LECTURE NOTES

1.0 DEFINITION OF ACCOUNTING

Accounting is the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions
and events which are in part at least of a financial character and interpreting the results thereof. (AICPA Committee on
Accounting Terminology)

2.0 STEPS IN THE ACCOUNTING PROCESS (CYCLE)

1. Analyze business documents
2. Journalize transactions
3. Post to ledger accounts
4. Prepare a trial balance
5. Prepare adjusting entries
6. Prepare financial statements (using a work sheet or from the adjusted individual accounts)
7. Close the nominal accounts
8. Prepare a post-closing trial balance (optional)
9. Prepare reversing entries (optional)

The accounting process can be described as a set of procedures used in identifying, recording, classifying, and interpreting
information related to the transactions and other events of a business enterprise.

3.0 RECORDING PHASE

3.1 Analyze business documents

3.1.1 Ascertain what transactions and events should be recognized.

3.1.2 Recognition is the process of incorporating in the balance sheet or income statement an item that meets the
definition of an element and satisfies the criteria for recognition.
3.1.3 Generally, an item that meets the definition of an element should be recognized if:
a) it is probable that any future economic benefit associated with the item will flow to or from the entity; and
b) the item has a cost or value that can be measured with reliability.

3.2 Record transactions

3.2.1 Originally record debits and credits in chronological order in a journal. Journal entries provide a systematic method
for summarizing a business event’s effect on the basic accounting equation.
3.2.2 In journalizing transactions:
• Use double entry accounting system. Basic accounting equation: Assets = Liabilities + Equity
• Debits are entries on left side of accounts and credits are entries to right side of accounts.
• Normal balances of the financial statements’ elements:
Assets and Expenses – Debit
Liabilities, Equity and Income – Credit

3.2.3 Journal

General journal - records all transactions not recorded in special journals.

3.3 Post transactions

3.3.1 Transfer debits and credits to ledger accounts which summarize changes in financial statement elements.

3.3.2 Posting is the process of transferring information from journal entries to ledger accounts.

3.3.2 An account is used to summarize the effects of transactions on each element of the expanded accounting equation.
A chart of accounts summarizes existing accounts used by a particular business.

3.3.3 Ledgers

General ledger is a collection of all control accounts - those appearing in financial statements.

4.0 REPORTING PHASE

4.1 Prepare a trial balance

4.1.1 Prepare a preliminary trial balance - a list of balances in general ledger accounts; first two columns of a worksheet.
4.1.2 A trial balance is a listing of all accounts and their balances and indicates whether total debits = total credits, thus
providing a general check on the accuracy of the recording and posting process applied throughout the accounting period.
4.2 Prepare adjusting entries
4.2.1 All relevant information that has not been recorded must be determined, recorded, and posted so that accounts
are updated prior to preparing financial statements.
4.2.2 Typical items for adjustment:
1. Accrued expenses—expenses incurred, but not to be paid until a following period.
2. Accrued income—income earned, but not to be received in cash until a following period.
3. Prepaid expenses—recorded cash payments for benefits not yet received or only partially so.
a. Was recorded by an original debit to an asset account—now, debit expense and credit asset.
b. Was recorded by an original debit to expense—now, debit asset and credit expense.
4. Unearned income—recorded cash receipts for services to be rendered in the future or only partially rendered at the
balance sheet date.
a. Was recorded by an original credit to an income account—now, debit income and credit liability.
b. Was recorded by an original credit to a liability account—now, debit liability and credit income.
5. Asset depreciation—a systematic allocation of an asset’s cost to expense and a reduction, using a contra (or offset)
account, in carrying value for a period during which the asset is used in operations.
6. Doubtful accounts—estimated amount of uncollectible accounts receivable charged to current period’s income as bad
debt expense.

Summary of the typical adjusting entries and the effect on profit, assets, liabilities and equity of the failure to prepare the
necessary adjusting entry:
Effect on
Nature of adjustment Adjusting journal entry Profit Assets Liabilities Equity
1. Accrued expense Expense xx Over NE Under Over
Payable xx
2. Accrued income Receivable xx Under Under NE Under
Income xx
3. Prepaid expense Prepaid expense xx Under Under NE Under
(expense method) Expense xx
4. Prepaid expense Expense xx Over Over NE Over
(asset method) Prepaid expense xx
5. Unearned income Income xx Over NE Under Over
(income method) Unearned income xx
6. Unearned income Unearned income xx Under NE Over Under
(liability method) Income xx

7. Depreciation Depreciation expense xx Over Over NE Over

Accumulated Dep. xx
8. Doubtful accounts Doubtful accounts exp. xx Over Over NE Over
Allow. For D/A xx
4.3 Prepare financial statements
4.3.1 Financial statements may be prepared from the adjusted account balances in the ledger or a
work sheet.
4.3.2 The objective of financial statements is to provide information about the financial position,
financial performance and cash flows of an entity that is useful to a wide range of users in making
economic decisions.
4.3.3 A complete set of financial statements comprises:
a) a statement of financial position as at the end of the period;
b) a statement of comprehensive income for the period;
c) a statement of changes in equity for the period;
d) a statement of cash flows for the period;

4.4 Close the nominal accounts

4.4.1 All nominal (temporary) account balances are brought to zero at the end of the period. Real
accounts are not closed.
4.4.2 To close income accounts – Debit income accounts and credit profit or loss summary account.
4.4.3 To close expense accounts – Debit profit or loss summary account and credit expense accounts.

4.4.4 To close profit or loss summary account – Credit balance (Profit), Debit profit or loss summary
account and credit retained earnings; Debit balance (Loss) Debit retained earnings and credit profit or
loss summary account.

4.5 Prepare a post-closing trial balance

The post-closing trial balance should show that all nominal accounts carry zero balances into the next
accounting period.

4.6 Prepare reversing entries

4.6.1 A reversing entry is made at the beginning of the next accounting period and is the exact
opposite of the adjusting entry made in the previous period.
4.6.2 The entries subject to reversal are:
• Accrual of income
• Accrual of expense
• Prepayment (using expense method), and
• Unearned income (using income method).

Note: The method used to process accounting information does not alter the steps in the accounting
cycle. When computerized accounting systems are used, the accounting records may change in
appearance, but the steps performed are the same as those in a manual system.