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THE ACCOUNTING CYCLE Monicpa

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									                                                                     SECTION IV. THE ACCOUNTING CYCLE




SECTION IV. THE ACCOUNTING CYCLE
Learning Objective

The main objective of this topic is to learn the accounting cycle, particularly the
methodology and steps involved in how to keep accounting journals and prepare
financial statements. Lack of knowledge about the actions to take at every step in the
accounting cycle and how to complete them leads to disorderly and unsystematic
accounting, and eventually to errors. Therefore, it is vitally important for accountants
to acquire the appropriate technique for an orderly and systematic approach based
on the approved accounting procedures and guidelines.


1. The Accounting Cycle

The accounting cycle is the combination of activities for analyzing, recording,
classifying, summarizing and reporting transactions in order to prepare Financial
Statements.

The accounting activities can be classified in the following steps:

                                       1. Analyze the transactions by reviewing the original documents
        During the
         current
         period




                                       2. Journalize the transactions

                                       3. Post the journal entries to ledgers

                                       4. Prepare a trial balance using the balances in the ledgers and
           At the end of the current




                                       fill out worksheet
                                       5. Journalize adjusting entries and post them to the ledgers

                                       6. Journalize closing entries and post them to the ledgers
                    period




                                       7. Prepare post-closing adjusted trial balance

                                       8. Prepare Financial Statements



The above steps of the accounting cycle apply to the process of preparing annual
financial statements. Please note that when interim financial statements are being
prepared, the entries for closing temporary accounts are not posted at that time to
the General Ledger but are kept open until year-end.

The relationship of the above steps can be demonstrated in the table below:




                                                         50
                                                             SECTION IV. THE ACCOUNTING CYCLE




          Input                   Development                                        Output


1                    2                   3                      4                    5
Analyze              Journalize          Post to                Prepare trial        Prepare
                                                                balance and fill
transactions                             GENERAL                                     Financial
                     JOURNALS                                   out worksheet
                                         LEDGER                                      Statements



                                                                        Reflect
                                            Adjusted trial             adjusting
                                            balance                     entries


                                      6
                                      Reflect adjusting entries
                                      in journals and post them
                                      to ledgers
                                      7
                                      Reflect closing entries in
                                      journals and post them to
                                      ledgers



  ___________________________________________________________________________________


      1                    The main objective of this step is to (a) identify the transactions
      Analyze              and events; and (b) verify the validity and accuracy of the
      transactions         original documents.

                           The key result from this step is compiling the original or source
                           documents. Source documents would be the basis for
                           accounting records and preparation of Financial Statements.
                           Source documents should meet certain requirements to be
                           considered as valid.

  Compile the source documents and determine which of them should be recorded. It
  means that the characteristic of each transaction and the affected accounts should
  be determined as to whether the transaction increases or decreases the amounts of
  assets, liabilities, income and expenses.

  While analyzing certain transaction, an accountant considers 3 questions that help
  him/her discover and analyze the changes caused by the transactions:

  o       What happened? Identify the account class affected by each transaction and
          determine the affected amount as to whether it is an increase or decrease.

  o       What accounting procedure should be applied? Applying Debit and Credit rules
          to record transactions, the following rules should be considered:




                                             51
                                                       SECTION IV. THE ACCOUNTING CYCLE




                                     Accounting Rules

       Asset:                              Increase by Dr entries
                                           Decrease by Cr entries

       Liabilities:                        Increase by Dr entries
                                           Decrease by Cr entries

       Equity:                             Increase by Cr entries
                                           Decrease by Dr entries

       Income:                             Increase by Cr entries
                                           Decrease by Dr entries

       Expenses:                           Increase by Dr entries
                                           Decrease by Cr entries

o   What accounting entries should be made?

An accounting entry should show the account and the amount to be debited; the
account and the amount to be credited; and the date when the transaction took place
is. Recording transactions in an account should comply with the principle accounting
equation Asset = Liability + Owners’ Equity.

Below are examples of how transactions are analyzed according to the above rules.
Please note that they do not relate to further discussion in this section.


    What will happen?               Accounting rule                 Recording entries

 Purchased equipment worth Tog 15,000 on January 2, 1999 in cash
 Increase in fixed asset of   Debit increase in asset.
 15,000.                                                    Dr. Fixed asset 15,000
 Decrease in cash of          Credit decrease in asset.              Cr. Cash      15,000
 15,000.
 Transferred Tog 1,500 which is prepaid rent for equipment for the next 3 months in Nov.,
 30, 1999
 Increase in prepaid          Debit increase in asset.
 expense of 1,500.                                          Dr. Prepaid expense 1,500
 Decrease in cash of 1,500. Credit decrease in asset.               Cr. Cash        1,500
 Received Tog 3,600 on Oct. 30, 1999 which is paid by tenant for rent of one-room office for
 a period of 6 months beginning from Nov.1, 1999.
 Increase in liability        Credit increase in liability.
 (Unearned revenue) of                                      Dr. Cash          3,600
 3,600.                       Debit increase in asset.          Cr. Unearned rev. 3,600

 Increase in cash of 3,600
 Purchased inventory on credit on Dec. 1, 1999 for Tog 24,300.
 Increase in inventory of     Debit increase in asset.
 24,300.                                                    Dr. Inventory 24,300
                              Credit increase in payable.      Cr. Acct. payable 24,300
 Increase in payable of
 24,300.
 Paid Tog 4,000 in March 30 for renting equipment beginning from 1st of January 1999.
 Increase in expense of       Debit increase in expense.
 4,000.                                                     Dr. Rent expense 4,000
                              Credit decrease in asset.         Cr. Cash            4,000




                                           52
                                                            SECTION IV. THE ACCOUNTING CYCLE




 Decrease in cash of 4,000.
 The company received Tog 58,000 in Oct. 1, 1999 for services rendered.
 Increase in revenue of       Credit increase in revenue.
 58,000.                                                     Dr. Cash 58,000
                              Debit increase in asset.         Cr. Service rev. 58,000
 Increase in cash of 58,000.
 Sent an invoice of Tog 30,000 Nov. 2 for services rendered in October and November.
 Increase in revenue of       Credit increase in revenue.
 30,000.                                                     Dr. Receivable 30,000
                              Debit increase in asset.          Cr. Service rev. 30,000
 Increase in asset of
 30,000.




                                    The transactions identified and analyzed at the 1st step
    2                               should be reflected in special journals or in the General
    Journalize transaction          Journal, if a special journal is not applicable.
    SPECIAL JOURNAL
                                    Journalizing is the beginning of official recording of
    GENERAL JOURNAL
                                    transactions. The journals show the debit and credit
                                    accounts and the amounts.

                                                                    Name of Journal
          How to reflect in the General Journal:    General Journal       Type of journal: GJ No:

                                         Sheet No. 10                 Current period: 01.12.2002

                                    Page 10



No.     Document         Description of            Amount       Title & code of account
        Date No.         transactions                             Debit       Credit
1
2       XII.1                 Inventory            24,300     Inventory   Account payable
                         purchased on credit                    1410           3101




                                                                          Account No.


       Description of transaction




                                              53
                                                          SECTION IV. THE ACCOUNTING CYCLE




                            Inventory purchasing journal IPJ No.12-02

                                Debited accounts:   Credited accounts:        Other accounts
                                Name & number         name & number
                                                    Acct     Cash        Amount    Debit   Credit
Date   Doc     Description of   Inventory           pay.     1010                  Acct.   Acct.
       .No.    transactions       1410              3101                           No.     No.

12     01     Purchase on         24,300            24,300
              credit
12     02     Returns from         1,200                                   1,200   1410    1420
              production
12     03     Cash                 1,000                         1,000
              purchase

              Amount              26,500            24,300       1,000     1,200
  At the end of the current
  period, posting entries
  should be made for the
  total amount in these
  columns.


The above example shows how to record the purchase on credit of Tog 24,300 worth
of inventory, the purchase of the Tog 1,000 worth of inventory for cash, and Tog
1,200 returns from production.




                                             54
                                                                    SECTION IV. THE ACCOUNTING CYCLE




       3                                          The transactions are posted from the General
       Posting entries                            Journal to the General Ledger. The General
                                                  Ledger consists of only control accounts
                                                  (general accounts).

                                    Inventory receipts journal IRJ No.12-02

                                       Title and code of       Title and code of        Other accounts
                                       debited accounts        credited accounts
          Doc                         Inventory              Accoun Cash           Amount    Debit      Credit
Date      um      Description of        1410                 t          1010                 Acct.      Acct.
          ent     transactions                               payabl                          No.        No.
          No.                                                e
                                                             3101

12        01      Purchases on          24,300               24,300
                  credit
          02      Returns from            1,200                                      1,200   1410       1420
                  production
          03      Cash                    1,000                            1,000
                  purchase

                  Amount                26,500               24,300        1,000     1,200


NOTE: 1410 is for raw materials, 1420 is for unfinished products, 1010 is for cash,
and 3101 for accounts payable.

                                        General Ledger: Inventory 1410
                              Debit transactions                          Credit transactions
     Date       From        From        From               Total      From               Total       Balance
                Inv.        Inv.        Cash               Amount     Inv.               Amount
                Receipts    Receipts Disb.                            Issuance
                journal     journal     Journal                       Journal

     11                                                                                              15,000
     12         24,300      1,200        1,000             26,500     29,500           29,500        12,000

           Also posted from
           other accounts.
                                        Balance in the unadjusted trial balance


                                         General Ledger: Account payable 3101
                             Debit transactions                      Credit transactions
           Date    From                            Amount       From                  Amount         Balance
                   Cash                                         Inv.
                   Receipts                                     Receipts
                   Journal                                      Journal

           11                                                                                        45,000
           12      50,000                          50,000       24,300                 24,300        19,300




                                                     55
                                                         SECTION IV. THE ACCOUNTING CYCLE




Every journal entry is posted to at least two accounts in the General Ledger. If a
compound entry is necessary, one transaction should be posted from a journal to
more than two accounts in the General Ledger. However, total debits of every entry
must equal to total credits.

At the end of the current period, posting entries should be completed, and therefore,
the required information for the General Ledger is provided.

At the end of the current period, an accountant should determine the balances of the
General Ledger accounts. These balances are the debit and credit balances which
should be reflected in the unadjusted trial balance.




 4
 Prepare trial balance,         This step covers the activities that are performed at
 and fill out worksheet         the end of the current period.
                                These activities are performed using the Worksheet.

The worksheet is a table with the following headings. This kind of worksheet is
known as a ”10 columns worksheet”.

    Title of     Trial          Adjusting        Adjusted trial   Income      Balance
    accounts     balance        entries          balance          Statement


The Trail Balance column:

       1. Debit and credit balances in the General Ledger at the end of the current
          period are listed and summarized in the Trial Balance column. Total debit
          and credit amounts should be equal.

The Adjusting Entries column:

       2. This column is filled out if any adjustments are to be made in order to
          keep the information in the Financial Statements current and accurate.
          Please see the Adjusting entries explained separately.

The Adjusted Trial Balance column:

       3. The adjusted balances include both the debit and credit balances in the
          trial balance before adjustment, and plus or minus the adjusted amount.
          This is the balance to be shown in the adjusted trial balance column. It
          means that the balances in the trial balance are revised through
          adjustment.




                                            56
                                                  SECTION IV. THE ACCOUNTING CYCLE




The Income Statement Column:

      4. The debit balances (or occasionally credit balances) of expense accounts
         from the adjusted trial balance are posted to the debit side of the Income
         Statement column.
      5. Likewise, the credit balances (or occasionally debit balances) of revenue
         accounts are posted to the debit side of the Income Statement column.
      6. In other words, the balances of temporary accounts are reflected in this
         column.
      7. After posting entries are made, the following two actions are performed in
         this column:

          a. Total income and expenses should be summarized, and the difference
             is recognized as profit or loss. If the difference is profit (total amount
             in the credit column exceeds the total amount in the debit column), the
             total difference is noted on the debit side of the Income Statement
             column. If the difference is loss (total amount in the debit column
             exceeds the total amount in the credit column), the total difference is
             noted on the credit side of the Income Statement column. The debit
             and credit sides must be equal. Please compare the closing entries
             made in the worksheet given in Table 2 with the above discussion in
             order to obtain clear understanding.

          b. The determined profit or loss amount should be reflected both in a
             separate row in both the Income Statement and Balance Sheet
             columns. In this case, the following procedures should be followed:
             The profit amount noted on the debit side of the Income Statement
             column is posted to the credit side of the Balance Sheet column.
             Whereas, the loss amount noted on the credit side of the Income
             Statement column is posted to the debit side of the Balance Sheet
             column.

      o   The total amount of income and expense and their difference are the
          basis for recording closing entries.

      o   The Income Statement column provides the core information for preparing
          Income Statement one of the components of the Financial Statements.

The Balance Sheet column:

      o   The balances in the permanent accounts (assets, liability and equity) are
          posted from the adjusted trial balance column to the Balance Sheet
          column.
      o   The important feature of the Balance Sheet column is that the beginning
          balance of Retained Earnings and the profit/loss for the current period are
          reflected in separate rows.
      o   Using the information in this column, the Balance Sheet (another
          component of the Financial Statements). The balances of the permanent
          accounts must be the same in both the Balance Sheet and the General
          Ledger.




                                       57
                                               SECTION IV. THE ACCOUNTING CYCLE




Completion of the Worksheet Preparation worksheet

The worksheet is an optional tool for making accounting information ready to be
included in Financial Statements, and its records are not official. In other words,
there is no formal requirement to prepare a worksheet. However, it helps check
and review the accuracy of records, and makes the activities more
understandable and transparent for preparing Financial Statements. If an
enterprise uses a worksheet, the format and procedures for preparing a
worksheet should be followed consistently considering the business
characteristics of the enterprise.

The order or steps of preparing a worksheet are shown in Table 1, and a
prepared worksheet is given in Table 2.




                                    58
                                                                     SECTION IV. THE ACCOUNTING CYCLE




Table 1. Sequence and Methodology for Preparing a Worksheet

                                                 WORKSHEET (SUMMARIZED)
                                                                                          (in thousands of Togrogs)
 Accounts            Trial balance         Adjusting          Adjusted trial       Income              Balance
   titles                                   entries             balance           Statement
                     Dr           Cr       Dr      Cr          Dr      Cr         Dr     Cr           Dr      Cr
Cash                  13.6                                      13.6                                  13.6
Account               64.8                                      64.8                                  64.8
payable
Allowance for                       2.0              (h)3.5                5.5                                 5.5
bad debt

Retained                           24.7                                  24.7                                 24.7
earnings
01.01
Sales                             720.0                                 720.0               720.0
Interest               2.1                  3.0                   5.1               5.1
expense

                     951.0        951.0



Bad debt                                  (h)3.5                  3.5               3.5
expense
                                          579.2      579.2     949.1    949.1
Total                                                                            678.1      720.0
revenue,
expenses
Tax expense                                                                        6.3
Tax payable                                                                                                    6.3
Net income                                                                        35.5                        35.5
or loss
Total                                                                            720.0      720.0   271.1    271.1




                                                                 After posting the income and expense amounts
   Trial balance totals             Reflects                     from the Adjusted Trial Balance to the Income
                                    adjustments and              Statement column, and the balance of the
                                    gives totals.                Balance Sheet accounts to the Balance Sheet
                                                                 column, the amounts in the Income Statement
                                                                 column are totalled.
           General Ledger: Cash 1010
  Date                Dr      Cr     Bal.
  1999                                                            By totalling the Income Statement column, the
           Cash                                                   profit/loss is determined by diffrence. Profit/loss
           expense                                                is placed on the side where the amount is less.
  31       Cash           106,5           13.6                    Thus, determine all Dr and Cr amounts
  Mar.     revenue
                                                                  including profit/loss. These amounts should be
                                                                  equal.
 Adjust the balance in Trial
 Balance by the adjusted
 amount.                                         “The profit amount (Tog 35.5) is posted from Income Statement
                                                 column to the Balance Sheet column.
                                                 Because this is an interim report, closing entries are reflected
                                                 neither in the journal nor in the ledger, the balance in the profit
                                                 account is not changed being the operating result of the current
                                                 period (Tog 24.7).
                                                 Total debit and credit amounts should be equal.




                                                       59
                                                    SECTION IV. THE ACCOUNTING CYCLE




The Income Statement column shows the amount to be reflected in the Income
Summary account.

Adjusting entries

Most of the accounting transactions are recorded by initial entries. But some of the
events are not proved by source documents related to initial entries. The effects of
such transactions and events are recorded at the end of the current period through
adjusting entries. The aim of adjusting entries is to correct and adjust the balance in
certain accounts in order to reflect the real condition at the end of the current period.

Principally, adjusting entries are based on accrual basis of accounting. In other
words, revenue is recognized and recorded in the period when it is earned, and
expense is recognized and recorded in the period when it is incurred. And if revenue
is earned, the expense related to this revenue also should be recognized and
recorded in the same reporting period.

The transactions that require adjusting entries are mostly those that are related to the
difference between by expense and cash outflow, and revenue and cash inflow. The
events to be adjusted are divided into the following types:

           Adjustment types                   Adjustment characteristics
     1   Prepaid expenses           The costs recorded but not yet recognized
                                    should be allocated to one or several reporting
                                    periods
     2   Accumulated expenses       Recognize and record unrecorded expenses
     3   Unearned revenue           Allocate recorded income to reporting periods
                                    and recognize the proportionate amount as
                                    income
     4   Accumulated revenue        Recognize and record unrecorded income
     5   Estimated items            h Depreciation expense is estimated and
                                    recorded
                                    h Bad debt expense is estimated using the
                                    indirect method and recorded.

   Prepaid expenses

Payment is settled, but the expense itself not yet incurred. Thus, it is recorded in an
asset account when payment is made. At the end of the current period, an
adjustment entry is made for the amount of expense incurred in the period.

Adjusting entry (a)

                 Prepaid rent                      Rent expense
           xi.30 1,500 500 (a)                     (a) 500


On November 30 of the reporting year, the organization paid Tog 1,500 for rent for
the next 3 months, Tog 500 of which applies to December. Thus, rent expense of
Tog 500 should be adjusted and recorded in the rent expense account.




                                         60
                                                        SECTION IV. THE ACCOUNTING CYCLE




   Accrued expenses

Unrecorded expenses are those that were already incurred in the reporting period,
but not yet recorded. For example, let us assume that an employee has worked for
several days since the last payroll payment. It means that labor expense has been
incurred but the payroll expense is not recorded because the employer has not yet
paid cash, or the employee has not yet claimed it. At the end of the current period,
these expenses are accrued, and they should be reflected in expense and liability
accounts using adjusting entries.

                     Payroll payable               Payroll expense
                              21,500 (a)         (a) 21,500

Let us assume that employees are paid on the 1st and 16th day of a month, and the
last half month payroll of December is paid on January 1 of the next year. Although
this payroll amount is not paid, the above adjusting entry is made on December 31,
and recognized as expense and recorded accordingly.

Let us assume that an organization has a 10% annual interest loan in the amount of
Tog 20,000 on December 1. The organization has not yet paid one month interest
expense on December 31, but the accrued expense should be recorded as follows:

                     Interest payable              Interest expense
                                100 (c)          (c) 100


Similarly, the expenses for electricity, heating, services and other expenses that are
not yet paid or claimed should be accrued and recorded at the end of the reporting
period.

   Unearned revenue

Revenue received before services were rendered and/or goods delivered is recorded
in a liability account as Unearned Revenue. The amount of this unearned revenue
actually earned at the end of the reporting period should be recorded. An adjusting
entry which has an effect of increasing revenue and decreasing liability is made. For
example, a company receives Tog 3,600 in advance for 6 months’ rent beginning
November 1, 1999. At December the lessor has rendered rent service for November
and December. The rent revenue for 2 months is recognized, and a corresponding
adjusting entry is made as follows:

                Unearned revenue                                 Rent revenue
           x xi.30      3,600              3,600 x.30                  (e) 1,200
             (e) 1,200


   Accrued revenue

Accrued revenue is revenue that is earned in the reporting period, but not yet
recorded because either the customer has not yet been invoiced or cash has not yet
been received, depending on the circumstances of the business. This is revenue that
has been earned but has not yet been recorded. It should be accrued through
adjustment and thus recorded.




                                           61
                                                     SECTION IV. THE ACCOUNTING CYCLE




A company issued a note receivable on November 1. The note has 12% annual
interest, maturity of 6 months. The interest is paid with together with the principal.
The company earns a 2 months’ interest on December 31. Thus, the company
should accrue the interest of Tog 200 (10,000*12%*6/12) and record it as interest
income.

                  Accrued Interest                Interest income
                     receivable
                 (e) 200                                      (e) 200


   Depreciation expense

Fixed assets provide benefit to an organization for several years. The organization
records the proportionate benefit received (used) from the asset as depreciation
expense. The asset depreciation expense is recorded at the end of a reporting period
using the following adjustment:

                   Accumulated                Depreciation expense
                   depreciation
                              10,000
                           (f) 5,000            (f) 5,000
                              15,000

       Bad debt

In order to recognize that receivables will not be fully collected from all customers, an
adjustment should be made. If such adjustment is not made, the receivable account
balance will exceed its net realizable value in the Balance Sheet. This reflects wrong
information. Assuming that the ending balance of accounts receivable is Tog 30,000,
and 10% of this balance is expected to become uncollectible, the net realizable value
of these receivables is actually Tog 27,000 (30,000-30,000x10%). Therefore, the bad
debt allowance account should be adjusted by Tog 1,000 to be added to its
beginning balance of Tog 2,000 to show an ending balance of Tog 3,000.

                Bad debt allowance                  Bad debt expense
                                 2,000
                             (h) 1,000            (h) 1,000
                                 3,000


Section 10 will discuss in detail about how to account for bad debts.

   Cost of Goods Sold

The periodic system is used for inventory accounting. In order to calculate the Cost
of Goods Sold, the ending balance of the inventory account must be adjusted.

       Dr. Cost of Goods Sold
       Dr. Inventory (ending balance)
                      Cr. Inventory (beginning balance)
                      Cr. Purchases
                      Cr. Inventory transportation costs




                                         62
                                                   SECTION IV. THE ACCOUNTING CYCLE




Examples of adjusting entries

The WORKSHEET given in Table 2 reflects the following adjusting entries:

1. The estimated bad debt expense is 0.5% of the net sales (gross sales – sales
   returns and allowances)
       Dr. Bad debt expense        3,586
              Cr. Bad debt allowance     3,586

2. Depreciation for buildings is 4% annually, and depreciation for furniture and
   equipment is 10% annually.
      Dr. Depreciation expense       3,600
              Cr. Accumulated depreciation (buildings) 3,600

       Dr. Depreciation expense  2,200
             Cr. Accumulated depreciation (Furniture & equipment)         2,200

3. Of the Tog 7800 prepaid insurance, the portion “used” in the current year was
   Tog 5,200.
       Dr. Insurance expense        5,200
              Cr. Prepaid insurance        5,200

4. Accrued payroll of the sales employees as of December 31 was Tog 5,000.
      Dr. Payroll expense 5,000
             Cr. Payroll payable           5,000

5. In the current year, Tog 9,400 was paid for advertising expenses, of which Tog
   740 of advertising service was not received by the end of year. Thus, the unused
   portion of the expense must be adjusted accordingly.
       Dr. Prepaid advertising expense      740
               Cr. Advertising expense             740

6. Supplies on hand were Tog 1,400. (When supplies were purchased, the
   transaction was recorded in the other office expenses account)
       Dr. Supplies Inventory 1,400
              Cr. Other office expenses 1,400

7. Accrued interest on accounts payable was Tog 3,000 as of December 31.
      Dr. Interest expense         3,000
              Cr. Interest payable              3,000

8. Inventory on hand on December 31 was Tog 76,000

       Dr. Cost of Goods Sold                533,700
       Dr. Sales returns and allowances        9,500
       Dr. Sales discounts                     9,600
       Dr. Inventory                           2,000
        Cr. Purchases                              540,000
        Cr. Inventory transportation cost            14,800




                                        63
                                                                                                                                    SECTION IV. THE ACCOUNTING CYCLE




Table 2. Fully prepared worksheet


                                          Trial balance           Adjusting entries         Adjusted trial balance    Income Statement      Balance Sheet
                                         Dr           Cr           Dr            Cr           Dr             Cr        Dr          Cr       Dr         Cr
Cash                                      13,600                                               13,600                                       13,600
Accounts receivable                       64,800                                               64,800                                       64,800
Bad debt allowance                                        2,000                 (1) 3,586                     5,586                              -      5,586
Merchandise, 1 January                    74,000                  (8) 2,000                    76,000                                       76,000
Building                                  90,000                                               90,000                                       90,000
Accumulated depreciation—building                     14,400                   (2a) 3,600                    18,000                                    18,000
Equipment                                 22,000                                               22,000                                       22,000
Accumulated depreciation—equipment                        6,600                (2b) 2,200                     8,800                                     8,800
Prepaid insurance                          7,800                                (3) 5,200        2,600                                       2,600
Accounts payable                                      34,200                                                 34,200                                    34,200
Notes payable                                         30,000                                                 30,000                                    30,000
Stock capital                                        100,000                                                100,000                                   100,000
Sales                                                720,000                                                720,000               720,000
Sales returns and allowances               2,800                                                 2,800                  2,800
Purchases                                540,000                              (8) 540,000
Purchase returns & allowances                             9,500   (8) 9,500
Retained earnings 1 Jan., 2001                        24,730                                                 24,730                                    24,730
Inflow transportation cost                14,800                               (8) 14,800
Sales employees’ payroll expense          54,000                  (4) 5,000                    59,000                  59,000
Advertising expense                        9,400                                  (5) 740        8,660                  8,660
General administrative payroll expense    31,000                                               31,000                  31,000
Electricity & heating expense             15,100                                               15,100                  15,100
Telephone & communication expense          1,700                                                 1,700                  1,700
Other office expenses                      2,000                                (6) 1,400          600                      600
Purchase discounts                                        9,600   (8) 9,600
Sales allowances                           5,900                                                 5,900                  5,900




                                                                                64
                                                                                                                SECTION IV. THE ACCOUNTING CYCLE




Interest expense                     2,130               (7) 3,000                 5,130               5,130
Total-trial balance                951,030   951,030
Bad debt expense                                         (1) 3,586                 3,586               3,586
Depreciation expense- building                          (2a) 3,600                 3,600               3,600
Depreciation expense – equipment                        (2b) 2,200                 2,200               2,200
Insurance expense                                        (3) 5,200                 5,200               5,200
Interest payable                                                     (7) 3,000               3,000                                   3,000
Payroll payable                                                      (4) 5,000               5,000                                   5,000
Prepaid advertisement                                      (5) 740                  740                                     740
Supplies, ending balance                                 (6) 1,400                 1,400                                   1,400
Cost of Goods Sold                                     (8) 533,700               533,700             533,700
Total-adjusted trial balance                              579,526    579,526     949,316   949,316
Total income & expense                                                                               678,176   720,000
Income tax expense                                                                                     6,300
Tax payable                                                                                                                          6,300
Net profit                                                                                            35,524                   -    35,524
TOTAL                                                                                                720,000   720,000   271,140   271,140




                                                                     65
                                                        SECTION IV. THE ACCOUNTING CYCLE




5                                        At this step, using the information reflected in
Reflect adjusting entries                the worksheet, adjustments are posted in the
in journals and post                     General Journal and then in relevant accounts
them to ledgers
                                         in the General Ledger from the General Journal.


    Adjustments are posted in the General Journal as follows:

                                          General Journal                Journal types GJ No: 7


                                                                  Reporting year 31 Dec. 2002
            Documents           Description of                     Accounts title and code
     No     Date No.             transactions       Amount          Debit           Credit
     1
     2      01.05             Adjusting entry to    533,700    CGS
                              record Cost of          9,600    Purchase
                              Goods Sold (if                   discounts
                              periodic                 2,000   Beginning
                              inventory system                 balance of
                              is used)                         inventory
                                                       9,500   Purchase
                                                               returns
                                                     54,000                       Purchases
                                                     14,800                       Inventory
                                                                                  transportation
                                                                                  cost


                              Estimated                3,600   Depreciation       Accumulated
                              accumulated                      expense            depreciation-
                              depreciation of                                     Building
                              building




    Posting from the General Journal to the General Ledger:
                      General account: Accumulated depreciation- building

                    Debit transaction               Credit transaction             Balance
    Month                        Amount     GJ                           Amount

    11                                                                             14,400
    12                                      3,600                        3,600     18,000

                                                                                            3,600
                            General account: Depreciation expense

                Debit transaction                   Credit transaction             Balance
    Month    GJ 7    GJ 7    Amount                                      Amount

    11
    12       3,600      2,200    5,800




                                           66
                                                                  SECTION IV. THE ACCOUNTING CYCLE




        6
                                          At this step, journal entries are made to close the
        Reflect closing entries in        temporary accounts in the General Journal, and then
        journals, and post them           posted to relevant accounts in the General Ledger.
        to ledgers                        Thus, the profit or loss from the Income Statement
                                          column in the worksheet is reflected in the accounting
                                          records through closing entries.

                                                      General Journal              Journal type GJ No. 8

                                                      Reposted for the year ended 31 December, 2002

                Document                                                     Accounts title & code
        No.     s                    Description of         Amount
                Date No.              transactions
                                                                           Debit               Credit

        1       01.05         Close the sales                720,000    Sales income
                              income account                 711,300                     Income Summary
                                                               2,800                     Sales returns
                                                               5,900                     Sales discounts

        2                     Close management &             130,646    Income           Management &
                              sales expense                             summary          sales expense
                              account                                                    account

        3                     Close other income &             5,130    Income           Other expenses
                              expense account                           summary

        4                     Close Cost of Goods            533,700    Income           Cost of Goods
                              Sold account                              summary          Sold

        5                     Tax expense                      6,300    Tax expense      Income summary

        6                     Record profit for the           35,524    Income           Retained earnings
                              current period                            summary



                        General account: Income summary
Date                         Debit transactions                              Credit transactions          Balance


        GJ8       GJ8       GJ8          GJ8      GJ8         Amount               GJ8       Amount
        50-00     70-00     80-00        41-02    9100

11                                                                                                        0

12      533,700   130,646   5,130        35,524   6,300       711,300    711,300             711,300      0


       Other general accounts are also reconstructed similarly.




                                                       67
                                                    SECTION IV. THE ACCOUNTING CYCLE




Closing entries

Closing entries include the following principal entries:
   1. Close income accounts to Income Summary.
   2. Close expense accounts to Income Summary.
   3. Close the Income Summary account into the income or loss account.
   4. When the periodic inventory system is used, a closing entry to should be
       made to record the ending balance of inventory and cost of goods sold (cost
       of the used material). Please note that this system is rarely used in Mongolia.

All income accounts (the credit side of the Income Statement column in the
worksheet) should be closed. To do this, debit each income account, and credit
Income Summary at the total amount of the balances in income accounts.

All expense accounts (debit side of the Income Statement column in the worksheet)
should be closed. To do this, debit Income Summary at the total amount of the
balances in expense accounts and credit each expense account.

After posting the first two closing entries to a ledger, the balance in the Income
Summary account would show net profit/loss in the current period. This amount
should be equal to the amount of net profit/loss in the Income Statement. The
following procedures should be followed when the Income Summary account is
closed:
        • If there is net profit, Income Summary is debited for the amount of the
           profit, and the Retained Earnings account is credited.
        • If there is loss, Income Summary is credited for the amount of the loss,
           and the Retained Earnings account is debited.

Closing entries made at the end of the year in the Income Summary account are
shown below by using T-accounts:

  Cost of Goods Sold                 Income Summary                   Sales revenue

  533,700    533,700               669,476     711,300             720,000    720,000


    Management & sales
        expenses                                                       Sales returns

             130,646                                                2,800     2,800
  130,646


    Other expenses                                                   Sales discounts
  5,130      5,130

                                                                     5,900    5,900

                                  6,300                           Net Income for the
     Tax expense                                                        Period

  6,300      6,300               35,524                                      35,524

                                   711,300     711,300




                                          68
                                                     SECTION IV. THE ACCOUNTING CYCLE




Post-closing trial               The Post-Closing Trial Balance is the listing of the
balance                          balances in the accounts after closing entries are
                                 made.

The Post-Closing Trial Balance is a tool for reviewing whether closing process was
done properly. It also helps to assure that the balances in the General Ledger at the
beginning of the next reporting period are accurate and balanced (equal). Because
the permanent account balances represent the beginning balances of the next
period, they should be balanced (equal).

The Post-Closing Trial Balance differs from Adjusted Trial Balance by the following
two important characteristics:
           (1) Because all temporary accounts are closed, the Post-Closing Trial
               Balance does not list any temporary accounts
           (2) Because equity accounts are adjusted through closing entries, they
               reflect the final ending balances.

The Post-Closing Trial Balance contains only the asset, liability and equity accounts.

After closing entries are posted in the General Ledger, the new ending balances in
permanent accounts should be listed and summarized in debit and credit columns.

If the amounts in debit and credit columns are equal, it means that closing entries
were made and posted to the General Ledger accurately.

                                      TRIAL BALANCE

                                                       Debit      Credit
           Cash                                         13,600
           Accounts receivable                          64,800
           Bad debt allowance                                       5,586
           Inventory                                     77,400
           Prepaid expenses                               3,340
           Building                                      90,000
           Accumulated depreciation                                18,000
           Equipment                                     22,000
           Accumulated depreciation                                 8,800
           Accounts payable                                        34,200
           Payroll payable                                          5,000
           Notes payable                                           30,000
           Interest payable                                         3,000
           Tax payable                                              6,300
           Owners’ equity                                         100,000
           Retained earnings                                       60,254
                                                        271,140   271,140




                                                              =




                                           69
                                                           SECTION IV. THE ACCOUNTING CYCLE




 7.                               At this step, using the information from the Income
 Preparation of
                                  Statement and
 Financial Statements


Balance Sheet columns in the fully prepared worksheet or the General Ledger
closing balances, one can prepare Financial Statements. Based on the worksheet,
the following statements can be prepared directly:
    1. Balance Sheet;
    2. Statement of Changes in Equity and
    3. Income Statement; and
    4. Cash Flow Statement is prepared on the basis of the above statements.

The main purpose of preparing Financial Statements is to present the available
information in the recognized form. Summarized Balance Sheet and Income
Statement based on the worksheet are presented below:

                                         Income Statement
                          For the financial Year ended 31 December 2002


                 Total sales revenue                                               720,000
                 Sales returns and allowances                                        2,800
                 Sales discounts                                                     5,900
                 Cost of Goods Sold                                                533,700
                                          Gross income                             177,600

                 General administrative & sales expense:                           130,646
                    Management payroll expense                                      31,000
                    Sales payroll expense                                           59,000
                    Utility expenses                                                15,100
                    Insurance expense                                                5,200
                    Advertising expense                                              8,660
                    Depreciation expense                                             5,800
                    Communication expense                                            1,700
                    Bad debt expense                                                 3,586
                    Other                                                              600
                                        Operating income                            46,954
                 Non-operating income
                 Non-operating expenses                                              5,130
                 Profit before tax                                                  41,824
                 Income tax expense                                                  6,300
                 Net profit                                                         35,524


                                Statement of Changes in Equity
                             Financial Year ended 31 December 2002
                                                    Owner’s equity        Profit       Total
                                                                                       equity
     Beginning balance                                       100,000       24,730       124,730
     Increased                                                     0            0
     Decreased:
     Operation gain of the current reporting year                  0       35,524
     (losses)
     Ending balance                                          100,000       60,254       160,254

                      The amount to be carried to the
                      Balance Sheet



                                              70
                                                       SECTION IV. THE ACCOUNTING CYCLE




                                            Balance Sheet
                                Financial Year ended 31 December 2002


                 ASSETS                   AMOUNT              LIABILITIES                  AMOUNT
     Current assets                                  Current liability
     Cash                                  13,600    Accounts payable                        34,200
     Accounts receivable                   64,800    Notes payable                           30,000
     Bad debt allowance                    (5,586)   Salary payable                           5,000
                                                     Interest payable                         3,000
     Inventory                              77,400   Tax payable                              6,300
     Prepaid expense                         3,340               Total current liability     78,500
                                                     Long term liability                          0
                   Total current assets    153,554                       Total liability     78,500

     Non-current assets                              EQUITY
     Building                               90,000
     Accumulated depreciation             (18,000)   Owner’s equity                         100,000
     Equipment                              22,000
     Accumulated depreciation              (8,800)   Retained earnings                       60,254
                Total non current asset     85,200                   Total equity           160,254
              TOTAL ASSETS                238,754         TOTAL LIABILITY &                 238,754
                                                          OWNER’S EQUITY




                From the Statement of
                  Changes in Equity




We have displayed simple examples excerpted from the Worksheet in order to show
you the methods of preparing Financial Statements. An accountant should refer to
the requirements in the applicable standards, accounting policies and approved
guidelines and procedures when he/she intends to prepare Financial Statements.




                                           71

								
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