UNIT 4: THE ACCOUNTING CYCLE

Chapters 2, 3, 4 of ebook

4.1 Analyzing business transactions from source documents

BUSINESS DOCUMENTS
Source documents that serve as basis for recording business transactions

Business transactions
A financial event that changes the resources and claims on the resources of a business entity

Document type Issued by Issued to Purpose

Purchase requisition Sales Purchasing List of goods to be ordered
department department
xxx Purchasing List of items needed by the requesting department
department department
Purchase order Buyer Seller Order of goods
Receiving report Receiving Purchasing After inspection, to show the quantity and
department department condition of the goods received
Invoice
Sales invoice Seller Buyer Delivery of goods
Purchase invoice Buyer Seller
Credit note Seller Buyer Return* of goods
Debit note Buyer Seller or for allowances**
Statement of account Seller Buyer
Service Customer Reminder [request] to pay
provider
Remittance advice Buyer Seller Inform that payment is made
(normally through bank transfer)
Receipt Seller Buyer Receive payment
(cash; cheque; bank transfer)
Promissory note A written promise to pay a specified amount
on a certain date
Voucher Payments made either by cash or by cheque
Petty cash voucher Payments from petty cash fund
Inventory take sheet/ Inventory count,
Stock take sheet basis for recording closing inventory
*return – actual return of goods
**allowance – no actual return of goods

Reasons for returns & allowances:

• Damaged goods
• Damage of goods during delivery
• Wrong specifications (size, color, shape)

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RULES OF DEBIT AND CREDIT
• Increases are recorded on the normal balance side of an account
• Decreases are recorded on the opposite side of the normal balance

ASSETS = LIABILITIES + OWNER'S EQUITY

Assets Liabilities Owner's Equity

dr cr dr cr dr cr
NB NB NB
+ - - + - +

Owner's Drawings Owner's Capital

dr cr dr cr
NB NB
+ - - +

Expenses Revenues
dr cr dr cr
NB NB
+ - - +
Accounts with NB of Dr Accounts with NB of Cr
+ on the Dr, - on the Cr - on the Dr, + on the Cr
• Assets • Liabilities
• Owner’s Drawings • Owner’s Capital
• Expenses • Revenues

Definition of Terms [listed in the order of discussion in the lecture videos]

• Account – a written record of the assets, liabilities, and owner's equity of a business
• Chart of accounts – a list of accounts used by a business to record its financial transactions
• Normal balance – the side of an account in the accounting equation
• Double entry system – an accounting system that involves recording effects of each transaction
as debits and credits
• Account balance – difference between the two sides of an account
• Footing – adding the amounts
• Rule / Ruling – represents a mathematical operation [ +, -, x, / ]
• Double rule / Double ruling – represents account balance and final answers

Permanent accounts vs Temporary accounts

• Permanent account / Real account – account that is brought forward to the next accounting period
• Temporary account / Nominal account – account that is closed at the end of the accounting period

Permanent accounts / Real accounts Temporary accounts / Nominal accounts

• Assets • Revenues
• Liabilities • Expenses
• Owner’s Capital • Owner’s Drawing

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ACCOUNTING CYCLE
A series of steps performed during each accounting period to classify, record, and summarize data for a business and to
produce needed financial information
1. Analyzing business transactions from source documents
2. Journalizing business transactions
3. Posting to the general ledger
4. Preparing a trial balance
5. Preparing a work sheet [optional]
6. Journalizing and posting adjusting entries
7. Preparing financial statements
8. Journalizing and posting closing entries
9. Preparing a post-closing trial balance
10. Journalizing and posting reversing entries

4.2 Journalizing business transactions

JOURNALIZING
Recording business transactions in a journal

Journal
• A chronological record of business transactions
• Book of original entry / Book of primary entry

Types of journal
• General journal – general-purpose journal for recording all types of entries
• Special journals – journals used for similar and repetitive transactions
o Sales journal – for credit sales
o Sales returns journal – for goods returned by customers
o Purchases journal – for credit purchases
o Purchases returns journal – for goods returned to suppliers
o Cash receipts journal – for cash receipts
o Cash payments journal – for cash payments
o Petty cash book – for small cash payments

Reminder: A complete journal entry should include source information for audit trail.

Audit trail
A chain of references that makes it possible to trace information, locate errors, and prevent fraud

Compound entry
A journal entry that contains more than one debit or credit

Correcting entry
A journal entry made to correct an erroneous entry

Common errors
• Transposition error – occurs when the digits are switched [E.g. 357 as 375 or 537]
• Transplacement error / Sliding error – occurs when a decimal point is misplaced [E.g. 375 as 37.50 or 3,750]

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4.3 Posting to the ledger
POSTING
Transferring information from a journal to a ledger

Ledger
• Permanent and classified record of all accounts of a business
• Book of final entry

Forms of ledgers
• Standard form [T-account form]
• Balance ledger form [Running balance form]

Types of ledgers
• General ledgers
• Subsidiary ledgers – groups of similar ledgers with combined balances equal to the balance of a specific general
ledger account
o Individual Accounts Receivables to support Accounts Receivables Control Account*
o Individual Accounts Payables to support Accounts Payables Control Account*
o Separate records of each Property, Plant, and Equipment account
(Land, Building, Machinery, Equipment, Vehicle, Furniture, Fixtures, Fittings)
o Separate records of each type of inventory
(merchandise inventory, raw materials, work in progress, finished goods)

* Control account – Summary account that is used check the mathematical accuracy of the ledgers it controls

4.4 Preparing a trial balance

TRIAL BALANCE
A statement to test the accuracy of total debits and credits after transactions have been recorded and posted

Uses
• A proof of accuracy at face value [‘prima facie’], it checks the mathematical accuracy of debit and credit balances
• If equal, it serves a basis for preparing financial statements
• If unequal, it may be used in locating errors

Limitations
• Not a proof of accuracy because there are errors that will still give an equal trial balance
• If the trial balance doesn’t agree, the trial balance can’t locate the actual error
• Takes time to prepare, the financial statements can be prepared directly from the balances of the ledger accounts

Errors that cause unequal Trial Balance

• Addition errors
• Only the debit side is recorded OR only the credit side is recorded
• Double recording on the same side
• Not the same amount of debit and credit

Finding Trial Balance errors

Mainly, tracing back the steps
1. Re-check the account balance
2. Re-add the total debit and the total credit
3. Re-check if each debit and each credit is recorded properly
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REFERENCE
• Price, J., Haddock, M., & Farina, M., (2024). College Accounting, 17th edition. McGraw-Hill Education.

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