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Unit: Process Financial

Transactions and Extract
Interim Reports

1. An Overview of accounting
Accounting is the process of identifying, measuring, recording, summarizing,
reporting/communicating/ & interpreting the Business Transactions to different users for
decision making purposes.
Business Transactions are the financial occurrences of an event that must be recorded in the
accounting records.
As businesses & society have become complex over years, accounting has developed new
concepts & techniques to meet the ever-increasing needs for financial information. Without
such information, many complex economic developments social programs might never be
undertaken.

Account as Information System

Accounting enables inter & intra businesses organization financial communication through
financial statements. Accounting is thus often called BUSINESS LANGUAGE.
Users of Accounting Information:

1. External Users

INVESTORS: need the accounting information to know the financial status of the
organization to make a decision whether to invest their capital in the entity.

BANKERS/LENDERS/ & SUPPLIERS: appraise the financial of soundness a business

organization & assess the risks involved just before they make a loan & grant credits.

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GOVERNMENT AGENCIES: are concerned with the financial activities of a business

organization for taxation purposes & regulations.

LABOR UNION: are also interested in the stability & profitability of the business
organization that hires them in negotiating labor contract.

2. Internal Users

THE MANAGEMENT: these are the responsible people for directing the operation of
enterprises, demand the accounting information to accelerate favorable trends & to reduce
those unfavorable, to evaluate the employees’ current performance & appraise them
accordingly, to plan the future.

2. Accounting Principles and Concepts

In order to ensure high-quality financial reporting, accountants present financial statements in
conformity with accounting standards that are issued by standard setting bodies. Presently,
there are two primary accounting standard-setting bodies—the International Accounting
Standards Board (IASB) and the Financial Accounting Standards Board (FASB). More than
130 countries follow standards referred to as International Financial Reporting Standards
(IFRS). IFRSs are determined by the IASB. The IASB is

United States follow standards issued by the FASB, referred to as generally accepted
accounting principles (GAAP).

As markets become more global, it is often desirable to compare the results of companies
from different countries that report using different accounting standards. In order to increase
comparability, in recent years the two standard-setting bodies have made efforts to reduce the
differences between IFRS and U.S. GAAP. This process is referred to as convergence. As a
result of these convergence efforts, it is likely that someday there will be a single set of high-
quality accounting standards that are used by companies around the world. Because
convergence is such an important issue, we provide at the end of each chapter a section called

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Another Perspective, to provide a comparison with IFRS. Some of the principles and concepts
are the following:

2.1. Accounting Principles

Measurement Principles
IFRS generally uses one of two measurement principles, the historical cost principle or the
fair value principle. Selection of which principle to follow generally relates to trade-offs
between relevance and faithful representation. Relevance means that financial information is
capable of making a difference in a decision. Faithful representation means that the numbers
and descriptions match what really existed or happened they are factual.

Historical Cost Principle

The historical cost principle (or cost principle) dictates that companies record assets at their
cost. This is true not only at the time the asset is purchased, but also over the time the asset is
held. For example, if ABC PLC purchases land for Br.300, 000, the company initially reports
it in its accounting records at Br.300, 000. But what does ABC do if, by the end of the next
year, the fair value of the land has increased to Br. 400,000? Under the historical cost
principle, it continues to report the land at Br.300, 000.

Fair Value Principle

The fair value principle states that assets and liabilities should be reported at fair value (the
price received to sell an asset or settle a liability). Fair value information may be more useful
than historical cost for certain types of assets and liabilities. For example, certain investment
securities are reported at fair value because market value information is usually readily

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available for these types of assets. In determining which measurement principle to use,
companies weigh the factual nature of cost figures versus the relevance of fair value. In
general, even though IFRS allows companies to revalue property, plant, and equipment and
other long-lived assets to fair value, most companies choose to use cost. Only in situations
where assets are actively traded, such as investment securities, do companies apply the fair
value principle extensively.

Revenue Realization Principle

Revenue represents the inflow of assets to a business enterprise arising from its operating
activities. Realization, on the other hand, refers to becoming real or true. Hence, revenue
realization principle addresses the question of identifying the critical event to make business
revenues real. According to the principle a business realize revenue at the moment when
goods are sold or services are delivered to customers. It does not matter whether cash is
collected or not to realize revenues.

Matching Principle

The revenues that are generated by a business are not realized without incurring an expense.
To realize revenue businesses are definitely required to assume certain expenses. Expenses
are outflows of assets for the purpose of operating activities of the business. Hence, the
matching principle asserts that expenses incurred by a business in the process of realizing
revenues should be reported in the same accounting period where revenues are realized. That
is, revenue should be associated (matched) to expenses incurred in the same period. Here also,
it does not matter whether expenses are paid in cash or not. The fact that they are incurred is
sufficient to match them against revenues.

2.2. Basic Assumptions

Business (Economic) Entity Concept

This concept assumes that the business organization is separate and distinct from the
individuals who contributed properties to it (i.e. Owner(s)). It states that the accounting
records of the business should be kept separate from the accounting records of the owners and
its other investment.

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Going Concern Concept

It assumes that once established a business organization is reasonably expected to last making
a profit for an indefinite time period. However, there are times where by businesses are
established for a limited period of time like for example Bazaars and Exhibitions in such
circumstance the concept of going concern is replaced by quitting- concern.

The concept of Unit of Measurement

This concept assumes that accounting information is reported in terms of a given currency
such as Birr, Dollar, Pound Sterling, Frank, Mark etc. It further assumes that monetary units
(currencies) are generally stable. Practical experience however, tells us that the values of
currencies can raise and fall due to inflation and deflation. The accounting profession has
given a due consideration to fluctuations in price levels and has incorporate techniques in
order to deal with price level changes you will learn those techniques in intermediate level
accounting course in the near future.

The accounting period Assumption

This principle states that accounting records should be maintained periodically. According to
this principle, the operating results and the financial conditions of a business enterprise are
reported in a given and specified time periods. The specified time periods of reporting could
be months, quarters of years, or years.

3. Types of Business Organizations

According to their type of activities or nature of operations, business organizations are
also classified in to three main types:
1. Service rendering businesses: - are business organizations that are predominantly
engaged in rendering of services to customers for the purpose of maximizing
profit.
Examples: Hotels, restaurants, cafeterias, bars, transport and communication services,
professional firms like consultations by accountants, lawyers, engineers etc.
2. Merchandising businesses: - is profit seeking businesses, which are engaged in

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purchasing and reselling of merchandises.

Examples: Supermarkets, boutiques, garment and shoe shops, drug stores, stationary
shops, auto spare parts, importers, exporters etc.
3. Manufacturing businesses: - are business organizations that are primarily
involved in the conversion of raw materials and parts in to finish goods; and sale
their finished goods to merchandising enterprises and consumers. Sometimes, they
sale goods to other manufacturing firms, which utilize the goods as raw materials
for production activities.
Examples: Cement factories, sugar factories, soap factories, textile factories, paper factories,
etc.

Forms of business organizations

There are three different legal forms of business organization: those are
1. Sole proprietorship: - A business owned by one person is generally a
proprietorship. The owner is often the manager/operator of the business. Small
service-type businesses (plumbing companies, beauty salons, and auto repair
shops), farms, and small retail stores (antique shops, clothing stores, and used-
book stores) are often proprietorships. Usually only a relatively small amount of
money (capital) is necessary to start in business as a proprietorship. The owner
(proprietor) receives any profits, suffers any losses, and is personally liable for all
debts of the business. There is no legal distinction between the business as an
economic unit and the owner, but the accounting records of the business activities
are kept separate from the personal records and activities of the owner.
2. Partnership: - A business owned by two or more persons associated as partners
is a partnership. In most respects a partnership is like a proprietorship except
that more than one owner is involved. Typically, a partnership agreement (written
or oral) sets forth such terms as initial investment, duties of each partner, division
of net income (or net loss), and settlement to be made upon death or withdrawal
of a partner. Each partner generally has unlimited personal liability for the debts
of the partnership. Like a proprietorship, for accounting purposes the
partnership transactions must be kept separate from the personal activities
of the partners.
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3. Corporation: - A business organized as a separate legal entity under corporation

law and having ownership divided into transferable shares is a corporation.
The holders of the shares (shareholders) enjoy limited liability; that is, they
are not personally liable for the debts of the corporate entity. Shareholders may
transfer all or part of their ownership shares to other investors at any
time (i.e., sell their shares). The ease with which ownership can change adds to
the attractiveness of investing in a corporation. Because ownership can be
transferred without dissolving the corporation, the corporation enjoys an
unlimited life.
4. Business Transactions and Accounting Equation

4.1. Business Transactions

Business transactions are events or activities which can be expressed in
terms of money value and which should be recorded in the books of an
enterprise.
Business transactions are economic events that should be recorded because
they affect the financial position of the business enterprises. These
businesses transactions are the raw materials of accounting reports, as
cotton is a raw material for a textile factory.
Business transactions may be described as:
 Simple transactions: Such transactions occur just only once. For
example, the payment of cash to settle the monthly telephone bill.
 Complex transactions: in this case, one transaction will initiate another
transaction & may bring several such networks. For example, assume
that a building is acquired partly paying cash & promising to pay the
remaining amount in the future. But for delaying the pay, interest shall
be paid for the seller monthly; when the building is used in business
operation of the Company, it decreases in value &such gradual
decrease in value called depreciation shall be taken into account.
Hence, a single transaction also brings other several transactions.
 External transaction: is a transaction between an organization & an
outside party. For example, the payment of telephone bill, the

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acquisition of building, the payment of interest etc.

 Internal transaction: are transactions within the organization itself.
For example
 the consideration of the decrease in the value of plant asset is an
internal transaction,
 recognition of uncollectible accounts,

4. 2. Accounting Equation
Assets: A resource controlled by the entity as a result of past events and from which
future economic benefits are expected to flow to the entity.
Equity: the right/claim of the owner against
the properties Example:XYZ Company
acquired an automobile of $100,000
Asset = Equity 100,000 = 100,000
Equity may be categorized into two broad principal subdivisions as:
1. The right of the creditors/ Liabilities
2. The right of the owner/ owner’s equity
Liabilities A present obligation of the entity arising from past events.
Asset = Liabilities + Owner`s Equity
Further consider the above example that $45,000 of the total amount is
borrowed from someone else to purchase an automobile & remaining is
contributed by the business itself. So, we can it in accounting equation as:
Asset = Liability + Owner`s Equity $45,000 + $55,000

Key Terms

Accounts Payable: a liability that is created from purchase on account

and/or raising funds through loan.
Prepaid Expenses: purchase of consumable goods or advance a\cash
payment for unused services Accounts Receivable: claim of the business
organization against the customer that is created as a result of sales on
account or performing a certain service at not for cash.

Revenues: income generated from sales of goods & services

Expenses: Decreases in economic benefits during the accounting period in
the form of outflows or depletions of assets or incurrences of liabilities that

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result in decreases in equity, other than those relating to distributions to

equity participants.
Example 1: Assume that Mr. John established a Sole Proprietorship to be
known as Long Taxi, and completed the following transactions during the
month of August:
August 1: Mr. John deposited $10,000 at bank in the name of his business
5: Mr. John purchased land for future building site, $7,500 for cash
8: Mr. John purchased gasoline, oil & other supplies agreeing to pay the amount on the near
future,$850
12: The business earned fares of $4,500 & received the amount for cash
18: Paid creditors on account for purchase of August 8, $400
27: Long taxi incurred & paid the following expenses for the month of August: wages
expense =$1,125, rent expense = $850, utilities expense = $150 & miscellaneous expense =
$75
30: Withdrew $1,000 for personal use
31: determined the cost of supplies on hand to be $250. Supplies of $600 have
been used in the operation

Required:

1. Analyze these transactions

2. Summarize the effect of transaction by Tabulation formula System

Solution: Tabulation System
Assets Liabilities Owner`s Equity Description
August

Cash Supplies Land A/P John, Capital

1 + 10,000 + 10,000 Investment
5 (7,500) + 7,500
8 + 850 +850
12 + 4,500 + 4,500 Fares earned
18 (400) (400)

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27 (2,200) (1,125) Wages expense

(850) Rent expense
(150) Utilities expense
(75) Misc. expense
30 (1000) (1000) Withdrawal
31 (600) (600) Supplies expense
$3,400 $25 0 $7,500 $450 $10,700

Note: The effect of every transaction is stated in terms of increase and/or

decrease in one or more accounting equation elements. The equality of the
two sides is always maintained; & the owner`s equity is increased by
additional investment & revenues and decreased by expenses &
withdrawals.

5. Definition of an Account
Account –a record showing separately the increases and decreases of a financial statement
item during a period.
5.1. Classifications of Accounts
Accounts are classified into five: assets, liabilities, capital, revenue and expenses. The first
three are called balance sheet accounts and the other two are called income Statement
accounts. Balance Sheet accounts are those reported on the balance sheet at the end of the
reporting period and Income Statement accounts are reported on the Income Statement.
The five groups of account are discussed below:
1. Assets: Resources owned by a business or individual are called assets. Assets could be
tangible or intangible. Tangible assets are assets having physical existence, like cash, land,
computer, stationery materials. Intangible assets do not have physical existence. Example:
Goodwill, Copyright, patent right.
On the balance sheet assets are classified into two current assets and non-current assets.
Current Assets: are those assets, which can be used, sold, or converted into cash within one
accounting year. Example: cash, supplies, prepayments, receivables etc.
Non-current Asset: All assets other than current assets are called non-current assets.
Example: land, patent right, office equipment, vehicles.

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2. Liabilities: Creditors’’ claims to the assets of a business; amounts owed to creditors are
called liabilities. Like assets, liabilities are classified in to two as current liabilities and non-
current liabilities
Current liabilities: The liabilities that are payable within the next (one) accounting year are
known as current liability. Example: Accounts Payable, Rent Payable, Salary Payable.
Non-Current Liabilities: Debts that are not required to be paid within the next accounting
period. Example long term notes payable.
3. Capital: The excess of the assets of a business over its liabilities is referred to as capital. It
is the equity of the owner in the business.
4. Revenue: Are increases in owner’s equity resulting from the main operations of the
business. Examples of revenue accounts are sales, interest income, tuition fee, and sales
commission.
5. Expenses: are decreases in owner’s equity in the process of earning revenue. For example,
a hotel has to pay salary to its workers for the services rendered to clients in order to get the
income form customers (revenue) the Hotel has pay salary to the employees (expense).
Example of expenses: Salary, insurance, depreciation, supplies, utilities, rent etc.

5.2. Chart of Accounts

The number and name of accounts used by an organization depends on the nature of its
operation. The list of accounts used by an organization and their codes is called the chart of
accounts. Look at the following chart of accounts.

Chart of Accounts
Asset Account number
Cash---------------------------------------------------------------------------11
Accounts Receivable------------------------------------------------------ 12
Supplies-----------------------------------------------------------------------13
Prepaid Insurance-----------------------------------------------------------14
Equipment------------------------------------------------------------------- 15
Accumulated Depreciation –Equipment--------------------------------16
Truck--------------------------------------------------------------------------17
Accumulated depreciation – Truck--------------------------------------18

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Liabilities
Accounts Payable------------------------------------------------------------21
Notes Payable-----------------------------------------------------------------22
Owners Equity
Owner’s Capital--------------------------------------------------------31
Owner’s Drawing-------------------------------------------------------32
Income Summary-------------------------------------------------------------33
Revenue
Service income----------------------------------------------------------------41
Expense
Salaries Expense --------------------------------------------------------------51
Rent Expense ------------------------------------------------------------------52
Utilities Expense---------------------------------------------------------------53
Supplies Expense--------------------------------------------------------------54
Insurance Expense-------------------------------------------------------------55
Maintenance Expense---------------------------------------------------------56
Depreciation Expense---------------------------------------------------------57
Truck Expense------------------------------------------------------------------58
Miscellaneous expense--------------------------------------------------------59
In the chart of accounts, the asset accounts are listed according to their liquidity. Liquidity is
the ease with which an asset can be converted in to cash. Cash is the most liquid asset so it is
listed first. Accounts other than cash will be listed in their frequency of use or in alphabetical
order.
The account number is a code to identify accounts. The number could be a two digit, three
digit or more digits. In the above example a three digits code is used.
When the chart of accounts is prepared in an organization we say the ledger is opened.

5.3. Nature of an account

In order to provide the necessary information to users, accountants maintain separate records
on each element of the financial statements. For example, to report the balance for cash at the
end of a year, a record regarding cash should be kept. The record includes beginning cash
balance, cash payments & cash collections during the period. This record is called an
account.

Definition: An account is a subdivision under the three elements of the accounting equation
used to record the changes over a single element in the financial statements. An account has
three parts, Title, Debit, and credit. For illustration purposes an account can be represented in
the form of capital letter ‘T’.

Example: Title

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Debit Credit

Dr Cr

6. Rules of Debits and Credits and Normal Balance of Accounts

As shown above every account has three parts. These parts are discussed below:

Title the name of the account. This is written at the top of the account.

Debit is the left hand side of an account Debit is abbreviated as Dr. When an amount is
entered on the left side of an account we say the account is debited or charged.

Credit is the right hand side of an account. Credit is abbreviated as Cr. An account is said to
be credited when an amount is entered on the right hand side of the account.

An account may increase or decrease on the debit side or on the credit side depending on the
nature of the account. In general, accounts appearing on the left hand side of the accounting
equation increase on their left side (Dr. side) and decrease on their right side (Cr. Side);
whereas accounts on the right side of the equation increase on their right side and decrease on
their left side.

6.1. The normal balance of an Account

The above general rule will be expanded as follows

Debit Credit

-Increase in assets -Decrease in assets

-Increase in expenses -Decrease in expenses

-Decrease in capital -Increase in Liabilities

-Decrease in liabilities -Increase in liabilities

-Decrease in revenue -Increase in revenue.

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Normal balance refers to the side of an account (Dr. or Cr.), which will have greater entries
than the other. The increasing side will be the normal balance for accounts.

Example: The normal balance of all asset accounts is debit.

7. Journalizing Business Transactions

When a business transaction takes place, source documents will be obtained and recorded.
The accounting record in which a transaction is initially recorded is known as a journal. The
journal is therefore referred to as “The book of original entry”.
The process of recording a business transaction in the accounting record is called
journalizing.
The Journal commonly used to record all types of transactions is the General Journal. This
Journal includes the following parts, entered step by step.
1. The date of the transaction
2. The title of the account debited
3. The title of the account credited
4. The amount of debit and credit
5. Brief explanation of the entry or reference to the source document.
Look at the following General Journal and notice where each of the above information is
found.
Journal page

Date Description P.R Debit Credit

Year

Month Da Debited account title XXX XX

y

Credited account title X XX XX

Explanation

There are also other types of Journals like, known as special journals that are used to record
specific types of transactions. The cash Journal, for instance, is used to record only
transactions affecting cash. The General Journal is used for illustrations in this chapter.
Special journals are discussed in unit 5.

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7.1. Steps in Journalizing a Transaction

The following steps should be followed in recording a transaction in the journal.

1. Record the date - Insert the year, the month, and the date as shown above.
2. Record the Debit- Insert the account debited in the description column and the amount
of debit in the debit column.
3. Record the credit- Insert the account credited below the debited account and indented
to the right in the description column and the amount of credit in the credit column.
4. Explanation- Write a brief explanation or reference to source document in the
description column, when necessary.
Each one set of debits and credits for a transaction is called a journal entry.

In recording a business transaction answer the following questions based on the transaction to
be recorded may help you.
a) Which accounts are affected?
b) Is each account increased or decreased?
c) Which account is debited and which is credited?
d) Prepare the complete journal entry.
Example: On January 10, 2003 Tamget P.L.C paid Birr 6,000 to its employees as a salary for
the first week of the year. This business transaction will be analyzed and recorded as follows.

a) Which accounts are affected? Answer: Cash and Salary Expense.

b) Is each account increased or decreased? Answer: cash is decreased and salary expense is
increased.
c) Which account is debited and which is credited? Answer: Salary Expense is debited
because increase in expenses is recorded on the debit side. And cash is credited because
decrease in assets is recorded on the debit side.
d) Prepare the complete Journal entry.

2003 Description

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Jan. 1 Salary expense 6000 00

0

Cash 6000 00

Payment of salary

Journal entry: is the complete presentation of the record in the journal.

Illustration:

The following list of selected transaction were completed by Bati Transport in the
month of January 2014. It is owned by Ato yimer
January 1. Ato yimer took Birr 450,000 from his personal savings and deposited it in the
name of Bati transport.
January 2. Bati Transport purchased two used trucks for Birr 150,000 each, on cash.
January 4. Bati Transport received a check for Birr 650 for services given to Alem Trading.
January 4. Received an invoice for truck expenses Birr 90.
January 11. Paid Birr 600 for Awash Insurance Company to buy an insurance policy for its
trucks.
January 16. Ato Yimer issued a check for Birr 9,400 to the workers as a salary for two weeks.
January 20. Bati trading Billed Muradu Supermarket for goods transported from Djibouti to
Gondar Birr 2,650
January 21. Ato Yimer wrote a check for birr 450 to have one of the trucks repainted
January 21. Bati trading purchased stationary materials and other supplies of Birr 740 on
account.
January 22. Office equipment of Birr 11,600 is bought on account.
January 23. Purchased an additional truck for Birr 250,000 paying birr 100,000 in cash and
issuing a note for the difference.
January 23. Recorded services billed to customers on account birr 14,600.
January 25. Received cash from customers on account Birr 15,000.
January 27. The owner withdrew Birr 500 in cash for his personal use.

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January 28. Paid Birr 9,400 to workers as a salary for the last two weeks of the month.
January 30. Paid telephone expense of Birr 95 and electric expenses of Birr 125 for the
month.
January 30. Paid other miscellaneous expenses Birr 50.
January 31. Paid Birr 4,000 as a rent for a building used for office space.

Required
Task1.1.finalize a business document by journalizing the above transaction

These transactions are journalized as follows:

Date Description Debit Credit

2003 Cash 450,000

Jan.1 Yimer Capital 450,000

To record investment by owner

2 Truck 300,000

Cash 300,000

Purchase of trucks

4 Cash 650

Service Income 650

Cash received from customers

4 Truck Expenses 90

Accounts Payable 90

Service received in advance

11 Prepaid Insurance 600

Cash 600

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Purchase of insurance policy

16 Salary Expense 9,400

Cash 9,400

Payment of salary

20 Accounts Receivable 2,650

Service Income 2,650

Provision of service

21 Truck Expense 450

Cash 450

Cash paid to repaint truck

21 Supplies 740

Accounts Payable 740

Purchase of supplies of account

22 Office Equipment 11,600

Accounts Payable 11,600

Purchase of equipment

23 Truck 250,000

Cash 100,000

Notes Payable 150,000

Purchase of truck

23 Accounts Receivable 14,600

Service Income 14,600

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Provision of service on account

25 Cash 15,000

Accounts Receivable 15,000

Collection of cash

27 Drawings 500

Cash 500

Owner withdrawals

28 Salary Expense 9,400

Cash 9,400

Payment of salary

30 Utilities Expense 220

Cash 220

Payment for telephone, electricity

30 Miscellaneous Expenses 50

Cash 50

Payment for various expenses

31 Rent Expense 4,000

Cash 4,000

Payment of Rent

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8. Posting (summarizing) accounts

After the information about a business transaction has been journalized, that information is
transferred to the specific accounts affected by each transaction. This process of transferring
the information is called posting.

An account could be of two types; the two-column account and the four-column account. We
will use the four-column account for our illustration. The two forms of accounts are given
below.
The two-column account:

Account Account number

Date Item P. Debit Date Item P.R Credit

R

The four-column account:

Account Account number

Date Item P. Debit Credit Balance

R
Debit Credit

8.1. The steps in posting are given below:

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1. Record the date and amount of Dr. and Cr. Entry to the account
2. Insert the Journal page number in the P.R (Post Reference) column of the account.
3. Insert the account number in the P.R column of the journal.
Note. The P.R Column is used for reference purposes. The P.R column of the journal shows
whether the entry is posted and the account to which it is posted. In the account, the P.R
Column shows the Journal page number from which the entry was brought.

The group of accounts used by an organization is called ledger.

Illustration: As mentioned above, to illustrate the posting process the four column account is
used and the entries to the cash account are posted as follows.

Account Cash Account Number

Balance
Date Item P.R Debit Credit Debit Credit
2003 450,000 00 450,000 00
Jan 1
2 300,000 00 150,000 00
4 650 00 150,650 00
11 600 00 150050 00
16 9,400 00 140650 00
21 450 00 140200 00
23 100,000 00 40200 00
25 15,000 00 55200 00
27 500 00 54200 00
28 9,400 00 45300 00
30 220 00 45,080 00
30 50 00 45,030 00
31 4,000 00 41,030 00

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Note. The item column is usually left blank. In some cases the word balance is written when
the account is carried forward to a new page.

9. Preparing the Trial Balance

After the posting phase is completed, we have to verify the equality of the debit and credit
balances. This is done through the use of the ‘Trial Balance’. A
The trial balance for our illustration, Bati Transport is presented below. The amounts are
taken from the balances of the accounts after all the transactions have been posted. Therefore,
after posting the above transactions, you should get the final balances shown on the trial
balance in the end.

Bait Transport

Trial Balance

January 31, 2003

Dr Cr

Cash 41,030 00

Accounts Receivable 2,250 00

Supplies 740 00

Prepaid Insurance 600 00

Office equipment 11,600 00

Truck 550,000 00

Accounts payable 12,430 00

Notes payable 150,000 00

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Yimer capital 450,000 00

Yimer drawing 500 00

Service income 17,900 00

Salary expense 18,800 00

Rent expense 4,000 00

Utilities expense 220 00

Maintenance expense 450 00

Truck expense 90 00

Miscellaneous expense 50 00

Total 630,330 00 630,330 00

The trial balance debit totals and credit totals are equal implies that the accounting work is
more likely to be free from any one or more of the following errors.

1. Error in preparing the trial balance including

-Addition error

-The amount of an account balance was incorrectly listed on the trial balance

- A debit balance was recorded as a credit or vice versa

- A balance was entirely omitted.

2. Error in posting, including

- An erroneous amount was posted to the account.

- A debit amount was posted as a credit or vice versa

- A debit or credit posting was omitted

23
 Prepared by: Chalachew A

10. Preparing Worksheet for Financial Statements

Most of the data required to prepare the accounting reports (financial statements) is now
gathered. The data will now be presented in a convenient form. The worksheet is a large
columnar sheet prepared to arrange in a convenient form all the accounting data required to
prepare financial statements. The worksheet has a heading and a body.

The heading has three parts:

i) Name of the Organization

ii) Name of the form (worksheet)
iii) Period of time covered.
The body contains five main parts each of them with two main columns. These parts are

1. The trial balance

2. The adjustment
3. The adjusted trial balance
4. The income statement
5. The balance sheet.

24
 The worksheet for Bait Transport is given below. The five parts of the body are discussed as
follows. You are advised to read and understand the discussions before you look at the respective
columns of the worksheet.

Bait Transport

Work Sheet

For the month ended jan.31,2003

Account Title Trial Balance Adjustment Adjusted Trial Income Balance sheeet
balance statement

1 Cash 41,030 41,030 41,030

©
2 Accounts 2,250 7,400 9,650 9,650
receivable
(a)
3 Supplies 740 340 400 400

(b)
4 Prepaid Insurance 600 450 150 150

5 Office equipment 11,600 11,600 11,600

6 Truck 550,00 550,00 550,00

0 0 0

7 Accounts payable 12,430 12,430 12,430

8 Notes payable 150,00 150,00 150,00

0 0 0

9 Yimer Capital 450,00 450,00 450,00

0 0 0

10 Yimer drawing 500 500 500

11 Service income 17,900 7,400 25,300 2530

0
12 Salary expense 18,800 18,800 18,800

13 Rent expense 4,000 4,000 4,000

14 Utilities expense 220 220 220

15 Maintenance 450 450 450

expense

16 Truck expense 90 90 90

17 Miscellaneous 50 50 50
Expense

18 630,33 630,33
0 0
(a)
19 Supplies expense 340 340 340

(b)
20 Insurance 450 450 450
expense

21 7290 7290 636,83 636,83

0 0

22 Net income

23 25300 2530 613,33 613,33

0 0 0

1. The trial balance column – this is the same trial balance we have prepared before. The trial
balance column of the work sheet can be brought direct from the ledger or from a separate trial
balance.
2. The Adjustment column – As mentioned previously, some account balances have to be
adjusted at the end of the year. The accounts in the ledger of our illustration that require
adjustment and the adjusting entry for the accounts are presented below.

a) Supplies – The supplies account has a debit balance of Birr 740. The cost of supplies in hand
on July 31 is determined to be Birr 400. The following adjusting entry is required to bring the
balance of the account up to date:

Supplies expense………………..340

Supplies……………………....340

b) Prepaid insurance – Analysis of the policy showed that three – fourth of the policy is
expired. That is only Birr 150 of the policy is applicable to future periods. The adjusting entry
to transfer the expired part of the insurance to expense will be.

Insurance expense ………...450

Prepaid insurance………...450

c) Service Income – At the end of the month unbilled fees for services performed to clients
totaled Birr 6,500. This amount refers to an income earned but to be collected in the future. The
journal entry to record it will be:

Accounts receivable………….7, 400

Service income……………..7,400

All the above adjusting entries will be inserted in the adjustment column of the worksheet in
front of the accounts affected.

3. The Adjusted Trial Balance Column: The accounts that require adjustment are now
adjusted. Transferring the trial balance column amounts combined with the adjustment column
amounts will complete the adjusted trial balance column of the worksheet.

4. The income statement and the balance sheet columns: Transfer the income statement
account balances (revenue &expenses) to the income statement and balance sheet account
balances (Asset, Liability &owners’ equity) to the balance sheet columns. Note that what we
have to transfer is the adjusted trial balance column amounts, to the corresponding columns.
Look at the 22nd row. It shows the net income for the month and it is added to the two columns
(Income statement Dr. and balance sheet cr.) as a balancing figure.

11. Preparing Financial Statement Preparation

After the work sheet is completed financial statements could be prepared easily. In chapter one
we have discussed four basic financial statements prepared by most organizations. Here, we will
prepare three of these statements for Bati Transport form the worksheet.

1. Income statement- All the data required to prepare the income statement is brought from the
worksheet.

Bait Transport

Income statement

For the month ended. Jan 31, 2003

Service Income …………………………………………………………Birr 25,300

Operating expenses

Salary expense………………………..Birr 18,800

Rent “…………………………………….4, 000

Maintenance expense ……………………… 450

Insurance “……………………………450

Supplies “…………………………….340

Utilities “……………………………..220

Truck “……………………………...90

Miscellaneous “………………………………50
 Total operating expense……………………………………… (24,400)

Net Income…………………………………………………Birr 900

2. Statement of owner’s equity: This statement shows the beginning balance of capital and the
changes that affected it.

The balance of the owners’ equity account (Yimer capital) in the worksheet may not be the
beginning one. Therefore, the ledger has to be reviewed to see if there was an additional
investment during the period or not. In our illustration there is no additional investment.
Bati Transport

Statement of Owner’s equity

For the month ended January 31, 2003

Yimer capital January 1, 2003……………………………Birr 450,000

Net income for the month………………….birr 900

Less: Withdrawal…………………………………...500 400

Yimer capital, January 31, 2003…………….…………….Birr 450,400

3. Balance sheet – The data to prepare this statement will be taken from the worksheet and the
other financial statements. Note that assets and liabilities are classified as current and non-
current-current.