CHAPTER TWO

ACCOUNTING CYCLE FOR SERVICE-GIVING BUSINESS

Overview of Chapter 2
As you recall from Chapter 1, we have analyzed business transactions of Melkam Internet café, in
the way that displays their effects on the elements of the accounting equation. Then we have
prepared a tubular summery the transactions and also the financial statements. This is so in this
way because the business is small. But what if we are going to record transactions of large business
like Teklehaimanot Hospital or Ethiopian Airlines? These firms entertain 100 or 1000 folds of the
monthly transactions of Melkam Internet Café within a single day. Do you think it seems practical
and wise to analyze each and every transactions in the way we did before? No. Record transaction
in this way would be impractical, expensive, and unnecessary. Though tabulation is a simple way
to show you how transaction and their respective effects are captured in the basic accounting
equation, it is not the formal system for recording business transactions at all. Instead, companies
use a set of systematic procedures and records to keep track of transaction data more easily. This
chapter introduces and illustrates the basic procedures used in the recording process and
completion of accounting cycle.
2.0 Chapter Learning Objectives
After completing this chapter you should be able to:
• Explain what an account is and how it helps in the recording process.
• Define the term debits and credits and explain their role in the recording process
• Identify the basic steps in the recording process.
• Explain what a journal is and how it helps in the recording process.
• Explain what a ledger is and how it helps in the recording process.
• Explain what posting is and how it helps in the recording process.
• Prepare a trial balance and explain its purposes.
[Link] Recording Process
The recording process holds detailed discussions on the terminologies of the elements used in
recording of business transactions. These are an account, the recording system and the proving
process.
2.1.1. The Account
 An account is an individual accounting record of increases and decreases in a specific asset,
liability, or equity item. An account is a sub division of the three elements of the accounting
equation For example; Melkam internet Cafe (the company discussed in Chapter 1) would have
separate accounts for Cash, Accounts Receivable, Accounts Payable, Service Revenue,
Salaries and Wages Expense, and so on.
2.1.2 Characteristics of an Account
The simplest (basic) form of an account consists of three parts: (1) an account title, (2) a left or
debit side, and (3) a right or credit side. We use this form often throughout this course to explain
basic accounting relationships. Illustration 2.1 shows the basic form of an account.
Illustration 2.1 Basic form of account.
Accounts Title
Debit Credit

As you see from the figures the format looks like the letter “T”, as a result the simplest form of an
account is referred to as a T-account
1. Account Title
The account title represents the name of the particular account which is written on the top of the
account.
2. Debits and Credits
The term debit indicates the left side of an account, where as the term credit indicates the right
side of the account. They are commonly abbreviated as Dr. for debit and Cr. for credit.
The termsdebit and credit repeatedly used in the recording of the increases and decreases of a
particular account.
The act of entering an amount on the left side of an account is called debiting. Whereas making
an entry on the right side is crediting the account.
The act of debiting or crediting by itself doesn’t represent an increase or a decrease in a specific
account. Increase or decrease of an account is determined on the basis of account classification
only.
2.1.3. Balance Side of an Account
Increasing side of an account is called balance side. An account shows a debit balance side if the
total of the debit amounts exceeds the credits. An account shows a credit balance side if the credit
amounts exceed the debits. Dear students’ illustration 2.1 shows you the recordings and the balance
determination of an account. Beside the illustration also shows you how the account format sparely
records increases and decreases in a particular account compared with tabular format dealt on
Chapter 1). The data for the illustration is taken from Melkam Internet Café tabular summery of
illustration 1.2.
Illustration 2.2 Tabular summary and account form for Melkam Internet Café Cash account
Tabular Summery of
Cash Account Form
Cash
Br.45,000
Debit 45,000 Credit 20,000
-20,000
8,500 1,200
+8,500
2,000 6,750
-1,200
2,200 2,500
+2,000
Bal.
_6,750 27,250
_2,200
_-2,500
27,250
Look, the above two formats for your comparison. Every positive figure in the tabular summary
represents an increase in cash and every negative figure represents a decrease in cash
balance. Notice also in the account form the increases and decreases in cash are recorded in
a separate side. I.e the increases in cash is recorded as debits, and the decreases as
credits. There is no need to uses + or – signs in the account format.

Having increases on one side and decreases on the other reduces recording errors and helps in
determining the totals of each side of the account as well as the account’s balance side. The balance
is determined by netting the two sides (subtracting one amount from the other). The account
balance, a debit of Br. 27,250, indicates that Melkam Internet Cafe had Br. 27,250 more increases
than decreases in cash. As a result cash has a debit balance side.

NB: For simplicity all accounts which, appear in the left hand side of the accounting equation has
a debit balance side. Whereas all those accounts which appeared on the right hand side of the
accounting equation has a credit Balance side.
 2.1.4. The Rules of Debit and Credit in a double entry system
In Chapter 1, you have learned the effect of a transaction each transaction has a dual effect on the
basic accounting equation and that maintains the accounting equation always in balance.
Thisfactprovides the basis for the double-entry system in the formal records of transactions.

Under the double-entry system, the dual (two-sided) effect of each transaction is recorded in
appropriate accounts as debits and credits. This system provides a logical method for recording
transactions and helps to ensure the recording accuracy. If every transaction is recorded with equal
debits and credits, the sum of all the debits to the accounts must equal the sum of all the credits.
The double-entry system for determining the equality of the accounting equation is much more
efficient than the plus/minus procedure used in Chapter 1. On the following pages, we will
illustrate debit and credit procedures in the double-entry system.
Rules of Debits and Credits for Asset, Liabilities and Owners Equity
In Illustration 2.2 above increases in Cash (an asset) were entered on the left side i.e debit, and
decreases in Cash were entered on the right side i.e credit. Since assets are found on the left side
of the basic accounting equation.
On the other hand increases in liabilities must be entered on the right or credit side, and decreases
in liabilities must be entered on the left or debit side. It is therefore follows that increases and
decreases in liabilities will have to be recorded oppositefrom increases and decreases in assets.
balance side or normal balance of an account is the side where the increaseing in the account is
recorded. For instance Asset accounts normally show debit balances. That is, debits to a specific
asset account should exceed credits to that account. Likewise, liability accounts normally show
credit balances. That is, credits to a liability account should exceed debits to that account.
As it is discussed in Chapter 1 indicated, owner’s equity has four subdivisions: Owner’s Capital,
drawing, revenues, and expenses. In a double-entry system, companies keep accounts for each of
these subdivisions, as explained below.
Owner’s capital has a credit balance side. Revenues increase equity, a revenue account use the
same debit/credit rules as owner’s capital account. As you know Drawing and Expenses decreases
equity account, they have the opposite Debit/credit rules as owner’s capital account. As a result
they have a debit normal balance.
Knowing the normal balance in an account may help you to trace errors. For example, a credit
balance in an asset account such as Equipment or a debit balance in a liability account such as
Accounts Payable usually indicates an error.

Summary of Debit/Credit Rules

Illustration 2.3 shows a summary of the debit/credit rules and effects on each type of account.
Study this diagram carefully. It will help you understand the fundamentals of the double-entry
system.
Illustration 2.3 Summary of debit/credit rules

Accounting
Equation Asset = Liabilities + Owners Equity
Account Owners
Classification Asset = Liability + Capital + Revenue - Expense - Drawing
Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.

Debit/Credit Rule + - - + - + - + + - + -

NB: in the above illustration, the plus sign represents an increase in an account where as minus
sign represents a decrease in an account.
The information in the above table is summarized as follows.
Debit Credit
- Increase in asset - Decrease in asset
- Decrease in Liability - Increase in Liability
- Decrease in equity - Increase in equity
- Decrease in revenue - Increase in revenue
- Increase in Expense - Decrease in Expense
Synopsis of Lecture
• Account is a subdivision of the elements in accounting equation
 • The simplest form of an account is referred to as a T-account
• The left side of an account is debit side and the right hand side of an account is credit
• Accounts with debit balances appear in the left column, and those with credit balances in
the right column.
• The increasing side of an account is normal balance or balance side
2.1.2 Classification of Accounts
Accounts are classified in to five. Namly Assets, Liability, Equity, Revenue (referred to as income)
and Expense. The first three are reported the statements of financial position accounts. So they are
called financial Position accounts. Whereas the last two are called Income statement accounts and
are called income statement accounts.

The simplified versions of the official account definitions provided by the FASB, using the IASB
definitional structure, are as follows.
i. Assets :- A resource controlled by the entity as a result of past events and from which future
economic benefits are expected to flow to the entity.

The following three characteristics must be present for an item to qualify as an asset:
1. The asset must provide probable future economic benefit that enables it to provide future
net cash inflows.
2. The entity is able to receive the benefit and restrict other entities’ access to that benefit.
3. The event that provides the entity with the right to the benefit has occurred.

Assets have features that help identify them in that they are exchangeable, legally enforceable, and
have future economic benefit (service potential). It is that potential that eventually brings in cash
to the entity and that underlies the concept of an asset.

IFRS based Classification of assets :-International Financial Reporting Standard made asset
classification as follows:

Property Plant and Equipments:- are asses held to be used in the production and supply of
goods or services, for administrative purpose, or for rental to others. As per IAS 16 Property,
plant, and equipment includes land,building structures (offices, factories, warehouses), and
equipment (machinery, furniture, tools). PPEs also include Biological assets (Bearer Plants) and
mineral recourses. Biological assets are Bearer plants that are used to produce agricultural
products, like Rubber tree, Fruit tree, Sheep, Dairy cattle etc. Mineral Recourses and Mineral
reserves used to produce such as oil, natural gas and mineral water etc.

Intangible Asset:- are identifiable assets, without physical existence, held for use in production
and supply of goods or services, for administrative purpose or, for rental to others. (IAS 38).
Intangible assets includes Brand, Copyrights, Trademarks, Trade secrets, Permits, Corporate
intellectual property etc.

Noncurrent Asset Held for Sale:-is a PPE that are available for immediate sale in its present
condition and its sale must be highly probable. In addition, the asset must be currently being
marketed actively at a price that is reasonable in relation to its current fair value. For example a
building in use by a business but the entity is committed to sale it on the moment the company gets
buyers.(IFRS 5)
Inventories:- Are asset held for sale in the normal course of business or in the process of
production for such sale or in the form of materials or supplies to be used in the production process
or in the rendering of services. Harvested and stored biological assets held for sale is also
categorized under inventories. (IAS2)
Biological Asset in Agricultural Activity and Agricultural Products:- assets point of harvest:-
assets that are agricultural products growing on bearer plant Example, Picked fruit, harvested sugar
cane or wool on the sheep at point of harvest. (IAS41).
Investment Property:- Are properties held to earn rentals or for capital application or both rather
than for use in production for use or for sale. For instance, holding a building or a land for rental
purpose is an investment property.
Financial Asset:- is cash, an equity investment of another company (e.g., ordinary or preference
shares), or a contractual right to receive cash from another party (e.g., loans, receivables, and
bonds).( IAS 32 and IFRS 7)
NB: the above are detailed classification for the assets; you are required to read more about the
classifications. However for the purpose of simplicity, assets generally are classified in to
noncurrent and current asset. Noncurrent assets are assets that cannot be easily and readily
converted into cash and cash equivalents. Non-current assets are also termed fixed assets, or long-
term assets which serve an entity for a period more than one year. Noncurrent asset is reclassified
in to three. These are PPEs, Mineral Recourses and Intangible Assets.
On the other hand Current assets are cash or other assets that companies reasonably expect to
convert into cash, sell, or consume in operations within a single operating cycle or within a year.
This includes Cash, account receivable, inventory etc. The general classification is within the
scope of the above asset category.
ii. Liabilities. A present obligation of the entity arising from past events, the settlement of which
is expected to result in an outflow from the entity of resources embodying economic benefits.
The following three characteristics must be present for an item to qualify as a liability:

1. A liability requires that the entity settle a present obligation by the probable future
transfer of an asset on demand when a specified event occurs or at a particular date.
2. The obligation cannot be avoided.
3. The event that obligates the entity has occurred.

IFRS based Classification of Liabilities:-IFRS categorized liabilities as follows:

Financial liabilities:- a contractual obligation to deliver cash or another financial asset, obligation
to exchange financial liabilities under unfavorable condition. Financial liability includes accounts
payables, deposit liabilities, bond issued etc.(FRS 9 and IAS39)

Lease liability:- a present obligation arising from lease agreements. Lease an agreement whereby
the leaser conveys to the lessee the right to use an asset for an agreed period of time in return for
payment. (IAS 17).

Employee Benefit liability:- a present obligation incurred by an entity in exchange for service
rendered by employees for the termination of employment. Employee benefits liability included,
salary payable, Bonus payable, pension payable, severance pay.(IAS 19)

Income Tax liability:- A present statutory obligation to pay taxes to the government based on
taxable profits(IAS12).
Provisions:- A provisionis a liability of uncertain timing or amount and sometimes referred to as
an estimated liability. Common types of provisions are obligations related to litigation, warrantees
or environmental damage etc.(IAS37).
Depending on the date of expected payment Liabilities can be classified in to Current and
Noncurrent liabilities. This classification is within the framework of the above category,
Current liabilities are obligationswhich are expected to be settled within its normal operating
cycle; or within 12 months after the reporting date. Current liabilities include Accounts payables,
salary payable, notes payables etc.
Non-current liabilities (sometimes referred to as long-termdebt) consist of an expected outflow
of resources arising from present obligations that are not payable within a year or the operating
cycle of the company, whichever is longer. Bonds payable, long-term notes payable, mortgages
payable, pension liabilities, and lease liabilities are examples of non-current liabilities.
iii. Equity. A residual interest in the assets of the entity after deducting all its liabilities.
iv. Income. Increases in economic benefits that result in increases in equity (other than those
related to contributions from shareholders). Income includes both revenues (resulting from
ordinary activities) and gains.
v. Expenses. Decreases in economic benefits that result in decreases in equity (other than those
related to distributions to shareholders). Expenses includes losses that are not the result of
ordinary activities
2.2. The Recording System
Recording system is an accounting system used to capture (Record) continues track of business
transaction.
Steps in the recording transactions
There are three basic steps in the recording process:
I. Analyze each transaction for its effects on the accounts.
II. Enter the transaction information in a journal.
III. Transfer the journal information to the appropriate accounts in the ledger.
I. Analyzing Business Transaction
Analyzing a business transaction is reviewing the information included in a particular business
document and identifies the transaction effect on a particular account. Business documents are
those source documents like Receipts, invoices, a check or a bill that provides evidence for the
occurrence of the transaction.
The analysis of business transaction answers the following three questions.
i. Which accounts are affected? helps to identify the specific account affected by a
particular transaction
ii. How are they affected? Helps to specify whether the identified accounts are increased
or decreased due to the transaction.
iii. Which account is to be debited and which account is to be credited by how much.
NB; dear students this activity is a pre-stage for the recording activity. It helps to enhance the
accuracy of the recording activity. The company then enters the transaction in the journal. Finally,
it transfers the journal entry to the designated accounts in the ledger.
The steps in the recording process occur repeatedly. In Chapter 1, we have illustrated the first step,
i.e transaction analysis, and in this chapter and the later chapters you will have more examples and
advanced illustrations to practice the recording activity.
2.2.1. The Journal and Recording Transactions
The journal is a format used to record a transaction for the first time. The process of enteringa
transaction from the source document in to a journal is called Journalizing. Companies uses a
journal to record transactions in chronological order (the order in which they occur). Thus,
the journal is referred to as the book of original entry. For each transaction, the journal shows the
debit and credit effects on specific accounts.

Types of Journal
There are two types of Journal: General journal and the Special journal. General journal is the
most basic form of Journal which is used to record all kinds of business transactions.
Whereas special journal is a journal used to record only as specific transaction type. For instance
cash journal records only a transaction which involves cash receipt or payments, purchase journal
records only purchase transaction only etc., for the matter of this course whenever we use the term
“journal” in this course, we mean the general journal, unless we specify otherwise.
Significances of recording transaction in a journal
The journal makes several significant contributions to the recording process:
1. It discloses the complete effects of a transaction in one place.
 2. It provides a chronological record of transactions.
3. It helps to prevent or locate errors because the debit and credit amounts for each entry
can be easily compared.
Illustration 2.3 Format for a General Journal
As shown [Link] a general journal has a space for date, account titles and
explanations, references, and two amount columns.
General Journal Page No.
Date Descriptions P/R Debit Credit

Parts of a General Journal

Companies make separate journal entries for each transaction. A complete entry consists of: (1)
the date of the transaction, (2) the accounts and amounts to be debited and credited, and (3) a brief
explanation of the transaction.
Illustration 2.4 shows the technique of journalizing, using the first two transactions of Melkam
Internet café. On August 1, Melkam invested Br. 45,000 cash to start the business and on August
2, Melkam purchased equipment for Br. 20,000 for cash. The number page 1 indicates that the
company records these two entries on the first page of the general journal.
Illustration 2.4 Steps of journalizing

General Journal Page 1

Date Account Title and Descriptions P/R Debit Credit
2016
Aug 1 Cash 45,000
Owner's capital 45,000
(Initial Investment)

2 Equipment 20,000
Cash 20,000
(purchase of equipment)

Steps in Journalizing Transaction

 1. Enter the date of the transaction in the Date column in the way it is shown on the above
table
2. Enter the name of the account to be debited in the “Account Titles and Description,”
column and record its respective amount in the Debit column. As you see from the above
table the account Cash is written bend to the extreme left end of the column, this is to
indicate that the account is recorded on the left hand side or debited.
3. Enter the name of the account to be credited in the “Account Titles and Description,”
column of the Journal and record its respective amount in the Credit column. As you see
from the above illustrations the account Owners capital is written bend to the right end of
the column, this is to indicate that specific account is recorded on the right side or credited.
4. Include brief description of the transaction on the line below the credit account title. A
space is left between journal entries. The blank space separates individual journal entries
and makes the entire journal easier to read.
5. The column titled P/R. (which stands for Post Reference) is left blank when the journal
entry is made. This column is used later when the journal entries are transferred to the
ledger accounts.
NB:
• Dear student’s as a beginner you might face difficulties in understanding while you have
tried to journalize transactions. But don’t worry, take it normal, what you are advised to
do is continue with practicing until you develop the knowhow to identify accounts, and
there balance sides to journalize them. Once you are able to journalize correctly and
properly, the other recording activities are so simple for you. The base for financial
reporting is the ability to journalize transactions properly. Note also that journal is the
source document or the base for further activities on the recording process so please take
time and record it properly and correctly.

Simple and Compound Entry

An individual record for debit or credit of a particular transaction is called journal entry. Journal
entries for a transaction which involves only two accounts i.e one debit and one credit account is
called simple entry. The journal entry on illustration 2.4 above is simple entries. Journal entries
which involve more than two accounts for a transaction is called compound entry. To illustrate let
us take transition 6 of Melkam Internet Café’ of chapter 1. On August 20, Melkam performed a
Br. 6,000 photocopy service to customers and receives cash of br. 2,000. Melkam billed the
customer balance of Br. 4,000 on account. The compound entry is as follow
Illustration 2.5 Compound Journal Entry
P/
Date Account Title and Descriptions R Debit Credit
2016
Aug 20 Cash 2,000
Accounts receivable 4,000
Service fee 6,000
(Sales of service for cash and on account)
NB; service fee is a revenue account.
Synopsis of Lecture
• Account is a place to record increases or decreases of in the element of a particular
accounting equation.
• Asset, liability, owner’s equity, revenue and expense are the five classification of an
account.
• Assets are resources owned by a business and are classified in to current and noncurrent
asset.

• The basic steps in the recording system are analyzing traction, recording transaction to a
journal and post the journal to a ledger.
• Journalizing is a process of entering a transaction in to a journal.
• A journal is a general journal if it records all business transaction, where as it is a special
journal if record is made specific transaction types only.
• a single record of the journal is called an entry
2.2.2. The Ledger
The entire group of accounts maintained by a company is the ledger. The ledger keeps in one place
all the information about changes in specific account balances. Companies may use various kinds
of ledgers for each account. But every accountmust have at least one ledger calleda general ledger.
A general ledger contains all the asset, liability, and equity accounts.
The ledger provides the balance in each of the accounts and keeps track of changes in these
balances. For example, the Cash account shows the amount of cash available to meet current
obligations. The Accounts Receivable account shows amounts due from customers. The Accounts
Payable account shows amounts owed to creditors. Each account is numbered for easier
identification.
Standard Form of Account
The simple T-account format of a ledger used in accounting course is often very useful for
illustration purposes. However, in practice, the account format (three-column format) is
appropriate and standardized for the formal posting process. The three-column form of an
accounthas three money columns—debit, credit, and balance. The balance in the account is
determined after posting each entry. Companies use the Postreference (P/R) columns to specifying
the source document for each posting and for cross checking purpose. Illustration 2.6 shows a
typical form, using assumed data from a cash account.
Illustration 2.6 Three-column form of account

Date Explanation P/R Debit Credit Balance

Posting

The process of transferring information from a journal to a ledger is called posting. This phase of
the recording process accumulates the effects of those journalized transactions into the respective
ledger accounts. Posting involves the following steps.
1. In the ledger, enter, the date and amount shown in the journal in the appropriate column
of the account(s) debited,
2. Enter the journal page number in the post reference column of the account
3. Enter account number in the post reference column of the journal.
4. In the ledger, enter, the date and amount shown in the journal, in the appropriate column
of the account(s) credited,
5. repeat step 2 and 3
Illustration 2.7 the following illustration shows you how to recording and post transactions.
On April 1, 2016, Ato Enkopa Bfikir established a House Finishing and Decor business, during
the month of April Ato Enkopa completed the following business transactions.
April 1. Enkopa transferred cash of Br. 50,000 fromhis personal bank account to the account
opened by the name of the business. He has Br. 175,000 left in his personal bank account and one
residential house worth br. 980,000 around Gereji.
April 3. Paid office rent for the month, Br. 3,000.
April 8. Purchased a used truck for Br.60,000, paying Br. 20,000 cash and giving a note payable
for the remainder.
April12. Purchased various equipments on account, Br. 10,000.
April 14. Purchased supplies for cash, Br. 3,200.
April 14. Paid for a one year property insurance premium Br. 2, 400.
April 18. Received cash for job completed, Br. 14, 800.
April 21. Paid creditor a portion of the amount owed for equipment on April 13 April, 15, 000.
April 23. Sent invoices to customers, of Br. 9,600 service delivered on account.
April 25. Received an invoice for truck expenses, to be paid in May Br.1,000.
April 26. Paid Telephone and electric expense of the month, Br. 650
April 27. Paid miscellaneous expenses, Br. 420.
April 27. Received cash from customers on account, Br. 4,000.
April 29. Paid salary and wages of employees for the month, Br. 6,400.
April 30. Ato Enkopa the owner withdrew cash for personal use, Br. 1,800.

Instructions:
i. Journalize the above transactions using the general journal
ii. Post the Journal in to a ledger
iii. prepare Trail Balance
Summary Illustration of Journalizing and Posting
i. Journalizing
Illustration 2.7.1 Journal entries of the above transactions
General Journal Page 1
Date Account Title and Descriptions P/R Debit Credit
2016
April 1 Cash 50,000
Enkopa Capital 50,000
 (Initial Investment)
3 Rent Expense 3,000
Cash 3,000
(Payment For rent)
8 Truck 60,000
Cash 20,000
Notes payable 40,000
(Purchase of Truck)
12 Office Equipment 10,000
Cash 10,000
(Purchase of Equipment)
14 Supplies 3,200
Cash 3,200
(Purchase of Supplies)
14 Prepaid Insurance 2,400
Cash 2,400
(Purchase of insurance coverage)
18 Cash 14,800
service fee 14,800
(cash received from customers)
21 Notes payable 15,000
Cash 15,000
(Cash Paid on account)
23 Accounts Receivable 9,600
Service Fee 9,600
(Provision of service)
25 Truck Expense 1,000
Accounts payable 1,000
(Payment for Truck Expense)
26 Utilities Expense 650
Cash 650
(payment for Light and telephone)
27 Miscellaneous Expense 420
Cash 420
(Payment for various Expenses)
Page 2
27 Cash 4,000
Accounts Receivable 4,000
(cash received on account)
29 Salary Expense 6,400
Cash 6,400
 (Salary payment)
30 Enkopa's Drawing 1,800
Cash 1,800
(Withdrawal of cash)
ii. Posting the Journal to a Ledger
Illustration 2.7.2. Posting the above journal to individual ledger accounts
Before posting a journal you need to prepare charts of account. This helps you to open a ledger
by the name of each account.
Charts of Account
The list of all accounts used by the business with their account numbers is called Charts of account.
The account number is the identification code given to each account. Depending on the size of the
businesses, companies might code their accounts using two or more digits. In a two digit coding
the first digit represents account classification and the second indicates the position of the account
with in the classification. For instance is 13 is given to an account Supplies: it is to mean that
supplies is an assets account listed third.
Here is the chart of account for Enkopa House Finishing and Décor.
Enkopa House Finishing and Décor
Charts of Account

Account Account
Account Title Number Account Title Number
Asset Owner’s Equity
Cash 11 Enkopa's capital 31
Accounts Receivable 12 Enkopa's Drawing 32

Supplies 13 Income Summery 33

Prepaid Insurance 14 Revenue 41
Office Equipment 15 Service Fee
Accumulated Depreciation – Equipment 15-1 Expenses
Truck 16 Salary Expense 51
Accumulated Depreciation – Truck 16-1 Rent Expense 52
Liabilities Utilities Expense 53
Notes Payable 21 Truck Expense 54
Accounts Payable 22 Miscellaneous Expense 55

NB:- Posting should be performed in chronological order. That is, the company should post all the
debits and credits of a particular day journal before proceeding to the next day journal entry.
Postings should be made on a timely basis to ensure that the ledger is up to date.
The reference column of a ledger account appoints the journal page from which the transaction
was posted. The explanation column of the ledger account is used infrequently because an
explanation already appears in the journal.
Illustration 2.7.2 below displayed all the postings of the above journal.
iii. Posting the Journal to a ledger
Illustration 2.7.2 posting of the above journal to the respective general ledgers accounts
Cash Account No.11
Date Explanation P/R Debit Credit Balance
2016
April 1 Jp1 50,000 50,000
3 Jp1 3,000 47,000
8 Jp1 20,000 27,000
12 Jp1 10,000 17,000
14 Jp1 3,200 13,800
14 Jp1 2,400 11,400
18 Jp1 14,800 26,200
21 Jp1 15,000 11,200
24 Jp1 2,000 13,200
26 Jp1 650 12,550
27 Jp1 420 12,130
27 Jp2 4,000 16,130
29 Jp2 6, 400 9, 730
30 Jp2 1,800 7, 930

Accounts Receivables Account No. 12

Date Explanation P/R Debit Credit Balance
2016
April 23 Jp1 9,600 9,600
27 Jp1 4,000 5,600

Supplies Account No. 13

Date Explanation P/R Debit Credit Balance
2016
April 14 Jp1 3,200 3,200
 Prepaid Insurance Account No. 14
Date Explanation P/R Debit Credit Balance
2016
April 14 Jp1 2,400 2,400

Office Equipment Account No. 15

Date Explanation P/R Debit Credit Balance
2016
April 14 Jp1 10,000 10,000

Truck Account No. 16

Date Explanation P/R Debit Credit Balance
2016
April 8 Jp1 60,000 60,000

Notes Payable Account No. 21

Date Explanation P/R Debit Credit Balance
2016
April 8 Jp1 40,000 40,000
21 15,000 25,000

Accounts Payable Account No. 22

Date Explanation P/R Debit Credit Balance
2016
April 25 Jp1 1,000 1,000

Unearned Service Revenue Account No. 23

Date Explanation P/R Debit Credit Balance

2016 25 Jp1 2,000 2,000

April
Enkopa's Capital Account No. 31
Date Explanation P/R Debit Credit Balance
2016
April 1 Jp1 50,000 50,000

April
Enkopa's Drawing Account No. 32
Date Explanation P/R Debit Credit Balance
 2016 30 Jp2 1,800 1,800

Service Fee Account No. 41

Date Explanation P/R Debit Credit Balance
2016 18 Jp1 14,800 14,800
23 Jp1 9,600 24,400

Salary Expense Account No. 51

Date Explanation P/R Debit Credit Balance
2016 29 Jp2 6,400 6,400

Rent Expense Account No. 52

Date Explanation P/R Debit Credit Balance
2016 3 Jp1 3,000 3,000

Utilities Expanse Account No. 53

Date Explanation P/R Debit Credit Balance
2016 26 Jp1 650 650

Truck Expense Account No. 54

Date Explanation P/R Debit Credit Balance
2016 25 Jp1 1,000 1,000

Miscellaneous Expense Account No. 55

Date Explanation P/R Debit Credit Balance
2016 27 Jp1 420 420

2.2.3. Trial Balance

A trial balance is a list of accounts and their balances at a given time. It list accounts in the order
in which they appear in the charts of account. Debit balances appear in the left column and credit
balances in the right column.

The trial balance proves the mathematical accuracy and equality of the total debits and the
total credits after posting. Under the double-entry system, this equality occurs when the sum of
the debit account balances equals the sum of the credit account balances. In addition, a trial
balance is useful in the preparation of financial statements.
The steps for preparing a trial balance are:
1. List the account titles and their balances.
2. Total the debit and credit columns.
3. Prove the equality of the two columns.
[Link] Balance
Illustration 2.7.3. Trial balance
Enkopa House Finishing and Decor
Trial Balance
For the month ended April30, 1016

Account Title Debit Balance Credit Balance

Cash 7,930
Accounts Receivable 5,600
Supplies 3,200
Prepaid Insurance 2,400
Office Equipment 10,000
Truck 60,000
Notes Payable 25,000
Accounts Payable 1,000
Unearned Service Revenue 2,000
Enkopa's capital 50,000
Enkopa's Drawing 1,800
Service fee 24,400
Salary Expense 6,400
Rent Expense 3,000
Utilities Expense 650
Truck Expense 1,000
Miscellaneous Expense 420
Total 102,400 102,400

The trial balance for Enkopa House Finishing and Décor as of April30, 2016, is shown in
illustration [Link] balances of the accounts in the above trial balance is taken from the ledger
balance of the individual ledger illustration 2.7.2. Before the preparation of a trial balance the
individual account balance of each account of ledger must be determined. The trial balance
prepared immediately after completion of posting is called unadjusted trial balance. The above
trial balance is known as an unadjusted trial balance. This is to distinguish it from the adjusted
trial balances that we will prepare in the next chapters.
Limitations of a Trial Balance
A trial balance does not guarantee freedom from recording errors, however. Numerous errors may
exist even though the totals of the trial balance columns agree. For example, the trial balance may
balance even when (1) a transaction is not journalized, (2) a correct journal entry is not posted, (3)
a journal entry is posted twice, (4) incorrect accounts are used in journalizing or posting, or (5)
offsetting errors are made in recording the amount of a transaction. As long as equal debits and
credits are posted, even to the wrong account or in the wrong amount, the total debits will equal
the total credits. The trial balance does not prove that the company has recorded all
transactions or that the ledger is correct.

Locating Errors
In locating errors the first activity is to determine the amount of the difference between the two
columns of the trial balance. After this amount is known, the following steps are often helpful:
1. If the difference is Br. 10, Br.100, or Br.1,000, it may be addition error, re-add the trial
balance columns.
2. If the difference is divisible by 2, scan the trial balance to see whether a balance equal to
half the error has been entered in the wrong column.
3. If the difference is divisible by 9, it is a transposition and slide error while copying. Retrace
the account balances to see whether they are incorrectly copied from the ledger. For
example, if a balance was Br. 43 and it was listed as Br.34, a Br.9 error has been made.
Reversing the order of numbers is called a transposition error.
4. If the difference is not divisible by 2 or 9, scan the ledger to see whether an account balance
in the amount of the error has been omitted from the trial balance, and scan the journal to
see whether a posting of that amount has been omitted.
Correction of Error
Occasional error in journalizing and posting transactions are unavoidable. Procedures used to
correct error in the journal and ledger varies according to the nature of the error and the
duration which it is discovered.
If an error in the journal is discovered before the entry is posted, the correction will be made
by drawing a line through the error and insert the correct account or amount immediately
above.
 If an entry in the journal is recorded correctly, but incorrectly posted to wrong side, i.e debit
as credit, it will be corrected by drawing a line through the error and posting the correct item
above it.
If an error in the journal is discovered after it is posted to the ledger, it will be corrected by
recording and posting correcting entries.
Procedures for Correcting Entries
Error Correction procedure
• Error in recording but not yet posted Draw a single line through the error
• Correct recording but incorrect posting Draw a single line through the error
• Incorrect journal entry is posted Journalize and post correcting entry
2.3. Completing an Accounting Cycle for Service Giving Business
Dear students in the previous part of this section we have tried to learn how business transactions
are recorded posted and preparing of trial balance. Now in this part we will try to complete the
accounting cycle and to issue financial statement. Then some accounts are adjusted and we have
also seen why and how to adjust accounts. Completion of the accounting cycle involves the
following completion activities,

i. Preparation of work sheet(optional Step)

ii. Preparation of financial statements
a. Income Statement
b. Statements of Owners Equity
c. Statements of financial position
iii. Record and post adjusting entries
iv. Record and post closing entries
v. Preparation of post closing trial balance

The following trial balance is taken from Enkopa House Finishing prepared for April 30, 2016.
This trial balance is prepared by taking the ending balance of each ledger. Such trial balance
is referred to as unadjusted trial balance. So, adjusting (updating) accounts are required before
preparation of financial statement. Although issues of Adjusting accounts will be deeply
discussed in chapter 3, the following are the reasons for adjustment
 1. To record those events which are not journalized daily, for example daily consumption of
supplies like a piece of paper
2. To record those costs, which expire with time and are therefore not recorded, for example
prepaid insurance or rent
3. To record those items previously unrecorded, for example accrued salary
Using the following information perform the instructions ordered below.
Enkopa House Finishing and Décor

Unadjusted Trial Balance

For the month ended April30, 1016

Account Title Debit Balance Credit Balance

Cash 7,930
Accounts Receivable 5,600
Supplies 3,200
Prepaid Insurance 2,400
Office Equipment 10,000
Truck 60,000
Notes Payable 25,000
Accounts Payable 1,000
Unearned Service Revenue 2,000
Enkopa's Capital 50,000
Enkopa's Drawing 1,800
Service fee 24,400
Salary Expense 6,400
Rent Expense 3,000
Utilities Expense 650
Truck Expense 1,000
Miscellaneous Expense 420
Total 102,400 102,400

Information for adjustments

• Supplies on hand April 30,2016 Br.1,200

• Insurance expired during April 30,2016 Br. 200
• Deprecation of for Truck April 30,2016 Br. 100
• Deprecation of office equipment for April 30,2016 Br. 150
• Revenue earned for April 30, 2016, Br.1,300
• Salary accrued but not yet paid Br. 1,250
Instructions:- using the above information perform:
 i. Prepare work sheet
ii. Prepare of financial statements
a. Income Statement
b. Statements of Owners Equity
c. Statements of financial position
iii. Record and post adjusting entries
iv. Recording and posting closing entries
v. Prepare Post Closing trial balance
vi. Preparation of post closing trial balance

i. Work Sheet

Worksheet is a working paper of an accountant. It showed the details of accounting works and
adjustment to check their arithmetical accuracy before preparing financial statements.

It is a multi-columnar sheet of paper used in the accounting cycle to facilitate the work of making
adjusting and closing entries and preparing financial statements. It is a working paper, which helps
the accountant to assemble all the ledger account balance and adjustment information together on
one schedule.

The basic objective of a worksheet is to organize the information needed to prepare financial
statement without recording and posting adjusting entries.

Worksheet is a working tool or a supplementary device for the accountant and not a permanent
accounting record.

A worksheet generally contains eight to ten columns. A ten column work sheet contains the
following five column heading. Each item needs two amount column, one for debit the other for
credit.

▪ Unadjusted Trial Balance:-a trial balance shows the balance of all accounts after adjustment
at the end of the accounting period.
▪ Adjustments:- Shows accounts that are adjusted as per the adjustment information.
▪ Adjusted trial balance:-a trial balance shows the balance of all accounts after adjustment at
the end of the accounting period.
▪ Income statement:- shows all revenue and expense accounts extended from the adjusted trail
balance.
▪ Balance sheet. Shows all asset, liability, and equity accounts extended from the adjusted trail
balance.

Steps in preparing worksheet

Step 1 entering unadjusted trial balance
Step 2 enter adjustments in the adjustments column
Step 3 prepare adjusted balance using unadjusted trial balance and adjustments column
Step 4 Extend the adjusted trial balance to the appropriate financial statements
Step 5 Total the income statement column and compute net income or net loss
Step 6 Extend the amount of the net income to credit column or the net loss to the debit column of
the balance sheet and equate the columns

Enkopa House Finishing and Décor

Work Sheet
For April 30,1016
Unadjusted Trial Adjusted trail Income
Adjustment Balance Sheet
Balance Balance Statement
Account Title
Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit
Cash 7,930 7,930 7,930
Accounts 5,600 5600 5600
Receivable
Supplies 3,200 a)2,000 1200 1200
Prepaid Insurance 2,400 b)200 2,200 2,200
Office Equipment 10,000 10,000 10,000
Accumulated
d)100 100 100
Depreciationequip.
Truck 60,000 60,000 60,000
Accumulated c)150 150 150
Depreciation
on truck
Notes Payable 25,000 25,000 25,000
Accounts Payable 1,000 1,000 1,000
Salary Payable g) 1250 1,250
Unearned Service 2,000 e)1,300 1250 700 700
Revenue
Enkopa's Capital 50,000 50,000 50,000
Enkopa's 1,800 1800 1,800
Drawing
Service fee 24,400 e)1,300 25,700 25,700
Salary Expense 6,400 g)1,250 7,650 7,650
Rent Expense 3,000 3,000 3,000
Utilities Expense 650 650 650
 Truck Expense 1,000 1000 1,000
Miscellaneous 420 420 420
Expense Expense
Supplies a)2,000 2000 2,000
Insurance b) 200 200 200
Expense
Deprecation c,d) 250 250 250
Expense
Total 102,400 102,400 5,400 5,400 103,900 103700 15,170 25700 88,730 78200
Net income 10,530 10,530
Total 25,700 25,700 88,730 88,730

Illustration 3.7 shows you how to prepare worksheet

a. Statements of profit or loss and other comprehensive income

Enkopa House Finishing and Décor

Statements of profit or loss and other Comprehensive Income
For April 30,1016

Revenues
Service Revenue Br. 25,700
Expenses
Salary Expense Br. 7,650
Rent expense 3,000
Utilities Expense 650
truck expense 1,000
Miscellaneous expense 420
supplies expense 2,000
insurance expense 200
Depreciation Expense 250
Total Expense 15,170
Net Income 10,530

b. Owners Equity Statement

Enkopa House Finishing and Décor

Statements of Owner's Equity
For April 30,1016

Owners Capital January 1, 50,000

Add Net income 10,530
sub total 60,530
Less Drawing 1,800
Owner's capital August 30, 58,730
 c. Statements of Financial Position

Enkopa House Finishing and Décor

Statements of Financial Position

For April 30,1016

Asset
Non Current Asset
Property, Plant and Equipment
Truck 60,000
Accumulated depreciation on truck 150

59,850
Equipment 10,000
Accumulateddepreciation on equipment 100

9,900
Total PPE’s 69,750
Current Asset
Prepaid Insurance 2,200
Supplies 1,200
Accounts Receivable 5,600
Cash 7,930
Total Current asset 16,930
Total Asset 86,680
Liability and Equity
Owners equity
Enkopa.’s Capital Br. 58,730
Liabilities
Accounts Payable 1,000
Salary Payable 1,250
Unearned Revenue 700
Notes Payable 25,000
Total Liability 27,950
Total Equity and liabilities Br. 86,680
 vii. Recording Adjusting Entry

Adjusting Entry

2016 30 Supplies Expense 2000

Supplies 2000
(Adjustment of supplies)
30 Insurance Expense 200
Prepaid Insurance 200
(Adjustment of insurance)
30 Deprecation Expense 150
Accumulated [Link] 150
(Recognition of Deprecation)
30 Deprecation Expense 100
Accumulated [Link] 100
30 Unearned Revenue 1,300
Service revenue 1,300
(Adjustments of unearned rev)
30 Salary Expense 1,250
Salary Payable 1,250
(Recording Accrued Salary)

vi. Recording Closing Entry

Closing Accounts

The revenue, expenses, and drawing accounts are temporary accounts used in classifying and
summarizing changes in the owner’s equity during the accounting period. At the end of the period,
the net effect of the balances in these accounts must be included in the permanent capital (Retained
Earnings) account through closing entry. The balances must also be removed from the temporary
accounts and transferred to permanent account so that will be ready for use in accumulating data
for the following account period. Both of these goals are accomplished by a series of entries is
called closing entries. Closing entries transfer the balances of temporary accounts to the owner’s
capital account.
The closing process involves the following four steps:

1. Revenue account balances are transferred to an account called Income Summary by debiting
each service fee and crediting Income Summary for the total revenue.

2. Expense account balances are transferred to an account called Income Summary by crediting
each expense account for its balance and debiting Income Summary for the total expenses.

3. The balance of Income Summary (net income or net loss) is transferred to the owner’s capital
account by debiting Income Summary for its balance and crediting the owner’s capital account

4. The balance of the Owner’s Drawing account is transferred to the Owner’s Capital account
debiting the owner’s capital account for the balance of the drawing account and crediting the
drawing account .

In the case of a net loss, Income Summary will have a debit balance after the first two closing
entries. In this case, credit Income Summary for the amount of its balance and debit the owner’s
capital account for the amount of the net loss. Closing entries are recorded in the journal and are
dated as of the last day of theaccounting period. In the journal, closing entries are recorded
immediately followingthe adjusting entries. The caption, Closing Entries, is often inserted above
the closing entriesto separate them from the adjusting entries
Closing Entries

Date Account Title and Descriptions P/R Debit Credit

2016 31 Service Fee 25,700

Income Summery 25,700
(Closing revenue Accounts)

31 Income Summery 15,170

Salary Expense 7,650
Rent Expense 3,000
Utilities Expense 650
Truck Expense 1,000
Miscellaneous expense 420
Supplies Expense 2,000
Insurance Expense 200
Depreciation Expense 250
(Closing Expense Accounts)

31 Income Summery 10,,530

Owner's Capital 10,530
(Closing income summery)
31 Owner’s Capital 1,800
Owner’s Drawing 1,800
(Closing Drawing account)

Post closing Trial Balance

A post-closing trial balance is prepared after the closing entries have been posted. Thepurpose of
the post-closing (after closing) trial balance is to verify that the ledger is inbalance at the beginning
of the next period. The accounts and amounts should agreeexactly with the accounts and amounts
listed on the statements of financial position at the end of the period.
 Enkopa House Finishing and Decor

Post Closing Trial Balance

For the month ended April30,1016

Account Title Debit Balance Credit Balance

Cash 7,930
Accounts Receivable 5,600
Supplies 1,200
Prepaid Insurance 2,200
Office Equipment 10,000
Accumulated deprecation 100
Truck 60,000
Accumulated deprecation 150
Notes Payable 25,000
Accounts Payable 1,000
Salary Payable 1250
Unearned Service Revenue 700
Enkopa's Capital 58,730
Total 86,930 86,930

SELF-EXAMINATION QUESTIONS

1. a debit signify
a. an increase in an asset account c. An increase in a liability account
b. a decrease in an asset account d. an increase in the owner’s capital
2. the type of account with the normal credit balance is:
a. Asset c. A revenue
b. Drawing d. An expense
4. the current asset category will include
a. cash c. Supplies on had
b. Accounts receivable d. all of the above
5. the receipt of cash from customers in payments of their accounts would be recorded by a
a. debit to cash, credit to accounts receivable
b. Debit to accounts receivable, credit to cash
 c. Debit to accounts payable, credit to accounts payable
d. debit to accounts payable, credit to cash
6. the form listing the balances and the titles of accounts in the ledger on a given date is the:
a. Income statement c. retained earning statement
b. statements of Financial position d. trial balance

ILLUSTRATIVE PROBLEM

Simret Abera, MD. has been practicing as a pediatrician for three years. During June, she has
completed the following transaction.

June 1, Paid office rent for June Br. 6,000

2, Purchased equipment on account Br. 20,000

5, Received Cash on account from patients Br. 10,000

8, Purchased X-Ray film and other supplies on account Br. 450

9, One of the items of equipment purchased on june2 was defective. it was returned with the
permission of the supplier, who agreed to reduce the account fot the amount charged for the item,
br. 200

12, paid cash to creditors on account, 7,600

16, Sold X-Ray film to another doctor at coat, as an accommodation, receiving cash, Br. 500

17, Paid cash for renewal of a 2-year property insurance policy, Br, 1,800

20, Discovered that the balance of cash, and accounts payable as of june1 were overstated by br
160. A payment of that amount to a creditor in May had not been recorded. Journalize the Br. 160
payments as of June 20.

23, Paid cash for laboratory analysis Br. 2,450

27, Paid cash from the business’s bank account for personal and family expenses br. 3,200

30, Recorded the cash received in payments of service to patients during June Br.13,700

30, Paid salaries of receptionists and nurses Br. 8,000

30, Paid water and electric expense Br,1,200

30, Recorded fees charged to patients on account for services performed Br, 3, 800
30, Paid telephone expense Br. 800

30, Paid miscellaneous expense br. 600

Samrwit’s Account titles, numbers, and balances as of June 1 are listed as follows: Cash, 11, Br,
3,123, Accounts receivables, 12, Br, 6,725, Supplies, 13 Br. 290, Prepaid Insurance, 14, Br. 365,
equipment, 15, Br. 19, 745, Accounts Payable, 21, BR. 765, Samrawit’s capital, 31,Br.29,483,
Samrawit’s drawing, 32,, Professional Fee, 41, Salary Expense, 51, rent expense, 53, Libratory
Expenses, 55 utility Expense, 56 Miscellaneous Expense, 59

Instructions

1. Open a ledger of four-column accounts for Dr. Samrawit as of june1 of the current year.
Enter the balances in the appropriate balance column and place a check mark (-) in the post
reference column.(Please check the equality of the debits and credits before proceeding to
the next instruction.
2. Record each transactions using general journal
3. Post the journal to the ledger, extending the month end balances to the appropriate balance
columns after all posting is completed.
4. Prepare a trial balance of june30.

Adjusting Accounts

The issue of Adjusting Accounts deals with the timing issue, the basics of adjusting entry and the
preparation of adjusted trial balance and financial statement.

Timing Issues
As per periodicity assumption, the economic life of the business is divided into artificial time
periods, i.e, a month, a quarter, or a year. An accounting period which covers less than a year
is an interim period and a financial report prepared for it is an interim report. An accounting time
period that covers one year or 12 months in length is called a fiscal year. A fiscal year usually
begins with the first day of a particular month and ends 12 months later on the last day of a month.
Many businesses use the calendar year (January 1 to December 31) as their accounting period.
Periodicity assumption requires revenues and expenses be reported in the proper period.
The Revenue Recognition Principle
As per IFRS revenue is recognized when the performance obligation is satisfied partially or
completely. The earning process goes in line with the satisfaction of a particular performance
obligation. In a service company revenue is usually considered to be earned at the time the service
is performed. Where as in a merchandising company revenue is considered to be earned at the time
the goods are delivered. Dear students you will learn the detailed concepts and applications of
revenue recognition principle in your Intermediate Financial Accounting I course.
To illustrate, assume that Dr. Leul Dental Clinic delivers brass dental service on December 25,
2016 but the customer going to pay for it on January 25, 2017. Here revenue should be recognized
on December 25 on the date service is performed rather than on January 25 cash is collected. At
December 31, the clinic would report a receivable on its statement of financial position and revenue
in its income statement for the service performed. This requires recording of the respective
adjusting entry.
Accrual versus Cash- Basis of Accounting
Under the accrual basis, companies record transactions that change a company’s financial
statements in the periods in which the events occur. This means that revenues should be
recognized in the period when service is performed and expenses should be recognized in the
period when incurred. Whether or not cash is received or paid. Accrual bases of accounting adhere
to revenue recognition principle. As you recalled from chapter one it is one of the assumption of
IFRS.

The alternative for the accrual basis is the cash basis of accounting. Under cash-basis accounting,
revenue is recognized when cash is received, when as expenses are recognized when cash is paid.
The cash basis seems appealing due to its simplicity, but it often produces misleading financial
statements. It fails to record revenue for a company that has performed services and expanse that
has incurred until cash is transacted. As a result, the cash basis does not obey the revenue
recognition principle.

The Basics of Adjusting Entries

At the end of the accounting period, many of the account balances in the ledger can be reported in
the financial statements without change. For example, the balances of the cash and office
equipment accounts are normally the amount reported on the balance sheet. Under the accrual
basis, however, some accounts in the ledger require updating because of the following reasons:

4. To record those events which are not journalized daily, for example daily consumption of
supplies like a piece of paper
5. To record those costs, which expire with time and are therefore not recorded, for example
prepaid insurance or rent
6. To record those items previously unrecorded, for example accrued salary
The process of updating an account is called adjusting. The journal entries recorded to that update
an account called adjusting entries. The entries are required each time when financial statement is
prepared. Each adjusting entries affect at least one income statement account and one balance sheet
account. Thus, an adjusting entry will always involve revenue or an expense account in one side
and an asset or a liability account in the other side.

Classifications and types of Adjusting Entries

Classification of Adjusting Entries

Adjusting entries can be categorized in to three. These are:

i. Prepayments or Deferrals (prepaid expense or unearned revenue),

ii. Accruals (Accrued revenue or Accrued expense), or
iii. Estimates ( Deprecation or amortization)
Types of Adjusting Entry

i. Prepayments (Deferrals)
To defer means to postpone or delay. Deferrals are expenses or revenues that are recognized at a
date later than the point when cash was originally paid or received. Companies make adjusting
entries for deferrals to record the portion of the deferred item that was incurred as an expense or
recognized as revenue during the current accounting period. The two types of deferrals are prepaid
expenses and unearned revenues.
Prepayments

1. Prepaid Expenses: Expenses paid in cash and recorded as assets before they are used or
consumed.

2. Unearned Revenues: Revenues received in cash and recorded as liabilities before they
are earned.

ii. Accruals

Accrual is the recognition of revenue or an expense that has arisen but has not yet been recorded.
The word “accrue” means to accumulate or grow in size. An accrual is the recognition of revenue
or an expense that has accumulated overtime but has not yet been recorded. In order to report the
company’s financial position and results of operation, the accruals requires adjustments. The
adjusting entries for accruals are used to record revenues earned and expenses incurred in the
current period. There are two types of accruals in accounting. These are:

Accruals

1. Accrued revenues: Revenues for services performed but not yet received in cash or
recorded.
2. Accrued expenses: Expenses incurred but not yet paid in cash or recorded.
iii. Estimates
Deprecation is an allocation of the cost of capital assets to expense over their useful [Link]
capital assets included office Equipments, Trucks or Building etc. These items give long years
service and their serving capacity will reduce as a passage of time through use. The cost of a
particular asset is allocated to expense by the amount of estimated reduction in periodic service
giving capacity. Here adjusting entries are required to recognise expenses resulted from usage of
capital assets.

Analyzing and Recording Adjusting Entries for Deferrals

Prepaid Expenses

When expenses are prepaid, an asset account called “prepaid expense” is increased (debited) to
show the service or benefit that the company will receive in the future. Examples of common
prepayments are insurance, supplies, advertising, and rent.
Prepaid expenses are costs that expire either with the passage of time (e.g., rent and
insurance) or through use (e.g., supplies). The expiration of these costs does not require daily
entries, which would be impractical and unnecessary. Accordingly, companies postpone the
recognition of such cost expirations until they prepare financial statements. At each statement date,
they make adjusting entries to record the expenses applicable to the current accounting period and
to show the remaining amounts in the asset accounts.
Prior to adjustment, assets are overstated and expenses are understated. Therefore, an adjusting
entry for prepaid expenses results in an increase (a debit) to an expense account and a
decrease (a credit) to an asset account.
Let’s look in more detail at some specific types of prepaid expenses, beginning with supplies.
Supplies
The purchase of supplies, such as paper and envelopes cleaning supplies, results in an increase (a
debit) to an asset account. During the accounting period, the company keeps using of the supplies
purchased without making the respective record. At the end of the accounting period, the company
counts the remaining supplies and deducts it from the unadjusted balance in the Supplies (asset)
account to determine the used portion. Then record an adjusting entry by debiting supplies
expenses and crediting supplies account for the used portion.

Illustration: As you remember the transaction 3 Enkopa House finishing and Décor of chapter 2,
the company purchased supplies costing Br. 3,200 on April 14,2016. The purchase was record by
debiting the asset account supplies. This account shows a balance of Br.3, 200 in the April 30 trial
balance. An inventory count at April 30 reveals that Br. 1,200 of supplies are remained on hand.
This means the company consumed supplies costing br. 2,000. This reduces supplies and increase
supplies expense by the amount consumed. As a result Enkopa needs to record this adjustment
using adjusting entries. Illustration 3.1 presents the adjustments.
2016
30 Supplies Expense 2,000
April
Supplies 2,000
(Adjustments for supplies Used)
After recording the adjusting entry it is posted to the appropriate accounts as follows.
Supplies Account No. 13

Date Explanation P/R Debit Credit Balance

2016
14 Jp1 3,200 3,200
April
30 Adjusting Entry 2,000 1,200

Supplies Expense Account No. 53

Date Explanation P/R Debit Credit Balance

2016 30 Adjusting Entry Jp1 2,000 2,000
April

NB: After adjustment, the asset account Supplies shows a balance of Br. 1,200, which is equal to
the cost of supplies on hand at the statement date. In addition, Supplies Expense shows a balance
of br. 2,000, which equals the cost of supplies used in April. If Enkopa did not make the
adjusting entry, April expenses are understated and net income is overstated by Br.
2,000. Moreover, both assets and equity will be overstated by Br.2,000 on the April 30
statement of financial position.

Insurance
Companies purchase insurance to protect themselves from losses due to fire, theft, and unforeseen
events. Insurance must be paid in advance, often for more than one year. The cost of insurance
(premiums) paid in advance is recorded as an increase (debit) in the asset account Prepaid
Insurance. At the financial statement date, companies increase (debit) Insurance Expense and
decrease (credit) Prepaid Insurance for the cost of insurance that has expired during the period.
Illustration: as you recall in previous chapter discussion Enkopa paid Br. 2,400 for a one year
insurance premium on April 14, 2016. The Company recorded the payment by increasing
(debiting) Prepaid Insurance and decreasing (Crediting) Cash. Prepaid insurance shows a debit
balance of Br.2,400 in the April 30, 2016 trial balance before adjustment. Insurance of Br. 200
expires each month. The adjusting entry is recorded in illustration 3.2 as follows.
 2016
30 Insurance Expense 200
April
Prepaid Insurance 200
(Adjustments for insurances Expired)
The above adjusting entry is posted to appropriate accounts as follows.
Prepaid Insurance Account No. 14

Date Explanation P/R Debit Credit Balance

2016
14 Jp1 2,400 2,400
April
30 Adjusting Entry 200 2,200

Insurance Expense Account No. 54

Date Explanation P/R Debit Credit Balance
2016 Adjusting
30 Entry Jp1 200 200
April

After posting the adjusting entry the asset Prepaid Insurance shows a balance of Br. 2,200, this
represents the unexpired cost for the remaining 11 months of coverage. On the other hand, the
balance in Insurance Expense equals the cost of insurance expired during April. If Enkopa does
not make this adjustment, April expenses are understated by Br. 200 and net income is
overstated by Br. 200. Moreover, both assets and equity will be overstated by 200 on the April
30 statement of financial position.
Alternative Treatment of Prepaid Expenses and Unearned Revenues
In discussing adjusting entries for prepaid expenses and unearned revenues, we have illustrated
transactions for which companies made the initial entries to statement of financial position
accounts. In the case of prepaid expenses, the company debited the prepayment to an asset account.
In the case of unearned revenues, the company credited a liability account to record the cash
received in advance.
Some companies use an alternative treatment: i.e. (1) When a company prepays an expense, it
debits an expense account instead of asset. (2) When it receives advance payment for future
services, it credits the amount to a revenue account instead of liability. Companies prefer to use
this alternatives if they think that prepayments are fully consumed in the period payment is made
and delivery of service is completed in the same period advance collection is made. This
alternative treatment of prepaid expenses and unearned revenues has the same effect on the
financial statements as the procedures described in the chapter.
Prepayments initially recognized as expense
To illustrate, assume that on December 1, 2016 Fresh Corner acquired supplies of Br. 1,000 for
cash. The company records prepayments initially as expanse and passes the following Journal
entry
2016 1 Supplies Expense 1000
Dec
Cash 1000
(to record purchase of supplies as expense)

As you see from the above illustration an expense account (supplies expense) recognized in
advance. Here the company expects that it will use all the supplies purchased before December 31.
If the supplies are used fully as expected there is no need for adjusting entry at the end of the
accounting period.
But what if, a br. 200 inventory of supplies is left un-used at the end of the month December 31.
If so adjusting entry is required to reduce the expense account (Supplies expense) and increase and
asset account (Supplies) by the amount of the unused portion of supplies as follows.
2016
31 Supplies 200
December
Supplies expense 200
(to record supplies inventory )
After recording the adjusting entry posting is made to the appropriate accounts as follows

supplies expense

Date Explanation P/R bit Credit Balance

2016 1 Jp1 1000 1,000
December 31 Adjusting entry Jp2 200 800
Supplies

Date Explanation P/R Debit Credit Balance

2016
31 Adjusting Entry Jp1 200 200
Dec

After posting the asset account Supplies shows a balance of Br.200, which is equal to the cost of
supplies on hand at December 31. In addition, Supplies Expense shows a balance of Br. 800. This
is equal to the cost of supplies used between December 1 and December 31. Without the adjusting
entry, expenses are overstated and net income is understated by 200 in the October income
statement. Also, both assets and equity are understated by Br.200 on the December 31 statement
of financial position.
Comparison of Adjustments of prepayments
Prepayments initially recorded as
Asset Expense
1 Supplies 1000 Supplies expense 1000
Cash 1000 Cash 1000
To record purchase of supplies
2 Supplies expense 800 Supplies 200
Supplies 800 Supplies expense 200
Adjustment at used portion Adjust at unused portion

supplies
Supplies
Debit Credit
Credit
Debit
Dec 1 - -
Dec 1, 1,000
Dec 31 200
800 Dec 31
Bal. Br. 200
Bal. Br. 200
 Supplies Expense Supplies Expense

Credit Credit
Debit Debit Dec1
Dec 1, - 1000 -

Dec.31 800 200 Dec31

Bal. Br.800
Bal. Br. 800

As you see from the above illustration the ending balance of supplies ledger under both treatments
the same Br. 200 and also supplies expanse account shows an equal balance of in both cases. As
a result the alternative treatment of prepaid expenses has the same effect on the financial statements
as the procedures described in the chapter.
Unearned Revenue
When companies receive cash before performing service, they record a liability by increasing
(crediting) Unearned Revenue. Advance collections for rent, magazine subscriptions, airplane
tickets and tuition may result in unearned revenues. Unearned revenue represents the presence of
performance obligation (liability) to deliver a service to particular customers. The company
subsequently recognizes revenues when service is performed. But performance of service does
not involve daily transaction. As a result the recognition of revenue delays until the date of
adjustment. Then, the company makes an adjusting entry to record the revenue earned for services
performed and the liability settled at the end of the accounting period. Typically, prior to
adjustment, liabilities are overstated and revenues are understated. Therefore, as shown
in Illustration 3.3, the adjusting entry for unearned revenues results in a decrease (a debit) to
a liability account and an increase (a credit) to a revenue account.

Alternative Terminology: Unearned revenue is sometimes referred to as deferred revenue.

Illustration: As you remember from Illustration 3.3 of chapter 2 Enkopa received Br. 2,000 from
clients in advance for the finishing service. Unearned Service Revenue shows a balance of Br.2,
000 in the April trial balance. Analysis reveals that the company performed Br.1, 300 services in
April.
The liability (Unearned Service Revenue) is therefore decreased, and equity (Service Revenue) is
increased by the amount.
 30 Unearned service Revenue 1,300
Service Revenue 1,300
(Adjustments for unearned revenue)

Unearned Service revenue Account No. 23

Date Explanation P/R Debit Credit Balance

2016
25 Jp1 2,000 2,000
April
30 Adjusting Entry 1,300 700

Service Revenue Account No. 41

Date Explanation P/R Debit Credit Balance

2016
18 14, 800 14,800
April
23 Jp1 9,600 24,400
30 Adjusting Entry 1,300 25,700

After recording and posting adjusting entries the liability Unearned Service Revenue now
shows a balance of Br.700 I.e the amount represents the remaining finishing services expected to
be performed in the future. On the other hand Service Revenue shows total revenue recognized in
April 26,600. Without this adjustment, revenues and net income are understated by Br. 1,300.
Moreover, liabilities are overstated and equity is understated by Br. 1,300 on the April 30
statement of financial position.
Advance Collections Initially Recognized as Revenue
Unearned Revenue
Unearned revenues are recognized as revenue at the time services are performed. Similar to the
case for prepaid expenses, companies may credit (increase) revenue account when they receive
cash for future services.

To illustrate, assume that on December 1Birhana Selam Printing press received Br. 8,000 in
advance to subscribe publishing service and expects to perform the services before December 31.
As per this expectation the company records advance collection as revenues.
 2016 1 Cash 8,000
December
Service fee 8,000
(to record advance collection )

If the publication service is fully performed as expected there is no need for adjusting entry at the
end of the accounting period.
But what if, a br. 1,800 worth subscription service is not yet performed on December 31. If so
adjusting entry is required to reduce the revenue account (Service fee) and increase a liability
account (unearned service fee) by the amount of the unfulfilled portion of supplies as follows.

2016
1 Service fee 1,800
December

Unearned service fee 1,800

(to adjust advance collection )

After recording the adjusting entry posting is made to the appropriate accounts as follows

Service fee

Date Explanation P/R Bit Credit Balance

2016
1 Jp1 8000 8, 000
December
31 Adjusting entry Jp2 1,800 6,200

Unearned service fee

Date Explanation P/R Debit Credit Balance

2016
31 Adjusting Entry Jp1 1,800 1,800
Dec

The liability account Unearned Service fee shows a balance of Br.1,800. This equals the services
that will be performed in the future. In addition, the balance in Service fee equals the services
performed in December. Without the adjusting entry, both revenues and net income are overstated
by Br. 1800 in the December income statement. Also, liabilities are understated by Br. 1,500, and
equity is overstated by Br.1,500 on the December 31 statement of financial position.

Comparison of Adjustments of unearned revenue

Unearned Initially Recorded as:
Liability Revenue
1 Cash 8,000 Cash 8,000
Unearned serv. fee 8,000 Service fee 8,000
To record purchase of supplies

2 Unearned serv. fee 6,500 Service fee 1,500

Supplies 6,500 Unearned [Link] 1,500
Adjustment at performed portion Adjust at unperformed portion

Unearned service fee

Credit
Debit
- 8,000 Dec 1

Dec 31 , 6,500 Bal. Br. 1,500

Unearned service fee

Debit Credit
-
- Dec 31
1,500 Dec31
Bal. Br. 1,500
 Service fee
Service fee
Credit
NB: Credit Dear
Debit - - Dec 1
Debit - 8,000 Dec1
Dec.31
Bal. Br.6,500 Dec 31 1,500
6,500 Dec 31 Bal. Br.6,500
student, under both treatments service fee, has a
balance of Br. 6,200 and unearned service fee has a balance of Br. 1,800. As a result application
of the treatments has the same effect on income statement and financial position statement.

NB: this alternative treatment for unearned revenue is not recommended by IFRS

Synopsis of lecture:
• As per periodicity assumption an accounting time period that covers a year in length or 12
months is called a fiscal year.
• The revenue recognition principle stats that revenue should be recognized in the period in
which it is measured reliably.
• The principle of expense recognition is referred to as the matching principle.
• The journal entries that bring the accounts up to date at the end of the accounting period
are called adjusting entries.
• Adjusting entries can be categorized in to three. i.e. Deferrals (prepaid expense or
unearned revenue),Accruals (Accrued revenue or Accrued expense), and Estimates (
Deprecation or amortization)
- Deferrals are expenses or revenues that are recognized at a date later than the point
when cash was originally paid or received
- Accrual is the recognition of revenue or an expense that has arisen but has not yet
been recorded.
Analyzing and Recording Adjusting Entries for Accruals
Accrued Revenue
Revenues for services performed but not yet collected and recorded at the statement date
are accrued revenues. Accrued revenues may accumulate (accrue) with the passing of time, as in
the case of interest revenue. These are unrecorded because the earning of interest does not involve
daily transactions. Companies do not record interest revenue on a daily basis because it is often
impractical to do so. Accrued revenues also may resulted from services that have been performed
but not yet billed or collected, as in the case of commissions and fees. These may be unrecorded
because only a portion of the total service has been performed and the clients will not be billed
until the service has been completed.

An adjusting entry records the receivable that exists at the statement of financial position date and
the revenue for the services performed during the period. Prior to adjustment, both assets and
revenues are understated. As shown in illustration 3.3, an adjusting entry for accrued revenues
results in an increase (a debit) to an asset account and an increase (a credit) to a revenue
account.
NB: For accruals, there may have been no prior entry, and the accounts requiring adjustment may
both have zero balances prior to adjustment.

Illustration: during the month April Enkopa performed finishing services worth Br. 800 that were
not billed to clients on or before April 30.

Because these services are not billed, they are not recorded. The accrual of unrecorded service
revenue increases an asset account called Accounts Receivable. It also increases equity by
increasing a revenue account, Service Revenue, as shown in illustration 3.4.

30 Accounts Receivable 800

Service Revenue 800
(Adjustments for unearned revenue)

Accounts Receivables Account No. 12

Date Explanation P/R Debit Credit Balance

2016
23 Jp1 9,600 9,600
April
30 Adjusting Entry 4,000 5,600
30 Adjusting Entry 800 6,400
 Service Revenue Account No. 41

Date Explanation P/R Debit Credit Balance

2016
18 14, 800 14,800
April
23 Jp1 9,600 24,400
30 Adjusting Entry 1,300 25,700
30 Adjusting Entry 800 26,500

After posting the adjusting entry the asset Accounts Receivable shows a balance of Br.6,400 i.e
(9,600-4,000+ 800) on the other hand the updated balance of service revenue is 26,500, i.e (Br.
14,800 + 9,600 +1,300+ 800). Without the adjusting entry, assets and equity on the statement
of financial position and revenues and net income on the income statement are understated.
Accrued Expenses
Expenses incurred but not yet paid or recorded at the statement date are called accrued expenses.
Salary payables, rent payable, Interest payable, are common examples of accrued expenses.

Companies make adjustments for accrued expenses to record the obligations that exist at the
statement of financial position date and to recognize the expenses that are applied to the current
accounting period. Prior to adjustment, both liabilities and expenses are understated. Therefore an
adjusting entry has to be made that result in an increase (a debit) to an expense account and
an increase (a credit) to a liability account.

Illustration: Enkopa paid salaries and wages on April 25 for its employees’ first two weeks of
work. The next payment of salaries will not occur until May 10. As illustration 3.5 Shows, five
working days salary of Br. 1,250 is remained unpaid and unrecorded in April (April 26–30).
Recording adjusting entries for accruals
2016
30 Salary Expense 1,250
April
Salary payable 1,250
(Recognition of Accrued Expense)
As you see from the above table, the company accrued 5 days salary and record adjusting entries
At April 30. The entry increases both an expense(salary expense) and a liability account (Salaries
Payable). It also decreases equity by increasing an expense account, Salaries and Wages Expense.
Posting Adjusting entries
Salary payable Account No. 24

Date Explanation P/R Debit Credit Balance

2016
30 Adjusting Entry Jp2 1,250 1,250
April

Salary Expense Account No. 51

Date Explanation P/R Debit Credit Balance

2016
29 Jp1 6,400 6,400
April
30 Adjusting entry Jp2 1,250 7,650

After posting the adjusting entry, the balance in Salaries and Wages Expense of Br.7,650 is the
actual salary and wages expense for April. The balance in Salaries and Wages Payable of Br. 1,250
is the amount of the liability for salaries and wages Enkopa owes as of April 30. Without the Br.1,
250adjustmentsfor salaries expense, the company understated expense by Br. 1,200 and its
liabilities by Br.1, 250.
Deprecation
A company typically owns a variety of assets that have long lives, such as buildings, equipment,
and motor vehicles. The period of service is referred to as the useful life of the asset. Because a
building is expected to be of service for many years, it is recorded as an asset, rather than an
expense, on the date it is acquired. As explained in Chapter 1, companies record such assets at
cost, as required by the historical cost principle. To follow the expense recognition principle,
companies allocate a portion of this cost as an expense during each period of the asset’s useful life.
Depreciation is the process of allocating the cost of an asset to expense over its useful life.
The acquisition of long-lived assets is essentially a long-term prepayment for the use of an asset.
An adjusting entry for depreciation is needed to recognize the cost that has been used (an expense)
during the period and to report the unused cost (an asset) at the end of the period. An important
point to understand here is that: Depreciation is a concept of cost allocation, not a valuation
concept. That is, depreciation allocates an asset’s cost to the periods in which it is used.
Depreciation does not attempt to report the actual change in the value of the asset.
Illustration 3.6, As per illustration 2.8 of chapter 2 Enkopa acquired equipment and Truck worth
Br. 10,000 and Br. 60,000. Assume that depreciation on the equipment and truck is Br. 1,200 and
1,800 a year, or br. 100 and 150 per month respectively.

30 Depreciation Expense 250

Accumulated depreciation-equipment 100
Accumulated depreciation-Truck 150
(Adjustments for unearned revenue)

Accumulated depreciation-equipment Account No. 15-1

Date Explanation P/R Debit Credit Balance

2016
30 Adjusting Entry Jp1 100 100
April

Accumulated depreciation- Truck Account No. 16-1

Date Explanation P/R Debit Credit Balance

2016
30 Adjusting Entry Jp1 150 150
April

Depreciation Expense Account No. 57

Date Explanation P/R Debit Credit Balance
2016 30 Adjusting Entry Jp1 250 250

April

Here rather than decrease (credit) the asset account directly, Enkopa credits Accumulated
Depreciation—Equipment and accumulated depreciation on Truck account. Accumulated
Depreciation is called a contra asset account. Such an account is offset against an asset account on
the statement of financial position. This account keeps track of the total amount of depreciation
expense taken over the life of the asset. To keep the accounting equation in balance, Enkopa
increasing an expense account, Depreciation Expense.

The balance in the Accumulated Depreciation—Equipment and Accumulated Depreciation –

Truck account will increase Br. 100 and 150 each month, and the balance in Equipment and truck
remains Br, 10,000 and br. 60,000 respectively.
Statement Presentation
As indicated, Accumulated Depreciation—Equipment is a contra asset account. It is offset against
Equipment on the statement of financial position. The normal balance of a contra asset account is
a credit. A theoretical alternative to using a contra asset account would be to decrease (credit) the
asset account by the amount of depreciation each period. But using the contra account is preferable
for a simple reason: It discloses both the original cost of the equipment and the total cost that has
been expensed to date. Thus, in the statement of financial position, Enkopa deducts Accumulated
Depreciation—Equipment from the related asset account. The same procedure is made while
presenting truck on the statements of financial position.

NB: All contra accounts have increases, decreases, and normal balances opposite to the account
to which they relate.

Statement of financial position presentation of accumulated depreciation

Equipment Br. 10,000

Less Accumulated Deprecations-Equipment 100

Br.9,000

The Adjusted Trial Balance and Financial Statements

After a company has journalized and posted all adjusting entries, adjusted trial balance is prepared
using updated balance of the ledger accounts. Adjusted trial balance shows the balances of all
adjusted accounts, at the end of the accounting period. The purpose of an adjusted trial balance is
to prove the equality of the total debit with the total credit after adjustment. The adjusted trial
balance is the basis for the preparation of financial statements.

Synopsis of Lecture
 • Adjusting entries should not involve debits or credits to cash.
• Adjusting entries for accruals will increase both a statement of financial position and an
income statement account.
• Each adjusting entry affects one statement of financial position account and one income
statement account.
• Adjusted trial balance is thebasis for the preparation of Financial Statements.

SELF EXAMINATION QUESTION

1. Which of the following is correct when a company uses accrual bases of accounting
a. Revenue is recognized only when cash is received
b. Expense should be recorded in the period when cash is paid
c. Revenue and expense relating for the period should be recognizes regardless of cash exchange
d. revenue should be recognized in accrual bases and expenses on cash payment basis
2. An accrued expense was overlooked to be recorded when preparing income statement, the effect of this
error is that
a. Net income is not affected but liability is overstated
b. Net income is overstated and liability is understated
c. Net income as well as liability are overstated
d. Net income as well as liability are understated
3. a staff salary remained unpaid as of the year end should be incurred by
a. debiting salary accrued and crediting staff salary expense
b. debiting staff salary expense and crediting salary accrued account
c. Debiting prepaid salary and credit staff salary account
d. debiting staff salary expense and crediting cash
4. Prepaid rent account has a balance of br. 9,800 at the beginning of the year, The company is agreed to
pay br. 1,200 per month. assume the company is unable to make any payment for rent during the year,
which of the following holds true at the end of the fiscal year?
a. Prepaid rent has a balance of br. 4,800
b. Accrued rent has a balance of Br. 9,800
c. Prepaid rent has a balance of br. 9,800
d. Accrued rent has a balance of Br. 4,800
5. Which of the following statements is incorrect concerning the worksheet?
a. The worksheet is essentially a working tool of the accountant.
b. The worksheet is distributed to management and other interested parties
c. The worksheet cannot be used as a basis for posting to ledger accounts.
d. Financial statements can be prepared directly from the worksheet before journalizing and
posting the adjusting entries.
6. In a worksheet, net income is entered in the following columns:
a. Income statement (Dr) and balance sheet (Dr).
b. Income statement (Cr) and balance sheet (Dr).
c. Income statement (Dr) and balance sheet (Cr).
7. When a net loss has occurred, Income Summary is:
a. Debited and Owner’s Capital is credited.
b. Credited and Owner’s Capital is debited.
c. Debited and Owner’s Drawings is credited.
d. Credited and Owner’s Drawings is debited.
8. The closing process involves separate entries to close (1) expenses, (2) drawings, (3)
revenues, and (4) income summary. The correct sequencing of the entries is:
a. (4), (3), (2), (1)
b. (3), (1), (4), (2)
c. (1), (2), (3), (4)
d. (3), (2), (1), (4)
9. The proper order of the following steps in the accounting cycle is:
a. Prepare unadjusted trial balance, journalize transactions, post to ledger accounts,
journalize and post adjusting entries.
b. Journalize transactions, prepare unadjusted trial balance, post to ledger accounts,
journalize and post adjusting entries.
c. Journalize transactions, post to ledger accounts, prepare unadjusted trial balance,
journalize and post adjusting entries.
d. Prepare unadjusted trial balance, journalize and post adjusting entries, journalize
transactions, post to ledger accounts.