CHAPTER TWO: ACCOUNTING CYCLE FOR SERVICE-GIVING BUSINESS

LEARNING OBJECTIVE

By the time you have finished this unit you should be able to:
 Explain the meaning and nature of an account.
 Apply debits and credits to record business transactions
 Define the terms journal, ledger, journalizing, posting, trial balance etc.
 define accruals and deferrals
 record adjustment journal entries for accruals and deferrals under various
alternatives
 tell the effect of overlooking adjustment journal entries for accruals and
deferrals
 Complete the accounting cycle
2.1 INTRODUCTION

In chapter 1, you have learned the relationship between the accounting equation and
business transactions. Every business transaction affects the elements of the
accounting equation. This accounting procedure will be discussed in detail. The
different and interrelated stages of the accounting cycle will be presented. The
chapter is lengthy, but essential for the remaining chapters in this course and other
accounting courses. Therefore, you are advised to study the chapter carefully.

2.2 NATURE OF AN ACCOUNT

In order to provide the necessary information to users, accountants maintain

separate records on each element of the financial statements. For example, to report
the balance for cash at the end of a year, a record regarding cash should be kept. The
record includes opening cash balance, cash payments & cash collections during the
period. This record is called an account.

Definition: An account is a subdivision under the three elements of the accounting

equation used to record the changes over a single element in the financial
statements. For illustration purposes an account can be represented in the form of
capital letter ‘T’. T-account has three parts, Title, Debit, and credit

Example
Title
Debit Credit
Dr Cr

2.3 CLASSIFICATIONS OF ACCOUNTS

Accounts are classified into five groups: assets, liabilities, capital, and
revenue/income and, expenses. The first three are called balance sheet (financial
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position) accounts and the other two are called income Statement accounts.
Balance Sheet accounts are those reported on the balance sheet at the end of the
reporting period and Income Statement accounts are reported on the Income
Statement.
The five groups of account are discussed below:

1. Assets: Resources owned by a business or individual are called assets. Assets

could be tangible or intangible. Tangible assets are assets having physical existence,
like cash, land, computer, stationery materials. Intangible assets do not have
physical existence. Example: Goodwill, Copyright, patent right.

On the balance sheet, assets are classified into two current assets and non – current
assets.

Current Assets – are those assets, which can be used, sold, or converted into cash
within one accounting year. Example: cash, supplies, prepayments, receivables etc.

Non-current Asset: All assets other than current assets are called non-current assets.
Example: land, patent right, office equipment, vehicles.

2. Liabilities: Creditors’ claims to the assets of a business. Amounts owed to creditors

are called liabilities. Like assets, liabilities are classified in to two as current liabilities
and non – current liabilities

Current liabilities: The liabilities that are payable within the next (one) accounting
year are known as current liability. Example: Accounts Payable, Rent Payable, Salary
Payable.

Non – Current Liabilities: Debts that are not required to be paid within the next
accounting period. Example long term notes payable.

3. Capital: The excess of the assets of a business over its liabilities is referred to as
capital. It is the equity of the owner in the business.

4. Revenue/income: Are increases in owner’s equity resulting from the main

operations of the business. Examples of revenue accounts are sales, interest income,
tuition fee, and sales commission.

5. Expenses: are decreases in owner’s equity in the process of earning revenue. For
example, a hotel has to pay salary to its workers for the services rendered to clients
in order to get the income from customers (revenue). Example of expenses: Salary,
insurance, depreciation, supplies, utilities, rent etc.

2.4 CHART OF ACCOUNTS

The number and name of accounts used by an organization depends on the nature of
its operation. The list of accounts used by an organization and their codes is called

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the chart of accounts. Look at the following chart of accounts of Bati Transport.

Bati Transport
Chart of Accounts

Asset Account number

Cash--------------------------------------------------------------------------11
Accounts Receivable------------------------------------------------------ 12
Supplies----------------------------------------------------------------------13
Prepaid Insurance-----------------------------------------------------------14
Equipment------------------------------------------------------------------- 15
Accumulated Depreciation –Equipment---------------------------------16
Truck--------------------------------------------------------------------------17
Accumulated depreciation – Truck----------------------------------------18

Liabilities
Accounts Payable-------------------------------------------------------------21
Notes Payable-----------------------------------------------------------------22

Owners Equity
Yimer Adem, Capital----------------------------------------------------------31
Yimer Adem, Drawing-------------------------------------------------------32
Income Summary-------------------------------------------------------------33

Revenue
Service income----------------------------------------------------------------41

Expense
Salaries Expense --------------------------------------------------------------51
Rent Expense ------------------------------------------------------------------52
Utilities Expense---------------------------------------------------------------53
Supplies Expense--------------------------------------------------------------54
Insurance Expense-------------------------------------------------------------55
Maintenance Expense---------------------------------------------------------56
Depreciation Expense---------------------------------------------------------57
Truck Expense-----------------------------------------------------------------58
Miscellaneous expense--------------------------------------------------------59

In the chart of accounts, the asset accounts are listed according to their liquidity.
Liquidity is the ease with which an asset can be converted in to cash. Cash is the most
liquid asset so it is listed first. Accounts other than cash will be listed in their
frequency of use or in alphabetical order. The account number is a code to identify
accounts. The number could be a two digit, three digit or more digits. In the above
example a two – digits code is used. When the chart of accounts is prepared in an
organization we say the ledger is opened.

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2.5 RULES OF DEBITS AND CREDITS

As shown above every account has three parts. These parts are discussed below:

Title – The name of the account. This is written at the top of the account.

Debit – is the left hand side of an account –Debit is abbreviated as ‘Dr.’. When an
amount is entered on the left side of an account we say the account is debited or
charged.
Credit – is the right hand side of an account. Credit is abbreviated as Cr. An account
is said to be credited when an amount is entered on the right hand side of the
account.

An account may increase or decrease on the debit side or on the credit side
depending on the nature of the account. In general, accounts appearing on the left
hand side of the accounting equation increase on their left side (Dr. side) and
decrease on their right side (Cr. Side); whereas accounts on the right side of the
equation increase on their right side and decrease on their left side. The above
general rule will be expanded as follows

Debit Credit
-Increase in assets -Decrease in assets
-Increase in expenses -Decrease in expenses
-Decrease in capital -Increase in Liabilities
-Decrease in liabilities -Increase in liabilities
-Decrease in revenue -Increase in revenue.

The normal balance of an Account

Normal balance refers to the side of an account (Dr. or Cr.), which will have greater
entries than the other. The increasing side will be the normal balance for accounts.
Example: The normal balance of all asset accounts is debit

2.6 JOURNALIZING BUSINESS TRANSACTIONS

When a business transaction takes place, source documents will be obtained and
recorded. The accounting record in which a transaction is initially recorded is known
as a journal. The journal is therefore referred to as “The book of original entry”.

The process of recording a business transaction in the accounting record is called

journalizing.

The Journal commonly used to record all types of transactions is the General Journal.
This Journal includes the following parts, entered step by step.
1. The date of the transaction
2. The title of the account debited
3. The title of the account credited

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 4. The amount of debit and credit
5. Brief explanation of the entry or reference to the source document.

Look at the following General Journal and notice where each of the above
information is found.
Journal page
Date Description P.R Debit Credit
Year
Month day Debited account title XXX XX
Credited account title X XX XX
Explanation

There are also other types of Journals like, known as special journals that are used to
record specific types of transactions. The cash Journal, for instance, is used to record
only transactions affecting cash. The General Journal is used for illustrations in this
chapter.

Steps in Journalizing a Transaction

The following steps should be followed in recording a transaction in the journal.

1. Record the date - Insert the year, the month, and the date as shown above.
2. Record the Debit- Insert the account debited in the description column and the
amount of debit in the debit column.
3. Record the credit- Insert the account credited below the debited account and
indented to the right in the description column and the amount of credit in the
credit column.
4. Explanation- Write a brief explanation or reference to source document in the
description column, when necessary.

Each one set of debits and credits for a transaction is called a journal entry.

In recording a business transaction answer the following questions based on the

transaction to be recorded may help you.

a) Which accounts are affected?

b) Is each account increased or decreased?
c) Which account is debited and which is credited?
d) Prepare the complete journal entry.

Example: On January 10, 2003 Tamget P.L.C paid Birr 6,000 to its employees as a
salary for the first week of the year.

This business transaction will be analyzed and recorded as follows.

a) Which accounts are affected? Answer: Cash and Salary Expense.
b) Is each account increased or decreased? Answer: cash is decreased and salary
expense is increased.

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 c) Which account is debited and which is credited? Answer: Salary Expense is
debited because increase in expenses is recorded on the debit side. And cash is
credited because decrease in assets is recorded on the debit side.
d) Prepare the complete Journal entry.

2003 Description
Jan. 10 Salary expense 6000 00
Cash 6000 00
Payment of salary

Note: A journal entry is the complete presentation of the record in the journal.

Illustration
To illustrate the complete accounting cycle, we will consider the following list of
selected transactions. The transactions were completed by Bati Transport in the
month of January 2003.

January 1. Ato Yimer took Birr 450,000 from his personal savings and deposited it in
the name of Bati transport.
January 2. Bati Transport purchased two used trucks for Birr 150,000 each, on cash.
January 4. Bati Transport received a check for Birr 650 for services given to Alem
Trading.
January 4. Received an invoice for truck expenses Birr 90.
January 11. Paid Birr 600 for Awash Insurance Company to buy an insurance policy
for its trucks.
January 16. Ato Yimer issued a check for Birr 9,400 to the workers as a salary for
two weeks.
January 20. Bati trading Billed Muradu Supermarket for goods transported from
Djibouti to Gondar Birr 2,650
January 21. Ato Yimer wrote a check for birr 450 to have one of the trucks repainted
January 21. Bati trading purchased stationary materials and other supplies of Birr
740 on account
January 22. Office equipment of Birr 11,600 is bought on account.
January 23. Purchased an additional truck for Birr 250,000 paying birr 100,000 in
cash and issuing a note for the difference.
January 23. Recorded services billed to customers on account birr 14,600.
January 25. Received cash from customers on account Birr 15,000.
January 27. The owner withdrew Birr 500 in cash for his personal use.
January 28. Paid Birr 9,400 to workers as a salary for the last two weeks of the month.
January 30. Paid telephone expense of Birr 95 and electric expenses of Birr 125 for
the month.
January 30. Paid other miscellaneous expenses Birr 50.
January 31. Paid Birr 4,000 as a rent for a building used for office space.

These transactions are journalised as follows:

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Date Description Debit Credit
2003 Cash 450,000
Jan.1 Yimer Capital 450,000
To record investment by
owner
2 Truck 300,000
Cash 300,000
Purchase of trucks
4 Cash 650
Service Income 650
Cash received from
customers
4 Truck Expenses 90
Accounts Payable 90
Service received in advance
11 Prepaid Insurance 600
Cash 600
Purchase of insurance policy
16 Salary Expense 9,400
Cash 9,400
Payment of salary
20 Accounts Receivable 2,650
Service Income 2,650
Provision of service
21 Truck Expense 450
Cash 450
Cash paid to repaint truck
21 Supplies 740
Accounts Payable 740
Purchase of supplies of
account
22 Office Equipment 11,600
Accounts Payable 11,600
Purchase of equipment
23 Truck 250,000
Cash 100,000
Notes Payable 150,000
Purchase of truck
23 Accounts Receivable 14,600
Service Income 14,600
Provision of service on
account
25 Cash 15,000
Accounts Receivable 15,000
Collection of cash

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27 Drawings 500
Cash 500
Owner withdrawals
28 Salary Expense 9,400
Cash 9,400
Payment of salary
30 Utilities Expense 220
Cash 220
Payment for telephone,
electricity
30 Miscellaneous Expenses 50
Cash 50
Payment for various expenses
31 Rent Expense 4,000
Cash 4,000
Payment of Rent

2.7 POSTING FROM THE JOURNAL TO THE LEDGER

After the information about a business transaction has been journalized, that
information is transferred to the specific accounts affected by each transaction. This
process of transferring the information is called posting.

An account could be of two types; the two-column account and the four-column
account. We will use the four-column account for our illustration. The two forms of
accounts are given below.

The two-column account:

Account Account number
Date Item P.R Debit Date Item P.R Credit

The four-column account:

Account Account number
Date Item P.R Debit Credit Balance
Debit Credit

The steps in posting are given below:

1. Record the date and amount of Dr. and Cr. Entry to the account
2. Insert the Journal page number in the P.R (Post Reference) column of the
account.
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 3. Insert the account number in the P.R column of the journal.
Note. The P.R Column is used for reference purposes. The P.R column of the journal
shows whether the entry is posted and the account to which it is posted. In the
account, the P.R Column shows the Journal page number from which the entry was
brought.

The group of accounts used by an organization is called ledger.

Illustration. As mentioned above, to illustrate the posting process the four column
account is used and the entries to the cash account are posted as follows.

Account Cash Account Number

Balance
Date Item P.R Debit Credit Debit Credit
200 450,000 00 450,000 00
3 1
Jan
2 300,000 00 150,000 00
4 650 00 150,650 00
11 600 00 150050 00
16 9,400 00 140650 00
21 450 00 140200 00
23 100,000 00 40200 00
25 15,000 00 55200 00
27 500 00 54200 00
28 9,400 00 45300 00
30 220 00 45,080 00
30 50 00 45,030 00
31 4,000 00 41,030 00

Note. The item column is usually left blank. In some cases the word balance is
written when the account is carried foreword to a new page.

2.8 THE TRIAL BALANCE

After the posting phase is completed, we have to verify the equality of the debit and
credit balances. This is done through the use of the ‘Trial Balance’. A trial balance is a
two column listing of the accounts in the ledger and their balance to make sure that
the total of debit balances equals the total of credit balances.

The trial balance for our illustration, Bati Transport is presented below. The amounts
are taken from the balances of the accounts after all the transactions have been
posted. Therefore, after posting the above transactions, you should get the final
balances shown on the trial balance in the end.

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 Bati Transport
Trial Balance
January 31, 2003

Cash 41,030 00
Accounts Receivable 2,250 00
Supplies 740 00
Prepaid Insurance 600 00
Office equipment 11,600 00
Truck 550,000 00
Accounts payable 12,430 00
Notes payable 150,000 00
Yimer capital 450,000 00
Yimer drawing 500 00
Service income 17,900 00
Salary expense 18,800 00
Rent expense 4,000 00
Utilities expense 220 00
Maintenance expense 450 00
Truuck expense 90 00
Miscellaneous expense 50 00
Total 630,330 00 630,330 00

2.8.1 Proof Provided by the Trial Balance

The trial balance debit totals and credit totals are equal implies that the accounting
work is more likely to be free from any one or more of the following errors.

1. Error in preparing the trial balance including

-Addition error
-The amount of an account balance was in correctly listed on the trial balance
- A debit balance was recorded as a credit or vice versa
- A balance was entirely omitted.

2. Error in posting, including

- An erroneous amount was posted to the account.
- A debit amount was posted as a credit or vice versa
- A debit or credit posting was omitted

2.8.2 Limitations of the Trial Balance

The trial balance amounts are equal doesn’t mean that the accounting work is free
from error. That is, there are errors that may take place without affecting the trial
balance totals. Some examples are mentioned below:
- Failure to record a transaction or to post a transaction
- Recording the same erroneous amount for both the debit and the credit

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 parts of a transaction.
- Recording the same transaction more than once.
- Posting part of a transaction to the correct side but the wrong account.
Note: All these errors have the same affect (increasing or decreasing) on the debit
totals and credit totals

2.9 ADJUSTMENTS
All the transactions recorded above in the journalizing step are the result of daily
transactions. Other transactions result from the passage of time or from the internal
operations of the business. For example, insurance premiums are paid for a certain
period of time and expire during that time period. Another example is office supplies
such as paper, pens & pencils.

At the end of the period the balances in accounts such as supplies and prepaid
insurance must be brought up to date. The supplies account balance, for example,
must be credited by the consumed part of the supplies, debiting supplies expense.

Example: Stationary materials totaling Birr 1,900.00 were purchased and recorded
during the year. At the end of the year, only Birr 150 of the supplies is left in hand.

The adjusting entry prepared at the end of the year to adjust the supplies account will
be:

2003 Supplies expense 1,750

Dec31 Supplies 1,750

Note: 1. Adjustments are dated as the last day of the year.

2. The accounting year here – we assume, runs from January 1- December 31.

Additional examples on adjustments will be given below under the topic ‘worksheet’

2.9.1 The Accrual Basis and the Cash Basis of Accounting

1. The cash basis of accounting – In this basis of accounting revenues are reported
in the period in which cash is received and expenses are reported in the period in
which cash is paid. Net in come will, therefore, be the difference between the cash
receipts (Revenues) and cash payments (expenses). This method will be used by
organizations that have very few receivables and payables. For most businesses,
however, the cash basis is not an acceptable method.

2. The accrual basis of accounting – Under this method revenues are reported in the
period in which they are earned, and expenses are reported in the period in which
they are incurred. For example, revenue will be recognized as services are
provided to customers or goods sold and not when cash is collected. Most
organizations use this method of accounting and we will apply this method in this
course.

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 2.9.2 The Matching Principle
This principle states that the expense of a period have to be matched with the
revenue of that period regardless of when payment is made. In order to do this, the
accrual basis of accounting requires the use of an adjusting process at the end of the
period so that revenues and expenses of the period will be determined properly.

2.10 WORKSHEET FOR FINANCIAL STATEMENTS

Most of the data required to prepare the accounting reports (financial statements) is
now gathered. The data will now be presented in a convenient form. The worksheet
is a large columnar sheet prepared to arrange in a convenient form all the accounting
data required to prepare financial statements. The worksheet has a heading and a
body.

The heading has three parts:

i) Name of the Organization
ii) Name of the form (worksheet)
iii) Period of time covered.

The body contains five main parts each of them with two main columns. These parts
are
1. The trial balance
2. The adjustment
3. The adjusted trial balance
4. The income statement
5. The balance sheet.

The worksheet for Bati Transport is given below. The five parts of the body are
discussed as follows. You are advised to read and understand the discussions before
you look at the respective columns of the worksheet.

Bati Transport
Work Sheet
For the month ended jan.31, 2003

Account Title Trial Balance Adjustment Adjusted Trial Income Balance

balance statement sheeet
1 Cash 41,03 41,03 41,03
0 0 0
©
2 Accounts 2,250 7,40 9,650 9,650
receivable 0
(a)
3 Supplies 740 340 400 400
(b)
4 Prepaid 600 450 150 150
Insurance
5 Office 11,60 11,60 11,60
equipment 0 0 0
6 Truck 550,0 550,0 550,0

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 00 00 00
7 Accounts 12,43 12,43 12,43
payable 0 0 0
8 Notes payable 150,0 150,0 150,0
00 00 00
9 Yimer, Capital 450,0 450,0 450,0
00 00 00
10 Yimer ,drawing 500 500 500
©
11 Service income 17,90 7,40 25,30 253
0 0 0 00
12 Salary expense 18,80 18,80 18,80
0 0 0
13 Rent expense 4,000 4,000 4,000
14 Utilities 220 220 220
expense
15 Maintenance 450 450 450
expense
16 Truck expense 90 90 90
17 Miscellaneous 50 50 50
Expense
18 630,3 630,3
30 30
(a)
19 Supplies 340 340 340
expense
(b)
20 Insurance 450 450 450
expense
21 7290 7290 636,8 636,8
30 30
22 Net income
23 25300 253 613,3 613,3
00 30 30

1. The trial balance column – this is the same trial balance we have prepared before.
The trial balance column of the work sheet can be brought direct from the ledger or
from a separate trial balance.

2. The Adjustment column – As mentioned previously, some account balances have

to be adjusted at the end of the year.

The accounts in the ledger of our illustration that require adjustment and the
adjusting entry for the accounts are presented below.

a) Supplies – The supplies account has a debit balance of Birr 740. The cost of
supplies in hand on July 31 is determined to be Birr 400. The following adjusting
entry is required to bring the balance of the account up to date:

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 Supplies expense…………………………….340
Supplies……………………………………..340

b) Prepaid insurance – Analysis of the policy showed that three – fourth of the policy
is expired. That is only Birr 150 of the policy is applicable to future periods. The
adjusting entry to transfer the expired part of the insurance to expense will be.

Insurance expense ……………………….450

Prepaid insurance………………………..450

c) Service Income – At the end of the month unbilled fees for services performed to
clients totaled Birr 6,500.

This amount refers to an income earned but to be collected in the future. The journal
entry to record it will be
Accounts receivable………………………….6,500
Service income………………………………6,500

All the above adjusting entries will be inserted in the adjustment column of the
worksheet in front of the accounts affected.

Note – The letters a, b & c are used to cross-reference the debits and credits to help
future review of the worksheet.

3. The Adjusted Trial Balance Column – The accounts that require adjustment are
now adjusted. Transferring the trial balance column amounts combined with the
adjustment column amounts will complete the adjusted trial balance column of the
worksheet.

4. The income statement and the balance sheet columns – Transfer the income
statement account balances (revenue &expenses) to the income statement and
balance sheet account balances (Asset, Liability &owners equity) to the balance sheet
columns. Note that what we have to transfer is the adjusted trial balance column
amounts, to the corresponding columns.

Look at the 22nd row. It shows the net income for the month and it is added to the two
columns (Income statement Dr. and balance sheet cr.) as a balancing figure.

2.11 FINANCIAL STATEMENT PREPARATION

After the work sheet is completed financial statements could be prepared easily. In
chapter one we have discussed four basic financial statements prepared by most
organizations. Here, we will prepare three of these statements for Bati Transport
form the worksheet.

1. Income statement: All the data required to prepare the income statement is

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brought from the worksheet.

Bati Transport
Income statement
For the month ended. Jan 31, 2003

Service Income …………………………………………………………Birr 25,300

Operating expenses:
Salary expense………………………………..Birr 18,800
Rent expense ………………………………….4, 000
Maintenance expense ……………….…………… 450
Insurance expense ……………………………450
Supplies expense …………………………….340
Utilities expense ……………………………..220
Truck expense …………………………….. .90
Miscellaneous expense ………………………………50
Total operating expense………………………………………24,400
Net Income…………………………………………………Birr 900
2. Statement of owner’s equity – This statement shows the opening balance of
capital and the changes that affected it. The balance of the owners equity account
(Yimer capital) in the worksheet may not be the beginning one. Therefore, the ledger
has to be reviewed to see if there was an additional investment during the period or
not. In our illustration there is no additional investment.

Bati Transport
Statement of Owner’s equity
For the month ended January 31, 2003

Yimer, capital January 1, 2003………………………………Birr 450,000

Net income for the month………………….birr 900
Less: Withdrawal…………………………………...500 400
Yimer capital, January 31, 2003……………….………..…….Birr 450,400
3. Balance sheet – The data to prepare this statement will be taken from the
worksheet and the other financial statements. Note that assets and liabilities are
classified as current and non – current.

Bati Transport
Balance sheet
January 31, 2003

Assets:

Plant Asset (None-Current Assets):

Office equipment………………………..…………..Birr 110,600

Truck………………………………….....………………550,000 561,600
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Current Assets:
Pre-paid Insurance…………………………………………Birr 150
Supplies……………………………………………………….. 400
Account Receivable…………………………………………… 9,650
Cash…………………………………………………………….41, 030

Total current assets……………………………………………………………Birr 51,230

Total asset…………………………………………………..…………………Birr 612,830

Owner’s equity and Liabilities

Yimer, Capital…………………………………………………………………….. 450,400

Liabilities
Non-current liabilities:
Notes payable……………………………………………………..150,000
Current liabilities:
Accounts payable……………………………………....………..Birr 12,430
Total liabilities……………………………………………………..……………Birr 162,430

Total owners’ equity and liability …………………………....………………….Birr 612,830

2.12 THE CLOSING PROCESS

Some of the accounts in the ledger are Nominal (temporary accounts) used to classify
and summarize the transactions affecting capital (owners equity). These accounts
will be closed after financial statements are prepared. That is, their balances will be
transferred to the Capital account. The temporary accounts that have to be closed
are revenue, expense and withdrawal accounts.
Steps in closing:

1. Closing revenue accounts - Debit each revenue account by its balance and credit
the ‘Income Summary’ account by the total revenue for the period.

Note: Income summary is an account used to close revenue and expense accounts.
This account will immediately be closed to the capital account at the end of the
closing process.

2. Closing expense accounts – Debit the income summary account by the total of
expenses for the period and credit each expense account by its balance.
3. Closing the income summary account – Income summary will be closed to the
capital account. The balance of this account depends on the nature of operation;
credit if result is profit and debit if result is loss.
4. Closing Withdrawal – Debit the owners equity account by the total of drawings
for the period and credit the drawing account.

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The temporary accounts of Bati transport are closed as follows.

2003 Income summary………………….25, 300

January Service income…………………………………25,300
31 (Closing revenue)

31 Salary expense………………………..18,800
Rent expense……………………………4,000
Maintenance expense………………….. 450
Insurance expense………………………..450
Supplies expense…………………………340
Utilities expense………………………….220
Truck expense …………………………… 90
Miscellaneous expense…………………….50
Income summary…………………………………24,400
(Closing expenses)

2003 Income summary………………900

January 31 Yemer, Capital………………………..900
(Closing income summary)
31 Yimer, capital…………………...500
Yimer, drawing………………………..500
(Closing withdrawal)

The above closing entries have transferred the balance of the temporary accounts to
the permanent capital account.

2.13 POST CLOSING TRIAL BALANCE

After the closing entries have been journalized and posted, a trial balance is prepared
to prove the equality of the general ledger before recording the new year’s
transactions. It should be noted that this trial balance includes only balance sheet
accounts. This is because the temporary income statement accounts are closed
during the closing process. This trial balance is called the post – closing trial balance.

In practice the ledger balance after closing may be checked by a simple calculator
print out rather than a formal trial balance. The post closing trial balance for Bait
Transport is presented below.
Bati Transport
Post – Closing trial balance
Jan 31, 2003

Cash……………………………………………Birr 41,030
Accounts Receivable ………………………………...9,650
Supplies…………………………………………………400
Prepaid insurance……………………………………….150

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 Office equipment……………………………………11,600
Truck……………………………………………….550, 000
Accounts payable…………………………………………………….Birr 12,430
Nots payable……………………………………………………………..150,000
Yimer, capital……………………………………………………………..450,400
Total……………………………………Birr 612,830 Birr 612,830

2.14 SUMMARY

Accountants go through a number of step-by-step procedures to record transactions

and to summarize the records in to useful repotrs in a systematic manner. These
procedures that accountants go through from the time a transaction is identified
until the time financial statements are prepared are together called the accounting
cycle. The accounting cycle is summarized below:
Input Process Output
1. When a transaction 2. Transactions are recorded in the journ 7.Preparing financial statement
happens, source
are prepared. 3.Posting to individual accounts

4.Preparing a trial balance after

determining the balance of each
ledger account

6.preparing and completing the work

sheet with adjustments

8.Adjustments are journalized and

posted

9.Closing entries are journalized and

posted

10.A post closing trial balance is

prepared

Exercise:

1. Indicate whether each of the following items below is an asset, liability, revenue,
expense, gain or loss account and whether it appears in the balance sheet or
income statement.

a) Office furniture
b) Income from services
c) Salaries paid to workers

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 d) Supplies on hand
e) Salary payable to workers
f) Cash
g) Income form sale of a used truck
h) Goods damaged by fire in the store

2. Given below is a list of selected transactions performed by John Décor during the
month of September 2002, the first month of operation.

a) Record the transactions in General Journal

b) Post each entry to the perspective account. Use the four – column account.
c) Prepare a trial balance
d) Prepare a worksheet. Assume the following adjustment for the accounts and
journalize them.
e) Prepare a Balance sheet, Income statement and statement of owner’s equity
f) close the temporary accounts.

Sept. 10 Mr. John transferred cash form his personal account to be used in the
business,
Birr 10,000.
“ 10 Paid rent for the month, Birr 500
“ 11 Purchased a truck for Birr 12,000 by paying Birr 3,000 Cash and giving a
notes payable for the difference.

“ 12 Purchased equipment on account Birr 1,460.

“ 13 Purchased supplies on account Birr 240.
“ 14 Paid insurance premiums of Birr 170 (Dr. prepaid insurance)
“ 15 Received cash for services completed Birr 360.
“ 16 Purchased Supplies on account Birr 240.
“ 18 Paid salaries of Birr 900.
“ 21 Paid its liabilities for the purchase of equipment
“ 24 Recorded sales on account Birr 2,080
“ 26 Received an invoice for truck expense Birr 115
“ 27 Paid utilities expense Birr 205.
“ 27 Paid miscellaneous expenses Birr 73.
“ 28 Received cash from customers on account birr 1,420
“ 30 Paid salaries to employees Birr 950
“ 30. The owner withdrew Birr 1, 750 for personal use.

3. The trial balance of Betty Beauty Saloon does not balance. The errors in the
accounting work are given below. Determine the correct balance of each account
and prepare the corrected trial balance.

Betty Beauty Saloon

Trial balance

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 April 30
Cash 5,902.00
Accounts Receivable 6,300.00
Supplies 1,600.00
Equipment 5,200.00
Accounts payable 4,300.00
Betty capital 10,000.00
Service income 4,700.00
Operating expenses 1,980.00
Total 20,982.00 19,200.00

The errors are the following:

 Cash received form a customer on account was recorded (both debit and credit)
as birr
 1,400 instead of Birr 1,120

 The purchase on account of an equipment costing Birr 780 was recorded as a

debit to
 operating expense and credit to accounts payable.

 Service was performed to clients Birr 1,780 for which accounts Receivable was
 debited birr 1,780 and service income was credit birr 178

 A payment of Birr 80 for telephone charges was debited to Operating Expense

and it was also debited to cash

 The ledger balance of the service income account is birr 4,700 rather than Birr
4,720.

4. As of June 30, 2004, the end of the current fiscal year, the accountant for Abay
General Trading completed the worksheet before journalizing and posting the
adjustments.

Required: (a) Compare the adjusted and unadjusted trial balances and prepare the
eight journal entries that were required to adjust the accounts.
(b) Prepare the journal entries that were required to close temporary accounts.

Abay General Trading

Trial Balance
June 30, 2004

Un adjusted Adjusted
Cash 12,825.00 12,825.00
Supplies 8,950.00 3,635.00

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Prepaid rent 19,500.00 1,500.00
Prepaid insurance 3,750.00 1,250.00
Equipment 92,150.00 92,150.00
Accumulated depreciation 53,480.00 66,270.00
equipment
Automobile 56,500.00 56,500.00
Accumulated depreciation 28,250.00 36,900.00
automobile
Accounts payable 8,310.00 8,730.00
Salary payable 3,400.00
Tax Payable 1,225.00
Ato Abay capital 41,245.00 41,245.00
Ato Abay drawing 18,600.00 18,600.00
Service income 261,200.00 261,200.00
Salary Expense 172,300 175,700.00
Rent Expense 18,000.00
Supplies Expense 5,315.00
Depreciation Expense Equipment 12,790.00
Depreciation Expense Automobile 8,650.00
Utilities Expense 4,700.00 5,120.00
Taxes Expense 1,500 2,725.00
Insurance Expense 2,500.00
Miscellaneous Expense 1,710.00 1,710.00
____ ____
Total 392,485.00 392,487.00 418,970.00 418,970.00

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