Unit Two

Accounting Cycle for a Service-Giving Business

2.1. Characteristics of Accounts
An account: is individual accounting record of increases & decreases in a
specific asset, liability, owner’s equity, Revenue and Expense item.
There are separate accounts for the items we used in trxns such as cash,
salaries expense, accounts payable, etc.
Are basic storage units for accounting data & are used to accumulate
amounts from similar trxns
Are records that kept for individual asset, liability, equity, revenue,
expense, and dividend components
Accounting form used to record changes caused by business trxns
 Accounting Cycle: is a sequence of procedures used to record, classify &
summarize accounting infn in financial reports, on a regular basis.
 is a series of steps done in each accounting period to keep records in an
orderly fashion.
 Usually starts from occurrence of business trxns
Detailed Steps in the Accounting Cycle

Analyze Business Journalize Post entries to the Prepare unadjusted

Transactions. transactions in the accounts in the trial balance.
journal. ledger.

Post-closing
trial balance

Journalize and post Prepare financial Prepare adjusted Journalize and

closing entries statements. trial balance. post adjusting
entries
2.2. Classification of Accounts
 There are 5 types of Accounts
1. Assets 4. Revenue
2. Liabilities 5. Expense
3. Owners' Equity
1. Assets: any physical thing (tangible) or right (intangible) that has a value
 Classified into two:
A. Current asset: Reasonably expected to be realized in cash or sold or used
up usually within one year or less.
 Example: cash, A/receivable, supplies, inventory, short term notes
receivable.
B. Plant assets (Fixed assets): tangible asset used in the business that are of
a permanent or relatively fixed nature.
 Example: equipment, machinery, buildings, and land.
2. Liabilities: debts owed to outsiders (creditors)
 Classified into two:
a. Current liabilities: liabilities due within a short time (one year or less)
and that are to be paid out of current assets.
E.g.: A/Payable, Short note payable, Salaries payable, Interest payable,
Tax payable, Unearned revenue.
b. Long term liability: liability that will not be due for a long time (more
than one year) or company’s obligations not expected to be paid
within one year
Example: Long term notes payable, Bonds payable, Lease liabilities.
3. Owner’s equity: residual claim against asset after TL are deducted.
4. Revenues: gross increase in OE as a result of sale of merchandize,
performance of service, rental of property, lending of money and other
business and professional activities.
5. Expenses: costs that have been consumed in process of producing
revenue.
 Drawings: represent the amount of withdrawals made by the owner.
Basic Form of Account
Simplest form an account consists of

1- Title of the account

2- Left or debit side
3- Right or credit side
Alignment of these parts resembles the letter T = T account
2.3. Chart of Accounts
Ledger: is entire group of accounts for a business entity.
Keeps in one place all infn about changes in specific account
balances
Classified into two:.
›General ledger: contains all assets, liabilities, OE, Revenue and
Expense accounts,
›Subsidiary Ledger: contains only one kind of account
Chart of accounts-list of accounts in the ledger.
It is outline order of accounts in the ledger
Accounts are normally listed in the order in which they appear
in financial statements.
For example:
B/sheet accounts are listed as Assets, liabilities, and OE.
Income statement accounts are listed as revenues and expenses
 Each account number has two digits
 1st digit indicates major division of ledger in w/c account is
placed.
 Accounts beginning with number:
› 1 - represents Assets;
› 2 – represents Liability;
› 3 – represents Owner’s equity and drawings;
› 4 – represents Revenue and
› 5 – represents Expenses.
 2nd digit indicates position of account within its division.
 Advantage of such numbering system is later insertion of new
accounts in their proper sequence without disturbing other
account number.
 Also serves as a guide in journalizing by showing the account
title that is to be used when you record business transactions.
Parts of Chart of Account
Balance Sheet Income Statement
Account No Account Title Account No Account Title
1. Asset Account 4. Revenues
11 Cash 41 Sales
12 A/Receivable 42 Fees Earned
13 Supplies 43 Interest Income
14 Prepaid Rent 44 Rent Income
15 Furniture 5. Expenses
16 Office equip 51 Supplies Expense
17 Accum. Deprn 52 Salaries Expense
2. Liability Account 53 Rent Expense
21 A/payable 54 Depreciation Expense
22 N/payable 56 Miscellaneous Expense
23 Salaries payable
24 Tax payable
3. OE Account
31 Biftu, Capital
32 Biftu Drawing
33 Income Summary
2.4 Rules of Debits and Credits
Debit indicates left and Credit indicates right hand side

It is abbreviated as Debit (Dr) and Credit (Cr)

Recording $/Br on left side of account is debiting account

Recording $/Br on right side is crediting account

If total of debit amounts is bigger than credits, account has debit balance

If total of credit amounts is bigger than debits, account has credit balance

Debit and Credit rules of accounts

Account Increase side Decrease side Normal Side

Any Asset Debit Credit Debit
Any Liability Credit Debit Credit
Owner’s equity (Capital) Credit Debit Credit
Any Revenue Credit Debit Credit
Any Expense Debit Credit Debit
2.5. Analyzing and Recording Business Transactions
1.Analyze each transaction (+, -)
2.Enter transaction into a journal
3.Transfer journal information to ledger accounts
Transactions: initially recorded in chronological order before they
are transferred to ledger
 Journal

 Journal/day book, is book of original entry for accounting data.

General journal: is original book of entry
Infn recorded on this book is usually extracted from source
documents such as invoices, receipts, contract agreements & other
relevant documents.
Show account to be debited & credited and short description.
Infn on this book will be posted to ledger.
Journal makes several significant contributions to recording process:
•It discloses in one place the complete effect of a transaction.
•It provides a chronological record of transactions.
•It helps to prevent or locate errors b/se debit and credit amounts for each entry
Special Journals:
A journal in which only one kind of business transaction
Used to record only one type of entries .
Differ from general journal or combination journal in that they are
meant only for specified types of transactions-only one type.
Journalizing
Process of recording a transaction in journal.
Entry in journal is called a journal entry.
Periodically, journal entries are transferred to the accounts in the
ledger.
Posting
Process of transferring debits & credits from journal entries to
accounts
Process of transferring information from journal to ledger for
purpose of summarizing and is ordinarily carried out in the
following steps:
•Record the amount and date . date and amounts of debits and credits
are entered in appropriate accounts.
•Record the posting reference in account . number of journal page is
entered in the account
Technique of Journalizing
Standard form & content of journal entries are as follows:
•Date of transaction is entered in Date column. Date recorded should include
year, month & day
•Debit account title (account to be debited) is entered 1 st at extreme left
margin of the column headed Account Titles and Explanation. The credit
account title (account to be credited) is then entered on the next line,
indented under the line above. A brief explanation of transaction is given.
•Amounts for the debits are recorded in the Debit (left) column and the
amounts for the credits are recorded in the credit (right) column.
•Space is left b/n journal entries. Blank space separates individual journal
entries & makes the entire journal easier to read.
•Column entitled Ref. (stands for reference) is left blank at the time the
journal entry is made.
Reference column is used later when the journal entries are transferred
to the ledger accounts.
At that time, ledger account number is placed in Reference column to
indicate where amount in journal entry was transferred. edited,
•Brief explanation of transaction.
 Toillustrate, on May 1, Mr. Danu invested Br.15, 000 cash in the
business, and office equipment was purchased for Br.7, 000 cash.
The
Thedate
dateof
ofthe
thetransaction
transactionisisentered
enteredinto
intothe
thedate
datecolumn.
column.

GENERAL JOURNAL
Date Account Titles and Explanation Ref. Debit Credit
2020
May. 1 Cash ……………………………... 15,000
Mr. Danu’s, Capital …………. 15,000
(invested cash in business)
1 Office Equipment ………………... 7,000
Cash ………………………….. 7,000
(purchased equipment for cash)
Step 1
The
The debit
debit account
account title
title isis entered
entered at
at the
the extreme
extreme left
left margin
margin of
of
the
theAccount
AccountTitles
Titlesand
andExplanation
Explanationcolumn.
column.
The
The credit
credit account
accounttitle
titleisisindented
indentedon
onthe
thenext
nextline.
line.
GENERAL JOURNAL
Date Account Titles and Explanation Ref. Debit Credit
2020
May. 1 Cash ……………………………... 15,000
Mr. Danu’s, Capital …………. 15,000
(invested cash in business)
Step 2
1 Office Equipment ………………... 7,000
Cash …………………………... 7,000
(purchased equipment for cash)
The
The amounts
amounts for
for the
the debits
debits are
are recorded
recorded in
in the
the Debit
Debit column
column
and
and the
the amounts
amounts for
for the
the credits
credits are
are recorded
recorded inin the
the Credit
Credit
column.
column.

GENERAL JOURNAL
Date Account Titles and Explanation Ref. Debit Credit
2020
May. 1 Cash ……………………………... 15,000
Mr. Danu’s, Capital …………... 15,000
(invested cash in business)
1 Office Equipment ………………... Step 3
Cash …………………………... 7,000
(purchased equipment for cash) 7,000
AAbrief
briefexplanation
explanationof
ofthe
thetransaction
transactionisisgiven.
given.

GENERAL JOURNAL
Date Account Titles and Explanation Ref. Debit Credit
2020 May.
1 Cash ……………………………... 15,000
Mr.Danu’s, Capital …………. 15,000
(invested cash in business)
1 Office Equipment ………………...
7,000
Cash …………………………...
7,000
(purchased equipment for cash)
Step 4
AAspace
spaceisisleft
leftbetween
betweenjournal
journalentries.
entries.
The
The blank
blank space
space separates
separates individual
individual journal
journal entries
entries and
and makes
makes the
the
entire
entirejournal
journaleasier
easierto
toread.
read.

GENERAL JOURNAL
Date Account Titles and Explanation Ref. Debit Credit
2012
May. 1 Cash ……………………………... 15,000
Mr. Danu’s, Capital ………….. 15,000
(invested cash in business)
Step 5
1 Office Equipment ………………... 7,000
Cash …………………………... 7,000
(purchased equipment for cash)
The
The column
column entitled
entitled Ref.
Ref. isis left
left blank
blank at
at the
the time
time journal
journal entry
entry
isis made
made and
and isis used
used later
later whenwhen the
the journal
journal entries
entries are
are
transferred
transferredto
tothe
theledger
ledgeraccounts.
accounts.

GENERAL JOURNAL Step 6

Date Account Titles and Explanation Ref. Debit Credit
2020
May. 1 Cash ……………………………... 15,000
Mr. Danu’s, Capital ………….. 15,000
(invested cash in business)
1 Office Equipment ………………... 7,000
Cash …………………………... 7,000
(purchased equipment for cash)
 If an entry involves only two accounts, one debit and one credit, it is
considered a simple entry.
 When three or more accounts are required in one journal entry, entry is
referred to as a compounds entry.
 To illustrate, assume that on June 1, Dula Company purchases a delivery
truck costing Br.14,000 by paying Br.8,000 cash and the balance on
account (to be paid at a later date).
 The entry is as follows:
GENERAL JOURNAL
Date Account Titles and Explanation Ref. Debit Credit
1996
June 1 Delivery Equipment……………….... 14,000
Cash ……………………….. 8,000
Accounts payable ………….. 6,000
(Purchased truck for cash with
balance on account)

 In a compound entry, it is important to determine that total debit and

credit amounts are equal..
LEDGER
Is a group of accounts maintained by a company
Classified into two type:

Subsidiary Ledgers

 Large number of individual accounts with a common characteristic can

be grouped together in separate ledger called subsidiary ledger.
 Each subsidiary ledger is represented in general ledger by a
summarizing account, called a controlling account.
 Sum of balances of accounts in a subsidiary ledger must equal the
balance of related controlling account.
 It is secondary ledger that supports controlling account in G/ledger.

 E.g A/Receivable (customers ledger), Accounts payable

 General ledger contains all assets, liabilities & OE accounts

Keeps in one place all infn about changes in specific account balances.
Should be arranged in statement order beginning with B/sheet accounts.
Infn in the ledger provides mgt with the balances in various accounts.
For example, Cash account enables mgt to determine amount of cash that
is available to meet current obligations
 Illustration:
 Nafyad Tola, Accountant, opened an office on Jan 1, 2015. During the month,
he completed the following transactions
 Jan-1: Transferred cash from a personal bank account to an account to be used
for the business, Br 30,000, equipment Br 2,400 and supplies Br 400.
Journal Page 1
Post
Date Description Ref. Debit Credit
2015 Jan 1 Cash $30,000 00
Equipment $2,400 00
Supplies $400 00
Nafyad, Capital $32,800 00
(Investment of Cash, Equipment and Supplies)
 Jan-4: Purchased used automobile for Br 18,300, paying Br 16,000 cash and
agreed to pay the remaining at the end of this month.
Journal Page 1
Post
Date Description Ref. Debit Credit
2015 Jan 4 Automobile 18,300 00
Cash 16,000 00
A/Payable 2,300 00
(Purchase of Automobile)
 Jan-5: Paid office rent for the month Jan cash Br 400
Journal Page 2

Date Description Post Ref. Debit Credit

2015 Jan 5 Rent Expense 400 00

Cash 400 00
(Paid rent for January)
 Jan-7: Paid cash for supplies Br 300
Journal Page 2
Date Description Post Ref. Debit Credit
2015 Jan 7 Supplies 300 00
Cash 300 00
(Purchased supplies on cash)

 Jan-8: Purchased office and equipment on account Br 4,200

Journal Page 2
Date Description Post Ref. Debit Credit
2015 Jan 8 Equipment 4,200 00
A/Payable 4,200 00
(Purchased Equipment on account)
 Jan-12:
Paid cash for insurance policies for the ff 6 months on
automobile Br 810
Journal Page 3
Date Description Post Ref. Debit Credit
2015 Jan 12 Prepaid insurance 810 00
cash 810 00
(Paid premium for 6-months policy)
 Jan-14: Received cash from a client for plans delivered, Br 5,700
Journal Page 3
Date Description Post Ref. Debit Credit
2015 Jan 14 Cash 5,700 00
Fees earned 5,700 00
(Received fees from customers)

 Jan-17: Paid cash to creditors on account Br 2,100

Journal Page 3
Date Description Post Ref. Debit Credit
2015 Jan 17 Account payable 2,100 00
Cash 2,100 00
(Paid creditors on account)
 Jan-25: Paid cash for miscellaneous expense Br 120
Journal Page 4
Date Description Post Ref. Debit Credit
2015 Jan 25 Miscellaneous exp 120 00
Cash 120 00
(Paid expenses)
 Jan-27: Recorded fee earned on plans delivered, payment to be received
in Feb, Br 4,500
Journal Page 4
Date Description Post Ref. Debit Credit
20125 Jan 27 A/Receivable 4,500 00
Fees earned 4,500 00
(Recorded fees earned on account)
 Jan-28: Paid salary of assistant Br 1,500
Journal Page 4
Date Description Post Ref. Debit Credit
2015 Jan 28 Salary expenses 1,500 00
Cash 1,500 00
(Paid salary exp for January)
 Jan-30. Paid A/payable Br 2,300 for automobile purchased on Jan 2
Journal Page 5
Date Description Post Ref. Debit Credit
2015 Jan 30 Account payable 2,300 00
Cash 2,300 00
(Paid creditors on account)

 Jan-31: Paid gas, oil, and repairs on automobile for April Br170
Journal Page 5
Date Description Post Ref. Debit Credit
2015 Jan 31 Utility expense 170 00
cash 170 00
(Paid expense for gas, oil & repairs)
 Jan-31: Nafyad withdraw Br 1,200 for personal use.
Journal Page 5
Date Description Post Ref. Debit Credit
2015 Jan 31 Nafyad, drawing 1,200 00
Cash 1,200 00
(Nafyad withdrew cash for personal use)
2.6 Preparation of Ledger
When posting is done manually, the debits & credits in the journal posted
in the order that they occur or if many items are to be posted at one time
all the debits may be posted first followed by the credits.
Posting of debits and credits from journal to ledger is performed in the
following manner:
1.Record date and amount of the entry in the account.
2.Insert number of journal page in posting reference column of account
3.Insert ledger account number in posting reference column of journal.
Preparation of Ledger
Account: Cash Account No 11
Post Balance
Date Item Ref. Debit Credit Debit Credit
Jan 1 Br 30,000 00 Br30,000 00
4 1 Br16,000 00 14,000 00
5 1 400 00 13,600 00
7 1 300 00 13,300 00
12 1 810 00 12,490 00
14 1 Br 5,700 00 18,190 00
17 2 2,100 00 16,090 00
25 2 120 00 15,970 00
28 2 1,500 00 14,470 00
30 2 2,300 00 12,170 00
31 2 170 00 12,000 00
31 2 1,200 00 Br10,800 00

Account: A/Receivable Account No 12

Post Balance
Date Item Ref. Debit Credit Debit Credit
27 2 Br4,500 00 Br4,500 00

Account: Prepaid Insurance Account No 13

Post Balance
Date Item Ref. Debit Credit Debit Credit
12 1 Br 810 00 Br 810 00
Preparation of Ledger
Account: Supplies Account No 14

Post Balance
Date Item Ref. Debit Credit Debit Credit

1 Br 400 00 Br 400 00
7 1 Br 300 00 Br 700 00

Account: Equipment Account No 15

Post Balance
Date Item Ref. Debit Credit Debit Credit
1 Br 2,400 00 Br 2,400 00
8 1 Br 4,200 00 Br 6,600 00

Account: Automobile Account No 16

Post Balance
Date Item Ref. Debit Credit Debit Credit
4 1 Br18,300 00 Br 18,300 00

Account: A/Payable Account No 21

Post Balance
Date Item Ref. Debit Credit Debit Credit
4 1 Br 2,300 00 Br 2,300 00
8 1 Br 4,200 00 Br 6,500 00
17 2 Br 2,100 00 Br 4,400 00
30 2 Br 2,300 00 Br 2,100 00
Preparation of Ledger
Account: Nafyad, Capital Account No 31

Post Balance
Date Item Ref. Debit Credit Debit Credit
1 1 Br 32,800 00 Br 32,800 00
Account: Nafyad, Drawing Account No 32

Post Balance
Date Item Ref. Debit Credit Debit Credit
31 1 Br 1,200 00 Br 1,200 00

Account: Fees earned Account No. 41

Post Balance
Date Item Ref. Debit Credit Debit Credit
14 2 Br 5,700 00 Br 5,700 00
27 2 Br 4,500 00 Br 10,200 00
Account: Rent expense Account No. 51

Post Balance
Date Item Ref. Debit Credit Debit Credit
5 1 Br 400 00 Br 400 00

Account: Salary expense Account No. 52

Post Balance
Date Item Ref. Debit Credit Debit Credit
28 2 Br 1,500 00 Br 1,500 00
Preparation of Ledger
Account: Utility expense Account No. 53
Post Balance
Date Item Ref. Debit Credit Debit Credit
31 2 Br 170 00 Br 170 00

Account: Miscellaneous expense Account No. 54

Post Balance
Date Item Ref. Debit Credit Debit Credit
25 2 Br 120 00 Br 120 00
2.7. Preparing a Trial Balance
A table that shows equality of debits and credits in the ledger.
Summary listing of the titles & balances of the accounts in the ledger.
Nafyad Trading
Trial Balance
Jan 31, 2015
Debit Credit
Cash Br10,800 00
Account receivable 4,500 00
Prepaid insurance 810 00
Supplies 700 00
Equipment 6,600 00
Automobile 18,300 00
Account payable 2,100 00
Nafyad, Capital 32,800 00
Nafyad, Drawing Br 1,200
Fees earned 10,200 00
Rent expense 400 00
Salary expense 1,500 00
Utility expense 170 00
Miscellaneous expense 120 00
45,100 00 45,100 00
2.8. The usefulness and Limitations of Trial Balance
Trial Balance is:
A list of accounts and their balances at a point in time.
Used to prove the equality of debit and credit amount in the ledger.
Does not provide complete proof of the accuracy of ledger.
The primary purpose of a trial balance is to prove the mathematical
equality of debits and credits after posting.
A trial balance also uncovers errors in journalizing and posting.
In addition, it is useful in the preparation of financial statements.
TB doesn’t prove all trxns that have been recorded or ledger is correct
Numerous errors may exist even though TB csolumns agree.
 For example, trial balance may balance even when:
A transaction is not journalized
A correct journal entry is not posted
A journal entry is posted twice
Incorrect accounts used in journalizing or posting
Offsetting errors are made in recording
Correction of errors
Prove the accuracy of TB totals by re-adding the columns
Compare the listings in TB with balance shown in ledger.
Make certain that no accounts have been omitted
Recomputed balance of each account in ledger
Trace postings in ledger back to journal, Place a small check mark beside
each item in ledger and also in the journal. If error is not found, examine
each account to see if there is an entry without a check mark. Do the
same with entries in the journal.
Prove the equality of debit and credits in journal
2.9. Adjusting Process-Accrual VS. Cash Basis of Accounting
Meaning of Adjusting Entries
Entries made at the end of accounting prd to bring balances of
accounts that do not show their true balance to be reported on
financial reports
Required every time financial statements prepared.
Accrual- Versus Cash-Basis Accounting
Accrual-Basis:
 Revenues are recognized as earned
 Expenses are recognized as incurred
Cash-Basis:
Revenue is recorded when cash is received (no matter
when it is "earned"), and
Expenses are recognized when cash is paid (no matter
when "incurred").
Need of Adjusting Entries
To report:
 All revenues earned during accounting period.
All expenses incurred to produce revenues earned in the same
accounting period.
To accurately report assets on the balance sheet date,
 Some assets may have been used-up during accounting
preriod
To accurately report liabilities on the balance sheet date.
 (Expenses may have been incurred, but not yet paid.)
Types of Adjusting Entries
Number of adjustments needed at end of each accounting prd
depends entirely upon nature of company’s business activities.
However, most adjusting entries fall into one of the ff:
Converting assets to expenses
Converting liabilities to revenue
Accruing unpaid expenses, and
Deferrals:
Are previously recorded assets, liabilities, revenues and expenses
that need to be adjusted at the end of the period to reflect revenues
earned or expenses incurred
Some of the deferred items for which adjusting entry made are:
Prepaid insurance,
Prepaid rent,
Office supplies,
Depreciation &
Unearned revenue.
Deferral adjustments are of two types:
a. Prepaid expense (Assets/expense) adjustments
 Transfer amounts from asset to expense accounts
b. Unearned revenue (deferred Revenue) Liability/revenue adjustment
 Transfer amounts from lia bility to revenue accounts.
Converting assets to Expenses /Prepaid Expense Adjustments:
Prepaid expenses are expenses paid in cash & recorded as assets
before they are used or consumed.
Expire with passage of time or through use & consumption.
 Asset-expense account r/n s/p exists with prepaid expenses.
 Prior to adjustment,
 Assets are overstated &
 Expenses are understated
 Adjusting entry results in a debit to expense account & a credit
to an asset account.
Converting Liab. to Revenue (Unearned Revenue) Adjustment
 These are cash received before providing products or services.
 Cash received is debited against liability account when received
 Revenues are recorded when work is done.
 So, we owe the work – it is a liability.
 At the end of the period, we reduce liability to reflect portion of
the work that has been done (this increases a revenue account).
 Unearned revenues are revenues received and recorded as
liabilities before they are earned.
 Unearned revenues are subsequently earned by rendering service
to a customer.
 Liability-revenue account r/n s/p exists with unearned revenues.
 Prior to adjustment,
 Liabilities are overstated &
 Revenues are understated.
Accrual Adjustments
Accruals are revenues that have been earned and expenses that
have been incurred by the end of current accounting period, but that
will be collected or paid in a future accounting period.
Accruals occur when no cash has been received or paid, but the
company has under-taken activities that result in earning revenues
or incurring expenses.
Unlike deferrals, no original entry has been recorded.
Examples:
•Interest earned but not yet collected on a loan : Accrued Interest
Receivable (Asset) (simply Interest Receivable) accrued revenue.
•Wages earned by employees but not yet paid : Accrued Wages &
Salaries Payable (Liability) (Wages & Salaries Payable)–accrued
expense.
Accrual adjustments are of two types:
a)Accrued revenue and
b)Accrued expenses
Accruing uncollected Revenue (Accrued Revenue):
Are revenues earned, but not yet received in cash.
May accumulate with passing of time as in case of interest &
rent, or through services performed, but not billed or collected.
Accrued revenue requires asset/revenue adjustment
Asset-revenue account r/n s/p exists with accrued revenues.
Prior to adjustment,
Both assets & revenues are understated.
Adjusting entry results in a debit to an asset account and a
credit to a revenue account
Accruing unpaid Expenses (Accrued Expense):
Are expenses incurred, but not yet paid or recorded.
Result from the same causes as accrued revenues & include
interest, rent, taxes and salaries expense.
Liability-expense account r/n s/p exists with accrued expenses
Prior to adjustment,
 both liabilities & expenses are understated.
Adjusting entry results in a debit to an expense & a credit to a
liability
Depreciation:
Process of allocating cost of asset to expense over its useful life in a
rational & systematic manner.
It is example of a deferred expense.
In this case, cost is deferred over a number of years, rather than a
number of months.
One simple approach is called straight-line method.
Under this method, an equal amount of asset cost is assigned to
each year of service life.
In other words, cost of asset is divided by years of useful life,
resulting in annual depreciation expense.
2.10 Preparing a Worksheet
Is a multiple column form that maybe used in adjustment
process & in preparing financial statements.
As its name suggests, worksheet is a working tool.
Is not a permanent accounting record.
Is a device used to make it easier to prepare adjusting entries &
f/Stm.
In small businesses with relatively few accounts &
adjustments, a work sheet may not be needed while it is
indispensable for large companies with numbers accounts.
There are five steps to prepare worksheet
•Prepare a trial balance on work sheet
•Enter the adjustments in adjustments in adjustments columns
•Enter adjusted balances in adjusted trial balance columns.
•Extend adjustment TB amounts to appropriate f/s columns
•Total statement columns, compute NI/loss, & complete
worksheet
 To prepare worksheet for Tola Trading, the ff adjustments are given
 Adjusting Entries
1. Prepaid insurance is Br 675 at the end of January.
 Out of 810 Br prepaid insurance,135 Br is already passed
• At the end of January supplies inventory shows Br 425.
 Out of 700 Br Supplies on hand, 275 Br is consumed/used up
1. Depreciation expense of equipment for the month is Br 250
2. Depreciation expense of automobile for the month is Br 450
 Adjusting entries of Tola Trading are journalized here under.
Adjusting Entries
a) Insurance expense ……..………………….. 135
Prepaid Insurance ………………………..…….…. 135
b) Supplies expense ……………………..……. 275
Supplies …………………………………………... 275
c) Depreciation expense- Equipment ………... 250
Accumulated depreciation- Equip……………....... 250
d) Depreciation expense- Automobile …….… 450
Accumulated depreciation- Automobile …….…... 450
 Nafyad Trading
Work Sheet
For the Month Ended January 31, 2015
Trial balance Adjustment Adjusted TB Income stmt Balance sheet
Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit
Cash 10,800 10,800 10,800
Account receivable 4,500 4,500 4,500
Prepaid insurance 810 (a) 135 675 675
Supplies 700 (b) 275 425 425
Equipment 6,600 6,600 6,600
Accum dep.- Equipt (c) 250 250 250
Automobile 18,300 18,300 18,300
Accum dep.-Auto (d) 450 450 450
Account payable 2,100 2,100 2,100
Tola, Capital 32,800 32,800 32,800
Tola, Drawing 1,200 1,200 1,200
Fees earned 10,200 10,200 10,200
Rent expense 400 400 400
Salary expense 1500 1500 1500
Utility expense 170 170 170
Miscellaneous exp 120 120 120
Total 45,100 45,100
Insurance expense (a) 135 135 135
Supplies expense (b) 275 275 275
Dep. expense Equip. (c) 250 250 250
Dep. expense Auto. (d) 450 450 450
1,110 1,110 45,800 45,800 3,300 10,200
Net income 6,900 6,900
10,200 10,200 42,500 42,500
2.11. Preparing Financial Statements from a Worksheet
After a worksheet has been completed, all the data that are required for
the preparation financial statements are at hand.
Nafyad Trading
Income Statement
For the Month Ended January 31, 2015
Fees earned 10,200
Rent expense 400
Salary expense 1,500
Utility expense 170
Miscellaneous expense 120
Insurance expense 135
Supplies expense 275
Depreciation expense- Equipment 250
Depreciation expense- Automobile 450
3,300 10,200
Net Income 6,900

Nafyad Trading
Statement of Owners’ Equity
For the Month Ended January 31, 2015
Tola, Capital- January 1, 2015 32,800
Net Income for the year 6,900
Less: withdrawals 1,200
Increase in owner’s equity 5,700
Tola, Capital- January 31, 2015 38,500
 Nafyad Trading
Balance Sheet
January 31, 2015
Assets
Current Assets
Cash 10,800
Account receivable 4,500
Prepaid insurance 675
Supplies 425
Total current Assets: 16,400
Plant Assets
Equipment 6,600
Less Accumulated dep.- Equipment 250 6350
Automobile 18,300
Les Accumulated dep.- Automobile 450 17,850
Total plant assets: 24,200
Total Assets 40,600
Current liabilities:
Account payable 2,100
Owners Equity
Tola, Capital 38,500
Total Liabilities and Equities 40,600
2.12 Adjusting and Closing Entries
Adjusting entries: at the end of accounting period adjusting entries
appearing in the work sheet are recorded in the journal and posted to the
ledger and it is dated as of the last day of the period, even though they are
usually recorded at a later date.
The adjusting entries of Nafyad Tola Trading are journalized here under.
Post
Date Description ref. Debit Credit

Adjusting Entries
a Insurance expense ……....…...….. 135
Prepaid Insurance ……...…… 135
b Supplies expense …………...…… 275
Supplies …………...…...….…. 275
c Depreciation expense- Equipt ...... 250
Accum deprn- Equip …….…. 250
d Deprn expense- Automobile ....… 450
Accum deprn- Auto …….….... 450
Closing Entries
An account title Income Summary account is used for summarizing the
data in the revenue and expense accounts- it is used only at the end of
accounting period & both opened & closed during the closing process.
Other account titles used for the summarizing account are expense &
revenue, profit & loss & income & expense summary.
Four entries are required in order to close the temporary accounts of
Nafyad Trading. These are:
•Each Revenue account is debited for the amount of its balance & income
summary is credited for the total revenue.
•Each Expense account is credited for the amount of its balance & income
summary is debited for the total expense
•Income Summary is debited for the amount of its balance (net income) &
the capital account is credited for the same amount.
•The drawing account is credited for the amount of its balance & the
capital account is debited for the same amount.
Closing entries for Nafyad Tola Trading is as follows
Fees earned …………….… 10,200
1
Income summary ….….... 10,200
Income summary …….…... 3,300
Rent expense ………..….. 400
Salary expense ………..... 1500
2 Utility expense ….…….... 170
Miscellaneous expense ... 120
Insurance expense …….. 135
Supplies expense ………. 275
Deprn expense-Equip …. 250
Deprn expense- Auto .… 450
Income summary …....…… 6,900
3
Nafyad, Capital ………..... 6,900
4 Tola, Capital …....…….... 1,200
Tola, Drawing ....…….. 1,200
2.13. Post-Closing Trial Balance
The last procedure of the accounting cycle is the preparation of a trial
balance after all of the temporary accounts have been closed.
It is to make sure that the ledgers are in balance at the beginning of the
new accounting period.
Nafyad Trading
Post Closing Trial Balance
Jan 31, 2015
Cash 10,800
Account receivable 4,500
Prepaid insurance 675
Supplies 425
Equipment 6,600
Accum depn- Equipment 250
Automobile 18,300
Accum depn- Automobile 450
Account payable 2,100
Tola, Capital 38,500
41,300 41,300