The Accounting Cycle

Lesson One: Accounting Cycle (this lesson)

Lesson Two: Basic Accounting Journal Entries
Lesson Three: Accounting Journals
Lesson Four: T Accounts
Lesson Five: Balancing T-accounts
Lesson Six: Posting Journals
Lesson Seven: Control Accounts
Lesson Eight: Trial Balance

There is a cycle of action in accounting for any business. This cycle is depicted
diagrammatically below:

1. SOURCE DOCUMENTS Source documents are documents, such as cash slips,

invoices, etc. that form the source of (and serve as proof for) a transaction. In other
words, they are the first documents that exist relating to a transaction.

Invoices, cash slips, receipts, check counterfoils, bank deposit slips and even
internet payment confirmations are all source documents.
Example:
On 01-01-2012 Uttara Store had the Following account balances: Cash and
Bank Tk 300,000 Furniture Tk 50,000. Accumulated Depreciation on
Furniture Tk 10,000. Inventory Tk 4,000.
During 2012 the Following Transactions took place,
(1) PurchasesTk 2,50,000 (on credit Tk 50,000)
(2) Sales Tk 4,00,000 (on credit Tk 60,000)
(3) Salaries paid Tk 50,000
(4) Mise expenses Tk 40,000
Information for adjustments:
(1) Inventory on 31-12-2012 Tk 6,000
(2) Depreciation on furniture 5,000
(3) Provide allowance for doubtful accounts at 2% on Account
receivable
(4) Salaries prepaid Tk 2,000

2. JOURNALS - These are chronological (date-order) records of

transactions entered into by a business. Journals are that first basic entry
of debit and credit for each transaction. In the examples we have been
doing in the previous chapters, where we have debited one account and
credited another, we have been doing journals
General Journal entry
Dates

Accout Titles

2009
Ja 1
n

Cash
Furnitur
Inventory
Accumulated Depreciation
Capital
(For investmant in the Bussiness)

Page no:-1
Post
Ref.
101
102
103
201
301

Debits

Credits

300,000
50,000
4000
10,000
344,000

ja
n

ja
n

Ja
n

Ja
n

Purchase
Cash
Accout Payable
(For Purchase cash and account)
Cash
Account Receivable
Sales
(For sales cash and account)
Salaries Expense
Cash
(For salaries expense paid in cash)
Miscellaneous Expense
Cash
(For miscellaneous expense pain in cash)

501
101
202

250,000

101
104
401

340,000
60,000

502
101

50,000

503
101

40,000

200,000
50,000

400,000
50,000
40,000

3. LEDGER (T-ACCOUNTS) - The ledger is a collective term for the

accounts of a business. (A ledger of accounts is like a school of fish). The
accounts are in the shape of a T and thus are often referred to as Taccounts. In this step we take all the debits and credits (journals) relating
to one account lets say bank and draw up an account for bank that
shows all the transactions relating to it.
General ledger
Dates
2009
Jan 1
2
3
4

Dates
2009
Jan 1

Cash
Explanation
P:R
Debit
Capital
Gj.1
300,000
Purchase
Gj1
Sales
Gj1
340,000
Salaries
Gj1
Misllaneou Gj1
s

account no. 101

Credit
Balance
300,000
200,000
100,000
440,000
50,000
390,000
40,000
350,000

Furnitur
Explanation
P:R
Debit
Capital
Gj.1
50,000

account no. 102

Credit
Balance
50,000

Inventory
Explanation
P:R
Debit
Capital
Gj.1
40,000

account no. 103

Credit
Balance
40,000

Accumulated Depreciation
Explanation
P:R
Debit
Furnitur
Gj.1

Account no. 201

Credit
Balance
10,000
10,000

Dates
2009
Jan 1

Capital
Explanation
P:R
Debit
Sundry
Gj.1
Assets

Account no. 301

Credit
Balance
344,000
344,000

Dates
2009
Jan 1
Jan 1

purchase
Explanation
P:R
Debit
Cash
Gj.1
200,000
Account
Gj1
50,000
Payable

Account no. 501

Credit
Balance
200,000
250,000

Sales
Explanation
P:R
Cash
Gj.1
Account
Gj1
Receivable

account no. 301

Credit
Balance
340,000
340,000
60,000
400,000

Dates
2009
Jan 1

Dates
2009
Jan 1

Dates
2009
Jan 1

Dates
2009
Jan 2

Debit

Account Payable
Explanation
P:R
Debit
Purchase
Gj.1

account no. 401

Credit
Balance
50,000
50,000

Dates
2009
Jan 2

Dates
2009
Jan 3

Dates
2009
Jan 4

Account Receivable
Explanation
P:R
Debit
sales
Gj.1
60,000

account no. 104

Credit
Balance
60,000

Salaries
Explanation
P:R
Debit
Cash
Gj.1
50,000

account no. 502

Credit
Balance
50,000

Miscellaneous
Explanation
P:R
Debit
Cash
Gj.1
40,000

account no. 503

Credit
Balance
40,000

4. TRIAL BALANCE - A sheet displaying all the accounts of a business,

drawn up as a trial (test) of whether the total of all the debit balances
equal the total of all the credit balances (A balance is the amount of an
item at a point in time. For example, The balance in the bank account on
the 1st of January was $5,000.). The trial balance is prepared as a final
check just before the financial statements are drawn up. Click here for a
brief lesson on the trial balance.
Trial Balance
January 31, 2009
Account no

Explanation

Post Ref.

Debit

Credit

101
102
103
201
301
501
401
202
104
502
503

A
L
C
l
E

Cash
Furnitur
Inventory
Accumulation Dep.
Capital
Purchase
Sales
Account Payable
Account Receivable
Salaries expense
Miscellaneous
Total

350,000
50,000
4,000
10,000
344,000
250,000
400,000
50,000
60,000
50,000
40,000
804,000

804,000

Account: no
1
2
3
4
5
Adjustting Entries

Dates Explanation
1
Income Summery
Opening Inventory
(To record opening inventor adjusted the
income summery)
2
Closing Inventory
Income Summery
(To record closig inventory adjusted the
income summery)
3
Depreceation on Furnitur
Accumulated Depreciation on Furnitur
(To record Depreciation and Accumulated
depriation adjusted)
4
Uncollectible expense

P,Ref. Debit Credit

402
4,000
103
4,000
102
402

6,000

504

5,000

6,000

5,000
505

1,200

Allowance for doutedful account

(To record uncollectible expense
adjusted0
Prepaid Salaries
Salaries Expense
(To record prepaid salaries adjusted)

203
104
502

1,200
2,000
2,000

Work Sheet
For the year Ended 31st December 2012
Explanation

Trial
Balance

Adjustment

Dr.

Dr.

Cr.

Cr.

Adjusted
Triel
Balance
Dr.
Cr.

Income
Statement

Balance
Sheet

Dr.

Dr.

Cr.

Cr.

cash
Furnitur
invetory
Accu.Dep.

Prepare the financial statements.

o
o
o
o

Income statement: prepared from the revenue, expenses, gains,

and losses.
Balance sheet: prepared from the assets, liabilities, and equity
accounts.
Statement of retained earnings: prepared from net income and
dividend information.
Cash flow statement: derived from the other financial
statements using either the direct or indirect method.

Income Statement
For the year ended 31th December 2012
Tk
Tk

Explanation
Sales
Less cost of good Sold:
Opening Inventory
Parchase

4,000
2,50,000
2,54,000
6,000

Less closing Inventory

Gross Profit
Less Operating Expense:
Salaries Expensa
Un Collectible Expense
Adminestrative Expense
Depreciation Expense
Miscellaneous Expense
Total Expense
Net profit

Tk
400,000

(2,48,000)
1,52,000

48,000
1,200
49,200
5,000
40,000
45,000

(94,200)
57,800

Balance Sheet
For the year ended 31th December 2012
Explanation
Assets
Cash
Account Receivable
Less Allowance for doubtful account
Closing Inventory
Prepaid salaries
Furnitur
Less Accumulated Deprciation

Tk

Tk
3,50,000

60,000
1,200
58,800
6,000
2,000
50,000
15,000
35,000
4,51,800

Total Assets
Liabilities
Accumulated Depreciation
Capital
Add Net Profit

3,44,000
57,800

Total Liabilities and owners Equity

Closing Entries

50,000
4,01,800
4,51,800

Date

Explanation
Income Summary
Opening Inventory
Closing Inventory
Income Summary
Sales
Income Summary
Income Summary
Purchase
Salaries
Depreciation
Uncallectible Expense
Misscellaneous Expense
Income Summary
Capital

P:R
402
103
103
402
401
402
402
501
502
504
505
503
402
301

Debit
4,000

Credit
4,000

6,000
6,000
400,000
400,000
344,200
25,000
48,000
5,000
1,200
40,000
57,800
57,800

Post-Closing Trial Balance

Acct:
no
101
102
104
203
104
202
201
301
103

Explanation
Cash
Furniture
Prepaid Salaries
Allowance for doubtful Acct:
Account Receivable
Account Payable
Accumuladed dep. On Furniture
Capital
Inventory
Total

P:R

Debit

Credit

350,000
50,000
2,000
1,200
6,000
50,000
15,000
401,800
6,000
468,000

468,000

Major Steps in Accounting Cycle

Following are the major steps involved in the accounting cycle. We will use a simple
example problem to explain each step.

1.
2.
3.
4.
5.
6.
7.
8.

Analyzing and recording transactions via journal entries

Posting journal entries to ledger accounts
Preparing unadjusted trial balance
Preparing adjusting entries at the end of the period
Preparing adjusted trial balance
Preparing financial statements
Closing temporary accounts via closing entries
Preparing post-closing trial balance

Flow Chart

The Accounting Process

(The Accounting Cycle)

The accounting process is a series of activities that begins with a transaction and ends
with the closing of the books. Because this process is repeated each reporting period, it is
referred to as the accounting cycle and includes these major steps:
2. Identify the transaction or other recognizable event.
3. Prepare the transaction's source document such as a purchase order or invoice.
4. Analyze and classify the transaction. This step involves quantifying the
transaction in monetary terms (e.g. dollars and cents), identifying the accounts
that are affected and whether those accounts are to be debited or credited.

5. Record the transaction by making entries in the appropriate journal, such as the
sales journal, purchase journal, cash receipt or disbursement journal, or the
general journal. Such entries are made in chronological order.
6. Post general journal entries to the ledger accounts.
__________________
The above steps are performed throughout the accounting period as transactions
occur or in periodic batch processes. The following steps are performed at the
end of the accounting period:
7. Prepare the trial balance to make sure that debits equal credits. The trial balance is
a listing of all of the ledger accounts, with debits in the left column and credits in
the right column. At this point no adjusting entries have been made. The actual
sum of each column is not meaningful; what is important is that the sums be
equal. Note that while out-of-balance columns indicate a recording error, balanced
columns do not guarantee that there are no errors. For example, not recording a
transaction or recording it in the wrong account would not cause an imbalance.
8. Correct any discrepancies in the trial balance. If the columns are not in balance,
look for math errors, posting errors, and recording errors. Posting errors include:
o
o
o
o

posting of the wrong amount,

omitting a posting,
posting in the wrong column, or
posting more than once.

9. Prepare adjusting entries to record accrued, deferred, and estimated amounts.

10. Post adjusting entries to the ledger accounts.
11. Prepare the adjusted trial balance. This step is similar to the preparation of the
unadjusted trial balance, but this time the adjusting entries are included. Correct
any errors that may be found.
12. Prepare the financial statements.
o
o
o

Income statement: prepared from the revenue, expenses, gains,

and losses.
Balance sheet: prepared from the assets, liabilities, and equity
accounts.
Statement of retained earnings: prepared from net income and
dividend information.

Cash flow statement: derived from the other financial

statements using either the direct or indirect method.

13. Prepare closing journal entries that close temporary accounts such as revenues,
expenses, gains, and losses. These accounts are closed to a temporary income
summary account, from which the balance is transferred to the retained earnings
account (capital). Any dividend or withdrawal accounts also are closed to capital.
14. Post closing entries to the ledger accounts.
15. Prepare the after-closing trial balance to make sure that debits equal credits. At
this point, only the permanent accounts appear since the temporary ones have
been closed. Correct any errors.
16. Prepare reversing journal entries (optional). Reversing journal entries often are
used when there has been an accrual or deferral that was recorded as an adjusting
entry on the last day of the accounting period. By reversing the adjusting entry,
one avoids double counting the amount when the transaction occurs in the next
period. A reversing journal entry is recorded on the first day of the new period.
Instead of preparing the financial statements before the closing journal entries, it is
possible to prepare them afterwards, using a temporary income summary account to
collect the balances of the temporary ledger accounts (revenues, expenses, gains, losses,
etc.) when they are closed. The temporary income summary account then would be
closed when preparing the financial statements.

Accounting Cycle Steps

1. Identifying and Analyzing Business Transactions
The accounting process starts with identifying and analyzing business transactions and
events. Not all transactions and events are entered into the accounting system. Only those
that pertain to the business entity are included in the process.
For example, a loan made by the owner in his name that does not have anything to do
with the entity is not accounted for.
The transactions identified are then analyzed to determine the accounts affected and the
amounts to be recorded.
The first step includes the preparation of business documents, or source documents. A
business document serves as basis for recording a transaction.

2. Recording in the Journals

A journal is a book paper or electronic in which transactions are recorded. Business
transactions are recorded using the double-entry bookkeeping system. They are recorded
in journal entries containing at least two accounts (one debited and one credited).
To simplify the recording process, special journals are often used for transactions that
recur frequently such as sales, purchases, cash receipts, and cash disbursements. A
general journal is used to record those that cannot be entered in the special books.
Transactions are recorded in chronological order and as they occur. Hence, journals are
also known as Books of Original Entry.

3. Posting to the Ledger

Also known as Books of Final Entry, a ledger is a collection of accounts that shows the
changes made to each account as a result of past transactions, and their current balances.
This is the core of the classifying phase.
After the posting process, the balances of each account can now be determined.
For example, all journal entries made to Cash would be transferred into the Cash account
in the ledger. Increases and decreases in cash will be entered into one ledger account.
Thus, the ending balance of Cash can be determined.

4. Unadjusted Trial Balance

A trial balance is prepared to test the equality of the debits and credits. All account
balances are extracted from the ledger and arranged in one report. Afterwards, all debit
balances are added. All credit balances are also added. Total debits should be equal to
total credits.
When errors are discovered, correcting entries are made to rectify them or reverse their
effect. Take note however that the purpose of a trial balance is only test the equality of
total debits and total credits and not to determine the correctness of accounting records.
Some errors could exist even if debits are equal to credits, such as double posting or
failure to record a transaction.

5. Adjusting Entries
Adjusting entries are prepared as an application of the accrual basis of accounting. At the
end of the accounting period, some expenses may have been incurred but not yet
recorded in the journals. Some income may have been earned but not entered in the
books.

Adjusting entries are prepared to have the accounts updated before they are summarized
into the financial statements.
Adjusting entries are made for accrual of income, accrual of expenses, deferrals (income
method or liability method), prepayments (asset method or expense method),
depreciation, and allowances.

6. Adjusted Trial Balance

An adjusted trial balance may be prepared after adjusting entries are made and before the
financial statements are prepared. This is to test if the debits are equal to credits after
adjusting entries are made.

7. Financial Statements
When the accounts are already up-to-date and equality between the debits and credits
have been tested, the financial statements can now be prepared. The financial statements
are the end-products of an accounting system.
A complete set of financial statements is made up of: (1) Statement of Comprehensive
Income (Income Statement and Other Comprehensive Income), (2) Statement of Changes
in Equity, (3) Statement of Financial Position or Balance Sheet, (4) Statement of Cash
Flows, and (5) Notes to Financial Statements.

8. Closing Entries
Temporary or nominal accounts, i.e. income statement accounts, are closed to prepare the
system for the next accounting period. Temporary accounts include income, expense, and
withdrawal accounts. These items are measured periodically.
The accounts are closed to a summary account (often, Income Summary) and then closed
further to the appropriate capital account. Take note that closing entries are made only for
temporary accounts. Real or permanent accounts, i.e. balance sheet accounts, are not
closed.

9. Post-Closing Trial Balance

In the accounting cycle, the last step is to prepare a post-closing trial balance. It is
prepared to test the equality of debits and credits after closing entries are made. Since
temporary accounts are already closed at this point, the post-closing trial balance contains
real accounts only.