3

The Accounting Information System

CHAPTER LEARNING OBJECTIVES

1. Describe the basic accounting information system.
2. Record and summarize basic transactions.
3. Identify and prepare adjusting entries.
4. Prepare financial statements from the adjusted trial balance and prepare closing entries.
5. Prepare financial statements for a merchandising company

6. Differentiate the cash basis of accounting from the accrual basis of accounting.
*7. Identify adjusting entries that may be reversed.
*8. Prepare a 10-column work sheet.
*9. Compare the accounting information systems under GAAP and IFRS.

CHAPTER REVIEW

1. Chapter 3 presents a concise yet thorough review of the accounting process. The basic
elements of the accounting process are identified and explained, and the way in which these
elements are combined in completing the accounting cycle is described.

Accounting Information System

2. (L.O. 1) The accounting information system collects and processes transaction data
and then disseminates the financial information to interested parties. To understand the
accounting process, one must be aware of the basic terminology employed in the process. The
basic terminology includes: events, transactions, accounts, real accounts, nominal
accounts, ledger, journal, posting, trial balance, adjusting entries, financial statements,
and closing entries. These terms refer to the various activities that make up the accounting
cycle. As we review the steps in the accounting cycle, the individual terms will be defined.
3. Double-entry accounting refers to the process used in recording transactions. The terms
debit and credit are used in the accounting process to indicate the effect a transaction has on
account balances. Also, the debit side of any account is the left side; the right side is the credit
side. Assets and expenses are increased by debits and decreased by credits. Liabilities, owners’
equity, and revenues are decreased by debits and increased by credits.

The Accounting Cycle

4. In a double-entry system, for every debit there must be a credit and vice-versa. This leads
us, then, to the basic equation in accounting: Assets = Liabilities + Stockholders’ Equity.


Note: All asterisked (*) items relate to material contained in the Appendices to the chapter.
3-2 Student Study Guide for Intermediate Accounting, 17th Edition

5. The first step in the accounting cycle is analysis of transactions and selected other
events. The purpose of this analysis is to determine which events represent transactions that
should be recorded.
6. Events can be classified as external or internal. External events are those between the
enterprise and its environment, whereas internal events relate to transactions totally within the
enterprise.

Journalizing

7. (L.O. 2) Transactions are initially recorded in a journal, sometimes referred to as the

book of original entry. A general journal is merely a chronological listing of transactions
expressed in terms of debits and credits to particular accounts. In addition to a general journal,
specialized journals are used to accumulate transactions possessing common characteristics.

Posting

8. The next step in the accounting cycle involves transferring amounts entered in the journal
to the general ledger. The ledger is a book that usually contains a separate page for each
account. Transferring amounts from a journal to the ledger is called posting. Transactions
recorded in a general journal must be posted individually, whereas entries made in specialized
journals are generally posted by columnar total.

Trial Balance

9. The next step in the accounting cycle is the preparation of a trial balance. A trial balance
is a list of all open accounts in the general ledger and their balances. While a company may
prepare a trial balance at any time in the accounting cycle, companies usually prepare one at the
end of an accounting period. A trial balance prepared after posting has been completed serves to
check the mechanical accuracy of the posting process and provides a listing of accounts to be
used in preparing financial statements.

Adjusting Entries

10. (L. O. 3) Preparation of adjusting journal entries is the next step in the accounting cycle.
Adjusting entries are entries made at the end of accounting period to bring all accounts up to date
on an accrual accounting basis so that correct financial statements can be prepared. Adjusting
entries are necessary to achieve a proper matching of revenues and expenses in the
determination of net income for the current period and to achieve an accurate statement of the
assets and equities existing at the end of the period. One common characteristic of adjusting
entries is that they affect at least one real account (asset, liability, or equity account) and one
nominal account (revenue or expense account). Adjusting entries can be classified as: (1)
deferrals (prepaid expenses, unearned revenues), or (2) accruals (accrued revenues,
accrued expenses).
11. Deferrals are expenses or revenues that are recognized at a date later than the point
when cash was originally exchanged. Accrued revenues and accrued expenses are revenues
and expenses recognized in the current period for which the corresponding payment or receipt of
cash is to occur in a future period. Estimated items are expenses such as bad debts and
depreciation whose amounts are a function of unknown future events or developments.
 Chapter 3: The Accounting Information System 3-3

Adjusted Trial Balance

12. After adjusting entries are recorded and posted, an adjusted trial balance is prepared. It
shows the balance of all accounts at the end of the accounting period. 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.

Financial Statements

13. (L.O. 4) From the adjusted trial balance a company can directly prepare its financial
statements.

Closing-Basic Process

14. After financial statements have been prepared, nominal (revenues and expenses)
accounts should be reduced to zero in preparation for recording the transactions of the next
period. This closing process requires recording and posting of closing entries. All nominal
accounts are reduced to zero by closing them through the Income Summary account. The net
balance in the Income Summary account is equal to net income or net loss for the period. The net
income or net loss for the period is transferred to stockholders’ equity by closing the Income
Summary account to Retained Earnings.

Post-Closing Trial Balance

15. A third trial balance may be prepared after the closing entries are recorded and posted.
This post-closing trial balance shows that equal debits and credits have been posted properly
to the Income Summary account.

Reverse Entries

16. After closing the books, a company may reverse some of the adjusting entries before
recording the regular transactions of the next period.
17. In summary, the steps in the accounting cycle performed every fiscal period are as
follows:
a. Enter the transactions of the period in appropriate journals.
b. Post from the journals to the ledger (or ledgers).
c. Take an unadjusted trial balance.
d. Prepare adjusting journal entries and post them to the ledger(s).
e. Take a trial balance after adjusting (adjusted balance).
f. Prepare the financial statements from the adjusted trial balance.
g. Prepare closing journal entries and post them to the ledger(s).
h. Take a trial balance after closing (post-closing trial balance).
i. Prepare reversing entries (optional) and post them to the ledger(s).

Prepare Financial Statements for a Merchandising Company

18. (L.O. 5) The financial statements for a merchandiser differ from those for a service
company as a merchandiser must account for gross profit on sales, income from operations,
income before taxes, and net income. The accounting cycle, however, is performed the same.
3-4 Student Study Guide for Intermediate Accounting, 17th Edition

Cash Versus Accrual Basis Accounting

*19. (L.O. 6) Cash Basis Accounting Versus Accrual Basis Accounting, is presented in
Appendix A of Chapter 3 for the purpose of demonstrating the difference between cash basis and
accrual basis accounting. Under the strict cash basis of accounting, revenue is recognized only
when cash is received, and expenses are recorded only when cash is paid. The accrual basis of
accounting recognizes revenue when the performance obligation is satisfied and expenses when
incurred without regard to the time of receipt or payment of cash.

*Reversing Entries

*20. (L.O. 7) Appendix B covers preparation and posting of reversing entries, the final step in
the accounting cycle. A reversing entry is made at the beginning of the next accounting period
and is the exact opposite of the adjusting entry made in the previous period. The recording of
reversing entries is an optional step in the accounting cycle that may be performed at the
beginning of the next accounting period. The entries subject to reversal are the adjusting entries
for accrued revenues and accrued expenses recorded at the close of the previous accounting
period.

Work Sheet

*21. (L.O. 8) Appendix C covers the use of a multicolumn (8, 10, 12, etc.) work sheet, which
serves as an aid to the accountant in adjusting the account balances and preparing the financial
statements. The work sheet provides an orderly format for the accumulation of information
necessary for preparation of financial statements. Use of a work sheet does not replace any
financial statements, nor does it alter any of the steps in the accounting cycle.

*IFRS Insights

*22. (L.O. 9) Since the passage of the Sarbanes-Oxley Act of 2002 (SOX), companies that
trade on U.S. exchanges are required to place renewed focus on their accounting systems to
ensure accurate reporting. There is continuing debate, however, whether foreign issuers should
have to comply with this extra layer of regulation.
*23. The overriding principle in converting to IFRS is full retrospective application of IFRS.
Retrospective application—recasting prior financial statements on the basis of IFRS—provides
financial statement users with comparable information.

GLOSSARY
Account. A systematic arrangement that shows the effect of
transactions and other events on a specific asset, liability or
equity.
Accrued expenses. Expenses incurred but not yet paid.
Accrued revenue. Revenues for which the performance obligation has been
satisfied, but for which cash has not yet been received.
Adjusted trial balance. A trial balance prepared immediately after all adjustments
have been posted.
 Chapter 3: The Accounting Information System 3-5

Adjusting entries. Entries made at the end of an accounting period to bring all
accounts up to date on an accrual accounting basis.
Balance sheet. The financial statement that shows the financial condition of
the enterprise at the end of the period.
Closing entries. The formal process by which all nominal accounts are
reduced to zero and the net income or net loss is
determined and transferred to the owners’ equity account.
Credit. The right side of an account.
Debit. The left side of an account.
Double-entry system. A system that records the dual effect of each transaction in
its appropriate account.
Event. A happening of consequence.
External event. A transaction between an entity and its environment.
Financial statements. Statements that reflect the collection, tabulation, and final
summarization of the accounting data.
General ledger. A collection of all the asset, liability, owners’ equity, revenue,
and expense accounts.
Income statement. The financial statement which measures the results of
operations during the period.
Internal event. A transaction that occurs within an entity.
Journal. The book of original entry where transactions and selected
other events are initially recorded.
Ledger. The book containing the accounts.
Nominal accounts. Nominal (temporary) accounts are revenue, expense and
dividend accounts; except for dividends, they appear on the
income statement.
Post-closing trial balance. A trial balance prepared immediately after closing entries
have been posted.
Posting. The process of transferring the essential facts and figures
from the book of original entry (journal) to the ledger
accounts.
Prepaid expense. An item paid and recorded in advance of its use or
consumption, part of it properly represents expense of the
current period and part represents an asset on hand at the
end of the period.
Real accounts. Real (permanent) accounts are asset, liability, and equity
accounts and they appear on the balance sheet.
*Reversing entries. Entries at the beginning of the next accounting period that
are the exact opposite of the adjusting entries made in the
previous period.
3-6 Student Study Guide for Intermediate Accounting, 17th Edition

Statement of cash flows. The financial statement which measures the cash provided
and used by operating, investing, and financing activities
during the period.
Statement of retained earnings. The financial statement which reconciles the balance of the
retained earnings account from the beginning to the end of
the period.
Subsidiary ledger. Contains the details related to a given general ledger
account.
Transaction. An external event involving a transfer or exchange between
two or more entities.
Trial balance. A list of all open accounts in the ledger and their balances.
Unearned revenue. Cash received and recorded as a liability because the
service obligation has not yet been satisfied by providing
goods or services to customers.
*Work sheet. A worksheet or spreadsheet used to help a company
prepare its financial statements.

CHAPTER OUTLINE

Fill in the outline presented below.

(L.O. 1) Basic Terminology

Double-Entry Recording Process

Identifying Steps in the Accounting Cycle

(L.O. 2) Journalizing

Posting to the Ledger

Trial Balance

(L.O. 3) Adjustments
 Chapter 3: The Accounting Information System 3-7

Chapter Outline (continued)

Prepaid Expense

Unearned Revenue

Accrued Liabilities or Expenses

Accrued Assets or Revenues

(L.O. 4) Prepare the Financial Statements

Closing Entries

Post-Closing Trial Balance

(L.O. 5) Prepare Financial Statements for a Merchandising Company

*(L.O. 6) Accrual versus Cash Basis

*(L.O. 7) Reversing Entries

*(L.O. 8) Using a Work Sheet

3-8 Student Study Guide for Intermediate Accounting, 17th Edition

REVIEW QUESTIONS AND EXERCISES

TRUE-FALSE

Indicate whether each of the following is true (T) or false (F) in the space provided.
_____ 1. (L.O. 1) Real (permanent) accounts are revenue and expense accounts and are
periodically closed.
_____ 2. (L.O. 1) In general, debits refer to increases in account balances, and credits refer
to decreases.
_____ 3. (L.O. 1) An example of an internal event would be a flood that destroyed a portion
of an entity’s inventory.
_____ 4. (L.O. 1) Double-entry accounting is the process that leads to the basic equality in
accounting expressed by the formula: assets = liabilities + stockholders’ equity.
_____ 5. (L.O. 2) A general journal may be used by any entity in recording its transactions,
whereas special journals may be used only by entities whose transactions meet
certain requirements.
_____ 6. (L.O. 2) If an entity fails to post one of its journal entries to its general ledger, the
trial balance will not show an equal amount of debit and credit balance accounts.
_____ 7. (L.O. 2) One purpose of a trial balance is to prove that debits and credits of an
equal amount are in the general ledger.
_____ 8. (L.O. 3) Adjusting entries are an optional step in the accounting process.
_____ 9. (L.O. 3) Adjusting entries are used to correct errors that occur during the posting
process.
_____ 10. (L.O. 3) Adjusting entries result from compliance with the revenue recognition and
expense recognition principles.
_____ 11. (L.O. 3) An adjustment for salaries and wages expense, incurred but unpaid at
year end, is an example of an accrued liability.
_____ 12. (L.O. 3) Bad debts are recorded in the period in which the sale was made to
ensure that receivables are reported at their net realizable value.
_____ 13. (L.O. 4) The Income Summary account used during the closing process is shown
in the stockholders’ equity section of the balance sheet.
_____ 14. (L.O. 4) It is not necessary to post the closing entries to the ledger accounts
because new revenue and expense accounts will be opened in the subsequent
accounting period.
_____ 15. (L.O. 4) The Interest Expense account is credited during the closing process.
_____ 16. (L.O. 4) The post-closing trial balance consists of asset, liability, stockholders’
equity, revenue and expense accounts.
_____ *17. (L.O. 7) Use of reversing entries does not change the amounts reported in the
financial statements for the previous period.
_____ *18. (L.O. 7) Reversing entries are made at the end of the accounting cycle to correct
errors in the original recording of transactions.
 Chapter 3: The Accounting Information System 3-9

_____ *19. (L.O. 7) In general, reversing entries are used for two types of adjusting entries:
accrued revenues and accrued expenses.
_____ *20. (L.O. 8) A worksheet completed through the adjusted trial balance column
provides the information needed for preparation of the financial statements without
reference to the ledger or other records.
_____ *21. (L.O. 8) The use of a worksheet at the end of each month or quarter permits the
preparation of interim financial statements even though the books are closed only
at the end of each year.
_____ *22. (L.O. 8) An adjusted trial balance that shows equal debit and credit columnar totals
proves the accuracy of the adjusting entries.

MULTIPLE CHOICE

Select the best answer for each of the following items and enter the corresponding letter in the
space provided.

_____ 1. (L.O. 1) The accounting equation (A = L + SE) must remain in balance:

A. throughout each step in the accounting cycle.
B. only when journal entries are recorded.
C. only at the time the trial balance is prepared.
D. only when formal financial statements are prepared.

_____ 2. (L.O. 1) Which of the following is correct regarding double-entry accounting?

A. Each transaction is recorded twice, once in the general journal and once in a
specialized journal.
B. Each transaction must involve two entries, either two debits, two credits, or one
debit and one credit.
C. Each transaction must result in equal amounts of debits and credits.
D. Each transaction appears in at least two of the financial statements.

_____ 3. (L.O. 2) A trial balance prepared at year end showed Puccineli Co.’s debit total
exceeding the credit total by $6,300. This discrepancy could have been caused by:
A. the balance of $47,000 in accounts receivable being entered in the trial
balance as $40,700.
B. an error in adding the Sales Journal.
C. the balance of $700 in the Equipment account being entered as a debit of
$7,000.
D. a net loss of $6,300.

_____ 4. (L.O. 2) Which of the following is not a principal purpose of an unadjusted trial
balance?
A. It proves that debits and credits of equal amounts are in the ledger.
B. It is the basis for any adjustments to the account balances.
C. It supplies a listing of open accounts and their balances.
D. It proves that debits and credits were properly entered in the ledger accounts.
3 - 10 Student Study Guide for Intermediate Accounting, 17th Edition

_____ 5. (L.O. 3) Which of the following journal entries is appropriate when a company
receives payment in advance for goods or services?
A. Debit cash and credit an expense account.
B. Credit cash and debit a revenue account.
C. Debit cash and credit a liability account.
D. Credit cash and debit a liability or revenue account.

_____ 6. (L.O. 3) During the first year of Wisnewski Co.’s operations, all purchases were
recorded as assets. Store supplies in the amount of $6,540 were purchased.
Actual year-end store supplies inventory amounted to $2,150. The adjusting entry
for store supplies will:
A. increase net income $4,390.
B. increase expenses by $4,390.
C. decrease store supplies by $6,540.
D. debit accounts payable for $2,150.

_____ 7. (L.O. 3) An adjusting entry should never include:

A. a debit to expense and a credit to a liability.
B. a debit to expense and a credit to revenue.
C. a debit to a liability and a credit to revenue.
D. a debit to revenue and a credit to a liability.

_____ 8. (L.O. 3) Which of the following is an example of an accrued liability?

A. Supplies purchased at the beginning of the year and debited to an expense
account.
B. Property taxes incurred during the year, to be paid in the first quarter of the
subsequent year.
C. Depreciation expense.
D. Rent, provided as a service during the period, cash to be received next year.

_____ 9. (L.O. 3) A prepaid expense can best be described as an amount:

A. Paid and currently matched with earnings.
B. Paid and not currently matched with earnings.
C. Not paid and not currently matched with earnings.
D. Not paid and currently matched with earnings.

_____ 10. (L.O. 3) Rent collected in advance by a landlord is a (an):

A. Accrued liability.
B. Deferred asset.
C. Accrued revenue.
D. Unearned revenue.

_____ 11. (L.O. 3) An accrued expense can best be described as an amount:

A. Paid and not currently matched with earnings.
B. Not paid and currently matched with earnings.
C. Not paid and not currently matched with earnings.
D. Paid and currently matched with earnings.
 Chapter 3: The Accounting Information System 3 - 11

_____ 12. (L.O. 3) The Murphy Company sublet a portion of its warehouse for five years at
an annual rental of $24,000, beginning on May 1, 2020. The tenant, Sheri Charter,
paid one year’s rent in advance, which Murphy recorded as a credit to unearned
rental income. Murphy reports on a calendar-year basis. The adjustment on
December 31, 2020 for Murphy should be:
Dr. Cr.
A. No entry
B. Unearned rental income 8,000
Rental income 8,000
C. Rental income 8,000
Unearned rental income 8,000
D. Unearned rental income 16,000
Rental income 16,000

_____ 13. (L.O. 4) Which of the following statements best describes the purpose of closing
entries?
A. To facilitate posting and preparing a trial balance.
B. To determine the amount of gain or loss for the period.
C. To reduce the balances of revenue and expense accounts to zero so that they
may be used to accumulate the revenues and expenses of the next period.
D. To complete the record of various transactions that were started in a prior
period.

_____ 14. (L.O. 4) If expenses are greater than revenues, the Income Summary account will
be closed by a debit to:
A. Income Summary and a credit to Cash.
B. Income Summary and a credit to Retained Earnings.
C. Cash and a credit to Income Summary.
D. Retained Earnings and a credit to Income Summary.

_____ 15. (L.O. 4) With regard to the accounting cycle, which of the following pairings of
activities provides a correct chronology?
A. The financial statements are prepared and later an adjusted trial balance is
prepared.
B. Reversing entries are prepared and later a post-closing trial balance is
prepared.
C. Closing entries are prepared and later financial statements are prepared.
D. Transactions are journalized and later posted to the ledger.

_____ *16. (L.O. 7) When a company makes reversing entries

A. it credits all cash payments of expenses to the related expense account.
B. it debits all cash payments of expenses to the related expense account.
C. it debits all cash receipts to the related revenue account.
D. all subsequent cash receipts and cash payments are credited to Income
Summary.
3 - 12 Student Study Guide for Intermediate Accounting, 17th Edition

_____ *17. (L.O. 7) If the following journal entry was made for the purchase of a three-year
insurance policy in February of the first year, would an adjusting entry and/or a
reversing entry be appropriate at the end of the first year?
Unexpired Insurance 3,000
Cash 3,000
Adjusting Entry Reversing Entry
A. Yes No
B. No Yes
C. Yes Yes
D. No No

_____ *18. (L.O. 8) A worksheet

A. can be used in place of financial statements.
B. is a formal device for accumulating, sorting, and recording information in the
general ledger.
C. is used to record and post the closing entries.
D. provides considerable assurance the company properly handled all of the
details related to end-of-period accounting.

REVIEW EXERCISES
1. (L.O. 3, 4) The accounts listed below have been taken from Davies Co.’s general ledger
as of December 31, 2020. The accounts all have normal balances. This is the end of Davies Co.’s
first year of operations.
Cash ............................................................................. $ 34,000
Buildings (net) .............................................................. 210,000
Note Payable................................................................ 72,000
Salary Expense ............................................................ 19,000
Inventory ...................................................................... 36,000
Accounts Payable ........................................................ 60,000
Common Stock............................................................. 185,000
Accounts Receivable.................................................... 48,000
Sales ............................................................................ _____
Notes Receivable ......................................................... 22,000
Bonds Payable ............................................................. 75,000
Rent Expense............................................................... 15,000
Land ............................................................................. 125,000
Cost of Goods Sold ...................................................... 165,000
Tax Expense ................................................................ 20,000
Tax Payable ................................................................. 31,000
Determine sales for the year and prepare the following items for Davies Co. as of the year
ended December 31, 2020:
a. trial balance,
b. income statement, and
c. balance sheet.
 Chapter 3: The Accounting Information System 3 - 13

a. ________________________________________________________________________
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b. ________________________________________________________________________
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3 - 14 Student Study Guide for Intermediate Accounting, 17th Edition

c. ________________________________________________________________________
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2. (L.O. 4) The following changes occurred in the account balances of Cihla’s Corporation
during 2020.
Accounts Increasing Amount
Cash $50,000
Inventory 30,000
Building 25,000
Capital Stock 30,000
Additional Paid-in Capital 10,000
Accounts Decreasing Amount
Accounts Receivable $10,000
Accounts Payable 20,000
The accounts shown above represent all the balance sheet accounts for Cihla’s Corporation with
the exception of Retained Earnings. No dividends were declared during 2020.
 Chapter 3: The Accounting Information System 3 - 15

Instructions
From the changes above, determine the amount of net income or net loss for 2020.
_____________________________________________________________________________
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3. (L.O. 3) The following data relate to the accounts of Scacco Company.

a. A three-year insurance policy was purchased on March 1, 2020. The $360 insurance
premium was fully paid on that date and a debit to Prepaid Insurance was recorded.
b. Unpaid salaries and wages at year end amount to $650.
c. Service Revenue was credited for $816 on May 1, 2020. The amount represents a
one-year advance payment for services to be performed by Scacco Company through
April 30, 2021.
d. The Supplies account shows a balance of $1,250 on December 31, 2020. A physical
count of the supplies on hand at this date reveals a total of $480 available.
e. Scacco Company holds bonds of another corporation that pay interest at a rate of
$900 per year. These bonds were purchased on August 1, 2020, and the first interest
payment will be received on August 1, 2021.
Instructions
Prepare the necessary adjusting journal entries indicated by each item for the year ended
December 31, 2020.
3 - 16 Student Study Guide for Intermediate Accounting, 17th Edition

General Journal
J1
Date Account Title Debit Credit
 Chapter 3: The Accounting Information System 3 - 17

4. (L.O. 2, 3, 4, 5, and *9) The post-closing trial balance of the Pat Callahan Company at
December 31, 2019 is shown below.
Account
No. Account Debit Credit
101 Cash $46,000
102 Investment in Bonds 50,000
103 Accounts Receivable 28,000
104 Allowance for Doubtful Accounts 900
105 Interest Receivable
106 Inventory (perpetual) *24,000
107 Building (15-year life) 45,000
108 Accumulated Depreciation-Building 12,000
109 Delivery Truck (5-year life, $3,000 18,000
salvage)
110 Accumulated Depreciation-Trucks 6,000
200 Accounts Payable 18,000
201 Notes Payable 29,000
202 Salaries and Wages Payable
203 Income Taxes Payable 5,000
300 Common Par Value $1.00 85,000
301 Retained Earnings 55,100
400 Sales
401 Interest Revenue
500 Operating Expenses
501 Salaries and Wages Expense
502 Depreciation Expense-Building
503 Depreciation Expense-Trucks
504 Bad Debt Expense
505 Cost of Goods Sold
506 Income Tax Expense
$211,000 $211,000
*Ending Inventory (12/31/20) $26,000.
The following transactions took place during 2020.

1. Collected: Accounts Receivable, $25,000; Interest on Bonds $5,000; Cash Sales,

$80,000 (Cost of Goods Sold $14,000).
2. Paid: Accounts Payable, $15,000; Notes Payable, $21,000; Income Taxes Payable,
$5,000; Operating Expenses, $37,000.
3. Purchased inventory, $32,000, of which $16,000 was purchased on account. (Assume
perpetual inventory.)
4. Made sales on account, $85,000 (Cost of Goods Sold $16,000).
5. On June 30, 2020, purchased a second delivery truck for $15,000, paying cash. The
truck has useful life of 10 years and a salvage value of $3,000.
3 - 18 Student Study Guide for Intermediate Accounting, 17th Edition

Instructions

a. Journalize each of the transactions above of the Pat Callahan Company. Some items
require more than one journal entry.
b. Post the entries to appropriate accounts. (You should set up a T-account for each
account noted on the trial balance.)
c. Prepare a trial balance after posting the journal entries and enter the amounts on a
10-column work sheet like the one shown in the text. Enter all the accounts shown on
the original trial balance.
d. Enter the following adjustments on the work sheet: (a) Accrued wages at year end
total $700; (b) Bad debt expense is estimated at 1% of credit sales; (c) Record
straight-line depreciation on the building and trucks; (d) Accrued interest on the
investments in bonds is $1,500; (e) Income tax expense for 2020 is $21,065. The tax
is not due until 2021.
e. Complete the income statement and balance sheet columns of the work sheet.
f. Prepare closing journal entries.
 Chapter 3: The Accounting Information System 3 - 19

a.
General Journal
J1
Date Account Title Debit Credit
3 - 20 Student Study Guide for Intermediate Accounting, 17th Edition

b.

Investment Accounts
Cash in Bonds Receivable

Allowance for Interest

Doubtful Accounts Receivable Inventory

Accumulated
Building Depreciation—Bldg Delivery Truck

Accumulated
Depreciation—Trucks Accounts Payable Notes Payable
 Chapter 3: The Accounting Information System 3 - 21

b. (continued)

Salaries and Income Taxes

Wages Payable Payable Common Stock

Retained Earnings Sales Interest Revenue

Salaries and Depreciation

Operating Expenses Wages Expense Expense—Bldg

Depreciation Bad Debts

Expense—Trucks Expense Cost of Goods Sold

Income
Tax Expense
3 - 22 Student Study Guide for Intermediate Accounting, 17th Edition

c. d. e. Pat Callahan Company

Ten-Column Work Sheet
December 31, 2020
Adjusted
Trial Trial Income Balance
Balance Adjustments Balance Statement Sheet
No. Account Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
101 Cash
102 Investment in Bonds
103 Accounts Receivable
104 Allowance for
Doubtful Accounts
105 Interest Receivable
106 Inventory
107 Building
108 Accumulated
Depreciation—Bldg
109 Delivery Trucks
110 Accumulated
Depreciation—
Trucks
200 Accounts Payable
201 Notes Payable
202 Salaries and Wages
Payable
203 Income Taxes
Payable
300 Common Stock
301 Retained Earnings
400 Sales
401 Interest Revenue
500 Operating Expense
501 Salaries and Wages
Expense
502 Depreciation
Expense—Bldg
503 Depreciation
Expense—Trucks
504 Bad Debts Expense
505 Cost of Goods Sold
506 Income Tax Expense
 Chapter 3: The Accounting Information System 3 - 23

Net Income

(f) ________________________________________________________________________
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3 - 24 Student Study Guide for Intermediate Accounting, 17th Edition

SOLUTIONS TO REVIEW QUESTIONS AND EXERCISES

TRUE-FALSE

1. (F) Real (permanent) accounts are asset, liability, and owners’ equity accounts. Nominal
(temporary) accounts are revenue and expense accounts. Nominal accounts are
periodically closed; real accounts are not.
2. (F) Debits are recorded on the left side of an account and can be increases or
decreases in account balances, depending on the account involved. Debits increase
asset and expense accounts; they decrease liability, owner equity, and revenue
accounts. Credits result in the opposite effect on account balances.
3. (F) This statement characterizes an external event rather than an internal event. Internal
events occur within an entity, whereas external events involve interaction between
an entity and its environment.
4. (T)
5. (F) Special journals can be used by any entity for any groups of transactions possessing
common characteristics.
6. (F) Failure to post one journal entry to the general ledger will misstate the debit and
credit side of a trial balance by the same amount. Thus, the trial balance will show
an equal amount of debits and credits.
7. (T)
8. (F) Adjusting entries are necessary in order for revenues to be recorded in the period in
which services are performed and for expenses to be recognized in the period in
which they are incurred and to achieve an accurate statement of assets, liabilities,
and equities at the end of the period.
9. (F) Adjusting entries are necessary in order for revenues to be recorded in the period in
which services are performed and for expenses to be recognized in the period in
which they are incurred and to achieve an accurate statement of assets, liabilities,
and equities at the end of the period. If errors are made in the posting process, they
are corrected by means of correcting entries, not adjusting entries.
10. (T)
11. (T)
12. (T)
13. (F) The income summary account is a clearing account through which all revenue and
expense accounts are closed at the end of an accounting period. Once the revenue
and expense accounts have been closed, any balance existing in the income
summary account is closed to retained earnings. Thus, the income summary
account never appears on a financial statement.
14. (F) Failure to post closing entries to the general ledger will leave a balance in revenue
and expense accounts from a previous period and the retained earnings account will
be misstated.
15. (T)
 Chapter 3: The Accounting Information System 3 - 25

16. (F) The post-closing trial balance consists only of asset, liability, and owners’ equity (the
real) accounts.
*17. (T)
*18. (F) Reversing entries are made to simplify the recording of a subsequent transaction
related to an adjusting entry. When an entry is reversed, the related subsequent
transaction can be recorded as if the adjusting entry had never been recorded.
Reversing entries have nothing to do with the correction of errors.
*19. (T)
*20. (T)
*21. (T)
*22. (F) An adjusted trial balance that shows equal debit and credit columnar totals proves
nothing more than the fact that each adjusting entry contained an equal amount of
debits and credits. Adjusting entries could have included the wrong total dollar
amount or an inappropriate account could have been debited or credited. Mistakes
such as these would still produce an adjusted trial balance that shows equal debit
and credit columnar totals.

MULTIPLE CHOICE

1. (A) If the accounting equation is out of balance at any time during the accounting cycle,
then an error has been made.
2. (C) The double-entry system records the dual effect of each transaction and every
transaction must be recorded with equal debits and credits.
3. (C)
Recorded debit amount ................................... $7,000
Actual debit balance ........................................ 700
Excess debit total ............................................ $6,300
4. (D) The trial balance accomplishes the things listed in the first three alternatives.
However, the purpose of the trail balance is not to prove that the debits and credits
were properly entered in the ledger accounts. The fact that the trial balance is in
balance proves that an equal amount of debits and credits were made, but there is
no assurance that the postings were made to the correct accounts.
5. (C) An advance payment for goods or services requires a debit to cash and a credit to a
liability account. When the goods or services are delivered to the customer, the
revenue is recognized by debiting the liability and crediting a revenue account.
6. (B)
Purchased .................................................... $6,540
Year-end inventory ....................................... 2,150
Used during year .......................................... $4,390

Adjusting entry: Supplies Expense 4,390

Supplies 4,390
3 - 26 Student Study Guide for Intermediate Accounting, 17th Edition

7. (B) All adjusting entries include one balance sheet account (asset or liability) and one
income statement account (revenue or expense). Thus, all alternatives other than
alternative B represent possible adjusting entry descriptions.
8. (B) An accrued liability is an item of expense that has been incurred during the period,
but has not been recorded or paid. The property taxes fits this definition, as they are
an expense of the period in which they were incurred and represent a liability until
they are paid in the subsequent period. The office supplies are a prepaid expense,
depreciation is an estimated item, and the rent is an accrued revenue item.
9. (B) A prepaid expense can best be described as an amount paid and not currently
matched with earnings. The journal entry to record a prepaid expense involves an
asset account and crediting cash. The asset is deferred to and expensed in future
years. Answer (A) is incorrect because it is not matched with earnings until it is
expensed in future years. Answers (C) and (D) are incorrect because a prepaid
expense is one that has been paid.
10. (D) Rent collected in advance by a landlord is an unearned revenue. Cash received in
advance should not be recognized as revenue until the performance obligation has
been satisfied. Answer (A) is incorrect because an accrued liability is the result of an
expense which has been incurred but not yet paid. Answer (B) is incorrect because
a deferred asset is a cost which has been incurred but the benefits will be received
in the future. Answer (C) is incorrect because an accrued revenue is revenue for
which the performance obligation has been satisfied but the cash has not yet been
received.
11. (B) An accrued expense can best be described as an amount not paid and currently
matched with earnings. The journal entry to record an accrued expense involves
debiting an expense account which is deducted from revenues in determining
income and crediting a liability account. Accrued expenses are generally incurred as
a result of passage of time (e.g., interest, rent, salaries, etc.). Answers (A) and (D)
are incorrect because by definition an accrued expense is one that has been
incurred but not yet paid. Answer (C) is incorrect because the purpose of accruing
an expense is to match it currently with earnings.
12. (D) Murphy Company should make an adjusting entry to recognize that two-thirds of the
performance obligation has been satisfied (8 months of an annual rental of $24,000)
should be recognized as rental income in 2020. The journal entry that should be
made is:
Unearned rental income 16,000
Rental income ($24,000 × 2/3) 16,000
13. (C) Closing entries represent the formal process by which all nominal accounts (revenue
and expense) are reduced to zero and the net income or net loss is determined and
transferred to owners’ equity.
14. (D) If expenses are greater than revenues, then the Income Summary account will have
a debit balance after closing entries have been made. Thus, to close the Income
Summary account the journal entry would include a debit to Retained Earnings and
a credit to Income Summary.
15. (D) Alternatives A, B, and C provide an incorrect chronology in the accounting cycle.
Alternative D provides a correct chronology.
 Chapter 3: The Accounting Information System 3 - 27

*16 (B) When a company makes reversing entries, all cash payments of expenses are
debited to the related expense account. This simplifies the recording process in an
accounting system.
*17 (A) An adjusting entry is necessary because a portion of the insurance has expired as of
the end of the first year. However, because this prepaid item was originally entered
in an asset account a reversing entry would be inappropriate.
*18 (D) A worksheet provides considerable assurance the company properly handled all of
the details related to end-of-period accounting.

REVIEW EXERCISES

1. a.

Davies Co.
Trial Balance
December 31, 2020

Cash.......................................................................... $34,000
Accounts Receivable ................................................ 48,000
Notes Receivable ...................................................... 22,000
Inventory ................................................................... 36,000
Building, net .............................................................. 210,000
Land .......................................................................... 125,000
Accounts Payable ..................................................... $60,000
Notes Payable........................................................... 72,000
Tax Payable .............................................................. 31,000
Bonds Payable .......................................................... 75,000
Common Stock ......................................................... 185,000
Sales ......................................................................... 271,000
Cost of Goods Sold ................................................... 165,000
Rent Expense ........................................................... 15,000
Salaries and Wages Expense ................................... 19,000
Tax Expense ............................................................. 20,000
$694,000 $694,000

b.

Davies Co.
Statement of Income
Year Ended December 31, 2020

Sales ......................................................................... $271,000

Cost of Goods Sold ................................................... 165,000
Gross Profit on Sales ................................................ $106,000
Expenses:
Rent Expense ........................................................... $ 15,000
Salaries and Wages Expense ................................... 19,000
Tax Expense ............................................................. 20,000
Total Expenses ....................................................... 54,000
3 - 28 Student Study Guide for Intermediate Accounting, 17th Edition

Net Income ................................................................ $52,000

 Chapter 3: The Accounting Information System 3 - 29

c.

Davies Co.
Balance Sheet
December 31, 2020

Assets
Current Assets:
Cash ............................................................... $ 34,000
Accounts Receivable ...................................... 48,000
Notes Receivable ........................................... 22,000
Inventory ........................................................ 36,000
Total Current Assets ..................................... $140,000
Fixed Assets:
Buildings (net) ................................................ $210,000
Land ............................................................... 125,000
Total Fixed Assets ........................................ 335,000
Total Assets .................................................... $475,000

Liabilities and Stockholders’ Equity

Current Liabilities:
Accounts Payable .......................................... $60,000
Note Payable.................................................. 72,000
Tax Payable ................................................... 31,000
Total Current Liabilities ................................. $163,000
Long-term Liabilities:
Bonds Payable ............................................... 75,000 $238,000
Stockholders’ Equity:
Common Stock............................................... 185,000
Retained Earnings .......................................... 52,000 237,000
Total Liabilities and Stockholders’ Equity ..... $475,000

2.
Net change in assets:
Cash ............................................................... $50,000
Accounts Receivable ...................................... (10,000)
Inventory ........................................................ 30,000
Building .......................................................... 25,000
Net Change .................................................. $ 95,000
Less net change in liabilities and owners’ equity:
Accounts Payable .......................................... ($20,000)
Capital Stock .................................................. 30,000
Additional Paid-in Capital ............................... 10,000
Net Change .................................................. (20,000)
Net Income for 2020 (Change in Retained Earnings) $ 75,000
3 - 30 Student Study Guide for Intermediate Accounting, 17th Edition

3.

a. Insurance Expense 100

Prepaid Insurance 100
b. Salaries and Wages Expense 650
Salaries Payable 650
c. Service Revenue 272
Unearned Service Revenue 272
d. Supplies Expense 770
Supplies 770
e. Interest Receivable 375
Interest Income 375

4. a.
Item 1: Cash 25,000
Accounts Receivable 25,000
Cash 5,000
Interest Revenue 5,000

Cash 80,000
Sales 80,000
Cost of Goods Sold 14,000
Inventory 14,000
Item 2: Accounts Payable 15,000
Cash 15,000
Notes Payable 21,000
Cash 21,000
Income Taxes Payable 5,000
Cash 5,000
Operating Expenses 37,000
Cash 37,000
Item 3: Inventory 32,000
Cash 16,000
Accounts Payable 16,000
Item 4: Accounts Receivable 85,000
Sales 85,000
Cost of Goods Sold 16,000
Inventory 16,000
Item 5: Delivery Truck 15,000
Cash 15,000
 Chapter 3: The Accounting Information System 3 - 31

b.
Investment Accounts
Cash in Bonds Receivable
46,000 15,000 (2) 50,000 28,000 25,000 (1)
(1) 25,000 21,000 (2) (4) 85,000
(1) 5,000 5,000 (2)
(1) 80,000 37,000 (2)
16,000 (2)
15,000 (5)
47,000 88,000

Allowance for Interest

Doubtful Accounts Receivable Inventory
900 24,000 14,000 (1)
(3) 32,000 16,000 (4)

26,000

Accumulated
Building Depreciation—Bldg Delivery Truck
45,000 12,000 18,000
(5) 15,000

33,000

Accumulated
Depreciation—Trucks Accounts Payable Notes Payable
6,000 (2) 15,000 18,000 (2) 21,000 29,000
16,000 (4)

19,000 8,000
3 - 32 Student Study Guide for Intermediate Accounting, 17th Edition

b. (continued)

Salaries and Income Taxes

Wages Payable Payable Common Stock
(2) 5,000 5,000 85,000

0 0

Retained Earnings Sales Interest Revenue

55,100 80,000 (1) 5,000 (1)
85,000 (3)

165,000

Salaries and Depreciation

Operating Expenses Wages Expense Expense—Bldg
(2) 37,000

Depreciation Bad Debts

Expense—Trucks Expense Cost of Goods Sold
(1) 14,000
(4) 16,000

30,000

Income
Tax Expense
c. d. e
Pat Callahan Company
Ten-Column Work Sheet
December 31, 2020
Trial Balance Adjustments Adjusted Trial Income Statement Balance Sheet
Balance
No. Account Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
101 Cash 47,000 47,000 47,000
102 Investment in Bonds 50,000 50,000 50,000
103 Accounts Receivable 88,000 88,000 88,000
104 Allowance for Doubtful 900 (b) 850 1,750 1,750
Accounts
105 Interest Receivable (d) 1,500 1,500 1,500
106 Inventory 26,000 26,000 26,000
107 Building 45,000 45,000 45,000
108 Accum. Deprec.—Bldg 12,000 (c) 3,000 15,000 15,000
109 Delivery Trucks 33,000 33,000 33,000
110 Accum. Deprec.—Trucks 6,000 (c) 3,600 9,600 9,600
200 Accounts Payable 19,000 19,000 19,000
201 Notes Payable 8,000 8,000 8,000
202 Salaries and Wages Payable (a) 700 700 700
203 Income Taxes Payable (e) 21,065 21,065 21,065
300 Common Stock 85,000 85,000 85,000
301 Retained Earnings 55,100 55,100 55,100
400 Sales 165,000 165,000 165,000
401 Interest Revenue 5,000 (d) 1,500 6,500 6,500
500 Operating Expense 37,000 37,000 37,000
501 Salaries and Wages Expense (a) 700 700 700
502 Depreciation Expense—Bldg (c) 3,000 3,000 3,000
503 Depreciation Expense— (c) 3,600 3,600 3,600
Trucks
504 Bad Debts Expense (b) 850 850 850
505 Cost of Goods Sold 30,000 30,000 30,000
506 Income Tax Expense (e) 21,065 21,065 21,065
Totals $356,000 $356,000 $ 30,715 $30,715 $386,715 $386,715 96,215 171,500 215,215
75,285 75,285
Net Income $171,500 $171,500 $290,500 $290,500
 Chapter 3: The Accounting Information System 3 - 34

f. Interest Revenue 6,500

Sales 165,000
Cost of Goods Sold 30,000
Operating Expenses 37,000
Salaries and Wages Expense 700
Depreciation Expense—Bldg. 3,000
Depreciation Expense—Trucks 3,600
Bad Debts Expense 850
Income Tax Expense 21,065
Income Summary 75,285
(To close revenues and expenses to income summary)

Income Summary 75,285

Retained Earnings 75,285
(To close income summary to retained earnings)