Accounting cycle
The Accounting Cycle
Steps in the Accounting Cycle
The accounting process consists of several steps typically followed within a given accounting period.
These steps are repeated for each accounting period throughout the operational life of the business.
Collectively, these steps form what is termed the accounting cycle.
Overview of the Accounting Cycle
Stage Overview:
Source Documents
Journalizing
Posting to Ledger
Trial Balance
Adjustments
Adjusted Trial Balance
Closing Entries
Source Documents in Accounting Transactions
Definition: Source documents are the primary records of accounting transactions.
Examples of Source Documents:
Invoices: Requests for payment sent from sellers to buyers for goods or services provided.
Receipts: Proof of payment received for a completed transaction.
Purchase Orders: Requests from buyers to sellers detailing desired products.
Bank Statements: Documents detailing deposits and withdrawals made from a bank account.
Deposit Slips: Forms completed when cash or checks are deposited into an account.
Credit Notes: Issued for returned goods to indicate the reversal of a transaction.
Cheques: Written orders directing a bank to pay a specified amount from the drawer's account.
Electronic Funds Transfer (EFT) Records: Documentation of electronic payments made.
Cash Register Receipts: Printed information from point-of-sale transactions for cash purchases.
Internal Memos: Used for transactions occurring within the company.
Purpose of Source Documents
Evidence: They establish that a financial transaction has taken place.
Accuracy: They contain details necessary to accurately record transactions in the accounting system.
Verification: Auditors and tax authorities utilize these documents to verify the integrity of financial statements and tax returns.
Record-keeping: They contribute to maintaining a verifiable audit trail and serve as legal evidence during disputes.
Step 2: Journalizing
Journalizing: The process of analyzing the dual effect of each transaction from the source documents and recording them chronologically in journals or books of prime entry.
Function of Journals: They act as formal links between source documents and corresponding ledger accounts.
Contents of a Journal
Essential Components:
Date of the transaction.
Titles of the accounts being debited and credited.
Amounts for both debit and credit entries.
A Brief Narration describing the transaction.
Example of Journal Entry
Format:
DATE
DETAILS/DESCRIPTION
DEBIT
CREDIT
Practical Illustration of Journal Entries (Example Transactions for A. Raisi)
Transaction Timeline:
July 1: Owner starts the shop with:
Sewing machine: TZS 500,000
Cash: TZS 300,000
July 2: Purchase of supplies for: TZS 50,000 cash.
July 3: Service transaction where he earned TZS 40,000 cash.
July 4: Service transaction on credit to neighbor M. Jumanne for TZS 60,000 by the end of the month.
July 5: Payment received for a service rendered: TZS 20,000.
July 6: Purchase of chairs on credit worth TZS 10,000.
Journal Entries
Example Entries:
July 1:
Debit: Cash TZS 300,000
Debit: Sewing Equipment TZS 500,000
Credit: A. Raisi, Capital TZS 800,000 (Initial investment)
July 2:
Debit: Sewing Supplies TZS 50,000
Credit: Cash TZS 50,000 (Bought for cash)
July 3:
Debit: Cash TZS 40,000
Credit: Sewing Income TZS 40,000 (For services rendered)
July 4:
Debit: M. Jumanne/Debtor TZS 60,000
Credit: Sewing Income TZS 60,000 (Debt for service)
July 5:
Debit: Cash TZS 20,000
Credit: Sewing Income TZS 20,000 (For sewing a dress)
July 6:
Debit: Shop Furniture/Chair TZS 10,000
Credit: Mwenge Furniture Mart/Creditor TZS 10,000 (On credit)
Step 3: Posting to the Ledger
Definition: Depositing collected account activities into the respective ledger accounts.
Classification: Accounts are sorted into assets, liabilities, capital, expenses, and revenues.
Posting Mechanism: Refers to transferring detailed entries from journals to ledgers, ensuring each transaction is grouped correctly.
General vs. Subsidiary Ledgers:
General Ledger (GL):
Central record aggregating all financial transactions with summarised balances for all accounts.
Used to prepare financial statements such as Balance Sheets and Income Statements.
Subsidiary Ledger:
Detailed records supporting specific accounts within the GL (e.g., individual customer accounts).
Facilitates reconciliation of credit transactions with detailed operational entries.
Organization of the Ledger Account Titles
Example Chart:
Assets:
Non-Current Assets:
Sewing Equipment (Account No 01)
Shop Furniture (Account No 02)
Current Assets:
Accounts Receivable - M. Jumanne (Account No 11)
Cash (Account No 12)
Liabilities:
Accounts Payable – Mwenge Furniture Mart (Account No 21)
A. Raisi, Capital (Account No 31)
Sewing Income (Account No 41)
Sewing Supplies (Account No 51)
Preparation of a Trial Balance
Definition: A formatted listing of all balances from the ledger accounts.
Balancing Process: Provides a summary by adding separately the debit and credit amounts.
If debit amounts exceed credits, the remaining amount is termed a debit balance.
Conversely, if credit amounts are higher than debit totals, it's a credit balance.
Nature of Accounts: Different types of accounts can typically only display debit or credit balances depending on their classifications.
Steps of Adjustments
Adjustment Process: Last adjustments are made at the end of an accounting period.
Associated with:
Accrual Concept: Recognizing accrued revenues and expenses while deferring prepaid expenses.
Historical Cost Concept: Implementing appropriate depreciation for assets.
Prudence Concept: Limiting profit recognition and factoring in potential losses to avoid overstatement.
Preparation of Financial Statements
Types of Statements:
Statement of Comprehensive Income (Profit and Loss Account): Indicates profitability by contrasting Revenue with Expenses.
Statement of Financial Position: Displays the assets owned, alongside liabilities and owner's equity. Formula:
Cash Flow Statement: Tracks cash inflows and outflows to show alteration in cash position over the accounting period.
Statement of Changes in Equity: Captures shifts in ownership interest (capital) across a time span; reconciles beginning and ending balances.
Highlights changes driven by factors like net income and withdrawals.
Improves transparency for investors regarding the application of profits or dividends.
Example Financial Statement for A. Raisi Tailoring Shop
Statement of Comprehensive Income (Week ending July 6, 200X):
Total Sewing Income: TZS 120,000
Less Sewing Supplies Expense: TZS 50,000
Net Profit: TZS 70,000
Statement of Financial Position (As of July 6, 200X):
Non-Current Assets:
Sewing Equipment: TZS 500,000
Shop Furniture: TZS 10,000
Total Non-Current Assets: TZS 510,000
Current Assets:
Cash: TZS 310,000
Accounts Receivable - M. Jumanne: TZS 60,000
Total Current Assets: TZS 370,000
Total Net Assets: TZS 870,000
Financed by Owner's Equity:
A. Raisi, Capital: TZS 800,000
Add: Net Profit: TZS 70,000
Total Owner's Equity: TZS 870,000
Statement of Cash Flow (As of July 6, 200X)
Categorized by operating, investing, and financing activities:
Operating Activities:
Net Profit: TZS 70,000
Decrease in Debtor: (TZS 60,000)
Increase in Creditor: TZS 10,000
Net Cash Flow from Operating Activities: TZS 20,000
Investing Activities:
(Increase) in Non-Current Assets: (TZS 510,000)
Net Cash Flow from Investment Activities: (TZS 510,000)
Financing Activities:
Increase in Capital: TZS 800,000
Net Cash Flow from Financing Activities: TZS 800,000
Change in Cash Flow: (A+B+C) results in TZS 310,000
Closing Cash Balance: TZS 310,000
Statement of Change in Equity (For the week ending July 6, 200X)
Opening Balance: TZS 0
Capital Introduced: TZS 800,000
Add: Profit: TZS 70,000
Less: Withdrawals or Dividends Paid: TZS 0
Closing Balance: TZS 870,000