Review of The Accounting Process

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Review of the Accounting Process

At the end of the topic, the learner will be able to:


•review the phases of accounting process
•acquire mastery in preparing year-end adjusting entries;
and
•understand the nature of reversing entries.

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

1. 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.

2. 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 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.

3. 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.

4. 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.

5. 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.

6. 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.

7. 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.

8. 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.

9. 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.

10. 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.

**END**

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