Merchandising Operations and the Multiple-Step Income Statement

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Financial AccountingTools for Business Decision
Making, 4th Ed.
Kimmel, Weygandt, Kieso
CHAPTER 3
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Chapter 3The Accounting Information System

• Analyze the effect of business transactions on
  the basic accounting equation.
• Explain what an account is and how it helps in
  the recording process.
• Define debits and credits and explain how they
  are used to record business transactions.
• Identify the basic steps in the recording process.

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Chapter 3The Accounting Information System

• Explain what a journal is and how it helps in the
  recording process.
• Explain what a ledger is and how it helps in the
  recording process.
• Explain what posting is and how it helps in the
  recording process.
• Explain the purposes of a trial balance.

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External and Internal 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.
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Exercise Types of Events
Internal
Not Recorded
External

1. A supplier of a companys raw material is paid an
   amount owed on account.

External
External
2. A customer pays its open account.
Not Recorded
3. A new chief executive officer is hired.
External
4. The biweekly payroll is paid.
Internal
5. Raw materials are entered into production.
Not Recorded
6. A new advertising agency is hired.
7. The accountant determines the federal income
taxes owed based on the income earned.
Internal
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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)

Payment terms are 2/10, n/30
NOTE Not all recordable events are supported by
a standard source document.
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Exercise Source Documents

1. Utilities expense for the month is recorded.

Purchase invoice
Sales invoice
2. A cash settlement is received from a pending
lawsuit.
Cash register tape
3. Owners contribute cash to start a new
corporation.
Time cards
4. The biweekly payroll is paid.
Promissory note
5. Cash sales for the day are recorded.
Stock certificates
6. Equipment is acquired on a 30-day open account.
Monthly utility statement
7. A sale is made on open account.
8. A building is acquired by signing an agreement
to repay a stated amount plus interest in six
months.
Other/ or- No source document normally available
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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.
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Sara Lee Corp. Assets Accounts
LO 2
Describe the qualitative characteristics of
accounting information.
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Chart of Accounts
LO 3
Analyze the effects of transactions on the
accounting equation.
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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.

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Graphic debits and credits (GENERALLY)
Balance Sheet
Income Statement
2004
2004
Assets
Revenues Gains
DEBITS
CREDITS
Liabilities
Expenses Losses
CREDITS
Equity
DEBITS
CREDITS
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ANOTHER CRUTCH

• Debit Card- comes from your checking account,
  which is an ASSET.
• Credit Card- creates a LIABILITY.
• DEBIT- ASSET
• CREDIT- LIABILITY

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Review
What is the normal balance for the following
accounts?
Cash
Debit
Credit
Accounts Payable
Accounts Receivable
Debit
Service Revenue
Credit
Common Stock
Credit
Salaries Expense
Debit
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Review
What is the normal balance for the following
accounts?
Dividends
Debit
Debit
Building
Taxes Payable
Credit
Unearned Revenus
Credit
Prepaid Insurance
Debit
Rent Expense
Debit
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Debits and Credits
Balance Sheet Income
Stmt.
-



Asset
Liab.
Equity
Rev.
Exp.
Debit
Credit
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DEBITS AND CREDITS- POSTING

• 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

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ACCOUNTING EQUATION- JOURNAL ENTRIES

• 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
• HOW IS THIS EXPRESSED IN A JOURNAL ENTRY?
• ACCOUNT DEBIT/ DR. CREDIT/ (CR)
• Cash 100,000
• Common Stock 100,000

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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
• HOW IS THIS EXPRESSED IN A JOURNAL ENTRY?
• ACCOUNT DEBIT/ DR. CREDIT/ (CR)
• Building 150,000
• Note payable 150,000

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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!!!!!

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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
• HOW IS THIS EXPRESSED IN A JOURNAL ENTRY?
• ACCOUNT DEBIT/ DR. CREDIT/ (CR)
• Inventory 60,000
• Accounts payable 60,000

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BY THE WAY

• WHAT IS THE DIFFERENCE BETWEEN THESE ENTRIES
• ACCOUNT DEBIT/ DR. CREDIT/ (CR)
• Inventory 60,000
• Accounts payable 60,000
• AND
• ACCOUNT DEBIT/ DR. CREDIT/ (CR)
• Accounts payable 60,000
• Inventory 60,000
• ANSWER
• NOTHING- IT IS ONLY A CONVENTION TO LIST THE
  DEBITS FIRST!

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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
• HOW IS THIS EXPRESSED IN A JOURNAL ENTRY?
• ACCOUNT DEBIT/ DR. CREDIT/ (CR)
• Accounts receivable 75,000
• Sales 75,000
• Cost of goods sold 30,000
• Inventory 30,000

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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
• HOW IS THIS EXPRESSED IN A JOURNAL ENTRY?
• ACCOUNT DEBIT/ DR. CREDIT/ (CR)
• Cash 40,000
• Accounts receivable 40,000

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Additional Terms
General Ledger a file that contains the
activity of all the accounts.
T Account a format used to illustrate the
increases, decreases and resulting total balance
for each account.
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Account Name
Credit / Cr.
Debit / Dr.
(T Account illustration with excel)
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Assets
Credit / Cr.
Debit / Dr.
NORMAL- DEBIT
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Liabilities
Credit / Cr.
Debit / Dr.
NORMAL- CREDIT
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Equity
Credit / Cr.
Debit / Dr.
NORMAL- CREDIT
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Revenue
Credit / Cr.
Debit / Dr.
NORMAL- CREDIT
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Expense
Credit / Cr.
Debit / Dr.
NORMAL- DEBIT
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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
• HOW IS THIS EXPRESSED IN A JOURNAL ENTRY?
• ACCOUNT DEBIT/ DR. CREDIT/ (CR)
• Cash 100,000
• Common Stock 100,000

WHAT WOULD THIS LOOK LIKE IN THE T-ACCOUNTS?
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ENTRY POSTED TO T-ACCOUNTS
ACCOUNT DEBIT/ DR. CREDIT/ (CR) Cash 100,00
0 Common Stock 100,000
100,000
100,000
100,000
100,000
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The Journal
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.
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Posting
Posting the process of transferring amounts
from the journal to the ledger accounts.
General Journal
GJ1
General Ledger
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Trial Balance
Trial Balance a list of each account and its
balance used to prove equality of debits and
credits.
LO 7
Explain the purposes of a trial balance.
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Event 9 Hiring of New Employees
Oct. 9 Sierra hired four new employees to begin
work on Oct. 15.
Accounting transaction has NOT occurred!
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Basic Steps in the Recording Process.

1. Analyze
2. Journalize
3. Post