Chap 3: The Accounting Information System

DEPRECIATION

Depreciation is the process of allocating the cost of an asset to expense over its useful life in a rational and systematic manner.

POSTING.

The process of transferring the essential facts and figures from the book of original entry to the ledger accounts.

CONTRA ASSET ACCOUNT

A contra asset account offsets an asset account on the balance sheet. Accumulated Depreciation—Equipment is a contra asset account. This means that the Accumulated Depreciation—Equipment account offsets the Equipment account on the balance sheet.

EVENT

A happening of consequence. An event generally is the source or cause of changes in assets, liabilities, and equity. Events may be external or internal.

ACCOUNT.

A systematic arrangement that shows the effect of transactions and other events on a specifi c element (asset, liability, and so on). Companies keep a separate account for each asset, liability, revenue, and expense, and for capital (owners' equity). Because the format of an account often resembles the letter T, it is sometimes referred to as a T-account.

TRANSACTION.

An external event involving a transfer or exchange between two or more entities.

DEFERRALS

Deferrals are expenses or revenues that are recognized at a date later than the point when cash was originally exchanged. The two types of deferrals are prepaid expenses and unearned revenues.

ADJUSTING ENTRIES.

Entries made at the end of an accounting period to bring all accounts up to date on an accrual basis, so that the company can prepare correct financial statements.

FINANCIAL STATEMENTS.

Statements that reflect the collection, tabulation, and final summarization of the accounting data. Four statements are involved: (1) The balance sheet shows the financial condition of the enterprise at the end of a period. (2) The income statement measures the results of operations during the period. (3) The statement of cash flows reports the cash provided and used by operating, investing, and financing activities during the period. (4) The statement of retained earnings reconciles the balance of the retained earnings account from the beginning to the end of the period.

JOURNAL.

The "book of original entry" where the company initially records transactions and selected other events. Various amounts are transferred from the book of original entry, the journal, to the ledger. Entering transaction data in the journal is known as journalizing.

LEDGER.

The book (or computer printouts) containing the accounts. A general ledger is a collection of all the asset, liability, owners' equity, revenue, and expense accounts. A subsidiary ledger contains the details related to a given general ledger account.

BOOK VALUE

The book value of any depreciable asset is the difference between its cost and its related accumulated depreciation.

CLOSING ENTRIES.

The formal process by which the enterprise reduces all nominal accounts to zero and determines and transfers the net income or net loss to an owners' equity account. Also known as "closing the ledger," "closing the books," or merely "closing." The closing process reduces the balance of nominal (temporary) accounts to zero in order to prepare the accounts for the next period's transactions.

REAL AND NOMINAL ACCOUNTS.

Real (permanent) accounts are asset, liability, and equity accounts; they appear on the balance sheet. Nominal (temporary) accounts are revenue, expense, and dividend accounts; except for dividends, they appear on the income statement. Companies periodically close nominal accounts; they do not close real accounts.

TRIAL BALANCE.

The list of all open accounts in the ledger and their balances. The trial balance taken immediately after all adjustments have been posted is called an adjusted trial balance. A trial balance taken immediately after closing entries have been posted is called a post-closing (or after-closing) trial balance. Companies may prepare a trial balance at any time.

ADJUSTED TRIAL BALANCE

The purpose of an adjusted trial balance is to prove the equality of the total debit balances and the total credit balances in the ledger after all adjustments. Because the accounts contain all data needed for financial statements, the adjusted trial balance is the primary basis for the preparation of financial statements.

DEBIT (Dr.) & CREDIT (Cr.)

The terms debit (Dr.) and credit (Cr.) mean left and right, respectively. These terms do not mean increase or decrease, but instead describe where a company makes entries in the recording process. That is, when a company enters an amount on the left side of an account, it debits the account. When it makes an entry on the right side, it credits the account. When comparing the totals of the two sides, an account shows a debit balance if the total of the debit amounts exceeds the credits. An account shows a credit balance if the credit amounts exceed the debits.

POST-CLOSING TRIAL BALANCE

The trial balance after closing is called the post-closing trial balance. The purpose of the post-closing trial balance is to prove the equality of the permanent account balances that the company carries forward into the next accounting period. Since all temporary accounts will have zero balances, the post-closing trial balance will contain only permanent (real)—balance sheet—accounts.