Week 2 Lecture: An Information System
The Cycle: Step-By-Step
Accounting is an information system. Its purpose is to process business transactions into communicable business
reports, which are called financial statements. The system includes a number of steps that are referred to as the
Accounting Cycle. Its referred to as a cycle because the steps repeat in every accounting period, which is each time
period for which financial statements will be produced. In your first project for this course (which is due next week),
you will complete the steps in the cycle.
Accounting starts with business transactions. Businesses buy things, earn money, borrow, owe money, and so on.
Each transaction is analyzed for its effects on the business' financial situation. Remember the accounting equation
from last week? Each transaction is analyzed in the context of the accounting equation: How does this event affect
the assets, liabilities, and equity of the company? For instance, when the owners invest money in the company, the
company has more cash and more equity for its owners. If the business buys a computer with cash to keep its books,
it now has exchanged one asset for another - more equipment and less cash. Modern accounting has roots back to the
14th century when Lucas Pacioli developed the debit/credit system that involves each transaction being recorded in
at least two places. This results in the accounting equation always remaining in balance. Transactions are recorded
so that what happens on one side of the equation will also happen on the other side, or will cancel out on the same
side of the equation. Assets must always equal liabilities plus equity.
As a way to organize information about transactions and the assets, liabilities, and equity of a company, information
is categorized into accounts. There will be multiple accounts that are considered assets, liabilities, or equity. Each
company is unique in the accounts that it uses and how it names them, although some are fairly standard, and all will
fit into five main categories. The first three of these categories are the components of the accounting equation -
assets, liabilities, and equity. The other two main categories are also considered equity, because they will affect the
amount of equity shown on the balance sheet. They are revenues and expenses.
One of the first things to understand about debits and credits is that what you think you already know about them
does not apply in accounting (unless you already know accounting). Most people have the perspective that debits are
bad things and credits are good. Forget this way of thinking - it will make this harder. Each account can be
represented with a large
. On the top is the name of the account and entries to the account are listed on the left and
right sides of the vertical T. So in this context,
means left side and
means right side. One side represents