a real account
• Permanent accounts are not closed at year-end.
The balances of these accounts will be carried
over to the next year.
• All balance sheet accounts are permanent
accounts excepts distribution accounts (e.g.
Dividend account is a temporary account)
Temporary account
• Also known as a nominal account
• Temporary accounts are closed at year-end to
Retained Earnings
• All income statement accounts are temporary
accounts
 Homework assignment
– E3-8, E3-17, P3-3