CHAPTER 3 The Accounting Information System ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC) Brief Exercises Exercises Problems 1, 2 1, 3, 4, 17 Topics Questions Transaction identification 1, 2, 3, 5, 7, 8 Real or nominal accounts 4, 7 14 Trial balance 6, 10 2, 3, 4 1, 2, 4, 7, 9 Adjusting entries 8, 11, 13, 14 3, 4, 5, 6, 7, 8, 9, 10 5, 6, 7, 8, 9, 10, 20 1, 2, 3, 4, 5, 6, 7, 8, 9, 10, 12 Financial statements for service companies 10 11, 12, 13, 15, 22, 23 1, 2, 4, 6 Closing 12 11 13, 14, 16 1, 4, 8, 9, 10, 12 Financial statements for merchandising companies Comprehensive accounting cycle *9 10 1, 4, 12 Cash vs. Accrual Basis 15, 16, 17 12 18, 19 *10 Reversing entries 18 13 20 *11 Worksheet 19 21, 22, 23 11 12 *These topics are dealt with in an Appendix to the Chapter Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) 31 ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE) Learning Objectives Brief Exercises Exercises Problems Understand basic accounting terminology Explain doubleentry rules Identify steps in accounting cycle Record transactions in journals, post to ledger accounts, and prepare a trial balance 1, 2, 3, 4, 5, 6, 7 1, 2, 3, 4, 17 1, 4, 9, 10 Explain the reasons for preparing adjusting entries and identify major types of adjusting entries. 3, 4, 5, 6, 7, 5, 6, 7, 8, 9, 10, 20 2, 3, 4, 5, 6, 7, 8, 9, 10, 12 11, 12 1, 2, 4, 6, 7, 8, 9, 10, 12 13, 14, 16 1, 4, 9, 10, 12 13, 14, 15 4, 10 11 Prepare financial statements from the adjusted trail balance Prepare closing entries Prepare financial statements for a merchandising company. *9 8, 9, 10 11 Differentiate the cash basis of accounting from the accrual basis of accounting 12 18, 19 *10 Identify adjusting entries that may be reversed 13 20 *11 Prepare a 10column worksheet 21, 22, 23 12 *These topics are dealt with in an Appendix to the Chapter 32 Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) ASSIGNMENT CHARACTERISTICS TABLE Level of Difficulty Time (minutes) Transaction analysis–service company Corrected trial balance Corrected trial balance Corrected trial balance Adjusting entries Adjusting entries Analyze adjusted data Adjusting entries Adjusting entries Adjusting entries Prepare financial statements Prepare financial statements Closing entries Closing entries Missing amounts Closing entries for a corporation Transactions of a corporation, including investment and dividend Cash to accrual basis Cash and accrual basis Adjusting and reversing entries Worksheet Worksheet and balance sheet presentation Partial worksheet preparation Simple Simple Simple Simple Moderate Moderate Complex Moderate Moderate Complex Moderate Moderate Simple Moderate Simple Moderate Moderate 15–20 10–15 15–20 10–15 10–15 15–20 15–20 10–15 15–20 25–30 20–25 20–25 10–15 10–15 10–15 10–15 10–15 Moderate Moderate Complex Simple Moderate Moderate 15–20 10–15 20–25 10–15 20–25 10–15 Transactions, financial statements–service company Adjusting entries and financial statements Adjusting entries Financial statements, adjusting and closing entries Adjusting entries Adjusting entries and financial statements Adjusting entries and financial statements Adjusting entries and financial statements Adjusting entries and financial statements Adjusting and closing Adjusting and closing Cash and accrual basis Worksheet, balance sheet, adjusting and closing entries Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Complex 25–35 35–40 25–30 40–50 15–20 25–35 25–35 25–35 25–35 30–40 30–35 35–40 40–50 Item Description E31 E32 E33 E34 E35 E36 E37 E38 E39 E310 E311 E312 E313 E314 E315 E316 E317 *E318 *E319 *E320 *E321 *E322 *E323 P31 P32 P33 P34 P35 P36 P37 P37 P38 P39 P310 *P311 *P312 Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) 33 LEARNING OBJECTIVES *9 *10 *11 *12 Understand basic accounting terminology Explain doubleentry 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 10column worksheet Compare the accounting information systems under GAAP and IFRS. 34 Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) CHAPTER REVIEW *Note: All asterisked (*) items relate to material contained in the Appendices to the chapter 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 (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. DoubleEntry Rules (L.O. 2) Doubleentry 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 In a doubleentry system, for every debit there must be a credit and viceversa. This leads us to the basic accounting equation: Assets = Liabilities + Stockholders’ Equity The Accounting Cycle (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 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 (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 Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) 35 Posting 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 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 36 Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) 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 PostClosing Trial Balance 15 A third trial balance may be prepared after the closing entries are recorded and posted This postclosing 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 (postclosing trial balance) i Prepare reversing entries (optional) and post to the ledger(s) Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) 37 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 AccrualBasis Accounting *20 (L.O. 8) CashBasis Accounting Versus AccrualBasis Accounting is presented in Appendix A of Chapter 3 for the purpose of demonstrating the difference between cash basis and accrualbasis 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 10column 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 38 Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) LECTURE OUTLINE Chapter provides a review of accounting procedures throughout the accounting cycle Depending on time constraints and students’ accounting course background, Chapter 3 can be approached in several different ways: (1) Spend 23 class sessions reviewing the chapter and Appendices 3A through 3C. (2) Spend 12 class sessions reviewing selected portions of the chapter and Appendix 3A. (3) Omit the chapter entirely It is assumed that all students have completed at least one course in financial accounting Therefore, students should already be familiar with the mechanics of journalizing, posting, and preparing adjusting entries and financial statements, etc. An important objective of a review of these procedural details is to prepare students: (1) to progress from mere memorization of required journal entries to an understanding of the entries’ impact on the financial statements, and (2) to visualize the effect of errors (both the failure to record transactions and the improper recording of transactions) on the financial statements The following lecture outline can be expanded upon or reduced to suit the needs of your class A (L.O. 1) Basic Terminology. Review the 11 terms defined on text pages 86 and 87 B (L.O. 2) DoubleEntry Rules Review the mechanics of debits and credits T EACHING T IP Use Illustration 31 in reviewing doubleentry rules for increasing and decreasing accounts Debits increase assets and expenses, while credits increase liabilities, stockholders’ equity, and revenues. The normal balance of an account is the same as the increase side Use Illustration 32 to discuss and provide examples of transactions affecting stockholders’ equity accounts. Emphasize the difference between nominal and real accounts C (L.O. 3) The Accounting Cycle T EACHING T IP Present an overview of the accounting cycle by using Illustration 33 (L.O. 4) Journalizing a General Journal b Special Journals Posting to the Ledger Trial Balance Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) 39 (L.O. 5) Adjusting Entries T EACHING T IP Use Illustration 34 in discussing adjusting entries Provide examples of each type and discuss the effect on the financial statements when failing to make each type of entry. The ability to classify adjusting entries into one of the accrualdeferral categories is necessary to an understanding of reversing entries a Prepaid expenses b Unearned revenues c Accrued revenues d Accrued expenses (L.O. 6) Prepare financial statements a Financial statements of a service company (L.O. 7) Prepare closing entries a Temporary accounts vs. permanent accounts b Postclosing trial balance D (L.O. 8) Financial statements of a merchandising company a Income statement b Classified balance sheet. c Closing entries. *E (L.O. 9) APPENDIX 3A. Cash basis versus accrualbasis accounting Strict cash basis. Recognize revenue when cash is received and expenses when cash is paid a Used by small businesses and individual taxpayers b Not acceptable under GAAP Modified cash basis. Recognize revenue when cash is received. Depreciable assets are capitalized and depreciated; prepaid assets are capitalized and expensed as used; and all other expenses are recognized as paid a Used by service organizations (CPAs, lawyers, doctors, and architects) b Not acceptable under GAAP if inventory is significant or if average annual gross receipts are at least $5 million 310 Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) Accrual basis. Revenues are recognized when earned and expenses when incurred Conversion from cash to accrual basis Weaknesses of the cash basis T EACHING T IP Use Illustration 35 to discuss the conversion of the cash basis to the accrual basis *F (L.O. 10) APPENDIX 3B. Using reversing entries T EACHING T IP Use Illustration 36 to compare journal entries made when reversing entries are used compared to when reversing entries are not used Emphasize that reversing entries are optional and that the financial statement amounts are identical whether or not reversing entries are used Use of reversing entries is optional In an accounting system which uses reversing entries, the following types of adjusting entries should be reversed: a Adjusting entries for unearned and prepaid items where the original amount was entered in a revenue or expense account b Adjusting entries for all accrued items *G.(L.O. 11) APPENDIX 3C. Using a worksheet: The accounting cycle revisited The worksheet does not replace the financial statements Worksheet columns Preparing the worksheet Preparing the financial statements from a worksheet Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) 311 *H (L.O. 12) IFRS Insights As indicated in this chapter, companies must have an effective accounting system. In the wake of accounting scandals at U.S. companies like Sunbeam, RiteAid, Xerox, and WorldCom, U.S lawmakers demanded higher assurance on the quality of accounting reports Since the passage of the SarbanesOxley 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 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 accounts—is 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 doubleentry 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 312 Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) required under SOX. Enhanced internal control standards apply only to large public companies listed on U.S. exchanges Firsttime adoption of IFRS a IFRS requires that information in a company’s 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 The overriding principle in converting to IFRS is full retrospective application of IFRS. Retrospective application—recasting prior financial statements on the basis of IFRS—provides financial statement users with comparable information Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) 313 ILLUSTRATION 31 DOUBLEENTRY ACCOUNTING SYSTEM 314 Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) ILLUSTRATION 32 TRANSACTIONS AFFECTING OWNERS’ EQUITY ACCOUNTS Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) 315 ILLUSTRATION 33 THE ACCOUNTING CYCLE 316 Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) ILLUSTRATION 34 TYPES OF ADJUSTING ENTRIES Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) 317 ILLUSTRATION 35 CONVERSION FROM CASH BASIS TO ACCRUAL BASIS 318 Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) ILLUSTRATION 36 REVERSING ENTRIES Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) 319 ... Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) LECTURE OUTLINE Chapter provides a review of accounting procedures throughout the accounting. .. Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) 35 Posting The next step in the accounting cycle involves transferring amounts entered in the journal... Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) 33 LEARNING OBJECTIVES *9 *10 *11 *12 Understand basic accounting terminology Explain doubleentry rules