The Financial Accounting Cycle

ACCT1005
Week 2: Accounting & the Business Environment

The Financial Accounting Cycle

University of the West Indies University of the West Indies

Prepared by Dwayney Paul Prepared by Dwayney Paul 2

The accounting cycle is the process by which accountants prepare

financial statements for an entity for a specific period of time Step 1: Accounting for Business Transactions
Business
Transaction
• A business transaction is an economic
Post Closing
event that has a direct impact on the
Record in
T-B Journal business.
The Financial – Requires exchange between two parties
Prepare Accounting Post to – The exchange can be measured in dollars
Final A/Cs
Cycle Ledger
– All business transactions affect the
accounting equation through different
Adjusted
T-B Extract Unadjusted accounts
Trial Balance (T-B)

Adjustments
University of the West Indies University of the West Indies
Prepared by Dwayney Paul 3 Prepared by Dwayney Paul 4

UWI, Mona School of Business & Management 1

The Financial Accounting Cycle

Once accountants have determined a transaction has

Recognition means the recording of a transaction
occurred they must decide
• There is a difficulty in deciding when a business
• When the transaction occurred transaction occurred as timing affects the
– The recognition issue financial statements
• What value to place on the transaction • According to IAS 18, Revenue is the gross inflow
– The valuation issue of economic benefits (cash, receivables, other
assets) arising from the ordinary operating
• How to categorize the components of the activities of an entity (such as sales of goods,
transaction sales of services, interest, royalties, and
– The classification issue dividends)

University of the West Indies University of the West Indies

Prepared by Dwayney Paul 5 Prepared by Dwayney Paul 6

Revenue Recognition A Business Event is different from a Business Transaction

• Recognition of revenue as defined in the IASB How would you categorize the Economic event
that affects
Framework, means incorporating an item that following? financial position

meets the definition of revenue (previous slide) Are Not Transactions Are Transactions
in the income statement when the following
• Customer inquires • Customer buys a
criteria is met: about a service service
– it is probable that any future economic benefit • Receiving products
• Ordering products
associated with the item of revenue will flow to the previously ordered
from suppliers
entity, and
– the amount of revenue can be measured with • Hiring new employees • Paying employees for
reliability work performed

University of the West Indies University of the West Indies

Prepared by Dwayney Paul 7 Prepared by Dwayney Paul 8

UWI, Mona School of Business & Management 2

The Financial Accounting Cycle

The Valuation issue focuses on assigning a monetary
value to a transaction
• According to GAAP, use original cost
– Also called historical cost principle
• The Cost principle states that a purchased asset
should be recorded at its actual cost;
• This refers to the Exchange price associated with a
business transaction at the point of recognition;
• Exchange price refers to
»Amount a buyer is willing to pay and a seller
is willing to receive
»Is objective (not influenced by emotion or
personal feelings)
University of the West Indies
Prepared by Dwayney Paul
Classification is the process of assigning
transactions to the appropriate accounts
• There are uncertainties associated with
assigning transactions to the appropriate
accounts and hence the rise of a classification
issue
• The proper classification of transactions depends
on
– Correctly analyzing the effect of each transaction on
the business
– Maintaining a system of accounts that reflects that
effect
University of the West Indies
9 Prepared by Dwayney Paul 10

An account is…..
• The basic summary device of accounting is the account,
the detailed record of the changes that have occurred in
a particular asset, liability, or owner’s equity during a
period of time
What are accounts? • Used to record transaction data
– Record data in a usable form
You should recall the
accounting equation
– Data can be quickly retrieved
here;
• Separate account used for each Assets = Liabilities +
– Asset Owner’s Equity
– Liability
– Component of owner’s equity (includes revenues and expenses)
University of the West Indies University of the West Indies
Prepared by Dwayney Paul 11 Prepared by Dwayney Paul 12

UWI, Mona School of Business & Management 3

The Financial Accounting Cycle

Examples of accounts we will be using Types of Accounts

Assets Liabilities Owner’s Equity
A/Cs Receivable, A/Cs Payable,
• Cash • Notes Payable • Capital Personal
Owner’s Equity
• Notes Receivable • Accounts • Withdrawals/
• Accounts Receivable Payable Drawings
• Office Supplies Real
• Mortgage • Revenues
• Land
• Loan • Expenses
• Building Non- Current Assets,
Cash, Inventory
• Equipment, Impersonal
Furniture & Fixtures
Nominal

Revenues, Expenses, Gains, Losses

University of the West Indies University of the West Indies
Prepared by Dwayney Paul 13 Prepared by Dwayney Paul 14

Types of Accounts cont’d Types of Accounts cont’d

Personal & Real Accounts are referred to as Nominal accounts are referred to as
permanent accounts temporary accounts
i.e. A/Cs Receivable, A/Cs Payable, OE, NCA, Cash, i.e. revenues, expenses, gains, losses &
Inventory drawings
Permanent accounts: – Contain information for one accounting period
• Accumulate information across accounting periods
Do not accumulate information across
• Are carried forward to the next accounting period accounting periods
• Are reflected on the Balance Sheet
– Are closed out at the end of the accounting
period to either the IS or SOE
University of the West Indies University of the West Indies
Prepared by Dwayney Paul 15 Prepared by Dwayney Paul 16

UWI, Mona School of Business & Management 4

The Financial Accounting Cycle

What is Double-Entry Accounting

• Financial Accounting is founded upon the double
entry system

• Each transaction affects at least two accounts

Double-Entry Accounting
• Double entry bookkeeping means recording the
dual effects of each business transaction.

• Total debits must equal total credits

University of the West Indies University of the West Indies
Prepared by Dwayney Paul 17 Prepared by Dwayney Paul 18

The T-Account Normal Account Balance Side on the account that is

increased

Name of A/C Normal Increase Decrease

Balance
Dr “Account Title” Cr
Assets Dr Dr Cr
Expenses Dr Dr Cr
Left Side Right Side Withdrawals Dr Dr Cr
Debit Credit
Liabilities Cr Cr Dr
Revenues Cr Cr Dr

Capital Cr Cr Dr
University of the West Indies University of the West Indies
Prepared by Dwayney Paul 19 Prepared by Dwayney Paul 20

UWI, Mona School of Business & Management 5

The Financial Accounting Cycle

Normal Balances Increase - Same Side as Normal

Decrease – Opposite Side of Normal Chart of Accounts
Assets
= Liabilities + OE
Accounts Begin With
Dr Cr
Assets 1
Account Normal Balance Liabilities 2
Assets Dr

Liabilities Cr Owner’s Equity (OE) 3

OE (Capital) Cr
Withdrawals/Drawings 4
Revenue Cr
Revenues 5
Expenses Dr

Withdrawals Dr Expenses 6
University of the West Indies University of the West Indies
Prepared by Dwayney Paul Prepared by Dwayney Paul
22
21

Steps in the Accounting Process

• Determine which accounts are affected
• Determine category for each account
• Determine whether each account
increased or decreased Journalizing & Posting to the Ledger
• Apply rules of Dr & Cr
• Place amount in account
• Let us examine the effect of some
transactions on the Accounting Equation!
University of the West Indies University of the West Indies
Prepared by Dwayney Paul
23 Prepared by Dwayney Paul 24

UWI, Mona School of Business & Management 6

The Financial Accounting Cycle

Journals Recording Transactions

Books of Original Entry (Diaries) Steps in the Journalizing Process:
Transactions listed in order of date 1) Determine which accounts are affected & the
(Chronologically)
type/category of each account
Special/Subsidiary Journals (SJ) may be used to 2) Determine whether each A/C increased or
record specific transactions
decreased
The General Journal (GJ) is used to record all 3) Apply rules of debit & credit to record
transactions for which a SJ is not kept.
transaction
Each transaction recorded in the GJ is followed by
a) On January 2, A. Matthews invests $35,000
a narration
of personal funds to start the business.
i.e. a brief description of the transaction.
Journalize the transaction.
Not required for transactions recorded in SJ
University of the West Indies University of the West Indies
Prepared by Dwayney Paul 25 Prepared by Dwayney Paul 26

Accounts are then grouped in a record called

The General Journal the General Ledger
General Journal
Date Accounts & Explanation F Dr $ Cr $
Jan. 2 Cash 35,000
A. Matthews, Capital 35,000
Initial investment from owner

 Date of Transaction
 Title of A/C Debited & the amount
 Title of A/C credited & the amount
 Description of transaction
University of the West Indies University of the West Indies
Prepared by Dwayney Paul 27 Prepared by Dwayney Paul 28

UWI, Mona School of Business & Management 7

The Financial Accounting Cycle

Ledgers Ledgers cont’d

• In the phrases of “keeping the books” Books of Accounts
and “auditing the books,” books refer to Ledgers contain all accounts utilized by an
the Ledger. Today’s ledger takes the entity during an accounting period.
form of a computer listing. Account – Detailed record of changes in a
particular A, L or OE account
–There are still manual businesses who Posting - process of transferring/copying
have each account on a separate information from the journal to the ledger
page/card.
General Ledger (GL) & Subsidiary Ledgers (SL)
University of the West Indies University of the West Indies
Prepared by Dwayney Paul 29 Prepared by Dwayney Paul 30

Posting to the Ledger – Matthew e.g. Trial Balance

The TB is an internal document.

Dr Cash A/C Cr It is a listing of all the accounts with their related
Jan. 2 35,000a balances.
Assets; Liabilities & OE
Dr Mathews, Capital A/C Cr Two functions:
1) Checks on the arithmetical accuracy of postings
Jan. 2 35,000a i.e. whether total debits equal total credits.
2) Assists in the preparation of the final accounts.
University of the West Indies University of the West Indies
Prepared by Dwayney Paul 31 Prepared by Dwayney Paul 32

UWI, Mona School of Business & Management 8