CHAPTER TWO

ACCOUNTING CYCLE
Accounting cycle Definition

 The accounting cycle is the name given to the

collective process of recording and processing
the accounting events of a company.

 The sequence of accounting procedures during a

fiscal period is called accounting cycle.

 The series of steps begin when a transaction occurs

and end with its inclusion in the financial
statements.
 The Accounting Cycle
9 Prepare 1
Analyze
post-closing
Business transactions
trial balance

2 Journalize transactions
in the journal.
8
Journalize and post
closing entries
3 Post entries to the
accounts in the ledger.

7 Prepare
statements
4 Prepare
unadjusted
trial balance

6 Prepare 5
adjusted Adjust
trial balance
 Cont…
 Accounting systems are designed to show the increase
and decrease in each financial statement item in a
separate record. This is called an account.
 Example – A separate record is kept for the increase&
decrease in cash, supplies, land, A/P, Fees earned,
expense etc
 Therefore, Accounts are means of accumulating in one
place all the information about changes in a specific
asset, a liability. or owner's equity.
 A file or other record containing all the separate accounts
of a business is called a ledger [A group of account for
a business entity].
 Formal format of Account
Account :------------------------- Account No:------------
Posting Balance
Date Item Reference Debit Credit Debit Credit

The simplest form of an account is known as a T-account and it

has three parts
A title -for recording the name of the item
A space for recording increase in the amount of the item, in
terms of money.
A space for recording decrease in the amount of the items,
in terms of money
Account Name.___A/C No.___
D ebit / D r. C redit / C r.
 Rules of Debits and Credits.

 The left side of the account is called the debit

side, and the right side is called the credit side.

 The amounts entered on the left side are called

debits and the account is said to be debited.

 The amount entered on the right side is called

credits and the account is said to be credited.
 Assets
Debit / Dr. Credit / Cr.

 Assets - Debits should

Normal Balance exceed credits.
Chapter
3-23
 Liabilities – Credits should
Liabilities
exceed debits.
Debit / Dr. Credit / Cr.
 Normal balance is on the
increase side.
Normal Balance

Chapter
3-24
 Owner’s Equity
Debit / Dr. Credit / Cr.
 Owner’s investments and revenues
increase owner’s equity (credit).

Normal Balance
 Owner’s drawings and expenses
Chapter
decrease owner’s equity (debit).
3-25

Owner’s Capital Owner’s Drawing Helpful Hint Because

Debit / Dr. Credit / Cr. Debit / Dr. Credit / Cr. revenues increase owner’s
equity, a revenue account
has the same debit/credit
rules as the Owner’s
Normal Balance Normal Balance
Capital account. Expenses
have the opposite effect.
Chapter
3-25 Chapter
3-23
 Revenue
Debit / Dr. Credit / Cr.

 The purpose of earning revenues

is to benefit the owner(s).
Normal Balance
 The effect of debits and credits on
Chapter
3-26
revenue accounts is the same as
their effect on Owner’s Capital.
Expense
Debit / Dr. Credit / Cr.
 Expenses have the opposite
effect: expenses decrease owner’s
equity.
Normal Balance

Chapter
3-27
 Summary of Debits/Credits Rules
Relationship among the assets, liabilities and owner’s equity of a business:

Basic
Assets = Liabilities + Owner’s Equity
Equation

Expanded
Basic
Equation

The equation must be in balance after every transaction. For every

Debit there must be a Credit.
 Increase Decrease Normal
Balance
 Asset Debit Credit Debit
 Liability Credit Debit Credit
 Owner's equity Credit Debit Credit
 Retained Earning Credit Debit Credit
 Drawing/Dividends Debit Credit Debit
 Revenue Credit Debit Credit

 Expense Debit Credit Debit

 Cont…
 Thus increase in asset is recorded in the debit side and
decreases are recorded in the credit side.
 Increase in liability and owner’s equity is recorded in
the credit side and decreases in these accounts are
recorded on the debit side.
 Every business transaction affects a minimum of two
accounts regardless of the complexity of a transaction
or the number of accounts affected, the sum of the
debits is always equal to the sum of the credits.
 Cont…
This equality of debit and credit for each transaction
is inherent in the equation A = L + C.

It is also b/c of this equality the system is known as

double entry accounting.

Revenues and investments - increase owner's equity

& the normal balance is credit balance where as
expense & Drawing decease owner's equity & the
normal balance is debit balance
 Sequence and numbering of ledger accounts

Accounts are usually arranged in the ledger in

financial statement order i.e. assets, first, followed by
liabilities, owner's equity, revenue and expenses.

The number of accounts maintained by a specific

enterprise is affected by the nature of its operations,
its volume of business, and the extent to which detail
are needed for taxing authorities, managerial
decisions, credit purposes etc
 Cont…
Chart of accounts
 It is a listing of the account titles and account numbers

being used by a given business.

 In numbering accounts in the ledger it is preferable to

use a flexible system of indexing so that it permits a
later insertion of new accounts in their proper
sequence without distributing the other account
numbers.
 In short, A list of account in the ledger is called chart
of account.
 Example - the chart of Account of Hiwot beauty salon

1. Asset 3. Owner’s equity

Cash ---------------------------11 Hiwot capital ------------ 31
A/R ----------------------------12 Hiwot Drawing ----------- 32

Supplies ---------------------13 Income summary --------- 33

Prepaid Rent ----------------- 14

Prepaid insurance ----------- 15 4. Revenue

Office equipment………… 18
Accum. depn. Off. Equip. . 19 fees earned -------------- 41
Furniture……………… ..110
Accum. depn. Furniture….111
Machinery…………......... 112
Accum. depn. Machinery...113 5. Expenses
Land…………………..…. 114
Supplies expense -----------51
2. Liabilities Salary expense ------------- 52
A/P ----------------------21 Rent expense --------------- 53
N/P ---------------------- 22 Insurance expense ---------- 54
 Journal
When a business transaction takes place, the first record
of it is done in a book called journal.
The journal records all the transactions of a business in
the order in which they occur.
The journal may therefore be defined as a
chronological record of accounting transactions.
It shows names of accounts that are to be debited and
credited, the amounts of the debits and credits and any
other additional but useful information about the
transaction.
 Cont…
Steps in journalizing:

1. Determine the effects of transactions on three

components of the accounting equation,

2. Determine which specific accounts are affected, and

3. Assure that total of the increases should be equal to

either increases on the other side of the equation or
to decreases on the same side, or a combination
there of.
Format of formal general Journal
 General Journal Page No. 1

Date Description P/R Debit Credit

2004 1 Cash 140,000
sep Furniture 50,000
Note payable 100,000
Hiwote capital 90,000
(investment by owners )

1 Prepaid rent 20,000

Cash 20,000
(prepayment for rent )

1 Machinery 35,000
Cash 10,000
A/p 25,000
(purchase of machinery )
1 Prepaid insurance 2,400
Cash 2,400
(Prepayment for insurance )
 General Journal Page No. 1

Date Description P/R Debit Credit

2 Office equipment 25,000
Cash 25,000
(Purchase of off. Equip )
4 Miscellaneous expense 800
Cash 800
(payment for advertisement )
7 Supplies 5,000
Cash 5,000
(purchase of supplies )
10 Land 60,000
Cash 60,000
(purchase of land )
15 Cash 150,000
Unearned revenue 150,000
(advance receipts of tuition fee)
 General Journal Page No. 1

Date Description P/R Debit Credit

17 Cash 5,000
Fees earned 5,000
(fee earned by service giving to
client )
20 A/p 15,000
Cash 15,000
(payment of liability )
20 Supplies 7,000
A/P 7,000
(Purchase supplies on account)
26 A/R 12,000
Fees earned 12,000
(Fees earned on account)
26 Salary expense 6,500
Cash 6,500
(payment for salary )
 General Journal Page No. 1

Date Description P/R Debit Credit

28 Miscellaneous expense 1,000
Cash 1,000
(payment for utilities )
28 A/p 7,000
Cash 7,000
(payment of liabilities )
30 Cash 5,000
A/R 5,000
(Receipt of cash from customers on
account )
30 Hiwot drawing 5,000
Cash 5,000
(withdrawal by the owner )
Posting

 It is process of transferring amounts from the

journal to the ledger accounts.
 Account : Cash Account No: 11
Posting Balance
Date Item Reference Debit Credit Debit Credit
2004 sep1 140,000 140,000
1 20,000 120,000
1 10,000 110,000
1 2,400 107,600
2 25,000 82,600
4 800 81,800
7 5,000 76,800
10 60,000 16,800
15 150,000 166,800
17 5,000 171,800
20 15,000 156,800
26 6,500 150,300
28 1,000 149,300
28 7,000 142,300
30 5,000 147,300
30 5,000 142,300
Account :Account receivable Account No:12
Posting Balance
Date Item Reference Debit Credit Debit Credit
2004
sept 26 12,000 12,000
30 5,000 7,000

Account :Supplies Account No:13

Posting Balance
Date Item Reference Debit Credit Debit Credit
2004
sept 7 5,000 5,000
20 7,000 12,000
Account : Prepaid rent Account No:14
Posting Balance
Date Item Reference Debit Credit Debit Credit
2004
sept 1 20,000 20,000

Account : Prepaid insurance Account No: 15

Posting Balance
Date Item Reference Debit Credit Debit Credit
2004
sept 1 2,400 2,400
Account : Office Equipment Account No: 18
Posting Balance
Date Item Reference Debit Credit Debit Credit
2004
sept 2 25,000 25,000

Account : Accumulated depreciation, office equipment Account No: 19

Posting Balance
Date Item Reference Debit Credit Debit Credit
Account :Furniture Account No: 110
Posting Balance
Date Item Reference Debit Credit Debit Credit
2004
sept 1 50,000 50,000

Account: Accumulated depreciation, Furniture Account No: 111

Posting Balance
Date Item Reference Debit Credit Debit Credit
Account : Machinery Account No:112
Posting Balance
Date Item Reference Debit Credit Debit Credit
2004
sept 1 35,000 35,000

Account : Accumulated depreciation, Machine Account No:113

Posting Balance
Date Item Reference Debit Credit Debit Credit
Account : Land Account No:114
Posting Balance
Date Item Reference Debit Credit Debit Credit
2004
sept 10 60,000 60,000
Account: Account payable Account No: 21
Posting Balance
Date Item Reference Debit Credit Debit Credit
2004
sept 1 25,000 25,000
20 15,000 10,000
20 7,000 17,000
28 7,000 10,000

Account: Notes payable Account No: 22

Posting Balance
Date Item Reference Debit Credit Debit Credit
2004
sept 1 100,000 100,000
Account: Unearned revenue Account No:23
Posting Balance
Date Item Reference Debit Credit Debit Credit
2004
sept 15 150,000 150,000

Account: Interest payable Account No:24

Posting Balance
Date Item Reference Debit Credit Debit Credit
Account : Salary payable Account No:25
Posting Balance
Date Item Reference Debit Credit Debit Credit
Account: Hiwot capital Account No: 31
Posting Balance
Date Item Reference Debit Credit Debit Credit
2004
sept 1 90,000 90,000

Account: Hiwot Drawing Account No: 32

Posting Balance
Date Item Reference Debit Credit Debit Credit
2004
sept 30 5,000 5,000
Account: Income summary Account No: 33
Posting Balance
Date Item Reference Debit Credit Debit Credit
Account: Fees earned Account No: 41
Posting Balance
Date Item Reference Debit Credit Debit Credit
2004
sept 17 5,000 5,000
26 12,000 17,000
Account: Supplies expense Account No:51
Posting Balance
Date Item Reference Debit Credit Debit Credit

Account: Salary expense Account No:52

Posting Balance
Date Item Reference Debit Credit Debit Credit
2004
sept 26 6,500 6,500
Account: Rent expense Account No:53
Posting Balance
Date Item Reference Debit Credit Debit Credit
2004
sept 30

Account: Insurance expense Account No:54

Posting Balance
Date Item Reference Debit Credit Debit Credit
2004
sept 30
Account: Interest expense Account No:55
Posting Balance
Date Item Reference Debit Credit Debit Credit

Account: Depreciation expense Account No:56

Posting Balance
Date Item Reference Debit Credit Debit Credit
Account: Miscellaneous expense Account No: 59
Posting Balance
Date Item Reference Debit Credit Debit Credit
2004
sept 4 800 800
28 1,000 1,800
The trial balance
 The equality of debits and credits in the ledger
must be proved at the end of each accounting
period. This is made by preparing a trial balance.

 Trial balance is two column, listing the account

titles and the debit or credit balance of all accounts
in the ledger to verify (proof) the equality of all
total debits with the total of all credit balances.
 If the two total agree, then the trial balance is
called in balance .
 Cont…
Procedures followed in preparing trial balance:
1. Determine the balance of each account in the
ledger

2. List accounts that have balance (Debit or Credit)

in the order they appear in the ledger:
• The left amount column is for debit balance &
• The right amount column is for Credit balances.

3. The debit and Credit balances are totaled to

determine their equality
 Hiwot Beauty Salon & Training centre
Unadjusted Trial Balance
September 30,2004
Cash 142,300

A/R 7,000

Supplies 12,000

Prepared Rent 20,000

Prepared insurance 2,400

Office equipment 25,000

Furniture 50,000

Machinery 35,000

Land 60,000

A/P 10,000
N/P 100,000
Unearned Revenue 150,000
Hiwot capital 90,000
Hiwot Drawing 5000
Fees Earned 17,000
Salary expenses 6,500
Miscellaneous expense 1800
367,000 367,000
 Cont…
 The trail balance does not provide complete proof of
accuracy of the ledger. It indicates only that the debits
and credits are equal.
 Among the types of errors that will not cause an
inequality in the trail balance totals are the following:
 Failure to record a transaction
 Failure to post a transaction
 Recording the same erroneous amount for both the debit and
the credit parts of a transaction
 Recording the same transaction more than once
 Posting a part of a transaction correctly as a debit or credit
but to the wrong accounts
 Accrual Vs Cash basis of accounting

 Accrual Concept - This principle requires, among other things, that revenues and expenses
should be recorded in the accounting period in which goods and services are sold and
delivered to customer and goods and services are consumed, respectively, without regard
to when cash is collected from the revenues and when cash is paid for the expenses.
 This method of recording and reporting revenues and expenses is called accrual basis of
accounting.
 Under the accrual basis of accounting, net income (loss) will be the difference between
revenues earned and expenses incurred in a given accounting period.
 The accrual basis of accounting requires that, by the end of an accounting period, revenues
earned but not collected in cash and expenses incurred but not paid in cash should be
identified and recorded. This too is done through the adjusting process.
 Cont…
 Another alternative way for recording and reporting revenues and
expenses is the cash basis of accounting.
 According to this basis of accounting, revenues are recorded and
reported only when collected in cash and expenses are recorded
and reported only when paid in cash.
 Under this accounting basis, net income (loss) for a given
accounting is determined by comparing revenues collected in
cash and expenses paid in cash in that particular accounting
period.
 ADJUSTMENTS
 Adjusting entries are required at the end of each accounting
period for accrual-basis accounting, prior to the preparation of
financial statements.
 The journal entries at the end of an accounting period to bring
the accounts up to date and to properly match revenues and
expenses are called adjusting entries.
 The purpose for adjusting entries are to:
• Bring balance sheet accounts up-to-date.
• Reflect proper amounts of revenues and expenses on the
income statement.
 Because of the adopting of accrual accounting, after the

preparation of trial balance, adjustments relating to the

accounting period have to be made in order to make the
financial statements complete.
 Cont…

There are four basic types of accounts require

adjusting entries as shown below:

1. Prepaid expenses

2. Unearned revenues

3. Accrued expenses

4. Accrued revenues
 Cont…
Prepaid expenses:
Items that have been initially recorded as assets and
expected to become expenses overtime or through the
usage in the normal operations of the business. i.e.
are advance payment of future expenses and are
recorded as assets when cash is paid.
Prepaid expenses are also known as deferred
expense
Example: Supplies, prepaid rent & prepaid insurance.
 Cont…
Assume the illustration of Hiwot beauty salon and training
center:
Example 1.
The physical count shows that at the end of September
supplies on hand is $ 4,000.
Balance of supplies during the month … 12,000
Supplies on hand @the end month……. 4,000
Supplies used…………………………. 8,000

The journal entry will be:

Supplies expense……………. 8,000
Supplies ……………………….. 8,000
 Cont…
Example 2.
The rent payment was for one year i.e $ 20,000, but one
month rent has already been incurred or used. So it
requires adjustment at the end of the month, therefore the
adjustment will be:
12 month ------ 20,000
1 month ------ ?
1/12 X20,000 =1,667 Rent expense for the month

The journal entry will be:

Rent expense …………….. 1,667
Prepaid rent ……………….. 1,667
 Cont…
Example 3.
The insurance payment $ 2,400 was for a 6 m
premium, but one month insurance is alr
expired. The expired portion of the premium
be calculated as follows:
2,400 = 400 Insurance expense for se
6
The journal entry will be:
Insurance expense ……………….. 400
Prepaid insurance …………………. 40
 Cont…

Unearned revenues:
Are advance receipt of future revenues and are
recorded as liabilities when cash is received. i.e.
Unearned Revenues are Revenues that have been
recorded but not yet earned.
Unearned revenues become earned revenues over
time or during normal operations.
Liabilities are created by receiving cash in advance
of providing services or delivering goods.
 Cont…
Example 4.
The $ 150,000 tuition fee received from students is a
liabilities to the business. But part of it becomes revenue
as of Sept. 30.
The earned portion of revenue will be calculated as
follows:

150,000 = 37,500 is revenue

4
The journal entry will be:
Unearned revenue ……………… 37,500
fees earned …………………………. 37,500
 Cont…
Accrued expense:-
 Expense that has been incurred but yet not paid.
Accumulated expenses that is unpaid and
unrecorded. i.e.
 Unrecorded Expenses are Expenses that have been
incurred but not yet recorded.
 Accrued expenses are liabilities owed to a business.
 Wages owed to employees at the end of a period
but not yet paid is an Accrued expense.
 Cont…
Example 5.
The salary paid at Sept. 26 is a 26 day salary from Sept. 1 to
Sept. 26, the salary from Sept 27 to Sept. 30 is not paid and
also not recorded. Therefore the adjustment is needed for
these 4 days:
6,500 -------26 days
?-------------4 days
4/26 X 6,500= 1,000 salary expense

The journal entry will be:

Salary expense-------------------------1,000
Salary payable-----------------------------1,000
 Cont…
Example 6.
The one month interest expense incurred on notes payable
(a bank note due in 5 years with an interest rate of 12%)
should be recorded: interest expense of the month will be
calculated as:
I = PRT
Where, I = interest, P = principal, R = rate & T = time
I = 100,000 x 0.12 x 1/12 = 1,000 interest expense

The journal entry will be:

Interest expense ………………. 1,000
Interest payable………………….. 1,000
 Cont…
Example 7. Plant Assets :
The expired cost of plant assets due to usage and
passage of time is called depreciation.
All plant assets, except land, lose their usefulness.
Depreciation is recorded as a debit to depreciation
expense and a credit to Accumulated depreciation.
Accumulated Depreciation is a contra – asset
account with credit balance, which shows the
depreciation accumulated since the purchase of the
plant assets.
 Cont…
 Assume that based on the calculation the depreciation of the
following plant assets is determined to be:
Office equipment-----------------------------315
Furniture--------------------------------------- 625
Machinery------------------------------------- 500
Total depreciation ……………… 1,440
The journal entry will be:
Depreciation expense …………….. 1,440
Accum. Depn., office equipment ……… 315
Accum. Depn., furniture………………. 625
Accum. Depn., machinery……………... 500
 Cont…
 Accrued revenues:
Are unrecorded revenues that have been earned and for which
cash has yet to be received. i.e. Unrecorded Revenues are
revenues that have been earned but not yet recorded.

Fees for services that an attorney or a doctor has provided but

not yet billed are accrued revenues.
Revenue that have been earned but yet not collected and
recorded.
The journal entry will be:
Account receivable ………….. xxxx
Fees earned……………………….xxxx
Summary of Basic Relationship
 Work sheet
 The worksheet is a multi – column sheet prepared to
arrange in a convenient form all the accounting data
required to prepare financial statements.
 It is not a formal record rather it is a working paper that

facilitates accurate preparation of financial statements.

Use of a Work sheet
 Reduces the possibility of overlooking the need for an
adjustment
 Provides a convenient means of verifying arithmetical
accuracy
 Provides for the arrangement of data in a logical form
 Provides the source data for the financial statements
 Hiwot beauty salon & training center
Work sheet
For the month ended sept 30, 2004
Trial balance Adjustment Adjusted trial balance Income statement Balance Sheet
Account title Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit

Cash 142,300
AIR 7,000
Supplies 12,000
Prepared Rent 20,000
Prepared insurance 2,400
Office equipment 25,000
Furniture 50,000
Machinery 35,000
Land 60,000
A/P 10,000
N/P 100,000
Unearned Revenue 150,000
Hiwot capital 90,000
Hiwot Drawing 5,000
Fees earned 17,000
Salary expense 6,500
Miscellaneous exp 1,800
367,000 367,000
 Hiwot beauty salon & training center
Work sheet
For the month ended sept 30, 2004
Trial balance Adjustment Adjusted trial balance Income statement Balance Sheet
Account title Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit

Cash 142,300
AIR 7,000
Supplies 12,000 8,000
Prepared Rent 20,000 1,667
Prepared insurance 2,400 400
Office equipment 25,000
Furniture 50,000
Machinery 35,000
Land 60,000
A/P 10,000
N/P 100,000
Unearned Revenue 150,000 37,500
Hiwot capital 90,000
Hiwot Drawing 5,000
Fees earned 17,000 37,500
Salary expense 6,500 1,000
Miscellaneous exp 1,800
367,000 367,000
Supplies expense 8,000
Rent expenses 1,667
Insurance expense 400
Deprecation expense 1440
Acc.Dep.office equip 315
Acc.Dep furniture 625
Acc. Dep Machinery 500
Salary payable 1,000
Interest expense 1,000
Interest payable 1,000
Total 51,007 51,007
Net income
 Hiwot beauty salon & training center
Work sheet
For the month ended sept 30, 2004
Trial balance Adjustment Adjusted trial balance Income statement Balance Sheet
Account title Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit

Cash 142,300 142,300

AIR 7,000 7,000
Supplies 12,000 8,000 4,000
Prepared Rent 20,000 1,667 18333
Prepared insurance 2,400 400 2,000
Office equipment 25,000 25,000
Furniture 50,000 50,000
Machinery 35,000 35,000
Land 60,000 60,000
A/P 10,000 10,000
N/P 100,000 100,000
Unearned Revenue 150,000 37,500 112,500
Hiwot capital 90,000 90,000
Hiwot Drawing 5,000 5,000
Fees earned 17,000 37,500 54,500
Salary expense 6,500 1,000 7,500
Miscellaneous exp 1,800 1,800
367,000 367,000
Supplies expense 8,000 8,000
Rent expenses 1,667 1,667
Insurance expense 400 400
Deprecation expense 1440 1440
Acc.Dep.office equip 315 315
Acc.Dep furniture 625 625
Acc. Dep Machinery 500 500
Salary payable 1,000 1,000
Interest expense 1,000 1,000
Interest payable 1,000 1,000
Total 51,007 51,007 370,440 370,440
Net income
 Hiwot beauty salon & training center
Work sheet
For the month ended sept 30, 2004
Trial balance Adjustment Adjusted trial balance Income statement Balance Sheet
Account title Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit

Cash 142,300 142,300

AIR 7,000 7,000
Supplies 12,000 8,000 4,000
Prepared Rent 20,000 1,667 18333
Prepared insurance 2,400 400 2,000
Office equipment 25,000 25,000
Furniture 50,000 50,000
Machinery 35,000 35,000
Land 60,000 60,000
A/P 10,000 10,000
N/P 100,000 100,000
Unearned Revenue 150,000 37,500 112,500
Hiwot capital 90,000 90,000
Hiwot Drawing 5,000 5,000
Fees earned 17,000 37,500 54,500 54,500
Salary expense 6,500 1,000 7,500 7,500
Miscellaneous exp 1,800 1,800 1,800
367,000 367,000
Supplies expense 8,000 8,000 8,000
Rent expenses 1,667 1,667 1,667
Insurance expense 400 400 400
Deprecation expense 1440 1440 1,440
Acc.Dep.office equip 315 315
Acc.Dep furniture 625 625
Acc. Dep Machinery 500 500
Salary payable 1,000 1,000
Interest expense 1,000 1,000 1,000
Interest payable 1,000 1,000
Total 51,007 51,007 370,440 370,440 21,807 54,500
Net income 32,693
54,500 54,500
 Hiwot beauty salon & training center
Work sheet
For the month ended sept 30, 2004
Trial balance Adjustment Adjusted trial balance Income statement Balance Sheet
Account title Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit

Cash 142,300 142,300 142,300

AIR 7,000 7,000 7,000
Supplies 12,000 8,000 4,000 4,000
Prepared Rent 20,000 1,667 18333 18333
Prepared insurance 2,400 400 2,000 2,000
Office equipment 25,000 25,000 25,000
Furniture 50,000 50,000 50,000
Machinery 35,000 35,000 35,000
Land 60,000 60,000 60,000
A/P 10,000 10,000 10,000
N/P 100,000 100,000 100,000
Unearned Revenue 150,000 37,500 112,500 112,500
Hiwot capital 90,000 90,000 90,000
Hiwot Drawing 5,000 5,000 5,000
Fees earned 17,000 37,500 54,500 54,500
Salary expense 6,500 1,000 7,500 7,500
Miscellaneous exp 1,800 1,800 1,800
367,000 367,000
Supplies expense 8,000 8,000 8,000
Rent expenses 1,667 1,667 1,667
Insurance expense 400 400 400
Deprecation expense 1440 1440 1,440
Acc.Dep.office equip 315 315 315
Acc.Dep furniture 625 625 625
Acc. Dep Machinery 500 500 500
Salary payable 1,000 1,000 1,000
Interest expense 1,000 1,000 1,000
Interest payable 1,000 1,000 1,000
Total 51,007 51,007 370,440 370,440 21,807 54,500 348,663 315,940
Net income 32,693 32,693
54,500 54,500 348,663 348,663
 Adjusted Trial Balance

 Prepared after all adjusting entries are

journalized and posted.

 The purpose is to prove the equality of debit

balances and credit balances in the ledger.

 Is the primary basis for the preparation of

financial statements.
 Hiwot Beauty Salon & Training center
Trial Balance
September 30,2004
Cash 142,300
A/R 7,000
Supplies 4,000
Prepared Rent 18333
Prepared insurance 2,000
Office equipment 25,000
Accumulated depn.-office equipment 315
Furniture 50,000
Accumulated depn.- Furniture 625
Machinery 35,000
Accumulated depn.-Machinery 500
Land 60,000
A/P 10,000
N/P 100,000
Unearned Revenue 112,500
Salary payable 1,000
Interest Payable 1,000
Hiwot capital 90,000
Hiwot Drawing 5,000
Fees Earned 54,500
Supplies expense 8,000
Salary expense 7,500
Rent Expense 1,667
Insurance expense 400
Interest expense 1,000
Depreciation expense 1,440
Miscellaneous expense 1,800
 Financial statement
 Financial statements are reports prepared to present the
financial performance and position of a business firm.
 A financial statement is a collection of data organized
according to logical and consistent accounting procedures.
Its purpose is to convey an understanding of some
financial aspects of a business firm.
 Summaries of financial activities are called financial
statements which are prepared on a regular basis at the end
of an accounting period.
 The accounting period typically is one year; however, it can
be any length of time for which records are maintained.
Usually the minimum is one month and the maximum
length of time is one year for financial statements.
 There are several types of financial statements, but
the most common/major financial statements used
to communicate accounting information about a
business are:
1. Income Statement,
2. Statement of Owner’s Equity
3. Balance Sheet
4. Cash flow statement
Income Statement:
 This is a summary of a business’s revenue and

expenses for a specific period of time. It only

shows revenue and expenses.
 The expenses in the income statement are listed in
order of size, beginning with the larger items.
 Miscellaneous expense is the last item, regardless
of its amount.
 Hiwot beauty salon & training centre
Income statement
For the month ended sept 30 , 2004

Fees ------------ $54,500

earned-----------------------------------
Operating Expense: 8,000
Supplies Expenses----------------------- 7,500
Salary expenses-------------------------- 1,667
Rent expenses---------------------------- 1,440
Depreciation expense------------------- 1,000
Interest expense-------------------------- 400
Insurance expense----------------------- 1,800
Miscellaneous ------------ 21,807
expense----------------- $ 32, 693
Total operating expense--------------------
Net income ----------------------------------
Statement of Owner’s Equity:
This is a summary of the changes that have occurred
in the owner’s equity during a specific period of time.

This statement shows either an increase or decrease in

the capital account.

The owner may have invested additional assets in the

business during the period and it should be added
with the beginning balance.
 Hiwot Beauty Salon & Training Centre
Statement of Owner’s Equity
For the month ended Sept. 30 , 2004

Hiwot capital sept. 1,2004------- $ 90,000

Net income for the month ------ 32,693
Less withdrawal -------------- (5000)
Increase in owner’s equity - 27,693
Hiwot capital sept. 30, 2004---- $117,693
Balance Sheet.
The balance sheet, sometimes called the statement of
financial Position. It is a listing of the firm’s assets,
liabilities, and owner’s equity at a specific point in time/ for
a specific date.

The total assets must equal the total liabilities and owner’s
equity. There are tow commonly used formats of the
balance sheet:
The account format: Which lists assets on the left side and
liability and owner’s equity on the right side.
The Report Format : Lists assets, Liability and Owner’s
equity vertically
 Hiwot Beauty Salon & Training Centre
Balance Sheet
Sept. 30 , 2004
Assets Liabilities
Current Assets Current Liabilities
Cash -----------------$ 142,300
A/R------------------- 7,000 Account Payable--------$10,000
Supplies-------------- 4,000 Salary Payable------------ 1,000
Prepaid Rent -------- 18,333 Interest Payable------------1,000
Prepaid insurance-- 2,000 Unearned Revenue------112,500
Total current assets--------------------- 173,633 Total Current Liability ---------------- 124,500
Plant Assets
Off. Equipment----------25,000 Long-term Liability:
Less Acc. Dep------------ (315)…….. 24,685 Notes Payable --------------------------- 100,000
Furniture----------------- 50,000 Total Liability-----------------------------224,500
Less Acc. Dep------------ (625) ……. 49,375
Machinery--------------- 35,000 Owner’s equity
Less Acc. Dep------------ (500) …… 34,500 Hiwot, capital--------------------------- 117,693
Land--------------------------------------- 60,000
Total plant assets----------------------- 168,560
Total Assets---------------------------- $342,193 Total Liability & owner’s equity---$342,193
 Closing Process

 The Closing Process is a step in the accounting cycle that occurs at

the end of the accounting period, after the financial statements
are completed. This serves to get everything ready for the next
year.
 Prepares account for recording the transaction of the next period.

i.e. When a new accounting period begins, the revenue and

expense accounts should show zero balances so that they contain
only data that refer to the new period.
Purpose of Closing Entries:
 Prepares the temporary accounts (revenue, expense, drawings) for

the next period’s postings by reducing their balances to zero.

 Updates the owner’s capital account in the ledger by transferring

net income (loss) and owner’s drawings to owner’s capital.

 Real vs Nominal Accounts

 Real accounts are permanent accounts not closed to a

zero balance at the end of the accounting period. These

accounts are carried forward to the next period.
 Nominal accounts are temporary accounts that are

closed to a zero balance at the end of each accounting

period.
 Closing entries reduce all nominal accounts to a zero

balance.
Closing Nominal Accounts
 Temporary (or nominal accounts): accumulate data from one
accounting period. Include all income statement accounts
(Revenue and expenses), withdrawals and income summary.
 Income Summary account is a special nominal account, used
only during the closing entry process. The Income Summary
account summarizes the revenues and expenses of the period.
The temporary balance in this account represents either the
amount of net income or the amount of net loss.
 Cont..
In summary, there are four steps involved in closing the books:
Step1: Close the revenue accounts into Income Summary. i.e. Debit each
revenue account for its balance, and credit the owner’s capital account for total
revenues.
Step2: Close the expense accounts into Income Summary. i.e. Debit the
owner’s capital account for total expenses, and credit each expense account for
its balance.
Step 3: Close Income Summary into Capital.
In closing income summary there are two cases:
If it has debit balance(loss): Debit the owner’s capital account
and credit income summary account.
If it has credit balance(net income): Debit income summary account and
credit the owner’s capital account
Step 4: Close Drawings into Capital. i.e. Debit owner’s capital for the balance in
the owner’s drawings account and credit owner’s drawings for the same amount.
 Post-Closing Trial Balance

 Provides a listing of all real account balances at the end of the

closing process. i.e. List of permanent accounts and their
balances from the ledger after all closing entries are journalized
and posted.
 The trial balance assures that total debits equal total credits for
permanent accounts prior to the beginning of the new
accounting period.
 Identical to those in the balance sheet
83

 Reading Assignment
1. Prepare statement of Cash flow
2. Depending on the opened accounts in the ledger,
post adjusting entries, Journalize and post closing
entries to the accounts and determine their balance.
3. Prepare post closing trial balance
4. What kind of errors are disclosed by trial balance
5. List and discus at least three limitations of trial
balance.
The End