Lect

ureNot
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ing-
I(BuEd-
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213)
/2004\
05

Chapt
er-
1Account
ingPr
inci
plesandPr
act
ices

1.
1Nat
ureandCl assifi
cati
onofBusi nessOr ganizati
ons
1.Defi
niti
on- Abusi nessor ganizati
onisaneconomi cent i
tywhichisengagedi n
convert
ingbasi cinput sintopr oductsf orsaleatpr ofi
tt ocustomer s.Thebasi c
i
nputsincluder aw mat eri
als( wood,met al,etc)
,labor( employee’
sphy si
caland
i
ntel
lectualef f
orts)
,capi tal(finance)and ent repreneur( owner/managerwho
combinesr aw mat erials,laborandcapi taltoproducepr oducts)
.Thepr oducts
mayi ncludegoods( tablesandchai rs)andser vi
ces( banki
ng,transpor t
ati
on,
educati
onal andheal t
hcar eserv i
ces).

2.Typesofbusi nessor ganizat ions-basedont het ypeofact i

viti
est heyperform or
areengagedi nt ogener atei ncome,busi nessor ganizati
onsmaybedi vi
dedi nto
thr
ee:
 Service-anent erpriset hatr enderspr ofessionalandt echni calservices.
E.g.banks, t
elecommuni cati
onandt r
anspor tati
oncompani es.
 Mer chandi sing -anent erpr
iset hatbuy sandr esell
sf inishedgoodst o
customer s. E. g. St ationery shops, r et
ail and whol esale st ores,
super market s,etc.
 Manuf act uri
ng-anent erpri
set hatbuy sandconv ert
sr aw mat eri
alsi nt
o
fi
nishedpr oduct sforsal etoot herbusinesses( mer chandi sing)ordirectto
consumer s.E. g.t extil
e and cementf actori
es,wood-and met al-wor k
shops, etc.

3.For
msofbusi nessor ganizati
ons-Thr eedi f
ferentlegal formsofbusi nesses:
 Solepr oprietorshi p -an ent erpr i
se owned byone per son and usual l
y
operatedandmanagedbyt hesameper son.Thesol epropr ietor shi
pf orm
ofbusi nessi snotasepar atel egalent i
tyf r
om i tsowner .Thel i
feofa
solepropr i
et orhipusuallydependsupont hel i
feoft heowner .
 Partner ship-anent erpriseownedbyt wo/ mor eper sonscal ledpar tners
andt hepar t
ner sar eusual lyengagedi noper ationsandmanagementof
theor gani zati
on.Li kethesol epropr i
etorshipform ofbusi ness, partnership
i
snotl egallysepar atefr om i tsowner s.Thel i
feofapar tner shi pusual l
y
dependsupont headmi ssi onofnew par tner/sorwi t
hdr awalofex i
sting
partner /s.
 Corpor at i
on - an ent erpr i
se owned by t wo/ more per sons cal led
sharehol der sorst ockholder s.Theuni quef eatureofacor por ationi sthatit
i
sal egalent it
yusual lyr eferredt oasanar tifi
cialpersonwhi chi ssolely
responsi blef orit sactanddebt .Fori thasani ndependentexi stence,its
l
ifedoesnotdependont headmi ssionorwi t
hdrawal ofshar ehol der/s.

Thi
scour sedealswi thfinancialaccounti
ngandr epor
ti
ngf orsolepr
opri
etorshi
p
for
m ofbusinessesengagedi nservicerender
ingormer chandi
singacti
vit
ies.And
Part
-I
Iofthiscoursedealswi thfinanci
alaccounti
ngandr eport
ingforotherforms
andtypesofbusinesses.

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1.
2TheRoleofAccount ingi nBusi nessEnv ironment
1.Definition-Account ingi sdef inedasani nformat ionsy stem concer nedwi th
coll
ect i
on,anal ysis and communi cat ion off i
nanci ali nformat i
on usef ulfor
decisionmaki ng.Fori ti susedasameanst oexchangei nf ormat ionamong
int
erest edpar ti
esconcer ningt hef inanci alper f
ormance,f i
nanci alposi tionand
rel
atedi ssuesofanor ganizat ion, itisal socommonl yknownast he“ languageof
business” .
Asani nfor mat ionsy st em,pr ocessofcol lecting,anal yzi
ngandcommuni cati
ng
inf
ormat ion, itinvol vest hef ol l
owi ngst eps:
 I dent ifying-t r
aci ngandcol lect i
ngr ecor dableeconomi cact iviti
es.Account i
ng
doesnotr ecor dandr epor tal leconomi cact i
v i
ti
esofanor gani zation.Rat her,
i
tr ecor dsandr epor tsonl yt hoseeconomi cact i
v i
ti
esoft heor gani zati
on
whi chcanbeexpr essedi nt ermsofmoney .
 Anal yzingandMeasur i
ng-Thi si nv olvesdet erminingwhet hert heeconomi c
activ it
ies br ing changes ( i
ncrease/ decr ease) asset s,l iabili
ti
es,capi t
al,
revenues,and/ orexpenses ( t
hese t er ms wi l
lbe def i
ned i n subsequent
sect ions)ofanor gani zationandexpr essingt hechangesi nmonet ar yter ms.
 Recor ding-make,i nasy stemat icway ,ar ecordoft heef fectsofeconomi c
activ it
iesonasset s, li
abiliti
es, capi tal, r
ev enuesandexpenses.
 Cl assi f
y i
ng-gr oupi ngr ecor dedef fect sofeconomi cact ivi
tiesi ntomeani ngful
classes.
 Summar izing -gat hering and ar rangi ng dat a needed f orpr epar at i
on of
repor tsandst at ement s.
 Repor ti
ng-pr epar ingst at ement sandr eportsinamannert hatsui tst heneed
ofuser ssoast ocommuni cat ei nfor mat i
onusef ul fordeci sionmaki ng.
 I nter preting-pr ov ideexpl anat iononr eportedi nformat ionsot hatuser scan
under standanduset hei nfor mat ionasabasi sf ordeci sionmaki ng.

2.Importance/purpose-Account i
ngcanbeseenasani mpor t
antpar tofthetot al
i
nformat i
on system ofan or ganizati
on.Peopl e,bothi nsideand out sidet he
business,havetomakedeci si
onsconcer ningtheall
ocationofscar ceresources.
Toensur ethattheser esourcesar eal l
ocatedinaneffi
cientandef f
ect i
vemanner ,
usersrequireeconomi cinf
or mationonwhi chtobasedeci si
ons.Itisther ol
eof
theaccount i
ngsy stem topr ov i
det hatinformationandt heul t
imatepur poseof
accountingistogi vepeoplebet terinformat i
ononwhi cht obasethei rdecisi
ons.
Someoft heusesofaccount i
ngi nfor
mat i
oni nrelati
ont ot heuser soft he
i
nformat i
onaredi scussedbel ow.

3.User sofAccount ingI nformat i

on-Account i
ngseekst osat i
sfytheneedsofa
wider ageofuser s.Inr elati
ont oapar t
icul
arbusiness,t heremaybev ari
ous
groupsofuser swhi char el i
kelytohav eaninteresti
nfinancialaspect sofi t
.The
maj orusersoff inanci alinformationar ecommonl ygr oupedas i nternaland
externalusers.
i
.I nternalusers aremai nlymanagementper sonnelofanor ganizat i
onwho
hav edir
ectinvolvementandcont r
oloverandwhoar er esponsiblefort heday -
to-dayaffai
rsoft heor ganizat
ion.Theyneedanduset hef inancialinformat i
on
tomakedeci sionsandpl ansf orthebusi nessactiviti
esi ncl
udingf inance,

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humanr esource,pr oductionandmar keti

ng,andexer ci
secontroltot ryto
ensurethatpl anscomet ofr
uiti
on.Managementpeopl euseaccount i
ng
i
nformati
ont o
o formulatel ong-,
medi um-andshort-
ter
m plans
o controlandev al
uateoperat
ionandperformance,and
o make ot hermaj ordecisions r
elated t
of inanci
ng and inv
estment ,
productcost ing and pr
ici
ng,selecti
ng productmix and allocati
ng
scarceresour ces.

i
i.Exter
nalusersont heotherhand,refertousersout
sideanorganizat
ionwho
arenotdirect
lyi
nvolvedintheday-to-
dayaffai
rsoftheorgani
zati
onbuthave
somei nt
eresti
nthefinanci
alandrelatedaf
fair
softheorgani
zati
on.

Ext
ernal usersi ncl ude:
 Exist i
ngandpot entialowner s/inv est orswhowantt oassesshow ef fectivel
y
manager sar er unningt hebusi ness,andt omakej udgment saboutt hel ikel
y
levelsofr i
skandr etur nassoci atedwi thi nv estmenti nt hebusi nessand
deci det oinv estorde- i
nv est.
 Exist i
ngandpot entialsuppl i
er sandcr editorswhoneedt oassesst heabi l
it
y
oft hebusi nesst opayf orgoodsandser vicessuppl i
edort obesuppl iedt oit
andt omeeti tsobl igationswhendue.
 Exist i
ngandpot entialempl oy ees( non- manager s)andl aboruni onst hatneed
to assess t he abi lity oft he busi ness t o cont inue pr ovidi
ng t hem wi t
h
empl oymentoppor tuniti
esandbet terr ewar df orser vi
cest heyr ender edor
mayr endert ot heor gani zation.
 Gov er nmentagenci eswhoneedt oassesshowmucht axt hebusi nessshoul d
pay ,whet heri tcompl i
eswi thappr ovedpr icingpol icies,pr otectthepubl i
c
from excessi v epr i
cechar gesbymonopol i
es, andsoon.
 Exist i
ngandpot entialcust omer swhowantt oassesst heabi l
i
tyoft heent it
y
to cont i
nue i n busi ness t o suppl yt hem wi tht he necessar ygoods and
serv i
cesandt oknowt hei rout st andi ngbal ances.
 Invest mentanal y stsandconsul tant swhowantt oassesst hel i
kelyr i
sksand
returnsassoci at edwi thi nvest menti nanor gani zationi nor dert odet ermine
invest mentpot ent i
alsandadv iset heirclientsaccor dingl y.
 Communi tyr epr esent ativeswhoneedt oassesst heabi l
it
yoft heent it
yt o
cont inue pr ov i
di ng empl oy ment oppor t
uni ti
es f or t he communi ty ,use
communi tyr esour ces, tosuppor tenv ir
onment al impr ov ement sandsoon.
 Compet i
torswhoneedt oassesst het hreatposedbyt hebusi nesst ot heir
mar ketshar e and pr ofit
abi li
ty ,and need f ora benchmar k bywhi ch to
compar eef f
iciencyandper f
or mance.

To make thei
rr espect
ive deci
sions,ext
ernalusers need among ot
hert
hings
account
ingi
nfor
mat i
onaboutabusi nessoft
heirconcer
n.

4.Character
ist
icofAccount
ingI
nfor
mation-account
inginfor
mati
oni smai
nly
quanti
tati
veexpr
essedinmonet
aryter
ms.Tobeusef ulfordeci
sionmaki
ng,

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accountingi nf
ormat i
onshouldbe
 Rel i
abl e-representfacts,
neutr
al,
freemateri
alerr
orsandbias.
 Rel evant-hi ghl
yrelatedtoandmakeadi ff
erenceindecisi
on.
 Under standable-user swithar easonabl
eknowl edgeofaccounting and
economi cactivi
ti
esshoul dbeabl etoeasilyunderstandandint
erpretthe
i
nformat ion.

Reli
abil
i
ty,rel
evancyand underst
andabi
l
ityar
e commonlycal
led t
he qual
i
tati
ve
charact
eri
sti
corat t
ri
but
est hatmakeaccount
inginf
ormat
ionusef
ulfordecisi
on
making.

5.Bookkeepingv ersusAccount i
ng-Bookkeepi ngref
erstotheartofrecordi
ng,ina
prescri
bedandsy st
emat i
cway ,theeconomicactiv
iti
esofanor ganizat
ion.I
tis
routi
ne and clericalin nature.Account i
ng,on theot herhand,goesbey ond
bookkeepingandi sconcernedwi th
 Desi gningaccount ingandr eporti
ngsystems
 Recor dingeconomi cactivi
ti
es
 Pr epari
ngr epor t
sandst atement s
 I nt
erpreti
ngr eportedinf
or mationand
 Rev iewingrecor dsandr eportsforthei
raccur
acy.

Thus,i
tcanbesaf
elyconcl
udedt
hatbookkeepi
ngi
soneandt
hesi
mpl
estpar
tof
account
ing.

6.Profession ofAccount ancy -Account i

ng i s an occupation which requires
advancededucat i
onandspeci altrai
ning.Aftercompletingtherequir
ededucat i
on
andt r
ainingaccount i
ngpr ofessionalsmaywor kaspr i
vateorpublicaccountant s.
 Pr ivate accountantsr efert ot hose accountants who wor kf ora si ngle
empl oyerothert hangov ernmentonsal arybasis.Priv
ateaccount antsmay
assumedi f
ferentposi ti
onswi t
hi nanor ganizat
ionincl
udingchiefaccountant ,
fi
nanci almanager ,
cont r
oller,
budgetof fi
cerandcostaccount ant.
 Publ i
c accountantsr efert ot hoseaccount antswho pr ovi
depr ofessional
servicestot hepublici ngener alonaf eebasi s.Theyincludecerti
fi
edpubl i
c
account ant
sandaut hor i
z edindependentaccount ants.

7.Special
ized Fi elds ofAccount i
ng -account ant s mayspeci al
ize in di
fferent
accountingf ieldsi ncludingf i
nancialaccounting,manager i
alaccount ing,cost
accountingandt axaccount ing.
 Financi alaccount ing-ar eaofaccount i
ngai medatser vi
ngi nf
or mati
onneeds
ofexternal users.
 Manager ial account i
ng - f iel
d of account i
ng concer ned wi t
h ser ving
i
nformat i
onneedsofi nternalusers-manager s.
 Cost account ing -a manager i
alaccount ing acti
vi
ty desi gned to hel p
manager si nidentifyi
ng,measur ingandcont roll
ingoper
atingcost s.
 Taxaccount i
ng-f ieldofaccount ingthatincludespreparingtaxr et
urnsand
pl
anni ngfut uretransactionstomi nimize(notofcour setoavoi dwhichi san

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i
ll
egalact
)amountpr
ofi
ttaxpay
abl
e.

8.Ev oluti
onofAccount i
ng-Account i
ngishi ghlyaf fectedbyt heeconomi c,soci al,
cultural,legal,technol ogicalandpol iti
caldev elopment sofasoci ety.Higher -
lev el
economi c,soci al,cul t
ural ,legal,t echnological,andpol i
ti
caldev elopment sofa
soci etyneedmor eel abor atedandsophi sticatedaccount ingsy st
ems.I nl i
newi th
the changes i nt he af orement ioned env i
ronment alf actors,account i
ng has
evol vedt hroughsev er
alphases.Thesephasesmaybegr oupedi ntot womaj or
classes: pr i
mi t
iveandmoder n.
 Pr imitive-pr imi ti
veaccount ingi sbel i
evedt ohav ebegunabout4000BC.At
thisst age,account i
ngwasi dentif
iedt obeunsy st
emat icandi ncompl et e
dealingwi t
hcer tai
naspect sandt y
pesofeconomi caf fai
rs( l
ikerecei ptsor
payment sofmoney ),whi chdoesnotpr ovidei nformat i
onsuf fi
cientenought o
evaluatet hefinanci alper formanceandposi tionofaneconomi centit
y .
 Moder n-moder naccount i
ngemer geswi tht heinvent i
onoft he“ Doubl e-entr y
account ingsy st em”i n1494byanI t
alianmonknamedLucaPaci oli.Doubl e-
entryaccount ingsy stem pr ovidesf orr ecor dingt hedual ,commonl ycal led
debitandcr edi t,aspect soff inancialaf f
airsofanent it
ywhi chenhancest he
accur acyofr ecor dsandf acil
itatespr eparationofr epor t
s.

1.
3General
lyAcceptedAccount ingPr inci
ples
1.Whatar eGener allyAccept edAccount ingPr i
nci
ples( GAAP) ?GAAP r eferto
specifi
cf undament albel ief
s,whi ch,on t hebasi sofr easons,demonst rat
ed
performance and gener alaccept ance,ar e generally essentialt o guide t
he
practi
cesofaccount i
ngandr epor ti
ngf ort hef i
nancialaffair
sofaneconomi c
entit
yi ncl
uding gov ernment al,non- government al
,busi nessand non- busi
ness
organizati
ons.Regar dlessoft henat ureoft heeconomi centitytheyaffect,t
hese
pri
nciplesarecol lecti
velyknownasGener allyAccept edAccount i
ngPr i
ncipl
es
(GAAP) .GAAP i ncludegener alconcept s,assumpt ions,pr i
nciplesaswel las
specifi
caccount ingandr eportingpr ocedur es,poli
ciesandmet hodssuchas
inventoryval
uati
on, revenuer ecogni t
ion,depreciati
oncomput ati
on, et
c.

GAAPar enotuni versall

yaccept edandst ati
cpr i
nciplesl i
kepr i
nci plesofnat ural
sciences. They ar e gener all
y accepted by account i
ng pr actiti
oners and
theoreti
cians,andot herconcer nedpar t
ies,i nagi vencount r
yorcont inent ,as
guideli
nesf oraccount i
ngandr eport
ingthef i
nancialaff
ai r
sofeconomi cent i
ti
es
operati
ngi nthesamecount ryorcont i
nent .Account i
ngst andar dsar einfluenced
byt he economi c,pol i
tical
,l egaland soci alenv i
ronmenti n whi ch theyar e
establi
shedandappl i
ed,t hus,subj ecttor evi
sionorchangei nl i
newi tht he
changesi nthepr eviousl yment i
onedenv ir
onment alfact ors.Member soft he
accountingpr of
ession, throughassoci ati
onsandi ndivi
dual inputi ntothepr ocess,
hav eovert i
mewor kedt oest abli
shaccount i
ngpr i
nciplesaccept edbybot hthe
accountingpr of
essionandt hepublicthatreliesont hepr ofession'sexper tise.

Thef oll
owing sect
ionsdi
scusssomeoft hebasicaccounti
ng assumpti
ons,
pri
nci
ples,andconceptst
hatguidetheaccounti
ngandr
eporti
ngpracti
cesforthe
fi
nancialaf
fai
rsofcommer ci
aleconomicenti
ti
es.

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2.Economi cEnt it
yAssumpt ion-Accor dingt ot hisassumpt ion,eacheconomi c
enti
tyexi stssepar atefrom andi ndependentofi tsowner /sandot hereconomi c
enti
tiesundert hesameordi ffer entowner /s.Thus,economi cev entscanbe
i
dent i
fi
edwi t
hapar t
icularuni tofaccount abili
ty.Andt heeconomi cact i
vit
iesof
anaccount i
ngent i
tycanbeandshoul dbekeptsepar ateanddi sti
nctf r
om i ts
owner /sandal lot herent it
ies.Fori nst ance,r ecordsandr eportsofpar t
icular
businessshoul dnotr eflecti tsowner ’sper sonaleconomi cact ivi
ti
es,assetsand
l
iabi
liti
esandt hatofanot herbusi nessot herthani tsowneconomi caffair
s.Thi s
assumpt ionest abl ishesl imi t/
boundar yast owhati nformat i
ont oincludei nt he
account i
ng r ecordsand r eport sofaneconomi cent it
yand t husmakest he
fi
nancialaccount ingandr epor tingpr act i
cesmanageabl e.Theaccount i
ngent ity
concept ,howev er,doesnotnecessar ilyr efert o alegalent i
ty.Fori nstance,
account i
ngassumesal lty pesofbusi nessor ganizati
ons( i
.e.solepropriet
or ship,
part
ner shipandcor poration)assepar ateandi ndependenteconomi cent iti
es.
Howev er, i
tisonl ycor por ationt hati slegal l
ytreatedassepar ateandi ndependent
enti
ty.

3.GoingConcer n/ Continuit
yAssumpt ion-Thi sassumpt i
onst atest hat,int he
absence ofi nformat i
on tot he contrary,t he lif
e ofan economi c enti
tyi s
i
ndet erminateandt heeconomi centi
tywi llcontinueinoper ationlongenought o
carryouti t
sexist ingobjecti
vesandcommi tment s.Thi
sassumpt i
onser vesasa
basisf orot herpr i
ncipl
essuch ast he hi stori
calcostpr inciple and affects
cl
assi f
icati
onofasset sandl i
abi
li
ti
esascur r
entandnon- cur r
entf orreporting
purposes.Becauseoft hisassumpti
on, l
iquidat i
onv al
uesofasset sandl iabi
lit
ies
arenotr elevantf orrecordi
ngandr eportingt hef i
nancialaf
f airsofaneconomi c
enti
ty.

Thegoingconcernassumpt i
onlosesi tval
ueifaneconomi cent i
tyi
sexpectedto
l
iqui
dateinthenearfuture.I
nsuchcases,anal ter
nativeassumptioncal
ledthe
l
iqui
dationorquit
ti
ngconcer nprevail
s.Andal lassetsandliabi
li
ti
esoftheentit
y
shoul
dber ecor
dedandr eport
edatt heirl
iquat
ion/disposalv
alues.

4.AccrualConcept-Thi sconceptr equirest hatf i

nancialaf fairsofaneconomi c
enti
tyshouldber ecogni zed( i
.e.recordedandr epor t
ed)ast heyoccurr egar dless
ofthet i
mingoft hei n/outf lowsofcashassoci atedwi tht heeconomi cev ents.
Accordingtothispr i
nci ple,forinstance, r
evenueshoul dber ecordedandr eported
whengoodsar edeliveredorser v
icesar erender edt ocust omer s,andexpenses
shouldber ecognizedwhengoodsandser vi
cesar econsumed.Thet i
mi ngoft he
i
n/outf l
owsofassoci atedcash,whi chmayhappeni nadvance,i mmedi atelyor
somet i
mei nt hef uture,shoul dnotdet ermi netheper iodi nwhi chther evenues
andexpensesshoul dber ecordedandr eported.Thisconceptav oidsdistor ti
onof
i
nformat i
ononf inancialper formanceandposi tionofaneconomi cent it
yt hat
ari
sesasar esultofmi smat chofcost s/expensesandr evenueswhent het iming
ofcashf l
owsi st r
eat edasabasi sf orr ecordingandr eportingt hef i
nanci al
aff
airsofaneconomi cent i
ty.

6
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5.Obj ectiv
ityPrincipl
e-Accor dingtothisprincipl
e,aneconomi cent i
ty’
sfinancial
affairstober ecordedi ni tsaccountingr ecordsandr eport
edoni tsfinancial
statement smustbesuppor tedbyobjecti
velydet erminableevidencesknownas
sour cedocument s.Thishel pst oenhancet her el
iabi
li
tyofinformationreported
byt heent it
yandt heconf idenceofuser sinr elyi
ngont hereportedaccounting
i
nf ormat i
on for maki ng economi c decisions.Obj ective evidences (source
document s)includesucht hingsasinvoices,v ouchers,checks,contractsand
phy sicalcountsofr esources.

Evidencessuppor tingt hef inanci alaf fairsofanent ityar enotal way sconcl usive.
Keepi ng account ing recor ds and pr epar i
ng r epor t
s mayr elyon j udgment s,
estimat esandot hersubj ect i
vef act or s.Insuchcases,t her ecor dsandr epor ts
shoul dbebasedont hemostobj ectiveev idenceav ailableandbekepti nsucha
wayt hatani ndependenti ndi vi
dual( e.g.anaudi tor)coul dv eri
fyt heiraccur acyor
rel
iabi l
ity.Thi smeanst hatt heindependenti ndi vi
dualshoul dbeabl et oar riveat
the same i nf ormat i
on usi ng t he bases t he infor mat i
on i sr ecor ded i nt he
account ingr ecor dsandr epor tedont hef i
nanci al statement s.
6.Histor icalCostPr i
nciple -Thi s pr inciple st ates t hatgoods and ser v
ices
purchased orsol d shoul d be r ecor ded i nt he account ing recor dsand t hen
repor ted on t hef i
nancialst atement satt hei nitialamountofcash orcash
equiv alentgi v enupt oacqui ret hem orr eceivedi nexchangef orsel l
ingt hem
rathert hanonanest i
mat ed/ appr aised/ assessedormar ketv alue.Suchamount
i
sknownast hehi storicalcost /exchangepr iceandi sret ainedi nt heaccount i
ng
recordsunt ilsucht i
met hatt hegoodsandser v icesar econsumed,sol dor
l
iquidat edandr emov ed.Thej ustificationf orusi ngt hehi stori
calcostasabasi s
forrecor dingandr eporti
ngf inanci alaf fair
si st hef actt hati tist hemostr eli
able
fi
gur eusual lysuppor tedbyobj ect ivelydet erminabl eev idences.I nsomecases,
howev er ,i t may be di f
ficultt o est abl i
sh hi st oricalcost . For i nstance,
goods/ ser vicesmaybeacqui red/ soldi nexchangef orot hergoods/ servicesori n
thef or m ofgi ftordonat ion.I nsuchsi tuations, thegoods/ servicesr eceiv ed/sold
arer ecor dedatt heirf ai
rmar ketv aluesort hef airmar ketv aluesoft hei t
ems
givenup/ recei vedi nexchangewhi chev erisobj ect i
v elydet erminabl e.

7.UnitofMeasur ementAssumpt i
on-Accor di
ngtothisassumpti
on,thenational
curr
ency( money)shouldbeusedasauni tofmeasureorcommondenomi nat or
forrecordi
ngandr eport
ingtheeconomicaffai
rsofaneconomicenti
tyoperating
i
nagi vencountr
y.Besides,theuni
tofmeasur eisassumedtoremainconst ant
overtimedespit
et hefactthatt
hepurchasi
ngpowerofmoneychangesov ertime.

Accordingt othisassumpt i
on,onl ythoseeconomi cactivi
tiescapableofbeing
expressedint er
msofmoneyshoul dber ecordedi ntheaccount i
ngrecor
dsand
ult
imatelyreport
edont hef i
nancial r
eport
sofaneconomi cent i
ty.However,many
fact
orsaf f
ectingeconomi cacti
v i
tiesandf ut
urepr ospect
sofaneconomi centit
y
cannotbeexpr essed in monet aryt er
ms.Fori nstance,such f act
orsast he
capabil
iti
es, dedicati
on and t rust of empl oyees includi
ng management ,
envir
onment alimpact( costsandbenef its)oft heexistenceoft heeconomic
enti
ty,andt her elat
ivestrengthsandweaknessesofcompet it
orscannotbe

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expressedinmonet aryt
erms.Althoughsuchmat t
ersareimport
anttoandhighly
affecttheoperati
onsandper f
ormancesofaneconomi centi
ty,atthepresent
ti
me,account ancydoesnotassumer esponsi
bil
i
tyforrecor
dingandr eport
ing
i
nfor mati
onofsuchki nd.Besides,account
ancydoesnotassumer esponsibi
lit
y
forrecordi
ngandr eport
ingtheeffect
sofchangesinpurchasi
ngpowerofmoney
onpr evi
ouslyr
ecordedv al
uesofgoodsandser vi
ces.

1.
4BusinessTr ansact i
onsandt heAccount i
ngEquat ion
1.El ement sofFi nancialSt atement s-ar eit
emst hatar erecordedi ntheaccount i
ng
records and t hen r epor t
ed on commonl y cal ed f
l inancialstatement s ofa
businessent i
tyrepor ts.Theel ement soff i
nanci alstatement sincludeasset s,
l
iabili
ti
es,capi t
al,
revenuesandexpenses.
i
. Asset s-ar eresour cesowned/ contr
oll
edbyaneconomi cent i
tyandwi t
ht he
potentialtoprov i
def utur ebenef i
tstothebusi ness.E.g.buil
ding, l
and,vehicle,
money , offi
cemachi nesuchascomput er,st ati
onerymat eri
als,fuel,I
nventory
(merchandi sehel df orsal e) ,Account sRecei vable( moneycl aimsagai nst
customer sf orgoodsandser v i
cessol dtot hem oncr edi
t),RentRecei vable
(moneycl ai
msagai nstl essee/ t
enant/r
ent erf orhousingser vi
cesr enderedt o
them butnoty etcol l
ected), Suppl i
es(alsocal l
edconsumabl e-refertoasset s
thatar eexpect edt obeconsumedwi thi
nav er
yshor tperi
odoft i
meand
incl
udesuchi temsasf uel,st ati
onerymat erial
s,cleaningmat erial
s,post age
andpost agest amps,et c)
,et c.Asseeni nt heabov ecases,moneycl aims
againstcust omerf orgoodsandser v
icesrender edtothem oncr editbasi
sar e
identi
fiedbynamesi ncludingasuf f
ixRecei vable.

i
i.Liabili
ti
es-obl i
gations/debtsofabusi nesst hatar i
seasar esultofbor rowing
and/ orbuy i
nggoodsandser vi
cesoncr edi t
.Li abili
ti
esmayr equi reuseof
businessasset ssuchascashand/ ordeli
v eryofgoodsandser vicesf ort hei
r
repay mentorset tl
ement .E. g.Account s Pay able( l
iabilit
y ar ising f r
om
purchaseofgoodsoncr edit)
,Salar yPayabl e(obl i
gat i
onf orpr of essionalor
technicalser vi
cesr eceivedf rom empl oy ees),Ut i
l
ityPay able( obl i
gat i
ont o
util
i
tycompani esf orutil
i
t yserv i
cessuchast elephone,el ectricityandwat er
servicesr eceivedbutnoty etpaid),BankLoanPay able(moneybor rowedf r
om
banks) ,InterestPay able(int
erestaccr uedonl oansnoty etr epai d) ,SalesTax
(VAT)Pay able( amountcol lectedf rom cust omer sonbehal fofandduet o
gover nment /taxaut hori
ty)andUnear nedRent( moneycol l
ect edf rom t enants
promi singt opr ovi
det hem housi ngser vi
cesi nt hef uture).Mostl iabili
tiesare
i
dent ifi
edbynamesi ncl
udingasuf fxPay
i ableorapr efxUnear
i ned.Li abil
iti
es
representcl aims/ r
ights ofcr edit
ors agai nstt he resour ces/ asset s ofa
businessorv al
ueofasset ssuppl i
edbycr editors.

i
ii
.Capi tal-alsocal l
edowner ’
sequit
y /
networ t
h/netasset
sr ef
ert or esources
contri
butedbyort hatbel ongtot heowner /sofabusi nessent i
t y
.Capi tal
representsclai
ms/ rightsofowner/ sagainstassetsofabusi ness.Capi tal
mayi ncludedirectinvestmentofresourcesbyowner /sandpr ofi
tgener ated
from businessoperat i
onsthatar
eaccumul atedoverti
meornotwi thdrawnby
theowner /sforpersonal use.

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i
v.Revenues-r efertomoneyorot herasset sreceivedi nexchangef orgoods
andser vi
cessol dt ocustomers.Busi nessor gani
zationsmaysel lgoodsand
ser
v icesoncashand/ orcredi
tbasis.
 Cashsal e-r efersto asi tuat
ionwher ecust omer sbuy inggoodsand
ser vi
cesar erequiredtoimmedi atelypayandaccor di
nglypai dcashfor
goodsandser vicessoldtothem.
 Cr editsale-r efer
st oasi t
uationwher ecust omersar eal l
owedt opay
moneysomet imei nthefuturef orgoodsandser vicescur r
entlysoldto
them. Cr edi
t sal e gi ves r ise t o an asset known as
Account s/ Rent/Commi ssi
on Recei v abl
er epresenti
ng t he rightoft he
busi nesstocl aim moneyorot herasset sfrom customer sbuyingitsgoods
andser v
icesoncr edi
t.

Revenuesmaybegener atedf rom di f

ferentact i
vitiesanddi ff
er enttermsmay
beusedt or efert hem accor dingl
y .Belowar esomeexampl es.
o Sel l
ing f inished goods such as f ood/ clothing i t
ems,st ati
onery
mat eri
als-Sal es
o Pr ov i
dingser v
icessuchast ransportation,audi t
ing,l egal,medi cal-
FeesEar ned
o Lendi ngmoney-I nter estIncome
o Leasi ng/ rent i
ngpr oper tes-Rent
i /RoyaltyIncome
o Pr ov i
dingbr okerageser vce-Commi
i ssionI ncome
v.Expenses-r efert o goodsand ser vi
cesconsumed/ used i n operating or
carrying onday -to-dayact ivi
ti
esofabusi ness.Li kesal esofgoodsand
services,expensesorpur chasesofgoodsandser vcesmaybeoncashor
i
creditbasis.
 Cash expense/ purchase - r eferst o a si tuat ion wher e a busi ness
immedi atelypay scashf orexpensesi tincur redorgoodsandser v
icesit
pur chased.
 Cr editexpense/ purchase -r eferst o a situat ion wher e a busi nessi s
allowedt opaymoneysomet imei nt hef utur ef orexpensesi tcurrentl
y
incurred or goods and ser vices it cur rently pur chased. Cr edi
t
expense/ pur chase gi ves r i
se t o an obl igat ion/al iabili
ty known as
Account s/Rent /Interest/Salary/Util
it
y Pay able representing the
rights/claimsofcr edit
or s/suppliersagainstt heasset soft hebusi ness.

Dif
ferenttermsareusedt or efertoexpensesbasedont het ypeofgoodsand
ser
v i
cesconsumed.Bel owar esomeexampl es.
o CostofGoodsSol d-expi redcost sfi
nishedgoodsr esult
ingfr
om sale
ofthegoodst ocustomer s
o Suppl iesExpense-repr esentingcostofsuppliesconsumed
o Ut i
lit
yExpenses-v alueofut i
l
ityservi
cesconsumed
o Wages/ Sal
aryExpenses-v aluesofser vi
cesreceivedf rom empl
oyees
o I nt
erestExpense-interestaccr ued/paidonloans
o Rent /Royalt
y Expense -v al
ue ofser v
ices receiv
ed f rom proper
ty

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owners
o Miscell
aneousExpenses-v
aluesofgoodsandservi
cesconsumedbut
minorenoughinamounttobeclassi
fi
edinei
theroftheabovet
ypesof
expenses

2.Business Transactions -are economi c act

ivi
ti
es ofa business thatbr i
ng
monet ar
ychangesi nit
sassets,li
abil
iti
es,capit
al,r
evenuesandexpensesand
shouldber ecordedi ntheaccount i
ngr ecordsoft hebusiness.Theyi ncl
ude
buyi
ng and sel l
ing goods and services and coll
ecti
ng and payi
ng money .
Businesstr
ansact i
onsarerawmat eri
alsorinputstotheaccount
ingprocess.

Businesst r
ansact i
onsmaybecat egorizedasexternalandinternaltransacti
ons.
 Ext ernaltransactions-r efertoexchangesofgoodsandser vicesbet weena
businessor ganizati
onandanout sidepar t
ysuchasi ndi
vidualsand/ orother
organizati
ons.E. g.buyingt elephoneser vi
cesf r
om ETC,sel l
i
nggoodst oa
customer ,purchasingvehi cl
ef r
om Ny al
aMot ors,et
c.
 I nt
ernaltransact i
ons-r efertoconsumpt i
onsofgoodsandser viceswithi
na
businessent itywhi chdonotaf fectexternalparty.E.g.useofpr evi
ously
purchasedst ati
oner ymat eri
als,f
uel,off
icemachine,etc.

3.The Accounting Equati

on -is a mathemati
calexpressi
on thatshows t
he
relat
ionshi
pbetweenassets,
li
abi
li
ti
esandcapit
alofabusiness.Bel
owarethr
ee
butf undamental
lythe same way s ofexpr
essi
ng the rel
ati
onshi
p bet
ween
elementsofthefi
nancial
stat
ements.
i
. Resour ces = Sour ce/Equiti
es/Cl
aimst oResour ces
Thisequat i
onindicatesthatr esourcesofabusi nessor ganizat
ioncomef rom
twomaj orsourcescollecti
velyknownasequi ti
esorcl aimst ot heresources.
Accordingly
,r esources ar e equal t o t hei
r sources/ equi
ti
es. Resources
contri
butedorinvestedbyowner /sarecal l
edowner ’
sequityorcapi t
alandthose
resourcessuppliedbycr edi
torsarei denti
fi
edasl iabi
li
ties.Expansionoft he
previ
ousequat i
ont ogiv erecogniti
ont othet wobasict ypesequi t
iesleadst o
anotherequati
ongi venbelow.

i
i.Assets = Li
abi
li
ti
es + Owner'sEquit
y
Thi
sindi
catest
hatabusi
nessmaygetit
sasset
sf r
om it
sowner /
sint
hef
orm of
i
nvest
mentand/orf
rom i
tscr
edi
tor/
sint
hefor
ml oanorcredi
t.

i
ii.Assets - Liabi
li
ti
es = Owner'sEqui t
y
Theaccount i
ngequat i
onmayf urt
herberear
ranged, asshownabove,t
oindi
cat
e
thatowner ’
sequityr epr
esentstheresi
dualinterestinbusinessasset
s.Thi
s
i
mpl iesthatcredi
torshav eprior
it
yorpr ef
erenti
alr i
ghtovertheassetsofa
businessupontheev entofli
qui
dati
on.

4. BusinessTransact
ionsandtheAccounti
ngEquat i
on-Businesstransact
ions
affectone ormor e el
ement
s ofthe accounti
ng equat
ion.Each business
transacti
onbri
ngsequaldol
l
aramountofnetchangesint
oboththeleftandri
ght

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sidesoft heaccount i
ngequat i
on.Asar esul
t,theequationremainsinbalance
(equal)regar
dlessoft henatureandcompl exi
tyoft het r
ansact
ion.Eachand
everybusinesstransact i
onisrecor
dedi nter
msoft hechanges( increasesand
decreases)itbringsi ntotheelementsoft heaccountingequation.Thus,the
accountingequat i
onisusedt okeept r
ackofchangesi ntheelement softhe
fi
nancialstat
ement .Example1-1ont henextpagewillbeusedt oi
llust
ratet
hese
facts.

Bel
owar esampl et r
ansactionsandt heiref f
ectsont heelementsofthef inancial
st
atements.
i
. Coll
ect i
onsofr esourcesf r
om
 owner /si
nt heform ofinvestment ,increasebothassetsandcapital
 cr editor/sintheform ofcr edit/loan, i
ncreasebothassetsandliabi
liti
es
 cust omer /
si nexchangef orgoodsandser vi
cessoldt othem,i ncrease
bothasset sandr ev enues
i
i.Consumpt i
onsofgoodsandser vicessuchas
 pr eviouslypur chased suppl ies,st ationerymat er
ial
sand f uel,increase
expensesanddecr easeasset s
 ut i
lity,housingandempl oyeeser vicesf orwhichmoneyi snoty etpai d,
i
ncr easebot hexpensesandl iabi l
it
ies
 moneyt aken outofbusi ness byt he ownerf orpersonaluse cal led
withdr awals,decr
easebot hasset sandcapi t
al

Not
et hatr
evenuesandexpensesr
epr
esenti
ncr
easesanddecr
easesi
ncapi
tal
,
r
especti
vel
y.

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Exampl e1-1
On Januar y3,2003,Al emu Haba,an ex- manageroft he CBE Fi nfine Br anch,
establi
shedhi sownconsul tancybusi ness.Henamedhi sbusi ness" AHConsul tancy
Servi
ces".Theobj ect iveoft hebusi nessi st or enderf inanci alconsul tancyser v i
ces
toclient
sonaf eebasi s.Thef ollowingbusi nessact i
vitiesoccur r
eddur ingt hef irst
mont hofoper at i
onsoft hebusi ness( Januar y3t oJanuar y31, 2003) .
1 Al emudeposi ted$20, 000cashi nabankaccounti nt henameofhi s
business-AHConsul tancySer vices.Hehas$250, 000cashi nhi sper sonal
bankaccountwi t hDashenBankand$50, 000cashi nasaf edeposi tboxat
hisresi dence.
2 Al emu t ransf er red f urniture wor th $30, 000 f rom hi s home f orof fice
purposesbyAHConsul tancySer vices.Heal sohasext rahomef urnitur e,
resident ialhouse and per sonalcarwor th $620, 000,$800, 000 and
$360, 000, respect i
vely.
3 Al emupur chasedof ficesuppl ieswor th$5, 000f rom v ar
ioussuppl iers
agreei ngt opayt hesum i nthenearf uture.Two- f
ifthoft hesuppl ieswi llbe
usedf orper sonalpur poseswhi let her emai ni ngi sf orusebyAH.Thr ee-
fi
fthoft hel iabili
tyi sar rangedt obeset t
ledf rom busi nesscashsour ces.
4 AHr ecei v ed$20, 000cashf orconsul tancyser v i
cesi tr enderedt oacash
cli
ent .
5 AHpai d$3, 000cashf oradv er t
isingai redt hroughETV.
6 AH f or ecast edt hatser vicesf eesi nt henextt woweekswi llamountt o
$5,000.
7 AHr ecei ved$10, 000addi ti
onal cashi nvest mentf rom Al emu-i tsowner .
8 AHr ender edconsul tancyser viceswor t
h$15, 000t ocl i
entspr omi singt o
payi nt henearf ut ure.
9 AHsol doneoft hef ur nit
urei nv est edbyi tsownerf or$5,000cash.The
furniturehadar ecor dedv alueof$5, 000.
10AH col lect ed$5, 000cashf rom cl ientswhor eceivedser vi
cesi nitem- 7
abov e.
11AHpai d$2, 000casht osuppl iersoncr edit.
12AH pur chased a used carf orbusi nesspur poses.Thebusi nesspai d
$8,000cashf ort hecar .Br oker sest imat edt hatt hecarcur r
ent l
ywor th
only$5, 000andt heI nlandRev enueassessedt hecarat$12, 000f or
proper tyt axpur poses.
13AHbor rowed$4, 000cashf r om DashenBank.Thel oani sr epay ableov er
tenmont hs.
14AHempl oy edanaccount antandasecr et aryf ormont hl
ysal aryof$1, 200
and$700, respect i
vely.
15AHi ncur redandpai dfort hef oll
owi ngexpenses
 Wages. ..
....
...
..
....
..
..
....
...
....
.....
....
..
...
...
. $6, 000
 Rent .
...
....
...
...
..
....
..
..
.....
..
.....
....
....
..
...
... 4, 500
 Ut ili
ti
es. ..
...
...
..
....
..
..
.....
..
....
.....
....
..
...
...
. 1, 200
 Ot her s..
.....
..
..
....
..
...
..
.....
...
....
.....
...
..
....
.. 800
16AHdet er mi nedt hatcostofsuppl i
esr emai nedonhandatt heendoft he
currentmont htot al $1,300.
17AHpai d$450casht oDashenBankconsi stingof$400pr i
ncipaland$50

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onemont hinterestont heloanduei nJanuar y

.
18AH pai di tsowner$5, 000cashf orpersonaluses( topayhouseut il
it
y
expenses) .
Required:
a)Anal yzet heabov et r
ansactionsandr ecor dthem intheaccount i
ngr ecordsofAH
Consul tancySer vi
cesand
b)Pr epar ef i
nanci alstatement sf ort
hebusi nessforthemont hofJanuar y2003.
1.
5Fi
nanci alSt atement s
1.Def initi
on-f inanci alstatement sar erepor tspreparedbyabusi nesst opr
ovide
fi
nanci ali nf
or mat i
onabouti tseconomi caf f
airstouser sfordeci sionmaking.
Business or gani zations pr eparef our basi cf inancialst at
ement s: i
ncome
statement ,statementofchangesi nowner ’sequity(capital
),balancesheetand
statementofcashf l
ows.Fi nancialstatement shav et womaj orpar t
s:theheader
wher et henameoft hebusiness,t het ypeoft hest atementandt het i
meperiod
thest atementcov ersarewr itten;
andt hemai npart(body )wheret heelementsof
thef i
nanci alstatement sarer eported.

2.IncomeSt atement-isusedtopr ovideinfor

mati
onaboutf i
nancialper
for
mance
ofabusi nessov erti
me.Thest atementsummar i
zestherevenuesearnedand
expensesi ncur
redi naspecif
icper i
odoft imesuchasamont horay ear.
Expensesar edeductedfrom r
ev enuesont heincomest atementtodetermine
whet hert
hebusi nessearnedaneti ncomeori ncurr
edanetl oss.Excessof
revenuesov erexpensesiscal
ledneti ncome,whileexcessofexpensesov er
revenuesiscalednetl
l oss.

3.Stat
ementofChangesinOwner ’sEquity-isasummar yofchanges( i
ncr
eases
anddecreases)i
nowner’
sequitythathaveoccurr
eddur ingaspecifi
cperiodof
ti
mesuchasamont horay ear.Thest at
ementincludesbeginni
ngandendi ng
capi
tal
balances,
addi
ti
onali
nvestment,wit
hdrawalandnetincome/loss.

4.BalanceSheet-i susedt opr ovideinfor

mat i
onaboutamount sandt ypesof
assetsabusi nessownsandamount sandt ypesofr esour cescont r
ibutedbyi ts
owner /
sandcr edi
tor/s.El
ement soft hebalancesheeti ncludeasset s,li
abil
i
ties
andcapi t
al.Thebalancesheetlistsassets,l
iabil
i
tiesandcapi talofabusi nesson
aspecificdate,usuallyatt
heendofamont horay ear.Ther ear etwof ormsofa
balancesheet:reportandaccount .
 Repor tf orm -listsassetsf i
rstfoll
owedbyl iabilit
iesandcapi tali nreport
writi
ngform
 Accountf orm -l i
stsassetsont heleftsideandl iabili
ti
esandcapi talont he
ri
ghtsideofthebal ancesheet

5.Stat
ementofCashFl ows-i susedt opr ovi
deinformati
onaboutsour cesand
usesofcashoveraspecif
icper
iodofti
mesuchasamont horay ear.Cashfl
ows
arecl
assi
fi
edbasedont heacti
vit
iesofanor gani
zaton:oper
i ati
ng, i
nvesti
ngand
fi
nanci
ng.
 Operati
ngactivi
ti
es-r ef
ertocashact iv
iti
esofabusi nessthatar eentered
i
ntodeter
minati
onofneti ncome/loss.Exampl esincludecashcol lect
ions

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fr
om cust
omer
sforgoodsandser vi
cessol
dtothem andcashpai
dforgoods
andservi
ces(
suchasutil
i
ties,suppl
iesandrent
)consumedi noper
ati
nga
busi
ness.

 Investi
ng activi
ti
es -referto cash act
ivi
ti
es ofa busi
ness thatinvol
ve
acquisi
tionandsal eofrel
ati
vel
ylong-
term asset
ssuchasfurni
ture,f
ixt
ures,
vehicl
es, bui
l
dingsandmachines.

 Fi
nancingact i
vit
ies-ref
ertocashact i
vit
iesofabusinessthataf
fectequi
ti
es
ofowner /
sandl ong-t
erm credi
torsofthebusiness.Examplesi
ncl
udemoney
i
nvestedandwi t
hdrewbyowner /s,pr
oceedsfrom bankloansandrepayment
ofpri
ncipalpartofbankloan.

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Chapt
er-
2TheAccount
ingSy
stem:Account
ingf
oraSer
viceEnt
erpr
ise

2.
1 Basi cAccountingRecor ds
1.Introduction-I nChapt er-1,wewer er ecor dingeffectsofbusi nesst r
ansact i
ons
usingt heaccount i
ngequat i
onformat.This,howev er,i
snotcost -andt i
me- eff
ecti
ve
whenanor gani
zati
onhasl argevol
umeoft ransacti
onst opr ocessandsev eralasset,
li
abi l
i
ty,capi t
al,revenue and expense i tems.As a r esult
,as t he vol ume of
transactionsgrowsandt henumberofspeci f
icelementsoft hefinancialstatements
increases,i twil
lbenecessar yt odesignandusesy stemat icwayofpr ocessing
transactionsandgener atingaccounti
ngi nformation.Thef ol
lowingsect i
onsdi scuss
ani mpr ovedsy st
em oft ransfor
mi ngbusinesst ransactionsi ntousef ulaccount i
ng
informat i
on.

2.Basi
c accounti
ng recor
ds-r ef
ertor ecor
dsor
ganizat
ionsuseintr
ansforming
busi
nesstransacti
onsinto usef
ulaccounti
ngi
nfor
mat i
onandi ude account
ncl s,
l
edgersandjournal
s.

2.
2 Nat ur
eandCl assifi
cati
onofAccount s
1.Def i
nit
ion-anaccounti sthebasicstorageunitforaccounti
ngdat a.Itisusedt o
classif
yt r
ansactionsint er
msoft hei
reffectsonspeci f
icasset,liabi
li
ty,capit
al,
revenue and expense i t
ems.Thus,a separ at
e accountis keptt or ecord and
accumul ate/st
oremonet aryeff
ectsoft r
ansacti
onsonsuchspeci fi
citemst hat
appearont hefi
nancialst
atementsasCash, Suppli
es,Account
sPay able,BankLoan
Pay abl
e,Al emu-Capi
tal,FeesEarned,RentI ncome,SalaryExpenseandSuppl i
es
Expense.

2.Nat
ureofanAccount-Thesi mpl estform ofanaccounti scalled“T”account .I
tis
sonamedbecausei tl ooksl
ikethecapi tall
ett
er" T"asshowni nthefigurebelow.In
i
tsmostel ementaryf orm,anaccount( i
.e.Taccount )
hasthreeparts:
o theaccountt it
le-usedt owr i
tethenameoft heaccountsuchasCash
o theleft(debit)side-apl acetor ecordincreasesordecr easesintheaccounti n
monet aryterms
o theright(credit
)si de-aplacet orecordincreasesordecreasesint heaccountin
monet aryterms

AccountTi
tl
e

Lef
t(Debi
t)Si
de Ri
ght(
Credi
t)Si
de

I
fmonet ar
yincreasesi
nanaccountarerecordedinthedebit/credi
tsi
de,t
hent
he
decr
easesinthesameaccountar
erecor
dedi nthecredi
t/debi
tside.

Busi
nessorgani
zati
onspracti
call
yusetheso-cal
l
edtwo-col
umn,t
hree-
column( see
anexampleofthi
saccountform onpage-
23)orfour
-col
umnaccountsf
orr ecor
ding
andstor
ingbusinesstransact
ions.Thepurposeoft hefi
rstt
wocol umnsi st o

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separatel
yrecordthei ncreasesanddecreases(debi
tsandcredit
s)int heaccount
andt hatoft
headdi ti
onalcolumnsi st
okeepr unni
ng(debi
torcredit
)bal anceofan
account.Forpict
orialrepresentat
ionofandf ormoreinf
ormati
onont het wo-and
four
-columnaccount s,readpage59ofy ourtext
book,Account
ingPr i
nciples,16t
h
edit
ionbyFessandWar ren.

3.Classif
icati
on ofAccount s -accounts maybe cl assif
ied i
ntot wo majorroot
categori bal
es: ancesheetandi ncomestatementaccounts.
i. Bal ancesheetaccount s-refertoaccountsthatappearont hebalancesheet
.
Theyi ncludeasset s,li
abil
iti
esandowner '
sequityaccount s.Theseaccounts
(exceptdr awingandi ncomesummar yaccounts)areal socalledpermanentor
realaccount s.Theyar esonamedbecauset heirbalanceswi l
lnotbeclosedat
theendofeachaccount ingper i
odratherarecarriedf or
wardf r
om periodto
periodsol ongasbusi nessactiv
iti
esconti
nue.

a.Assets-i ncludeanyt angi bleandi nt angibleit

emst hathav emonet aryv al
uet o
andownedbyabusi ness.Asset sar ef ur
therdivi
dedi ntocur rentandnon- curr
ent.
o Cur rentasset s-i nclude cashandot herasset st hatar eexpect edt obe
conver t
edi ntocash,sol dorconsumedwi thi
nav eryshor tperiodoft i
me
usuall
yoney earorl ess.Exampl esi nclude
 Cash-coi nsandpapermoneyonhandordeposi tedatbank.
 Account sRecei vabl e-claimsagai nstcustomer s( debtors)forgoodsand
servicessol doncr edit
.Theyar ebasedonor alpr omiseorgoodf ai
th
rat
hert hansuppor tedbywr i
ttenev idences.
 Not es Receivabl e -cl aims agai nstcust omer s suppor ted by wr i
tten
evidences.
 Mer chandiseI nvent ory-fini
shedgoodshel dforr esale.
 Pr epai dExpenses( assets)-i ncludeconsumabl ei temssuchassuppl i
es
andadv ancepay ment sforsuchi temsasi nsurance( Prepai
dI nsurance)
andr ent(PrepaidRent ).

o Non- currentasset s-alsocal l

edf ixed/ pl
antasset srefertoasset swiththe
potentialtopr ovidebenefi
tt othebusi nessf orr elativ
elylongper iodoft i
me,
atleastmor et hanay ear.Theyi ncl udel and,bui ldings,vehicles,machi nery
,
equipment ,patent,furni
ture,fixtur es and l ong-term r ecei
v ables.Al lnon-
currentasset shel df
orusei noper ations,exceptl andhel dforpur posesother
thanagr icult
ure,losethei
ruseful nesswi t
ht hepassageoft i
meorasar esul
t
ofusage.Suchdecl ineinusef ulnessi scal leddepr eciati
onoramor t
izat
ion
andi sabusi nessexpensei dentifi
edasDepr eciationorAmor tizationExpense.

b.Liabili
ti
es-r efertoobl igati
onsofabusi nesst opaycash,per f
orm servi
ceor
deli
v ergoodst oitscredi t
or.Liabi
l
iti
esar efurtherdivi
dedi ocur
nt rentandnon-
current.
o Cur rentl
iabil
it
ies-r efertoobligat
ionst hatmustbepai d/set
tl
edwi t
hinone
yearorl ess.Theyincl udeAccount sPay able,NotesPayabl
e,Salar
yPay able,
Income/ SalesTaxPay abl
eandRentPay able.
o Non- curr
entl i
abil
it
ies-al socall
edl ong-termliabi
li
ti
esrefertoobli
gations

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thatareexpectedt obesettl
edoveranextendedperi
odoftimeusuall
ymore
thanay ear.Examplesincl
udeMortgageNotesPayableandBondsPayabl
e.A
partofal ong-t
erm debtwhichi
sduewi t
hinay earorlessi
srecl
assi
fi
edand
report
edascur rentli
abi
li
ty.

c.Owner ’
sEqui ty-r eferst or esidualclai
m oft heowneragai nsttheasset sofa
business.Forsol eproprietorshipandpar tnershipf or
msofbusi nesses,owner ’
s
equityaccountsinclude:
o Capi tal-usedt oaccumul ateinvestment smadebyt heowner /
partnerand
profi
tearnedbyt hebusi nessbutnotwi t
hdr awnbyt heowner /partner.Capital
accounti sidenti
fiedbyt henameoft heowner /par
tnerandt hewor dcapital.
E.g.Alemu, Capit
al .
o Dr awi ng -used t o accumul atemoneyorot herassetst aken outoft he
businessbyt heowner /partnerforper sonalconsumpt i
on.Drawi ngdecr eases
capitalofabusi ness.Li kecapi t
al,drawingaccounti sidenti
fi
edbyt hename
oftheowner /
partnerandt hewor ddrawi ng.E.g.Alemu, Drawing.
o I ncomeSummar y-usedt osummar izeef fectsofrevenuesandexpenseson
thecapitalofbusi ness.

i
i. Incomest atementaccount s -r efertoaccount st hatappearont heincome
statement.Theyi ncluder evenueandex penseaccount s.Theseaccountsar e
usedt otempor ar
il
yaccumul ateef fect
sofr evenueandexpenset ransacti
onson
capitalofa busi ness.These account s,t ogetherwi th drawi
ng and income
summar yaccount s,arealsocal ledt empor aryornomi nalaccounts.Theyar eso
namedbecauset heirbalanceswi l
lbeclosedt ozerobyt heendofanaccount ing
periodthuswi l
lnotbecar ri
edf or wardfrom per iodtoper i
od.Bytheendoft he
accountingperiod,balancesofsuchaccount sar esummar i
zedandt r
ansferred
tothecapitalaccount.Thus, theseaccount sexistforonl
yoneaccount ingperiod.

a.Revenues-r ef
ert ogrossi ncreasesinowner ’
sequityasar esultofinfl
owsof
cashoranyot herassetsi nexchangef ori
nventor
iessold,servicesrendered,
properti
esleased, moneylendoranyot heracti
vi
typerfor
medbyt hebusinessto
generateincome.Rev enuesi nclude:
o Sal es-from salesofinvent ori
es
o FeesEar ned-from performi ngservi
ces
o Rent /Roy al
tyIncome-f rom lett
ingother
suseonesownpr operti
essuchas
buil
dingandmachi ner
y
o I nt
erestIncome-f rom lendi ngmoney

b.Expenses-r efertoexpiredcostofgoodsandser vi
cesconsumedi ngener ati
ng
rev
enuesorcar r
yingouttheday -
to-
dayaffair
sofabusi ness.Expensesi nclude:
o CostofGoodsSol d-expiredcostofinventori
essoldtocustomer s
o Salary/WagesExpense-costofser vicesreceivedfr
om empl oyees
o Ut i
li
ti
esExpenses-costofut il
it
yser vi
cesconsumed,suchast elephone,
el
ectri
cit
yandwat erser
vices.
o Depr eci
ationExpense-expi redcostoftangiblenon-cur
rentassetsasar esult
ofusageorpassageoft i
me.

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4.RulesofDebi tand Cr edi

t-ar econv enti
ons/principl
es( partoft he GAAP)f or
recordi
ngi ncreasesanddecr easesi nanaccount .Accor dingt othesepr i
nciples
o I ncreasesi nanassetaccountar erecordedont hedebi tsidewhi edecr
l easesar e
recor dedont hecreditsi
de.
o I ncreasesi nal iabil
it
yaccountar erecordedont hecr editsidewhi edecr
l eases
arer ecor dedont hedebitside.
o I ncreasesi nanowner ’
sequi t
yaccountar er ecordedont hecr editsi dewhi l
e
decreasesar erecordedont hedebi tside.
o Forr evenuesr epresentincreasesi n owner’sequi ty,i ncreases i nar evenue
accountar er ecordedont hecr edi
tsidewhi edecr
l eases,i fany,arer ecor dedon
thedebi tside.
o Forexpensesanddr awi
ngsr epresentdecreasesi nowner ’
sequity ,increasesi n
expenseanddr awingaccount sarerecordedi nt hedebi tsidewhi edecr
l eases,if
any, arer ecordedint hecreditside.

5.Normalbal anceofanAccount-Accountbal ancer ef

erstot hediffer
encebet ween
tot
alincreaseandt otaldecreaserecordedinanaccount .Totalincreaserecordedin
anaccounti susual lygreaterthanthetotaldecreaserecordedi nthesameaccount .
Thus,theusual( normal )balanceofanaccounti spositi
ve.Thisi mpli
est hatthe
normalbal anceofanasset ,anexpenseoradr awingaccounti sdebitwhil
ethatofa
l
iabi
li
ty,capi talorr evenueaccounti scr edi
t.Abnor malbalanceinanaccountmay
ari
seasar esultof
 Recor dinger rors-f oranyaccount
 Bankov erdr
aft( over-
drawingbankaccount )-forcashatbankaccount
 Ov er-collect
ion-f orrecei
v abl
eaccounts
 Ov erpay ment-f orpay abl
eaccount s
 Rev ersingent ri
es-f orrevenueandexpenseaccount s

The f
oll
owing t
able summar
izes t
he r
ules ofdebi
tand cr
edi
tand t
he nor
mal
bal
ancesofaccount
s.

Normal
AccountTy
pe I
ncr
eases Decr
eases
bal
ance
BalanceSheetAccount
s
Asset Debi
t Cr
edi
t Debi
t
Liabi
li
ty Cr
edi
t Debi
t Cr
edi
t
Owner ’
sEqui
ty
Capit
al Cr
edi
t Debi
t Cr
edi
t
Drawing Debi
t Cr
edi
t Debi
t
IncomeSummar y Mayhav
eacredi
t/
debitbal
ancef
or
i
ncome/loss
I
ncome St
atement
Accounts
Revenue Cr
edi
t Debi
t Cr
edi
t
Expense Debi
t Cr
edi
t Debi
t

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6.Number i
ngandSequenci ngAccount s-Thenumber ingsy stem usedt oidenti
fy
account sdependsont hesize,compl exit
yandnat ureoft hebusi nessactivi
tyan
organizati
on isi nvol
v ed.Smal lor ganizati
ons may use i denti
f i
cati
on number s
consisti
ngofonet ot hreedigit
swhi lelargeor ganizati
onsusenumber swit
hmor e
thanthreedigit
s.Thenumber i
ngsy stem usuallystartswi thbal ancesheetaccount s
andf oll
owswi t
hi ncomest at
ementaccount s.Achar tofaccount s( seeonthenext
page)i susuall
ypr eparedt ofacil
it
atet heanal ysi
sofbusi nesst ransacti
onsint he
account i
ngcycleandt hef ormulati
onofj ournalent ri
es.Eachdi gi
tmaki ngupan
accountnumberhasi tsownpur pose.Fori nst
ance, thef i
rstdi gi
tmayshowwhet her
theaccounti sclassif
iedasabal ancesheetorani ncomest atementaccountand
theotherdigi
tsfurtheridentif
ypossibleclassif
icati
onsoft heaccount .

7.ChartofAccount s-referstotheli
stoft
heti
tlesandrelat
edident
ifi
cat
ionnumbers
ofallgener
alledger(t
obedi scussedi
nthenextsect
ions)account
sabusinessuses
forrecordi
ngi t
sfinancialaf
fair
s.Bel
ow i
sanexampl eofchar tofaccountsf
ora
cert
ainbusiness.

Account oft hi
schapt er).Thenumberofaccount s
Number Name to be mai ntained and t he number ing
BalanceSheetAccount s system t o be used depends upon t he
100 Asset nature and si ze of a busi ness.Smal l
111 Cash bus i
nesse sma yu s eav e r
yf ewn umb er of
112 Account sReceivable accounts and a number i
ng sy stem
121 Buildings consisti
ngofone, twoort hreedigits.Whi le
200 Liabili
ty bigcompani esmayusesev eralaccount s
211 Account sPay abl
e andt heirnumber ingsy stem mayconsi st
221 Mor tgageNot esPayable
300 Owner ’
sEqui ty
ofsev eraldi git
s.I nanycase,abusi ness
301 Alemu, Capital sho ul
d u se a flexibl
e n umb ering sy
s t
em
302 Alemu, Drawing that may accommodat e new account s
303 IncomeSummar y needed due t o expansi on in oper ati
ons.
IncomeStatementAccount s Besides,eachdi gitinanaccountnumber
400 Revenue may show t he maj or di vision/type,
401 FeesEar ned subdivi
sionandposi t
ionoft heaccounti n
402 InterestIncome thesubdi visi
on.Fori nstance,number s“ 1”,
500 Expense “1”and“ 2”i nt heaccountnumber112f or
501 SalaryExpense
Accounts Recei vable may i ndicatet hat
502 Ut i
li
tyExpense
AccountsRecei vableisanassetaccount ,
Notet hataccounti dent if
icationnumber sitssubdi vi
sionwi t
hint heassetgr oupi s
areneededf orar r angi ngaccount sint he currenta nd l
ies i
n t
he se cond posit
io n
Gener alLedgerandf orpost i
ngr ef
erence within cur rent asset s subdi visi
on,
purposes( discussedi nt henextsect ions respecti
v el
y .

2.
3 Ledger s
1.Defi
nit
ion-Ledgerref
erstoakindoffol
der/r
ingbi
nderusedtoarr
angeandputin
oneplaceallaccount
susedbyabusi ness.Account
sareplacedintheledgeri
n
sequenceandeachaccountmaytakeoneormorepagesofthel
edger.

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2.Ty
pes-t wot ypesofl edgers:generalandsubsi diar
y .
o Gener all edger-al edgert hatcont ai
nsallaccount sthatappearont hebal ance
sheetandi ncomest atementofabusi ness.Gener all edgeraccount sar ecal led
controllingaccount sbecauset heyshowt het otalbalanceofacer tainel ementof
thef i
nanci alstat ementssuchasAccount sRecei vableandAccount sPay able
regardlessoft heamountofmoneyexpect edt obecol lect
edf rom eachcr edi t
customerand t heamountofmoneypay abl
et o each cr edi
tor ,respect ively.
Cont r
ollingaccount sar eassignedwi thandi dentif
iedbyt hei
rrespect iveaccount
number s.Accor di
ngt heyar epl acedint hegener all edgeraccor di
ngt ot hei r
numer ical orders.
o Subsidiar yledger-al edgert hatcontai
nsaccount sshowi ngdetail
sofcont roll
ing
account s.Forexampl e,Account sReceivabl eLedger ,also called cust omer s’
ledger,cont ainsaccount sofi ndivi
dualcreditcustomer sshowi ngt heamountof
moneyduef rom eachcr editcustomer.Subsi di
aryl edgeraccount sar ei dent i
fied
byt henameoft hecr edi
tcust omerorcr editorandar eaccor di nglyarr anged
alphabet icall
y.

Notethatabusinessmaysetupbot hgener
alandsubsidi
aryl
edgersnotonl
yfor
AccountsRecei
vableandAccount
sPayabl
ebutalsoforanyaccountforwhi
chthe
busi
nesswantstohavedetai
ledi
nfor
mati
onabout.

2.
4 Jour nal
s
1.Defini
tion-Jour nal ,alsocal l
edt hebookofor i
ginalentry,referst oabusi ness
documentwher e effectsofbusi nesst r
ansact i
onson speci f
icel ement soft he
fi
nancial st
atement sarer ecordedinorcopi edfrom sourcedocument s.InChapter-1,
wehav eseenhow t or ecordandsummar izeeffectsofbusi nesst ransacti
onson
asset,l
iabil
ityandowner ’
sequityit
emsusi ngt heaccount i
ngequat i
onf ormat.Such
system,howev er,isnotpr acti
cable orisnotcost -and t i
me- eff
ectiv
e when a
businesshast housandsoft r
ansactionstor ecordandsev eralasset,li
abil
it
y,capit
al,
revenue and expense i tems.Di rectl
yr ecording business t r
ansact i
ons int he
account sisnotal sowi seandmayr esul
ti nrecordingerrorswhi chmaybeeasi ly
avoidedbyusi ngjour nals.Thus,organizat
ionsdesi gnanduset hej ournaltoini
ti
ally
recordbusinesstransact i
ons.

Transactions arer ecorded int he journalchr onologi

cal l
y( i.
e.in or deroft heir
occurrence)based on t he r ules of debi t
s and cr edits and t he double-entr
y
account i
ngsy stem.Doubl e-entryaccount i
ngr eferstot hesy st
em ofr ecordingthe
dual,call
eddebi tandcredi t
,effect sofbusi nesst r
ansact i
ons.Asar esult
,recordi
ng
tr
ansact i
onsiniti
all
yinthej ournal helps,
amongot hert
hings, t
o
 Ensur ethatalleff
ectsofabusi nesstransactionarer ecorded
 Hav einonepl aceacompl eteinformationaboutar ecordedt r
ansact i
on
 Easi lyidenti
fyrecordinger rors,and
 Hav eanhi stori
calrecordoft r
ansact i
ons.

2.Ty
pes-t
wot
ypesofj
our
nal
s:gener
alandspeci
al.

20
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nci
plesofAccount
ing-
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213)
/2004\
05

o Generaljour
nal-a t wo-col
umn form used tor ecord anykind ofbusiness
tr
ansacti
on(seesampleonpage-20).
o Speci
aljournal-aj ournaldesi
gned t
or ecordf requentl
yoccurr
ing i
dentical
tr
ansacti
ons.Det
ail
eddiscussi
onsonspecialj
ournalsaredefer
redtoChapter-
5.

Anor gani
zat
ionmayuseonlygener
aljournalorbothgener
alandspecialj
our
nal
s
dependinguponthev
olumeandsimi
lar
iti
esofitsbusi
nesstr
ansact
ions.

2.
5 Account i
ngCy cl
e
1.Def initi
on-Account ingcy clereferst ot hepr ocedures( st
eps)forgat
heri
ngbusiness
transact i
ons,pr ocessi ngandconv erti
ngt hem i nt
ousef ulaccounti
nginformati
on
thatwi llbecommuni catedt ouser stoser veasabasi sforinv
estment
,cr edi
tand
simi lareconomi cdeci sions.
2.Pr ocedur es/Stepsi nt heAccount ingCy cl
e-Theaccount ingcycl
econsistsofthe
followi ngspeci ficprocedur es:
Analyzingbusi nessdocument sandt ransacti
ons
Journalizingbusi nesst ransact ions
Postingj ournalentr i
est oaccount s
Preparingunadj ust edtrialbalance
Journalizingandpost ingadj ust ingent r
ies
Preparingadj ustedt ri
albal ance
Preparingf i
nancialst atement s
Journalizingandpost ingcl osingent r
ies
Preparingpost -closingt ri
albal ance
Journalizingandpost ingr eversi ngent r
ies(opt
ional)

Theaf
orement
ionedpr
ocedur
esar
edi
scussedi
nthef
oll
owi
ngmaj
orsect
ions.

2.
6 Jour nali
zing
1.Def
init
ion-Jour nal
i
zingr
efer
stot
hepr
ocessofr
ecor
dingbusi
nesst
ransact
ionsi
n
journals.

2.St
eps-Thef ol
lowi ngst epsmaybecar ri
edoutt oj our nali
zebusi nesst ransactions:
Col l
ectsour cedocument s-Sour cedocument sshow t hatat r
ansact ion
hasr eallyoccur r
edandgi vecompl et
ei nfor mat i
onaboutt hetransact i
onsuchas
dateoft het ransaction,part
iesandamountofmoneyi nv olved,termsofpay ment,
etc.
Anal yze t r
ansact i
ons -Thi si nv olves det er
mi ning speci fi
c account s
affected ( cash,f ees earned,et c)by t he transact ion,cl assificati
on oft he
account s affected ( asset
,l i
abil
it
y,et c),di rection oft he effect( increase or
decrease) ,monet ar yamountoft heef fect( $400,$100,et c)andhow t or ecord
theincr easeanddecr ease(debitorcredi t).
Jour nalize-Recor dthedualef fect soft ransact ionsi nchr onologicalor der
usingt her ulesofdebi t
sandcr edi
ts.Bel ow ar esampl egener alj ournaland
additi
onalst epsneededt ojournali
zebusi nesst ransact ions.
i
i

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Gener
alJour
nal Page-
8
-
Dat
e Descr
ipt
ion PR Debi
t Cr
edi
t
Year Dat
e NameofAccounttobeDebi
ted Monet
aryDr
Month NameofAccounttobeCredi
ted Monet
aryCr
Br
iefexpl
anat
ionaboutt
het
ransact
ion
i
i
ii
i
v v v
i
Notethef oll
owi ngwhenj our nal izi
ngt ransact ions.
i
.Wr i
tet hey ear ,mont handdat eoft het ransact i
oni nt hedat ecol umn.The
yearandmont hneednotber epeat edf orsubsequentent riesunt ilanew
pageoranew mont h/ yearbegi nswhi let hedat emayber epeatedi nas
muchast henumberofi ndependentent ri
est ober ecor ded.
ii
.Wr i
tet henameoft heaccountt obedebi t
edont hef irstli
necust omar i
ly
placed at t he ext r eme l eft of t he descr iption col umn. Ent er the
correspondi ngdebi tamountont hesamel ineint heext r
emel eftoft hedebi t
column.Anent rywhi chi ncludesmor et hanonedebi tormor et hanone
creditiscal ledacompoundj ournalent r
y.Regar dlessofhow manydebi ts
orcr edit
sar econt ai nedi nacompoundj ournalent ry,allt hedebi tsar e
enteredbef oreanycr edi t
.
i
ii
.Wr i
tet henameoft heaccountt obecr editedont hel i
nebel ow t hedebi t
entrysomehow i ndent edi .e.placedabout1i nchi nt ot her ightsi deoft he
descr i
pti
oncol umn.Ent ert hecor r
espondi ngcr editamountont hesame
l
inei ntheext remel ef toft hecr editcol umn.
i
v.Wr i
teabr iefexpl anat i
onoft het r ansact i
onont hel inei mmedi at
elybel ow
thel astaccountcr edi ted.Thi sexpl anationi ncludesanydat aneededt o
i
dent if
ythet ransact ion,suchast henameoft hecust omerorsuppl i
er.The
explanationneedsnott obei ndent ed.
v.Leav eabl ankl i
nebel ow eachent ry.Thi sspaci ngcauseseachj our¬nal
entrytost andoutcl ear lyasasepar ateuni tandmakest hej our naleasiert o
read.
vi
.Leav ethePR( whichst andsf orpost i
ngr eference)col umnbl ankatt hetime
ofmaki ng t he j our nalent r
y .When t he debi ts and cr edi ts ar el ater
transferr
edt oaccount si nt hel edger ,thei dent i
f i
cat i
onnumber soft he
account swhi cht heent riesar epost edt owi llbel istedi nt hiscol umnt o
provideacr ossr eferencewi t
ht hel edger .

Whetheratr
ansacti
onresul
tsi
nsingleorcompoundent
ry,equaldol
l
aramount
s
ofdebi
tsandcredi
tsshoul
dberecorded.

Example2-1
OnMar ch1,2002, TahirMuktar,
af amousbusi nessmaninAddis,openedabusiness
named“ Uni
versalGar age”whichisorganizedasasolepropriet
orshi
p.Thebusiness
i
sestabli
shedtor endercarrepair,
mai nt
enanceandr el
atedservi
cesf orf
ees.Below
arechartofaccountsf orandselectedtransacti
onscompletedbyUni ver
salGarage
i
nMar ch2002.

22
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a)Char
tofaccount
s
Univ
ersalGar
age
Char
tofAccount
s
100ASSETS 300OWNER'SEQUI TY
110CURRENTASSETS 301Tahi
r,Capit
al
111Cash 302Tahi
r,Drawings
112AccountsReceivabl
e 303I
ncomesSummar y
114Suppli
es
116PrepaidRent 400REVENUES
117PrepaidI
nsurance 401FeesEarned
120PLANTASSETS 410OtherI
ncome
121Land
123Machi ner
y 500EXPENSES
123.1AccumulatedDepreci
ati
on-
Machiner
y 501Sal aryExpenses
125Of f
iceEquipment 502Suppl i
esExpenses
125.
1Accumul at
edDepreci
ati
on-
Off
iceEquipment 503RentExpenses
200LIABILITIES 504Insur anceExpenses
210CURRENTLI ABILI
TIES 505Depr eciati
onExpenses
211AccountPay abl
e 506Inter estExpenses
213Salari
esPay abl
e 510Mi scel l
aneousExpenses
216Int
erestPay able 507Utiliti
esExpense
220NON- CURRENTLI ABILI
TIES 508Adv erti
singExpense
221Long- term BankLoan 509Mi scel l
aneousExpenses

b)Transact i
ons
Mar1Recei vedt hefollowi ngasset sfrom itsowner ,Tahir
:
Cash....
..
..
....
..
..
..
...
...
...
..
...
..
..
...Br, 8,
300
Supplies....
...
..
..
...
..
....
..
...
..
..
...
. 2, 000
OfficeEqui pment ..
....
..
...
..
..
...
. 10, 000
2Bor rowedBr5, 000f rom DashenBank
3PaidBr1, 800f orrentonabui ldingl easedf orbusinesspurposes
3Pur chasedwel dingandot herrepai rmachi neryforBr3,600cash
4PaidBr200f orar adioadv erti
sement
8Soldf orBr200cashanol dofficeequi pmentwi thar ecordedcostofBr200
13Paidweekl ysal ar
yBr1, 200
16Recei vedBr4, 400f rom ser vi
cesr ender edoncash
20Paidweekl ysal ar
yBr1, 200.
20Deliveredser viceoncr edit,Br6, 000
21Pur chasedaddi t
ionalr epairmachi neryonaccountf orBr2, 000fr
om Sámi
-
Engineer
s
23Recei vedBr5, 000addi tionalcashi nvestmentf rom itsowner
24Repai dBr1, 000bankl oanandpai dBr100i nt
erestonbankl oan
26Pur chasedsuppl i
esf orBr800cash
27PaidBr100f orcust omerent ertainmentandot heritems
27Paidweekl ysal ar
yBr1, 200
31PaidBr500f orelectricityandot herut i
li
tiesconsumeddur i
ngthemonth
31Recei vedBr4, 200cashf rom cr editcust omer s
31PaidTahi rBr1, 800f orper sonal uses

23
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Required:
a)Jour nal i
zet heabov et ransact ionsi nat wo-col
umnj our
nal
b)Postt hej ournalentri
est of our -columnaccount s
c)Pr epar e and compl et e a wor ksheetbased on t he foll
owing addit
ional
i
nfor mat i
on
. Costofsuppl
i iesremai nedunconsumedonMar31i sBr900
i
i.Theamountpai donMar3i sforat hree-mont
hr ent
i
i.Theamount
i sofdepr eciat i
onf ormachi ner
yandof fi
ceequi pmentare
estimat edt obeBr560andBr1, 900r espect
ivel
y
i
v.Uni versalGar age usual ly pay s Br1, 200 f
orempl oyee's salar
y every
satur dayf orasix-
daywor kweekendedont hatday
v.I nterestonbankl oanaccr uedbutnotpai donMar ch31t ot
alBr100
d)Pr epar ef i
nancialstatement sf orthemont h
e)Jour nal i
zeandpostadj ustingent ri
es
f) Journal i
zeandpostcl osingent ri
es
g)Pr epar epost -cl
osingt ri
albal ance

2.
7 Post i
ng
1.Defi
niti
on-Post i
ngr efer
st ot heprocesst r
ansfer
ri
ngmonet ar
yamount sofdebi
t
andcreditentr
iesfrom thegener alj
ournaltotheaccountsintheledgerwhi
chare
aff
ectedbyt hedebitandcr editentr
ies.Posti
ngisnecessar
yt ocl
assif
yandgroup
si
milarbusinesstransacti
onsi nt er
msoft hei
reffect
sonspeci f
icasset,l
i
abi
li
ty,
capi
tal,
revenueandexpensei tems.

2.St
eps–Thef ol l
owi ngst epsmaybecar r
iedouti npost i
ngj ournalentri
est ogener al
l
edgeraccount s:
.Locat
i eint hegener alledgert hefirstaccountdebi tedint hef ir
stgener aljournal
entr
y .
i.Copyt
i hedat e( i
.e.y ear ,monthanddat e)oft heent rytobepost edf rom the
j
ournalt ot hedat ecol umnoft hegener alledgeraccount .
i
i.Copyt
i hedebi tamountf rom thegener alj ournalt othedebi tcolumnoft he
part
icul araccountaf f
ect edinthegener alledger.
i
v.Recor dt hegener aljour nalpageint hepost ingreferencecolumnoft heaccount
debitedi nt hegener alledger.
v.Recor dt he i denti
f i
cat i
on numberoft he accountdebi ted int he post i
ng
ref
erencecol umnoft hegener aljournalf r
om whi chthedebi tamounti scopied
toindi catet hatt hedebi tamounti spost edt otheappr opriateaccounti nthe
gener alledger .
v.Det
i ermi neand wr it
et hebal anceoft heaccounti ni tsbal ancecol umn i f
avail
abl e.
vi.Theexpl
i anat i
oncol umnoft heaccounti susedt ogiv edescr i
pti
onofspeci al
entr
iessuchasadj usting,closi
ng,r eversi ngandcor recti
ngent ri
espost edto
theaccount .Ent riesr ecordi
ng nor maland r ecurri
ng t r
ansact i
onsneed no
explanat ion.
vi
i.Repeatt
i heabov epost i
ngpr oceduresf orthecr editpor t
ionoft hejour nalentry.

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Cash AccountNo.11
Dat
e Expl
anat
ion PR Debi
t Cr
edi
t Bal
ance
GeneralJournal 2000
Page-10- June 1 Bal
ance - - - 500
Date Descri
pti
on PR Debi
t Credi
t 2 10 100 - 600
2000
June 2 Cash…………. . 11 100 ii
i v
i
Sal
es………. 41 100
Sales of i
v
invent
ory v
Sal
es AccountNo.41
2 Supplies.
.…….
.
Cash……….
i100
i 100 Dat
e Expl
anat
ion PR Debi
t Cr
edi
t Bal
ance
Purchase of 2000
supply June 2 10 100 100

Exampl
e2-
2

Requi
red:Compl
eter
equi
rement“
b”ofexampl
e2-
1onpage-
22.

2.
8 Tr
ialBal
ance
1.Defini
ti
on-Tr i
albalancer
efer
stol
i
stofal
lgener
all
edgeraccount
sandt
hei
r
respect
ivebal
ances.

2.Ty
pes-Thr eetypes:
o UnadjustedTrialBalance-preparedbef
oreaccountbal ancesareadjusted
o Adj
ust edTri
alBal ance-preparedaft
eraccountbalancesar eadjust
ed
o Post-
closingTrialBalance-preparedaf
tertemporaryaccount sareclosed.

3.Purpose-Regar dl
essofi t
sty pe,tr
ialbalancei spr epar
edi nordertocheckwhet her
tot
aldollaramount sofdebitsandcr edi
tsr ecordedi nt hegeneralledgeraccount s
areequal .I
fthet ot
aldebitandt otalcreditareequal ,theledgerissai dtobei n
balance.Theagr eementoft hedebi tandcr editt ot
alsoft het r
ialbalancegi v es
assurancethat:
Equaldebit
sandcr edit
shav ebeenr ecordedf oreachinternalandext ernal
tr
ansacti
on.
Thedebitorcredi
tbalanceofeachaccounthasbeencor rectl
ycalculated.
Thedeterminati
onoft otaldebitandcr editbalancesoft hetrialbalance
hasbeencor r
ectl
yperformed.

Exampl
e2-
3

Requi
red:
Basedony
ouranswer
sforr
equi
rement
s“a”and“
b”ofexampl
e2-
1onpage-

25
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ureNot
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/2004\
05

22,
prepar
eunadj
ust
edt
ri
albal
ance.

4.ErrorsandTheTr i
alBal ance-I fthetrialbal ancedoesnotbal ance,iti
ndi
catesthat
thereisaner rororar eerrorssomewher eint heaccount ingpr ocesswhichshouldbe
discoveredandcor rected.Errorsthatmaypossi bl
yr esultindisagreementbetween
thetwot otalsofat rialbal
ancei nclude:
Post ingunequaldebi tandcr edi tamount sf oranent ry;
Post ingadebi tentryasacr edi torv i
cev ersa;
Arithmet i
cmi stakesinbal ancingaccount s;
Clericalerrorsincopyingaccountbal ancesi nt
ot het r
ialbal
ance;
Listingadebi tbalancei nt hecr editcolumnoft het r
ialbal
anceorv ice
versa;and
Error si
ndet erminingthedebi tandcr edittotal
soft het ri
albal
ance.

Equali
tyoft het otaldebitsandtot
alcreditsont hetri
albalance,however,doesnot
i
mpl ythattransact i
onsar ecorr
ect
lyanalyzedandr ecorded.Belowar eexamplesof
err
orswhi chcannotbedi scover
ed/det
ectedbypr epari
ngat rial
balance:
Failuretojournali
zeand/
orpostat ransacti
on
Jour nal
izi
ngand/ orpost
ingthesamet ransacti
onmor ethanonce
Jour nal
izi
ngand/ orpost
ingat ransacti
oncor r
ectlybutinortot hewrong
account
Jour nal
izi
ngand/ orpost
ingerroneousbutequaldol l
aramountsofdebits
andcr edits

Despitet heselimi t
ati
ons,t hetri
albalanceisausef uldevi
ce.I tnotonlyprovi
des
assurance t hatt he ledgerisi n balance,butitalso serves as a conve¬ni
ent
spri
ngboar df orthepr eparati
onoff i
nancialst
atements.Thetr i
albal
ance,however
,
i
smer elyawor kingpaper ,usefult
ot heaccountantbutnoti
nt endedfordist
ri
but
ion
touser sofaccount inginformati
on.

5.Procedurestol ocateerrors-Asamat t
eroff act,t hereisnoonebestwayof
l
ocatingerror
s.Howev er,thef oll
owi ngpr ocedur es,donesequent i
all
y,maysav e
consider
ableti
meandef f
orti nlocati
nger rors.
i.Recalculatethedebitandcr edittotalsofthet r
ialbalance.
i
i.Compar e amount sl isted on t he trialbal ance wi ththe r
elated account
bal
ancesintheledger .
ii
i.Recalculateaccountbal ancesint heledger.
iv.Checkaccur acyofpost ingfrom t hejournaltot hel edger
.
v.Checkt heequalit
yofdol l
aramount sofdebi tandcr edi
tent
ri
esint hej
ournal
.

Thedi f
ferencebet weent het otaldebi tandt otalcr editbalancesmayi ndi
cat
et he
natur
eandl ocationoft heer ror,thus,av oidt heneedf orsequentiall
yperfor
mingall
theaforement i
onedpr ocedures.Forexampl e,
Adi f
ferenceof10; 100; 1000; etc,indi catesaddi t
ionerror.I
nt hi
scase,y
ou
needt oper form procedur es(i)and( i
ii)t odiscov ertheerror.
Adi f
fer encediv isi
bleev enlyby2i ndi catespost i
ngt ot heledgeradebit
entryorlistingont hetrialbalanceadebi tbal anceascr editorv i
cever
saor

26
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nci
plesofAccount
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213)
/2004\
05

omi ssi
onofadebi torcr editentrypost i
ngt otheledgerorli
sti
ngadebi tor
creditbalanceofanaccountont hetri
albalance.Insuchcases,youneedt o
perform procedures(i
i)and( iv).
A differ
encedi vi
sibleev enlyby9i ndicat
essl i
deort r
ansposit
ioner r
or.
Sli
deer rorreferstoerrorinpl aci
ngdeci malpoint,f
orexample,writ
ing22.50
as2. 25or225.Whi letransposi ti
oner r
orr ef
ersmi spl
acementofdi gi
ts,for
exampl e,writ
ing225as252or522.Sucher rorsmayhappeni nanyst epi n
theaccount i
ngpr ocess,thus,y ouneedt oper f
orm allt
heprocedur
esneeded
tolocateaner rorwit
houtdi scriminat
ion.

6.Correcti
nger ror s-Onceaner r
ori sdi scover
ed,i thast obecor r
ected.Way sof
corr
ectinger r
orsdependupont henat ur eofandt heplaceintheaccount i
ngpr ocess
theerrorislocated.
Drawi ngasi nglelineov eraner r
oneousamount /i
ncorrectaccountname
andwr iti
ngt hecor rectamount /accounttit
leisacommonwayofcor recti
ng
simpleer rorsduet oincorr
ectj ournalentr
iesnoty etpost
edt otheaccount sin
theledgerandpost ingincorrectdebit/cr
editpartofanent r
y.
Journal i
zingandpost i
ngcor r
ecti
ngent ri
esi sanotherandper hapst he
bestwayofcor recti
nger r
orscommonl yusedt ocor r
ectcompl exer r
orsdue
toincorrectjournalentri
espost edtotheaccount sintheledger.

Example2-4
Purchaseofof
fi
cesuppl
iesnotyetconsumedfor$4,000cashwaserr
oneousl
y
recor
dedasadebitt
oRentExpenseandcredi
ttoAccountsPay
abl
eaccount
s.

Requi
red:Pr
epar
ejour
nalent
ri
est
ocor
rectt
heabov
eer
ror
.

27
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ureNot
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2.
9 TheAdj ust
ingPr ocess
2.
9.1 NatureandChar acteri
stics
1.Defi
niti
on-Adj ust i
ngpr ocessreferstotheprocedur eofupdatingaccountbalances
byrecordingtransactionswhi charenotusuall
yr ecordedinthepr ev
iousst
epsoft he
accounti
ngpr ocess.Itisdoneatt heendofanaccount i
ngperiodsoast odetermine
thecor r
ectbal ancesofaccount sneeded to pr eparefinancialstat
ements.The
jour
nalent r
iesr equir
edt oupdat eaccountbalancesbyt heendofanaccount ing
peri
odar ecaledadj
l ustingent r
ies.

2.Bases ofAdj ust

ing Ent ries -Adj ust i
ng ent ri
es ar e done mai nl
ybased on t he
fol
l
owi ngGAAP:
i
. Account ing Per iod ( Per i
odicit
y) Pr inciple -Thi s pri
nciple say st hat the
i
ndet erminatel i
feofbusi nessor ganizationi sdi videdintodi st
inctsmal l
erand
equal( comparabl e)per iodssuchasmont hs, quartersory earscaledaccount
l ing
per i
ods.Thi sisdonei nor dertor eportf inanciali nf
ormat i
ononat imelyand
regular manner . Although busi ness or gani zati
ons may pr epare financial
statement scov eringdi fferentperiods,theper iodicit
yprincipl
er equir
est hatset
off i
nancialstatement sshoul dbepr epar edatl eastoncei nay ear.Financial
statement sprepar edf oraccount ingper iodl esst hanoney eararer ef
erredtoas
i
nt erimfinancialst at
ement s.

A 12- month(annual)accounti
ngperi
odadopt edbyabusi nessenterpri
seis
caled f
l iscalyear.Anannualaccountingperiodmayst artatanymont hbut
should end af ter12 months.Business organizat
ions usuall
y adopted an
accountingperiodthatcoi
nci
deswit
ht hecal
endary eari.
e.anaccounti
ngper i
od
star
tingonJanuar y1andendingonDecember31.

Iti
snotunusualforbusinessorgani
zationtobuygoodsandser v
icesthatcanbe
consumedoveraper iodoftimemor et hanoney ear
.Fortheperiodi
cit
yprinci
ple
requi
resbusi
nessor ganizat
iontopr eparef i
nanci
alstat
ement satleastonan
annualbasi
s,itisnecessaryt oall
ocat ethecostofsuchgoodsandser vi
ces
amongdi f
fer
entaccount i
ngper i
odssoast oknow theexpir
edcost soft hese
goodsandservices(cal
ledexpenses)duet ousageinagivenaccountingperiod
orduetopassageoft i
me.Thi si
sdonet hr
oughtheadjust
ingprocess.

i
i.AccrualConcept-Thi sprincipler equir
es,amongot hert
hings, t
hatrevenuesand
expensesshoul d ber ecorded i nt heaccount i
ng per i
odi nwhi chgoodsand
servi
ces are sold and deliv ered to customerand goods and ser vi
ces ar e
consumed,r especti
vely,wit houtr egardt o when cash i scol l
ected from t he
revenuesandwhencashi spai df ortheexpenses.Thi smet hodofr ecordingand
report
ingrevenuesandexpensesi scaledaccr
l ualbasisofaccount ing.Under
theaccrualbasi
sofaccount ing, netincome( l
oss)wi l
lbethedi ff
erencebet ween
revenuesearnedandexpensesi ncurredinagivenaccount i
ngper iod.Theaccr ual
basisofaccountingrequirest hat,bytheendofanaccount i
ngper i
od,rev enues
earnedbutnotcol l
ectedi ncashandex pensesi ncurr
edbutnotpai di ncash
should be i
dentif
ied and r ecor ded.Thist oo,isdone t hrough the adj ust
ing

28
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pr
ocess.

Anotheralter
nati
vewayf orrecor
dingandr eporti
ngr ev
enuesandexpensesi sthe
cashbasi sofaccounting.Accordingtot hisbasisofaccounting,r
evenuesar e
recor
dedandr epor
tedonlywhencol l
ectedi ncashandexpensesar er ecorded
andr eport
edonl ywhenpai dincash.Undert hisaccounti
ngbasis,netincome
(l
oss)f oragivenaccountingisdeterminedbycompar ingrev
enuescollectedin
cashandexpensespai dincashint hatpart
icularaccounti
ngperi
od.

Exampl e2-5
Anent erpr
isehaspr ovi
dedser vi
cestoitscustomerinMarch.Whenshouldthe
enterpr
iserecognizetherevenueunder(a)cashbasi
sand(b)accr
ualbasi
s,i
fthe
customerpaidf ortheser
v i
cesin(a)Februar
y,(
b)Marchor(c)Apr
il
?

Example2-6
Anenterpr
isehasbeendoingbusinessinMar chinaleasedoffi
ce.Whenshoul
d
theent
erpri
serecogni
zerentexpenseunder(a)cashbasisand(b)accr
ualbasi
s,
i
ftheenter
prisepai
dfort
her enti
n(a)Februar
y ,
(b)Marchor(c)Apri
l
?

i
ii
.RevenueRecogni t
ionPr i
nciple–Thi sprinci
plest
atesthatrevenuesar erecorded
whentwomai ncri
teri
aaremet :
Therevenuegener ati
ngact i
vit
iescoll
ecti
vel
ycalledtheear ni
ngprocessi s
substanti
all
ycompl eted,whi chgener al
lymeanst hatgoodsar esol dand
del
iveredorservi
cesar eperformedt ocustomersand
Anexchangehast akenpl acei.e.thebusinesshasr eceiv
edadef i
nit
e
amountofcashoranyot herassetssuchasr eceiv
ables–buy er’
spromi seto
pay–i nexchangefort hegoodsandser vi
cesdeli
vered.

i
v.Mat chi
ngPr i
nciple-Inor dertoaccuratelydeterminenetincome( loss)f ora
giv
en account i
ng period,a business enti
tymustdet er
mine allexpenses i t
i
ncur r
edtogener aterevenuesanddeductt hem f r
om (matchthem agai nst)the
revenuesearnedinthesameper iod.Asar esul
texpensesincl
udingexpiredcost s
whichwer enotr ecordedinprev i
ouspr oceduresoft heaccounti
ngpr ocess
shouldbeidentif
iedandr ecor
dedbyt heendofanaccount ingperi
odthrought he
adjusti
ngprocess.

2.
9.2 Defer
ralsandAccr ual
s
1.Int
roducti
on – Notal laccounts bal
ances need adj
ust
mentatthe end ofan
accounti
ngper iod.I
temst hatneedadjust
ingentri
esbytheendofanaccounti
ng
peri
odarebr oadlydi
videdi
ntodefer
ralsandaccrual
s.

2.Deferral
s–r ef
ertogoodsandservi
cescol
lect
edorpaidi
nadv anceofbenefi
tgi
ven
orr ecei
ved.Defer
ral
saref ur
therdivi
ded i
nto pr
epai
d expenses and unear
ned
revenues.

i
) Pr
epai
d Expenses -ar
egoodsand ser
vicespai
dforbef
oret
heyar
eused.

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Examplesofpr epai
dexpensesincl
udepr
epai
dinsurance,pr
epai
drent
.Inthe
broadestsense,
prepai
dexpensesal
soi
ncl
udebui
l
dingsandoffi
cemachi
ner
y.

Att hetimeofacqui sit

ion,cost
soft heseitemsr epresentassetandast i
me
passesorwhent heasset sareconsumedi npartori nt ot
al,t
hecostsare
chargedint
oexpenses.Expi r
edcostsofprepaidassetsarenotr ecor
dedondail
y
basis.Thecommonpr acti
ceistorecordt
hem bytheendofanaccount i
ngper
iod
throughadjusti
ng entri
es.Att het i
meofacqui siti
on,pr epai
di t
emsmaybe
recordedei
therasassetsorasexpenses.

a)Prepai
dexpensei
nit
ial
lyr
ecor
dedasAsset
s– Undert hi
sapproach,t
he
fol
lowi
ngent
ri
esar
eneededtor
ecor
dev
ent
saffect
ingt
hesei
tems.

Att
hetimeofacqui
sit
ion
Prepai
dRent……………………………………… xx
Cash………………………………………. xx

Att
heendofanaccount i
ngper
iod–t
orecor
dtheexpi
redcost(
expense)
RentExpense……………………………………… yy
PrepaidRent
………………………………. y
y

Att
hebegi
nni
ngofthenextaccount
ingper
iod
Noentr
yisneededbecausetheunexpi
redbal
ancei
sint
heassetaccount
asi
twasini
ti
all
yrecor
ded.

b) Prepai dexpensesinit
iall
yrecor dedasExpenses–I nsteadofbeingdebited
toanassetaccount ,prepaidi
t emsmaybedebi tedt oanexpenseaccountat
thet imeofacqui si
ti
on.Chargi ngpr epaiditemst oexpenseaccountatt he
timeofpur chasedoesnot ,howev er,i
mpl ythatt heseit
emsar eexpenses.It
ratheri sanalter
nati
vewayofr ecor di
ngt heseitems.I ti
sthepassageoft i
me
and/ orusaget hatdeterminet hechar gingoft hecostoft hesei t
emst o
expenseaccount .Thef ol
lowingj ournalent r
iesar eneededtor ecor
dev ents
affectingtheseitems.

Att
heti
meofacqui si
ti
on
RentExpense……………………………………… xx
Cash….……………………………………. xx

Att
heendofanaccounti
ngperi
od–torecor
dtheunexpi
redcost(
asset
)
Prepai
dRent……………………………………… yy
RentExpense……………………………… y y

Atthebegi nningofthenextaccounti
ngperi
od– t oret
urntheunexpi
red
bal
ancebackt otheaccountwher
eini
twasini
ti
all
yrecor
ded,anent
rycal
led
rev
ersingentry
, i
smadeasf ol
l
ows
RentExpense……………………………………… yy

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Pr
epai
dRent……………………………… y
y

Notet
hatr
ever
singent
ri
es(r
efert
opage-
36)aret
heexactopposi
tesofadj
ust
ing
ent
ri
eswhi
chinvol
vethesamedoll
aramount
sofdebi
tsandcredit
sandaccount
names.

Exampl
e2-7
OnAugust1,2002,ABC Stat
ioner
ypaid$2,400cashforoney eari
nsur
ance
cov
eragefori
tsi
nvent
oryi
tems.Theenter
pri
se’
saccount
ingper
iodendsonDecember
31.

Requi
red:
Pr epar
e allthe j
our
nalentri
es necessaryto handlethe abov
e
transacti
onundert
heappr
oachesofrecor
dingpr
epai
ditems:
a)asasset
b)asexpense

c)Compar i
sonoft heApproaches– Whet hertouset heassetorex pense
approachdependsontheaccounti
ngphil
osophyoft heorgani
zat
ion.Though
these appr
oachesaccountf orpr
epaiditemsi n dif
fer
entways,t he f
inal
balancesofther
elat
edexpenseandassetaccount
sar ethesame.

i
i)PlantAsset s–I nbroadertermspl antasset sar eexampl esofpr epai dexpenses
i
nt hattheyrepresentbenefitsthatwi l
lbeconsumedandchar gedi ntoexpenses
overal ongper i
odoft ime.Unlikeot herpr epaidexpenses,whi chmaybei ni
ti
all
y
recordedasassetorexpense,acqui siti
onofpl antassetsi srecordedasadebi t
toonl yassetaccount s.Theexpi redcostofpl antassetsasar esultofusage
and/orpassageoft i
mei scalleddepr eciati
onexpense.Li keot herexpiredcosts
rel
atedt opr epaiditems,depr eciationexpensei srecor dedatt heendofan
accounting peri
od through theadj usting process.Depr eci
ation iscommonl y
comput edbydi vi
dingthedifferencebet weent heor i
ginalcostandsal vagevalue
(second-handmar ketv al
ueofanol dasset )oft heplantassetbyi t
sestimated
useful(economic)lif
e.Thef oll
owingj ournalentryismadet orecor dexpiredcost
ofplantassets:

Depr
eciat
ionExpense…………………………… xx
AccumulatedDepr
eci
ati
on……………… xx

Notethatexpir
edcostofpl antassetsisnotr ecordedasadi r
ectreduct
ionfr
om
therelated pl
antassetaccount sr atheritisr ecor ded i
n an accountcal
led
accumul at
eddepreciat
ion.Thi
si sacont raplantassetaccountwhosebal ance
wil
lbededuct edfrom theor i
ginalcostoft her elatedplantassetsoast o
deter
mi netheunexpir
edcostofthepl antassetcalledbookv alue.

Exampl
e2-8
OnJanuar
y1,2002,ABCStat
ioner
ypur chasedoff
icemachi
neryf
or$50,
000cash.
Themachi
neryhasanesti
mat edeconomi cli
feof10yearsandsal
vageval
ueof

31
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05

$5,
000att heendofi
tsusef
ull
i
fe.Theent
erpr
ise’
saccount
ingper
iodendson
December31.

Requi
red:
Det
ermi
neandrecorddepr
eciat
ionexpensefort
hey earendedDecember
31,
2002andcal
culat
ethebookv al
ueofthemachiner
yont hesamedat
e.

i
ii
)Unear nedRevenues–r efert
oassetscollect
edbef oregoodsandser v
icesare
deli
vered to cust
omers.Unearned r
evenuesr epresentl
iabi
l
iti
esbecauset he
business enti
tyhas eit
hertor ef
und ordel i
v ergoods and ser
vices t
ot he
customersint hef
utur
e.

Att het imeacquisit

ion,t heassetscoll
ected r
epresentliabi
lit
yand ast i
me
passesorwhent hebusi nessdeli
ver
sthenecessarygoodsandser vi
cesinpart
ori nt otal
,the li
abil
it
ies willbe tr
ansferr
ed tor evenue account.Adv ance
coll
ections ear
ned through ti
me ordel i
veryofgoods and ser vi
ces are not
recordedondailybasis.Thecommonpr acti
ceistor
ecor dthem byt heendofan
account i
ngperi
odt hr
oughadj usti
ngentri
es.Atthetimeofcol lecti
on,unearned
revenuesmayber ecordedei t
herasli
abil
it
yorasrevenue.

a)Unear
nedrevenuesini
ti
all
yrecordedasLiabi
li
ti
es–Underthi
sappr
oach,
the
fol
l
owingent
riesar
eneededt orecor
deventsaff
ect
ingt
heseit
ems.

Att
heti
meofcollect
ion
Cash………………………………………. xx
Unear
nedRent……………………. xx

Att
heendofanaccount
ingper
iod–t
orecor
drev
enueear
ned
Unear
nedRent….
………………………… y
y
RentI
ncome………………………. y
y

Att
hebeginni
ngofthenextaccounti
ngper
iod
Noent r
yisneededbecauset heunear
nedrentbal
ancei
sint
hel
i
abi
l
ity
accountasitwasi
nit
ial
l
yrecorded.

b)Unearnedr evenuei ni
ti
all
yr ecordedasRevenues–I nsteadofbeingcredited
toaliabil
i
tyaccount ,unearnedr evenuemaybecr edi
tedtoar ev
enueaccount
atthet i
meofcol lect
ion.Cr edi
tingr ev
enueaccountf oradvancecoll
ecti
ons
doesnot ,howev er,implythatt hecol l
ecti
onsrepresentearnedrevenues.It
rat
herisanal ternati
vewayofr ecordingthesei
tems.Itisthepassageoftime
and/ordeliveryofgoodsandser vicesthatdeterminerevenuerecognit
ion.
Thef oll
owingj ournalentri
esar eneededt or
ecor deventsaffect
ingthese
i
tems.

Att
heti
meofcollect
ion
Cash………………………………………. xx
RentI
ncome………………………. xx

32
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Att
heendofanaccount
ingper
iod–t
orecor
dtheunear
nedpor
ti
on
RentI
ncome…….………………………… y
y
Unear
nedRent
……………………. yy

Att hebeginningoft henextaccount i

ngper i
od– toreturntheunear
ned
rev
enuebal ancebackt ot heaccountwherei
nitwasi
nit
ial
l
yr ecor
ded,
anentr
y
cal
ledreversi
ngent ry
,ismadeasf ol
lows
Unear
nedRent .
.…………………………… yy
RentIncome. .
……………………… yy

Example2-9
OnAugust1,2002,ABCRentalCompanycollect
ed$24,000cashforoneyearr
enton
abuil
dingitl
easedtodi
ff
erentorgani
zat
ionsforbusi
nesspurposes.Thecompany’
s
accounti
ngperi
odendsonDecember31.

Requi
red:
Prepar
eal lthej
ournalentr
iesnecessar
yt ohandletheabov
etr
ansact
ion
undertheapproachesofrecordi
ngunearnedrevenues:
a)asliabil
it
y
b)asr evenue

c)Compari
sonoft heApproaches– Thought heseapproachesaccountfor
unear
nedrevenuesindi
ff
erentway
s,thefi
nalbalancesoftherel
atedr
evenue
andli
abi
l
ityaccount
sarethesame.

3.Accr
uals–r ef
ertor
evenuesalreadyearnedandexpensesal
readyincur
redbynot
yetrecor
dedandnoty etcoll
ectedincashandpai dincash,respecti
vel
y.Thus,
accr
ualsaredi
vi
dedi
ntoaccruedrevenuesandaccr
uedexpenses.

i
) Accruedrevenues – arerevenuesear nedbutnotyetcoll
ect
edincashand
recor
ded.Accruedrevenuesrepresentasset
s.Thefol
l
owingentr
iesar
eusual
l
y
neededtohandletr
ansacti
onsrelatedtoaccr
uedrev
enues:

Att
heendofcurr
entaccount
ingper
iod
RentRecei
vable…………………………… xx
RentIncome………………………. xx

Att
hebegi
nningofnextaccount
ingper
iod
RentIncome……………………………… xx
RentRecei
vabl
e…………………. . xx

Example2-10
OnSept ember1,2002,ABCTr av
elAgencyenteredintoacont ractwi
thEthi
opian
Air
li
nest osellpassengert
icketsforcommission.Thecont ractenti
tl
edABC t o
semiannual
lycol
lect$4commi ssi
ononeachticketsold.Unt
ilt
heendoft hecur
rent

33
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/2004\
05

year,December31,2002,ABC sol
d 4,
000 t
icket
sforwhi
chno commi
ssi
on i
s
coll
ect
edt odat
e.
Requi
red:
Prepar
eal
lthej
our
nalent
ri
esnecessar
ytohandl
etheabov
etr
ansact
ion.

i
i)Accruedexpenses–r epresentvalueofgoodsandser vi
cesconsumedbutnot
yetpaidincashandr ecorded.Accr uedexpensesrepresentl
i
abil
it
iesf
orgoods
andser v
icesalreadyconsumed.Thef ol
lowingentri
esar eusuall
yneededto
handletr
ansact
ionsrel
at edtoaccruedexpenses:

Att
heendofcurr
entaccounti
ngper
iod
RentExpense……………………………… xx
RentPayable………………………. xx

Atthebegi nni
ngofnextaccountingperi
od
RentPay able………………………………. . xx
RentExpense………………………. xx
Exampl e2-11
Sinceitsest abli
shmentonAugust1,2002,ABC St at
ioner
yhasbeenconsumi ng
diff
erentuti
li
tyserv i
ces.Bi
ll
sfrom t
heuti
li
tycompaniesarenotexpect edtoar
ri
veby
theendoft hecur rentaccounti
ngperi
od.Pastexperi
enceindicatesthatt
heval
ueof
util
i
tyservi
cesconsumedt i
llt
heendofthecurrentaccounti
ngper i
od,December31,
2002, t
otal$4,500.

Requi
red:
Prepar
eal
lthej
our
nalent
ri
esnecessar
ytohandl
etheabov
etr
ansact
ion.

2.
10 Wor ksheet
1.Defi
nit
ion–Wor ksheetisamulti-
columnarsheetofpaperusedt
ogat
her
,ar
range
andsummar izedataneededforpreparat
ionof
 Financial
statements,
and
 Adjusti
ngandcl osi
ngentr
ies.

2.Pur pose–Wor ksheet,si

mi l
artoar oughpaper ,i
susedbyaccount antstofacil
it
ate
andmi nimizeer rorsduringpreparati
onoff i
nancialst at
ementsandadj ust
ingand
closingent ri
es.Thewor ksheethel psor gani
zati
ont ot r
yprepar
ationofadj ust
ing
ent r
iesandf i
nanci alstat
ementsbef oretheyaredi rectl
yenteredi
ntothepermanent
recor dsi.e.journalsandl edgers,andputt hem ont hefi
nanci
alstatement sfor
distri
butiont o externalusers.Unliket hef i
nancialst at
ements,worksheeti sfor
i
nt ernaluseonl y.Iti
snotf ordi
stri
butiont ooutsi
der s.Thus,t
heuseofwor ksheetis
opt i
onal.

3.Steps–Thef oll
owingpr oceduresmaybeusedt opr epareandcompl etethefive-
columnwor ksheet:
i
. Unadj ustedtri
albalance– Copynamesandbal ancesofallaccountsf r
om the
generall
edgertotheunadjust edt
ri
albal
ancecolumnoft hewor ksheet
.
i
i.Adj ustment–Ent eradjust
ingentri
esint
headjustmentcolumnoft heworksheet.
i
ii
.Adj ustedtri
albalance–Det ermi
neandenteradj ustedaccountbalancesinthe

34
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05

adjustedt r
ialbal
ancecolumn.Tot aldebit
sandt otal
credit
s
i
v.Incomest atement–Tr ansferadjustedbalancesofincomest at
ementaccounts
tothei ncomest atementcolumn.Neti ncomeappear sonthedebit
v
.Bal ancesheet– Tr ansferadjust
edbal ancesofbal ancesheetaccount
stot he
balancesheetcol umn.Netincomeappear sont hedebit

Exampl
e2-
12

Requi
red:
Using t
he wor
ksheeton t
he nextpage,compl
eter
equi
rement“
c”of
example2-
1onpage-22.

35
 Lect
ureNot
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05

Univ
ersalGarage
Wor ksheet
ForthemonthendedMar ch31,2002
Unadjust
edTrial Adjust
edTrial
Adjust
ments I
ncomeSt
atement Bal
anceSheet
AccountTi
tl
es Balance Bal
ance
Debit Cr
edit Debit Credi
t Debit Cr
edit Debi
t Cr
edi
t Debi
t Cr
edi
t
Cash
Account sReceivabl
e
Suppli
es
PrepaidRent
Machiner y
Offi
ceEqui pment
Account sPay abl
e
Long-term BankLoan
Tahir
,Capi t
al
Tahir
,Dr awings
FeesEar ned
Salar
yExpenses
Miscellaneous
Expenses
Total

36
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05

2.
11 Preparat
ion ofFinanci
alSt atements – Busi
ness or
gani
zat
ions commonly
prepar
et hefol
lowingbasicfinanci
alstat
ement
st obedist
ri
butedtoexter
nal
users.
1. I ncomeSt at
ement
2. St atementofChangesinOwner ’
sEquit
y
3. Bal anceSheet
4. St atementofCashFlows

Exampl
e2-
13

Requi
red:
Compl
eter
equi
rement“
d”ofexampl
e2-
1onpage-
22.

2.
12 Account ingper
iod-endEnt
ri
es
1.Jour nal
izi
ngandPost ingAdj
usti
ngEnt
ri
es–Datedattheendofanaccounti
ng
period,adjusti
ngentri
esareneededt
oupdat
ebal
ancesofaccount
sint
hegeneral
ledger.

Exampl
e2-
14

Requi
red:
Compl
eter
equi
rement“
e”ofexampl
e2-
1onpage-
22.

2.Jour nalizi
ng and Post ing Closing Entries – Dated as oft he lastdate ofan
account i
ngper i
od,closingentri
esar eneededt osummar i
zeandt r
ansfereffectsof
tempor aryaccountsont hecapi
talofabusi ness.Thebal anceofdrawingaccounti s
directlyt r
ansfer
redt ot hecapitalaccountwhi lebalancesofr evenueandex pense
account saref i
rstsummar i
zedi nandcl osedt oanothert emporaryaccountcal l
ed
IncomeSummar ywhichi sult
imatelycl
osedt othecapi talaccount.Cl
osingent ri
es
make t empor ary accountsr eady forr ecording r
ev enue,expense and dr awing
transact i
onsoft henextaccount i
ngperiod.Thef oll
owi ngst epsmaybef ol
lowedi n
thecl osingprocess:
i) closeallrevenueaccount stoIncomeSummar yAccount
FeesEar ned………………………………. xx
RentI ncome……………………………… xx
I
ncomeSummar y……………………. . xxx

i
i
)cl
oseallexpenseaccount
stoIncomeSummar
yAccount
IncomeSummar y………………………… xxx
SalaryExpense………………………. xx
RentExpense………………………… xx
Miscell
aneousExpenses…………….. xx

i
i
i)cl
osedebi
torcreditbalanceofI
ncomeSummaryt
oCapi
talAccount
IncomeSummar y(credi
tbal
ance)………. xx
AAA,Capit
al ………………………. . xx

i
v)cl
osedr
awi
ngAccountt
oCapi
talAccount

37
 Lect
ureNot
es/
Pri
nci
plesofAccount
ing-
I(BuEd-
111/
213)
/2004\
05

AAA,
Capit
al…………………………….xx
AAA,Drawi
ng………………………. xx

Exampl
e2-
15

Requi
red:
Compl
eter
equi
rement“
f”ofexampl
e2-
1onpage-
22.

3.Prepari
ng Post -
closing Tr i
al Bal ance – Thi s, contai
ning onl y
real/
permanent/balancesheetaccount,i
spr epar
edtocheckwhet
hert
heledgeri
sin
balanceaf
terjournali
ngandpost i
ngclosi
ngent ri
es.

Exampl
e2-
16

Requi
red:
Compl
eter
equi
rement“
g”ofexampl
e2-
1onpage-
22.

4.Journal izi
ng and Post ing Rev ersing Entri
es – Rev ersing entri
es aret he exact
opposi tes( r
everse)ofadj usti
ngent r
ies.Theyinv olveaccountt it
lesanddebi tand
creditamount sthesameast hatofadj usti
ngentries.Pr eparedasoft hef irstdayof
thenextaccount i
ngperiod,rev ersingent r
ieshel
pt osi mpl i
fyandf aci
l
itateanal y
ses
and r ecording oft r
ansacti
ons i n subsequentaccount i
ng period.Not et hatall
adjustingent ri
esar enotr eversedatt hebeginningoft henextaccount i
ngper iod.
Thegener alprincipl
eist hatanadj usti
ngent r
ywhi chi ncreasesbal ancesheet
account s( non-
cont ra account )shoul d be rever sed i fiti st he policy ofan
organizat i
ont opreparereversingent r
ies.

Exampl
e2-
17

Requi
red:
Basedony ouranswerforrequi
rement“
e”ofexample2-1onpage22,
ident
if
yt headjust
ingentr
iestoberever
sedandrepapert
heappl
icabl
e
rever
singentri
es.

38