UNIT-III COMPLETION OF THE ACCOUNTING CYCLE

3.1 ADJUSTMENTS

All the transactions recorded above in the journalizing step are the result of daily transactions. Other
transactions result from the passage of time or from the internal operations of the business. For
example, insurance premiums are paid for a certain period of time and expire during that time period.
Another example is office supplies such as paper, pens & pencils.
At the end of the period the balances in accounts such as supplies and prepaid insurance must be brought
up to date. The supplies account balance, for example, must be credited by the consumed part of the
supplies, debiting supplies expense.
Example. Stationary materials totaling Birr 1,900.00 were purchased and recorded during the year. At
the end of the year, only Birr 150 of the supplies are left in hand.
The adjusting entry prepared at the end of the year to adjust the supplies account will be
1990 Supplies expense 1,750
Dec31 Supplies 1,750

Note: 1. Adjustments are dated as the last day of the year.

2. The accounting year here – we assume, runs from January 1- December 31.
Additional examples on adjustments will be given below under the topic ‘worksheet’

3.2.1. The Accrual Basis and the Cash Basis of Accounting

1. The cash basis of accounting – In this basis of accounting revenues are reported in the period in
which cash is received and expenses are reported in the period in which cash is paid. Net in come
will, therefore, be the difference between the cash receipts (Revenues) and cash payments
(expenses). This method will be used by organizations that have very few receivables and payables.
For most businesses, however, the cash basis is not an acceptable method.
2. The accrual basis of accounting – Under this method revenues are reported in the period in
which they are earned, and expenses are reported in the period in which they are incurred. For
example, revenue will be recognized as services are provided to customers or goods sold and not
when cash is collected. Most organizations use this method of accounting and we will apply this
method in this course.

3.2.2 The Matching Principle

We have discussed three concepts and principles in accounting in unit one. Now we will see one more
principle, the matching principle. This principle states that the expense of a period have to be matched
with the revenue of that period regardless of when payment is made. In order to do this, the accrual
basis of accounting requires the use of an adjusting process at the end of the period so that revenues and
expenses of the period will be determined properly.

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 3.3 WORKSHEET FOR FINANCIAL STATEMENTS

Most of the data required to prepare the accounting reports (financial statements) is now gathered. The
data will now be presented in a convenient form. The worksheet is a large columnar sheet prepared to
arrange in a convenient form all the accounting data required to prepare financial statements. The
worksheet has a heading and a body.
The heading has three parts:
i) Name of the Organization
ii) Name of the form (worksheet)
iii) Period of time covered.
The body contains five main parts each of them with two main columns. These parts are
1. The trial balance
2. The adjustment
3. The adjusted trial balance
4. The income statement
5. The balance sheet.
The worksheet for Bati Transport is given below. The five parts of the body are discussed as follows.
You are advised to read and understand the discussions before you look at the respective columns of the
worksheet.

Bati Transport Work Sheet For th3e month ended jan.31,2003

Account Title Trial Balance Adjustment Adjusted Trial balance Income statement Balance sheeet
1 Cash 41,030 41,030 41,030
©
2 Accounts receivable 2,250 7,400 9,650 9,650
(a)
3 Supplies 740 340 400 400
(b)
4 Prepaid Insurance 600 450 150 150
5 Office equipment 11,600 11,600 11,600
6 Truck 550,000 550,000 550,000
7 Accounts payable 12,430 12,430 12,430
8 Notes payable 150,000 150,000 150,000
9 Yimer Capital 450,000 450,000 450,000
10 Yimer drawing 500 500 500
©
11 Service income 17,900 7,400 25,300 25300
12 Salary expense 18,800 18,800 18,800
13 Rent expense 4,000 4,000 4,000
14 Utilities expense 220 220 220
15 Maintenance expense 450 450 450
16 Truck expense 90 90 90
17 Miscellaneous Expense 50 50 50
18 630,330 630,330
(a)
19 Supplies expense 340 340 340
(b)
20 Insurance expense 450 450 450
21 7290 7290 636,830 636,830
22 Net income
23 25300 25300 613,330 613,330

1. The trial balance column – this is the same trial balance we have prepared before. The trial balance
column of the work sheet can be brought direct from the ledger or from a separate trial balance.
2. The Adjustment column – As mentioned previously, some account balances have to be adjusted at
the end of the year.

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The accounts in the ledger of our illustration that require adjustment and the adjusting entry for the
accounts are presented below.
a) Supplies – The supplies account has a debit balance of Birr 740. The cost of supplies in hand on July
31 is determined to be Birr 400. The following adjusting entry is required to bring the balance of the
account up to date:
Supplies expense…………………………….340
Supplies……………………………………..340
b) Prepaid insurance – Analysis of the policy showed that three – fourth of the policy is expired. That
is only Birr 150 of the policy is applicable to future periods. The adjusting entry to transfer the expired
part of the insurance to expense will be.
Insurance expense ……………………….450
Prepaid insurance………………………..450
c) Service Income – At the end of the month unbilled fees for services performed to clients totaled Birr
6,500.
This amount refers to an income earned but to be collected in the future. The journal entry to record it
will be
Accounts receivable………………………….6,500
Service income………………………………6,500
All the above adjusting entries will be inserted in the adjustment column of the worksheet in front of the
accounts affected.
Note – The letters a, b & c are used to cross-reference the debits and credits to help future review of the
worksheet.
3. The Adjusted Trial Balance Column – The accounts that require adjustment are now adjusted.
Transferring the trial balance column amounts combined with the adjustment column amounts will
complete the adjusted trial balance column of the worksheet.
4. The income statement and the balance sheet columns – Transfer the income statement account
balances (revenue &expenses) to the income statement and balance sheet account balances (Asset,
Liability &owners equity) to the balance sheet columns. Note that what we have to transfer is the
adjusted trial balance column amounts, to the corresponding columns.
Look at the 22nd row. It shows the net income for the month and it is added to the two columns (Income
statement Dr. and balance sheet cr.) as a balancing figure.

3.4 FINANCIAL STATEMENT PREPARATION

After the work sheet is completed financial statements could be prepared easily. In chapter one we have
discussed four basic financial statements prepared by most organizations. Here, we will prepare three of
these statements for Bati Transport form the worksheet.
1. Income statement All the data required to prepare the income statement is brought
from the worksheet.
Bati Transport Income statement For the month ended. Jan 31, 2003

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Service Income …………………………………………………………Birr 25,300
Operating expenses
Salary expense………………………..Birr 18,800
Rent “…………………………………….4,000
Maintenance expense ……………………… 450
Insurance “ ……………………………450
Supplies “ …………………………….340
Utilities “……………………………..220
Truck “ …………………………….. .90
Miscellaneous “………………………………50
Total operating expense………………………………………24,400
expense………………………………………24,400
Net Income…………………………………………………Birr 900
2. Statement of owner’s equity – This statement shows the beginning balance of capital and the
changes that affected it.
The balance of the owners equity account (Yimer capital) in the worksheet may not be the beginning
one. Therefore, the ledger has to be reviewed to see if there was an additional investment during the
priod or not. In our illustration there is no additional investment.

Bati Transport Statement of Owner’s equity For the month ended January 31, 2003
Yimer capital January 1, 2003………………………………Birr 450,000
Net income for the month………………….birr 900
Less:
Less: Withdrawal…………………………………...500
Withdrawal…………………………………...500 400
Yimer capital, January 31, 2003……………….…………….Birr 450,400

3. Balance sheet – The data to prepare this statement will be taken from the worksheet and the other
financial statements. Note that assets and liabilities are classified as current and non – current.
Bati Transport Balance sheet January 31, 2003
Assets
Current Assets:
Cash…………………………………………Birr 41, 030
Accounts Receivable…………………………….. 9,650
Supplies…………………………………………… 400
Prepaid insurance…………………………………….150
insurance…………………………………….150
Total current assets……………………………………………Birr 51,230
Plant Asset (None-Current Assets):
Assets):
Office equipment……………………………..Birr 110,600
Truck………………………………………………550,000
Truck………………………………………………550,000 561,600
Total asset………………………………………………………Birr 612,830
Liabilities
Current liabilities
Accounts payable……………………………..Birr 12,430
Non-current liabilities
Notes payable……………………………………..150,000
payable……………………………………..150,000

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 Total liabilities……………………………………………………Birr 162,430
Owner’s equity
Ato Yimer Capital…………………………………………………………….. 450,400
Total liability and owners equity………………………………………….Birr 612,830

3.5 THE CLOSING PROCESS

Some of the accounts in the ledger are temporary accounts used to classify and summarize the
transactions affecting capital (owners’ equity). These accounts will be closed after financial statements
are prepared. That is, their balances will be transferred to the Capital account. The temporary accounts
that have to be closed are revenue, expense and withdrawal accounts.
Steps in closing:
1. Closing revenue accounts - Debit each revenue account by its balance and credit the
‘Income Summary’ account by the total revenue for the period.
Note: Income summary is an account used to close revenue and expense accounts. This account will
immediately be closed to the capital account at the end of the closing process.
2. Closing expense accounts – Debit the income summary account by the total of
expenses for the period and credit each expense account by its balance.
3. Closing the income summary account – Income summary will be closed to the
capital account. The balance of his account depends on the nature of operation; credit if result is
profit and debit if result is loss.
4. Closing Withdrawal – Debit the owners equity account by the total of drawings for
the period and credit the drawing account.
The temporary accounts of Bati transport are closed as follows.
2003 Income summary………………….25,300
January Service income…………………………………25,300
31 Closing revenue
31 Salary expense………………………..18,800
rent expense……………………………4,000
Maintenance expense………………….. 450
Insurance expense………………………..450
Supplies expense…………………………340
Utilities expense………………………….220
Truck expense …………………………… 90
Miscellaneous expense…………………….50
Income expense…………………………………24,400
Closing expenses
2003 Income summary………………900
January 31 Yemer Capital………………………..900
Closing income summary
31 Yimer capital…………………...500
Yimer drowing………………………..500
Closing with drowal

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The above closing entries have transferred the balance of the temporary accounts to the permanent
capital account.
3.6 POST CLOSING TRIAL BALANCE

After the closing entries have been journalized and posted, a trial balance is prepared to prove the
equality of the general ledger before recording the new year’s transactions. It should be noted that this
trial balance includes only balance sheet accounts. This is because the temporary income statement
accounts are closed during the closing process. This trial balance is called the post – closing trial
balance.
balance.
In practice the ledger balance after closing may be checked by a simple calculator print out rather than a
formal trial balance. The post closing trial balance for Bait Transport is presented below.
Bati Transport Post – Closing trial balance Jan 31, 2003
Cash……………………………………………Birr 41,030
Accounts Receivable ………………………………...9,650
Supplies…………………………………………………400
Prepaid insurance……………………………………….150
Office equipment……………………………………11,600
Truck……………………………………………….550,000
Accounts payable…………………………………………………….Birr 12,430
Nots payable……………………………………………………………..150,000
Yimer capital……………………………………………………………..450,400
capital……………………………………………………………..450,400
Total……………………………………Birr 612,830 Birr 612,830

EXERCISES:
1.Judy has been practicing as a doctor for three years. During June, 2010 she completed the following
transactions.
June 1 paid office rent $600
2 purchased equipment on account $2100
5Received cash on account from patients $4150
8 purchased X-ray film and other supplies on account $145
9 one of the items of equipment purchased on june 2 was defective. It was returned with the permission
of the supplier, who agreed to reduce the account for the amount charged for the item $125
12 Paid cash to creditors on account $1250
16 sold x-ray film to another doctor at cost as an accommodation, receiving cash $63
17 Paid cash for renewal of a 2 year property insurance policy $370
20 Discovered that the balance of the cash account and of the accounts payable account as of June1 were
overstated by $50. A payment of that amount to a creditor in May had not been recorded. Journalize the
$50 payment as of June 20.
23 Paid cash for laboratory analyses $245
27 Paid cash from business bank account for personal and family expenses $1250.
30 Recorded the cash received in payment of services to patients during June $1720
30Paid salaries of receptionist and nurses $1725
30 Paid gas and electricity expenses $157
30 Paid water expenses $29

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30 Recorded fees charged to patients on account for services performed in June $4,145
30 Paid telephone expenses $74
30 Paid misc. expenses $132
Balances on June1st are as follows: cash $3,123, Accounts receivable $6,725, Supplies $290, Prepaid
insurance $365, equipment $19,745, Accounts payable $765, capital $29,483,
Required: Prepare journal, ledger and Trial Balance.

2. Trial Balance

Cash 1631
Accounts receivable 1775
Supplies 1850
Prepaid rent 2400
Photographic equipment 17500
Accounts payable 2000
Capital 20650
Drawings 1500
Sales 5525
Salary expenses 1150
Misc. exp 369

Prepare worksheet, closing entries, post-adjusted trial balance

Adjustments: supplies on hand $890
Rent paid for 3 months
Depreciation on photographic equipment is $175
Salaries outstanding $115

3.Trial Balance
Cash 2425
Laundry supplies 1870
Prepaid insurance 620
Equipment 37650
Accm. Depreciation 9700
Accts. Payable 925
Capital 22180
Drawings 10200
Revenue 39125
Expenses 12415
Rent 3600
Utilities expenses 2715
Misc. expenses 435
Adjustments: Inventory of supplies $480
Insurance premium expired during the year $315
Depreciation on equipment $1960
Wages accrued but not paid $140
Required: prepare worksheet, adjustment entries, closing entries, trial balance