BFA104 Accounting Context &

Method

Topic 2

The Accounting Cycle

(Two-column journal and ledger accounts: Debit and Credit reasoning, closing and balancing

procedures)

3

Reading and Independent Study

• Read pages 94 to 100

 • Prepare answers to Discussion Questions 7, 9

and 10

 • Prepare answers to Exercises 3.7 and 3.13

• Prepare answers to Problems 3.2 and 3.9

• Complete the vocabulary sheets

Key terms and procedures

• Balance day (end of financial period) procedures• Balancing procedure (ledger accounts)• Balancing T-form income statement accounts• Closing procedure• Closing journal entries• Permanent (balance sheet) accounts• Posting (from journal to ledger accounts)• Post-closing trial balance• Profit and loss summary • Temporary (income statement) accounts

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5

Lecture Case Study: JC Transporters Ltd

• Last week we worked on introducing the double entry bookkeeping process and the accounting system by looking at analysing transactions into debits and credits and posting to the ledger for Extreme Sports Ltd

• This week we are going to complete Extreme Sports Ltd from the start again, but analysing transactions using a general journal, posting to the general ledger, footing accounts and preparing a trial balance and preparing and posting closing general journal entries and finally balancing the balance sheet (real) accounts.

• But a point to note, we need to be very aware of how to analyse transactions into their debit and credit component. We have to be able to go straight from the transaction to the general journal entry.

6

Revision of Last Week

General Ledger Accounts

+ - +- +-

Assets Liabilities Owner’s Equity

= +

+-

Income

+-

Expense

+ -

Posting Rules

+ - +- +-

Assets Liabilities Owner’s Equity

= +

+-

Revenue

+-

Expense

+ -

Debit and Credit rules

9

All assets accounts = All liability accounts + All equity accounts Dr + Cr - Dr - Cr + Dr - Cr +

Debit todecrease

Credit toincrease

Normalbalance

Debit toIncrease

Credit todecrease

Normalbalance

Debit todecrease

Credit toincrease

Normalbalance

Debit toincrease

Credit todecrease

Normalbalance

Debit todecrease

Credit toincrease

Normalbalance

Expense accounts

Dr + Cr - Income accounts

Dr - Cr +

Posting Rules

Assets Liabilities Owner’s Equity

Revenues Expenses

Increases Debit Credit Credit Credit Debit

Decreases Credit Debit Debit Debit Credit

General Ledger Account Format

The T format of a general ledger account is set out in the following way:

100 Cash at bank Date Particulars Folio Amount Date Particulars Folio Amount

General Ledger Account Format

• Another way to format a ledger account is in the continuous balancing format.

100 Cash at bank Date Particulars Folio Debit Credit Balance

How to analyse a transaction

1. Ask what two or more accounts are affected (e.g. Cash at bank and Capital)?

2. What type of account is each account (i.e. A, L, OE, I, or E)

3. Is each account increasing or decreasing?

4. Apply the posting rules to determine whether each account is debited or credited.

5. What amount is each account debited or credited by?

Transaction

Basic analysis

Equation analysis

Debit-credit analysis

Journal entry

Posting

1 October, the owner contributed $10 000 cash.

The asset Cash at Bank is increased by $10 000; Owner’s Equity (specifically Capital) is increased $10 000

Assets = Liabilities + Owner'sEquity

Cash at bank Capital

+10 000 +10 000

Cash at bank, asset, increases, debit, $10 000Capital, owner’s equity, increases, credit, $10 000

Oct. 1 Capital 300 10 000

Oct. 1 Cash at bank 100 10 000

Cash at bank

Capital

Date Account Affected

Type Increase/ Decrease

Debit/ Credit

Amount

1 Oct. Cash at bank A Increase Debit 10 000 Capital OE Increase Credit 10 000

Analysing Transactions• However, the transaction analysis is replaced by a formal

document called a general journal.

Transaction

Basic analysis

Equation analysis

Debit-credit analysis

Journal entry

Posting

1 October, the owner contributed $10 000 cash.

The asset Cash at Bank is increased by $10 000; Owner’s Equity (specifically Capital) is increased $10 000

Assets = Liabilities + Owner'sEquity

Cash at bank Capital

+10 000 +10 000

Cash at bank, asset, increases, debit, $10 000Capital, owner’s equity, increases, credit, $10 000

Date Account titles and explanationPost Ref Debit Credit

1 Oct. Cash at bank 100 10 000 Capital 300 10 000Owner contribution of cash

Oct. 1 Capital GJ1 10 000

Oct. 1 Cash at bank GJ1 10 000

Cash at bank

Capital

General journal

• Once analysed transaction is recorded first in a record called a journal and then ‘posted’ (transferred) to ledger accounts

• A journal has the following advantages:– It gives a complete record of all transactions– Presented in chronological order– Which is useful for locating and reducing

mistakes (as debits and credits shown together)

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The General Journal

General Journal GJ01

Date Details Folio Debit Credit

2012

July 01 Cash at Bank 100 10,000

Capital 300 10,000

Capital contributed by owner

The general journal has a specific format:Note the column

headings

The debit entry is written first and is hard up

against the margin

The credit entry is last

and is indented from the margin

The transaction has

a narration

The transaction is finished off by

underlining

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Accounting Cycle

Transactions

Source documents

General Journal

General Ledger

Trial balance (six column worksheet)

Financial Statements

Closing entries

Points

How to analyse a transaction

Double entry bookkeeping

Rules for posting to ledger accounts

Chart of accounts

Source documents

Ledger folio numbers

Debit and credit

Ledger account formats

Closing entries

Footing and balancing accounts

Balance ‘real’ accounts

20

Accounting Cycle

Transactions

Source documents

General Journal

General Ledger

Trial balance (six column worksheet)

Financial Statements

Closing entries

Balance ‘real’ accounts

Pencil foot accounts

Balance accounts

21

Extreme Sports Ltd: Accounting Cycle, general journal and posting to general ledger

Lecture case Study 2

Enter the following transactions into the pro-formas provided for Extreme Sports.• May 29 2013 owner of Extreme Sports contributes

$100 000 cash as start- up capital for her new business.

• June 7 2013 bought office furniture for the business $5000 cash.

• June 14 paid cash for wages $750.• June 15 purchased sports equipment on credit from

Dunlop Ltd $5000.• June 28 cash received for sports services provided

$5000.

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Lecture case study 2Date Particulars Post

RefDebit Credit

29 May Cash at bank 100 000

Share capital 100 000

Capital contribution by owners

7 June Office Furniture 5 000

Cash at bank 5 000

Purchased office furniture

14 June Wages expense 750

Cash at bank 750

Paid wages

15 June Sports Equipment 5 000

Accounts payable - Dunlop 5 000

Purchased sports equipment

28 June Cash at bank 5 000

Services revenue 5 000

Earned services revenue

Extreme Sports Ledgers

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Extreme Sports Ledgers

•

25

26

Extreme Sports Ltd: Pencil footing accounts and producing a trial balance

27

The Trial Balance• After completing the Debit/Credit record keeping transactions for

a period the sum of all accounts with net debit totals (balances) must equal the sum of all net credit totals (balances)

• This means listing all the ledger accounts in a special sequence of balance sheet accounts followed by income statement accounts and entering their $ totals in a debit or credit column (as shown in the next slide and on p7 in the Your Tasks notes)

• If both column totals are the same and all account balances are normal we can conclude, subject to some other tests, that record keeping has been ‘done properly’

• If we include account codes the trial balance reflects the firm’s chosen chart of accounts

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JC TransportersTrial Balance

At 31 December 2009

Code DR CR

BALANCE SHEET ACCOUNTSCash at bank 100 57,600Accounts receivable 101 120,000

Spare parts and fuel 102 13,200Land and buildings 150 40,000Office equipment 151 9,000*

Motor vehicles 152 120,000*

Bank loan 250 90,000Share capital 300 112,000

Retained profits 301INCOME STATEMENT ACCOUNTSTransport fees revenue 400 450,000

Operating expenses 500 206,400

Spare parts and fuel expense 501 6,800Depreciation expense 502 31,000*Income tax expense 503 48,000

652,000 652,000

Proves arithmetical accuracy of transactions

Chart of accounts?

Definitions of elements?

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How useful is the trial balance?

• It does not prove that:– All transactions are recorded (nothing left out)– Transaction have been posted to the correct accounts– Transactions are not duplicated– There are no compensating mistakes

• If tests* show that none of the above apply and that the balances are accurate and complete– The trial balance items can be used to prepare the balance

sheet and income statement– It is even more useful if extended into a six-column worksheet

* What sort of tests?

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JC Transporters Trial Balance at 31 December

2009Income statement Balance sheet

ref DR CR DR CR DR CRBALANCE SHEET ACCOUNTSCash at bank 100 57,600 57,600Accounts receivable 101 120,000 120,000Spare parts and fuel 102 13,200 13,200Land and buildings 150 40,000 40,000Office equipment 151 10,000 10,000Accumulated depreciation 152 1,000 1,000Motor vehicles 153 150,000 150,000Accumulated depreciation 154 30,000 30,000Bank loan 250 90,000 90,000Share capital 300 112,000 112,000Retained profits 301INCOME STATEMENT ACCOUNTTransport fees revenue 400 450,000 450,000Operating expenses 500 206,400 206,400Spare parts and fuel expense 501 6,800 6,800Depreciation expense 502 31,000 31,000Income tax expense 503 48,000 48,000

683 000 683 000 292 200 450 000

Net profit for the year 157,800 157,800450,000 450,000 390,800 390,800

Used to prepare the income statement

Used to prepare the balance sheet

Accumulated depreciation?

31

Separate Slides on closing process and closing entries

32

Temporary and permanent accounts

• According to their function, ledger accounts can be classified as temporary or permanent

– Temporary (Nominal) Accounts are:• Income Statement Accounts• Reduced to zero balances (closed) at the end of each

accounting period

– Permanent (Real) Accounts• Balance Sheet Accounts• Ending balances are carried forward to next accounting

period

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Closing entries• Remember that all income and expense items appear in the

balance sheet in the total for retained profits

• Therefore these items must be transferred to the retained profits account using closing journal entries

• The word closing means that once the amounts are transferred the income and expense account balances are zero (and ready for transactions in the next accounting period)

• So the income statement accounts ‘hold’ transactions temporarily for an accounting period

• A profit and loss summary account is used to collect income and expense totals until the net profit/loss is transferred to the permanent balance sheet account for retained profits

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Stages in the closing process

1. Income accounts are closed to P&L Summary– Debit income– Credit P&L summary

2. Expense accounts are closed to P&L summary– Debit P&L summary– Credit expense

3. Profit & Loss Summary balance then closed to retained profits

– Debit P & L summary (assuming a profit)– Credit retained profits account

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Fees revenueProfit & loss summary

400600

450 000450 000

Profit & loss summaryOperating expensesIncome tax expenseSpares & fuel expenseDepreciation expense

600500503501502

292 200206 400

48 0006 800

31 000

Profit & loss summaryRetained profits

600301

157 800157 800

What would a compounded entry

look like?

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Overview of the closing process

Profit & Loss Summary

Expenses 292,200Retained prof 157,800

450,000

Income 450,000

450,000

CapitalBal. c/d 157,800

157,800

Balance NilP&L summ 157,800

157,800Bal. b/d 157,800

Income

P&L summ 450,000

Total 450,000

Expenses

Total 292,200

P&L summ 292,200

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3

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Stages in the closing process

1. Income accounts are closed to P&L Summary– Debit income– Credit P&L summary

2. Expense accounts are closed to P&L summary– Debit P&L summary– Credit expense

3. Profit & Loss Summary balance then closed to retained profits

– Debit P & L summary (assuming a profit)– Credit retained profits account

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Extreme Sports Ltd: Closing entries

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Balancing T-form balance sheet accounts

• To ‘clean up’ the balance sheet accounts and make them ready for the new period’s transactions they must be balanced

• This is not a problem with running balance accounts as the balance column is updated after each transaction

• T-form accounts need an extra balancing procedure as illustrated in the next slide

• After the T accounts are balanced an extra check is to produce a post-closing trial balance, which should show only balance sheet accounts and balances

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Cash at bank101

Date Description Ref Debit + Date Description Ref Credit –

2009 Share capital J1 112 000 2009 Land & building J1 40 000

Jan 1 Accounts receivable

J1 330 000 Jan 1 Office equipment J1 10 000

Motor vehicles J2 30 000

Spare parts & fuel

J2 20 000

Operating expenses

J2 206 400

Income tax expense

J2 48 000

Bank loan J2 30 000

Dec 31

Balance c/d 57 600

442 000 442 000

2010 Balance b/d 57 600

41

Accounting Cycle

Transactions

Source documents

General Journal

General Ledger

Trial balance

Financial Statements

Closing entries

PointsHow to analyse a transaction

Double entry bookkeeping

Rules for posting to ledger accounts

Chart of accounts

Source documents

Ledger folio numbers

Debit and credit

Ledger account formats

Closing entries

42

JC Transporters Ltd: Complete accounting cycle for 2009 (if time)

To do before next lecture

Chapter readings for this week’s topic

Independent practice – individually attempt this topic’s lecture task(s) and tutorial tasks

Tutorial - attend to check your work & understanding (ask questions)

Workshop – check your work & understanding (ask questions)

Topic consolidation- re-read or further reading;- Ask questions on MyLO discussion boards and/or in study groups;- If stuck, bring your workings/notes to staff consultation.

Pre-read next week’s chapter(s)

Next Lecture

Completing the Accounting Cycle

(adjusting entries; a worksheet approach)

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