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CHAPTER TWO

2. Accounting cycle for service-giving business

2.1. Characteristics of an account

The transaction completed by an enterprise during a specific period may cause increase or
decrease in many different asset, liability or owner’s equity items. The type of record used to
recording individual transactions is called an account. Or accounting systems are designed to
show the increases and decreases in each accounting equation element as a separate record is
called an account.
The simplest form of an account has three parts: (1) a title, which is the name of the item
recorded in the account; (2) a space for recording increases in the amount of the item; and (3) a
space for recording decreases in the amount of the item. This form of an account is known as a T
account, because its similarity to the letter T.

Title
Debit Credit

Amounts entered on the left side of an account are called debits. Amounts entered on the right
side of an account are called credits. When amounts are entered in the left side of the T-account
it is said to be debited and when amounts are entered in the right side of the T-account it is said
to be credited.
The principal accounting sequence of a fiscal period called the accounting cycle. The most
significant output of the accounting cycle is the financial statements. The followings are the
accounting cycle sequence:

1. Transactions are analyzed and recorded in a journal (journal entries).

2. Journal entries posted to the ledger.
3. Trial balance is prepared, adjustments are made and work sheet is completed.
4. Financial statements are prepared.
5. Adjusting and closing entries are journalized.
6. Adjusting and closing entries are posted to the ledger.
7. Post closing trial balance is prepared

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2.2. Classification of accounts

I. Balance sheet accounts are classified as assets, liabilities, and owner’s equity.

II. Income statement accounts are classified as revenues and expenses.

I. Balance sheet accounts

1. Assets - Any physical thing (tangible) or right (intangible) that has a monetary value.

- Assets are economic resources that are expected to provide future benefits to the
organization.

- Assets are categorized as current assets and plant assets.

a. Current assets- an assets that might be expected to be realized in cash or sold or used up
within one year or less in business operation. It includes cash, accounts receivable, notes
receivable, prepaid expenses, etc.

Cash - is any medium of exchange that a bank will accept at face value, such as: bank deposit,
currency, checks, coins, money orders, bank drafts, paper money, etc.

Notes receivable- is claims against debtors evidenced by written promise.

Accounts receivable -are claim against debtors, but less formal than notes receivable.

Prepaid expenses –when payments are made in advance for economic benefits that expire
until sometime later. For example, prepaid insurance, office supplies,
store supplies, legal fees, and prepaid rent.

b. Plant assets- are tangible assets used in the business that are of a permanent or relatively
fixed nature. Sometimes called as fixed assets. It includes equipment, machinery, buildings,
land, etc. except land, plant assets gradually wear out or lose their useful life. This is called
depreciation expense.

2. Liabilities – are debts owed to outsiders or creditors. There are two categories of
liabilities i.e. current liabilities and long term liabilities.

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a. Current liabilities – are those liabilities that will be due within one year or less. Include:
Accounts payable, Notes payable, Tax payable, Interest payable, Wages and salaries payable,
etc.

b. Long term liabilities – are those liabilities that will be due after long time. When a note is
accompanied by security in the form of mortgage, the obligation referred as mortgage note
payable.

3. Owner’s Equity – it is the residual claim against the assets of the business after the total
liabilities are deducted (Net Assets of the business). For corporations, it is termed as
stockholder’s equity (shareholders’ equity or stockholders’ investment). Stockholders’
equity has components of capital stock and retained earnings. Capital stock is the
investment of stockholders in corporation type of business; also retained earnings are the net
income retained in the business.
a. Capital accounts- when a person invests in his or her own business, the investment is
recorded in an account carrying the owner’s name and the word capital.
b. Drawing represents the amount of withdrawal made by the owner of sole proprietor
ship. For corporation, dividend represents the distribution made for stockholders of
the corporation.
II. Income statement accounts
1. Revenues– are the gross increases in owner’s equity as a result of selling of goods,
rendering of service etc. for customers. Examples: sales, professional fees, commissions
revenue, fares earned, interest income etc.
2. Expenses – are costs that were incurred (have been consumed) during generating
revenue.

2.3. Chart of accounts

A group of accounts for a business entity is called a ledger. A list of the accounts in the ledger is
called a chart of accounts. Chart of accounts is a list of all accounts used by a business with
their identification number. The number of accounts maintained by specific business affected by
the type of business operation, the volume of business, managerial decision, tax authority, etc.

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There are five types of accounts i.e. assets accounts, liability accounts, owner’s equity
accounts, revenue accounts, and expense accounts. 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.

To illustrate: chart of accounts for balance sheet accounts and income statement accounts are
the followings:

Balance sheet accounts Income statement accounts

1. Assets 4. Revenues
11 cash 41 fees earned
12 Accounts receivable 5. Expenses
13 Supplies 51 Supplies Expense
14 Prepaid Rent 52 Salary Expense
2. Liabilities 53 Rent expense
21 Accounts payable 54 Depreciation Expense
22 Salaries Payable
3. Owner’s equity
31 Owner’s Capital
32 Owner’s drawing
33 Income Summaries
2.4 Rules of debit and credit
Title
Debit Credit

The right side

The left side
of the account
of the account
is called the
is called the
Credit side
Debit side

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Debit Credit
- Increase in asset accounts - Decrease in asset accounts
- Decrease in liability accounts - Increase in liability accounts
- Decrease in owner’s equity accounts - Increase in owner’s equity accounts

Expanded rules of debit and credit for balance sheet accounts

Balance sheet accounts
Assets Liabilities
Asset Accounts Liability Accounts

Debit Credit Debit Credit

For Increases for decrease for Decreases for increases

Owner’s Equity Accounts

Debit Credit

For decreases for increases

Every business transaction affects a minimum of two accounts. The transaction initially entered
in a record called journal (the book of initial entry). The process of recording a transaction in
the journal is called journalizing. The form of presentation is called a journal entry.
Illustration: Davis Carl establishes a business, to be known as Carl Repair, by initially
depositing $ 3,500 cash in bank. The journal entry for the above transaction could be as follows:
Cash…………………..…………………………. $3, 500
Carl Capital………………………………………… $3,500
The data in the journal entry are transferred to the appropriate accounts by a process known as
posting. The accounts after posting the above journal entry appear as follow:
Cash Carl Capital
$3,500 $3,500

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Carl purchased equipment at a cost of $ 2,800; Carl paid $ 1,800 in cash by writing a check and
agreed to pay the remaining $ 1,000 within one week.
Equipment ……………………………………………….2, 800
Cash ……………………………………………………………1,800
Account payable ………………………….………………..….1, 000
Cash Account Payable
3,500 1,800 1,000

Equipment
2,800 Carl Capital
3,500

This equality of debit and credit for each transaction is inherent in the equation A= L + OE. It is
because duality that the system is known as double – entry accounting.
Income statement accounts
Revenue increases owner’s equity. Just as increases in owner’s equity are recorded as credits,
increases in revenues during an accounting period are recorded as credits.
Expenses have the effect of decreasing owner’s equity, and just as decreases in owner’s equity
are recorded as debits, increase in expenses accounts are recorded as debits
Income Statement Accounts
Debit for decreases in Credit for Increase in
Owner’s Equity Owner’s Equity

Expense Accounts Revenue Accounts

Debit Credit Debit Credit

For Increases for decrease for decreases for increases

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At the end of the accounting period, all revenue and expense account balances are transferred to
a summarizing account and the account then said to be closed. Because revenue and expense
accounts are periodically closed, they are called temporary accounts or nominal accounts
Owner Withdrawals
The debit and credit rules for recording owner withdrawals are based on the effect of owner
withdrawals on owner’s equity. Since owner’s withdrawals decrease owner’s equity, the owner’s
drawing account is increased by debits. Likewise, the owner’s drawing account is decreased by
credits. Thus, the rules of debit and credit for the owner’s drawing account are as follows:
Drawing Account
Debit for Credit for
Increases (+) decreases (-)

2.5. Normal Balances of accounts

The sum of the increases in an account is usually equal to or greater than the sum of the
decreases in the account. Thus, the normal balance of an account is either a debit or credit
depending on whether increases in the account are recorded as debits or credits. For example,
since asset, expense, withdrawal accounts are increased with debits, so as these accounts
normally have debit balances. Likewise, liability, owners’ equity and revenue accounts normally
have credit balances.
2.6. Analyzing and recording transactions
Journals and accounts

The initial record of each transaction is evidenced by a business document, such as sales tickets,
or bills. On the basis of evidence provided by the business documents, the transactions are
entered in chronological order in a journal. Using the rules of debit and credit, transactions are
initially entered in a record called a journal. In this way, the journal serves as a record of when
transactions occurred and were recorded. The amounts of debits and credits in the journal are
then transferred or posted to the accounts in the ledger. A transaction is first recorded in a
journal. Periodically, the journal entries are transferred to the accounts in the ledger. The process
of transferring the debits and credits from the journal entries to the accounts is called posting.

The process of recording a transaction in the journal is called journalizing. The entry in the
journal is called a journal entry.
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The following is a useful method for analyzing and journalizing transactions:

1. Carefully read the description of the transaction to determine whether an asset, a liability, an
owner’s equity, revenue, an expense, or a drawing account is affected.
2. For each account affected by the transaction, determine whether the account increases or
decreases.
3. Determine whether each increase or decrease should be recorded as a debit or a credit,
following the rules of debit and credit shown in Exhibit 3.
4. Record the transaction using a journal entry.
The standard form of journal
Date Description Post Ref. Debit Credit
1 March 1
1
2007
2 2

The standard form of ledger

Account: _________ Account No. ___
Post Balance
Date Item Ref. Debit Credit Debit Credit
1 1
2 2
Illustration of journalizing and posting

ANN Hill operated a photographic business known as Hill Photographic Studio:

March 1. The following assets were invested in the enterprise: cash $ 3,500; accounts receivable
$950; supplies $ 1200 and photographic equipment $ 15,000.

Cash ……………………………………………………..3,500
Accounts Receivable……………………………….……950
Supplies………….………………………………………..1,200
Photographic Equipment………………………………..15,000
AnnHill, Capital…………………………………………………....20,650

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March 1. Ann Hill paid $ 2,400 for rental contract; the payment is for 3 month rent.
Prepaid Rent…………………………………………………2,400
Cash……………………………………………………………..2,400
March 4. Purchased photographic equipment on account from Palmer photographic Equipment
Inc. for$ 2,500:
Photographic Equipment…………...………….……..…..2,500
Accounts Payable…………………………..……………………2,500
March 5. Received $ 850 from customers in payment of their accounts:
Cash…………………………………….……………..…850
Accounts Receivable………………………………………….850
March 6. Paid $ 125 for news paper advertisement:
Miscellaneous Expense………………….…………….…125
Cash………………………………………………………..…….125
March 10. Paid $ 500 to Palmer Photographic Equipment Inc. to apply on the $ 2,500 debt owed
them:
Accounts Payable…….………………………………………500
Cash………………………………………………………………500
March 13. Paid receptionist $ 575 for two week’s salary:
Salary Expense……………………………………….……..575
Cash……….…………………………………….………………..575
March 16. Received $ 1,980 from fees earned for the first half of March:
Cash……………………………………………..1,980
Fees earned …………………………………..…………….……..1,980
March 27.Purchased supplies, $650 on cash.
Supplies…………………………………………..…………650
Cash……………………………………………..……………..650
March 27. Paid receptionist $ 575 for two week’s salary:
Salary Expense………………….……..……………..575
Cash……………………………….…………………….575
March 31. Paid $69 for telephone bill for the month:
Miscellaneous (utility) Exp………………………………69
Cash………………….………………………………..…..69

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March 31.Paid $ 175 for electricity bill for the month:

Miscellaneous (utility) Exp……………………………..175
Cash………………………………………………..…175
March 31. Received $ 1,870 from fees earned for the second half:
Cash………………………………………1,870
Fees earned…………………………………………..….1, 870
March 31. Sales on account totaled $1,675 for the month:
Accounts Receivable……………………..1,675
Sales……………………….………………………..1,675
March 31. Hill withdrew $1,500 for her personal use:
Ann Hill Drawing…………………………….1,500
Cash………………………………….…………..1,500
Posting of the above illustration to the account (ledger)
Account: Cash Account No. 11
Post Balance
Date Item Ref. Debit Credit Debit Credit
Mar 1 3500 3500
1 2400 1100
5 850 1950
6 125 1825
10 500 1325
13 575 750
16 1980 2730
20 650 2080
27 575 1505
31 69 1436
31 175 1261
31 1870 3131
31 1500 1631

Account: A/R Account No. 12

Post Balance
Date Item Ref. Debit Credit Debit Credit
Mar 1 950 950
5 850 100
31 1675 1775

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Account: Supplies Account No. 14

Post Balance
Date Item Ref. Debit Credit Debit Credit
Mar 1 1200 1200
20 650 1850

Account: Prepaid Rent Account No. 15

Post Balance
Date Item Ref. Debit Credit Debit Credit
Mar 1 2400 2400

Account: Photographic Equipment Account No. 18

Post Balance
Date Item Ref. Debit Credit Debit Credit
Mar 1 15000 15000
4 2500 17500

Account: A/P Account No. 21

Post Balance
Date Item Ref. Debit Credit Debit Credit
Mar 1 2500 2500
500 2000

Account: Ann Hill, Capital Account No. 31

Post Balance
Date Item Ref. Debit Credit Debit Credit
Mar 1 20650 20650

Account: Ann Hill, Drawing Account No. 32

Post Balance
Date Item Ref. Debit Credit Debit Credit
Mar 31 1500 1500

Account: fees earnd Account No. 41

Post Balance
Date Item Ref. Debit Credit Debit Credit
Mar 16 1980 1980
31 1870 3650
31 1675 5525

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Account: Salary Expense Account No. 52

Post Balance
Date Item Ref. Debit Credit Debit Credit
Mar 13 575 575
27 575 1150

Account: Miscellaneous Expense Account No. 59

Post Balance
Date Item Ref. Debit Credit Debit Credit
Mar 6 125 125
31 69 194
31 175 369
2.7. Preparing a trial balance
Trial balance
The equality of debits and credits in the ledger should be verified at the end of each accounting
period. Such verification is called a trial balance. Errors may occur in posting debits and credits
from the journal to the ledger. One way to detect such errors is by preparing a trial balance.
Double-entry accounting requires that debits must always equal credits. The trial balance verifies
this equality.
The steps in preparing a trial balance are as follows:
Step 1: List the name of the company, the title of the trial balance, and the date the trial balance
is prepared.
Step 2: List the accounts from the ledger and enter their debit or credit balance in the Debit or
Credit column of the trial balance.
Step 3: Total the Debit and Credit columns of the trial balance.
Step 4: Verify that the total of the Debit column equals the total of the Credit column.

Example for Ann Hill photographic studio is as follows:

Hill Photographic Studio
Trial Balance
March 31, 1990

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Cash 1,631
Accounts Receivable 1,775
Supplies 1,850
Prepaid Rent 2,400
Photographic Equipment 17,500
Accounts Payable 2,000
Ann Hill, Capital 20,650
Ann Hill Drawing 1500
Fees earned 5,525
Salary Expense 1,150
Miscellaneous Expense 369
28,175 28,175

2.8. The usefulness and limitations of a trial balance

Proof Provided By the Trial Balance
The trial balance does not provide complete proof of accuracy of the ledger. It indicates only that
the debits and credits are equal. If the two totals of trial balance are not equal, it is probably due
to one or more of the following types of errors:
1. Error in preparing trial balance:
a. One of the columns of the trial balance was incorrectly added.
b. The amount of an account balance was incorrectly recorded on the trial balance.
c. A debit balance was recorded as credit, or vice versa, or a balance was omitted entirely.
2. Error in determining the account balance:
a. A balance was incorrectly computed.
b. A balance was entered in the wrong balance column.
3. Error in recording a transaction in the ledger
a. An erroneous amount was posted to the account.
b. A debit entry was posted as a credit, or vice versa.
c. A debit or credit posting was omitted.

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Among the types of errors that will not cause an inequality in the trial balance totals are the
following:
1. Failure to record a transaction or to post a transaction.
2. Recording the same erroneous amount for both the debit and credit parts of a transaction.
3. Recording the same transaction more than one.
4. Posting a part of a transaction correctly as a debit or credit but not to the wrong account.
Discovery of errors
The existence of an error can be determined in various ways:
1. By audit procedures
2. By chance discovery, or
3. Through the medium of the trial balance.
Types of error
1. Addition
For example, a difference of $10, $100, or $1,000 between totals is frequently the result of error
in addition.
2. Omission
A difference between totals can happen due to the omission of a debit or a credit posting or, if it
is divisible evenly by 2, to the posting of a debit or a credit, or vice versa. For example, if the
debit and credit totals of a trial balance are $ 20,640 and $20,236 respectively, the difference of
$404 may indicate that a credit posting of that amount was omitted or that a credit of $202 was
erroneously posted as a debit.
3. Transpositions:
It is the erroneous rearrangement of digit, such as writing $ 542 as $524 or $452.
4. Slide
It is the entire number is erroneously moved one or more spaces to the right or the left, such as
writing $542.00 as $54200 or $54.20.

2.9. The adjusting process – Accrual Vs. cash basis of accounting

Matching principle
Revenues and expenses may be reported on the income statement by:

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1. The cash basis of accounting, or

2. The accrual basis of accounting.
When the cash basis is used, revenues are reported in the period, in which cash is received, and
expenses are reported in the period in which cash is paid. I.e. net income or net loss is the
difference between cash received from revenues and cash disbursements for expenses.

When the accrual basis of accounting is used, revenues are reported in the period in which they
are earned, and expenses are reported in the period in which they are incurred in an attempt to
produce revenues.

NB. Most enterprises use the accrual basis of accounting. Generally accepted accounting
principles (GAAP) requires the use of the accrual basis, so that revenues recognized are
matched with the expenses incurred in producing the revenues.

Adjustments

Some of the trial balance amounts are not correct. The amounts listed for prepaid expenses are
normally overstated. This is because of the day to day consumption or expiration of these assets
has not been recorded. There are two effects on the ledger when the daily reduction in prepaid
expenses is not recorded:

1. Asset accounts are overstated, and

2. Expense accounts are understated, then the net income will be overstated or the net loss
understated.
For example, salary expense incurred between the last payday and the end of the accounting
period would not be recorded in the account.
The entries required to record at the end of an accounting period to bring the accounts up to date
and to assure the proper matching of revenues and expenses are called adjusting entries.
Adjusting Entries
Adjusting entries are journal entries that are required at the end of an accounting period to bring
the ledger up-to-date. Adjusting entries can be classified as either deferrals or accruals.
- Deferrals: - 1. Prepaid Expenses. Expense that are paid in cash before they are used
or consumed.

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2. Unearned Revenues. Revenues received in cash before delivering

goods or services.

- Accruals: - 1. Accrued Expenses: Expenses incurred but not yet paid in cash or
recorded.

2. Accrued revenues. Revenues earned but not yet received in cash or

recorded.

Prepaid expenses (deferred expenses)

It is already paid before using the service or property. Such as: prepaid rent, prepaid insurance.

Illustration:

a. The inventory of supplies on March 1 is $1,850 & March 31 is determined that $890 is on
hand, the amount to be moved from asset account to expense account is $960 i.e. (1,850-
890=960).

Supplies Expense………………………………………….960
Supplies……………...…………………………………………960
b. Prepaid rent was used for one month (March 1 up to March 31).

Rent Exp…………………………………………….800
Prepaid Rent………………………………………….800
Plant Assets
As time passes, equipment’s do lose its capacity to provide useful service. This decrease in
usefulness is a business expense, which is called depreciation. This expired portion of the cost
of plant asset is both an expense and a reduction in the asset. The adjusting entry to record is
depreciation expense debited and accumulated depreciation credited.

c. The estimated amount of depreciation of the photographic equipment for the month is
assumed to be $175:

Depreciation expense …………………………………………………175

Accumulated Depreciation - Photo. Equip………….……………175

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Accrued Expenses (Liabilities)

Accrued expense is an accumulated expense that is unpaid and unrecorded, such as: unpaid and
unrecorded amount of salary for employees. The accrued expense and the related liabilities must
be recorded in the account by the adjusting entry.

d. The debit of $ 575 on March 13 and 27 in the salary expense account were biweekly
payments on Fridays for the payroll periods ended on those days. The salaries expense on
Monday and Tuesday, March 30 and 31 total $ 115.

Salary Expense………………………………………….115

Salary Payable…………………………..…………………..115

2.10. preparing a work sheet

A type of working paper frequently used by accountants prior to preparation of financial

statements is called work sheet.
Benefits of Work Sheet
Work sheet is not a required report (it is not available to external decision makers), yet using of
work sheet has several benefits, such as:
- Aids the preparation of financial statements.
- Reduce the possibilities of errors.
- Links accounts and adjustments to their impacts in the financial statements.
Work sheet has an account title column and ten columns, ranged in five parts of debit and
credit columns. The main headings are: Unadjusted trial balance, adjustments, adjusted trial
balance, income statement and balance sheet.
Trial Balance Column
The trial balance data can be assembled directly on the work sheet form or can be prepared on
another sheet and then copied on to the work sheet form.

Adjustments Column

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Both the debit and credit parts of an adjustment should be inserted on the appropriate lines before
going on to another adjustment.
a. Supplies: Supplies account………………………………………………………….$1,850
Less: Supplies on hand……………………………………………………..890
Supplies Expense……………………………………………………………960
b. Rent: Prepaid rent (for 3 month)……………..…………..……………………….…$2,400
Less: Remaining prepaid rent (2 month)……………………….…….……….1,600
Rent Expense for March……..…………………………………………………800
c. Depreciation: depreciation of photographic equipment is estimated to be $175 for the month:
Depreciation expense……………………………..…….175
Accumulated depreciation ………………..…….………175
d. Salaries: Salaries accrued but not yet paid at the end of the month of March is $115. This is
an increase in expense and an increase in liability.
Adjusted Trial Balance

The data in the trial balance columns are combined with the adjustments data and extend to the
adjusted trial balance columns.

Income Statement and Balance Sheet

The data in the adjusted trial balance columns are extended to one of remaining four columns.
The amounts of assets, liabilities, owner’s equity and drawing (or dividends) are extended to the
balance sheet columns; and the revenues and expenses are extended to income statement
columns.

The net income or net loss for the period is the amount of the difference between the totals of the
two income statement columns. If the credit column total is greater than the total of debit
column, the excess is the net income. The net balance will be transferred to the capital account
(or retained earnings account) in the ledger. This transfer is accomplished on the work sheet by
entries in the income statement and balance sheet.

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Illustration: For Hill Photographic Studio work Sheet is transferred as debt in income statement
column and credit in balance sheet.

Hill Photographic Studio

Work Sheet
For the Month Ended March 31, 1990
Trial Balance Adjustments Adjusted Trial Income Balance Sheet
Account Title bal Statement
Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit
Cash 1631 1631 1631
Accounts receivable 1775 1775 1775
Supplies 1850 (a) 960 890 890
Prepaid Rent 2400 (b) 800 1600 1600
Photo. Equip. 17500 17500 17500
Accounts Payable 2000 2000 2000
Ann Hill Capital 20650 20650 20650
Ann Hill Drawing 1500 1500 1500
Fees earned 5525 5525 5525
Salary Expense 1150 (d)11 1265 1265
5
Miscellaneous 369 369 369
Expense
28175 28175
Supplies Expense (a)96 960 960
0
Rent Expense (b)80 800 800
0
Depreciation Exp. (c)17 175 175
5
Accumulated Depn. (c )175 175 175
Salaries Payable (d) 115 115 115
2050 2050 28465 28465 3569 5525 24896 22940
Net income 1956 1956
5525 5525 24896 24896

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2.11. Preparing financial statements from a worksheet

Financial statements
Work sheet is an aid in preparing financial statement. The income statement, statement of
owner’s equity and balance sheet prepared from work sheet. For Hill Photographic Studio, the
financial statements are presented as follows

Hill Photographic Studio

Income Statement
For Month Ended March 31, 1990

Fees earned 5,525

Operating Expenses:
Salary Expense 1,265
Supplies Expense 960

Rent Expense 800

Depreciation expense 175

Miscellaneous Expense 369

Total Operating Expenses 3,569

Net Income 1,956

Hill Photographic Studio

Statement of Owner’s Equity
For Month Ended March 31, 1990

Ann Hill Capital, March 1,1990…………………….. 20,650

Net Income for the Month……………………….…. 1956
Less:
Withdrawals……………………………………….…. 1500
Increase in Owner’s Equity……………………..….. 456
Ann Hill Capital, March 31, 1990………………...… 21106

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Hill Photographic Studio

Balance Sheet
March 31, 1990

Assets
Current Assets:
Cash 1,631
Account Receivable 1,775
Supplies 890
Prepaid Rent 1,600
Total Current Assets 5,896
Plant Assets:
Photographic Equipment 17,500
Less: Accumulated Depreciation 175 17,325
Total Assets 23,221
Liabilities
Current Liabilities:
Account Payable 2,000
Salaries Payable 115
Total Liabilities 2,115
Owner’s Equity
Ann Hill, Capital 21,106
Total Liabilities and owner’s Equity 23,221

2.12. Adjusting and closing entries

Adjusting entries
At the end of the accounting period, the adjusting entries appearing in the work sheet are
recorded in the journal and posted to the ledger. The adjusting entries are dated as of the last day
of period.
The adjusting entries for Hill Photographic Studio as of March 31 are as follows:
Supplies Expense…………………………………………..960
Supplies………………………………..……………………….960

Rent Expense……………………………….…………….800
Prepaid rent……………………………………………………800
Depreciation Expense…........................175
Accumulated depreciation………………….………………….175
Salary Expense…….………………………....115
Salary Payable…………………………….……………………..115

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Closing entries
The revenue, expense, and drawing (or dividends) accounts are temporary accounts used in
classifying and summarizing changes in the owner’s equity during the accounting period. At the
end of the period, the net effect of the balances in these accounts must be recorded in the
permanent capital (or retained earnings) account. The balance must also be removed from
temporary accounts, these processes done by closing entries.
Journalizing and posting closing entries

An account title income summary is used for summarizing the data in the revenue and expense
accounts (used only at the end of accounting period). And opened and closed during the closing
process.

Four entries are required to close temporary account. They are as follows:

1. Each revenue debited and income summary is credited for the total revenues.
2. Each expense is credited and income summary is debited for the total of expenses.
3. Income summary is debited for the amount of its balance if income is generated and
capital account is credited. If it is net loss, capital account is debited and income
summary is credited for the amount of its balance.
4. The drawing account is credited for the amount of its balance, and capital account
debited.

Closing entry for Hill Photographic Studio is as follows:

Fees earned……………..………………………………….5525
Income Summary…………………………………….5525
Income Summary…………………………………3569
Salary Expenses……………………………………....1265
Miscellaneous Expenses…..……………………….…369
Supplies Expenses……………………………………..960
Rent Expenses…………………………………...……..600
Depreciation Expenses…………………………………175
Income Summary…………………………………1956
Ann Hill, Capital………………………………………..1956

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Ann Hill, Capital………………………………….1500

Ann Hill drawing……………………………………….1500

After journalizing, the closing entries should be posted to the ledger. The sales, expenses, income
summary, and drawing accounts then get zero balance.

2.13.Post - closing trial balance

The last procedure of the accounting cycle is the preparation of post closing trial balance after all
of the temporary accounts has been closed. The purpose of the post closing trial balance is to
make sure that the ledger is balance at the beginning of the new accounting period. The
following is Hill Photographic Studio post closing trial balance as of March 31, 1990:

Hill Photographic Studio

Post Closing Trial Balance
March 31, 1990

Cash 1,631
Accounts receivable 1,775
Supplies 890
Prepaid Rent 1,600
Photographic Equipment 17,500
Accumulated Depreciation 175
Accounts Payable 2,000
Salary Payable 115
Ann Hill, Capital 21,106
23,396 23,396

FISCAL YEAR

The maximum length of an accounting period is usually one year (12 months). The annual
accounting period adopted by an enterprise is known as fiscal year.

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