Chapter Two: The Accounting Cycle for Service Giving Business

Accounting Cycle
The accounting cycle is the sequence of accounting procedures during a fiscal period. The activities to be undertaken in the
accounting cycle include:
 Analyzing and recording business transactions in a journal
 Posting entries to the accounts in a ledger
 Taking trial balance
 Planning adjustments in a worksheet and completing the worksheet
 Preparing financial statements
 Recording and posting adjusting and closing entries
 Preparing post-closing trial balance.

Definition of an Account
The basic summary device of accounting is the account. It is the detailed record of all the changes that have occurred in a
particular asset, liability, or owner’s equity during a period.
An account is an individual record of increases and decreases in a specific asset, liability, stockholders’ equity, revenue, or
expense item.

Example – A separate record is kept for the increase & decrease in cash, supplies, land, Accounts payable, Fees earned,
salary expenses etc.

Therefore, Accounts are means of accumulating in one place all the information about changes in a specific asset, liability,
owner's equity, expense, or revenue. A file or other record containing all the separate accounts of a business is called a
ledger [a group of accounts for a business entity].

Classification of Accounts
Accounts in the ledger are customarily listed in the order in which they appear in the financial statements and are classified
according to common characteristics.

Financial Position Accounts are classified as assets, liability and owner’s equity.
a. Assets
Assets are any physical thing (tangible) or right (intangible) that has a monetary value. Asset is resources that owned /
controlled by business enterprise as a result of past transactions or events from which future economic benefits may be
obtained. Assets are classified as current, fixed assets and intangible asset.
 Current assets are those tangible assets that may reasonably be expected to be realized in cash or sold or used up
usually within one year or less, through the normal operations of the business. It includes cash, accounts receivable,
notes receivable, prepaid expenses, etc.

 Cash - is any medium of exchange that a bank will accept at face value. It include - bank deposits,
currency, checks, bank drafts, and money order.
 Notes Receivable (N/R) - is claims against debtors evidenced by written promise to pay a sum of money

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 at definite time.
 Account Receivable (A/R) - are also claims against debtors, but are less formal than notes. They arise
from sales of services or merchandise on account.
 Prepaid Expenses - includes supplies on hand & advance payments of expenses such as insurance &
property taxes.

 Plant Assets are assets used in the business that are of a permanent or relatively fixed nature. Are those assets
acquired to be used for relatively long period of time (more than a year). Sometimes called as fixed assets or plant
asset. It includes equipment, machinery, buildings, land, etc. Except land, plant assets gradually wear out or lose their
useful life (capacity to give service). And said to be depreciated.
 Intangible Assets are assets which are used in the operation of business but which have no physical substance and are
noncurrent. Example- Goodwill, Copyright, patent and trade mark.

b. Liabilities
Liabilities are debts owed to outsiders (creditors) and are frequently described on the statement of financial position by titles
that include the word '' payable ''. Liabilities are also classified as current and long term liabilities described as follows.
 Current liabilities – are liabilities that will be due within a short time (usually one year or less) and that are to be paid
out of current assets. Example - Note payable, Account payable, salaried payable, interest payable.
 Long - term liabilities – are liabilities that will be due for a comparatively long time (usually more than one year).
Example - Mortgage payable - purchases of real estate and certain types of equipment often are financed by the
issuance of mortgage payable.

c. Owner’s equity
Owner’s equity is the residual claim against the assets of the business after the total liabilities are deducted. For corporation,
owner's equity is described as stockholder equity. Stockholder equity in corporation might have more than two components,
i.e., capital stock and retained earnings. Capital stock represents the investment of stockholders in corporate type of
business, and retained earnings are the portion of net income retained in the business.
Drawing represents the amount of withdrawal made by the owner of sole proprietorship and/or partnership. For corporation,
dividend represents the distribution made for its stockholders.
Statement of financial position account balances are carried forward from year to year and because of their permanence
are referred to as real accounts (or permanent accounts).

Income statement accounts include Revenue and Expense.

a. Revenues

Revenue is an earnings of the business, result from providing goods or services to other economic entities. May arise from
different sources, and are identified by various names depending on the nature of the business. E.g Fees earned, Rent earned,
Sales revenue, Commission revenue, Interest income etc.

If an enterprise has various types of revenue, a separate account should be maintained for each. Remember revenues
increase owner's equity

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b. Expenses

Expenses are those costs that have been consumed in the process of producing revenue. Like revenues, expenses take many
forms and are identified by various names depending on the type of asset consumed or services used. E.g Salary expense,
Advertising expense, Supplies expense, rent expense, Interest expense etc. A separate account should be maintained for each
type of expense. Remember expenses decrease owner's equity

Income statement accounts are said to be temporary accounts or nominal.

Chart of Accounts
Chart of accounts is a listing of the account titles and account numbers being used by a given business. In numbering
accounts in the ledger it is preferable to use a flexible system of indexing so that it permits a later insertion of new
accounts in their proper sequence without distributing the other account numbers. A list of account in the ledger is called
chart of account.
Accounts in the ledger may be numbered consecutively such as: asset accounts represented by 1, liability accounts
represented by 2, owner’s equity accounts represented by 3, revenue accounts represented by 4, and expense accounts
represented by 5.
Example - The chart of Account of Amen, Attorney is as follows:

Balance Sheet Accounts

1. Asset 2. Liabilities
11 Cash 21 Accounts payable
12 Accounts receivable 23 Unearned Rent
14 Supplies 3. Owner’s Equity
15 Prepaid insurance 31 Amen, capital
16 Plant, property and equipment 32 Amen, Drawing
Income Statements Account
4. Revenue
41 Fees earned
5. Expenses
51 Rent Expenses
52 Wages Expenses
54 Utilities Expenses
55 Supplies Expenses
59 Miscellaneous Expenses
Nature of an Account
The simplest form of an account (which is called T- account) has three parts.
 A title for recording the name of the item
 A space for recording increase in the amount of the item, in terms of money
 A space for recording decrease in the amount of the items, in terms of money

Rule of Debit and Credit

The left side of the account is called the debit side, and the right side is called the credit side. The amounts entered on the
left side are called debits or charges, and the account is said to be debited or charged. The amount entered on the right

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side is called credit and the account is said to be credited. The following is the simplest form of account named as T-
Account because of its similarity with the letter T.
Title Acct No

Left side Right side

Debit side Credit side

Thus, increase in asset is recorded in the debit side and decreases are recorded in the credit side. Increase in liability and
owner’s equity is recorded in the credit side and decreases in these accounts are recorded on the debit side. Every business
transaction affects a minimum of two accounts. Regardless of the complexity of a transaction or the number of accounts
affected, the sum of the debits is always equal to the sum of the credits. This equality of debit and credit for each
transaction is inherent in the equation Asset = Liabilities + Owner’s equity. It is also because of this equality the system is
known as double entry accounting.

The account category (asset, liability, equity) governs how we record increases and decreases. Assets are on the opposite side
of the equation from liabilities and owner’s equity. Therefore, increases and decreases in assets are recorded in the opposite
manner from increases and decreases in liabilities and owner’s equity. Liabilities and owner’s equity are on the same side, so
they are treated in the same way.

So Assets (accounts on the Left side) will increase with a Debit entry. Liabilities and Owners equity (accounts on the right
side) will increase with a Credit entry. They will decrease with the opposite entry.

Revenues increase owner's equity and just as increases in owners' equity are recorded as Credit, increases in revenue are
recorded as credits. Decreases are recorded on the opposite, Debit side. Expenses and Drawings have a decreasing effect on
owners' equity, and just as decreases in owners' equity are recorded as Debit, increases in expense and drawing account are
recorded as debits. Decreases are recorded on the opposite, Credit side.
The normal balance of an account is on the side where an increase in the account is recorded. Thus, asset, expense and
drawing accounts normally show debit balances, and liability, owners’ equity and revenue accounts normally show credit
balances.
The following table summarizes the normal balance of all accounts.

Financial position accounts Increase Decrease Normal

Asset Debit Credit Debit
Liability Credit Debit Credit
Owner's equity
Owner's Capital Credit Debit Credit
Owner's Drawing Debit Credit Debit
Income statement Accounts
Revenue Credit Debit Credit
Expense Debit Credit Debit

To illustrate the ideas, consider the following transactions:

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 The owner invested Br. 40,000 cash in the business. (Cash Debit and Owner's capital Credit)
 Purchased supplies on account, Br. 30,000. (Supplies Debit and Accounts payable Credit)
 Received Br. 5,700 in cash from cash customers. (Cash Debit and Fees earned Credit)
 Paid salaries to employees Br. 1,500. (Salary expense Debit and Cash Credit)
 Withdrew Br. 1,000 cash for personal use. (Owners Drawing Debit and Cash Credit)
Steps in Accounting Cycle
1. Recording Transactions in the Journal
The initial record of each transaction is evidenced by a business document, such as checks, sales tickets, or bills. On the
basis of evidence provided by the business documents, the transactions are entered in chronological order in a journal.

Journal is a permanent document used for initial (first) or original recording of the day to day business transactions. It is
often called book of original entry or document of original entry. For each transaction the journal shows the debit and
credit effects on specific accounts.

Journalizing is the process of recording business transactions in a journal. The following is the flow of activities in the first
two steps of accounting cycle.

Business Business Entry recorded Entry posted

Transaction document in to
Occurs prepared journal ledger
Companies may use various kinds of journals, but every company has the most basic form of journal, a general journal. In
general, a journal consists of a date column, a description column to record the accounts, a column to list the accounts
number and a debit & credit column for listing the amounts to be recorded as a debit or credit to each account.
The standard form of the two column journal is:
Journal: Page no.
Date Description Posting Debit Credit
reference
2014 Sep. 1 Debit account title XXXX
Credit account title XXXX
(Explanation)

Procedures in recording transactions in a two column journal

 Recording the date – year, month & day of the first transaction
 Recording the debit account & amount. The debit account is written in the left margin
 Recording the credit account & amount. The credit account is written in the right margin
 Writing explanation about the Nature of the transaction.
In recording a business transaction answer the following questions based on the transaction to be recorded may help you.
a. Which accounts are affected?

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 b. Is each account increased or decreased?
c. Which account is debited and which is credited?
d. Prepare the complete journal entry.
Example. On January 10, 2015 Tamget P.L.C paid Br. 6,000 to its employees as a salary for the first week of the year. This
business transaction will be analyzed and recorded as follows.
a. Which accounts are affected? Answer: Cash and Salary Expense.
b. Is each account increased or decreased? Cash is decreased and salary expense is increased.
c. Which account is debited and which is credited? Answer: Salary Expense is debited because increase in expenses is
recorded on the debit side and cash is credited because decrease in assets is recorded on the credit side.
d. Prepare the complete Journal entry.

General Journal Page no------

Date Description P/R Debit Credit
2015 Jan. 10 Salary Expense 6,000
Cash 6,000
(Payment of salary expense)

Illustration
Amen opened a law office on October 1, of the current year. During the first month of operations, the business completed the
following transactions:
October 1. Amen deposited Br. 17,950 cash in the business bank account Amen, Attorney.
3. Purchased supplies, Br. 2,040 on account.
4. Paid Br. 2,400 for three months insurance coverage.
6. Performed legal service for a client and received cash, Br. 2,160.
8. Purchase equipment on cash, Br. 12,000.
12. Prepared legal documents for a client on account, Br. 2,640.
15. Paid secretary’s wage, Br. 1,100.
19. Performed consulting service for a client on account, Br. 2,800.
21. Paid for creditors on account, Br. 1,670
25. Received cash from clients on account, Br. 3,800.
31. Paid secretary’s wages, Br. 1,100.
31. Paid rent expense, Br. 850.
31. Paid telephone expense of Br. 230 and electric expenses of Br. 120 for the month.
31. Paid other miscellaneous expenses Br. 630.
31. Withdrew Br. 1,500 for personal use.

Instruction: Prepare the complete journal entry for Amen Company for the month of October.

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Solution:
General Journal Page No……1……
Date Description P.R Debit Credit
2015, Oct. 1 Cash 11 17,950
Amen, Capital 31 17,950
Initial investment
3 Supplies 14 2,040
Accounts Payable 21 2,040
Purchase of Supplies on account
4 Prepaid Insurance 15 2,400
Cash 11 2,400
Purchase of insurance policy
6 Cash 11 2,160
Fees Earned 41 2,160
Performed service for cash
8 Plant, Property & Equip. 16 12,000
Cash 11 12,000
Purchase of equipment on cash
12 Accounts Receivable 12 2,640
Fees Earned 41 2,640
Performed service on account

General Journal Page No……2……

15 Wage Expense 52 1,100
Cash 11 1,100
Payment of Wages
19 Accounts Receivable 12 2,800
Fees Earned 41 2,800
Performed service on account
21 Accounts Payable 21 1,670
Cash 11 1,670
Paid cash on account
25 Cash 11 3,800
Accounts Receivable 12 3,800
Received cash on account
31 Wage Expense 52 1,100
Cash 11 1,100
Payment of Wages
31 Rent Expense 51 850
Cash 11 850
Payment of Rent
31 Utilities Expense 54 350
Cash 11 350
Payment for telephone & electricity
31 Miscellaneous Expenses 59 630
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 Cash 11 630
Payment for various expenses
31 Amen, Drawing 32 1,500
Cash 11 1,500
Owner withdrawals
2. Posting from the Journal to the Ledger
After the information about a business transaction has been journalized, that information is transferred to the specific
accounts affected by each transaction. This process of transferring journal entries to the ledger accounts is called posting.
This phase of the recording process accumulates the effects of journalized transactions into the individual accounts. Ledger
is the entire group of accounts maintained by a company. It is also called book of secondary entry.
Accounts may be put either in the two-column account or four-column account. We will use the four-column account for our
illustration. The standard form of the four column account is:

Account:___________ A/C No.:_____

Date Item Pos. Debit Credit Balance
Ref. Debit Credit

Steps in posting
 Write the name of the account and its related identification number
 Enter year, month, and date of the transaction in the date column
 Enter the amount by which it is affected in the debit or credit column
 Insert the journal page number in the posting reference column of the account and the account number in the
posting reference column of the journal
 Determine the accounts balance and enter it in the appropriate sub-column of the balance column.
N.B: The post reference column is used for reference purposes. The post reference column of the journal shows whether the
entry is posted and the account to which it is posted. In the ledger account, the post reference column shows the Journal
page number from which the entry was brought.
Illustration. As mentioned above, to illustrate the posting process the four column account is used and the entries to each
account are posted as follows.
Account: Cash Account number: 11
Date Item P.R Debit Credit Balance
Debit Credit
2015, Oct. 1 1 17,950 17,950
4 1 2,400 15,550
6 1 2,160 17,710
8 1 12,000 5,710

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 15 2 1,100 4,610
21 2 1,670 2,940
25 2 3,800 6,740
31 2 1,100 5,640
31 2 850 4,790
31 2 350 4,440
31 2 630 3,810
31 2 1,500 2,310

Account: Accounts Receivable Account number: 12

Date Item P.R Debit Credit Balance
Debit Credit
2015, Oct. 12 1 2,640 2,640
19 2 2,800 `5,440
25 2 3,800 1,640

Account: Supplies Account number: 14

Date Item P.R Debit Credit Balance
Debit Credit
2015, Oct. 3 1 2,040 2,040

Account: Prepaid Insurance Account number: 15

Date Item P.R Debit Credit Balance
Debit Credit
2015, Oct. 4 1 2,400 2,400

Account: Plant, Property & Equipment Account number: 18

Date Item P.R Debit Credit Balance
Debit Credit
2015, Oct. 8 1 12,000 12,000

Account: Accounts Payable Account number: 21

Date Item P.R Debit Credit Balance
Debit Credit
2015, Oct. 3 1 2,040 2,040
21 2 1,670 370

Account: Amen, Capital Account number: 31

Date Item P.R Debit Credit Balance

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 Debit Credit
2015, Oct. 1 1 17,950 17,950

Account: Amen, Drawing Account number: 32

Date Item P.R Debit Credit Balance
Debit Credit
2015, Oct. 31 2 1,500 1,500

Account: Fees Earned Account number: 41

Date Item P.R Debit Credit Balance
Debit Credit
2015, Oct. 6 1 2,160 2,160
12 1 2,640 4,800
19 2 2,800 7,600

Account: Rent Expenses Account number: 51

Date Item P.R Debit Credit Balance
Debit Credit
2015, Oct. 31 2 850 850

Account: Wage Expenses Account number: 52

Date Item P.R Debit Credit Balance
Debit Credit
2015, Oct. 15 2 1,100 1,100
31 2 1,100 2,200

Account: Utilities Expenses Account number: 54

Date Item P.R Debit Credit Balance
Debit Credit
2015, Oct. 31 2 350 350

Account: Miscellaneous Expenses Account number: 59

Date Item P.R Debit Credit Balance
Debit Credit
2015, Oct. 15 2 630 630

3. The trial balance

After the posting phase is completed, we have to verify the equality of the debit and credit balances. This is done through the
use of the ‘Trial Balance’. A trial balance is a two column listing of the accounts in the ledger and their balance to make

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sure Amen Company that the
total of Trial Balance debit
Month Ended October 31, 2015
balances equals
Cash 2,310
the total of credit
Accounts receivable 1,640
balances. If the
Supplies 2,040
two totals
agree, Prepaid Insurance 2,400 the trial
balance Plant, Property & Equip. 12,000 is called
in balance.
Accounts payable 370
Amen, Capital 17,950
Amen, withdrawals 1,500
Fees earned 7,600
Rent expense 850
Wage expense 2,200
Utilities Expense 350
Miscellaneous expense 630
25,920 25,920
Procedures followed in preparing trial balance
 Determine the balance of each account in the ledger
 List accounts that have balance (Debit or Credit) in the order they appear in the ledger, the left amount column is for
debit balance & the right amount column is for Credit balances.
 The debit and Credit balances are totaled to determine their equality

The trial balance for our illustration, Amen Attorney is presented below. The amounts are taken from the balances of the
accounts after all the transactions have been posted.

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Uses of Trial balance
 To check the equality of total debits & total credits posted to the accounts in the general ledger
 Some errors can be detected & corrected before financial statements are prepared
 Facilities preparation of financial statements. Because of all accounts are available in one place.
Common Types of Errors
 Transposition – the erroneous rearrangement of digits
Example- Writing 265 as 625 or 562 etc

 Sliding – it is the erroneous movement of one or more spaces to the right or the left
Example- writing 625 as 6.25 or 6,250

The Adjusting Process

To measure income, a business must bring the records up to date at the end of the period. This process is called adjusting
the books, and it requires special journal entries called adjusting entries.
The Basics of Adjusting Entries
In order for revenues and expenses to be reported in the correct period, companies make adjusting entries at the end of the
accounting period. Adjusting entries make it possible to report correct amounts on the statement of financial position and on
the income statement.
The trial balance—the first summarization of the transaction data—may not contain up-to-date and complete data. This is
true for several reasons:
 Some events are not recorded daily because it is not efficient to do so. For example, companies do not record the daily
use of supplies or the earning of wages by employees.
 Some costs are not recorded during the accounting period because they expire with the passage of time rather than as
a result of daily transactions. Examples are rent, insurance, and charges related to the use of equipment.
 Some items may be unrecorded. An example is a utility bill that the company will not receive until the next accounting
period.
Types of Adjusting Entries

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Adjusting entries are classified as either deferrals or accruals. Each of these classes has two subcategories.
Deferrals:
 Prepaid Expenses: Expenses paid in cash and recorded as assets before they are used or consumed.
 Unearned Revenues: Cash received and recorded as liabilities before revenue is earned.
Accruals
 Accrued Revenues: Revenues earned but not yet received in cash or recorded.
 Accrued Expenses: Expenses incurred but not yet paid in cash or recorded.

Adjusting Entries for Deferrals

Deferrals are either prepaid expenses or unearned revenues. Companies make adjustments for deferrals to record the
portion of the deferral that represents the expense incurred or the revenue earned in the current period.

Prepaid Expenses
Because accrual accounting requires that expenses are recognized only in the period in which they are incurred, these
prepayments are recorded as assets called prepaid expenses or prepayments. When expenses are prepaid, an asset account
is increased (debited) to show the service or benefit that the company will receive in the future. But prepayments can also
be recorded as an expense at the time of payment rather than recording them as an asset. Examples of common
prepayments are insurance, supplies, advertising, and rent. In addition, companies make prepayments when they purchase
buildings and equipment.

Prepaid expenses are costs that expire either with the passage of time (e.g., rent and insurance) or through use (e.g.,
supplies). The expiration of these costs does not require daily journal entries. Companies postpone recognizing these costs
until they prepare financial statements. At each statement date, they make adjusting entries: (1) to record the expenses that
apply to the current accounting period, and (2) to show the unexpired costs in the asset accounts.
Example: On January 1, 2014, ABC Co. pays $18,000 for a 3-year insurance contract. The companies have fiscal years ending
December 31. For ABC Co., journalize and post the entry on January 1 and the adjusting entry on December 31.
January 1. Prepaid Insurance ..................... 18,000
Cash................................ 18,000
ABC Co. recorded the payment by increasing (debiting) Prepaid Insurance. This account shows a balance of $18,000 in the
December 31 trial balance. Insurance of $6,000 ($18,000/3) expires each month. Thus, ABC Co. makes the following adjusting
entry.
December 31. Insurance Expenses................. 6,000
Prepaid Insurance ............. 6,000
Example: The supplies account balance at the beginning of the month September was $12,000. The physical count at the end
of the month (September 30) shows that supplies on hand are $4,000. Thus, supplies used during the month is $8,000.
Therefore, the adjusting entry prepared at the end of the month is:
September 30. Supplies Expenses ................... 8,000
Supplies............................. 8,000

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Depreciation: Companies typically own buildings, equipment, and vehicles. These long-lived assets provide service for a
number of years. Thus, each is recorded as an asset at cost, rather than an expense, in the year it is acquired. The term of
service is referred to as the useful life.

All plant assets except land lose their usefulness. Depreciation is the process of allocating the cost of an asset to expense
over its useful life in a rational and systematic manner. Depreciation is recorded as a debit to depreciation expense and a
credit to Accumulated depreciation. Accumulated Depreciation is a contra account which shows the depreciation accumulated
since the purchase of the plant assets.
Example: At the end of its first year, the trial balance of ABC Co. shows Equipment $30,000. Depreciation for the year is
estimated to be $5,000. Prepare the adjusting entry for depreciation at December 31,
December 31. Depreciation Expense- Equipment .............................. 5,000
Accumulated Depreciation- Equipment ................ 5,000
Unearned Revenues
Unearned revenues represent liabilities created by receiving cash in advance to provide services or deliver goods in the
future. Examples are rent, magazine subscriptions, and customer deposits for future service. Similarly, colleges consider
tuition received prior to the start of a semester as unearned revenue. It may not be practical to make daily journal entries
as the revenue is earned. Instead, we delay recognizing earned revenue until the end of the period. Then the company makes
an adjusting entry to record the revenue that has been earned and to show the liability that remains.
Example: XYZ Advertising Agency received $1,200 on October 1 for advertising services expected to be completed by December
31. XYZ credited the payment to Unearned Service Revenue; this account shows a balance of $1,200 in the October 31 trial
balance. For XYZ Co., journalize and post the entry on October 1 and the adjusting entry on October 31.
October 1. Cash............................................... 1,200
Unearned Revenue ............. 1,200
Analysis reveals that the company earned $400 (1,200/3) of those fees in October. Thus, it makes the following adjusting entry
on October 31.
October 31. Unearned Revenue ..................... 400
Service Revenue ..............400
Adjusting Entries for Accruals
Companies make adjusting entries for accruals to record revenues earned and expenses incurred in the current accounting
period that have not been recognized through daily entries.
Accrued Revenues
Revenues earned but not yet recorded at the statement date are accrued revenues. Accrued revenues may accumulate
(accrue) with the passing of time, as in the case of interest revenue and rent revenue. Or they may result from services that
have been performed but are neither billed nor collected. The former are unrecorded because the earning process (e.g., of
interest and rent) does not involve daily transactions. The latter may be unrecorded because the company has provided only
a portion of the total service.
An adjusting entry for accrued revenues serves two purposes: (1) It shows the receivable that exists at the financial position
date, and (2) it records the revenues earned during the period. Prior to adjustment, both assets and revenues are understated.
Therefore, an adjusting entry for accrued revenues increases (debits) an asset account and increases (credits) a revenue
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account.
Example: In October ABC Attorney earned $200 for legal services that have not been recorded. ABC Co. makes the following
adjusting entry on October 31.
October 31. Accounts Receivable ................ 200
Fees earned ................... 200
Accrued Expenses
Expenses incurred but not yet paid or recorded at the statement date are accrued expenses. Interest, rent, taxes, and
salaries are typical accrued expenses. Accrued expenses result from the same causes as accrued revenues. In fact, an
accrued expense on the books of one company is accrued revenue to another company.
An adjusting entry for accrued expenses serves two purposes: (1) It records the obligations that exist at the financial position
date, and (2) it recognizes the expenses of the current accounting period. Prior to adjustment, both liabilities and expenses
are understated. Therefore, an adjusting entry for accrued expenses increases (debits) an expense account and increases
(credits) a liability account.
Example: ABC Company signed a $50,000, 3-month note payable on October 1. The note requires ABC Co. to pay interest at an
annual rate of 12%. ABC Co. makes the following accrued expense adjusting entry on October 31.
October 31. Interest Expenses............................. 500
Interest Payable ..................... 500
Interest = Principal X Rate X Time
= 50,000 X 12% X 1/12 = 500
Worksheet for Financial Statement
Worksheet is a multi – columnar sheet of paper used to summarize data needed for preparation of financial statement,
adjusting entries, and closing entries. Worksheet is a large columnar sheet designed to arrange in convenient form all the
accounting data required at the end of the period.
Uses of a Work sheet
 Reduces the possibility of overlooking the need for an adjustment
 Provides a convenient means of verifying arithmetical accuracy
 provides for the arrangement of data in a logical form
 Provides the source data for the financial statements
Explanation of worksheet columns
1. The trial balance column – this is the same trial balance we have prepared before. The trial balance column of the
work sheet can be brought direct from the ledger or from a separate trial balance.
2. The Adjustment column – As mentioned previously, some account balances have to be adjusted at the end of the year.
The accounts in the ledger of our illustration that require adjustment and the adjusting entry for the accounts are
presented below.
3. The Adjusted Trial Balance Column – The accounts that require adjustment are now adjusted. The Adjusted Trial
Balance columns give the adjusted account balances. Each amount in these columns is computed by combining the trial
balance amounts plus or minus the adjustments.
4. The income statement and the statement of financial position columns – Transfer the income statement account

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 balances (revenue & expenses) to the income statement and financial position account balances (Asset, Liability
&owners’ equity) to the statement of financial position columns.
The trial balance of Amen Company at October 31, 2015, the end of the accounting period, and the data need to determine
year-end adjustments are as follows:

Adjustment data:
a. Inventory of supplies at October 31, $840
b. Insurance premiums expired during the month, $800
c. Depreciation expense on equipment during the month, $1,000
d. Accrued service revenue, $2,300
Instructions:
1. Record the trial balance on a ten column work sheet and complete the work sheet
2. Prepare an income statement, statement of changes in equity and statement of financial position
3. On the basis of the adjustment data in the worksheet, journalize the adjusting entries
4. On the basis of the data in the worksheet, journalize the closing entries

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 1.
Amen Company
Work Sheet
Month Ended October 31, 2015
Account Title Trial Balance Adjustments Adjusted Trial Balance Income Statement Statement of financial
position
Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
Cash 2,310 2,310 2,310
Accounts receivable 1,640 d) 2,300 3,940 3,940
Supplies 2,040 a) 1,200 840 840
Prepaid Insurance 2,400 b) 800 1,600 1,600
Equipment 12,000 12,000 12,000
Accumulated depreciation c) 1,000 1,000 1,000
Accounts payable 370 370 370
Amen, Capital 17,950 17,950 17,950
Amen, withdrawals 1,500 1,500 1,500
Fees earned 7,600 d) 2,300 9,900 9,900
Rent expense 850 850 850
Wage expense 2,200 2,200 2,200
Utilities Expense 350 350 350
Miscellaneous expense 630 630 630
25,920 25,920
Supplies expense a) 1,200 1,200 1,200
Insurance expense b) 800 800 800
Depreciation expense c) 1,000 1,000 1,000
5,300 5,300 29,220 29,220 7,030 9,900 22,190 19,320
Net Income 2,870 2,870
9,900 9,900 22,190 22,190

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2.
Amen Company
Income Statement
Month Ended October 31, 2015
Revenue:
Fees Earned . . . . . . . . . . . . . . . . . . . . . . ………… . . . . . . . . . . . . $9,900
Expenses:
Rent expense . . . . . . . . . . .. . . . . . . . . . . . . . . . . . $850
Wage expense . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,200
Utilities expense . . . . . . . . . . . . . . . . . . . . . . . . . . 350
Supplies expense . . . . . . . . . . . . . . . . . . . . . . . . . 1,200
Insurance expense ………………………………... 800
Miscellaneous expense …………………………… 630
Depreciation expense . . . . . . . . . .. . . . . . . . . . . . . 1,000
Total expenses . . . . . . . . . . . . . . . . . . . . ………………….. . . . . . . 7,030
Net income . . . . . . . . . . . . . . . . . . . …….... . . . . . . . . . …. . . . . . . . . . . . $2,870

Amen Company
Statements of changes in Equity
Month Ended October 31, 2015
Amen, capital, October 1, 2012 . . . . . . . . . . . . …………. . . . . . . . . . $17,950
Add: Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,870
Less: Withdrawals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,500
Increase in owner’s equity …………………………………………….. 1,370
Amen, capital, October 31, 2012 . . . . . . . . . . . . . . ………….. . . . . . . $19,320

Amen Company
Statement of Financial position
October 31, 2015
Current Asset: Current Liabilities
Cash . . . . . . . . . . . . . . .. . . $2,310 Account Payable ………… $370
Accounts receivable . . ... . . 3,940 Owner’s Equity
Supplies . . . . . . . . . . . . …. . . 840 Amen, Capital ……....… 19,320
Prepaid insurance . . . . . . . 1,600
Total current asset ……………. $8,690 Total Liabilities and
Plant Asset: and owner’s equity …… 19,690
Equipment . . …………. . $12,000
Less: Accum. Depr. ……... 1,000 11,000
Total Asset ……………………….. $19,690

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3. Adjusting entries
a. Supplies Expense (↑ expense; debit). . . . . . . . . . . . . . .. . . . . 1,200
Supplies (↓ asset; credit). . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,200
b. Insurance Expense (↑ expense; debit) . . . . . . . . . . . . . . .. . . . . 800
Prepaid Insurance (↓ asset; credit). . . . . . . . . .... . . . . . . . . . . . . 800
c. Depreciation Expense—Furniture (↑ expense; debit). . ... . . . 1,000
Accumulated Depreciation-Equipment (↓ asset; credit) . . . . . 1,000
d. Accounts Receivable (↑ asset; debit) . . . . . . . .. . . . . . . . . . . . 2,300
Fees Earned (↑ revenue; credit) . . . . . . . . . . . . . . . . . . . .. . . . 2,300

The Closing Process

Some of the accounts in the ledger are temporary accounts used to classify and summarize the transactions affecting
capital (owners’ equity). These accounts will be closed after financial statements are prepared. That is, their balances will
be transferred to the Capital account. The temporary accounts that have to be closed are revenue, expense and withdrawal
accounts.
Steps in closing:
a. Closing revenue accounts - Debit each revenue account by its balance and credit the ‘Income Summary’ account by
the total revenue for the period.
Note: Income summary is an account used to close revenue and expense accounts. This account will immediately be
closed to the capital account at the end of the closing process.
b. Closing expense accounts – Debit the income summary account by the total of expenses for the period and credit
each expense account by its balance.
c. Closing the income summary account – Income summary will be closed to the capital account. The balance of this
account depends on the nature of operation; credit if result is profit and debit if result is loss.
d. Closing Withdrawal – Debit the owners’ equity account by the total of drawings for the period and credit the
drawing account.

4. Closing Entries
October 31. Service Revenue . . . . . . . . . . . . . . . . . . . 9,900
Income Summary . . . ….. . . . . . . . . 9,900

31. Income Summary . . . . . . . . . . . . . . . . . . 7,030

Rent Expense . . . . . . . ……... . . . . . . 850
Wage Expense . . . . . ... . . . . . . . . . 2,100
Supplies Expense . . . . . . . . . . . . . . 1,200
Insurance Expense ……………...….. 800
Depreciation Expense . . . . . . . . . . . 1,000
Utilities Expense . . . . . . . . . . . . . . . . 350
Miscellaneous Expense …....………. 630

31. Income Summary ($9,900 − $7,030) . . . .. . . . . . . 2,870

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 Amen, Capital . . . . . . . . . . . . . ………... . . . . . 2,870
31. Amen, Capital . . . . . . . . . . . . . . . . . …. . . . . . . . 1,500
Amen, Withdrawals . . . . . . . . . . . …. ………. . 1,500

Post-Closing Trial Balance

After the closing entries have been journalized and posted, a trial balance is prepared to prove the equality of the general
ledger before recording the New Year’s transactions. It should be noted that this trial balance includes only statement of
financial position accounts. This is because the temporary income statement accounts are closed during the closing
process. This trial balance is called the post – closing trial balance.

Amen Company
Post-Closing Trial Balance
Month Ended October 31, 2015

Account Title Trial Balance

Cash 2,310
Accounts receivable 3,940
Supplies 840
Prepaid Insurance 1,600
Equipment 12,000
Accumulated depreciation 1,000
Accounts payable 370
Amen, Capital 19,320
20,690 20,690

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