THE ACCOUNTING CYCLE

A DAC 501: FINANCIAL ACCOUNTING PRESENTATION.

BY

HERICK ONDIGO SCHOOL OF BUSINESS, UoN

The Accounting Cycle

The accounting cycle is the process by which

accountants prepare financial statements for an entity for a specific period of time.

The Accounting Cycle

For a new business, it begin by setting up ledger

accounts. For an established business, begin with account balances carried over from the previous period.

The Steps In The Accounting Cycle

Analyze source documents & record business transactions in a journal 2. Post journal entries to the ledger accounts 3. Prepare unadjusted trial balance (TB) 4. Journalize and post end of period adjustments (EOPA) 5. Prepare adjusted Trial Balance 6. Prepare /Create financial statements & reports from data in adjusted TB 7. Journalize and post the closing entries 8. Prepare the post-closing trial balance 9. Prepare and post reversing entries
1.

Detailed Steps in the Accounting Cycle

Analyze Business Transactions . Journalize transactions in the journal. Prepare unadjusted trial balance.

Post entries to the accounts in the ledger.

Post-closing trial balance Prepare financial statements. Prepare adjusted trial balance. Journalize and post adjusting entries

Journalize and post closing entries

Analysis and Recording Business Transactions

Business transaction is an economic event that

causes a change in the financial position Financial Position:

What the entity controls How the entity controls them (claims)

Fundamental Accounting Equation

ASSETS = EQUITIES

ASSETS = LIABILITIES + OWNERS' EQUITY

How do we use the Accounting equation?

Recall the Basic Accounting Equation: Assets = Liabilities + Shareholders Equity Implications: Total Asset=Claims against the assets Therefore : If assets increase : either Liabilities and/or Shareholders should also increase and vice versa For example: borrow cash, cash (asset) will increase and Liabilities will increase when it is paid back: cash (asset) will decrease and liabilities will decrease

How do we record/Account?
An ACCOUNT (ledger Account) : is an

accounting device used to record changes in a of a specific asset, liability or owners equity item Has 3 elements: title, debit side and credit side (also called the T-Account) Changes in the accounts are entered manually into a book called a ledger or computerized ledger Basic forms of book ledgers: the two-column account format, and the running format account Chart of accounts

Definition of Ledger Account

Ledger Account Complete listing of business transactions for an individual account Where you look if you want to find the balance of any given account General Ledger A loose-leaf book or computer file containing all the Ledger Accounts Each account from the chart of accounts has its own

ledger account in the general ledger Complete listing of all account tittles and account names/codes used by an entity is called the chart of accounts - It is like a table of content in a book

Forms of Ledgers
Two-Column Account
Account Account No:

Date

Item

Post. Ref. *

Debit

Date

Item

Posting Reference

Credit

T-Account form that depicts the two-column account:

Account Name Account No:

Left-hand or Debit Side

Right-hand or Credit Side

How do accounts behave?

Assets = Liabilities + Shareholders Equity + + + So Assets increase on the left hand or debit side then they decrease on the credit side Assets credit

+ debit

Behavior of Accounts cont

Liabilities and Owners Equity accounts increase on the credit side, decrease on the debit side Liabilities or Owners Equity Accounts debit + credit

Transaction Analysis and The Duality Concept

Double entry system states that every transactions

affects at least two accounts. Therefore If an asset account increases (decreases), because of duality concept there must be a corresponding: 1. increase(decrease) in a specific liability account 2. or a decrease(increase) in a another asset account 3. or an increase(decrease) in owners' equity account.

What Is a General Journal?

The book in which a person enters the original

record of a business transaction

Commonly referred to as a book of original entry

Chronological listing of all the business

transactions for the company

Each listing records the debits and credits associated with that business transaction

A book or a location on a hard drive where all

business transactions are listed

Like a diary
Accounting Is Fun!

Whats in a Journal Entry?

Date 2. At least one debit entry Debit account, use exact account title, do not indent titles 3. At least one credit entry Credit account, use exact account title, indent titles 4. An explanation of the transaction: Check number Invoice number Accounts receivable customer name Many other elements OR details as appropriate Remember: the accountant must leave a good audit trail so that users of accounting information can understand what occurred with each transaction
1.

DR=CR

Illustration of the accounting process

1. On Jan 1 2010 Ms.Farida invested $100,000 at the inception of the business, Express Travel Agency

Event Assets Liabilities Owners No Equity 1 +100.000 No change +100.000 Total 100.000 0 100.000
GENERAL JOURNAL Page 1 Date Account Title and Description Acct.No. Debit 1 Jan 2004 Cash Capital Investment by the shareholders 100 100.000 500 100.000 Credit

2. On 1 January employed a full time secretary and a sales representative.

Event No Assets Liabilities Owners Equity 1 +100.000 No change +100.000 2 No change No change No change Total 100.000 0 100.000

3. On 1 January rented an office building and paid 3 months rent of $600.

Event No

Total

Assets 1 +100.000 2 No change 3 +600 -600 100.000

Liabilities Owners Equity No change +100.000 No change No change No change No change No change No change 0 100.000
Credit 600

GENERAL JOURNAL Page 1 Date Account Title and Description Acct.No. Debit 1 Jan 2004 Prepaid Rent Cash Payment of 3 months of rent in advance 180 100 600

4. On 2 January office furniture and equipment is purchased for $ 15,000 , for which $ 5,000 is paid in cash and the rest would be paid later in January and February 2010.

Event No 1 2 3 4 Total

Assets Liabilities Owners Equity +100.000 No change +100.000 No change No change No change +600 No change No change -600 No change No change +15.000 +10.000 No change -5.000 110.000 10.000 100.000
Page 1 Debit 15.000 5.000 10000 Credit 255 100 320

GENERAL JOURNAL 2 Jan 2004 Furniture and Equipment

Date Account Title and Description Acct.No Cash Accounts Payable Purchase of furniture and equipment

5. On 3 January insured the office building and the equipment effective from 1 January to 31 December 2010 and paid $ 120 for the whole period.
Event No 1 2 3 4 5 Total Assets Liabilities Owners Equity +100.000 No change +100.000 No change No change No change +600 No change No change -600 No change No change +15.000 +10.000 No change -5.000 +120 No change No change -120 110.000 10.000 100.000

GENERAL JOURNAL 3 Jan 2004 Prepaid Insurance

Page 1 Credit 120 180 100 120

Date Account Title and Description Acct.No. Debit Cash Purchase of insurance policy

6. On 5 January the company signed an agreement with Keya Airline to sell their airline tickets and receive commissions in return.

Event No

Total

Assets Liabilities Owners Equity 1 +100.000 No change +100.000 2 No change No change No change 3 +600 No change No change -600 No change No change 4 +15.000 +10.000 No change -5.000 5 +120 No change No change -120 6 No change No change No change 110.000 10.000 100.000

7. On 10 January Express Travel Agency borrowed $15,000 from the bank at an annual interest rate of 24% for six months. The principal and the interest of the loan will be paid together on 10 July 2010.

Event No 1 2 3 4 5 6 7 Total

Assets Liabilities Owners Equity +100.000 No change +100.000 No change No change No change +600 No change No change -600 No change No change +15.000 +10.000 No change -5.000 +120 No change No change -120 No change No change No change +15.000 +15.000 No change 125.000 25.000 100.000

7. On 10 January Express Travel Agency borrowed $ 15,000 from the bank at an annual interest rate of 24% for six months. The principal and the interest of the loan will be paid together on 10 July 2010.

GENERAL JOURNAL 10 Jan 2004 Cash

Page 1 100 15.000 300 15.000

Date Account Title and Description Acct.No. Debit Credit Bank Loan Borrowing from the bank

8. On 10 January purchased office supplies for $2.500 in cash.

Event No 1 2 3 4 5 6 7 8 Total

Assets Liabilities Owners Equity +100.000 No change +100.000 No change No change No change +600 No change No change -600 No change No change +15.000 +10.000 No change -5.000 +120 No change No change -120 No change No change No change +15.000 +15.000 No change +2.500 No change No change -2.500 125.000 25.000 100.000

8. On 10 January purchased office supplies for $2,500 in cash.

GENERAL JOURNAL 10 Jan 2004ce Supplies Offi

Page 1 136 2.500 100 2.500

Date Account Title and Description Acct.No. Debit Credit Cash Purchase of office supplies

9. During the first half of January the agency sold tickets to various customers and on 16 January issued a commission invoice to clients amounting to $5,000 that will be collected later in January 2010.

Event No 1 2 3 4 5 6 7 8 9 Total

Assets Liabilities Owners Equity +100.000 No change +100.000 No change No change No change +600 No change No change -600 No change No change +15.000 +10.000 No change -5.000 +120 No change No change -120 No change No change No change +15.000 +15.000 No change +2.500 No change No change -2.500 +5.000 No change +5.000 130.000 25.000 105.000

9. During the first half of January the agency sold tickets to various customers and on 16 January issued a commission invoice to clients amounting to $ 5,000 that will be collected later in January 2010.

Rev enue Accounts Left or Debit Side Right or Credit Side Decrease Incre a s e

GENERAL JOURNAL 16 Jan 2004 Accounts Receivable

Page 1 120 5.000 5.000

Date Account Title and Description Acct.No. Debit Credit Commission Revenue 600 Recognition of commission on ticket sales

10. On 20 January the company paid $5,000 for the furniture and equipment that were purchased on 2 January.

Event No 1 2 3 4 5 6 7 8 9 10 Total

Assets Liabilities Owners Equity +100.000 No change +100.000 No change No change No change +600 No change No change -600 No change No change +15.000 +10.000 No change -5.000 +120 No change No change -120 No change No change No change +15.000 +15.000 No change +2.500 No change No change -2.500 +5.000 No change +5.000 -5000 -5000 No change 125.000 20.000 105.000

10. On 20 January the company paid $5.000 for the furniture and equipment that were purchased on 2 January.

GENERAL JOURNAL 20 Jan 2004 Payable Accounts

Page 1 320 5.000 100 5.000

Date Account Title and Description Acct.No. Debit Credit Cash Payment for an accounts payable

11. On 22 January received $7,500 from a customer for organizing the accounting conference that will be held on February 2, 2010.
Event No 1 2 3 4 5 6 7 8 9 10 11 Total Assets Liabilities Owners Equity +100.000 No change +100.000 No change No change No change +600 No change No change -600 No change No change +15.000 +10.000 No change -5.000 +120 No change No change -120 No change No change No change +15.000 +15.000 No change +2.500 No change No change -2.500 +5.000 No change +5.000 -5.000 -5.000 No change +7.500 +7.500 No change 132.500 27.500 105.000

11. On 22 January the company received $7.500 from a customer for organizing the accounting conference that will be held on 2 February 2010.

GENERAL JOURNAL 22 Jan 2004 Cash

Page 1 100 7.500 7.500

Date Account Title and Description Acct.No. Debit Credit Unearned Revenues 340 Receipt of advance payment from a customer

12. The company received the full payment of commission charged to Kenya Airlines of $ 5.000 on 23 January.

E ent No v 1 2 3 4 5 6 7 8 9 10 11 12 Total

As s ets +100.000 No change +600 -600 +15.000 -5.000 +120 -120 No change +15.000 +2.500 -2.500 +5.000 -5.000 +7.500 +5.000 -5.000 132.500

Liabilities No change No change No change No change +10.000 No change No change +15.000 No change No change -5.000 +7.500 No change 27.500

Owners E quity +100.000 No No No No change change change change

No change No change No change No change +5.000 No change No change No change 105.000

12. The company received the full payment of commission charged to Kenya Airline s of $ 5,000 on 23 January.

GENERAL JOURNAL 23 Jan 2004 Cash

Page 1 100 5.000 5.000

Date Account Title and Description Acct.No. Debit Credit Accounts Receivable 120 Receipt of payment from a customer

13. On 24 January paid salaries of $ 9,000 employees in cash.

Event No Assets 7 8 9 10 11 12 13 Total +15.000 +2.500 -2.500 +5.000 -5.000 +7.500 +5.000 -5.000 -9.000 123.500

Liabilities +15.000 No change No change -5.000 +7.500 No change No change 27.500

Owners Equity No change No change +5.000 No change No change No change -9.000 96.000

13. On 24 January paid salaries of $ 9,000 employees in cash.

Expense Accounts Left or Debit Side Right or Credit Side Increase Decrease

GENERAL JOURNAL 24 Jan 2004 Expense Salary Cash Payment of salaries

Page 1 770 9.000 100 9.000

Date Account Title and Description Acct.No. Debit Credit

14. During the second half of January the agency sold tickets to various customers and on 31 January issued a commission invoice to Kenya Airline amounting to $ 7,500 which will be collected in February 2010.

Event No Assets 8 9 10 11 12 13 14 Total +2.500 -2.500 +5.000 -5.000 +7.500 +5.000 -5.000 -9.000 +7.500 131.000

Liabilities No change No change -5.000 +7.500 No change No change No change 27.500

Owners Equity No change +5.000 No change No change No change -9.000 +7.500 103.500

14. During the second half of January the agency sold tickets to various customers and on 31 Jan sent an invoice to Kenya Airline amounting to $7,500 which will be collected in February 2010

GENERAL JOURNAL 31 Jan 2004 Receivable Accounts

Page 1 120 7.500 7.500

Date Account Title and Description Acct.No. Debit Credit Commission Revenues 600 Recognition of commission on ticket sales

15. Ms. Farida ( the proprietor) withdrew $ 3,000 on 31 January for her personal use.

Event No Assets 7 8 9 10 11 12 13 14 15 Total +15.000 +2.500 -2.500 +5.000 -5.000 +7.500 +5.000 -5.000 -9.000 +7.500 -3.000 128,000

Liabilities +15.000 No change No change -5.000 +7.500 No change No change No change No change 27,500

Owners Equity No change No change +5.000 No change No change No change -9.000 +7.500 -3.000 100,500

15. Ms. Farida withdrew $ 3.000 on 31 January for personal use.

Owners' Withdrawals or Dividends Left or Debit Side Right or Credit Side Increase Decrease

GENERAL JOURNAL 31 Jan 2004 Withdrawals

Page 1 XXX 100 3,000 3,000

Date Account Title and Description Acct.No. Debit Credit Cash Withdrawal by the owner

Summary of Journalizing
Steps: 1. Determine the effects of transactions on three components of the accounting equation, 2. Determine which specific accounts are affected, and 3. Assure that total of the increases should be equal to either increases on the other side of the equation or to decreases on the same side, or a combination there of.

Behavior of Accounts- Summary

Assets = + Dr Cr Liabilities + + Dr Cr Owners Equity + Dr Cr Expense Revenue + + Dr Cr Dr Cr

Withdrawals/Dividends + Dr Cr

Accounting Cycle-Revisited
Adjust the accounts and prepare trial balance

Analyze and record the transactions

Post the transactions and prepare trial balance

Close the accounts and prepare trial balance

Prepare the financial statements

Posting -Defined

The process of transferring figures from the journal to the ledger accounts It simply involves transferring data from one accounting entry into another The purpose is to classify and summarize transactions and events affecting specific elements of the financial statements

Four-Step Posting Process

1. Transfer transaction date to accounts date column 2. Transfer the debit/credit amount and calculate the 3. 4.

new balance Write journal page number in posting reference column of ledger as a cross-reference Go back to journal and write account number in posting reference column of journal as a crossreference Cross-reference The ledger account number in the Post. Ref. column of the journal and the journal page number in the Post. Ref. column of the ledger account

Posting to The Ledger illustrated

GENERAL JOURNAL Page 1 Date Account Title and Description Acct.No. Debit 1 Jan 2004 Cash Capital Investment by the shareholders 100 100.000 500 100.000 Credit

LEDGER - Cash Date Description 1 Jan 2004 Capital

LEDGER - Capital Date Description 1 Jan 2004 Cash

Acc. No. 100 Ref Debit P1 Credit Debit Credit Balance Balance 100,000 100,000

Acc. No. 500 Ref Debit P1 Credit 100,000 Debit Credit Balance Balance 100,000

Posting illustrated
LEDGER - Cash Acc. No. 100 Date Description 1 Jan Capital 1 Jan Office rent 2 Jan Office furniture and equipment 3 Jan insurance expense 10 Jan Bank loan 10 Jan Office supplies 20 Jan Accounts payable 22 Jan Unearned Revenue 23 Jan Acccounts Recievable 24 Jan salaries expense 31 Jan Withdrawal Debit Credit 100,000 600 5,000 120 15,000 2,500 5,000 7,500 5,000 9,000 3,000

Exercise
Post all the above transactions (journal entries)

to the following ledger accounts:

Prepaid Rent, Office supplies, Prepaid insurance, Office Furniture & Equipment, Bank loan, Accounts Payable, Unearned Revenue, Capital, Withdrawals, Commission Revenue, & Salary Expense

Cast the ledger accounts Determine the balances carried down (Bal c/d)

and balances brought down (b/d) Prepare a summary of the ledger balances in a two columnar listing to derive the Trial Balance( TB)

SUMMARY -Normal Balances of Accounts

Category of the Account Increase Recorded By Normal Balance

Assets

Debits

Debit

Liabilities
Shareholders Equity

Credits

Credit

Capital Dividends or Withdrawals

Credits Debits

Credit Debit

Revenues Expenses

Credits Debits

Credit Debit

Preparing a Trial Balance

List the ledger account balances

in two columns on the trial balance Left column = Debits Right column = Credits Trial balance proves DR = CR

The Balancing of Accounts, The Trial Balance & Financial statements

Introduction: In the previous exercise , you have learned the principles of double entry and how to post to the ledger accounts. The next step in our progress towards the financial statements is the trial balance. Before transferring the relevant balances at the year end to the financial statements, it is usual to test the accuracy of the double entry bookkeeping records by preparing a trial balance. This is done by taking all the balances on every account. Due to the nature of double entry, the total of the debit balances will be exactly equal to the total of the credit balances.

The Balancing of Accounts & The Trial Balance

Question: Once you have closed all the accounts, what would do? Answer: Prepare a Trial Balance Question: What is a Trial Balance then? What is it for? How does it look like? Answer: A Trial Balance is a list of nominal ledger account and their balances at a given date. It is usually prepared on the last day of the accounting period. It consists of a Debit and a Credit balance. Its purposes:
(1) It is prepared to check that the total of debit balances is the same as the total of credit balances and offer reassurance that the double entry recording from day books has been done correctly. (2) For preparation of statement of income and the statement of financial position

The Balancing of Accounts & The Trial Balance

The rules to prepare the Trial Balance: Total Debit Entries = Total Credit Entries

Debit Assets Expenses Drawings

Credit Income/ Revenue Liabilities Capital

The Balancing of Accounts & The Trial Balance

Steps to preparing the Trial Balance: 1) Balance/cast ALL the ledger accounts in the books. 2) List all the Debit balances on the debit side and add them up. 3) List all the Credit balances on the credit side and add them up.

4) Ideally the trial balance should balance after step 3

The Balancing of Accounts & The Trial Balance What if the trial balance shows unequal debit and credit balances? If the columns of the trial balance are not equal, there must be an error in recording or processing the transactions. 4 Errors revealed by the trial balance: The errors revealed are those errors which cause the Trial Balance totals to disagree. (i.e do not balance) There are FOUR types of errors revealed by a trial balance: 1) Posting to the wrong side of an account. 2) Errors in calculation and balancing 3) Incorrect amounts entered on one entry 4) Omission of one entry.

The Balancing of Accounts & The Trial Balance

Question: How do we locate all of the above errors? Answers: 1) Check day-book (journal) totals 2) Check additions of Ledger accounts, ensure each balance is correct 3) Check all ledger account balances have been recorded in the Trial Balance. 4) Check all balances have been entered in the Trial Balance on the correct side. 5) Check additions have been done correctly

The Balancing of Accounts,& The Trial Balance

Question: Once you are sure there is no mistake made in the Trial Balance, what do you do in the next step? Answers: Prepare End of Period Adjustment & then prepare the following statements: 1) Statement of Income 2) Statement of Financial Position In short, these are the steps: 1) Trial Balance 2) End of Period Adjustments 3) Statement of Income 4) Statement of Financial position

The Balancing of Accounts & The Trial Balance However, a trial balance will not disclose the following types of errors: (Errors not revealed by the trial balance) 1) Errors of omission Complete omission of a transaction, because neither a debit nor a credit is made. 2) Errors of commission This happens when original figure incorrectly entered. (Correct double entries but incorrect amounts were recorded)

The Balancing of Accounts & The Trial Balance 3) Compensating errors This happens where errors cancel out each other. (eg an error of 100 is exactly cancelled by another 100 error elsewhere). 4) Errors of principles This happens when the wrong type of account had been used (eg the purchase of a motor van is debited to a expense account, such as motor expenses, rather than a fixed asset account) 5) Complete reversal of entries This happens when an account should be debited but was credited (and vice versa)

The Trial Balance

Expre s s Trave l Age ncy Trial Balance 31-Jan-10 in $ Accounts De bit Cash 102,280 Accounts Receivable 7,500 Office Supplies 2,500 Prepaid Rent 600 Prepaid Insurance 120 Office Furniture and Equipment 15,000 Bank Loan Accounts Payable Unearned Revenues Capital Withdrawal 3,000 Commission Revenues Salary Expenses 9,000 Total 140,000

Cre dit

15,000 5,000 7,500 100,000 12,500 140,000

THE END

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