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UNIT .2 THE ACCOUNTING CYCLE UNIT .2 THE ACCOUNTING CYCLE

ContentsContents

2.0 Aims & Objectives2.0 Aims & Objectives

2.12.1 Introduction Introduction

2.22.2 Nature of an Account Nature of an Account

2.32.3 Classification of Accounts Classification of Accounts

2.42.4 Chart of Accounts Chart of Accounts

2.52.5 Rules of Debits and credits Rules of Debits and credits

2.62.6 Journalizing Business Transactions Journalizing Business Transactions

2.72.7 Posting From the Journal to the Ledger Posting From the Journal to the Ledger

2.82.8 The Trial Balance The Trial Balance

2.8.12.8.1 Proof provided by the Trial Balance Proof provided by the Trial Balance

2.8.22.8.2 Limitations of the Trial Balance Limitations of the Trial Balance

2.92.9 AdjustmentsAdjustments

2.9.12.9.1 The Accrual Basis and Cash Basis of AccountingThe Accrual Basis and Cash Basis of Accounting

2.9.22.9.2 The Matching PrincipleThe Matching Principle

2.102.10 Worksheet for Financial Statements Worksheet for Financial Statements

2.112.11 Financial Statement Preparation Financial Statement Preparation

2.122.12 The Closing Process The Closing Process

2.132.13 Post Closing Trial Balance Post Closing Trial Balance

2.142.14 SummarySummary

2.152.15 Answers to Check Your Progress Questions Answers to Check Your Progress Questions

2.162.16 Model Exam Questions Model Exam Questions

2.172.17 Glossary of Terms Glossary of Terms

2.0 AIMS & OBJECTIVES2.0 AIMS & OBJECTIVES

By the time you have finished this unit you should be able to:By the time you have finished this unit you should be able to:

-- explain the meaning and nature of an account.explain the meaning and nature of an account.

-- apply debits and credits to record business transactionsapply debits and credits to record business transactions

-- define the terms journal, ledger, journalizing, posting, trial balance etc.define the terms journal, ledger, journalizing, posting, trial balance etc.

-- complete the accounting cyclecomplete the accounting cycle

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2.1 INTRODUCTION2.1 INTRODUCTION

In unit 1, you have learned the relationship between the accounting equation and businessIn unit 1, you have learned the relationship between the accounting equation and business

transactions. Every business transaction affects the elements of the accounting equation. Thistransactions. Every business transaction affects the elements of the accounting equation. This

accounting procedure will be discussed in detail. accounting procedure will be discussed in detail. The different and interrelated stages of theThe different and interrelated stages of the

accounting cycle will be presented.accounting cycle will be presented. The chapter is lengthy, but essential for the remaining The chapter is lengthy, but essential for the remaining

chapters in this course and other accounting courses. Therefore, you are advised to study thechapters in this course and other accounting courses. Therefore, you are advised to study the

chapter carefully.chapter carefully.

2.2 NATURE OF AN ACCOUNT2.2 NATURE OF AN ACCOUNT

In order to provide the necessary information to users, accountants maintain separate recordsIn 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 theon 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 cashend 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 anbalance, cash payments & cash collections during the period. This record is called an

accountaccount..

Definition: Definition: An account is a subdivision under the three elements of the accounting equationAn 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 hasused 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 inthree parts, Title, Debit, and credit. For illustration purposes an account can be represented in

the form of capital letter ‘T’.the form of capital letter ‘T’.

ExampleExample

TitleTitle

Debit Credit Debit Credit

Dr Cr Dr Cr

2.3 CLASSIFICATIONS OF ACCOUNTS2.3 CLASSIFICATIONS OF ACCOUNTS

Accounts are classified into five: Accounts are classified into five: assets, liabilities, capital, revenue and, expensesassets, liabilities, capital, revenue and, expenses . The first. The first

three are called three are called balance sheet accountsbalance sheet accounts and the other two are called and the other two are called incomeincome StatementStatement

accountsaccounts. Balance Sheet accounts are those reported on the balance sheet at the end of the. 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.reporting period and Income Statement accounts are reported on the Income Statement.

The five groups of account are discussed belowThe five groups of account are discussed below

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1. Assets:1. Assets: Resources owned by a business or individual are called Resources owned by a business or individual are called assetsassets. Assets could be. Assets could be

tangible or intangible. Tangible assets are assets having physical existence, like cash, land,tangible or intangible. Tangible assets are assets having physical existence, like cash, land,

computer, stationery materials. Intangible assets do not have physical existence. Example:computer, stationery materials. Intangible assets do not have physical existence. Example:

Goodwill, Copyright, patent right.Goodwill, Copyright, patent right.

On the balance sheet assets are classified into two current assets and non – current assets. On the balance sheet assets are classified into two current assets and non – current assets.

Current AssetsCurrent Assets – are those assets, which can be used, sold, or converted into cash within one – are those assets, which can be used, sold, or converted into cash within one

accounting year. Example: cash, supplies, prepayments, receivables etc.accounting year. Example: cash, supplies, prepayments, receivables etc.

Non-current Asset:Non-current Asset: All assets other than current assets are called non-current assets. All assets other than current assets are called non-current assets.

Example: land, patent right, office equipment, vehicles. Example: land, patent right, office equipment, vehicles.

2. Liabilities:2. Liabilities: Creditors’ claims to the assets of a business; amounts owed to creditors are Creditors’ claims to the assets of a business; amounts owed to creditors are

called called liabilities.liabilities. Like assets, liabilities are classified in to two as current liabilities and non – Like assets, liabilities are classified in to two as current liabilities and non –

current liabilitiescurrent liabilities

Current liabilities:Current liabilities: The liabilities that are payable within the next (one) accounting year are The liabilities that are payable within the next (one) accounting year are

known as current liability. Example: Accounts Payable, Rent Payable, Salary Payable.known as current liability. Example: Accounts Payable, Rent Payable, Salary Payable.

Non – Current Liabilities:Non – Current Liabilities: Debts that are not required to be paid within the next accounting Debts that are not required to be paid within the next accounting

period. Example long term notes payable. period. Example long term notes payable.

3. Capital:3. Capital: The excess of the assets of a business over its liabilities is referred to as capital. It 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.is the equity of the owner in the business.

4. 4. Revenue:Revenue: Are increases in owner’s equity resulting from the main operations of the Are increases in owner’s equity resulting from the main operations of the

business.business.

Examples of revenue accounts are sales, interest income, tuition fee, and sales commission.Examples of revenue accounts are sales, interest income, tuition fee, and sales commission.

5. Expenses:5. Expenses: are decreases in owner’s equity in the process of earning revenue. For example, 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 thea 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).income form customers (revenue) the Hotel has pay salary to the employees (expense).

Example of expenses: Salary, insurance, depreciation, supplies, utilities, rent etc.Example of expenses: Salary, insurance, depreciation, supplies, utilities, rent etc.

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2.4 CHART OF ACCOUNTS2.4 CHART OF ACCOUNTS

The number and name of accounts used by an organization depends on the nature of itsThe 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 operation. The list of accounts used by an organization and their codes is called the chart ofchart of

accounts.accounts. Look at the following chart of accounts of Bati Transport. Look at the following chart of accounts of Bati Transport.

Bati TransportBati Transport

Chart of AccountsChart of Accounts

AssetAsset Account numberAccount number

Cash--------------------------------------------------------------------------11Cash--------------------------------------------------------------------------11

Accounts Receivable------------------------------------------------------ 12Accounts Receivable------------------------------------------------------ 12

Supplies----------------------------------------------------------------------13Supplies----------------------------------------------------------------------13

Prepaid Insurance-----------------------------------------------------------14Prepaid Insurance-----------------------------------------------------------14

Equipment------------------------------------------------------------------- 15Equipment------------------------------------------------------------------- 15

Accumulated Depreciation –Equipment---------------------------------16Accumulated Depreciation –Equipment---------------------------------16

Truck--------------------------------------------------------------------------17Truck--------------------------------------------------------------------------17

Accumulated depreciation – Truck----------------------------------------18Accumulated depreciation – Truck----------------------------------------18

LiabilitiesLiabilities

Accounts Payable-------------------------------------------------------------21Accounts Payable-------------------------------------------------------------21

Notes Payable-----------------------------------------------------------------22Notes Payable-----------------------------------------------------------------22

Owners EquityOwners Equity

Yimer Adem, Capital----------------------------------------------------------31Yimer Adem, Capital----------------------------------------------------------31

Yimer Adem Drawing-------------------------------------------------------32Yimer Adem Drawing-------------------------------------------------------32

Income Summary-------------------------------------------------------------33Income Summary-------------------------------------------------------------33

RevenueRevenue

Service income----------------------------------------------------------------41Service income----------------------------------------------------------------41

ExpenseExpense

Salaries Expense --------------------------------------------------------------51Salaries Expense --------------------------------------------------------------51

Rent Expense ------------------------------------------------------------------52Rent Expense ------------------------------------------------------------------52

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Utilities Expense---------------------------------------------------------------53Utilities Expense---------------------------------------------------------------53

Supplies Expense--------------------------------------------------------------54Supplies Expense--------------------------------------------------------------54

Insurance Expense-------------------------------------------------------------55Insurance Expense-------------------------------------------------------------55

Maintenance Expense---------------------------------------------------------56Maintenance Expense---------------------------------------------------------56

Depreciation Expense---------------------------------------------------------57Depreciation Expense---------------------------------------------------------57

Truck Expense-----------------------------------------------------------------58Truck Expense-----------------------------------------------------------------58

Miscellaneous expense--------------------------------------------------------59Miscellaneous expense--------------------------------------------------------59

In the chart of accounts, the asset accounts are listed according to their liquidity. Liquidity isIn 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 isthe 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 alphabeticallisted first. Accounts other than cash will be listed in their frequency of use or in alphabetical

order.order.

The account number is a code to identify accounts. The number could be a two digit, threeThe 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. 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.When the chart of accounts is prepared in an organization we say the ledger is opened.

2.5 RULES OF DEBITS AND CREDITS2.5 RULES OF DEBITS AND CREDITS

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

TitleTitle – The name of the account. This is written at the top of the account.– The name of the account. This is written at the top of the account.

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

CreditCredit – is the right hand side of an account. Credit is abbreviated as Cr. An account is said – is the right hand side of an account. Credit is abbreviated as Cr. An account is said

to be to be credited credited when an amount is entered on the right hand side of the account.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 theAn 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 accountingnature 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);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 onwhereas accounts on the right side of the equation increase on their right side and decrease on

their left side. their left side.

The above general rule will be expanded as followsThe above general rule will be expanded as follows

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DebitDebit CreditCredit

-Increase in assets-Increase in assets -Decrease in assets-Decrease in assets

-Increase in expenses-Increase in expenses -Decrease in expenses-Decrease in expenses

-Decrease in capital-Decrease in capital -Increase in Liabilities-Increase in Liabilities

-Decrease in liabilities-Decrease in liabilities -Increase in liabilities-Increase in liabilities

-Decrease in revenue-Decrease in revenue -Increase in revenue.-Increase in revenue.

Check Your Progress Exercise - 1Check Your Progress Exercise - 1

1.1. Unlike other accounts on the right hand side, expenses increase on the debit side andUnlike other accounts on the right hand side, expenses increase on the debit side and

decrease on the credit side. Explain the reason.decrease on the credit side. Explain the reason.

……………………………………………………………………………………………………………………………………………………………………………………………………

……………………………………………………………………………………………………………………………………………………………………………………………………

……………………………………………………………………………………………………………………………………………………………………………………………………

The normal balance of an AccountThe normal balance of an Account

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

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

2.6 JOURNALIZING BUSINESS TRANSACTIONS2.6 JOURNALIZING BUSINESS TRANSACTIONS When a business transaction takes place, When a business transaction takes place, source documentssource documents will be obtained and recorded. will be obtained and recorded.

The The accounting recordaccounting record in which a transaction is initially recorded is known as a in which a transaction is initially recorded is known as a journaljournal. The. The

journal is therefore referred to as “The book of original entry”. journal is therefore referred to as “The book of original entry”.

The process of recording a business transaction in the accounting record is calledThe process of recording a business transaction in the accounting record is called

journalizingjournalizing. .

The Journal commonly used to record all types of transactions is the General Journal. ThisThe Journal commonly used to record all types of transactions is the General Journal. This

Journal includes the following parts, entered step by step.Journal includes the following parts, entered step by step.

1.1. The date of the transactionThe date of the transaction

2.2. The title of the account debitedThe title of the account debited

3.3. The title of the account creditedThe title of the account credited

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4.4. The amount of debit and creditThe amount of debit and credit

5.5. Brief explanation of the entry or reference to the source document.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 isLook at the following General Journal and notice where each of the above information is

found.found.

JournalJournal page page

DateDate DescriptionDescription P.RP.R DebitDebit CreditCredit

YearYear

MonthMonth dayday Debited account title Debited account title XXX XXX XXXX

Credited account title Credited account title X XX X XX XXXX

Explanation Explanation

There are also other types of Journals like, known as There are also other types of Journals like, known as special journalsspecial journals that are used to record that are used to record

specific types of transactions. The cash Journal, for instance, is used to record onlyspecific 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.transactions affecting cash. The General Journal is used for illustrations in this chapter.

Special journals are discussed in unit 5.Special journals are discussed in unit 5.

Steps in Journalizing a Transaction Steps in Journalizing a Transaction

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

1.1. Record the date - Insert the year, the month, and the date as shown above.Record the date - Insert the year, the month, and the date as shown above.

2.2. Record the Debit- Insert the account debited in the description column and the amountRecord the Debit- Insert the account debited in the description column and the amount

of debit in the debit column.of debit in the debit column.

3.3. Record the credit- Insert the account credited below the debited account and indentedRecord 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.to the right in the description column and the amount of credit in the credit column.

4.4. Explanation- Write a brief explanation or reference to source document in theExplanation- Write a brief explanation or reference to source document in the

description column, when necessary.description column, when necessary.

Each one set of debits and credits for a transaction is called a Each one set of debits and credits for a transaction is called a journal entryjournal entry..

In recording a business transaction answer the following questions based on the transaction toIn recording a business transaction answer the following questions based on the transaction to

be recorded may help you.be recorded may help you.

a)a) Which accounts are affected?Which accounts are affected?

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b)b) Is each account increased or decreased?Is each account increased or decreased?

c)c) Which account is debited and which is credited?Which account is debited and which is credited?

d)d) Prepare the complete journal entry.Prepare the complete journal entry.

Example. On January 10,2003 Tamget P.L.C paid Birr 6,000 to its employees as a salary forExample. 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.the first week of the year.

This business transaction will be analyzed and recorded as follows.This business transaction will be analyzed and recorded as follows.

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

b)b) Is each account increased or decreased? Answer: cash is decreased and salary expenseIs each account increased or decreased? Answer: cash is decreased and salary expense

is increased.is increased.

c)c) Which account is debited and which is credited? Answer: Salary Expense is debitedWhich 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 becausebecause increase in expenses is recorded on the debit side. And cash is credited because

decrease in assets is recorded on the debit side.decrease in assets is recorded on the debit side.

d)d) Prepare the complete Journal entry.Prepare the complete Journal entry.

20032003 DescriptionDescription

Jan. Jan. 1010 Salary expense Salary expense 6000 6000 0000

Cash Cash 6000 6000 0000

Payment of salary Payment of salary

Note: A Note: A journal entryjournal entry is the complete presentation of the record in the journal. is the complete presentation of the record in the journal.


Journalize the following transaction by answering 4 questions suggested above. Journalize the following transaction by answering 4 questions suggested above.

On January 11, 2003 Tamget bought a building for Birr 150,000 on credit.On January 11, 2003 Tamget bought a building for Birr 150,000 on credit.

IllustrationIllustration

To illustrate the complete accounting cycle, we will consider the following list of selected To illustrate the complete accounting cycle, we will consider the following list of selected

transactions. The transactions were completed by Bati Transport in the month of Januarytransactions. The transactions were completed by Bati Transport in the month of January

2003.2003.

January 1. Ato yimer took Birr 450,000 from his personal savings and deposited it in theJanuary 1. Ato yimer took Birr 450,000 from his personal savings and deposited it in the

name of Bati transport.name of Bati transport.

January 2. Bati Transport purchased two used trucks for Birr 150,000 each, on cash.January 2. Bati Transport purchased two used trucks for Birr 150,000 each, on cash.

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January 4. Bati Transport received a check for Birr 650 for services given to Alem January 4. Bati Transport received a check for Birr 650 for services given to Alem

Trading. Trading.

January 4. Received an invoice for truck expenses Birr 90.January 4. Received an invoice for truck expenses Birr 90.

January 11. Paid Birr 600 for Awash Insurance Company to buy an insurance policy forJanuary 11. Paid Birr 600 for Awash Insurance Company to buy an insurance policy for

its trucks.its trucks.

January 16. Ato Yimer issued a check for Birr 9,400 to the workers as a salary for January 16. Ato Yimer issued a check for Birr 9,400 to the workers as a salary for

two weeks. two weeks.

January 20. Bati trading Billed Muradu Supermarket for goods transported from January 20. Bati trading Billed Muradu Supermarket for goods transported from

Djibouti to Gondar Birr 2,650 Djibouti to Gondar Birr 2,650

January 21. Ato Yimer wrote a check for birr 450 to have one of the trucks repaintedJanuary 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 January 21. Bati trading purchased stationary materials and other supplies of Birr 740 on

account account

January 22. Office equipment of Birr 11,600 is bought 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 January 23. Purchased an additional truck for Birr 250,000 paying birr 100,000 in cash

and issuing a note for the difference. and issuing a note for the difference.

January 23. Recorded services billed to customers on account birr 14,600.January 23. Recorded services billed to customers on account birr 14,600.

January 25. Received cash from customers on account Birr 15,000.January 25. Received cash from customers on account Birr 15,000.

January 27. The owner withdrew Birr 500 in cash for his personal use.January 27. The owner withdrew Birr 500 in cash for his personal use.

January 28. Paid Birr 9,400 to workers as a salary for the last two weeks of the month.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 January 30. Paid telephone expense of Birr 95 and electric expenses of Birr 125 for the

month. month.

January 30. Paid other miscellaneous expenses Birr 50.January 30. Paid other miscellaneous expenses Birr 50.

January 31. Paid Birr 4,000 as a rent for a building used for office space.January 31. Paid Birr 4,000 as a rent for a building used for office space.

These transactions are journalised as follows:These transactions are journalised as follows:

DateDate DescriptionDescription DebitDebit CreditCredit

20032003Jan.1Jan.1

CashCash Yimer Capital Yimer Capital To record investment by owner To record investment by owner

450,000450,000450,000450,000

22 TruckTruck Cash Cash Purchase of trucks Purchase of trucks

300,000300,000300,000300,000

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44 CashCash Service Income Service Income Cash received from customers Cash received from customers

650650650650

44 Truck ExpensesTruck Expenses Accounts Payable Accounts Payable Service received in advance Service received in advance

90909090

1111 Prepaid InsurancePrepaid Insurance Cash Cash Purchase of insurance policy Purchase of insurance policy

600600600600

1616 Salary ExpenseSalary Expense Cash Cash Payment of salary Payment of salary

9,4009,4009,4009,400

2020 Accounts ReceivableAccounts Receivable Service Income Service Income Provision of service Provision of service

2,6502,6502,6502,650

2121 Truck ExpenseTruck Expense Cash Cash Cash paid to repaint truck Cash paid to repaint truck

450450450450

2121 SuppliesSupplies Accounts Payable Accounts Payable Purchase of supplies of account Purchase of supplies of account

740740740740

2222 Office EquipmentOffice Equipment Accounts Payable Accounts Payable Purchase of equipment Purchase of equipment

11,60011,60011,60011,600

2323 TruckTruck Cash Cash Notes Payable Notes Payable Purchase of truck Purchase of truck

250,000250,000100,000100,000150,000150,000

2323 Accounts ReceivableAccounts Receivable Service Income Service Income Provision of service on account Provision of service on account

14,60014,60014,60014,600

2525 CashCash Accounts Receivable Accounts Receivable Collection of cash Collection of cash

15,00015,00015,00015,000

2727 DrawingsDrawings Cash CashOwner withdrawalsOwner withdrawals

500500500500

2828 Salary ExpenseSalary Expense Cash Cash Payment of salary Payment of salary

9,4009,4009,4009,400

3030 Utilities ExpenseUtilities Expense Cash CashPayment for telephone, electricityPayment for telephone, electricity

220220220220

3030 Miscellaneous ExpensesMiscellaneous Expenses Cash Cash Payment for various expenses Payment for various expenses

50505050

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3131 Rent ExpenseRent Expense Cash Cash Payment of Rent Payment of Rent

4,0004,0004,0004,000

2.7 POSTING FROM THE JOURNAL TO THE LEDGER2.7 POSTING FROM THE JOURNAL TO THE LEDGER

After the information about a business transaction has been journalized, that information isAfter the information about a business transaction has been journalized, that information is

transferred to the specific accounts affected by each transaction. This process of transferringtransferred to the specific accounts affected by each transaction. This process of transferring

the information is called the information is called postingposting..

An account could be of two types; the two-column account and the four-column account. WeAn 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 givenwill use the four-column account for our illustration. The two forms of accounts are given

below.below.

The two-column account:The two-column account:

AccountAccount Account number Account number

DateDate ItemItem P.RP.R Debit Debit DateDate ItemItem P.RP.R CreditCredit

The four-column account:The four-column account:

AccountAccount Account number Account number

DateDate ItemItem P.RP.R Debit Debit CreditCredit BalanceBalance

DebitDebit CreditCredit

The steps in posting are given below:The steps in posting are given below:

1.1. Record the date and amount of Dr. and Cr. Entry to the accountRecord the date and amount of Dr. and Cr. Entry to the account

2.2. Insert the Journal page number in the P.R (Post Reference) column of the account.Insert the Journal page number in the P.R (Post Reference) column of the account.

3.3. Insert the account number in the P.R column of the journal.Insert the account number in the P.R column of the journal.

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Note. The P.R Column is used for reference purposes. The P.R column of the journal showsNote. 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.Rwhether 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.Column shows the Journal page number from which the entry was brought.

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

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

Account CashAccount Cash Account Number Account Number

DateDate ItemItem P.RP.R DebitDebit CreditCreditBalanceBalanceDebitDebit CreditCredit

20032003JanJan 11

450,000450,000 0000 450,000450,000 0000

22 300,000300,000 0000 150,000150,000 000044 650650 0000 150,650150,650 00001111 600600 0000 150050150050 00001616 9,4009,400 0000 140650140650 00002121 450450 0000 140200140200 00002323 100,000100,000 0000 4020040200 00002525 15,00015,000 0000 5520055200 00002727 500500 0000 5420054200 00002828 9,4009,400 0000 4530045300 00003030 220220 0000 45,08045,080 00003030 5050 0000 45,03045,030 00003131 4,0004,000 0000 41,03041,030 0000

NoteNote. The item column is usually left blank. In some cases the word balance is written when. The item column is usually left blank. In some cases the word balance is written when

the account is carried foreword to a new page. the account is carried foreword to a new page.

Check Your Progress Exercise -3Check Your Progress Exercise -3

Rule the other accounts used by Bati Transport and post the respective Dr. & Cr. entries (HintRule the other accounts used by Bati Transport and post the respective Dr. & Cr. entries (Hint

17 accounts, including cash, are used by Bati Transport). Don’t continue without doing this17 accounts, including cash, are used by Bati Transport). Don’t continue without doing this

because the following discussion assumes you have done this exercise!because the following discussion assumes you have done this exercise!

2.8 THE TRIAL BALANCE2.8 THE TRIAL BALANCE

After the posting phase is completed, we have to verify the equality of the debit and creditAfter 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 trial balance is a two columnbalances. This is done through the use of the ‘Trial Balance’. A trial balance is a two column

46

listing of the accounts in the ledger and their balance to make sure that the total of debitlisting of the accounts in the ledger and their balance to make sure that the total of debit

balances equals the total of credit balances.balances equals the total of credit balances.

The trial balance for our illustration, Bati Transport is presented bellow. The amounts areThe trial balance for our illustration, Bati Transport is presented bellow. The amounts are

taken from the balances of the accounts after all the transactions have been posted. Therefore,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 trialafter posting the above transactions, you should get the final balances shown on the trial

balance in the end.balance in the end.


Trial BalanceTrial Balance

January 31, 2003January 31, 2003

Cash Cash 41,03041,030 0000Accounts ReceivableAccounts Receivable 2,2502,250 0000SuppliesSupplies 740740 0000Prepaid InsurancePrepaid Insurance 600600 0000Office equipmentOffice equipment 11,60011,600 0000TruckTruck 550,000550,000 0000Accounts payableAccounts payable 12,43012,430 0000Notes payableNotes payable 150,000150,000 0000Yimer capitalYimer capital 450,000450,000 0000Yimer drawingYimer drawing 500500 0000Service incomeService income 17,90017,900 0000Salary expenseSalary expense 18,80018,800 0000Rent expenseRent expense 4,0004,000 0000Utilities expenseUtilities expense 220220 0000Maintenance expenseMaintenance expense 450450 0000Truuck expenseTruuck expense 9090 0000Miscellaneous expenseMiscellaneous expense 5050 0000 Total Total 630,330630,330 0000 630,330630,330 0000

2.8.1 Proof Provided by the Trial Balance2.8.1 Proof Provided by the Trial Balance

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

1.1. Error in preparing the trial balance including Error in preparing the trial balance including

-Addition error-Addition error

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

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

47

- A balance was entirely omitted.- A balance was entirely omitted.

2. Error in posting, including 2. Error in posting, including

- An erroneous amount was posted to the account.- An erroneous amount was posted to the account.

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

- A debit or credit posting was omitted- A debit or credit posting was omitted

2.8.2 Limitations of the Trial Balance 2.8.2 Limitations of the Trial Balance

The trial balance amounts are equal doesn’t mean that the accounting work is free from error.The trial balance amounts are equal doesn’t mean that the accounting work is free from error.

That is, there are errors that may take place without affecting the trial balance totals. SomeThat is, there are errors that may take place without affecting the trial balance totals. Some

examples are mentioned below:examples are mentioned below:

-- Failure to record a transaction or to post a transactionFailure to record a transaction or to post a transaction

-- Recording the same erroneous amount for both the debit and the credit parts of aRecording the same erroneous amount for both the debit and the credit parts of a

transaction.transaction.

-- Recording the same transaction more than once.Recording the same transaction more than once.

-- Posting part of a transaction to the correct side but the wrong account.Posting part of a transaction to the correct side but the wrong account.

Note: All these errors have the same affect (increasing or decreasing) on the debit totals andNote: All these errors have the same affect (increasing or decreasing) on the debit totals and

credit totalscredit totals

2.9 ADJUSTMENTS2.9 ADJUSTMENTS

All the transactions recorded above in the journalizing step are the result of daily transactions.All the transactions recorded above in the journalizing step are the result of daily transactions.

Other transactions result from the passage of time or from the internal operations of theOther transactions result from the passage of time or from the internal operations of the

business. For example, insurance premiums are paid for a certain period of time and expirebusiness. For example, insurance premiums are paid for a certain period of time and expire

during that time period. Another example is office supplies such as paper, pens & pencils.during that time period. Another example is office supplies such as paper, pens & pencils.

At the end of the period the balances in accounts such as supplies and prepaid insurance mustAt the end of the period the balances in accounts such as supplies and prepaid insurance must

be brought up to date. The supplies account balance, for example, must be credited by thebe brought up to date. The supplies account balance, for example, must be credited by the

consumed part of the supplies, debiting supplies expense. consumed part of the supplies, debiting supplies expense.

Example. Stationary materials totaling Birr 1,900.00 were purchased and recorded during theExample. Stationary materials totaling Birr 1,900.00 were purchased and recorded during the

year. At the end of the year, only Birr 150 of the supplies are left in hand.year. At the end of the year, only Birr 150 of the supplies are left in hand.

The adjusting entry prepared at the end of the year to adjust the supplies account will beThe adjusting entry prepared at the end of the year to adjust the supplies account will be

48

19901990 Supplies expenseSupplies expense 1,7501,750

Dec31Dec31 Supplies Supplies 1,7501,750

Note:Note: 1. Adjustments are dated as the last day of the year. 1. Adjustments are dated as the last day of the year.

2. The accounting year here – we assume, runs from January 1- December 31. 2. The accounting year here – we assume, runs from January 1- December 31.

Additional examples on adjustments will be given below under the topic ‘worksheet’Additional examples on adjustments will be given below under the topic ‘worksheet’

2.9.1 The Accrual Basis and the Cash Basis of Accounting2.9.1 The Accrual Basis and the Cash Basis of Accounting

1.1. The cash basis of accountingThe cash basis of accounting – – In this basis of accounting revenues are reported inIn this basis of accounting revenues are reported in

the period in which cash is received and expenses are reported in the period in which cashthe period in which cash is received and expenses are reported in the period in which cash

is paid. Net in come will, therefore, be the difference between the cash receiptsis paid. Net in come will, therefore, be the difference between the cash receipts

(Revenues) and cash payments (expenses). This method will be used by organizations(Revenues) and cash payments (expenses). This method will be used by organizations

that have very few receivables and payables. For most businesses, however, the cashthat have very few receivables and payables. For most businesses, however, the cash

basis is not an acceptable method.basis is not an acceptable method.

2.2. The accrual basis of accountingThe accrual basis of accounting – Under this method revenues are reported in the – Under this method revenues are reported in the

period in which they are earned, and expenses are reported in the period in which they areperiod in which they are earned, and expenses are reported in the period in which they are

incurred. For example, revenue will be recognized as services are provided to customersincurred. For example, revenue will be recognized as services are provided to customers

or goods sold and not when cash is collected. Most organizations use this method ofor goods sold and not when cash is collected. Most organizations use this method of

accounting and we will apply this method in this course.accounting and we will apply this method in this course.

2.9.2 The Matching Principle2.9.2 The Matching Principle

We have discussed three concepts and principles in accounting in unit one. Now we will seeWe have discussed three concepts and principles in accounting in unit one. Now we will see

one more principle, the matching principle. This principle states that the expense of a periodone more principle, the matching principle. This principle states that the expense of a period

have to be matched with the revenue of that period regardless of when payment is made. Inhave to be matched with the revenue of that period regardless of when payment is made. In

order to do this, the accrual basis of accounting requires the use of an adjusting process at theorder to do this, the accrual basis of accounting requires the use of an adjusting process at the

end of the period so that revenues and expenses of the period will be determined properly.end of the period so that revenues and expenses of the period will be determined properly.

2.10 WORKSHEET FOR FINANCIAL STATEMENTS 2.10 WORKSHEET FOR FINANCIAL STATEMENTS

Most of the data required to prepare the accounting reports (financial statements) is nowMost 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 largegathered. The data will now be presented in a convenient form. The worksheet is a large

49

columnar sheet prepared to arrange in a convenient form all the accounting data required tocolumnar 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.prepare financial statements. The worksheet has a heading and a body.

The heading has three parts:The heading has three parts:

i)i) Name of the OrganizationName of the Organization

ii)ii) Name of the form (worksheet)Name of the form (worksheet)

iii)iii) Period of time covered.Period of time covered.

The body contains five main parts each of them with two main columns. These parts areThe body contains five main parts each of them with two main columns. These parts are

1.1. The trial balanceThe trial balance

2.2. The adjustment The adjustment

3.3. The adjusted trial balanceThe adjusted trial balance

4.4. The income statementThe income statement

5.5. The balance sheet.The balance sheet.

The worksheet for Bati Transport is given below. The five parts of the body are discussed asThe worksheet for Bati 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 thefollows. You are advised to read and understand the discussions before you look at the

respective columns of the worksheet.respective columns of the worksheet.


Work SheetWork Sheet

For th3e month ended jan.31,2003For th3e month ended jan.31,2003

Account TitleAccount Title Trial BalanceTrial Balance AdjustmentAdjustment Adjusted TrialAdjusted Trial balancebalance

IncomeIncome statementstatement

Balance sheeetBalance sheeet

11 CashCash 41,03041,030 41,03041,030 41,03041,03022 Accounts receivableAccounts receivable 2,2502,250 ©©7,4007,400 9,6509,650 9,6509,65033 SuppliesSupplies 740740 (a)(a)340340 400400 40040044 Prepaid InsurancePrepaid Insurance 600600 (b)(b)450450 150150 15015055 Office equipmentOffice equipment 11,60011,600 11,60011,600 11,60011,60066 TruckTruck 550,000550,000 550,000550,000 550,000550,00077 Accounts payableAccounts payable 12,43012,430 12,43012,430 12,43012,43088 Notes payableNotes payable 150,000150,000 150,000150,000 150,000150,00099 Yimer CapitalYimer Capital 450,000450,000 450,000450,000 450,000450,0001010 Yimer drawingYimer drawing 500500 500500 5005001111 Service incomeService income 17,90017,900 ©©7,4007,400 25,30025,300 25300253001212 Salary expenseSalary expense 18,80018,800 18,80018,800 18,80018,8001313 Rent expenseRent expense 4,0004,000 4,0004,000 4,0004,0001414 Utilities expenseUtilities expense 220220 220220 2202201515 Maintenance expenseMaintenance expense 450450 450450 450450

50

1616 Truck expenseTruck expense 9090 9090 90901717 MiscellaneousMiscellaneous

ExpenseExpense5050 5050 5050

1818 630,330630,330 630,330630,3301919 Supplies expenseSupplies expense (a)(a)340340 340340 3403402020 Insurance expenseInsurance expense (b)(b)450450 450450 4504502121 72907290 72907290 636,830636,830 636,830636,8302222 Net incomeNet income2323 2530025300 2530025300 613,330613,330 613,330613,330

1. The trial balance column1. The trial balance column – this is the same trial balance we have prepared before. The – 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 atrial balance column of the work sheet can be brought direct from the ledger or from a

separate trial balance.separate trial balance.

2. The Adjustment column2. The Adjustment column – As mentioned previously, some account balances have to be – As mentioned previously, some account balances have to be

adjusted at the end of the year.adjusted at the end of the year.

The accounts in the ledger of our illustration that require adjustment and the adjusting entryThe accounts in the ledger of our illustration that require adjustment and the adjusting entry

for the accounts are presented below.for the accounts are presented below.

a) Suppliesa) Supplies – The supplies account has a debit balance of Birr 740. The cost of supplies in – 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 tohand 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:bring the balance of the account up to date:

Supplies expense…………………………….340Supplies expense…………………………….340

Supplies……………………………………..340Supplies……………………………………..340

b) Prepaid insuranceb) Prepaid insurance – Analysis of the policy showed that three – fourth of the policy is – 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 adjustingexpired. 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.entry to transfer the expired part of the insurance to expense will be.

Insurance expense ……………………….450Insurance expense ……………………….450

Prepaid insurance………………………..450Prepaid insurance………………………..450

c) Service Incomec) Service Income – At the end of the month unbilled fees for services performed to clients – At the end of the month unbilled fees for services performed to clients

totaled Birr 6,500.totaled Birr 6,500.

This amount refers to an income earned but to be collected in the future. The journal entry toThis amount refers to an income earned but to be collected in the future. The journal entry to

record it will be record it will be

51

Accounts receivable………………………….6,500Accounts receivable………………………….6,500

Service income………………………………6,500Service income………………………………6,500

All the above adjusting entries will be inserted in the adjustment column of the worksheet inAll the above adjusting entries will be inserted in the adjustment column of the worksheet in

front of the accounts affected.front of the accounts affected.

Note Note – The letters a, b & c are used to cross-reference the debits and credits to help future– The letters a, b & c are used to cross-reference the debits and credits to help future

review of the worksheet.review of the worksheet.

3. The Adjusted Trial Balance Column3. The Adjusted Trial Balance Column – The accounts that require adjustment are now – The accounts that require adjustment are now

adjusted. Transferring the trial balance column amounts combined with the adjustmentadjusted. Transferring the trial balance column amounts combined with the adjustment

column amounts will complete the adjusted trial balance column of the worksheet.column amounts will complete the adjusted trial balance column of the worksheet.

4. The income statement and the balance sheet columns4. The income statement and the balance sheet columns – Transfer the income statement – Transfer the income statement

account balances (revenue &expenses) to the income statement and balance sheet accountaccount balances (revenue &expenses) to the income statement and balance sheet account

balances (Asset, Liability &owners equity) to the balance sheet columns. Note that what webalances (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. have to transfer is the adjusted trial balance column amounts, to the corresponding columns.

Look at the 22Look at the 22ndnd row. It shows the net income for the month and it is added to the two 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.columns (Income statement Dr. and balance sheet cr.) as a balancing figure.

2.11 FINANCIAL STATEMENT PREPARATION2.11 FINANCIAL STATEMENT PREPARATION

After the work sheet is completed financial statements could be prepared easily. In chapterAfter 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,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.we will prepare three of these statements for Bati Transport form the worksheet.

1. Income statement1. Income statement All the data required to prepare the income statement is brought All the data required to prepare the income statement is brought

from the worksheet. from the worksheet.


Income statementIncome statement

For the month ended. Jan 31, 2003For the month ended. Jan 31, 2003

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

Operating expensesOperating expenses

Salary expense………………………..Birr 18,800Salary expense………………………..Birr 18,800

52

Rent “…………………………………….4,000Rent “…………………………………….4,000

Maintenance expense ……………………… 450Maintenance expense ……………………… 450

Insurance “ ……………………………450Insurance “ ……………………………450

Supplies “ …………………………….340Supplies “ …………………………….340

Utilities “……………………………..220Utilities “……………………………..220

Truck “ …………………………….. .90Truck “ …………………………….. .90

Miscellaneous “………………………………50Miscellaneous “………………………………50

Total operating expense………………………………………Total operating expense………………………………………24,40024,400

Net Income…………………………………………………Birr 900Net Income…………………………………………………Birr 900

2. Statement of owner’s equity2. Statement of owner’s equity – This statement shows the beginning balance of capital and – This statement shows the beginning balance of capital and

the changes that affected it.the changes that affected it.

The balance of the owners equity account (Yimer capital) in the worksheet may not be theThe 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 additionalbeginning one. Therefore, the ledger has to be reviewed to see if there was an additional

investment during the priod or not. In our illustration there is no additional investment.investment during the priod or not. In our illustration there is no additional investment.


Statement of Owner’s equityStatement of Owner’s equity

For the month ended January 31, 2003For the month ended January 31, 2003

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

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

LessLess: Withdrawal…………………………………...: Withdrawal…………………………………...500500 400400

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

3. Balance sheet3. Balance sheet – The data to prepare this statement will be taken from the worksheet and – 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 nonthe other financial statements. Note that assets and liabilities are classified as current and non

– current.– current.

53


Balance sheetBalance sheet

January 31, 2003January 31, 2003

AssetsAssets

Current Assets:Current Assets:

Cash…………………………………………Birr 41, 030Cash…………………………………………Birr 41, 030

Accounts Receivable…………………………….. 9,650Accounts Receivable…………………………….. 9,650

Supplies…………………………………………… 400Supplies…………………………………………… 400

Prepaid insurance…………………………………….Prepaid insurance…………………………………….150150

Total current assets……………………………………………Birr 51,230Total current assets……………………………………………Birr 51,230

Plant Asset (None-Current Assets)Plant Asset (None-Current Assets)::

Office equipment……………………………..Birr 110,600 Office equipment……………………………..Birr 110,600

Truck………………………………………………Truck………………………………………………550,000550,000 561,600561,600

Total asset………………………………………………………Birr Total asset………………………………………………………Birr 612,830612,830

LiabilitiesLiabilities

Current liabilitiesCurrent liabilities

Accounts payable……………………………..Birr 12,430Accounts payable……………………………..Birr 12,430

Non-current liabilitiesNon-current liabilities

Notes payable……………………………………..Notes payable……………………………………..150,000150,000

Total liabilities……………………………………………………Birr 162,430Total liabilities……………………………………………………Birr 162,430

Owner’s equityOwner’s equity

Ato Yimer Capital…………………………………………………………….. Ato Yimer Capital…………………………………………………………….. 450,400450,400

Total liability and owners equity………………………………………….Birr Total liability and owners equity………………………………………….Birr 612,830612,830

54

2.122.12 THE CLOSING PROCESS THE CLOSING PROCESS

Some of the accounts in the ledger are temporary accounts used to classify and summarize theSome of the accounts in the ledger are temporary accounts used to classify and summarize the

transactions affecting capital (owners equity). These accounts will be closed after financialtransactions affecting capital (owners equity). These accounts will be closed after financial

statements are prepared. That is, their balances will be transferred to the Capital account. Thestatements are prepared. That is, their balances will be transferred to the Capital account. The

temporary accounts that have to be closed are revenue, expense and withdrawal accounts.temporary accounts that have to be closed are revenue, expense and withdrawal accounts.

Steps in closing:Steps in closing:

1.1. Closing revenue accounts - Closing revenue accounts - Debit each revenue account by its balance andDebit each revenue account by its balance and

credit the ‘Income Summary’ account by the total revenue for the period.credit the ‘Income Summary’ account by the total revenue for the period.

Note:Note: Income summary is an account used to close revenue and expense accounts. This Income summary is an account used to close revenue and expense accounts. This

account will immediately be closed to the capital account at the end of the closing process.account will immediately be closed to the capital account at the end of the closing process.

2.2. Closing expense accounts Closing expense accounts – Debit the income summary account by the– Debit the income summary account by the

total of expenses for the period and credit each expense account by its balance.total of expenses for the period and credit each expense account by its balance.

3.3. Closing the income summary account Closing the income summary account – Income summary will be closed– Income summary will be closed

to the capital account. The balance of his account depends on the nature of operation;to the capital account. The balance of his account depends on the nature of operation;

credit if result is profit and debit if result is loss.credit if result is profit and debit if result is loss.

4.4. Closing WithdrawalClosing Withdrawal – Debit the owners equity account by the total of – Debit the owners equity account by the total of

drawings for the period and credit the drawing account.drawings for the period and credit the drawing account.

The temporary accounts of Bati transport are closed as follows.The temporary accounts of Bati transport are closed as follows.

20032003 Income summary………………….25,300Income summary………………….25,300

JanuaryJanuary Service income…………………………………25,300Service income…………………………………25,300

31 31 Closing revenueClosing revenue

31 31 Salary expense………………………..18,800Salary expense………………………..18,800

rent expense……………………………4,000rent expense……………………………4,000

Maintenance expense………………….. 450Maintenance expense………………….. 450

Insurance expense………………………..450Insurance expense………………………..450

Supplies expense…………………………340Supplies expense…………………………340

55

Utilities expense………………………….220Utilities expense………………………….220

Truck expense …………………………… 90Truck expense …………………………… 90

Miscellaneous expense…………………….50Miscellaneous expense…………………….50

Income expense…………………………………24,400Income expense…………………………………24,400

Closing expenses Closing expenses

20032003 Income summary………………900Income summary………………900

January 31January 31 Yemer Capital………………………..900Yemer Capital………………………..900

Closing income summaryClosing income summary

31 31 Yimer capital…………………...500Yimer capital…………………...500

Yimer drowing………………………..500Yimer drowing………………………..500

Closing with drowalClosing with drowal

The above closing entries have transferred the balance of the temporary accounts to theThe above closing entries have transferred the balance of the temporary accounts to the

permanent capital account.permanent capital account.


Post all the above closing entries and recompute the Post all the above closing entries and recompute the balancebalance of all the accounts affected. of all the accounts affected.

2.13 POST CLOSING TRIAL BALANCE2.13 POST CLOSING TRIAL BALANCE

After the closing entries have been journalized and posted, a trial balance is prepared to proveAfter the closing entries have been journalized and posted, a trial balance is prepared to prove

the equality of the general ledger the equality of the general ledger before recording the new year’s transactions.before recording the new year’s transactions. It should be It should be

noted that this trial balance includes only balance sheet accounts. This is because thenoted that this trial balance includes only balance sheet accounts. This is because the

temporary income statement accounts are closed during the closing process. This trialtemporary income statement accounts are closed during the closing process. This trial

balance is called the balance is called the post – closing trial balancepost – closing trial balance..

In practice the ledger balance after closing may be checked by a simple calculator print outIn practice the ledger balance after closing may be checked by a simple calculator print out

rather than a formal trial balance. The post closing trial balance for Bait Transport israther than a formal trial balance. The post closing trial balance for Bait Transport is

presented below.presented below.

56


Post – Closing trial balancePost – Closing trial balance

Jan 31, 2003Jan 31, 2003

Cash……………………………………………Birr 41,030Cash……………………………………………Birr 41,030

Accounts Receivable ………………………………...9,650Accounts Receivable ………………………………...9,650

Supplies…………………………………………………400Supplies…………………………………………………400

Prepaid insurance……………………………………….150Prepaid insurance……………………………………….150

Office equipment……………………………………11,600Office equipment……………………………………11,600

Truck……………………………………………….550,000Truck……………………………………………….550,000

Accounts payable…………………………………………………….Birr 12,430Accounts payable…………………………………………………….Birr 12,430

Nots payable……………………………………………………………..150,000Nots payable……………………………………………………………..150,000

Yimer capital……………………………………………………………..Yimer capital……………………………………………………………..450,400450,400

Total……………………………………Birr Total……………………………………Birr 612,830612,830 Birr Birr 612,830612,830

2.14 SUMMARY2.14 SUMMARY

Accountants go through a number of step-by-step procedures to record transactions and toAccountants go through a number of step-by-step procedures to record transactions and to

summarize the records in to useful repotrs in a systematic manner. These procedures thatsummarize the records in to useful repotrs in a systematic manner. These procedures that

accountants go through from the time a transaction is identified until the time financialaccountants go through from the time a transaction is identified until the time financial

statements are prepared are together called the accounting cycle. The accounting cycle isstatements are prepared are together called the accounting cycle. The accounting cycle is

summarized below:summarized below:

Input Process

Output

1. When a transaction 1. When a transaction happens, source documentshappens, source documents are prepared.are prepared.

2. Transactions are recorded in the journal 2. Transactions are recorded in the journal

3.Posting to individual accounts 3.Posting to individual accounts

4.Preparing a trial balance after4.Preparing a trial balance after determining the balance of each ledgerdetermining the balance of each ledger accountaccount

6.preparing and completing the work6.preparing and completing the work sheetsheet with adjustments with adjustments

8.Adjustments are journalized and posted8.Adjustments are journalized and posted

7.Preparing financial statements7.Preparing financial statements

57

9.Closing entries are journalized and9.Closing entries are journalized and postedposted

10.A post closing trial balance is prepared10.A post closing trial balance is prepared

2.15 ANSWERS TO CHECK YOUR PROGRESS QUESTIONS2.15 ANSWERS TO CHECK YOUR PROGRESS QUESTIONS


Expenses are found on the right hand side of the accounting equation; they are elements of Expenses are found on the right hand side of the accounting equation; they are elements of

the owners equity account. When expenses increase capital will decrease and vice versa.the owners equity account. When expenses increase capital will decrease and vice versa.

Because of this reverse effect of expenses on capital they increase on the Dr. sided andBecause of this reverse effect of expenses on capital they increase on the Dr. sided and

decrease on the Cr. side, unlike other right hand side accounts.decrease on the Cr. side, unlike other right hand side accounts.


a) Building and Accounts payablea) Building and Accounts payable

b) Both accounts are increased.b) Both accounts are increased.

c) Building is debited and accounts payable is creditedc) Building is debited and accounts payable is credited

d) Journal entry:d) Journal entry:

2003,2003, Building……………………………150,000Building……………………………150,000

Jan 11Jan 11 Accounts payable…………………………..150,000Accounts payable…………………………..150,000

Purchase of building on credit. Purchase of building on credit.


Prepare a four – column account for each account and post the respective entries to thePrepare a four – column account for each account and post the respective entries to the

accounts. Compare the ending balance of each account in your answer with their balance inaccounts. Compare the ending balance of each account in your answer with their balance in

the trial balance.the trial balance.


After all the closing entries are posted all temporary accounts will have zero balances. On theAfter all the closing entries are posted all temporary accounts will have zero balances. On the

other hand, permanent accounts will have non- zero balances. Example: Yimer Capital = Birrother hand, permanent accounts will have non- zero balances. Example: Yimer Capital = Birr

450,400, supplies Birr 400.450,400, supplies Birr 400.

58

A complete list of the permanent accounts and their balances is given on the post – closingA complete list of the permanent accounts and their balances is given on the post – closing

trial balance.trial balance.

2.16 MODEL EXAM QUESTIONS2.16 MODEL EXAM QUESTIONS

1.1. Indicate whether each of the following items below is an asset, liability, revenue,Indicate whether each of the following items below is an asset, liability, revenue,

expense, gain or loss account and whether it appears in the balance sheet or incomeexpense, gain or loss account and whether it appears in the balance sheet or income

statement.statement.

a) Office furniturea) Office furniture

b) Income from servicesb) Income from services

c) Salaries paid to workersc) Salaries paid to workers

d) Supplies on handd) Supplies on hand

e) Salary payable to workerse) Salary payable to workers

f) Cashf) Cash

g) Income form sale of a used truckg) Income form sale of a used truck

h) Goods damaged by fire in the storeh) Goods damaged by fire in the store

2.2. Given below is a list of selected transactions performed by John Décor during theGiven below is a list of selected transactions performed by John Décor during the

month of September 2002, the first month of operation.month of September 2002, the first month of operation.

a) Record the transactions in General Journala) Record the transactions in General Journal

b) Post each entry to the perspective account. Use the four – column account.b) Post each entry to the perspective account. Use the four – column account.

c) Prepare a trial balancec) Prepare a trial balance

d) Prepare a worksheet. Assume the following adjustment for the accounts and journalized) Prepare a worksheet. Assume the following adjustment for the accounts and journalize

them.them.

e) Prepare a Balance sheet, Income statement and statement of owner’s equitye) Prepare a Balance sheet, Income statement and statement of owner’s equity

f) close the temporary accounts.f) close the temporary accounts.

Sept. 10 Mr. John transferred cash form his personal account to be used in the business, Sept. 10 Mr. John transferred cash form his personal account to be used in the business,

Birr 10,000. Birr 10,000.

“ 10 Paid rent for the month, Birr 500 “ 10 Paid rent for the month, Birr 500

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“ 11 Purchased a truck for Birr 12,000 by paying Birr 3,000 Cash and giving a notes “ 11 Purchased a truck for Birr 12,000 by paying Birr 3,000 Cash and giving a notes

payable for the difference.payable for the difference.

“ 12 Purchased equipment on account Birr 1,460. “ 12 Purchased equipment on account Birr 1,460.

“ 13 Purchased supplies on account Birr 240. “ 13 Purchased supplies on account Birr 240.

“ 14 Paid insurance premiums of Birr 170 (Dr. prepaid insurance) “ 14 Paid insurance premiums of Birr 170 (Dr. prepaid insurance)

“ 15 Received cash for services completed Birr 360. “ 15 Received cash for services completed Birr 360.

“ 16 Purchased Supplies on account Birr 240. “ 16 Purchased Supplies on account Birr 240.

“ 18 Paid salaries of Birr 900. “ 18 Paid salaries of Birr 900.

“ 21 Paid its liabilities for the purchase of equipment “ 21 Paid its liabilities for the purchase of equipment

“ 24 Recorded sales on account Birr 2,080 “ 24 Recorded sales on account Birr 2,080

“ 26 Received an invoice for truck expense Birr 115 “ 26 Received an invoice for truck expense Birr 115

“ 27 Paid utilities expense Birr 205. “ 27 Paid utilities expense Birr 205.

“ 27 Paid miscellaneous expenses Birr 73. “ 27 Paid miscellaneous expenses Birr 73.

“ 28 Received cash from customers on account birr 1,420 “ 28 Received cash from customers on account birr 1,420

“ 30 Paid salaries to employees Birr 950 “ 30 Paid salaries to employees Birr 950

“ 30. The owner withdrew Birr 1, 750 for personal use. “ 30. The owner withdrew Birr 1, 750 for personal use.

3.3. The trial balance of Betty Beauty Saloon does not balance. The errors in theThe trial balance of Betty Beauty Saloon does not balance. The errors in the

accounting work are given below. Determine the correct balance of each account andaccounting work are given below. Determine the correct balance of each account and

prepare the corrected trial balance.prepare the corrected trial balance.

Betty Beauty SaloonBetty Beauty Saloon

Trial balanceTrial balance

April 30April 30

CachCach 5,902.005,902.00

Accounts ReceivableAccounts Receivable 6,300.006,300.00

SuppliesSupplies 1,600.001,600.00

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EquipmentEquipment 5,200.005,200.00

Accounts payableAccounts payable 4,300.004,300.00

Betty capitalBetty capital 10,000.0010,000.00

Service incomeService income 4,700.004,700.00

Operating expensesOperating expenses 1,980.001,980.00

Total Total 20,982.0020,982.00 19,200.0019,200.00

The errors are the following:The errors are the following:

Cash received form a customer on account was recorded (both debit and credit)Cash received form a customer on account was recorded (both debit and credit)

as birr as birr

1,400 instead of Birr 1,1201,400 instead of Birr 1,120

The purchase on account of an equipment costing Birr 780 was recorded as aThe purchase on account of an equipment costing Birr 780 was recorded as a

debit to debit to

operating expense and credit to accounts payable.operating expense and credit to accounts payable.

Service was performed to clients Birr 1,780 for which accounts ReceivableService was performed to clients Birr 1,780 for which accounts Receivable

was was

debited birr 1,780 and service income was credit birr 178debited birr 1,780 and service income was credit birr 178

A payment of Birr 80 for telephone charges was debited to Operating ExpenseA payment of Birr 80 for telephone charges was debited to Operating Expense

and it was also debited to cashand it was also debited to cash

The ledger balance of the service income account is birr 4,700 rather than BirrThe ledger balance of the service income account is birr 4,700 rather than Birr

4,720.4,720.

4.4. As of Sene 30 1994, the end of the current fiscal year, the accountant for AbayAs of Sene 30 1994, the end of the current fiscal year, the accountant for Abay

General Trading completed the worksheet before journalizing and posting theGeneral Trading completed the worksheet before journalizing and posting the

adjustments.adjustments.

Required: (a) Compare the adjusted and unadjusted trial balances and prepare the eightRequired: (a) Compare the adjusted and unadjusted trial balances and prepare the eight

journal entries that were required to adjust the accounts.journal entries that were required to adjust the accounts.

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(b) Prepare the journal entries that were required to close temporary accounts.(b) Prepare the journal entries that were required to close temporary accounts.

Abay General TradingAbay General Trading

Trial BalanceTrial Balance

Sene 30, 1994Sene 30, 1994

Un adjustedUn adjusted AdjustedAdjustedCashCash 12,825.0012,825.00 12,825.0012,825.00SuppliesSupplies 8,950.008,950.00 3,635.003,635.00Prepaid rentPrepaid rent 19,500.0019,500.00 1,500.001,500.00Prepaid insurancePrepaid insurance 3,750.003,750.00 1,250.001,250.00EquipmentEquipment 92,150.0092,150.00 92,150.0092,150.00Accumulated depreciation equipmentAccumulated depreciation equipment 53,480.0053,480.00 66,270.0066,270.00AutomobileAutomobile 56,500.0056,500.00 56,500.0056,500.00Accumulated depreciation automobileAccumulated depreciation automobile 28,250.0028,250.00 36,900.0036,900.00Accounts payableAccounts payable 8,310.008,310.00 8,730.008,730.00Salary payableSalary payable 3,400.003,400.00Tax PayableTax Payable 1,225.001,225.00Ato Abay capitalAto Abay capital 41,245.0041,245.00 41,245.0041,245.00Ato Abay drawingAto Abay drawing 18,600.0018,600.00 18,600.0018,600.00Service incomeService income 261,200.00261,200.00 261,200.00261,200.00Salary ExpenseSalary Expense 172,300172,300 175,700.00175,700.00Rent ExpenseRent Expense 18,000.0018,000.00Supplies ExpenseSupplies Expense 5,315.005,315.00Depreciation Expense EquipmentDepreciation Expense Equipment 12,790.0012,790.00Depreciation Expense AutomobileDepreciation Expense Automobile 8,650.008,650.00Utilities ExpenseUtilities Expense 4,700.004,700.00 5,120.005,120.00Taxes ExpenseTaxes Expense 1,5001,500 2,725.002,725.00Insurance ExpenseInsurance Expense 2,500.002,500.00Miscellaneous ExpenseMiscellaneous Expense 1,710.001,710.00 ________ 1,710.001,710.00 ________ Total Total 392,485.00392,485.00 392,487.00392,487.00 418,970.00418,970.00 418,970.00418,970.00

2.17 GLOSSARY OF TERMS2.17 GLOSSARY OF TERMS

AccountAccount –a record showing separately the increases and decreases of a financial statement –a record showing separately the increases and decreases of a financial statement

item during a period.item during a period.

T accountT account- the simplest format of an account, which resembles the letter ‘T’.- the simplest format of an account, which resembles the letter ‘T’.

Chart of Accounts-Chart of Accounts- a list of the account s used by an organization and their codes. a list of the account s used by an organization and their codes.

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DebitDebit- the left side of an account.- the left side of an account.

CreditCredit- the right side of an account.- the right side of an account.

Source DocumentsSource Documents- documents such as an invoice or a cash receipt voucher that evidence the- documents such as an invoice or a cash receipt voucher that evidence the

occurrence of a transaction.occurrence of a transaction.

JournalJournal- a book or record where a transaction’s full debits and credits and other details are- a book or record where a transaction’s full debits and credits and other details are

first recorded.first recorded.

Journal EntryJournal Entry-the debits and credits recorded in the journal for one transaction.-the debits and credits recorded in the journal for one transaction.

LedgerLedger- a book, where increases and decreases in each account are separately recorded. It is- a book, where increases and decreases in each account are separately recorded. It is

therefore the collection of the individual accounts of an organization.therefore the collection of the individual accounts of an organization.

Trial BalanceTrial Balance – a form showing the final balance of each ledger account. It is used to – a form showing the final balance of each ledger account. It is used to

somehow check if any errors were made during the period.somehow check if any errors were made during the period.

Work SheetWork Sheet –a working paper that accountants use to collect adjustment data and to easly –a working paper that accountants use to collect adjustment data and to easly

prepare the financial statements.prepare the financial statements.

AdjustmentsAdjustments – entries required to up-date some accounts before preparing financial – entries required to up-date some accounts before preparing financial

statements.statements.

Post Closing Trial BalancePost Closing Trial Balance- a trial balance prepared after all the accounts have been closed.- a trial balance prepared after all the accounts have been closed.

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