EELO

UNIVERSITY
Faculty of Engineering
Course: Principles of Accounting and
Economics
Sophomore Class
Chapter 3: Accounting Cycle
Lecturer: Suleiman Bashir Omar
TEL: 063-4454287 EMAIL: [email protected]
 Chapter outline
After reading this chapter, the students will be able to understand:
What is accounting cycle
Collecting and analyzing accounting documents
Posting in journal
Posting in ledger account
Trial balance
Adjustment entries
Financial statements
 Accounting Cycle
The accounting cycle is a series of steps done in each accounting period to keep
records in an orderly fashion. You can use the general journal to record all of
the transactions of a business.
The accounting cycle refers to nine steps, repeated in each reporting period, to
verify transactions & prepare financial statements for internal and external users.
All accounting systems use some variation of these nine steps to record, analyze
and summarize business transactions and events. This procedure helps
organizations ensure that their financial records are accurate, current, and
reflect Generally Accepted Accounting Principles.
Entrepreneurs and business owners should understand the accounting cycle,
even if they do not keep their own books. Accounting is used every day in
business to make projections, secure financing, and assess opportunities and
more.
Accounting cycle refers to the specific tasks involved in completing an
accounting process. The length of an accounting cycle can be monthly,
quarterly, half-yearly, or annually. It may vary from organization to
organization but the process remains the same. The following chart shows the
basic steps in an accounting cycle:
Steps Of The Accounting Cycle
• Collecting and Analyzing Accounting Documents
The first step in the accounting cycle is to first analyze a transaction and its
source documents, then apply double-entry accounting to recognize its effect on
account balances. Business Documents are records that are evidence of
transactions.
Transactions are the exchange of goods or services between entities, as well as
other events that have an economic impact on a business.
It is a very important step in which you examine the source documents and
analyze them. For example, receipt, invoice and purchase related documents.
This is a continuous process throughout the accounting period.
 Commonly Used Source Documents

• source document: A paper prepared as the evidence that a

transaction occurred.
• Invoice: A source document that lists the quantity, description, unit
price, and total cost of the items sold and shipped to a buyer.
• Receipt: A source document that serves as a record of cash received.
• Memorandum: A brief written message that describes a transaction
that
takes place within a business.
• check stub: A source document that lists the same information that
appears on a check and shows the balance in the checking account
before and after each check is written.
• Posting in Journal
On the basis of the above documents, you pass journal entries using
double entry system in which debit and credit balance remains equal.
This process is repeated throughout the accounting period.
• A journal is an accounting record in which business transactions are
entered in chronological order.
• Journal entries record transaction information; debits equal credits.
• Journal is a record of financial transactions in order by date.
Traditionally, a journal has been defined as the book of original entry.
The definition was more appropriate when transactions were written
in a journal prior to manually posting them to the accounts in the 
general ledger or subsidiary ledger.
 9

Journal entries record transaction information; debits equal credits.

Journal
General Journal Entry Format
Date Debit Entry............ xx Date Description Debits Credits
Credit Entry................... xx Jan 1 Cash 5,000
Explanation.
Revenue 5,000
Received cash for
services provided.

4 Supplies 12,000
Accounts Payable 12,000
Purchased supplies
on account.
• Posting in Ledger Accounts
The third step in the accounting cycle is posting. After recording
transactions in the journal, they are transferred and posted to the
ledger. It is important to leave this paper trail (or in computerized
accounting, electronic trail) to verify accuracy and troubleshoot later
in the process if accounts are not adding up.
Debit and credit balance of all the above accounts affected through
journal entries are posted in ledger accounts.
A ledger is simply a collection of all accounts. Usually, this is also a
continuous process for the whole accounting period.
• Preparation of Trial Balance
Trial balance is a summary of all the balances of ledger accounts
irrespective of whether they carry debit balance or credit balance. Since
we follow double entry system of accounts, the total of all the debit and
credit balance as appeared in trial balance remains equal.
Usually, you need to prepare trial balance at the end of the accounting
period.
Double-entry accounting ensures that the sum of debit account
balances equals the sum of credit account balances. A trial balance is
used to confirm this.
A trial balance is a list of TRIAL BALANCE
accounts and their balances at a Debits Credits
point in time. Account balances Cash 3,000
are reported in their appropriate Account receivable 2,000
Prepaid insurance 1,000
debit or credit columns of a trial Rental revenue
balance. A trial balance can be 5,000
Supplies 12,000
used to confirm this and to Accounts Payable
follow up on any abnormal or 11,500
Equipment 2,000
unusual balances. Common stock 22,000 20,000
• Posting of Adjustment Entries
In this step, the adjustment entries are first passed through the journal,
followed by posting in ledger accounts, and finally in the trial balance.
Since in most of the cases, we used accrual basis of accounting to find
out the correct value of revenue, expenses, assets and liabilities
accounts, we need to do these adjustment entries. This process is
performed at the end of each accounting period.
• Adjusted Trial Balance
Taking into account the above adjustment entries, we create adjusted
trial balance. Adjusted trial balance is a platform to prepare the
financial statements of a company.
• Preparation of Financial Statements
• Financial statements are the set of statements like Income
and Expenditure Account or Trading and Profit & Loss
Account, Cash Flow Statement, Fund Flow Statement, Balance
Sheet or Statement of Affairs Account. With the help of trial
balance, we put all the information into financial statements.
• Financial statements clearly show the financial health of a firm
by depicting its profits or losses.
• Post-Closing Entries
• All the different accounts of revenue and expenditure of the firm
are transferred to the Trading and Profit & Loss account. With
the result of these entries, the balance of all the accounts of
income and expenditure accounts come to NIL.
• The net balance of these entries represents the profit or loss of
the company, which is finally transferred to the owner’s equity
or capital account. We pass these entries only at the end of
accounting period.
• Post-Closing Trial Balance
• Post-closing Trial Balance represents the balances of Asset, Liabilities &
Capital account. These balances are transferred to next financial year as
an opening balance.
The post-closing trial balance lists the balances of the accounts that were
not closed, such as assets, liabilities, and owner's equity. This trial balance
helps verify that permanent accounts balance, with equal debit and credit
sums, and that all temporary accounts were closed properly.
 Debit and Credit
• T-charts
• Let’s say we have an account (the name
T-charts are a quick and easy way to keep doesn’t matter just yet) that has two
track of debits and credits. All debits are debits ($500 and $2000) and three
recorded on the left side of the chart, and credits ($400, $150, and $50) applied to
all credits are recorded on the right. A it. Recorded in a t-chart, it might look
typical t-chart may look like this… like this…
Account Account
Name $ 500
Name $ 400
Debit side Credit side
$ 2000 $ 150
$ 50

That’s wonderful and all, but what is the result of all those debits and credits?
 • So we have $2500 on the debit side, and $600 on the
Going back to the “things to credit side. We then find the difference (subtracting
remember”, we know that the numbers) to determine the result. This is the
debits and credits work just balance of the account. Always start with the larger
like left and right. To find number and subtract the smaller number ($2500 -
out the result we start by $600 = $1900). Then take the result and put it at the
making subtotals of the two bottom of the chart, on the side that had the largest
sides. subtotal in the beginning (debit in this example). The
Account Name
$ 400
finished t-chart would look like this…
Account Name
$ 500 $ 500 $ 400
$ 2000 $ 150 $ 150
$ 2000
$ 50 $ 50
$ 2500 $ 600
Balance: $ 1900
 19

The Accounting Equation with T-Accounts

Assets = Liabilities + Owners’ Equity

DR CR DR CR DR CR
+ - - + - +
• Generally these types of accounts are increased with a debit:
• Dividends (Draws)
Expenses
Assets
Losses
• You might think of D - E - A - L when recalling the accounts that
are increased with a debit.
• Generally the following types of accounts are increased with a credit:
• Gains
Income
Revenues
Liabilities
Stockholders' (Owner's) Equity
• You might think of G - I - R - L - S when recalling the accounts that are increased
with a credit.
• After you have identified the two or more accounts involved in a business
transaction, you must debit at least one account and credit at least one
account.
• To debit an account means to enter an amount on the left side of the
account. To credit an account means to enter an amount on the right side
of an account.
• To decrease an account you do the opposite of what was done to increase
the account. For example, an asset account is increased with a debit.
Therefore it is decreased with a credit.
 For every transaction, there must be at least one debit and one credit.
• Debit and Credit Rules
• The rules governing the use of debits and credits are as follows:
• All accounts that normally contain a debit balance will increase in amount when
a debit (left column) is added to them, and reduced when a credit (right column)
is added to them. The types of accounts to which this rule applies are expenses,
assets, and dividends.
• All accounts that normally contain a credit balance will increase in amount when
a credit (right column) is added to them, and reduced when a debit (left column)
is added to them. The types of accounts to which this rule applies are
liabilities, revenues, and equity.
• The total amount of debits must equal the total amount of credits in a
transaction. Otherwise, an accounting transaction is said to be unbalanced, and
will not be accepted by the accounting software.