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Chapter 3

Chapter 3 notes

Financial Accounting
Course Code
G.Quan Fun

of 1
Chapter 3 The Accounting Information System Notes
Accounting Transactions
x accounting information system : the system of collecting and processing transaction data and communicating financial
information to interested parties
x an accounting information system begins with determining what transaction data should be collected and processed
x not all events are recorded and reported as AT, only events that cause changes in A, L, or SE should be recorded
x accounting transaction : an economic event that is recorded in the financial statements because it involves an exchange that
effects assets, liabilities, or shareholders’ equity
Summary of Transactions
x firstly, each transaction must be analyzed for its effect on the three main components of the accounting equation (assets,
liabilities, and shareholders’ equity) and, secondly, the two sides of the equation must always be equal
The Account
x account : an individual accounting record of increases and decreases in a specific asset, liability, or shareholdersequity item
x T account : basic form of an account, with a debit (left) side and a credit (right) side showing effect of transactions on account
Debits and Credits
x debit : the left side of an account
x credit : the right side of an account
x double-entry accounting system : a system that records the dual effect of each transaction in appropriate accounts
Summary of Debit and Credit Effects
x assets are increased by debits, liabilities and shareholders’ equity are increased by credits
Steps in the Recording Process
x the basic steps in the recording process are:
1. analyze each transaction for its effect on the accounts
2. enter the transaction information in a general journal (book of original entry)
3. transfer the information from the general journal to the appropriate accounts in the general ledger (book of accounts)
The Journal
x general journal : the book of original entry in which transactions are recorded in chronological order
x the general journal makes several contributions to the recording process:
1. it discloses complete effect of transaction in one place, including explanation and identification of source document
2. it provides a chronological record of transactions
3. it helps to prevent and locate errors, because debit and credit amounts for each entry can be quickly compared
The Ledger
x general ledger : book of accounts that contains companys assets, liabilities, shareholders’ equity, revenue, expense accounts
x chart of accounts : a list of company’s accounts and account numbers, which identify where the accounts are in general ledger
x posting : the procedure of transferring journal entries to the general ledger accounts
x posting should be done in chronological order, that is, all debits and credits of a journal entry should be posted before going on to
the next journal entry
The Trial Balance
x trial balance : a list of general ledger accounts and their balances at a specific time, usually at the end of the each month
Limitations of a Trial Balance
x errors may exist in the trial balance even though the columns agree, due to many reasons
x in the trial balance as long as equal debits and credits are posted, even to the wrong account or in the wrong amount, the total
debits will equal the total credits; however, it is still useful in preparing financial statements
Summary of Study Objectives
1. Analyze the effects of transactions on the accounting equation. Each business transaction has a dual effect on the accounting
equation. For example, if an individual asset is increased, there must be a corresponding decrease in another asset, or an increase
in a specific liability or in shareholders’ equity.
2. Define debits and credits and explain how they are used to record transactions. The term debit and credit mean the same
thing as left and right, respectively. Assets, dividends, and expenses are increased by debits and decreased by credits. The normal
balance of these accounts is a debit balance. Liabilities, common shares, retained earnings, and revenues are increased by credits
and decreased by debits. The normal balance of these accounts is a credit balance.
3. Identify the basic steps in the recording process. The basic steps in the recording process are (a) analyzing each transaction for
its effect on the accounts, (b) entering the transaction information in a general journal, and (c) posting (transferring) the
information in the general journal to the appropriate accounts in the general ledger. These are also the first three steps in the
accounting cycle.
4. Prepare a trial balance. The preparation of a trial balance is the fourth step in the accounting cycle. The trial balance is a list of
accounts and their balances at a specific time. The main purpose of the trial balance is to prove the mathematical equality of
debits and credits after posting. A trial balance also uncovers errors in journalizing and posting and is useful in preparing
financial statements.