ch03 accounting information system

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Adeng Pustikaningsih, M.Si.

Dosen Jurusan Pendidikan Akuntansi Fakultas Ekonomi

Universitas Negeri Yogyakarta

CP: 08 222 180 1695

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PREVIEW OF CHAPTER

Intermediate Accounting IFRS 2nd Edition

Kieso, Weygandt, and Warfield

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1. Understand basic accounting terminology.

2. Explain double-entry rules.

3. Identify steps in the accounting cycle.

4. Record transactions in journals, post to ledger accounts, and prepare a trial balance.

5. Explain the reasons for preparing adjusting entries.

6. Prepare financial statements from the adjusted trial balance.

7. Prepare closing entries.

8. Prepare financial statements for a merchandising company.

After studying this chapter, you should be able to:

The Accounting Information

System

3

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

Collects and processes transaction data.



Disseminates financial information to interested parties.



Varies widely from business to business.

► Nature of business

► Type of transactions

► Size of business

► Volume of data

► Informational demands

ACCOUNTING INFORMATION SYSTEM

Accounting Information System (AIS)

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Helps management answer such questions as:

 How much and what kind of debt is outstanding?

 Were our sales higher this period than last?

 What assets do we have?

 What were our cash inflows and outflows?

 Did we make a profit last period?

 Are any of our product lines or divisions operating at a loss?

 Can we safely increase our dividends to shareholders?

 Is our rate of return on net assets increasing?

ACCOUNTING INFORMATION SYSTEM

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

Event



Transaction



Account



Real Account



Nominal Account



Ledger



Journal



Posting



Trial Balance



Adjusting Entries



Financial Statements



Closing Entries

ACCOUNTING INFORMATION SYSTEM

LO 1

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The Accounting Information

System

3

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 An account shows the effect of transactions on a given asset, liability, equity, revenue, or expense account.

 Double-entry accounting system (two-sided effect).

 Recording done by debiting at least one account and crediting another.

 DEBITS must equal CREDITS.

Debits and Credits

ACCOUNTING INFORMATION SYSTEM

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Account Name

Debit / Dr. Credit / Cr.

Debits and Credits

 An arrangement that shows the effect of transactions on an

account.

 Debit = Left

 Credit = Right

Account

An Account can be

illustrated in a

T-Account form.

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Account Name

$10,000 $3,000 Transaction #2

8,000

Balance

Transaction #1

Transaction #3

If the sum of Debit entries are

greater than

the sum of

Credit entries, the account will have a debit balance.

Debits and Credits

LO 2

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Account Name

If the sum of Credit entries are

greater than

the sum of

Debit entries, the account will have a credit balance.

$10,000 $3,000 Transaction #2

8,000 Transaction #3

Balance

Transaction #1

Debits and Credits

LO 2

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Chapter 3-23

Assets

Normal Balance

Chapter 3-27

Normal Balance Normal Balance Expense Expense Chapter 3-24 Liabilities Liabilities

Normal Balance

Chapter 3-25

Normal Balance

Equity

Chapter 3-26

Normal Balance Normal Balance Revenue Revenue Normal Balance Credit Normal Balance Debit

Debits and Credits Summary

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Statement of Financial

Position

=

+

-Asset

Liability

Equity

Revenue

Expense

Debit

Credit

Debits and Credits Summary

Income Statement

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Relationship among the assets, liabilities and equity of a

business:

The equation must be in balance after every transaction. For

every Debit there must be a Credit.

ILLUSTRATION 3-3

Expanded Equation and Debit/Credit Rules and Effects

The Accounting Equation

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Assets

=

Liabilities

+

Equity

1. Owners invest $40,000 in exchange for ordinary

shares.

+ 40,000

Double-Entry System Illustration

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Assets

=

Liabilities

+

2. Disburse $600 cash for secretarial wages.

- 600

(expense)

Equity

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Assets

=

Liabilities

+

3. Purchase office equipment priced at $5,200, giving a

10 percent promissory note in exchange.

+ 5,200

Equity

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Assets

=

Liabilities

+

4. Received $4,000 cash for services performed

.

+ 4,000

(revenue)

Equity

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Assets

=

Liabilities

+

5. Pay off a short-term liability of $7,000

.

- 7,000

Equity

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Assets

=

Liabilities

+

6. Declared a cash dividend of $5,000.

+ 5,000

- 5,000

Equity

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Assets

=

Liabilities

+

7. Convert a non-current liability of $80,000 into ordinary

shares

.

- 80,000

+ 80,000

Equity

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Assets

=

Liabilities

+

8. Pay cash of $16,000 for a delivery van

.

- 16,000

+ 16,000

Note that the accounting equation equality is maintained after recording each transaction.

Equity

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Ownership structure dictates the types of accounts that are

part of the equity section.

Proprietorship or

Partnership Corporation

 Share capital

 Share premium

 Dividends

 Retained Earnings

Financial Statements and Ownership Structure

 Capital account

 Drawing account

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Financial

Statements

and Ownership

Structure

Investments by shareholders Net income retained in the business

ILLUSTRATION 3-4

Financial Statements and Ownership Structure

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Financial Statements and Ownership Structure

ILLUSTRATION 3-5

Effects of Transactions on Equity Accounts

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The Accounting Information

System

3

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Transactions

Journalization

Statement preparation Closing

Post-closing trail balance Reversing entries

Trial balance Posting

Adjusted trial balance

Adjustments Work

Sheet

ILLUSTRATION 3-6

THE ACCOUNTING CYCLE

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An item should be recognized in the financial statements if it

1. meets the definition of an element,

2. is probable that any future economic benefit

associated with the item will flow to or from the entity, and

3. has a cost or value that can be measured reliably.

THE ACCOUNTING CYCLE

Identifying and Recording Transactions and

Other Events

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The Accounting Information

System

3

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General Journal a chronological list of transactions and other events, expressed in terms of debits and credits to accounts. Journal Entries are recorded in the journal.

September 1: Shareholders invested ฀15,000 cash in the corporation in exchange for ordinary shares.

ILLUSTRATION 3-7

Journalizing

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Posting The process of transferring amounts from the journal to the ledger accounts.

ILLUSTRATION 3-8

Posting

ILLUSTRATION 3-7

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Posting – Transferring amounts from journal to ledger.

ILLUSTRATION 3-8

Posting a Journal Entry

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An Expanded Example

The purpose of transaction analysis is

(1) to identify the type of account involved, and

(2) to determine whether a debit or a credit is required.

Keep in mind that every journal entry affects one or more of the following items: assets, liabilities, equity, revenues, or expense.

Posting

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1. October 1: Shareholders invest ฀100,000 cash in an advertising venture to be known as Pioneer Advertising Agency Inc.

Share Capital Ordinary 100,000

Cash 100,000

Oct. 1

Debit Credit

Cash

100,000 100,000

Debit Credit

Share Capital Ordinary

ILLUSTRATION 3-9

Posting

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2. October 1: Pioneer purchases office equipment costing ฀50,000 by signing a 3-month, 12%, ฀50,000 note payable.

Notes payable 50,000

Equipment 50,000

Oct. 1

Debit Credit

Equipment

50,000 50,000

Debit Credit Notes Payable

ILLUSTRATION 3-10

Posting

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3. October 2: Pioneer receives a ฀12,000 cash advance from KC, a client, for advertising services that are expected to be completed by December 31.

Unearned Service Revenue 12,000

Cash 12,000

Oct. 2

Debit Credit

Cash

100,000 12,000

Debit Credit

Unearned Service Revenue

12,000

ILLUSTRATION 3-11

Posting

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4. October 3: Pioneer pays ฀9,000 office rent, in cash, for October.

Cash 9,000

Rent Expense 9,000

Oct. 3

Debit Credit

Cash

100,000 9,000

Debit Credit

Rent Expense

12,000

9,000

ILLUSTRATION 3-12

Posting

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5. October 4: Pioneer pays ฀6,000 for a one-year insurance policy that will expire next year on September 30.

Cash 6,000

Prepaid Insurance 6,000 Oct. 4

Debit Credit

Cash

100,000 6,000

Debit Credit

Prepaid Insurance

12,000

9,000 6,000

ILLUSTRATION 3-13

Posting

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6. October 5: Pioneer purchases, for ฀25,000 on account, an estimated 3-month supply of advertising materials from

Aero Supply.

Accounts Payable 25,000

Supplies 25,000

Oct. 5

Debit Credit

Supplies

25,000 25,000

Debit Credit

Accounts Payable

ILLUSTRATION 3-14

Posting

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7. October 9: Pioneer signs a contract with a local newspaper for advertising inserts (flyers) to be distributed starting the last Sunday in November. Pioneer will start work on the

content of the flyers in November. Payment of ฀7,000 is due following delivery of the Sunday papers containing the

flyers.

ILLUSTRATION 3-15

Posting

A business transaction has not occurred. There is only an

agreement between Pioneer Advertising and the newspaper for the services to be provided in November. Therefore, no journal entry is necessary in October.

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8. October 20: Pioneer’s board of directors declares and pays a ฀5,000 cash dividend to shareholders.

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9. October 26: Employees are paid every four weeks. The total payroll is ฀2,000 per day. The pay period ended on Friday, October 26, with salaries of ฀40,000 being paid.

Cash 40,000

Salaries and Wages Expense 40,000 Oct. 26

Debit Credit

Cash

100,000 40,000

Debit Credit

Salaries and Wages Expense

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10. October 31: Pioneer receives ฀28,000 in cash and bills

Copa Company ฀72,000 for advertising services of ฀100,000 provided in October.

Accounts Receivable 72,000

Cash 28,000 Oct. 31 Debit Credit Cash 100,000 72,000 Debit Credit Accounts Receivable 12,000 9,000 6,000 5,000 40,000

Service Revenue 100,000

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A Trial Balance

 List of each account and its balance in the order in which they appear in the ledger.

 Debit balances listed in the left column and credit balance in the right column.

 Used to prove the mathematical equality of debit and credit balances.

 Uncovers errors in journalizing and posting.

Trial Balance

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ILLUSTRATION 3-19

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The Accounting Information

System

3

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Makes it possible to:

 Report on the statement of financial position the

appropriate assets, liabilities, and equity at the statement date.

 Report on the income statement the proper revenues and expenses for the period.

► Revenues are recorded in the period in which services are performed.

► Expenses are recognized in the period in which they are incurred.

Adjusting Entries

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Adjusting Entries

1. Prepaid Expenses.

Expenses paid in cash before they are used or consumed.

Deferrals

3. Accrued Revenues. Revenues for services performed but not yet

received in cash or recorded.

4. Accrued Expenses.

Expenses incurred but not yet paid in cash or recorded. 2. Unearned Revenues.

Cash received before services are performed.

Accruals

Illustration 3-20

Types of Adjusting Entries

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Deferrals are

expenses or revenues that are recognized at a

date later than the point when cash was originally exchanged.

Two types of deferrals

 Prepaid expenses

 Unearned revenues

If a company does not make an adjustment for these deferrals,

 the asset and liability are overstated, and

 the related expense and revenue are understated.

Adjusting Entries for Deferrals

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Prepaid Expenses.

Assets paid for and recorded before a

company uses them.

Adjusting Entries for Prepaid Expenses

 Insurance

 Supplies

 Advertising

Cash Payment

BEFORE

Expense Recorded

 Rent

 Buildings and equipment

Prepayments often occur in regard to:

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Supplies.

Pioneer purchased advertising supplies costing

฀25,000 on October 5. Prepare the journal entry to record the purchase of the supplies.

Cash 25,000

Supplies 25,000

Oct. 5

Debit Credit

Supplies

25,000 25,000

Debit Credit

Cash

Adjusting Entries for Prepaid Expenses

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Supplies

. An inventory count at the close of business on

October 31 reveals that ฀10,000 of supplies are still on hand.

Supplies 15,000

Supplies Expense 15,000 Oct. 31

Debit Credit

Supplies

25,000 15,000

Debit Credit

Supplies Expense

15,000

10,000

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Adjusting Entries for

Prepaid Expenses

Statement

Presentation:

Supplies identifies that portion of the asset’s cost that will provide future economic benefit.

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Statement

Presentation:

Supplies expense shows a balance of ฀15,000, which

equals the cost of supplies used in October

ILLUSTRATION 3-35

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Insurance.

On Oct. 4th_{, Pioneer paid}฀6,000 _{for a one-year fire}

insurance policy, beginning October 1. Show the entry to record the purchase of the insurance.

Cash 6,000

Prepaid Insurance 6,000 Oct. 4

Debit Credit

Prepaid Insurance

6,000 6,000

Debit Credit

Cash

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Insurance

.

An analysis of the policy reveals that ฀500 (฀6,000 ÷

12) of insurance expires each month. Thus, Pioneer makes the following adjusting entry.

Prepaid Insurance 500

Insurance Expense 500 Oct. 31

Debit Credit

Prepaid Insurance

6,000 500

Debit Credit

Insurance Expense

500

5,500

Adjusting Entries for Prepaid Expenses

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Statement

Presentation:

Prepaid Insurance represents the

unexpired cost for the remaining 11 months of

coverage.

ILLUSTRATION 3-35

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Statement

Presentation:

Insurance

expense identifies that portion of the asset’s cost that expired in

October.

ILLUSTRATION 3-35

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Depreciation.

Pioneer estimates depreciation on its office

equipment to be ฀400 per month. Pioneer recognizes depreciation for October by the following adjusting entry.

Accumulated Depreciation 400 Depreciation Expense 400

Oct. 31

Debit Credit

Depreciation Expense

400 400

Debit Credit

Accumulated Depreciation

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Statement

Presentation:

Accumulated

Depreciation is a contra asset

account.

ILLUSTRATION 3-35

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Statement

Presentation:

Depreciation

expense identifies that portion of the asset’s cost that expired in

October.

ILLUSTRATION 3-35

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Receipt of cash before the services are performed is recorded as a liability called unearned revenues.

 Rent

 Airline tickets

 Tuition

Cash Receipt

BEFORE

Revenue Recorded

 Magazine subscriptions

 Customer deposits

Unearned revenues often occur in regard to:

Adjusting Entries for Unearned Revenues

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Unearned Revenue.

Pioneer received ฀12,000 on October 2

from KC for advertising services expected to be completed by December 31. Show the journal entry to record the receipt on Oct. 2nd_.

Unearned Service Revenue 12,000

Cash 12,000

Oct. 2

Debit Credit

Cash

12,000 12,000

Debit Credit

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Debit Credit

Service Revenue

100,000 12,000

Debit Credit

4,000

8,000

Unearned Revenues.

An evaluation of the service Pioneer

performed for Knox during October, the company determines that it should recognize 4,000 of revenue in October.

Unearned Service Revenue 4,000 Oct. 31

4,000

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Statement

Presentation:

Unearned service

revenue represents the remaining advertising services expected to be performed in the future.

ILLUSTRATION 3-35

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Statement

Presentation:

Service revenue

shows total revenue recognized in

October.

ILLUSTRATION 3-35

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Accruals are made to

record

 revenues for services performed and

 expenses incurred in the current accounting period.

Without an accrual adjustment, the

 revenue account (and the related asset account) or the

 expense account (and the related liability account) are understated.

Adjusting Entries for Accruals

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Revenues recorded for services performed for which cash has

yet to be received at statement date are

accrued revenues

.

Adjusting Entries for Accrued Revenues

 Rent

 Interest

 Services performed

BEFORE

Accrued revenues often occur in regard to:

Cash Receipt

Revenue Recorded

Adjusting entry results in:

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Accrued Revenues.

In October Pioneer performed services

worth ฀2,000 that were not billed to clients on or before October 31. Pioneer makes the following adjusting entry.

Accounts Receivable 2,000 Oct. 31 Debit Credit Accounts Receivable 72,000 Debit Credit Service Revenue 100,000 4,000 2,000 106,000 2,000 74,000

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ILLUSTRATION 3-35

Statement Presentation

Accrued Revenues

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Expenses incurred but not yet paid in cash or recorded.

 Rent

 Interest

BEFORE

Accrued expenses often occur in regard to:

Cash Payment

Expense Recorded

 Taxes

 Salaries

Adjusting entry results in:

Adjusting Entries for Accrued Expenses

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Accrued Interest.

Pioneer signed a three-month, 12%, note

payable in the amount of ฀50,000 on October 1. The note

requires interest at an annual rate of 12 percent. Three factors determine the amount of the interest accumulation:

1

2

3

ILLUSTRATION 3-29

Formula for Computing Interest

Adjusting Entries for Accrued Expenses

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Interest Payable 500

Interest Expense 500

Oct. 31

Debit Credit

Interest Expense

500 500

Debit Credit

Interest Payable

Accrued Interest.

Pioneer signed a three-month, 12%, note

payable in the amount of ฀50,000 on October 1. Prepare the adjusting entry on Oct. 31 to record the accrual of interest.

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ILLUSTRATION 3-35

Statement Presentation

Accrued Expenses

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Accrued Salaries.

At October 31, the salaries and wages for

these days represent an accrued expense and a related liability to Pioneer. The employees receive total salaries of ฀10,000 for a

five-day work week, or ฀2,000 per day.

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Salaries and Wages Payable 6,000 Salaries and Wages Expense 6,000

Oct. 31

Debit Credit

40,000 6,000

Debit Credit

Salaries and Wages Payable

Accrued Salaries.

Employees receive total salaries of ฀10,000 for

a five-day work week, or ฀2,000 per day. Prepare the adjusting entry on Oct. 31 to record accrual for salaries.

6,000

46,000

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ILLUSTRATION 3-35

Statement Presentation

Accrued Expenses

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Salaries and Wages Expense 34,000 Salaries and Wages Payable 6,000 Nov. 23

34,000 6,000

Accrued Salaries

. On November 23, Pioneer will again pay total

salaries of ฀40,000. Prepare the entry to record the payment of salaries on November 23.

Cash 40,000

6,000

Debit Credit

34,000 6,000

Debit Credit

Salaries and Wages Payable

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Bad Debts.

Assume Pioneer reasonably estimates a bad debt

expense for the month of ฀1,600. It makes the adjusting entry for bad debts as follows.

Allowance for Doubtful Accounts Bad Debt Expense

Oct. 31

1,600 1,600

ILLUSTRATION 3-32

Adjustment for Bad Debt Expense

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ILLUSTRATION 3-35

Statement Presentation

Accrued Expenses

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Shows the balance of all accounts,

after adjusting

entries, at the end of the accounting period.

Proves the equality of the total debit and credit balances

ILLUSTRATION 3-33

Adjusted

Trial

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The Accounting Information

System

3

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Financial Statements are prepared directly from the

Adjusted Trial Balance.

Statement

of Financial

Position

Income

Statement

Retained

Earnings

Statement

Preparing Financial Statements

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ILLUSTRATION 3-35

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To achieve the vision of 24/7 accounting, a company must be able to update revenue, income, and statement of financial position numbers every day within the quarter (and potentially publish them on the

Internet). Such real-time reporting responds to the demand for more timely financial information made available to all investors not just to analysts with access to company management.

Two obstacles typically stand in the way of 24/7 accounting:

having the necessary accounting systems to close the books on a daily basis, and reliability concerns associated with unaudited real-time

data. Only a few companies have the necessary accounting capabilities.

WHAT’S YOUR PRINCIPLE24/7 ACCOUNTING

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The Accounting Information

System

3

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Closing Entries

 Reduce the balance of nominal (temporary) accounts to zero in preparation for the next period’s transactions.

 Transfer all revenue and expense account balances (income statement accounts) to Retained Earnings.

 Statement of financial position (asset, liability, and equity) accounts are not closed.

 Dividends are closed directly to Retained Earnings.

 Income Summary account may be used however it has no effect on the financial statements.

Basic Process

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Closing Entries

Retained Earnings 5,000

Dividends 5,000

Service Revenue 106,000 Salaries & Wages Expense 46,000

Supplies Expense 15,000 Rent Expense 9,000 Insurance Expense 500 Interest Expense 500 Depreciation Expense 400 Bad Debt Expense 1,600

Retained Earnings 33,000 ILLUSTRATION 3-33

Closing Journal Entries:

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Illustration 3-38

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Accounting Cycle Summarized

1. Enter the transactions of the period in appropriate journals.

2. Post from the journals to the ledger (or ledgers).

3. Prepare an unadjusted trial balance (trial balance).

4. Prepare adjusting journal entries and post to the ledger(s).

5. Prepare a trial balance after adjusting (adjusted trial balance).

6. Prepare the financial statements from the adjusted trial balance.

7. Prepare closing journal entries and post to the ledger(s).

8. Prepare a trial balance after closing (post-closing trial balance).

9. Prepare reversing entries (optional) and post to the ledger(s).

Reversing entries are covered in Appendix 3B.

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The economic volatility of the past few years has left companies hungering for more timely and uniform financial information to help them react quickly to fast-changing conditions. As one expert noted, companies were extremely focused on trying to reduce costs as well as better plan for the future, but a lot of them

discovered that they didn’t have the information they needed and they didn’t have the ability to get that information. The unsteady recession environment also made it risky for companies to interrupt their operations to get new

systems up to speed. So what to do? Try to piecemeal upgrades each year or start a major overhaul of their internal systems? One company, for example, has standardized as many of its systems as possible and has been steadily upgrading them over the past decade. Acquisitions can also wreak havoc on reporting systems. This company is choosy about when to standardize for companies it acquires, but it sometimes has to implement new systems after international deals. In other situations, a major overhaul is needed. For

example, it is common for companies with a steady stream of acquisitions to have 50 to 70 general ledger systems. In those cases, a company cannot

react well unless its systems are made compatible. So is it the big bang (major overhaul) or the piecemeal approach? It seems to depend. One thing is

certain good accounting systems are a necessity. Without one, the risk of failure is high.

WHAT’S YOUR PRINCIPLEHEY, IT’S COMPLICATED

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The Accounting Information

System

3

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ILLUSTRATION 3-39

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ILLUSTRATION 3-40

Financial Statements of a Merchandising Company

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ILLUSTRATION 3-41

Financial

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ACCOUNTING INFORMATION SYSTEMS

As indicated in this chapter, companies must have an effective accounting system. In the wake of accounting scandals at U.S. companies like Sunbeam,

Rite-Aid, Xerox, and WorldCom, U.S. lawmakers demanded higher assurance on the quality of accounting reports. Since the passage of the Sarbanes-Oxley Act of 2002 (SOX), companies that trade on U.S. exchanges are required to place renewed focus on their accounting systems to ensure accurate reporting.

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Relevant Facts

Following are the key similarities and differences between U.S. GAAP and IFRS related to accounting information systems.

Similarities

• International companies use the same set of procedures and records to keep track of transaction data. Thus, the material in Chapter 3 dealing with the account, general rules of debit and credit, and steps in the recording process the journal, ledger, and chart of accounts is the same under both U.S. GAAP and IFRS.

• Transaction analysis is the same under U.S. GAAP and IFRS but, as you will see in later chapters, different standards sometimes impact how transactions are recorded.

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Relevant Facts

Similarities

• Both the FASB and IASB go beyond the basic definitions provided in this textbook for the key elements of financial statements, that is, assets, liabilities, equity, revenues, and expenses.

• A trial balance under U.S. GAAP follows the same format as shown in the textbook. As shown in the textbook, currency signs are typically used only in the trial balance and the financial statements. The same practice is followed under U.S. GAAP.

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Relevant Facts

Differences

• Rules for accounting for specific events sometimes differ across countries. For example, European companies rely less on historical cost and more on fair value than U.S. companies. Despite the differences, the double- entry accounting system is the basis of accounting systems worldwide.

• Internal controls are a system of checks and balances designed to prevent and detect fraud and errors. While most public U.S. companies have these systems in place, many non-U.S. companies have never completely documented them nor had an independent auditor attest to their effectiveness. Both of these actions are required under SOX. Enhanced internal control standards apply only to large public companies listed on U.S. exchanges.

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About The Numbers

Debate about requiring foreign companies to

comply with SOX centers on whether the higher costs of a good

information system are making the U.S. securities markets less competitive. Presented are statistics for initial public offerings

(IPOs) in the years since the passage of SOX.

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About The Numbers

Note the U.S. share of IPOs has steadily

declined, and some critics of the SOX provisions attribute the decline to the increased cost of

complying with the internal control rules, others are not so sure. These

commentators argue that growth in non-U.S.

GLOBAL ACCOUNTING INSIGHTS

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On the Horizon

High-quality international accounting requires both high-quality accounting standards and high-quality auditing. Similar to the convergence of U.S. GAAP and IFRS, there is a movement to improve international auditing standards. The International Auditing and Assurance Standards Board (IAASB) functions as an independent standard-setting body. It works to establish high-quality auditing and assurance and quality-control standards throughout the world. Whether the IAASB adopts internal control provisions similar to those in SOX remains to be seen. You can follow developments in the international audit arena at http:// www.ifac.org/iaasb/.

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Most companies use accrual-basis accounting. They

 recognize revenue when the performance obligation is satisfied and

 expenses in the period incurred,

without regard to the time of receipt or payment of cash.

Under the strict cash-basis, companies

 record revenue only when they receive cash, and

 record expenses only when they disperse cash.

Cash basis financial statements are not in conformity with IFRS.

LO 9 Differentiate the cash basis of accounting from the accrual basis of accounting.

APPENDIX

3A

CASH-BASIS ACCOUNTING VERSUS

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Illustration: Quality Contractor signs an agreement to construct a garage for ฀22,000. In January, Quality begins construction, incurs costs of ฀18,000 on credit, and by the end of January delivers a finished garage to the buyer. In February, Quality collects ฀22,000 cash from the customer. In March, Quality pays the ฀18,000 due the creditors.

ILLUSTRATION 3A-1

Advance slide in presentation mode to reveal answers.

APPENDIX

3A

ACCRUAL-BASIS ACCOUNTING

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Illustration: Quality Contractor signs an agreement to construct a garage for ฀22,000. In January, Quality begins construction, incurs costs of ฀18,000 on credit, and by the end of January delivers a finished garage to the buyer. In February, Quality collects ฀22,000 cash from the customer. In March, Quality pays the ฀18,000 due the creditors.

APPENDIX

3A

ILLUSTRATION 3A-2

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CONVERSION FROM CASH TO ACCRUAL BASIS

Illustration: Dr. Diane Windsor, like many small business owners, keeps her accounting records on a cash basis. In the year 2015, Dr. Windsor received ฀300,000 from her patients and paid ฀170,000 for operating

expenses, resulting in an excess of cash receipts over disbursements of

฀130,000 (฀300,000 - ฀170,000). At January 1 and December 31, 2015, she has accounts receivable, unearned service revenue, accrued

liabilities, and prepaid expenses as shown below.

ILLUSTRATION 3A-5

APPENDIX

3A

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ILLUSTRATION 3A-8

APPENDIX

3A

SERVICE REVENUE COMPUTATION

LO 9

To convert the amount of cash received from patients to service

revenue on an accrual basis, we must consider changes in accounts receivable and unearned service revenue during the year.

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ILLUSTRATION 3A-11

APPENDIX

3A

OPERATING EXPENSE COMPUTATION

LO 9

To convert cash paid for operating expenses during the year to

operating expenses on an accrual basis, we must consider changes in prepaid expenses and accrued liabilities.

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3-113 LO 9

APPENDIX

3A

CONVERSION FROM CASH BASIS TO

ACCRUAL BASIS

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THEORETICAL WEAKNESSES OF THE CASH BASIS

 Today’s economy is considerably more lubricated by

credit than by cash.

 The accrual basis, not the cash basis, recognizes all aspects of the credit phenomenon.

 Investors, creditors, and other decision makers seek

timely information about a company’s future _{cash flows.}

APPENDIX

3A

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3-115 LO 10 Identifying adjusting entries that may be reversed. ILLUSTRATION 3B-1

APPENDIX

3B

USING REVERSING ENTRIES

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APPENDIX

3B

ILLUSTRATION OF REVERSING ENTRIES-DEFERRALS

ILLUSTRATION 3B-2

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1. All accruals should be reversed.

2. All deferrals for which a company debited or credited the original cash transaction to an expense or revenue account should be reversed.

3. Adjusting entries for depreciation and bad debts are not reversed.

Reversing entries do not have to be used.

APPENDIX

3B

SUMMARY OF REVERSING ENTRIES

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3-118 LO 11 Prepare a 10-column worksheet.

A company prepares a worksheet either on

 columnar paper or

 within a computer spreadsheet.

A company uses the worksheet to adjust

 account balances and

 to prepare financial statements.

APPENDIX

3C

USING A WORKSHEET: THE ACCOUNTING

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 Trial Balance Columns

 Adjustment Columns

APPENDIX

3C

CYCLE REVISITED

WORKSHEET COLUMNS

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APPENDIX

3C

CYCLE REVISITED

ILLUSTRATION 3C-1 (Partial)

Use of a Worksheet

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ILLUSTRATION 3C-1

Use of a Worksheet

APPENDIX

3C

USING A

WORKSHEET: THE ACCOUNTING

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The Worksheet:

 provides information needed for preparation of the

financial statements.

 Sorts data into appropriate columns, which facilitates the

preparation of the statements.

APPENDIX

3C

CYCLE REVISITED

PREPARING FINANCIAL STATEMENTS FROM A

WORKSHEET

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ILLUSTRATION 3-40

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ILLUSTRATION 3-41

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