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AcFn 1031
Chapter Two
Accounting cycle for service-giving
business
(Ch 2 Part I-The Recording Phase)
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 2. Accounting cycle for service-giving business

Chapter Outline
The Accounting Cycle
Account: Classification and Nature of Accounts
Chart of Accounts
Rules of Debit and Credit
-The Recording phase of the Accounting Cycle
 Analyzing and recording (journalizing) transactions
 Posting transactions
 Trial Balance
The Summarizing Phase Of the Account Cycle
 Adjusting entries
 Preparation of financial statements
 Closing entries
 Post-closing trial balance preparation
• Reversing entries
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 2.1 The Recording Phase of the Accounting Cycle

Objectives of the Recording Phase

After studying this phase, you should be able to:
• Explain what an account is and how it helps in the recording process.
• Define debits and credits and explain their use in recording business
transactions.
• Identify the basic steps in the recording process.
• Explain what a journal is and how it helps in the recording process.
• Explain what a ledger is and how it helps in the recording process.
• Explain what posting is and how it helps in the recording process.
• Prepare a trial balance and explain its purposes.

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 ..2. The Accounting Cycle for service Business

The Accounting Cycle


The accounting system employs certain routine procedures to convert raw data in to information
The Accounting Cycle: is sequence of accounting procedure for a fiscal period.
It starts with analyzing and journalizing business transactions and ends with
preparation of post closing trial balance.
Financial statements prepared for users are the end results of an accounting system.
The activities in the accounting cycle can be summarized in to two phases,
1. the recording phase and
2. the summarizing and reporting phase

• 

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 The Recording Phase

The Recording phase

 This phase of the accounting cycle focuses on

accumulation of financial data in accounting records.
Transactions are recorded using double entry system

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 …The Recording Phase
 Tabular analysis of transaction is used to
understand the basic concept of double entry
system
 However, it is not practical to use tabular system
to formally record and summarize transactions
 In practice, transactions are recorded in ledger
accounts.

What is an account?
What is a ledger?

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 Account
• An account is an individual accounting record
of increases and decreases in a specific asset,
liability, or owner’s equity item.
• It is a form used to record increase or decrease
caused by transactions on each item of asset,
liability and capital
• There are separate accounts for the items we
used in transactions such as cash, salaries
expense, accounts payable, etc.
• Ledger is a group of accounts. (eg. Asset
accounts, Liability accounts…)
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 Classification of Accounts
• Accounts in ledger are listed in the order in which
they appear in the financial statements. Balance
sheet accounts are classified as Asset, Liabilities,
and Owner’s equity.
• Income statement accounts are classified as
Revenues and Expenses.
• The size of Accounts of an organization depends
on factors such as:
– the nature and size of its activities
– The extent of details needed by the management for
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 Chart of Account
• To easily identify the location of each, all accounts in the
general ledger are numbered.
• Chart of Account shows the list of account titles and account
numbers assigned to each account.
• In assigning an account number a business may use
– two-digit, three- digit or four-digit numbering system;
– it depends on the volume of transaction and extent of detailed
information required by the organization.
– In any case, the first digit always stands for the major classification of
the general ledger.
– For two-digits numbering system the second digit is used to indicate
the position/location of the account with in the division; and for three
or four digit numbering system
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 Chart of Account
For Example, in service business, with two digit
numbering system,
• Account No. 11 refers to the 1st asset account
• Account No. 17 refers to the 7th asset account
• Account No. 23 refers to the 3rd liability account
• Account No. 31 refers to the 1st capital account
• Account No. 42 refers to the 2nd revenue account
• Account No. 54 refers to the 4th expense account
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 Chart of Account
• A two-digit Numbering system permits 9 accounts in each division of ledger.
Eg. Asset: 11-19,
Liability: 21-29, etc.
A Three-digit Numbering system permits 99 accounts in each division of ledger.
Eg. Asset: 101-199,
Liability: 201-299 etc.
Small businesses with limited number of transactions can use two-digit
numbering.
Large organizations with large volume of transaction can use three or more digit
numbering, since it permits the accumulation of detailed data about each type
of asset, liability, revenue and expense.
 
 
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 Nature of an Account

Nature of an Account
• An account can be ruled in various ways;
– in two column form,
– In three column form, or
– In four-amount column form.
• In whatever form it is ruled, an account has three basic
parts.
– The heading: A place to write the title which describes the
nature of the items being recorded in the account (cash, salary
expense etc).
– The Debit part (Left hand side)
– The Credit part (Right hand side)
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 Nature of an Account

The ” T” Account
-The simplest form of an account

Account Name
Debit / Dr. Credit / Cr.

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 …… Nature of an Account

• Why an account has two sides?

– One side is used to record all increases
– Another side is used to record all decreases
• Account balance
– It is the difference between two sides total
– It appears in the side showing larger amount
• Normal balance of an account is positive
since usually increases exceed decreases

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 Nature of an Account
…Why an account has two sides?
Comparison tabular summary with account

An account clearly show increases in one side, decreases in another side

and the balance.
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 DEBITS AND CREDITS

• Debit indicates left and Credit indicates right

• Recording amounts on the left side of an account is
debiting/charging the account
• Recording amounts on the right side is crediting the
account
• If the total of debit amounts is bigger than credits, the
account has a debit balance
• If the total of credit amounts is bigger than debits, the
account has a credit balance

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 …The Recording Phase

Double-entry accounting system

A recording system showing two-sided effect.
Recording done by debiting at least one account and
crediting another. More than one account can be
debited/credited.
Equal amounts recorded in debit and credit side
Debit signify Left side
Credit signify Right Side

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DEBITING AN ACCOUNT

Cash
Debits Credits
15,000

Example: The owner makes an initial

investment of $15,000 to start the
business. Cash is debited as the
owner’s Capital is credited.
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 CREDITING AN ACCOUNT

Cash
Debits Credits
7,000

Example: Monthly rent of $7,000 is paid. Cash

is credited as Rent Expense is
debited.
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 Debits and Credits

If Debit entries are greater than Credit

entries, the account will have a debit balance.
Account Name
Debit / Dr. Credit / Cr.

Transaction #1 $10,000 $3,000 Transaction #

Transaction #3 8,000

Balance $15,000

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 Debits and Credits
If Credit entries are greater than Debit
entries, the account will have a credit balance.

Account Name
Debit / Dr. Credit / Cr.
Transaction # $10,000 $3,000 Transaction #
8,000 Transaction #

Balance $1,000

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 Debit and Credit Rules

Debit and Credit Rules of Accounts

• Permanent/real/open accounts: refers to balance sheet
accounts, Asset, Liability, and Capital; the balances of these
accounts are carried forward from year to year.
• Temporary/nominal/Closed accounts: refers to temporary
capital accounts, Revenue, Expense, Dividend & Drawing.
At the end of each fiscal period, the balances in these
accounts are closed to the real capital accounts through a
process known as closing.

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 Debit and Credit Rules …..
• The debit and credit rules for permanent accounts have
been developed on the basis of the accounting equation.
• In accounting equation, assets are on the left side of the
equation and liabilities and capital are on the right side of
the equation.
• Assets increased on the left-hand side or debit side and
liabilities and owner’s equity accounts increased on the
right hand side or credit side.
• Decreases are recorded opposite to the increase side.

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 Debit and Credit Rules …..
• The debit and credit rules for revenue and expense accounts
have been developed by considering the relationship of revenue and
expense to the owners equity account.
• Revenue and expenses are income statement accounts;
• Revenue is a gross increase in capital and expense is a gross
decrease in capital.
• At the end of each fiscal period, the balances in income statement
accounts, revenue and expenses, are closed to income summary
account and the net effect, net income or net loss is transferred to
the real capital account.
• Since revenue and expenses accounts are the details of the capital or
owner’s equity account, they are also called temporary capital
accounts.
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 Debit and Credit Rules …..
• Revenue Increases owners equity,
–increase side of owners equity account and
revenue account is the same, credit.
• Expense decreases capital, the decrease
side of owners equity account is debit, so
the increase side for an expense account is
debit. An increase in expense causes a
decrease in capital.
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 Debit and Credit Rules …..
• The same logic is used for the increase and decrease side of drawing
and dividend accounts:
–Drawing decreases owner’s capital, the decrease side of owners
equity account is debit, so the increase side for drawing account is
debit. An increase in drawing causes a decrease in owner’s capital.
–Dividend decreases retained earning, one of the real owners equity
account of the corporation. The decrease side of retained earning
account is debit, so the increase side for dividend account is debit.
An increase in dividend causes a decrease in retained earning
account.

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 Rules of Debits and Credits
Increase and decrease sides
. Expanded Accounting Equation
(Assets = Liabilities + Equity + Revenues - Expenses - Dividends)

Assets Liabilities Equity

= +
Debit Credit Debit Credit Debit Credit

+ - - + - +
Common Stock
Debit Credit
The side you increase
on is called the - +
Retained Earnings
normal balance Debit Credit

- +
Dividends Expenses Revenues
Debit Credit Debit Credit Debit Credit

+ - + - - +

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 Rules of Debit and Credit
Increase Decrease Financial statement
Account Side Side Balance Nature of the
account
Asset Debit Credit Debit Balance sheet
Permanent/Real/Ope
n
Liability Credit Debit Credit Balance sheet
Permanent/Real/Ope
n
Capital/Stockholder’s
equity:
Capital, Capital Balance sheet
Stock, Credit Debit Credit Permanent/Real/Ope
and Retained n
Earning Capital accounts
Contra Capital Capital statement,
Drawing, Dividend Debit Credit Debit Accounts, Retained Earning
Temporary/ Statement
Nominal/Closed
Temporary Capital Income Statement
Revenue Credit Debit Credit accounts,
Temporary/
Nominal/Closed
Temporary Capital Income Statement
Expense Debit Credit Debit accounts,
Temporary/
Nominal/Closed

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 Debit and Credit Rules …..
• when an account that normally has a debit
balance actually has a credit balance, or vice
versa, it is an indication of an accounting error
or of an unusual situation.
• For example, a credit balance in office
equipment, an asset account could result only
from an accounting error; on the other hand, a
debit balance in accounts payable could result
from an overpayment.
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 Flow of Accounting Data

• The flow of accounting data from the time the transaction

occurs to its recording in ledger may be diagrammed as
follows:

Business Business Entry

Documents Entry Posted to
Transaction recorded in ledger
occur prepared journal

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 Flow of Accounting Data….

• Business Transaction: it is an economic event that must be

recorded in accounting records.
• Source Document : It is written evidence to support entries
recorded in journal. A source document may be cash receipt,
sales invoice, bills, cash register tapes etc. An entry should
not be recorded in journal without being supported by
approved source document.
• Journal: A Journal is the first book in which the records of
a business are written. Each record in a journal is known as
entry. There are different types of journals such as the
(general journal, combination journal
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 Flow of Accounting Data….

General Journal It is a two-amount column book used to record

all kinds of business transactions.
Each entry recorded in a general journal has four parts -the
date part;
-the debit part which contains the account/s
debited and the amount;
-the credit part which contains the account/s
credited and the amount; and
-the source document and explanation part.
Journalizing : is the task of recording transactions in a journal
Analyzing comes before transactions are recorded in journals.
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 Sequence of activities in the Accounting
Cycle
Step 1: Analyzing and Journalizing Business transactions
• Business transactions occurring should be analyzed in three
steps,
– 1. Determining whether the item affected is asset, liability, capital,
revenue, or expense;
– 2. Determining the effect of the transaction on the account, whether
the account affected increases or decreases and the amount
– 3. Determining whether the effect of the transaction should be
recorded as a debit or credit.
• After a transaction is analyzed, the entry is journalized and
posted to the accounts in the ledger.

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 Step 1: Analyzing and Journalizing business
transactions
Steps in Journalizing using General Journal:
– 1. Record the date
– 2. Record the debit part of the entry (the account
title and the amount debited)
– 3. Record the Credit part of the entry (the account
title and the amount credited)
– 4. Record the explanation and the source
document

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 Step 2: Posting from General Journal to the Ledger
 

Step 2: Posting from General Journal to the Ledger

 Each entry recorded in a journal needs to be transferred to the
respective ledger accounts.
• Posting: is the process of transferring the entries in a journal to
accounts in a ledger  
Steps in posting
1. Record the date and the amounts of the entry in the account;
2. Insert the number of the journal page in the Posting Reference
column of the account; and
3. Insert ledger accounts number in the post reference column of
the journal.
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 Step 2: Posting from General Journal to the
Ledger
• Purpose of Post Reference
– The major purpose of the 'Posting Reference' is to cross
refer the journal and the ledger:
– In the ledger, it refers the page of the journal from which
the entry is made (the source); and
– in the journal, it refers the account to which the entry is
posted. In the journal, the post reference column also
serves to identify the entries posted from those not yet
posted. The entries for which account numbers are filled
in the post reference column indicate that posting is
completed.
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 2.4 The Trial Balance

Preparing TB–The 3rd step in the Accounting Cycle

•Trial Balance
–It is a means of proving the equality of the debits and credits in the ledger.
–It shows the list of accounts and their balances on specific date usually end of the
accounting period.
How to prepare a TB?
–To prepare a trial balance, account balances of the accounts in the ledger should be
determined.
Why it is needed?
•It is part of the checking process.
•If debit side total of a trial balance is not equal to the total of the credit side, it is an
indication for the existence of error
•Therefore, at the end of the accounting period, before preparing financial statements,
the equality of debits and credits in the ledger should be verified.
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 Trial balance…..
• If the two sides total of a trial balance are equal, the trial
balance is said to be “in balance”
• If the two sides of a trial balance are not equal, the trial
balance is said to be “Out of balance” and it may be an
indication of one or more of the following errors;
1. Error in preparing the trial balance:
–Incorrect addition of one of the sides of the trial balance;
–Wrong figures recorded in the trial balance;
–A debit balance recorded as a credit, or vice versa;
–A balance omitted entirely.
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 Trial balance……
2. Error in determining account balances:
– Balance computed incorrectly;
– Balance entered in the wrong column.
3. Error in recording a transaction in the
ledger.
– Wrong or erroneous amount posted to the account;
– A debit entry posted as a credit or vice versa;
– Omission of a debit or a credit posting.

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 Trial balance……
Errors that cannot be detected by a Trial Balance
• A trial balance is not a complete proof of the accuracy of the ledger; this is a
limitation of a trial balance.
• There are some errors that wouldn't cause the trial balance to be out of balance,
and these types of errors couldn’t be detected by trial balance. This happens when
both the debit and the credit sides are affected equally. Errors that don't cause the
trial balance to be out of balance include:
– 1. Failure to record a transaction or post a transaction (omission of a
transaction)
– 2. Recording the same erroneous amount for both the debit and credit parts of
a transaction
– 3. Recording the same transaction more than once; and
– 4. Posting a part of a transaction correctly as debit or credit but to the wrong
account.
 In order to prepare accurate financial statements,
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 Trial balance……
• Discovery of Errors: The existence of errors
in the accounts may be determined in various
ways such as:-
– By preparing a trial balance
– By chance discovery; and
– By audit procedures;

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Discovering errors by Preparing Trial balance
Discovering Errors by Preparing a Trial balance:
• When the debit side of the trial balance is not equal with the credit side, it
indicates the existence of errors in ledger.
Clues for Locating Errors
• The amount of the difference between the two sides of the trial balance may
clue as to the nature of the error committed.
 
– l. A difference of figures like 100; 1,000; 10,000; etc. between the two total of the trial
balance is mostly the result of an error in addition. Therefore, re-add the trial balance
and re-compute the account balances,
– 2. If the difference between the two sides of the trial balance is divisible by two, it
indicates one of the following errors:
• Posting of a debit as a credit or vice versa; or
• Omission of one of the debit or credit posting,
– 3 If the two sides of the trial balance read a difference divisible by nine, it indicates
either a transposition or a slide error.
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 Trial Balance….
• A transposition error is the error in re-arrangement
of digits; for example, writing 452 as 542; or 945 as
495.
• A slide error is error caused by moving of the entire
number one or more spaces to the right or to the left;
for example writing 1,200 as 12,000; or 1,200 as 120.
• In general, to locate errors it is essential to check the
journalizing, posting, and the trial balance in their
reverse order.

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 How to Correct Errors
Correction of Errors
• When an error is discovered in either the journal or the ledger,
it must be corrected.
• The method of correction depends on the nature of the error
and the stage at which it is discovered.
– If an error is discovered in a journal before it is posted to the ledger,
the correction can be made by drawing a line through the incorrect
item and writing the correct item immediately above. This kind of
correction can also be used when a posting error involves entering an
incorrect amount in the ledger.
– If an error is due to posting to a wrong account, it needs to be
corrected by recording another entry called correcting entry.

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