ACCOUNTING CYCLE FOR SERVICE-GIVING BUSINESSES

An account is an individual record of increases and decreases in a specific asset, liability, stockholders’ equity, revenue,
or expense item.  In its simplest form, an account consists of three parts: (1)a title, (2) a left or debit side, and (3) a right
or credit side.  Because the format of an account resembles the letter T, we refer to it as a T-account.

DEBIT AND CREDIT PROCEDURES DOUBLE-ENTRY SYSTEM

 Each transaction must affect two or more accounts to keep the basic accounting equation in balance.
 Recording done by debiting at least one account and crediting at least one other account. DEBITS MUST EQUAL
CREDITS
Assets - Debits should exceed credits.  Liabilities – Credits should exceed debits.  Normal balance is on the
increase side.
Issuance of share capital and revenues increase equity (credit).  Dividends and expenses decrease equity (debit).
All accounts that normally contain a debit balance will increase in amount when a debit (left column) is added to
them, and reduced when a credit (right column) is added to them. The types of accounts to which this rule applies are
expenses, assets, and dividends

Rules of Debits and Credits: Assets are increased by debits and decreased by credits. Liabilities are increased by
credits and decreased by debits. Equity accounts are increased by credits and decreased by debits.

All accounts that normally contain a credit balance will increase in amount when a credit (right column) is
added to them, and reduced when a debit (left column) is added to them. The types of accounts to which this
rule applies are liabilities, revenues, and equity.
Rule 3: Contra Accounts Offset Paired Accounts

Contra accounts reduce the balances of the accounts with which they are paired. This means that (for example)
a contra account paired with an asset account behaves as though it were a liability account.

Rule 4: Entries Must Balance

The total amount of debits must equal the total amount of credits in a transaction. Otherwise, a transaction is
said to be unbalanced, and the financial statements from which a transaction is constructed will be inherently
incorrect. An accounting software package will flag any journal entries that are unbalanced, so that they cannot
be entered into the system until they have been corrected.

Impact of the Debit and Credit Rules

By following these debit and credit rules, you will be assured of making entries in the general ledger that are
technically correct, which eliminates the risk of having an unbalanced trial balance. However, just following
the rules does not guarantee that the resulting entries will be correct in substance, since that also requires a
knowledge of how to record transactions within the applicable accounting framework (such as Generally
Accepted Accounting Principles or International Financial Reporting Standards).

The purpose of earning revenues is to benefit the shareholders.  The effect of debits and credits on revenue accounts is
the same as their effect on equity.  Expenses have the opposite effect: expenses decrease equity.

Summary of Debit/Credit Rules

STEPS IN THE RECORDING PROCESS

Although it is possible to enter transaction information directly into the accounts without using a journal, few businesses
do so. Practically every business uses three basic steps in the recording process:
1) Analyze each transaction for its effects on the accounts.
2) Enter the transaction information in a journal.
3) Transfer the journal information to the appropriate accounts in the ledger. The recording process begins with the
transaction.  Business documents, such as a sales receipt, a check, or a bill, provide evidence of the transaction
THE JOURNAL
Book of original entry.  Transactions recorded in chronological order.  Companies may use various kinds of journals,
but every company has the most basic form of journal, a general journal.  Contributions to the recording process: 1.
Discloses the complete effects of a transaction. 2. Provides a chronological record of transactions. 3. Helps to prevent or
locate errors because the debit and credit amounts can be easily compared.
JOURNALIZING - Entering transaction data in the journal. Illustration: On September 1, shareholders invested €15,000
cash in the corporation in exchange for ordinary shares, and Softbyte purchased computer equipment for €7,000 cash.
SIMPLE AND COMPOUND ENTRIES Illustration: On July 1, NOH Company purchases a delivery truck costing
NT$420,000. It pays NT$240,000 cash now and agrees to pay the remaining NT$180,000 on account.
Illustration 2-15 Compound Journal Entry

THE LEDGER
The entire group of accounts maintained by a company is the ledger.  The ledger keeps in one place all the information
about changes in specific account balances.  Companies may use various kinds of ledgers, but every company has a
general ledger. It contains all the asset, liability, and equity accounts.

POSTING: Transferring journal entries to the ledger accounts is called posting.  Posting involves the following steps.
1) In the ledger, enter, in the appropriate columns of the account(s) debited, the date, journal page, and debit amount
shown in the journal.
2) In the reference column of the journal, write the account number to which the debit amount was posted. 3) In the
ledger, enter, in the appropriate columns of the account(s) credited, the date, journal page, and credit amount shown in the
journal. 4) In the reference column of the journal, write the account number to which the credit amount was posted
Illustration 2-18 shows these four steps using Softbyte Inc.’s first journal entry, the issuance of ordinary shares for
€15,000 cash
CHART OF ACCOUNTS: The number and type of accounts differ for each company.  The number of accounts depends
on the amount of detail management desires. For example, the management of one company may want a single account
for all types of utility expense. Another may keep separate expense accounts for each type of utility, such as gas,
electricity, and water.  Most companies have a chart of accounts. This chart lists the accounts and the account numbers
that identify their location in the ledger.  The numbering system that identifies the accounts usually starts with the SoFP
accounts and follows with the IS accounts.
Illustration 2-19 Chart of accounts for Pioneer Advertising Agency Inc.

THE RECORDING PROCESS ILLUSTRATED

Illustrations 2-20 through 2-29 show the basic steps in the recording process, using the October transactions of Pioneer
Advertising Agency Inc.  Pioneer’s accounting period is a month. A basic analysis and a debit-credit analysis precede
the journalizing and posting of each transaction.  For simplicity, we use the T-account form in the illustrations instead of
the standard account form.  The purpose of transaction analysis is first to identify the type of account involved, and then
to determine whether to make a debit or a credit to the account
THE UNADJUSTED TRIAL BALANCE

A Trial Balance is a list of accounts and their balances at a given time.  Customarily, companies prepare a trial balance at
the end of an accounting period.  They list accounts in the order in which they appear in the ledger.  Debit balances
appear in the left column and credit balances in the right column.  The trial balance proves the mathematical equality of
debits and credits after posting.

Under the double-entry system, this equality occurs when the sum of the debit account balances equals the sum of the
credit account balances. A trial balance may also uncover errors in journalizing and posting.  In addition, a trial balance
is useful in the preparation of financial statements. The steps for preparing a trial balance are:
1. List the account titles and their balances.
2. Total the debit and credit columns.
3. Prove the equality of the two columns

LIMITATIONS OF A TRIAL BALANCE: A trial balance does not guarantee freedom from recording errors, however.
 Numerous errors may exist even though the totals of the trial balance columns agree.
Trial balance may balance even when:
1. A transaction is not journalized.
2. A correct journal entry is not posted.
3. A journal entry is posted twice.
4. Incorrect accounts are used in journalizing or posting.
5. Offsetting errors are made in recording the amount of a transaction.
ADJUSTING ENTRIES- TIMING ISSUES
Accountants divide the economic life of a business into artificial time periods (Time Period Assumption)

FISCAL AND CALENDAR YEARS

Monthly and quarterly time periods are called interim periods.  Most large companies must prepare both quarterly and
annual financial statements.  Fiscal Year = Accounting time period that is one year in length.  Calendar Year = January
1 to December 31.

Accrual- Versus Cash-Basis of Accounting

ACCRUAL-BASIS OF ACCOUNTING: Transactions recorded in the periods in which the events occur.  Companies
recognize revenues when they perform services (rather than when they receive cash).  Expenses are recognized when
incurred (rather than when paid).
ACCRUAL- VERSUS CASH-BASIS OF ACCOUNTING
Cash-Basis of Accounting  Revenues are recorded when cash is received.  Expenses are recorded when cash is paid. 
Cash-basis of accounting is not in accordance with International Financial Reporting Standards (IFRS)
RECOGNIZING REVENUES AND EXPENSES
REVENUE RECOGNITION PRINCIPLE: Recognize revenue in the accounting period in which the performance
obligation is satisfied.
RECOGNIZING REVENUES AND EXPENSES
EXPENSE RECOGNITION PRINCIPLE: Match expenses with revenues in the period when the company makes efforts
to generate those revenues. “Let the expenses follow the revenues.
THE BASICS OF ADJUSTING ENTRIES: Adjusting Entries Ensure that the revenue recognition and expense
recognition principles are followed. Necessary because the trial balance may not contain up-to-date and complete data.
Required every time a company prepares financial statements.  Will include one income statement account and one SoFP
account.
TYPES OF ADJUSTING ENTRIES

Pioneer Advancing agency inc Trial Balance October 31.2014

ADJUSTING ENTRIES FOR DEFERRALS:

Deferrals are expenses or revenues that are recognized at a date later than the point when cash was originally exchanged.
There are two types of deferrals:
Prepaid Expenses and Unearned Revenues.
PREPAID EXPENSES
Payments of expenses that will benefit more than one accounting period.
Cash Payment BEFORE Expense Recorded.
Prepayments often occur in regard to
 Insuranc
 Supplies
 Advertising
 Rent ,Buildings and Equipment P
 Expire either with the passage of time or through use.
 Adjusting entry:
 Increase (debit) to an expense account and
 Decrease (credit) to an asset account
Illustration: Pioneer Advertising Inc. purchased supplies costing ₺2,500 on October 5. Pioneer recorded the
purchase by increasing (debiting) the asset Supplies. This account shows a balance of ₺2,500 in the October
31 trial balance. An inventory count at the close of business on October 31 reveals that ₺1,000 of supplies are
still on hand.
Supplies Expense 1,500
Supplies 1,500

DEPRECIATION  Buildings, equipment, and motor vehicles (assets that provide service for many years)
are recorded as assets, rather than an expense, on the date acquired.  Depreciation is the process of allocating
the cost of an asset to expense over its useful life.  Depreciation does not attempt to report the actual change
in the value of the asset.
Accumulated Depreciation is called a Contra Asset Account
All Contra Accounts have increases, decreases, and normal balances opposite to the account to which they
relate.
Statement Presentation  Accumulated Depreciation is a contra asset account (credit).  Appears just after the
account it offsets (Equipment) on the SOFP.  Book Value is the difference between the cost of any
depreciable asset and its accumulated depreciation.
ADJUSTING ENTRIES FOR ACCRUALS
Accruals are made to record  Revenues for services performed but not yet recorded at the statement date
(accrued revenues). OR  Expenses incurred but not yet paid or recorded at the statement date (accrued
expenses)
Revenues for services performed but not yet received in cash or recorded. Accrued revenues often occur in
regard to:  Rent  Services performed  Interest A
Adjusting entry records the receivable that exists and records the revenues for services performed. 
Adjusting entry: ► Increases (debits) an asset account and ► Increases (credits) a revenue account.