I've attached the question as a word file. I also attached the source material as well as some helpful files that my instructor posted. I am asking forrahuljain.exp for this question.

Exercise 3-9 Journal Date Account Titles and Explanation Debit Credit 4-May Accounts Payable 700 Cash 700 To record amount paid on account for supplies previously purchased. c03TheAccountingInformationSystem.qxd 9/2/10 1:38 PM Page 100 chapter 3 THE ACCOUNTING INFORMATION SYSTEM the navigator Scan Study Objectives Read Feature Story Scan Preview Read Text and Answer Do it! p. 110 p. 116 p. 119 study objectives After studying this chapter, you should be able to: p. 128 Work Using the Decision Toolkit Review Summary of Study Objectives Work Comprehensive Do it! p. 133 Answer Self-Test Questions Complete Assignments Go to WileyPLUS for practice and tutorials 100 Read A Look at IFRS p. 159 1 Analyze the effect of business transactions on the basic accounting equation. 2 Explain what an account is and how it helps in the recording process. 3 Define debits and credits and explain how they are used to record business transactions. 4 Identify the basic steps in the recording process. 5 Explain what a journal is and how it helps in the recording process. 6 Explain what a ledger is and how it helps in the recording process. 7 Explain what posting is and how it helps in the recording process. 8 Explain the purposes of a trial balance. 9 Classify cash activities as operating, investing, or financing. c03TheAccountingInformationSystem.qxd 9/8/10 1:18 PM Page 101 feature story How organized are you financially? Take a short quiz. sending us some moneynow what did we do with Answer yes or no to each question: that?\" To ensure the accuracy of your balance and the Does your wallet contain so many cash machine security of your funds, Fidelity Investments, like all receipts that you've been declared a walking fire other companies large and small, relies on a sophisti- hazard? cated accounting information system. That's not to say Is your wallet such a mess that it is often faster to that Fidelity or any other company is error-free. In fact, fish for money in the crack of your car seat than to dig around in your wallet? Was Steve Nash playing high school basketball the last time you balanced AC C I D E NTS HAP P E N your bank account? if you've ever really messed up your checkbook register, you may take some comfort from one accountant's mistake at Fidelity Investments. The accountant failed to include a minus sign while doing a calcula- Have you ever been tempted to burn down your tion, making what was actually a $1.3 billion loss look house so you don't have to try to find all of the re- like a $1.3 billion gainyes, billion! Fortunately, like ceipts and records that you need to fill out your tax most accounting errors, it was detected before any returns? real harm was done. No one expects that kind of mistake at a company If you think it is hard to keep track of the many like Fidelity, which has sophisticated computer sys- transactions that make up your life, imagine what it is tems and top investment managers. In explaining the like for a major corporation like Fidelity Investments. mistake to shareholders, a spokesperson wrote, Fidelity is one of the largest mutual fund manage- \"Some people have asked how, in this age of technol- ment firms in the world. If you had your life savings ogy, such a mistake could be made. While many of invested at Fidelity Investments, you might be just our processes are computerized, accounting systems slightly displeased if, when you called to find out are complex and dictate that some steps must be han- your balance, the representative said, \"You know, I dled manually by our managers and accountants, and kind of remember someone with a name like yours people can make mistakes.\" INSIDE CHAPTER 3 . . . Why Accuracy Matters (p. 109) Keeping Score (p. 115) Boosting Microsoft's Profits (p. 119) 101 c03TheAccountingInformationSystem.qxd 8/3/10 1:33 PM Page 102 preview of chapter 3 As indicated in the Feature Story, a reliable information system is a necessity for any company. The purpose of this chapter is to explain and illustrate the features of an accounting information system. The organization and content of the chapter are as follows. The Accounting Information System Accounting Transactions Analyzing transactions Summary of transactions Steps in the Recording Process The Account Debits and credits Debit and credit procedures Stockholders' equity relationships Summary of debit /credit rules The journal The ledger Chart of accounts Posting The Recording Process Illustrated Summary illustration of journalizing and posting The Trial Balance Limitations of a trial balance The Accounting Information System The system of collecting and processing transaction data and communicating financial information to decision makers is known as the accounting information system. Factors that shape these systems include: the nature of the company's business, the types of transactions, the size of the company, the volume of data, and the information demands of management and others. Most businesses use computerized accounting systemssometimes referred to as electronic data processing (EDP) systems. These systems handle all the steps involved in the recording process, from initial data entry to preparation of the financial statements. In order to remain competitive, companies continually improve their accounting systems to provide accurate and timely data for decision making. For example, in a recent annual report, Tootsie Roll states, \"We also invested in additional processing and data storage hardware during the year. We view information technology as a key strategic tool, and are committed to deploying leading edge technology in this area.\" In addition, many companies have upgraded their accounting information systems in response to the requirements of Sarbanes-Oxley. In this chapter, we focus on a manual accounting system because the accounting concepts and principles do not change whether a system is computerized or manual, and manual systems are easier to illustrate. Accounting Transactions To use an accounting information system, you need to know which economic events to recognize (record). Not all events are recorded and reported in the financial statements. For example, suppose General Motors hired a new employee or purchased a new computer. Are these events entered in its accounting records? The first event would not be recorded, but the second event would. We call economic events that require recording in the financial statements accounting transactions. An accounting transaction occurs when assets, liabilities, or stockholders' equity items change as a result of some economic event. The purchase of a 102 c03TheAccountingInformationSystem.qxd 8/3/10 1:33 PM Page 103 Accounting Transactions computer by General Motors, the payment of rent by Microsoft, and the sale of a multi-day guided trip by Sierra Corporation are examples of events that change a company's assets, liabilities, or stockholders' equity. Illustration 3-1 summarizes the decision process companies use to decide whether or not to record economic events. 103 Illustration 3-1 Transaction identification process Bank Home Accounting Ballence Events DELL Purchase computer Criterion Discuss guided trip options with potential customer Pay rent Is the financial position (assets, liabilities, or stockholders' equity) of the company changed? Yes No Yes Record Don't record Record Record/ Don't Record ANALYZING TRANSACTIONS In Chapter 1, you learned the basic accounting equation: Assets Liabilities Stockholders' Equity In this chapter, you will learn how to analyze transactions in terms of their effect on assets, liabilities, and stockholders' equity. Transaction analysis is the process of identifying the specific effects of economic events on the accounting equation. The accounting equation must always balance. Each transaction has a dual (double-sided) effect on the equation. For example, if an individual asset is increased, there must be a corresponding: Decrease in another asset, or Increase in a specific liability, or Increase in stockholders' equity. Two or more items could be affected when an asset is increased. For example, if a company purchases a computer for $10,000 by paying $6,000 in cash and signing a note for $4,000, one asset (equipment) increases $10,000, another asset (cash) decreases $6,000, and a liability (notes payable) increases $4,000. study objective 1 Analyze the effect of business transactions on the basic accounting equation. c03TheAccountingInformationSystem.qxd 104 8/3/10 1:33 PM Page 104 chapter 3 The Accounting Information System The result is that the accounting equation remains in balanceassets increased by a net $4,000 and liabilities increased by $4,000, as shown below. Assets Liabilities $10,000 6,000 Stockholders' Equity $4,000 $ 4,000 $4,000 Chapter 1 presented the financial statements for Sierra Corporation for its first month. You should review those financial statements (on page 17) at this time. To illustrate how economic events affect the accounting equation, we will examine events affecting Sierra Corporation during its first month. In order to analyze the transactions for Sierra Corporation, we will expand the basic accounting equation. This will allow us to better illustrate the impact of transactions on stockholders' equity. Recall from the balance sheets in Chapters 1 and 2 that stockholders' equity is comprised of two parts: common stock and retained earnings. Common stock is affected when the company issues new shares of stock in exchange for cash. Retained earnings is affected when the company earns revenue, incurs expenses, or pays dividends. Illustration 3-2 shows the expanded equation. Illustration 3-2 Expanded accounting equation Assets Liabilities Stockholders' Equity Common Stock Retained Earnings Revenues Expenses Dividends If you are tempted to skip ahead after you've read a few of the following transaction analyses, don't do it. Each has something unique to teach, something you'll need later. (We assure you that we've kept them to the minimum needed!) EVENT (1). INVESTMENT OF CASH BY STOCKHOLDERS. On October 1, cash of $10,000 is invested in the business by investors (primarily your friends and family) in exchange for $10,000 of common stock. This event is an accounting transaction because it results in an increase in both assets and stockholders' equity. Basic Analysis The asset Cash is increased $10,000, and stockholders' equity (specifically Common Stock) is increased $10,000. Assets Equation Analysis Liabilities Stockholders' Equity Cash (1) Common Stock $10,000 $10,000 Issued stock c03TheAccountingInformationSystem.qxd 8/3/10 1:33 PM Page 105 Accounting Transactions The equation is in balance after the issuance of common stock. Keeping track of the source of each change in stockholders' equity is essential for later accounting activities. In particular, items recorded in the revenue and expense columns are used for the calculation of net income. EVENT (2). NOTE ISSUED IN EXCHANGE FOR CASH. On October 1, Sierra borrowed $5,000 from Castle Bank by signing a 3-month, 12%, $5,000 note payable. This transaction results in an equal increase in assets and liabilities. The specific effect of this transaction and the cumulative effect of the first two transactions are: Basic Analysis The asset Cash is increased $5,000, and the liability Notes Payable is increased $5,000. Assets Stockholders' Equity Notes Payable Common Stock $10,000 5,000 $10,000 $5,000 $15,000 $5,000 $10,000 (2) Liabilities Cash Equation Analysis $15,000 Total assets are now $15,000, and liabilities plus stockholders' equity also total $15,000. EVENT (3). PURCHASE OF OFFICE EQUIPMENT FOR CASH. On October 2, Sierra purchased equipment by paying $5,000 cash to Superior Equipment Sales Co. This event is a transaction because an equal increase and decrease in Sierra's assets occur. Basic Analysis The asset Equipment is increased $5,000; the asset Cash is decreased $5,000. Assets Equation Analysis (3) Liabilities Stockholders' Equity Notes Payable Common Stock $15,000 5,000 $5,000 $10,000 $5,000 $5,000 $10,000 Equipment $15,000 $5,000 $10,000 Cash $15,000 The total assets are now $15,000, and liabilities plus stockholders' equity also total $15,000. EVENT (4). RECEIPT OF CASH IN ADVANCE FROM CUSTOMER. On October 2, Sierra received a $1,200 cash advance from R. Knox, a client. This event is a transaction because Sierra received cash (an asset) for guide services for multi-day trips that are expected to be completed by Sierra in the future. Although Sierra received cash, it does not record revenue until it has performed the work. In some industries, such as the magazine and airline industries, customers are expected to prepay. These companies have a liability to the customer until they deliver the magazines or provide the flight. When the company eventually provides the product or service, it records the revenue. 105 c03TheAccountingInformationSystem.qxd 106 8/3/10 1:33 PM Page 106 chapter 3 The Accounting Information System Since Sierra received cash prior to performance of the service, Sierra has a liability for the work due. The asset Cash is increased $1,200; the liability Unearned Service Revenue is increased $1,200 because the service has not been provided yet. That is, when an advance payment is received, an unearned revenue (a liability) should be recorded in order to recognize the obligation that exists. Basic Analysis Equation Analysis Assets Equipment $10,000 1,200 (4) $5,000 Unearned Service Revenue Common Stock $5,000 $10,000 $1,200 $5,000 $11,200 Notes Payable Stockholders' Equity $5,000 $1,200 $10,000 Cash Liabilities $16,200 $16,200 EVENT (5). SERVICES PROVIDED FOR CASH. On October 3, Sierra received $10,000 in cash from Copa Company for guide services performed for a corporate event. This event is a transaction because Sierra received an asset (cash) in exchange for services. Guide service is the principal revenue-producing activity of Sierra. Revenue increases stockholders' equity. This transaction, then, increases both assets and stockholders' equity. Basic Analysis The asset Cash is increased $10,000; the revenue Service Revenue is increased $10,000. Equation Analysis Cash $11,200 10,000 $21,200 $5,000 $5,000 (5) Equipment Notes Pay. $5,000 Liabilities $5,000 Unearned Serv. Rev. $1,200 $1,200 Stockholders' Equity Common Stock $10,000 $10,000 Rev. Retained Earnings Exp. Div. $10,000 Service Revenue $10,000 Assets $26,200 $26,200 Often companies provide services \"on account.\" That is, they provide service for which they are paid at a later date. Revenue, however, is earned when services are performed. Therefore, revenues would increase when services are performed, even though cash has not been received. Instead of receiving cash, the company receives a different type of asset, an account receivable. Accounts receivable represent the right to receive payment at a later date. Suppose that Sierra had provided these services on account rather than for cash. This event would be reported using the accounting equation as: Assets Liabilities Stockholders' Equity Accounts Receivable Revenues $10,000 $10,000 Service Revenue Later, when Sierra collects the $10,000 from the customer, Accounts Receivable declines by $10,000, and Cash increases by $10,000. c03TheAccountingInformationSystem.qxd 9/2/10 1:39 PM Page 107 107 Accounting Transactions Assets Cash Stockholders' Equity Accounts Receivable $10,000 Liabilities $10,000 Note that in this case, revenues are not affected by the collection of cash. Instead we record an exchange of one asset (Accounts Receivable) for a different asset (Cash). EVENT (6). PAYMENT OF RENT. On October 3, Sierra Corporation paid its office rent for the month of October in cash, $900. This rent payment is a transaction because it results in a decrease in an asset, cash. Rent is an expense incurred by Sierra Corporation in its effort to generate revenues. Expenses decrease stockholders' equity. Sierra records the rent payment by decreasing cash and increasing expenses to maintain the balance of the accounting equation. Basic Analysis The expense account Rent Expense is increased $900 because the payment pertains only to the current month; the asset Cash is decreased $900. Equation Analysis Assets Equipment $21,200 900 (6) $5,000 Notes Pay. $5,000 Unearned Serv. Rev. $1,200 Common Stock $10,000 Retained Earnings Exp. Rev. Div. $10,000 $900 $5,000 $20,300 Stockholders' Equity $5,000 $1,200 $10,000 $10,000 Rent Expense $900 Cash Liabilities $25,300 $25,300 EVENT (7). PURCHASE OF INSURANCE POLICY FOR CASH. On October 4, Sierra paid $600 for a one-year insurance policy that will expire next year on September 30. Payments of expenses that will benefit more than one accounting period are identified as assets called prepaid expenses or prepayments. Basic Analysis The asset Cash is decreased $600. The asset Prepaid Insurance is increased $600. Equation Analysis Assets Cash (7) $20,300 600 Equipment $5,000 Liabilities Notes Pay. $5,000 Unearned Serv. Rev. $1,200 Stockholders' Equity Common Stock $10,000 Rev. Retained Earnings Exp. $10,000 $900 $600 $600 $5,000 $5,000 $1,200 $10,000 $10,000 $900 $19,700 Prepaid Insurance $25,300 $25,300 The balance in total assets did not change; one asset account decreased by the same amount that another increased. Div. c03TheAccountingInformationSystem.qxd 108 8/3/10 1:33 PM Page 108 chapter 3 The Accounting Information System EVENT (8). PURCHASE OF SUPPLIES ON ACCOUNT. On October 5, Sierra purchased supplies on account from Aero Supply for $2,500. In this case, \"on account\" means that the company receives goods or services that it will pay for at a later date. Basic Analysis The asset Supplies is increased $2,500; the liability Accounts Payable is increased $2,500. Equation Analysis Assets Cash Supplies Prepd. Insur. $19,700 $600 Equipment $5,000 Notes Pay. Unearned Serv. Rev. $1,200 Stockholders' Equity Common Stock $10,000 Rev. Retained Earnings Exp. $10,000 $10,000 Div. $900 $900 $2,500 $600 $5,000 $5,000 $2,500 $1,200 $10,000 $2,500 $19,700 Accounts Payable $5,000 $2,500 (8) Liabilities $27,800 $27,800 EVENT (9). HIRING OF NEW EMPLOYEES. On October 9, Sierra hired four new employees to begin work on October 15. Each employee will receive a weekly salary of $500 for a five-day work week, payable every two weeks. Employees will receive their first paychecks on October 26. On the date Sierra hires the employees, there is no effect on the accounting equation because the assets, liabilities, and stockholders' equity of the company have not changed. Basic Analysis An accounting transaction has not occurred. There is only an agreement that the employees will begin work on October 15. (See Event (11) for the first payment.) EVENT (10). PAYMENT OF DIVIDEND. On October 20, Sierra paid a $500 dividend. Dividends are a reduction of stockholders' equity but not an expense. Dividends are not included in the calculation of net income. Instead, a dividend is a distribution of the company's assets to its stockholders. Basic Analysis The dividends account is increased $500; the asset Cash is decreased $500. Equation Analysis Assets Cash $19,700 500 $2,500 $600 $5,000 Stockholders' Equity $5,000 $2,500 $1,200 $10,000 Retained Earnings Rev. Exp. Div. $10,000 $900 $500 $27,300 $1,200 $10,000 $10,000 $900 $500 $19,200 $2,500 $600 $5,000 $5,000 $2,500 (10) Liabilities SupPrepd. EquipNotes Accts. Unearned Common plies Insur. ment Pay. Pay. Serv. Rev. Stock $27,300 EVENT (11). PAYMENT OF CASH FOR EMPLOYEE SALARIES. Employees have worked two weeks, earning $4,000 in salaries, which were paid on October 26. c03TheAccountingInformationSystem.qxd 8/3/10 1:33 PM Page 109 Accounting Transactions 109 Salaries Expense is an expense that reduces stockholders' equity. This event is a transaction because assets and stockholders' equity are affected. Basic Analysis The asset Cash is decreased $4,000; the expense account Salaries Expense is increased $4,000. Equation Analysis Assets Cash $19,200 (11) 4,000 Supplies $2,500 Liabilities Stockholders' Equity Prepd. EquipNotes Accts. Unearned Common Insur. ment Pay. Pay. Serv. Rev. Stock $600 $5,000 $5,000 $2,500 $1,200 $10,000 Rev. Retained Earnings Exp. Div. $10,000 $10,000 $10,000 $4,900 $500 $1,200 $500 $15,200 $2,500 $600 $5,000 $5,000 $2,500 $ 900 4,000 $23,300 $23,300 Investor Insight Why Accuracy Matters While most companies record transactions very carefully, the reality is that mistakes still happen. For example, bank regulators fined Bank One Corporation (now Chase) $1.8 million because they felt that the unreliability of the bank's accounting system caused it to violate regulatory requirements. Also, in recent years Fannie Mae, the government-chartered mortgage association, announced a series of large accounting errors. These announcements caused alarm among investors, regulators, and politicians because they fear that the errors may suggest larger, undetected problems. This is important because the home-mortgage market depends on Fannie Mae to buy hundreds of billions of dollars of mortgages each year from banks, thus enabling the banks to issue new mortgages. Finally, before a major overhaul of its accounting system, the financial records of Waste Management Company were in such disarray that of the company's 57,000 employees, 10,000 were receiving pay slips that were in error. The Sarbanes-Oxley Act of 2002 was created to minimize the occurrence of errors like these by increasing every employee's responsibility for accurate financial reporting. ? In order for these companies to prepare and issue financial statements, their accounting equations (debits and credits) must have been in balance at year-end. How could these errors or misstatements have occurred? (See page 158.) SUMMARY OF TRANSACTIONS Illustration 3-3 (page 110) summarizes the transactions of Sierra Corporation to show their cumulative effect on the basic accounting equation. It includes the transaction number in the first column on the left. The right-most column shows the specific effect of any transaction that affects stockholders' equity. Remember that Event (9) did not result in a transaction, so no entry is included for that event. The illustration demonstrates three important points: 1. Each transaction is analyzed in terms of its effect on assets, liabilities, and stockholders' equity. 2. The two sides of the equation must always be equal. 3. The cause of each change in stockholders' equity must be indicated. Salaries Expense c03TheAccountingInformationSystem.qxd 110 8/3/10 1:33 PM Page 110 chapter 3 The Accounting Information System Illustration 3-3 Summary of transactions Assets Sup Cash plies Prepd. Equip- (1) $10,000 (2) 5,000 (4) Pay. Stockholders' Equity Accts. Unearned Common Pay. Serv. Rev. Stock 5,000 (3) Notes Insur. ment Liabilities Retained Earnings $5,000 $1,200 $10,000 600 Rent Expense $600 $2,500 500 (11) Service Revenue $ 900 $2,500 (8) Div. Issued stock 900 (10) $5,000 (5) 10,000 (7) Exp. $10,000 1,200 (6) Rev. 4,000 $500 Dividends 4,000 $600 $5,000 $5,000 $2,500 $1,200 $10,000 $10,000 $4,900 Salaries Expense $500 $2,500 $15,200 $23,300 $23,300 DECISION TOOLKIT DECISION CHECKPOINTS INFO NEEDED FOR DECISION Has an accounting transaction occurred? Details of the event TOOL TO USE FOR DECISION Accounting equation HOW TO EVALUATE RESULTS If the event affected assets, liabilities, or stockholders' equity, then record as a transaction. before you go on... Do it! TRANSACTION ANALYSIS A tabular analysis of the transactions made by Roberta Mendez & Co., a certified public accounting firm, for the month of August is shown below. Each increase and decrease in stockholders' equity is explained. Liabilities Assets Equipment Accounts Payable $7,000 $7,000 1. $25,000 2. 3. 8,000 4. 850 $7,000 $32,150 $39,150 Action Plan Analyze the tabular analysis to determine the nature and effect of each transaction. Keep the accounting equation in balance. Remember that a change in an asset will require a change in another asset, a liability, or in stockholders' equity. $7,000 Common Stock Retained Earnings Revenue Expenses $25,000 Issued stock $8,000 $25,000 $8,000 $850 Service Revenue Rent Expense $850 Cash Stockholders' Equity $39,150 Describe each transaction that occurred for the month. Solution 1. The company issued shares of stock to stockholders for $25,000 cash. 2. The company purchased $7,000 of equipment on account. 3. The company received $8,000 of cash in exchange for services performed. 4. The company paid $850 for this month's rent. Related exercise material: BE3-1, BE3-2, BE3-3, Do it! 3-1, E3-1, E3-2, E3-3, and E3-4. c03TheAccountingInformationSystem.qxd 8/3/10 1:33 PM Page 111 The Account 111 study objective 2 The Account Rather than using a tabular summary like the one in Illustration 3-3 for Sierra Corporation, an accounting information system uses accounts. An account is an individual accounting record of increases and decreases in a specific asset, liability, stockholders' equity, revenue, or expense item. For example, Sierra Corporation has separate accounts for Cash, Accounts Receivable, Accounts Payable, Service Revenue, Salaries Expense, and so on. (Note that whenever we are referring to a specific account, we capitalize the name.) In its simplest form, an account consists of three parts: (1) the title of the account, (2) a left or debit side, and (3) a right or credit side. Because the alignment of these parts of an account resembles the letter T, it is referred to as a T account. The basic form of an account is shown in Illustration 3-4. Dr. Title of Account Left or debit side Cr. Explain what an account is and how it helps in the recording process. Illustration 3-4 form of account Basic Right or credit side We use this form of account often throughout this book to explain basic accounting relationships. DEBITS AND CREDITS The term debit indicates the left side of an account, and credit indicates the right side. They are commonly abbreviated as Dr. for debit and Cr. for credit. They do not mean increase or decrease, as is commonly thought. We use the terms debit and credit repeatedly in the recording process to describe where entries are made in accounts. For example, the act of entering an amount on the left side of an account is called debiting the account. Making an entry on the right side is crediting the account. When comparing the totals of the two sides, an account shows a debit balance if the total of the debit amounts exceeds the credits. An account shows a credit balance if the credit amounts exceed the debits. Note the position of the debit side and credit side in Illustration 3-4. The procedure of recording debits and credits in an account is shown in Illustration 3-5 for the transactions affecting the Cash account of Sierra Corporation. The data are taken from the Cash column of the tabular summary in Illustration 3-3. Tabular Summary Cash $10,000 5,000 -5,000 1,200 10,000 -900 -600 -500 -4,000 $15,200 Balance (Debit) Cash 10,000 (Credits) 5,000 1,200 10,000 15,200 3 Define debits and credits and explain how they are used to record business transactions. Illustration 3-5 Tabular summary and account form for Sierra Corporation's Cash account Account Form (Debits) study objective 5,000 900 600 500 4,000 c03TheAccountingInformationSystem.qxd 112 8/3/10 1:33 PM Page 112 chapter 3 The Accounting Information System Every positive item in the tabular summary represents a receipt of cash; every negative amount represents a payment of cash. Notice that in the account form we record the increases in cash as debits, and the decreases in cash as credits. For example, the $10,000 receipt of cash (in red) is debited to Cash, and the $5,000 payment of cash (in blue) is credited to Cash. Having increases on one side and decreases on the other reduces recording errors and helps in determining the totals of each side of the account as well as the account balance. The balance is determined by netting the two sides (subtracting one amount from the other). The account balance, a debit of $15,200, indicates that Sierra had $15,200 more increases than decreases in cash. That is, since it started with a balance of zero, it has $15,200 in its Cash account. International Note 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. DEBIT AND CREDIT PROCEDURES Each transaction must affect two or more accounts to keep the basic accounting equation in balance. In other words, for each transaction, debits must equal credits. The equality of debits and credits provides the basis for the doubleentry accounting system. Under the double-entry system, the two-sided effect of each transaction is recorded in appropriate accounts. This system provides a logical method for recording transactions. The double-entry system also helps to ensure the accuracy of the recorded amounts and helps to detect errors such as those at Fidelity Investments as discussed in the Feature Story. If every transaction is recorded with equal debits and credits, then the sum of all the debits to the accounts must equal the sum of all the credits. The double-entry system for determining the equality of the accounting equation is much more efficient than the plus/minus procedure used earlier. Dr./Cr. Procedures for Assets and Liabilities In Illustration 3-5 for Sierra Corporation, increases in Cashan assetwere entered on the left side, and decreases in Cash were entered on the right side. We know that both sides of the basic equation (Assets Liabilities Stockholders' Equity) must be equal. It therefore follows that increases and decreases in liabilities will have to be recorded opposite from increases and decreases in assets. Thus, increases in liabilities must be entered on the right or credit side, and decreases in liabilities must be entered on the left or debit side. The effects that debits and credits have on assets and liabilities are summarized in Illustration 3-6. Illustration 3-6 Debit and credit effectsassets and liabilities Debits Credits Increase assets Decrease liabilities Decrease assets Increase liabilities Asset accounts normally show debit balances. That is, debits to a specific asset account should exceed credits to that account. Likewise, liability accounts normally show credit balances. That is, credits to a liability account should exceed debits to that account. The normal balances may be diagrammed as in Illustration 3-7. Illustration 3-7 Normal balancesassets and liabilities Assets Debit for Credit for increase decrease Normal balance Liabilities Debit for Credit for decrease increase Normal balance c03TheAccountingInformationSystem.qxd 8/3/10 1:33 PM Page 113 The Account Knowing which is the normal balance in an account may help when you are trying to identify errors. For example, a credit balance in an asset account, such as Land, or a debit balance in a liability account, such as Salaries Payable, usually indicates errors in recording. Occasionally, however, an abnormal balance may be correct. The Cash account, for example, will have a credit balance when a company has overdrawn its bank balance (written a check that \"bounced\"). In automated accounting systems, the computer is programmed to flag violations of the normal balance and to print out error or exception reports. In manual systems, careful visual inspection of the accounts is required to detect normal balance problems. 113 Helpful Hint The normal balance is the side where increases in the account are recorded. Dr./Cr. Procedures for Stockholders' Equity In Chapter 1, we indicated that stockholders' equity is comprised of two parts: common stock and retained earnings. In the transaction events earlier in this chapter, you saw that revenues, expenses, and the payment of dividends affect retained earnings. Therefore, the subdivisions of stockholders' equity are: common stock, retained earnings, dividends, revenues, and expenses. COMMON STOCK. Common stock is issued to investors in exchange for the stockholders' investment. The common stock account is increased by credits and decreased by debits. For example, when cash is invested in the business, cash is debited and common stock is credited. The effects of debits and credits on the common stock account are shown in Illustration 3-8. Debits Credits Decrease Common Stock Increase Common Stock Illustration 3-8 Debit and credit effectsCommon Stock The normal balance in the Common Stock account may be diagrammed as in Illustration 3-9. Illustration 3-9 Normal balanceCommon Stock Common Stock Debit for Credit for decrease increase Normal balance RETAINED EARNINGS. Retained earnings is net income that is retained in the business. It represents the portion of stockholders' equity that has been accumulated through the profitable operation of the company. Retained earnings is increased by credits (for example, by net income) and decreased by debits (for example, by a net loss), as shown in Illustration 3-10. Debits Credits Decrease Retained Earnings Increase Retained Earnings Illustration 3-10 Debit and credit effectsRetained Earnings c03TheAccountingInformationSystem.qxd 114 8/3/10 1:33 PM Page 114 chapter 3 The Accounting Information System The normal balance for Retained Earnings may be diagrammed as in Illustration 3-11. Illustration 3-11 Normal balanceRetained Earnings Retained Earnings Debit for Credit for decrease increase Normal balance DIVIDENDS. A dividend is a distribution by a corporation to its stockholders. The most common form of distribution is a cash dividend. Dividends result in a reduction of the stockholders' claims on retained earnings. Because dividends reduce stockholders' equity, increases in the Dividends account are recorded with debits. As shown in Illustration 3-12, the Dividends account normally has a debit balance. Illustration 3-12 Normal balanceDividends Dividends Debit for Credit for increase decrease Normal balance REVENUES AND EXPENSES. When a company earns revenues, stockholders' equity is increased. Revenue accounts are increased by credits and decreased by debits. Expenses decrease stockholders' equity. Thus, expense accounts are increased by debits and decreased by credits. The effects of debits and credits on revenues and expenses are shown in Illustration 3-13. Illustration 3-13 Debit and credit effectsrevenues and expenses Debits Credits Decrease revenue Increase expenses Increase revenue Decrease expenses Credits to revenue accounts should exceed debits; debits to expense accounts should exceed credits. Thus, revenue accounts normally show credit balances, and expense accounts normally show debit balances. The normal balances may be diagrammed as in Illustration 3-14. Illustration 3-14 Normal balancesrevenues and expenses Expenses Debit for Credit for increase decrease Normal balance Revenues Debit for Credit for decrease increase Normal balance c03TheAccountingInformationSystem.qxd 8/3/10 1:33 PM Page 115 The Account Investor Insight Keeping Score The Chicago Cubs baseball team has these major revenue and expense accounts: Revenues Admissions (ticket sales) Concessions Television and radio Advertising ? Expenses Players' salaries Administrative salaries Travel Ballpark maintenance Do you think that the Chicago Bears football team would be likely to have the same major revenue and expense accounts as the Cubs? (See page 158.) STOCKHOLDERS' EQUITY RELATIONSHIPS Companies report the subdivisions of stockholders' equity in various places in the financial statements: Common stock and retained earnings: in the stockholders' equity section of the balance sheet. Dividends: on the retained earnings statement. Revenues and expenses: on the income statement. Dividends, revenues, and expenses are eventually transferred to retained earnings at the end of the period. As a result, a change in any one of these three items affects stockholders' equity. Illustration 3-15 shows the relationships of the accounts affecting stockholders' equity. Illustration 3-15 Stockholders' equity relationships Balance Sheet Assets Liabilities Stockholder's equity Common stock Retained earnings Income Statement Revenues Less: Expenses Net income or net loss Retained Earnings Statement Begining retained earnings Add: Net income Less: Dividends Ending retained earnings Investments by stockholders Net income retained in the business 115 c03TheAccountingInformationSystem.qxd 116 8/3/10 1:33 PM Page 116 chapter 3 The Accounting Information System SUMMARY OF DEBIT/CREDIT RULES Illustration 3-16 summarizes the debit/credit rules and effects on each type of account. Study this diagram carefully. It will help you understand the fundamentals of the double-entry system. No matter what the transaction, total debits must equal total credits in order to keep the accounting equation in balance. Illustration 3-16 Summary of debit/credit rules Assets = Liabilities + Stockholders' Equity Basic Equation Expanded Basic Equation Debit / Credit Rules Assets = Dr. Cr. + - Liabilities Dr. Cr. - + + Common + Stock Retained Earnings Dr. Cr. + - Dr. Cr. + - - Dividends + Revenues - Dr. + Cr. - Dr. - Cr. + Expenses Dr. + Cr. - before you go on... DEBITS AND CREDITS FOR BALANCE SHEET ACCOUNTS Action Plan First identify asset accounts for each different type of asset invested in the business. Then identify liability accounts for debts incurred by the business. Remember that Hair It Is Inc. will need only one stockholders' equity account for common stock when it begins the business. The other stockholders' equity accounts will be needed only after the business is operating. Do it! Kate Browne, president of Hair It Is Inc., has just rented space in a shopping mall for the purpose of opening and operating a beauty salon. Long before opening day and before purchasing equipment, hiring assistants, and remodeling the space, Kate was strongly advised to set up a double-entry set of accounting records in which to record all of her business transactions. Identify the balance sheet accounts that Hair It Is Inc. will likely need to record the transactions necessary to establish and open for business. Also, indicate whether the normal balance of each account is a debit or a credit. Solution Hair It Is Inc. would likely need the following accounts in which to record the transactions necessary to establish and ready the beauty salon for opening day: Cash (debit balance); Equipment (debit balance); Supplies (debit balance); Accounts Payable (credit balance); Notes Payable (credit balance), if the business borrows money; and Common Stock (credit balance). Related exercise material: BE3-4, BE3-5, Do it! 3-2, and E3-7. Steps in the Recording Process study objective 4 Identify the basic steps in the recording process. Although it is possible to enter transaction information directly into the accounts, few businesses do so. Practically every business uses these basic steps in the recording process: 1. Analyze each transaction in terms of its effect on the accounts. 2. Enter the transaction information in a journal. 3. Transfer the journal information to the appropriate accounts in the ledger. c03TheAccountingInformationSystem.qxd 8/3/10 1:33 PM Page 117 Steps in the Recording Process 117 The actual sequence of events begins with the transaction. Evidence of the transaction comes in the form of a source document, such as a sales slip, a check, a bill, or a cash register tape. This evidence is analyzed to determine the effect of the transaction on specific accounts. The transaction is then entered in the journal. Finally, the journal entry is transferred to the designated accounts in the ledger. The sequence of events in the recording process is shown in Illustration 3-17. Illustration 3-17 The recording process The Recording Process JOURNAL Invoice LEDGER JOURNAL ASSETS LIABILITIES Stockholders' Equity Analyze each transaction Enter transaction in a journal Transfer journal information to ledger accounts THE JOURNAL Transactions are initially recorded in chronological order in journals before they are transferred to the accounts. For each transaction the journal shows the debit and credit effects on specific accounts. (In a computerized system, journals are kept as files, and accounts are recorded in computer databases.) Companies may use various kinds of journals, but every company has at least the most basic form of journal, a general journal. The journal makes three significant contributions to the recording process: 1. It discloses in one place the complete effect of a transaction. 2. It provides a chronological record of transactions. 3. It helps to prevent or locate errors because the debit and credit amounts for each entry can be readily compared. Entering transaction data in the journal is known as journalizing. To illustrate the technique of journalizing, let's look at the first three transactions of Sierra Corporation in equation form. On October 1, Sierra issued common stock in exchange for $10,000 cash: Assets Cash $10,000 Liabilities Stockholders' Equity Common Stock $10,000 Issued stock study objective 5 Explain what a journal is and how it helps in the recording process. Ethics Note Business documents provide evidence that transactions actually occurred. International Outsourcing Services, LLC, was accused of submitting fraudulent documents (store coupons) to companies such as Kraft Foods and PepsiCo for reimbursement of as much as $250 million. Ensuring that all recorded transactions are backed up by proper business documents reduces the likelihood of fraudulent activity. c03TheAccountingInformationSystem.qxd 118 8/3/10 1:33 PM Page 118 chapter 3 The Accounting Information System On October 1, Sierra borrowed $5,000 by signing a note: Assets Cash Liabilities $5,000 Stockholders' Equity Notes Payable $5,000 On October 2, Sierra purchased equipment for $5,000: Assets Cash Liabilities Stockholders' Equity Equipment $5,000 $5,000 Sierra makes separate journal entries for each transaction. A complete entry consists of: (1) the date of the transaction, (2) the accounts and amounts to be debited and credited, and (3) a brief explanation of the transaction. These transactions are journalized in Illustration 3-18. Illustration 3-18 Recording transactions in journal form GENERAL JOURNAL Date Account Titles and Explanation Debit Credit 2012 Oct. 1 1 2 Cash Common Stock (Issued stock for cash) 10,000 10,000 Cash Notes Payable (Issued 3-month, 12% note payable for cash) 5,000 Equipment Cash (Purchased equipment for cash) 5,000 5,000 5,000 Note the following features of the journal entries. 1. The date of the transaction is entered in the Date column. 2. The account to be debited is entered first at the left. The account to be credited is then entered on the next line, indented under the line above. The indentation differentiates debits from credits and decreases the possibility of switching the debit and credit amounts. 3. The amounts for the debits are recorded in the Debit (left) column, and the amounts for the credits are recorded in the Credit (right) column. 4. A brief explanation of the transaction is given. It is important to use correct and specific account titles in journalizing. Erroneous account titles lead to incorrect financial statements. Some flexibility exists initially in selecting account titles. The main criterion is that each title must appropriately describe the content of the account. For example, a company could use any of these account titles for recording the cost of delivery trucks: Equipment, Delivery Equipment, Delivery Trucks, or Trucks. Once the company chooses the specific title to use, however, it should record under that account title all subsequent transactions involving the account. c03TheAccountingInformationSystem.qxd 8/4/10 1:22 PM Page 119 Steps in the Recording Process 119 Accounting Across the Organization Boosting Microsoft's Profits Bryan Lee is head of finance at Microsoft's Home and Entertainment Division. In recent years the division lost over $4 billion, mostly due to losses on the original Xbox videogame player. With the Xbox 360 videogame player, Mr. Lee hoped the division would become profitable. He set strict goals for sales, revenue, and profit. \"A manager seeking to spend more on a feature such as a disk drive has to find allies in the group to cut spending elsewhere, or identify new revenue to offset the increase,\" he explains. For example, Microsoft originally designed the new Xbox to have 256 megabytes of memory. But the design department said that amount of memory wouldn't support the best special effects. The purchasing department said that adding more memory would cost $30which was 10% of the estimated selling price of $300. But the marketing department \"determined that adding the memory would let Microsoft reduce marketing costs and attract more game developers, boosting royalty revenue. It would also extend the life of the console, generating more sales.\" Microsoft doubled the memory to 512 megabytes. Source: Robert A. Guth, \"New Xbox Aim for Microsoft: Profitability,\" Wall Street Journal (May 24, 2005), p. C1. ? In what ways is this Microsoft division using accounting to assist in its effort to become more profitable? (See page 158.) before you go on... Do it! The following events occurred during the first month of business of Hair It Is Inc., Kate Browne's beauty salon: JOURNAL ENTRIES 1. Issued common stock to shareholders in exchange for $20,000 cash. 2. Purchased $4,800 of equipment on account (to be paid in 30 days). 3. Interviewed three people for the position of beautician. In what form (type of record) should the company record these three activities? Prepare the entries to record the transactions. Solution Each transaction that is recorded is entered in the general journal. The three activities are recorded as follows. 1. Cash Common Stock (Issued stock for cash) 2. Equipment Accounts Payable (Purchased equipment on account) 20,000 20,000 4,800 4,800 Action Plan Record the transactions in a journal, which is a chronological record of the transactions. Make sure to provide a complete and accurate representation of the transactions' effects on the assets, liabilities, and stockholders' equity of the business. 3. No entry because no transaction occurred. Related exercise material: BE3-6, BE3-9, Do it! 3-3, E3-6, E3-8, and E3-9. THE LEDGER The entire group of accounts maintained by a company is referred to collectively as the ledger. The ledger keeps in one place all the information about changes in specific account balances. Companies may use various kinds of ledgers, but every company has a general ledger. A general ledger contains all the assets, liabilities, stockholders' equity, revenue, and expense accounts, as shown in Illustration 3-19 (page 120). Whenever we use the term ledger in this textbook without additional specification, it will mean the general ledger. study objective 6 Explain what a ledger is and how it helps in the recording process. c03TheAccountingInformationSystem.qxd 120 8/3/10 1:33 PM Page 120 chapter 3 The Accounting Information System Illustration 3-19 The general ledger Individual Asset Accounts Equipment Land Supplies Cash Individual Liability Accounts Individual Stockholders' Equity Accounts Interest Payable Salaries Payable Accounts Payable Notes Payable Salaries Expense Service Revenue Dividends Retained Earnings Common Stock Illustration 3-20 Chart of accounts for Sierra Corporation CHART OF ACCOUNTS The number and type of accounts used differ for each company, depending on the size, complexity, and type of business. For example, the number of accounts depends on the amount of detail desired by management. The management of one company may want one single account for all types of utility expense. Another may keep separate expense accounts for each type of utility expenditure, such as gas, electricity, and water. A small corporation like Sierra Corporation will not have many accounts compared with a corporate giant like Ford Motor Company. Sierra may be able to manage and report its activities in 20 to 30 accounts, whereas Ford requires thousands of accounts to keep track of its worldwide activities. Most companies list the accounts in a chart of accounts. They may create new accounts as needed during the life of the business. Illustration 3-20 shows the chart of accounts for Sierra Corporation in the order that they are typically listed (assets, liabilities, stockholders' equity, revenues, and expenses). Accounts shown in red are used in this chapter; accounts shown in black are explained in later chapters. SIERRA CORPORATIONCHART OF ACCOUNTS Assets Liabilities Cash Accounts Receivable Supplies Prepaid Insurance Equipment Accumulated Depreciation Equipment Notes Payable Accounts Payable Interest Payable Unearned Service Revenue Salaries Payable study objective Explain what posting is and how it helps in the recording process. 7 Stockholders' Equity Revenues Expenses Common Stock Service Revenue Salaries Expense Retained Earnings Supplies Expense Dividends Rent Expense Income Summary Insurance Expense Interest Expense Depreciation Expense POSTING The procedure of transferring journal entry amounts to ledger accounts is called posting. This phase of the recording process accumulates the effects of journalized transactions in the individual accounts. Posting involves these steps: 1. In the ledger, enter in the appropriate columns of the debited account(s) the date and debit amount shown in the journal. 2. In the ledger, enter in the appropriate columns of the credited account(s) the date and credit amount shown in the journal. The Recording Process Illustrated Illustrations 3-21 through 3-31 on the following pages show the basic steps in the recording process using the October transactions of Sierra Corporation. Sierra's accounting period is a month. A basic analysis and a debit-credit analysis precede the journalizing and posting of each transaction. Study these transaction c03TheAccountingInformationSystem.qxd 8/3/10 1:33 PM Page 121 The Recording Process Illustrated 121 analyses carefully. The purpose of transaction analysis is first to identify the type of account involved and then to determine whether a debit or a credit to the account is required. You should always perform this type of analysis before preparing a journal entry. Doing so will help you understand the journal entries discussed in this chapter as well as more complex journal entries to be described in later chapters. Accounting Cycle Tutorial The diagrams in Illustrations 3-21 to 3-31 review the accounting cycle. If you would like additional practice, an Accounting Cycle Tutorial is available on WileyPLUS. The illustration to the left is an example of a screen from the tutorial. Event 1 On October 1, stockholders invest $10,000 cash in an outdoor guide service company to be known as Sierra Corporation. Basic Analysis The asset Cash is increased $10,000, and stockholders' equity (specifically Common Stock) is increased $10,000. Assets (1) Debit-Credit Analysis Journal Entry = Cash Equation Analysis = +$10,000 + Stockholders' Equity Common Stock +$10,000 Issued stock Debits increase assets: debit Cash $10,000. Credits increase stockholders' equity: credit Common Stock $10,000. Oct. 1 Cash Common Stock (Issued stock for cash) Cash Posting Liabilities Oct. 1 10,000 10,000 10,000 Common Stock Oct. 1 10,000 Illustration 3-21 Investment of cash by stockholders c03TheAccountingInformationSystem.qxd 122 8/3/10 1:33 PM Page 122 chapter 3 The Accounting Information System Illustration 3-22 of note payable Issue Event 2 On October 1, Sierra borrows cash of $5,000 by signing a 3-month, 12%, $5,000 note payable. Basic Analysis The asset Cash is increased $5,000, and the liability Notes Payable is increased $5,000. Assets = Cash = Equation Analysis (2) Debit-Credit Analysis Journal Entry +$5,000 Liabilities Notes Payable +$5,000 + Debits increase assets: debit Cash $5,000. Credits increase liabilities: credit Notes Payable $5,000. Oct. 1 Cash Notes Payable (Issued 3-month, 12% note payable for cash) Cash Posting Stockholders' Equity Oct. 1 1 5,000 5,000 Notes Payable 10,000 5,000 Oct. 1 5,000 Illustration 3-23 Purchase of equipment Event 3 On October 2, Sierra used $5,000 cash to purchase equipment. Basic Analysis The asset Equipment is increased $5,000; the asset Cash is decreased $5,000. = Liabilities Assets Equation Analysis Debit-Credit Analysis Cash (3) -$5,000 + + Stockholders' Equity Equipment +$5,000 Debits increase assets: debit Equipment $5,000. Credits decrease assets: credit Cash $5,000. Journal Entry Oct. 2 Posting Oct. 1 1 Equipment Cash (Purchased equipment for cash) Cash 10,000 Oct. 2 5,000 5,000 5,000 5,000 Oct. 2 Equipment 5,000 c03TheAccountingInformationSystem.qxd 8/3/10 1:33 PM Page 123 The Recording Process Illustrated Event 4 Basic Analysis On October 2, Sierra received a $1,200 cash advance from R. Knox, a client, for guide services for multi-day trips that are expected to be completed in the future. The asset Cash is increased $1,200; the liability Unearned Service Revenue is increased $1,200 because the service has not been provided yet. That is, when an advance payment is received, an unearned revenue (a liability) should be recorded in order to recognize the obligation that exists. Assets (4) Debit-Credit Analysis Journal Entry Posting = Cash Equation Analysis = +$1,200 + Liabilities Unearned Serv. Rev. +$1,200 Stockholders' Equity Oct. 2 Cash Unearned Service Revenue (Received advance from R. Knox for future service) Cash 10,000 Oct. 2 5,000 1,200 Oct. 1 1 2 1,200 Unearned Service Revenue Oct. 2 1,200 5,000 Illustration 3-25 Services provided for cash Basic Analysis The asset Cash is increased $10,000; the revenue Service Revenue is increased $10,000. Assets Journal Entry Cash (5) = = Liabilities + Stockholders' Equity Revenues +$10,000 +$10,000 Service Revenue Debits increase assets: debit Cash $10,000. Credits increase revenues: credit Service Revenue $10,000. Oct. 3 Cash Service Revenue (Received cash for services provided) Cash Posting Helpful Hint Many liabilities have the word \"payable\" in their title. But, note that Unearned Service Revenue is considered a liability even though the word payable is not used. 1,200 On October 3, Sierra received $10,000 in cash from Copa Company for guide services provided in October. Debit-Credit Analysis Illustration 3-24 Receipt of cash in advance from customer Debits increase assets: debit Cash $1,200. Credits increase liabilities: credit Unearned Service Revenue $1,200. Event 5 Equation Analysis 123 Oct. 1 1 2 3 10,000 Oct. 2 5,000 1,200 10,000 10,000 10,000 Service Revenue 5,000 Oct. 3 10,000 c03TheAccountingInformationSystem.qxd 124 8/3/10 1:33 PM Page 124 chapter 3 The Accounting Information System Illustration 3-26 Payment of rent with cash Event 6 On October 3, Sierra paid office rent for October in cash, $900. Basic Analysis The expense account Rent Expense is increased $900 because the payment pertains only to the current month; the asset Cash is decreased $900. Assets Equation Analysis Cash (6) Debit-Credit Analysis Journal Entry = + = Liabilities Stockholders' Equity Expenses -$900 Rent Expense -$900 Debits increase expenses: debit Rent Expense $900. Credits decrease assets: credit Cash $900. Oct. 3 Rent Expense Cash (Paid cash for October office rent) 900 900 Cash Posting Illustration 3-27 Purchase of insurance policy with cash Event 7 Basic Analysis Oct. 1 1 2 3 5,000 900 Oct. 3 Assets Prepaid Cash + Insurance +$600 -$600 = Liabilities + Stockholders' Equity Debits increase assets: debit Prepaid Insurance $600. Credits decrease assets: credit Cash $600. Oct. 4 Prepaid Insurance Cash (Paid 1-year policy; effective date October 1) Oct. 1 1 2 3 10,000 Oct. 2 3 5,000 4 1,200 10,000 600 600 Prepaid Insurance Cash Posting 900 The asset Cash is decreased $600. Payments of expenses that will benefit more than one accounting period are identified as prepaid expenses or prepayments. When a payment is made, an asset account is debited in order to show the service or benefit that will be received in the future. Therefore, the asset Prepaid Insurance is increased $600. (7) Journal Entry 10,000 Oct. 2 3 5,000 1,200 10,000 On October 4, Sierra paid $600 for a 1-year insurance policy that will expire next year on September 30. Equation Analysis Debit-Credit Analysis Rent Expense 5,000 900 600 Oct. 4 600 c03TheAccountingInformationSystem.qxd 8/3/10 1:33 PM Page 125 The Recording Process Illustrated 125 Illustration 3-28 Purchase of supplies on account Event 8 On October 5, Sierra purchased an estimated 3 months of supplies on account from Aero Supply for $2,500. Basic Analysis The asset Supplies is increased $2,500; the liability Accounts Payable is increased $2,500. Assets (8) Debit-Credit Analysis = Supplies Equation Analysis = +$2,500 Liabilities Accounts Payable +$2,500 + Stockholders' Equity Debits increase assets: debit Supplies $2,500. Credits increase liabilities: credit Accounts Payable $2,500. Journal Entry Oct. 5 Posting Oct. 5 Supplies Accounts Payable (Purchased supplies on account from Aero Supply) Supplies 2,500 2,500 2,500 Accounts Payable Oct. 5 2,500 Illustration 3-29 Hiring of new employees Event 9 Basic Analysis On October 9, Sierra hired four employees to begin work on October 15. Each employee will receive a weekly salary of $500 for a 5-day work week, payable every 2 weeksfirst payment made on October 26. An accounting transaction has not occurred. There is only an agreement that the employees will begin work on October 15. Thus, a debit-credit analysis is not needed because there is no accounting entry. (See transaction of October 26 (Event II) for first payment.) c03TheAccountingInformationSystem.qxd 126 8/3/10 1:33 PM Page 126 chapter 3 The Accounting Information System Illustration 3-30 Payment of dividend Event 10 Basic Analysis Equation Analysis Debit-Credit Analysis Journal Entry On October 20, Sierra paid a $500 cash dividend to stockholders. The Dividends account is increased $500; the asset Cash is decreased $500. = = Assets Cash (10) + Liabilities Stockholders' Equity Dividends -$500 -$500 Debits increase dividends: debit Dividends $500. Credits decrease assets: credit Cash $500. Oct. 20 Dividends Cash (Declared and paid a cash dividend) 500 500 Dividends Cash Posting Illustration 3-31 Payment of cash for employee salaries Oct. 1 1 2 3 10,000 Oct. 2 3 5,000 4 1,200 20 10,000 5,000 900 600 500 Oct. 20 500 Event 11 On October 26, Sierra paid employee salaries of $4,000 in cash. (See October 9 event.) Basic Analysis The expense account Salaries Expense is increased $4,000; the asset Cash is decreased $4,000. Assets Equation Analysis Debit-Credit Analysis Journal Entry Cash (11) = = Liabilities + Stockholders' Equity Expenses -$4,000 -$4,000 Salaries Expense Debits increase expenses: debit Salaries Expense $4,000. Credits decrease assets: credit Cash $4,000. Oct. 26 Salaries Expense Cash (Paid salaries to date) 4,000 4,000 Cash Posting Oct. 1 1 2 3 10,000 Oct. 2 5,000 3 1,200 4 10,000 20 26 Salaries Expense 5,000 900 600 500 4,000 Oct. 26 4,000 c03TheAccountingInformationSystem.qxd 8/3/10 1:33 PM Page 127 The Recording Process Illustrated 127 SUMMARY ILLUSTRATION OF JOURNALIZING AND POSTING The journal for Sierra Corporation for the month of October is summarized in Illustration 3-32. The ledger is shown in Illustration 3-33 (on page 128) with all balances highlighted in red. Illustration 3-32 General journal for Sierra Corporation GENERAL JOURNAL Date Account Titles and Explanation Debit Credit 2012 Oct. 1 1 2 2 3 3 4 5 20 26 Cash Common Stock (Issued stock for cash) 10,000 10,000 Cash Notes Payable (Issued 3-month, 12% note payable for cash) 5,000 Equipment Cash (Purchased equipment for cash) 5,000 Cash Unearned Service Revenue (Received advance from R. Knox for future service) 1,200 Cash Service Revenue (Received cash for services provided) 5,000 5,000 1,200 10,000 10,000 Rent Expense Cash (Paid cash for October office rent) 900 Prepaid Insurance Cash (Paid 1-year policy; effective date October 1) 600 Supplies Accounts Payable (Purchased supplies on account from Aero Supply) 900 600 2,500 2,500 Dividends Cash (Paid a cash dividend) 500 Salaries Expense Cash (Paid salaries to date) 4,000 500 4,000 c03TheAccountingInformationSystem.qxd 128 8/3/10 1:33 PM Page 128 chapter 3 The Accounting Information System Illustration 3-33 General ledger for Sierra Corporation GENERAL LEDGER Cash Oct. 1 1 2 3 10,000 5,000 1,200 10,000 Bal. Oct. Unearned Service Revenue 2 3 4 20 26 Oct. 5,000 900 600 500 4,000 2 1,200 15,200 1,200 Bal. Supplies Common Stock Oct. 5 2,500 Oct. Bal. 2,500 Bal. Prepaid Insurance 1 10,000 10,000 Dividends Oct. 4 600 Oct. 20 500 Bal. 600 Bal. 500 Equipment Service Revenue Oct. 2 5,000 Oct. Bal. 5,000 Bal. Notes Payable Oct. 10,000 10,000 Salaries Expense 1 5,000 Oct. 26 4,000 5,000 Bal. Bal. 4,000 Accounts Payable Oct. 3 5 Rent Expense Oct. 2,500 Bal. 2,500 3 Bal. 900 900 before you go on... POSTING Do it! Selected transactions from the journal of Faital Inc. during its first month of operations are presented below. Post these transactions to T accounts. Date Account Titles July 1 9 24 Action Plan Journalize transactions to keep track of financial activities (receipts, payments, receivables, payables, etc.). To make entries useful, classify and summarize them by posting the entries to specific ledger accounts. Debit Cash Common Stock Accounts Receivable Service Revenue Cash Accounts Receivable Credit 30,000 30,000 6,000 6,000 4,000 4,000 Solution Cash July 1 24 Accounts Receivable 30,000 4,000 July 9 Common Stock July 1 6,000 July 24 4,000 Service Revenue 30,000 Related exercise material: BE3-10, Do it! 3-4, and E3-11. July 9 6,000 c03TheAccountingInformationSystem.qxd 8/3/10 1:33 PM Page 129 The Trial Balance 129 The Trial Balance A trial balance lists accounts and their balances at a given time. A company usually prepares a trial balance at the end of an accounting period. The accounts are listed in the order in which they appear in the ledger. Debit balances are listed in the left column and credit balances in the right column. The totals of the two columns must be equal. The trial balance proves the mathematical equality of debits and credits after posting. Under the double-entry system this equality occurs when the sum of the debit account balances equals the sum of the credit account balances. A trial balance may also uncover errors in journalizing and posting. For example, a trial balance may well have detected the error at Fidelity Investments discussed in the Feature Story. In addition, a trial balance is useful in the preparation of financial statements. These are the procedures for preparing a trial balance: study objective 8 Explain the purposes of a trial balance. 1. List the account titles and their balances. 2. Total the debit column and total the credit column. 3. Verify the equality of the two columns. Illustration 3-34 presents the trial balance prepared from the ledger of Sierra Corporation. Note that the total debits, $28,700, equal the total credits, $28,700. Illustration 3-34 Sierra Corporation trial balance SIERRA CORPORATION Trial Balance October 31, 2012 Debit Cash Supplies Prepaid Insurance Equipment Notes Payable Accounts Payable Unearned Service Revenue Common Stock Dividends Service Revenue Salaries Expense Rent Expense Credit $15,200 2,500 600 5,000 $ 5,000 2,500 1,200 10,000 500 10,000 4,000 900 $28,700 Helpful Hint Note that the order of presentation in the trial balance is: Assets Liabilities Stockholders' equity Revenues Expenses $28,700 LIMITATIONS OF A TRIAL BALANCE A trial balance does not prove that all transactions have been recorded or that the ledger is correct. Numerous errors may exist even though the trial balance column totals agree. For example, the trial balance may balance