ACCOUNTING PROCESS

Accounting Information System

 Collects and processes transaction data and then disseminates the financial information to interested
parties

Basic terminology
 Event – a happening of consequence; generally is the source or cause of changes in assets, liabilities,
and equity; may be external or internal
 Transaction – external event involving a transfer or exchange between two or more entities
 Account (T-account) – systematic arrangement that shows the effect of transactions and other events
on a specific element
 Real (permanent) accounts – asset, liability, and equity accounts; appear on SFP
 Nominal (temporary) accounts – revenue, expense and dividend accounts; except for dividends, they
appear on income statement; periodically closed by companies
 Ledger – book (or electronic) records containing the accounts
o General ledger – collection of all ALE, revenue and expense accounts
o Subsidiary ledger – contains the details related to a given general ledger account
 Journal – book of original entry; where company initially records transactions and selected events;
transferred to the ledger
o Journalizing – entering transactions
 Posting – process of transferring from book or original entry to ledger accounts
 Trial balance – list of all open accounts in the ledger and their balances
o Adjusted trial balance – trial balance taken immediately after all adjustments have been
posted
o Post-closing (after-closing) trial balance – trial balance taken immediately after closing
entries have been posted
o May be prepared by companies any time
 Adjusting entries – made at the end of an accounting period to bring all accounts up to date on an
accrual basis
 Financial statements – statements that reflect the collection, tabulation and final summarization of
accounting data
o Statement of financial position
o Income statement (or statement of comprehensive income)
o Statement of cash flows
o Statement of retained earnings
 Closing entries – formal process by which enterprise reduces all nominal accounts to zero and
determines and transfers the net income or net loss to an equity account

The Accounting Cycle

1. Identification and measurement of transactions and other events
2. Journalization
3. Posting
4. Trial balance preparation
5. Adjustments (worksheet – optional)
6. Adjusted trial balance
7. Statement preparation
8. Closing
9. Post-closing trial balance (optional)
 10. Reversing entries (optional)
I – Identification and measurement of transactions and other events
 Although IFTS provides guidelines, no simple rules exist that state which events a company should
record.
 An item should be recognized in the FS if it
o Meets the definition of an element
o Probable that any future economic benefit associated with the item will flow to or from the
entity
o Has a cost or value that can be measured reliably
 Transactions recorded may be an exchange between two entities where each receives and sacrifices
value
 A company records as many transactions as possible that affect its financial position

II – Journalization
 A general ledger chronologically lists transactions and other events, expressed in terms of debits and
credits to accounts
 In some cases, a company uses special journals
 Special journals summarize transactions possessing a common characteristic, using them reduces
bookkeeping time

III – Posting
 Transferring journal entries to the ledger accounts
 Involves the following steps:
o In the ledger, enter in the appropriate columns of the debited account the date, journal page,
and debit amount shown
o In the reference column of the journal, write the account number to which the debit amount
was posted
o In the ledger, enter in the appropriate column of the credited account the date, journal page,
and credit amount shown in the journal
o In the reference column of the journal, write the account number to which the credit amount
was posted
 Completed when a company records all of the posting reference numbers opposite the account titles
in the journal
 The number in the posting reference serves two purposes
o Indicates the ledger account number of the account involved
o It indicates the completion of posting for the particular item

IV – Trial balance preparation

 Lists accounts and their balances at a given time
 Usually prepared at the end of an accounting period
 Lists the accounts in the order in which they appear in the ledger
 Totals of left and right columns must agree
 The trial balance proves the mathematical equality of debits and credits after posting
 Trial balance also uncovers errors in journalizing and posting
 It is useful in the preparation of FS
 Procedures:
o Listing the account titles and their balances
o Totaling the debit and credit columns
o Proving the equality of both columns
  A trial balance does not prove that a company recorded all transactions or that the ledger is correct
 Numerous errors may exist even though trial balance columns agree
 Trial balance may balance even when a company
o Fails to journalize a transaction
o Omits posting a correct journal entry
o Posts a journal entry twice
o Uses incorrect accounts in journalizing or posting
o Makes offsetting errors in recording the amount of a transaction

V – Adjustments
 Are made in order for revenues to be recorded in the period in which services are preformed and for
expenses to be recognized in which they are incurred
 Ensure that companies follow the revenue recognition and expense recognition principles
 Makes it possible to report on the SFP the appropriate ALE at the statement date
 Makes it possible to report on the income statement the proper revenues and expenses for the period
 However, the trial balance – the first pulling together of the transaction data – may not contain up-to-
date and complete data, because of the following reasons:
o Some events are not journalized daily because it is not expedient (e.g. consumption of
supplies, earning of salaries and wages by employees)
o Some costs are not journalized during the accounting period because these costs expire with
the passage of time rather than as a result of recurring daily transactions (e.g. depreciation,
rent and insurance)
o Some items may be unrecorded (e.g. utility bill received in the next period)
 Required every time a company prepares FS
 Requires thorough understanding of entity’s operations and interrelationship of accounts
 Often prepared after the SFP date but dates the entries as of SFP date

VI – Adjusted trial balance

 Prepared after journalizing and posting all adjusting entries
 Purpose: to prove the equality of total debit and credit balances in the ledger after all adjustments
 The primary basis for the preparation of FS

VII – Statement preparation

VIII – Closing
 Basic Process
o The closing process reduces the balance of nominal (temporary) accounts to zero in order to
prepare the accounts for the next period’s transactions
o Income Summary account – matches revenues and expenses
 Used only at the end of each accounting period
 Represents the net income or net loss for the period
 Is then transferred to an equity account (Retained Earnings or Capital account)
o Closing entries are all posted to appropriate ledger accounts
 Closing entries
o Cautions in preparing closing entries:
 Avoid unintentionally doubling the revenue and expense balances rather than
zeroing them
 Do not close dividends through the income summary account – they are not
expenses, and not a factor in determining net income
 o Post-closing entries
 All temporary accounts have zero balances after closing entries

IX – Post-closing trial balance (optional)

 Third trial balance after posting the closing entries
 Purpose: to prove the equality of the permanent account balances that the company carries forward
into the next accounting period
 Will contain only permanent (real)–SFP–accounts
 Provides evidence that the company has properly journalized and posted the closing entries
 Shows that the accounting equation is in balance at the end of the accounting period
 Does not prove that company has recorded all transactions or that ledger is correct

X – Reversing entries (optional)

 The exact opposite of the adjusting entry made in the previous period
 An optional bookkeeping procedure

Adjusting entries

Types of adjusting entries

1. Deferrals
a. Prepaid expenses: expenses paid in cash before used or consumed
b. Unearned revenues: cash received before services are performed
2. Accruals
a. Accrued revenues: revenues for services performed but not yet received in cash or recorded
b. Accrued expenses: expenses incurred but not yet paid in cash or recorded

Adjusting entries for deferrals

 Deferrals – expenses or revenues that are recognized at a date later than the point when cash was
originally exchanged
 If a company does not make an adjustment for these deferrals, the asset and liability are overstated,
and the related expense and revenue are understated
 Thus, the adjusting entry for deferrals will decrease a statement of financial position account and
increase an income statement account

Prepaid expenses
 Assets paid for and recorded before a company uses them
 Examples: insurance, supplies, advertising, rent (also buildings and equipment)
 Costs that expire either with passage of time (rent and insurance) or use and consumption (supplies)
 Expiration does not require daily entries, an unnecessary and impractical task
 Without adjustment, expenses are understated and net income, assets and equity are all overstated
by the expired portion amount
 Depreciation is the process of allocating the cost of an asset to expense over its useful life in a
rational and systematic manner
o Under IFRS, the acquisition of productive facilities is viewed as a long-term prepayment for
services
o The need for making periodic adjusting entries for depreciation is therefore the same for
other prepaid expenses
o Depreciation is an estimate rather than a factual measurement of the expired cost
o Accumulated depreciation – contra asset account which offsets an asset account; used
instead of debiting the original entry for the PPE account
 o Note that asset’s book value generally differs from its fair value
 Reason: depreciation is an allocation concept, not a valuation concept
 Depreciation allocates an asset’s cost to the period in which it is used, it does not
attempt to report actual change in the value of the asset

Date Transaction Particulars Dr Cr

Beg. initial entry to record prepaid Prepaid Asset xx
expenses Cash xx
End. adjustment for prepaid Expense (expired portion) xx
expenses Prepaid Asset xx

Unearned revenues
 Liability recorded when companies receive cash before services are performed
 Company now has a performance obligation to provide service to its customers
 Example: rent, magazine subscriptions, and customer deposits for future service
 Opposite of prepaid expenses
 Unearned revenue on the books of one company is likely to be prepayment on the books of the
company that made the advance payment
 Liabilities are overstated and revenues, net income and equity are all understated prior to
adjustment

Date Transaction Particulars Dr Cr

Beg. initial entry to record Cash xx
unearned revenue Unearned Revenue xx
End. adjustment for unearned Unearned Revenue xx
revenue Revenue (earned portion) xx

Adjusting entries for accruals

 Made to record revenues for services performed and expenses incurred in the current accounting
period
 Without accrual adjustment, revenue account (and related asset account) or expense account (and
related liability account) are understated
 Adjusting entry for accruals will increase both a statement of financial position and an income
statement account

Accrued revenues
 Revenues for services performed but not yet recorded at the statement date
 May accumulate (accrue) with the passing of time (interest revenue)
 May also result from services performed but not yet billed nor collected because only a portion of
total service has been performed (commissions and fees)
 Prior to adjustment, assets and revenues are understated
 Adjusting entry: increase asset account, and increase a revenue account

Accrued expenses
 Expenses incurred but not yet paid or recorded at the statement date (interest, rent, taxes and
salaries)
 Result from same causes as accrued revenues
 An accrued expense on the books of one company is an accrued revenue to another company
 Prior to adjustment, liabilities and expenses are understated
 Adjusting entry: increase expense account, increase liability account
 Bad debts
 o Proper recognition of revenues and expenses dictates recording bad debts as an expense of
the period in which a company recognize revenue for services performed instead of the
period in which the company writes off accounts or notes
o Proper valuation of the receivable balance also requires recognition of uncollectible
receivables
o Proper recognition and valuation require an adjusting entry
o Without this adjustment, assets will be overstated and expense will be understated
o Adjusting entry: increase expense account, decrease asset account

Reversing entries

 Simplifies recording of transactions in the next accounting period

 Does not, however, change the amounts reported in the FS for the previous period

Illustration: (of optional use of reversing entries)

Transactions Reversing entries not used Reversing entries used
paid salaries and wages occurred Salaries and Wages Expense Salaries and Wages Expense
Dec 10 to Dec 24 Cash Cash
incurred salaries and wages Dec Salaries and Wages Expense Salaries and Wages Expense
25 to Dec 31, to be paid Jan 8 Salaries and Wages Payable Salaries and Wages Payable
Closing entry (Dec 31) Income Summary Income Summary
Salaries and Wages Expense Salaries and Wages Expense
Reversing entry (Jan 1) none Salaries and Wages Payable
Salaries and Wages Expense
subsequent entry, payment partly Salaries and Wages Payable Salaries and Wages Expense
for Dec 25 to Dec 31 accrued, and Salaries and Wages Expense Cash
partly for Jan 1 to Jan 8 Cash

 When a company makes reversing entries, it debits all cash payments of expenses to the related
expense account

Reversing entries – deferrals

 In some cases, a company records deferrals directly in expense or revenue accounts
 When this occurs, a company may also reverse deferrals

Illustration: (supplies)
Transactions Reversing entries not used Reversing entries used
purchase supplies with cash Supplies (asset method) Supplies Expense (expense method)
Cash Cash
Adjusting entry – amount of Supplies expense (used portion) Supplies (unused portion)
supplies on hand Supplies Supplies Expense (unused portion)
Closing entry (Dec 31) Income Summary Income summary
Supplies expense (used portion) Supplies expense (used portion)
Reversing entry (Jan 1) None Supplies expense (unused portion)
Supplies (unused portion)

 If the company initially debits supplies expense when it purchases the supplies, it then makes a
reversing entry to return to the expense account the cost of unconsumed supplies
 The company then continues to debit supplies expense for additional purchases of office supplies
during the next period
 Deferrals are generally entered in real accounts (assets and liability method) thus making reversing
entries unnecessary
Summary
 All accruals should be reversed
 All deferrals for which a company debited or credited the original cash transaction to an expense or
revenue account should be reversed
 Adjusting entries or depreciation and bad debts are not reversed