BANGLADESH UNIVERSITY OF PROFESSIONALS

(BUP)

TERM PAPER ON
ACCOUNTING CYCLE
ACCOUNTING INFORMATION SYSTEMS (ALD-1101)

SUBMITTED TO:
ASSISTANT PROF. MOHAMMED MOIN UDDIN REZA

SUBMITTED BY:
SYED RADEEYAL KABIR
ID: 2221141111
SECTION A
 ABSTRACT

Over the course of this assignment, the most important aspects of the accounting life cycle will
be explained in detail. To help with this process, a narrative story has been incorporated to assist
in the reader’s understanding of all the concepts. From the recommended text book, chapters 1,
2, 3 and 4 have provided ample source material to aid in the preparation of this assignment. The
key topics to be discussed are: transactions, journal entries, posting to the general ledger, trial
balance and financial statements.

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Table of Contents
CHAPTER 1 (INTRODUCTION)................................................................................................................ 3
CHAPTER 2 (TRANSACTIONS) ............................................................................................................... 4
CHAPTER 3 (JOURNAL ENTRIES) .......................................................................................................... 7
CHAPTER 4 (LEDGERS) .......................................................................................................................... 10
CHAPTER 5 (TRIAL BALANCE) ............................................................................................................ 13
CHAPTER 6 (FINANCIAL STATEMENTS) ........................................................................................... 14

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 CHAPTER 1 (INTRODUCTION)
Bob Richards is an aspiring entrepreneur with the hopes of one day establishing his own empire
in the business scene. However, the hopes instantly of running a mega corporation or multinational
is farfetched, even in the eyes of Bob himself. He knows careful steps must be taken to build his
business from the ground running. Therefore, he has decided to venture out into the commercial
world and start his own sole proprietorship business, investing $200,000 of his savings which he
accumulated from his previous job as a territorial manager at a local firm.

His plan is to operate as a marketing agency, offering advice and carrying out major marketing
decisions for businesses, mostly targeting ones similar in size to his own. Through his previous
job, he has amassed considerable knowledge about the market conditions and feels has ample
resources operate a business of such scale. Although he may have the technical and operational
know-how, the one vital department that he lacks in is accounting. This is a major setback as the
fundamental aim of any new business would be to make as much profit as possible, as quickly as
possible that all deal with accounting. As a result, he has decided to heed the help of his friend,
John Simmons, currently working as an accountant at a large multinational company.

One day, both the friends finally took some time off their busy schedules and met to discuss the
growing worries of Bob. Both exchanged pleasantries and dived right in to the matter at hand.

‘I know it sounds easy to just hire an accountant but I just haven’t found the right mixture of
qualities in anyone so far. No one I interviewed had any prior experience in working for a smaller
firm with the aspirations of competing with the big players in the market. I also want to have
considerable control in everything and be able to fully grasp the meaning behind the numbers
through accounting knowledge.’ Said Bob.

‘I understand. With your skillset, you are likely to succeed in this field and it is tough finding
employees with the right mindset. Accounting knowledge is essential in running a business at it
allows you to fully grasp what is happening in your business at all times and know how it is
performing. I will try my best to help you out by sharing my own knowledge so that you can
perform to the best of your abilities and not have to worry about accounting.’ Said John.

‘Thank you so much! I knew I could rely on you in tough times. So when can we get started?’ said
Bob.

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 CHAPTER 2 (TRANSACTIONS)
‘Now let’s start with the accounting cycle, which start with transactions’. Said John.

‘Sounds good. However, could you please elaborate on those terms you mentioned?’ Said Bob

‘Sure. The accounting cycle is the holistic process of recording and processing all financial
transactions of a company, from when the transaction occurs, to its representation on the financial
statements. The accounting cycle incorporates all the accounts, journal entries, T accounts, debits,
and credits, adjusting entries over a full cycle.

To start off, we should know what transactions really mean. Financial transactions start the
process. If there were no financial transactions, there would be nothing to keep track of.
Transactions may include a debt payoff, any purchases or acquisition of assets, sales revenue, or
any expenses incurred.’ Said John.

‘I think I can grasp the essence of what you mean. However, it would be much better if you could
show some examples in your explanations. That would really be the icing on the cake!’ Said Bob.

‘No worries, I knew you would ask for this so I came prepared. Before we dive straight in, you
should first know what assets, liabilities and owner’s equity mean.’ Said John.

‘I certainly have heard of those terms. Let’s see, an asset could be a computer that I can use to mail
potential clients. Liabilities could be a bank loan that I have taken which must be paid back and
owner’s equity could be the amount I have invested to start my business.’ Said Bob.

‘Excellent! You already sound like a professional accountant. At this rate you will be set in no
time. Since you have the basic idea I think we can start with some examples of transactions. The
first thing you must note down is the accounting equation.

Assets=Liabilities + Owner’s equity

EXAMPLES:

Let’s think about the money you spent to start your business. It was $200,000. While recording
this transaction, it is obvious that owner’s equity has increased and can be recorded as owner’s
capital. However, we must ensure the equation matches on both sides. To do this, assets clearly

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have to be increased by the same amount. This is because all assets of a business either come from
the owner or from liabilities. So, we can increase the assets section under the name of cash.

Now, let’s look at another example. Think back to the computer you purchased for your business.’
Said John.

‘Yeah. It cost a whopping $15,000 but it sure does have the firepower so it has been worth the
money.’ Said Bob.

‘This computer will be recorded as an asset since you can derive future benefit from it. To match
both sides, we will lower the asset section as you are technically using cash that you previously
invested. So, there is actually no real change in the equation. Such a transaction can be classified
as having a structural change.’ Said John.

‘Makes sense. How about the previous transaction? What would you call that?’ Said Bob.

‘Good question. When both sides of the equation are affected, we call it a net change. Let’s look
at another example. Suppose you are purchasing supplies on credit. Increased supplies will raise
assets but this time cash will not be affected. As you are buying on credit, or a short term loan, you
must pay back your supplier on a future date. Thus, the liabilities section much be increased.

Now let’s turn our attention towards expenses and revenues. These items fall under the owner’s
equity column and can sometimes be a bit tricky. However, as long as you understand the basic
principles, you should be fine.’ Said John.

‘Ah yes, revenues and expenses. The meat and potatoes of everyday business. I think I know what
these indicate and what they are. A revenue item could be a service that my business offers and I
receive cash in return. An expense can be easily identified as recurring costs like rent or electricity.
But I am not sure as to how they directly affect owner’s equity.’ Said Bob.

‘Before answering your question, I would like to emphasize the importance of the accruals concept
of accounting. Revenues should be recorded when earned and expenses when incurred. Exchange
of cash isn’t always necessary to record transactions. Let’s look at this example.

Supposed you incurred an advertising expense on credit. So, you must pay it back later but for
now we must record it as a liability, under the name of accounts payable. So, the liability section
must increase. The advertising expense will go under owner’s equity and actually reduce it.

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To answer your question, expenses reduce owner’s equity and revenues increase it. This is because
expenses reduce profit which reduces owner’s equity. The impact of revenues is exactly the
opposite as it increases profit and in turn owner’s equity. If the previous transaction was cash
based, expenses would still increase but this time assets would decrease as cash decreases.

Now let’s look into a revenue based transaction. If your business performs a service for cash, can
you tell me how you would record it?’ Said John.

‘Okay let me think. I suppose I would increase the revenue column which actually increases
owner’s equity and assets would increase as I receive cash.’ Said Bob.

‘Perfect. I see you are getting the hang of it. On the other hand, if the service was performed on
credit, owner’s equity would still be affected in the same manner but this time the assets would
increase under the name of accounts receivable.

Before moving on to the next step of the accounting process, the final transaction you should be
acquainted with is the case of drawings or withdrawal. As the owner of the business, you have the
right to withdraw cash or an asset item for personal use. To record this, we must deduct the asset
section by the amount withdrawn and reduce owner’s equity under the column of owner’s
drawings. Owner’s equity decreases as the money withdrawn actually reduces owner’s capital and
the effect of a withdrawal by the owner has the opposite of the effect of an investment by the
owner.’ Said John.

‘Sounds good. So I were to withdraw $500 from my business, I would record it by simply
increasing the withdrawal section which reduces owner’s equity and reduce cash under the assets
column.’ Said Bob.

‘That is exactly how you should do it. I see that you have gotten used to the first part of the
accounting cycle. Now, I can confidently move on to the next part as transactions have pretty much
been covered through all the examples. Note that as a beginner, you may still face problems even
in the initial recording process. In such cases, try to take a step back and always refer back to the
original accounting equation’. Said John.

‘Thank you for the advice and I shall try my best.’ Said Bob.

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 CHAPTER 3 (JOURNAL ENTRIES)
‘The second stage of the accounting cycle deals with journal entries. Honestly, a personal favorite
of mine as it comprises everything we learned before and adds on new elements such as debits and
credits all the while being easy to carry out and understand compared to the later stages.’ Said
John.

‘That sounds interesting. However, I am not so sure about the concept of debits and credits
although I certainly have heard of them before. Could you please elaborate on those?’ Asked Bob.

‘Certainly. Debits indicate the left side of an account, while credits indicate the right side. They
are commonly abbreviated as Dr. for debit and Cr. for credit and do not usually indicate an increase
or decrease, as is commonly thought. We use these terms repeatedly in the recording process to
describe where entries are made in accounts. When comparing the totals of the two sides, an
account shows a debit balance if the total of the debit amounts exceeds the credits and a credit
balance if the credit amounts exceed the debits.’ Said John.

‘I think I can grasp the theory of debits and credits but I still don’t understand how it is connected
to what we previously learned.’ Said Bob.

‘That is only natural so don’t worry. First, you must know that assets normally have a debit balance
and liabilities and owner’s equity both normally have credit balance. So, anything that increases
an asset item would be recorded on the debit side and anything that decreases an asset would
normally be recorded on the credit side.’ Said John.

‘I understand. So, if we were to look at liability or owner’s equity items, anything that would
increase them would be recorded on the credit side and anything that would decrease them would
decrease them would be recorded on the debit side. Am I correct?’ asked Bob.

‘Absolutely, you sure are getting the hang of this. I think we can move onto some examples now.
Let’s look back at some of the examples we mentioned before.

EXAMPLES:

To start off, owner investment of $200000 in cash. To record this, we must first identify which
accounts this transaction affects. Clearly, both assets and owner’s equity are being affected. Now,
we must understand if it is increasing the respective accounts or decreasing it. In both cases, the

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respective accounts are increasing. As a result, we must debit the cash account under assets and
credit owner’s capital under owner’s equity. The amount to be debited and credited will be same
for both sides, $200,000.’ Said John

‘I think I get it but I think I can understand better if I try to tackle one of the problems myself. Is
that okay?’ Asked Bob.

‘Sure, I love the drive. Tell me the journal entries if you purchase computer equipment worth
$15,000 for cash.’ Said John.

‘Let’s see, both are asset items so they would normally have a debit balance. I bought a computer
so it must be debited by $15,000 under computer equipment. To buy it, I gave up cash which is an
asset. Thus, cash must be credited by the same amount.’ Said Bob.

‘Correct. New try solving this one. Purchased supplies worth $1,500 on credit.’ Said John.

‘The accounts being affected are assets and liabilities. Since supplies increase assets, it will be a
debit entry worth $1,500. I bought the supplies on credit which means I must pay back the same
amount later. Therefore, accounts payable should be increased and this should be a credit entry.’
Said Bob.

‘Great work. Note that if this transaction were to involve cash, we would instead credit cash under
assets. Now let’s move on to revenues and expenses. As explained before, revenue increases
owner’s equity and expenses decreases it. Therefore, a revenue item must be recorded on the credit
side whereas an expense account always falls under the debit side. Let’s look at an example.
Suppose you offered services worth $20,000 on cash and incurred advertising expenses of $2,500.
To record this, we must debit cash by $20,000 and credit revenue by the same amount. In case of
expenses, advertising expense would be debited by $2,500 and cash would be credited by the same
amount as we are paying money. Note that services can be performed and expenses incurred on
credit. In such cases, we will simply use trade receivables or payables rather than using cash.’ Said
John.

‘I understand completely. I think we have one example left. In case of drawings, how would we
record these?’ Asked Bob.

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‘Drawings will always decrease Owner’s equity and thus must be debited while recording in a
journal. On the credit side, we will use whatever asset the owner has taken out. This could be cash
or any other asset item.

With these out of the way, I think we can look at an actual General Journal.

PARTICULARS DEBIT ($) CREDIT ($)

CASH A/C 200,000

CAPITAL A/C 200,000

(To record owner invested in cash.)

COMPUTER EQUIPMENT A/C 15,000

CASH A/C 15000

(To record computer bought on cash.)

INVENTORY A/C 1,500

ACCOUNTS PAYABLE A/C 1,500

(To record supplies bought on credit.)

CASH A/C 20,000

SERVICE REVENUE A/C 20,000

(To record cash received from performing service.)

ADVERTISEMENT EXPENSE A/C 2,500

CASH A/C 2,500

(To record cash paid for advertisement expense.)

DRAWINGS A/C 1,000

CASH A/C 1,000

(To record owner’s drawing of cash.)

TOTALS 240,000 240,000

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Note that the debit column matches with the credit side. This helps to prevent or locate errors
because the debit and credit amounts for each entry can be easily compared. There are two other
benefits to journalizing entries which. First, it discloses in one place the complete effects of a
transaction. Second, it provides a chronological record of transactions.’ Said John.

‘Makes sense. Although the table may take some time for me to get used to, the theories should
stick.’ Said Bob.

‘That’s great. I think we are ready to move on to the next stage of the accounting cycle.’ Said John.

CHAPTER 4 (LEDGERS)
‘To start off, I think it’s best if we first know what we are dealing with. The ledger provides the
balance in each of the accounts. Companies may use different types of ledgers but all must have a
general ledger. This contains all the asset, liability, and owner’s equity accounts. After completing
the general journal, we must post to the general ledger where a summary of all transactions to
individual accounts can be seen. This process is known as posting. Are you able to keep up?’
Asked John.

‘Just about. I fully understand the definition of the ledger but I’m still not sure about the posting
process. Could you elaborate on that?’ Asked Bob.

‘No problem. The procedure of transferring journal entries to the ledger accounts is called posting.
This phase of the recording process accumulates the effects of journalized transactions into the
individual accounts. To understand this better, I think we should look into some examples.’ Said
John.

‘I agree. That would help to clear things up.’ Said Bob.

EXAMPLES:

Before diving straight in, I should clarify the steps involved in this process. First, you should know
what a ledger looks like. It must have at least four columns being particulars, debit, credit and
balance. Secondly, identify the transactions in the journal that may affect the particular ledger
account. Thirdly, enter the transaction. To do this, simply use the same balances as given in the

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journal on the correct side. Under particulars, you must enter the name of the opposite account in
the journal. For example, here is how the capital a/c would look like:

CAPITAL A/C

PARTICULARS DEBIT($) CREDIT($) BALANCE($)

CASH A/C 200,000 200,000

As explained, the amount registered will still be the same and on the credit side as owner has
invested cash. In the particulars section, we will write cash to indicate which account has caused
such a change in the capital account.’ Said John.

‘I understand. The process may seem a little tricky, but with sufficient practice, I’m sure I can get
the hang of it.’ Said Bob.

‘Absolutely. Let’s now have a look at how some of the other accounts should look like in the
general ledger:

CASH A/C

PARTICULARS DEBIT($) CREDIT($) BALANCE($)

DR.
CAPITAL A/C 200,000 200,000
COMPUTER EQUIPMENT A/C 15,000 185,000
SERVICE REVENUE A/C 20,000 205,000
ADVERTISEMENT EXPENSE A/C 2,500 202,500
DRAWINGS A/C 1,000 201,500

COMPUTER EQUIPMENT A/C

PARTICULARS DEBIT($) CREDIT($) BALANCE($)

DR.
CASH A/C 15,000 15,000

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 INVENTORY A/C

PARTICULARS DEBIT($) CREDIT($) BALANCE($)

DR.
ACCOUNTS PAYABLE A/C 1,500 1,500

ACCOUNTS PAYABLE A/C

PARTICULARS DEBIT($) CREDIT($) BALANCE($)

CR.
INVENTORY A/C 1,500 1,500

SERVICE REVENUE A/C

PARTICULARS DEBIT($) CREDIT($) BALANCE($)
CR.
CASH A/C 20,000 20,000

ADVERTISEMENT EXPENSE A/C

PARTICULARS DEBIT($) CREDIT($) BALANCE($)

DR.
CASH 2,500 2,500

DRAWINGS A/C

PARTICULARS DEBIT($) CREDIT($) BALANCE($)

DR.
CASH 1,000 1,000

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With that, we have completed all the ledger accounts and can move on to the next stage of the
accounting cycle.’ Said John.

‘Sounds good. So far I have no queries and feel that I can move on to the next stage.’

CHAPTER 5 (TRIAL BALANCE)

‘The next step in the cycle is the trial balance. This is drawn at the end of the accounting period
where a total balance is calculated for the accounts. In other words, a trial balance is a list of
accounts and their balances at a given time. The process of making one is also quite simplistic.
Using information from the general ledger, the three fundamental steps are listing the account titles
and their balances in the appropriate debit or credit column, totaling the debit and credit columns
and verifying the equality of the two columns.’ Said John.

‘Sounds good. However, just as before I think an example could really help clear things out.’ Said
Bob.

EXAMPLES:

‘I agree but before that you should first know what a trial balance looks like. It usually has three
columns which are particulars, debit and credit. Here is an example:

TRIAL BALANCE

PARTICULARS DEBIT($) CREDIT($)

CAPITAL A/C 200,000
CASH A/C 201,500
COMPUTER EQUIPMENT A/C 15,000
INVENTORY A/C 1,500
ACCOUNTS PAYABLE A/C 1,500
SERVICE REVENUE A/C 20,000
ADVERTISEMENT EXPENSE A/C 2,500
DRAWINGS A/C 1,000
TOTALS 221500 221500

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As you can see, the debits match with the credits, confirming the accuracy of recording. While
making a trial balance, you must end up with the same balance on both sides.’ Said John.

‘I see. I can grasp the idea of a trial balance but still can’t wrap my head around its importance.
Why must we create a trial balance?’ Asked Bob.

‘Making a trial balance is extremely important as it is a significant part of the cycle. To break it
down, there are three main benefits. First of all, the trial balance proves the mathematical equality
of debits and credits after posting. Secondly, a trial balance may also uncover errors in journalizing
and posting. Lastly, a trial balance is useful in the preparation of financial statements, which we
will discuss in detail later.’ Said John.

‘Makes sense. So the trial balance is a crucial part in the cycle as it provides a fail-safe check of
all the recording that has taken place.’ Said Bob.

‘I wish if it were that simple. The trial balance does come with a few limitations. It does not
guarantee freedom from recording errors. Numerous errors may exist even though the totals of the
trial balance columns agree. This could happen when a transaction is not journalized, a correct
journal entry is not posted or when a journal entry is posted twice.’ Said John.

‘I guess I was wrong to assume that the trail balance was without flaws. When you mentioned
financial statements, did you mean the next step of the cycle?’ Asked Bob.

‘Exactly, that will be the last stage we will be discussing.’ Said John.

CHAPTER 6 (FINANCIAL STATEMENTS)

‘Finally, we can move on to the final stage of the accounting cycle. This is arguably the most
important part of the recording process as these statements will be vital to carrying out business
activities. Examples could be attracting investment, negotiating a loan, evaluating business
performance for decision making, etc. The four financial statements are the income statement or
statement of comprehensive income, owner’s equity statement, statement of financial position and
cash flow statement. Among these, we will be discussing the statement of comprehensive income
and statement of financial position in detail.’ Said John.

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‘I understand. I also recognize some of the statements you mentioned. I remember going through
the statement of financial position of some limited companies to decide whether to invest in them.’
Said Bob.

‘That’s good to hear as this means you already know the basics of these work. To be safe, I will
still brush over these. An income statement presents the revenues and expenses and resulting net
income or net loss for a specific period of time whereas a balance sheet reports the assets,
liabilities, and owner’s equity at a specific date.’ Said John.

‘Makes sense. I think I am ready for some examples.’ Said Bob.

EXAMPLES:

‘As always we must first know what these statements actually look like. In this case, both
statements look fairly similar with at least two columns. These are particulars and another column
for recording the balances and these values we will use must come from the trial balance as
mentioned. The statement of comprehensive income will only include revenue and expense items
as its primary objective is to show whether the firm has made a profit or not. The statement of
financial position will include all asset, liability and owner’s equity items. Here is an example:

STATEMENT OF COMPREHENSIVE INCOME

PARTICULARS ($)
SERVICE REVENUE 20,000
LESS:EXPENSES
ADVERTISEMENT EXPENSE (2,500)
NET PROFIT 17,500

Since there was only one expense incurred, the net profit will be $17,500. Note that this will be
transferred to the statement of financial position but before that we must make some adjustments.
These have to do with the owner’s equity balance. Since only closing balances are used in financial
statements, we must adjust the opening capital with the entries that have affected it. These are
drawings and net profit. Drawings will clearly reduce owner’s equity and net profit will increase
owner’s equity.’ Said John.’

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‘I understand. According to you, the new owner’s equity balance should be $216,500 after the
adjustments and this will go directly to the statement of financial position?’ Asked Bob.

‘Exactly, let’s look at this example:

STATEMENT OF FINANCIAL POSITION

PARTICULARS ($)
NON-CURRENT ASSETS:
COMPUTER EQUIPMENT 15,000
CURRENT ASSETS:
CASH 201,500
INVENTORY 1500
TOTAL ASSETS 218,000

OWNER’S EQUITY
CAPITAL (200,000+17,500-1,000) 216,500
LIABILITIES:
ACCOUNTS PAYABLE 15,00
TOTAL EQUITY AND LIABILITY 218,000

Note that the assets section is divided in two parts, non-current and current. This basically helps
to separate long term assets from short term ones. Most importantly, the balance of the assets
section matches the total equity and liability section. This is proof of recording accuracy as assets
must equal liabilities and capital as we discussed previously with the accounting equation.’ Said
John.

‘It all makes sense. Starting from transactions all the way to financial statements, each have their
own importance but are unique. With this, I feel I have obtained ample knowledge about
accounting to at least grasp the numbers of my business until I find someone suitable to do it for
me. Thank you so much for all the help you have provided today. I shall remain in your debt or as
you would say it, open an accounts payable account!’ Said Bob.

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