Accounting cycle

The Accounting CycleThe Accounting Cycle The accounting cycle is the process by The accounting cycle is the process by

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

The Accounting CycleThe Accounting Cycle

1. Analyze business transactions

2. Journalize the transactions

6. Prepare an adjusted trial balance

7. Prepare financial statements

8. Journalize and post closing entries

9. Prepare a post-closing trial balance

4. Prepare a trial balance

3. Post to ledger accounts

5. Journalize and post adjusting entries


For a new business, begin by setting up For a new business, begin by setting up ledger accounts.ledger accounts.

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

Account:Account:

• An account is an individual accounting An account is an individual accounting record of increases and decreases record of increases and decreases labeled as debits and credits. labeled as debits and credits.

• There are separate accounts for each There are separate accounts for each classification type such as cash, salaries classification type such as cash, salaries expense, accounts payable, etcexpense, accounts payable, etc..

According to Pacioli, “ Double-entry accounting is based on a simple concept: each party in a business transaction will receive something and give something in return. In accounting terms, what is received is a debit and what is given is a credit. The T account is a representation of a scale or balance.”

Luca PacioliDeveloper ofDouble-EntryAccounting,

c1494

Scale or Balance

ReceiveDEBIT

GiveCREDIT

Double entry accountingDouble entry accounting

Debits and CreditsDebits and Credits

Two of the most familiar accounting terms are Two of the most familiar accounting terms are “debits and “debits and credits.”credits.” In the double-entry system, debits must always In the double-entry system, debits must always equal credits for the accounting equation.equal credits for the accounting equation.

Debit (from the Latin word debere) means Debit (from the Latin word debere) means “left.”“left.” It is often It is often abbreviated as “dr.”abbreviated as “dr.”

Credit (from the Latin word credere) means Credit (from the Latin word credere) means “right.”“right.” It is It is often abbreviated as “cr.”often abbreviated as “cr.”

Recording done by debiting at least one account and crediting another.

DEBITS must equalmust equal CREDITS.

Account Name

Debit / Dr. Credit / Cr.


An arrangement that shows the effect of transactions on an account.Debit = “Left”Credit = “Right”

AccountAccount

An Account can An Account can be illustrated in a be illustrated in a

T-Account T-Account form.form.

Account Name



If Debit entries are greater thangreater than Credit entries, the account will have a debit balance.

$10,000 Transaction #2$3,000

$15,000$15,000

8,000Transaction #3

Balance

Transaction #1

Account Name



If Credit entries are greater thangreater than Debit entries, the account will have a credit balance.

$10,000 Transaction #2$3,000

$1,000$1,000

8,000 Transaction #3

Balance

Transaction #1

Chapter 3-23

AssetsAssetsDebit / Dr. Credit / Cr.

Normal BalanceNormal Balance

Chapter 3-27



ExpenseExpense

Chapter 3-24

LiabilitiesLiabilitiesDebit / Dr. Credit / Cr.


Chapter 3-25



EquityEquity

Chapter 3-26



RevenueRevenue

Normal Balance Credit

Normal Balance Debit

Debits and Credits SummaryDebits and Credits Summary

Balance Sheet Balance Sheet Income StatementIncome Statement

= + -Asset Liability Equity Revenue Expense

Debit

Credit

Debits and Credits SummaryDebits and Credits Summary

Basic Accounting EquationBasic Accounting Equation

Relationship among the assets, liabilities and Relationship among the assets, liabilities and stockholders’ equity of a business: stockholders’ equity of a business:

The equation must be in balance after every transaction. For every Debit there must be a Credit.

Ownership structure dictates the types of accounts that are part of the equity section.

Proprietorship or

PartnershipCorporation

Capital Account Drawing Account

Common Stock Additional Paid-in

Capital Dividends Declared Retained Earnings

Ownership StructureOwnership Structure


Transactions

1. Journalization

6. Financial Statements

7. Closing entries

8. Post-closing trail balance

9. Reversing entries

3. Trial balance

2. Posting

5. Adjusted trial balance

4. AdjustmentsWork Sheet

Transactions and EventsTransactions and Events

What to Record?What to Record?

FASB states, “transactions and other events and circumstances that affect a business enterprise.”

Types of Events:Types of Events:• External – between a business and its environment. • Internal – event occurring entirely within a business.

1. A supplier of a company‘s raw material is paid an amount owed on account. External

Not Recorded

2. A customer pays its open account. External

3. A new chief executive officer is hired. Not Recorded

4. The biweekly payroll is paid.

5. Raw materials are entered into production. Internal

External

6. A new advertising agency is hired. Not Recorded

7. The accountant determines the federal income taxes owed based on the income earned.

Internal

Review “Transactions and Events”Review “Transactions and Events”

External Internal

Transactions are initially recorded (journalized) in Transactions are initially recorded (journalized) in chronological order before they are transferred to chronological order before they are transferred to the ledger accounts.the ledger accounts.

AA journal makes several contributions to recording journal makes several contributions to recording process:process:

1. Discloses in one place the complete effect of a 1. Discloses in one place the complete effect of a transactiontransaction

2. Provides a chronological record of transactions2. Provides a chronological record of transactions

3. Helps to prevent or locate errors as debit and 3. Helps to prevent or locate errors as debit and credit amounts for eachcredit amounts for each entry can be compared entry can be compared

THE JOURNALTHE JOURNAL

JOURNALIZINGJOURNALIZING

• Entering transaction data in the journal is Entering transaction data in the journal is known as journalizing.known as journalizing.

• Separate journal entries are made for Separate journal entries are made for eacheach transaction.transaction.

• A complete entry consists of:A complete entry consists of:1. The date of the transaction,1. The date of the transaction,2. The accounts and amounts to be 2. The accounts and amounts to be debited and debited and credited, credited,3. A brief explanation of transaction.3. A brief explanation of transaction.

1. Journalizing

TECHNIQUE OF JOURNALIZINGTECHNIQUE OF JOURNALIZING

The date of the transaction is entered into the date The date of the transaction is entered into the date column.column.The debit account title is entered at the extreme left The debit account title is entered at the extreme left margin of the Account Titles and Explanation column. The margin of the Account Titles and Explanation column. The credit account title is indented on the next line.credit account title is indented on the next line.

GENERAL JOURNAL J1

Date Account Titles and Explanation Ref. Debit Credit 2005 Sept. 1 Cash 15,000 R. Neal, Capital 15,000 (Invested cash in business) 1 Computer Equipment 7,000 Cash 7,000 (Purchased equipment for cash)

When three or more accounts are required in one When three or more accounts are required in one journal entry, the entry is referred to as a compound journal entry, the entry is referred to as a compound entry.entry.

COMPOUND JOURNAL ENTRYCOMPOUND JOURNAL ENTRY

2

1

3

Posting Posting – the process of transferring amounts from the journal to the ledger accounts.

Cash Acct. No. 100Date Explanation Ref. Debit Credit Balance

General Ledger

Account Title Ref. Debit CreditJan. 3 Cash 100,000

Common stock 100,000

Date

General Journal

Jan. 3 Sale of stock GJ1 100,000 100,000

100

GJ1

2. Posting2. Posting

Trial BalanceTrial Balance – a list of each account and its balance; used to prove equality of debit and credit balances.

Account Debit CreditCash 140000Accounts receivable 35,000 Inventory 30,000 Building 150,000 Accounts payable 60,000$ Note payable 150,000 Common stock 100,000 Retained earningsSales 75,000 Cost of goods sold 30,000

385000 385000

3. Trial Balance3. Trial Balance

4. Adjusting Entries4. Adjusting Entries

Adjustments (adjusting entries) - end-of-period entries that assign the financial effects of implicit transactions to the appropriate time periods.Adjustments are usually made when the financial statements are about to be prepared.

Adjusting entriesAdjusting entries - needed to ensure that the - needed to ensure that the revenue revenue recognitionrecognition and and matching principlesmatching principles are followed. are followed.

Revenues Revenues - - Revenues are the economic resources flowing into a business as a result of operational activities (such as providing goods or services to other economic entities). Sales revenue, service revenue, and investment revenues are subdivisions of revenues. Increase in Revenues will increase Owner' Equity.

cont’d cont’d

Expenses Expenses - - Expenses are the outflow of a business’s economic resources resulting from the operational activities (such as purchasing goods or receiving services from other economic entities). They are the cost of doing business. Expenses can be termed in different ways according to the business activities. Cost of goods sold, administrative expenses, selling expenses, financial expenses are special terms of expenses. Increase in expenses will decrease owner' equity. Revenues and expenses are the subdivisions of Owner' Equity.

Classes of Adjusting EntriesClasses of Adjusting Entries

1. Prepaid Expenses. Expenses paid in cash and recorded as assets before they are used or consumed.

Prepayments3. Accrued Revenues.

Revenues earned but not yet received in cash or recorded.

4. Accrued Expenses. Expenses incurred but not yet paid in cash or recorded.

2. Unearned Revenues. Revenues received in cash and recorded as liabilities before they are earned.

Accruals

Payment of cash that is recorded as an asset because Payment of cash that is recorded as an asset because service or benefit will be received in the future. service or benefit will be received in the future.

Adjusting Entries – “Prepaid Expenses”Adjusting Entries – “Prepaid Expenses”

insurancesuppliesadvertising

Cash Payment Expense RecordedBEFORE

rentmaintenance on equipmentfixed assets

Prepayments often occur in regard to:Method: create Asset accounts to account for them.

Example:Example: OnOn Jan. 1 Jan. 1stst, Phoenix Corp. paid $12,000 for 12 , Phoenix Corp. paid $12,000 for 12 months of insurance coverage. Show the journal entry to months of insurance coverage. Show the journal entry to record the payment on Jan. 1record the payment on Jan. 1stst. .


Cash 12,000Prepaid insurance 12,000Jan. 1

Debit CreditPrepaid Insurance

12,00012,000 12,00012,000

Debit CreditCash

Example:Example: On Jan. 1On Jan. 1stst, Phoenix Corp. paid $12,000 for 12 , Phoenix Corp. paid $12,000 for 12 months of insurance coverage. Show the adjusting journal months of insurance coverage. Show the adjusting journal entry required at Jan. 31entry required at Jan. 31stst. .


Prepaid insurance 1,000Insurance expense 1,000Jan. 31

Debit CreditPrepaid Insurance

12,00012,000 1,0001,000

Debit CreditInsurance expense

1,0001,000

11,00011,000

Receipt of cash that is recorded as a liability because Receipt of cash that is recorded as a liability because the revenue has not been earned.the revenue has not been earned.

Adjusting Entries – “Unearned Revenues”Adjusting Entries – “Unearned Revenues”

rentairline ticketsschool tuition

Cash Receipt Revenue RecordedBEFORE

magazine subscriptionscustomer deposits

Unearned revenues often occur in regard to:Method: create a liability to account for it.

Example:Example: On NovOn Nov. 1. 1stst, Phoenix Corp. received $24,000 from , Phoenix Corp. received $24,000 from city School for 3 months rent in advance. Show the journal city School for 3 months rent in advance. Show the journal entry to record the receipt on Nov. 1entry to record the receipt on Nov. 1stst. .

Unearned rent revenue 24,000Cash 24,000Nov. 1

Debit CreditCash

24,00024,000 24,00024,000

Debit CreditUnearned Rent Revenue

Adjusting Entries – “Unearned Revenues”Adjusting Entries – “Unearned Revenues”

Example:Example: On Nov. 1On Nov. 1stst, Phoenix Corp. received $24,000 from , Phoenix Corp. received $24,000 from city High School for 3 months rent in advance. Show the city High School for 3 months rent in advance. Show the adjusting journal entry required on Nov. 30adjusting journal entry required on Nov. 30thth. .

Rent revenue 8,000Unearned rent revenue 8,000Nov. 30

Debit CreditRent Revenue

8,0008,000 24,00024,000

Debit CreditUnearned Rent Revenue

Adjusting Entries –Adjusting Entries – “Unearned Revenues”“Unearned Revenues”

8,0008,000

16,00016,000

Revenues Received in AdvanceRevenues Received in AdvanceThe transactions regarding prepaid expenses and The transactions regarding prepaid expenses and

unearned revenues are really mirror images of each unearned revenues are really mirror images of each other.other.

LiabilitiesLiabilities(Unearned(UnearnedRevenues)Revenues)

RevenuesRevenuesEarnedEarned

Seller

Adjustments

Buyer

AssetsAssets(Prepaid(PrepaidExpenses)Expenses)

ExpensesExpensesIncurredIncurred

Adjustments

Appear inBalance Sheet

Appear inIncome Statement

Appear inBalance Sheet

Appear inIncome Statement

Revenues earned but not yet received in cash or Revenues earned but not yet received in cash or recorded.recorded.

Adjusting Entries – “Accrued Revenues”Adjusting Entries – “Accrued Revenues”

rentinterestservices performed

BEFORE

Accrued revenues often occur in regard to:

Cash ReceiptRevenue Recorded

Adjusting entry results in:

Method: Create an Asset Account to account for it.

Example:Example: On July 1On July 1stst, Phoenix Corp. invested $300,000 in , Phoenix Corp. invested $300,000 in securities that return 5% interest per year. Show the securities that return 5% interest per year. Show the journal entry to record the investment on July 1journal entry to record the investment on July 1stst. .

Cash 300,000Investments 300,00

0July 1

Debit CreditInvestments

300,000300,000 300,000300,000

Debit CreditCash


Example:Example: On July 1On July 1stst, Phoenix Corp. invested $300,000 in , Phoenix Corp. invested $300,000 in securities that return 5% interest per year. Show the securities that return 5% interest per year. Show the adjusting journal entry required on July 31adjusting journal entry required on July 31stst. .

Interest revenue 1,250Interest receivable 1,250July 31

Debit CreditInterest Receivable

1,2501,250 1,2501,250

Debit CreditInterest Revenue


Expenses incurred but not yet paid in cash or Expenses incurred but not yet paid in cash or recorded.recorded.

Adjusting Entries – “Accrued Expenses”Adjusting Entries – “Accrued Expenses”

rentinteresttaxes

BEFORE

Accrued expenses often occur in regard to:

Cash Payment, if any*Expense Recorded

salariesbad debts*

Adjusting entry results in:

Method: Create a Liability Account to account for it.

Notes payable 200,000Cash 200,00

0Feb. 2

Debit CreditCash

200,000200,000 200,000200,000

Debit CreditNotes Payable


Example:Example: On Feb. 2On Feb. 2ndnd, Phoenix Corp. borrowed $200,000 at a , Phoenix Corp. borrowed $200,000 at a rate of 9% per year. Interest is due on first of each month. rate of 9% per year. Interest is due on first of each month. Show the journal entry to record the borrowing on Feb. 2Show the journal entry to record the borrowing on Feb. 2ndnd..

Example:Example: On Feb. 2On Feb. 2ndnd, Phoenix Corp. borrowed $200,000 at a , Phoenix Corp. borrowed $200,000 at a rate of 9% per year. Interest is due on first of each month. rate of 9% per year. Interest is due on first of each month. Show the adjusting journal entry required on Feb. 28Show the adjusting journal entry required on Feb. 28thth..

Interest payable 1,500Interest expense 1,500Feb. 28

Debit CreditInterest Expense

1,5001,500 1,5001,500

Debit CreditInterest Payable


Shows the balance of all accounts, after adjusting entries, at the end of the accounting period.

5. Adjusted Trial Balance5. Adjusted Trial Balance

Assets(Various)Unbilled Services ReceivableInventoryPrepaid RentPrepaid InsuranceBuildingsEquipmentLand

Liabilities(Various)Accrued Wages PayableAccrued Interest PayableUnearned RevenueOwner’s Equity

StockRetained Earnings

6. Preparing Financial Statements6. Preparing Financial Statements

Financial Statements are prepared directly from the Adjusted Trial Balance.

Balance Sheet

Income Statement

Statement of Cash Flows

Statement of

Retained Earnings

Adjusted Trial Balance Debit CreditCash 140000Accounts receivable 35,000 Building 190,000 Note payable 150000Common stock 100,000 Retained earnings 38,000 Dividends declared 10,000 Sales 185,000 Interest income 17,000 Cost of goods sold 47,000 Salary expense 25,000 Depreciation expense 43,000

490000 490000

Balance SheetAssets

Cash 140,000$ Accounts receivable 35,000 Building 190,000

Total assets 365,000$ Liabilities

Note payable 150,000 Stockholders' equity

Common stock 100,000 Retained earnings 115,000

Total liab. & equity 365,000$

6.6. Preparing Financial StatementsPreparing Financial Statements

Balance SheetAssume the following Adjusted Trial Balance

Adjusted Trial Balance Debit CreditCash 140,000$ Accounts receivable 35,000 Building 190,000 Note payable 150,000$ Common stock 100,000 Retained earnings 38,000 Dividends declared 10,000 Sales 185,000 Interest income 17,000 Cost of goods sold 47,000 Salary expense 25,000 Depreciation expense 43,000

490,000$ 490,000$

Income StatementRevenues:

Sales 185,000$ Interest income 17,000

Total revenue 202,000 Expenses:

Cost of goods sold 47,000 Salary expense 25,000 Depreciation expense 43,000

Total expenses 115,000 Net income 87,000$

6. Preparing Financial Statements6. Preparing Financial Statements

Income StatementAssume the following Adjusted Trial Balance

Adjusted Trial Balance Debit CreditCash 140,000$ Accounts receivable 35,000 Building 190,000 Note payable 150,000$ Common stock 100,000 Retained earnings 38,000 Dividends declared 10,000 Sales 185,000 Interest income 17,000 Cost of goods sold 47,000 Salary expense 25,000 Depreciation expense 43,000

490,000$ 490,000$

Statement of Retained Earnings

Beginning balance 38,000$ + Net income 87,000 - Dividends (10,000) Ending balance 115,000

6. Preparing Financial Statements6. Preparing Financial StatementsStatement of Retained Earnings

Assume the following Adjusted Trial Balance

7. Closing Entries7. Closing Entries

• To reduce the balance of the income statement To reduce the balance of the income statement ((revenuerevenue and and expenseexpense) accounts to zero. ) accounts to zero.

• To transfer net income or net loss to owner’s To transfer net income or net loss to owner’s equity.equity.

• Balance sheet (Balance sheet (assetasset, , liabilityliability, and , and equityequity) ) accounts are not closed.accounts are not closed.

• Dividends are closed directly to the Retained Dividends are closed directly to the Retained Earnings account.Earnings account.


ExampleExample: Assume the following Adjusted Trial Balance: Assume the following Adjusted Trial Balance

Account Debit CreditCash 140000Accounts receivable 35,000 Building 190,000 Note payable 150000Common stock 100,000 Retained earnings 38,000 Dividends declared 10,000 Sales 185,000 Interest income 17,000 Cost of goods sold 47,000 Salary expense 25,000 Depreciation expense 43,000

490000 490000

Example:Example: Prepare the Closing journal entry from the Prepare the Closing journal entry from the adjusted trial balance on the previous slide.adjusted trial balance on the previous slide.


Sales 185,000

Income summary 202,000Interest income 17,000

Income summary 115,000Cost of goods sold 47,000Salary expense 25,000Depreciation expense 43,000

Income summary 87,000Retained earnings 87,000

Retained earnings 10,000Dividends declared 10,000

ByByHashim KhanHashim KhanBBA(Hons)BBA(Hons)IMStudiesIMStudies

University Of PeshawarUniversity Of Peshawar

Date post:	02-Jul-2015
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Accounting cycle

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