Debre Tabor University Department of Accounting & Finance

DEBRE TABOR UNIVERSITY FACULTY OF BUSINESS & ECONOMICS

DEPRTMENT OF ACCOUNTING AND FINANCE
Course syllabus
Module Topic:-………………………………………………………………Principle of
Accounting I
Course title:-……………………………………………………………….. Principle of
Accounting I
Total hour:-…………………………………………………………………………………….. 64
hours
Course instructor:-…………………………………………………………………………...Aychew
B.
Course
code…………………………………………………………………………………….AcFn2011
Contact Hours (per week)
…………………………………………………………………………..4crh
ETCTS
Credit………………………………………………………………………………………...6crh
Total Contact Hour
………………………………………………………………………………....64hr

Course Description
This course is designed to provide introductory knowledge of accounting principle,
concepts and practice. At the end of this course students will be able to furnish the
basic concepts of accounting cycle, accounting for service & merchandising
enterprises, accounting system design, accounting for cash and accounting for
receivable. Student centered approach will be practiced during the learning and
teaching process. Moreover, students progress will be assessed both in formative
and summative way of evaluation.

Learning out come

At the end of the course, students will be able to:-
 Describe accounting principle and practice K,L1
 Explain the accounting cycle K , L2
 Illustrate completion of accounting cycle K, L4
 Illustrate accounting system design & internal control K,L4
1 Principle accounting I Module Prepared By A.B |
2006 E.C
Debre Tabor University Department of Accounting & Finance

 Differentiates a merchandising inventory K, L4

 Show periodic reporting for merchandizing enterprise S, L2
 Show accounting for cash S, L2
 Show accounting for receivable S, L2
Material Needed
 Handouts (the student will be provided on hand at each class)
 Printed materials (avail in library)
 Black board, chalk, handouts
 Internet access

Teaching Method
 Brain storming  Interactive lecture
 Group discussion  Peer teaching
 Students self-learning
Assessment: - In the entire of this course, formative and summative ways
are used to evaluate the student’s progress.
 Formative assessment
Attendance ……………………………5% Test …………………………….30%
Class participation …………………..5% Quiz ……………………………10%
Individual & group assignment …10%
 Summative Evaluation
Final Exam ………………………….40%
Note:- The following objectives, contents, methods and assessment of the course
are aligned with the hierarchy of learning and domain of education.
 Domination of education
 Knowledge (K)
 Attitude (A)
 Skill (S)
Hierarchy of learning- Simple to complex (levels 1-6)
Level 1 (Knowledge): Define, describe, level, list…
Level 2 (comprehension): Convert defines, distinguish, estimate…
Level 3 (Application): charge, compute, demonstrate, manipulate
Level 4 (Analysis): Breakdown, relate, inter….
Level 5 (Synthesis): Compose, create, design, generate …
Level 6 (Evaluate): appraise, conclude, criticize, relate…
Assessment: all assessment should contain the specific learning domain, hierarchy
of learning and possible answers.

2 Principle accounting I Module Prepared By A.B |

2006 E.C
Debre Tabor University Department of Accounting & Finance

Table 1:- Summary of the course objective aligning with: content, methods and
assessment by incorporative hierarchy of learning and domain of learning on
accounting principle I.

Domain and
hierarchy of
Objective Content Methods learning Assessment
Unit one:- Introduction to accounting & business
At the end of this unit,
students will be able to:-
1.1 Define the term 1.1. definition of accounting 1.1. interactive 1.1. L1 (K) 1.1. Define the term
accounting lecture accounting
1.2 Describe the nature 1.2. the nature and users of 1.2. Group 1.2. L1 &6 (K) 1.2. Describe the internal
and users of accounting accounting information discussion and external users of
information  Internal users accounting information
 External users
1.3. Describe the role 1.3. The role of accounting in business
of accounting in 1.3. interactive 1.3. Describe the role of
1.3. L1,(K)
business. lecture accounting in business

1.4. Describe the 1.3. accounting professions & special 1.3. interactive 1.3. L1,(K) 1.3. Describe the professions
professions & specialized fields lecture & Group & specialized fields of
fields of accounting discussion accounting
1.5 Differentiate Types 1.4. Types & Forms of business 1.4. Interactive 1.4. L4 (K) 1.4. differentiate the
& forms of business organizations lecture common forms & types of
organizations Types of business organization business ownership
 Manufacturing
 Merchandizing
 Service
Forms of business
 Sole proprietorship

3 Principle accounting I Module Prepared By A.B | 2006 E.C

Debre Tabor University Department of Accounting & Finance

Domain and
hierarchy of
Objective Content Methods learning Assessment
 Partnership
 Corporations
1.6 Explain accounting 1.5. Accounting principle and practice 1.5. interactive 1.5. L4 (K) 1.5. Explain the concepts of
principle and practice lecture Group accounting principle and
discussion practice
1.7 Illustrate the 1.6. Business transaction and 1.6. Interactive 1.6. L4 (K) 1.6. illustrate business
business transaction and accounting equation lecture and group transaction and accounting
accounting equation discussion equation
1.8 Prepare financial 1.6. financial statement 1.7. Interactive 1.7. L4 (A) 1.7. prepare how each
statement  Income statement lecture and group components of F/s are
discussion prepared
 Balance sheet
 Statement of owners equity
 Statement of cash flow
Unit 2:- Accounting cycle
At the end of this unit,
the students will be able
to:-
2.1. define accounting 2.1. definition accounting cycle 2.1. Brainstorming 2.1. L1, K 2.1. Define accounting cycle
cycle and interactive briefly
lecture
2.2. describe the 2.2. classification of accounts 2.2. Brainstorming 2.2. L1 (K) 2.2. describe the five
classification of accounts  Assets and interactive classification of accounts
lecture
 Liabilities
 Owner’s equity
 Expense
 Revenue
2.3. Illustrate chart of 2.3. chart of an account and nature of 2.3. Group 2.3. L4(K) 2.3. Illustrate chart of
account and nature of an an account discussion account
account
2.4. Describe nature of 2.4. Nature of an account 2.4. interactive 2.4. L4(K) 2.4. Describe the nature of an
an account lecture and group account
discussion
2.5. Illustrate journal 2.5. Journal and accounts 2.5. Group 2.5. L4 (A) 2.5. Illustrate journal and

4 Principle accounting I Module Prepared By A.B | 2006 E.C

Debre Tabor University Department of Accounting & Finance

Domain and
hierarchy of
Objective Content Methods learning Assessment
and account  Two column journal discussion account
 Four column journal (account)

2.6. Prepare the trial 2.6. Trial balance 2.6. Interactive 2.6. L4(A) 2.6. Prepare trial balance
balance lecture and group
discussion
2.7. Describe matching 2.7. Matching principle 2.7.Brainstorming 2.7. L1(K) 2.7. Describe matching
principle and Group principle
discussion
2.8. Illustrate the nature 2.8. Nature of adjusting process 2.8.group 2.8. L4(K) 2.8. Illustrate the nature of
of adjusting process discussion adjusting process
2.9. Prepare worksheet 2.9. Work sheet for financial statement 2.9. group 2.9. L4 (A) 2.9. Prepare worksheet for
for financial statement discussion and financial statement
interactive lecture
2.10. show the nature of 2.10. Nature of closing process 2.10. Interactive 2.10. L2(S) 2.10. show the nature of
closing process lecture and group closing process
discussion
2.11. prepare post 2.11. Post closing trial balance 2.11. Interactive 2.11. L4(A) 2.11. Prepare post closing
closing trial balance lecture and group trial balance
discussion
2.12. show reversing 2.12. Reversing entries 2.12. Interactive 2.12. L2(S) 2.11. show reversing entries
entries lecture and group
discussion
Unit 3:- Accounting for merchandizing business
At the end of this unit,
students will be able to:-
3.1. Illustrate 3.1. Accounting for purchase of 3.1. Brainstorming 3.1. L1 (K) 3.1 Illustrate accounting for
accounting for purchase merchandise and interactive purchase
of merchandise lecture
3.2. Illustrate 3.2. Accounting for sales of 3.2. peer teaching 3.2. L1 (K) 3.2. Illustrate accounting for
accounting for sales of merchandise sales
merchandise
3.3. Illustrate 3.3. Transportation cost and sales tax 3.3. Interactive 3.3. L4(K) 3.3. Illustrate accounting for
accounting for lecture and group transportation cost and sales
transportation cost and discussion tax

5 Principle accounting I Module Prepared By A.B | 2006 E.C

Debre Tabor University Department of Accounting & Finance

Domain and
hierarchy of
Objective Content Methods learning Assessment
sales tax
3.4. Describe 3.4. Merchandize inventory system 3.4. Group 3.4. L3(A) 3.4. Describe merchandizing
merchandizing inventory discussion inventory system
system
3.5. prepare 3.5. Merchandize inventory 3.5. Group 3.5. L4(A) 3.5. prepare merchandise
merchandise inventory adjustment discussion and inventory adjustment
adjustment interactive lecture
3.6. show work 3.6. work sheet for merchandise 3.6. interactive 3.6. L2 (S) 3.6. show work sheet for
sheet for merchandise enterprise lecture merchandise enterprise
enterprise
3.7. prepare financial 3.7. financial statements for 3.7. self learning 3.7. L3 (K) 3.7. compute financial
statement for merchandize enterprise and brainstorming statement for merchandize
merchandize enterprise enterprise
3.8. illustrate adjusting 3.8. adjusting entries 3.8. group 3.8. L4 (A) 3.8. illustrate adjusting
entries discussion entries
3.9. prepare closing 3.9.closing entries 3.9. peer teaching 3.9. L4 (A) 3.9. prepare closing entries
entries and group
discussion
Unit 4:- Accounting System
At the end of this unit,
students will be able to:-
4.1. Define an accounting 4.1. Basic accounting system 4.1. interactive 4.1. L1, K 4.1. Define an accounting
system lecture system
4.2. Describe Manual & 4.2. Manual & computerized 4.2. Group 4.2. L1(K) 4.2. Describe the difference
computerized accounting accounting system discussion and between manual &
system interactive lecture computerized accounting
system.
4.3. Prepare subsidiary & 4.3. Subsidiary ledger & controlling 4.3. Group 4.3. L4 (A) 4.3. Prepare subsidiary &
controlling accounts account discussion and controlling accounts
interactive lecture
4.4. Show special 4.4. Special Journals 4.4. Group 4.4. L2 (S) 4.4. Show special journals
journals discussion and
interactive lecture
Unit 5:- Cash

6 Principle accounting I Module Prepared By A.B | 2006 E.C

Debre Tabor University Department of Accounting & Finance

Domain and
hierarchy of
Objective Content Methods learning Assessment
At the end of this unit,
students will be able to:-
5.1. describe control over 5.1. control over cash 5.1. brainstorming 5.1. L1,6(K) 5.1. describe control over
cash & interactive cash
lecture
5.2. Illustrate internal 5.2. internal control on cash receipt 5.2. group 5.2. L4 (A) 5.2. Illustrate internal control
control on cash receipt (bank reconciliation) discussion on cash receipts(bank
(bank reconciliation reconciliation)
statement)
5.3. Illustrate internal 5.3. internal control of cash payment 5.3. interactive 5.3. L4 (A) 5.3. Illustrate internal control
control of cash payment (petty cash) lecture & peer of cash payment (petty cash)
(petty cash) teaching
5.4. Show the accounting 5.4. petty cash 5.4. interactive 5.4. L2 (S) 5.4. Show the accounting for
for petty cash lecture & peer petty cash
teaching
Unit 6:- Account receivable
At the end of this unit,
students will be able to:-
6.1.describe 6.1. classification of receivables 6.1. brainstorming 6.1. L1&6(K) 6.1. describe classification of
classification of & interactive receivables
receivables lecture
6.2. compute 6.2. determination of due date & 6.2. interactive 6.2. L3(K) 6.2. compute determination
determination of due interest lecture of due date & interest of the
date & interest of the note
note
6.3. illustrate accounting 6.3. accounting for receivable 6.3. self learning 6.3.L4(K) 6.3. illustrate accounting for
for not receivable & group note receivable
 Discounting note receivable
discussion
 Dishonored note receivables
6.4. show accounting for 5.4.accounting for uncollectable 6.4. interactive 6.4. L2(S) 6.4. show accounting for
uncollectable lecture uncollectable

Text Book
 Fees & warren, Accounting Principles,16 th edition, South Western Publishing Company (any recent editions)

7 Principle accounting I Module Prepared By A.B | 2006 E.C

Debre Tabor University Department of Accounting & Finance

Reference
 Smith, Keith & Stephens, Accounting Principles, 3 rd edition and above McGraw Book company, 1989 and
beyond.
 Herman son, Edwards & Salmon son, Accounting Principles, 4 th edition Richard D. Inc 1989.
 Larson, Kermit D, Fundamental Accounting Principles 12 th edition and above R. Irwin Inc. 1990 and beyond.
 Meigs Walter B, Accounting the basis for business decision 6 th edition and McGraw-Hill international book
company, 1984 & beyond.
 Niswonger & Fees, Accounting Principles, South Western Publishing Company 13 th edition.
 Carl S. Warren, James M. Reeve, Jonathan E. Duchac Accounting principle South Western Publishing Company
22th edition,
 Slater, Collage Accounting a practical approach, 2004 prentice hall business publishing 9 th edition.

8 Principle accounting I Module Prepared By A.B | 2006 E.C

Debre Tabor University Department of Accounting & Finance

UNIT ONE
ACCOUNTING PRINCIPLES & PRACTICES

Unit Description

This unit briefly states the objective of accounting, nature & forms of
business, profession of accountancy, principles & practices, business
transactions (asset, liabilities & owners equity), accounting equation and
financial statements.
Unit Objective
At the end of this unit, students will be able to:-
 Define the term accounting
 Describe the nature and users of accounting information
 Describe the role of accounting in business.
 Describe the professions & specialized fields of accounting
 Differentiate Types & forms of business organizations
 Explain accounting principle and practice
 Illustrate the business transaction and accounting equation
 Prepare financial statement

INTRODUCTION
Peoples in all civilization have maintained various types of records of business
activities. The oldest known are clay tablet record of the payment of wages in
Babylonian around 3600 B.C. there are numerous evidences of record keeping and
system of accounting control in ancient Egypt & in the Greek city state. The earliest
known English records were compiled at the direction of William the conqueror in
the eleventh centaury to ascertain the financial resources of the kingdom.
The evolution of the system of record keeping which come to be called “Double
entry system “was strongly influenced by Venetian merchants. The first known
description of the system is published in Italy in 1494 by Luca Pacioli a Franciscan
monk, was a mathematician who thought in various universities, he did the text and
Leonardo da vinci the illustration. Scholars define the system “it is the most
beautiful innovation of the human sprite, & every good business man should use it
in their economic undertaking & it provides for recording of both aspects of
transactions.
The expanded business operations initiated by the industrial revolution (the mid 18 th
and 19th) required increasingly large amounts of money to build factories &
purchase of merchandise this needs for large amount of capital resulted in
development of the corporate form of organization in 1845 , this were led the
emergency of specialized field of cost accounting. In the year 1913 all business

9 Principle accounting I Module Prepared By A.B |

2006 E.C
Debre Tabor University Department of Accounting & Finance

enterprises organized as corporation or partnership as well as many individuals,

were required to maintain sufficient records to enable them to file accurate tax
returns.
In today world accounting is capable of supplying financial information that is
essential for the efficient operation and for the evaluation of performance of any
economic unit in society. This will led to computerize the system & make it
international
Non & socioeconomic.
Systematic Emergence of Public
systematic recording corporate accounting for
recording organization & independent
cost accounting review

Government
intervention
Primitive Double entry Industrial (Enactment of
Accounting system revolution federal income
tax law)
Accounting Future

Computerized accounting, International accounting, socio-economic

accounting

Activity 1
Define double entry system?
………………………………………………………………………………………………………
…………………………………………………………………………………………………

1.1. Definition of Accounting

Objective 1:- Define accounting

What is accounting?

This is not an easy question. The scope and definition of accounting changes
throughout time, In general, it is argued that accounting is concerned with the
provision of information about the position and performance of an enterprise that is
useful to a wide range of potential users in making decisions

Accounting can be defined as an information system that provides reports to users

of information about the economic activities and condition of a business. It is
expected to as “the language of business”. The objective of accounting is to record,
10 Principle accounting I Module Prepared By A.B |
2006 E.C
Debre Tabor University Department of Accounting & Finance

summarize, report & interpret economic data for use by many groups. (Fees
Warren, 16th edition)
Accounting is an information system that measures, processes & communicates
financial information about an economic entity. An economic entity is a unit that
exists independently, such as a business, a hospital, or a governmental body etc.
From this definition we understand that (Belverd E.Needles ,Marian Powers & Susan
V, Crosson)
 Accounting measures business activities by recording data about them for
future use.
 The data are stored until needed & then processed to become useful
information.
 The information is communicated through reports to decision makers.
Accounting is the process that analyzes records, classifies, summarizes, reports,
and interprets financial information (College Accounting: A practical Approach 9e by
Slater).

Accounting has been defined by the American Accounting Association Committee

(AAA) as: “. . . the process of identifying, measuring and communicating economic
information to permit informed judgments and decisions by users of the
information”. This may be considered as a good definition because of its focus on
accounting as an aid to decision making. The American Institute of Certified and
Public Accountants Committee on Terminology defined accounting as: “Accounting
is the art of recording classifying and summarizing, in a significant manner and in
terms of money, transactions and events which are, in part at least, of a financial
character and interpreting the results thereof”. Of all definitions available, this is the
most acceptable one because it encompasses all the functions which the modern
accounting system performs. Another popular definition on accounting was given by
American Accounting Principles Board (AAPB) in 1970, which defined it as:
“Accounting is a service society. Its function is to provide quantitative information,
primarily financial in nature, about economic entities that is useful in making
economic decision, in making reasoned choices among alternative courses of
action”. This is a very relevant definition in a present context of business units
facing the situation of selecting the best among the various alternatives available.
The special feature of this definition is that it has designated accounting as a
service activity.

Activity 2
Based on the definition describe the word economic entity?
………………………………………………………………………………………………………………
………………………………………………………………………………………………………………

1.2. Users of Accounting Information

Objective 2:- Describe the nature & users of accounting system.

11 Principle accounting I Module Prepared By A.B |

2006 E.C
Debre Tabor University Department of Accounting & Finance

Who are the users of accounting information system?

The people who use accounting information to make decision fall in to three
categories:

1. Those who manage a business

2. Those outside a business enterprise who have a direct financial interest in the
business
3. Those who have an indirect financial interest in a business

Users of accounting information can be categorized as internal & external users of

information.

1. Internal users of information: - Includes the managers and employers of the

organizations for the preparation of plan, decision making & stability of the given
business.
2. External users of information:- includes
 Investors: - to know the financial status & future prospects of the existing
business.
 Bankers & suppliers:- for granting loans & credits
 Government agencies: - for taxation & formulation of regulations.
 Employee union: - stability of business organizations for their members.

Accounting as a provider of information to users

Identification Investors
of users Bankers
Suppliers
Governmental Agencies
User information
Labor Unions
needs
Employees
Management

Economic
Data Accounting Report User Decision
System

Financial Statements Investing

Special Reports Approving Reports
Tax returns Assessing Taxes
Regulatory Report Negotiating labor
Management Reports Contracts

12 Principle accounting I Module Prepared By A.B |

2006 E.C
Debre Tabor University Department of Accounting & Finance

Establishing
Budgets
Activity 3

What does it mean economic data? Describe the relationship

between economic data & accounting system?
………………………………………………………………………………………………………
…………………………………………………………………………………………………

1.3. The Role of Accounting in Business

Objective 3:- Describe the role of accounting in business

What is the role of accounting in business? The simplest answer to this question is
that accounting provides information for managers to use in operating the business.
In addition, accounting provides information to other stakeholders to use in
assessing the economic performance and condition of the business. In a general
sense, accounting can be defined as an information system that provides reports to
stakeholders about the economic activities and condition of a business. As we
indicated earlier in this chapter, we will focus our discussions on accounting and its
role in business. However, many of the concepts in this module apply also to
individuals, governments, and other types of organizations. For example, individuals
must account for activities such as hours worked, checks written, and bills due.
Stakeholders for individuals include creditors, dependents, and the government. A
main interest of the government is making sure that individuals pay the proper
taxes. You may think of accounting as the “language of business.” This is because
accounting is the means by which business information is communicated to the
stakeholders. For example, accounting reports summarizing the profitability of a
new product help Coca-Cola’s management decide whether to continue selling the
product. Likewise, financial analysts use accounting reports in deciding whether to
recommend the purchase of Coca-Cola’s stock. Banks use accounting reports in
determining the amount of credit to extend to Coca-Cola. Suppliers use accounting
reports in deciding whether to offer credit for Coca-Cola’s purchases of supplies and
raw materials. State and federal governments use accounting reports as a basis for
assessing taxes on Coca-Cola.

A business must first identify its stakeholders. It must then assess the various
informational needs of those stakeholders and design its accounting system to meet
those needs. Finally, the accounting system records the economic data about
business activities and events, which the business reports to the stakeholders
according to their informational needs. Stakeholders use accounting reports as a
primary source of information on which they base their decisions. They use other

13 Principle accounting I Module Prepared By A.B |

2006 E.C
Debre Tabor University Department of Accounting & Finance

information as well. For example, in deciding whether to extend credit to an

appliance store, a banker might use economic forecasts to assess the future
demand for the store’s products. During periods of economic downturn, the demand
for consumer appliances normally declines. The banker might inquire about the
ability and reputation of the managers of the business. For small corporations,
bankers may require major stockholders to personally guarantee the loans of the
business. Finally, bankers might consult industry publications that rank similar
businesses as to their quality of products, customer satisfaction, and future
prospects for growth.

1.4. The Profession & Specialized Fields of Accounting

Objective 4:- describe the professions & specialized fields of accounting

1.4.1. Professions of Accounting

1.4.1.1. Private Accounting
The scope of activities and duties of private accountants varies widely. Private
accountants are frequently called management accountants. If they are
employed by a manufacturer, they may be referred to as industrial or cost
accountants. The chief accountant in a business may be called the controller.
Various state and federal agencies and other not-for-profit agencies also employ
accountants. The Institute of Certified Management Accountants, an affiliate of the
Institute of Management Accountants (IMA), sponsors the Certified Management
Accountant (CMA) program. The CMA certificate is evidence of competence in
management accounting. Becoming a CMA requires a college degree, two years of
experience, and successful completion of a two-day examination. Continuing
professional education is required for renewal of the CMA certificate. In addition,
members of the IMA must adhere to standards of ethical conduct. The Institute of
Internal Auditors sponsors a similar program for internal auditors. Internal auditors
are accountants who review the accounting and operating procedures prescribed by
their firms. Accountants who specialize in internal auditing may be granted the
Certified Internal Auditor (CIA) certificate
.
1.4.1.2. Public Accounting
In public accounting, an accountant may practice as an individual or as a member of
a public accounting firm. Public accountants who have met a state’s education,
experience, and examination requirements may become Certified Public
Accountants (CPAs). The requirements for obtaining a CPA certificate differ among
the various states. All states require a college education in accounting, and most
states require 150 semester hours of college credit. In addition, a candidate must
pass an examination prepared by the American Institute of Certified Public
Accountants (AICPA). Most states do not permit individuals to practice as CPAs until
14 Principle accounting I Module Prepared By A.B |
2006 E.C
Debre Tabor University Department of Accounting & Finance

they have had from one to three years’ experience in public accounting. Some
states, however, accept similar employment in private accounting as equivalent
experience. All states require continuing professional education and adherence to
standards of ethical conduct.

Activity 4
Based on our country, list those organizations which use public & those which use
private accounting? Justify their reason?
………………………………………………………………………………………………………………
………………………………………………………………………………………………………………

1.4.2. Specialized Fields

I. Financial accounting: - Concerned with, recording of transactions for a
business enterprise, periodic preparation of various reports from such records
per GAAP (General Accepted Accounting Principles).
II. Auditing:- Independent review of accounting records to provide reasonable
assurance whether the statement is prepared based on GAAP or not
III. Cost Accounting: - emphasizes the determination & control of costs.
IV. Managerial Accounting: - use both historical and estimated data in
assisting management in daily operations and in planning future operation.
V. Tax Accounting: - Encompasses the preparation of tax return & its
consequence.
VI. Accounting System: - Concerned with the design & implementation of
procedures for the accumulation & reporting of financial data.
VII. Budgetary Accounting: - provides comparison of actual operation with the
predetermined plan.
VIII. International Accounting:- Concerned with special problems associated
with international trade (Multinational business organization)
IX. Social accounting: - Measurement of social costs & benefits.
X. Not for profit Accounting: - Recording, reporting & planning of various
government NFPs financial statements.

Activity 5

Discuss the advantage of the above listed specialized fields of accounting in

private & public institution?

………………………………………………………………………………………………………
………………………………………………………………………………………………………
………………………………………………………
15 Principle accounting I Module Prepared By A.B |
2006 E.C
Debre Tabor University Department of Accounting & Finance

1.5. The Nature of a Business

Objective 5:- Differentiate the type & forms of business organizations. List the
types of business organizations?

A business is an organization in which basic resources (inputs) such as, materials &
labor are assembled and processed to provide goods or services (output) to
customers. Business come in all sizes from local coffee house to huge industries. A
business customer is individuals or other business that purchase goods or services
in exchange for money or other items of value. Therefore, the objective of most
business is to maximize profit (the difference between the amounts received from
customers and paid for the inputs used.

1.5.1. Types of Business

There are three different types of businesses that are operated for profit:
manufacturing, merchandising, and service businesses. Each type of business has
unique characteristics.
Manufacturing businesses: - change basic inputs into products that are sold to
individual customers.
Merchandising businesses: - also sell products to customers. However, rather
than making the products, they purchase them from other businesses (such as
manufacturers). In this sense, merchandisers bring products and customers
together.
Service Business: - provide services rather than making the products,

1.5.2. Forms of Business

The above 3 types of business can be formed as a proprietorship, partnership,

corporation, or Limited Liability Corporation. In the following paragraphs, we briefly
describe each form and discuss its advantages and disadvantages.
A proprietorship is owned by one individual. More than 70% of the businesses in
the United States are organized as proprietorships. The popularity of this form is
due to the ease and the low cost of organizing. The primary disadvantage of
proprietorships is that the financial resources available to the business are limited
to the individual owner’s resources. Small local businesses such as hardware stores,
repair shops, laundries, restaurants, and maid services are often organized as
proprietorships. As a business grows and more financial and managerial resources
are needed, it may become a partnership.
A partnership is owned by two or more individuals. Like proprietorships, small
local businesses such as automotive repair shops, music stores, beauty salons, and

16 Principle accounting I Module Prepared By A.B |

2006 E.C
Debre Tabor University Department of Accounting & Finance

clothing stores may be organized as partnerships. Currently, about 10% of the

businesses in the United States are organized as partnerships.
A corporation is organized under state or federal statutes as a separate legal
taxable entity. The ownership of a corporation is divided into shares of stock. A
corporation issues the stock to individuals or other businesses, who then become
owners or stockholders of the corporation. A primary advantage of the corporate
form is the ability to obtain large amounts of resources by issuing stock. For this
reason, most companies that require large investments in equipment and facilities
are organized as corporations. About 20% of the businesses in the United States
are organized as corporations. Given that most large companies are organized as
corporations, over 90% of the total dollars of business receipts are received by
corporations. Thus, corporations have a major influence on the economy.

Activity 6

Give examples of manufacturing, merchandise & service types of business

based on our country case.
………………………………………………………………………………………………………
………………………………………………………………………………………………………
……………………………………………
Differentiate forms of business based on formation, ownership, liability &
their winding up process?
………………………………………………………………………………………………………
………………………………………………………………………………………………………
……………………………………………………………………………………………………
1.6. Accounting Principles & Concept
Objective 6:- Explain accounting principles & practices.
In accounting, like physical & biological sciences experiments and changes are
never ending. Capable scholars devote their time & their intellectual engagement to
the development of accounting principles and concepts. For this unit purpose we
can see business entity & cost concept. Accounting principles & concepts further
explained in Principle accounting II module.
1.6.1. Business Entity Concept
The individual business unit is the business entity for which economic data are
needed. This entity could be an automobile dealer, a department store, or a grocery
store. The business entity must be identified, so that the accountant can determine
which economic data should be analyzed, recorded, and summarized in reports. The
business entity concept is important because it limits the economic data in the
accounting system to data related directly to the activities of the business. In other
words, the business is viewed as an entity separate from its owners, creditors, or

17 Principle accounting I Module Prepared By A.B |

2006 E.C
Debre Tabor University Department of Accounting & Finance

other stakeholders. For example, the accountant for a business with one owner (a
proprietorship) would record the activities of the business only, not the personal
activities, property, or debts of the owner.
1.6.2. The Cost Concept
If a building is bought for $150,000, that amount should be entered into the buyer’s
accounting records. The seller may have been asking $170,000 for the building up
to the time of the sale. The buyer may have initially offered $130,000 for the
building. The building may have been assessed at $125,000 for property tax
purposes. The buyer may have received an offer of $175,000 for the building the
day after it was acquired. These latter amounts have no effect on the accounting
records because they did not result in an exchange of the building from the seller to
the buyer. The cost concept is the basis for entering the exchange price, or cost, of
$150,000 into the accounting records for the building. Continuing the illustration,
the $175,000 offer received by the buyer the day after the building was acquired
indicates that it was a bargain purchase at $150,000. To use $175,000 in the
accounting records, however, would record an illusory or unrealized profit. If, after
buying the building, the buyer accepts the offer and sells the building for $175,000,
a profit of $25,000 is then realized and recorded. The new owner would record
$175,000 as the cost of the building. Using the cost concept involves two other
important accounting concepts— objectivity and the unit of measure. The
objectivity concept requires that the accounting records and reports be based upon
objective evidence. In exchanges between a buyer and a seller, both try to get the
best price. Only the final agreed upon amount is objective enough for accounting
purposes. If the amounts at which properties were recorded were constantly being
revised upward and downward based on offers, appraisals, and opinions, accounting
reports could soon become unstable and unreliable. The unit of measure concept
requires that economic data be recorded in dollars. Money is a common unit of
measurement for reporting uniform financial data and reports. For example if a
building is.

Activity 7

For the sake of taxation accountants prepare a combined financial statement of

Dashen & Bedele bear factory. This two business enterprises owned by different
stakeholders, is the business entity concept applied correctly by accountants? If
yes/no why?
………………………………………………………………………………………………………………
………………………………………………………………………………………………………………
………………………………………………………………………………………………………………

Land with an assessed value of $100,000 for property tax purpose is acquired by a
business enterprise for $175,000. At what amount should the land be recorded by
the purchaser? Which principle is applies?

18 Principle accounting I Module Prepared By A.B |

2006 E.C
Debre Tabor University Department of Accounting & Finance

………………………………………………………………………………………………………………
………………………………………………………………………………………………………………
……………………………………………………………………………………………………………

1.7. Business Transactions & Accounting

Equation
Objective 6:- illustrate business transactions & accounting equations

Business transactions are the occurrence of event or a condition that must be

recorded. Examples

 Payment of monthly bill $175.

 Purchase of $2500 merchandise on account.
 Purchase of land & building $210,000

Accounting Equation

Asset = Equity (if the asset is owned by the owner only)

Asset= Liability + Owners equity

ASSET

Liability Owners Equity

Right of debtor Right of Owners

Where:-
Asset: - is the property owned by a business enterprise
Liability: - is the property owed by a business enterprise
Owners equity: - the residual claim of a business
Each transaction from the simplest to the most complex can be stated interms of
the resulting changes on the accounting equation.

Assume that john long establish a sole proprietorship to be known as long taxi.
Transactions related to the business are shown bellow.

Illustration 1
19 Principle accounting I Module Prepared By A.B |
2006 E.C
Debre Tabor University Department of Accounting & Finance

a) Long’s deposit $10,000 in a bank account in the name of long taxi.

b) Purchase land as a future building site for which $7,500 in cash.
c) Long taxi purchase $850 of gasoline, oil & other supplies from various suppliers
agreeing to pay in the near future.
d) During the month, $400 is paid to creditors on account.
e) Long taxi earned fares of $ 4,500 in cash.
f) Various business expenses incurred and paid during for the month were as
follows wages $1,125, rent $850,utilities $150 miscellaneous $75
g) Supplies on hand $250 at the end of the month.
h) Long withdraws from the business $1,000 in cash for his personal use.

Required

a) Show the effect of transactions on the business equations.

Solution

Asset = Liability + owner’s

equity
Cash + Supplies + Land = Account payable + John
long capital
a. +10,000 - - - + 10,000
investment
b. -7,500 - +7,500 - -
Bal. 2,500 - 7,500 - 10,000
c. - +850 - +850 -
Bal. 2,500 850 7,500 850 10,000
d. -400 - - -400 -
Bal. 2,100 850 7,500 450 10,000
e. +4,500 - - - +4,500 Fees
earned
Bal. 6,600 850 7,500 450 14,500
f. -2,200 - - - -1,125
wages expense
-850 rent
expense
20 Principle accounting I Module Prepared By A.B |
2006 E.C
Debre Tabor University Department of Accounting & Finance

-150 utlity
expense
-75
misc.expense
Bal. 4,400 850 7,500 450 12,300
g. - -600 -600 Supp.
Expense
Bal. 4,400 250 7,500 450 11,700
h. – 1,000 - - - -1,000
withdrawal
Bal. 3,400 250 7,500 450 10,700

1.8. Financial Statements

Objective 8:- Prepare financial statements

After transactions have been recorded and summarized, reports are prepared for
users. The accounting reports that provide this information are called financial
statements. The principal financial statements of a proprietorship are income
statement, statement of owner’s equity, balance sheet, and statement of cash
flows. The order in which the statements are normally prepared and the nature of
the data presented in each statement are as follows:

1.8.1. For sole proprietor

1.8.1.1. Income Statement
A summary of the revenue and expenses for a specific period of time, such as a
month or a year, the income statement reports the revenues and expenses for a
period of time, based on the matching concept. This concept is applied by matching
the expenses with the revenue generated during a period by those expenses. The
income statement also reports the excess of the revenue over the expenses
incurred. This excess of the revenue over the expenses is called net income or
net profit. If the expenses exceed the revenue, the excess is a net loss. The
effects of revenue earned and expenses incurred during the month for Long taxi
were shown in the equation as increases and decreases in owner’s equity (capital).
Net income for a period has the effect of increasing owner’s equity (capital) for the
period, whereas a net loss has the effect of decreasing owner’s equity (capital) for
the period.
Long taxi
Income Statement
For the month ended August 31,19x1

21 Principle accounting I Module Prepared By A.B |

2006 E.C
Debre Tabor University Department of Accounting & Finance

Fees earned 4 5 0 0 0
0
Operating expenses
Wages expense 1 1 2 5 0
0
Rent expense 8 5 0 0
0
Supplies expense 6 0 0 0
0
Utilities expense 1 5 0 0
0
Miscellaneous expense 7 5 0
0
Total operating expenses 2 8 0 0 0
0
Net 1 7 0 0 0
income 0

1.8.1.2. Statement of Owner’s Equity

A summary of the change in owners’ equity of a business entity that have occurred
during a specific period, The statement of owner’s equity reports the changes in the
owner’s equity for a period of time. It is prepared after the income statement
because the net income or net loss for the period must be reported in this
statement. Similarly, it is prepared before the balance sheet, since the amount of
owner’s equity at the end of the period must be reported on the balance sheet.
Because of this, the statement of owner’s equity is often viewed as the connecting
link between the income statement and balance sheet.
Long taxi
Statement of owner’s equity
For the month ended August 31,19x1
Investment during the month 1 0 0 0 0 0
0
Net income for the month 1 7 0 0 0
0
Less:- Withdrawal 1 0 0 0 0
0
Increase in owners’ equity 7 0 0 0

22 Principle accounting I Module Prepared By A.B |

2006 E.C
Debre Tabor University Department of Accounting & Finance

0
John long ,capital August 31,19x 1 0 7 0 0 0
0

1.8.1.3. Balance Sheet

A list of assets, liabilities and owners equity as of a specific date, the assets section
of the balance sheet normally presents assets in the order that they will be
converted into cash or used in operations. Cash is presented first, followed by
receivables, supplies, prepaid insurance, and other assets. The assets of a more
permanent nature are shown next, such as land, buildings, and equipment.
Long taxi
Balance sheet
August 31,19x1
Assets
Cash 3 4 0 0 00
Supplies 2 5 0 00
Land 7 5 0 0 00
Total assets 1 1 1 5 0 00
Liabilities
Account payable 4 5 0 00
Owner’s equity
John long capital 1 0 7 0 0 00
Total liabilities & owners equity 1 1 1 5 0 00

1.8.1.4. Statement of Cash Flows

A summary of the cash receipts and cash payments for a specific period of time,
such as a month or a year, The statement of cash flows consists of three sections,
(1) operating activities, (2) investing activities, and (3) financing activities. Each of
these sections is briefly described below.
Cash Flows from Operating Activities
This section reports a summary of cash receipts and cash payments from
operations. The net cash flow from operating activities will normally differ from the
amount of net income for the period. This difference occurs because revenues and
expenses may not be recorded at the same time that cash is received from
customers or paid to creditors.
Cash Flows from Investing Activities
This section reports the cash transactions for the acquisition and sale of relatively
permanent assets.
Cash Flows from Financing Activities
23 Principle accounting I Module Prepared By A.B |
2006 E.C
Debre Tabor University Department of Accounting & Finance

This section reports the cash transactions related to cash investments by the owner,
borrowings, and cash withdrawals by the owner. Preparing the statement of cash
flows requires an understanding of concepts that we have not discussed in this
chapter. Therefore, we will illustrate the preparation of the statement of cash flows
in a later chapter.
Long taxi
Statement of owner’s equity
For the month ended August 31,19x1
Cash flow from operating activities
 Cash received from customers 4 5 0 0 00
 Deduct cash payment for expenses & payment (2 6 0 0 00
to creditors
)
Net cash flow from operating activities 1 9 0 0 00
Cash flow from operating activities
 Cash payment for acquisition of land (7 5 0 0 00
)
Cash flow from financing activities
 Cash received as owner’s investment 1 0 0 0 0 00
 Deduct cash withdrawal by owner (1 0 0 0 00
)
Net cash flow from financing activates 9 0 0 0 00
Net cash flow & August 31,19x1 cash balance 3 4 0 0 00

1.8.2. For corporation

In addition to the above explained financial statements corporations prepare
Retained earnings statement it includes:
 Change in stakeholder’s equity.
 Net income related in the business.
Assessment
1. A profit-making business operating as a separate legal entity and in which
ownership is divided into shares of stock is known as a:
A. Proprietorship. C. partnership
B. Service business. D. Corporation
2. The resources owned by a business are called:
A. Assets. C. The accounting equation.
B. Liabilities. D. Owner’s equity

24 Principle accounting I Module Prepared By A.B |

2006 E.C
Debre Tabor University Department of Accounting & Finance

3. A listing of a business entity’s assets, liabilities, and owner’s equity as of a

specific date is a(n):
A. Balance sheet. C. Statement of owner’s equity.
B. Income statement. D. Statement of cash flows

4. If total assets increased $20,000 during a period and total liabilities increased
$12,000 during the same period, the amount and direction (increase or decrease) of
the change in owner’s equity for that period is a(n):
A. $32,000 increase. C. $8,000 increase.
B. $32,000 decrease. D. $8,000 decrease.

5. If revenue was $45,000, expenses were $37,500, and the owner’s withdrawals
were $10,000, the amount of net income or net loss would be:
A. $45,000 net income. C. $37,500 net loss.
B. $7,500 net income. D. $2,500 net loss

Answer

1. D 4. C
2. A 5. B
3. A

Illustrations 2 (Group)
Transactions related to Saba trading

1. Saba deposits $25,000 in a bank account.

2. Saba trading acquires a land a mounted $20,000 for cash.
3. Buying supplies for $1,350 & agreeing to pay to the supplier in the near feature.
4. Saba trading provided service to customers, earning fees of $7,500 & receiving
the amount in cash.
5. Expense paid during the month were as follows
 Wages expense $ 2,125
 Rent expense $ 800
 Utilities expense $ 450
 Miscellaneous expense $ 275
6. Saba trading pays $950 to creditors during the month.
7. At the end of the month supplies on hand is $ 550
8. Saba withdraws $2,000 for personal use.

Required

a. Show the effect of transactions on the business equations.

Illustrations 3 (Group)

25 Principle accounting I Module Prepared By A.B |

2006 E.C
Debre Tabor University Department of Accounting & Finance

The asset & liabilities of Morgan dry cleaners on October 1 of the current year are
as follows: cash, $5,000 account receivable $3,000, supplies $2,000 land $21,000
account payable $3,000 Morgan dry cleaners is a sole proprietorship owned &
operated by M.A Morgan. Currently a building, delivery truck and equipment are
being rented pending expansion to new facilities. The actual work of dry cleaning is
done by another company at wholesale rates. Business transactions during the
month are summarized as follows.

a. Received cash from cash customers for dry cleaning sales $ 7,000
b. Paid creditors on account $2,000
c. Received cash from Morgan as additional investment $ 4,000
d. Paid rent for the month $1,000
e. Charged customers for dry cleaning sales on account $1,000
f. Purchase supplies on account $ 500
g. Received cash from cash customer on account $2,000
h. Received monthly invoice for dry cleaning expense for the month $1,500
i. Paid the following expense wages 1000 truck expense 500 utility 500
miscellaneous 100
j. Determine by taking an inventory the cost of supplies used during the month
$200

Required

a. Show the effect of transactions on the business equations.

26 Principle accounting I Module Prepared By A.B |

2006 E.C
Debre Tabor University Department of Accounting & Finance

UNIT TWO
Accounting Cycle
Unit Description
In this unit the nature of transactions & their effect on business enterprise,
the detail of these transactions, classification of accounts according to
common characteristics as balance sheet account & income statement
account & the preparation of journals, accounts & trial balance were
described.

Unit objectives

At the end of this unit students will be able to:-

 Define accounting cycle
 Describe the classification of accounts
 Illustrate chart of account and nature of an account
 Describe nature of an account
 Illustrate journal and account
 Prepare trial balance
 Describe matching principle
 Illustrate the nature of adjusting process
 Prepare worksheet for financial statement
 Show the nature of closing process
 Prepare post closing trial balance
 Show reversing entries

2.1. Accounting cycle

Objective 1:- Define accounting cycle
27 Principle accounting I Module Prepared By A.B |
2006 E.C
Debre Tabor University Department of Accounting & Finance

The transaction completed by an enterprise during a specific period may

cause increases & decreases in many different assets, liability & owners
equity items. Transactions can be analyzed & recorded in terms of their
effect on the equation; such a format is not practical as a design for actual
accounting system.
The accounting process that begins with analyzing & journalizing
transactions & ends with summarizing & reporting these transactions is
called accounting cycle. Understanding of all phases of the accounting
cycle is essential as a foundation for further study of accounting principles
and the use of accounting data by management. The basic flow of
accounting cycle is stated bellow.

Journalizing Posting
Journal Ledger

Business
Document Trial Balance

Accounting Cycle

Post - closing
trial balance Work Sheet

Adjusting & Closing Entry

Journalized & Posted to Financial
ledger Statement

Fig 1:- Accounting cycle

1. Transactions analyzed & recorded in journal.

2. Transactions posted to ledger
3. Trial balance prepared, adjustment data assembled & worksheet completed
4. Financial statement prepared
5. Adjusting & closing entries journalized
6. Adjusting & closing entries posted to ledger
28 Principle accounting I Module Prepared By A.B |
2006 E.C
Debre Tabor University Department of Accounting & Finance

7. Post-closing trial balance prepared

Accountants provide information on business transactions for use in directing

operations & for the preparation of timely periodic financial statements. This
objective is met by keeping a separate record (account) & a group of related
accounts is called ledger.

2.2. Classification of accounts

Objective 2:- Describe the classification of accounts
Accounts in the ledger are customarily listed in the order in which they
appear in financial statements & are classified according to the common
characteristics. Based on financial statement accounts can be categorized as
balance sheet & income statement account.
2.2.1. Balance sheet accounts
A. Assets: - any physical thing (tangible) or right (intangible) that has a monitory
value. It can be classified as,

Current assets: - cash and other assets that may reasonably be expected to be
realized in cash or sold or used up usually one year or less.

I. Cash: - a medium of exchange that a bank will accept at face value (includes
bank deposit, currency, checks, bank drafts & money order).
II. Note receivable: - claims against debtors evidenced by a written promise to
pay a sum of money at definite time to the order of a specified person or
bearer.
III. Account receivable: - arise from sale of service or merchandise on account
less formal than note receivable.
IV. Prepaid expense: - includes supplies on hand, advance payments,
insurance & property taxes.

Plant assets: - tangible assets used in the businesses that are/of a permanent or
relatively fixed in nature. It includes equipment, machinery, building & land.

B. Liabilities: - debts owed to the outsider (creditor). It includes

Current liability :- liability that will be due within a short time (usually one year or
less) and that are to be paid out of current assets. It includes note payable, account
payable, salary payable, interest payable & tax payable.

Long-term liability: - liability that will be due more than one year.

29 Principle accounting I Module Prepared By A.B |

2006 E.C
Debre Tabor University Department of Accounting & Finance

C. Owner’s equity: - the residual claims against the assets of a business after the
total liabilities are deducted. It consists of
 Capital: - the owners equity in a sole proprietorship & partnership.
 Capital stock: - the investment of stockholders.
 Retained earnings :- represents the net income retained in the business
 Drawing & dividend: - drawing represents the amount of withdrawals made
by the owner of sole proprietorship & partnership. Dividend is distribution of
income to stakeholders.
2.2.2. Income statement accounts
D. Revenue: - the gross increase in owners’ equity as a result of sale of
merchandise, performance of service for customers, rental of property, lending
of money & professional activities.
E. Expanses: - costs that have been consumed in the process of producing
revenue.

Activity 8

Describe the nature of the assets that compose under the category of current &
plant assets?

………………………………………………………………………………………………………………
………………………………………………………………………………………………………………
………………………………………………………………………………………………………………

Identify each of the following as current or plant asset

a. equipment d. accounts receivable

b. cash’ e. supplies
c. building f. land

2.3. Chart of accounts

Objective 3:- Illustrate chart of account & nature of an account
The number of accounts maintained by a specific enterprise is affected by the
nature of its operation, its volume of business, the extent to which details are
needed for taxing authorities, managerial decisions credit purpose etc...
Chart of account is the listing of the accounts in the ledger it is used as a reference
or index. To illustrate

Balance sheet Income statement

1. Assets 14. Supplies

11. Cash 15. Prepaid rent
12. Account receivable 18. Photographic equipment
30 Principle accounting I Module Prepared By A.B |
2006 E.C
Debre Tabor University Department of Accounting & Finance

19. Accumulated deprecation 5. Expense

2. Liabilities 51. Supplies expense
21. Account payable 52. Salary expense
22. Salaries payable 53. Rent expense
3. Owners equity 54. Depreciation expense
31. X-capital 55. Miscellaneous expense
32. Y-capital
33. Income summary
4. Revenue
41. Sales
Note:-

 The first digit represents the account division

 The second digit represents the position of the account in the division.

The initial preparation of the ledger based on the chart of accounts is often referred
to as opening the ledger.

Activity 9

Suppose XYZ business Asset accounts of balance sheet statement shows 120
accounts how many digits should used by a given business chart of account? Why?
………………………………………………………………………………………………………………
………………………………………………………………………………………………………………
………………………………………………………………………………………………………………
2.4. Nature of accounts
Objective 4:- Describe the nature of an account
2.4.1. The simplest form of an account has three parts
1. Title:- the name of the item recorded
2. The space of recording increase
3. The space of recording decrease

Title
Left side Right side
Debit (charge) Credit

The left side of the account is called the debit side & the right side is called
Credit. The amount entered in the left side to be debited (charge) & the amount
entered in the right side to be credited. Every business transaction affects a
minimum of two accounts (the concept of double entry system).

31 Principle accounting I Module Prepared By A.B |

2006 E.C
Debre Tabor University Department of Accounting & Finance

2.4.2. Normal Balances of accounts (the rule of debit & credit)

Increase Decrease Normal

balance
1. Balance sheet account
 Asset Debit Credit Debit
 Liability Credit Debit Credit
 Owners equity
 Capital stock Credit Debit Credit
 Retained earning Credit Debit Credit
 Drawing & dividend Debit Credit Debit
2. Income statement
 Revenue Credit Debit Credit
 Expense Debit Credit Debit

Activity 10

During the month, a business enterprise has a substantial number of transactions

affecting each of the following accounts. State for each account whether it is likely to
have (a) debit entries only (b) credit entries only (c) both debit & credit entries

(1) Rent expense (5) Betty moxley drawing

(2) sales (6) account receivable
(3) miscellaneous expense (7) note payable
(4) Account payable (8) cash

2.5. Journal & Ledger

Objective 5:- Describe Journal & Accounts
2.5.1. Journal
The information is initially entered in a record called a journal. The process of
recording a transaction in the journal is called journalizing & the form of
presentation is called journal entry.
Example 1:- Carl Davis establishes a business venture by initially depositing $
3,500 cash in bank account. Journal entry to record the given transaction is

Cash $3,500
Carl Davis capital $3,500

The data in the journal entry are transferred to the appropriate account by a
process known as posting.
Cash Owners equity

32 Principle accounting I Module Prepared By A.B |

2006 E.C
Debre Tabor University Department of Accounting & Finance

$3,500 $3500

An entry composed of two or more debits or two or more credits is called a

compound journal entry. The flow of accounting data from the time a transaction
occurs to its recording in the ledger may be presented as.

Business
transactio
n Business
occurs
documen
t Entry
prepared recorded
in Entry pos
ted
the journ to the led
al ger

N.B :- The transactions are entered in chronological order in a journal.

2.5.1.1. Two column & four column accounts

2.5.1.1. 1. Two column journal (account)
Before a transaction is entered in a two column journal it should be analyzed
according to the following sequences of steps
1. Determine whether an asset, liability, owner’s equity, revenue or expense is
affected.
2. Determine whether the affected assets, liabilities, owners equity revenue or
expense increase or decrease
3. Determine whether the effect of transaction should be recorded as debit or
credit.
The process of recording a transaction in a two column journal includes
a. Record the date (year , month & date)
b. Record the debit
c. Record the credit
d. Write an explanation
Example: - assume that $ 1822.25 is received from cash sales for May 1, 2004.
Journal entry
Debit Credit
Cash $1822.25
Sales $1822.25
(cash sales for the day)

Advantages of four column account

 Each debit & credit appearing chronological order.
 Debit & credit amount is more easily determined.

33 Principle accounting I Module Prepared By A.B |

2006 E.C
Debre Tabor University Department of Accounting & Finance

 Makes it easier to examine the data in an account.

2.5.2. Ledger
As we discussed in the preceding section, a transaction is first recorded in a journal.
Periodically, the journal entries are transferred to the accounts in the ledger. The
ledger is a history of transactions by account or a group of accounts for a business
entity the process of transferring the debits and credits from the journal entries to
the accounts is called posting.

Form of two column account

Account: - Cash page
Date Description Post Debit Date Descriptio Pos Credit
Ref n t
Ref
200 1
4
May
Form of four column account
Account: - Cash page
Date Description Post Debit Credit Normal
reference Balance
Debit Credit
200 1
4
May
N.B. Post reference is not used until the debit & credits are posted to the
appropriate account in the ledger.

Activity 11

Suppose in the month June 2002 ABC trading receive birr 1,200 from cash sale,
Based on the information prepare Journal entry, two column & four column account
(Ledger),
………………………………………………………………………………………………………………
………………………………………………………………………………………………………………
………………………………………………………………………………………………………………
2.6. Trial balance
Objective 6:- Prepare trial balance

34 Principle accounting I Module Prepared By A.B |

2006 E.C
Debre Tabor University Department of Accounting & Finance

The equality of debit & credits in the ledger should be verified at the end of each
accounting period. It does not provide a complete proof of the accuracy of the
ledger. It indicates only that the debits & the credits are equal.

Types of errors in trial balance

1. Error in preparing the trial balance

 One of the columns of the trial balances was incorrectly added
 The amount of an account balance was incorrectly recorded in trial balance.
 The debit balances was recorded on the trial balance as a credit, or vice versa
or a balance was omitted entirely.
2. Error in determining the account balances such as
 A balance was incorrectly computed.
 A balance was entered in the wrong balance column.
3. Error in recording a transaction in the ledger such as
 An erroneous amount was posted to the account.
 A debit entry was posted as a credit or vice versa.
 A debit or a credit posting was omitted.

Among the type of errors that will not cause an inequality in the trial balance total
are

1. Failure to record a transaction or to post a transaction.

2. Recording the same erroneous amount for both the debit & credit parts of a
transaction.
3. Recording the same transaction more than once.
4. Posting a part of a transaction correctly as a debit or credit but to the wrong
account.

Common types of errors

 Transposition :- erroneous rearrangement of digits (542 as 452)

 Slide :- erroneously moved one or more space (542.5 as 54.25)

Activity 12

When a trial balance is prepared an account balance of birr 36,750 is listed as

63,750 and an account balance of 54,000 is listed as 5,400. Identify the
transposition & the slide errors?

………………………………………………………………………………………………………………
………………………………………………………………………………………………………………
………………………………………………………………………………………………………………

When a purchase of supplies of birr 950 for cash was recorded. Both the debt & the
credit were journalized & posted as birr 590 (a) would this error cause the trial

35 Principle accounting I Module Prepared By A.B |

2006 E.C
Debre Tabor University Department of Accounting & Finance

balance to be out of balance? (b) Would the answer be the same if the birr 950
entry had been journalized correctly? But the credit to cash had been posted as birr
590?

………………………………………………………………………………………………………………
………………………………………………………………………………………………………………
……………………………………………………………………………………………………………

2.7. Matching principle

Objective 7:- Describe Matching principle
States that revenue & expenses should be properly matched at the end of a
given accounting period. Revenue & expense of a business enterprise is
recognized through cash basis or accrual bases of accounting.
a. Cash basis of Accounting: - revenues are reported in the period in
which cash is received and expenses are reported in the period in which
cash is paid i.e. sales would be recorded only cash is received from
customers; salary expense is recorded in the period cash is paid to
employees. Therefore, net income/loss would be the difference between
cash receipts & cash disbursements.
b. Accrual basis of Accounting : - revenues are reported in the period in
which they are earned & expenses are reported in the period in which
they are incurred i.e. revenues would be recognized as services are
provided to customers and not when cash is received from customers.
Supplies expenses would be recognized when the supplies are used and
not when the cash is paid for supplies purchased. Therefore, accrual basis
of accounting requires the use of adjusting process at the end of
accounting period.
2.8. Nature of the adjusting process
Objective 8:- Illustrate the nature of adjusting process
The entries required at the end of accounting period to bring the accounts up to
date & to assure the proper matching of revenue & expenses are called adjusting
entries .
2.8.1. Adjusting entries for plant assets
Example 3:- after trial balance is prepared the amount of depreciation for the
month is assumed to be $175
Depreciation expense 175
Accumulated depreciation 175
Effect of adjusting entry
 Income statement: - Expense will be understated by 175 & Net income will
be overstated by 175
36 Principle accounting I Module Prepared By A.B |
2006 E.C
Debre Tabor University Department of Accounting & Finance

 Statement of owner’s equity: - Net income will be overstated by 175 &

Ending owners equity will be overstated by 175
 Balance sheet: - Asset will be overstated by 175 & Owners equity will be
overstated by 175
Example 4:- The salary expense debited $575 on March 13 & 27 were bi weakly
payments on alternate Fridays for the payroll period on those days. The salaries
earned on Monday & Tuesday March 30 & 31 total $115
Salary expense 175
Salary payable 175
Effect of adjusting entry
 Income statement: - Expense will be understated by 115 & Net income will
be overstated by 115
 Statement of owner’s equity:- Net income will be overstated by 115 &
Ending owners equity will be overstated by 115
 Balance sheet: - Liability will be understated by 115 & Owners equity will be
overstated by 115
2.8.2. Adjustment for deferrals & Accruals
Deferrals: - is a delay of the recognition of expenses already paid or
revenue already received. Deferred expenses expected to benefit a short
period of time or listed on the balance sheet as current asset (deferred
charges)
Adjusting entries for prepaid expense (Deferrals)
Example 1:- At the end of March the supplies account balance $1,850. Assuming
that the inventory of supplies on March 31 is determined to be $890
Supplies expense 960
Supplies 960
(Adjusting entry to record prepaid expense)

Effect of adjusting entry

 Income statement: - Expense will be understated by 960 & Net income will
be overstated by 960
 Statement of owner’s equity: - Net income will be overstated by 960 &
ending owner’s equity will be overstated by 960
 Statement of owner’s equity: - Asset will be overstated by 960 & Owners
equity will be overstated by 960

Example 2:- the debit balance of $2400 prepaid rent account represents
prepayment of March 1 of 19 X1 rent for three month. March April & May at the end
of March adjusting entries shows.
Rent expense 800
Prepaid rent 800

37 Principle accounting I Module Prepared By A.B |

2006 E.C
Debre Tabor University Department of Accounting & Finance

Effect of adjusting entry

 Income statement: - Expense will be understated by 800 & Net income will
be overstated by 800.
 Statement of owner’s equity: - Net income will be overstated by 800 &
ending owner’s equity will be overstated by 800
 Balance sheet: - Asset will be overstated by 800 & Owners equity will be
overstated by 800

Example 3: - 1,910 of insurance premium have expired during the year

recorded as
Insurance expense 1,910
Dec 31 Prepaid insurance 1,910

Adjusting entries for unearned revenue (Deferrals)

Deferred revenues may be listed on the balance sheet as current liabilities;
they are called unearned revenues or revenues received in advance they are
considered as deferred credits.
Example: - the business earns 2400 four month rent of building
Unearned rent 600
Dec 31 rent income 600

Accruals: - is an expense that has not been paid or revenue that has
not been received. Accrued expense may be described on balance sheet as
accrued liabilities.
Example: - assume that on Dec 31, 2005 the end of fiscal year, the sales
salary expense account has a debit balance of 59250 & the office salary
expense 20660 salary have been paid every two weak and the records of the
business shows that the accruals for sales salaries & office salaries are 780 &
360.

Sales salary expense 780

Office salaries expense 360
Dec 31 salaries payable 1,140

Accrued revenues: - may be described on the balance sheet as accrued

assets.
Example: - assume that the interest earned but not collected as Dec 31,
1990 is birr 2002

Interest receivable 200

38 Principle accounting I Module Prepared By A.B |
2006 E.C
Debre Tabor University Department of Accounting & Finance

Dec 31 interest income 200

Activity
What term is used to describe (a) delay of the recognition of an expense
already paid or of revenue already received (b) an expense that has not
been paid or revenue that has not been received?
………………………………………………………………………………………………………
………………………………………………………………………………………………………
……………………
2.9. Work sheet for financial statements
Objective 9:- Prepare worksheet for financial statements
A type of working paper frequently used by accountants prior to preparation
of financial statement is called a worksheet. It serves as an aid for the
preparation of financial statements. The main headings of five sets of
worksheet column are
a) Trial balance d) Income statement
b) Adjustment e) Balance sheet
c) Adjusted trial balance
Work sheet:
 Reduces possibility of overlooking the need for adjustment.
 A means of verifying arithmetical accuracy.
 Provides for the arrangement in logical form.
 Provides the source data for financial statement.
Worksheet is identified by
 The name of the enterprise
 Nature of the form
 The period of time involve

Activity 13
Indicate with a Yes or No whether or not each of the following accounts normally
requires an adjusting entry.
a. Cash c. Wages Expense e. Accounts Receivable
b. Prepaid Rent d. Office Equipment f. Unearned Rent

Classify the following items as (1) prepaid expense, (2) unearned revenue, (3) accrued
expense, or (4) accrued revenue.
a. Wages owed but not yet paid. c. Fees received but not yet earned.
b. Supplies on hand. d. Fees earned but not yet received.
2.10. Nature of the closing process

39 Principle accounting I Module Prepared By A.B |

2006 E.C
Debre Tabor University Department of Accounting & Finance

Objective 10:- Show the nature of closing process

An account can be classified as permanent (balance sheet accounts) and
temporary (nominal) accounts such as revenue expense and drawing (dividend)
at the end of the period the net effect of the balances in this accounts must be in
the permanent owners equity (retained earnings) accounts . The balances
removed from temporary accounts through closing entries. An account titled
income summery is used for summarizing the data in the revenue & expense
account. It is used only at the end of the accounting period and is both opened &
closed during the closing process.

The revenue expenses & drawing (dividend) account are temporary accounts used in
classifying & summarizing changes in the owner’s equity during the accounting period.
At the end of the period the net effects of the balances in these accounts must be
recorded in the permanent capital (retained earnings) account. The balance must also be
removed from the temporary accounts, so that they will be ready for use in accumulating
data for the following accounting period. Both these goals are accomplished by a series
of entries called closing entries.

The account titled income summary is used for summarizing the data in the revenue &
expense account. It is used only at the end of the accounting period & is both opened &
closed during the closing process temporary accounts of a sole proprietorship at the end
of the period to be closed are:-
 Revenue  Net income (loss)
 Expense  Drawing
The account titles & amounts needed in journalizing the closing entries may be obtained
from any one of the three sources
 Work sheet
 Income statement & statement of owner’ equity
 Ledger
Closing entries
1. Closing entry for revenues
Revenue xx
March 31,19x1 Income summary xx
(Closing entry for Revenues)
2. Closing entry for expense
Income summary xx
March 31,19x1 Expenses xx
(Closing entry for Expenses)
3. To close net income or loss

40 Principle accounting I Module Prepared By A.B |

2006 E.C
Debre Tabor University Department of Accounting & Finance

Income summary xx
March 31,19x1 X-Capital xx
(Closing entry for Net income)
If the company incurs loss closing entry is reversed debited the capital
account and credited income summery account.

4. To close drawing
X-Capital xx
March 31,19x1 X- drawing xx
(Closing entry for personal withdrawal)
N. B. The only difference between closing entries of sole proprietorship &
corporation is instead of capital accounts retained earning account is used.

5. To close net income or loss

Income summary xx
March 31,19x1 Retained earning xx
(Closing entry for Net income)
If the company incurs loss closing entry is reversed debited the capital
account and credited income summery account.
6. To close drawing
Retained earnings xx
March 31,19x1 Dividend xx
(Closing entry for Dividend)
N. B. The only difference between closing entries of sole proprietorship &
corporation is instead of capital accounts retained earning account is used.
Activity 14

After the accounts have been adjusted at July 31, the end of the fiscal year, the
following balances are taken from the ledger of XYZ Services Co.:
 XYZ Capital $615,850  Rent Expense 65,000
 XYZ Drawing 25,000  Supplies Expense 18,250
 Fees Earned 380,450  Miscellaneous Expense 6,200
 Wages Expense 250,000
Journalize the four entries required to close the accounts.
………………………………………………………………………………………………………………
………………………………………………………………………………………………………………

2.11. Post closing trial balance

41 Principle accounting I Module Prepared By A.B |
2006 E.C
Debre Tabor University Department of Accounting & Finance

Objective 11:- Prepare post closing trial balance

The last procedure of the accounting cycle is the preparation of trial balances after
all of the temporary accounts have been closed. The accounts & amounts in post
closing trial balances should agree with the accounts & amounts listed on the
balance sheet at the end of period.

Illustration of Accounting Cycle

1. March 1:- Ann hill operated in photographic business in her home. The
following assets were invested in the enterprise cash $3,500 account
receivables $950 supplies $ 1,200 & photographic equipment $15,000
2. March 1:- paid $2,400 on a lease rental contract the payment represents three
months rent of quarters for the studio.
3. March 4:- Purchase additional photographic equipment on account from
palmer photographic equipment inc $2,500
4. March 5:- received $850 from customers in payment of their account.
5. March 6:- paid $125 for newspaper advertisement.
6. March 10:- paid $500 to palmer photographic equipment inc. applies on the
$2,500 debt owed them.
7. March 13:- paid reception $575 for two weeks salary.
8. March 16:- received $1,980 from sales for the first half of March.
9. March 20:- paid $650 for supplies.
10. March 27:- paid reception $575 for two weeks salary.
11. March 31:- paid $69 for telephone bill for the month.
12. March 31:- paid $175 for electric bill for the month.
13. March 31:- received $1,870 from sales for the second half of the month.
14. March 31:- sales on account totaled $1,675 for the month.
15. March 31:- Hill withdraws $1,500 for her personal use.
Additional Information
a. The cost of supplies on hand at the end of the period was 890
b. Prepaid rent has a balance of 2400 this amount covers 3 months’ rent their four,
rent expense for the month march amounted 800 (2400/3).
c. Depreciation of photographic equipment is estimated at 175 for the month.
d. Salaries accrued but not paid at the end of March amounted to 115.
Required
a. Prepare journal entries
Journal
Page - 1
Date Description P Debit Credit
/
R
1990 1 Cash 3 5 0 0 0

42 Principle accounting I Module Prepared By A.B |

2006 E.C
Debre Tabor University Department of Accounting & Finance

March 0
Account receivable 9 5 0 0
0
Supplies 1 2 0 0 0
0
Photographic 1 5 0 0 0 0
equipment 0
Ann hill capital 2 0 6 5 0 0
0
1 Prepaid rent 2 4 0 0 0
0
Cash 2 4 0 0 0
0
4 Photographic 2 5 0 0 0
equipment 0
Account 2 5 0 0 0
payable 0
5 Cash 8 5 0 0
0
Account 8 5 0 0
receivable 0
6 Miscellaneous 1 2 5 0
expense 0
Cash 1 2 5 0
0
10 Account payable 5 0 0 0
0
Cash 5 0 0 0
0
13 Salary expense 5 7 5 0
0
Cash 5 7 5 0
0
16 Cash 1 9 8 0 0
0
Sales 1 9 8 0 0
0
20 Supplies 6 5 0 0
0
Cash 6 5 0 0
0
27 Salary expense 5 7 5 0
0
Cash 5 7 5 0
43 Principle accounting I Module Prepared By A.B |
2006 E.C
Debre Tabor University Department of Accounting & Finance

0
31 Miscellaneous 6 9 0
expense 0
Cash 6 9 0
0
31 Miscellaneous 1 7 5 0
expense 0
Cash 1 7 5 0
0
31 Cash 1 8 7 0 0
0
Sales 1 8 7 0 0
0
31 Account receivable 1 6 7 5 0
0
Sales 1 6 7 5 0
0
31 Ann hill drawing 1 5 0 0 0
0
Cash 1 5 0 0 0
0

b. Post journal entries to the ledger

Account:- Cash Account
number 11
Date Item P/ Debit Credit Balance
R Debit Credit
1990 1 1 3 5 0 0 0 3 5 0 0 00
Marc 0
h
1 1 2 4 0 0 0 1 1 0 0 00
0
5 1 8 5 0 0 1 9 5 0 00
0
6 1 1 2 5 0 1 8 2 5 00
0
10 1 5 0 0 0 1 3 2 5 00
0
13 1 5 7 5 0 7 5 0 00
0
16 1 1 9 8 0 0 2 7 3 0 00
0
20 1 6 5 0 0 2 0 8 0 00
0

44 Principle accounting I Module Prepared By A.B |

2006 E.C
Debre Tabor University Department of Accounting & Finance

27 1 5 7 5 0 1 5 0 5 00
0
31 1 6 9 0 1 4 3 6 00
0
31 1 1 7 5 0 1 2 6 1 00
0
31 1 1 8 7 0 0 3 1 3 1 00
0
31 1 1 5 0 0 0 1 6 3 1 00
0
Account:- Account Receivable
Account number 12
Date Item P/ Debit Credit Balance
R Debit Credit
1990 1 1 9 5 0 0 9 5 0 00
March 0
5 1 8 5 0 0 1 0 0 00
0
3 1 1 6 7 5 0 1 7 7 5 00
1 0
Account: - Supplies Account
number 13
Date Item P/R Debit Credit Balance
Debit Credit
1990 1 1 1 2 0 0 0 1 2 0 0 00
Marc 0
h
20 1 6 5 0 0 1 8 5 0 00
0
31 Adjustmen
9 6 0 0 8 9 0 00
t
0
Account:- Prepaid rent
Account number 15
Date Item P Debit Credit Balance
/ Debit Credit
R
1990 1 1 2 4 0 0 0 2 4 0 0 00
March 0
31 Adjusting
8 0 0 0 1 6 0 0 00
0

45 Principle accounting I Module Prepared By A.B |

2006 E.C
Debre Tabor University Department of Accounting & Finance

Account:- Photographic equipment

Account number 18
Date Item P/ Debit Credit Balance
R Debit Credit
1990 1 1 1 5 0 0 0 0 1 5 0 0 0 0
March 0 0
4 1 2 5 0 0 0 1 7 5 0 0 0
0 0
Date Item P/R Debit Credit Balance
Debit Credit
1990 3 Adjusting 1 7 5 0 1 7 5 0
Marc 1 0 0
h

Date Item P/ Debit Credit Balance

R Debit Credit
1990 4 1 2 5 0 0 0 2 5 0 0 0
March 0 0
1 1 5 0 0 0 2 0 0 0 0
0 0 0

Date Item P/R Debit Credit Balance

Debit Credit
1990 3 Adjustin 1 1 1 5 0 1 1 5 0
March 1 g 0 0
Date Item P/ Debit Credit Balance
R Debit Credit
1990 1 1 2 0 6 5 0 0 2 0 6 5 0 0
March 0 0
Date Item P/ Debit Credit Balance
R Debit Credit
1990 31 1 1 5 0 0 0 1 5 0 0 0
Marc 0 0
h
31 Closing 1 5 0 0 0 - - - - -
0
Date Item P Debit Credit Balance
/ Debit Credit
R
1990 16 1 1 9 8 0 0 1 9 8 0 0
March 0 0
31 1 1 8 7 0 0 3 8 5 0 0
0 0

46 Principle accounting I Module Prepared By A.B |

2006 E.C
Debre Tabor University Department of Accounting & Finance

31 1 1 6 7 5 0 5 5 2 5 0
0 0
31 Closing 5 5 2 5 0 - - - - -
0
Account: - Supplies Expense
Account number 51
Date Item P/ Debit Credit Balance
R Debit Credit
1990 3 Adjusting
9 6 0 0 9 6 0 0
March 1 0 0
3 Closing 9 6 0 0 - - - -
1 0
Account: - Salary Expense Account
number 52
Date Item P/ Debit Credit Balance
R Debit Credit
1990 1 1 5 7 5 0 5 7 5 0
March 3 0 0
2 1 5 7 5 0 1 1 5 0 0
7 0 0
3 Adjusting
1 1 5 0 1 2 6 5 0
1 0 0
3 Closing 1 2 6 5 0 - - - - -
1 0
Account: - Rent expense Account
number 53
Date Item P/ Debit Credit Balance
R Debit Credit
1990 3 Adjusting
8 0 0 0 8 0 0 0
March 1 0 0
3 Closing 8 0 0 0 - - - -
1 0
Account: - Depreciation expense
Account number 54
Date Item P/ Debit Credit Balance
R Debit Credit
1990 3 Adjusting
1 7 5 0 1 7 5 0
March 1 0 0
3 Closing 1 7 5 0 - - - -
1 0

47 Principle accounting I Module Prepared By A.B |

2006 E.C
Debre Tabor University Department of Accounting & Finance

Account: - Miscellaneous Expense Account

number 59
Date Item P/ Debit Credit Balance
R Debit Credit
1990 6 1 1 2 5 0 1 2 5 0
March 0 0
3 1 6 9 0 1 9 4 0
1 0 0
3 1 1 7 5 0 3 6 9 0
1 0 0
3 3 6 9 0 - - - -
1 0

48 Principle accounting I Module Prepared By A.B |

2006 E.C
Debre Tabor University Department of Accounting & Finance

d. Prepare trial balance

Hall photographic studio
Trial balance
March 31, 1990
Cash 1 6 3 1 0
0
Account receivable 1 7 7 5 0
0
Supplies 1 8 5 0 0
0
Prepaid rent 2 4 0 0 0
0
Photographic equipment 1 7 5 0 0 0
0
Account payable 2 0 0 0 00
Ann hill capital 2 0 6 5 0 00
Ann hill drawing 1 5 0 0 0
0
Sales 5 5 2 5 00
Salary expense 1 1 5 0 0
0
Miscellaneous expense 3 6 9 0
0
2 8 1 7 5 0 2 8 1 7 5 00
0

5. Prepare adjusting entries

Date Description P/R Debit Credit

1990 31 Supplies expense 9 6 0 0
Marc 0
Supplies 9 6 0 0
0
31 Rent expense 8 0 0 0
0
Prepaid rent 8 0 0 0
0
31 Depreciation 1 7 5 0
expense 0
Acc/dep/equipme 1 7 5 0
nt 0
31 Salary expense 1 1 5 0
0
Salary payable 1 1 5 0

49 Principle accounting I Module Prepared By A.B |

2006 E.C
Debre Tabor University Department of Accounting & Finance

50 Principle accounting I Module Prepared By A.B |

2006 E.C
Debre Tabor University Department of Accounting & Finance

e. Prepare worksheet
Hill photographic studio
Worksheet
For the month ended March 31,19x1
Account tittles Trial balance Adjustment Adjusted trial Income Balance
balance statement sheet
Debit Credit Debit Credit Debit Credit Debit Credit Debit Credi
t
Cash 1,631 1,631 1631
Account receivable 1,775 1,775 1775
Supplies 1,850 960 890 890
Prepaid rent 2,400 800 1,600 1600
Photographic equipment 17,500 17,500 17500
Account payable 2,000 2,000 2000
Ann hill capital 20,650 20,650 2065
0
Ann hill drawing 1,500 1,500 1500
Sales 5,525 5,525 5,525
Salary expense 1,150 115 1,265 1,265
Miscellaneous expense 369 369 369
28,175 28,175
Supplies expense 960 960 960
Rent expense 800 800 800
Depreciation expense 175 175 175
Accumulated depreciation 175 175 175
Salary payable 115 115 115
2,050 2,050 28,465 28,465 3,569 5,525 24896 2294
0
Net income 1,956 1956
5,525 5,525 24,89 24,8

51 Principle accounting I Module Prepared By A.B | 2006 E.C

Debre Tabor University Department of Accounting & Finance

Account tittles Trial balance Adjustment Adjusted trial Income Balance

balance statement sheet
Debit Credit Debit Credit Debit Credit Debit Credit Debit Credi
t
6 96

52 Principle accounting I Module Prepared By A.B | 2006 E.C

Debre Tabor University Department of Accounting & Finance

f. Prepare financial statements

Hill photographic studio
Income Statement
For the month ended March 31,19x1
Fares earned 5 5 2 5 0
0
Operating expenses
Wages expense 1 2 6 5 0
0
Rent expense 9 6 0 0
0
Supplies expense 8 0 0 0
0
Utilities expense 1 7 5 0
0
Miscellaneous expense 3 6 9 0
0
Total operating expenses 3 5 6 9 0
0
Net income 1 9 5 6 0
0
g.

Hill photographic studio

Statement of owner’s equity
For the month ended August 31,19x1
Investment during the month 2 0 6 5 0 0
0
Net income for the month 1 9 5 6 0
0
Less:- Withdrawal 1 5 0 0 0
0
Increase in owners’ equity 4 5 6 0
0
John long ,capital August 31,19x 2 1 1 0 6 0
0

Hill photographic studio

Balance sheet
August 31,19x1
Assets

53 Principle accounting I Module Prepared By A.B | 2006 E.C

Debre Tabor University Department of Accounting & Finance

Current Assets
Cash 1 6 3 1 00
Account Receivable 1 7 7 5 00
Supplies 8 9 0 00
Prepaid Rent 1 6 0 0 00
Total Current Assets 5 8 9 6 00
Plant Assets
Photographic equipment 1 7 5 0 0 00
Less:- accumulated depreciation 1 7 5 00
Total Assets 2 3 2 2 1 00
Liabilities
Current Liability
Account Payable 2 0 0 0 00
Salaries payable 1 1 5 00
Total Liabilities 2 1 1 5 00
Owner’s equity
Ann hill capital 2 1 1 0 6 00
Total liabilities & owners equity 2 3 2 2 1 00

h. Prepare closing entries

Date Description P/R Debit Credit

1990 3 Laundry revenue 5 5 2 5 0
March 1 0
Income summary 5 5 2 5 0
0
(To close revenue)
3 Income summary 3 5 6 9 0
1 0
Salary expense 1 2 6 5 0
0
Miscellaneous 3 6 9 0
expense 0
Supplies expense 9 6 0 0
0
Rent expense 8 0 0 0
0
Dep. expense 1 7 5 0
0
(To close expenses)
3 Income summary 1 9 5 6 0
1 0
Ann hill capital 1 9 5 6 0
0

54 Principle accounting I Module Prepared By A.B | 2006 E.C

Debre Tabor University Department of Accounting & Finance

(To close net Income)

3 Ann hill capital 1 5 0 0 0
1 0
Ann hill drawing 1 5 0 0 0
0

N.B. when the company incurs a loss closing entry is reversed debit the capital account &
credit income summary account.
i. Prepare post closing trial balances
Hall photographic studio
Post- closing Trial balance
March 31, 1990
Cash 1 6 3 1 0
0
Account receivable 1 7 7 5 0
0
Supplies 8 9 0 0
0
Prepaid rent 1 6 0 0 0
0
Photographic equipment 1 7 5 0 0 0
0
Accumulated depreciation 1 7 5 00
Account payable 2 0 0 0 00
Salary payable 1 1 5 00
Ann hill capital 2 1 1 0 6 00
2 3 3 9 6 0 2 3 3 9 6 00
0

2.12. Reversing entries

Objective 12:- Show reversing entry
Reversing entry is the exact reverse of the adjusting entry. The main purpose of
reversing entry will be:-
1. To record routine transactions that occurs in the following accounting period (to
reduce the likelihood of errors in the subsequent recording of transactions.
2. To reverse deferred expenses & revenues when they are initially recorded as
expenses /revenue instead of asset/ liability.
To reverse routine transactions that occurs in the following accounting period. The
amounts & the accounts are the same as the adjusting entry; the debit & credit are
merely reversed.
55 Principle accounting I Module Prepared By A.B | 2006 E.C
Debre Tabor University Department of Accounting & Finance

2.12.1. Reversing entries for accrued liabilities

Example1: - assume ABC trading salaries are paid on Friday for the five day a weak.
The balances in salary expense as Friday Dec 27 is 62,500 Salary accrued for
Monday & Tuesday Dec 30 & 31 total 500. But, the next weak salary paid on Friday,
January 3, of the following year total 1,250 (salary accrued but not paid)
Adjusting entry Reversing entry
Dec 31 Salary expense 500 Jan 1 Salary payable 500
Salary payable 500 Salary expense 500
1) Reversing entries for accrued assets
Example2: - assume that an enterprise has a note receivable on which birr 6,000 of
interest due every six months if 4,000 of interest income has been earned /accrued/
on December 31 end of the year adjusting & reversing entry (interest earned but not
collected)
Adjusting entry Reversing entry
Dec 31 I/receivable 500 Jan 1 I/income 500
I/income 500 I/receivable 500
To reverse deferred revenues & expenses when they are initially recorded as
revenue / expense instead of liability/asset
2.12.2. Reversing entries for deferred expense
Example3: - a premium on insurance policies acquired during May 1, 2005 was birr
2,034. Premium expired during the year is 906.
Date Prepaid insurance initially prepaid insurance recorded
recorded as asset initially as expense
Jan 10 Prepaid insurance 2,034 Insurance expense 2,034
Cash Cash
2,034 2,034
(Journal entry) (Journal entry)
Jan 31 Insurance expense 906 Prepaid insurance 1,128
Prepaid insurance 906 Insurance expense
(Adjusting entry) 1,128
(Adjusting entry to transfer
amount unused to the appropriate
asset account)
Jan 31 Income summary 906 Income summary 906
Insurance expense 906 Insurance expense 906
(Closing entry) (Closing entry)
Feb 3 Reversing entry not required b/c Insurance expense 1,128
amount prepaid at beginning of Prepaid insurance
new period is in the asset 1,128

56 Principle accounting I Module Prepared By A.B | 2006 E.C

Debre Tabor University Department of Accounting & Finance

account. (reversing entry)

2.12.3. Reversing entry for deferred revenue

Example:- assume that on Oct 1/2005 a business rents a portion of its building for
a period of one year receiving birr 7,200 in payment for the entire term of lease. On
Dec 31, 2005 at the fiscal year 1/4th has been earned & 3/4th has not been earned.
Date Unearned revenue recorded Unearned revenue recorded
initially as liabilities initially as revenue
Dec 10 Cash 7,200 Cash 2,034
Unearned revenue Rent income
7,200 2,034
(Journal entry) (Journal entry)
Dec 31 Unearned rent 1,800 Rent income 5,400
Rent income 1,800 Unearned rent
(Adjusting entry) 5,400
(Adjusting entry to transfer
amount used to the appropriate
Liability account)
Dec 31 Rent income 1,800 Rent income 1800
Income summary Income summary 1800
1,800 (Closing entry)
(Closing entry)
Jan 3 Reversing entry not required b/c Unearned rent 5,400
amount unearned at beginning Rent income
of new period is in the liability 5,400
account. (reversing entry)

Assessment

1) A debit may signify a(n):

A. Increase in an asset account. C. Increase in a liability
B. Decrease in an asset account.
account. D. Increase in the owner’s
capital account
2) The type of account with a normal credit balance is:

57 Principle accounting I Module Prepared By A.B | 2006 E.C

Debre Tabor University Department of Accounting & Finance

A. An asset. C. a revenue
B. Drawing. D. An expense.
3) A debit balance in which of the following accounts would indicate a likely error?
A. Accounts Receivable C. Fees Earned
B. Cash D. Miscellaneous Expense
4) If the estimated amount of depreciation on equipment for a period is $2,000,
the adjusting entry to record depreciation would be:
A. Debit Depreciation Expense, $2,000; credit Equipment, $2,000.
B. Debit Equipment, $2,000; credit Depreciation Expense, $2,000.
C. Debit Depreciation Expense, $2,000; credit Accumulated Depreciation,
$2,000.
D. Debit Accumulated Depreciation, $2,000; credit Depreciation Expense,
$2,000.
5) If the equipment account has a balance of $22,500 and its accumulated
depreciation account has a balance of $14,000, the book value of the
equipment would be:
A. $36,500. C. $14,000.
B. $22,500 D. $8,500.

Answer

1. A 4. C
2. C 5. D
3. C

CHAPTER THREE
Accounting for a Merchandise Enterprise
Unit Description

58 Principle accounting I Module Prepared By A.B | 2006 E.C

Debre Tabor University Department of Accounting & Finance

This chapter illustrates the accounting system of merchandising enterprise the way of
acquiring of merchandise for resale to customers, the difference between the activities
performed by service enterprises & merchandise enterprise, the year end adjustment
procedures & the preparation of financial statements for merchandise enterprises.
Unit Objective
At the end of this unit, students will be able to:-

 Illustrate accounting for purchase of merchandise

 Illustrate accounting for sales of merchandise
 Illustrate accounting for transportation cost and sales tax
 Describe merchandizing inventory system
 prepare merchandise inventory adjustment
 show work sheet for merchandise enterprise
 Prepare financial statement for merchandize enterprise
 illustrate adjusting entries
 prepare closing entries
3. Introduction

The revenue activities of a service business involve providing services to customers.

On the income statement for a service business, the revenues from services are
reported as fees earned. The operating expenses incurred in providing the services
are subtracted from the fees earned to arrive at net income. In contrast, the revenue
activities of a merchandising business involve the buying and selling of merchandise.
A merchandising business must first purchase merchandise to sell to its customers.
When this merchandise is sold, the revenue is reported as sales, and its cost is
recognized as an expense called the cost of merchandise sold. The cost of
merchandise sold is subtracted from sales to arrive at gross profit. This amount is
called gross profit because it is the profit before deducting operating expenses.
Merchandise on hand (not sold) at the end of an accounting period is called
merchandise inventory. Merchandise inventory is reported as a current asset on
the balance sheet.

In the remainder of this chapter, we illustrate merchandiser financial statements and

transactions that affect the income statement (sales, cost of merchandise sold, and
gross profit) and the balance sheet (merchandise inventory).
The operations of a merchandising business involve the purchase of merchandise for
sale (purchasing activity), the sale and distribution of the products to customers
(sales activity), and the receipt of cash from customers (collection activity). This
overall process is referred to as the operating cycle. Thus, the operating cycle begins

59 Principle accounting I Module Prepared By A.B | 2006 E.C

Debre Tabor University Department of Accounting & Finance

with spending cash, and it ends with receiving cash from customers. Operating
cycles differ, depending upon the nature of the business and its operations. For
example, the operating cycles for tobacco, distillery, and lumber industries are much
longer than the operating cycles of the automobile, consumer electronics, and home
furnishings industries.
Likewise, the operating cycles for retailers are usually shorter than for manufacturers
because retailers purchase goods in a form ready for sale to the customer. Of course,
some retailers will have shorter operating cycles than others because of the nature
of their products. For example, a jewelry store or an automobile dealer normally has
a longer operating cycle than a consumer electronics store or a grocery store.
Businesses with longer operating cycles normally have higher profit margins on their
products than businesses with shorter operating cycles. For example, it is not
unusual for jewelry stores to price their jewelry at 30%–50% above cost. In contrast,
grocery stores operate on very small profit margins, often below 5%. Grocery stores
make up the difference by selling their products more quickly.

3.1. Accounting for purchase of merchandise

Objective1:- Illustrate accounting for purchase of merchandise
Purchase of merchandise are usually identified in the ledger as “purchase” thus a
merchandise enterprise can accumulate in the purchase account the cost of all
merchandise purchased for resale during the accounting period. When purchases are
made for cash, the transaction could be recorded as:
Purchase xx
Cash xx

When purchase are made on account:

Purchase xx
Account payable xx

The arrangements agreed upon by the buyer and the seller as to when payments for
merchandise are to be made is called the credit term and the period in which the
buyer is allowed a certain amount of time, in which to pay. It is usual the credit
period to begin with the date of the sale as shown by the date of the invoice or bill.
If payment is due within a stated number of days after the date of the invoice for
example, 30 days the term are said to be “net 30 days” & presented as n/30. If
payment is due by the end of the month in which the sale was made, it may be
expressed as n/eom. As a means of encouraging payment before the end of credit
period, the seller may offer a discount for the early payment of cash expressed as
“2/10,n/30” means that

60 Principle accounting I Module Prepared By A.B | 2006 E.C

Debre Tabor University Department of Accounting & Finance

The credit period is 30 days.


The buyer may deduct 2% of the amount of the invoice if payment is

made within 10 days of the invoice date.
From the buyers stand points, it is important to take advantage of all available
discounts even though it may be necessary to borrow the money to make the
payment.
Example: - assume the invoice for birr 1,500 is received by xyz corporation, the
invoice with term “2/10,n/30” is to be paid within the discount period with money
borrowed for the remaining 20 days of the credit period. If an annual interest rate of
12% is assumed, the net savings to the buyer is
 Discount of 2% on birr 1,500………………………………..30.00
 Interest for 20 days ………………………………………… 9.80
 Saving effected by borrowing ………………………………20.20
Discount taken by the buyer for early payment of an invoice are called purchases
discounts. It is a deduction from the amount initially recorded in purchase i.e. it is a
contra (offsetting) account to purchase & it is recorded as:
Account payable xx
Cash xx
Purchase discount xx
(When payment is made for merchandise purchased on account)
The buyers (debtor) communicate with the seller through debit memorandum,
when merchandise is returned (purchase return) or a price adjustment (purchase
allowance) is requested & this is confirmed by the seller (creditor) through credit
memorandum.

Debit Memorandum Credit Memorandum

Prepared by the Prepared by the
buyer/debtor Seller/Creditor

Example: - assume that from May 1 purchase of birr 1,500 the debit memorandum
shows merchandise amounted birr 62.50 is returned to the seller. This is recorded as
Account payable 62.50
Purchases return & allowance 62.50
Activity
What distinguishes a merchandise enterprise from a service enterprise?
…………………………………………………………………………………………………………………
…………………………………………………………………………………………………………………
……………………………………………………………………
61 Principle accounting I Module Prepared By A.B | 2006 E.C
Debre Tabor University Department of Accounting & Finance

What is the name of the account in which purchase of merchandise are recorded?
…………………………………………………………………………………………………………………
…………………………………………………
What is the meaning of (a) 2/10,n/60 (b) n/30 (c) n/eom
…………………………………………………………………………………………………………………
…………………………………………………………………………………………………………………
………………………………………………………………………………………………………
3.2. Accounting for sales of merchandise
Objective2:- Illustrate accounting for sale of merchandise
Merchandise sales are usually identified in the ledger as “sales”. When sale is made
in cash recorded as,
Cash xx
Sales xx
When sale are made on account:
Account receivable xx
Sales xx
The seller refers to the discount taken by the buyer for early payment of an invoice
as sales discount it is recorded as:
Cash xx
Sales discount xx
Account receivable xx
When merchandise sold be returned by the buyer for early payment of an invoice as
sales discount, it is recorded as “sales return” & when merchandise is defective
the buyer may be allowed a reduction from original price at which the goods were
sold called “sales allowance”.
Example: - suppose the product (Merchandise) valued 225 were returned because
of defectiveness. The journal entry to record sales return is:
Sales return & allowance xx
Account Receivable xx
Activity
How does accounting for sales to customers using bank credit cards, such as Master
Card & VISA differs from accounting for sales to customers using non bank credit
cards? Such as American Express
…………………………………………………………………………………………………………………
…………………………………………………………………………………………………………………
…………………………………………………………………………………………

62 Principle accounting I Module Prepared By A.B | 2006 E.C

Debre Tabor University Department of Accounting & Finance

After the amount due on a sale of $2000, terms 2/10,n/eom is received from a
customer within the discount period the seller consents to the return of the entire
shipment
(a) What is the amount of the refund owed to the customer?
…………………………………………………………………………………………………………………
……………………………………………………………………………………………………………
(b)What account should be debited & credited by the seller to record the return &
the refund?
…………………………………………………………………………………………………………………
……………………………………………………………………………………………
3.3. Transportation Costs & Sales tax
Objective3:- Illustrate accounting for transportation cost and sales tax
3.3.1. Transportation costs
The terms of the agreement between buyer & seller include provisions concerning
when the ownership (tittles) passes to the buyer & which party is bearing the cost of
delivery. The buyer is to absorb the transportation cost and the terms are said to be
FOB shipping point. FOB shipping point means that the seller places the
merchandise “free on board” at the shipping point and the buyer is responsible for
the transportation cost beyond that point. If ownership passes to the buyer when the
merchandise is received by the buyers, the seller is to assume the cost of
transportation & the terms are said to be FOB destination. The seller places the
merchandise “free on board” to its destination by paying the delivery costs.
Example: - assume Durban plc. Purchase merchandise from Ambasel trading on
account birr 900 terms FOB shipping points 2/10,n/30 with prepaid transportation
costs of birr 50 the entry to record the given transaction.
Purchase xx
Transportation in xx
Account Payable xx
N.B. when the terms provided for a discount for early payment the discount is based
on the amount of sale rather than on invoice total.
When the agreement states that the seller is to bear the delivery costs (FOB
Destination) the amount paid by the seller for delivery are debited to transportation
out the total of such costs incurred during a period is reported on the sellers’ income
statement as a “selling expense”.
3.3.2. Sales tax
At the time of cash sales the seller collects the sales tax when a sale is made on
account, the buyer is charged for the tax. Example: - a sale of birr 100 on account,
subjected to a tax of 4% could be recorded by the following entry
Account receivable 104
63 Principle accounting I Module Prepared By A.B | 2006 E.C
Debre Tabor University Department of Accounting & Finance

Sales 100
Sales tax payable 4
When sale tax is paid recorded as
Sales tax payable 4
Cash 4
Activity
Who bears the transportation cost when the term of sales are (a) FOB shipping point
(b) FOB destination
…………………………………………………………………………………………………………………
…………………………………………………………………………………………………………………
…………………………………………………………………………………
A sale of merchandise on account for $500 is subject to a 6% sales tax
(a) Should the sales tax be recorded at the time of sale or when payment is received?
…………………………………………………………………………………………………………………
…………………………………………………………………………………………………………
(b) What is the amount of sale?
……………………………………………………………………………………………………
(c) What is the amount debited to account receivable?
………………………………………………………………………………………………………
(d)What is the title of the account to which the $30 is credited?
………………………………………………………………………………………………………
3.4. Merchandise inventory system
Objective4:- Describe merchandise inventory system
There are two main systems for accounting for merchandise held for sale
1. Periodic system: - In this system, the revenue from sales are recorded when
sales are made but no attempt is made on the sales date to record the cost of
merchandise sold many merchandise enterprise use this system. It is only by
detailed listing of the merchandise on hand (physical inventory) at the end of
accounting period that a determination is made of
1. The cost of merchandise sold during the period.
2. The cost of inventory on hand at the end of the period.
2. Perpetual system: - Both the sales amount and the cost of merchandise sold
amount are recorded when each item of merchandise is sold the accounting records
continuously (perpetually) disclosed the inventory on hand. Cost of merchandise sold
is computed as:

CMS = beginning inventory + purchase + ending inventory

= beginning inventory + net purchase + transportation in – ending
inventory
Net 64 Principle accounting
purchase = PurchaseI Module
– purchase returnPrepared By A.B – purchase |discount
& allowance 2006 E.C
Debre Tabor University Department of Accounting & Finance

Activity

Explain the difference between periodic & perpetual inventory system?

…………………………………………………………………………………………………………………
…………………………………………………………………………………………………………………
…………………………………………………………………………………………………………………
………………………………………………

3.5. Merchandise inventory adjustment

Objective 5:- Prepare merchandise inventory adjustment
At the end of the period it is necessary to remove from merchandise inventory the
amount representing the inventory at the beginning of the period and to replace it
with the amount representing the inventory at the end of the period. This is
accomplished by two adjusting entries (adjustment for beginning inventory).

Income summary xx
Merchandise inventory xx
To adjust the cost of merchandise inventory at the end of the period,
Merchandise inventory xx
Income summary xx
3.6. Financial Statements for merchandise enterprise
Objective 6:- Prepare financial statement for merchandize enterprise
The basic financial statements for a merchandise enterprise, including the income
statement, statement of owner’s equity, & balance sheet are similar to those of
service enterprise. The basic differences between the financial statements of a
merchandise enterprise & a service enterprise includes, the cost of merchandise sold
section of the income statement. For the purpose of this module we can see the type
of income statement for merchandise enterprise.
Income Statement
There are two widely used forms for the income statement multiple step & single
step
a. Multiple-step form:- the multiple step income statement is so called because of
its many sections, subsections, and intermediate balance. It consists of revenue

65 Principle accounting I Module Prepared By A.B | 2006 E.C

Debre Tabor University Department of Accounting & Finance

from sale, cost of merchandise sold, gross profit, operating expense, income from
operations, other income, other expense, & net income.
Cox Co.
Income Statement
For year ended December 31, 1990
Revenue from sales
Sales
720,185
Less: - Sales returns & allowance 6,140
Sales discount 5,790 11,930
Net sales
708,255
Cost of merchandise sold
Merchandise inventory beg. 59, 700
Purchase 521,980
Less: - Purchase return & allowance 9,100
Purchase discount 2,525 11,625
Net purchase 510,355
Add:- transport in 17,400
Cost of merchandise purchased 527,755
Merchandise available for sale 587,455
Less: - Merchandise inventory end. 62,150
Cost of merchandise sold
525,305
Gross profit
182,950
Operating expense
Selling expense
Sales salary expense 60,030
Advertizing expense 10,860
D/E- store equipment 3,100
Misc. selling expense 630
Total selling expense 74,620
Administrative expense
Office salary expense 21,020
Rent expense 8,100
D/E- office equipment 2,490
Insurance expense 1,910
Office supplies expense 610
Misc.admin.expense 760
Total administrative expense 34,890
Total operating expense
109,510
Income from operation
73,440

66 Principle accounting I Module Prepared By A.B | 2006 E.C

Debre Tabor University Department of Accounting & Finance

Other income
Interest income 3,800
Rent income 600
Total other income 4,400
Other expense
Interest expense 2,440 1,960
Net income
75,400

b. Single step form: - The single step form of income statement derives its name
from the fact that the total of all expenses is deducted from the total of all
revenue. The single step form has the advantage of being simple & it emphasizes
total revenue & total expenses as the factors that determine net income. An
objection to the single step form is that such relationships as gross profit to sales
& income from operations to sales are not as readily determinable as they are
when the multiple forms is used.
Cox Co.
Income Statement
For year ended December 31, 1990
Revenue
Net sales 708,255
Interest income 3,800
Rent income 600
Total revenue 712,655
Expense
Cost of merchandise sold 525,305
Selling expense 74,620
Administrative expense 34,890
Interest expense 2,440
Total expense 637,255
Net income 75,400

3.7. Closing entries of merchandise enterprise

Objective 7:- Prepare closing entries

The closing entries are recorded in the journal immediately following the adjusting
entries. Closing entries of merchandise enterprises

a. Entries to close revenue

Sales xx
Purchase return & allowance xx
Purchase discount xx
Other income xx

67 Principle accounting I Module Prepared By A.B | 2006 E.C

Debre Tabor University Department of Accounting & Finance

Income summary xx
b. Entries to close costs & expenses
Income summary xx
Sales return & allowance xx
Sales discount xx
Purchase xx
Transport in xx
Operating expenses
c. To close net income
Income summary xx
Retained earnings xx
d. To close dividend
Retained earnings xx
Dividend xx

Assessment
1. If merchandise purchased on account is returned, the buyer may inform the seller
of the details by issuing a(n):
A. Debit memorandum. C. Invoice.
B. Credit memorandum. D. Bill
2. If merchandise is sold on account to a customer for $1,000, terms FOB shipping
point, 1/10, n/30, and the seller prepays $50 in transportation costs, the amount
of the discount for early payment would be:
A. $0. C. $10.00.
B. $5.00. D. $10.50
3. The income statement in which the total of all expenses is deducted from the total
of all revenues is termed the:
A. Multiple-step form. C. Account form.
B. Single-step form. D. report form
4. On a multiple-step income statement, the excess of net sales over the cost of
merchandise sold is called:
A. Operating income. C. Gross profit.
B. Income from operations. D. Net income.
5. Which of the following expenses would normally be classified as other expense on
a multiple-step income statement?
A. Depreciation expense—office C. Insurance expense
equipment D. Interest expense
B. Sales salaries expense

Answer
68 Principle accounting I Module Prepared By A.B | 2006 E.C
Debre Tabor University Department of Accounting & Finance

1. A 4. C
2. C 5. D
3. B

CHAPTER FOUR
ACCOUNTING SYSTEM
Unit Description
Accounting systems used by large and small businesses employ the basic principles
of the accounting cycle discussed in the previous chapters. However, these
accounting systems include features that simplify the recording and summary
process. In this chapter, we will discuss these simplifying procedures as they apply to
both manual and computerized environments.
Unit Objective
At the end of this unit, students will be able to:-

 Define accounting system

 Describe Manual & Computerized accounting system
 Prepare Subsidiary ledger & controlling accounts
 Show Special journal

4.1. Basic Accounting Systems

Objective1:- Define Accounting system
69 Principle accounting I Module Prepared By A.B | 2006 E.C
Debre Tabor University Department of Accounting & Finance

An accounting system is the methods and procedures for collecting, classifying,

summarizing, and reporting a business’s financial and operating information. The
accounting system for most businesses, however, is more complex. Accounting
systems for large businesses must be able to collect, accumulate, and report many
types of transactions. Accounting systems evolve through a three-step process as a
business grows and changes. The first step in this process is analysis, which consists
of (1) identifying the needs of those who use the business’s financial information and
(2) determining how the system should provide this information. In the second step,
the system is designed so that it will meet the users’ needs. This system included a
chart of accounts, a two column journal, and a general ledger. Finally, the system is
implemented and used. The system was used to record transactions and prepare
financial statements.
Once a system has been implemented, feedback, or input, from the users of the
information can be used to analyze and improve the system. Internal controls and
information processing methods are essential in an accounting system. Internal
controls are the policies and procedures that protect assets from misuse, ensure that
business information is accurate, and ensure that laws and regulations are being
followed. We will discuss internal controls in more detail in the preceding Chapters.
Processing methods are the means by which the system collects, summarizes, and
reports accounting information. These methods may be either manual or
computerized.

Many large businesses continually review their accounting system & may constantly
be involved in changing same part of it. The job of installing or changing an
accounting system, either in its entirety or only in part, is made up of three phases

1. System analysis: - The goal of system analysis is to determine information

needs, the source of such information, & the deficiencies in procedures & data
processing method presently used. The analysis usually begins with a review of
the organization stricture & the job description of the personnel affected. This
review is followed by a study of the forms, records, procedures, processing
methods & reports used by the enterprise. The source of such information is
usually the firms systems manual.
2. System design: - accounting system are changed as a result of the kind of the
analysis previously described. The design of the new system may involve only
minor changes from the existing system. Such as revision of a particular form and
the related procedures & processing methods, or it may be a complete revision of
the entire system. System designers must have a general knowledge of the
qualities of different kinds of data processing equipment, and the ability to

70 Principle accounting I Module Prepared By A.B | 2006 E.C

Debre Tabor University Department of Accounting & Finance

evaluate alternatives. Although successful systems design depends to a large

extent upon the creativity, imagination, and general capabilities of the designer,
observance of the broad principles.
3. System implementation: - the final phase of the creation or revision of an
accounting system is to carry out or implement the proposals.

4.2. Manual Vs Computerized accounting system

Objective2:- Describe Manual & Computerized accounting system

4.2.1. Manual Accounting Systems

Accounting systems may be either manual or computerized. Understanding a manual
accounting system assists in recognizing the relationships between accounting data
and accounting reports. In addition, most computerized systems use principles used
in a manual system. in manual system first. all transactions were manually recorded
in all-purpose (two-column) journal. The journal entries were then posted individually
to the accounts in the ledger. Such manual accounting systems are simple to use
and easy to understand. Manually kept records may serve a business reasonably well
when the amount of data collected, stored, and used is relatively small. For a large
business, such manual processing is too costly and time consuming; thus, a
computerized system is preferred. For example, a large company such as
communication companies has millions of telephone fees earned on account with
millions of customers daily. Each telephone fee on account requires an entry debiting
Accounts Receivable and crediting Fees Earned. In addition, a record of each
customer’s receivable must be kept. Clearly, a simple manual system would not
serve the business needs of a business company. When a business has a large
number of similar transactions, using an all-purpose journal is inefficient and
impractical. In such cases, subsidiary ledgers and special journals are useful. As a
business becomes more complex, the manual system can be supplemented or
replaced by a computerized system.

4.2.2. Computerized Accounting Systems

Computerized accounting systems have become more widely used as the cost of
hardware and software has declined. In addition, computerized accounting systems
have three main advantages over manual systems. First, computerized systems
simplify the record-keeping process. Transactions are recorded in electronic forms
and, at the same time, posted electronically to general and subsidiary ledger
accounts. Second, computerized systems are generally more accurate than manual
systems. Third, computerized systems provide management current account balance

71 Principle accounting I Module Prepared By A.B | 2006 E.C

Debre Tabor University Department of Accounting & Finance

information to support decision making, since account balances are posted as the
transactions occur. How do computerized accounting systems work? Many
transactions must first be authorized. This means that the transaction is approved by
management before it is permitted. For example, most sales and purchase
transactions must first be authorized before they are permitted. Without this step,
sales may be made to customers that have insufficient credit, or purchases may be
made for items that are not needed. Most computerized accounting systems include
authorization steps in the software. Once authorized, the transaction can be
completed. The completed transaction must be recorded in the accounting system.
In computerized accounting systems, details of the specific transaction are input on a
computer screen.
The computer screen is often tailored to the specific transaction, much the way a
special journal is tailored to a specific transaction. Once the computer screen is
completed, the transaction is submitted into the computer system, often by the click
of a button. The submitted transaction updates information in a database. A
database collects, stores, and organizes information so it can be quickly retrieved.
Once transaction details have been submitted to the database, managers are able to
create reports from the database to answer questions about the business.

4.3. Subsidiary ledger & controlling accounts

Objective3:- Prepare Subsidiary ledger & controlling accounts

An accounting system should be designed to provide information on the amounts

due from various customers (accounts receivable) and amounts owed to various
creditors (accounts payable). A separate account for each customer and creditor
could be added to the ledger. However, as the number of customers and creditors
increases, the ledger becomes awkward to use when it includes many customers and
creditors. A large number of individual accounts with a common characteristic can be
grouped together in a separate ledger called a subsidiary ledger. The primary ledger,
which contains all of the balance sheet and income statement accounts, is then
called the general ledger. Each subsidiary ledger is represented in the general ledger
by a summarizing account, called a controlling account. The sum of the balances of
the accounts in a subsidiary ledger must equal the balance of the related controlling
account. Thus, you may think of a subsidiary ledger as a secondary ledger that
supports a controlling account in the general ledger.

The individual accounts with customers are arranged in alphabetical order in a

subsidiary ledger called the accounts receivable subsidiary ledger, or customer’s
ledger. The controlling account in the general ledger that summarizes the debits and
credits to the individual customer accounts is Accounts Receivable. The individual

72 Principle accounting I Module Prepared By A.B | 2006 E.C

Debre Tabor University Department of Accounting & Finance

accounts with creditors are arranged in alphabetical order in a subsidiary ledger

called the accounts payable subsidiary ledger, or creditor’s ledger. The related
controlling account in the general ledger is Accounts Payable.
4.4. SPECIAL JOURNALS
Objective4:- Show Special journal
One method of processing data more efficiently in a manual accounting system is to
expand the all-purpose two-column journal to a multicolumn journal. Each column in
a multicolumn journal is used only for recording transactions that affect a certain
account. For example, a special column could be used only for recording debits to
the cash account, and another special column could be used only for recording
credits to the cash account. The addition of the two special columns would eliminate
the writing of Cash in the journal for every receipt and every payment of cash. Also,
there would be no need to post each individual debit and credit to the cash account.
Instead, the Cash Dr. and Cash Cr. columns could be totaled periodically and only the
totals posted. In a similar way, special columns could be added for recording credits
to Fees Earned, debits and credits to Accounts Receivable and Accounts Payable, and
for other entries that are often repeated. An all-purpose multicolumn journal may be
adequate for a small business that has many transactions of a similar nature.
However, a journal that has many columns for recording many different types of
transactions is impractical for larger businesses. The next logical extension of the
accounting system is to replace the single multicolumn journal with several special
journals. Each special journal is designed to be used for recording a single kind of
transaction that occurs frequently. For example, since most businesses have many
transactions in which cash is paid out, they will likely use a special journal for
recording cash payments. Likewise, they will use another special journal for
recording cash receipts. Special journals are a method of summarizing transactions,
which is a basic feature of any accounting system.
The format and number of special journals that a business uses depends upon the
nature of the business. A business that gives credit might use a special journal
designed for recording only revenue from services provided on credit. On the other
hand, a business that does not give credit would have no need for such a journal. In
other cases, record-keeping costs may be reduced by using supporting documents as
special journals. The transactions that occur most often in a small- to medium-size
service business and the special journals in which they are recorded are as follows:
 Providing services on account recorded in Revenue journal
 Receipt of cash from any source recorded in Cash receipts journal
 Purchase of items on account recorded in Purchases journal
 Payment of cash for any purpose recorded in Cash payments journal

73 Principle accounting I Module Prepared By A.B | 2006 E.C

Debre Tabor University Department of Accounting & Finance

Revenue (Sales) Journal: - The revenue journal is used only for recording fees
earned on account. Cash fees earned would be recorded in the cash receipts journal.
The sale of products is recorded in a sales journal, which is similar to a revenue
journal.
Revenue (Sales) journal
Date Invoice Account debited Post Account
no reference receivable
debited sales
credited

Cash Receipts Journal: - All transactions that involve the receipt of cash are
recorded in a cash receipts journal. Thus, the cash receipts journal has a column
entitled Cash. All transactions recorded in the cash receipts journal will involve an
entry in the Cash Dr. Column. The kinds of transactions in which cash is received
and how often they occur determine the titles of the other columns.
Cash receipt journal
Date Accoun P Account Sales Account Sales Cash
t / s credited receiva discoun debite
credite R credited ble t d
d credited debited

Purchases Journal: - The purchases journal is designed for recording all

purchases on account. Cash purchases would be recorded in the cash payments
journal. The purchases journal has a column entitled Accounts Payable Cr. The
purchases journal also has special columns for recording debits to the accounts most
often affected.
Purchase Journal
Dat Account P/ Account Purcha Supplie Other Accounts
e credited R s se s debited
payable debited debited Accou P Amoun
credit nt / t
R

Cash Payments Journal: - The special columns for the cash payments journal are
determined in the same manner as for the revenue, cash receipts, and purchases
journals. The determining factors are the kinds of transactions to be recorded and
74 Principle accounting I Module Prepared By A.B | 2006 E.C
Debre Tabor University Department of Accounting & Finance

how often they occur. The cash payments journal has a Cash Cr. column; all
transactions recorded in the cash payments journal will involve an entry in this
column. Payments to creditors on account happen often enough to require an
Accounts Payable Dr. column. Debits to creditor accounts for invoices paid, often
called bills, are recorded in the Accounts Payable Dr. column.
Cash payment journal
Dat CK. Account P Other Account Purchas Cash
e NO debited / accounts payable e debit
R debited debited discount ed
s
credited

Assessment
1. The initial step in the process of developing an accounting system is called:
A. Analysis C. implementation
B. Design. D. Feedback.
2. The policies and procedures used by management to protect assets from misuse,
ensure accurate business information, and ensure compliance with laws and
regulations are called:
A. Internal controls. C. Systems design.
B. Systems analysis. D. Systems implementation.
3. A payment of cash for the purchase of services should be recorded in the:
A. Purchases journal. C. Revenue journal.
B. Cash payments journal. D. cash receipts journal
4. When there are a large number of individual accounts with a common
characteristic, it is common to place them in a separate ledger called a(n):
A. Subsidiary ledger. C. Accounts payable ledger.
B. Creditor’s ledger. D. Accounts receivable ledger.
5. Which of the following would be used in a computerized accounting
system?
A. Special journals
B. Accounts receivable control accounts
C. Electronic invoice form
D. Month-end postings to the general ledger
Answer

1. A 4. A
2. A 5. C
3. B
75 Principle accounting I Module Prepared By A.B | 2006 E.C
Debre Tabor University Department of Accounting & Finance

CHAPTER FIVE
CASH
Unit Description
In this chapter the qualities of a properly designed accounting system & the principle
of internal control for directing operations were discussed. It also presents the
application of these internal control principles to the design of an effective system
for controlling cash & the accounting for cash transactions.

Unit objectives
At the end of this unit, students will be able to:-
 Describe control over cash
 Illustrate internal control on cash receipt (bank reconciliation statement)
 Illustrate internal control of cash payment (petty cash)
 Show the accounting for petty cash
5.1. Control over Cash
Objective1:- Describe control over cash
Why we need control over cash? Cash is the asset most likely to be diverted & used
improperly by employees. Many transactions either directly or indirectly affect cash.
Therefore, cash is effectively safeguarded by special controls. One of the major
devices for maintaining control over cash is the bank account. To get the most

76 Principle accounting I Module Prepared By A.B | 2006 E.C

Debre Tabor University Department of Accounting & Finance

benefit from a bank account all cash received must be deposited in the bank and all
payments must be made by checks drawn. It allows double records of cash.
 by the business &
 by the bank
Compensating balance: - the minimum cash balance that a bank may require
maintaining in a bank account which is stated in the loan agreement. The forms used
by a business in connection with a bank account are:-
1) Signature card: - a card that must be signed by each person authorized to sign
checks drawn on the account. The card is used by the bank to determine the
authenticity of the signature or checks presents to it for payment.
2) Deposit Tickets: - the details of a deposit are listed by the depositor on a printed
form supplied by the bank.
3) Check: - a written instrument signed by the depositor, ordering the bank to pay a
certain sum of money to the order of the designated person. There are three
parties to a check, these are:-
a. Drawer:- The one who signs the check (order the bank)
b. Drawee:- The bank on which the check is drawn
c. Payee:- The one to whose order the check is drawn
When checks are issued to pay bills, they are recorded as credit to cash on the day
issued, even though; they are not presented to the bank until some later time. When
checks are received from customers, they are recorded as debits to cash on the
assumptions that the customer has enough money on deposit
Note:-
 Checks may be obtained in many style
 The name addresses of depositor are printed on each check.
 Checks are numbered in sequential to facilitate the depositor internal control.
 Internal control means the detailed procedures adopted by an enterprise to
control its operation.
Checks issued to a creditor on account are usually accompanied by a notification of
the specific invoice that is being paid called remittance advice. Their purpose is to
make sure that proper credit is recorded in the account of creditor.
Activity
Why is cash the asset that often warrants the most attention in the design of an
effective internal control structure?
…………………………………………………………………………………………………………………
…………………………………………………………………………………………………………………
…………………………………………………………
Distinguish between the drawer and payees of a check

77 Principle accounting I Module Prepared By A.B | 2006 E.C

Debre Tabor University Department of Accounting & Finance

…………………………………………………………………………………………………………………
…………………………………………………………………………………………………………………
……………………
What name is often given to the notification attached to a check that indicates the
specific invoice that is being paid?
…………………………………………………………………………………………………………………
……………………………………………………………………………………………
5.1.1. Bank Statement
Banks usually maintain an original & a copy of all checking account transactions,
when this is done the original becomes the statement of the account that is mailed
to the depositors usually once each month. The bank statement shows;-
 The beginning balance
 Checks & other debits (Deductions) by the bank)
 Deposits & other credits (Additions by the bank)
 Balance at the end of the period
The bank may have debited the account for service charges or for deposited checks
returned because of insufficient funds.

Activity
Do items reported on the bank statement as debits represent (a) additions made by
the bank to the depositors balance, or (b) deductions made by the bank from the
depositor’s record?
…………………………………………………………………………………………………………………
…………………………………………………………………………………………………………………
…………………………………………………………………………………
5.1.2. Bank Reconciliation
When all cash receipts are deposited in the bank & all payments are made by check,
the cash account is often called cash in bank. It is an asset for the depositor & a
liability for the bank. Therefore, it requires two ledgers depositor & bank ledger. The
two balances should be equal, but they are not likely to be equal on any specific date
because,
 Delay by either parties in recording the transaction (a time lag)
 Errors by either party in recording transaction
Delay in recording
It is the time lag of one day or more between the date a check is written & the date
that is presented to the bank for payment (depositor side). The bank may debit/
credit the depositors account for transactions about which the depositor will not be
informed until latter.

78 Principle accounting I Module Prepared By A.B | 2006 E.C

Debre Tabor University Department of Accounting & Finance

To correct the above errors the depositors own records should be reconciled with the
bank statement. The bank statement is divided in to two sections
(1)Balances according to bank statement
(2)Balances according to depositors ledger
Importance of bank reconciliation
 It is a means of comparing recorded cash on depositor record & bank
statement.
 It provides for finding & correcting errors & irregularities.
Procedure used in finding the reconciling items
 Deposits not recorded by the bank are added to the balance according to the
bank statement. (Checking individual deposit listed on the bank statement with
recorded deposit).
 Checks issues that have not been paid by the bank are outstanding & deducted
from the balances according to the bank statement.
 Credit memorandum not recorded in the cash receipts journal are added to the
balance according to the depositors record.
 Debit memorandums not recorded in the cash receipt journals are deducted
from the balances according to depositor’s record.
 If the amount for which a check was written had been recorded erroneously by
the depositor, the amount of error should be added to or deducted from the
balances according to the depositor’s record.
 Errors by the bank should be added to or deducted from the balances
according to the bank statement.
Activity
What is the purpose of preparing bank reconciliation?
…………………………………………………………………………………………………………………
…………………………………………………………………………………………………………………
…………………………………………………………………………………
Describe the term not sufficient fund (NSF)? & what entry should be made if a check
received from a customer and deposited is returned by the bank for lack of sufficient
fund?
…………………………………………………………………………………………………………………
…………………………………………………………………………………………………………………
………………………………………………………………………………
Illustration
1. The bank statement for XYZ company indicates a balance of birr 3,359.78 as of
July 31,2005
2. The balances of cash in bank in XYZ company ledger as of the same date is birr
2,234.99

79 Principle accounting I Module Prepared By A.B | 2006 E.C

Debre Tabor University Department of Accounting & Finance

3. Deposit of July 31 not recorded on July 31 not recorded on bank statement birr
816.20
4. Checks outstanding no 813 birr 1,061 no 878 birr 435.39 no 883 birr 48.60
5. Note plus interest of birr 8 collected by bank (Credit memorandum) not recorded
in cash receipts Journal birr 408
6. Bank service charges (Debt memo) not recorded in cash payment journal birr 300
7. Check no 879 for birr 732.26 to ABC trading on account, recorded in cash
payment journal as birr 723.26
XYZ Company
Bank Reconciliation
July 31, 1990
Balance per bank statement…………………………………………………………3,359.78
Add: - Deposit of July 31, not recorded by bank…………………………………816.20

4,175.98
Deduct: - Outstanding checks
CK No 812 1,061.00
CK No 878 435.39
CK No 883 48.60
1,544.99
Adjusted balance
2,630.99
Balance per depositor record
2,234.99
Add: - note & interest collected by bank
408.00
Deduct:- Bank service charges 3.00
Errors in recording CK No 879 9.00 (12.00)
Adjusted balance
2,630.99
Entries Based on Bank reconciliation
Cash in bank 408
Note receivable 400
Interest Income 8
(To record note collected by bank)
Miscellaneous Administration expense 3
Account payable 9
Cash in bank 12
(To record bank service charge & errors in recording check number)
5.2. Internal control of cash receipt
80 Principle accounting I Module Prepared By A.B | 2006 E.C
Debre Tabor University Department of Accounting & Finance

Objective2:- Illustrate internal control over cash receipt

Sources of cash receipt may be from cash customers or charged customers making
payment on account. The amount of cash actually received during a day often does
not agree with the record of cash receipts & no error can be found in the record. It
must be recorded in cash short & over account.
Example: - The actual cash received from on account sale amounted 4,577.60. But
the cash register shows birr 4,580.76. To record this
Cash in bank 4,577.60
Cash short & over 3.16
Sales 4,580.76
If there is a debit balance in the cash short & over account, at the end of the period it
is an expense “Miscellaneous & administrative expense”. If there is a credit
balance, it is revenue & may be listed in the “Other income” section. If the amount
is larger the management of the business should take corrective action.
Activity
In which section of the income statement would a credit balance in cash short & over
be reported?
…………………………………………………………………………………………………………………
……………………………………………………………………………………………
5.3. Internal control of cash payment
Objective3:- Illustrate internal control over cash payment
Every payment of cash is evidenced by a check signed by a designed official. In
enterprises of even moderate size several departments have their own
responsibilities (issuing purchase order, inspecting goods received). In order to
integrate related activities one of the best systems used for this purpose is the
voucher system.
5.3.1. Basic feature of the voucher system
Voucher system is made up of records, method & procedures used in providing &
recording liabilities & payment a voucher system uses:-
Vouchers: - any document that serves as proof of authority to pay cash or it is a
special form on which is recorded relevant data about a liability & the details of its
payment.
Voucher register: - after approval by the designed official, each voucher is
recorded in a journal known as voucher register.

81 Principle accounting I Module Prepared By A.B | 2006 E.C

Debre Tabor University Department of Accounting & Finance

Unpaid voucher file:- after a voucher has been recorded in the voucher register; it
is filed in unpaid voucher file, where it remains until it is paid.
Paid voucher file:- after payment voucher are usually filled in a numerical order in
voucher file,
Check register: - the payment of a voucher is recorded in a check register. it is a
complete record of all checks.

5.4. Petty cash

Objective3:- Show the accounting for petty cash
In most business there is a frequent need for the payment of relatively small
amounts such as postage due, transportation charges & urgently needed supplies.
Payment by check in such a cases would result in delay, announce & exclusive
expense of maintaining the records. This may be done by maintaining a special cash
fund called petty cash.
In establishing a petty cash fund estimate the amount of cash needed for
disbursement of relatively small amounts for a certain period (a month, weak).
To record the amount in the voucher register as:-
Petty cash XX
Account payable XX
To record the amount in the voucher register as:-
Account payable XX
Cash in bank XX
Example: - assume that a voucher system is used and that a petty cash fund of birr
100 is established on August 1 to record this:-
August 1 Petty cash 100
Account payable 100
(Voucher register)
August 1 Account payable 100
Cash in bank 100
(Check register)
Disbursements are not recorded in the account until the fund is replenished, to
replenish this expenditure should be debited & account payable credited.
Example: - at the end of August, the petty cash receipts indicates expenditures for
the following items
 office supplies 28
 postage (office supplies) 22
 store supplies 35

82 Principle accounting I Module Prepared By A.B | 2006 E.C

Debre Tabor University Department of Accounting & Finance

 miscellaneous admin expense 3.70

To record this
August 31 Office supplies 50.00
Store supplies 35.00
Mis/admin/expense 3.7
Account payable 88.70
(Voucher register)

August 31 Account payable 88.70

Cash in bank 88.70
(Check register)
Activity
What is meant by the term voucher as applied to the voucher system?
…………………………………………………………………………………………………………………
…………………………………………………………………………………………………………………
………………………………………………………………………………
Before a voucher for the purchase of merchandise is approved for payment, three
documents should be compared to verify the accuracy of liability name these three
documents?
…………………………………………………………………………………………………………………
…………………………………………………………………………………………………………………
………………………………………………………………………………
Assessment
Which of the following is not an element of internal control?
A. Control environment C. Compliance with laws and
B. Monitoring regulations
D. Control procedures
2. The bank erroneously charged Tropical Services’ account for $450.50 for a check
that was correctly written and recorded by Tropical Services as $540.50. To reconcile
the bank account of Tropical Services at the end of the month, you would:
A. Add $90 to the cash balance according to the bank statement.
B. Add $90 to the cash balance according to Tropical Services’ records.
C. Deduct $90 from the cash balance according to the bank statement.
D. Deduct $90 from the cash balance according to Tropical Services’ records.
3. In preparing bank reconciliation, the amount of checks outstanding would be:
A. Added to the cash balance according to the bank
B. Deducted from the cash balance according to the bank statement.
C. Added to the cash balance according to the company’s records.
D. Deducted from the cash balance according to the company’s records.
4. Journal entries based on the bank reconciliation are required for:
A. Additions to the cash balance according to the company’s records.
B. Deductions from the cash balance according to the company’s records.
C. Both A and B.
83 Principle accounting I Module Prepared By A.B | 2006 E.C
Debre Tabor University Department of Accounting & Finance

D. Neither A nor B.
5. A petty cash fund is:
A. Used to pay relatively small amounts.
B. Established by estimating the amount of cash needed for disbursements of
relatively small amounts during a specified period.
C. Reimbursed when the amount of money in the fund is reduced to a
predetermined minimum amount.
D. All of the above.

Answer
1. C 4. C
2. C 5. D
3. B

84 Principle accounting I Module Prepared By A.B | 2006 E.C

Debre Tabor University Department of Accounting & Finance

CHAPTER SIX
ACCOUNT RECEIVABLE
Unit Description
In this chapter the revenue from sales on credit basis accounted, control over
receivables, characteristics of receivable methods of accounting for uncollectable
were briefly explained & illustrated.

Unit Objectives
At the end of this unit, students will be able to:-
 Describe classification of receivables
 Compute determination of due date & interest of the note
 Illustrate accounting for not receivable
 Show accounting for uncollectable
6.1. Classification of receivables
Objective1:- Describe classification of receivables
The term receivables include all money claims against peoples, organizations or
other debtors. Receivables are acquired by a business in various kinds of
transactions the most common being the sale of merchandise or service on a credit
basis. For most business the principal receivable are accounts receivable & note
receivable. Receivables can be classified as:-
 Note receivable
 Trade (account) receivable
 Interest receivable
 Loan to employees
 Loan to affiliated companies
For most business the principal receivables are account receivable & note receivable.
Note Receivable & Account Receivable
Note Receivable (promissory Account Receivable (Open
note) account)
Formal instrument of credit Less formal
A written promise to pay a sum of No written promise
money on demand or at a definite

85 Principle accounting I Module Prepared By A.B | 2006 E.C

Debre Tabor University Department of Accounting & Finance

time.
Usually used for credit periods of Used for less than 60 days
more than 60 days
A strong legal claim in the court There is no strong legal claim in court
action action
N.B. A general account ledger should be maintained for each type of receivable with
subsidiary ledger.

Activity

What are the advantages to the creditor of a note receivable in comparison to

an account receivable?

………………………………………………………………………………………………………
………………………………………………………………………………………………………
……………………………………………

In what section of the balance sheet should a note receivable be listed if its
term is (a) 60 days (b) 3 years?

………………………………………………………………………………………………………
………………………………………………………………………………………

Control over Receivable

Control over receivable includes:-
1. Separation of business operation & the accounting for receivables (division of
work). Employee who handles receivables should separate from credit approvals
or collection of receivables.
2. Separation of responsibility for related functions it helps to cross check activities.

Activity
The account receivable clerk is also responsible for handling cash receipts, which
principle of internal control is violated in this situation?
…………………………………………………………………………………………………………………
…………………………………………………………………………………………………………………
………………………

Parties Participated in Note Receivable are:-

Payee: - The one to whose order the note is payable (Creditor)
Maker: - The one making the promise (Debtor)

86 Principle accounting I Module Prepared By A.B | 2006 E.C

Debre Tabor University Department of Accounting & Finance

6.2. Characteristics of Note Receivable

Objective2:- Compute determination of due date & interest of the note
1. Due date:-
- The date a note is to be paid.
- It is also called maturity date.
- The period of time between the issuance date and the due date of a short-
term note may be stated in either day/month.

Example: - The due date of 90 day note receivable amounted 2500 started on
march 16 is determined as:-

Term of the note 90

March (days) 31
Date of note 16 15
No of days remaining 75
April (days) 30
No of days remaining 45
May (days) 31
No of days remaining 14
June (due date) (14)
2. Interest: - money paid for the use of money lent, a reward for saving or payment
made for the use of person money. Based on interest note receivable can be
categorized as:-
A. Interest Bearing: - the note that provides for the payment of interest for the
period between the issuance date & due date.
B. Non- interest bearing: - if a note makes to no provision for interest.

Interest is computed as:-

I=PRT
where, I= interest, P=principal, R= rate & T= time

Example: - a note amounted 2,500, 90 day 10% interest is computed as

Given: - P= 2,500 R= 10% T= 90 day

I=PRT

= 2,500 X 10/100 X 90/360 = 62.50

87 Principle accounting I Module Prepared By A.B | 2006 E.C

Debre Tabor University Department of Accounting & Finance

3. Maturity date: - The amount that is due at the maturity or due date. The
maturity value of a non- interest bearing note is the face amount.
Maturity value = Principal + Interest
MV = P + I
= P + 1 (PRT)

Based on the above example maturity date of the note is computed as:-
MV= P + I Or P + 1 (PRT)
= 2,500 + 1(2,500 X10/100 X90/360)
= 2,500 + 62.50
= 2,562.50
Activity 1
Based on the following data determine due date, interest & maturity value

Date of Face Term of Interest Due Interest Maturit

note amou note rate date y value
nt
April 5 5,000 60 days 9%
May 20 8,000 90 days 11%
June 30 10,000 75 days 12%
August 9 3,000 120 days 10%
October 11 7,500 60 days 12%

Account receivable xx
(To record non-interest bearing note)
Example: - assume the account of XYZ enterprise, which has a balance of $ 9,200, is
past due, a 90 day non-interest bearing note for the amount, dated may 16, 1990

May 16 Note receivable 9,200

Account receivable 9,200
When the 9,200 due on the note is collected, the following entry would be recorded
in the cash receipt journal.

Aug 14 Cash 9,200

Note receivable 9,200
When the note is collected with interest, the entry to be recorded as:
Cash 9,384
Note receivable 9,200
Interest income 184
6.3.1. Interest bearing note receivable

88 Principle accounting I Module Prepared By A.B | 2006 E.C

Debre Tabor University Department of Accounting & Finance

If the note received from a customer on account is interest bearing, interest must be
recorded as appropriate.
Example: - assume that a 30 day, 12%, note dated Dec 21, 1990 is accepted in
settlement of the account of ABC co. which has a balance of birr 6,000. The entry to
record transaction,
Dec 21 Note receivable 6,000
Account receivable 6,000
(Received 30 day, 12% note)
An adjusting entry would be recorded for the accrual of the interest from Dec 21 to
31
I = PRT = 6,000 x 12/100 x 10/360 = 20
Dec 21 Interest receivable 20
Interest income 20
Interest receivable is reported on balance sheet as current asset and interest income
as other income in balance sheet. At the time the note matures & payment is
received the entry to be recorded as:-
Jan 20 Cash 6,060
Note receivable 6,000
Interest income 60
6.3.2. Discounting note receivable
A company in need of cash may transfer its notes receivable to a bank by
endorsement. The discount (interest) changed by the bank is computed on the
maturity value of the note for the period of time the bank must hold the note,
namely the time that will pass between the date of the transfer and the due date of
the note. The amount of the proceeds paid to the endorser is the excess of the
maturity value over the discount.
Example: - assume that a 90 day, 12% note receivable for birr 1,800, dated Nov.8 is
discounted at the payee’s bank on Dec 3 at the rate of 14%
Face value of the note dated Nov 8 1,800.00
Interest on note 90 days at 12% 54.00
Maturity value of note due Feb 6 1,854.00
Discount period (Dec 3 – Feb 6) 65 days
Discount on maturity value 65 days at 14% 46.87
Proceed 1,807.13
Dec 3:- Journal entry to record the above event

Cash 1,807.13
Note receivable 1,800
Interest income 7.13

89 Principle accounting I Module Prepared By A.B | 2006 E.C

Debre Tabor University Department of Accounting & Finance

The proceeds from discounting a note receivable may be less than face value. When
this situation occurs, the excess of the face value over the proceeds is recorded as
interest expense. Factors that affect the difference between proceed & face values
are:-
- The difference between interest rate and discount rate
- The full term of note & the length of the discount period
The endorser of a note is committed to pay the note legally required if the maker
should default and the amount is considered to be contingent liability. If the
maker pays the promised amount at maturity contingent liability is removed without
any action in the part of the endorser.

6.3.3. Dishonored note receivable

If the maker of the note fails to pay the debt on the due date, the note is said to be
dishonored. In this case, the note is no longer negotiable and the holder transfers
the claim including any interest due to account receivable account. To record a 30
day 12% note face value amounted 6,000
Account receivable 6,060
Note receivable 6,000
Interest income 60
(Dishonored note & interest)
If there had been some assurance that the maker would pay the note with in a
relatively short time action would have been delayed until the matter was solved.
When a discounted note receivable is dishonored the holder usually notifies the
endorser of such fact and asks for payment the endorser is legally responsible to pay
the amount due on the note.
Example: - assume that the 1,800, 90 day 12% note discounted on Dec 3 is
dishonored at maturity by the maker. The entry to record the payment by the
endorser as:
Feb 6 Account receivable 1,854
Cash 1,854
The holder of dishonored note gives the endorser a notarized statement of the fact of
the dishonor. The fee for this statement known as a protest fee is charged to the
endorser. Who can in turn charge is to the maker of the note,

6.4. Uncollectable Receivable

Objective4:- Show accounting for uncollectable
When merchandise or services are sold without the immediate receipt of cash a part
of the claims against customers usually proves to be uncollectable. The fact that a
debtor fails to pay on account according to a sale contract or dishonors a note on the

90 Principle accounting I Module Prepared By A.B | 2006 E.C

Debre Tabor University Department of Accounting & Finance

due date does not necessary mean that the account will be uncollectable. Factors to
determine uncollectable are:-
- Bankruptcy of debtor
- closing of the debtor’s business
- disappearance of the debtor
- failure of repeated attempts to collect
- barring of collection by the statute of limitations
6.4.1. Methods of Uncollectable receivable
There are two methods of accounting for uncollectable receivable that are believed
to be uncollectable
1. Allowance (reserve) method: - it is a method based on careful study estimate
uncollectable. The estimate of uncollectable based on past experience & forecasts
of future business activities from sale & analysis of receivable.
Example: - based on past experience ABC trading estimates birr 3,000 is
uncollectable from the total receivable amount of birr 105,000 at the end of
accounting period the adjusting entry to record is:-
Uncollectable account expense 3,000
Allowance for doubtful account 3,000
When an account is believed to be uncollectable it is written off the allowance
account as:-
Allowance for doubtful account xx
Account receivable xx
When the amount is collected the above entry is reversed
Account receivable xx
Allowance for account receivable xx
2. Direct write-off method: - This method suggests uncollectable should be
recorded when it is certain. The entry to write off an account when it is believed to
be uncollectable

Uncollectable account expense xx

Account receivable xx
Assessment
1. At the end of the fiscal year, before the accounts are adjusted, Accounts
Receivable has a balance of $200,000 and Allowance for Doubtful Accounts has a
credit balance of $2,500. If the estimate of uncollectible accounts determined by
aging the receivables is $8,500, the amount of bad debt expense is:
A. $2,500.. C. $8,500
B. $6,000. D. $11,000.
2. At the end of the fiscal year, Accounts Receivable has a balance of $100,000 and
Allowance for Doubtful Accounts has a balance of $7,000. The expected net
realizable value of the accounts receivable is:
91 Principle accounting I Module Prepared By A.B | 2006 E.C
Debre Tabor University Department of Accounting & Finance

A. $7,000. C. $100,000.
B. $93,000. D. $107,000.
3. What is the maturity value of a 90-day, 12% note for $10,000?
A. $8,800 C. $10,300
B. $10,000 D. $11,200
4. What is the due date of a $12,000, 90-day, 8% note receivable dated August 5?
A. October 31 C. November 3
B. November 2 D. November 4
5. When a note receivable is dishonored, Accounts Receivable is debited for what
amount?
A. The face value of the note
B. The maturity value of the note
C. The maturity value of the note less accrued interest
D. The maturity value of the note plus accrued interest

Answer
1. B 4. C
2. B 5. B
3. C

Reference

 Fees & warren, Accounting Principles,16 th edition, South Western Publishing Company
 Smith, Keith & Stephens, Accounting Principles, 3 rd edition and above McGraw Book
company, 1989 and beyond.
 Herman son, Edwards & Salmon son, Accounting Principles, 4 th edition Richard D. Inc
1989.
 Larson, Kermit D, Fundamental Accounting Principles 12 th edition and above R. Irwin
Inc. 1990 and beyond.
 Meigs Walter B, Accounting the basis for business decision 6 th edition and McGraw-Hill
international book company, 1984 & beyond.

92 Principle accounting I Module Prepared By A.B | 2006 E.C

Debre Tabor University Department of Accounting & Finance

 Niswonger & Fees, Accounting Principles, South Western Publishing Company 13 th

edition.
 Carl S. Warren, James M. Reeve, Jonathan E. Duchac Accounting principle South
Western Publishing Company 22th edition,
 Slater, Collage Accounting a practical approach, 2004 prentice hall business
publishing 9th edition.

93 Principle accounting I Module Prepared By A.B | 2006 E.C