The accounting cycle refers to a series of sequential
steps or procedures performed to complete the
accounting process.
STEPS IN COMPLETING THE ACCOUNTING CYCLE
Step 1 Identification of the events
Identify whether the event is a business transaction or
not. If activities and events occurring during a given
period of time affect the business’ financial position and
are capable of being assigned monetary values, they are
referred to as business transactions.
Documents are evidences of transactions that occurred.
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Official receipt is issued when cash is received by
the entity.
Invoice is issued when service or merchandise is
given to a customer or client. This is a commercial
document that itemizes a transaction between a
buyer and a seller. If goods or services were
purchased on credit, this usually specifies the terms
of the deal, and provides information on the
available methods of payment.
Check is used as a substitute for cash.
Step 2 Transactions are recorded in the journal
Information from documents will be the bases in
recording all transactions of the business. Transactions
are initially recorded chronologically in the journal.
Chronological means, ‘in order’. Transactions are
recorded in the order of date of transaction.
Step 3 Journal entries are posted to the ledger
Posting is the process of transferring the debits and
credits from the journal to the ledger.
The ledger is a collection of accounts that shows the
changes made to each account as a result of past
transactions, and their current balances.
After posting all transactions to the ledger, the balances
of each account can be computed.
Step 4 Preparation of a Trial Balance
Trial Balance is a list of accounts with debit or credit
ledger balances. This is prepared to check the equality
of debits and credits in the ledger.
All account balances are extracted from the ledger and
arranged in the trial balance showing debit balances in
the debit column and credit balances in the credit
column. All the balances are added and total debits
should equal total credits
Step 5 Preparation of the Worksheet including adjusting
entries
This will help in the preparation of financial statements.
Worksheet is used to simplify the adjusting and closing
process, then it will be easier to transfer data from the
unadjusted trial balance to the financial statements. An
accounting worksheet is a tool used to help
bookkeepers and accountants complete the accounting
cycle and prepare year-end reports.
Step 6 Preparation of the Financial Statements
Financial Statements contain financial information
which is useful for decision – making purposes. The
Financial Statements include
1.
2.
3.
4.
Statement of Financial Position (SFP)
Statement of Comprehensive Income (SCI)
Statement of Changes in Equity (SCE)
Statement of Cash Flows (CFS)
Elements of FS:
 Assets
 Liabilities
 Equity
 Revenue
 Expenses
Step 7 Adjusting journal entries are journalized and
posted
To record deferrals, expiration of deferrals and other
events from the worksheet. Adjusting entries are
posted so that balances in adjusted accounts are
presented in the correct amounts. Adjusted balances
are shown in the adjusted trial balance.
Step 8 Closing entries are journalized and posted
Close Revenues and Expense accounts to the Revenue
and Expense Summary account. The balance of the
Revenue and expense Summary account is closed to
Owner’s Capital account. Owner’s Drawing Account is
closed to Owner’s Capital account.
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Step 9 Preparation of a Post-closing Trial Balance
This step is done to check the equality of debits and
credits after the closing entries. The post closing trial
balance is a list of all accounts and their balances after
the closing entries have been journalized and posted to
the ledger. The post-closing trial balance contains only
balance sheet items such as assets, liabilities and ending
capital
2.
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Step 10 Reversing journal entries are journalized and
posted
Reversing entries are prepared to simplify the recording
of certain regular transactions in the next accounting
period. Reversing entries are made on the first day of
the next accounting period to remove certain adjusting
entries made.
FINANCIAL STATEMENTS
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3.
Land
Leasehold improvements
Machinery
Equipment
Building
Furniture
Intangible Assets – are lone-lived assets without
physical characteristics and whose value lies in the
rights, privileges and competitive advantages that
they give the owner.
Patent
Franchise
Copyright
Goodwill
Trademark
Liabilities are present obligation of the enterprise
and from which an outflow of resources are
expected upon its settlement.
Current liabilities are those obligations due to be
paid within one year.
Accounts payable
Notes payable
Salaries payable
Utilities payable
Non-current liabilities are those obligations that
are not due to be paid within one year.
Long term note payable Long term loan payable
Bond payable
Mortgage payable
Equity is the residual or what is left when liabilities
are deducted from assets.
I. Statement of Financial Position / Balance Sheet
– depicts the financial position of a business entity and
is affected by
Accounting Equation is “ASSETS = LIABILITY + EQUITY”.
The total assets should always equal the total liabilities
and equity.
1. the economic resources it owns and controls,
2. its financial structure and
3. its liquidity and solvency.
Contra asset accounts have credit balances which are
deducted from respective Asset accounts which have
debit balances. These include but not limited to:
Allowance for Bad Debts, Accumulated Depreciation…
ELEMENTS:
1. Assets are resources controlled by the enterprise
and from which future economic benefits are
expected to flow to the firm when it is realized.
 Current assets are those assets that are expected
to be converted to cash, sold or consumed during
the next 12 months within the business normal
operating cycle if longer than one year.
Cash
Notes receivable
Accounts Receivables
Prepaid rent
Supplies
Accrued income
Prepaid expense
Merchandise inventory
 Non-current assets all assets other than current
assets. They are used to operate the business and
are not held for sale.
Allowance for Bad Debts deducted from total Accounts
Receivable to compute the total accounts collectible.
Accumulated Depreciation refers to the aggregate of
the wear and tear on the asset.
Format:
1. Account form consists of two columns displaying
assets on the left column of the report and liabilities
and equity on the right column.
2. Report form has one column. This form is more of a
traditional report that is issued by companies. Assets
are always present first followed by liabilities and
equity.
II. Statement of Comprehensive Income / Income
Statement
– displays components of the profit and loss. Begins
with the profit and loss (bottom line of the income
statement) and displays the items of other
comprehensive income for the reporting period.
ELEMENTS:
 Revenues – inflow of economic benefit such as
sales from income generating activities
 Expenses – outflow of resources
In service business the revenue title is usually Service
Revenue or other title recognized when services have
rendered to the client. While in merchandising business
the revenue title is just the Sales.
Gain results from such activities that meet the
definition of income but may or may not arise in
ordinary course of business activities.
Format:
1. SINGLE-STEP APPROACH
Nature of expense – this form presents the expenses
according to their nature: depreciation, advertising,
transportation, employee benefits. This is normally used
for a simple business such as that of a service provider.
To simplify the format, two sections may be formed,
one for revenues and the other for expenses.
2. MULTI-STEP APPROACH
Function of expense – presents the expenses according
to its function or use: cost of sales, distribution cost,
administrative cost and financial cost, to name a few.
Two main sections:
The operating section contains information about
revenues and expenses of the principle business
activities. The gross profit and the operating profit
figures are calculated in the operating section of a
multi-step income statement. All operating revenues
are grouped at the top of the income statement.
The operating expenses are sub-classified into cost of
goods sold, selling expenses and administrative
expenses. Selling expenses are those which are incurred
directly on making sales.
The non-operating section is usually labeled as 'other
incomes and expenses' contains those revenues and
expenses which are not earned directly through
principle business activities but are incidental to them.
For example gains/losses on sales of investments or
fixed assets, interest revenue/expense etc. It also
includes extraordinary items of revenues and expenses
which are infrequent and unusual such as loss due to
natural calamity.
III. Statement of Changes in Equity
– can be considered a bridge between Statement of
Financial Position and the Statement of Comprehensive
Income since the income/loss computed in the SCI is
reported in the Statement of Changes in Equity. The
amount of capital at the end of the period as shown in
the statement is presented in the owner’s equity
section of the SFP
Contains the following:
 Beginning Capital
 Net Income (loss)
 Additional Investments
 Withdrawals
 Ending Capital
Sole Proprietorship
Owner’s Capital Beginning
Add: Additional Investments
Less: Drawings
Owner’s Capital Ending
Partnership
Partner’s Capital Beginning
Add: Additional Partner’s Investments
Less: Partner’s Drawings
Partner’s Capital Ending
Corporation
Preferred Shares
Additional Premium
Common Shares
Additional Premium
Retained Earnings
Total Shareholders’ Equity
IV. Statement of Cash Flows
– summarizes the inflows and outflows of cash that are
directly associated with the:
1. Operating Activities – cash from the daily operation
of the business.
2. Investment Activities – represent the extent to
which expenditures have been made for resources
intended to generate future income and cash flow.
3. Financial Activities – these are cash flows
transaction with non-trade creditors and
shareholders.
FORMS OF BUSINESS ORGANIZATION:
Sole Proprietorship – This business has a single owner
called the proprietor who generally is also the manager.
Advantages
1.
2.
3.
4.
5.
6.
Easiest form of business to set up
Owner receives all the profit
Owner has the freedom to manage
Few legal restrictions
Easy to dissolve
Owner, not business is taxed
Disadvantages
1. Unlimited liability of owner for debts of the
business
2. Difficulty of raising capital
3. Over-all direction may become a burden on owner
when business grows
4. Limited opportunity for employees since
organization is not permanent
5. Death, imprisonment or insanity of the owner
automatically terminates the business
Partnership – In a contract of partnership, two or more
persons bind themselves to contribute money property,
or industry to a common fund, with the intention of
dividing the profit among themselves.
Advantages
1. Greater source of capital that a sole proprietorship
2. Allows for specialization of managerial skills as well
as pooling of partners’ knowledge
3. Few legal restrictions than a corporation
4. Each partner, as individual, is taxed not the
partnership business
5. Better credit standing than a sole proprietorship
Disadvantaged
1. Restricted transfer of ownership
2. Unlimited liability of partners for debts of the
business
3. One part’s action can legally bind the firm (mutual
agency)
4. Partnership friction mar terminate the agreement
5. Duration of partnership is limited by the lives of
partners
Corporation – is an artificial being created by operation
of law, having the right of succession and the powers,
attributes and properties expressly authorized by law or
incident to its existence. A corporation is a business
owned by its stockholders.
Advantages
1. Life of a corporation is almost perpetual renewable
every 50 years
2. Ownership is easily transferred
3. Owners have limited liability for the debts of the
firm
4. Greater source of capital
5. Permits the use of management specialist
Disadvantages
1. More difficult and expensive to organize than the
other forms of business
2. Subject to more legal restrictions
3. Subject to higher tax on business income
4. Stockholders have little control over the
management of the business
5. Subject to more government controls