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Course Materials:

REVIEW THE PHASES OF ACCOUNTING PROCESS


The steps in accounting process includes:
1. Business events/ Transactions are documented.
2. Analyze the transactions, and for record in the journal.
3. Post journal entries to applicable ledger accounts
4. Trial Balance is prepared
5. Adjusting entries are journalized and posted
6. Preparation of Adjusted Trial Balance
7. Preparation of Financial Statements
8. Preparation of closing entries
9. Preparation of Post Closing Trial Balance
10.Reversing entries are journalized and posted
Business events/ Transactions are documented
This cycle starts with a business event or simply called transactions. Verifiability of
transactions must be supported by underlying business documents such as sales receipts, sales
invoice, purchase invoice, check vouchers among others. These source documents will be the
basis for recording of transactions.

Analyzation of the Transactions and for Record in the Journal


Accounting journals are often called the book of original entry. It is a record of business
transactions and events for a specific account in chronological order. For the transactions to be
recorded it must influence the elements of financial statements and meet the criteria of recognition
identified in the framework of accounting:
a. There is a future economic benefit associated with the item that flow to the entity
b. There is monetary amount at which the elements are to be recognized and reported.

The accounting system that requires every business transactions or event to be recorded
in at least two accounts is called double entry accounting system. This is the same concept behind
the accounting equation. Every debit that is recorded must be matched with a credit and must be
equal in every accounting transaction in their total There are two general classification of journal,
the General Journal and the Special Journal
The general journal is often used by small entity with only few transactions and also called
two column journals. For an entity with numerous transactions, special journals are being used in
addition to general journal that are used to help divide and organize business transactions.
Here’s a list of the special accounting journals used:
• Cash Receipts Journal
• Cash Disbursements Journal
• Purchases Journal
• Sales Journal

Each of the journals has a specific purpose and are used for recording specific types of
transactions. For example, the cash receipts journal contains all of the cash sale transactions.
The accounts receivable or credit sales journal contains all the transactions for credit sales.
Purchases Journal are used for all credit purchase, while cash purchases transactions are
recorded in cash disbursement journal. All other transactions such as adjusting and closing, and
reversing entries are recorded in the general journal. The use of special journal the help
management organize and analyze accounting information.

Post journal entries to applicable ledger accounts


Ledger is a complete listing of all the accounts use in the chart of accounts. The entries
from the journals are transferred to this ledger accounts. Each journal entry is transferred from
the journal to the corresponding ledger accounts. The debits are always transferred to the left side
and the credits are always transferred to the right side of the ledger. Since most accounts will be
affected by multiple journal entries and transactions, there are usually several numbers in both
the debit and credit columns. The account balances of each account are calculated at the bottom
and get its total. This process is called pencil footing. Notice that these are account balances—
not column balances. The total difference between the debit and credit columns will be displayed
on the bottom of the corresponding side. The purpose of this process is to show the effects of
transactions on the elements of financial statements. The use of special journals facilitates the
posting process and only the total are entered in the ledger. However, the general journal is posted
individually. For controlling account in the ledger, the entity has subsidiary ledger
for accounts with various details. For instance, the customers account serves as subsidiary ledger
for accounts receivable, creditors accounts for accounts payable, raw materials inventory
accounts and different property items for property and equipment accounts.
Most entities have computerized accounting systems that update ledger accounts as soon
as the journal entries are input into the accounting system. Manual accounting systems are
usually posted weekly or monthly. Just like journalizing, posting entries is done throughout each
accounting period.

Trial Balance is prepared


The preparation of Trial Balance determined the equality of debits and credits in the ledger
but does not give assurance of error free during journalizing and posting process. The total
amount indicated in the Trial Balance summarizes the effect of the transactions on each account
of the ledger for a accounting period. Accounts are usually listed in order of their account number.
Most charts of accounts are numbered and presented in the order starting with the assets,
liabilities, equity accounts and ending with income and expense accounts. The total balances of
the accounts are not yet updated and may require adjustments.
Adjusting entries are journalized and posted

Adjusting entries are journalized and posted


Adjusting entries, also called adjusting journal entries (AJE’s) are made at the end of
accounting period before the financial statements are prepared. This is the fourth step in the
accounting cycle. Adjusting entries are most used in accordance with the matching principle - to
match revenue and expenses in the period in which they occur.
Adjustments are also necessary for revenues from which cash are not yet collected and
for expenses incurred but not yet been paid these commonly called accruals. While accounts
recorded cash receipts from which revenue have not yet been earned and for recorded cash
payments for which expenses that are not yet incurred are called deferrals. Adjustments for
financial assets like receivables are needed to reflect its impairment. The adjusting entries affects
the real account also known as permanent account and nominal account also known as temporary
accounts. Real accounts are assets, liabilities and equity from which its balances are being carried
forward to the next accounting period while nominal accounts such as income, expenses, income
summary and drawings are brought to zero. The three (3) different types of adjusting journal
entries as follows:
1. Prepayments
2. Accruals
3. Non-cash expenses (Asset Depreciation and amortization, Impairment of Asset)
Each one of these entries adjusts income or expenses to match the current accounting
period usage. This concept is based on the time period principles which states that accounting
records and activities can be divided into separate time periods.
In this process, we are separating the income and expenses into the amounts that were
used in the current accounting period and deferring the amounts that are going to be used in
future periods.

Prepayments
Prepaid expenses are goods or services used in the operations of the entity that have
been paid for but have not been consumed at the end of accounting period. Upon purchase the
amount is initially recorded either asset or expense account. As the time passes its operations, it
is necessary to determine the portion of used up during the current period and the unused portion
for use to subsequent period. If the prepayment was originally recorded to expense account, the
year end adjustment recognizes the asset portion or the unused balance. While if the prepayment
was originally recorded as an asset, the year end adjustment recognizes the expense and
recognizes the expenses or used portion. Both instances needed adjusting entries for the asset
account would represent the unused portion while the expense account reports the balance
representing the used portion during the accounting period.
On the other hand, unearned revenues consist of income received from customers, but
no goods or services have yet been provided to them. In this case, the entity owes the customers
a good or service and must record the liability in the current period until the goods or services are
provided. The entity that received cash before the sale of goods and services may record the
collection with the option of recording using the revenue method or the liability method. At the end
of accounting period, the portion of amount collected that is not yet earned and for deliver on
future date, the account originally credited represents mixed account- revenue and liability. This
needed adjustment before preparing the financial statements to adjust the mixed account and
identify revenue earned in the current period and the amount deferred for future period.

Accruals
Some expenses accrue from day to day, but the company ordinarily records them only
when they are paid. Accrued expenses are expenses incurred but are not yet paid at the end of
the fiscal period. They are both an expense and a liability. Hence, they are referred to as accrued
liability, accrued payable, or accrued expense.
On the other hand, accrued revenues are revenues earned but not yet received at the end
of the period. An example of this type of adjustment would be services that have been performed
but have not been billed or collected. To present an accurate picture of the affairs of the business,
the revenue earned must be recognized on the income statement and the asset on the balance
sheet.

Non-cash expenses
Adjusting journal entries are also used to record expenses like depreciation, amortization,
and depletion. These expenses are often recorded at the end of accounting period because they
are usually calculated on a period basis. For example, depreciation is usually calculated on an
annual basis. Thus, it is recorded at the end of the year. This also relates to the matching principle
where the assets are used during the year and written off after they are used.
Property Plant and Equipment (PPE) and Intangible asset (IA) accounts are assets of the
entities that are being used for its operations and recorded that must be also adjusted to reflect
its value. The recognition of depreciation for PPE and amortization of IA applies the recognition
principle of systematic and rational allocation. Depreciation is the systematic allocation of expense
on the life or usefulness of the asset. The adjustment recognizes the Depreciation Expense and
the decrease is recorded by crediting the contra asset account – Accumulated Depreciation.
For intangible assets (IA), the charge to operation for its utilization is recorded by crediting
Accumulated Amortization. Such as amortization is the systematic and rational allocation of cost
of the intangible assets over its economic benefits. The cost of these assets is initially recognized
as an asset and systematically spread the expense portion over its period of benefit or usefulness.
For impairment of asset, accounts such as loans and receivables should be appropriately
reported at net realizable value. The significant portion of credit sales regardless the entities effort
of its collection, there is always a probability of not being collected at its full amount. At the end of
accounting period the unrecoverable amount is recognized as impairment loss or also known as
Bad debts or Uncollectibles. Based on this, an adjusting entry is made by debit to Uncollectible
Accounts Expense and credit the contra asset account Allowance for Uncollectible (if using the
allowance method).
As to inventories, there are two methods of inventory systems – the Perpetual Inventory
and Periodic Inventory system. When the entity uses periodic (physical system) in recording
inventory, an adjustment is necessary to set-up the ending inventory. Before the end of accounting
period adjustments, the inventory account still reflects its beginning balances since
the purchases of merchandise are recorded using Purchases account. Thus, the amount of ending
inventory are cannot be determined unless a physical count is made for the period. The
adjustment of inventory is accompanied by recognizing the Cost of Goods Sold using the function
expense method for presentation for operating expenses in the Statement of Income and
Expenses. The other alternative of the entity to record the adjustment for inventory that does not
establish the Cost of Goods Sold in the accounts but merely adjust the Inventory account is in the
Closing entry using the temporary account Income Summary. When perpetual inventory records
are maintained, the Inventory and the Cost of Goods Sold balance that appears in the ledger
reflects the updated amounts and does not need to require further adjusting entry. Inventories are
required to be stated at lower of cost or market and reduced to net realizable value.
An entity should account for the tax consequences of each transaction and other events
in the same way it accounts for other events or transactions. For proper measurement of the profit
or loss of an entity, adjustments for income taxes must be made. Income taxes may not be paid
within the same accounting period, but this represents liability for the current period. Normally the
adjusting entries for income taxes is prepared after all the accounts have been adjusted and the
profit and loss are computed. The computed tax expense is to be debited to Income Tax Expense
and credited to Income Tax Payable. Additional adjusting entries for the recognition of deferred
tax asset and deferred tax liability coming from the existence of taxable temporary differences
and deductible temporary differences.
In general, recording adjusting journal entries is quite simple and involves these three
main steps as follows:
1. Determine current account balance
2. Determine what current balance should be
3. Record adjusting entry
These adjustments are then made in journals and carried over to the account ledgers and
accounting worksheet. This accounting worksheet is a tool and optional in the process but will
help the preparation of the financial reports.
After the balances on the unadjusted trial balance, the entity can then make end of period
adjustments like depreciation expense and expense accruals. These adjusted journal entries are
posted to the trial balance turning it into an adjusted trial balance.

Preparation of Adjusted Trial balance


An adjusted trial balance is a listing of all company accounts that will appear on the
financial statements after year-end adjusting journal entries have been made. Both the debit and
credit columns are calculated at the bottom of a trial balance and these debit and credit totals
must always be equal. If they aren’t equal, the trial balance was prepared incorrectly, or the journal
entries weren’t transferred to the ledger accounts accurately. This step is included in the
preparation of worksheet have been done.
The accounting worksheet is essentially a spreadsheet that tracks each step of the
accounting cycle. This is typically having five sets of columns that start with the unadjusted trial
balance accounts and end with the financial statements. In other words, an accounting worksheet
is basically a spreadsheet that shows all of the major steps in the accounting cycle side by side.

Preparation of Financial Statements


The financial statements are the end results of the accounting process. These presents
the effects of transactions completed by the entity during the accounting period. The concept
financial reporting and the process of the accounting cycle are focused on providing external users
with useful information in the form of financial statements. The financial statements prepared by
the entity include:
• a statement of financial position as at the end of the period;
• a statement of profit or loss and other comprehensive income for the period;
• a statement of changes in equity for the period;
• a statement of cash flows for the period;
• notes, comprising significant accounting policies and other explanatory information

IAS 1 sets out framework and overall requirements for the preparation and
presentation of financial statements. These guidelines are for their structure and
minimum requirements of the content of financial statements. The requirement for an
entity to present a complete set of financial statements Summary, Profit and Loss
Summary, or Expenses and Revenue Summary which summarizes the net effect of
total income and expenses. The balance of these accounts represents the profit or loss
for the period. If the result is credit balance there is profit, if debit balance there is loss.

Preparation of closing entries


In the closing process, each account affects the computation of the profit or loss
for the period is to be debited or credited for the amount that will result in zero balance,
such account is the Income Summary account. The Income Summary account and the
Dividends account are finally transferred to Retained Earnings account. At the end of the
year, all the temporary accounts are closed and only nominal (temporary) accounts are
being carried for the next accounting period.

Preparation of Post Closing Trial Balance


The post closing trial balance is a list of all accounts and their balances after the
closing entries have been journalized and posted to the ledger. The purpose of preparing
the post closing trial balance is to verify that all temporary accounts have been closed
properly. The only accounts in the post closing trial balance are the accounts that found
in the statement of financial position. These accounts are the real (permanent) accounts
which represents the asset, liabilities and equity accounts for the next accounting
period.

Preparation of Reversing Entries


Reversing entries, or reversing journal entries, are journal entries made at the
beginning of the next accounting period to reverse or cancel out adjusting journal entries
made at the end of the previous accounting period. This is the last step in the accounting
cycle.
Reversing entries are made because previous year accruals and prepayments will be
paid off or used during the new accounting period and no longer needed to be recorded
as liabilities and assets. These entries are optional depending on whether or not there
are adjusting entries that need to be reversed. Not all adjusting entries need to be
reversed, only these type of adjustments as follows:
• For accruals – Accrued Income, Accrued Expenses
• For deferrals– Only that create and asset or liability and are originally entered in
nominal accounts such as:
o Prepaid Expenses using the expense method
o Unearned income using the income method

When the adjusting entries made for accrued income or expense account, a
reversing entry must be made to eliminate the need for monitoring their respected
balances of the receivable and payable which are created during the adjusting entries.
The collection and payment in the ensuing period are recorded in the usual revenue
and expense account.

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