PROCESS FINANCIAL TRANSACTIONS AND EXTRACT INTERIM REPORTS

Objectives
After studying this chapter, you should be able to:
 Review the seven basic steps of the accounting cycle.
 Prepare a work sheet.
 Prepare financial statements from a work sheet.
 Prepare the adjusting and closing entries from a work sheet.
 Explain what is meant by the fiscal year and the natural business year.
 Analyze and interpret the financial solvency of a business by computing working capital and
the current ratio.

WHAT IS ACCOUNTING AND ACCOUNTING CYCLES?

Accounting is a process of identifying, measuring, recording, analyzing and communicating the
economic transaction of the business entities.

ACCOUNTING CYCLE
The accounting process that begins with analyzing and journalizing transactions and ends with
summarizing and reporting these transactions is called the accounting cycle. The most important
output of this cycle is the financial statements.

Steps to the Accounting Cycle

 The term, accounting cycle, refers to the steps involved in accounting for all of the business
activities during an accounting period. These steps are repeated each reporting period.
1. Transactions are analyzed a source of document.
2. Recorded in the journal or journalizing.
3. Transactions are posted to the ledger.
4. Prepared unadjusted trial balance.
5. prepared a trial balance , adjustment data are assembled, and an optional work sheet is
completed
6. Financial statements are prepared.
7. Adjusting entries are journalized.
8. Closing entries are journalized.
9. A post-closing trial balance is prepared.
10. Prepared Reverse entry.
The Role of Accounting Records
 The cyclical process of collecting financial information and maintaining accounting data.
 A record does far more than facilitate the preparation of financial statements.
 Managers and employees of a business frequently use the information stored in the accounting
records for such purposes as:
1. Establishing accountability for the assets and/or transactions under an individual’s control.
2. Keeping track of routine business activities—such as the amounts of money in company bank
accounts, amounts due from credit customers, or amounts owed to suppliers.
3. Obtaining detailed information about a particular transaction.
4. Evaluating the efficiency and performance of various departments within the organization.
5. Maintaining documentary evidence of the company’s business activities. (For example, tax
laws require companies to maintain accounting records supporting the amounts reported in
tax returns.

Chart of Accounts
A group of accounts for a business entity is called a ledger. A list of the accounts in the ledger is called
a chart of accounts. The accounts are normally listed in the order in which they appear in the financial
statements.

The balance sheet accounts are listed first, in the order of assets, liabilities, and owner’s equity. The
income statement accounts are then listed in the order of revenues and expenses. Each of these
major account groups is described next.

1. Assets are resources owned by the business entity. These resources can be physical items, such as
cash and supplies, or intangibles that have value.
 Examples of intangible assets include patent rights, copyrights, and trademarks.
 Examples of other assets include accounts receivable, prepaid expenses (such as insurance),
buildings, equipment, and land.
2. Liabilities are debts owed to outsiders (creditors). Liabilities are often identified on the balance
sheet by titles that include the word payable.
 Examples of liabilities include accounts payable, notes payable, and wages payable. Cash
received before services are delivered creates a liability to perform the services. These future
service commitments are called unearned revenues.
 Examples of unearned revenues are magazine subscriptions received by a publisher and
tuition received by a college at the beginning of a term.
3. Owner’s equity is the owner’s right to the assets of the business after all liabilities have been paid.
 For a proprietorship, the owner’s equity is represented by the balance of the owner’s capital
account.
 A drawing account represents the amount of withdrawals made by the owner.
4. Revenues are increases in owner’s equity as a result of selling services or products to customers.
  Examples of revenues include fees earned, fares earned, commissions revenue, and rent
revenue.
5. Expenses result from using up assets or consuming services in the process of generating revenues.
 Examples of expenses include wages expense, rent expense, utilities expense, supplies
expense, and miscellaneous expense. A chart of accounts should meet the needs of a
company’s managers and other users of its financial statements.
Bank Accounts

A major reason that companies use bank accounts is for internal control. Some of the control
advantages of using bank accounts are as follows:
1. Bank accounts reduce the amount of cash on hand.
2. Bank accounts provide an independent recording of cash transactions.
Reconciling the balance of the cash account in the company’s records with the cash balance according
to the bank is an important control.
3. Use of bank accounts facilitates the transfer of funds using EFT systems.
Bank Statement Banks usually maintain a record of all checking account transactions. A summary of
all transactions, called a bank statement, is mailed to the company (depositor) or made available
online, usually each month.

The bank statement shows the beginning balance, additions, deductions, and the ending balance.

6. Checks or copies of the checks listed in the order that they were paid by the bank may accompany
the bank statement. If paid checks are returned, they are stamped “Paid,” together with the date
of payment. Many banks no longer return checks or check copies. Instead, the check payment
information is available online. The company’s checking account balance in the bank records is a
liability. Thus, in the bank’s records, the company’s account has a credit balance. Since the bank
statement is prepared from the bank’s point of view, a credit memo entry on the bank statement
indicates an increase (a credit) to the company’s account.
7. Owner Withdrawals The debit and credit rules for recording owner withdrawals are based on the
effect of owner withdrawals on owner’s equity. Since owner’s withdrawals decrease owner’s
equity, the owner’s drawing account is increased by debits. Likewise, the owner’s drawing account
is decreased by credits.

Likewise, a debit memo entry on the bank statement indicates a decrease (a debit) in the company’s
account.

This relationship is shown below:

VALLEY NATIONAL BANK OF LOSANGELEs
PAGE 1
ACCOUNT NUMBER 1627042
FROM 6/30/09 TO 7/31/09
BALANCE 4,218.60
DEPOSITS 13,749.75
WITHDRAWALS 14,698.57
OTHER DEBITS AND
CREDITS 90.00CR
NEW BALANCE 3,359.78
* – – CHECKS AND OTHER DEBITS – – – –– * – – – –DEPOSITS –* –DATE * *BALANCE *
No. 850 819.40 No. 852 122.54 585.75 07/01 3,862.41
No. 854 369.5 No. 853 20.15 421.53 07/02 3,894.29
No. 851 600 No. 856 190.7 No. 857 52.5 781.30 07/03 3,832.39
No. 855 25.9 No. 858 160 662.50 07/05 4,308.96
No. 860 921.2 NSF 300 503.18 07/07 3,590.94

Classification of Account
Account- is the separate record used to show the decrease or increase in each financial statements.
Is the accounting record which is used to sort and summarize increase or decrease in specific asset,
liability, owner’s equity, and revenue and expense items. Or the type of record used to recording
individual transactions is called an account.
Balance sheet account as classified asset, liability, owners’ equity, and Income statement account -
for every revenue and expense appearing account.
 The asset, liability, owner’s capital, and drawing amounts are extended to (placed in) the Balance
Sheet columns.

Income statement account – classified as revenue and expenses.

 The revenue and expense amounts are extended to (placed in) the Income Statement columns.
Two common classes of assets are tangible asset and Intangible asset
A. Asset: is any tangible and intangible that has monetary value on exchanges.
 Assets are commonly divided into classes for presentation on the balance sheet. Two of these
classes are (1) current assets and (2) long term asset like: property, plant, and equipment.
1. Current Assets Cash and other assets that are expected to be converted to cash or sold or used up
usually within one year or less, through the normal operations of the business, are called current
assets.
 In addition to cash, the current assets usually owned by a service business are notes receivable,
accounts receivable, supplies, and other prepaid expenses.
2. FIXED ASSETS OR PLANT ASSETS.

These assets include equipment, machinery, buildings, and land. With the exception of land, fixed
assets depreciate over a period of time.
 The cost, accumulated depreciation and book value of each major type of fixed asset is normally
reported on the balance sheet or in accompanying notes.
 Intangible Asset – is asset that is lack of physical properties controlled by business.
Example: Good will, patent, copy right trade mark
B. Liabilities
 Liabilities are the amounts the business debt owned to creditors. The two most common classes
of liabilities are (1) current liabilities and (2) long-term liabilities.
1. Current Liabilities- Liabilities that will be due within a short time (usually one year or less) and that
are to be paid out of current assets are called current liabilities. The most common liabilities in
this group are notes payable and accounts payable. Other current liability accounts commonly
found in the ledger are Wages Payable, Interest Payable, Taxes Payable, and Unearned Fees.
2. Long-Term Liabilities- Liabilities that will not be due for a long time (usually more than one year)
are called long-term liabilities.
If had long-term liabilities, they would be reported below the current liabilities.
As long-term liabilities come due and are to be pa.id within one year, they are classified as current
liabilities. If they are to be renewed rather than paid, they would continue to be classified as long-
term. When an asset is pledged as security for a liability, the obligation may be called a mortgage
note payable or a mortgage payable.
e. g note payable for long term , bond payable, mortgage payable etc.
Notes receivable are amounts customers owe. They are written promises to pay the amount of
the note and possibly interest at an agreed rate. Accounts receivable are also amounts customers
owe, but they are less formal than notes and do not provide for interest. Accounts receivable
normally result from providing services or selling merchandise on account. Notes receivable and
accounts receivable are current assets because they will usually be converted to cash within one
year or less.
C. Owner’s Equity
 The owner’s right to the assets of the business is presented on the balance sheet below the
liabilities section. The owner’s equity is added to the total liabilities, and this total must be equal
to the total assets. Such as;
 Capital: is owner equity of sole proprietorship and partnership.
 Capital stock: is owner equity of stockholder equity.
 Retained earnings: is the net income of corporation.
 Revenue: is the profit or net income of proprietorship and partnership.
 Dividend: is the share distribution of the corporation.
 Withdrawal: is proprietorship and partnership.
 Income statement account – classified as revenue and expenses.
Revenue - is group of gross profit increase owner equity resulted from sale of goods and services to
customer.
 Other revenues are: - Commission fees
 Professional fees
 Fees earned
 Interest income
 Unearned revenue
General Journal
 The effects of business transactions on the individual asset, liability, and owners’ equity accounts.
In an actual accounting system, however, the information about each business transaction is
initially recorded in an accounting record called the journal.
 The journal is a chronological (day-by-day) record of business transactions. At convenient
intervals, the debit and credit amounts recorded in the journal are transferred (posted) to the
accounts in the ledger. The updated ledger accounts, in turn, serve as the basis for preparing the
company’s financial statements. The simplest type of journal is called a general journal.
 Note the way in which transactions are recorded in the general journal:
 The name of the account to be debited is written first, and the dollar amount to be debited
appears in the left-hand money column.
 The name of the account credited appears below the account debited and is indented to the right.
The dollar amount credited appears in the right-hand money column.
 A brief description of each transaction appears immediately below each journal entry.

LEDGER AND CHART OF ACCOUNTS

 An accounting system includes a separate record for each item that appears in the financial
statements. For example, a separate record is kept for the asset cash, showing all increases and
decreases in cash resulting from the many transactions in which cash is received or paid. A similar
record is kept for every other asset, for every liability, for owners’ equity, and for every revenue
and expense account appearing in the income statement.
 The record used to keep track of the increases and decreases in financial statement items is
termed a “ledger account” or, simply, an account. The entire group of accounts is kept together in
an accounting record for a business entity called a ledger.
 Ledger is a collection of all the accounts of the company.
 A complete listing of account title and account number in the ledger is called chart of account.
There are five types of accounts i.e. assets accounts, liability accounts, owner’s equity accounts,
revenue accounts, and expense accounts.
 Account are numbered to be permit interring and purpose of reference
 Based on size of company each will has two or more digit.
 The first digit indicate the major division of ledger account in which Asset represent 1, liability
2, owner equity 3, revenue 4 and expense 5.
 The second digit indicate the position of account within its division
Example: cash = 11 Asset - Cash
 This numbering system is help in setting a new account without disturbing the other account
number.
 There are different accounts:

Nature of Account
The simples form an account has three categories.
1. Account title- name of account
2. The left side debit (Dr) and the amount decrease
3. The right side credit (Cr) or increase record
Example: see the following T- account
Account Title (cash)
Left side Right side
(Debit) (credit)
 Assume. Mr. x deposit $ 10,000 in bank by the name
Cash Capital
10,000 10,000
Rule of debit and credit
 Every business transaction affects minimum full account.
 The sum of debit affect should equal with the sum of the credit one. this principle is

Double-Entry Accounting—the Equality of Debits and Credits

 The rules for debits and credits are designed so that every transaction is recorded by equal
dollar amounts of debits and credits. The reason for this equality lies in the relationship of the
debit and credit rules to the accounting equation:
Assets = Liabilities _ Owners’ Equity
Debit Balances Credit Balance
GENERAL RULES OF DEBIT
Debit Credit
Increase in asset accounts - Decrease in asset accounts
Decrease in liability accounts - Increase in liability accounts
Decrease in owner’s equity accounts - Increase in owner’s equity
accounts
If this equation is to remain in balance, any change in the left side of the equation (assets) must be
accompanied by an equal change in the right side (either liabilities or owners’ equity).
According to the debit and credit rules that we have just described, increases in the left side of the
equation (assets) are recorded by debits, while increases in the right side (liabilities and owners’
equity) are recorded by credits. This system is often called double-entry accounting.
The phrase double-entry refers to the need for both debit entries and credit entries, equal in dollar
amount, to record every transaction.
All asset account is increased by debit or left hand side and decrease by credit or right hand side.
All liabilities and owner equity account is increased by credit or right hand side and decrease by debit
or left hand side.
The rule to record revenue and expense is derived from rule of owner equity.
 Revenue is increased by credit or right hand side and decrease by debit or left hand side.
 Revenue is increased owner equity and owner equity increased on credit or right hand side and
decrease by debit or left hand side.
 Expense is decrease owner equity and owner equity decrease on left hand side or debit and
increased by debit or left hand side. So
 Expense is increased by left hand side or debit and decrease on right hand side with credit or right
side.
 Drawing and dividend also decrease owner equity; thus increased by left hand side or debit and
decrease on right hand side with credit or right side.
 Normal Balance of Account
Account balance difference between total decrease and increase in account. Usually balance of an
account is positive
I.e. the sum of increase recorded in an account is usually equal to or greater than the sum of the
decrease recorded in account.
Type Increase Decrease Normal Balance
Asset Debit Credit Debit
Liabilities Credit Debit Credit
Owner Equity Credit Debit Credit
Revenue Credit Debit Credit
Expense Debit Credit Debit
Drawing Debit Credit Debit

Analyzing and Recording Transaction

Every business transaction affects a minimum of two accounts. The transaction initially entered in
a record called journal. The process of recording a transaction in the journal is called journalizing.
The form of presentation is called a journal entry.

Journal: is the initial book used to record business transaction chronologically. Before accounting
record in journal.it is should be analyzed according to the following sequences of
I. Determine whether an asset, liabilities or owner equity. Revenue and expenses.
II. Determine whether the effect increase or decrease the account.
III. Determine the affect transaction debit or credit.
Steps in recording transaction in journal
1. Recorded date
2. Record debit account and amount
3. Record credit account and amount
4. Write source of document (explanation)
USES OF JOURNAL

 The journal shows all information about a transaction in one place; also provide an explanation
of the transaction.

 The journal provides chronological records of all the event in the life of the business.

 It helps to prevent errors.

RECORDING TRANSACTIONS IN THE JOURNALS (JOURNALIZING TRANSACTION)

Journalizing is the process of recording transaction in a business book called journal. There are two
commonly used type of journal; general journal and special journal.

General journal: is commonly used to record all type of transaction.

Special journal: is used to record specific type of transaction. Ex. Cash, purchase,

Before transaction is entered into two column journal it should be analyzed according to the
following steps:

Determine which element of accounting equation is affected.

 Determine which accounts are increased or decreased.
 Determine which accounts are debited and which are credited.

STEPS IN JOURNALIZING

1. Record the date - Insert the year, month and date.

2. Record the debit
3. Record the credit
4. Write an explanation: write a brief explanation or reference to source document in

POSTING

Posting - is the transferring data from journal to ledger account.

 The account could be two columns or four column shown:

 Posting is the process of transferring debits and credits from the journal to the appropriate
account in the ledger.

 A ledger account is a means of accumulating in one place all the information about changes in
specific asset, liability, owner’s equity, revenue and expense accounts.

 Each amount listed in the debit column of the journal is posted by entering into the debit side of
an account in the ledger and each amount listed in the credit column of the journal is posted to
the credit side of ledger account.
Description Column
The post reference column is left blank when the transaction is initially recorded. When the debits
and credits are latter transfer to ledger account the number of ledger account will be listed in this
column to provide a convenient cross reference with the ledger.

ILLUSTRATION OF JOURNALIZING AND POSTING

ANN Hill operated a photographic business known as Hill Photographic Studio:

March 1. The following assets were invested in the enterprise: cash $ 3,500; accounts receivable
$950; supplies $ 1200 and photographic equipment $ 15,000.

Date Description Post Ref. Debit Credit

1 March 2007 Cash 3,500 1

Account receivable 950

1 Supplies 1,200

Photographic equipment 15,000

Ann Hill, capital 20,650

March 1. Ann Hill paid $ 2,400 for rental contract; the payment is for 3 month rent.

Date Description Post Ref. Debit Credit

March 2007 Prepaid rent 2,400

1
Cash 2,400

March 4. Purchased photographic equipment on account from Palmer photographic Equipment Inc.
for$ 2,500:

Date Description Post Ref. Debit Credit

March 2007 4 Photographic equipment 2,500

 Account payable 2,500

March 5. Received $ 850 from customers in payment of their accounts:

Date Description Post Ref. Debit Credit

March 2007 Cash 850

5
Account receivable 850

March 6. Paid $ 125 for news paper advertisement:

Date Description Post Ref. Debit Credit

March 2007 Miscellaneous expense 125

6
Cash 125

March 10. Paid $ 500 to Palmer Photographic Equipment Inc. to apply on the $ 2,500 debt owed them

Date Description Post Ref. Debit Credit

March 2007 Account payable 500

10
Cash 500

March 13. Paid receptionist $ 575 for two week’s salary:

Date Description Post Ref. Debit Credit

March 2007 Supplies expense 575

13
Cash 575

March 16. Received $ 1,980 from sales for the first half of March:
 Date Description Post Ref. Debit Credit

March 2007 Cash 1,980

16
Sales 1,980

March 27. Purchased and paid $650 for supplies:

Date Description Post Ref. Debit Credit

March 2007 Supplies 650

27
Cash 650

March 27. Paid receptionist $ 575 for two week’s salary:

Date Description Post Ref. Debit Credit

March 2007 Salary expense 575

27 Cash 575

March 31. Paid $69 for telephone bill for the month:

Date Description Post Ref. Debit Credit

March 2007 miscellaneous expense 69

31
cash 69

March 31. Paid $ 175 for electricity bill for the month:

Date Description Post Ref. Debit Credit

March 2007 miscellaneous expense 175

31
cash 175
March 31. Received $ 1,870 from sales for the second half:

Date Description Post Ref. Debit Credit

March 2007 Cash 1,870

31
Sales 1,870

March 31. Sales on account totaled $1,675 for the month:

Date Description Post Ref. Debit Credit

March 2007 Account receivable 1,675

31
Sales 1,675

March 31. Hill withdrew $1,500 for her personal use:

Date Description Post Ref. Debit Credit

March 2007 Ann Hill drawing 1,500

31
Cash 1,500

Posting journal entries to ledger

Posting is the process of transferring debits and credits from the journal to the appropriate account in
the ledger.

A ledger account is a means of accumulating in one place all the information about changes in specific
asset, liability, owner’s equity, revenue and expense accounts.

Each amount listed in the debit column of the journal is posted by entering into the debit side of an
account in the ledger and each amount listed in the credit column of the journal is posted to the
credit side of ledger account.
The posting process is performed in the following manner.

1. Record the date and the amount of entry in the account.

2. Insert the number of the journal page in the post reference column of the account in the ledger.

3. Insert the ledger account number in post reference column of the journal.

POSTING OF THE ABOVE ILLUSTRATION TO THE LEDGER

Account: Cash Account No. 11

Post Balance
Date Item Ref. Debit Credit Debit Credit
Mar 1 3500 3500
1 2400 1100
5 850 1950
6 125 1825
10 500 1325
13 575 750
16 1980 2730
20 650 2080
27 575 1505
31 69 1436
31 175 1261
31 1870 3131
31 1500 1631

Account: AR Account No. 12

Post Balance
Date Item Ref. Debit Credit Debit Credit
Mar 1 950 950
5 850 100
31 1675 1775
Account: Supplies Account No. 14
Post Balance
Date Item Ref. Debit Credit Debit Credit
Mar 1 1200 1200
20 650 1850

Account: Prepaid Rent Account No. 15

Post Balance
Date Item Ref. Debit Credit Debit Credit
Mar 1 2400 2400
Account: Photographic Equipment Account No. 18
Post Balance
Date Item Ref. Debit Credit Debit Credit
Mar 1 15000 15000
4 2500 17500

Account: AP Account No. 21

Post Balance
Date Item Ref. Debit Credit Debit Credit
Mar 1 2500 2500
500 2000

Account: Ann Hill, Capital Account No. 31

Post Balance
Date Item Ref. Debit Credit
Debit Credit
Mar 1 20650 20650

Account: Ann Hill, Drawing Account No. 32

Post Balance
Date Item Ref. Debit Credit
Debit Credit
Mar 31 1500 1500
Account: Sales Account No. 41
Post Balance
Date Item Ref. Debit Credit
Debit Credit
Mar 16 1980 1980

31 1670 3650

31 1675 5525

Account: Salary Expense Account No. 52

Post Balance
Date Item Ref. Debit Credit Debit Credit
Mar 13 575 575
27 575 1150

Account: Miscellaneous Expense Account No. 59

Post Balance
Date Item Ref. Debit Credit Debit Credit
Mar 6 125 125
31 69 194
31 175 369

TRIAL BALANCE

The equality of debits and credits in the ledger should be verified at the end of each accounting
period. Such a verification, which is called a trial balance. Example for Ann Hill photographic studio is
as follows:
 Hill Photographic Studio
Trial Balance
March 31, 1990
Cash
Accounts Receivable
Supplies
Prepaid Rent
Photographic Equipment
Accounts Payable 2,000
Ann Hill, Capital 20,650
Ann Hill Drawing
Sales 5,525
Salary Expense
Miscellaneous Expense
28,175 28,175

Illustration Problem
A given below list of selected transaction performed by JOHN DÉCOR during the month of
September 2012, the first operation
Sept. 1 Mr. John transferred birr 10,000 cash from his personal account to be used in the business.
“ 10 The business paid rent for September birr. 500
“ 11 The business purchased a truck for birr. 12,000 by paying birr. 3000 cash and giving a notes
payable for the balance.
“ 12 The business purchased equipment on account birr. 20,400.
“ 13 The business purchased supplies on account birr. 2,400.
“ 14 The business paid insurance premium of birr 3,600 (Dr. prepaid insurance )
“ 15 The business received cash for services completed Birr. 30,600.
“ 16 The business purchased supplies on account birr. 1,400.
“ 21 The business paid its liabilities for the purchase of equipment.
“ 24 The business recorded sales on account birr.2,080.
“ 26 The business received invoice for truck expense Birr 1,150.
“ 27 The business paid utilities expense birr 2,000.
“ 28 The business received cash from customer on account Birr. 1420.
“ 30 The business paid salaries to employees birr.950.
“ 30 The owner withdrew birr. 1700 for personal use.
 Required:
1. Record Transactions in general journal
2. Transactions are posted to the ledger.
3. Prepared unadjusted trial balance.
4. prepared a trial balance , adjustment data are assembled,
5. prepared work sheet is completed ( an optional)
6. Financial statements are prepared.
7. Adjusting entries are journalized and Closing entries are journalized.
8. A post-closing trial balance is prepared and Prepared Reverse entry.
Additional information
The data needed to determine the yearend adjustments are as follows:
 Inventory supplies at Sep. 30, 2012----------------------- Birr. 2,800.
 Insurance premium expired during the year --------------------- 150
 Deprecation of the year--------------------------------------------1,360
 Wage accrued but not paid at September 30, 2012-------------- 140
Solution
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
2012
Sept. 1 Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .10,000
Capital Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,000
(Owners invest cash in the business)
10 Rent expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,00 \
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,00
(Cash paid for rent).
11 Trucks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,000
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,000
Notes Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9,000
Purchased Truck Paid part cash and balance note payable )
12 Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .20,400
Accounts Payable . . . . . . . . . . . . . . . . . . . . . . 20,400
(Purchased equipment on credit form)
13 Supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,400
Accounts Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,400
(Purchased tools and equipment on credit from)
14 Prepaid insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . .. 3,600
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . 3,600
(Record payment of insurance)
15 Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30,600
Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30,600
(Sale on cash)
 16 Supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,400
Accounts Payable . . . . . . . . . . . . . . . . . . . . . . . . . . 1,400
21 Account payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20,400
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20,400

24 Accounts Receivable . . . . . . . . . . . . . . . . . . . . . . .. . . . 600

Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 600
Record Sale on account)
26 Truck expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1150
Invoice payable . . . . . . . . . . .. . . . . . . . . . . . .. . . . . . . . 1150
(To record truck expense)
27 Utilities expense . . . . . . . . . . . . . . . . . . . . . . . 2,000
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,000
28 Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,420
A/ Receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1420
30 Wage expense . . . . . . . . . . . . . . . . . . . . . . . . 950
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 950
30 Withdrawals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,700
Cash . . . . . . . . . . . .. . . . . .. . . . . . . . . . . . . . . . . . . . 1,700

Unadjusted Trial Balance Columns

 Accountants often use working papers for collecting and summarizing data they need for
preparing various analyses and reports. Such working papers are useful tools, but they are not
considered a part of the formal accounting records. This is in contrast to the chart of accounts,
the journal, and the ledger, which are essential parts of the accounting system. Working papers
are usually prepared by using a spreadsheet program on a computer.
 The work sheet is a working paper that accountants can use to summarize adjusting entries and
the account balances for the financial statements.

Trial Balance Column

The trial balance data can be assembled directly on the work sheet form or can be prepared on
another sheet and then copied on to the work sheet form.
Adjustments Column illustration
For Example: Both the debit and credit parts of an adjustment should be inserted on the appropriate
lines before going on to another adjustment.
Supplies: Supplies account balance …………………………………$1,850
Less: Supplies on hand…………………………………..890
Supplies Expense…………………………………………960
Rent: Prepaid rent (for 3 month)…………………….…... $2,400
Less: Remaining prepaid rent (2 month) ……………….1,600
Rent Expense for March…………………………………..800
Depreciation: depreciation of photographic equipment is estimated to be $175 for the month:
Depreciation expense…………….175
Accumulated depreciation ……………175
Salaries: Salaries accrued but not yet paid at the end of the month of March is $115. This is an
increase in expense and an increase in liability.
ADJUSTMENTS
 Some of the trial balance amounts are not correct. The amounts listed for prepaid expenses are
normally overstated. This is because of the day to day consumption or expiration of these assets
has not been recorded. There are two effects on the ledger when the daily reduction in prepaid
expenses is not recorded:
 Asset accounts are overstated, and
 Expense accounts are understated, then the net income will be overstated or the net loss
understated.
 For example, salary expense incurred between the last payday and the end of the accounting
period would not be recorded in the account.
 The entries required to record at the end of an accounting period to bring the accounts up to date
and to assure the proper matching of revenues and expenses are called adjusting entries.
ADJUSTING ENTRIES
Adjusting entries are journal entries that are required at the end of an accounting period to bring
the ledger up to date. Adjusting entries can be classified as either deferrals or accruals.
Deferrals - 1. Prepaid Expenses- Expenses paid in cash before they are used or consumed.
2. Unearned Revenues- Revenues received in cash before delivering goods or services.
Accruals - 1. Accrued Expenses- Expenses incurred but not yet paid in cash or recorded.
2. Accrued revenues- Revenues earned but not yet received in cash or recorded.
Prepaid expenses (deferred expenses)
It is already paid before using the service or property. Such as: prepaid rent, prepaid insurance.

Illustration: The inventory of supplies on March 31 is determined that $890 is on hand, the
amount to be moved from asset account to expense account is $960 i.e. (1,850-890=960).
Supplies Exp………………………………………….960
Supplies…………………………………………………960
Prepaid rent was used for one month (March 1 up to March 31).
Rent Exp………………………………………………..800
Prepaid Rent………………………………………… s.800
Plant Assets
 As time passes, equipment's do lose its capacity to provide useful service. This decrease in
usefulness is a business expense, which is called depreciation. This expired portion of the cost
of plant asset is both an expense and a reduction in the asset. The adjusting entry to record is
depreciation expense debited and accumulated depreciation credited.
(a) Supplies. The supplies account has a debit balance of $2,000. The cost of the supplies on hand
at the end of the period is $760.
 Enter the adjustment by writing (1) $1,240 in the Adjustments Debit column on the same line
as Supplies Expense
(b) Prepaid Insurance. The prepaid insurance account has a debit balance of $2,400, which
represents the prepayment of insurance for 24 months beginning December 1. Thus, the
insurance expense for December is $100 ($2,400/24).
C) Unearned Rent. The unearned rent account has a credit balance of $360, which represents the
receipt of three months’ rent, beginning with December. Thus, the rent revenue for December is
$120.
Unearned rent -------120
Rent Revenue --- 120
(d) Wages. Wages accrued but not paid at the end of December total $250. This amount is an increase
in expenses and an increase in liabilities. Enter the adjustment by writing (1) $250 in the Adjustments
Debit column on the same line as Wages Expense and (2) $250 in the Adjustments Credit column on
the same line as Wages Payable.
(e) Accrued Fees. Fees accrued at the end of December but not recorded total $500. This amount is an
increase in an asset and an increase in revenue. Enter the adjustment by writing (1) $500 in the
Adjustments Debit column on the same line as Accounts Receivable and (2) $500 in the Adjustments
Credit column on the same line as Fees Earned.
(f) Depreciation. Depreciation of the office equipment is $50 for December. Enter the adjustment by
writing (1) $50 in the Adjustments Debit column on the same line as Depreciation Expense and (2) $50
in the Adjustments Credit column on the same line as Accumulated Depreciation.
 Total the Adjustments columns to verify the mathematical accuracy of the adjustment data. The
total of the Debit column must equal the total of the Credit column
 The data needed to determine the yearend adjustments are as follows:
Inventory supplies at Sep. 30, 2012---------------- Birr. 2,800.
Insurance premium expired during the year ---------- 150
Deprecation of the year----------------------------1,360
Wage accrued but not paid at September 30, 2012------- 140
Solution
Entry: a. supplies expense---------------------------2800
Supplies ----------------------------------2800
(To record supplies on hand)
b. insurance expense -------------------------------- 12.5
Prepaid insurance----------------------------12.5
(To record payment of insurance premium)
c. Depreciation expense ------------------------------ 113.33
Accumulated depreciation--------------------113.33
(To record depreciation of equipment)
D. wage expense ------------------------------------140
Wage payable ------------------------------140
(To record accrued wage)
WORK SHEET
 A type of working paper frequently used by accountants prior to preparation of financial
statements is called work sheet.
Benefits of Work Sheet
 Work sheet is not a required report (it is not available to external decision makers), yet using of
work sheet has several benefits, such as:
◦ Aids the preparation of financial statements.
◦ Reduce the possibilities of errors.
◦ Links accounts and adjustments to their impacts in the financial statements.
 Work sheet has an account title column and ten money columns, ranged in five parts of debit and
credit columns. The main headings are: adjustments, adjusted trial balance, income statement
and balance sheet.

Income Statement and Balance Sheet Columns

 The work sheet is completed by extending the adjusted trial balance amounts to the Income
Statement and Balance Sheet columns. The amounts for revenues and expenses are extended to
the Income Statement columns. The amounts for assets, liabilities, owner’s capital, and drawing
are extended to the Balance Sheet columns.
 The data in the adjusted trial balance columns are extended to one of remaining four columns.
The amounts of assets, liabilities, owner’s equity and drawing (or dividends) are extended to the
balance sheet columns; and the revenues and expenses are extended to income statement
columns.
 The net income or net loss for the period is the amount of the difference between the totals of the
two income statement columns,
 Statement of Owner’s Equity
 The first item normally presented on the statement of owner’s equity is the balance of the
proprietor’s capital account at the beginning of the period.
 If the owner’s withdrawals had exceeded the net income, the order of the net income and the
withdrawals would have been reversed. The difference between the two items would then be
deducted from the beginning capital account balance. Other factors, such as additional
investments or a net loss, also require some change in the form, as shown in the following
example:
Allan Johnson, capital, January 1, 2005--------$39,000
Additional investment during the year---------6,000
Total investment ----------------------------- $45,000
Less: Net loss for the year----------------------- $ 5,600
Withdrawals---------------------------------- 9,500
Decrease in owner’s equity------------------ 15,100
Allan Johnson, capital, December 31, 2005 ---- $29,900

JOURNALIZING AND POSTING ADJUSTING ENTRIES

 At the end of the accounting period, the adjusting entries appearing in the work sheet are
recorded in the journal and posted to the ledger. The adjusting entries are dated as of the last
day of period.
 The account titles and balances needed in preparing these entries may be obtained from the
work sheet, the income statement and the statement of owner’s equity, or the ledger. If a work
sheet is used, the data for the first two entries appear in the Income Statement columns. The
amount for the third entry is the net income or net loss appearing at the bottom of the work
sheet. The amount for the fourth entry is the drawing account balance that appears in the
Balance Sheet Debit column of the work sheet.

ADJUSTING AND CLOSING ENTRIES

 The balances of the accounts reported on the balance sheet are carried forward from year to
year. Because they are relatively permanent, these accounts are called real accounts. The
balances of the accounts reported on the income statement are not carried forward from year
to year. Likewise, the balance of the owner’s withdrawal account, which is reported on the
statement of owner’s equity, is not carried forward. Because these accounts report amounts for
only one period, they are called temporary accounts or nominal accounts.
 To report amounts for only one period, temporary accounts should have zero balances at the
beginning of a period. How are these balances converted to zero? The revenue and expense
account balances are transferred to an account called Income Summary. The balance of Income
Summary is then transferred to the owner’s capital account.
  The balance of the owner’s drawing account is also transferred to the owner’s capital account.
The entries that transfer these balances are called closing entries. The transfer process is called
the closing process.
 EXPENSES are transferred to Income Summary
 DRAWINGS are transferred to Owner's Capital
 REVENUES are transferred to Income Summary
 NET INCOME or NET LOSS is transferred to Owner's Capital
 At the beginning of the closing process, Income Summary has no balance. During the closing
process, Income Summary will be debited and credited for various amounts. At the end of the
closing process, Income Summary will again have no balance. Because Income Summary has the
effect of clearing the revenue and expense accounts of their balances, it is sometimes called a
clearing account
Record close expense: Income summary---xx
Expense ----------xx
Record close revenue: Revenue --------------------xx
Income summary--------xx
Record close income summary: Income summary ----------xx
O. Capital ----------------------xx
Record close drawing: Capital ------------------------------xx
Drawing -------------------------xx
CLOSING ENTRIES
 The revenue, expense, and drawing (or dividends) accounts are temporary accounts used in
classifying and summarizing changes in the owner’s equity during the accounting period. At the
end of the period, the net effect of the balances in these accounts must be recorded in the
permanent capital (or retained earnings) account. The balance must also be removed from
temporary accounts, these processes done by closing entries.
Journalizing and Posting Closing Entries
 Four closing entries are required at the end of an accounting period, as outlined in Exhibit 8. The
account titles and balances needed in preparing these entries may be obtained from the work
sheet, the income statement and the statement of owner’s equity, or the ledger.
Closing entry for Hill Photographic Studio is as follows:
Sales…………………………………………………….5525
Income Summary…………………………………….5525
Income Summary…………………………………3569
Salary Expenses………………………………….1265
Miscellaneous Expenses…………………………. 369
Supplies Expenses…………………………………..960
Rent Expenses……………………………………....600
Depreciation Expenses……………………………..175
Income Summary…………………………………1956
Ann Hill, Capital…………………………………..1956
Ann Hill, Capital………………………………….1500
Ann Hill, drawing……………………………….1500
After journalizing, the journal entries should be posted to the ledger. The sales, expenses, income
summary, and drawing accounts then get zero balance.
POST CLOSING TRIAL BALANCE
 The last procedure of the accounting cycle is the preparation of post-closing trial balance after all
of the temporary accounts has been closed. The purpose of the post-closing trial balance is to
make sure that the ledger is balance at the beginning of the new accounting period. The following
is Hill Photographic Studio post-closing trial balance as of March 31, 1990:
FISCAL YEAR
 The maximum length of an accounting period is usually one year (12 months). The annual
accounting period adopted by an enterprise is known as fiscal year.