Financial and Managerial Accounting

The Accounting Cycle

Course leader : Kirubel Asegdew (Asst. prof.)

 Chapter Two: The Recording Process
Learning Objectives
After studying this chapter, you should be able to:

[1] Explain what an account is and how it helps in the recording process.
[2] Define debits and credits and explain their use in recording business
transactions.
[3] Identify the basic steps in the recording process.

[4] Explain what a journal is and how it helps in the recording process.

[5] Explain what a ledger is and how it helps in the recording process.

[6] Explain what posting is and how it helps in the recording process.

[7] Prepare a trial balance and explain its purposes.

The Account

◆ Record of increases and decreases

Account in a specific asset, liability, equity,
revenue, or expense item.
◆ Debit = “Left”
◆ Credit = “Right”

An account can be Account Name

illustrated in a T- Debit / Dr. Credit / Cr.
account form.
The Account

Debits and Credits

Double-entry system
► Each transaction must affect two or more accounts to
keep the basic accounting equation in balance.

► Recording done by debiting at least one account and

crediting another.

► DEBITS must equal CREDITS.

 Debits and Credits

If Debit amounts are greater than Credit amounts, the

account will have a debit balance.
Account Name
Debit / Dr. Credit / Cr.

Transaction #1 $10,000 $3,000 Transaction #2

Transaction #3 8,000

Balance $15,000
 Debits and Credits

If Debit amounts are less than Credit amounts, the

account will have a credit balance.
Account Name
Debit / Dr. Credit / Cr.

Transaction #1 $10,000 $3,000 Transaction #2

8,000 Transaction #3

Balance $1,000
Debits and Credits
Assets ◆ Assets - Debits should exceed
Debit / Dr. Credit / Cr.
credits.

◆ Liabilities – Credits should

Normal Balance
exceed debits.
Chapter
3-23

◆ Normal balance is on the

Liabilities
Debit / Dr. Credit / Cr.
increase side.

Normal Balance

Chapter
3-24
 Debits and Credits
Equity ◆ Issuance of share capital and
Debit / Dr. Credit / Cr.
revenues increase equity (credit).

◆ Dividends and expenses

Normal Balance
decrease equity (debit).
Chapter
3-25

Share Capital Retained Earnings Dividends

Debit / Dr. Credit / Cr. Debit / Dr. Credit / Cr. Debit / Dr. Credit / Cr.

Normal Balance Normal Balance Normal Balance

Chapter Chapter Chapter

3-25 3-25 3-23
Debits and Credits
◆ The purpose of earning
Revenue
Debit / Dr. Credit / Cr. revenues is to benefit the
shareholders.

Normal Balance
◆ The effect of debits and credits
Chapter
on revenue accounts is the
3-26

same as their effect on equity.

Expense
Debit / Dr. Credit / Cr.
◆ Expenses have the opposite
effect: expenses decrease
equity.
Normal Balance

Chapter
3-27
 Debit/Credit Rules
Liabilities
Debit / Dr. Credit / Cr.
Normal Normal
Balance Balance
Debit Credit Normal Balance

Assets Chapter
3-24

Equity
Debit / Dr. Credit / Cr.
Debit / Dr. Credit / Cr.

Normal Balance
Normal Balance

Chapter
3-23

Expense Chapter
3-25
Revenue
Debit / Dr. Credit / Cr.
Debit / Dr. Credit / Cr.

Normal Balance
Normal Balance

Chapter
3-27 Chapter
3-26
 Debit/Credit Rules
Statement of
Financial Position Income Statement
Asset = Liability + Equity Revenue - Expense

Debit

Credit
Equity Relationships
Summary of Debit/Credit Rules
Relationship among the assets, liabilities and equity of a
business:
Illustration

The equation must be in balance after every transaction.

For every Debit there must be a Credit.
Steps in the Recording Process

Transfer journal information to

Analyze each transaction Enter transaction in a journal ledger accounts

Business documents, such as a sales slip, a check, a bill, or

a cash register tape, provide evidence of the transaction.
Steps in the Recording Process
The Journal
◆ Book of original entry.

◆ Transactions recorded in chronological order.

◆ Contributions to the recording process:

1. Discloses the complete effects of a transaction.

2. Provides a chronological record of transactions.

3. Helps to prevent or locate errors because the debit and

credit amounts can be easily compared.
Steps in the Recording Process

Journalizing - Entering transaction data in the journal.

Illustration: On September 1, shareholders’ invested €15,000 cash
in the corporation in exchange for share of stock, and Softbyte
purchased computer equipment for €7,000 cash.

General Journal

Date Account Title Ref. Debit Credit

Sept. 1 Cash 15,000
Share capital-ordinary 15,000

Equipment 7,000
Cash 7,000
Steps in the Recording Process

Simple and Compound Entries

Illustration: On July 1, Tsai Company purchases a delivery truck
costing $420,000. It pays $240,000 cash now and agrees to pay
the remaining $180,000 on account.

General Journal

Date Account Title Ref. Debit Credit

July 1 Equipment 420,000
Cash 240,000
Accounts payable 180,000
Steps in the Recording Process
The Ledger
◆ General Ledger contains the entire group of accounts
maintained by a company.
Steps in the Recording Process
Standard Form of Account
 Steps

Posting –
process of
transferring
amounts from
the journal to
the ledger
accounts.
Chart of Accounts
Accounts and account numbers arranged in sequence in which
they are presented in the financial statements.
 The Recording Process Illustrated

Follow these steps:

1. Determine what
type of account is
involved.
2. Determine what
items increased or
decreased and by
how much.
3. Translate the
increases and
decreases into
debits and credits.
Illustration 2-20
The Recording Process Illustrated
The Recording Process Illustrated
The Recording Process Illustrated
The Recording Process Illustrated
The Recording Process Illustrated
The Recording Process Illustrated
The Recording Process Illustrated
The Recording Process Illustrated
The Recording Process Illustrated
Illustration 2-31
Trial Balance
Timing Issues
Accountants divide the economic life of a business into
artificial time periods (Time Period Assumption).

.....
Jan. Feb. Mar. Apr. Dec.

◆ Generally a month, a quarter, or a year.

◆ Also known as the “Periodicity Assumption”

Timing Issues
Fiscal and Calendar Years
◆ Monthly and quarterly time periods are called interim
periods.

◆ Most large companies must prepare both quarterly and

annual financial statements.

◆ Fiscal Year = Accounting time period that is one year in

length.

◆ Calendar Year = January 1 to December 31.

Timing Issues

Accrual- vs. Cash-Basis Accounting

Accrual-Basis Accounting
◆ Transactions recorded in the periods in which the
events occur.

◆ Revenues are recognized when the services are

performed, rather than when cash is received.

◆ Expenses are recognized when incurred, rather than

when paid.
Timing Issues

Accrual- vs. Cash-Basis Accounting

Cash-Basis Accounting
◆ Revenues recognized when cash is received.

◆ Expenses recognized when cash is paid.

◆ Cash-basis accounting is not in accordance with

International Financial Reporting Standards (IFRS).
Timing Issues

Recognizing Revenues and Expenses

Revenue Recognition Principle
Recognize revenue in the
accounting period in which the
performance obligation is
satisfied.

In a service enterprise,
revenue is considered to be
earned at the time the service
is performed.
Timing Issues

Recognizing Revenues and Expenses

Expense Recognition Principle
Match expenses with
revenues in the period when
the company makes efforts to
generate those revenues.

“Let the expenses follow

the revenues.”
Timing Issues
IFRS relationships in revenue
and expense recognition
The Basics of Adjusting Entries

Adjusting Entries
◆ Ensure that the revenue recognition and expense
recognition principles are followed.

◆ Necessary because the trial balance may not contain

up-to-date and complete data.

◆ Required every time a company prepares financial

statements.

◆ Will include one income statement account and one

statement of financial position account.
The Basics of Adjusting Entries

Types of Adjusting Entries

Categories of adjusting entries

Deferrals Accruals
1. Prepaid Expenses. 3. Accrued Revenues.
Expenses paid in cash before Revenues for services
they are used or consumed. performed but not yet
received in cash or recorded.

2. Unearned Revenues. 4. Accrued Expenses.

Cash received before services Expenses incurred but not yet
are performed. paid in cash or recorded.
 The Basics of Adjusting Entries

Types of Adjusting Entries

Trial Balance –
Each account is
analyzed to
determine whether
it is complete and
up-to-date.

Illustration 3-3
The Basics of Adjusting Entries

Adjusting Entries for Deferrals

Deferrals are either:

◆ Prepaid expenses

OR

◆ Unearned revenues.
The Basics of Adjusting Entries

Prepaid Expenses
Payment of cash, that is recorded as an asset because
service or benefit will be received in the future.

Cash Payment BEFORE Expense Recorded

Prepayments often occur in regard to:

◆ insurance ◆ rent
◆ supplies ◆ equipment
◆ advertising ◆ buildings
The Basics of Adjusting Entries

Prepaid Expenses
◆ Expire either with the passage of time or through use.

◆ Adjusting entry:
► Increase (debit) to an expense account and

► Decrease (credit) to an asset account.

The Basics of Adjusting Entries

Illustration: Pioneer Advertising Agency

purchased supplies costing $2,500 on
October 5. Pioneer recorded the payment
by increasing (debiting) the asset
Supplies. This account shows a balance
of $2,500 in the October 31 trial balance.
An inventory count at the close of
business on October 31 reveals that
$1,000 of supplies are still on hand.

Oct. 31 Supplies expense 1,500

Supplies 1,500
The Basics of Adjusting Entries
Illustration
The Basics of Adjusting Entries

Illustration: On October 4, Pioneer

Advertising paid $600 for a one-year fire
insurance policy. Coverage began on
October 1. Pioneer recorded the payment
by increasing (debiting) Prepaid Insurance.
This account shows a balance of $600 in
the October 31 trial balance. Insurance of
$50 ($600 ÷ 12) expires each month.

Oct. 31 Insurance expense 50

Prepaid insurance 50
The Basics of Adjusting Entries
Illustration
The Basics of Adjusting Entries

Depreciation
◆ Buildings, equipment, and vehicles (assets with long
lives) are recorded as assets, rather than an expense,
in the year acquired.

◆ Depreciation allocates a portion of the asset’s cost as

an expense during each period of the asset’s useful life.

◆ Depreciation does not attempt to report the actual

change in the value of the asset.
The Basics of Adjusting Entries

Illustration: For Pioneer Advertising, assume

that depreciation on the equipment is $480 a
year, or $40 per month.

Oct. 31
Depreciation expense 40
Accumulated depreciation 40

Accumulated Depreciation is called a contra

asset account.
The Basics of Adjusting Entries
Illustration
The Basics of Adjusting Entries

Statement Presentation
◆ Accumulated Depreciation is a contra asset account
(credit).
◆ Appears just after the account it offsets (Equipment) on
the statement of financial position.
◆ Book value is the difference between the cost of any
depreciable asset and its accumulated depreciation.
Illustration
The Basics of Adjusting Entries

Illustration
 The Basics of Adjusting Entries

Unearned Revenues
Receipt of cash that is recorded as a liability because service
has not be performed.

Cash Receipt BEFORE Revenue Recorded

Unearned revenues often occur in regard to:

◆ Rent ◆ Magazine subscriptions
◆ Airline tickets ◆ Customer deposits
The Basics of Adjusting Entries

Unearned Revenues
◆ Adjusting entry is made to record the revenue for
services performed and to show the liability that remains.

◆ Results in a decrease (debit) to a liability account and

an increase (credit) to a revenue account.

Illustration
The Basics of Adjusting Entries

Illustration: Pioneer Advertising received $1,200 on October 2

from R. Knox for advertising services expected to be completed by
December 31. Unearned Service Revenue shows a balance of
$1,200 in the October 31 trial balance. Analysis reveals that the
company earned $ 400 of those fees in October.

Oct. 31 Unearned service revenue 400

Service revenue 400
The Basics of Adjusting Entries
Illustration
The Basics of Adjusting Entries

Illustration
The Basics of Adjusting Entries

Adjusting Entries for Accruals

Accruals are made to record

◆ Revenues for services performed

OR

◆ Expenses incurred

in the current accounting period that have not been

recognized through daily entries.
 The Basics of Adjusting Entries

Accrued Revenues
Revenues for services performed but not yet received in cash
or recorded.

Revenue Recorded BEFORE Cash Receipt

Accrued revenues often occur in regard to:

◆ Interest ◆ Rent
◆ Services performed
The Basics of Adjusting Entries

Accrued Revenues
◆ Adjusting entry shows the receivable that exists and
records the revenues for services performed.

◆ Adjusting entry:
► Increases (debits) an asset account and
► Increases (credits) a revenue account.

Illustration
The Basics of Adjusting Entries

Illustration: In October Pioneer Advertising

Agency recognized $200 for advertising
services performed but not recorded.

Oct. 31
Accounts receivable 200
Service revenue 200

On November 10, Pioneer receives cash of $

200 for the services performed.

Nov. 10 Cash 200

Accounts receivable 200
The Basics of Adjusting Entries
Illustration
The Basics of Adjusting Entries
Illustration
The Basics of Adjusting Entries

Accrued Expenses
Expenses incurred but not yet paid in cash or recorded.

Expense Recorded BEFORE Cash Payment

Accrued expenses often occur in regard to:

◆ Rent ◆ Taxes
◆ Interest ◆ Salaries
The Basics of Adjusting Entries

Accrued Expenses
◆ Adjusting entry records the obligation and recognizes the
expense.

◆ Adjusting entry:
► Increase (debit) an expense account and
► Increase (credit) a liability account.

Illustration
The Basics of Adjusting Entries

Illustration: Pioneer Advertising signed a three-month note

payable in the amount of $5,000 on October 1. The note requires
Pioneer to pay interest at an annual rate of 12%.
Illustration

Oct. 31 Interest expense 50

Interest payable 50
The Basics of Adjusting Entries
Illustration
The Basics of Adjusting Entries

Illustration: Pioneer Advertising last paid salaries on October 26;

the next payment of salaries will not occur until November 9. The
employees receive total salaries of $2,000 for a five-day work
week, or $400 per day. Thus, accrued salaries at October 31 are
$1,200 ($ 400 x 3 days).
Illustration 3-19
The Basics of Adjusting Entries
Illustration
The Basics of Adjusting Entries

Illustration
The Basics of Adjusting Entries

Summary of Basic Relationships

Illustration
The Adjusted Trial Balance
Adjusted Trial Balance

◆ Prepared after all adjusting entries are journalized and

posted.

◆ Purpose is to prove the equality of debit balances and

credit balances in the ledger.

◆ Is the primary basis for the preparation of financial

statements.
Illustration
Preparing Financial Statements

Financial Statements are prepared directly from the

Adjusted Trial Balance.

Retained Statement
Income
Earnings of Financial
Statement
Statement Position
Illustration
Illustration
Using a Worksheet

Preparing a Worksheet
◆ Multiple-column form used in preparing financial
statements.

◆ Not a permanent accounting record.

◆ Five step process.

◆ Use of worksheet is optional.

Steps in Preparing a Worksheet
Illustration
 Steps in Preparing a Worksheet
1. Prepare a Trial Balance on the Worksheet Illustration
Adjusted Income Statement of
Trial Balance Adjustments Trial Balance Statement Financial Position
Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
Cash 15,200
Supplies 2,500
Prepaid Insurance 600
Equipment 5,000
Notes Payable 5,000
Accounts Payable 2,500
Unearned Revenue 1,200
Share Capital-Ordinary 10,000
Dividends 500
Service Revenue 10,000

Salaries and Wages Exp. 4,000

Rent Expense 900
Totals 28,700 28,700

Trial balance amounts come

directly from ledger accounts.
Include all accounts
with balances.
 Steps in Preparing a Worksheet
Illustration
General journal
showing adjusting
entries

Adjusting
Journal
Entries
 Steps in Preparing a Worksheet
2. Enter the Adjustments in the Adjustments Columns
Adjusted Income Statement of
Trial Balance Adjustments Trial Balance Statement Financial Position
Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
Cash 15,200
Supplies 2,500 (a) 1,500
Prepaid Insurance 600 (b) 50
Equipment 5,000
Adjustments Key:
Notes Payable 5,000 (a) Supplies Used.
Accounts Payable 2,500
Unearned Revenue 1,200 (d) 400 (b) Insurance Expired.
Share Capital-Ordinary 10,000
(c) Depreciation Expensed.
Dividends 500
Service Revenue 10,000 (d) 400 (d) Service Revenue Earned.
(e) 200
Salaries and Wages Exp. 4,000 (g) 1,200
(e) Service Revenue Accrued.
Rent Expense 900 (f) Interest Accrued.
Totals 28,700 28,700
Supplies Expense (a) 1,500 (g) Salaries Accrued.
Insurance Expense (b) 50
Accumulated Depreciation (c) 40
Depreciation Expense (c) 40
(e)
Accounts Receivable 200 Enter adjustment amounts, total
(f)
Interest Expense 50
Interest Payable (f) 50 adjustments columns,
(g)
Salaries and Wages Payable 1,200 and check for equality.
Totals 3,440 3,440

Add additional accounts as needed.

 Steps in Preparing a Worksheet
3. Complete the Adjusted Trial Balance Columns
Adjusted Income Statement of
Trial Balance Adjustments Trial Balance Statement Financial Position
Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
Cash 15,200 15,200
Supplies 2,500 (a) 1,500 1,000
Prepaid Insurance 600 (b) 50 550
Equipment 5,000 5,000
Notes Payable 5,000 5,000
Accounts Payable 2,500 2,500
Unearned Revenue 1,200 (d) 400 800
Share Capital-Ordinary 10,000 10,000
Dividends 500 500
Service Revenue 10,000 (d) 400 10,600
(e) 200
Salaries and Wages Exp. 4,000 (g) 1,200 5,200
Rent Expense 900 900
Totals 28,700 28,700
Supplies Expense (a) 1,500 1,500
Insurance Expense (b) 50 50
Accumulated Depreciation (c) 40 40
Depreciation Expense (c) 40 40
(e)
Accounts Receivable 200 200
(f)
Interest Expense 50 50
Interest Payable (f) 50 50
(g)
Salaries and Wages Payable 1,200 1,200
Totals 3,440 3,440 30,190 30,190

Total the adjusted trial balance

columns and check for equality.
 Steps in Preparing a Worksheet
4. Extend Amounts to Financial Statement Columns
Adjusted Income Statement of
Trial Balance Adjustments Trial Balance Statement Financial Position
Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
Cash 15,200 15,200
Supplies 2,500 (a) 1,500 1,000
Prepaid Insurance 600 (b) 50 550
Equipment 5,000 5,000
Notes Payable 5,000 5,000
Accounts Payable 2,500 2,500
Unearned Revenue 1,200 (d) 400 800
Share Capital-Ordinary 10,000 10,000
Dividends 500 500
Service Revenue 10,000 (d) 400 10,600 10,600
(e) 200
Salaries and Wages Exp. 4,000 (g) 1,200 5,200 5,200
Rent Expense 900 900 900
Totals 28,700 28,700
Supplies Expense (a) 1,500 1,500 1,500
Insurance Expense (b) 50 50 50
Accumulated Depreciation (c) 40 40
Depreciation Expense (c) 40 40 40
(e)
Accounts Receivable 200 200
(f)
Interest Expense 50 50 50
Interest Payable (f) 50 50
(g)
Salaries and Wages Payable 1,200 1,200
Totals 3,440 3,440 30,190 30,190 7,740 10,600

Extend all revenue and expense account

balances to the income statement columns.
 Steps in Preparing a Worksheet
5. Total Columns, Compute Net Income (Loss)
Adjusted Income Statement of
Trial Balance Adjustments Trial Balance Statement Financial Position
Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
Cash 15,200 15,200 15,200
Supplies 2,500 (a) 1,500 1,000 1,000
Prepaid Insurance 600 (b) 50 550 550
Equipment 5,000 5,000 5,000
Notes Payable 5,000 5,000 5,000
Accounts Payable 2,500 2,500 2,500
Unearned Revenue 1,200 (d) 400 800 800
Share Capital-Ordinary 10,000 10,000 10,000
Dividends 500 500 500
Service Revenue 10,000 (d) 400 10,600 10,600
(e) 200
Salaries and Wages Exp. 4,000 (g) 1,200 5,200 5,200
Rent Expense 900 900 900
Totals 28,700 28,700
Supplies Expense (a) 1,500 1,500 1,500
Insurance Expense (b) 50 50 50
Accumulated Depreciation (c) 40 40 40
Depreciation Expense (c) 40 40 40
(e)
Accounts Receivable 200 200 200
(f)
Interest Expense 50 50 50
Interest Payable (f) 50 50 50
(g)
Salaries and Wages Payable 1,200 1,200 1,200
Totals 3,440 3,440 30,190 30,190 7,740 10,600 22,450 19,590
Net Income 2,860 2,860
Totals 10,600 10,600 22,450 22,450
Compute Net Income or Net Loss.
Using a Worksheet

Preparing Statements from a Worksheet

◆ Income statement is prepared from the income
statement columns.

◆ Statement of financial position and retained earnings

statement are prepared from the statement of financial
position columns.

◆ Companies journalize and post adjusting entries.

Preparing Statements from a Worksheet
Illustration
Preparing Statements from a Worksheet
Illustration
Preparing Statements from a Worksheet
Illustration
Using a Worksheet

Preparing Adjusting Entries from a Worksheet

◆ Adjusting entries are prepared from the adjustments
columns of the worksheet.

◆ Journalizing and posting of adjusting entries follows the

preparation of financial statements when a worksheet is
used.
Closing the Books

At the end of the accounting period, the company makes

the accounts ready for the next period.
Illustration
Closing the Books

Preparing Closing Entries

Closing entries formally recognize, in the general ledger, the
transfer of
◆ net income (or net loss) and
◆ dividends
to retained earnings.

Closing entries are only made at the end of the annual

accounting period.
 Closing the Books

Note:
Dividends are closed directly Illustration

to retained earnings and not

to Income Summary because
Retained earnings is a
dividends are not an permanent account; all
other accounts are
expense. temporary accounts.
 Closing the Books

Closing
Entries
Illustrated
Closing the Books

Posting
Closing
Entries
Preparing a Post-Closing Trial Balance
Purpose is to prove the equality of the permanent account
balances after journalizing and posting of closing entries.

Illustration
Summary of the Accounting Cycle
Illustration

1. Analyze business transactions

9. Prepare a post-closing 2. Journalize the

trial balance transactions

8. Journalize and post

3. Post to ledger accounts
closing entries

7. Prepare financial
4. Prepare a trial balance
statements

6. Prepare an adjusted trial 5. Journalize and post

balance adjusting entries
End of Discussion
Thank you for your attention