Overview of a Financial Accounting System

Overview of a Financial Accounting Overview of a Financial Accounting SystemSystem Financial StatementsFinancial Statements Nature of TransactionsNature of Transactions Steps in the Accounting ProcessSteps in the Accounting Process Post-Closing Trial BalancePost-Closing Trial Balance Relationships Among Financial Relationships Among Financial

Statements, Trial Balances, Ledgers, Statements, Trial Balances, Ledgers, Journals, Documents, and Journals, Documents, and TransactionsTransactions

Internal ControlsInternal Controls

Financial StatementsFinancial Statements

= + +Assets Liabilities CapitalStock

RetainedEarnings

Revenues ExpensesNet

Income(Loss)

=+

Balance Sheet - Beginning of the period

I n co m e S tatem en t

= + +Assets Liabilities CapitalStock

RetainedEarnings

Balance Sheet - End of the period

(Dividends)+

Statement of R/E

mmm... it looks like these are fairly stated according to GAAP.

CPA

Nature of TransactionsNature of Transactions Exchanges between business firms, for example:Exchanges between business firms, for example:

– Sale to a customer,Sale to a customer,– Purchase of goods,Purchase of goods,– Payment or receipt of cashPayment or receipt of cash

Adjustments to accounts, for example:Adjustments to accounts, for example:– Recording of accrued salaries,Recording of accrued salaries,– Depreciation expense,Depreciation expense,– Adjustments to prepaid accountsAdjustments to prepaid accounts

Identify theexchanges

oradjustmentsthat must be

recorded

Determinewhich

Accountsare effected

Assignproper

values tothe

transactions

Record thetransactions

in thecorrect time

period

Post thetransactions, summarize

into thefinancial

statements

Steps in the Accounting ProcessSteps in the Accounting Process

TransactionsOccur

DocumentsPrepared

Recorded inJournals

Posted toLedgers

UnadjustedGen. LedgerTrial Balance

AdjustingEntries

Prepared andPostedAdjusted

Trial BalancePrepared

FinancialStatementsPrepared

ClosingEntries Made

NEW YEAR

Transactions OccurTransactions Occur

While a Business Goes While a Business Goes Through Four Major Through Four Major

CyclesCycles

Financial

Cycle

Four Major Cycles of business operations

Expenditure Cycle

Financial

Cycle

$


Expenditure Cycle

Conversion Cycle

Financial

Cycle

$R. M., D.L.,

P. P. Eq.


Expenditure Cycle

Conversion Cycle

Revenue

Cycle

Financial

Cycle

$R. M., D.L.,

P. P. Eq.

Finished

Goods


Expenditure Cycle

Conversion Cycle

Revenue

Cycle

Financial

Cycle

$R. M., D.L.,

P. P. Eq.

Finished

Goods$


Documents Prepared Documents Prepared

Before theBefore thetransactiontransaction

After theAfter thetransactiontransaction

At theAt thesame timesame time

InternallyInternallyPreparedPrepared

ExternallyExternallyPreparedPrepared

PurchasePurchaseorderorder

ReceivingReceivingReportReport

SalesSalesInvoiceInvoice

CustomerCustomerpurchasepurchase

orderorderShippingShipping

DocumentDocumentVendor’sVendor’sInvoiceInvoice

Record in JournalsRecord in Journals Every transaction during an Every transaction during an

accounting period is accounting period is recorded in a journal,recorded in a journal,

Debits and credits for each Debits and credits for each transaction must be equal,transaction must be equal,

Use of special journals Use of special journals reduces the recording costs reduces the recording costs and facilitates the search and facilitates the search process.process.

The number and titles of The number and titles of special journals will depend special journals will depend on the accounting on the accounting information needs and information needs and system design preferences system design preferences of management.of management.

Typical Journals:Typical Journals:– Sales Journal,Sales Journal,– Cash Receipts Cash Receipts

Journal,Journal,– Purchases Journal,Purchases Journal,– Cash Cash

disbursements disbursements journal,journal,

– Payroll journal,Payroll journal,– General journal.General journal.

Post to LedgersPost to Ledgers General LedgerGeneral Ledger

– The number and description of general ledger The number and description of general ledger accounts depend on the needs of the accounts depend on the needs of the management and all account titles for a company management and all account titles for a company are included in the chart of accounts.are included in the chart of accounts.

– All transactions must be posted from the journals All transactions must be posted from the journals to the general ledger before financial statements to the general ledger before financial statements are prepared. When specialized journals are are prepared. When specialized journals are used some similar transactions are grouped and used some similar transactions are grouped and only the total amount is posted to the general only the total amount is posted to the general ledger.ledger.

– It includes the accumulated total of all It includes the accumulated total of all transactions, since the inception of the company.transactions, since the inception of the company.

Post to LedgersPost to Ledgers Subsidiary LedgersSubsidiary Ledgers

– Used to handle Used to handle detailed information detailed information for a general ledger for a general ledger account.account.

– Agrees in total to the Agrees in total to the corresponding corresponding general ledger general ledger account.account.

– Same amounts are Same amounts are posted to both posted to both subsidiary and subsidiary and general ledgers.general ledgers.

Typical Subsidiary Typical Subsidiary Ledgers:Ledgers:– Accounts receivable,Accounts receivable,– Accounts payable,Accounts payable,– Delivery equipment,Delivery equipment,– Depreciation Depreciation

expense,expense,– Accumulated Accumulated

depreciation,depreciation,– Common stock,Common stock,– InventoryInventory

Unadjusted General Ledger Trial Unadjusted General Ledger Trial BalanceBalance List of all general ledger accounts,List of all general ledger accounts, Prepared as an aid in preparing adjusting Prepared as an aid in preparing adjusting

entries.entries. Before an unadjusted trial balance is prepared Before an unadjusted trial balance is prepared

all the transactions other than adjusting entries all the transactions other than adjusting entries must be recorded in the journals and posted to must be recorded in the journals and posted to the ledgers.the ledgers.

Prepare and Post Adjusting Prepare and Post Adjusting EntriesEntries Prepared at the end of the period before the Prepared at the end of the period before the

preparation of the financial statements,preparation of the financial statements, every adjusting entry effects both the balance every adjusting entry effects both the balance

sheet and the income statement,sheet and the income statement, Total debits = total credits, for each adjusting Total debits = total credits, for each adjusting

entry,entry, recorded in the general journal,recorded in the general journal, each prepared separately,each prepared separately, posted individually to the proper ledger account,posted individually to the proper ledger account, most adjusting entries are not posted to most adjusting entries are not posted to

subsidiary ledgers.subsidiary ledgers.

Six General Types of Adjusting Six General Types of Adjusting EntriesEntries Prepaid expensePrepaid expense Accrued expenseAccrued expense Accrued revenueAccrued revenue Unearned revenueUnearned revenue Estimated itemsEstimated items Inventory adjustmentInventory adjustment

WorksheetWorksheet

Account Unadjusted Trial Balance Adjustments Adjusted Trial

BalanceIncome

Statement Balance SheetAccount UnadjustedTrial BalanceAdjustments Adjusted

Trial Balance

IncomeStatementBalance Sheet

Income Summary - Net Income (Loss)

Prepare Financial StatementsPrepare Financial Statements Income statement, retained earnings statement, Income statement, retained earnings statement,

balance sheet, and cash flow statementbalance sheet, and cash flow statement Descriptions and details must be stated Descriptions and details must be stated

according to GAAP,according to GAAP, Similar account balances are summarized in to Similar account balances are summarized in to

summary accounts,summary accounts, Accounts are grouped, current and non-current, Accounts are grouped, current and non-current,

operating and non-operating, etc.operating and non-operating, etc. Footnotes and other required disclosures made.Footnotes and other required disclosures made.

Closing Entries MadeClosing Entries Made At the end of each accounting yearAt the end of each accounting year, all , all nominal nominal

accounts accounts are closed.are closed. We don’t necessarily close the accounts every time we We don’t necessarily close the accounts every time we

prepare the financial statements, prepare the financial statements, only at the year endonly at the year end.. Nominal accounts Nominal accounts are:are:

– Revenue accounts, closed to Income Summary.Revenue accounts, closed to Income Summary.– Expense accounts, closed to Income Summary.Expense accounts, closed to Income Summary.– Income Summary Account, closed to R/E.Income Summary Account, closed to R/E.– Dividend Account, closed to R/E.Dividend Account, closed to R/E.– Drawing accounts in partnerships and sole Drawing accounts in partnerships and sole

proprietorships, closed to the partner’s Capital Acc.proprietorships, closed to the partner’s Capital Acc.

Closing EntriesClosing Entries Complete the accounting process for the current Complete the accounting process for the current

period, period, Prepared after all the adjustments are recorded Prepared after all the adjustments are recorded

in the journals and posted to the ledger.in the journals and posted to the ledger. All nominal accounts All nominal accounts mustmust be closed out, so that be closed out, so that

the company starts a new year with zero the company starts a new year with zero balance in those accounts.balance in those accounts.

Each closing entry must be recorded in the Each closing entry must be recorded in the general journal and individually posted to the general journal and individually posted to the appropriate general ledger account.appropriate general ledger account.

FlowchartingFlowcharting Need for a written description of an Accounting Need for a written description of an Accounting

System,System, Narrative descriptions,Narrative descriptions, FlowchartsFlowcharts

– Systems flowchartSystems flowchart– Internal control flowchartInternal control flowchart– Program flowchartProgram flowchart

Flowcharting symbols,Flowcharting symbols, Flowcharting techniques,Flowcharting techniques, Overall approach.Overall approach.

Need for a Written DescriptionNeed for a Written Description Completeness and effectiveness of an accounting Completeness and effectiveness of an accounting

system,system, Provides a record for training new employees and Provides a record for training new employees and

reminding old ones how the system should reminding old ones how the system should operate,operate,

Assists in making improvements to the existing Assists in making improvements to the existing system,system,

Serves as a communication tool in explaining the Serves as a communication tool in explaining the systemsystem– to company personnelto company personnel– to people out side the company such as to people out side the company such as

independent auditors.independent auditors.

A Description of an AIS should A Description of an AIS should includeinclude The origin of every document and record in the The origin of every document and record in the

system,system, All processing that takes place,All processing that takes place, The disposition of every document and record in the The disposition of every document and record in the

system. Such as filing, sending documents to system. Such as filing, sending documents to customers or other departments, or destroying customers or other departments, or destroying documents.documents.

The department or personnel performing the duties.The department or personnel performing the duties. The existing internal controlsThe existing internal controls

– separation of dutiesseparation of duties– authorizations and approvalsauthorizations and approvals– internal verificationinternal verification

Narrative DescriptionsNarrative Descriptions A written description of a company's AIS.A written description of a company's AIS. It is difficult to describe a complex accounting It is difficult to describe a complex accounting

system in a narrative,system in a narrative, Lengthy explanations are difficult to understand Lengthy explanations are difficult to understand

and remember.and remember. However, it is OK to use narratives for simple However, it is OK to use narratives for simple

systems if it is simple and it includes all the systems if it is simple and it includes all the important information a description should important information a description should include.include.

FlowchartsFlowcharts A graphical description.A graphical description. Three common types of flowcharts are used in Three common types of flowcharts are used in

describing an AIS,describing an AIS,– Systems flowchartSystems flowchart, shows the flow of , shows the flow of

documents and records in the organization.documents and records in the organization.– Internal control flow chartInternal control flow chart, same as a systems , same as a systems

flowchart but also shows the segregation of flowchart but also shows the segregation of duties, and other internal controls.duties, and other internal controls.

– Program flowchart,Program flowchart, very detailed and usually very detailed and usually used only by the programmers and other used only by the programmers and other computer specialists.computer specialists.