chapter 3

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Rotman Commerce
Alexander Edwards

Chapter 3: The accounting information system Accounting Transaction  Accounting information system: the system of collecting and processing transaction data and communicating financial information to decision-maker is known as the accounting information system.  an accounting system begins with determining what is relevant transaction data should be collected and processed.  Only those events what caused change in assets, liabilities, and shareholder’s equity should be recorded.  Accounting transaction: occurs when assets, liabilities, or shareholder’s equity items change as a result of some economic events. Analyzing transaction Assets = Liabilities + Shareholder’s assets  In order to balance the accounting equation, each transaction will have a dual (double-sided) effect on the equation. For example, if there is an increase in assets, there has to be an increase in liabilities or shareholder’s equity or both by the same amount, in order to balance the accounting equation.  * Read all the transactions in this section for a better idea * The account  Account: is an individual accounting record of increases and decreases in a specific assets, liability or shareholder’s equity item.  In its simplest form, an account consists of 3 parts: (1) the title of the account, (2) a left or debit side, (3) a right or credit side.  T Account: because the alignment of these parts of an account resembles the letter T. It is referred to as a T account.  *See illustration 3-3 in page 113* Debits and Credits  The term debit or Dr means left and the term credit or Cr means right.  Credits and debit are merely directional signals used in the recording process to describe where entries are made in the accounts.  The act of entering an amount in the left side of the account is called debiting the account and the entering an amount in the right side of an account is called crediting the account.  When the 2 side of the account is compared, if the debit amount exceed the credit amount then the account has a debit balance. Conversely, if the credit amount exceeds the debit amount then the account has a credit balance.  Recoding transaction can affect 2 or more accounts and change their balance. The use of debit and credit explains the effect of these changes.  When record transaction, the debit movement of accounts must equal to the credit movements of accounts.  The equality of debits and credits is the basis for the double entry Accounting System, in which the dual (two-sided) affect of each transaction is recorded in appropriate accounts. This system provides a logical method for recording transaction and ensuring that the amounts are recorded accurately.  If every transaction is recorded with equal debits and credits than the sum of all the debits to the accounts must equal to the sum of all the credits.  On the left hand side of the accounting equation which has the asset accounts’ be taxing that increases in asset accounts’ are recorded by debits and the decrease in asset accounts’ are recorded by credits  On the right hand side of the accounting equation, increase and decreases in liabilities and shareholders’ equity have to be recorded opposite from increases and decreases in assets. Therefore, increases in liabilities and shareholders’ equity are recorded by credits and decreases by debits Assets  If we apply the accounting a collation to a T account for assets, we can see that increases in assets must be entered on the left or debit side and decreases in assets must be entered arm them right or credit side.  Asset accounts’ normally showed debit balances, meaning that debits to this specific asset accounts’ should exceed credits to that account.  Knowing accounts level balance may help when you are trying to identify errors Liabilities and shareholders’ equity  Liability and shareholders’ equity accounts are increased by credits and decreased by debits  Increases are entered on the right or credit side of the T account, and decreases are entered on the left or debit side of the T account.  Liability and shareholders’ equity accounts normally show credit balances.  Because assets are on the opposite side of the account in creation from the liabilities and shareholders’ equity, increases and decreases in assets are recorded opposite from increases and decreases in liabilities and shareholders’ equity, therefore this way, the total amount of debits always equals to the total amount of credits and the accounting equation stays in balance.  All assets and liability accounts have the same debit/credit rule procedures, meaning that all asset accounts’ are increased by debits and decreased by credits and all liability accounts are increased by credits and decreased by debits.  However shareholders’ equity consists of different components at they do not all walls in the same direction. Increases and decreases in shareholders’ equity:  Common shares which are issued in exchange for the shareholders’ investment and retained earnings that are the portion of shareholders’ equity that has been accumulated through the profitable operation of the company, both increases shareholders’ equity.  So common shares account increases by crediting and decreases the debiting.  Retained earnings are divided further into revenues and expenses and dividends.  Revenues increases retained earnings which increases the shareholders’ equity, therefore, it increases by crediting.  The normal balance in common shares, retained earnings and revenue accounts is a credit balance  Expense decreases retained earnings which decrease as shareholders’ equity, it increases by debiting  Dividends are a distribution to the shareholders of retained earnings, which reduces retained earnings, and reduces shareholders’ equity, so it increases by debiting and decreases by crediting.  Dividends and expense accounts would have a normal credit balance  Expenses along with revenues combined to determine profit. Since expenses are the negative factor of the calculation of profit and the revenues are the positive factor of the calculation, it is logical that the increase and decrease sites of expense account should be the reverse of revenue accounts. Summary of debit and credit affects Steps in the recording process  The procedures used in the recording process are part of what is called the accounting cycle, which consists of nine steps in total, the first three steps of the accounting cycle is called the recording process  In step one. Each transaction is analyzed to determine if it has an effect on the accounts. Evidence of the transaction comes from a source document, such as a sales slip, cheque, bill, or a register tape.  Deciding whether a transaction has occurred and if so what to record is the most critical point in the accounting process.  In step 2, the transaction information is recorded as a journal entry, in the general journal ( a book of original entry).  In step 3, the information is tr
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