Fundamentals Accounting I

CHAPTER Three and Four
THE ACCOUNTIG CYCLE for Service Business
Objectives
After studying this chapter, you should be able to:
1. Review the basic steps of the accounting cycle.

2. Explain the meaning and nature of accounts.
3. Apply the rules of debits and credits to record business transactions.
4. Prepare a work sheet.
5. Prepare financial statements from a work sheet.
6. Prepare adjusting and closing entries from a work sheet.
.
7. Explain what is meant by the fiscal year and the natural business year.
8.Identify accounts which have to be closed and prepare closing entries.
9. Identify accounts which require reversing at the beginning of the
next fiscal period and prepare reversing entries.
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3.1. Accounting Cycle Defined
It is a complete sequence of accounting procedures that are repeated in the same order
during each accounting period.
The basic procedures/phases in the accounting cycle are:
1. Identifying and analyzing business transaction.
2. Recording business transaction in a journal.
3. Classifying data by posting transactions from the journal to a ledger.
4. Preparation of unadjusted trial balance.
5. Adjusting, correcting, and updating recorded data; completion of the
worksheet.
6. Preparation of financial statements.
7. Closing nominal accounts to summarize the operation of the accounting period.
8. Preparation of post closing trial balance.
9. Reversing certain adjusting entries to facilitate the recording process in the
subsequent accounting period.
3.2. The Use of Accounts for Recording Transaction
The transactions completed by an enterprise during a specific time period may cause
increases and/or decreases in many different asset, liability, owners’ equity, revenue, and
expense items. To have the details of these transactions readily available and to prepare
financial statements, the effects of these transactions must be recorded in a systematic
manner. The accounting form that is used to record such effects in terms of increase and/or
decrease for each individual asset, liability, owner’s equity, revenue and expense items is
called an account. A group of related accounts that comprise a complete unit, such as all of
the accounts of a specific business enterprise, is called a ledger.
An account could be of three types:
1. The T account
2. The two-column account, and
3. The four-column account.
 The T Account
The T account is the simplest form of an account. It has got its name from the fact that
it resembles the capital letter T.
It has three major parts
 The title - for recording the name of the item.
 The debit, or left side- a space for recording the increases and/or decreases
in the amount of an item, in terms of money
 The credit, or right side- a space for recording the increases and/or decreases
in the amount of an item, in terms of money
The T Account _ Format

Title
Debit = (Left side) Credit = (Right side)
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 The Two-Column Account
The Two-Column Account _ Format

Account Account number
Date Item P.R Debit Date Item P.R Credit
 The Four-Column Account

Advantages of the four –column account over the two- column account:-
 It uses only one date column i.e., it saves time.
 It provides an easy means of analyzing and examining the accounts.
 It shows the chronological order (facilitates easily location of accounts)
 The most advantage is making balances of accounts always available.
The Four-Column Account _ Format

Account Account number
Balance
Date Item P.R Debit Credit Debit Credit
Notes:
- Often Debits and Credits are abbreviated as “Dr” and “Cr” respectively, based on
the Latin terms “Debere” and “Credere”
- Amounts entered on the left side of an account, regardless of the account title, are
called debits or charges to the account , and the account is said to be “Debited” or
“Charged”
- Amounts entered on the right side of an account, regardless of the account title, are
called credits , and the account is said to be “Credited”
3.3. Classification of Accounts

Accounts are classified into five as: Asset, Liability, owner’s equity, Revenue, and
Expense. According to their common characteristics the first three accounts are known as
Balance Sheet Accounts and the other two accounts are called Income Statement
Accounts.
1. Balance Sheet accounts: are those accounts that are reported on the balance sheet at the
end of the reporting period. It includes:-
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a) Assets
They are properties/resources with monetary value that are owned by a business or
individuals. Assets could be tangible or intangible. Tangible assets are those assets
having physical existence, like Cash, Land, Computer, Stationery Materials etc. Intangible
assets are those assets that do not have physical existence like for example: Goodwill,
Copyright, Patent Right etc. On the other hand for the purpose of presentation on the
balance sheet assets are classified into two as Current Assets and Non – Current Assets.
i. Current Assets – are those assets, which can be used, sold, or converted into cash
within one accounting period. Example: cash, supplies, prepayments, receivables
etc.
ii. Non-current Assets: all assets other than current assets are called non-current
assets. They are also known as plant assets or fixed assets. Examples: land, office
equipment, building, trucks etc.
b) Liabilities
They are debts owed to outsiders (creditors) and frequently described on the balance
sheet by titles that include the word “payable”. Like assets, liabilities are classified in to
two as Current Liabilities and Non – Current Liabilities
i. Current Liabilities: are liabilities that will be due within short time (usually one
year or less). Examples: Accounts Payable, Rent Payable, Salary Payable etc.
ii. Non – Current Liabilities: are debts that are not required to be paid within one
accounting period. They are also called long term liabilities. Examples: long term
notes payable, mortgage payable etc.
c) Owner’s Equity
It is a residual claim against the asset of the business after the total liabilities are
deducted. For a corporation, owner’s equity is frequently called stockholders equity or
shareholders equity. Examples:
Capital Account- for sole proprietor ship and partnership.
Capital stock and Retained earnings - for corporation
Drawing account – for sole proprietor ship and partner ship.
Dividend account – for corporation.
2. Income Statement Accounts: are those accounts that are reported on the income
statement during the accounting period. It includes:-
a) Revenues
They are gross increases in owner’s equity resulting from the main operations of the
business. Examples of revenue accounts are fees earned, fares earned, sales, interest
income, insurance premium, sales commission etc.
b) Expenses
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They are decreases in owner’s equity in the process of earning revenue. Examples of
expenses are insurance expense, depreciation expense, supplies expense, utilities expense,
rent expense etc.
3.4. Chart of Accounts

It is a listing of the account titles and account numbers (codes) being used by a given
business. In numbering (coding) accounts the first digit indicates the major division of the
ledger in which the account is placed. Accounts beginning with 1 represent assets; 2,
liabilities; 3, owner’s equity; 4, revenue; 5, expenses. The second digits indicate the position
of the account within its division. 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 disturbing the
other account numbers.
Example: Look at the following chart of accounts for Bati Transport, a Sole Proprietorship
owned by Ato Yimer.
Bati Transport
Chart of Accounts
1. Assets 2. Liabilities 5. Expenses

21 Accounts Payable 51 Salaries Expenses
11 Cash 22 Notes Payable 52 Rent Expenses
12 Accounts Receivable 53 Utilities Expenses
14 Supplies 3. Owners Equity 54 Supplies Expenses
15 Prepaid Insurance 31 Yimer, Capital 55 Insurance Expenses
16 Equipments 32 Yimer, Drawing 56 Maintenance Expenses
17 Acc. Deprn -Equipments 33 Income Summary 57 Depreciation Expenses
18 Trucks 4. Revenue 58 Truck Expenses
19 Acc. Deprn. -Trucks 41 Service income 59 Misc. Expenses
In the chart of accounts, the asset accounts are listed according to their liquidity.
Liquidity is the ease with which an asset can be converted in to cash. Cash is the most
liquid asset so it is listed first. Accounts other than cash will be listed in their frequency
of use or in alphabetical order. The account number listed in front of each account is a
code to identify accounts. The number could be a two digit, three digit or more digits.
In the above example a two – digits code is used. When the chart of accounts is
prepared in an organization we say the ledger is opened.
3.5. Rules of Debit and Credit

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

Balance sheet accounts:
Increase in asset accounts - decrease in asset accounts
Decrease in liability accounts - increase in liability accounts
Decrease in owner’s equity accounts_ - increase in owner’s equity accounts _
except for drawing account (increasing) except for drawing account (decreasing)
Income statement Accounts:
Decrease in revenue accounts - increase in revenue accounts
Increase in expense accounts - decrease in expense accounts
- Normal Balance of Accounts (Balance Sides of Accounts)
Normal balance refers to the side of an account (Dr. or Cr.), which will have greater entries
than the other.
The sum of the increases recorded in an account is usually equals to or greater than the
sum of the decreases recorded in the account. For this reason, the normal balances of all
accounts are positive rather than negative and it is always recorded in the increasing
side of an account.
- Summary on the Rules of Debits and Credits:
Increase Decrease Normal Balance

Balance sheet accounts:
1. Asset Debit Credit Debit
2. Liability Credit Debit Credit
3. Owner's equity/stock holder’s equity
Capital Capital Stock Credit Debit Credit
Retained Earning Credit Debit Credit
Drawing Dividends Debit Credit Debit
Income statement Accounts:
1. Revenue Credit Debit Credit
2. Expense Debit Credit Debit
3.6. Recording Business Transactions in a Journal

When a business transaction takes place, source documents will be obtained and
recorded. The accounting record in which a transaction is initially recorded is known as
a journal. The journal is therefore referred to as “The book of original entry”. The
process of recording a business transaction in the accounting record is called
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Journalizing. Each one set of debits and credits for a transaction is called a journal
entry. An entry composed of two or more debits or of two or more credits is called
Compound Journal.
 The Journal commonly used to record all types of transactions is the General
Journal. Thus; in general journal transactions are recorded chronologically
indicating the dual effect of each transaction in to a minimum of two financial
statement accounts.
Look at the following format for a two column General Journal.
General Journal Page ________

Date Description P.R Debit Credit
Year
Month day Debited account title XXX XX
Credited account title X XX XX
Explanation
There are also other types of Journals like, Special journals that are used to record
specific types of transactions. The cash Journal, for instance, is used to record only
transactions affecting cash. The General Journal is used for illustrations in this chapter.
Special journals will be discussed later on Chapter five.
In recording a business transaction the following three basic questions must be

answered:
1. Which accounts are affected?
2. Is each account increased or decreased?
3. Which account is debited and which is credited?
- Steps in Journalizing a Transaction

The following steps should be followed in recording a transaction in the journal.
1. Record the date - Insert the year, the month, and the date as shown above on the
format.
2. Record the Debit- Insert the account debited in the description column and the
amount of debit in the debit column.
3. Record the credit- Insert the account credited below the debited account and
indented to the right in the description column and the amount of credit in the
credit column.
4. Explanation- Write a brief explanation or reference to source document in the
description column, when necessary.
Example: On January 10, 2003 3F Company paid Birr 6,000 to its employees as a
salary for the first week of the year.
This business transaction will be analyzed and recorded as follows.
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1. Which accounts are affected? Answer: Cash and Salary Expense.
2. Is each account increased or decreased? Answer: cash is decreased and salary
expense is increased.
3. Which account is debited and which is credited? Answer: Salary Expense is
debited because increase in expenses is recorded on the debit side. And cash is
credited because decrease in assets is recorded on the credit side.
4. Prepare the complete Journal entry.
2003 Description P.R Debit Credit

Jan. 10 Salary expense 6000 00
Cash 6000 00
(Payment of salary)
Illustration - 1
Hiwot Beauty Salon and Training Center, a newly established business with the aim of
providing training on beauty salon on fee basis as well as rendering decoration service
to clients has the following accounts in its ledger (chart of accounts).
1. Assets 2. Liabilities
111 Cash 211 A/Payable 5. Expenses
112 A/R 212 Notes Payable 511 Supplies expense
113 Supplies 213 Unearned Revenue 512 Salary expense
114 Prepaid Rent 214 Salary Payable 513 Rent expense
115 Prepaid Insurance 215 Interest Payable 514 Insurance expenses
121 Office Equip’t 515 Interest expense
122 Furniture 3. Owner’s equity 516 Depreciation
123 Machinery 311 Hiwot, Capital expense
124 Land 312 Hiwot, Drawing 517 Utilities expense
125 Acc. Depr -Equp’t
n 313 Income Summary 518 Misc. expenses
126 Acc. Depr - n
Furniture 4. Revenue
127Acc. Deprn – 411 Fees Earned
Machinery
The following assets and liability were invested by Hiwot, on January 1, 2012 at the
start of the business.
Cash Birr 140,000
Furniture 50,000
Notes payable 100,000 (a bank note due in 5- years with an interest rate of
12 % & equal yearly installment payments)
The following transactions were took place for the month January, 2012 for Hiwot
Beauty Salon and Training Center.
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January 1. Hiwot paid a one year rent of Birr 20, 000
January 1. Purchased machinery at cost of Birr 35,000 by paying Birr 10,000 and agreed
to pay the remaining amount in the near future
January 1. Paid a six month insurance premium for Birr 2,400
January 2. Purchased office equipment for Birr 25,000
January 4. Paid Birr 800 for television advertisement
January 7. Purchased supplies worth of Birr 5,000
January 10. Purchased a land for Birr 60,000 which will be used for future building site
January 15. Received a total of Birr 150,000 advance payment from trainees for a four
month tuition fee starting from January 1
January 17. Received Birr 5,000 form clients for decorating services rendered
January 20. Paid Birr 15,000 partial payment to creditors for the January 1 purchase of
machinery
January 20. Purchased additional supplies on account for Birr 7,000
January 26. Send a bill to customers for the service rendered on account for Birr 12,000
January 26. Paid Birr 6,500 salary to employees
January 28. Paid Birr 1,000 utilities expenses
January 28. Paid to creditors on account for the January 20 purchase of supplies
January 30. Received cash from customer on account for Birr 5,000
January 31. Hiwot withdrew a cash of Birr 5,000 for personal use
Required:
Record the above transactions of Hiwot Beauty Salon and Training Center in a Two
Column General Journal with provided chart of accounts of the business.
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Two Column General Journal Page 1
Date Description PR Debit Credit
2012 1 Cash 111 140,000 00
Jan. Furniture 122 50,00 00
Note payable 212 100,000 00
Hiwot, capital 311 90,000 00
(investment by the owner )
1 Prepaid rent 114 20,000 00
Cash 111 20,000 00
(prepayment for rent )
1 Machinery 123 35,000 00
Cash 111 10,000 00
A/P 211 25,000 00
(purchase of machinery )
1 Prepaid insurance 115 2,400 00

Cash 111 2,400 00
(prepayment for insurance )
2 Office equipment 121 25,000 00
Cash 111 25,000 00
(purchase of office equip’t )
4 Miscellaneous expense 518 800 00
Cash 111 800 00
(payment for advertisement )
7 Supplies 113 5,000 00
Cash 111 5,000 00
(purchase of supplies )
10 Land 124 60,000 00
Cash 111 60,000 00
(Purchase of Land )
15 Cash 111 150,000 00
Unearned revenue 213 150,000 00
(advance receipts of tuition fee)
17 Cash 111 5,000 00
Fees earned 411 5,000 00
(fee earned by service giving to
client )
20 A/Payable 211 15,000 00
Cash 111 15,000 00
(payment of liability )
20 Supplies 113 7,000 00
A/Payable 211 7,000 00
(purchase of supplies on account)
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26 A/Receivable 112 12,000 00
Fees earned 411 12,000 00
(fees earned on account)
26 Salary expense 512 6,500 00
Cash 111 6,500 00
(payment for salary )
28 Utilities expenses 517 1,000 00
Cash 111 1,000 00
(payment for utilities )
28 A/Payable 211 7,000 00
Cash 111 7,000 00
(payment of liability )
30 Cash 111 5,000 00
A/Receivable 112 5,000 00
(receipt of cash from customers on
account )
31 Hiwot, drawing 312 5,000 00
Cash 111 5,000 00
(withdrawal by the owner )
Exercise: John has opened a new business so called “Bright Consulting”. Journalize the
following transactions that are occurred during the month of January, 2012 for Bright
consulting. Use the following pages: For transactions occurred from January 1 up to 12, page
1; for transactions occurred from January 15 up to 30, page 2 with the following Chart of
accounts:
Bright consulting
Chart of Accounts
Assets:
101 Cash Owner’s equity: Expenses:
142 Office Supplies 311 John, Capital 511 Rent expense
181 Office Equipments 312 John, Drawing 521 Utilities expenses
525 Misc. expenses
Liability: Revenue:
202 Account payable 411 Fees Earned
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Transactions occurred for Bright consulting during January are the following:
January 1: John invested cash in the business, Birr 200,000
January 2: Paid office rent, Birr 1,000
January 5: Purchased office equipments on account, Birr 30,000
January 10: Received cash for services rendered, Birr 1,500
January 12: Paid a magazine subscription, Birr 300
January 15: Purchased office supplies on account, Birr 6,000
January 20: Made a payment on account for January 5 transaction, Birr 3000
January 25: Received cash for services rendered, Birr 7000
January 28: Paid utilities bill, Birr 1700
January 30: John withdrew cash for personal use, Birr 2000
3.7. Posting to the Ledger

After the information about a business transaction has been journalized, that
information is transferred to the specific accounts affected by each transaction. This
process of transferring the information from the journal to a ledger is called Posting.
The steps in posting using the four column account are given below:
1. Write the name of the account and its related identification number (Account
number).
2. Enter the year, month, and date of the transaction in the date column.
3. Insert the Journal page number in the P.R (Post Reference) column of the
account.
 Note: The P.R Column is used for reference purposes. The P.R column of
the journal shows whether the entry is posted and the account to which it is
posted. In the account, the P.R Column shows the Journal page number
from which the entry was brought.
4. Enter the amount by which it is affected in the debit or credit column.

5. Determine the accounts balance & enter it in the appropriate sub-column of the
balance column.
- SHORT SUMMARY:
The flow of accounting data from the time a transaction occurs to its recording in
the ledger is diagramed as follows:
Business Business Entry Entry

TRANSACTION DOCUMENT recorded in posted to
Occurs Prepared JOURNAL LEDGER
22
Illustration- 2
Post the recorded transactions of Hiwot Beauty Salon and Training Center, during
January 2012, using the four column account.
Account: Cash Account number

111
Balance
2012
Jan. 1 Balance  140,000 00
1 1 20,000 00 120,000 00
1 1 10,000 00 110,000 00
1 1 2,400 00 107,600 00
2 1 25,000 00 82,600 00
4 1 800 00 81,800 00
7 1 5,000 00 76,800 00
10 1 60,000 00 16,800 00
15 1 150,000 00 166,800 00
17 1 5,000 00 171,800 00
20 1 15,000 00 156,800 00
26 2 6,500 00 150,300 00
28 2 1,000 00 149,300 00
28 2 7,000 00 142,300 00
30 2 5,000 00 147,300 00
31 2 5,000 00 142,300 00
Account: A/Receivable Account number 112

Balance
2012
Jan. 26 2 12,000 00 12,000 00
30 2 5,000 00 7,000 00
Account: Supplies Account number 113

Balance
2012
23
Jan. 7 1 5,000 00 5,000 00
20 1 7,000 00 12,000 00
Account: Prepaid Rent Account number114

Balance
2012
Jan. 1 1 20,000 00 20,000 00
Account: Prepaid Insurance Account number 115

Balance
2012
Jan. 1 1 2,400 00 2,400 00
Account: Office Equipment Account number 121

Balance
2012
Jan. 2 1 25,000 00 25,000 00
Account: Furniture Account number 122

Balance
2012
Jan. 1 balance  50,000 00
Account: Machinery Account number123

Balance
2012
Jan. 1 1 35,000 00 35,000 00
Account: Land Account number 124

Balance
24
2012
Jan. 10 1 60,000 00 60,000 00
Account: A/Payable Account number 211

Balance
2012
Jan. 1 1 25,000 00 25,000 00
20 1 15,000 00 10,000 00
20 1 7,000 00 17,000 00
28 2 7,000 00 10,000 00
Account: Notes Payable Account number 212

Balance
2012
Jan. 1 balance  100,000 00
Account: Unearned Revenue Account number 213

Balance
2012
Jan. 15 1 150,000 00 150,000 00
Account: Hiwot, Capital Account number 311

Balance
2012
Jan. 1 balance  90,000 00
Account: Hiwot, Drawing Account number 312

Balance
25
2012
Jan. 31 2 5,000 00 5,000 00
Account: Fees Earned Account number 411

Balance
2012
Jan. 17 1 5,000 00 5000 00
26 2 12,000 00 17,000 00
Account: Salary Expense Account number 512

Balance
2012
Jan. 26 2 6,500 00 6,500 00
Account: Utilities Expense Account number 517

Balance
2012
Jan. 28 2 1,000 00 1,000 00
Account: Misc. Expense Account number 518

Balance
2012
Jan. 4 1 800 00 800 00
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3.8. The Trial Balance, Its Uses and Limitations
Trial Balance
A trial balance is a two column listing of the accounts in the ledger and their
balance to make sure that the total of debit balances equals the total of credit balances.
It is a statement that tests the accuracy of total debits and credits after transactions
have been posted to the ledger.
To prepare a trial balance, perform the following steps.
1. Enter the trial balance headings showing the company name, report title
and closing date for the accounting period.
2. List the account names in the same order as they appear on the financial
statements.
Asset
Liability
Owner’s equity
Revenue, and
Expense
3. Enter the ending balance of each account in the appropriate debit or credit
column(this is obtained from the accounts in the ledger)
4. Total the debit column.
5. Total the credit column.
6. Compare the total debits with the total credits.
Uses of a Trial Balance
 It provides the business man with a means of discovering errors which may
have been committed in writing the book of accounts in accordance with the
rules of double entry system.
 It is used to check (proof) the accuracy of the ledger. In other words, the
proof of the equality of debits and credits in the ledger ( i.e. ∑ Debits = ∑
Credits)
 It facilitates the preparation of financial statements.
Limitations of Trial Balance

The trial balance does not provide complete proof of accuracy of the ledger. It
indicates only that the debits and credits are equal. The trial balance amounts are equal
doesn’t mean that the accounting work is free from error. That is, there are errors that
may take place without affecting the trial balance totals.
Some examples are mentioned below:
 Failure to record a transaction or to post a transaction.
 Recording the same erroneous amount for both the debit and credit parts of a
transaction.
 Recording the same transaction more than once.
 Posting part of a transaction to the correct side but the wrong account.
Please Note: All these errors have the same effect (increasing or decreasing) on the
debit totals and credit totals
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Errors detected through the medium of trial balance
If the total of a trial balance are not equal, (i.e. ∑ Debits ≠ ∑ Credits), it is probably
due to one or more of the following types of errors.
1. Errors in preparing the trial balance
 One of the columns of the trial balance was incorrectly added.
 A debit balance was recorded on the trial balance as credit or vice versa, or a
balance was omitted entirely.
 The amount of an account balance was incorrectly recorded on the trial
balance.
2. Errors in posting a transaction in the ledger, such as:
 An erroneous amount was posted to the account.
 A debit entry was posted as a credit, or vice versa.
 A debit or credit posting was omitted.
3. Errors in determining the account balance, such as:
 A balance was incorrectly computed
 A balance was entered in the wrong balance column.
Procedures in locating errors when the trial balance does not equal:-
1. Re-add the trial balance (specifically if the difference are 10, 100,1000, etc)
2. If the difference is evenly divisible by 2,
 Look through the account to see if the amount has been recorded on
the wrong side of an account or check if this amount has been
recorded in the wrong column of the trial balance.
3. If the difference is evenly divisible by 9, the error is as a result of:-
 Transpositions: - the erroneous rearrangement of digits such as
writing 542 as 524 or 452.
 Slides: - implies the entire number is erroneously moved one or
more space to the right or to the left. Example: writing 140 as 14.0 or
as1.40.
4. Re compute the balance of each account in the ledger.
5. Trace the posting in the ledger back to the journal.
6. Verify the equality of the debit and credit in the journal.
Illustration- 3
Prepare the Trial balance for Hiwot Beauty Salon and Training Center, at the closing
date of the accounting period (i.e. @ January 31, 2012).
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Hiwot Beauty Salon and Training Center
Trial balance
January 31, 2012
Debit Credit
Cash 142,300 00
A/Receivable 7,000 00
Supplies 12,000 00
Prepaid Rent 20,000 00
Prepaid Insurance 2,400 00
Office Equipment 25,000 00
Furniture 50,000 00
Machinery 35,000 00
Land 60,000 00
Account Payable 10,000 00
Notes Payable 100,000 00
Unearned Revenue 150,000 00
Hiwot ,Capital 90,000 00
Hiwot, Drawing 5000 00
Fees Earned 17,000 00
Salary Expenses 6,500 00
Utility Expense 1,000 00
Miscellaneous Expense 800 00
Total 367,000 00 367,000 00
Exercises:
1. The accounts in the ledger of Alex Company as of June 30, 2012 are listed in
alphabetical order as follows. All accounts have normal balances. The balance of cash
account has been intentionally omitted.
 Account Payable _______________________ Birr 21,900
 Account Receivable_____________________ 28,500
 Cash __________________________________ ?
 Alex, Capital___________________________ 150,000
 Alex, Drawing__________________________ 28,000
 Fees Earned____________________________ 350,000
 Insurance Expense______________________ 5,000
 Land__________________________________ 125,000
 Miscellaneous Expense__________________ 9,900
 Notes Payable _________________________ 25,000
 Pre Paid Insurance______________________ 3,150
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 Rent Expense___________________________ 48,000
 Salary Expense_________________________ 215,000
 Supplies_______________________________ 3,900
 Supplies Expense_______________________ 6,100
 Utilities Expense________________________ 41,500
Required: Prepare a trial balance, for Alex Company listing the accounts in their proper
order and insert the missing figure for Cash.
2. Lakeview Carpet Installation, a sole proprietor ship owned by Joan Key, has the
following trial balance as of September 30 of the current year.
Cash 8,820 00
Supplies 1,800 00
Pre-Paid Insurance 400 00
Equipment 22,500 00
A/Payable 5,000 00
Joan Key, Capital 36,720 00
Joan Key, Drawing 8,000 00
Sales 59,750 00
Wages Expense 31, 500 00
Rent Expense 1,800 00
Advertising Expense 5,700 00
Gas, electricity& water expense 5, 650 00
Total 103,995 00 126,470 00
The debit and credit totals of the trial balance are not equal as a result of the following
errors:-
a. The balance of cash was understated by Br.700.
b. A cash receipt of Br. 470 was posted as a debit to cash of Br, 740.
c. A credit of Br. 325 to A/R was not posted.
d. A return of Br. 245 of defective supplies was erroneously posted as a Br. 425
credit to supplies.
e. An insurance policy acquired at a cost of Br. 400 was posted as a credit to pre-
paid insurance.
f. The balance of notes payable was overstated by Br.5, 000.
g. A credit of Br.910 in account payable was over looked when determining the
balance of the account.
h. A debit of Br. 1,000 for a withdrawal by the owner was posted as a debit to
wages expense.
30
i. The balance of Br. 18,000 in the rent expense was entered as Br. 1,800 in the trial
balance.
j. Miscellaneous expense, with a balance of Br. 1,100 was omitted from the trial
balance.
Required:-
Prepare a correct trial balance for Lakeview Carpet Installation as of September 30 of
the current year.
Solutions for the Exercises:

Alex Company
Trial Balance
As Of June 30, 2012
Cash x
Account Receivable 28,500 00
Supplies 3,900 00
Pre Paid Insurance 3,150 00
Land 125,000 00
A/Payable 21,900 00
Alex, Capital 150,000 00
Alex, Drawing 28,000 00
Fees Earned 350,000 00
Salary Expense 215,000 00
Supplies Expense 6,100 00
Utilities Expense 41,500 00
Insurance Expense 5,000 00
Miscellaneous Expense 9,900 00
Total X+514,050 00 546,900 00
Cash* = 32,850
Lakeview Carpet Installation
Corrected Trial Balance
September 30, 2012
Cash 9,250 00
Supplies 1,980 00
Pre-Paid Insurance 1,200 00
Equipment 22,500 00
A/Payable 5,910 00
31
Joan Key, Capital 36,720 00
Joan Key, Drawing 9,000 00
Sales 59,750 00
Wages Expense 30, 500 00
Advertising Expense 5,700 00
Gas, electricity& water expense 5, 650 00
Miscellaneous expense 1,100 00
Total 122,380 00 122,380 00
2.9. Adjustments; Completion of the Worksheet

Basis of Accounting
They are accounting methods/approaches used for the determination of net
income. There are two basis of accounting:
1. Cash basis of accounting
2. Accrual basis of accounting
1. Cash Basis of Accounting
Under this basis of accounting revenue is recorded only when cash is received and
expenses are recorded when cash is actually paid. Thus, the determination of net income
rests on cash inflows and cash outflows related with operating activities; rather than the
realization of revenue and incurrence of expenses.
2. Accrual Basis of Accounting
Under this basis of accounting revenue is recorded when realized and expenses are
recorded when they are actually incurred, without regard to the time of cash collection
and disbursements.
GAAP’s accepts the use of accrual basis of accounting. Because, the revenue
realization & mating principles are applicable under accrual basis of accounting; accrual
basis of accounting in turn requires the use of accrual- deferral system of accounting.
Hence, it requires year end adjustments for proper determination of financial statement
items.
Matching principle: the accounting concept that support the reporting of revenues and
related expenses in the same accounting period.
Adjusting Entries
At the end of the accounting period, there are accounts which show incorrect (not
up-to-date) balances. For instance, pre payments and supplies are being used up, plant
assets with the exception of land are wearing out and functionally depreciating, and
employees are earning salaries though, have not yet been paid. Hence, such conditions
should be considered and recorded to bring the accounts up to date. Unless, financial
statements that will be prepared for the period; will be incorrect to the extent of the
amount required to be updated.
The entries that are required at the end of the accounting period to bring the
accounts up-to-date and to assure the proper matching of revenues and expenses of the
period are called adjusting entries.
32
Characteristics of Adjusting Entries
- It is Year End procedure
- It brings accounts up to date
- It affects both aspects of balance sheet and income statement
Purpose of Adjusting Entries
- To measure and report all assets and liabilities accurately
- To measure and report net income correctly under the accrual basis of
accounting
When an adjustment is needed?

Adjustment is necessary under the following three major conditions/circumstances.
1. Deferrals
2. Accruals, and
3. Estimated items
1. Deferrals
They are expenses paid but their incurrence is postponed or revenues received
whose earning is postponed (deferred) to another period.
They can be classified in to two major types:
i. Deferred Expenses/ Prepaid Expenses, and
ii. Deferred Revenues/ Unearned Revenues
i. Deferred Expenses/ Prepaid Expenses

They are short term prepayments where cash is already paid awaiting for future
incurrence of expenses. Examples: Prepaid Rent, Prepaid Insurance, Prepaid
Advertising, Supplies etc.
There are two alternative approaches of accounting for prepaid expenses:-
A) Asset Approach ( Balance Sheet Approach)
B) Expense Approach ( Income Statement Approach)
A) Asset Approach ( Balance Sheet Approach)
Under this approach, prepaid expenses are debited to asset accounts up on their
accusation. Then, by year end they are adjusted to expense accounts. This approach is
preferable if prepaid expenses are not expected to be expired in the current accounting
period. Here, the adjustment should be made for the expired portion of the prepaid
expense.
B) Expense Approach ( Income Statement Approach)
Under this approach, prepaid expenses are debited to expense accounts when they
are acquired. Then, by year end, they are adjusted to an asset account if there is any
unexpired portion. This approach is preferable if prepaid expenses are expected to be
fully consumed in the current accounting period. Here, the adjustment should be made
for the unexpired portion of the prepaid expense.
33
ii. Deferred Revenues/ Unearned Revenues
When a business enterprise receives payments of goods and services before the
goods are delivered or services are performed, a liability exists until performance takes
place and such conditions are commonly referred to as unearned revenue/deferred
revenues. Examples: Unearned Subscriptions, Unearned Rent, Unearned Advertising
incomes, Unearned Construction Fees etc.
The amount received in advance can be recorded in to two approaches:
A) Liability approach( Balance Sheet Approach)
B) Revenue approach( Income Statement Approach)
A) Liability approach( Balance Sheet Approach)

Under this approach, advance receipts are credited to liability accounts up on the
receipt. Here, adjustment is required to record the earned portion as revenue by
reducing the liability account.
B) Revenue approach( Income Statement Approach)
Here, advance receipts are credited to revenue account up on the receipt and
adjustment is required to record the unearned portion as a liability by reducing the
revenue account.
2. Accruals
Literally, to accrue means to accumulate. Therefore, accruals indicate accumulated
revenues or expenses for which cash has not been received or paid. In other words,
accruals refer to revenues earned but not yet received or expenses incurred but not
paid.
Accruals can be classified in to two major types:
i. Accrued Expenses
ii. Accrued Revenues
i. Accrued Expenses
They are expenses that relate to (are used in) the current accounting period but has
not yet been paid and do not yet appear in the accounting records. Thus, to measure
expenses accurately for the period an adjustment is necessary to record the accrued
expense and the corresponding liability account. Examples: Accrued salaries, Accrued
Interest on Notes Payable, Accrued Payroll Taxes etc.
ii. Accrued Revenues
They are revenues that have been earned but not yet received and recorded.
Examples: Accrued Interest on Notes Receivable, Accrued Rents on property rented to
others etc.
3. Estimated items
i. Plant Assets _ Depreciation
All plant assets with the exception of land loss their capacity to provide useful
services. This decrease in usefulness is a business expense, which is called
34
depreciation. To report the depreciation of the period, the depreciation expense
account will be debited and the accumulated depreciation account would be credited.
i.e. Depreciation expense________________ xxx

Accumulated depreciation _________________xxx
Notes:
- Accumulated depreciation account is a contra asset accounts since, it is offset
against asset account.
- Accumulated depreciation is deducted from the cost of respective asset to
determine the book value of the asset.
Illustration _ 4:
Based on the information’s those are previously given as well as the additional
information’s presented below for Hiwot Beauty Salon & Training Center; prepare the
adjusting entries that should be made on January 31, 2012.
Additional information’s:
The physical count made by the business at the end of the month shows that
supply on hand is Birr 4,000.
According to the computation that was made by the business, the depreciation
expense of the following plant assets is determined to be:
- Office equipment -------------------- Birr 315
- Furniture ------------------------------ 625
- Machinery ---------------------------- 500
Total -----------------------------Birr 1,440
Solutions:
1. Deferred expenses (prepaid expenses)
a) Supplies
Supplies available (balance of account) --------------- Birr 12,000
Less: Supplies on hand (balance on Jan 31, 2012) ----------- (4,000)
Supplies used up (consumed/expired) --------------- Birr 8,000
2012 Supplies expense------- Birr 8000
Jan. 31 Supplies-------------------------------- Birr 8000
b) The rent payment was for one year, but a one month rent has already been incurred
thus, 20,000 = 12 months
X = 1 month
X = 20,000
12
= Birr 1667
2012 Rent expense------- Birr 1667
Jan. 31 Prepaid rent-----------------------Birr 1667
c) The insurance premium payment was for six months, thus for one month
2400 = 6 months
35
X = 1 month
X = 2400
6
= Birr 400
2012 Insurance expense------- Br 400
Jan. 31 Prepaid insurance-----------------------Br 400
Activity: if the above adjustments of deferred expenses/prepaid expenses are not
recorded what effects will be seen on:
- The income statement.
- The statement of owners equity, and
- The balance sheet of Hiwot Beauty Salon & Training Center.
2. Deferred revenues
d) Birr 150,000 tuition fee received from trainees was treated as a liability of the
business. However, part of it becomes revenue as of January 31, 2012. Thus,
150,000 = 4 months
X = 1 month
X = 15,000 = Birr 37,500
4
2012 Unearned revenue------- Birr 37,500
Jan. 31 Fees earned-----------------------Birr 37,500
3. Accrued expenses
e) The salary paid at January 26, 2012 is a 26 day salary from January 1 up to January
26; the salary from January 26 up to January 31 is not paid and also recorded.
Therefore, the adjustment is needed for these 5 days
6500 = 26 days
X = 5 days
X= 32,500 = Birr 1250
26
2012 Salary expense ------- Br 1250
Jan. 31 Salary payable-----------------------Br 1250
f) At the start of the business Hiwot invested a birr 100,000 bank note @ 12 % interest
rate that will be due in 5 years with an equal yearly installment. Since, an interest
expense is accrued for a month adjustment is needed:
I = prt
I = 100,000 * 0.12 *(1/12) = Birr 1000
2012 Interest expense ------- Br 1000
Jan. 31 Interest payable-----------------------Br 1000
4. Accrued Revenues
They are revenues that have been earned but not yet received and recorded. However,
we have no such an item for Hiwot Beauty Salon & Training Center.
5. Estimated items:
36
g) Plant assets _ Depreciation
As it was clearly indicated in the additional information the plant assets of the
business presented below are depreciated with the following amounts.
- Office equipment -------------------- Birr 315
- Furniture ------------------------------ 625
- Machinery ---------------------------- 500
Total -----------------------------Birr 1,440
2012 Depreciation expense ------------------ Birr 1440
Jan. 31 Acc. Deprn -Equp’t---------------------------- Birr 315
Acc. Deprn -Furniture------------------------- 625
Acc. Depr – Machinery----------------------
n 500
2.10. Worksheet for Financial Statements

Worksheet is a Multi – Columnar sheet of paper used to gather and summarize data
needed for preparation of financial statements. It is a type of working paper frequently
used by accountants prior to preparation of financial statements. The worksheet is
identified by (1) the name of the business, (2) the nature of the form (worksheet), (3) the
period of time involved.
Uses of Work Sheet
- It reduces the possibility of overlooking the need for an adjustment
- It provides a convenient means of verifying arithmetical accuracy
- It provides for the arrangement of data in a logical form
- It provides the source data for the financial statements
The main headings in the worksheet except the account title are:
Trial Balance________________ Dr and Cr
Adjustment Column__________ Dr and Cr
Adjusted Trial Balance________ Dr and Cr
Income Statement____________ Dr and Cr
Balance Sheet________________ Dr and Cr
The basic form of a Ten Column worksheet and the procedure (Five steps) for
preparing it;
Account titles Trial Adjustments Adjusted Income Balance
balance trial balance statement sheet
Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
--------------------
--------------------
Step 1: Prepare a
trial balance Step 3: Enter adjusted
balances
Step 4: Extend adjusted balance to
Step 2: Enter adjustment data appropriate statement column
Step 5: Total the statement columns,
compute net income (net loss)37 and
complete the worksheet
Note: Each step must be performed in the prescribed sequence
Illustration _ 5: prepare a worksheet for Hiwot Beauty Salon & Training center.
38
Solution for the worksheet
Hiwot Beauty Salon & Training center
Worksheet
For the month ended January 31, 2012
Trial Balance Adjustments Adjusted Trial Balance Income Statement Balance Sheet
Account titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
Cash 142,300 142,300 142,300
A/Receivable 7,000 7,000 7,000
Supplies 12,000 (a) 8000 4000 4000
Prepaid Rent 20,000 (b) 1667 18333 18333
Prepaid Insurance 2,400 (c) 400 2000 2000
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
Account Payable 10,000 10,000 10,000
Notes Payable 100,000 100,000 100,000
Unearned Revenue 150,000 (d) 37500 112500 112500
Hiwot ,Capital 90,000 90,000 90,000
Hiwot, Drawing 5000 5000 5000
Fees Earned 17,000 (d) 37500 54500 54500
Salary Expenses 6,500 (e) 1250 7750 7750
Utility Expense 1,000 1,000 1,000
Miscellaneous Expense 800 800 800
Totals 367,000 367,000
Supplies expense (a) 8000 8000 8000
Rent expense (b) 1667 1667 1667
Insurance expense (c) 400 400 400
Salary payable (e)1250 1250 1250
Interest expense (f) 1000 1000 1000
Interest payable (f)1000 1000 1000
Depreciation expense (g)1440 1440 1440
Accumulated deprn- Equipment (g)315 315 315
Accumulated deprn- Furniture (g)625 625 625
Accumulated deprn- Machinery (g)500 500 500
Totals 51257 51257 370,690 370,690 22057 54500 348633 316190
Net Income 32443 32443
Balance 54500 54500 348633 348633
39
2.11. Preparations of Financial Statements
Illustration _ 6: prepare the following financial statements for Hiwot Beauty Salon &
Training center.
a) Income statement
b) Statement of owner’s equity
c) Balance sheet
Solutions:
a) Income statement
Hiwot Beauty Salon & Training Centre

Income Statement
For The Month Ended January 31, 2012
Fees earned ------------------------------------------------------------------------------ Birr 54, 500
Less: Operating Expenses:
- Supplies Expenses --------------------------------------- 8,000
- Salary expenses ------------------------------------------- 7,750
- Rent expenses---------------------------------------------- 1,667
- Depreciation expense------------------------------------ 1,440
- Interest expense ------------------------------------------- 1,000
- Utility expense--------------------------------------------- 1,000
- Insurance expense ---------------------------------------- 400
- Miscellaneous expense----------------------------------- 800
Total operating expense----------------------------------------------------------------- (22,057)
Net income ----------------------------------------------------------------------- 32, 443
b) Statement of owner’s equity

Statement of Owner’s Equity
For The Month Ended January 31, 2012
Hiwot, capital January 1, 2012 ------------------------------------------------------Birr 90,000
Add: Net income for the month –-------------------------------------32,443
Less: withdrawal --------------------------------------------------------- (5000)
Increase in owner’s equity ---------------------------------------------------------------- 27,443
Hiwot, capital January 31, 2012----------------------------------------------------Birr 117, 443
40
c) Balance sheet
Balance Sheet
January 21, 2012
Assets:
Current Assets:
Cash…………………………………………Birr 142,300
Accounts Receivable…………………………….. 7,000
Supplies…………………………………………… 4,000
Prepaid rent…………………………………… ...18,333
Prepaid insurance…………………………………2,000
Total current assets……………………………………………Birr 173,633
Plant Asset (None-Current Assets):

Office equipment………………Birr 25,000
Less: Acc. Deprn. –Equip’t…………... (315) 24,685
Furniture …………………………… 50,000
Less: Acc. Deprn. –Furniture………... (625) 49,375
Machinery……………………………..35,000
Less: Acc. Deprn. –Machinery………... (500) 34,500
Land………………………………………………..60,000
Total plant assets………………………………………………… 168,560
Total asset…………………………………………………………………Birr 342,193
Liabilities:
Current liabilities:
Accounts payable……………………………..Birr 10,000
Unearned revenue……………………………. 112,500
Salary payable………………………………… 1,250
Interest payable………………………………. 1,000
Total current liabilities………………………………………….. Birr 124,750
Non-current liabilities:
Notes payable…………………………………………………………………..100,000
Total liabilities……………………………………………………..Birr 224,750
Owner’s equity
Hiwot, Capital ………………………………………………………………… 117443
Total liability and owners equity………………………………Birr 342,193
41
2.12. Journalizing and Posting Adjusting Entries
At the end of the accounting period, the adjusting entries appearing in the worksheet are
recorded in the journal and posted to the ledger. This procedure brings the ledger in to
agreement with the data reported on the financial statements. Each entry may be supported by
an explanation; however, a suitable caption above the first adjusting entry is sufficient.
Illustration _7: Journalize and post the adjusting entries of Hiwot Beauty Salon & Training
center.
Solutions:
1. Journalizing Adjusting Entries

Adjusting Entries
2012 Supplies Expense 511 8000 00
Jan. 31 Supplies 113 8000 00
Rent Expense 513 1667 00
31 Prepaid Rent 114 1667 00
Insurance Expense 514 400 00
31 Prepaid Insurance 115 400 00
Unearned Revenue 213 37500 00
31 Fees Earned 411 37500 00
Salary Expense 512 1250 00
31 Salary Payable 214 1250 00
Interest Expense 515 1000 00

31 Interest Payable 215 1000 00
Depreciation Expense 516 1440 00
31 Acc. Deprn. –Equipment 125 315 00
Acc. Deprn. –Furniture 126 625 00
Acc. Deprn. –Machinery 127 500 00
42
2. Posting Adjusting Entries
Account: Supplies Account number 113

Balance
2012
Jan. 7 1 5,000 00 5,000 00
20 1 7,000 00 12,000 00
31 adjusting 3 8,000 00 4,000 00
Account: Supplies Expense Account number 511

Balance
2012
Jan. 31 adjusting 3 8,000 8,000 00
Account: Prepaid Rent Account number114

Balance
2012
Jan. 1 1 20,000 00 20,000 00
3 adjusting 3 1,66 00 18,333 00
1 7
Account: Rent Expense Account number 513

Balance
2012
Jan. 31 adjusting 3 1,667 00 1,667 00
Account: Prepaid Insurance Account number 115

Balance
2012
Jan. 1 1 2,400 00 2,400 00
31 adjusting 3 400 00 2,000 00
43
Account: Insurance Expense Account number 514
Balance
2012
Jan. 31 adjusting 3 400 00 400 00
Account: Unearned Revenue Account number 213

Balance
2012
Jan. 15 1 150,000 00 150,00 00
0
31 adjusting 3 37,500 0 112,50 00

0 0

Balance
2012
Jan. 17 1 5,000 00 5000 00
26 2 12,000 00 17,000 00
31 adjusting 3 37,500 00 54,500 00

Balance
2012
Jan. 26 2 6,500 00 6,500 00
31 adjusting 3 1,250 00 7,750 00
Account: Salary Payable Account number 214

Balance
44
2012
Jan. 31 adjusting 3 1,250 00 1,250 00
Account: Interest Expense Account number 515

Balance
2012
Jan. 31 adjusting 3 1,000 00 1,000 00
Account: Interest Payable Account number 214

Balance
2012
Jan. 31 adjusting 3 1,000 00 1,000 00
Account: Depreciation Expense Account number 516

Balance
2012
Jan. 31 adjusting 3 1,440 00 1,440 00
Account: Acc. Deprn. -Equipment Account number 125

Balance
2012
Jan. 31 adjusting 3 315 00 315 00
Account: Acc. Deprn. -Furniture Account number 126

Balance
2012
Jan. 31 adjusting 3 625 00 625 00
Account: Acc. Deprn. -Machinery Account number 127

Balance
45
2012
Jan. 31 adjusting 3 500 00 500 00
2.13. Closing Entries

The revenue, expense, and drawing/dividend accounts are temporary accounts used to
accumulate data related to a specific accounting period. At the end of each accounting period,
the balance of these temporary/nominal accounts are transferred or closed, to owner’s
capital/retained earnings account. The periodic closing (clearing out) of the balance of
temporary/nominal accounts is done by using closing entries.
Closing entries have two major purposes:
1. To transfer net income or loss to owner’s capital/retained earnings account.
2. To establish a zero balance in each of temporary accounts to start the next accounting
period.
An account titled income summary is used for summarizing the data in the revenue and
expense accounts. It is used only at the end of accounting period and is both opened and
closed during the closing process. The other name of income summary account is revenue and
expenses summary account, or Profit and loss summary account.
Procedures to close the accounts
1. To close revenue account

Each revenue account is debited for the amount of its balance, and income summary is
credited for the total revenue.
2. To close expense account

Each expense account is credited for the amount of its balance, and income summary is
debited for the total expense.
3. To close income summary account

After closing the revenue and expense account to income summary, the balance of income
summary is equal to the net income or loss
a) If the result is net income, then debit income summary and credit owner’s capital
account.
b) If the result is net loss, then credit income summary and debit owner’s capital
account.
c) If the result is Zero (i.e. no profit /no loss), then no closing entry.
4. To close drawing account
46
The drawing account is credited for the amount of its balance, and the owner’s capital
account is debited for the same amount.
Illustration _8: Journalize and post the closing entries of Hiwot Beauty Salon & Training center.
Solutions:
1. Journalizing Closing Entries

Closing entries
2012 Fees Earned 411 54,500 00
Jan. 31 Income Summary 313 54,500 00
Income Summary 313 22,057 00
Supplies Expense 511 8,000 00
Salary Expense 512 7,750 00
Rent Expense 513 1,667 00
31 Depreciation Expense 516 1,440 00
Interest Expense 515 1,000 00
Utility Expense 517 1,000 00
Insurance Expense 514 400 00
Miscellaneous Expense 518 800 00
Income Summary 313 32,443 00
31 Hiwot, Capital 311 32,443 00
Hiwot, Capital 311 5,000 00
31 Hiwot, Drawing 312 5,000 00
2. Posting Closing Entries
Account: Hiwot, Capital Account number 311

Balance
2012
Jan. 1 balance  90,000 00
3 closing 4 32,443 0 122,443 00
1 0
3 closing 4 5,000 00 117,443 00
1
47
Balance
2012
Jan. 17 1 5,000 00 5000 00
26 2 12,000 00 17,000 00
31 adjusting 3 37,500 00 54,500 00

31 Closing 4 54,500 00 - -
Account: Income Summary Account number 313

Balance
2012
Jan. 31 closing 4 54,500 0 54,500 00
0
31 closing 4 22,057 00 32,443 00
31 closing 4 32,443 00 - -
Account: Supplies Expense Account number 511

Balance
2012
Jan. 31 adjusting 3 8,000 8,000 00
31 closing 4 8,000 00 - -

Balance
2012
Jan. 26 2 6,500 00 6,500 00
31 adjusting 3 1,250 00 7,750 00

31 closing 4 7,750 0 - -
0
Account: Rent Expense Account number 513

Balance
2012
Jan. 31 adjusting 3 1,667 00 1,667 00
31 closing 4 1,667 00 - -
48
Account: Depreciation Expense Account number 516
Balance
2012
Jan. 31 adjusting 3 1,440 00 1,440 00
31 closing 4 1,440 00 - -
Account: Utilities Expense Account number 517

Balance
2012
Jan. 28 2 1,000 00 1,000 00
31 closing 4 1,000 00 - -
Account: Interest Expense Account number 515

Balance
2012
Jan. 31 adjusting 3 1,000 00 1,000 00
31 closing 4 1,000 00 - -
Account: Insurance Expense Account number 514

Balance
2012
Jan. 31 adjusting 3 400 00 400 00
31 closing 4 400 00 - -
Account: Misc. Expense Account number 518

Balance
2012
Jan. 4 1 800 00 800 00
3 closing 4 800 00 - -
1
Account: Hiwot, Drawing Account number 312
Balance
2012
Jan. 31 2 5,000 00 5,000 00
31 closing 4 5,000 00 - -
49
2.14. Post Closing Trial Balance
The last procedure of the accounting cycle is the preparation of trial balance after all
temporary / nominal accounts have been closed. The purpose of the post closing (after
closing) trial balance is to make sure that the ledger is in balance at the beginning of the new
accounting period. It is prepared to retest the equality of the account balances b/c errors may
have been introduced in the process of adjusting and closing entries. It will show only balance
for the permanent accounts (or real accounts).
Illustration _8: Prepare a post closing trial balance for Hiwot Beauty Salon & Training center.
Solution:
Hiwot Beauty Salon and Training Center
Post Closing Trial balance
January 31, 2012
Cash 142,300 00
Supplies 4,000 00
Prepaid Rent 18,333 00
Prepaid Insurance 2,000 00
Office Equipment 25,000 00
Accumulated depr -Equipment
n. 315 00
Furniture 50,000 00
Accumulated depr - Furniture
n. 625 00
Machinery 35,000 00
Accumulated deprn.- Machinery 500 00
Land 60,000 00
Account Payable 10,000 00
Unearned Revenue 112,500 00
Salary Payable 1,250 00
Interest Payable 1,000 00
Hiwot ,Capital 117,443 00
Total 343,633 00 343,633 00
50
2.15. Reversing Entry
It is an optional procedure in the accounting cycle used to reverse certain adjusting entries
to facilitate the recording process in the subsequent accounting period. Generally reversing
entry is necessary for:-
Deferred costs initially recorded as an expense.
Deferred revenues initially recorded as revenue.
Accrued expenses
Accrued revenues
Examples:
a) Deferred costs /Pre paid expenses initially recorded as an expense.
Adjustment Supplies………..xx
Supplies expense…..xx
Reversing entry Supplies expense……xx

Supplies……………..xx
b) Deferred revenues/ Unearned Revenues initially recorded as revenue.
Adjustment Rent revenue………..xx

Unearned rent…………..xx
Reversing entryUnearned rent…………..xx

Rent revenue………..xx
c) Accrued expenses
Adjustment Salary expense………..xx

Salary payable…………..xx
Reversing entrySalary payable…………..xx

Salary expense………..xx
d) Accrued revenues
Adjustment Interest receivable………..xx

Interest income…………..xx
Reversing entry Interest income…………..xx

Interest receivable………..xx
51
Exercises:
Q_1: Assume that Z – Company acquired a supply at the cost of br.5, 000 on January 1, 2004.
But at the end of 2004, the cost of supplies used was determined to be Br.4450.Record all the
necessary journal entries, adjusting entries, and reversing entries; using both balance sheet
and income statement approaches.
Q_2: XYZ Company received Br. 300,000 on cash for its building as a rent from its customers
in advance during year 1. However, Br. 50,000 represents payment for which a house rent
service to be delivered in the subsequent period. Record all the necessary journal entries,
adjusting entries, and reversing entries; using both balance sheet and income statement
approaches.
Q_3: Suppose the following facts for an enterprise that pays salaries weekly and ends its fiscal
year on Dec 31 of each year. Salaries are paid on Friday for the 5 (five) day week ending on
Friday. The balance in salary expense as of Friday Dec 27 is Br. 62,500. Salaries accrued for
Monday and Tuesday Dec 30 and Dec 31, total Br.500. Salaries paid on Friday, Jan 3 of the
following year total Br.1, 250.
Instructions
a. Journalize adjusting entry on Dec 31.
b. What will be the balance of salary expense and salary payable after the adjusting entries
has been posted?
c. Record reversing entry for accrued salaries.
d. Record payment of salary on Friday (Jan 3 of the following year) , assume no reversing
entry was made(no transaction “c”)
e. Record payment of salary on Friday (Jan 3 of the following year), assuming reversing
entry was made (transaction “c” was recorded and posted).
Q_4: Assume that an enterprise has a note receivable on which Br. 6,000 of interest is due
every six months. If Br. 4,000 of interest income has been earned (accrued) on Dec31, the end
the year.
Required:
a. Record adjusting entries
b. Record receipt of cash with out reversing entry.
c. Record reversing entry.
d. Record receipt of cash with reversing entry.
52

Fundamentals Accounting I

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Fundamentals Accounting I

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CHAPTER Three and Four

THE ACCOUNTIG CYCLE for Service Business

1. Review the basic steps of the accounting cycle.

The T Account _ Format

Debit = (Left side) Credit = (Right side)

The Two-Column Account _ Format

 The Four-Column Account

The Four-Column Account _ Format

3.3. Classification of Accounts

3.4. Chart of Accounts

1. Assets 2. Liabilities 5. Expenses

3.5. Rules of Debit and Credit

Debit sides signify: Credit sides signify:

- Normal Balance of Accounts (Balance Sides of Accounts)

- Summary on the Rules of Debits and Credits:

Increase Decrease Normal Balance

3.6. Recording Business Transactions in a Journal

Look at the following format for a two column General Journal.

General Journal Page ________

In recording a business transaction the following three basic questions must be

- Steps in Journalizing a Transaction

2003 Description P.R Debit Credit

1 Prepaid insurance 115 2,400 00

3.7. Posting to the Ledger

4. Enter the amount by which it is affected in the debit or credit column.

Business Business Entry Entry

Account: Cash Account number

Account: A/Receivable Account number 112

Account: Supplies Account number 113

Account: Prepaid Rent Account number114

Account: Prepaid Insurance Account number 115

Account: Office Equipment Account number 121

Account: Furniture Account number 122

Account: Machinery Account number123

Account: Land Account number 124

Account: A/Payable Account number 211

Account: Notes Payable Account number 212

Account: Unearned Revenue Account number 213

Account: Hiwot, Capital Account number 311

Account: Hiwot, Drawing Account number 312

Account: Fees Earned Account number 411

Account: Salary Expense Account number 512

Account: Utilities Expense Account number 517

Account: Misc. Expense Account number 518

Limitations of Trial Balance

Solutions for the Exercises:

2.9. Adjustments; Completion of the Worksheet

When an adjustment is needed?

i. Deferred Expenses/ Prepaid Expenses

A) Liability approach( Balance Sheet Approach)

i.e. Depreciation expense________________ xxx

2.10. Worksheet for Financial Statements

Hiwot Beauty Salon & Training Centre

b) Statement of owner’s equity

Hiwot Beauty Salon & Training Centre

Plant Asset (None-Current Assets):

Two Column General Journal Page 3

Interest Expense 515 1000 00

Account: Supplies Account number 113

Account: Supplies Expense Account number 511

Account: Prepaid Rent Account number114

Account: Rent Expense Account number 513

Account: Prepaid Insurance Account number 115

31 adjusting 3 400 00 2,000 00