Accounting Cycle Notes 17 Jul 20

Accounting Cycle
A cycle is something that has a starting point and then some things are happening
and ends at the starting point again and repeat itself again. If you have to run around
the school block and it is 400 metres to run around the block and you have to do 800
metres, what are you going to do? You will start in front of the school, run around the
block and ends where you started. If you run around the block, you would have done
400 metres, to get to your 800 metres, you have to do it again to get to your 800
metres.
In accounting it works exactly the same; there is a cycle that needs to be done. It has
a starting point and it ends at the starting point again and then it repeats itself again.
An Accounting cycle looks as follows:
1. Transaction
A = E + L
Balance Sheet
2. Source Documents
Income Statement
3. Journals
6. Financial Statements
4. Posting to Ledger
5. Trial Balance
1. Transaction
Your mother sends you to the local shop to go and buy bread and milk. You get the
bread and milk and go to the pay point. The cashier will scan the bread and milk and
tell you what you owe. You will give her the money and the bread and milk is yours.
Two things happened here, you wanted the bread and milk and the shop wanted
money for it. A transaction happened between you and the shop.
No matter what type of enterprise is started, everything that happens in a business
must be recorded. All activities involving monetary value that take place between the
business and other enterprises (people) must at some point be recorded in the
books of the enterprise. These activities are known as transactions.
2. Documents
When you gave the money for the bread and milk, the cashier gave you your change
and a piece of paper. This piece of paper is a proof that you bought and milk there
and you paid for it. We call this proof a document.
Proof must be given that these transactions have already taken place. The evidence
of these transactions is known as source documents. A document can be a receipt,
cheque, deposit slip, etc. The information on these documents must be recorded in
the books of the business.
A source document is a proof that a transaction has actually taken place. If your
parents want to buy a television set, they go to a shop and buy the television set.
They paid for it and received proof (receipt) that they paid for it. When they arrived
home, they switch the television set on, but it did not work. They can only return the
television set to the shop if they can proof that they bought the television set there.
A business works exactly the same manner. For all transactions entered into with
individuals/suppliers, proof must be supplied.
3. Subsidiary books (Journals)
A business will collect all the documents and sort it out in receipts and payments. In
grade 8 we are going to look at receipts and payments. All money that the business
received, will be entered in the Cash Receipts Journal (abbreviation, CRJ) and all
money paid out of the business will be entered in the Cash Payments Journal
(abbreviation, CPJ).
We call the CRJ and CPJ the books of first entry, thus it is the first place where the
business will record the transactions that happens during the month. A business will
record all these transactions in these journals for a month.
4. Ledger
At the end of the month the journals must be closed of – this means the amounts
must be added up. The journals must be posted to the general ledger. The ledger is
a list of the accounts of a business.
 The General Ledger is a list of all the accounts that the business has.
 The type of accounts depends on the type of business. For example, a
hairdresser has some accounts that are different to those of a spaza shop.
However, both businesses have many accounts that are the same, for example
water and electricity, stationery, wages, rent, and so on.
 The accounts in a General Ledger look similar to a capital T, which is why
they are sometimes referred to as T-accounts. The heading is at the top of
the T.
 The left and right side have the same columns.
 The left-hand side is called the debit side and the right-hand side is called the
credit side.
 Posting to the General Ledger is done through a double-entry system.
 The double-entry system means that, for every time you write something on the
debit side (left-hand side) of a ledger account, you need a matching entry on the
credit side (right-hand side) of a different account.`
5. Trial Balance
After the journals are posted to the General Ledger, the accounts must be balanced
and a trial balance needs to be prepared. The aim of a Trial Balance is to see that all
transactions recorded properly in the business. If you add up a trial balance the debt
and credit side must be the same. We therefore say it test the double entry system
used in the ledger.
 A Trial Balance is a statement which lists all the balances on all the
accounts in the double entry system.
 A Trial Balance has a debit and credit side. All accounts in the General Ledger
with a debit balance will be entered in the Trial Balance on the debit side and all
accounts in the General ledger with a credit balance will be entered in the Trial
Balance on the credit side.
 Both sides will be added separately, if both sides are the same, we say the Trial
balance ‘balance’.
 However, if both sides are not the same, then errors have occurred.
6. Financial statements:
 Preparing of financial statements is the final step in the Accounting cycle.
 Financial statements are prepared at the end of the financial year, thus after
twelve months.
 Financial statements consists of an Income statement and a Balance sheet
Income statement
 An income statement shows if a business has made a profit or a loss i.e. the
performance of the business.
 If the income of a business is more than expenses, then it made a profit. If the
business expenses is more than income, the business made a loss
 With a sole trader, the profit or loss belongs to the owner.
 If it is a profit, it will increase the owners’ equity with the amount.
 If it is a loss, it will decrease the owners’ equity with the amount.
 At the end of the year, profit or losses will be transferred to the capital account in
the balance sheet.
 What will be the owners’ equity at the end of the financial year?
 Capital balance at the beginning of the year + additional contributions during the
year + profit at the end of the year (minus if it is a loss) – drawings that the owner
did during the year = capital balance at the end of the year.
Balance sheet
 A balance sheet is a statement that reflects the financial position of a business at
a specific date (after twelve months of business).
 The balance sheet reflects the assets, liabilities and owners’ equity of a business.
 Does this seem familiar to you? Do you recall doing the personal statement of net
worth in Grade 7?
 A balance sheet and a personal statement of net worth are the same thing.
 In the balance sheet, total assets must equal to owners’ equity plus liabilities
(A = OE + L).
 If it is the same, we say the balance sheet ‘balances’.

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Accounting Cycle

3. Subsidiary books (Journals)

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