Chapter 3

Processing AccountingInformation

External and Internal Events

Event: a happening of consequence to an entity External event: interaction between an entity

and its environment Internal event: occurs entirely within an entity Transaction: any event, external or internal, that

is recognized in a set of financial statements

LO 1

Role of Source Documents in an Accounting System

Source document: used as evidence to record a transaction

Different Forms: Purchase Invoice Sales Invoice Cash register tape Time cards

LO 2

Analyze the Effects of Transactions on the Accounting Equation

Accounting equation:

Assets =Liabilities + Stockholders’ Equity

Issuance of Capital Stock

Glengarry Health Club is started when Karen Bradley and Kathy Drake file articles of incorporation with the state to obtain a charter. Each invests $50,000 in the business. In return, each receives 5,000 shares of capital stock

Acquisition of Property inExchange for a Note

Company buys a piece of property for $200,000. The seller agrees to accept a five-year promissory note. The property consists of land valued at $50,000 and a newly constructed building valued at $150,000

Acquisition of Equipment on anOpen Account

Karen and Kathy contact an equipment supplier and buy $20,000 of exercise equipment: treadmills, barbells, and stationary bicycles. The supplier agrees to accept payment in full in 30 days

Sale of Monthly Memberships on Account

During January, the owners sell 300 monthly club memberships for $50 each, or a total of $15,000. The members have until the 10th of the following month to pay

Sale of Court Time for Cash

In addition to memberships, Glengarry sells court time. Court fees are paid at the time of use and amount to $5,000 for the first month

Payment of Wages and Salaries

Wages and salaries for the first month amount to $10,000

Payment of Utilities

Cost of utilities for the first month is $3,000. Glengarry pays this amount in cash

Collection of Accounts Receivable

Amount received from members in payment of their accounts is $4,000

Payment of Dividends

Karen and Kathy, acting on behalf of Glengarry Health Club, decide to pay a dividend of $1,000 on the shares of stock that each of them owns, or $2,000 in total

Cost Principle

Requires assets such as equipment to be recorded at cost to acquire and continue to report this amount on all balance sheets until the asset is disposed

These assets are not carried at market value, but at original cost (with few exceptions)

Accounts

Account: record used to accumulate monetary amounts for each asset, liability, revenue, expense, and component of stockholders’ equity

Chart of Accounts: numerical list of all of the accounts an entity uses

LO 4

The General Ledger

A book, a file, a hard drive, or another device containing all of the accounts

Identify and Analyze

The accounting equation is the basis for financial statements

For every transaction, three questions must be answered:

1. What type of activity did the transaction reflect?2. What accounts are affected by the transaction, and

are they increased or decreased?3. Which financial statements are affected by the

transaction?

Identify and Analyze

Wages and salaries for the first month amount to $10,000 for Glengarry

T account

T Account: format for showing amounts coming into and leaving an account

Example 3.2—Using a T Account

Debits and Credits

Tools to record increases and decreases in accounts

Debits increase asset accounts, and credits increase liability and stockholders’ equity accounts

Additionally, debits increase expense accounts, and credits increase revenue accounts

LO 5

Summary of the Rules for Increasing and Decreasing Accounts

Example 3.3—Determining Normal Account Balances

Debits and Credits Applied to Transactions

Cash100,000(1)

Capital Stock100,000 (1)

Debits and Credits Applied to Transactions

(2) Acquisition of property in exchange for a note

150,000(2) 200,000 (2)Building Notes Payable

50,000(2)Land

Debits and Credits Applied to Transactions

(3) Acquisition of equipment on an open account

20,000(3) 20,000 (3)Equipment Accounts Payable

Debits and Credits Applied to Transactions

(4) Sale of monthly memberships on account

15,000(4) 15,000 (4)Accounts Receivable Membership Revenue

Debits and Credits Applied to Transactions

T Accounts reflect current and previous

postings to the account for each period

(5) Sale of court time for cash

100,0005,000

(1)(5)

5,000 (5)Cash Court Fee Revenue

Debits and Credits Applied to Transactions

(6) Payment of wages and salaries

100,0005,000

(1)(5)

Cash Wage & Salary Expense10,000(6)10,000 (6)

Debits and Credits Applied to Transactions

(7) Payment of utilities

100,0005,000

(1)(5)

Cash Utilities Expense3,000(7)10,000 (6)

3,000 (7)

Debits and Credits Applied to Transactions

(8) Collection of accounts receivable

Cash100,000

5,00010,000 3,000

4,000

(6)(7)

(1)(5)(8)

Accounts Receivable15,000 4,000 (8)(4)

Debits and Credits Applied to Transactions

Cash100,000

5,00010,000 3,000

4,000 2,000

(9) Payment of dividends

(6)(7)(9)

(1)(5)(8)

Dividends2,000(9)

Journal

Chronological record of a company’s transactions

Book of original entry Transactions are periodically posted from the

journal to ledger accounts Journalizing: act of recording journal entries

LO 6

Posting

Process of transferring amounts from a journal to the ledger accounts

Example 3.6—Posting from the Journal to the Ledger

Trial Balance

List of each account and its balance at a specific point in time

Used to prove the equality of debits and credits Normally prepared at the end of the accounting

period Basis for preparation of financial statements

LO 7

Example 3.7—Preparing a Trial Balance

End of Chapter 3