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CHAPTER 3

The Accounting Information System


LEARNING OBJECTIVES
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Understand basic accounting terminology.


Explain double-entry rules.
Identify steps in the accounting cycle.
Record transactions in journals, post to ledger accounts, and prepare a trial balance.
Explain the reasons for preparing adjusting entries and identify major types of adjusting
entries.
Prepare financial statements from the adjusted trial balance.
Prepare closing entries.
Prepare financial statements for a merchandising company.
Differentiate the cash basis of accounting from the accrual basis of accounting.
Identify adjusting entries that may be reversed.
Prepare a 10-column worksheet.
Compare the accounting information systems under GAAP and IFRS.

Copyright 2013 John Wiley & Sons, Inc. K i eso, Intermediate Accounting, 15/e Instructors Manual ( For Instructor Use Only)

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CHAPTER REVIEW
*Note: All asterisked (*) items relate to material contained in the Appendices to the chapter.
1. Chapter 3 presents a concise yet thorough review of the accounting process. The basic
elements of the accounting process are identified and explained, and the way in which
these elements are combined in completing the accounting cycle is described.
Accounting Information System
2. (L.O. 1) The accounting information system collects and processes transaction data and
then disseminates the financial information to interested parties. To understand the
accounting process, one must be aware of the basic terminology employed in the
process. The basic terminology includes: event, transaction, account, real accounts,
nominal accounts, ledger, journal, posting, trial balance, adjusting entries, financial
statements, and closing entries. These terms refer to the various activities that make
up the accounting cycle.
Double-Entry Rules
3. (L.O. 2) Double-entry accounting refers to the process used in recording transactions.
The terms debit and credit are used in the accounting process to indicate the effect
a transaction has on account balances. The debit side of any account is the left side; the
right side is the credit side. Assets and expenses are increased by debits and decreased
by credits. Liabilities, stockholders equity, and revenues are decreased by debits and
increased by credits.
4. In a double-entry system, for every debit there must be a credit and vice-versa. This leads
us to the basic accounting equation: Assets = Liabilities + Stockholders Equity.
The Accounting Cycle
5. (L.O. 3) The first step in the accounting cycle is analysis of transactions and selected
other events. The purpose of this analysis is to determine which events represent
transactions that should be recorded.
6. Events can be classified as external or internal. External events are those between an
entity and its environment, whereas internal events relate to transactions totally within an
entity.
Journalizing
7. (L.O. 4) Transactions are initially recorded in a journal, sometimes referred to as the
book of original entry. A general journal is merely a chronological listing of transactions
expressed in terms of debits and credits to particular accounts. No distinction is made in
a general journal concerning the type of transaction involved. In addition to a general
journal, specialized journals are used to accumulate transactions possessing common
characteristics.
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Copyright 2013 John Wiley & Sons, Inc. K i eso, Intermediate Accounting, 15/e Instructors Manual ( For Instructor Use Only)

Posting
8. The next step in the accounting cycle involves transferring amounts entered in the journal
to the general ledger. The ledger is a book that usually contains a separate page for each
account. Transferring amounts from a journal to the ledger is called posting. Transactions
recorded in a general journal must be posted individually, whereas entries made in
specialized journals are generally posted by columnar total.
Trial Balance
9. The next step in the accounting cycle is the preparation of a trial balance. A trial balance is
a list of accounts and their balances at a given time. An entity may prepare a trial balance
at any time in the accounting cycle. A trial balance prepared after posting has been
completed serves to check the mechanical accuracy of the posting process and provides
a listing of accounts to be used in preparing financial statements.
Adjusting Entries
10. (L.O. 5) Preparation of adjusting journal entries is the next step in the accounting cycle.
Adjusting entries are entries made at the end of accounting period to bring all accounts
up to date on an accrual accounting basis so that correct financial statements can be
prepared. Adjusting entries are necessary to achieve a proper matching of revenues and
expenses in the determination of net income for the current period and to achieve an
accurate statement of the assets and equities existing at the end of the period. One
common characteristic of adjusting entries is that they affect at least one real account
(asset or liability account) and one nominal account (revenue or expense account).
Adjusting entries can be classified as: (1) deferrals (prepaid expenses, unearned
revenues), or (2) accruals (accrued revenues, accrued expenses).
11. Prepaid expenses and unearned revenues refer to situations where cash has been paid
or received but the corresponding expense or revenue will not be recognized until a future
period. Accrued revenues and accrued expenses are revenues and expenses recognized
in the current period for which the corresponding payment or receipt of cash is to occur in
a future period.
Adjusted Trial Balance
12. After adjusting entries are recorded and posted, an adjusted trial balance is prepared. It
shows the balance of all accounts at the end of the accounting period.
Financial Statements
13. (L.O. 6) From the adjusted trial balance, a company can directly prepare its financial
statements.

Copyright 2013 John Wiley & Sons, Inc. K i eso, Intermediate Accounting, 15/e Instructors Manual ( For Instructor Use Only)

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Closing Process
14. (L.O. 7) After financial statements have been prepared, nominal (revenue and expense)
accounts should be reduced to zero in preparation for recording the transactions of the next
period. This closing process requires recording and posting of closing entries. All nominal
accounts are reduced to zero by closing them through the Income Summary account. The
net balance in the Income Summary account is equal to net income or net loss for the
period. The net income or net loss for the period is transferred to an owners equity account
by closing the Income Summary account to Retained Earnings.
Post-Closing Trial Balance
15. A third trial balance may be prepared after the closing entries are recorded and posted.
This post-closing trial balance shows that equal debits and credits have been posted
properly to the Income Summary account.
Reversing Entries
16. Reversing entries are made at the beginning of an accounting period to remove the
effects of some adjusting entries. They are optional.
Accounting Cycle Summarized
17. In summary, the steps in the accounting cycle performed every fiscal period are as follows:
a. Enter the transactions of the period in appropriate journals.
b. Post from the journals to the ledger (or ledgers).
c. Take an unadjusted trial balance (trial balance).
d. Prepare adjusting journal entries and post to the ledger(s).
e. Take a trial balance after adjusting (adjusted trial balance).
f. Prepare the financial statements from the adjusted trial balance.
g. Prepare closing journal entries and post to the ledger(s).
h. Take a trial balance after closing (post-closing trial balance).
i.

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

Copyright 2013 John Wiley & Sons, Inc. K i eso, Intermediate Accounting, 15/e Instructors Manual ( For Instructor Use Only)

Financial Statements for a Merchandising Company


18. The income statement classifies amounts into such categories as gross profit, income
from operations, income before taxes, and net income. The statement of retained
earnings shows the changes in retained earnings during the period. A classified balance
sheet classifies assets and liabilities into current and noncurrent.
19. Closing entries of a merchandising company require that the Cost of Goods Sold account
be closed along with the other expense accounts.
*Cash Versus Accrual-Basis Accounting
*20. (L.O. 8) Cash-Basis Accounting Versus Accrual-Basis Accounting is presented in
Appendix A of Chapter 3 for the purpose of demonstrating the difference between cash
basis and accrual-basis accounting. Under the strict cash basis of accounting, revenue
is recognized only when cash is received, and expenses are recorded only when cash is
paid. The accrual basis of accounting recognizes revenue when it is earned and expenses
when incurred without regard to the time of receipt or payment of cash.
*Reversing Entries
*21. (L.O. 9) Appendix B covers preparation and posting of reversing entries, the final step in
the accounting cycle. A reversing entry is made at the beginning of the next accounting
period and is the exact opposite of the adjusting entry made in the previous period. The
recording of reversing entries is an optional step in the accounting cycle that may be
performed at the beginning of the next accounting period. The entries subject to reversal
are the adjusting entries for accrued revenues and accrued expenses recorded at the
close of the previous accounting period.
*Worksheet
*22. (L.O. 10) Appendix C covers the use of a 10-column worksheet, which serves as an aid to
the accountant in adjusting the account balances and preparing the financial statements.
The worksheet provides an orderly format for the accumulation of information necessary for
preparation of financial statements. Use of a worksheet does not replace any financial
statements, nor does it alter any of the steps in the accounting cycle.

*H. (L.O. 12) IFRS Insights


1. 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.
Copyright 2013 John Wiley & Sons, Inc. K i eso, Intermediate Accounting, 15/e Instructors Manual ( For Instructor Use Only)

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2. Relevant facts
a. Similarities
(1) 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 accountsis the same under both GAAP
and IFRS.
(2) Transaction analysis is the same under IFRS and GAAP, but, as you will see
in later chapters, different standards sometimes impact how transactions are
recorded.
(3) Both the IASB and FASB go beyond the basic definitions provided in this
textbook for the key elements of financial statements, that is, assets,
liabilities, equity, revenues, and expenses.
(4) A trial balance under IFRS follows the same format as shown in the textbook.
As shown in the textbook, dollar signs are typically used only in the trial
balance and the financial statements. The same practice is followed under
IFRS, using the currency of the country in which the reporting company is
headquartered.
b. Differences
(1) 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.
(2) Internal controls are a system of checks and balances designed to prevent
and detect fraud and errors. While most companies have these systems in
place, many 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.
3. First-time adoption of IFRS.
a. IFRS 1 requires that information in a companys first IFRS statements (1) be
transparent, (2) provide a suitable starting point, and (3) have a cost that does not
exceed the benefits. As a result, many companies will be going through a substantial
conversion process to switch from their reporting standards to IFRS.
b.

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The overriding principle in converting to IFRS is full retrospective application of


IFRS. Retrospective applicationrecasting prior financial statements on the basis
of IFRSprovides financial statement users with comparable information.

Copyright 2013 John Wiley & Sons, Inc. K i eso, Intermediate Accounting, 15/e Instructors Manual ( For Instructor Use Only)

ILLUSTRATION 3-1
DOUBLE-ENTRY ACCOUNTING SYSTEM

Copyright 2013 John Wiley & Sons, Inc. K i eso, Intermediate Accounting, 15/e Instructors Manual ( For Instructor Use Only)

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ILLUSTRATION 3-2
TRANSACTIONS AFFECTING OWNERS EQUITY ACCOUNTS

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Copyright 2013 John Wiley & Sons, Inc. K i eso, Intermediate Accounting, 15/e Instructors Manual ( For Instructor Use Only)

ILLUSTRATION 3-3
THE ACCOUNTING CYCLE

Copyright 2013 John Wiley & Sons, Inc. K i eso, Intermediate Accounting, 15/e Instructors Manual ( For Instructor Use Only)

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ILLUSTRATION 3-4
TYPES OF ADJUSTING ENTRIES

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Copyright 2013 John Wiley & Sons, Inc. K i eso, Intermediate Accounting, 15/e Instructors Manual ( For Instructor Use Only)

ILLUSTRATION 3-5
CONVERSION FROM CASH BASIS TO ACCRUAL BASIS

Copyright 2013 John Wiley & Sons, Inc. K i eso, Intermediate Accounting, 15/e Instructors Manual ( For Instructor Use Only)

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ILLUSTRATION 3-6
REVERSING ENTRIES

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Copyright 2013 John Wiley & Sons, Inc. K i eso, Intermediate Accounting, 15/e Instructors Manual ( For Instructor Use Only)