The Accounting Cycle of a Service Business (Steps 1-4)

Definition

The accounting cycle is a series of sequential steps used to record, classify, and summarize financial transactions.

  • It repeats every accounting period.

  • Steps 1 to 3 occur during the period.

  • Steps 4 to 9 occur at the end of the period.

  • The last step is optional and happens at the beginning of the next period.

STEP 1: TRANSACTION ANALYSIS

Four Basic Steps

  1. Identify the transaction using source documents.

  2. Determine the accounts affected:

    • Assets

    • Liabilities

    • Equity

    • Revenue

    • Expenses

  3. Determine whether each account increases or decreases.

  4. Apply debit and credit rules.

THE JOURNAL

Definition

The journal is a chronological record of transactions. It is called the book of original entry.

Purpose

  • Records transactions before they are transferred to the ledger.

General Journal Format

  1. Date

  2. Account Titles and Explanation

    • Debit account is written first (left side)

    • Credit account is indented below

  3. Folio (Posting Reference)

  4. Debit Column

  5. Credit Column

TYPES OF JOURNAL ENTRIES

Simple Entry

  • Involves two accounts:

    • One debit

    • One credit

Compound Entry

  • Involves three or more accounts

STEP 2: JOURNALIZING TRANSACTIONS

Definition

Journalizing is the process of recording transactions in the journal.

RULES OF DEBIT AND CREDIT

Debit an Account When:

  1. Asset increases

  2. Equity decreases

    • Owner withdrawal (Drawing)

    • Expenses

  3. Liability decreases

Credit an Account When:

  1. Liability increases

  2. Equity increases

    • Owner investment

    • Revenue

  3. Asset decreases

DOUBLE-ENTRY SYSTEM RULES

  1. At least two accounts are affected in every transaction.

  2. Total debits must equal total credits.

  3. The accounting equation remains balanced.

SAMPLE TRANSACTIONS (AxServe Services)

Jan 1 – Owner Investment

  • Cash increases (Debit 120,000)

  • Capital increases (Credit 120,000)

Jan 5 – Purchase of Equipment

  • Office Equipment increases (45,000)

  • Cash decreases (20,000)

  • Accounts Payable increases (15,000)

Jan 9 – Advance Rent

  • Prepaid Rent increases (12,000)

  • Cash decreases (12,000)

Jan 11 – Service for Cash

  • Cash increases (25,000)

  • Service Revenue increases (25,000)

Jan 15 – Service on Account

  • Accounts Receivable increases (38,000)

  • Service Revenue increases (38,000)

Jan 19 – Equipment Purchase with Note

  • Office Equipment increases (30,000)

  • Cash decreases (10,000)

  • Notes Payable increases (20,000)

Jan 20 – Collection from Customer

  • Cash increases (20,000)

  • Accounts Receivable decreases (20,000)

Jan 22 – Advance Payment from Client

  • Cash increases (10,000)

  • Unearned Service Revenue increases (10,000)

Jan 26 – Owner Withdrawal

  • Drawing increases (Debit 5,000)

  • Cash decreases (5,000)
    Note: Drawing has a normal debit balance.

Jan 31 – Payment of Expenses

  • Salaries Expense increases (9,000)

  • Utilities Expense increases (5,000)

  • Cash decreases (14,000)

JOURNALIZING RULES

  1. Write the date first.

  2. Debit accounts are written on the left.

  3. Credit accounts are indented below debit accounts.

  4. Debit amounts go in the debit column.

  5. Credit amounts go in the credit column.

  6. Write a brief explanation below the entry.

FORMATTING GUIDELINES

  • Do not write peso signs.

  • Do not use commas or decimal points in columns.

  • Use correct spacing between entries.

  • Capitalize account titles.

  • Do not split entries across pages.

  • Follow the chart of accounts for correct account names.

STEP 3: POSTING TO THE LEDGER

THE LEDGER

Definition

The ledger is the group of all accounts used by the company. It is called the book of final entry.

Classification of Accounts

  1. Balance Sheet (Real Accounts)

    • Assets

    • Liabilities

    • Owner’s Equity

  2. Income Statement (Nominal Accounts)

    • Revenue

    • Expenses

Key Idea

  • Journal → arranged by date (chronological)

  • Ledger → arranged by account

CHART OF ACCOUNTS

Definition

A chart of accounts is a list of all account titles with corresponding account numbers.

Arrangement

  1. Balance Sheet accounts first:

    • Assets

    • Liabilities

    • Owner’s Equity

  2. Income Statement accounts next:

    • Revenue

    • Expenses

Purpose

  • Used for indexing and cross-referencing

POSTING TO THE LEDGER

Definition

Posting is the process of transferring data from the journal to the ledger.

Steps in Posting

  1. Copy the date from the journal to the ledger.

  2. Copy the journal page number to the J.R. column.

  3. Transfer:

    • Debit → debit column

    • Credit → credit column

  4. Write the account number in the P.R. column of the journal.

LEDGER BALANCES

  • Add both debit and credit columns.

  • Determine balance:

    • If Debit > Credit → Debit balance

    • If Credit > Debit → Credit balance

USE OF T-ACCOUNTS

Definition

A T-account is a simple tool used to analyze increases and decreases in accounts.

Parts of a T-Account

  1. Account Title

  2. Debit (left side)

  3. Credit (right side)

Rules in T-Accounts

Debit Side

  • Increase in Assets

  • Decrease in Liabilities

  • Decrease in Owner’s Equity (withdrawals, expenses)

Credit Side

  • Decrease in Assets

  • Increase in Liabilities

  • Increase in Owner’s Equity (investment, revenue)

STEP 4: PREPARATION OF TRIAL BALANCE

THE TRIAL BALANCE

Definition

The trial balance is a list of all accounts and their balances used to check if:

  • Total debits = Total credits

Important Note

  • It checks equality, not accuracy

Steps in Preparing Trial Balance

  1. List all account titles in numerical order

  2. Write balances in:

    • Debit column

    • Credit column

  3. Add both columns

  4. Check if totals are equal

POSSIBLE ERRORS IN TRIAL BALANCE

1. Transposition Error

  • Digits are reversed

  • Example:

    • 48 → 84

    • 234 → 432

2. Transplacement (Slide Error)

  • Decimal point misplaced

  • Example:

    • 100 → 10

    • 67.89 → 678.9

Key Tip

  • If the difference is divisible by 9, it may be one of these errors

IMPORTANT REMINDER

  • Debit total must always equal credit total

  • If not equal, there is an error that must be corrected