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B-ACTG111 BSA16 1st Sem ( 2021-2022 )

Module 4 - Financial Statements of a Service-Oriented Business

Lesson Proper & Learning Activities

Immersive Reader

ACCOUNTING CYCLE  

The accounting cycle is a series of steps designed to translate the financial transactions into financial statements. The process helps
to ensure that all transactions are accounted for and that the financial statements are complete and accurate. A one full accounting cycle starts by analyzing and recording each financial transaction
and ends with a financial report and preparation of opening balances for the next accounting period. An accounting cycle varies depending on the needs of the company, most companies would like
to analyze their performance on a monthly, quarterly or on a semi-annual basis. It is a basic requirement however to prepare the financial statements annually for financial reporting purposes, thus,
a full accounting cycle normally covers a 12-month period. Periodicity or reporting period assumption implies that the life of the business is divided into uniform periods of time so that regular
financial statements can be prepared. The accountant may use either a calendar accounting period or a fiscal accounting period. A calendar accounting period is a twelve-month period ending on
December 31 while a fiscal accounting period is a twelve-month period that ends on any month other than December 31. An academic institution may observe a Fiscal Period that coincides with its
Academic Year, viz, 12 months starting September 2021 and ending August 31, 2022. 

Accounting cycle could be divided between 8 to 10 steps.  From the illustration, Step #5 - Worksheet Preparation is optional, because it could facilitate easier preparation of Adjusting Journal Entries
and Financial Statements for manual accounting systems, but digital or automated accounting systems can do away with the worksheet preparation.  Some cycles would also include Reversing
Journal Entries upon start of the new accounting period, i.e., after the preparation of Post Closing Trial Balance, but some practitioners also consider this to be optional.

Steps 1 & 2:  Analyze the Source Documents and Record the transaction to General Journal

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Accounting cycle begins after the occurrence of a business transaction that has impact on the financial statements. The most common examples are sales, purchases, collections and payments
supported with business papers or documents. The effect on the financial statements are analyzed and recorded in the books of original entry called journals in chronological order. 

Step 3: Posting to General Ledger

From general journal, each entries will be posted to the general ledger. Ledger is the formal form of T Account used by accountants to summarize the effect of every financial transactions on each
account and immediately determine its balances.

Steps 1-3 are continuously performed all throughout the accounting period.

Step 4: Preparation of Unadjusted Trial Balance

At the end of the reporting period, the balances of each of the accounts found in the ledger are extracted and a trial balance will be prepared to prove the duality of the recording process. That is, the
total debits and credits balances must be equal. 

Step 5: Preparation of Worksheet

With so many adjustments to gather and analyze, a worksheet is needed to gather and "workout" the adjustments. A worksheet is a columnar paper where the first two columns are provided for
the trial balance which contains the unadjusted balances of each accounts. The next two columns are for the adjustments and from which adjusted balances are determined. From the adjusted
balances, the income statement and the statement of financial position are prepared.  

Step 6: Journalizing and Posting of Adjusting Entries

Adjusting entries are entries prepared at the end of the accounting period to update some accounts and ensure their accuracy before preparing the financial statements. These are recorded in the
general journal at the end of accounting period and posted to the general ledger to update the balances of each accounts. 

Step 7: Preparation of Adjusted Trial Balance

The adjusted trial balance reflects the correct and adjusted balances of each accounts and used as a basis in the preparation of financial statements. The balances are extracted from the ledgers after
the adjusting entries are posted. 

Step 8: Preparation of Financial Statements

From the adjusted trial balance, we are now ready to prepare the financial statements as the next step in the accounting cycle. The use of worksheet eases the preparation of financial statements. The
adjusted balances of revenue and expenses accounts will be used to prepare the income statement and determine the net income. The resulting net income/loss will then be added to or deducted
from the owner’s equity. The owner’s drawings will be deducted afterward to determine the ending balance of owner’s equity. The adjusted balances of assets and liabilities plus the final balance of
owner’s equity will be presented to the statement of financial position.

Step 9: Journalizing and Posting of Closing Entries

After all the adjustments have been journalized and posted and the financial statements prepared, the income and expense accounts and owner’s drawing account have to be closed. Closing the
books means bringing these temporary or nominal accounts to zero balance by transferring them to the capital account or owner’s equity. After the closing entries, the books are “cleared” of these
accounts so that in the next reporting period, the books are ready for a new set of temporary or nominal accounts.  

Step 10: Preparation of Post-Closing Trial Balance

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After accomplishing so many accounting steps, there is a need to prepare another trial balance to prove the equality of the debits and credits. The Post Closing Trial Balance is prepared after closing
the books and contains only real accounts with balances since nominal accounts were already closed to equity accounts as mentioned in Step 8. It has the same accounts as those found in the
statement of financial position.  

We recall in Modules 2 and 3, you have learned to (1) analyze business transactions; (2) prepare general journal entries for financial transactions; and (3) post the journal entries to general ledgers -
these cover Steps 1 & 2 in the Accounting Cycle. This time, we proceed with  Steps 3 to 8, but skipping Step 5 because this is an optional step in the cycle. We shall make use of the Worksheet in the
succeeding modules that we'll take up for Merchandising operations. 

Refer to your reading assignments and exercises on Chapter 5 of your accompanying textbook via Connect too, for better understanding and development of your skills in preparing the Trial
Balance and the Financial Statements. 

Immersive Reader

The Trial Balance

The Trial Balance is a list of accounts with ledger balances.  Recall the acronym that helps you easily remember the normal balances of accounts: D-ADE and C-LER?  On the Debit
side are Asset, Drawing, and E xpense accounts; while on the Credit side are L iabilities, E quity, and Revenue accounts.

As you watch the accompanying video that illustrates the preparation of Trial Balance using MS Excel, observe the following:

1.  The heading consists of three lines:     Name of the Business

  Title of the report (Trial Balance)

  Date

2.  Account titles are arranged according to how they are arranged in the Chart of Accounts (Assets, L iabilities, Capital, Revenues, E xpenses)

3.  The amounts corresponding the accounts are lifted from the General Ledger balances. Note that even accounts with zero balances still appear in the Trial Balance.

4.  The Peso sign appears only on the first debit amount and the first credit amount, and on the totals.

5.  The debit and credit columns are summed up (totalled), and the total amounts are double ruled.

Supplemental video courtesy of Prof. Arlene Jalos, - part-time and former ACTG111 Instructor at DLSU-Dasmariñas
Immersive Reader

As mentioned in the previous page, the trial balance is a tool that helps us establish the equality of debits and credits.  So if the total debits do not equal total credits, then
error(s) must have been committed.  Such error(s) may have been due to any or a combination of the ff:

1. Posting from the Journal to the Ledger on the wrong side.

2. Posting a wrong amount.
3. Error on ledger footing (i.e., erroneously adding the debit or credit side of a ledger account(s))
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4. Copying/transferring wrong balances from the Ledger to the Trial Balance  

These errors should be properly detected and corrected before ruling and double ruling the totals. Here are ways to detect such errors: 

1. Add the debit and credit columns of the trial balance again.  If the difference is still there, go further by adding all the debit balances and the credit balances of the
ledgers.
2. Check if the difference is divisible by two - the error is probably in posting on the wrong side; e.g., posting a debited account in the journal entry to the credit side of the
ledger; or copying a debit balance from the ledger to the credit side of the trial balance.
3. Check also if the difference is divisible by 9 or a multiple of 9 - the error could either be a "transposition" or "transplacement".   
1. Transposition happens when the order (or position) of the digits is interchanged, for example:  an amount of P30,030 was copied as P30,300; the difference is 270 - a
figure that is divisible by 9 (and the result is exactly 30).  
2. Transplacement happens when the decimal point is misplaced (or slides), for example:  an amount of P30,030.00 was copied as P3,003.00; the difference is P27,027,
which when divided by 9, would give us the lower value  - P3,003. 

The above mentioned errors may happen either in copying from the Ledger to the Trial Balance or in posting from the Journal to the Ledger.  So you need to be diligent in
checking, especially if the process is still performed manually.  Computerized or digital accounting systems are no longer prone to these errors because it has the capability to
automatically process journal entries into financial reports.

However, not all errors may be detected through the inequality of the debit and credit columns of a Trial Balance.  Have you heard of the expression "garbage in, garbage out"?  It
means, having incorrect information (or analysis) at the beginning of the process will also yield incorrect results.  This is true, whether the accounting system in place is
manually done or assisted by a computerized process.  Yes, your Trial Balance may show equality of the debit and credit columns, yet these errors may have been committed in
the process:           

1. Failure to record a legitimate financial transaction.

2. A transaction was journalized but it was not posted. 
3. An erroneous amount was debited and credited for an entry - and was carried forward up to posting and preparation of Trial Balance.
4. A recorded transaction (or a journal entry) was posted twice.
5. An amount is posted to the correct side, but to the wrong account; e.g., a debit entry to Rent Expense was posted to Repairs Expense.
6. A wrong account title was used in recording the transaction.

Watch this accompanying video and see how the above errors could be detected and subsequently corrected. 

Supplemental video courtesy of Prof. Arlene Jalos, - part-time and former ACTG111 Instructor at DLSU-Dasmariñas

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