CHAPTER 2

THE ACCOUNTING CYCLE

 LEARNING OBJECTIVES
 Explain how the concepts of recognition,
valuation, and classification apply to
business transactions and why they are
important factors in ethical financial
reporting.
 Explain the double-entry system and the
usefulness of T accounts in analyzing
business transactions.
 Demonstrate how the double-entry system is
applied to common business transactions.
 Prepare a trial balance, and describe its
value and limitations.
Explain how the concepts of recognition, valuation,
and classification apply to business transactions
 Business transactions are economic events that affect a
company’s financial position.
 To measure a business transaction, you must decide

ECONOMIC EVENTS

RECOGNITION when the transaction occurred (the

recognition issue),
VALUATION what value to place on the transaction
(the valuation issue), and
CLASSIFICATION how the components of the
transaction should be categorized (the
classification issue).
BUSINESS TRANSACTIONS THAT AFFECT FINANCIAL POSITION
Recognition
 The recognition issue refers to the decision when a business transaction
should be recorded.
 This issue is important because the date on which a transaction is
recorded affects amounts in the financial statements.
 To illustrate some of the factors involved in the recognition issue, suppose
a company wants to purchase an office desk. The following events take
place:
1. An employee sends a purchase requisition for the desk to the purchasing
department.
2. The purchasing department sends a purchase order to the supplier.
3. The supplier ships the desk.
4. The company receives the desk.
5. The company receives the bill from the supplier.
6. The company pays the bill.
 According to accounting tradition, a transaction should be recorded when
title of merchandise passes from the supplier to the purchaser and creates
an obligation to pay.
 Thus, depending on the details of the shipping agreement for the desk, the
transaction should be recognized (recorded) at the time of either event 3 or
4.
 The preset time at which a transaction should be
recorded is the recognition point.
 Some examples of economic events that should and
should not be recorded as business transactions:
 Events That Are Not Recorded Events That Are Recorded
 A customer inquires about the A customer buys a service.
availability of a service.
 A company hires a new employee. A company pays an employee
for work performed.
 A company signs a contract to A company performs a service.
provide a service in the future.
Valuation
 The valuation issue focuses on assigning a
monetary value to a business transaction.
 GAAP states that all business transactions
should be valued at fair value when they occur.
 Fair value is defined as the exchange price of an
actual or potential business transaction between
market participants.
 This practice of recording transactions at
exchange price at the point of recognition is
commonly referred to as the cost principle.
Example: Determine the value of the following transaction.

 A company provides printing paper to a local weekly

newspaper printing press in exchange for an advertisement

for 52 issues.

 Determining the value of a sale or purchase transaction isn’t difficult

when the value equals the amount of cash that changes hands.
However, barter transactions, in which exchanges are made but no
cash changes hands, can make valuation more complicated. Barter
transactions are quite common in business today.
Classification

 The classification issue has to do with

assigning all the transactions in which a
business engages to appropriate categories
 Assets
 Liabilities
 Capital
 Revenue
 Expenses and costs
 The Role of Accounting Records

All accountants play a pivotal roll in establishing and maintaining

economic information about the company.

Establishes
Establishesaccountability
accountabilityfor
forassets
assetsand
andother
othertransactions.
transactions.

Keeps
Keepstrack
trackof
ofroutine
routinebusiness
businessactivities.
activities.

Obtains
Obtainsdetailed
detailedinformation
informationabout
aboutaaparticular
particular
transaction.
transaction.

Evaluates
Evaluatesefficiency
efficiencyand
andperformance
performancewithin
withincompany.
company.

Maintains
Maintainsevidence
evidenceof
ofaacompany’s
company’sbusiness
businessactivities.
activities.
 The accounting process

e ss
usin ction Inputs Process Outputs
B nsa
Tra 1)1) Income
Income
Statement
Statement
1. Accounts 2) Balance Sheet
1. Accounts 2) Balance Sheet
2. Journal 3) Cash Flow
2. Journal 3) Cash Flow
3. General
3. General
Ledger
Ledger
4.4. Trial
Trial
Balance
Balance

What is the chart of accounts?

It is the list of accounts used by a business.

Each business entity has its unique chart of accounts.
Every chart of accounts has the same numbered account
categories:
– Assets, Liabilities, Owner’s Equity
– Revenues, Expenses
 JOURNAL
What is a journal?
It is the book of original entry.
Initially transactions are recorded in a journal and then
transfer to the general ledger accounts.
Journalizing is the process of entering information as
debits and credits to the correct accounts.
The steps in journalizing
In journalizing Debits are always recorded first.
Indent, then record the credit below the debit.
A short explanation is included on the second line.
Leave a space between journal entries.
The Ledger
 An accounting system has a separate record for
each item appears in the financial statements.
 The record used to keep track of the increase and
decrease in financial statement item is termed as a
ledger account or simple an account.
 Accounts are individual records showing increases
and decreases of specific item.
 A group of accounts is called a ledger. It means that
the entire group of accounts is kept together in an
accounting record is called a ledger.
The Use of Accounts
 It is useful to accumulate and summarize the
change of an item due to business transaction
during the accounting period.
 Increases are recorded on one side of the T-
account, and decreases are recorded on the
other side.
 Simplest form of ledger account is “T” account.
 T-account has three elements Title of the Account
 A title part Left Right
 A left side and or or
Debit Credit
 A right side
Side Side
 Debit and Credit Rules for different accounts
Debits and credits affect accounts as follows:

A = L + OE
ASSETS LIABILITIES EQUITIES
Debit Credit Debit Credit Debit Credit
for for for for for for
Increase Decrease Decrease Increase Decrease Increase
Double Entry Accounting
The Equality of Debits and Credits
•The rule of debts and credits are designed so that every
transaction is recorded by equal amounts of debits and credits.
•This is due to the relationship of the rule of debits and
credits with the accounting equation.

A = L + OE
Debit
balances = Credit
balances

In the double-entry accounting system, every transaction

is recorded by equal dollar amounts of debits and credits.
Let’s record selected transactions for Abeba’s Care Service company in the
accounts.


 May
May 1:
1: Abeba
Abeba and
and her
her family
family invested
invested $8,000
$8,000 in
in
her
her Care
Care Service
Service company
company andand received
received 800
800 shares
shares
of
of stock.
stock.

Will Capital Stock

Will Cash increase
increase or
or decrease?
decrease?
The Journal
In an actual accounting system, transactions are initially
recorded in the journal.

GENERAL JOURNAL

Date Account Title P/R Debit Credit

2007 1 Cash 8 000
May

Capital stock 8 000

CK. No. 1 owners invest cash in the
business
Posting Journal Entries to the Ledger Accounts
 All transactions are recorded in the journal, then amounts
are copied to the ledger accounts named on the journal
line.
 Once the amounts are entered into the accounts, a posting
reference (PR) must be entered in the journal.
 New balances are computed in the running ledger
accounts.
 Posting simple means updating the ledger accounts for the
effects of the transactions recorded in a journal.
 Posting involves copying information from the journal to
the ledger accounts.
 Posting Journal Entries to the Ledger
Accounts
GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
2007
May 1 Cash 8,000
Capital Stock 8,000
Ck No. 1 Owners invest cash in the business.

General Ledger
Cash
Date Debit Credit Balance
2007
May 1 8,000 8,000
 Posting Journal Entries to the Ledger
Accounts
GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
2007
May 1 Cash 8,000
Capital Stock 8,000
Owners invest cash in the business.

General Ledger
Capital Stock
Date Debit Credit Balance
2007
May 1 8,000 8,000
 Posting Journal Entries to the Ledger
Accounts
GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
2007
May 2 Tools & Equipment 2,500
Cash 2,500
Purchased office equipment.

Let’s
Let’s see
see what
what the
the cash
cash account
account looks
looks like
like after
after
posting
posting the
the cash
cash portion
portion of
of this
this transaction
transaction forfor
Abeba’s
Abeba’s Care
Care Service
Service company.
company.
Ledger Accounts After Posting
General Ledger
Cash
Date Debit Credit Balance
2005
May 1 8,000 8,000
2 2,500 5,500

This
This ledger
ledger format
format is
is referred
referred to
to as
as aa
running
running balance.
balance.
What is Net Income?
 Net income is an increase in owners’ equity from profits
of the business.
 Net income doesn’t consist of any specific assets.
Rather it is a computation of the overall effect of many
business transactions on owners’ equity during the
accounting period.
 Net income may be distributed to shareholders or retain
in the organization, or distribute part of Net income and
retain the remaining within the organization.

A = L + OE
Increase Decrease Increase

Either (or both) of these effects occur . . . but this is what “net
as net income is earned . . . income” really means.
Retained Earnings

 The balance in the Retained Earnings account

represents the total net income of the corporation over
the entire lifetime of the business, less all amounts which
have been distributed to the stockholders as dividends.

A = L + OE
Capital Retained
Stock Earnings
 The Realization Principle: When To
Record Revenue
Realization Principle
 Revenue should be recognized at the time goods are sold and
services are rendered. At this point the business transaction
has completed its earning process.
 Assume that ABC company has taken a contract on September
2016 to render service to Z company. ABC company
performed the service on October 2016 and will receive
$2000 from Z company on November 20, 2016.
In which month ABC company should recognize the revenue
earned?
 The Matching Principle:
When To Record Expenses
Matching Principle
 According to Matching principle, Expenses should be recorded in the
period in which they are used up to generate revenue.
 In measuring Net income for the period, revenue should offset by all
the expenses incurred in producing that revenue.
 This concept of offsetting expenses against revenue on a basis of
cause and effect is called Matching principle.
Expenses are the cost of the goods and services used up in
the process of earning revenue.
 An expenses always causes a decrease in owner’s equity.
The result of change of an expense transaction in the
accounting equation can be either a decrease in assets or a
increase in liabilities.
...

 Example: On June 10, 2017 ABC company has paid $1000

salaries of May 2017 for its employees. ABC company prepares
financial statements at the end of a month.

 In which month this salaries amount should record in the book of

ABC company?

 In deciding when to record an expense, the critical question is

 “ in which period does the cash expenditure help to produce revenue?”
not “when does the cash payment occur?”
 Trial
Trial Balance
Balance

A trial balance is a summary of balances of all

accounts recorded in the ledger.
Objectives of Preparing a Trial Balance
check the arithmetical accuracy of the ledger accounts;
help in locating errors; and
 provide a basis for preparing the financial statements.

The trial balance lists the accounts that have balances

in the same order as they appear in the chart of
accounts.
Trial balance is the proof of debit and credit balances
of all the accounts in the ledger.
 Abeba’s Care Service company
All balances
Unadjusted Trial Balance are taken from
May 31, 2007 the ledger
Cash $ 3,925 accounts on
Accounts receivable 75
Tools & equipment 2,650 May 31 after
Truck 15,000 considering all
Notes payable $ 13,000 of Abeba’s
Accounts payable 150
Capital stock 8,000
transactions
Dividends 200 for the month.
Sales revenue 750
Gasoline expense 50 Proves equality
Total $ 21,900 $ 21,900 of debits and
credits.
Detection of Errors Revealed by the Non-agreement of
Trial Balance
 If the trial balance does not balance, the accountant should
initiate the following steps to detect and locate the errors:
 Recast the totals of debit and credit columns of the trial balance.

 Compare the account head/title and amount appearing in the trial

balance, with that of the ledger to detect any difference in amount or
omission of an account.

 Re-do and check the correctness of balances of individual accounts

in the ledger.

 Re-check the correctness of the posting in accounts from the books

of original entry.
... If the difference between the debit and credit columns is divisible by
two, there is a possibility that an amount equal to one-half of the
difference may have been posted to the wrong side of another
ledger account.
 The difference may also indicate a complete omission of a posting.
 If the difference is a multiple of 9 or divisible by 9, the mistake
could be due to transposition of figures.
For example, if a debit amount of $ 459 is posted as $954, the
debit total in the trial balance will exceed the credit side by $ 495
(i.e. 954- 459 = 495). This difference is perfectly divisible by 9.
 A mistake due to wrong placement of the decimal point may also be
checked by this method. Thus, a difference in trial balance divisible
by 9 helps in checking the errors for a wrong placement of decimal
point. Example. $478.5 posted as $4785.00; difference $4785.00-
478.50= 4306.50 divided by 9 = 478.50
Errors Disclosed by Trial Balance
 If the Trial Balance does not balance, it will indicate that certain
errors have been committed which have affected the agreement
of the Trial Balance. The accountant will then proceed to find out
the errors and ultimately the errors will be located.
 Such errors are called 'Errors Disclosed by Trial Balance or
Errors which affect the agreement of Trial Balance.
 Wrong amounts in the ledger
 Posting to the Wrong Side of an account
 Posting of Wrong Amount to an account
 Omission of Posting of One Side of an Entry
 Double posting in a Single Account
 Errors of Totalling and Balancing of Accounts in the Ledger
Errors that can not disclosed by trial balance
 There are many benefits of trial balance but there are also numerous errors
which can not be disclosed or revealed from making trial balance.
1. Errors of omission
If we forget to pass the journal entry of any transaction, both side of trial
balance will not be affect with this.
2. Errors of commission
These types of errors are happened due to negligence of accountant and can not
be found by making trial balance. Suppose, we sold of $ 10,000 goods but
recorded in books as $1000.  
3. Errors of compensating 
Suppose, accountant wrote $ 500 less in the debit side of purchase account and
same time he also wrote $500 less in credit side of sale account. Because one
mistake is compensated with other error.
4. Writing the amount to the correct side but to the wrong account
Suppose if you have purchased machinery but you debited purchase account in
journal entry.
5. Errors of duplicating : pass the journal entry twice
Accruals and Deferrals
 What are deferral and accrual?
 Deferrals and accruals are helpful in properly matching
revenues and expenses.
 A deferral is a delays of the recognition of either an expense
that has been paid or a revenue that has been collected.
 Example
 Prepaid expenses represent the cost of goods and services
purchased that are not entirely used up at the end of the year
 When revenue is received before goods are delivered or services
performed, the revenue is said to be unearned
 An accrual is an expense that has not been paid or a revenue
that has not yet been received.
 Many expenses which accumulate on a daily basis are only
recorded at set intervals. At the end of an accounting period a
portion of such expenses (for instance, salaries) often remains
unpaid.
 At the end of an accounting period, all revenues earned but not yet
collected are accrued revenues which require adjusting entries. .
Accruals and Deferrals
 When should expenses and revenues be
recognized?
 When we are talking about the timing of revenue
or expense recognition; the applied basis of
accounting method must be identified.

 The two mostly used methods of accounting are

  cash basis accounting and 

 accrual basis accounting

 When revenue and expenses are recognized Under the
cash basis accounting?

 Under the cash basis accounting, revenues are

recognized when cash is received, regardless of time
services are provided or products are sold; and
expenses are recognized when cash is paid, regardless
of time costs are incurred
 When revenue and expenses are recognized Under the
accrual basis accounting?
 On the other hand, under the accrual basis
accounting, revenues and expenses are recorded
when earned and incurred, accordingly, regardless of
the time cash is exchanged (i.e. received or paid).
 MIXED BASIS ACCONTING OR MODIFIED ACCRUAL
ACCOUNTING.doc
 The Adjustment Process
 Why do we need adjusting entries?
 Adjusting entries are needed whenever revenue or expenses
affect more than one accounting period.
 Adjusting entry needed to
 bring the accounting records up to date.
 state properly assets, liabilities, and owners’ equity at the
end of the accounting period.
 Every adjusting entry involves a change in either a revenue
or expense and an assets or a liability.
 Each adjusting entry affects at least one Balance Sheet
account and at least one Income Statement account.
 Adjusting entries DO NOT involve debits and credits to
cash.
 Adjusting Entries
 The types of adjusting entries may be classified in to the
following groups

1. Allotment of recorded costs (converting assets to expenses)

2. Allotment of recorded revenue (Converting liabilities into revenue)

3. Recording Accrual of unrecorded expenses

(Recording un recorded expenses) and

4. Recording Accrual of unrecorded revenue

(Record unrecorded revenues)
 NECESSARY ADJUSTING ENTRIES AT THE END OF
THE PERIOD

 The following entries are necessary, when there are:

1. Accrued revenues (accrued assets) and accrued expenses
(accrued liabilities):

 Accrued revenue is recognized before cash is received

 Entry:-
Dr Asset and
Cr Revenue
 Accrued expense is recognized before cash is paid
 Entry:-
Dr Expense and
Cr Liability
And/or
2. Deferred revenues (unearned revenues) and
deferred expenses (prepaid expenses):
 Deferred revenue is recognized after cash is received
 Adjusting entry for deferred revenues:-
Dr Liability and
Cr Revenue
 Deferred expense is recognized after cash is paid
 Adjusting entry for deferred expenses:-
Dr Expense and
Cr Asset
 1. Converting Assets to Expenses
End of Current Period

Prior Periods Current Period Future Periods

Adjusting
AdjustingEntry
Entry

Recognizes
Recognizesportion
portion
Transaction
Transaction of
ofasset
assetconsumed
consumed
Paid
Paidcash
cashininadvance
advance as
asexpense,
expense,and
and
of
ofincurring
incurringexpense
expense 
Reduces
Reducesbalance
balanceofof
(creates
(createsananasset).
asset). asset
assetaccount.
account.
When an adjusting entry is used to convert an asset to expense, a transaction took place
in a prior period that involved the advance payment of an expense.

The adjusting entry is made at the end of the current period to recognize the converting
of the prepaid asset into an expense. The asset account is reduced and the expense
account is increased. Examples for adjusting entries.doc
4-42
 2. Converting Liabilities to Revenue
End of Current Period
Prior Periods Current Period Future Periods

Adjusting
AdjustingEntry
Entry

Recognizes
Recognizesportion
portion earned
earnedas as
Transaction revenue,
revenue,
Transaction
Collect and
Collectcash
cashin
inadvance
advanceof ofearning
earning and
revenue 
Reduces
Reducesbalance
balanceof
of liability
revenue(creates
(createsaaliability).
liability). liability
account.
account.

The adjusting entry is necessary when cash has been collected in advance of earning revenue.

At the end of the accounting period, an adjusting entry will need to be recorded to recognize
the revenue earned during the period and to reduce the liability account.
 3. Accruing Unpaid Expenses
End of Current Period
Prior Periods Current Period Future Periods

Transaction
Transaction
Pay
Paycash
cashin in
settlement
settlementof of
liability.
liability.

One of the keys to understanding the accrual of expenses is to realize that an expense has been
incurred in the current accounting period but will not be paid until the following accounting
period should be recorded in the current period.

If Companies cannot follow this practice, current expenses would be recorded in the wrong
accounting period and this violate the matching principle.
 4. Accruing Uncollected Revenue
End of Current Period

Prior Periods Current Period Future Periods

Adjusting
AdjustingEntry
Entry Transaction
Transaction

Recognizes
Recognizesrevenue
revenueearned
earnedbut
but Collect
Collectcash
cashininsettlement
settlement
not
notyet
yetrecorded,
recorded,and
and of
ofreceivable.
receivable.

Records
Recordsreceivable.
receivable.

A revenue accrual is necessary when revenue has been earned in the current accounting
period but the cash will not be collected until the next period.

In the adjusting entry we will be record as receivable, an asset account, and recognize the
revenue earned as revenue.
Adjusting Entries and Accounting Principles
Costs
Costsare
are matched
matchedwith
withrevenue
revenuein
intwo
twoways:
ways:


Direct
Directassociation
associationof ofcosts
costs with
withspecific
specificrevenue
revenue
transactions.
transactions.


Systematic
Systematicallocation
allocation of
of costs
costsover
over the
the“useful
“useful
life”
life”of
ofthe
theexpenditure.
expenditure.

Adjusting entries help us match costs with revenues either directly by

associating certain costs with specific revenues, or through the allocation
process. Allocation is used to record depreciation expense.
 Effects of the Adjusting Entries
Income Statement Balance Sheet
Net Owners'
Adjustment Revenue Expenses Income Assets Liabilities Equity
Type I
Converting Assets to Expenses No effect Increase Decrease Decrease No effect Decrease
Type II
Converting Liabilities to Revenue Increase No effect Increase No effect Decrease Increase
Type III
Accruing Unpaid Expenses No effect Increase Decrease No effect Increase Decrease
Type IV
Accruing Uncollected Revenue Increase No effect Increase Increase No effect Increase
 Adjusted Trial Balance

Abeba’s Care Service

Adjusted Trial Balance All balances
Cash
May 31, 2005
$ 3,925 are taken from
Accounts receivable
Tools & equipment
75
2,650
the ledger
Accum. depreciation: tools & eq.
Truck 15,000
$ 50
accounts on
Accum. depreciation: truck
Notes payable
250
13,000
May 31 after
Accounts payable
Capital stock
150
8,000
preparing the
Dividends 200 two
Sales revenue 750
Gasoline expense 50 depreciation
Depreciation exp.: tools & eq. 50
Depreciation exp.: truck 250 adjusting
Total $ 22,200 $ 22,200
entries.
 The Work Sheet
The work sheet is a useful device for
understanding the flow of accounting data
from the unadjusted trial balance to the
financial statements.
Trial Balance Adjustments Adjusted TB
Accounts Dr Cr Dr Cr Dr Cr

Adjustments
Adjustmentsare areentered
enteredhere.
here. Two
Two
possibilities: Adjustments
Adjustmentsarearecombined
combined
possibilities:
with
withthe
thetrial
trialbalance.
balance.
1.1.Deferrals
Deferrals––Existing
Existingbalances
balancesare
are Account
Accountbalances
balancesare
arenow
now
changed.
changed. adjusted.
adjusted.
2.2.Accruals
Accruals––New
Newinformation
informationisis
entered.
entered.
 Abeba Care Service
Work sheet
May 31, 2005
Adjusted
Trial Balance Adjustments Trial Balance
Account Title Debit Credit Debit Credit Debit Credit
Cash 3 925 3925
Accounts receivable 75 75
Tools & equipment 2650 2650
Accum. Dep.: tools & eq. - 50 50
Truck 15000 15000
Accum. Dep.: truck - 250 250
Notes payable 13000 13000
Accounts payable 150 150
Capital stock 8000 8000
Dividends 200 200
Sales revenue 750 750
Gasoline expense 50 50
Dep. exp.: tools & eq. - 50 50
Dep. exp.: truck - 250 250
21900 21900 300 22,200 22,200

The
The Unadjusted
Unadjusted
Trial
Trial Balance
Balance The
The adjusted
adjusted Trial
Trial
Balance
Balance 50
Financial Statements
 Abeba Care Service
Income Statement
For The Month Ended May 31, 2005

Revenue:
Sales Revenue $750

Expenses:
Gasoline expense $ 50
Accu. Dep. Exp. Tool & equip. 50
Accu. Dep. truck expense 250
Total expenses 350
Net income $ 400

Every amount on this income statement was taken from the

Income Statement column of the work sheet.52
Adjusting and Closing Entries
Adjusting
Adjusting and
and Closing
Closing Entries
Entries
Adjusting entries are recorded in the journal at the
end of the accounting period.

If a work sheet has been prepared, the data for

these entries are in the Adjustments columns.
 The
The Closing
Closing Process
Process
Income Summary
Expenses are Revenues are
2 transferred to
Income Summary 1 transferred to
Income Summary

3 Net Income or Net Loss is transferred

to Owner’s Capital/Retained Earnings

OWNER’S CAPITAL/Retained Earnings

4
Drawings / Dividends are transferred to
Owner’s Capital/Retained Earnings
 Adjusting
Adjusting and
and Closing
Closing Entries
Entries
Income Summary
Expenses are Revenues are
2 transferred to
Income Summary 1 transferred to
Income Summary

3
The
Net Income
The IncomeorSummary
Income Net Loss is
Summary
account does
does not
transferred
account appear
to Owner’s
not on
appearCapital
on
the
the financial
financial statements.
statements.
OWNER’S CAPITAL

4
Drawings/dividends are transferred to
Owner’s Capital/Retained Earnings
 The
The Closing
Closing Process
Process
Gasoline Expense
Bal. 50 Income Summary Sales Revenue
Dep. Expense: Tool & Equ. Bal. 750
Bal. 50
Dep. Expense: Truk
Bal. 250 Note: The
balances shown
Retained Earnings
are adjusted
Bal. 400
balances before
closing. The
following
Dividends sequence
Bal. 200 demonstrates the
closing process.
 The
The Closing
Closing Process
Process
Income Summary
Gasoline Expense
350 750
Bal. 50 50 Sales Revenue
400
Dep. Expense: Tool & Equ. 750 Bal. 750

Bal. 50 50
Retained Earnings
Dep. Expense: Truk
200 400
Bal. 250 250

Debit Income Summary for the Debit each revenue account for the
Dividends amount of its balance and credit
total expenses and credit each
expense account for its balance. 200 Income summary for the total
revenue.

Debit the capital account /retained Debit Income Summary for the amount
earning for the balance of the drawing of its balance (in this case, the net
account/ dividend and credit income) and credit Retained Earnings
drawing/dividend for the same the capital account.
Post-closing Trial
Post-closing Trial Balance
Balance
Abeba Care Service
Post-Closing Trial Balance
May 31, 2005
Cash 3925
Accounts Receivable 75
Tools & equipment 2650
Accumulated Dep. Tools & Equip. 50 2600
Turk 15000
Accumulated Dep.: Turk 250 14750
Notes Payable 13000
Accounts Payable 150
Capital stock 8000
Retained Earnings 200
21350 21350

59
 Reversing Entries
 After the accounting records have been adjusted and closed at the
end of an accounting period, reversing entries may be made on the
first day of the next accounting period.
 The purpose of the reversing entries is to simplify the recording of
routine transactions by disposing of the accrued items (assets and
liabilities), which were entered in the balance sheet accounts
through adjusting entries.
General guidelines for reversing entries when requires
1. When adjusting entry create an assets or liability account which
normally is not used during the accounting period, reversing
entry is required.
2. When an adjusting entry adjusts an asset or liability account
which normally is used to record transactions during the
period, no reversing entry is required.
 Exercise
Mr X began his working career in the accounting department of ABC
company. Although Mr. X had taken some formal course of study in
accounting, he gradually developed a thorough knowledge of accounting
policies and eventually he was promoted to the position of chief
accountant.
While attending a regional meeting of accounting executives, Mr X
puzzled by a statement made in a group discussion. The statement was:
“Reversing entries are frequently very helpful in accounting for business
transactions; however they are seldom, if ever, essential to the record-
keeping function.” Mr X was concerned because reversing entries had
been used regularly by ABC company and he had always considered
them essential.
Instructions:-
1.Explain why reversing entries are not essential but why they may be
helpful. Your answer should include an explanation as to when reversing
entries are appropriate and when they should not be used.
2. Using the data below, demonstrate with journal entries
how reversing entries may be used or ignored. The
accounting policy is to debit supplies Expense for all
supplies purchased. The value of supplies on hand on
December 31, year 4 was determined by count to be
Birr 1,150. The balance in the asset account, Inventory
of supplies, in the ledger was zero. The following
adjusting entry was made:
Inventory of supplies 1,150
Supplies expense 1,150
To record inventory of supplies on December 31, year 4.

During year 5 supplies were purchased at a cost of Birr

17,500 and debited to supplies expense. The inventory of
supplies on December 31, year 5 was Birr 850.
 The Accounting Cycle

Make end-of-
Journalize year
Post entries to Prepare trial
transactions. adjustments.
the ledger balance.
accounts.

Prepare after-closing Journalize and Prepare Prepare adjusted

trial balance. post closing financial trial balance.
entries. statements.