LION ETHIOPIA TOURISM HOTEL AND BUSINESS

COLLEGE
Material for FRONT OFFCE AND FOOD BEVERAGE
DEPARTMENT LEVEL-4
Unit of Competency: prepare Financial reports
Definition of business and Types of Business
Enterprises
A business is an organization in which basic resources (inputs), such as
materials and labor, are assembled and processed to provide goods or services
(outputs) to customers.
The objective of most businesses is to earn a profit. Profit is the difference
between the amounts received from customers for goods or services and the
amounts paid for the inputs used to provide the goods or services.
Business Enterprises can be classified on two bases: [a] Ownership right:
Sole proprietorship, Partnership, & corporation [b] the activities they
perform: Service rendering, Merchandising & manufacturing.
1. Sole proprietorship is owned by one individual.
 The owner is often the manager/operator of the business.
 Although there is no legal distinction between the businesses as an
economic unit & the owner, the records of the business activities are
kept separate from the personnel records and activities of the owner.
E.g. Small service type businesses & retail stores such as barbershops, law
offices, clothing stores, bookstores, etc.

Characteristics
 Limited amount of capital investment.
 The owner acts as a manger.
 The owner is personally liable for all debts incurred by the business.
( unlimited liability).
 The owner receives any profits & suffers any losses.
  Ease of formation-no complicated legal formalities.
 Single taxation.
 Limited life.
2. Partnership-is owned by two or more persons voluntarily associated as
partners.
 It is owned by two or more individuals in accordance with a contractual
arrangement.
 when partnership is created, an agreement ( written or oral) should be
set forth such terms as initial investment by each partner ,duties of
each partner, division of net income ( or net loss) & settlement to be
made upon death or withdrawal of a partner, etc.
 Like a proprietorship, for accounting purposes, the partnership affairs
must be kept separate from the personal activities of the partners.
E.g. It is often used to organize retail & service type businesses, including
professional practices (lawyers, doctors, architects & CPA), etc.
Characteristics
 Similar to sole proprietor ship in many aspects.
3. Corporation is a business organized as a separate legal entity with
ownership divided in to transferable shares of capital stock.
 Capital stock certificates are issued by the corporation to each
stock holder
showing the number of shares he or she owns.
 Owners are called Stockholders /Share holders.
Characteristics
 Large amount of capital investment.
 Limited liability- The owners are not personally liable to the debts of
the corporate entity.
 Unlimited life because ownership can be transferred through shares
of stock without dissolving the corporation.
 Double taxation.
  Complicated legal formalities.
 Transferable units called shares of stock.

The Role of Accounting in Business

 What is the role of accounting in business? The simplest answer is
that accounting provides information for managers to use in
operating the business. In addition, accounting provides information
to other users in assessing the economic performance and condition
of the business.

Definition & Importance of Accounting

Accounting is the process of identifying, measuring, recording, classifying,
summarizing, and communicating or reporting financial information to users
or interested parties to make sound decisions. This information is primarily
financial & generally stated in monetary terms. Accounting, then, is a
measurement & communication process used to report on the activity of profit-
seeking business organizations and not-for-profit organizations. As a
measurement and communication process for business, accounting supplies
information that permits informed judgments and decisions by users of the
data .In general, the major objective of accounting is providing information to
decision makers.
 Identification - the first part of the process that involves selecting those
events that are considered evidence of economic activity relevnt to a
particular organization.
E.g. selling goods & services, buying goods & services, payment to
creditors & for expenses, collection of cash from customers are
examples of economic or financial events.
 Measurement - expressing economic events in terms of monetary units.
E.g. birr, cents, dollars, etc.
 Recording -involves a systematic way of keeping economic events. It
involves different journals, source documents .It consists of keeping a
chronological diary of measured events in an orderly & systemic manner.
  Communicating - the preparation & distribution of accounting reports,
the most common of which are called financial statements. A vital
element in communicating economic events is the accountant’s ability
and responsibility to analyze and interpret the reported information.
 Reports - include financial statements ,management reports, special
reports, tax returns, regulatory reports, etc
 Users’ decisions - include investment decisions, financing decisions,
dividend decisions, assessing taxes, negotiating labor contracts,
approving loans, establishing budgets, etc.
2. Characteristics of Accounting Information
 Accounting information is composed principally of financial data about
business transactions expressed in terms of money.
 It is financial in nature – it can be expressed in terms of monetary units.
 It is quantitative in nature–deals primarily with measurable events.
 Understandable, useful for decision making, accurate, relevant, reliable,
etc.
 The transactions, the sources for accounting information could be
maintained either by a manual accounting system or by an automated
data processing machines.
 The transactions are raw materials of accounting information where as
various summaries, analysis & reports are the primary end products.
3. Users of Accounting Information
The information that a specific user of financial information needs
depends upon the kinds of decisions that user makes. The difference in
decisions divides the users of financial information in to two broad groups.
1] Internal users of accounting information are managers who plan, organize,
and run business.
 These include marketing mangers, production supervisors, financial
directors & company officers, etc.
  Management needs accounting information to conduct day-to-day
operations & to evaluate current operations and in planning future
operations.
2] External Users. There are several types of external users of accounting
information.
a. Investors need accounting information on the financial condition and results
of operations of an enterprise to assess the profitability and risky ness of their
investments in the enterprise.
b. Creditors such as suppliers and bankers use accounting information to
appraise the financial soundness of business organization and assess the risks
involved before making loans or granting credit.
c. Governmental agencies are concerned with the financial activities of
business organization for purposes of taxation & regulation E.g. Taxing
authorities & Regulatory agencies.
d. Customers are interested in whether a company will continue to honor
product warranties & otherwise support its product lines.
e. Employees & Labor unions are also interested in the stability & the
profitability of the organization that hires them.
f. Economic planners use accounting information to analyze & forecast
economic activity.
Accounting Cycle for a Service Business Organization
The sequence of accounting procedures during a fiscal period is called the
accounting cycle. It begins with the analysis and the journalizing of
transactions & ends with the post closing trial balance .The most significant
outputs of the accounting cycle are the financial statements .The basic
phases of the accounting cycle are:
1. Transactions are analyzed & recorded in a Journal.
2. Transactions are posted to the ledger.
3. Trial balance is prepared, data needed to adjust the accounts are
assembled, &
the worksheet is completed.
 4. Financial statements are prepared.
5. Adjusting & Closing entries are journalized.
6. Adjusting & Closing entries are posted to the ledger.
7. Post closing trial balance is prepared.
8. Reversing certain adjusting entries to facilitate the recording process
in the
subsequent accounting period.
3.1 Accounts, Journals & Ledgers
A. Account
An accounting system includes a separate record for each item that appears in
the financial statements. The form of a record used to record the increases &
decreases in a single financial statement item is called an account or
sometimes a ledger account. The entire group of accounts is kept together in
an accounting record is called a ledger. An account is a means of
accumulating in one place all the information about changes in specific
financial statement, such as a particular asset or liability. For example, the
cash account provides a company’s current cash balance, a record of its cash
receipts & a record of its cash disbursements. In its simplest form, an
account has only three elements:
1) a title;
2) a left side, which is called the debit side; &
3) a right side, which is called the credit side. This form of an account
is called a T account because of its resemblance to the letter ‘T’.

Classification of Accounts
Accounts in the Ledger are customarily listed in the order in which they
appear in the financial statements & are classified according to common
characteristics. Basically there are five groups: Assets, Liabilities, Capital,
and Revenue& Expenses in the case of service enterprises.
  Balance Sheet accounts are classified as Assets, Liabilities, & Owner’s
equity.
 Income Statement accounts are classified as revenues & expenses.
In addition, there may be sub groups with in the major categories.
1. Asset- is any physical (tangible) or right (intangible) thing that has
monetary value.
 Assets are customarily divided in to groups for presentation on their
balance sheet.
 The two groups used most often are:
(a) Current Assets-are cash and other assets that may reasonably be
expected to be realized in cash or sold or used up usually with in one year or
less, through the normal operations of the business. E.g. Cash, A/R, N/R,
Supplies, Prepaid Expenses
(b) Plant assets - are tangible assets used in the business that are of a
permanent or relatively fixed nature. E.g. Equipment, Machinery, Buildings,
Land, etc.
 With the exception of Land, such assets gradually wear out or other wise
lose their usefulness with the passage of time. They are said to
depreciate.
2. Liabilities- are debts owed to (creditors) outsiders. The two categories
occurring most frequently are:
(a) Current Liabilities – are liabilities that will be due with in a short
time (usually
one year or less) and that are to be paid out of current assets. E.g. N/P, A/P,
Salary payable, Interest payable, Taxes payable, etc
(b) Long-term Liabilities - are Liabilities that will not be due for
accomplishing long time (usually more than one year) are called Long term
liabilities or fixed liabilities. E.g. Mortgage notes payable.
3. Owner’s Equity - is a residual claim against the assets of the business
after the total Liabilities are deducted.
 4. Revenues- are the gross increases in owner’s equity as a result of
operational
activities for the purpose of earning income. E.g. Sales revenue, Service
revenue
5. Expenses- are costs that have been consumed in the process of producing
revenue
or expired costs. E.g. .Salary expense, Utilities, etc.
B. Journal
An accounting record in which transactions are initially recorded in
chronological (day–by-day) order before being transferred to the accounts is
called a journal. Thus, the journal is referred to as the book of original
entry. For each transaction, the journal shows the debit & credit effects on
specific accounts. Companies may use various kinds of journals, but every
company has the most basic form of a journal, a general journal. Typically, a
general journal has spaces for dates, account titles & explanations, references &
two amount columns.
* The journal makes several significant contributions to the recording process:
 It discloses in one place the complete effect of a transaction.
 It provides a chronological record of transactions in the life of a business.
 It helps to prevent or locate errors because the debit and credit amounts
for each entry can be readily compared.
C. The Ledger
The entire group of accounts kept together in accounting record is referred to
as the Ledger. The Ledger keeps in one place all the information about
changes in specific account balances. The unit of organization for the
journal is the transaction; where as the unit of organization for the
ledger is the account. Companies my use various kinds of ledgers but every
co. has a general ledger. A general Ledger contains all the Assets, Liabilities,
and Owner’s Equity accounts. The Ledger should be arranged in statement
order beginning with the balance sheet accounts .First in order are Asset
accounts, followed by Liability , Owner’s capital, Owner’s Drawing,
Revenue & Expense accounts. The information in the ledger provides
management with the balances in various accounts.
*The account forms used in a manual system include the following:
a) Two-column account form
b) Three- Column account form
c) Four-column account form
*Ledger accounts often are classified as Nominal or Temporary account and
Real or permanent accounts
 The Nominal accounts are closed at the end of each accounting period by
transferring their balances to other accounts. E.g. Revenue, Expense,
Drawing o r Dividend accounts.
 The Real or Permanent accounts remain open and normally show a
balance after the accounting records are closed. E.g. Asset, Liability &
Capital accounts.
 During an accounting period, a balance sheet account or Income
statement account may contain both real and nominal portions. Such
accounts are known as mixed accounts. E.g. Prepaid expenses,
Unearned Revenues, etc.
3.2. Chart of Accounts
The number of accounts maintained by a specific enterprise is affected by the
nature of its operations, its volume of business, and the extent to which details
are needed for taxing authorities, managerial decisions, credit purposes, etc. For
example, one enterprise may have separate accounts for executive salaries,
Office salaries & Sales salaries, while another may find it satisfactory to record
all types in a single salary expense account.
 A chart of accounts is listing of the account titles & account numbers
being used by a given business in a ledger. The accounts are numbered
to permit it indexing & also for use as references. Although accounts in
 the ledger may be numbered consecutively as in the pages of a book, a
flexible system of indexing is preferable.
 The initial preparation of the ledger based on the chart of accounts is often
referred to as Opening the ledger.
Example 1: For a small service business, each account number has two
digits:
 The first digit indicates the major division of the ledger in which
the account is placed. Accounts beginning with:
1 - represent Assets
2 - represent Liabilities
3 - represent Owner’s Equity ( Capital & Drawing)
4 - represent Revenues
5- represent Expenses.
 The second digit indicates the position of the account within its
division.
A numbering system of this type has the advantage of permitting the later
insertion of new accounts in their proper sequence without distributing the
other account numbers. For large enterprises with a number of departments or
branches, it is not unusual for each account number to have four or more
digits.
E.g. Chart of accounts for a certain service enterprise

A/C No. Balance sheet accounts A/C No. Income Statement Accounts

1.Assets 4. Revenues

11. Cash 41 Sales revenue

12. A/R 5. Expenses

14. Supplies 51. Supplies expense

15. Prepaid rent 52 Salary expense

18. Photographic Equipment 53. Rent Expense

19 Accumulated Depreciation 54. Depreciation Expense

 55. Miscellaneous Expense
2. Liabilities
21. A/P

23. Unearned Revenue

3. Owner’s Equity
31 A.B Capital
32. A.B Drawing

33. Income Summary

3.3 Journalizing & Posting

Recording Transactions in a Journal
The process of recording a transaction in the journal is called journalizing.
The form of presentation is called a journal entry.
 If an entry involves only two accounts, one debit and one credit, it is
considered a
Single entry.
 When three or more accounts are required in one journal entry, the entry
is referred to as a compound entry.
Steps of Journalizing
Step 1: Record the date: Year, Month, & Day.
Step 2: Record the Debit: Debit account title & amount.
Step3: Record the Credit: Credit account title & amount.
Step 4: Write an Explanation.
Rules of Debits and Credits
The left side of an account is called the debit side and the right side is called
the credit side .The word charge is sometimes used as synonym for debit.
Amounts entered on the left side of an account , regardless of the account
title ,are called debits or charges to the account and the account is said to be
debited or charged .Amounts entered in on the right side of an account are
called credits, and the account is said to be credited.
 The rues of debit and credit and normal account balances are summarized
in the following table:
Balance Sheet accounts Increase Decrease Normal(account)
balance
 Asset Debit Credit Debit
 Liability Credit Debit Credit
 Owner’s Equity or
Shareholders Equity:
 Capital stock Credit Debit Credit
 Retained Earnings Credit Debit Credit
 Drawings/Dividends Debit Credit Debit
Income Statement accounts
 Revenue Credit Debit Credit
 Expense Debit Credit Debit

Posting the Journal

The process of transferring the debits and credits from the general Journal to
the proper Leger accounts is called Posting. Each amount listed in the debit
column of the journal is posted by entering it on the debit side of an account in
the ledger & each amount listed in the credit column of the journal is posted to
the Credit side of a ledger account. This phase of the recording process
accumulates the effects of journalized transactions in the individual accounts.
 The post reference column in the Journal indicates the account numbers
where the amount in the journal entry was posted and the post reference
column of Ledger account indicates the journal page from which the
transaction has been posted.
Steps of posting
Step1: Post to debit account: Date, Journal Page number & amount.
 Step 2: Enter the debit account number in Journal Post reference
column.
Step 3: Post to credit account: Date, Journal Page number and account.
Step 4: Enter credit account number in Journal Post reference column.
3.4 Trial Balance
It is a two column schedule listing the names & balances of all the accounts in
the order in which they appear in the ledger after posting.
 It is a proof the equality of debit & credit balances in the ledger.
Under the double entry systems this equality will occur when the sum
of the debit account balances equals the sum of credit account
balances.
Steps of preparing a trial balance
1. Listing the account titles & their balances.
2. Totaling the debit & credit columns.
3. Proving the equality of the two columns.
Uses of the trial balance
 The primary purpose of a trial balance is to prove the mathematical
equality of debits & credits in the ledger after posting.
 It also uncovers errors in journalizing and posting.
 In addition, it is useful in the preparation of financial statements.
Limitations of the Trial Balance
 It does not prove that the transactions have been correctly analyzed &
recorded in the proper accounts or that the ledger is correct.
 It proves only one aspect of the ledger, and that is the equality of debits &
credits.
 It does not provide a complete proof of the accuracy of the ledger.
Errors that cause an inequality of the two totals in the trial balance
1. Errors in preparing the trial balance.
 Incorrect addition of one of the columns of the trial balance.
  Incorrect recording of the amount of an account balance on the trial
balance.
 Recording of the debit balance as a credit or vice versa, or omitting the
balance entirely.
2. Errors in determining the account balances.
 Incorrect computation of the account balances.
 Entering the account balances in the wrong balance column.
3. Errors in recording a transaction in the ledger.
 Posting an erroneous amount to the accounts.
 Posting a debit entry as accredit or vice versa.
 Omission of debit or credit posting.
Errors that will not cause an inequality in the trial balance totals
 Failure to record a transaction or to post a transaction.
 Recording the same erroneous amount for both the debit & the credit
parts of a transaction.
 Recording the same transaction more than once.
 Posting a part of a transaction correctly as a debit or credit but to the
wrong account.
Discovery of errors
The existence of errors in the accounts may be determined in various ways:
1. by audit procedures.
2. by chance discovery.
3. through the medium of the trial balance.
Steps of locating errors
1) Determine the amounts of the difference between the two columns of trial
balance.
 It gives a clue as to the nature of the error or where it occurred.
2) If the error (the amount of difference between totals of a trial balance) is of
10,100, 1000, etc, re add the trial balance columns & re compute the
account balances.
  A difference between totals is due to error in addition, omission of a debit
or credit posting.
3) If the error is divisible by two, scan the trial balance to see whether a
balance equal to
half the error has been entered in the wrong column .It is due to the posting
of debit as a credit or vice versa.
4) Transposition error & slide error.
 Transposition error is the erroneous rearrangement of digits or reversing
the order of numbers.
 Slide error is the erroneous movement of the entire number one or more
spaces to the right or the left.
 If an error of either type has occurred, & there are no other errors,
the discrepancy between the two trial balance totals will be evenly
divisible by nine (9). If so, retrace the account balance on the trial
balance to see whether they are incorrectly copied from the ledger.
5) If the error is not divisible by two or nine (e.g. 365), scan the ledger to see
whether an
account balance has been omitted from the trial balance & scan the journal
to see
whether an account balance has been omitted .
6) Finally, the general procedure is to retrace the various steps in the
accounting process, beginning with the last step & working back to the original
entries in the journal.
General procedures of disclosing the errors
1. Verify the accuracy of the trial balance totals by re-adding the columns.
2. Compare the listings in the trial balance with the balances shown in the
ledger, making certain that no accounts have been omitted.
3. Recompute the balance of each account in the ledger.
4. Trace the postings in the ledger back to the journal, placing a small check
mark by the item in the ledger & also in the journal .If the error is not found,
examine each account to see if there is an entry with out a check mark. Do the
same with the entries in the journal . Verify the equality of the debits and
credits in the journal.
5. Verify the equality of the debits and credits in the journal.
3.5 Work Sheet for Financial Statements
Before journalizing & posting adjustments, it is necessary to determine and
assemble the relevant data. Such collections of data, preliminary drafts of
financial statements, and other useful analysis prepared by accountants are
generally called working papers.
A type of working paper is frequently used by accountants prior to the
preparation of financial statements is called a work sheet.
 A work sheet is a multiple column form that may be used in the
adjustment process and in preparing financial statements. It does not
substitute the formal financial statements. Thus, the use of a work sheet
is optional.
 As its name suggests, the work sheet is a working tool or a supplementary
device or working paper. It is not a permanent accounting record; it is
neither journal nor a part of the general ledger.

When a worksheet is used, financial statements are prepared from the work
sheet. The adjustments are entered in the worksheet columns and are then
journalized and posted after the financial statements have been prepared. A
form commonly used has an account title column & ten money columns
(Ten column worksheet) arranged in five pairs of debit and credit
columns. The main headings of the five sets of money columns are as follows:
1] Trial balance (Unadjusted) 4] Income statement
2] Adjustments 5] Balance sheet
3] Adjusted trial balance
Uses of worksheet
 It reduces the possibility of overlooking the need for an adjustment.
  It provides a convenient means of verifying arithmetical accuracy.
 It provides for the arrangement of data in a logical form and
 It provides the source data for the financial statements.
Steps of preparing a worksheet
1] Prepare a trial balance on the worksheet.
 The data for the trial balance come directly from the ledger accounts.
2] Enter the adjustments in the adjustment columns.
 Cross referencing (indexing & keying) the related debit and credit of
each adjustment by letters is useful to anyone who may have occasion to
review the work sheet .It is also helpful later when the adjusting entries
are recorded in the journal.
 If the titles of some of the accounts to be adjusted do not appear in the
trial balance because they had no balance prior to adjustment, they
should be inserted in the account title column below the trial balance
totals as they are needed.
 It is important to recognize that the adjustments are not journalized until
after the work sheet is completed and the financial statements have been
prepared,
3] Enter adjusted balances in the adjusted trial balance columns.
 The data in the trial balance columns are combined with the adjustments
data and extended to the Adjusted Trial balance columns to obtain an
adjusted balance of an account.
 For each account on the worksheet, the amount in the adjusted trial
balance columns is equal to the account balance appears in the ledger
after the adjusting entries have been journalized and posted.
4] Extend adjusted trial balance amounts to appropriate financial statements
columns.
 Asset, Liability & Capital account balances to their appropriate balance
columns in the balance sheet columns.
  Revenue & Expense account balances to their appropriate balance
columns in the Income statement columns.
5] Total the statement columns.
 The net income or net loss for the period is then found by computing the
difference between the totals of the two Income statement columns.
 If total credits in the income statement columns exceed total debits, a net
income has resulted. The amount of the net income is entered in the
income statement debit column and the balance sheet credit
column.
 If the total debits in the income statement columns exceed total credits, a
net loss has occurred. The amount of the net loss is entered in the
Income statement credit column and the balance sheet debit
column.
 After the net income or net loss has been entered, a new column totals are
determined & they should be identical in each the statement columns.
 If either the Income statement columns or the balance sheet columns are
not equal after the net income or net loss has been entered, an error has
been made in completing the worksheet. Then, compute the net income
or net loss and complete the worksheet.
3.6 Adjusting entries
Cash Basis vs. Accrual Basis of Accounting
Revenues & expenses may be reported on the income statement by:
1. Cash Basis of Accounting: It states that, revenues are reported in the
period in which cash is received, & expenses are reported in the period in
which cash is paid.
 It does not require adjusting entries at the end of the accounting period.
 It is not supported by GAAP.( e.g. matching principle)
2. Accrual basis of Accounting: It states that revenues are reported in the
period in which they are earned and expenses are reported in the period in
which they are incurred in an attempt to produce revenues.
  It requires the use of adjusting entries or process at the end of the
accounting period to match revenues and expenses for the period
properly.
 It is supported by GAAP. (e.g. matching principle)
Adjustments
The entries required 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.
 Every adjusting entry affects both a balance sheet accounts and an Income
statement
accounts. This characteristic of adjusting entries reflects their dual purpose:
(a) to measure all assets and liabilities accurately, &
(b to measure net income correctly by matching expired costs &
expenses
with realized revenue.
* The two types of end -of – period adjusting entries are those:
(a) to apportion prepayments of expenses and revenues, &
(b) to record accrued revenues & expenses.
A. Apportionment of Recorded Costs
Costs that will benefit more than one accounting period frequently are
incurred. These costs must be apportioned between periods in a manner that
approximates the usefulness derived from the goods and services in the
realization of revenue; this apportionment process is a necessary step under
the matching principle to determine net income of each period. However, the
adjusting entry will vary depending on the accounting procedure followed in
recording the original procedure. E.g. Depreciation of plant assets, expiration of
prepaid expenses such as Prepaid Insurance, Prepaid Rent, Supplies, etc
B. Apportionment of Recorded Revenue
When business enterprises receive payment for goods and services before the
goods are delivered or the services are performed, a liability exists until
 performance takes place. The adjusting entry records the earned revenue for
the period. E.g. Unearned rent, Unearned advertising ,etc.

C. Accrual of Unrecorded Expenses

The incurring of certain expenses is related to the passage of time. These
expenses generally are not recorded until payment is made, unless the end of
an accounting period comes before the required date of payment. The adjusting
entry records the accrued expenses for the period. E g. Salary expense,
Interest expense, etc
D. Accrual of Unrecorded Revenues
Revenue that has been realized but not recorded must be recognized at the end
of an accounting period. In order to measure accurately the results of
operations under the matching principle, revenue is recognized in the
accounting period earned. E.g. Interest revenue, Rent revenue, etc.
E. Valuation of Accounts Receivable
Proper matching of revenues and expenses dictates recording uncollectible
receivable as an expense of the period in which revenue is earned instead of
the period in which the accounts or notes are written off. Proper matching and
valuation require adjusting entry.
Doubtful accounts expense generally is reported as an operating expense in the
income statement. E.g. Uncollectible accounts expense.
3.7 Financial statements
After a work sheet has been completed, the statement columns contain all the
data that are required for the preparation of financial statements.
 The income statement is prepared from the Income statement
columns and, the balance sheet and owner’s equity statement are
prepared from the balance sheet columns.
A. Income statement
The Income statement is prepared from the income statement columns of the
worksheet.
 The sequence of expenses as listed on the worksheet may be changed in order to
present
them on the Income statement in the order of size.
B. Statement of Owner’s Equity
The amount listed on the work sheet as the capital of a sole proprietor does not
always represent the account balance at the beginning of the accounting
period. The proprietor may have invested additional asset in the business
during the period. Hence it is necessary to refer to the account in the ledger to
determine the beginning balance and any additional investments. The
amount of net income or net loss and the amount of the drawings appearing in
the balance sheet columns of the work sheet are then used to determine the
ending capital account balance.
 The amount shown for owner’s capital on the work sheet is the account
balance before considering drawing’s and net income or net loss.
 When there have been no additional investments of capital by the owner
during the period, this amount is the balance at the beginning of the
period.
C. Balance sheet
The work sheet is the source of all the data reported on the balance sheet, with
the exception of the amount the sole proprietor‘ s capital which can be
obtained from the statement of owner’s equity. The stock holder’s equity
section of the balance sheet of a corporation is subdivided in to capital stock
& retained earnings. The amount to be reported for the latter is obtained
from the retained earnings statement.
D. Retained Earnings statement
It summarizes the changes that have been occurred during a period. If dividend
payments are debited to dividends, the amount will appear on the work sheet.
If dividend is debited directly to Retained Earnings, it is necessary to refer to
ledger to determine the beginning balance of Retained earnings & the amount
of the dividends debited during the period.
 3.8 Journalizing & Posting Adjusting Entries
At the end of the accounting period, the data the adjustment columns of the
work sheet are journalized and posted to the Ledger. This procedure brings the
ledger in to agreement with the data reported on the financial statements. The
adjusting entries are dated as of the last day of the period, even though they
are usually recorded at a later date.
3.9 Journalizing & Posting Closing Entries
The revenue, expense and drawing (or dividend) 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 ( Retained
Earnings ) account. The balances must also be removed from the temporary
accounts, so that thy will be ready for use in accumulating data for the
following accounting period. Both of these goals are accomplished by a series of
entries called closing entries.
 These entries produce a zero balance in each temporary account so that
it can be used to accumulate data in the next accounting period separate
from the data of prior periods.
 In preparing closing entries, each Income statement account could be
closed directly to Owner’s capital .However, to do would result in
excessive detail in the permanent owner’s capital account. Accordingly,
the revenue and expense accounts are closed to another temporary
account, Income summary, and only the net income or net loss is
transferred from this account to owner’s capital or retained earnings.
It is used only at the end of the accounting period and is both opened
and closed during the closing process. Other account titles used for the
summarizing account are Expense & Revenue summary, Profit &
Loss
summary, Income & Expense Summary.
  As the entry to close an account is posted, a line should be inserted in
both balance columns opposite the final entry. Transactions affecting the
accounts in the following period will be posted in spaces immediately
below the closing entry.
 After the closing entries have been journalized and posted to the ledger,
the balance in the capital account will correspond to the amounts
reported on the statement of owner’s equity & balance sheet.
*In closing the books, it is necessary to distinguish between temporary and
permanent accounts.
1) Temporary or Nominal accounts relate only to the given accounting
period & closed at the end of the period.
 They include all Income Statement & Owner’s drawing or dividend
accounts.
2) Permanent or Real accounts relate to one or more future accounting
periods & are
not closed at the end of the period. Instead their balances are carried
foreword into the next accounting period.
 They consist of all balance sheet accounts including Owner’s
capital.
*Four entries are required in order to close the temporary accounts at the end
of the accounting period. They are as follows:
 Each revenue account is debited for the amount of its balance,
and Income summary is credited for the total revenue.
 Each expense account is credited for the amount of its balance
and Income summary is debited for the total expense.
 Income summary is debited for the amount of its balance (net
income) and the capital account is credited for the same
amount.{ Debit & Credit are reversed if there is a net loss.}
  The drawing/dividend account is credited for the amount of its
balance, and the capital or retained earnings account is
debited for the same amount.
Sources of data for closing Entries
Closing entries are journalized in the general journal. The account titles &
amounts needed in journalizing & closing the entries may be obtained from any
one of the three sources:
 Work sheet.{ adjusted Trial balance or statement columns}
 Income statement & Owner’s equity statement.
 Ledger. {adjusted balances in the Ledger}
3.10 Post – Closing Trial Balance
After all closing entries have been journalized and posted, another trial balance,
called a
Post –closing trial balance is prepared from the ledger. The post –closing
trial balance is a list of permanent accounts and their balances after closing
entries have been journalized and posted. The purpose of the post closing trial
balance is:
 To prove the equality of the permanent account balances that are carried
forward in to the next accounting period.
 The accounts and amounts should agree exactly with the accounts and
amounts listed on the balance sheet at the end of the period.
 to make sure that the ledger is in balance at the beginning of the new
accounting period.
 It provides evidence that the journalizing & posting of closing entries have
been properly completed. However, as in the case of the trial balance, it
does not prove that all transactions have been recorded or that the ledger
is correct. E. g. The post closing trial balance will balance if a transaction
is not journalized and posted or if a transaction is journalized and posted
twice.
  In addition, it shows that the accounting equation is in balance at the end
of the accounting period.

 Illustration on the Accounting Cycle for a Service

 Business Organization
 For the past several years, John Abrams has operated a Telephone repair
sevice in his home on a part time basis. As of September 1, Abrams
decided to move to rented quarters and to devote full time to the
business, which was to be known as AIWA TV entered into the following
transactions during September:
 Sep.1. The following assets, were received from John Abrams: Cash,
$7,500; A/R, $ 900; Supplies, $1,250; and Service Equipment,
$11,000.There was no Liabilities received.
1. Paid three months’ rent on a lease rental contract, $ 2,250.
2. Paid the premiums on property and casualty insurance policies,
$1,740.
4. Purchased additional service equipment on account from Glorious PLC
$ 2,500.
6. Received cash from customers on account, $ 500.
9. Paid cash for a newspaper advertisement, $110.
11. Paid for Glorious PLC. Part of the debt incurred on Sep.4, $1,250.
12. Recorded sales on account for the period September 1-12, $1,000.
13. Paid receptionist for two weeks ‘salary, $500.
17. Recorded cash from cash customers for service revenue earned during
the first half of Septembr,$1,100.
17. Bought office supplies for cash $950.
20. Recorded Sales on account for the period Sep. 13-20, $700.
24. Recorded cash from customers for service revenue earned for the
period September 17-24,$ 1,850.
27. Received cash from customers on account, $ 1,200.
27. Paid receptionist for two week’ salary, $ 500.
 30. Paid telephone bill for September, $75.
30. Paid electricity bill for September, $140.
30. Recorded cash from cash customers for Service revenue earned for the
period September 25-30, $950.
30. Recorded sales on account for the remainder of Sep.,$800.
30. Abrams withdrew $ 1,500 for personal use.
 Instructions:
 1. Open a ledger of four –column accounts for AIWA TV, using the
following titles and account numbers: cash, 11; Accounts Receivable,
12; Supplies, 14; Prepaid Rent, 15; Prepaid Insurance, 16; Service
Equipment, 18; Accumulated depreciation, 19 Accounts payable,
21; Salaries payable, 22; John Abrams, Capital, 31; John Abrams’
Drawing, 32; Income Summary, 33; Service Revenue, 41; Salary
Expense, 51; Rent Expense, 52; Supplies Expense, 53; Depreciation
Expense, 54; Insurance Expense, 55; Miscellaneous Expense, 59.

2. Record the transaction in the two-column journal.

3. Post the journal to the Ledger, extending the month-end balances to the
appropriate balance columns after al posting is completed.
4. Prepare a trial balance as of September 30, on a ten-column work sheet,
listing all the accounts in the order given the Ledger. Complete the work
sheet, using the following data:
a. Insurance expired during September……….....$145
b. Inventory of Supplies on Sep.30……………..1,520
c. Depreciation of Store Equipment for Sep……....200
d. Accrued receptionist salary on Sep.30……….…100
e. Rent expired during September…………………750
5. Prepare an Income Statement, a Statement of Owner’s Equity, and a
Balance Sheet.
6. Journalize & Post the adjusting entries.
7. Journalize & Post the closing entries.
8. Prepare a Post-Closing trial balance.

 Answers to Illustration 3.1

 2) Journal Entries
Date Description Debit Credit
2003 7500
Sep.1. Cash
A/R 900

Supplies 250
Service equipment 11,000

Johan Abrams Capital 20,650

1. Prepaid rent 2,250
Cash 2,250
Prepaid insurance 1740
2.
1740
Cash
4. Service equipment 2500
A/P 2500
500
6. Cash
500
A/R
9 Miscellaneous Expense 110
Cash 110

11. A/P 1250

Cash 1250

12 A/R 1000

Service revenue 1000

13. Salary expense 500

Cash 500
17. Cash 1100

Service revenue 1100

 17. Supplies 950

Cash 950

20. A/R 700

Service revenue 700

24. Cash 1850

Service revenue 1850

27. Cash 1200
A/R 1200

27. Salary expense 500

Cash 500

30. Miscellaneous expense 75

Cash 75

30. Miscellaneous expense 140

30 Cash 140

30. Cash 950

Service revenue 950

30. A/R 800

Service revenue 800

30. Johan Abrams Drawing 1500

Cash 1500





 4) Work sheet

AIWA TV
Work sheet
For the Month Ended Sep.30,2003

Adjusted Trial Income Balance

Trial Balance Adjustments Balance Statement. sheet
Account Title
   Credi Credi Credi
  Debit Credit  Debit t Debit Credit  Debit t Debit t
Cash 4085 4085 4085
A /R 1700 1700 1700
Supplies 2200 680(b) 1520 1520
Prepaid Rent 2250 750(e) 1500 1500
Prepaid
Insurance 1740 145(a) 1595 1595
Service 1350 1350
Equipment 0 13500 0
Acc.
Depreciation 200(c) 200 200
A/P 1250 1250 1250
Salaries Payable 100(b) 100 100
J.A Capital 20650 20650 20650
J.A Drawing 1500 1500 1500
Income
Summary

Service Revenue 6400 6400 6400

100(b
Salary Expense 1000 ) 1100 1100
Misc. Exp. 325 325 325
2830
0 28300
  ==== =====
Rent Expense 750(e) 750 750
680(b
Supplies Exp. ) 680 680
Depreciation
Exp. 200(c) 200 200
Insurance Exp. 145(a) 145 145
1875 1875 28600 28600 2540
  ==== ==== ==== ===== 3200 6400 0 22200
Net Income 3200 3200
2540
6400 6400 0 25400
  ===== ===== ===== =====

 6) Adjusting Entries

Date Description Debit Credit
2003 Insurance expense 145
Sep.30
145
Prepaid Insurance
Supplies expense 680
30.
Supplies 680

200
30. Depreciation expense
 Accumulated depreciation 200

Salary expense 100

30.
Salary payable 100

Rent expense 750

30.
Prepaid rent 750


 7) Closing Entries

Date Description Debit Credit
2003 Service revenue 6,400
Sep.30
Income Summary 6,400

30 Income Summary 3,200

Salary expense 1,100

Miscellaneous expense 325

Rent expense 750

Supplies expense 680

Depreciation expense 200

Insurance expense 145

30 Income Summary 3,200

J.A. Capital 3,200

30 J.A. Capital 1500

J.A Drawings 1
50
0

8) Post-Closing Trial Balance

AIWA-TV
Post Closing Trial Balance
Sep.30, 2003
 Account title Debit Credit
Cash 4085

A/R 1700

Supplies 1520

Prepaid Rent 1500

Prepaid Insurance 1595

Service Equipment 13500

Accumulated Deprecation 200

A/P 1250

Salaries Payable 100

J.A Capital
22350

TOTAL
23900 23900
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