Accounting in the information age

The current changes in accounting calls for investigating how the organisational ideal types
of the information age, the network, the immaterial and the virtual corporation, utilise
accounting systems for various purposes: Creating organisational transparency, indexing
economic efficiency and producing information for valuation. This is contrasted with how the
same functions are/were performed by the ideal types of the mercantile era, the trading
company, and of the industrial era, the industrial corporation. The conclusion reached is that
the business processes of corporations in the information age are difficult to capture within
the limits of the traditional accounting framework. Because of this, we can find substantial
evidence today that IT and the corporations of the information age are radically transforming
both the forms and functions of accounting.

Accounting is an information and measurement system that aims to identify, record, and
communicate relevant, reliable, and comparable information about business activities. It
helps assess opportunities, products, investments, and social and community responsibilities.
Summary of Accounting Activities Record keeping or bookkeeping is the recording of
transactions and events, either manually or electronically. Accounting also identifies and
communicates information on transactions and events, and it includes the crucial processes of
analysis and interpretation.

Identifying: Select transactions and events Recording: Input, measure and classify
Communicating: Prepare, analyse and interpret the best software and recordkeeping cannot
make up for lack of accounting knowledge. Technology is a key part of modern business and
plays a major role in accounting. Technology reduces the time, effort, and cost of
recordkeeping while improving clerical accuracy. Consulting, planning, and other financial
services are now closely linked to accounting. These services require sorting through data,
interpreting their meaning, identifying key factors, and analysing their implications.

Identify users and uses of accounting. Users of accounting are both internal and external.
Some users and uses of accounting include (a) managers in controlling, monitoring, and
planning; (b) lenders for measuring the risk and return of loans; (c) shareholders for assessing
the return and risk of stock; (d) directors for overseeing management; and (e) employees for
judging employment opportunities.
Accounting is often called the language of business because all organizations set up an
accounting information system to communicate data to help people make better decisions.
Internal users of accounting information are those directly involved in managing and
operating an organization. They use the information to help improve the efficiency and
effectiveness of an organization. Managerial accounting provides information needs for
internal decision makers.
Research and development managers need information about projected costs and revenues of
any proposed changes in products and services. Purchasing managers need to know what,
when, and how much to purchase. Human resource managers need information about
employees' payroll, benefits, performance, and compensation. Production managers depend
on information to monitor costs and ensure quality. Distribution managers need reports for
timely, accurate, and efficient delivery of products and services. Marketing managers use
reports about sales and costs to target consumers, set prices, and monitor consumer needs,
tastes, and price concerns. Service managers require information on the costs and benefits of
looking after products and services.
Financial statements and accounting transactions

Every accounting transaction has to follow the dictates of the accounting equation, which

states that any transaction must result in assets equalling liabilities plus shareholders' equity.
For example: ... A receipt of cash from a customer result in an increase in cash (asset) and a
decrease in accounts receivable (asset).

Financial statements represent a formal record of the financial activities of an entity. These

are written reports that quantify the financial strength, performance and liquidity of a
company. Financial Statements reflect the financial effects of business transactions and
events on the entity.
Main types of financial statements are:
1. Statement of Financial Position
Statement of financial position, also known as the balance sheet, presents the financial
position of an entity at a given date. Statement of financial position helps users of financial
statements to assess the financial soundness of an entity in terms of liquidity risk, financial
risk, credit risk and business risk.
It is comprised of the following three elements:
  Assets: Something a business owns or controls (e.g. cash, inventory, plant and
machinery, etc)
 Liabilities: Something a business owes to someone (e.g. creditors, bank loans, etc)
 Equity: What the business owes to its owners. This represents the amount of capital
that remains in the business after its assets are used to pay off its outstanding
liabilities. Equity therefore represents the difference between the assets and liabilities.

Example
Following is an illustrative example of a Statement of Financial Position prepared under the
format prescribed by IAS
Presentation of Financial Statements.
Statement of Financial Position as at 31st December 2013

2013 2012
Notes
USD USD
ASSETS

Non-current assets
Property, plant & equipment 9 130,000 120,000
Goodwill 10 30,000 30,000
Intangible assets 11 60,000 50,000
220,000 200,000

Current assets
Inventories 12 12,000 10,000
Trade receivables 13 25,000 30,000
Cash and cash equivalents 14 8,000 10,000
45,000 50,000
TOTAL ASSETS 265,000 250,000

EQUITY AND LIABILITIES

Equity
Share capital 4 100,000 100,000
Retained earnings 50,000 40,000
Revaluation reserve 5 15,000 10,000
Total equity 165,000 150,000

Non-current liabilities
Long term borrowings 6 35,000 50,000

Current liabilities
Trade and other payables 7 35,000 25,000
Short-term borrowings 8 10,000 8,000
Current portion of long-term borrowings 6 15,000 15,000
Current tax payable 9 5,000 2,000

Total current liabilities 65,000 50,000

Total liabilities 100,000 100,000
TATAL EQUITY AND LIABILITIES 265,000 250,000

Classification of Components
Statement of financial position consists of the following key elements:
Assets
An asset is something that an entity owns or controls in order to derive economic benefits
from its use. Assets must be classified in the balance sheet as current or non-current
depending on the duration over which the reporting entity expects to derive economic benefit
from its use. An asset which will deliver economic benefits to the entity over the long term is
classified as non-current whereas those assets that are expected to be realized within one year
from the reporting date are classified as current assets.
Assets are also classified in the statement of financial position on the basis of their nature:

 Tangible & intangible: Non-current assets with physical substance are classified
as property, plant and equipment whereas assets without any physical substance are
classified as intangible assets. Goodwill is a type of an intangible asset.

 Inventories balance includes goods that are held for sale in the ordinary course of the
business. Inventories may include raw materials, finished goods and works in
progress.

 Trade receivables include the amounts that are recoverable from customers upon
credit sales. Trade receivables are presented in the statement of financial position after
the deduction of allowance for bad debts.

 Cash and cash equivalents include cash in hand along with any short term investments
that are readily convertible into known amounts of cash.

Liabilities
A liability is an obligation that a business owes to someone and its settlement involves the
transfer of cash or other resources. Liabilities must be classified in the statement of financial
position as current or non-current depending on the duration over which the entity intends to
settle the liability. A liability which will be settled over the long term is classified as non-
current whereas those liabilities that are expected to be settled within one year from the
reporting date are classified as current liabilities.
Liabilities are also classified in the statement of financial position on the basis of their nature:

 Trade and other payables primarily include liabilities due to suppliers and contractors
for credit purchases. Sundry payables which are too insignificant to be presented
separately on the face of the balance sheet are also classified in this category.

 Short term borrowings typically include bank overdrafts and short term bank loans
with a repayment schedule of less than 12 months.

 Long-term borrowings comprise of loans which are to be repaid over a period that
exceeds one year. Current portion of long-term borrowings include the instalments of
long term borrowings that are due within one year of the reporting date.

 Current Tax Payable is usually presented as a separate line item in the statement of
financial position due to the materiality of the amount.

Equity
Equity is what the business owes to its owners. Equity is derived by deducting total liabilities
from the total assets. It therefore represents the residual interest in the business that belongs
to the owners.
Equity is usually presented in the statement of financial position under the following
categories:

 Share capital represents the amount invested by the owners in the entity

 Retained Earnings comprises the total net profit or loss retained in the business after
distribution to the owners in the form of dividends.

 Revaluation reserve contains the net surplus of any upward revaluation of property,

plant and equipment recognized directly in equity

2. Income statement
Income statement, also known as the profit and loss statement, reports the company's
financial performance in terms of net profit or loss over a specified period. Income Statement
is composed of the following two elements:

 Income: What the business has earned over a period (e.g. sales revenue, dividend
income, etc)
 Expense: The cost incurred by the business over a period (e.g. salaries and
wages, depreciation, rental charges, etc)

Income statement, also known as Profit & Loss Account, is a report of income, expenses and
the resulting profit or loss earned during an accounting period.
Example
Following is an illustrative example of an income statement prepared in accordance with the
format prescribed by IAS
Presentation of Financial Statements.
Income Statement for the Year Ended 31st December 2013

2013 2012
Notes
USD USD

Revenue 16 120,000 100,000

Cost of Sales 17 (65,000) (55,000)

Gross Profit 55,000 45,000

Other Income 18 17,000 12,000

Distribution Cost 19 (10,000) (8,000)
Administrative Expenses 20 (18,000) (16,000)
Other Expenses 21 (3,000) (2,000)
Finance Charges 22 (1,000) (1,000)

(15,000) (15,000)
Profit before tax 40,000 30,000

Income tax 23 (12,000) (9,000)

Net Profit 28,000 21,000

Basis of preparation
Income statement is prepared on the accruals basis of accounting.
This means that income (including revenue) is recognized when it is earned rather than when
receipts are realized (although in many instances income may be earned and received in the
same accounting period). Expenses are recognized in the income statement when they
are incurred even if they are paid for in the previous or subsequent accounting periods.
Income statement does not report transactions with the owners of an entity.

Hence, dividends paid to ordinary shareholders are not presented as an expense in the income
statement and proceeds from the issuance of shares is not recognized as an income.
Transactions between the entity and its owners are accounted for separately in the statement
of changes in equity.
Components
Income statement comprises of the following main elements:
Revenue
Revenue includes income earned from the principal activities of an entity. So for example, in
case of a manufacturer of electronic appliances, revenue will comprise of the sales from
electronic appliance business. If the same manufacturer earns interest on its bank account, it
shall not be classified as revenue but as other income.
Cost of sales
Cost of sales represents the cost of goods sold or services rendered during an accounting
period. Hence, for a retailer, cost of sales will be the sum of inventory at the start of the
period and purchases during the period minus any closing inventory.
In case of a manufacturer however, cost of sales will also include production costs incurred in
the manufacture of goods during a period such as the cost of direct labour, direct material
consumption, depreciation of plant and machinery and factory overheads, etc. Net profit or
loss is arrived by deducting expenses from income.
Other income
Other income consists of income earned from activities that are not related to the entity's
main business. For example, other income of an entity that manufactures electronic
appliances may include:

 Gain on disposal of fixed assets

 Interest income on bank deposits

 Exchange gain on translation of a foreign currency bank account

Distribution cost
Distribution cost includes expenses incurred in delivering goods from the business premises
to customers.
Administrative expenses
Administrative expenses generally comprise of costs relating to the management and support
functions within an organization that are not directly involved in the production and supply of
goods and services offered by the entity.
Examples of administrative expenses include:

 Salary cost of executive management

 Legal and professional charges

 Depreciation of head office building

 Rent expense of offices used for administration and management purposes

 Cost of functions / departments not directly involved in production such as finance

department, HR department and administration department

Other expenses
This is essentially a residual category in which any expenses that are not suitably classifiable
elsewhere are included.
Finance charges
Finance charges usually comprise of interest expense on loans and debentures. The effect of
present value adjustments of discounted provisions are also included in finance charges (e.g.
unwinding of discount on provision for decommissioning cost).

Income tax
Income tax expense recognized during a period is generally comprised of the following three
elements:

 Current period's estimated tax charge

 Prior period tax adjustments

  Deferred tax expense

Prior period comparatives

Prior period financial information is presented alongside current period's financial results to
facilitate comparison of performance over a period. It is therefore important that prior period
comparative figures presented in the income statement relate to a similar period.
Purpose & use
Income Statement provides the basis for measuring performance of an entity over the course
of an accounting period.
Performance can be assessed from the income statement in terms of the following:

 Change in sales revenue over the period and in comparison to industry growth

 Change in gross profit margin, operating profit margin and net profit margin over the
period

 Increase or decrease in net profit, operating profit and gross profit over the period

 Comparison of the entity's profitability with other organizations operating in similar

industries or sectors

Income statement also forms the basis of important financial evaluation of an entity when it is
analysed in conjunction with information contained in other financial statements such as:

 Change in earnings per share over the period

 Analysis of working capital in comparison to similar income statement elements (e.g.

the ratio of receivables reported in the balance sheet to the credit sales reported in the
income statement, i.e. debtor turnover ratio)

 Analysis of interest cover and dividend cover ratios

3. Cash flow statement

Cash flow statement, presents the movement in cash and bank balances over a period as
classified under operating, investing and financing activities. The movement in cash flows is
classified into the following segments:

 Operating Activities: Represents the cash flow from primary activities of a business.

 Investing Activities: Represents cash flow from the purchase and sale of assets other
than inventories (e.g. purchase of a factory plant)

 Financing Activities: Represents cash flow generated or spent on raising and

repaying share capital and debt together with the payments of interest and dividends.

Example
Following is an illustrative cash flow statement presented according to the indirect
method suggested in IAS

Statement of cash flows:

ABC PLC
Statement of Cash Flows for the year ended 31 December 2013

2013 2012
Notes
USD USD

Cash flows from operating activities

Profit before tax 40,000 35,000
Adjustments for:
  Depreciation 4 10,000 8,000
  Amortization 4 8,000 7,500
  Impairment losses 5 12,000 3,000
  Bad debts written off 14 500 -
  Interest expense 16 800 1,000
  Gain on revaluation of investments (21,000) -
  Interest income 15 (11,000) (9,500)
  Dividend income (3,000) (2,500)
  Gain on disposal of fixed assets (1,200) (1,850)
35,100 40,650
Working Capital Changes:
  Movement in current assets:
    (Increase) / Decrease in inventory (1,000) 550
    Decrease in trade receivables 3,000 1,400
  Movement in current liabilities:
    Increase / (Decrease) in trade payables 2,500 (1,300)
Cash generated from operations 39,600 41,300
  Dividend paid (8,000) (6,000)
  Income tax paid (12,000) (10,000)
Net cash from operating activities (A) 19,600 25,300

Cash flows from investing activities

Capital expenditure 4 (100,000) (85,000)
Purchase of investments 11 (25,000) -
Dividend received 5,000 3,000
Interest received 3,500 1,000
Proceeds from disposal of fixed assets 18,000 5,500
Proceeds from disposal of investments 2,500 2,200
Net cash used in investing activities (B) (96,000) (73,300)

Cash flows from financing activities

Issuance of share capital 6 1000,000 -
Bank loan received - 100,000
Repayment of bank loan (100,000) -
Interest expense (3,600) (7,400)
Net cash from financing activities (C) 896,400 92,600

Net increase in cash & cash equivalents (A+B+C) 820,000 44,600

Cash and cash equivalents at start of the year 77,600 33,000
Cash and cash equivalents at end of the year 24 897,600 77,600

Basis of preparation
Statement of cash flows presents the movement in cash and cash equivalents over the period.
Cash and cash equivalents generally consist of the following:

 Cash in hand

 Cash at bank
  Short term investments that are highly liquid and involve very low risk of change in
value (therefore usually excludes investments in equity instruments)

 Bank overdrafts in cases where they comprise an integral element of the

organization's treasury management (e.g. where bank account is allowed to float
between a positive and negative balance (i.e. overdraft) as opposed to a bank
overdraft facility specifically negotiated for financing a shortfall in funds (in which
case the related cash flows will be classified under financing activities).

As income statement and balance sheet are prepared under the accruals basis of accounting, it

is necessary to adjust the amounts extracted from these financial statements (e.g. in respect of
non-cash expenses) in order to present only the movement in cash inflows and outflows
during a period. All cash flows are classified under operating, investing and financing
activities as discussed below.
Operating activities
Cash flow from operating activities presents the movement in cash during an accounting
period from the primary revenue generating activities of the entity. For example, operating
activities of a hotel will include cash inflows and outflows from the hotel business (e.g.
receipts from sales revenue, salaries paid during the year etc), but interest income on a bank
deposit shall not be classified as such (i.e. the hotel's interest income shall be presented in
investing activities).
Profit before tax as presented in the income statement could be used as a starting point to
calculate the cash flows from operating activities. Following adjustments are required to be
made to the profit before tax to arrive at the cash flow from operations:

1. Elimination of non-cash expenses (e.g. depreciation, amortization, impairment

losses, bad debts written off, etc)

2. Removal of expenses to be classified elsewhere in the cash flow statement (e.g.

interest expense should be classified under financing activities)

3. Elimination of non-cash income (e.g. gain on revaluation of investments)

4. Removal of income to be presented elsewhere in the cash flow statement (e.g.

dividend income and interest income should be classified under investing activities
unless in case of for example an investment bank)
 5. Working capital changes (e.g. an increase in trade receivables must be deducted to
arrive at sales revenue that actually resulted in cash inflow during the period)
Investing activities
Cash flow from investing activities includes the movement in cash flow as a result of the
purchase and sale of assets other than those which the entity primarily trades in (e.g.
inventory). So for example, in case of a manufacturer of cars, proceeds from the sale of
factory plant shall be classified as cash flow from investing activities whereas the cash inflow
from the sale of cars shall be presented under the operating activities.
Cash flow from investing activities consists primarily of the following:

 Cash outflow expended on the purchase of investments and fixed assets

 Cash inflow from income from investments

 Cash inflow from disposal of investments and fixed assets

Financing activities
Cash flow from financing activities includes the movement in cash flow resulting from the
following:

 Proceeds from issuance of share capital, debentures & bank loans

 Cash outflow expended on the cost of finance (i.e. dividends and interest expense)

 Cash outflow on the repurchase of share capital and repayment of debentures & loans

Purpose & importance

Statement of cash flows provides important insights about the liquidity and solvency of a
company which are vital for survival and growth of any organization. It also enables analysts
to use the information about historic cash flows to form projections of future cash flows of an
entity (e.g. in NPV analysis) on which to base their economic decisions.

By summarizing key changes in financial position during a period, cash flow statement serves
to highlight priorities of management. For example, increase in capital expenditure and
development costs may indicate a higher increase in future revenue streams whereas a trend
of excessive investment in short term investments may suggest lack of viable long term
investment opportunities.
Furthermore, comparison of the cash flows of different entities may better reveal the relative
quality of their earnings since cash flow information is more objective as opposed to the
financial performance reflected in income statement which is susceptible to significant
variations caused by the adoption of different accounting policies.
4. Statement of changes in equity
Statement of changes in equity, also known as the statement of retained earnings, GAAP
details the movement in owners' equity over a period by presenting the movement in
reserves comprising the shareholders' equity.
The movement in owners' equity is derived from the following components:

 Net Profit or loss during the period as reported in the income statement attributed to
the shareholders

 Share capital issued or repaid during the period

 Dividend payments to shareholders

 Effect of correction of prior period error

 Increase or decrease in share capital reserves

 Gains or losses recognized directly in equity (e.g. revaluation surpluses)

 Effects of a change in accounting policy or correction of accounting error

Example
Following is an illustrative example of a Statement of changes in equity prepared according
to the format prescribed by IAS
Presentation of Financial Statements.

ABC Plc
Statement of changes in equity for
the year ended 31st December 2012
 Share Retained Revaluation Total
Capital Earnings Surplus Equity
USD USD USD USD

Balance at 1 January 2011 100,000 30,000 - 130,000

Changes in accounting policy - - - -

Correction of prior period error - - - -

Restated balance 100,000 30,000 - 130,000

Changes in equity for the year

2011

Issue of share capital - - - -

Income for the year - 25,000 - 25,000
Revaluation gain - - 10,000 10,000
Dividends - (15,000) - (15,000)

Balance at 31 December 2011 100,000 40,000 10,000 150,000

Changes in equity for the year

2012

Issue of share capital - - - -

Income for the year - 30,000 - 30,000
Revaluation gain - - 5,000 5,000
Dividends - (20,000) - (20,000)

Balance at 31 December 2012 100,000 50,000 15,000 165,000

Components
Following are the main elements of statement of changes in equity:
Opening balance
This represents the balance of shareholders' equity reserves at the start of the comparative
reporting period as reflected in the prior period's statement of financial position. The opening
balance is unadjusted in respect of the correction of prior period errors rectified in the current
period and also the effect of changes in accounting policy implemented during the year as
these are presented separately in the statement of changes in equity (see below).
Effect of changes in accounting policies
Since changes in accounting policies are applied retrospectively, an adjustment is required in
stockholders' reserves at the start of the comparative reporting period to restate the opening
equity to the amount that would be arrived if the new accounting policy had always been
applied.
Effect of correction of prior period error
The effect of correction of prior period errors must be presented separately in the statement of
changes in equity as an adjustment to opening reserves. The effect of the corrections may not
be netted off against the opening balance of the equity reserves so that the amounts presented
in current period statement might be easily reconciled and traced from prior period financial
statements.
Restated balance
This represents the equity attributable to stockholders at the start of the comparative period
after the adjustments in respect of changes in accounting policies and correction of prior
period errors as explained above.
Changes in share capital
Issue of further share capital during the period must be added in the statement of changes in
equity whereas redemption of shares must be deducted therefrom.
The effects of issue and redemption of shares must be presented separately for share capital
reserve and share premium reserve.
Dividends
Dividend payments issued or announced during the period must be deducted from
shareholder equity as they represent distribution of wealth attributable to stockholders.
Income / loss for the period
This represents the profit or loss attributable to shareholders during the period as reported in
the income statement.
Changes in revaluation reserve
Revaluation gains and losses recognized during the period must be presented in the statement
of changes in equity to the extent that they are recognized outside the income statement.
Revaluation gains recognized in income statement due to reversal of previous impairment
losses however shall not be presented separately in the statement of changes in equity as they
would already be incorporated in the profit or loss for the period.
Other gains & losses
Any other gains and losses not recognized in the income statement may be presented in the
statement of changes in equity such as actuarial gains and losses arising from the application
of IAS employee benefit.
Closing balance
This represents the balance of shareholders' equity reserves at the end of the reporting period
as reflected in the statement of financial position.
Purpose & importance
Statement of changes in equity helps users of financial statement to identify the factors that
cause a change in the owners' equity over the accounting periods.
Whereas movement in shareholder reserves can be observed from the balance sheet,
statement of changes in equity discloses significant information about equity reserves that is
not presented separately elsewhere in the financial statements which may be useful in
understanding the nature of change in equity reserves.
Examples of such information include share capital issue and redemption during the period,
the effects of changes in accounting policies and correction of prior period errors, gains and
losses recognized outside income statement, dividends declared and bonus shares issued
during the period.
Accounting transactions
Accounting transactions refer to any business activity that results in a direct effect on the
financial status and financial statements of the business. Such transactions come in many
forms, including:

 Sales in cash and credit to customers

 Receipt of cash from a customer by sending an invoice
 Purchase of fixed assets and movable assets
 Borrowing funds from a creditor
 Paying off borrowed funds from a creditor
 Payment of cash to a supplier from a sent invoice
It is imperative to remember that every transaction should show the balance between the
assets and the liabilities, or the debit and the credit, such that a receipt of cash from a
customer equals an increase in revenue or that a purchase from a supplier equals an increase
in expenses and a decrease in cash.
Types of accounting transactions based on institutional relationship
The types of accounting transactions may be based on various points of view. The first one
that we will discuss is the types of accounting transactions according to institutional
relationship, namely external and internal transactions.
 
1. External transactions
They involve the trading of goods and services with money. Therefore, it can be said that any
transaction that is entered into by two persons or two organizations with one buying and the
other one selling is considered an external transaction. It is also called a business transaction.
Example: If Company a buys raw materials for its production from Company B, then it is
called an external transaction.
2. Internal transactions
They don’t involve any sales but other processes within the organization. This may include
computing the salary of the employees and estimating the depreciation value of a certain
asset.
Types of accounting transactions based on the exchange of cash
Based on the exchange of cash, there are three types of accounting transactions, namely cash
transactions, non-cash transactions, and credit transactions.
1. Cash transactions
They are the most common form of transactions, which refer to those that are dealt with cash.
For example, if a company purchases office supplies and pays it with cash, debit card, or
check, then it is a cash transaction.
2. Non-cash transactions
They are unrelated to transactions that specify if cash’s been paid or if it will be paid in the
future. For example, if Company A purchases a machine from Company B and sees that it is
defective, returning it will not entail any cash spent, so it falls under non-cash transactions. In
other words, transactions that are not cash or credit are non-cash transactions.
3. Credit transactions
They are the opposite of cash transactions because payment is promised at an agreed future
date. The dates vary as sometimes the transactions must be paid after 30 days, 60 days, or 90
days, depending on the cost of the purchase.
Types of accounting transactions based on visibility
According to visibility, there are two types of accounting transactions, the visible and the
invisible transactions.
1. Visible transactions
They are also called real transactions because they involve real assets such as machinery,
tools, and furniture.
2. Invisible transactions
Such transactions cannot be seen, as the name suggests. They include discounts, depreciation
of assets, and interest payments for acquired assets, to name a few.
Types of accounting transactions based on objective
There are three types of accounting transactions based on objective, namely business, non-
business, and personal transactions.
1. Business transactions
They happen every day that keep the business running such as sales and purchases, rent for
office space, advertisements, bills, and others.
2. Non-business transactions
They are transactions that don’t involve a sale or purchase but may involve donations and
social responsibility.
3. Personal transactions
Personal transactions are those that are performed for personal purposes such as birthday
expenditures.

Double-entry recording of accounting transactions

In relation to recording accounting transactions, the double-entry method of recording is to be
used, which means that there are always two sides to the record, the debit and the credit sides.
Normally, debit is on the left and credit is on the right and no matter the transactions, the two
will always show the same value if all of the parts are added together, making the journal a
balanced one.
Analysing and recording transactions
The five major steps in the accounting cycle are:
  Analyse business activity using transaction analysis based on the related source
documents.
 Record results of the transaction analysis chronologically in the general journal and
create a trial balance.
 Adjust the recorded data to update all accounts for expense and revenue recognition
not previously recognized.
 Report the adjusted financial data in the form of financial statements.
 Close the books by posting the adjusting and closing entries, which “zero out” the
temporary accounts.

The fiscal year is the annual accounting period adopted by a firm. A firm using a fiscal year
ending on December 31 is on a calendar-year basis.
Examples of source documents that underlie business transactions are invoices sent to
customers, invoices received from suppliers, bank checks, bank deposit slips, cash receipt
forms, and written contracts.
A general journal is a book of original entry that may be used for the initial recording of any
type of transaction. It contains space for dates and for accounts to be debited and credited,
columns for the amounts of the debits and credits, and a posting reference column for
numbers of the accounts that are posted.
When entries are posted, the page number and identifying initials of the appropriate journal
are placed next to the amounts in the appropriate accounts. The account number is entered
beside the related amount posted in the journal's posting reference column.
This procedure enables interested users to trace amounts in the ledger back to the originating
journal entry and permits us to know which entries have been posted.
An adjusting journal entry is a journal entry made at the end of an accounting period to
reflect accrual accounting. It usually affects a balance sheet account and an income statement
account and rarely involves cash.
A chart of accounts is a list of the accounts appearing in the general ledger, with the account
numbering system indicated. Normally the accounts are classified as asset, liability, owners'
equity, revenue, and expense accounts, and often the numbering system identifies the account
classification.
Adjusting accounts for financial statements
Many of the transactions reflected in the accounting records through the first two steps of the
accounting cycle affect the net income of more than one period. Therefore, adjustments to the
account balances are ordinarily necessary at the end of each accounting period to record the
proper amount of revenue and to match expenses with revenue properly. This process is also
intended to achieve a more accurate picture of financial position by adjusting balance sheet
amounts to show unexpired costs, up-to-date amounts of obligations, and so on.

Allocating assets to expense to reflect expenses incurred during the period.

Example:
Recording supplies used by debiting supplies expense and crediting supplies.
Allocating payments received in advance by crediting the revenue account to reflect revenues
earned during the period.
Example:
Recording service fees earned by debiting unearned service fees and crediting service fees
earned. Accruing expenses to reflect expenses incurred during the period that are not yet paid
or recorded.
Example:
Recording unpaid wages by debiting wages expense and crediting wages payable.
Accruing revenues to reflect revenues earned during the period that are not yet received or
recorded.
Example:
Recording commissions earned by debiting commission’s receivable and crediting
commissions earned.
Jan. 31 Insurance expense (+E, -SE)……………………………………………………… 78
Prepaid insurance (-A) ……………………………………………………………………..78
To record insurance expense for January ($1,872/24 = $78).
A contra account is an account that is related to, and deducted from, another account when
financial statements are prepared or when book values are computed. Accumulated
depreciation is deducted from the cost of a depreciable asset in computing and portraying the
asset's book value.
The building is five years old by the end of 2015, so the accumulated depreciation of
$800,000 represents five years of depreciation at an annual rate of $160,000 ($800,000/5). If
the annual depreciation is $160,000, then the expected life of the building must be 25 years.
At the end of 2022, the building will be twelve years old, and the accumulated depreciation
will be 12×$160,000, or $1,920,000. The book value of the building (defined as original cost
less accumulated depreciation) will be $2,080,000.
(a) Jan. 1 Cash (+A)………………………………………………………..9,720
Subscriptions received in advance (+L)………………………………………………… 9,720
To record receipt of two-year subscriptions.
(b) Jan. 31 Subscriptions received in advance (-L) ………………………..405
Subscriptions revenue (+R, +SE)………………………………………………………… 405
To record subscription revenue earned during
January ($9,720/24 = $405).
Jan. 31 Wages expense (+E, -SE) …………………………………………190
Wages payable (+L) ……………………………………………………………………….190
To record unpaid wages for Jan. 30–31
[($475/5)  2 = $190].
Jan. 31 Interest receivable (+A) ……………………………………………360
Interest income (+R, +SE) ………………………………………………………………….360
To record interest earned during January.
The temporary accounts—sometimes called nominal accounts—are closed at year-end. They
consist principally of the income statement accounts (expense and revenue accounts). (The
Income Summary account and the Dividend account are also closed if they are used.)
Step 1) Close revenue accounts: Debit each revenue account for an amount equal to its
balance, and credit the retained earnings account for the total of revenues.
Step 2) Close expense accounts: credit each expense account for an amount equal to
its balance, and debit the Retained Earnings account for the total of expenses.
A post-closing trial balance ensures that an equality of debits and credits has been maintained
throughout the adjusting and closing procedures and that the general ledger is in balance to
start the next period. Only balance sheet accounts appear in a post-closing trial balance.
Depreciation Expense and Supplies Expense are temporary accounts that should have been
closed and should not appear in the post-closing trial balance.
Accounting for merchandising activities
Merchandising Activities

Merchandising means selling products to retail customers. Merchandisers, also called

retailers, buy products from wholesalers and manufacturers, add a mark-up or gross profit
amount, and sell the products to consumers at a higher price than what they paid. When you
go to the mall, all the stores there are retailers, and you are a retail customer.

Retailers deal with an inventory: all the goods (products) they have for sale. They account
for inventory purchases and sales in one of two ways: Periodic and Perpetual. As the names
suggest these methods refer to how often the inventory account balances are updated.

Periodic and perpetual Inventory systems

In a Periodic system, inventory account balances are updated once a year (some companies
may do it more often, but all must do so at least once per year).

In a Perpetual system, inventory account balances are updated after each sale. This type of
system is much more complex. Scanning cash registers, bar coded merchandise, and similar
devices are used to update the inventory records after each sale. Obviously, this type of
system is very expensive, but it gives managers a high degree of control over inventory, helps
purchasing agents order replacement merchandise in time, detects and deters theft and helps
identify other problems relating to inventory.

The main differences between the two relate to the journal entries used to record purchases
and sales. The system a company chooses should be cost effective and provide the desired
levels of inventory management. Special journals are often used to record sale and purchase
transactions.

Accounts used in merchandising activities

You can usually tell whether a company is using the Periodic or Perpetual system by the
accounts they use to record inventory purchases. Here's a chart that shows the differences:

[COGS = Cost of Goods Sold]

Method Periodic Perpetual

Account used to Purchases Inventory
record inventory
purchases:
Appears on: Income Statement Balance Sheet
No adjustment to inventory is Merchandise cost is transferred
When a sale is made: necessary; merchandise cost is from Inventory to Cost of Goods
already on the Income Statement Sold -an Income Statement account
Adjust Inventory balance to agree Adjust Inventory balance to agree
Year-end procedures: with year-end physical count and with year-end physical count and
merchandise value merchandise value
Transfer Purchases balance to
Other procedures: Balances should now be correct
Cost of Goods Sold
Physical Inventory
The physical inventory simply means the actual, real, tangible, touchable stuff the company
has for resale. In the case of a manufacturing company, the physical inventory includes raw
materials, the value of goods in the process of production, and the value of finished goods.

Taking a physical inventory means counting the number of units of stuff you have for sale.
This is usually done at the end of the year, so the balance sheet Inventory amount accurately
reflects the true value of the ending physical inventory.

If you run a grocery store, you would count all the cans, packages and containers of food, and
everything else you have available for sale. You would then have to assign a value to
everything: its cost to you when you bought each item. A small piece of your inventory
records might look something like the one below.

Quantity is the number of units on the shelf, and also in boxes in storage; this is the amount
we counted in taking the physical inventory. Unit Cost is what was paid for each unit of
product. The extension column is the total cost of each item.

Item Quantity Unit Cost Extension

soup, tomato, can, 8 oz. 65 .24 15.60
soup, chicken noodle, can, 8 oz. 79 .21 16.59
soup, cream of mushroom, can, 8 oz. 53 .16 8.48
Once all items are counted, priced and extended, the total cost is the ending value for
Inventory.
Adjusting the Inventory Account
The Inventory account usually does not agree with the physical count. If the Periodic method
is being used, the Inventory account has the balance as adjusted at the end of the prior year. If
the Perpetual method is being used, the Inventory account should be close to the physical
value calculated from the physical inventory count. There will always be a difference, and the
accounts must be adjusted so the Inventory account agrees with the physical count and
valuation. You will study valuation methods more in the lesson on inventory.

The Inventory account is adjusted to agree with the physical count and valuation. Let's look
at an example of how the adjustment is made. The Inventory account has a balance of
$12,500. You take a physical count and calculate the correct inventory value is $11,975. You
will decrease inventory by $525 to adjust the Inventory account the equal the actual physical
inventory value.

General Journal

Date Account Debit Credit

  Dec-31 Cost of Goods Sold $525  
     Inventory   $525
To adjust Inventory to year-end
     
physical count and valuation
General Ledger
Inventory
[a Balance Sheet account]

 Date  Description  Debit  Credit Balance

Jan-1 Beginning balance forward 12,500   12,500
Dec-31 Year-end adjustment   525 11,975
         
Cost of goods sold

[An Income Statement account]

 Date  Description  Debit  Credit Balance

Dec-31 Balance      100,000
Dec-31 Year-end Inventory adjustment 525   100,525
         
The adjusting entry correctly uses an Income Statement account and a Balance Sheet account.
The additional merchandise cost is transferred to the Income Statement in this case, but the
reverse adjustment could just as easily be made.

Inventory shrinkage
If you throw a good wool sweater in a washing machine full of hot water, what will happen?
The sweater will shrink, or get smaller. Well, inventory also shrinks.

But not because we washed it in hot water. In fact inventory shrinkage occurs for a number of
reasons, and it is just as it sound - inventory gets smaller. But how should this happen?
Things happen to merchandise while the store has it available for sale. Here are some of the
things:

 Theft: by employees or customers

 Spoilage: milk, meat, vegetables, past the expiration date
 Obsolescence: computers, software, clothing (last year's styles)
 Display: merchandise put on display often can't be sold later or must be discounted
 Grazing: customers or employees eating food available for sale
 Damage: broken bottles, bent cans, frozen foods left out of the freezer
The sum total of all these items contributes to the difference between the Inventory account
and the physical count. There might also have been errors made in the Inventory account
during the year, adding to the difference.

Special Sales and Purchase Accounts

Merchandisers use a few special accounts. When a sale is made, sometimes the customer
returns merchandise for a refund. We do not reduce the sales revenue account. We enter the
refund in a different account. This is done to help track the number and dollar amount of
these types of transactions.

Sales accounts deal with customers and sale transactions:

  Sales Returns and Refunds
 Sales Allowances
 Sales Discounts
Purchase accounts deal with suppliers and purchase transactions

 Purchase Returns and Refunds

 Purchase Allowances
 Purchase Discounts

Notice the close similarity between the account titles. They are almost identical, but apply on
opposite sides of the purchase and sales cycles. Sales accounts are used in conjunction with
selling merchandise and dealing with customers. Purchase accounts are used in conjunction
with buying merchandise and dealing with suppliers.

By tracking these types of transactions in their own account managers have the opportunity to
better understand their business. Are too many refunds being given? Why? Are we buying
defective merchandise from a certain supplier? Are Sales Allowances cutting into our gross
profit too much? Are we taking advantage of our Purchase Discounts when available?

The key to business profits is to identify each and every item that can be improved, and then
improve it. Managers can raise prices. But they can also cut costs, reduce waste, increase
efficiency, take discounts when available, and many other things to improve the profitability
of their business.

Freight in versus delivery expense

Freight In is the cost to have merchandise shipped to your store. Freight In is a cost of
purchasing merchandise, and becomes part of Cost of Goods Sold in the Income Statement.
Sometimes a company has to pay a separate charge for Freight In. At other times the cost
may be included in the cost of merchandise from the supplier. In any case, the cost of Freight
In is added to the cost of the merchandise.

Example:
XYZ, Co. buys 100 units of Product R for $7500. The trucking company charges $500 for the
shipment. The total cost of the merchandise is $8000. Each unit costs $8000 / 100 = $80.
They should set their selling price based on a cost of $80. Delivery Expense is the cost to ship
or deliver merchandise to your customer after a sale. Delivery Expense is a Selling Expense,
and is included under that caption in the Income Statement.

Merchandising company
A merchandising company is an enterprise that buys and sells goods to earn a profit.

1. Wholesalers sell to retailers.

2. Retailers sell to consumers.

A merchandiser’s primary source of revenue is sales, whereas a service company’s primary
source of revenue is service revenue. When merchandise is purchased for resale to customers,
the account, Merchandise Inventory, is debited for the cost of the goods. Purchases may be
made for cash or on account (credit). The purchase is normally recorded by the
purchaser when the goods are received from the seller.

Inventory methods for ending inventory and cost of goods sold

Cost of goods sold and inventory

Remember, cost of goods sold is the cost to the seller of the goods sold to customers. Cost of
Goods Sold is an EXPENSE item. Even though we do not see the word Expense this in fact
is an expense item found on the Income Statement as a reduction to Revenue. For a
merchandising company, the cost of goods sold can be relatively large. All merchandising
companies have a quantity of goods on hand called merchandise inventory to sell to
customers. Merchandise inventory (or inventory) is the quantity of goods available for sale
at any given time.
Methods of Cost of Goods Sold:

 FIFO (First in, First out) – this means you will use the OLDEST inventory first to
fill orders. This also means the oldest costs will appear in Cost of Goods Sold (since
this is an Expense account this also means oldest costs will appear in the Income
Statement). The most recent costs are shown in the Inventory asset account balances
and are provided on the Balance Sheet. This is an advantage because you are now
reporting Inventory at the current cost which better reflects what it would cost to
 replace inventory if that would become necessary due to a disaster. FIFO shows the
actual flow of goods…typically you will sell the oldest inventory before the newest
inventory.
 LIFO (Last in, First out) – this means you will use the MOST RECENT inventory
first to fill orders. Cost of goods sold will reflect the current or most recent costs and
are a better representation of matching since you are matching revenue will current
costs of the inventory. The Balance Sheet will show inventory at the oldest inventory
costs and may not represent current market value.
 Weighted Average (also called Average Cost) – this method is best used when the
prices change from purchase to purchase and you want consistency. The weighted
average method smooths out price changes so you have a steady stream of cost instead
of sharp increases and decreases. You will calculate a new Average Cost after each
Purchase (Sales will not change the average cost).
 Specific Identification – clearly, this will be your favourite method it is the easiest to
calculate in our examples because it specifically tells you which purchases inventory
comes from. This is most often used for high priced inventory – think car sales for
example. When a car dealership purchases a blue BMW convertible for $20,000 and
later sells it for $60,000…they will want to show the exact cost of the BMW it sold as
opposed to the cost of another car. So, specific identification exactly matches the costs
of the inventory with the revenue it creates.
Okay, enough theory – how do these calculations work exactly? There are a couple of ways
you can do them – there is an Inventory Record or a shortcut calculation. You will see both
because they are both beneficial. Most computer systems will show you the Inventory Record
form so you need to understand how to read it. However, it can be time consuming and not
practical for homework and test situations so you learn the alternative method as well. 
When calculating the Cost of Goods Sold for a sale, you must IGNORE the selling price. The
selling price has NOTHING to do with the cost. We are trying to determine how much the
items we sold originally cost us – that is the purpose behind cost of goods sold. Next thing to
remember, you can only use items that occurred BEFORE the sale (meaning, you cannot use
a purchase from August 28 when calculating cost of goods sold on August 14 – why? It
hasn’t happened yet). We will pick inventory from the different purchases and use
the purchase price to calculate the cost of goods sold.
FIFO (First in, First Out)
Under the FIFO method, we will use the oldest inventory at the time of the sale first. You
must calculate Cost of Goods Sold for each sale individually.

Goods Inventory Balance (or Ending Inventory

Date Cost of Goods Sold
Purchased  

Beginning
Jan 1 300 units x $10 = $3,000
Balance

300 units x $10 = $3,000 (from Jan 1)

200 x $15 =
Jan 2 200 units x $15 = $3,000 (from Jan 2)TOT
$3,000
purchases to date, $3,000 +$ 3,000)

300 units x $10 = $3,000

(from Jan 1) 200 units x $15 = $3,000
Jan 8
Total COGS for 300 units $ (beg inventory is zero and the Jan 2 purcha
3,000

200 units x $15 = $3,000 (from Jan 2)

Jan 100 x $17 =
100 units x $17 = $1,700 (from Jan 11)
11 $1,700
TOTALS 300 units $4,700

200 units x $15 = $3,000

(from Jan 2)
Jan 50 units x $17 = $850 (from 50 units x $17 = $850 (from Jan 11)
15 Jan 11) (Jan 2 purchase has been used and 50 units
TOTAL COGS for 250
units $3,850

50 units x $17 = $850 (from Jan 11)

Jan 300 x $20 =
300 units x $20 = $6,000
18 $6,000
TOTALS (End. Inventory) 350 Units $6,8
Total cost of goods sold for January would be $6,850 (3,000 + 3,850). Sales would be Jan 8
Sales (300 units x $30) $9,000 + Jan 11 Sales (250 units x $40) $10,000 or $19,000. The
gross profit (or margin) would be $12,150 ($19,000 Sales – 6,850 cost of goods sold). The
journal entries for these transactions would be (assuming all transactions on credit):
Note: No journal entry is prepared for beginning inventory since it is a rollover from
last period’s ending balance.

Date Account Debit

Jan 2 Merchandise Inventory 3,000

Accounts Payable

Jan 8 Accounts Receivable 9,000

Sales

Cost of goods sold 3,000

Merchandise Inventory

Jan 11 Merchandise Inventory 1,700

Accounts Payable

Jan 15 Accounts Receivable 10,000

Sales

Cost of goods sold 3,850

Merchandise Inventory

Jan 18 Merchandise Inventory 6,000

Accounts Payable

LIFO (Last in, First out)

Under the LIFO method, we will use most recent purchases at the time of the sale first. You
must calculate cost of goods sold for each sale individually.

Inventory Balance (or Ending Inventor

Date Goods Purchased Cost of Goods Sold
 

Jan 1 Beginning Balance 300 units x $10 = $3,000

300 units x $10 = $3,000 (from Jan 1)

200 units x $15 = $3,000 (from Jan 2)
Jan 2 200 x $15 = $3,000
TOTALS 500 units $6,000
(sum of purchases to date, $3,000 +$ 3,0

Jan 8 200 units x $15 = $3,000 (from Jan 2) 200 units x $10 = $2,000 (from Jan 1)
 100 units x $10 = $1,000 (from Jan 1)
(Jan 2 purchase has been used and 200
Total COGS for 300 units $ 4,000

200 units x $10 = $2,000 (from Jan 1)

Jan 11 100 x $17 = $1,700 100 units x $17 = $1,700 (from Jan 11)
TOTALS 300 units $3,700

100 units x $17 = $1,700 (from Jan 11)

50 units x $10 = $500 (from Jan 1)
Jan 15 150 units x $10 = $1,500 (from Jan 1)
(Jan 11 purchase has been used and 50
TOTAL COGS for 250 units $3,200

50 units x $10 = $500 (from Jan 1)

Jan 18 300 x $20 = $6,000 300 units x $20 = $6,000
TOTALS (End. Inventory) 350 Units $6,5

Total cost of goods sold for the month would be $7,200 (4,000 + 3,200). Since total Sales
would the same as we calculated above Jan 8 Sales (300 units x $30) $9,000 + Jan 11 Sales
(250 units x $40) $10,000 or $19,000. The gross profit (or margin) would be $11,800
($19,000 Sales – 7,200 cost of goods sold).
The journal entries for these transactions would be would be the same as show above the only
thing changing would be the AMOUNT of cost of goods sold used in the Jan 8 and Jan 15
entries.
Capital Assets
A capital asset is defined to include property of any kind held, whether connected with their
business or profession or not connected with their business or profession. It includes all kinds
of property, movable or immovable, tangible or intangible, fixed or circulating. Thus, land
and building, plant and machinery, motorcar, furniture, jewellery, route permits, goodwill,
tenancy rights, patents, trademarks, shares, debentures, securities, units, mutual funds, zero-
coupon bonds etc. are capital assets. For firms, a capital asset is an asset that has a useful
life longer than one year end is not intended for sale during the normal course of business.
For individuals, capital asset typically refers to anything the individual owns for personal
or investment purposes. This excludes property held for sale in the normal course of
business, money received or about to be received from the sale of that property,
depreciable personal property used for business (such as rental property), protected creative
works (such as copyrights on a book), and government publications purchased or received for
free from the government.
How it works (Example):
Capital assets usually include buildings, land, and major equipment. For example, Company
XYZ might own a factory building on three acres of land, and the factory might be full of
expensive equipment. The building, the land, and the equipment are all usually considered
capital assets. Construction in progress, trademarks, patents, copyrights, vehicles, intellectual
property, and art can also count. Capital assets are recorded on the balance sheet at their
historical cost, less any accumulated (or amortization in the case of intangible assets). So if
Company XYZ paid $100,000 for a piece of equipment in the factory, it would record it as a
$100,000 asset on its balance sheet.
But as the asset ages and becomes worth less, Company XYZ would increase the amount of
accumulated depreciation associated with the equipment, so that the equipment's net book
value reflects its reduced value.
Why it matters:
Companies have some leeway in deciding what to count as a capital asset. A $10 stapler, for
example, has a useful life of more than one year, but because it is of such little monetary
value, it is often administratively easier to expense the stapler (that is, to reflect its cost as an
expense on the income statement) than to have the accounting staff set up
a depreciation schedule for the stapler. Thus, many companies create written capital asset
policies that dictate what assets must be capitalized and include a minimum threshold of
purchase price.
It is also important to note that the Financial Accounting Standards Board (FASB) and
the IRS both have some influence over the limits of the useful lives of capital assets. They do
this to prevent companies from assigning their capital assets extremely long useful lives in
order to record tiny depreciation expenses (and thus inflate profits).
Property Plant and Equipment
The property, plant, and equipment (PP&E) account, also known as tangible fixed assets,
represents the non-current, physical, illiquid assets that are expected to generate long-term
economic benefits for a firm including land, buildings, and machinery. They are tangible
capital asset shown on the balance sheet of a business and used to generate revenues and
profits.  PP&E plays a key part in the financial planning and analysis of a company’s
operations and future expenditures, especially with regards to capital expenditures.
The PP and E account is important for the operations of a firm because it gives the company
the resources necessary to produce its products. The value of PP&E depends on its age and
original cost. All fixed assets are recorded at their purchase price and listed on the balance
sheet at their historical cost. As time goes on, the assets are depreciated each period slowly
decreasing their book value reported.
The total amount of property, plant, and equipment reported on the long-term assets section
of the balance sheet includes items like buildings, equipment, furniture, and vehicles net of
accumulated depreciation. It also includes land, which is not depreciated . PP&E are fixed
assets that a business uses to produce products and services in pursuit of making a profit.

Example
A large poultry firm purchases a poultry farming plant for a cost of $35 million. The
management has decided to make some changes at the installation site, reaching a total cost
of $500,000, and to perform a site inspection for a cost of $350,000. The firm’s accountants
estimate that the plant has a life of 12 years and a salvage value of $7 million.

They are asked to calculate the book value of the fixed assets that will be reported on the
Year 3 balance sheet using the straight-line depreciation method.

The accumulated depreciation for the PP&E is calculated as follows:

Total costs: $35,000,000 + $500,000 + $350,000 = $35,850,000

Accumulated Depreciation – $35,850,000 – $7,000,000 = $28,850,000

Depreciation in Year 1: $28,850,000 / 12 years = $2,404,167

Year 1 Book Value: $28,850,000 – $2,404,167 = $26,445,833

Depreciation in Year 2: $2,404,167

Accumulated depreciation in Year 2: $2,404,167 + $2,404,167 = $4,808,334

Year 2 Book Value: $28,850,000 – $4,808,334 = $24,041,666

Depreciation in Year 3: $2,404,167

Accumulated depreciation in Year 3: $2,404,167 + $2,404,167 + $2,404,167 = $7,212,501

Year 3 Book Value: $28,850,000 – $7,212,501 = $21,637,499

 
The PP&E account is often denoted as net of accumulated depreciation. This means that if a
company does not purchase additional new equipment (therefore, its capital expenditures are
 zero), then Net PP&E should slowly decrease in value every year due to depreciation. This
can be better determined by a depreciation schedule.
PP&E is a tangible fixed-asset account item and is generally very illiquid. A company can
sell its equipment, but not as easily as it can sell its inventory or investments such as bonds or
stock shares. The value of PP&E between companies will vary with the operations.
For example, a construction company will generally have a significantly higher property,
plant, and equipment balance than an accounting firm does.
Reporting and Analysing Cash Flows
A cash flow statement is essential to any business as it can be the basis of budgeting by
assessing the timing and fixing the future cash flows. The statement of cash flow like other
two key. A financial statement is a collection of reports presenting inflows and outflows of
cash in forms of receipt and payment. This involves various activities of business including
operating, investing and financing during a specific period.

A cash flow statement finds out the inward and outward flow of money in a business and
therefore acts as a bridge between the income statement and balance sheet. The change in
cash per period, as well as the beginning and ending balances of cash, are present in a cash
flow statement. While summarizing the amount of cash and cash equivalents flowing in and
out of the company, also measures to manage company’s cash position.

Cash flow statement format

The format of cash flow statement includes mainly three parts namely, cash from working
activities, cash from investing activities and cash from financing activities. GAAP, a fourth
part, the disclosure of non-cash activities is included when cash flow statement is produce
under the generally accepted accounting principles

Operating Cash flow

Operating activities reflects the amount of cash generated from products and services of a
company and includes the primary revenue producing activities of the business.

There are two modes of presentation of operating cash flows-

1. direct presentation
2. Indirect presentation.
 The direct presentation is a simple but rarely used method which presents operating cash
flows simply as a list of cash flows.
On the other hand, an indirect method is widely used and hence a common presentation of
operating cash flows as a reconciliation from profit to cash flow.

Under the indirect method, amortization, deferred tax, depreciation, revenue received from
investing activities and profit or loss associated with a noncurrent asset are included.

Investing cash flow

The acquisition and disposal of non-current assets and any other sources of cash from a
company’s investments are included in investing activities. Typically, investing cash flows
include the cash flow associated with buying and selling the property, marketable securities
and therefore cash changes from investing are ‘cash out’ items. For example, lending money
is considered an investing activity.

Financing cash flow

Borrowing and repaying the money, issuing stock and paying dividends are some of the
financing activities. These activities result in changes in the size of equity capital and
borrowings of the entity.

How to prepare a cash flow statement

1. Information is considered from the income statement for the current year
2. Balance sheet for the past two years
3. Adjustments of net income for deferrals
4. Accruals take place
This is applied to convert the accrual basis income statement into a cash flow statement. The
statement of cash flow follows activity format and includes, operating cash flows, investing
cash flows and financing cash flows. There are two methods to control the cash flow
statement. For both the methods, investing cash flows and financing cash flows remain
identical. The operating section of the statement can be produced through either direct or
indirect method.

The direct method shows the major classes of gross cash receipts and gross cash payments.
On the other hand, the direct method follows net income and adjustment of profit/loss by the
effect of the transaction. The underlying accounting ideas remain the same.  Hence, working
cash flows provide identical result under the direct or indirect method of preparing the cash
flow statement. The difference lies in the presentation. Although the direct method is set by
IASB, for providing useful information; more than 90% of companies use the indirect
method.

Cash flow statement: Direct and Indirect method

The direct and indirect method are two forms of producing a statement of cash flows. The
direct method involves tallying all instances of received and paid cash and the total represents
the resulting cash flow. However, in the indirect method, the accounting line items are used
to show cash flow.

Below is a statement of cash example:

Direct Method:

Operating Activities

Cash received from customers ………………………………. 800

Cash paid to suppliers ………………………………………. (150)

Employee compensations ……………………………………. (200)

Other operating expenses paid ……………………………….. (250)

Net Cash from operating activities ………………………… 200

Investing Activities

Sale of land …………………………………………………….. 200

Purchase of equipment ………………………………………… (300)

Net cash from investing activities ……………………………… 100

Financing Activities

Common Share dividends ………………………………………. (200)

Payment on long-term debt ……………………………………… (300)

Net cash from financing activities ………………………………. (500)

Beginning Cash balance ………………………………………….. X

Ending Cash balance ……………………………………………… Y

Indirect Method:

Operating Activities

Net income …………………………………………………………. 50,000

Add: Depreciation expense …………………………………………. 10,000

A decrease in AR …………………………………………………… 2,000

Increase in inventory ……………………………………………….. 3,000

A decrease in prepaid expense ……………………………………… 4,000

Increase in accounts payable ……………………………………….. 5,000

Net Cash from operating activities …………………………………. XXX

Investing Activities

Sale of land …………………………………………………………… 200

Purchase of equipment ………………………………………………. (300)

Net cash from investing activities ………………………………………. 100

Financing Activities

Common Share dividends …………………………………………….. (200)

Payment on long-term debt …………………………………………… (300)

Net cash from financing activities ……………………………………. (500)

Beginning Cash balance ……………………………………………… X

Ending Cash balance …………………………………………………. Y

Cash flow statements show both positive and negative cash flow. While positive cash flows
are healthy, negative cash flow should not raise a red flag automatically. Further analysis of
cash flows over various periods enables an investor to assess a company’s performance.
An analysis of cash flow statements can reveal many things like the quality of earnings
through comparison of cash from operating activities to company’s net income. For example,
earnings are said to be higher if cash from operating activities is higher than net income.

The statement of cash flow is a significant measure of profitability and present and future
outlook for a company. It decides the strength of a company and provides data whether a
company has enough cash to pay its expenses or not.

Accounting terms

 Accounting equation: Assets = liabilities + owner's equity. The accounting equation

is the basis for the financial statement called the balance sheet.
 Accounts payable: Also called A/P, accounts payable are the bills your business
owes to suppliers.
 Accounts receivable: Also called A/R, accounts receivable are the amounts owed to
you by your customers.
 Accrual method of accounting: With the accrual method, you record income when
the sale occurs, not necessarily when you receive payment. You record an expense when
you receive goods or services, even though you may not pay for them until later.
 Adjusting entries: Special accounting entries that must be made when you close the
books at the end of an accounting period. Adjusting entries are necessary to update your
accounts for items that are not recorded in your daily transactions.
 Aging report: An aging report list customers' accounts receivable amounts and their
due dates. It alerts you to any slow-paying customers. You can also prepare an aging
report for your accounts payable, which will help you manage your outstanding bills.
 Allowance for bad debts: Also called reserve for bad debts, it is an estimate of
uncollectable customer accounts. Often dubbed a "contra" account because it is listed with
the assets, it will have a credit balance instead of a debit balance. For balance
sheet purposes, it is a reduction of accounts receivable

Learning Objective 1:

Explain the accounting cycle.

Summary

The steps in preparing financial statements for users repeated each reporting period.

Learning Objective 2:

Explain the steps in processing transactions.

Summary
The accounting cycle captures business transactions and events, analyses and records their
effects, and summarizes and prepares information useful in making decisions. Transactions
and events are the starting points in the accounting cycle.

Source documents help in analysing them. The effects of transactions and events are recorded
in the accounting books. Postings and the trial balance help summarize and classify these
effects. The final step is providing this information in useful reports or financial statements to
decision makers.

Learning Objective 3:

Describe source documents and their purpose.

Summary

Source documents are business papers that identify and describe transactions and events.
Examples are sales invoices, cheques, purchase orders, bills, and bank statements. Source
documents help ensure accounting records include all transactions. They also help prevent
mistakes and theft, and are important to internal control. Source documents provide objective
evidence making information more reliable and useful.

Learning Objective 4:

Describe an account and its use in recording information about transactions.

Summary

An account is a detailed record of increases and decreases in a specific asset, liability, or

equity item. Information is taken from accounts, analysed, summarized, and presented in
useful reports and financial statements for users.

Learning Objective 5:

Describe a ledger and a chart of accounts.

Summary
A ledger is a record containing all accounts used by a company. This is what is referred to as
the books. The chart of accounts is a listing of all accounts and usually includes an
identification number assigned to each account.

Learning Objective 6:

Define debits and credits and explain their role in double-entry accounting.

Summary

Debit refers to left, and credit refers to right. Debits increase assets, withdrawals and
expenses, while credits decrease them. Credits increase liabilities, capital and revenues, while
debits decrease them. Double-entry accounting means every transaction affects at least two
accounts. The total amount debited must equal the total amount credited for each transaction.
The system for recording debits and credits follows from the accounting equation. The debit
side is the normal balance for assets, owner’s withdrawals, and expenses, and the credit side
is the normal balance for liabilities, owner’s capital, and revenues.

Learning Objective 7:

Analyse the impact of transactions on accounts.

Summary

We analyse transactions using the concepts of double-entry accounting. This analysis is

performed by determining a transaction’s effects on accounts. These effects are recorded in
journals and posted to accounts in the ledger.

Learning Objective 8:

Record transactions in a journal and post entries to a ledger.

Summary

We record transactions in a journal to give a record of their effects. Each entry in a journal is
posted to the accounts in the ledger. This provides information in accounts that is used to
produce financial statements. Balance column ledger accounts are widely used and include
columns for debits, credits and the account balance after each entry.
Learning Objective 9:

Prepare and explain the use of a trial balance.

Summary

A trial balance is a list of accounts in the ledger showing the debit and credit balances in
separate columns. The trial balance is a convenient summary of the ledger’s contents and is
useful in preparing financial statements. It reveals errors of the kind that produce unequal
debit and credit account balances.

Chapter Outline I.

The Accounting Cycle

Refers to the steps in preparing financial statements for users. The steps are repeated each
reporting period. The steps are: analyse transactions, journalize, post, prepared unadjusted
trial balance, adjust, prepare adjusted trial balance, prepare statements, close, and prepared
post-closing trial balance.

II. Transactions and Documents

Relies on source documents Source documents identify and describe transactions and events
entering the business process. Examples are sales invoices, cheques, and purchase orders,
charges to customers, and bills from suppliers, employee earnings records, and bank
statements. Source documents provide objective evidence about transactions, making
information more reliable and useful.

B. Analyse transactions and events using the accounting equation to understand how they
affect organization performance and financial position.

C. Record, summarize and classify the effects in the accounting books.

III. Accounts and Double-Entry Accounting

A. An account is a detailed record of increases and decreases in a specific asset, liability, or

equity item.

B. Separate accounts are kept for each type of asset, liability, and equity item. Examples of
the different types of accounts are:
1. Assets: are resources controlled by an organization that have current and future benefits.
They have value and are used in the operations of the business to create revenue. Some asset
accounts are:

a. Cash: includes money and any form of exchange that a bank accepts for deposit.

b. Accounts Receivables: recorded when services are performed for or goods are sold to
customers in return for promises to pay in the future, transactions are on credit or on account.
c. Note Receivable: or promissory note: an unconditional written promise to pay a definite
sum of money on demand or on a defined future date.

Chapter Outline

d. Prepaid Expenses: asset account containing payments made for assets that are not used
until later. As these assets are used up, the costs of the used assets become expenses.
Examples are supplies, prepaid insurance, prepaid rent, and advance payments for services.

e. Equipment: Assets used in a business, such as computers, furniture, counters, and

showcases. f. Buildings: Space provided for use as a store, office, warehouse, or factory.

g. Land: Cost is separated from the cost of buildings to provide more useful information

2. Liabilities: are obligations to transfer assets or provide services to other entities. Some
asset accounts are: a. Accounts payable: produced when purchases are made by a promise to
pay later. b. Note payable: when an organization formally recognizes a promise to pay by
signing a promissory note. c. Unearned revenues: a liability that is satisfied by delivering
products or services in the future.

3. Equity accounts: include: a. Owner’s capital: owner’s investments recorded in an account

identified by the owner’s name and the title Capital. b. Owner’s withdrawals: an account with
the owner’s name and the word Withdrawals.

c. Revenues and Expenses: revenues earned and expenses incurred for a period. C. The
ledger, is a record containing of all accounts used by a business. The chart of accounts is a list
of all accounts used by a company. D. A T-account is an informal tool used in showing the
effects of transactions and events on specific accounts. Its shape looks like the letter T. The
format includes: 1. the account title on top, the left or debit side (Dr.), and the right or credit
side (Cr.). 2. Liabilities: Accounts Payable, Notes Payable, and Unearned Revenues. 3.
Equity: Owner’s Capital, Owner’s Withdrawals, Revenues and Expenses.
4. A T-account provides one side for recording in increases in the item and the other side for
decreases. An account balance is the difference between the increases and decreases recorded
in an account.

E. Double-entry accounting means every transaction affects and is recorded in at least two
accounts. The total amount debited must equal the total amount credited. Therefore, the sum
of the debits for all entries must equal the sum of the credits for all entries. The sum of the
debit account balances must equal the sum of the credit account balances.

F. The system for recording debits and credits balances follows the accounting equation. The
normal balance of each account refers to the debit or credit side where increases are recorded.
1. Assets are on the left side of the equation; therefore the left or debit side is the normal
balance for assets.

Increases in assets are debited to asset accounts. Decreases in assets are credited to asset
accounts.

2. Liabilities and owner’s equity are on the right side; therefore the right or the credit side is
the normal balance for liabilities and equity. Increases in liabilities and owner’s equity are
credited, and decreases are debited.

3. Owner’s Investments, Owner’s Withdrawals, revenues, and expenses are changes in

owner’s equity. Owner’s Investments and Revenues increase owner’s equity, and are
credited. Withdrawals and expense accounts decrease owner’s equity, and are debited.

IV. Analysing Transactions

Step one: analyse a transaction and its source document(s). Step two: Apply double-entry
accounting to identify the effect of a transaction on account balances.

Recording and Posting Transactions

Journalizing is the process of recording transactions in a journal. Recording transactions in a

journal avoid the potential for error and the difficulty in tracking mistakes. A general journal
gives a complete record of each transaction in one place, linking directly the debits and
credits for each transaction. B. Posting is the process of transferring journal entry information
from the journal to the ledger. This step occurs only after debits and credits for each
transaction are entered into a journal.

VI. Trial Balance. A trial balance is a list of accounts and their balances at a point in time.
Account balances are reported in the debit or credit columns. The sum of debit account
balances must equal the sum of credit account balances.

B. One purpose for preparing a trial balance is to test for the equality of the debit and credit
account balances. Another reason is to simplify the task of preparing the financial statements.
C. When a trial balance does not balance, one or more errors exist (the columns are not
equal), at least one error has occurred in one of the following steps:

1. Preparing journal entries 2. Posting entries to the ledger 3. Computing account balances 4.
Copying account balances to the trial balance 5. Totalling the trial balance columns. Any
errors must be found and corrected before preparing the financial statements

THREE PARTS OF AN ACCOUNT

ACCOUNT TITLE

Left Side Right Side Called

(2DEBI (3) CREDIT

Rules for using accounts have balance sides (Debit or Credit) To increase any account, use
the balance side To decrease any account, use the side opposite the balance Finding account
balances If total debits = total credits, the account balance is zero. If total debits are greater
than total credits, the account has a debit balance equal to the difference of the two totals. If
total credits are greater than total debits, the account has a credit balance equal to the
difference of the two totals

REAL ACCOUNTS ALL ACCOUNTS HAVE BALANCE SIDES BALANCE SIDES FOR
ASSETS, LIABILITIES, AND EQUITY ACCOUNTS ARE BASED ON THE SIDE OF
EQUATION THEY ARE ON. ASSETS = LIABILITIES + OWNER’S EQUITY are on
the left side of the equation; therefore they have are on the right side of the equation;
therefore they have LEFT-SIDE BALANCE RIGHT-SIDE BALANCE DEBIT
BALANCE CREDIT BALANCE All Asset Accts All Liability Accts All Equity Accts
Normal Debit Credit Debit Credit Debit Credit Balance + side - side - side + side - side + side
*In a sole proprietorship, there is only one owner’s equity account, which is called capital.
For that reason, the terms equity and capital are often used interchangeably. When
corporations are discussed in detail, you will learn many (shareholder’s) equity accounts.
Owner’s equity is an account classification like assets. Owner’s name, capital, is the account
title.

Problem I

The following statements are either true or false. Place a (T) in the parentheses before each
true statement and an (F) before each false statement.

1. ( ) Credits are used to record increases in assets, withdrawals, and expenses.

2. ( ) The process of recording transactions in a journal is called posting.

3. ( ) In double-entry accounting, all errors are avoided by being sure that debits and credits
are equal when transactions are recorded.

4. ( ) The cost of renting an office during the current period is an expense; however, the cost
of renting an office six periods in advance is an asset.

5. ( ) Liability accounts include accounts payable, unearned revenues, and equipment.

Problem II

You are given several words, phrases, or numbers to choose from in completing each of the
following statements or in answering the following questions. In each case select the one that
best completes the statement or answers the question, and place its letter in the answer space
provided.

_______ 1. Leo Foreman’s company had a capital balance of $23,400 on June 30 and
$28,600 on July 31. Net income for the month of July was $15,000. How much did Foreman
withdraw from the business during July?

a. $5,200.

b. $9,800.

c. $15,000.

d. $20,200.

e. $0.
________ 2. Which of the following transactions does not affect the owner’s equity in a
proprietorship?

a. Investments by the owner.

b. Withdrawals of cash by the owner.

c. Cash receipts for revenues.

d. Cash receipts for unearned revenues.

e. Cash payments for expenses.

________ 3. A ledger is:

a. A book of original entry in which the effects of transactions are first recorded.

b. The collection of all accounts used by a business.

c. A book of original entry in which any type of transaction can be recorded.

d. A book of special journals.

e. An account with debit and credit columns and a third column for showing the balance o f
the account.

________ 4. The following transactions occurred during the month of October:

1) Paid $1,500 cash for store equipment.

2) Paid $1,000 in partial payment for supplies purchased 30 days previously.

3) Paid October’s utility bill of $600.

4) Paid $1,200 to owner of business for his personal use.

5) Paid $1,400 salary of office employee for October.

What was the total amount of expenses during October?

5a. $3,000.

b. $4,500.

c. $2,000.

d. $3,500.
e. $5,700.

________ 5. The journal entry to record the completion of legal work for a client on credit
and billing the client $1,700 for the services rendered would be:

a. Accounts Receivable ..........................................................................................1,700

Unearned Legal Fees .................................................................................. 1,700

b. Legal Fees Earned ...............................................................................................1,700

Accounts Receivable.................................................................................. 1,700

c. Accounts Payable ...............................................................................................1,700 Legal

Fees Earned ...................................................................................... 1,700

d. Legal Fees Earned ................................................................................................1,700

Sales .............................................................................................................. 1,700

e. Accounts Receivable ..........................................................................................1,700 Legal

Fees Earned ....................................................................................... 1,700

Problem V

Many of the important ideas and concepts discussed in Chapter 3 are reflected in the
following list of key terms. Test your understanding of these terms by matching the
appropriate definition with the terms. Record the number identifying the most appropriate
definition in the blank space next to each term.

_____ Account _____ Journalizing

_____ Account balance _____ Normal balance

_____ Accounting cycle _____ Ledger

_____ Balance column ledger account _____ Note Receivable

_____ Chart of accounts _____ Posting

_____ Compound journal entry _____ Posting Reference (PR) column

_____ Credit _____ Prepaid expenses

_____ Debit _____ Promissory Note

_____ Double-entry accounting _____ Source documents

_____ External transactions _____ T-account

_____ General Journal _____ Trial balance

_____ Internal transactions _____ Unearned revenues

_____ Journal

1. The most flexible type of journal; can be used to record any kind of transaction.

2. An asset account containing payments made for assets that are not used until later.

3. The steps repeated each reporting period for the purpose of preparing financial statements
for users.

4. A list of accounts and their balances at a point in time; the total debit balances should equal
the total credit balances.

5. The debit or credit side on which an account increases

6. A place or location within an accounting system in which the increases and decreases in a
specific asset, liability, or equity are recorded and stored.

7. A list of all accounts used by a company; includes the identification number assigned to
each account.

8. An unconditional written promise to pay a definite sum of money on demand or on a

defined future date(s); also called note receivable.

9. Liabilities created when customers pay in advance for products or services; created when
cash is received before revenues are earned; satisfied by delivering the products or services in
the future.

10. A record where transactions are recorded before they are recorded in accounts; amounts
are posted from the journal to the ledger; also called the book of original entry.

11. A journal entry that affects at least three accounts.

12. An account with debit and credit columns for recording entries and a third column for
showing the balance of the account after each entry is posted.

13. An unconditional written promise to pay a definite sum of money on demand or on a

defined future date(s); also called promissory note.
14. A column in journals where individual account numbers are entered when entries are
posted to the ledger. A column in ledgers where journal page numbers are entered when
entries are posted.

15. The process of recording transactions in a journal.

16. An entry that increases asset, expense, and owner’s withdrawals accounts or decreases
liability, owner’s capital, and revenue accounts; recorded on the left side of a T-account.

17. The process of transferring journal entry information to ledger accounts.

18. A simple characterization of an account form used as a helpful tool in showing the effects
of transactions and events on specific accounts.

19. An entry that decreases asset, expenses, and owner’s withdrawals accounts or increases
liability, owner’s capital, and revenue accounts; recorded on the right side of a T-account.

20. The difference between the increases (including the beginning balance) and decreases
recorded in an account.

21. These are the source of information recorded with accounting entries and can be in either
paper or electronic form.

22. An accounting system where every transaction affects and is recorded in at least two
accounts; the sum of the debits for all entries must equal the sum of the credits for all entries.
23. A record containing all accounts used by a business.

24. Exchanges between the entity and some other person or organization.

25. Exchanges within an organization that can also affect the accounting equation.

Problem Vl

Complete the following by filling in the blanks.

1. Assets are resources controlled by an organization that have ________________ and

_________________ benefits. They have value and are used in the operations of the business
to create ________________.
2. A ______________________ is an amount of cash that the business is expecting to receive
in the future. When services are performed for or goods are sold to customers in return for
promises to pay in the future, a (n) ______________________ is recorded. A
______________________, or a ______________________, is an unconditional written
promise to pay a definite sum of money on demand or on a defined future date.

3. A ______________________ is an obligation to transfer assets or provide services to other

entities. Purchases of merchandise, supplies, equipment or services made by an oral or
implied promise to pay later produce __________ ____________. ___________
___________ is satisfied by delivering products or services in the future.

4. Four transactions that affect equity are ______________________,

______________________, ______________________, and ______________________.

5. The process of recording transactions in a journal is called ______________________.

The process of transferring journal entry information to the ledger is called
_____________________.

6. The ______________________________________ creates a link between a journal entry

and the ledger accounts by providing a cross-reference for tracing the entry from one record
to the other.

7. Notes receivable and prepaid insurance are examples of a (n) _________________

account. Unearned revenues and interest payable are examples of a (n) _________________
account. 8. Balances of _____________________ and ____________________ accounts
flow into the income statement. Then, net income from the income statement and balances
from __________________ and __________________ accounts flow into the statement of
changes in owner’s equity. Then, ending owner’s equity and balances from
________________ and _________________ accounts flow into the balance sheet.

9. a. The normal balance of an asset account is a ______________________.

b. The normal balance of a liability account is a ______________________.

c. The normal balance of the capital account is a ______________________.

d. The normal balance of the withdrawals account is ______________________.

e. The normal balance of a revenue account is a ______________________.

f. The normal balance of an expense account is a ______________________.

10. The steps in preparing a trial balance are:_______________________________________

_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________

11. A trial balance that balances is not absolute proof that no errors were made because
____________________________________________________________________.

12. One frequent error that is made is called a _____________________, which occurs when
two digits within a number are switched. This type of error probably has occurred if the
difference between the two trial balance columns is evenly divisible by
____________________

Solutions for Chapter 3

Problem I

1. F

2. F

3. F

4. T

5. F

Problem II

1. B

2. D

3. B
4. C

5. E

Problem V

Account.............................................6 Journalizing...................................... 15

Account balance............................... 20 Normal balance..................................

5 Accounting cycle ................................3 Ledger............................................. 23

Balance column ledger account.......... 12 Note Receivable ............................... 13

Chart of accounts...............................7 Posting............................................. 17

Compound journal entry..................... 11 posting reverence (PR) column......... 14

Credit............................................... 19 Prepaid expenses................................ 2
Debit................................................ 16 Promissory note.................................. 8

Double-entry accounting ................... 22 Source documents............................ 21

External transactions......................... 24 T-account ........................................ 18

General journal...................................1 Trial balance...................................... 4

Internal transactions.......................... 25 Unearned revenues............................. 9

Journal............................................. 10

Problem VI

1. Current, future, revenue

2. Receivable, account receivable, note receivable, promissory note

3. Liability, account payable, unearned revenue

4. Investment by the owner, withdrawals by the owner, revenues, expenses

5. Journalizing, posting

6. Posting Reference (PR) column

7. Asset, liability

8. Revenue, expense; capital, withdrawals; asset, liability

9. (a) debit; (b) credit; (c) credit; (d) debit; (e) credit; (f) debit

10. (1 ) Determine the balance of each account; (2) List in their ledger order the accounts
having balances, with the debit balances in one column and the credit balances in another; (3)
Add the debit balances; (4) Add the credit balances; (5) Compare the two totals for equality.

11. Some types of errors do not create unequal debits and credits

12. Transposition, nine