LaiACCT1200/fall20 (lecture 3)

ADA University, School of Business

ACCT1200 Principles of Financial Accounting, Fall 2020
Lecture 3 – Accounting Cycle 1

 Reminder: objective of financial accounting – the reporting of financial results and

financial position in the form of financial statements for the use of both
insiders and outsiders.

 The financial statements / reports include: profit and loss account; balance sheet;
cash flow statement. Companies also include non-financial statements in their annual
reports such as the chairman’s report; the directors’ report and the auditors’ report.

 Financial statements are the end-products of the financial accounting process which is
called the accounting cycle.

 Overview of the accounting cycle:

o In general, the accounting cycle consists of the following steps or processes:
(a) Occurrence of transactions: transactions are financial or economic events
which are measurable in monetary terms and recorded in the accounting
books. Examples are cash and credit sales and purchases. What do you think
should be the first transaction common to all business entities?
(b) Recording of these transactions in journals or books of original entry –
examples of books of original entry are sales journals, purchase journals,
cash book.
(c) Transferring or “posting” of the entries from the journals to the ledger
accounts or ledger. The ledger account is a form of record used to record
increases and decreases in a single item. In the ledger accounts, the items are
separated and classified.
(d) Balancing of the accounts in the ledger(s) at the end of the accounting period
to determine debit or credit balances.
(e) Making end of the period adjustments – for example, the recording of
depreciation as an expense at the end of the accounting period.
(f) Preparing the trial balance – to prove the equality of debit and credit balances
in the ledger.
(g) Preparing the financial statements – the profit and loss account and the
balance sheet.
(h) Closing the accounts – all the revenue and expense accounts will be closed.
(i) Audit – after which the accounting cycle process repeats itself for a new
accounting period.

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 LaiACCT1200/fall20 (lecture 3)

 Classification of accounts – there are five (only five) elements or major categories of
accounts, namely Assets, Liabilities, Equity (Capital), Expenses and Revenue.

 Assets – resources owned by a business entity. Assets can be (a) tangible or intangible;
(b) fixed (capital) or current.
o Tangible assets – land, buildings, plant and machinery, vehicles, warehouses,
office furniture and equipment, stocks (inventories), debtors (account
receivables), money in the bank, cash.
o Intangible assets – goodwill; patent rights; franchise rights.

 Fixed assets – assets which will be used in the business for periods of more than a
year. To allocate the total cost over its useful life, a tangible fixed asset is
depreciated while an intangible fixed asset is amortized. Which accounting
principle is being applied here? The two common methods of calculating
depreciation are the straight-line method and the reducing balance method (more
about these later).
 Current assets – a current asset is an asset which will be used up (or can be
converted into cash) within the current accounting period (normally taken as a
period of one year). Liquidity is the term used to describe how readily a current
asset can be converted into cash.
 From the examples given above, can you now classify them into fixed and
current assets.

● Liabilities – amounts owed by an entity to outside parties. Examples are loans from the
bank, individuals, other corporations; bank overdrafts; creditors (accounts payable); taxes
payable. Liabilities are also categorized into current (due in less than one year) or long-
term (due in more than 1 year).

● Equity / capital is the investment made by the owners in the business. In the case of
corporations, capital can be in the form of common shares (common stock), preferred
shares, retained profit or reserves.

 Examples of expenses (or revenue expenditures) are salaries & wages; office rental;
payment for utilities, insurance, advertising, delivery; interest payment; depreciation /
amortization.

 Examples of revenue are sales, interest received, dividends received, commissions

received.

Homework: Find out what is: capital expenditure, return inwards, return outwards, discount
allowed, discount received?

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 LaiACCT1200/fall20 (lecture 3)

 Double-entry rules – knowledge of the double-entry rules is required before recording

can be made in the journals and ledgers. The rules of debit and credit (Pacioli’s rules)
are as follows:

Element or classification of account Debit Credit

Asset + ─

Liability ─ +
Equity ─ +
Revenue ─ +
Expense + ─

 Transaction analysis – beginners may find this useful before recording the entries in the
journals / ledgers. The following steps are involved:
(a) Determine the two accounts affected / involved.
(b) Classify the two accounts according to the 5 elements identified as above.
(c) Determine whether there is an increase or decrease in each of the two accounts.
(d) Record the entries in the books of account according to the double-entry rules.

o Examples:
1 January 2018 Adele started her business by depositing $10,000 in the bank.
2 January 2018 Bought office furniture costing $4,000 on credit from
Mebel Co.
4 January 2018 Purchased goods costing $3,000 which was paid by check.
6 January 2018 Sold goods for $1,500 on credit to Gaga.
8 January 2018 Paid office rent for the first month of operation issuing a check
for $800.
9 January 2018 Paid Mebel Co. $4,000 by check.

The transaction analyses for the first two transactions are as follows:
Date Accounts Account Element Increase/decrease Debit/Credit
01.01 bank asset increase debit
capital equity increase credit
02.01 furniture asset increase debit
Mebel Co. liability increase credit

Conduct a transaction analysis for the other transactions.

 As noted earlier, transaction analyses are helpful for beginners, seasoned book-keepers
would perform them mentally, and so would you after a bit of practice.

Readings:
o F Wood & A Sangster, Business Accounting 1, 13th edition, 2015, Pearson, chapters 1-4.

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o Leiwy, Danny and Perks, Robert; “Accounting: Understanding and Practice”, 4th
edition, 2013, McGraw-Hill Education, chapter 9
LaiACCT1200/fall20 (tutorial 3)

ADA University, School of Business

ACCT1200 Principles of Financial Accounting, Fall 2020
Tutorial 3 – Accounting Cycle 1

 Issue 1: What are the following accounts used for (a) capital; (b) trade creditors;
(c) trade debtors; (d) stock; (e) sales; (f) purchases; and (g) drawings?

 Issue 2: What is the difference between (a) discounts allowed account and discounts
received account? (b) sales return (return inwards) account and purchases
return (return outwards) account?

 Issue 3: From your understanding of the double-entry rules, can you explain why the
bank credits your bank statement when you deposit cash into your bank
account and debits your account when you withdraw cash from the ATM
machine?

 Issue 4:
(i) Posting the transactions in bookkeeping means:
(a) making the first entry of a double entry transaction.
(b) entering items in a cash book.
(c) making the second entry of a double entry transaction.
(d) transferring the entry from a journal to the ledger account.
(ii) Amortization is;
(a) the allocation of the cost of a tangible asset over its useful life.
(b) the allocation of the cost of an intangible asset over its estimated life.
(c) the periodic / installment payment charged by a finance company for a
loan taken from it.
(d) none of the above.

 Issue 5:
Davies buys and sells goods on cash and credit terms. The following is a list of her
transactions for January 2018:
(a) Capital introduced by Davies and paid into the bank.
(b) Goods purchased on credit terms from Swallow.
(c) Goods sold to Hill for cash.
(d) Cash paid for purchase of goods.
(e) Dale buys goods from Davies on credit.
(f) Motoring expenses paid by cheque.

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 Required: State which account in Davies’ book of account should be debited and which
account should be credited for each transaction.
LaiACCT1200/fall20 (tutorial 3)

 Issue 6:
Harry started a new business on 1 January 2018. The following transactions cover his
first three months in business:
(a) Harry contributed an amount in cash to start the business.
(b) He transferred some of the cash to a business bank account.
(c) He paid an amount by cheque for rental of business premises.
(d) Bought goods on credit from Paul.
(e) Purchased a van paying by cheque.
(f) Sold some goods for cash to James.
(g) Bought goods on credit from Nancy.
(h) Paid motoring expenses in cash.
(i) Returned some goods to Nancy.
(j) Sold goods on credit to Mavis.
(k) Harry withdrew some cash for personal use.
(l) Bought goods from David paying in cash.
(m) Mavis returned some goods.
(n) Sent a cheque to Nancy.
(o) Cash received from Mavis.
(p) Harry receives a cash discount from Nancy.
(q) Harry allows Mavis a cash discount.
(r) Cheque withdrawn at the bank in order to open a petty cash account.
Required: State which account in Harry’s books of account should be debited and which
account should be credited for each transaction.

 Issue 7:
You have just been recruited as the accountant of a new company which has not
started operations yet. One of your immediate responsibilities is to set up the financial
accounting system of the company. In setting up any financial accounting system,
knowledge of the accounting cycle is essential. Briefly outline the steps / processes
contained in the accounting cycle.