Master in Law and Management 2022 / 2023

Accounting
Part 2

The accounting process

Need for an accounting process
• Companies face thousands of events and
transactions during an accounting period
(typically one year)
• Need for an effective way of analyzing and
having the information ready to prepare the
financial statements: the accounting process

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The accounting process
• The accounting process deals with:
– documents
– accounts
– journal
– ledgers
– trial balance
– financial statements

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The accounts
• An accounting system keeps a separate record
for each item that is part of the financial
statements
• This separate record is called an account
• The monetary effects of transactions are
recorded and accumulated in each account

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The account
• An account consists of three parts:
– Title: designation of the account
– Left (or debit) side
– Right (or credit) side

Title of the account

Debit side Credit side

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The account
• Entries are recorded as debits or credits
• Each account has a balance, which is the
difference between the two types of entries:
– If total debits > total credits
• the account has debit balance = D – C
– If total credits > total debits
• the account has credit balance = C – D

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Assets accounts
• Increases are recorded as debits
• Decreases are recorded as credits
• Usually have debit balances

Asset account
Increases Decreases

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Liabilities and Owners’ Equity accounts
• Increases are recorded as credits
• Decreases are recorded as debits
• Usually have credit balances

Liability / Owners’ Equity account

Decreases Increases

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Expenses accounts
• Increases are recorded as debits
• Decreases are recorded as credits
• Usually have debit balances

Expense account
Increases Decreases

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Revenues accounts
• Increases are recorded as credits
• Decreases are recorded as debits
• Usually have credit balances

Revenue account
Decreases Increases

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Double entry accounting
• In every transaction record, the total amount
entered as debits must equal the total amount
entered as credits
• The rules for debits and credits were designed so
that the accounting equation always holds if total
debits equal total credits in each transaction

D=C
Assets Liabilities Equity
= +
+ – – + – +
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Double-entry accounting
• Steps to record a transaction:
1. Identify the accounts affected and classify them
by type of account (A, L, OE, R, E)
2. Determine the direction of the effect (increase
or decrease) on each account
3. Verify that the accounting equation (A=L+OE)
remains in balance
Remember that revenues and expenses change net
income, which is part of owners’ equity
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The accounting process
• The accounting process usually follows the
following steps:
1. Analyze each transaction for its effects on the
accounts
2. Enter the transaction in a journal
3. Post the journal information to ledger accounts
4. Prepare and record adjusting entries
5. Prepare a trial balance
6. Prepare the financial statements

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The journal
• The journal is a chronological record of
transactions, showing for each transaction the
debits and credits to be entered in specific
ledger accounts, and a brief description
• At convenient intervals, the debit and credit
amounts recorded in the journal are
transferred (or posted) to the accounts in the
ledger and summarized in a trial balance

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The journal
GENERAL JOURNAL
Date Description Debit Credit Amount
2019
Collection of accounts 12 – Check 211 – Accounts
6th Jan 2 500
receivable deposits receivable
Payment of accounts 221 – Accounts 12 – Check
8th Jan 7 000
payable payable deposits
Services rendered for 12 – Check 72 – Services
20th Jan 4 000
cash deposits rendered

(…)

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The trial balance
• A trial balance is a two-column schedule
listing the names and balances of all the
accounts in the order they appear in the
ledger
• The trial balance allows to check the equality
between debit balances and credit balances
(which guarantees the accounting equation)

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Trial balance
TRIAL BALANCE – January 31st, 2019
Balance
Account title Debit Credit
Cash 300
Accounts receivable 2 000
Accounts payable 400
Tangible fixed assets 15 000
Share capital 10 000
Retained earnings 5 800
Services rendered 4 100
Wages expenses 3 000
Total 20 300 20 300

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Advantages of the trial balance
• The trial balance proves the equality of the debit
and credit entries in the company's accounting
system
– Typical errors when total debits and credits of the
trial balance do not agree:
• posting of a debit as a credit or vice-versa
• mistakes in determining account balances
• mistakes in recording the transaction amounts
• All information needed to prepare the balance
sheet and the income statement are resumed in a
very simple document

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Limitations of the trial balance
• The trial balance does not allow to detect errors
such as:
– failure to record a business transaction
– improper analysis of the accounts affected by the
transaction
– the posting of debit or credit entries to the wrong
accounts

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