CHAPTER 2: Accounting Cycle

1. The Accounting Cycle

Introduction

The accounting cycle is a series of procedures that involves specific steps in recording,
classifying, summarizing, and interpreting transactions and events for a business entity. This
is commonly called as accounting process. It is the process of keeping track of business
transactions by recording and reporting them.

Key Notes:

Recording

1. Identification of Accountable Transactions. Business transactions or events are analyzed

and identified whether they are accountable or not.

2. Journalizing. The transactions are recorded in the book of original entry known as the
journal. The transactions are recorded chronologically with the appropriate accounts and
amounts.

3. Posting. The transactions from the journal are classified in the book of final entry known as
the ledger. The ledger classifies the transactions effecting the increases and decreases for each
account.

Summarizing

4. Trial Balance. The summary of accounts balances from the ledger is prepared in the list of
accounts known as the trial balance. This is the proof that the ledger debit balance and credit
balances are equal and is in balance.

5. Adjusting Entries. Adjusting journal entries are made at the end of the accounting period to
assign revenues to the period in which they are earned and expenses to the period in which they
are incurred.

Reporting

6. Financial Statements. The following financial statements are prepared: statement of

financial position, statement of financial performance, statement of changes in equity, statement
of cash flows and the notes to the financial statements. These financial statements provide useful
information to interested parties for their decision-making.

7. Closing Entries. The temporary nominal accounts are eliminated from the accounts by
recording and posting the closing entries. This will prepare the accounting records for the next
accounting period.

8. Post-Closing Trial Balance. After the closing entries are posted, the post-closing trial
balance is prepared to check that the debit and credit balances of the remaining accounts are
correct.

Optional

9. Recording of Reversing Entries. At the beginning of the next accounting period, selected
adjusting journal entries made at the previous accounting period are reversed to “normalize” the
recording of the related actual transactions.

2. Identifying and Analyzing Business Transactions

Business transactions or events are analyzed whether they are accountable or not. Only
transactions which are identified to be accountable transactions are recorded in the
accounting records. A transaction or event is accountable when it meets the following
criteria:

a. It affects the business entity.

b. It can be measured in terms of money.
c. It occurred on a specific date or for a specific period.
d. It affects the assets, liabilities or equity of the business.
 e. It is supported by a document.

Examples of accountable transactions:

Mr. Luca Pacioli established Pacioli General Services and had the following transactions:

 √ Investment of P100,000 capital funds by Mr. Pacioli into the business

 √ Receipt of a Charge Invoice from a supplier for the purchase of a desktop computer
amounting to P30,000.
 √ Purchase of supplies amounting to P8,000 in cash.
 √ Issuance of a Service Invoice for an amount of P40,000 to a customer for services
rendered on account.
 √ Receipt of P28,000 cash from customers in payment of their account.
 √ Payment in cash and receipt of an official receipt from supplier for payment of
accounts, P22,000.
 √ Cash payment of P12,000 for the salary of an employee.
 √ Mr. Pacioli withdrew P10,000 cash from the business.

Examples of non-accountable transactions:

 The owner of the business spent P80,000 for his wedding.

 A secretary was hired for P15,000 monthly salary.
 The company has been using the electricity for the first month of its operations but has
not yet received the electric bill.
 The company has been recognized by the local government unit as the best service
provider in the locality. It is foreseen to grow into a P10 million company in the next few
years.

Business Documents

The business documents forms serve as evidence to support the accountable transactions or
events. These documents provide the data concerning the parties involved, the exchange
made, the date and the money value of the exchange made. Some of the common business
documents include the following:

1.
1. Sales Invoice – document issued to customer for specific materials or
supplies furnished or services rendered. It is called Purchase Invoice from the
point of view of the customer.
2. Delivery Receipt – document signifying delivery of goods and receipt of
inventory.
3. Official Receipt – document issued to acknowledge receipt of cash.
4. Deposit Slip – document used to deposit cash and cheques to a bank.
 5. Purchase Invoice – a bill from a vendor for specific materials or supplies
furnished or services rendered. It is called Sales Invoice from the point of view
of the supplier.
6. Disbursement Voucher – a written, approved record of payment of cash.
7. Withdrawal Slip – document used to withdraw cash from a bank.
8. Cheque Issuance Record – a record of cheques issued by the company.
9. Promissory Notes – a written promise to pay a certain sum of money to the
payee. It may sometimes bear an interest over a period of time.
10. Bank Statement – a document listing the bank transactions of the depositor.
11. Billing Statement or Statement of Account – document listing the unpaid
invoices of a customer. Oftentimes, it lists chronologically the invoices,
payments and adjustments to the account of the company.
12. Business Letters – correspondences to other companies, organizations or
government entities which may serve as a basis in recording an accountable
transaction or event.

3. Record transactions in the Journal

This is also known as journalizing. The transactions are chronologically recorded in the
journal. General Journal are also known as the Books of Original Entry.

The transactions are recorded through a journal entry. A Journal Entry shows the record of
the effects of a transaction or an event expressed in terms of debit and credit. An entry with
one debit and one credit is a simple journal entry, while an entry with one or more debits
and credits is a compound journal entry. A journal entry has the following elements:

1. The date of the transaction

2. The accounts debited and credited
3. The monetary values of the accounts debited and credited
4. The posting reference code of the destination ledger account
5. A brief and clear explanation of the transaction

A sample journal entries are as follows:

Note: Throughout the course, you will notice that we always use the word “account”.
An account can be thought of as a collection of related entries. For example, every entry that
relates to our receivables from customers will be recorded in the “Accounts Receivable
account”.

The specific account titles and codes to use are maintained in a Chart of Accounts. It is a
list of the account codes and titles that must be used in recording transactions in the
Journal. It shall be maintained and updated for necessary changes, like additions of new
accounts, change of titles and codes and removal of accounts that will no longer be used.

The accounts are normally listed in the order in which they appear in the financial
statements. An account code identifies the account which will serve as its cross-reference in
the journal and ledger.

A sample is as follows:
The accountable transactions are recorded in the general journal following the Basic
Accounting Equation:

Assets = Liabilities + Equity

This equation will guide the bookkeeper in recording the transaction. After the recording of
each transaction using a journal entry, the accounting equation will maintain its equality.
This is possible under the double-entry accounting system.

Under the Double Entry Accounting System, at least two accounts will be recorded for
each accountable transaction. The amount in every transaction must be entered in one
account as a debit (left side of the account)and in another account as a credit (right side of
the account). Because of the two-fold effect of transactions, the total effect on the left
(Debit) will always be equal to total the effect on the right (Credit).

Effect of Accounting Entries to the Accounts

Note: It's more easy to remember the above effects when you familiarize yourself with the
increase effect on accounts. The side where the account increase its amount/value is
actually the Normal Balance of that account.

4. Posting to the Ledger

After the entries are recorded in the journal, the entries are posted into the ledger.
A ledger is a collection of all of the accounts of the company, the debits and credits under
each account, and the resulting balances. For example, the cash ledger will summarize all
the transactions that involved cash. In bookkeeping, Ledgers are important because they
summarize all transactions to show the running/ending balance of a specific account.

Posting to the ledger is the classifying phase of accounting. Posting refers to the process of
transferring entries in the journal into the accounts in the ledger. While journal is called the
Books of Original entry, because journal entries are transferred in the ledger, the general
ledger is often called the book of final entry.

Each account has an assigned account number and the individual accounts are properly
arranged. Each journal entry is posted into the related ledger account indicating the
following:

 Date
 Description
 Posting Reference - serves as the cross-reference between the journal entry and the
ledger account posting.
 Debit and Credit amount
 Running Balance of the account

Sample General Ledger:

The Posting Reference GJ-1 refers to:
GJ-General Journal
1-Page 1
5. Preparing Trial Balance

After the recording phase (Analyzing, Journalizing, and Posting), we enter the next step of
the accounting cycle, the preparation of trial balance.

Trial balance is a listing of all the balances of the different accounts as of a given date. The
account names are listed as arranged in the ledger and the balances are placed either on
the debit or credit column. The total of all accounts with debit balances must equal to the
total of all accounts with credit balances after the posting process. This trial balance is
called an unadjusted trial balance (no adjustments yet).

There are other two types of trial balance: the adjusted trial balance which is prepared after
adjusting entries, and the post-closing trial balance which is prepared after closing entries.

Purpose of Trial Balance:

a. To check the accuracy of posting in the ledger by testing the equality of the debits
and credits.
b. It aids in locating errors in posting.
c. It serves as the basis in the preparation of the financial statements.

Errors in the Accounting Process

When the total debits and total credits are not equal, this automatically signifies that there
is an error in the recording or posting of entries. Some of the errors that could occur are the
following:


o Journal entry with unequal debit and credit.
o Posting to the incorrect debit or credit of an account.
o Incorrectly footing the account balance, or trial balance.
o Forwarding the wrong amount from the ledger to the trial balance.
o Listing the account balance to the wrong side of the trial balance.

The trial balance does not guarantee that the records are accurate even if the total of debits
and total of credits are equal. The following errors will not be detected by the preparation of
a trial balance:


 o Failing to record a transaction or event.
o Multiple recording and posting of a transaction or event.
o Entries or posting to the wrong account.
o Recording and posting of amounts with transposition and trans-placement
errors.

Here is an example of a Trial Balance: