Chapter 3
The
Accounting
Cycle
(1) Identify, analyze & record business
transactions in journals.
(2) Post to ledger accounts.
(3) Prepare a trial balance as the
starting point of the 10-column
worksheet.
(4) Prepare adjusting entries.
(5) Prepare adjusted trial balance.
(6) Prepare financial statements.
(7) Prepare closing entries & postclosing trial balance.
(8) Identify adjusting entries that may
be reversed.
The
Accounting
Cycle:
Step 1
• Event: A happening of consequence.
May be external or internal. Generally
triggers a change in assets, liabilities or
equity.
Identify,
analyze &
record
business
transactions
in journals.
• Transaction: An external event involving
a transfer or exchange between two or
more entities.
• Journal: The book of original entry.
Transactions are recorded in journal
entry form in their entirety.
• Account: An account represents an area
of similar economic interest.
The
Accounting
Cycle:
Step 1
Identify,
analyze &
record
business
transactions
in journals.
Double Entry System of Accounting.
A
logical method for recording transactions. It recognizes that
there are at least two events or changes for each transaction.
Debit (or sum of the debits) will always equal the credit (or
the sum of the credits).
Account Name
A Debit
enters an amount
on the left-hand side of an
account. It does not mean
A Credit
enters an amount on
the right-hand side of an account.
It does not mean increase or decrease.
increase or decrease.
Balance Sheet Equation:
Assets = Liabilities + Owner Equity
Assets will always equal the sources of those assets.
That is, assets belong to either the creditors or the owners.
The
Assets
Accounting
debit
credit
Cycle:
Step 1
+ -
Liabilities
debit
Owners Equity
credit
debit
- +
Identify,
analyze &
record
business
transactions
in journals.
credit
- +
Expense
debit
+-
Revenue
credit debit
credit
- +
A Journal Entry:
Double
Entry
Debit &
Credit
Rules
Date
Dr. Account name
XX
Dr. Account name
XX
Cr. Account name
Explanation
XX
The
Accounting
Cycle:
Step 2
Post to
ledger
accounts.
– Posting: The carrying of the essential
facts from the journal to the ledger.
• Ledger: The book (manual or computer)
of “T” accounts.
– General ledger (GL) is the book of control or
general accounts.
– Subsidiary ledger contains the detail of a
specific control or general account (e.g.,
Accounts Receivable).
The
Accounting
Cycle:
Step 2
Post to
ledger
accounts.
Types
of
accounts
Real Accounts exits from one period
to the next and are not closed.
Real accounts are the balance
sheet accounts including asset,
liability and equity accounts
(except dividends).
Nominal Accounts exist in name
only. At the end of each period,
they are closed. Nominal
accounting are the income
statement accounts--Revenue and
expense as well as the dividends
account.
The
Accounting
Cycle:
Step 3
Prepare
a trial
balance
as the
starting
point
of the
10-column
worksheet.
• Trial Balance: A list of all open accounts in
the GL (Assets, Liabilities, Owners’ Equity,
Revenues, Expenses … in order) and their
balances. Done to prove the equality of debits
and credits.
– Unadjusted--taken after routine entries are posted.
– Adjusted--taken after adjusting entries are posted.
– Post-closing--taken after closing entries are posted.
This will not detect omissions or errors
where debits = credits. It only determines,
after adjusting, if total debits = credits.
The
Accounting
Cycle :
Step 4
Prepare
Adjusting
Entries
4 General
Types
Of
Adjusting
Entries
Adjusting Journal Entries (AJE’s) are prepared
to bring the books up to date as of the close of the
accounting period.
Dr. Expense
Cr. Asset (such as “prepaid ...” or “accumulated depr”)
Defer (or apportion) an expense and reduce an asset
Dr. Unearned Revenue (to reduce the liability)
Cr.Revenue
Defer (or apportion) unearned revenue and reduce a liability
Dr. Expense
Cr. Liability
Accrue an unrecorded expense
Dr. Receivable
Cr. Revenue
Accrue an unrecorded revenue
The
Accounting
Cycle:
Step 6
• Financial Statements: The primary reporting vehicles
for accounting information. They are the result of the
collection, tabulation and summation of accounting data. The
following four statements comprise a complete set of financial
statements (“taken as a whole”):
– Balance sheet--Financial condition
Prepare
Financial
Statements
(position) of an enterprise at the end of the
period. … real accounts
– Income statement--Shows the results of
operations for the period. … nominal
accounts
– Statement of cash flows--Reports cash activity for
the period by operating, investing and financing flows.
– Statement of retained earnings--Reconciles the
beginning and ending balances in the owner equity
account.
The
Accounting
Cycle:
Step 7
Prepare
Closing
Entries
& the
PostClosing
Trial
Balance
Prepare Closing Entries:
– to empty the nominal (I/S, dividends)
accounts in preparation for use in the
next period.
– to update the inventory account if the
merchandiser uses a periodic
inventory procedure.
– to formally calculate net income or
loss.
– to update retained earnings.
The
Accounting
Cycle:
Step 8
Closing
A
Merchandise
Cycle:
Inventory
Methods
Inventory Methods:
• Periodic:
– Use of the purchases and contra accounts, Freight-in.
– Adjust inventory at end of period within the context of
closing.
– Cost of Goods Sold (COGS) is a calculated figure
– Closing involves purchases, sales, contras, Freight-in.
• Perpetual:
– Inventory is kept up-to-date--Debited when bought,
credited when sold-Returns & Allowances, discounts
flow through the inventory account.
– Cost of Goods Sold is a known figure.
– No purchase contras to close.
The
Accounting
Cycle:
Step 8
Prepare
Reversing
Entries
Reversing entries are optional and are used
to ease the preparation of journal entries
throughout the accounting period without regard
to the accounting period.