CHAPTER THREE

INTRODUCTION -

In the previous units we were recording effects of

business transactions using the accounting equation
format. This, however, is not cost- and time-effective
when an organization has large volume of
transactions to process several asset, liability, capital,
revenue and expense items.
 The
The purpose
purpose of of this
this
chapter
chapter is
is to
to review
review thethe
basic
basic steps
steps of
of the
the
accounting
accounting process.
process.
 Learning Objectives

1. Identify and explain the basic steps in the accounting process

(accounting cycle).

2. Analyze and Journalize transactions

3. Summarize transactions by posting to accounts in the ledger.

4. Prepare adjusting entries

5. Produce financial statements, and

6. Close nominal accounts and prepare post-closing trial balance

 Basic Accounting Records
Account – refers to the basic storage unit for accounting data used to
There are classify transactions in terms of their effects on specific asset, liability,
three basic capital, revenue and expense items.
accounting
Ledger - refers to a kind of folder/ring binder used to arrange and put in
records
one place all accounts used by a business
organizations
use in Journal: - also called the book of original entry, refers to a business
transforming document where effects of business transactions on specific elements of
business the financial statements are recorded in or copied from source documents
transactions chronologically (i.e. in order of their occurrence) based on the rules of
into useful debits and credits and the double-entry accounting system.
accounting
information
 Nature and Classification of Accounts

Definition - an account is the basic storage unit for accounting data. It is

used to classify transactions in terms of their effects on specific asset,
liability, capital, revenue and expense items. Thus, a separate account is
kept to record and accumulate/store monetary effects of transactions on
such specific items that appear on the financial statements as Cash,
Supplies, Accounts Payable, Bank Loan Payable, Capital, Fees Earned,
Rent Income, Salary Expense and Supplies Expense.
 Classification of Accounts -
• ACCOUNTS MAY BE CLASSIFIED INTO TWO MAJOR ROOT
CATEGORIES: BALANCE SHEET AND INCOME STATEMENT ACCOUNTS.

1. BALANCE SHEET ACCOUNTS - REFER TO ACCOUNTS THAT APPEAR

ON THE BALANCE SHEET

 ASSETS (CURRENT VS NON-CURRENT)

 LIABILITIES(CURRENT VS NON-CURRENT)

 OWNERS’ EQUITY

2. INCOME STATEMENT ACCOUNTS - REFER TO ACCOUNTS THAT

APPEAR ON THE INCOME STATEMENT

 REVENUES

 EXPENSE
 Rules of Debit and Credit -

are conventions/principles for recording increases and decreases

in an account.

Normal Balance side

An Increase side

A decrease side
 Chart of Accounts

Refers to the list of the titles and related identification numbers of all accounts a
business uses for recording its financial affairs

The number of accounts to be maintained and the numbering system to be used

depends upon the nature and size of a business

For instance, numbers “1”, “1” and “2” in the account number 112 for Accounts
Receivable may indicate that Accounts Receivable is an asset account, its subdivision
within the asset group is current and lies in the second position within current assets
subdivision, respectively.
 Account
Number Name
Balance Sheet Accounts
100 Asset
111 Cash
112 Accounts Receivable
121 Buildings
200 Liability
211 Accounts Payable
221 Mortgage Notes Payable
300 Owner’s Equity
301 Alemu, Capital
302 Alemu, Drawing
303 Income Summary
Income Statement Accounts
400 Revenue
401 Fees Earned
402 Interest Income
500 Expense
501 Salary Expense
502 Utility Expense
 Ledger

Ledger refers to a kind of folder/ring binder

used to arrange and put in one place all
accounts used by a business. Accounts are
placed in the ledger in sequence and each
account may take one or more pages of the
ledger
 Journals
• JOURNAL, ALSO CALLED THE BOOK OF ORIGINAL ENTRY,

REFERS TO A BUSINESS DOCUMENT WHERE EFFECTS OF BUSINESS

TRANSACTIONS ON SPECIFIC ELEMENTS OF THE FINANCIAL

STATEMENTS ARE RECORDED IN OR COPIED FROM SOURCE

DOCUMENTS

• TRANSACTIONS ARE RECORDED IN THE JOURNAL

CHRONOLOGICALLY (I.E. IN ORDER OF THEIR OCCURRENCE)

BASED ON THE RULES OF DEBITS AND CREDITS AND THE

DOUBLE-ENTRY ACCOUNTING SYSTEM.

• DOUBLE-ENTRY ACCOUNTING REFERS TO THE SYSTEM OF

RECORDING THE DUAL, CALLED DEBIT AND CREDIT, EFFECTS OF

BUSINESS TRANSACTIONS.
 Double-Entry Accounting

A system of recording transactions in

a way that maintains the equality of
the accounting equation.

Assets = Liabilities + Owners’ Equity

or

A = L + OE
 Double-Entry Accounting Facts
 For every transaction, there must be at

least one debit and one credit.

 Debits must always equal credits for each

transaction.

 Debits are always entered on the left side

of an account and credits are always

entered on the right side.
 The Accounting Cycle

The accounting cycle is a series of steps

done in each accounting period to keep
records in an orderly fashion to help
accountants prepare financial
statements for an entity for a specific
period of time.
 The Steps In The
Accounting Cycle
1. Analyze source documents & record business transactions in a
journal
2. Post journal entries to the ledger accounts
3. Prepare unadjusted trial balance (TB)
4. Journalize and post end of period adjustments (EOPA)
5. Prepare adjusted Trial Balance
6. Prepare /Create financial statements
7. Prepare the post-closing trial balance
1. ANALYZE SOURCE DOCUMENTS & RECORD
BUSINESS TRANSACTIONS IN A JOURNAL

Step 1 Step 2 Step 3

Collect and Journalize

verify source Analyze each each
documents. transaction. transaction.
 Commonly Used Source Documents
source document
A paper prepared as the evidence that a transaction occurred.
Invoice
A source document that lists the quantity, description, unit
price, and total cost of the items sold and shipped to a buyer.
receipt
A source document that serves as a record of cash received.
memorandum
A brief written message that describes a transaction that
takes place within a business.

check stub
A source document that lists the same information that
appears on a check and shows the balance in the checking account before
and after each check is written.
 ANALYZE TRANSACTION.

THE ACCOUNTING CYCLE BEGINS WITH THE ANALYSIS OF

TRANSACTIONS. THE PROPER ANALYSIS OF
BUSINESS TRANSACTIONS IS IMPORTANT BECAUSE IT ENSURES
THAT ENTRIES IN THE JOURNAL ARE CORRECT.
• Determine the debit and credit portions of each transaction by analyzing the source
document.
• In the real world, you must examine this document to determine what happened in
a business transaction.
 THE ACCOUNTING CYCLE
• JOURNAL ;-A CHRONOLOGICAL RECORD OF THE TRANSACTIONS OF A BUSINESS.

• JOURNALIZING;- THE PROCESS OF RECORDING BUSINESS TRANSACTIONS IN

JOURNALS.

• POSTING REFERS TO THE PROCESS TRANSFERRING MONETARY AMOUNTS OF

DEBIT AND CREDIT ENTRIES FROM THE GENERAL JOURNAL TO THE ACCOUNTS
IN THE LEDGER WHICH ARE AFFECTED BY THE DEBIT AND CREDIT ENTRIES.

• THE PURPOSE IS TO CLASSIFY AND SUMMARIZE TRANSACTIONS AND EVENTS

AFFECTING SPECIFIC ELEMENTS OF THE FINANCIAL STATEMENTS AND
DETERMINE ACCOUNT BALANCE.
 Journalizing

Two Columns of the General Journal

Two Columns of the General Journal

The left column for The right column for

recording debits recording credits

general journal
An all-purpose journal in which all the transactions of a business may
be recorded.
 RECORDING A GENERAL
JOURNAL ENTRY

Seven steps to determining each journal entry

Identify the accounts affected.

Classify the accounts affected.

Determine the amount of increase or decrease for each

account affected
Determine which accounts are debited and for what amount.

Determine which accounts are credited and for what amount.

Determine the complete entry in T-account form

Determine the complete entry in general journal entry form.

 Recording a General
Journal Entry
Here is an example showing the analysis of a business transaction and its general journal entry:

Business Transaction

Zip issued a $3,000 check to purchase a computer system.

 Question 1

Describe the general journal entry for the following event.

On January 16, 20-- On Time Delivery issued Check 243 to Comfort Space for $4,000
to buy office furniture.

Office Furniture 4 00000

20-- Cash in Bank 4 00000
 Posting

• Posting refers to the process transferring monetary amounts of debit

and credit entries from the general journal to the accounts in the

ledger which are affected by the debit and credit entries.

• The purpose is to classify and summarize transactions and events

affecting specific elements of the financial statements and determine

account balance
 Determine Account Balances and
Prepare a Trial Balance

 Determine the account balance for each

Account.
 Prepare a Trial Balance, which is a listing
of all account balances. It provides a
means to assure that debits equal credits.
 TYPES, AND PURPOSE
THREE TYPES:

• UNADJUSTED TRIAL BALANCE - PREPARED BEFORE ACCOUNT BALANCES

ARE ADJUSTED

• ADJUSTED TRIAL BALANCE - PREPARED AFTER ACCOUNT BALANCES ARE

ADJUSTED

• POST-CLOSING TRIAL BALANCE - PREPARED AFTER TEMPORARY ACCOUNTS

ARE CLOSED.

PURPOSE –

REGARDLESS OF ITS TYPE, TRIAL BALANCE IS PREPARED IN ORDER TO CHECK

WHETHER TOTAL DOLLAR AMOUNTS OF DEBITS AND CREDITS RECORDED IN
THE GENERAL LEDGER ACCOUNTS ARE EQUAL. IF THE TOTAL DEBIT AND
TOTAL CREDIT ARE EQUAL, THE LEDGER IS SAID TO BE IN BALANCE.
 PREPARING A TRIAL BALANCE

• LIST THE LEDGER ACCOUNT

BALANCES IN TWO COLUMNS ON THE
TRIAL BALANCE

• LEFT COLUMN = DEBITS

• RIGHT COLUMN = CREDITS

• TRIAL BALANCE PROVES DR = CR

 The Balancing of Accounts & The Trial Balance

The rules to prepare the Trial Balance:

Total Debit Entries = Total Credit Entries

 The Balancing of Accounts & The Trial Balance

Steps to preparing the Trial Balance:

1)Balance/cast ALL the ledger accounts in the

books.

2)List all the Debit balances on the debit side and

add them up.

3)List all the Credit balances on the credit side and

add them up.
 Adjustments / Adjusting Entries

Adjusting entries are required at the end of each

accounting period for accrual-basis accounting, prior to
preparing the financial statements. The purpose for
adjusting entries are to:
Bring balance sheet accounts current.

Reflect proper amounts of revenues and

expenses on the income statement.

 Accrual Vs Cash basis of accounting

Accrual Concept - This principle requires, among other things, that revenues and expenses should be recorded
in the accounting period in which goods and services are sold and delivered to customer and goods and
services are consumed, respectively, without regard to when cash is collected from the revenues and when
cash is paid for the expenses.

This method of recording and reporting revenues and expenses is called accrual basis of accounting.

Under the accrual basis of accounting, net income (loss) will be the difference between revenues earned and
expenses incurred in a given accounting period.

The accrual basis of accounting requires that, by the end of an accounting period, revenues earned but not
collected in cash and expenses incurred but not paid in cash should be identified and recorded. This too is done
through the adjusting process.
Another alternative way for recording and reporting revenues and
expenses is the cash basis of accounting.

According to this basis of accounting, revenues are recorded and reported

only when collected in cash and expenses are recorded and reported only
when paid in cash.

Under this accounting basis, net income (loss) for a given accounting is
determined by comparing revenues collected in cash and expenses paid in
cash in that particular accounting period.
Tips Regarding Adjusting Entries
 Adjusting entries always incorporate a balance sheet account
and an income statement account.

 Adjusting entries never involve a cash account.

 Most Common Adjusting Entries

1. Unrecorded Revenues--Revenues that have been earned but not yet

recorded.

2. Unearned Revenues--Revenues that have been recorded but not yet earned.

3. Unrecorded Expenses--Expenses that have been incurred but not yet

recorded.

4. Prepaid Expenses--Expenses that have been recorded but not yet incurred.

5. Adjustment for Plant Assets, And Bad Debt Expense

Three-Step Process for Adjusting Entries
 Identify the original entries that were made, if any. (Original

entries are only made for unearned revenues and prepaid

expenses.)

 Determine what the correct balances should be at this point in

time.

 Make the adjustments needed to correct the balances.

 Example: Accrued Expenses
At the end of the fiscal period, Rosi, Inc., had accrued
salaries and wages totaling $2,150.

Adjusting Entry
12/31 Salaries and Wages Expense 2,150
Salaries Payable 2,150
To record accrued salaries and
wages.
 Example: Accrued Revenues
Rosi, Inc., holds a note receivable from a customer on
which interest totaling $250 has accrued.

Adjusting Entry
12/31 Interest Receivable 250
Interest Revenue 250
To record accrued interest on a
note receivable.
 Example: Prepaid Expenses
Rosi, Inc.’s trial balance shows that the asset account
Prepaid Insurance has a balance of $8,000. By December
31, only $3,800 applies to future periods.

Adjusting Entry
12/31 Insurance Expense 4,200
Prepaid Insurance 4,200
To record expired insurance.

$8,000
$8,000--$3,800
$3,800
 Example: Deferred Revenues
Rosi, Inc., receives a payment of $2,550 from a customer
prior to the services being rendered. By December 31,
$2,075 in services have been provided.

Original
Originalcredit
creditto
toaarevenue
revenueaccount.
account. $2,550
$2,550--$2,075
$2,075

Adjusting Entry
12/31 Rent Revenue 475
Unearned Rent Revenue 475
To record unearned rent revenue.
 Example: Deferred Revenues
Rosi, Inc., receives a payment of $2,550 from a customer
prior to the services being rendered. By December 31,
$2,075 in services have been provided.

Original
Originalcredit
creditto
toaaliability
liabilityaccount.
account.

Adjusting Entry
12/31 Unearned Rent Revenue 2,075
Rent Revenue 2,075
To record rent revenue
($2,550 - $475).
 Preparing Adjusted Trial Balance and Financial
Statements

• After all transactions have been recorded, a trial balance prepared, and
adjusting entries made, the financial statements are prepared.

Record Prepare Trial Make Prepare

Trans- Balance Adjusting Financial
actions Entries Statements
 Closing Nominal Accounts

 Real accounts are permanent accounts not closed to a zero balance at the end

of the accounting period. These accounts are carried forward to the next

period.

 Nominal accounts are temporary accounts that are closed to a zero balance at

the end of each accounting period.

 Closing entries reduce all nominal accounts to a zero balance.

 The Closing Process
Revenues
xxx

Since
Since the
the revenue
revenue account
account is
is aa nominal
nominal account,
account,
itit is
is closed
closed at
at the
the end
end of
of the
the period
period by
by debiting
debiting its
its
balance
balance and
and crediting
crediting income
income summary
summary
 The Closing Process

Expenses

The
The expense
expense account
account isis credited
credited in
in
xxx order
order to
to close
close the
the account
account at
at the
the
end
end ofof the
the period.
period.
 The Closing Process

The
The withdrawal
withdrawal account,
account, which
which is
is also
also nominal,
nominal, is
is
credited
credited to
to close
close out
out the
the balance.
balance.

xxx
 Post-Closing Trial Balance

Provides a listing of all real account balances at the end of the closing
process.

The trial balance assures that total debits equal total credits prior to the
beginning of the new accounting period.

Only real accounts will have a balance at this time.

 Comprehensive Illustration
Use the data given for Matref consulting in chapter
two to illustrate the whole accounting cycle
Session
Ended!