Accounting Records and Systems

1. 4 Accounting Records and Systems

2. Why learn basic record keeping procedures? • Accounting is best learned by doing. • Debit-credit mechanism provides an analytical framework.

3. The Account • Device used for calculating net change • Simplest form is T-account. • Increases listed on one side; decreases listed on other side. • Balanced periodically.

4. Permanent Accounts • = real accounts = balance sheet accounts. • Reported on balance sheet. • Carried forward into next period: • In this sense, they are permanent.

5. Temporary Accounts • Revenue and expense accounts. • Details of income statement and changes in retained earnings (RE). • Helps summarize operating activity. • Avoids cluttering RE account. • At end of accounting period, amounts are totaled, combined and transferred to RE. • Balances at beginning of each period are 0.

6. General Ledger • General ledger contains all accounts. • Some accounts may be in summary form. • E.g. accounts receivable, inventory, fixed assets. • Detail or subsidiary ledgers kept for above.

7. Chart of Accounts • List of all accounts. • Numbers assigned to accounts to make summaries for Balance Sheet and Income Statement easier. • Minimum # is # of BS and IS lines. • Usually many more. • Management determines # of accounts based on information needs. • May be several levels of detail. • Can view as building blocks summarized in various ways.

8. Debit and Credit • Left hand side (LHS) of an account arbitrarily called debit side. • RHS is credit side. • To debit or charge (credit) means to make an entry to LHS (RHS). • For each transaction: • dr. (debit) = cr. (credit) • Assets = Liabilities + Owners’ Equity • Thus double entry bookkeeping.

9. Rules for Dr. and Cr. • Asset accounts: • Increases on LHS (Dr.) • Decreases on RHS (Cr.) • Liability and OE accounts: • Necessarily the opposite to maintain fundamental accounting equation: • Increases on RHS (Cr.) • Decreases on LHS (Dr.)

10. Rules for Dr. and Cr. (Continued) • Revenue and expense accounts can be viewed as part of Retained Earnings or Owners’ Equity. • Since revenues increase RE and expenses decrease RE: • Revenue (& RE) accounts • Increases on RHS (Cr.) • Decreases on LHS (Dr.) • Expense accounts • Increases on LHS (Dr.) • Decreases on RHS (Cr.)

11. Fundamental Accounting Equation Owners’ Equity = Assets Liabilities + Debit Credit Debit Credit Debit Credit - + + - - +

12. Summary of Accounting Process or Accounting Cycle • Analysis of transactions. (Judgment) • Journalize original entries . (Mechanical) • Post from journal to ledger. (Mechanical) • Make adjusting entries. (Judgment) • Journalize and post closing entries. (Mechanical) • Prepare financial statements (Judgment)

13. Transaction Analysis • Assets = Liabilities + Owners’ Equity • Dr. = Cr. • Record which ever half of entry is more obvious. • Example entry for Owner contributing $5,000 cash for stock: Cash 5,000 Paid-in-capital 5,000

14. Balancing Accounts & Trial Balance • Original entries: • Obvious: checks written, sales made, etc. • Trial balance. • List of all accounts & amounts; separate columns for dr. and cr. • Shows equality of dr. and cr. • Still could be errors. • Convenient for making adjusting entries and preparing financial statements (BS & IS).

15. Owner invests $5,000 in Business Cash (1) 5,000 Paid-in-Capital (1) 5,000

16. Firm Pays $750 for Rent Cash (1) 5,000 (2) 750 Prepaid Expense (2) 750

17. Adjusting Entries • Modifies account balances at end of period. • Types: • Recorded costs to be apportioned among 2 or more periods. • Unrecorded expenses. • Recorded revenues to be apportioned over 2 or more periods. • Unrecorded revenues.

18. Adjusting Entries - Exercise #1 • We purchased equipment for $20,000. The equipment has a life of 5 years. • What are the depreciation entries for years 1 and 2? (Assume straight line) • How much is the accumulated depreciation (contra asset) at the end of year 2? • What is a contra asset account? • What is the book value at the end of year 2 ? • What is the fair (or market or current) value of the equipment at the end of year 2?

19. Adjusting Entries - Exercise #2 • Prepare entries for the following: • We purchase office supplies on 1/15 for $14,000. • On hand at YE (12/31) are $3,000 of office supplies.

20. Adjusting Entries - Exercise #3 • Prepare entries for the following: • Credit sales for the year are $1,000,000. • At year end, we estimate we will collect all but approximately 1.5% of our sales from customers due to customers that go bankrupt or disappear.

21. Closing Entries • Temporary or IS accounts are closed out to the clearing account Income Summary (= Profit & Loss Summary = Expense and Revenue Summary). • Close out = zero out = transfer balance to another account • Income summary account is closed out to RE. • Only Permanent Accounts remain open.

22. Journal • Alltransactions are originally recorded or entered in a journal (hence book of original entry). • Journal: • Contains accounts and amounts to be debited and credited. • Device for reclassifying and summarizing. • Amounts are transferred or posted from the journal to the ledger (i.e. T account).

23. Accounting System • Consists of: • Journals. • Ledgers. • Rules for using them. • Manual, computerized, or anything between. • In a computerized system: • Bookkeeping steps are done electronically.

24. Objectives of Accounting System • To process information efficiently (low cost). • To obtain reports quickly. • To ensure a high degree of accuracy. • To minimize possibility of theft or fraud.

25. Internal Accounting Controls • Basic Principle: make it as difficult as is practical for people to be dishonest or careless. • Activities that reduce possibility of theft, or intentional or unintentional mistakes.

26. Examples of Internal Controls • Separation of duties: • Record keeping. • Custody of assets. • Authorization of transactions. • Reconciliations. • Bank accounts. • Detail ledgers to control accounts in general ledger.

27. What a Computer Based Accounting System Does • Mechanical steps are bookkeeping. • A computer based system performs some or all bookkeeping steps: • Records and stores data. • Performs arithmetic operations on data. • Sorts and summarizes data. • Prepares reports.

28. Inputs • Data entry clerk using a keyboard. • Point of origin: Factory time records, inventory counts, receiving records. • Scanning device reading bar codes. • Purchase orders from customer transmitted electronically.

29. Processing and Output Examples • Processing: • Only accept entries if debits equal credits. • Assigning seat numbers for airline, or concert. • Outputs • Reports including tables and graphs. • Routine or customized.

30. Modules • Interconnected software programs. Examples: • Order entry. Processes sales orders, records shipments, and related accounts receivable. • Purchasing: Issues purchase orders. • Personnel and Payroll: Keeps employee records and issues paychecks.

31. Opportunities and Problems with Computer Systems • Efficiency over manual systems. • Off the shelf systems available for small companies. • Modifying to unique complexities of a company may be costly. • Paper trail replaced by electronic records. • Technological advances making systems obsolete. • Challenge of educating users.

32. 4 End of Chapter 4