Chapter: Two - The Accounting Cycle

Introduction:
The accounting cycle is the process by
which accountants prepare Financial
statements for an entity for a specific period
of time.
 The Accounting Cycle

For a new business, it begin by setting up

ledger accounts.
For an established business, begin with

account balances carried over from the

previous period.
 The Steps In The Accounting
Cycle

1. Analyze source documents & record business

transactions in a journal
2. Post journal entries to the ledger accounts
3. Prepare unadjusted trial balance (TB)
4. Journalize and post end of period adjustments
(EOPA)
5. Prepare adjusted Trial Balance
6. Prepare/Create financial statements &
reports from data in adjusted TB
7. Journalize and post the closing entries
8. Prepare the post-closing trial balance
9. Prepare and post reversing entries
 Detailed Steps in the Accounting Cycle

Analyze Journalize Prepare

Business Post entries unadjusted
transactions to the
Transaction in the trial
s. accounts in balance.
journal. the ledger.

Post-closing
trial balance

Prepare Journalize
Prepare
Journalize and financial and post
adjusted
post closing statements. adjusting
trial
entries entries
balance.
 Analysis and Recording Business
Transactions

Business transaction is an economic event

that causes a change in the financial position
Financial Position:
 What the entity controls
 How the entity controls them (claims)
 Fundamental Accounting
Equation

ASSETS = EQUITIES

ASSETS = LIABILITIES + OWNERS' EQUITY

How do we use the “Accounting” equation?
Recall the Basic Accounting Equation:
Assets = Liabilities + Shareholders’ Equity
Implications:
Total Asset=Claims against the assets
Therefore :
If assets increase: either Liabilities and/or
Shareholders’ should also increase and vice
versa
For example: borrow cash, cash (asset) will
increase and Liabilities will increase
when it is paid back: cash (asset) will
decrease and liabilities will decrease
 How do we record/Account?
An ACCOUNT (ledger Account): is an
accounting device used to record changes in a
specific asset, liability or owners’ equity item
Has 3 elements: title, debit side and credit
side (also called the “T-Account”)
Changes in the accounts are entered
manually into a book called a ledger or
computerized ledger
Basic forms of book ledgers: the two-column
account format, and the running format
account
Chart of accounts
 Definition of Ledger Account

Ledger Account
Complete listing of business transactions for an
individual account
Where you look if you want to find the balance of
any given account
General Ledger
 A loose-leaf book or computer file containing all the
Ledger Accounts
Each account from the chart of accounts has its
own ledger account in the general ledger
Complete listing of all account tittles and
account names/codes used by an entity is called
the chart of accounts - It is like a table of
content in a book
 Forms of Ledgers
Two-Column Account
Account Account No:

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

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

Account Name Account No:

Left-hand or Right-hand or

Debit Side Credit Side

 How do accounts behave?

Assets = Liabilities + Shareholders’

Equity
+ + +

So Assets increase on the left hand or debit

side then they decrease on the credit side

Assets
+ -
debit credit
 Behavior of Accounts cont…

Liabilities and Owners’ Equity accounts

increase on the credit side, decrease on the
debit side
Liabilities or Owners’ Equity Accounts
- +
debit credit
 Transaction Analysis and The Duality Concept

Double entry system states that every

transactions affects at least two accounts.
Therefore
• If an asset account increases (decreases),
because of duality concept there must be a
corresponding:
1. increase(decrease) in a specific liability account
2. or a decrease(increase) in a another asset
account
3. Or an increase(decrease) in owners' equity
account.
 What Is a General Journal?

The book in which a person enters the

original record of a business transaction
 Commonly referred to as a book of original entry
Chronological listing of all the business
transactions for the company
 Each listing records the debits and credits
associated with that business transaction
A book or a location on a hard drive where all
business transactions are listed
 Like a diary

Accounting Is Fun!
 What’s in a Journal Entry?

1. Date
2. At least one debit entry
 Debit account, use exact account title, do not
indent titles
3. At least one credit entry
 Credit account, use exact account title, indent titles

4. An explanation of the transaction:

 Check number
 Invoice number DR=CR
 Accounts receivable customer name
 Many other elements OR details as appropriate…
 Remember: the accountant must leave a good audit
trail so that users of accounting information can
understand what occurred with each transaction
 Illustration of the accounting
process
1. On Jan 1 2010 Ms.Farida invested $100,000 at the
inception of the business, Express Travel Agency

Eve nt Asse ts Liabilitie s Owne rs’

No Equity
1 +100.000 No change +100.000
Total 100.000 0 100.000
GENERAL JOURNAL Page 1
Date Account Title and Description Acct.No. Debit Credit
1 Jan 2004
Cash 100 100.000
Capital 500 100.000
Investment by the shareholders
2. On 1 January employed a full time secretary and a
sales representative.

Event No Assets Liabilities Owners’ Equity

1 +100.000 No change +100.000
2 No change No change No change
Total 100.000 0 100.000
3. On 1 January rented an office building and paid 3
months rent of $600.

Eve nt No Asse ts Liabilitie s Owne rs’ Equity

1 +100.000 No change +100.000
2 No change No change No change
3 +600 No change No change
-600 No change No change
Total 100.000 0 100.000

GENERAL JOURNAL Page 1

Date Account Title and De scription Acct.No. De bit Cre dit
1 Jan 2004
Prepaid Rent 180 600
Cash 100 600
Payment of 3 months of rent in advance
4. On 2 January office furniture and equipment is purchased for
$ 15,000 , for which $ 5,000 is paid in cash and the rest would
be paid later in January and February 2010.

Eve nt No Asse ts Liabilitie s Owne rs’ Equity

1 +100.000 No change +100.000
2 No change No change No change
3 +600 No change No change
-600 No change No change
4 +15.000 +10.000 No change
-5.000
Total 110.000 10.000 100.000

GENERAL JOURNAL Page 1

Date Account Title and De scription Acct.No De bit Cre dit
2 Jan 2004
Furniture and Equipment 255 15.000
Cash 100 5.000
Accounts Payable 320 10000
Purchase of furniture and equipment
5. On 3 January insured the office building and the equipment
effective from 1 January to 31 December 2010 and paid $ 120
for the whole period.

Eve nt No Asse ts Liabilitie s Owne rs’ Equity

1 +100.000 No change +100.000
2 No change No change No change
3 +600 No change No change
-600 No change No change
4 +15.000 +10.000 No change
-5.000
5 +120 No change No change
-120
Total 110.000 10.000 100.000

GENERAL JOURNAL Page 1

Date Account Title and De scription Acct.No. De bit Cre dit
3 Jan 2004
Prepaid Insurance 180 120
Cash 100 120
Purchase of insurance policy
6. On 5 January the company signed an agreement
with Kenya Airline to sell their airline tickets and
receive commissions in return.

Event No Assets Liabilities Owners’ Equity

1 +100.000 No change +100.000
2 No change No change No change
3 +600 No change No change
-600 No change No change
4 +15.000 +10.000 No change
-5.000
5 +120 No change No change
-120
6 No change No change No change
Total 110.000 10.000 100.000
 7. On 10 January Express Travel Agency borrowed
$15,000 from the bank at an annual interest rate of
24% for six months. The principal and the interest
of the loan will be paid together on 10 July 2010.

Event No Assets Liabilities Owners’ Equity

1 +100.000 No change +100.000
2 No change No change No change
3 +600 No change No change
-600 No change No change
4 +15.000 +10.000 No change
-5.000
5 +120 No change No change
-120
6 No change No change No change
7 +15.000 +15.000 No change
Total 125.000 25.000 100.000
7. On 10 January Express Travel Agency borrowed $
15,000 from the bank at an annual interest rate of
24% for six months. The principal and the interest of
the loan will be paid together on 10 July 2010.

GENERAL JOURNAL Page 1

Date Account Title and Description Acct.No. Debit Credit
10 Jan 2004
Cash 100 15.000
Bank Loan 300 15.000
Borrowing from the bank
8. On 10 January purchased office supplies for $2.500 in cash.

Event No Assets Liabilities Owners’ Equity

1 +100.000 No change +100.000
2 No change No change No change
3 +600 No change No change
-600 No change No change
4 +15.000 +10.000 No change
-5.000
5 +120 No change No change
-120
6 No change No change No change
7 +15.000 +15.000 No change
8 +2.500 No change No change
-2.500
Total 125.000 25.000 100.000
8. On 10 January purchased office supplies for
$2,500 in cash.

GENERAL JOURNAL Page 1

Date Account Title and Description Acct.No. Debit Credit
10 Jan 2004
Office Supplies 136 2.500
Cash 100 2.500
Purchase of office supplies
9. During the first half of January the agency sold tickets to
various customers and on 16 January issued a commission
invoice to clients amounting to $5,000 that will be collected
later in January 2010.

Eve nt No Asse ts Liabilitie s Owne rs’ Equity

1 +100.000 No change +100.000
2 No change No change No change
3 +600 No change No change
-600 No change No change
4 +15.000 +10.000 No change
-5.000
5 +120 No change No change
-120
6 No change No change No change
7 +15.000 +15.000 No change
8 +2.500 No change No change
-2.500
9 +5.000 No change +5.000
Total 130.000 25.000 105.000
9. During the first half of January the agency sold
tickets to various customers and on 16 January issued
a commission invoice to clients amounting to $ 5,000
that will be collected later in January 2010.
Revenue A c c ount s
Left or Debit S ide Right or Credit S ide
Dec reas e I ncre a se

GENERAL JOURNAL Page 1

Date Account Title and Description Acct.No. Debit Credit
16 Jan 2004
Accounts Receivable 120 5.000
Commission Revenue 600 5.000
Recognition of commission on ticket sales
10. On 20 January the company paid $5,000 for the
furniture and equipment that were purchased on 2 January.

Eve nt No Asse ts Liabilitie s Owne rs’ Equity

1 +100.000 No change +100.000
2 No change No change No change
3 +600 No change No change
-600 No change No change
4 +15.000 +10.000 No change
-5.000
5 +120 No change No change
-120
6 No change No change No change
7 +15.000 +15.000 No change
8 +2.500 No change No change
-2.500
9 +5.000 No change +5.000
10 -5000 -5000 No change
Total 125.000 20.000 105.000
10. On 20 January the company paid $5.000 for the
furniture and equipment that were purchased on 2 January.

GENERAL JOURNAL Page 1

Date Account Title and Description Acct.No. Debit Credit
20 Jan 2004
Accounts Payable 320 5.000
Cash 100 5.000
Payment for an accounts payable
11. On 22 January received $7,500 from a customer for
organizing the accounting conference that will be held on
February 2, 2010.
Eve nt No Asse ts Liabilitie s Owne rs’ Equity
1 +100.000 No change +100.000
2 No change No change No change
3 +600 No change No change
-600 No change No change
4 +15.000 +10.000 No change
-5.000
5 +120 No change No change
-120
6 No change No change No change
7 +15.000 +15.000 No change
8 +2.500 No change No change
-2.500
9 +5.000 No change +5.000
10 -5.000 -5.000 No change
11 +7.500 +7.500 No change
Total 132.500 27.500 105.000
11. On 22 January the company received $7.500
from a customer for organizing the accounting
conference that will be held on 2 February 2010.

GENERAL JOURNAL Page 1

Date Account Title and Description Acct.No. Debit Credit
22 Jan 2004
Cash 100 7.500
Unearned Revenues 340 7.500
Receipt of advance payment from a customer
12. The company received the full payment of commission
charged to Kenya Airlines of $ 5.000 on 23 January.

Event No As s ets Liabilities Owners ’ Equity

1 +100.000 No change +100.000
2 No change No change No change
3 +600 No change No change
-600 No change No change
4 +15.000 +10.000 No change
-5.000
5 +120 No change No change
-120
6 No change No change No change
7 +15.000 +15.000 No change
8 +2.500 No change No change
-2.500
9 +5.000 No change +5.000
10 -5.000 -5.000 No change
11 +7.500 +7.500 No change
12 +5.000 No change No change
-5.000
Total 132.500 27.500 105.000
12. The company received the full payment of
commission charged to Kenya Airline s of $ 5,000
on 23 January.

GENERAL JOURNAL Page 1

Date Account Title and Description Acct.No. Debit Credit
23 Jan 2004
Cash 100 5.000
Accounts Receivable 120 5.000
Receipt of payment from a customer
13. On 24 January paid salaries of $ 9,000 employees in
cash.

Event No Assets Liabilities Owners’ Equity

7 +15.000 +15.000 No change
8 +2.500 No change No change
-2.500
9 +5.000 No change +5.000
10 -5.000 -5.000 No change
11 +7.500 +7.500 No change
12 +5.000 No change No change
-5.000
13 -9.000 No change -9.000
Total 123.500 27.500 96.000
13. On 24 January paid salaries of $ 9,000
employees in cash.

Expense Accounts
Left or Debit Side Right or Credit Side
Incre a se Decrease

GENERAL JOURNAL Page 1

Date Account Title and Description Acct.No. Debit Credit
24 Jan 2004
Salary Expense 770 9.000
Cash 100 9.000
Payment of salaries
14. During the second half of January the agency sold tickets
to various customers and on 31 January issued a
commission invoice to Kenya Airline amounting to $ 7,500
which will be collected in February 2010.

Event No As s ets Liabilities Owners ’ Equity

8 +2.500 No change No change
-2.500
9 +5.000 No change +5.000
10 -5.000 -5.000 No change
11 +7.500 +7.500 No change
12 +5.000 No change No change
-5.000
13 -9.000 No change -9.000
14 +7.500 No change +7.500
Total 131.000 27.500 103.500
14. During the second half of January the agency sold tickets to
various customers and on 31 Jan sent an invoice to Kenya Airline
amounting to $7,500 which will be collected in February 2010

GENERAL JOURNAL Page 1

Date Account Title and Description Acct.No.Debit Credit
31 Jan 2004
Accounts Receivable 120 7.500
Commission Revenues 600 7.500
Recognition of commission on ticket sales
15. Ms. Farida ( the proprietor) withdrew $
3,000 on 31 January for her personal use.

Event No Assets Liabilities Owners’ Equity

7 +15.000 +15.000 No change
8 +2.500 No change No change
-2.500
9 +5.000 No change +5.000
10 -5.000 -5.000 No change
11 +7.500 +7.500 No change
12 +5.000 No change No change
-5.000
13 -9.000 No change -9.000
14 +7.500 No change +7.500
15 -3.000 No change -3.000
Total 128,000 27,500 100,500
15. Ms. Farida withdrew $ 3.000 on 31 January for
personal use.

Owners ' W ithdrawals or Dividends

Left or Debit Side Right or Credit Side
Incre a se Dec reas e

GENERAL JOURNAL Page 1

Date Account Title and Description Acct.No. Debit Credit
31 Jan 2004
Withdrawals XXX 3,000
Cash 100 3,000
Withdrawal by the owner
 Summary of Journalizing

Steps:
1. Determine the effects of transactions
on three components of the
accounting equation,
2. Determine which specific accounts are
affected, and
3. Assure that total of the increases
should be equal to either increases on
the other side of the equation or to
decreases on the same side, or a
combination there of.
 Behavior of Accounts- Summary
Assets = Liabilities + Owners’ Equity
+ - - + -
+
Dr Cr Dr Cr Dr Cr
Expense Revenue
+ - - +
Dr Cr Dr Cr

Withdrawals/Dividends
+ -
Dr Cr
 Accounting Cycle-Revisited

Adjust the
Analyze and accounts
Post the
record the and prepare
transactions and
transactions trial balance
prepare trial
balance

Prepare the
Close the financial
accounts and statements
prepare trial
balance
 Posting -Defined

• The process of transferring figures from the

journal to the ledger accounts
• It simply involves transferring data from one
accounting entry into another
• The purpose is to classify and summarize
transactions and events affecting specific
elements of the financial statements
 Four-Step Posting Process

1. Transfer transaction date to account’s date

column
2. Transfer the debit/credit amount and
calculate the new balance
3. Write journal page number in posting
reference column of ledger as a cross-
reference
4. Go back to journal and write account number
in posting reference column of journal as a
cross-reference.
 Cross-reference
 The ledger account number in the Post. Ref.
column of the journal and the journal page
number in the Post. Ref. column of the ledger
account
 Posting to The Ledger
illustrated
GENERAL JOURNAL Page 1
Date Account Title and De scription Acct.No. De bit Cre dit
1 Jan 2004
Cash 100 100.000
Capital 500 100.000
Investment by the shareholders

LEDGER - Cash Acc. No. 100

Date Description Ref Debit Credit Debit Credit

Balance Balance
1 Jan 2004
Capital P1 100,000 100,000

LEDGER - Capital Acc. No. 500

Date Description Ref Debit Credit Debit Credit

Balance Balance
1 Jan 2004
Cash P1 100,000 100,000
 Posting illustrated
LEDGER - Cash Acc. No. 100

Date Description Debit Credit

1 Jan Capital 100,000
1 Jan Office rent 600
2 Jan Office furniture and equipment 5,000
3 Jan insurance expense 120
10 Jan Bank loan 15,000
10 Jan Office supplies 2,500
20 Jan Accounts payable 5,000
22 Jan Unearned Revenue 7,500
23 Jan Acccounts Recievable 5,000
24 Jan salaries expense 9,000
31 Jan Withdrawal 3,000
 Exercise

Post all the above transactions (journal

entries) to the following ledger accounts:
 Prepaid Rent, Office supplies, Prepaid insurance, Office
Furniture & Equipment, Bank loan, Accounts Payable,
Unearned Revenue, Capital, Withdrawals, Commission
Revenue, & Salary Expense
Cast the ledger accounts
Determine the balances carried down (Bal c/d)
and balances brought down (b/d)
Prepare a summary of the ledger balances in a
two columnar listing to derive the Trial Balance(
TB)
 SUMMARY -Normal Balances of
Accounts
Category of the Increase Normal Balance
Account Recorded By

Assets Debits Debit

Liabilities Credits Credit
Shareholders’ Equity

Capital Credits Credit

Dividends or Debits Debit
Withdrawals
Revenues Credits Credit
Expenses Debits Debit
 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 &
Financial statements
Introduction:
 In the previous exercise, you have learned the principles
of double entry and how to post to the ledger accounts.
The next step in our progress towards the financial
statements is the trial balance.
 Before transferring the relevant balances at the year end
to the financial statements, it is usual to test the accuracy
of the double entry bookkeeping records by preparing a
trial balance. This is done by taking all the balances on
every account. Due to the nature of double entry, the
total of the debit balances will be exactly equal to the
total of the credit balances.
 The Balancing of Accounts & The Trial Balance

• Question: Once you have closed all the accounts, what would do?
• Answer: Prepare a Trial Balance
• Question: What is a Trial Balance then? What is it for? How
does it look like?
• Answer: A Trial Balance is a list of nominal ledger account
and their balances at a given date. It is usually
prepared on the last day of the accounting period.
It consists of a Debit and a Credit balance.
• Its purposes:
(1) It is prepared to check that the total of debit balances is the same
as the total of credit balances and offer reassurance that the double
entry recording from day books has been done correctly.
(2) For preparation of statement of income and the statement of
financial position
 The Balancing of Accounts & The Trial Balance

The rules to prepare the Trial Balance:

Total Debit Entries = Total Credit Entries

Debit Credit
Assets Income/ Revenue
Expenses Liabilities
Drawings Capital
 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.

4) Ideally the trial balance should balance after step 3

 The Balancing of Accounts & The Trial Balance

What if the trial balance shows unequal debit and credit

balances?
If the columns of the trial balance are not equal, there must
be an error in recording or processing the transactions.
 4 Errors revealed by the trial balance:
The errors revealed are those errors which cause the Trial
Balance totals to disagree. (i.e do not balance)
There are FOUR types of errors revealed by a trial balance:
1) Posting to the wrong side of an account.
2) Errors in calculation and balancing
3) Incorrect amounts entered on one entry
4) Omission of one entry.
 The Balancing of Accounts & The Trial Balance

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

Answers:1) Check day-book (journal) totals

2) Check additions of Ledger accounts, ensure each
balance is correct
3) Check all ledger account balances have been
recorded in
the Trial Balance.
4) Check all balances have been entered in the Trial
Balance on the correct side.
5) Check additions have been done correctly
The Balancing of Accounts,& The Trial Balance

Question: Once you are sure there is no mistake made in the

Trial Balance, what do you do in the next
step?

Answers: Prepare End of Period Adjustment & then

prepare the following statements:
1) Statement of Income
2) Statement of Financial Position

In short, these are the steps:

1) Trial Balance
2) End of Period Adjustments
3) Statement of Income
4) Statement of Financial position
 The Balancing of Accounts & The Trial Balance

However, a trial balance will not disclose the following

types of errors: (Errors not revealed by the trial balance)

1) Errors of omission
Complete omission of a transaction, because
neither a debit nor a credit is made.

2) Errors of commission
This happens when original figure incorrectly
entered. (Correct double entries but incorrect amounts
were recorded)
 The Balancing of Accounts & The Trial Balance
3) Compensating errors
This happens where errors cancel out each other. (eg an
error of £100 is exactly cancelled by another £100 error
elsewhere).
4) Errors of principles
This happens when the wrong type of account had been
used (eg. the purchase of a motor van is debited to an
expense account, such as motor expenses, rather than a
fixed asset account)
5) Complete reversal of entries
This happens when an account should be debited but was
credited (and vice versa)
 The Trial Balance
Expre ss Trave l Age ncy
Trial Balance
31-Jan-10
in $
Accounts De bit Cre dit
Cash 102,280
Accounts Receivable 7,500
Office Supplies 2,500
Prepaid Rent 600
Prepaid Insurance 120
Office Furniture and Equipment 15,000
Bank Loan 15,000
Accounts Payable 5,000
Unearned Revenues 7,500
Capital 100,000
Withdrawal 3,000
Commission Revenues 12,500
Salary Expenses 9,000
Total 140,000 140,000
 THE END OF CHAPTER TWO

THANK YOU