THE ACCOUNTING CYCLE

THE ACCOUNTING CYCLE

A DAC 501: FINANCIAL ACCOUNTING

PRESENTATION.BY

HERICK ONDIGOSCHOOL OF BUSINESS, UoN

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

1. 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 Balance6. Prepare /Create financial statements &

reports from data in adjusted TB7. Journalize and post the closing entries8. Prepare the post-closing trial balance9. Prepare and post reversing entries

Detailed Steps in the Accounting Cycle

Analyze Business

Transactions.

Journalize transactions

in the journal.

Post entries to the

accounts in the ledger.

Prepare unadjusted

trial balance.

Prepare financial

statements.

Post-closing trial balance

Journalize and post closing

entries

Journalize and post adjusting

entries

Prepare adjusted

trial balance.

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’ EquityImplications:Total Asset=Claims against the assetsTherefore :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 accountGeneral 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

Date Item Post. Ref. * Debit Date ItemPosting Reference Credit

Account No:Account

Left-hand or Right-hand or

Debit Side Credit Side

Account Name Account No:

Two-Column Account

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

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

+ - debit credit

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.

Accounting Is Fun!

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 transactionA book or a location on a hard drive where

all business transactions are listed Like a diary

What’s in a Journal Entry?

1. Date2. 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

DR=CRDR=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 No

Assets Liabilities Owners’ Equity

1 +100.000 No change +100.000Total 100.000 0 100.000

GENERAL JOURNAL Page 1Date Account Title and Description Acct.No. Debit Credit

1 Jan 2004Cash 100 100.000

Capital 500 100.000

Investment by the shareholders

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 changeTotal 100.000 0 100.000

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


1 +100.000 No change +100.000

2 No change No change No change3 +600 No change No change

-600 No change No changeTotal 100.000 0 100.000

GENERAL JOURNAL Page 1Date Account Title and Description Acct.No. Debit Credit

1 Jan 2004Prepaid Rent 180 600

Cash 100 600

Payment of 3 months of rent in advance

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.


1 +100.000 No change +100.000


-600 No change No change4 +15.000 +10.000 No change

-5.000Total 110.000 10.000 100.000

GENERAL JOURNAL Page 1

Date Account Title and Description Acct.No Debit Credit

2 Jan 2004Furniture and Equipment 255 15.000

Cash 100 5.000 Accounts Payable 320 10000Purchase 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.


1 +100.000 No change +100.000



-5.0005 +120 No change No change

-120Total 110.000 10.000 100.000


Date Account Title and Description Acct.No. Debit Credit

3 Jan 2004Prepaid Insurance 180 120

Cash 100 120Purchase 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.


1 +100.000 No change +100.000




-1206 No change No change No change

Total 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.


1 +100.000 No change +100.000




-1206 No change No change No change7 +15.000 +15.000 No change

Total 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.



10 Jan 2004Cash 100 15.000

Bank Loan 300 15.000Borrowing from the bank

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


1 +100.000 No change +100.000




-1206 No change No change No change7 +15.000 +15.000 No change8 +2.500 No change No change

-2.500Total 125.000 25.000 100.000

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



10 Jan 2004Office Supplies 136 2.500

Cash 100 2.500Purchase 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.


1 +100.000 No change +100.000





-2.5009 +5.000 No change +5.000

Total 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.

Left or Debit Side Right or Credit SideDecrease Increase

Revenue Accounts



16 Jan 2004Accounts Receivable 120 5.000

Commission Revenue 600 5.000Recognition 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.


1 +100.000 No change +100.000





-2.5009 +5.000 No change +5.000

10 -5000 -5000 No changeTotal 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.



20 Jan 2004Accounts Payable 320 5.000

Cash 100 5.000Payment 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.


1 +100.000 No change +100.000





-2.5009 +5.000 No change +5.000

10 -5.000 -5.000 No change11 +7.500 +7.500 No change

Total 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.



22 Jan 2004Cash 100 7.500

Unearned Revenues 340 7.500Receipt 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.


1 +100.000 No change +100.000





-2.5009 +5.000 No change +5.000

10 -5.000 -5.000 No change11 +7.500 +7.500 No change12 +5.000 No change No change

-5.000Total 132.500 27.500 105.000

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



23 Jan 2004Cash 100 5.000

Accounts Receivable 120 5.000Receipt of payment from a customer

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


7 +15.000 +15.000 No change8 +2.500 No change No change

-2.5009 +5.000 No change +5.000


-5.00013 -9.000 No change -9.000

Total 123.500 27.500 96.000

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

Left or Debit Side Right or Credit SideIncrease Decrease

Expense Accounts



24 Jan 2004Salary Expense 770 9.000

Cash 100 9.000Payment of salaries

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.


8 +2.500 No change No change-2.500

9 +5.000 No change +5.00010 -5.000 -5.000 No change11 +7.500 +7.500 No change12 +5.000 No change No change

-5.00013 -9.000 No change -9.00014 +7.500 No change +7.500

Total 131.000 27.500 103.500

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



31 Jan 2004Accounts Receivable 120 7.500

Commission Revenues 600 7.500Recognition of commission on ticket sales

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


7 +15.000 +15.000 No change8 +2.500 No change No change

-2.5009 +5.000 No change +5.000


-5.00013 -9.000 No change -9.00014 +7.500 No change +7.50015 -3.000 No change -3.000

Total 128,000 27,500 100,500

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

Left or Debit Side Right or Credit SideIncrease Decrease

Owners' Withdrawals or Dividends



31 Jan 2004Withdrawals XXX 3,000

Cash 100 3,000Withdrawal 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- SummaryAssets = Liabilities + Owners’ Equity + - - + -

+Dr Cr Dr Cr Dr Cr Expense Revenue + - - + Dr Cr Dr Cr

Withdrawals/Dividends + - Dr Cr

Accounting Cycle-Revisited

Analyze and record the transactions

Post the transactions and prepare trial balance

Adjust the accounts 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 account’s date column

2. Transfer the debit/credit amount and calculate the new balance

3. Write journal page number in posting reference column of ledger as a cross-reference

4. Go back to journal and write account number in posting reference column of journal as a cross-reference

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 1Date Account Title and Description Acct.No. Debit Credit

1 Jan 2004Cash 100 100.000

Capital 500 100.000

Investment by the shareholders

LEDGER - Cash Acc. No. 100

Date Description Ref Debit Credit Debit Balance

Credit Balance

1 Jan 2004Capital P 1 100,000 100,000

LEDGER - Capital Acc. No. 500

Date Description Ref Debit Credit Debit Balance

Credit Balance

1 Jan 2004Cash P 1 100,000 100,000

LEDGER - Cash Acc. No. 100

Date Description Debit Credit1 Jan Capital 100,0001 Jan Office rent 6002 Jan Office furniture and equipment 5,0003 Jan insurance expense 12010 Jan Bank loan 15,00010 Jan Office supplies 2,50020 Jan Accounts payable 5,00022 Jan Unearned Revenue 7,50023 Jan Acccounts Recievable 5,00024 Jan salaries expense 9,00031 Jan Withdrawal 3,000

Posting illustrated

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 accountsDetermine 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)

Category of the Account Increase Recorded By

Normal Balance

Assets Debits Debit

Liabilities Credits Credit

Shareholders’ Equity

Capital Credits Credit

Dividends or Withdrawals Debits Debit

Revenues Credits Credit

Expenses Debits Debit

SUMMARY -Normal Balances of Accounts

Preparing a Trial Balance

List the ledger account balances in two columns on the trial balanceLeft column = DebitsRight 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 rules to prepare the Trial Balance:

Total Debit Entries = Total Credit Entries

Debit Credit

Assets

Expenses

Drawings

Income/ Revenue

Liabilities

Capital


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


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 balancing3) Incorrect amounts entered on one entry4) Omission of one entry.


Question: How do we locate all of the above errors?

Answers: 1) Check day-book (journal) totals2) Check additions of Ledger accounts, ensure each balance is correct3) 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 Balance2) End of Period Adjustments 3) Statement of Income4) Statement of Financial position


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)


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

Accounts Debit CreditCash 102,280Accounts Receivable 7,500Office Supplies 2,500Prepaid Rent 600Prepaid Insurance 120Office Furniture and Equipment 15,000Bank Loan 15,000Accounts Payable 5,000Unearned Revenues 7,500Capital 100,000Withdrawal 3,000Commission Revenues 12,500Salary Expenses 9,000Total 140,000 140,000

Express Travel AgencyTrial Balance

31-Jan-10in $

THE END

THANK YOU

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