Chapter 3

The Accounting Information

System

The Accounting Equation

Assets = Liabilities + Shareholders Equity
Assets = Liabilities + Capital + Retained
Earnings*
*Retained Earnings = Revenues Expenses
Dividends
Assets = Liabilities + Capital + Revenues Expenses
Dividends
2

The Accounting Cycle:

Steps
1.
2.
3.
4.
5.
6.
7.
8.
9.

Journalize the transaction

Post the transaction to general ledger (and
sub-ledgers) accounts
Prepare the (unadjusted) trial balance
Prepare necessary adjusting journal entries
Prepare the (adjusted) trial balance
Prepare financial statements
Prepare closing journal entries for the year
Prepare post-closing trial balance (optional)
Prepare reversing entries (optional)

3. Preparation of Trial
Balance
PIONEER ADVERTISING AGENCY INC. at October 31, 2010
Cash
80,00
0
Notes
Payable
50,00
0
Dividen
ds
5,000
Revenu
e
100,00
0

Account
Credit

Debit

Cash
80,000
Accounts Receivable
72,000
Advertising Supplies
25,000
Prepaid Insurance
6,000
Office Equipment
50,000
Notes Payable
50,000
Accounts Payable
25,000
Unearned Service Revenue
12,000
Common Shares
100,000
Dividends
5,000
Service Revenue
100,000
4
Salaries Expense
40,000

3. Preparation of Trial
Balance

The trial balance only proves the

mathematical accuracy of the ledger
Errors may still exist such as the following:
1. Transaction not recorded
2. Journal entry posted twice
3. Incorrect accounts or amounts used

Reasons for adjusting entries include:

To record those events that are not journalized
daily
To record those costs, which expire with time
and are therefore not recorded
To record item previously unrecorded
5

4. Adjusting Entries
Prepayments

1. Prepayments made in
cash and recorded as
assets before item is used
(Prepaid Expenses)
2. Revenue received in
cash and recorded as
liabilities before being
earned (Unearned Revenue)

Accruals

3. Revenues earned but not

yet received in cash and not
recorded (Accrued Revenues)
4. Expenses incurred but
not yet paid in cash and not
recorded (Accrued Expenses)
6

1.
1. Adjusting
Adjusting Entries
Entries for
for Prepaid
Prepaid
Expenses
Expenses

Payment of cash that is recorded as an asset because

service or benefit will be received in the future.
Cash Payment

BEFORE

Expense Recorded

Prepayments often occur in regard to:

insurance

advertising

rent

On 12/01/2011 Coca-Cola paid $200m of

insurance coverage for certain product liability
and other claims that may occur in 2012. What j/e
is recorded on Dec. 01, 2011? Jan 2012?

2.
2. Adjusting
Adjusting Entries
Entries for
for Unearned
Unearned
Revenues
When payment is received Revenues
from customers for services (or goods)
that will be provided in a future accounting period, a liability
(unearned revenue) is recognized

Cash Receipt

BEFORE

Revenue Earned

Prepayments often occur in regard to:

Magazine
Subscriptions

advertising

rent

CTV receives $3m for advertising on 12/15 for ads

that will run in Jan., Feb., and March. What is the
j/e to record the cash received? What j/e is
recorded by CTV in Jan., Feb., and March?

3.
3. Adjusting
Adjusting Entries
Entries for
for Accrued
Accrued
Revenues
Revenues

Revenues earned but not yet received in cash or

recorded.

Adjusting entry results in:

Revenue Recorded

BEFORE

Cash Receipt

Accrued revenues often occur in regard to:

Rent

Interest

Services performed

In January, TDCT earned $231m in interest from

customers that has not been received. What is the
j/e recorded 1/31?

4.
4. Adjusting
Adjusting Entries
Entries for
for Accrued
Accrued
Expenses
Expenses
Expenses
incurred but not yet paid in cash or recorded.
Adjusting entry results in:
Expense Recorded

BEFORE

Cash Payment

Accrued expenses often occur in regard to:

Taxes

Salaries

Coca-Cola incurred $2.962B in

income taxes during 2011 that will
be paid March 15th, 2012. What is
the j/e recorded 12/31/2011? And

7. Closing Entries
Closing entries are made to close all
nominal accounts (revenue and
expense accounts) for the year
The balances in these accounts are
transferred to a clearing account
(Income Summary)
The balance in Income Summary
represents net income or net loss for
the period
Real (or permanent) accounts are not
closed
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7. Closing Entries
The following closing entries are made (assume
net income for the year):
1. Income Summary

$$$

Expense Accounts (Individually)

2. Revenue Accounts (Individually)

$$$
$$$

Income Summary
3. Income Summary

$$$
$$$

Retained Earnings
4. Retained Earnings
Dividends

$$$
$$$
$$$
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