UNI

T1.I
NTRODUCTI
ONTOACCOUNTI
NG

1.
0AI
MS&OBJECTI
VES

Af
terstudyingthisunit,
youshoul dbeabl eto:
- expl ainthemeani ngofAccount ing
- ident if
ytheuser sandusesofaccount i
ng
- expl ainthev ar
iousbranchesi nt heprofessionofaccounting
- expl ainthemeani ngof“ generall
yaccept edaccount i
ngprinci
ples”
,
- expl aint he meani ng ofbusi ness entity assumption,costpr inci
ple and
monet aryunitassumpt ion
- st atet he basic accounting equat i
on and expl ai
nt he meaning ofasset s,
l
iabil
iti
es,andowner ’
sequity
- anal yzetheef f
ectsofbusi nesst ransacti
onsont hebasicaccountingequation,
and
- pr epareani ncomest atement ,owner ’
sequitystatement,andbalancesheet.
1.
1INTRODUCTI ON

We l i
vei nt he i nformat ion age- at i
me ofcommuni cat i
on,and a t ime when
i
nformat i
oni sav i
talresour ce.I nt hisi nformat ioner a,how wel ive,withwhom we
associ ated,dependonaccesst oandunder standi ngofi nformat ion.
Thesamei st ruef orbusi nesses( busi nessesar eoneormor ei ndivi
dualssel l
ing
product sorser v
icesf orpr of i
t).Busi nessest hathav ebet teraccesst oi nfor mat ion
andt hatpr ocessi nformat ionmor equi cklyandaccur atelydot hebest .
Businessi sanar t
ifi
cialper sonorl egalbodywhi chi sengagesi nt o3act i
vit
ies, such
asgi vingser vice( servicebusi ness) ,pur chasedgoodsf ort hepur poseofr esel l
ing
(mer chandisingbusi ness)andpr oducedormanuf actur edgoodsandser vi
cesf ort he
purposeofsel ling( manuf act uringbusi ness) .
Globalcomput ernet wor ksandt el ecommuni cationsequi pmentnow al l
ow ust oget
accesst oallty pesofbusi nessi nf ormat ion.Butt ot akeadv antageoft hese, weneed
knowl edgeofi nformat i
onsy stems.
Aninf ormat i
onsy stem ist hecol l
ect ing,pr ocessing, andr epor ti
ngt odeci si
onmaker s.
Under standingandpr ocessi ngi nf ormat ioni sthecor eofaccount i
ng.
Theki ndofi nfor mat i
onpr ocessedi naccount ingi sf i
nanci ali.e.ofamonet ar
ynat ur e.
Providingi nformat i
onaboutwhatbusi nessesown,whatt heyowe,andhow t hey
performi stheai m ofaccount i
ng.Account i
ngi s,ani nfor mat ionandmeasur ement
system t hatident if
ies,recor ds, andcommuni catesr elev ant, rel
iable,andcompar able
i
nformat i
onaboutanor gani zation’ s(abusi ness’s)economi cact i
viti
es.
Theref ore,ast udyofaccount i
nghel pspeopl emakebet terandi nfor
meddeci sions
aboutassessi ngoppor tunit i
es,pr oduct s,i nvestment s,andsoci alandcommuni ty

1
responsibil
it
ies.
Butt heuseofaccount i
nginf ormat i
oni snotl i
mitedtoaccountant sorpeopl ein
business.You can use account ing i
nformat i
on i
ny ourdailylife.You can use
accountinginformat i
ont ogetal oanforahouseort ostartanewbusi ness.
Thest udyofaccount i
ng,theref ore,opensy ounewandexci ti
ngpossi bil
itiesbothin
termsofbecomi ngapr of
essionalaccount antandusingaccountingi nformationin
yourdailylif
e.
Thiscour sediscussest hefundament alprincipl
esinvol
vedinprocessingaccount ing
i
nf or
mat onofbusi
i nessent erpr i
ses.
Under st
andingt hesef undament alpri
ncipl
esi sveryimport
antbecausef or t
hcoming
coursest hatyouar egoingtot akei naccount i
ngwillbui
l
dont hesepr i
nciples.
1.2. DEFI NITION, I
MPORTANCE, ANDUSERSOFACCOUNTI NGI NFORMATI ON

1.2.1.Account ingDef i
ned
Def initionofAccount ing
Account ing i st he pr ocess of i dentif
y i
ng,measur i
ng,r ecor ding,cl assify i
ng,
summar izingandcommuni cat i
ng( preparing,anal y zi
ngandi nter pretingaccount ing
reportsf oruser s).
Inshor t,iti sani nfor mat ionsy stem t hatmeasur esbusi nessact i
viti
es,pr ocesses
thatinf or mat ioni ntor epor ts, andcommuni cat est her esul t
st odeci sionmaker s.
Let’stakeacl oserl ookatt heact iviti
esi nvolvedi nt hepr ocess:
1. Thef irstpar toft hepr ocess–i dent ify i
ng–i nv olvessel ect ingt hoseev ents
thatar econsi der ed ev i
denceofeconomi cact i
vit
yr elev antt o apar t
icular
organi zat ion. Thesal eofgoodsbyTesf aySuperMar ket ,ther ender i
ngof
ser vi
cebyEt hiopi anTel ecommuni cat i
onsCor poration,t hepay mentofsal ar y
byt heCommer cialBankof Et hiopia,andt hepur chaseofBui l
dingbyAxume
Uni versityar eexampl esofeconomi cev ent s.
2. Oncei dent i
fied,account antmeasur edi nBi r
randcent s,economi cev entsar e
recor ded t o pr ovideaper manenthi st oryoft hef inanci alact i
vitiesoft he
organi zat ion. Recor ding consi sts of keepi ng a chr onol ogicaldi ary of
measur edev ent sinanor der lyandsy stemat icmanner .Inr ecor ding, economi c
ev entsar eal socl assi fiedandsummar ized.( Thi swi llbedi scussedi ndet ailin
uni t
-2)
3. Thi sident if
yingandr ecordi ngact ivi
tyi sofl ittl
euseunl esst hei nfor mat ioni s
communi catedt oi nteresteduser s.Thei nformat i
oni scommuni cat edt hr ough
thepr epar ationanddi stribut i
onofaccount ingr epor ts,t hemostcommonof
whi char ecal ledf inanci alst atement s.
AVi talel ementi ncommuni catingeconomi cev ent si stheaccount ant’sabi li
tyand
responsi bili
tyt oanal yzeandi nter pretther epor tedi nf ormat ion.Anal ysi si nvol ves
theuseofr atios, per cent ages, graphsandchar tst oshowt hei mpor tanceoff i
nanci al
trendsandr elationshi ps.I nterpr etationinv olv esexpl ai
ningt ot heusert hemeani ng,
2
andl i
mit
ati
onofr eporteddat a. Theanal ysisandi nterpret
ati
onpar tisl ef
tfor
advancedcoursesi
naccount i
ng.
Asaccountingplaysani mportantroleinthedeci si
onmaki ngpr ocessofbusi ness
enti
ti
es,i
tisoftencall
edthelanguageofbusi ness.Asar esul
t,whet heryouar ean
economist
,amar keter
,invest
or ,suppli
eroranyot her,tobesuccessf ul,youshould
beabl eto “speak”andbef ami l
i
arwi t
ht hebasi ct ermsusedi nt hebusiness
envi
ronment.
1.2.
2 Roles/I
mportance/ofAccount i
ngandUser sofAccount ingInformat i
on
Rol
es/
Impor
tanceofaccount
ing/
Themai npur poseofaccount ingistoprov i
def i
nancialinformati
ontobeusedf or
deci
sion-maki ng.Fori nstance,Businessexecuti
vesandmanager sneedthefinancial
i
nformat i
onpr ovi
dedbyt heaccount ingsystem tohel pt hem pl
anandcont rolthe
acti
vit
iesoft hebusi ness.Out sider
ssuchasbanker s,potenti
ali
nvest
ors,andlabour
uni
onsandot her salsoneedaccount i
nginformati
on.
I
nshor tthegoaloft heaccount ingsystem ist o provideusefulinf
ormat i
ont o
decisi
onmaker s.Thus,account i
ngistheconnect i
ngl i
nkbet weendeci
sionmaker s
andbusi nessoper ati
ons.
Tosum upi mpor tanceofaccount i
ng
Deter
mi nest heoper ati
onr esult
softheorganizat
ion.
Faci
l
itat
esr
ati
onal
deci
sionmaki
ng,
fordeci
sionmaker
s.
Keepssy
stemat
icr
ecor
dofbusi
nesst
ransact
ion.
Itpl
ay simpor tantr olei nalleconomi csocialsystem.
1.3BOOKKEEPI NGVERSUSACCOUNTI NG
Peopleof tenf ailtounder standt hedi ff
erencebet weenaccount i
ngandbookkeepi ng.
Bookkeepi ngi st hepr ocessofr ecordingbusi nessact i
vit
ies,
andkeepi ngt herecords.
Itist her ecor d-maki ngphaseofaccount i
ng. Ther ecordingoft ransactionsi n
Bookkeepi ngt endst obemechani calandr epeti
tive;i
tisonl yasmal landpr obably
thesimpl estbuti mpor tantpar tofaccount ing.
Account i
ng,ont heot herhand,i ncludest hedesi gnofani nformat ionsy st
em t hat
meet suser s’needs.Themaj orgoal sofaccount ingar etheanal ysis,int er
pretat
ion,
anduseofi nfor mat ion.Account ingincludessy st
em desi gn,budget i
ng, costanalysi
s,
auditi
ngandt axpl anningandpr epar ati
on.
A per sonmi ghtbecomear easonabl ypr of
ici
entbookkeeperi naf ew weeksor
mont hs;howev er,tobecomeapr ofessionalaccount antrequiressev eralyearsof
studyandexper ience.
CheckYourPr ogr essExer cise-1
1.Answert hef ollowingquest ionsandcompar ey ouranswerwi tht heanswerkeyat
theendoft heuni t.
a.Def ineaccount i
ng

3
 b.Writ
einfewwordstheimportanceofaccount
ing.
c.Descri
bethebasi
cdist
inct
ionbetweenaccounti
ngandbookkeepi
ng.
User
sofAccount
ingI
nfor
mat
ion
Today ’saccount ant sf ocusont heul ti
mat eneedsoft hosewhouseaccount i
ng
i
nformat i
on, whet hert heuser sar einsideoroutsi det hebusi ness.Account i
ngi snot
anendbyi t
sel f
. Thei nformat i
ont hataccount i
ngpr ov idesallowsuser st omake
“r
easonabl echoi cesamongal ternativ
eusesofscar cer esour cesint heconductof
business”
Thepeopl ewhouseaccount inginformat i
onbasi callyf allint otwocat egories:
1.Ext ernal User s, and
2.I nternal User s
1)Ext ernalUser s:Ext ernalUser sofaccount ingi nfor mat i
onar eparties,whi chare
notdi r
ectlyinv olv edi nr unningt hebusi nessent erpr ise.Thesei ncludel enders,
shar eholders ( st ock hol ders), suppl i
ers, empl oy ees Uni ons, gov ernment
(regulatorybodi es)and ot hers. Ext ernaluser sr ely( depend on)account i
ng
i
nf ormat i
ont ohel pt hem makebet terdecisionsi nt ryingt oachievetheirgoal s.
The ar ea ofaccount ing aimed atser ving ext ernaluser si s called Fi nancial
Account i
ng.I tsmai nobj ect
iveist opr ovidet oext er naluser sinfor
mat i
ont hrough
fi
nanci alstatement s.
Eachext ernaluserhasi tsownspeci fi
edi nformat ion- needdependi ngupont he
decisionst obemade.Thati st osay ,allext ernaluser sdonothav et hesame
i
ntent i
ons( objectiv es)whent heyuset hei nformation.
I
nt hef oll
owi ngpar agr aphswewel lt r
yt odi scusshow someext ernaluser suse
account i
nginformat ion.
a)Lender
s/Cr
edi
tor
s
Credi
torsl
endmoneyorotherresour
cestoanor
ganizat
ion.Lender
sincl
udebanks,
mortgageandfi
nancecompani
es.Lendersl
ookf
orinfor
mat i
ontohelpt
hem assess
theabil
i
tyofbor
rowerst
orepaythei
rdebt
s.
b)Shar
e-hol
der
s(St
ockhol
der
s)
Sharehol
der shavel egalcont r
oloverpar torallofacor porati
on.Wheni tcomestoa
corporat
ion,shar ehol ders ar
e notdi rectl
yi nvolv ed i
nt he managementoft he
corporat
ion. Howev er,asowner s,t heyhav ecl aimsov erthepr operti
esofthe
organi
zation.Financial report
shelptoanswershar ehol
ders’quest
ionssuchas:
-Whati sthei ncomeoft heorganizati
onf ort hecur
rentandpastper i
ods?
-aret heproper ti
esadequatet omeetbusi nessplan?
-wi l
lthebusinesscont i
nuetobepr ofi
tablei nthefuture?
c)Empl
oyees`l
abourUni
ons
Empl oyees`l
aborunionsar einter
est
edi njudgi
ngthefai
rnessofthei
rwagesand
assessi
ngf ut
urej
obpr ospects.Theyalsouseaccount
ingr
eportsasevi
dencet
oask
forbonuses,whentheorganizati
onissuccessful
.
d)Gover
nment
4
TheI nlandRev enueAut hori
tyr equiresor ganizat i
onst opreparef inancialrepor ts,in
ordertocomput etaxes.
2)I nternalUser s:Thesear eper sonst hatar edi r
ectl
yi nvolv
edi nmanagi ngand
oper at
inganor gani zati
on.Theyi ncl
udemanager sandot herimpor tantdeci sion
maker s.Thei nt ernalroleofaccount ingi stopr ovideinformationt ohel pimpr ove
theef fi
ciencyandef f
ectivenessofanor ganizat ion.
Thear eaofaccount ingai medatser vi
ngt hedeci sion-makingneedsofi nternaluser s
i
scal led ManagementAccount i
ng. I nternaluser softenhav eaccesst oal otof
pri
vateandv al uablei nformat i
on.Internalrepor t
sai mt oanswerquest ionsl i
ke:
 Whatar emanuf acturingcost sperpr oduct ?
 Whi chser viceact i
vit
iesar emostpr ofitable?
 Whatl ev elofsal esisnecessar ytobr eakev en?
1.
4THEACCOUNTI NGPROFESSI ON
I
fy ouj ustjoinedt heaccount i
ngpr ofession, youmaybewonder ingwhatj oby ouwi l
l
bedoi ngint hef utur e.Youpr obablywoul dappl yy ourexper ti
seinoneoft hreemaj or
fi
elds:
 Publ i
cAccount i
ng
 Pr i
vateAccount ingor
 Not–f or–pr ofitAccount i
ng
i
)Publ
i
caccount
ing
InPubli
cAccount i
ngy ouwoul dof f
erexper tservi
cet othegener alpubli
cinmucht he
samewayt hatadoct orservespatientsandal awy erservesclients.Amaj orpor t
ion
ofpubli
caccount i
ngpr acti
ceisinvolvedwi thAuditi
ng.I nthisarea, acert
if
iedPubl i
c
Accountant(CPA)exami nes,t
hef inancialstat
ement sofcompani esandexpr esses
opini
onast othefairnessofpr esentati
on.Whenpr esentat
ioni sfair
,usersconsider
thestat
ement stober eli
able.
Managementconsul ti
ngi sanot herar eaofpubl icaccount ing. I nthiscase,t he
accountantconsult
st hemanagementgener al
l
yaboutt hegrowt handdev el
opment
ofthebusinessenterpri
se.
i
i
)Pr
ivat
eAccount
ing
I
nsteadofwor kingi npubl i
caccount i
ng,anaccount antmaybeanempl oyeeofa
businessenter pri
se. Inpr ivateaccount i
ng,y ouwoul dbeinvolv
edi noneoft he
fol
lowingacti
v i
ties:
1.CostAccount ing:Det ermini
ngt hecostofpr oducingspeci
fi
cpr oduct
s.
2.Budget ing:Assisti
ngmanagementi nquant if
yinggoalsconcer ni
ngrevenues,
costsofgoodssol d, andoper atingexpenses.
3. GeneralAccount ing:r ecording dai l
yt ransacti
ons and prepari
ng fi
nancial
stat
ement sandrelatedinformat ion.
4. Account inginformat ionsystems:desi gningbot hmanualandcomput eri
zed
dataprocessingsy stems.
5.TaxAccount i
ng:pr eparingtaxr eturns(-formst obef i
ll
edbyacompanyand
5
 r
etur
nedtoataxi
ngauthori
ty)andengagingi
nt axplanni
ngfort
hecompany.
6.I
nter
nalAudi
ti
ng:rev
iewingacompany ’soperationstodet
erminecompl
i
ance
wi
thmanagementpoli
ciesandevaluat
ingeff
iciencyofoper
ati
ons.
i
i
i)Notf
orPr
ofi
tAccount
ing
Likebusinessesthatexisttomakeapr ofit
,not-f or
-profitor
gani
zationsalsoneed
sound f i
nancialreporti
ng and control. Donor st o such organizati
ons want
i
nf or
mat i
onabouthow wel ltheorganizati
onhasmeti t
sobject
ivesandwhet her
continuedsupportisjust
ifi
ed.Ineachoft hesecases,account i
ngexperti
seishighly
valued.
Checky ourProgressExercise-2
1.Whatar ethebasiccategori
esoftheuser sofaccountinginf
ormation?
…………………………………………………………………………………………………………………………………………………
…………………………………………………

2._
____i
stheareaofaccount
ingai
medatser
vingext
ernaluser
sofaccount
ing
i
nfor
mati
on.

3._
__istheareaofaccount
ingai
medatser
vingt
hedeci
sion-
maki
ngneedsof
i
nter
nal
user
s.

4.Whatar
ethet
hreemaj
orf
iel
dsofengagementf
oraccount
ant
s?
…………………………………………………………………………………………………………………………………………………
…………………………………………………

1.
5.ACCOUNTI
NGPRI
NCI
PLESANDCONCEPTS

Accounting,asi tist r
uef orotherdi sciplines,hasgoti tsownpr i
nciplesandpr actices.
Onemustbeabl et ounder standt hesepr inci
plesandpr acti
cest ounder standand
preparef i
nanci alst atement sandr epor t
s. Thepr i
ncipl
esandconcept susedi n
accounti
ng ar e cal led Gener all
yAccept ed Account i
ng Pri
ncipl
es ( GAAP) .These
pri
ncipl
esgui deaccount ant
showt or ecordandr epor tbusi
nessact i
v i
ti
es.
GAAPar edev elopedov eralongspanofy earsbyt heaccounti
ngpr ofessi
on.Thati s,
thei
rdev elopmenti snotr ev ol
utionar yr atherev oluti
onary. Themai npur poseof
thesebasicr ulesi stogui deaccount ant sinmeasur i
ngandr eport
ingf i
nancialevents
ofbusinessent erpri
ses.
GAAPar enotl iket heunchangeabl el awsofnat urefoundi nbiol
ogyandchemi stry.
Theycanbechangedasbet termet hodsar edevelopedorasci rcumst anceschange.
Generall
y,itisf rom r esearch,pract ice,andpr onouncement sofpr ofessi
onalbodi es
thatGAAPev olv e.
I
nt hisunit,wewi lldiscusst hreeoft hegener allyacceptedaccount ingpr inci
ples:
BusinessEnt i
tyconcept ,Costpr i
nci pleandMonet aryUnitAssumpt i
on.
6
i
)Busi
nessEnt
it
yConcept
Account antsf requent lyr efert o a busi ness organization as an account ing or
businessent ity.Abusi nessent i
tyi sanybusi nessor gani zati
on,suchasa“ super
mar ket”
,l aundr y,bar berry,ora hot el,whi ch existas an economi c unit. For
accountingpur poses,eachbusi nessent erprisehasasepar ateexi stencef rom i ts
owner s,credit
or s, empl oyees, customer sandot herbusinesses.
Thissepar ateexi stenceoft hebusi nessent erpri
sei sknownast hebusi nessent it
y
concept.Thus, t hebusi nessent it
yshoul dhav eacompl et
el ysepar atesetofr ecor ds
andi t
sfinancial recor dsandr eportsshoul dreferonlyaboutt hebusi nessent erpr i
ses.
Forexampl e,W/ roManahasgotherownt wobusi nessent erprisesonecal ledAsadu
ManaSuperMar ket,andanot herhot elcal l
edBahr iHat seyHot el.EachBusi ness
woul dbeconsi der edasani ndependenteconomi cbusi nessuni t
.Theact i
v i
tiesof
eachbusi nessar ekeptsepar atel
yf r
om eachot herandf rom t heowner ’sper sonal
records.LetsayW/ OManaboughtahouset oliv
ei nWaj irat20AdinearGr ager bo.
This house woul d notbe r ecorded and r eport
ed int he r ecords ofei thert he
supermar ketort hehot el.Theper sonalsav ingaccountshehaswi l
lnotaswel lbe
i
ncludedi nt hef inanci alrepor tsofei theroneoft hebusi nesses.Shemusthav et o
opensepar atebankaccount sf orthet wobusi nesses.Thesupermar ketshoul dnot
recordthepay mentofsal aryt oempl oy eesoft hehot el
.
i
i
)Thecostpr
inci
ple
Thecostpr i
nciplest ates“ proper ti
esandser vi
cesacqui redbybusi nessent erprises
mustber ecor dedatact ual amount spai dorassumedi nacqui ri
ngt hepr operties.”
Forexampl e, Moder nAdv ertisingCompanyi sconsi der ingt hepur chaseofabui l
di ng.
Theselleroft hebui l
dingof feredapr iceofBi rr10,000whi let hebuy erf ir
stof fereda
pri
ceofBi rr8000.Howev er,af t
ercer t
ainbar gaining,t hesel leragr eedt osel lt he
bui
lding forBi rr9000 and t hebuy erpai dt hatamount .Accor ding t ot he“ cost
pri
ncipl
e”t hebuy erhast or ecordt hebui ldingi ni
t sr ecor dsatbi rr9000-t heact ual
amountpai dt ogett hebui lding.
Thebuy ermayr eceiveanof ferofBi rr12,000f ort hebui ldingamont haf teri fhas
beenacqui red. Thi shasnoef fectont heaccount ingr ecor dsbecausei tdoesn’ t
ori
ginat
ef rom anact ualexchange.I tissimpl yamer eof f
er .
I
fthebuy ersel l
st hebui ldingf orBi r
r20, 000af terpur chasi ngi t,agai nofBi rr.11, 000
wouldber eal i
zed.Thenewownerwoul duseBi rr20,000ast hecostoft hebui lding.
I
nanexchangebet weenabuy erandasel ler,bothat temptt ogett hebestpr ice.Onl y
amountsagr eeduponandpai dar eobj ecti
veenoughf oraccount i
ngpur poses.
Monet
aryUni
tAssumpt
ion
Allbusinessacti
vi
ti
es(event
s)arerecordedi
nt er
msofmoney( -
Bir
r,Dol
l
ar,Poundor
anyot hercurrency)
. Ofcour se,inf
ormation ofa non -
fi
nanci
alnatur
ecan be
recorded,butiti sonlythr
ough ther ecor
ding ofdoll
ar(Bi
rr
)amount sthatthe
acti
viti
esofabusi nesscanbemeasur ed.Moneyi stheonl
yfact
orcommont oal
l
businessactivi
ti
es.Ther
efor
e,itistheonlypracti
caluni
tofmeasurementthatcan
7
producef i
nanci al dat at hatcanbecompar ed.
Themonet ar yuni tusedbyabusi nessdependsont hecount ryinwhi chi texi sts.For
exampl e,inEt hi opi at hebasi cuni tofmeasur ementi st hebi rr
,asi st hedol larint he
U.S.A, andPoundSt erli
ngi nt heUni tedKi ngdom.
CheckYourPr ogr essExer cise- 3
1.Theabbr ev i
at ionGAAPst andsf or_ ___ ____ ____ ____ ____ __
_ _____.
2.Whatdowemeanby“ GAAPar enotl iket heunchangeabl el awsofnat ure” ?
…………………………………………………………………………………………………
3.Whydoweneedt or ecor dal lbusi nessact iviti
esi nt ermsofmoney ?
…………………………………………………………………………………………………Whati st he pr i
nci plet hat
says pr oper ties acqui red bybusi ness ent erpr ises mustbe r ecor ded atact ual
amount spai d?
………………………………………………………………………………………………… FORMS OF BUSI NESS
ORGANI ZATI ONS
Ther e ar et hree basi cf orms ofbusi ness or gani zat i
ons:sol e pr oprietorships,
partner ships,andcor por ations.Account antsr ecogni zeeachf or m asaneconomi c
unitsepar atef ormi tsowner s( Busi nessEnt i
tyConcept ).
Inthiscour se,wewi llbegi nbyt heaccount ingf orsol epr opri
etor shipsbecausei ti s
thesi mpl estf orm ofaccount i
ng.
1.Sol ePr opr ietor shi ps
Asol epr opr i
et orshi pi sabusi nessownedbyoneper sonandusual l
ymanagedbyt he
owner .Nospeci all egalr equi rement smustbemett ost artasol epr oprietorshi pand
usual l
yonl yal imi tedi nv est menti sr equi redt obegi noper ati
ons.
Asol epr opr iet orshi pi sasepar ateent ityf oraccount i
ngpur poses( Businessent ity
Concept )buti ti snotasepar at elegalent i
tyf rom t heowner s.Thati s, f
rom t helegal
pointofv iew,t heownerandt hebusi nessar et reat edasoneandt hesame.The
ownerwi l
l behel dper sonal l
yr esponsi bl ef ort hedebt sandact i
onsoft hebusi ness.
Fori nstance,assumeFl owerLaundr yi sasol epr oprietor shipownedbyAt oAl emu.
Assumeal sot hatt hebusi nesshasbor r owedBi rr10, 000f rom t heCommer cialBank
ofEt hiopi aandf ailedt opayi tsdebt s. I nt hiscase,i ft heCommer ci
alBankof
Ethiopiacan’ tr ecov ert heamounti tl entf rom t hepr oper tiesoft hecompanyi tcango
totheext entofsel li
ngt heowner ’
sper sonal pr oper ti
es.
2.Par tner shi ps
APar t
ner shi pi sl ikeasol epr oprietor shi pi nmostway sexceptt hati thasmor ethan
oneowner . A par tner shipi snotal egalent i
tysepar atef rom t heowner sbutan
associ ationt hatbr ingst oget hert het al ent sandr esour cesoft woormor epeopl e.
Theowner sofapar tnershi par eknownaspar tner s.
Thepar tner sshar et hepr ofitsandl ossesoft hepar tner shipaccor dingt oanagr eed
–onf ormul a.Theper sonalr esour cesofeachpar tnercanbecal ledont opayt he
obli
gat ionsoft hepar tnershi p.Thati s, eachpar tneri sper sonallyr esponsi bl efort he
debt soft hepar t
ner ship.Fr om anaccount i
ngst andpoi nt ,howev er ,apar tner shipisa
8
busi nessent it
ysepar atef r
om t heper sonal acti
vitiesoft hepar t
ner s.
3.Cor por ati
ons
A busi ness or ganized as a separ atel egalent i
ty wi th owner shi p di v i
ded i nto
transf er ableuni tsofcapi taliscal ledacor porati
on.Theowner sofacor porat i
onar e
called st ockhol ders or shar ehol ders. The cor por ati
on i ssues capi t
alst ock
cer ti
ficat est oeachst ockhol dershowi ngt henumberofshar es( or stock)heorshe
owns.Thest ockhol dersar ef reet osel lal lorpar toft heseshar est oot heri nvest ors
atanyt i
me.Thi sease oft ransf erofowner shi p addst ot he at tract ivenessof
i
nv est ingi nacor poration.Si nceacor por ati
oni sasepar atelegalent ity ,theowner s
(stockhol der s)ar enotper sonal lyliablef ort hedebt soft hecor por at i
on.Thei rriskof
l
ossi sl imi tedtot heamountt heypai d( i
nv ested) .Becauseoft hisl i
mi tedl iabili
tyi na
cor por ationshar eholder sarewi ll
ingt oinv estinr iskier,butpot ent i
allymor epr ofitable,
act i
vities.
Ev ent houghcor porationsar ef eweri nnumbert hanpr oprietorshipsandpar t
ner shi ps,
theycont ributeal ottot heeconomi esofmanycount r
iesinmonet aryt er ms
1.7BUSI NESSTRANSACTI ONSANDTHEACCOUNTI NGEQUATI ON
Busi nessTr ansact i
onandt heAccount ingEquat ion
ABusi nessTr ansact i
on
Abusi nesst r
ansact i
oni sanoccur renceofanev entoracondi ti
ont hatmustbe
recor ded.Apar t
icularbusi nesst ransact ionmayl eadt oanev entorcondi ti
ont hat
resul tinanot hert ransact i
on.Tr ansact i
onsmaybedi videdi ntoi nter nal andext er nal.
A.Ext er nalt r
ansact i
ons: Exchangesoreconomi cev entst akepl acebet weent he
busi nessent erpriseandanot herent i
ty.E. g.purchaseofgoodsf rom asuppl i
er ,
sal es
ofgoodst ocust omer s, borrowingmoneyf rom abank.

B.I nter
nalt ransactions:such as t he expi rati
on ort ransferofcostwi t
hint he
enterpri
se.E. g.Depr eciat
ionofpl antasset s,t r
ansferofpr oductioncost sf r
om wor k
i
n pr ocess i nventoryt ot he finished goods i nvent or y.A tr ansacti
on can be an
exchange( suchast hepur chaseorsal eofpr oper t
y ,pay mentorcol l
ectionofal oan
etc.
)bet weent woormor epar t
ies.At r
ansact i
oncanal sobeanev entt hathast he
sameef f ectasanexchanget ransact ionbutdoesn’ ti nv ol
veanexchanget ransacti
on.
Someexampl esof“ nonexchange”t ransactionsar el ossesf r
om f ir
e,flood;phy sical
wearandt earonequi pment ;donat ionofpr oper tyandsof ort
h.
.Foragi v ent ransactiontoqual ifytober ecordedi thas:
1.t ober elatedt othebusi nessent erpri
se
2.t obemeasur ableint ermsofmoney
3.t obecompl eted/happened/act i
on.
(i
.e. itshoul dnotbeamer epr omi seori ntention;i tmustbeatl eastpar ti
ally
compl etedt ober ecorded)
1.7.1Asset s, Li
abili
ti
esandOwner ’sEqui t
y
Anasseti sar esourcecont r
oll
edbyt heent ityasar esultofpastev ent sandf r
om

9
whi chf utur eeconomi cbenef itsar eexpect edtof lowt otheent it
y.
Thef ollowi ngt hr eechar act er i
st i
csmustbepr esentf orani tem t oqualifyasanasset :
1.Theassetmustpr ov i
depr obabl efut ureeconomi cbenef i
tthatenabl esi ttopr ovide
futurenetcashi nflows.
2.Theent ityisabl et or ecei vet hebenef itandr est ri
ctot herent it
ies’accesst ot hat
benef i
t.
3.Theev entt hatpr ov idest heent itywitht her i
ghtt ot hebenef ithasoccur r ed
Ify ouhav enot i
ced,i nanyor gani zationy ouwi llf i
ndpr opertiessuchasabui l
ding,
furnitur e, land, vehi clesandt hel ike.Suchpr oper tiesownedbybusi nessent erpri
ses
arer ef erredt oasAsset s.Exampl esofasset s
1.Pr oper ty ,plantandequi pment ;
2.I nvest mentpr oper ty;
3.I ntangi bl easset s;
4.Fi nanci al asset s( excl udingamount sshownunderi t
ems5, 8,and9) ;
5.I nvest ment saccount edf orusi ngt heequi tymet hod;
6.Bi ologi cal asset s;
7.I nvent or ies;
8.Tr adeandot herr ecei vabl es;
9.Cashandcashequi v alent s;
10.Thet ot alofasset scl assi fiedashel df orsaleandasset sincludedi ndi sposal
Gr oupscl assi fiedashel df orsal ei naccor dancewi thI FRS5, Noncur rentAsset s
Hel df orSal eandDi scont i
nuedOper ations
Tobuyt heseasset s, busi nessesgetmoneyf r
om t wosour ces:invest ment smadeby
owner soramount sbor rowedf rom cr editors.Al iabi l
it
yi sapr esentobl i
gat ionoft he
ent it
yar isingf r om pastev ent s,t heset tl
ementofwhi chi sexpect edt or esulti nan
out fl
owf rom t heent i
tyofr esour cesembody i
ngf ut urebenef i
ts.
Thef ollowi ngt hr eechar act er i
st i
csmustbepr esentf orani tem t oqualifyasal iabili
ty:
1.Al iabilityr equi rest hatt heent ityset tl
eapr esentobl igationbyt hepr obabl ef uture
transf erofanassetondemandwhenaspeci fi
edev entoccur soratapar ti
cul ardat e.
2.Theobl igat ioncannotbeav oi ded.
3.Theev entt hatobl i
gat est heent i
tyhasoccur r
ed.
Ther ef ore,bot howner sandcr edi torshav eacl aim ov ert heasset soft hebusi ness
ent erpr i
se.Thecl aimsorr ight sofowner sar er efer r
edt oasEqui ti
es.I ft heasset s
ownedbyabusi nessamountt oBi r
r50, 000t heequi t
iesi nt heasset smustal so
amountt oBi rr50, 000.Ther elationshi pbet weent het womaybest atedi nt hef orm
ofanequat ion, asf ollows:

Economi
cResour
ces=cl
aimsovert
her
esour
ces
Asset
s =Equit
ies.

Equit
ymaybesubdi v
idedint otwopr i
nci
palt ypes:t
heright
sofcredit
orsandthe
ri
ghtsofowners.Theright
sofcr edi
torsrepresentdebtsofthebusinessandare
cal
ledLi
abi
li
ti
es.Theri
ghtsofownersarecalledOwner s’
Equit
y(capi
tal
).
Assets=equi
ti
es
10
 Equiti
es =Li abil
ity+Owner ’
sequi t y
Thi
sequat ioncanbewr i
ttenas:
Asset s=liabili
ty+Owner ’
sEqui t
y
NB:Liabi
lit
iesshoul dal way sbepl acedbef or eowner ’
sequityint heaccount i
ng
equat
ionsincecr editorshav epr eferenti
al ri
ghtsorcl aimsagai nsttheassets.Tohel p
youunderstandt his,assumeXcompanyhast ot alasset sofBr.5000,li
abi
li
tiesofBr
2000andowner ’sequi t
yofBr3000.I ft
hebusi nessi st obecl osed,theassetsoft he
companywi llbesol danddi st r
ibutedt ot heclaimant s.Inaccount i
ng,theOwner ’sare
giv
entheirshar eafterthecr editorsar egi v
ent heirent ireshare.Forexample, assume
theasset
sar esoldf orBr4, 500.Thecr editorswi llbegi ventheirshareofBr .2,000
andwhatev err emai ned(Br .
2,500) i
sgi vent otheowner s.Ift
heasset sweresol dfor
Br.7,
000,t hecr editorswoul dhav ebeengi vent heirshar eofBr .2,
000andt he
remai
ningbal anceBr5, 000woul dhav ebeengi v ent ot heowner s.

Li
abil
i
ties
Asset
s &
Capi
tal

Asy oucannot i
ce,theownersar
egivenwhatev
eri sleft(i
tcouldbegreaterorless
thantheirshar
e).Thati
swhywesai downer
shav eresidualcl
aim overtheasset
sof
thebusinesswhereascredi
tor
saresai
dtohavepriori
tyclam overtheasset
sast hey
arepaidfir
st

CheckYourPr ogressExercise-4
1 Busi nessorgani
zati
onsar eclassi
fi
edintothree,basedonwhat ?
…………………………………………………………………………………………………
2 Whatdowemeanbyt het erm‘unl
imit
edliabi
li
ty’
?
…………………………………………………………………………………………………Whi chofthethreeformsof
businessorigi
nati
onsis(are)separat
elegalenti
ty(enti
ti
es)from t
hei
rowners?
…………………………………………………………………………………………………
3 _ ______
_____
_____
__r epresentsthe clai
m ofowner ’
s againstassets ofthe
businessenter
pri
se.

4 AssumetotalassetofBr60,
000,andowner’
sequit
yofBr45, 000.Deter
minethe
amountofl
i
abili
ty.
…………………………………………………………………………………………………
5 L=A-
CIsthi
sanaccept abl
ewayofwrit
ingt
hebasicaccounti
ngequation?Expl
ain.
…………………………………………………………………………………………………
6 Whatdowemeanwhenwesay“ ownershavearesi
dualclai
m ov ert
heassetsof
11
 thebusinessent er
prise”
?
…………………………………………………………………………………………………
7 Def i
neabusi nesstransacti
on,andgi veatleastfourexamples.
…………………………………………………………………………………………………
1.7.
2Tr ansactionsandt heAccountingEquat ion
Allbusi
nesst ransacti
onsf r
om thesimpl estt
ot hecompl excanbestatedinter
msof
theresult
ingef f
ectont hethreebasi
cel ementsoft heaccounti
ngequation.Howev er
,
i
ti simpor t
antt oremembert hateacht r
ansacti
onl eavestheequati
oni nbalance.
Assetsalway sequal t
hesum ofl i
abil
it
iesandowner ’
sequity
.

12
13
14
15
16
 Owner
’sEqui
ty

Decreasedby: I
ncr
easedby
:Owner’sI
nvest
mentand
Owner
’swi
thdr
awalsand Expenses Rev
enues

Therel
ati
onshi
poftheaboveelementsandt hei
reffectont
hecapi
tal
bal
ancecanbe
shownas:
EC=BC+I–W +R-E
Where: EC – EndCapitalBal
ance
BC -Beginni
ngCapi t
alBalance.
I-Owner ’
sInvest
ment
W -Owner ’
sWi t
hdrawals
R -Rev enue
E -Expense.

1.
8FI
NANCI
ALSTATEMENTSOFSOLEPROPRI
ETORSHI
PS

Aftert heef fectoft hei ndi v i

dualtransact i
onshasbeendet ermined,t heessent ial
i
nf ormat ioni scommuni cat edt ouser satcer tai
ni ntervals.Theaccount i
ngr epor
ts,
whi chcommuni cat et hisi nf ormation,ar ecal ed f
l inanci alstatement s. Fi nancial
statement saresai dt obet hecent ralfeaturesofaccount i
ngbecauset heyar ethe
primar ymeansofcommuni catingimpor tantaccount inginformationt ouser s.
Financialst atement s ar et he means oft ransf
er r
ing t he concise picture oft he
prof i
tabilityandf inanci al posi ti
onoft hebusi nesstoi nterestedpar ti
es.
Themaj orf i
nanci alst atement susedt ocommuni cat eaccount i
ngi nformat ionabout
abusi nessar e:
- i ncomest atement
- bal ancesheet
- st atementofowner ’
sEqui ty
- st atementofcashf lows( wil
lbedi scussedinseni orcourses)
Sincet hesef inanci alst atement sareinasenset heendpr oductsoft heaccount i
ng
process,ast udentwhoacqui resacl earunderst andi ngoft hecont entandmeani ng
off inanci alstatement swi llbei nanexcel l
entposi t
iont oappr eciatethepur poseof
theear lierstepsofr ecor dingandcl assifyingbusinesst ransactions.
1.8.1TheI ncomeSt atement
Thei ncomest at ementi saf inancialst at
ementt hatsummar izest heamountof
17
revenuesear nedandexpensesi ncurredbyabusi nessov eraper i
odoft i
me. I t
repor t
st hepr ofitabili
tyoft hebusi nessbycompar ingr evenuesandexpensesf ora
stated per i
od oft i
mesuchasamont horay ear .Inaccount i
ngpr of i
tabili
tyi s
measur edf oraper iodoft imet hanonadai lybasi s.Thoughmeasur i
ngdai l
ycoul d
bepossi ble,itwi llnotbepr actical andbenef i
cialtot hebusi nessent er
pri
se.
Ifther evenueofaper iodexceedst heexpensesoft hatsameper i
od,neti ncome
results.Ifexpensesar egr eatert hant her evenuesofaper iod,wesayt her eisanet
l
oss, t
hati s,thebusi nesshasoper atedunpr ofitabl
y .
N.B. Thedet ermi nationofper iodicneti ncome( netl oss)i samat chingpr ocess
i
nv olvingt wost eps.Fi rstrevenuesear nedar er ecogni zeddur i
ngtheperiod.Second,
the expenses i ncurred to gener ater evenues ar e mat ched (compar ed)agai nst
revenuest odet er mineneti ncomeornetl oss.
Allfinanci alstat ement shav eaheadi ngt haty oucanf indinanyki ndofar epor t.The
headi ngoft hesest atement si dent i
fi
est hecompany ,thet ypeofst at
ement ,andt he
ti
meper iodcov er edbyt hest at ement .Not et hatt hepr i
mar yfocusoft hei ncome
statementi sr epor ti
ngt hesuccessorpr ofitabil
ityoft hecompany ’
soperationsov era
speci fi
edper i
odoft ime.Toi ndi catethati tappl i
esf oraper i
odoft i
me,t hei ncome
statementi sdat ed“ Forthemont hended…”
Thef ol l
owi ngi sani ncomest at ementf ort hemont hendedSept ember30, 200x.

1.8.
2Owner ’
sEqui
tyStatement
Thisisastatementthatsummar i
zest hechangesinowner ’
sequi
tyforaspecifi
c
peri
odoft i
me.Dat aforthepreparat
ionofowner’sequitystat
ementareobtai
ned
fr
om theowner’
sequitycol
umnoft hetabul
arsummar y(I
ll
ustr
ati
on1-)andfr
om the
i
ncomest at
ement.Theheadingofthisstat
ementidenti
fi
esthecompany,t
hetypeof

18
stat
ement ,andt hetimeper iodcoveredbyt hestatement.Thet i
meper iodisthe
sameast hatcoveredbyt hei ncomest atementandt heref
orei sdated“Fort he
MonthEndedAugust30,2013. ”Thebegi nningowner ’
sequityamounti sshownon
thefi
rstlineoft hestatement .Then,theowner ’
sinvestments,netincomeandt he
owner’
sdr awingsarei dent
if
iedinthestat
ement .
Theinformat i
onprovidedbyt hi
sstatementi ndi
catesthereasonswhyowner ’
sequit
y
hasincreasedordecr easeddur i
ngtheper i
od.TheOwner ’sequityst
atementf ort
he
monthofAugusti sshownbel ow:

13.Bal anceSheet
Iti
sal i
stofasset s,liabi
lit
iesandowner ’
sequi tyofabusi nessent ityasofaspeci f
ic
date.Theasset ssect ionofabal ancesheet( l
efthandsi de)begi nswi t
hcash
foll
owedbyr eceivabl es,suppli
es, prepaidinsur anceandot herasset sthatcanbe
conv ertedint ocashorusedupi nt henearf utur e.Theasset sofr elati
velypermanent
naturesuchasl and, buildi
ngandequi pmentf ollowt hatorder.Inthel i
abili
tyand
owner ’sequi tysect i
onoft hebalancesheet( ri
ghthandsi de),theliabil
it
iesare
present edfirstfollowedbyowner ’sequi t
y.
Form ofBal ancesheet( statementf or mat)
Ast herei snouni versalform, t
hef orm oft hebal ancesheetpr esentati
onv ari
esin
practice.Thebal ancesheeti sprepar edinoneoft wobasi sforms: Accountf orm and
Repor tforms
I.Theaccountf orm ofbal ancesheet :Inthisf orm ofbalancesheet ,assetsare
reportedont helef t-
side&l i
abil
i
ties&owner s'equityont herighthandsi de.
_ ____
____
_________
_____
Asset s Liabilit
y

Owner
’sEqui
ty

19
Ther
epor
tfor
m ofbal
ancesheet
:Int
hisf
orm ofbal
ancesheet
,li
abi
l
iti
es&equi
ty
secti
onsareli
stedi
nsequent
ial
orderdi
rectl
ybel
owt
heassetsect
ion
-Li
stsasset
s,Li
abil
i
tyandOwner’
sequit
yv er
ti
cal
l
y

_
_____
____
___
_____
_
_
____

Asset
s

Li
abi
li
ty
Owner’
sEqui
ty

Youcanchooseei
theroft
het
wof
ormat
sfory
ourbal
ancesheetpr
epar
ati
on.

The f
ollowi
ng is a bal
ance sheetprepar
ed based on t
he sampl
etr
ansact
ions
i
ll
ust
ratedinthechapter
.
MR.X.Tax
Bal
anceSheet
Sept
ember30,200x

Asset
s Li
abil
it
y
Cash…………Birr_
___
___
.00 Accountspay
abl
e…… Bi
rr_
___
_.00
Suppl
ies……………___
___
.00
20
 Land………………_
___
__.
00 Owner’sEquity
AtoDawitGem. ,Capi
talBr_
____
.00.
__
___
___
_ Total
Liabil
i
tiesand
Tot
alAsset
s…….
._
____
__.
00 Owner’sequity
……...
Bir
r__
___.
00

Thedoubl el
inei sdr awnonl ywhent het ot
alassetsont hel eftsi dear eequaltot otal
l
iabi l
it
iesandOwner ’sequi ty
.
Besur et ocarefull
yexami net hef ormatandcont entofeachst at ement .
4.St atementofCashFl ows
Thest atementofcashf l
owsr epor tsthecashcomi ngin(cashr ecei pt
s)andt he
amountofcashgoi ngout( cashpay ment s)duri
ngaper iod.Busi nessact i
v i
ti
esr esul
t
i
nanetcashi nfl
ow( recei ptsgr eaterthanpay ments)oranetcashout f
low
(pay ment sgreatert hanr eceipts).Thi sstat
ementi sreportedint hreesections:
oper atingactivit
ies,inv estingact ivi
ties,andfi
nancingact i
viti
es.
I.CashFl owf rom Oper at i
ngAct ivi
ti
es
Thi ssect i
onincludescasht ransact i
onst hatenterintothedet er mi nati
onofnet
i
ncomeornetl oss.Thenetcashf lowf rom operati
ngactiviti
esnor mal l
ydiffer
sf rom
theamountofneti ncomef ort heper iod.
II.CashFl owf r
om I nv estingAct ivi
ti
es
Thi ssect i
onincludest hecasht ransactionfortheacquisit
ionandsal eofrelat
ively
l
ongt erm orper manentt ypeofasset s.
III.CashFl owf rom Fi nanci ngAct ivi
ties
Thi ssect i
onincludest hecasht ransactionrel
atedt ocashi nvest mentbyt heowner ’s
andbor rowingandwi thdr awalsbyt heowner .
NB:thecashbalanceatthebegi
nni
ngoftheperi
odisaddedtotheincr
ease(
or
decr
ease)incashfortheperi
odtoobt
ainthecashbal
anceattheendoftheper
iod.
Thebasicf
eaturesoft
hefourstatement
sandthei
rint
err
elat
ionshi
psar
eil
l
ust
rat
ed
bytaki
ngdat
af r
om Mr.Xt
axibusinessasfol
l
ow:

21
CheckYourPr
ogr
essExer
cise-
5

1._
___
___
___
___ar
easset
susedorconsumedi
nthepr
ocessofgener
ati
ngr
evenue.

2.Drawi ngsareasset st
akenoutofthebusinessfort
heowner’spersonalbenefi
t.
Doy ouadv i
seowner stowithdr
aw cashorinkind(i
.e.f
urni
tur
e,automobile.
.)?
Why ?
…………………………………………………………………………………………………
3.Listthef ourfact
orsthatchangeowner’
sequity
.Whatisthei
reffectonowner ’
s
equity?
…………………………………………………………………………………………………Whatar ethef ourfi
nancial
st
atement s?
…………………………………………………………………………………………………
4.Ev er
yf i
nancialst
atementhasthr
eeli
nesasaheading,

1stline___
___ __
________
________
____
nd
2 l i
ne___________
_______
________
_
rd
3l ine_____________
_______
______
FinancialSt
atementf orCor porati
on
Business enter prises wi t
hl arge amountofasset s are usually organized as
corporati
onsandhav emanyowner s,caledst
l ockholders.Thef i
nancialstatements
ofcor porat
ionsar esimilart othoseofsol epr opri
etorshipandpar tnershi
pexcept
thatretai
nedear ningsstatementi spreparedinsteadofst at
ementofowner ’sequity.
Theowner ’
sequi tysectionofbal ancesheeti sr ef
erredt oasst ockholders'equit
y
ratherthanowner ’sequity.Inadditi
on,thecashf lowsf r
om financingactivi
tiesfora
22
corpor ati
onar i
sef rom thesal eofcapit
alst ockandt hepay mentofdi v
idends,rat
her
thanf rom owner ’sinvestmentanddr awings.
1.Ret ainedEar ning
Theemphasi sinr eport
ingt hechangesint hest ockhol
ders’equit
yisont hechanges
nr
i etainedear nings,orneti ncomer et
ainedi nthebusiness.Thechangesi nret
ained
earning t hathav e occurred duri
ng a per iod arer eport
ed inr etai
ned earnings
statement .Changei nt heamountofear ningsr etai
nedint hebusinesswoul dhav e
resultedf rom (1)neti ncomeand( 2)distribut
ionofear nings,cal
leddi vi
dends,to
owner s.

2.Bal
anceSheet
Theonl
ydif
fer
encebet
weenthebal
ancesheetofsol
epropri
etor
shi
por/and
part
ner
shi
pandcorpor
ati
onist
hatt
hestockhol
ders’
equit
ysecti
onispr
esented
rat
hert
hanowner’
sequi
ty.

23
3.St
atementofCashFl
ows

Theonl ydif
ferencebetweencashflowsstat
ementofcorpor
ati
onandsole
propri
etorshipor/andpar
tner
shipisonthecashfl
owsfrom fi
nanci
ngact
ivi
ti
es
secti
on, i
.e.
,cashf l
owsari
sefrom t
hesaleofcapi
tal
stockandthecashpayment
sto
stockholdersinthefor
m ofdiv
idends.

24
4.I
ncomeSt
atement

Simil
ar wit
hthe i
ncome st
atement pr
epar
ed f
or sol
e pr
opr
iet
orshi
p or
/and
part
nershi
p

1.
9SUMMARY

Expl
aint
he meani
ng ofaccount
ing. Account
ing i
sthe pr
ocess ofi
dent
if
ying,
measuringrecor
dingandcommuni cati
ngtheeconomi ceventsofanor gani
zat
ion
(busi
nessornonbusiness)tointer
esteduser
soft heinf
ormati
on.Accounti
nghelps
usintheall
ocati
onofscarceresourcesi
naneffi
cientandeff
ecti
vemanner.

I
dent
if
ythe user
s and uses ofaccount
ing.(
a)Managementuses account
ing
i
nformationi nplanni
ngcont roll
ingandev aluatingbusi nessoper ations.(b)Inv estors
(owners)judget hewi sdom ofbuy ing,holding,orsel li
ngt heirfinanciali
nterest son
thebasisofaccount ingdat a,i
.e.toseehowt heirinvestmenti sdoi ng.(c)Cr editors
eval
uatet herisksofgr anti
ngcr edi
torlendingmoney .Ot hergroupsofuser sinclude
taxi
ng aut hori
ti
es,regul at
ory agencies,cust omer s,laboruni ons,and economi c
pannier
s.Theseuser sar egroupedintot wo: 1-Internalusersand i i
-Exter
nal user s.

Explai
nthemeani
ngofgener
all
yaccept
edaccount
ingpr
inci
ples:Gener
all
yaccept
ed
accounti
ngpr
inci
pl eacommonsetofst
esar andar
dsusedbyaccountant
s.
25
Expl
aint
hemeani
ngofbusi
nessent
it
yassumpt
ion,costpr
inci
pleandt
hemonet
ary
unitassumpt i
on. Thebusinessent i
tyconceptstatestheeconomi cev ent
sofa
parti
cularbusinessshouldbeidenti
fi
edseparatefr
om otherentiti
esandt heowner ’
s
personalr ecords. The costprinci
plerequir
es propert
ies acquir
ed bybusi ness
enterpr
isest ober ecor
dedatactualamountspaidand/ orassumedi nacqui r
ingthe
properti
es. Themonet ar
yunitassumpt i
onr equi
resonlyt r
ansactionscapabl eof
beingexpr essedi nter
msofmoneybei ncl
udedi ntheaccount ingr ecordsoft he
businessent er
prise.

Stat
ethebasicaccount
ingequat
ionandexplai
nthemeani
ngofasset
s,l
i
abi
l
iti
es,
andowner
’sequi
ty.Thebasi
caccount
ingequati
oni
s:

Asset
s=Li
abi
l
iti
es+Owner
’sEqui
ty.

Asset sar er esour

cesownedbyabusi ness,l
iabi
li
ti
esr epresentthecl ai
m ofcreditors
ont hetot alassets,andowner ’sequit
yistheowner shipclaim ont hetotalassets.It
i
sof tenref erredtoasr esidual equi
ty.
Analyzet heef f
ect
sofbusi nesst r
ansacti
onsont hebasi caccount i
ngequat i
on.Each
businesst ransacti
onmusthav eadualef fectont heaccount i
ngequat i
on. For
exampl e,ifanasseti sdecr eased,theremustbeacor responding ( 1)Increasei n
anotherasset ,or(2)decreasei naspecifi
cli
abil
i
ty,or( 3)decreasei nowner’sequi t
y.
Aftereacht r
ansact i
on,theequal i
tyofassetstot hesum ofl i
abili
tiesandOwner ’s
equitymustbemai ntai
ned.

Prepareanincomestatement,owner’
sequitystatement,andbalancesheet. An
i
ncomest at
ementpresent
st herev
enuesandexpensesofacompanyf oraspecifi
c
peri
odoft i
me.Anowner ’
sequityst
atementsummar izesthechangesinowner ’
s
equit
ythathaveoccur
redforaspecif
icper
iodoft i
me.Abal ancesheetrepor
tsthe
assets,
li
abi
li
ti
es,
andowner ’
sequit
yofabusinessataspecifi
cdat
e.

1.
10ANSWERSTOCHECKYOURPROGRESSEXERCI
SES

CheckYourPr
ogr
essExer
cise-1

1)Accounti
ng i s the pr ocess of i denti
fyi
ng, measuring, recor
ding and
communi cat
ingeconomicev entstopermitinf
ormeddecisi
onsanddeci si
onsby
theusersofthei
nformati
on.
2)Accounti
ngasani nformationsy st
em helpsother
stomakei nfor
meddecisi
ons
abouttheuseofscarceresources.
3)Bookkeepingist
her ecor
dingpar tofaccounti
ng.Accounti
ngi ncl
udesanal
yti
cal
26
 i
nter
pret
ati
onphasesi
naddi
ti
ont
other
ecor
dingphase.

CheckYourPr
ogr
essExer
cise–2

1) i
)int
ernalusers i i
)externaluser
s.
2)Fi
nancialAccounting
3)ManagementAccount i
ng
4) i
) Publicaccount i
ng
ii
)Pr i
vateaccount i
ng
iii
)Not–f or-prof
itaccounti
ng
CheckYourPr
ogr
essExer
cise-3
1.General
l
yAcceptedAccount i
ngPri
nciples.
2.GAAP,ar e open forchange whenev erbett
ermet hods ar
e developed oras
cir
cumstanceschange.
3.Iti
stheonlycommonuni tofmeasur ementtoallbusi
nessenterpr
ises.Thatis,
whycompar i
sonoft wounrel
atedbusinessent
erpri
sesispossi
ble.
4.TheCostPrinci
ple
CheckYourPr
ogr
essExer
cise–4
1.Basedont henumberofpeopl ewhoownt hem andt hest y
leofowner ship.
2.Unlimmi ttedLi abili
tyrefer st othef actt hatt hel iabili
tyoft heowner sofasol e
proprietorshi pandapar t
ner shipisnotl i
mi tedt ot heext entoft hei
rinv estment ,
butitext endst ot hei
rper sonal properties.
3.Onlycor por ations
4.Owner ’sEqui t
y
5.Liabil
ity
=Asset–Owner ’
sEqui ty=>Liabili
ti
es=60, 000- 45,000=15,000
6.Thoughi tismat hemat i
callycor r
ect;itdoesn’ trefl
ectt hepracti
cal factthatcapi tal
i
swhati sl eftaf terdeduct i
ngl i
abilit
iesf rom asset sascr editor’sclaimst ake
precedenceov ert hoseofowner s.Ther ef
or e,liabilit
yi snotwhati sl eftaf t
er
owner st aket hei rshares.
7.Whent heasset sofabusi nessar enotsuf fi
cientt osat isfyallthecl ai
msofbot h
owner sandcr editors,fir
stcr editorsar epai di nf ullandowner st akewhat ever
remains( i
.e.ther esi
due)ev enifthismeanst heywi llnotbefullypaid.
8.A transact ioni sanev entt hathast ober ecordedbyaccount ant sbecausei t
affectst heeconomi cst atusoft hebusi ness.Thepur chaseofequi pment ,the
consumpt ionofsuppl i
es,t hecol l
ect i
onofmoneyf r
om debt ors,pay mentt o
credit
or s,andt hepr ovisionofser vicet ocust omer sar ecommonexampl esof
transactionst hataccount antshav etor ecorddai l
y.
CheckYourPr
ogr
essExer
cise-5
1.Suppl
ies
2. I ti
snotadvi
sabl
eforowner
stowit
hdrawinki
nd(
suchasavehi
cleorf
urni
tur
e)
becausethi
smayi nt
err
uptthebusi
ness'
soper
ati
onforsometi
meunt i
lthe
27
 wi
thdr
awnasset
sar
erepl
aced.

3.Fact or Eff
ectonowner sequi ty
Rev enues I
ncrease
Expenses Decrease
Inv est ment I
ncrease
Dr awi ngs Decrease
4.The i ncome st at ement ,the bal ance sheet ,st atementofowner ’
s equi tyand
statementofcashf lows.
-Nameofcompany
-Nameofr epor t(statement )
-Per i
odcov eredbyf i
nanci al statement
1.11 MODELEXAMI NATI ONQUESTI ONS
1.Guj icompanyhadt hef oll
owi ngamount sofasset sandl iabi
li
ti
esatt hebegi nni
ng
andendofl asty ear :
Asset s Liabili
ti
es
Beginni ngoft hey ear ………………Br .
75, 000 Br .30,000
Endoft hey ear ….……………………120, 000 46,
000
Deter mi net heneti ncomeornetl ossofGuj iforthey earundereachoft hef oll
owing
unrelat edassumpt i
ons:
a)Ownermadenoaddi t
ionali nv estmentandwi t
hdrew noamountdur ingthe
year
b)Ownermadenoaddi ti
onali nv est mentbutwi thdrewBr.17,500t opayf orher
personal expenses
c)Ownerwi thdr ewnoamountdur ingt hey earbutmadeaddi tionalinv estment
ofBr .32,500cash.
d)Ownerwi thdr ewBr .17,
500andi nvest edBr .25,000cashdur ingthey ear .
2.Foreachoft hef ollowinggi v eanexampl eofat r
ansacti
ont hatcr eatest he
descr ibedef f
ect s:
a)Decr easesal i
abi l
ityanddecr easesanasset
b) I ncreasesanassetanddecr easesanot herasset
c) Decr easesanassetanddecr easesowner sequi t
y
d) I ncreasesal i
abi l
i
tyanddecr easesowner sequi ty
e) I ncreasesanassetandi ncreasesal i
abi l
it
y
f ) Decr easesanassetanddecr easesal i
abil
ity
Mimist artedanew busi nesscal l
edOmoCompanyandcompl etedt hef oll
owing
tr
ansact i
onsdur ingNov ember :
Nov .1Mi mit ransf er red56, 000outofaper sonalsav i
ngsbankaccountt oachecki ng
accountshei nt henameoft hebusi ness.
1.Rent edof ficespaceandpai dcashf ort hemont h’srentof800
3.Pur chasedel ect r
icalequi pmentf or14, 000bypay i
ng3,200andagr eeingto
28
 payt he r emai ningbal ancei nsixmont hs
5.Pur chasedof fi
cesuppl iesbypay i
ng900cash.
6.Compl etedel ectrical wor kandr eceived1,
000cashf ordoingt
hewor
k.
3.Pur chased3, 800ofof ficeequi pmentoncr edit
15.Compl etedel ectrical wor koncr editi
ntheamountof4, 000
20.Pai dfort heof fi
ceequi pmentpur chasedonNov .9
24.Bil
ledacust omerf orel ectricalworkcompl eted600
28.Recei ved4, 000f ort hewor kcompl etedonNov .
15
30.Paidsal aryofempl oy ees1, 200
30.Paidt hemont hlyut ili
tiesbi ll440
30.Withdr ew700f rom t hebusi nessforpersonal use
Requi
red:
1.Ar ranget hef oll
owi ngasset ,liabili
tyandowner ’sequi t
yt it
lesi nat abl ejustl i
ke
il
lustrated int his uni t:Cash,Account s Recei vabl e,Of fi
ce Suppl ies,Of fi
ce
Equi pment ,Electri
cal Equi pment ,Account sPay ableandMi mi Capital.
2.Useaddi t
ionsandsubt r
act ionst oshow t heef fectofeacht ransact i
onont he
it
emsi nt heequat ion.Show new t otalsaf t
ereacht r
ansact ion.Nextt oeach
changei nowner sequi tyst atewhet hert hechangewascausedbyani nv estment ,
revenue, expenseorwi thdr awal .
3.Pr epar eani ncomest atement ,ast atementofowner ’
sequi ty,andabal ancesheet
1.12GLOSSARYOFTERMS
Account i
ng-t hepr ocessofi dent ify
ingmeasur i
ng, r
ecor ding, andcommuni cati
ngt he
economi cev entsofanor gani zationt oint eresteduser soft hei nformat ion.
Asset s–Resour cesownedbyabusi ness.
Auditing–t heexami nationoff i
nanci alst atement sbyacer t
ifi
edpubl i
caccount antin
ordert oexpr essanopi nionast ot hef airnessofpr esentat ion.
BalanceSheet–Af i
nanci alst atementt hatr epor tstheasset s, l
iabil
iti
es, andowner ’
s
equityonaspeci fi
cdat e.
BasicAccount i
ngEquat ion- Asset s=Li abili
ties+owner ’
sequi t
y
Bookkeepi ng–Apar tofaccount i
ngt hati nvolvesonl yt her ecordingofeconomi c
events.
Corpor ation – a busi ness or ganized as a separ atel egalent it
y underst ate
corpor ati
onl awhav ingowner shipdi videdi ntot ransferableshar esofst ock.
CostPr i
nciple–anaccount ingpr inciplet hatst atest heasset sshoul dber ecordedat
thei
ract ual cost.
Drawi ngs–Wi thdrawal sofcashorot herasset sfrom t hebusi nessf ort heowner ’
s
personal use.
Economi c( Business)Ent ityAssumpt i
on–Anassumpt iont hatst atesabusi ness
enterpr i
semustbegi v ensepar ateanddi sti
nctexi stencef rom t heowner s,cr editors,
customer sandanyot herpar ty.
Expenses-t hecostofasset sconsumedorser vi
cesusedi nt hepr ocessofear ning
29
revenue.
Incomest at ement–Af inancialstatementt hatpr esent st her evenuesandexpenses
andr esul tingneti ncomeornetl ossofacompanyf oraspeci f
icperiodoft ime.
Investmentbyowner–t heasset sputint ot hebusi nessbyt heowner .
Liabili
ties–Repr esentst heclaim ofcr editorsont heasset soft hebusi ness.
Monet ar yuni tassumpt ion–Anassumpt ionst atingt hatonl ytransact i
onst hatcan
beexpr essed i nt ermsofmoneybei ncl uded i nt heaccount i
ng recor dsoft he
business.
NetI ncome–t heamountbywhi chr evenuesexceedexpenses.
Netl oss–t heamountbywhi chexpensesexceedr ev enues.
Owner ’sEqui tySt atement–Af inancialst atementt hatsummar i
zest hechangesi n
owner ’sequi tyf oraspeci f
icper i
odoft ime.
Partner shi p–Anassoci ati
onoft woormor eper sonst ocar ryonabusi nessasco-
owner sf orpr ofit.
Privateaccount ing–Anar eaofaccount ingwi t
hi nacompanyt hati nv olv
essuch
activi
tiesascostaccount i
ng,budget i
ng, andaccount ingi nf ormationsy stems.
Publ i
cAccount ing–Anar eaofaccount i
ngi nwhi cht heaccount antof f er
sexpert
servicet ot hegener alpubliconaf eebases.
Rev enues–t hegr ossi ncreasei nOwner ’sequi ty,resul ti
ngf orm businessact i
vi
ti
es
enteredi nf orthepur poseofear ningincome.I tist heamountchar gedt ocust omers
forserv icessol dorgoodsdel iveredtot hem.
TaxAccount ing-anar eaofpubl icaccount i
ngi nvolv ingt axadv i
ce,taxpl anning,and
preparingt axr et ur
ns.
Transact ions–Theeconomi cev ent
soft hebusi nessr ecor dedbyt heaccount ant.

30
CHAPTERTWO:2.
1ACCOUNTI
NGCYCLEFORSERVI
CEBUSI
NESS

Inunit1,y ouhav el earnedt her el

at ionshipbet weent heaccount ingequat i
onand
businesst r
ansact ions. Ev er ybusi nesst ransact ion affect st heel ement soft he
account i
ngequat i
on.Thi saccount ingpr ocedur ewi l
lbedi scussedi ndet ail. The
diff
erentandi nt err
elatedst agesoft heaccount ingcycl ewi l
lbepr esented. The
chapteri slengthy ,butessent ialfort her emai ningchapt ersi nt hi
scour seandot her
account i
ngcour ses.Ther efore,youar eadv isedt ost udyt hechapt ercar eful
ly.
2.2NATUREOFANACCOUNT
In ordert o prov i
de t he necessar yi nf
or mat i
on t o user s,account ants mai ntain
separater ecordsoneachel ementoft hef inancial statement s.Forexampl e,tor epor t
thebal ancef orcashatt heendofay ear,ar ecor dr egar dingcashshoul dbekept .
Ther ecor di ncludesbegi nningcashbal ance,cashpay ment s& cashcol l
ect i
ons
duringtheper i
od.Thi srecordiscalledanaccount .
Defini
tion:Anaccounti sasubdi visionundert het hreeel ement soft heaccount ing
equation used t or ecordt he changes ov era si ngle el ementi nt he financi al
statement s.Anaccounthast hreepar t
s,Ti tle,Debi t,andcr edit. Fori l
lustration
purposesanaccountcanber epresent edint hef orm ofcapi tallett
er‘ T’.
Exampl e
Titl
e
Debi t Cr edit
Dr Cr

2.
3CLASSI
FICATI
ONSOFACCOUNTS

31
Account sar ecl assi fi
edi nt of i
v e:asset s,l i
abi l
ities,capi tal,r evenueand,expenses.
Thef irstt hr eear ecal led bal ancesheetaccount s andt heot hert woar ecal led
i
ncomeSt atementaccount s. Bal anceSheetaccount sar et hoser epor tedont he
balancesheetatt heendoft her epor tingper iodandI ncomeSt at ementaccount sar e
repor tedont heI ncomeSt at ement .
Thef iv egr oupsofaccountar edi scussedbel ow
1.Asset s:Resour cesownedbyabusi nessori ndi v
idualar ecal ledasset s.Asset s
couldbet angi bleori ntangi ble.Tangi bleasset sar easset shav i
ngphy sical exi st
ence,
l
ike cash,l and,comput er ,st at ioner ymat erials. I ntangi bl e asset s do nothav e
physi cal exi st ence.Exampl e: Sof twar e,Goodwi ll,Copy right, patentr ight.
Ont hebal ancesheetasset sar ecl assi f
iedint ot wocur rentasset sandnon–cur rent
asset s.
CurrentAsset s–ar et hoseasset s,whi chcanbeused,sol d,orconv ertedi ntocash
withinoneaccount i
ngy ear .Exampl e: cash, suppl ies, prepay ment s, r
ecei vabl eset c.
Non- cur r
entAsset :Al lasset sot hert hancur rentasset sar ecal l
ednon- currentasset s.
Exampl e: l
and, pat entr ight ,of ficeequi pment , vehi cles.
2.Li abi l
ities: Cr editors’cl ai mst ot heasset sofabusi ness;amount sowedt o
creditor sar ecal edl
l iabi l
ities.Li keasset s,li
abi l
iti
esar ecl assi fi
edi nt ot woascur rent
l
iabiliti
esandnon–cur rentl iabi liti
es
Currentl iabilities:Thel iabi l
itiest hatar epay abl ewi thi
nt henext( one)account ingy ear
areknownascur r
entl iabi l
ity. Exampl e:Account sPay able,RentPay abl e,Sal ary
Pay abl e.
Non– Cur r
entLi abili
ties:Debt st hatar enotr equi r
edt obepai dwi thint henext
account i
ngper iod.Exampl el ongt erm not espay abl e.
3.Capi tal :Theexcessoft heasset sofabusi nessov eri tsl iabili
tiesi sr efer redtoas
capital .Itist heequi tyoft heowneri nt hebusi ness.
4.Rev enue:Ar eincr easesi nowner ’
sequi t
yr esult ingf rom t hemai noper ationsoft he
business.
Exampl esofr ev enueaccount sar esal es,i nteresti ncome,t uitionf ee,andsal es
commi ssi on.
5.Expenses:ar edecr easesi nowner ’sequi tyi nt hepr ocessofear ningr ev enue.For
exampl e,ahot elhast opaysal ar yt oi tswor kersf ort heser v i
cesr ender edt ocl i
ent s
i
nor dert ogett hei ncomef orm cust omer s( revenue)t heHot elhaspaysal aryt ot he
empl oy ees( expense) .
Exampl eofexpenses: Sal ary ,insur ance, depr eciat ion,suppl i
es, ut il
iti
es, rentet c.
2.4CHARTOFACCOUNTS
Thenumberandnameofaccount susedbyanor gani zat i
ondependsont henat ureof
i
tsoper ation.Thel i
stofaccount sandt hei
rcodesusedbyanor ganizat i
oni scal led
thechar tofaccount s.Lookatt hef ollowi ngchar tofaccount sofBat iTr anspor t
.

Bat
iTr
anspor
t
32
 Char
tofAccount
s

Asset Accountnumber
Cash- --
---
-----
--
---
--
--
---
----
--
---
--
---
---
---
---
--
----
---
--
--
---
--
--
--
---
---
11
Account sRecei vable- -
--
---
--
---
---
---
---
--
----
---
--
--
---
--
--
--
---
---
----
-12
Suppl ies- -
----
--
---
--
---
---
---
--
---
---
---
---
--
---
----
---
---
--
--
--
---
--
--
---
---13
Pr epai dInsur ance----
---
---
--
----
---
--
--
---
----
---
---
--
--
--
---
--
--
----
----
--
14
Equi pment --
--
---
--
--
---
----
--
---
--
---
---
---
---
--
----
---
--
--
---
--
--
--
---
---
--15
Accumul at edDepr eciation–Equi pment -
--
---
--
--
--
---
--
----
----
---
---
--16
Truck- -
---
---
----
---
--
--
---
----
--
---
--
---
---
--
---
---
----
---
--
--
---
--
--
--
---
---
-17
Accumul at eddepr eciati
on–Tr uck----
---
---
--
--
--
---
--
--
----
----
--
----
--
-18
Liabi l
it
ies
Account sPay abl
e---
----
--
---
--
----
---
--
---
----
---
--
---
--
--
--
---
--
--
------
--
--21
Not esPay able---
--
---
---
---
---
--
---
---
--
---
---
----
---
--
--
---
--
--
--
--
----
----
--
22
Owner sEqui ty
YimerAdem, Capital---
--
---
--
---
---
---
---
--
----
---
--
---
--
--
--
---
--
----
----
--
-31
YimerAdem Dr awing- -
--
---
--
---
----
--
---
----
--
---
---
--
--
--
---
--
--
------
--
-32
I
ncomeSummar y---
---
---
---
--
---
---
--
---
---
----
---
--
--
---
--
--
--
--
----
----
--
-33
Rev enue
Ser v i
cei ncome- -
--
---
----
--
---
--
---
---
---
---
--
----
---
--
---
--
--
--
---
--
----
----
-41
Expense
Sal ar i
esExpense- -
----
---
--
---
---
---
--
---
---
----
---
--
--
--
---
--
--
--
----
----
--
--51
RentExpense- -
--
--
---
----
--
---
--
----
---
--
---
----
---
--
---
--
--
--
---
--
--
------
--
-52
Ut i
litiesExpense- -
---
----
--
---
--
---
---
---
---
--
----
---
--
---
--
--
--
---
--
----
----
--
53
Suppl iesExpense- -
----
---
--
---
---
---
--
---
---
----
---
--
--
--
---
--
--
--
----
----
--
--54
I
nsur anceExpense- ---
---
---
--
---
---
--
---
---
----
---
--
--
---
--
--
--
--
----
----
--
---55
Mai nt enanceExpense- -
--
---
---
---
--
---
---
----
---
--
--
--
---
--
--
--
----
----
--
----
56
Depr eci ationExpense- --
---
--
---
----
--
---
----
--
---
---
--
--
--
---
--
--
------
--
---
-57
TruckExpense- --
--
---
----
--
---
--
---
----
--
---
----
--
---
--
---
--
--
--
---
--
-----
---
-58
Mi scel l
aneousexpense- --
--
---
---
---
---
--
----
---
--
--
---
--
--
--
---
---
----
---
----
59
I
nt hechar tofaccount s,theassetaccount sar el i
stedaccor di
ngt ot hei
rl i
qui
dity.
Liqui di tyist heeasewi thwhi chanassetcanbeconv er t
edi ntocash.Cashi sthe
mostl i
qui dassetsoi tislistedf i
rst.Account sot hert hancashwi llbelist
edi nthei
r
frequencyofuseori nal phabet i
cal order .
Theaccountnumberi sacodet oident if
yaccount s.Thenumbercoul dbeat wodi gi
t,
threedi gitormor edi git
s.I ntheabov eexampl eat hr ee–di git
scodei sused.
Whent hechar tofaccount si spr eparedi nanor ganizat i
onwesayt hel edgeris
opened.
2.5RULESOFDEBI TSANDCREDI TS
Asshownabov eev eryaccounthast hreeparts.Thesepar tsarediscussedbel ow:
Title–Thenameoft heaccount .Thi si swritt
enatt het opoft heaccount .
33
Debi
t–i
sthel
efthandsi
deofanaccount–Debi
tisabbr
evi
atedas‘
Dr.
’
.Whenan
amounti sent er edont hel ef tsi deofanaccountwesayt heaccounti sdebitedor
charged.
Credit–i sther ighthandsi deofanaccount .Cr editisabbr ev iatedasCr .Anaccount
i
ssai dt obecr editedwhenanamounti sent eredont her i
ghthandsi deoft he
account .
Anaccountmayi ncr easeordecr easeont hedebi tsi deoront hecr editside
dependi ngont henat ur eoft heaccount .I ngener al,account sappear ingont heleft
handsi deoft heaccount ingequat ioni ncreaseont heirl eftsi de( Dr.side)and
decreaseont hei rrightsi de( Cr .Si de) ;wher easaccount sont her ightsi deoft he
equat i
oni ncr easeont hei rrightsi deanddecr easeont heirleftsi de.
Theabov egener al r
ulewi llbeexpandedasf ollows
Debi t Cr edi t
-I
ncreasei nasset s -Decr easei nasset s
-I
ncreasei nexpenses -Decr easeinexpenses
-Decreasei ncapi tal -Increasei nLi abi
lit
ies
-Decreasei nl iabi liti
es -Increasei nliabi l
it
ies
-Decreasei nr ev enue -Increasei nrev enue.
CheckYourPr ogr essExer cise-1
1.Unl i
keot heraccount sont her i
ghthandsi de, expensesi ncr easeont hedebi tside
anddecr easeont hecr edi tsi de.Expl aint her eason.
……………………………………………………………………………………………
Thenor malbal anceofanAccount
Nor malbal ancer eferst ot hesi deofanaccount( Dr.orCr .),whi chwi llhav egreater
entri
est hant heot her.Thei ncr easi ngsi dewi l
l bet henor mal balancef oraccount s.
Exampl e:Thenor mal bal anceofal l assetaccount sisdebi t
2.6JOURNALI ZINGBUSI NESSTRANSACTI ONS
Whenabusi nesst ransact iont akespl ace,sour cedocument swi l
lbeobt ainedand
recorded.Theaccount ingr ecor di nwhi chat ransact i
onisi nitiall
yr ecor dedisknown
asaj our nal.Thej ournal i
st her ef orer efer redt oas“ Thebookofor i
ginal entry”.
Thepr ocessofr ecor dingabusi nesst r ansact ioni ntheaccount i
ngr ecor di scalled
j
our nali
zing.
TheJour nal commonl yusedt or ecor dal ltypesoft ransactionsi stheGener al Journal
.
ThisJour nalincl udest hef ollowi ngpar t
s, ent eredst epbyst ep.
1.Thedat eoft het ransact i
on
2.Thet i
tleoft heaccountdebi ted
3.Thet i
tleoft heaccountcr edi ted
4.Theamountofdebi tandcr edi t
5.Br iefexpl anat ionoft heent ryorr efer encet ot hesour cedocument .
Look att he f ol l
owi ng Gener alJour naland not i
ce wher e each oft he abov e
i
nf ormationi sf ound.
34
 Journal page
Dat e Descr
ipt
ion P.
R Debi
t Credit
Year
Mont h day Debi tedaccountt it
le XXX XX
Credi tedaccountt i
tle XXX XX
Expl anat ion
Ther ear eal soot hert ypesofJour nal slike,knownasspeci aljournalst hatareused
tor ecor dspeci fict ypesoft ransact i
ons.ThecashJour nal ,forinstance,isusedt o
recordonl yt ransact i
onsaf fect i
ngcash.TheGener alJour nalisusedf orill
ustrat
ions
i
nt hischapt er .Speci al j
our nal sar edi scussedi nuni t5.
St epsi nJour nal izingaTr ansact ion
Thef ollowi ngst epsshoul dbef ollowedi nr ecor dingat ransact i
oni nthej our
nal.
1.Recor dt hedat e-I nser tthey ear ,
t hemont h,andt hedat easshownabov e.
2.Recor dt heDebi t-I nser tt heaccountdebi tedi nt hedescr i
ptioncol umnandt he
amountofdebi ti nt hedebi tcol umn.
3.Recor dt hecr edit-I nser tt heaccountcr edi tedbel owt hedebi t
edaccountand
i
ndent edt ot her ighti nt hedescr ipt i
oncol umnandt heamountofcr editinthe
cr editcol umn.
4.Expl anat ion-Wr iteabr i
efexpl anat ionorr efer encet osour cedocumenti nthe
descr ipt i
oncol umn, whennecessar y.
Eachonesetofdebi tsandcr edi tsf orat ransact ioni scal edaj
l ournalent ry.
Inr ecor dingabusi nesst ransact ionanswert hef ol lowi ngquest ionsbasedont he
transact iont ober ecor dedmayhel py ou.
a)Whi chaccount sar eaf f
ect ed?
b)I seachaccounti ncr easedordecr eased?
c)Whi chaccounti sdebi tedandwhi chi scr edited?
d)Pr epar ethecompl etej ournal ent ry.
Exampl e.OnJanuar y10, 2003TamgetP. L.Cpai dBi r r6,000t oi t
sempl oyeesasa
salaryfort hef irstweekoft hey ear .
Thisbusi nesst ransact ionwi llbeanal yzedandr ecor dedasf ol l
ows.
a)Whi chaccount sar eaf fect ed?Answer : CashandSal aryExpense.
b)I seachaccounti ncr easedordecr eased?Answer :cashi sdecreasedandsal ar
y
expensei si ncreased.
c)Whi chaccounti sdebi tedandwhi chi scr edited? Answer :SalaryExpensei s
debi t
edbecausei ncr easei nexpensesi srecor dedont hedebi tside.Andcashi s
credi tedbecausedecr easei nasset sisr ecor dedont hedebi tside.
d)Pr epar et hecompl et eJour nal entry.
2003 Descr iption
Jan. 10 Sal ar yexpense 6000 00
Cash 6000 00
Pay mentofsal ary
35
Not
e:Aj
our
nalentryi
sthecompletepresent
ationoftherecordi
nthejournal
.
CheckYourProgressExercise-2
Jour
nal
i
zethefoll
owi
ngtransact
ionbyanswering4quest i
onssuggestedabove.
 OnJanuary11,
2003Tamgetboughtabui l
dingforBir
r150,
000oncr edi
t.
I
ll
ust
rat
ion
Toi l
l
ust r
atet hecompl eteaccount ingcy cl e,wewi l
lconsi derthef ol l
owi ngl istof
selectedt r
ansact i
ons. Thet ransact ionswer ecompl etedbyBat iTr anspor ti nthe
mont hofJanuar y2003.
Januar y1.At oy i
mert ookBi rr450, 000f rom hi sper sonalsav i
ngsanddeposi teditin
thenameofBat i tr
anspor t.
Januar y2.Bat iTr anspor tpur chasedt wousedt rucksf orBirr150, 000each, oncash.
Januar y4.Bat iTranspor tr eceiv edacheckf orBi r
r650f orser v
icesgi vent oAl em
Trading.
Januar y4.Recei vedani nv oicef ortruckexpensesBi r
r90.
Januar y11.Pai dBi rr600f orAwashI nsur anceCompanyt obuyani nsur ancepol i
cy
for i
tst rucks.
Januar y16.At oYi meri ssuedacheckf orBi rr9,400t ot hewor kersasasal aryf or
twoweeks.
Januar y20.Bat itradingBi ll
edMur aduSuper mar ketf orgoodst ranspor t
edf rom
Djibout itoGondarBi r
r2,650
Januar y21.At oYi merwr oteacheckf orbi rr450t ohav eoneoft het r
ucksr epainted
Januar y21.Bat itradingpur chasedst ationar ymat erial
sandot hersuppl iesofBi r
r
740on
account
Januar y22.Of f
iceequi pmentofBi rr11, 600i sboughtonaccount .
Januar y23.Pur chasedanaddi ti
onalt ruckf orBi r
r250, 000pay ingbi rr100, 000i n
cash
andi ssui nganot ef orthedi fference.
Januar y23.Recor dedser v i
cesbi l
l
edt ocust omer sonaccountbi rr14,600.
Januar y25.Recei vedcashf rom cust omer sonaccountBi rr15,000.
Januar y27.Theownerwi thdr ewBi r
r500i ncashf orhi sper sonal use.
Januar y28.Pai dBi r
r9, 400t owor ker sasasal aryf orthel astt woweeksoft he
mont h.
Januar y30.Pai dt elephoneexpenseofBi rr95andel ectr
icexpensesofBi rr125f or
the
mont h.
Januar y30.Pai dot hermi scel laneousexpensesBi rr50.
Januar y31.Pai dBi rr4,000asar entf orabui l
dingusedf orof f
icespace.
Theset ransactionsar ejour nalizedasf ollows:

36
Dat
e Descr
ipt
ion Debi
t Cr
edi
t
2003 Cash 450,
000
Jan.
1 Yi merCapi tal 450,
000
Tor ecor dinv est mentbyowner
2 Truck 300,
000
Cash 300,
000
Pur chaseoft rucks
4 Cash 650
Ser v
iceI ncome 650
Cashr ecei vedf rom customers
4 TruckExpenses 90
Account sPay able 90
Ser vicer ecei vedi nadv ance
11 Prepai dInsur ance 600
Cash 600
Pur chaseofi nsur ancepol i
cy
16 SalaryExpense 9,
400
Cash 9,
400
Pay mentofsal ary
20 Account sRecei vabl e 2,
650
Ser viceIncome 2,
650
Pr ov i
sionofser vice
21 TruckExpense 450
Cash 450
Cashpai dtor epai nttr
uck
21 Suppl ies 740
Account sPay able 740
Pur chaseofsuppl i
esofaccount
22 OfficeEqui pment 11,
600
Account sPay able 11,
600
Pur chaseofequi pment
23 Truck 250,
000
Cash 100,
000
Not esPay abl e 150,
000
Pur chaseoft r
uck
23 Account sRecei vabl e 14,
600
Ser v
iceI ncome 14,
600
Pr ov i
sionofser viceonaccount
25 Cash 15,
000
Account sRecei vable 15,
000

37
 Collecti
onofcash
27 Drawings 500
Cash 500
Ownerwi t
hdrawals
28 SalaryExpense 9,
400
Cash 9,
400
Pay mentofsal ary
30 Uti
lit
iesExpense 220
Cash 220
Pay mentf ort
elephone,
elect
ri
cit
y
30 MiscellaneousExpenses 50
Cash 50
Pay mentf orvari
ousexpenses
31 RentExpense 4,
000
Cash 4,
000
Pay mentofRent
2.
7POSTI
NGFROM THEJOURNALTOTHELEDGER

Afterthe inf
ormat i
on abouta busi ness transacti
on has been j
our
nalized,that
i
nformationistransferredtot hespecificaccount saff
ectedbyeacht ransacti
on.
Thisprocessoftransferr
ingtheinfor
mationiscalledposti
ng.
Anaccountcoul dbeoft wot ypes;thetwo-columnaccountandt hef our-col
umn
account.Wewi lluset hefour-
columnaccountf orouril
lustr
ati
on.Thetwof ormsof
accountsaregiv
enbel ow.
Thet
wo-
col
umnaccount
:
Account Accountnumber
Date I
tem P.
R Debi
t Dat
e I tem P.
R Cr
edi
t

Thef
our
-col
umnaccount
:
Account Accountnumber
Date I
tem P.
R Debi
t Cr
edi
t Bal
ance
Debi
t Cr
edi
t

Thest
epsi
npost
ingar
egi
venbel
ow:
1.Recor dt hedateandamountofDr.andCr.Entrytot
heaccount
2.I nser
tt heJournalpagenumberi ntheP. R(PostRef
erence)col
umnoft he
account.
3.I nser
ttheaccountnumberintheP.Rcolumnoft hej
our
nal.
Note.TheP. RCol umnisusedforref
erencepurposes.TheP.
Rcolumnoft hej
ournal
showswhet hert heentr
yispostedandt heaccountt owhi
chitisposted. I
nthe

38
account,t
heP. RCol
umnshowst heJour nalpagenumberf r
om whichtheent r
ywas
brought.
Thegroupofaccountsusedbyanor ganizationiscal
ledledger.
Il
lust
rati
on.Asment ionedabove,toil
lustratethepost i
ngprocessthef ourcol
umn
accountisusedandtheentr
iestothecashaccountar epostedasfol
lows.
AccountCash AccountNumber
Balance
Date I
tem P.R Debi t Credit Debit Cr
edi
t
200 450, 000 00 450,000 00
3 1
Jan
2 300,000 00 150, 000 00
4 650 00 150,650 00
11 600 00 150050 00
16 9,400 00 140650 00
21 450 00 140200 00
23 100,000 00 40200 00
25 15,000 00 55200 00
27 500 00 54200 00
28 9,400 00 45300 00
30 220 00 45, 080 00
30 50 00 45, 030 00
31 4,000 00 41, 030 00

Not e.Theitem columnisusual lyl

eftblank. Insomecasest hewor dbal anceis
writtenwhentheaccounti
scar ri
edforewordt oanewpage.
CheckYourPr ogressExercise-3
Rulet heotheraccount
susedbyBat iTransportandpostther espect
iveDr .&Cr .
entries(Hi
nt17accounts,incl
udingcash,areusedbyBatiTransport)
.Don’tconti
nue
withoutdoingthisbecauset hef ol
l
owingdi scussi
onassumesy ouhavedonet hi
s
exercise!
2.8THETRI ALBALANCE

Aftertheposti
ngphasei scompl eted,wehav etov er
if
yt heequal i
tyofthedebitand
creditbal
ances.Thi sisdonet hr
ought heuseoft he‘TrialBalance’.Atri
albal
anceis
atwocol umnl i
sti
ngoft heaccount sint heledgerandtheirbalancet omakesurethat
thetotalofdebi
tbal ancesequalsthet otalofcredi
tbalances.
Thet ri
albal
ancef orourill
ust
rati
on, BatiTransportispresentedbel l
ow.Theamount s
aretakenf rom thebal ancesoft heaccount safterallthet ransacti
onshavebeen

39
post
ed.Theref
ore,aft
erposti
ngtheabovetr
ansact
ions,y
oushoul
dgett
hef
inal
bal
ancesshownont hetr
ial
bal
ancei
ntheend.

BatiTransport
Tr
ialBalance
January31, 2003

Cash 41,030 00
Account sRecei vabl e 2,250 00
Suppl i
es 740 00
Prepai dInsur ance 600 00
Officeequi pment 11,600 00
Truck 550,000 00
Account spay abl e 12, 430 00
Not espay able 150, 000 00
Yimercapi tal 450, 000 00
Yimerdr awi ng 500 00
Serv icei ncome 17, 900 00
Salar yexpense 18,800 00
Rentexpense 4,000 00
Util
itiesexpense 220 00
Mai nt enanceexpense 450 00
Truuckexpense 90 00
Miscel l
aneousexpense 50 00
Total 630,330 00 630, 330 00
2.
8.1Pr oofPr ov idedByt heTr ialBalance
Thetri
al bal ancedoesnotpr ov
idecompl etepr oofofaccur acyoft heledger .I
t
i
ndicatesonl yt hatt hedebi tsandcr edit
sar eequal .I
fthet wototalsoft ri
albalance
arenotequal ,itispr obabl yduet ooneormor eoft hefol
lowingty pesofer rors:
1.Er rorinpr epar i
ngt ri
albalance:
a.Oneoft hecolumnsoft het ri
albalancewasi ncor rectl
yadded.
b.Theamountofanaccountbal ancewasi ncorr
ect lyrecordedont he
tri
al balance.
c.Adebi tbal ancewasr ecor dedascr edit,orvi
cev ersa,orabal ance
wasomi ttedent i
rely
.
2.Er rorindet ermi ni
ngt heaccountbal ance:
a.Abal ancewasi ncorrectlycomput ed.
b.Abal ancewasent er
edi nt hewr ongbal ancecolumn.
3.Er rorinr ecordingat ransact i
oni nthel edger
a.Aner roneousamountwaspost edtotheaccount .

40
 b.Adebi
tent
rywaspostedasacr
edit
,orv
icev
ersa.
c.Adebi
torcr
edi
tpost
ingwasomitt
ed.

Amongt hetypesofer ror

sthatwi l
l notcauseaninequali
tyint
het r
ialbalancetotal
s
ar
ethefoll
owi ng:
1.Fai l
uret orecordatransactionort opostatransact
ion.
2.Recor dingt hesameer r
oneousamountf orboththedebitandcr editpar
tsofa
tr
ansact i
on.
3.Recor dingt hesamet ransactionmor ethanone.
4.Post i
ngapar tofatransactioncor r
ectl
yasadebi torcreditbutt othewr ong
account.

2.
8.2. DISCOVERYOFERRORS
Theexi
stenceofanerr
orcanbedet er
minedinvar
iousways:
1. Byauditprocedures
2. Bychancedi scover
y,or
3. Throughthemedi um oft
hetri
albal
ance.
2.8.
3. TYPESOFERROR
a.Addi t
ion:Forexampl e,adi f
ferenceof$10, $100, or$1,000betweent otal
s
isfrequent lytheresul toferrorinaddition.
b. Omi ssi
on:Adi fferencebet weent otal
scanhappenduet ot he
omi ssionofadebi toracr editpostingor ,i
fitisdivisi
bleevenl
yby2, tothe
post i
ngofadebi toracr edit,orv i
cev ersa.Forexampl e,ift
hedebi tand
credittot alsofat rialbalancear e$20, 640and$20, 236r espect
ivel
y ,t
he
diff
erenceof$404mayi ndicatethatacr edi
tpost i
ngoft hatamountwas
omi tt
edort hatacr editof$202waser r
oneousl ypostedasadebi t.
c. Transpositions:Itist heerroneousr earrangementofdigit,such
aswr i
ting$542as$524or$452.
Sli
de:Itistheentirenumberi ser roneousl ymov edoneormor espacest other i
ghtor
thelef
t,suchaswr iti
ng$542. 00as$54200or$54. 20
2.8.
4.Li mi tati
onsoft heTr i
alBal ance

Thetri
albal anceamount sareequaldoesn’ tmeant hattheaccount ingwor kisfree
fr
om error.Thati s,thereareer r
orst hatmayt akepl acewi thoutaf fect
ingthetrial
bal
ancet otals.Someex amplesar ement ionedbelow:
- Fai lur
etor ecordatransactionort opostat ransact
ion
- Recor di
ngt hesameer roneousamountf orbot hthedebi tandt hecredi t
partsofat ransact
ion.
- Recor di
ngt hesamet ransactionmor ethanonce.
- Post i
ngpar tofatr
ansact i
ont ot hecorr
ectsi debutthewr ongaccount .
Note:Allt heseer r
orshav ethesameaf fect(i
ncreasingordecr easing)ont hedebi t

41
totalsandcr edi ttot als
2.9ADJUSTMENTS
Allt het ransact ionsr ecor dedabov ei nt hej our nalizingst epar et her esul tofdai l
y
transact i
ons.Ot hert ransact ionsr esul tfrom t hepassageoft i
meorf rom t hei nternal
oper at i
onsoft hebusi ness.Forexampl e,insur ancepr emiumsar epai df oracer tain
periodoft imeandexpi r
edur i
ngt hatt i
meper iod.Anot herexampl eisof ficesuppl ies
suchaspaper ,pens&penci ls.
Att heendoft heper iodt hebal ancesi naccount ssuchassuppl iesandpr epaid
i
nsur ancemustbebr oughtupt odat e.Thesuppl iesaccountbal ance,f orexampl e,
mustbecr editedbyt heconsumedpar toft hesuppl i
es, debitingsuppl i
esexpense.
Exampl e.St at ionar ymat erialst ot alingBi rr1, 900.00wer epur chasedandr ecorded
duringt hey ear .Att heendoft hey ear ,onlyBi rr150oft hesuppl i
esar el ef tinhand.
Theadj ust i
ngent rypr epar edatt heendoft hey eartoadj ustt hesuppl iesaccountwi ll
be
1990 Suppl iesexpense 1,750
Dec31 Suppl ies 1,750
Not e:1.Adj ust ment sar edat edast hel astdayoft hey ear.
2.Theaccount ingy earher e–weassume, r
unsf rom Januar y1-December31.
Addi tional exampl esonadj ust ment swi llbegi venbel owundert het opi c‘wor ksheet ’
2.9.1TheAccr ualBasi sandt heCashBasi sofAccount i
ng
1.Thecashbasi sofaccount ing–I nt hisbasi sofaccount ingr ev enuesar erepor t
ed
i
nt heper iodi nwhi chcashi sr ecei vedandexpensesar er epor tedi nt heper i
odi n
whi chcashi spai d.Neti ncomewi ll,t
her efore,bet hediffer encebet weent hecash
recei pts( Rev enues)andcashpay ment s( expenses) .Thi smet hodwi llbeusedby
organi zat ionst hathav ev er yfewr eceivabl esandpay ables.Formostbusi nesses,
howev er,thecashbasi si snotanaccept ablemet hod.
2.Theaccr ualbasi sofaccount ing–Undert hismet hodr ev enuesar er epor tedi n
theper i
odi nwhi cht heyar eear ned,andexpensesar er epor t edi nt heper iodi n
whi cht heyar ei ncur red.Forexampl e,revenuewi llberecogni zedasser vicesar e
prov idedt ocust omer sorgoodssol dandnotwhencashi scol l
ect ed. Most
organi zat ionsuset hismet hodofaccount ingandwewi llappl yt hismet hodi nthis
cour se.
2.9.2TheMat chingPr i
nci ple
Wehav edi scussedt hr eeconcept sandpr i
nci plesinaccount ingi nuni tone.Nowwe
wi l
lseeonemor epr i
nci ple,t hemat chingpr incipl
e. Thi spr incipl est at est hatthe
expenseofaper iodhav et obemat chedwi tht herev enueoft hatper iodr egar dlessof
whenpay menti smade.I nor dert odot his, t
heaccr ualbasisofaccount ingr equires
theuseofanadj ust ingpr ocessatt heendoft heper i
odsot hatr ev enuesand
expensesoft heper iodwi llbedet er mi nedpr oper ly.

42
 2.10.Adjust
ment
2.10.1.TYPESOFADJUSTI
NGENTRI
ES

Abusi nessmayneedt omakeadozenormor eadj ust i

ngent riesatt heendofeach
account ingper i
od.Theexactnumberofadj ustment swi l
ldependupont henat ureof
thecompany ’sbusi nessact ivi
ties.But ,al ladj ust ingent ri
esf al lint ot wogener al
categor i
es:
1. Adj ust ingent riest oappor tiondef erral s
2. Adj ust ingent riest or ecor daccr ual s
1. ACCOUNTI NGFORDEFERRALS
Definition:-Thewor d“ def er”meanst odel ayorpostpone.I naccount i
ng,Def errals
aret hedel ay( orpostponment )int her ecogni tionofanexpenseal readypai dor
revenueal readyr ecei ved.
Defer redi temsconsi stofadj ust i
ngent riesi nv olv i
ngdat apr ev i
ouslyr ecor dedi n
account s.Theseent r
iesi nvolvet het ransf erofdat aal readyr ecor dedi nassetand
l
iabil
ityaccount st oexpenseandr ev enuesaccount s.
TypesofDef er r
al s
Defer redi temscoul dbegr oupedi ntot womaj ort y pes:
i. Def erral st oappor ti
onpr epay ment s
ii
. Def erral st oappor ti
onadv ancer ecei pts
I. Account ingTr eat mentf orPr epay ment s( Defer r
edExpenses)
Compani esof tenmakeadv anceexpendi turest hatbenef itmor et hanoneper iod,
beforer ecei vingt heser v ice.Suchexpendi turest hatar emadebef orer ecei vi
ngt he
servicear ecal ledPr epai dExpensesorDef er redExpenses.Att hei niti
alpoi ntof
payment ,thet ot aladv ancepay menti sanassetnotanexpenset ot hebusi ness
enterpr isepay ingi nadv ance.Thi si sbecause,accor dingt ot heaccr ualbasi sof
account ing,t her ecogni tionofexpensei snotr el atedt ot hepay mentofcash.Rat her
i
tisr el atedt ot her ecei vingoft heser v i
ce;t hati s, incur r
ingoft heexpense.Asf aras
thecompanyhasnotr ecei vedt heser v i
cet het otaladv ancepay mentr emai nst obe
anassett ot hebusi nessent erprise.
Howev er,eacht imet hecompanyr ecei v est heser vice, theassetwi l
lbeconv ertedt o
anexpense.Thati s,t hepar toft headv anceex pendi t
uret hathasbenef i
tedcur rent
operat ionsi st reat edasanexpenseoft heper iodi nwhi cht heser vi
cei sr eceivedas
youcansee, eacht imet heser v iceisr ecei v ed( expensei ncurred)nopay mentwi l
lbe
made, becauset hepay menthasal readybeenmadei nadv ance.
Andt hepar toft headv ancepay mentt hathasnotbeenconsumedorhasnotbeen
expired( used)i st reat edasanassetappl icablet of utureoper ations.I tisthr ought he
useofadj ust ingent riest hatweappor tion( di vide)t hepr epaymenti nt ousedand
unusedpor ti
on.Theadj ust i
ngent r
yf ort headj ust mentofpr epay ment susesanasset
andexpenseaccount s.
Therear et woal ter nativemet hodsofr ecodi ngpr epay mentatt hei niti
alpoi ntof
43
payment.
1. Theassetmet hod
2. Theexpensemet hod
Wehav etri
edtodiscusstheassetmethodofr
ecor
dingpr
epay
mentsi
ntheprevi
ous
chapter
s.Inthischapter,wewi l
lseebothmethodstohelpyouunder
standthe
al
ternat
ivemethodsofrecordi
ngprepay
ments.

Toi l
lust
ratethealt
ernativ
emethodsofrecor
dingprepay
ment s,assumeonJan.
1,2002CHAMOADVERTI ZMENTCOMPANYpai dBr.36,
000forr entf
orthecomi
ng
threeyearsforof
fi
cei thasrent
edfr
om SHALACOMPANY.Al so,assumethatt
he
fi
scalyearofCHAMOADV.COMPANYendsonDecember31.
I
I. Recor
ding Prepayments(Def
err
ed Expenses) I
nit
ial
lyi
n an Asset
Account(TheAssetMethod)
Thet ot aladv ancepay menti sdebi tedt oanassetaccount ,inCHAMOADV.CO. S’
caset oaPr epai dRentAccount .Recor di
ngt het otaladv ancepay menti nanasset
accountdoesnoti mpl ythati twillremai nt obeanasset .Aswement i
onedear li
er ,at
theinitialpoi ntofpay ment ,t
het ot alamountpai dinadv ancei sanasset .Howev er,as
eachdaypasses,par toft heassetexpi r
esandbecomesanexpense.I naccount ing,
wedon’ ttransf ert heexpi r
edpor ti
oneachdayf rom t heassett oanexpenseaccount .
Ratherwedel ayitunt i
l t
heendoft heaccount i
ngper iod.
Theadj ustingent ryusedi nt hiscase, debitsanexpenseaccountandcr edi
tanasset
fortheamountt hathasexpi redi .
e.t hepor ti
onf orwhi chser vicehasbeenr eceived.
Letsseet hesef orCHAMOADV.CO. ,OnJan.2,2002t hef ol
lowi ngjournalent r
ywi l
l
bemadebyCHAMOADV.CO.
 Pr epai dRent…………………………36, 000
Cash…………………………………36, 000
Tor ecor dadv ancepay mentofr entfor3y ear s.
Asy oucannot i
ce,t het otaladv ancepay mentwasdebi tedt oanassetaccount ,and
obv i
ousl yascashwaspai dthecashaccounti scr edited.
Afteroney earonDec.31,2002,t hecompanyhasusedt heof fi
cef oroney ear.We
sayf rom t het ot aladv ancepay ment ,Br.12,000( =Br .36, 000/3Br .12000)has
expired.Butunt i
ladj ustment ,theused por ti
on Br .12000 r emainsi nt heasset
account ;itist hr oughadj ustmentt hatwet r
ansf ert heusedpor ti
ont oanexpense
account .
Theadj ustingent ryt hatt r
ansf erst heusedpor ti
ont ot heexpenseaccountf or
CHAMOADV.CO.madeonDec.31, 2002i s:
RentExpense………………Br .12,000
Pr epaidRent……………………. .Br .12,
000
Aftert headj ust i
ngent ryhasbeenpost ed,theRentExpenseaccountwi llhav ea
balanceofBr .12, 000andpr epai dRentnowshowst hecor r
ectbal anceofBr .24, 000
(Thepor ti
ont hathasnotexpi redorused) .Thisr el
ati
onshi pcanbeshownusi nga“ T”
44
accountasfol
lows:
PrepaidRent RentExpense
Dr. Cr
. Dr
. Cr
.
Jan.1,
200236, 000 12,000 Dec.31,2002 Dec.31,200212,000
(Payment) (Adj
usti
ng) (Adj
usti
ng)

Bal
anceBr
.24000

Theusedpor t
ionBr .36000=Br .12000
3
i
stransfer
redfrom t heassettoanexpenseaccount
I
fCHAMOADV. CO.decidest oleavet heof f
icei
trentedonDec.31,
2002,doyouthi
nk
thatitwi
llber efundedtheamounti tpai dofJan.1,2002?No,becausei
thasalr
eady
usedt heofficef oroney ear.Asar esult,theamounti tshoul
dber ef
undedisthe
unusedpor t
ionoft heprepayment .Buti nourcase,CHAMOADV.CO.hasnotdeci ded
toleavetheof f
ice.
2.Recordi
ng Pr
epayment
sIni
ti
all
yin an Expense Account(
The Expense
Method)
Inouri llust r
ationf orCHAMOADV.CO. ,adv ancepay ment sforr entthatwillbenefi
t
threey ear soper at i
onwer erecordedbyadebi ttoanassetaccount ,PrepaidRent.
Howev er,eacht imet heserviceisused( i
.e.stayint heof fice)itisobv i
oust hatthe
assetwi llbeconv er t
edt oanexpenseaccount .Asar esul tsomecompani esfoll
ow
an al t
ernat i
vepr act i
ceofr ecording pr epay mentsdi rectlyt o an expensebyt he
assumpt iont hatt hepr epaymentwi l
lbef inall
yconv ertedt oanexpense.Remember
that,thought hepr epay menti srecor dedi niti
all
y(directly
)i nanexpenseaccount ,i
t
sti
llremai nstobeanassett ot hecompanyasf arast heser v i
ceisnotr ecei
ved.
InCHAMOADV. CO. ’Scaset hef oll
owi ngj ournalentrywi llbemadeonJan.1, 2001,
thedat eofadv ancepay ment.
RentExpense…………………. .36,000
Cash…………………………36, 000
Tor ecor dadv ancepay ment smadef orrentf orthreey ears.
Recor ding t he pr epay mentdi r
ectlyi n an expense accountdoesn’ tnecessar il
y
i
ndi catet hatt het ot aladvancepay mentwi llexpireduringt hey ear.Thatis,partofthe
prepay mentmi ghtr emai nunexpired( unused)att heendoft hey ear.Whent hereis
unusedpor t
ion,anadj ustmenti sneededt otransfert heunusedpor ti
onf rom the
expenseaccountt ot heassetaccount .Theadj usti
ng ent rywi l
ldebitan asset
accountandcr edi tanexpenseaccountf ort heamountf orwhi chnoser viceis
received( unexpiredpet it
ion).
OnDec.31, 2002, thef oll
owingadj usti
ngent ryismadebyCHAMOADV.Company .
Prepai dRent ………………………….24000
45
 RentExpense……………………….
.24000
Tor ecor
dt headj
ust
mentthattransf
ert
heunexpi
redpor
ti
onf
rom an
expenset
o
assetaccount
.
Theunexpi
redamountiscomputedas:
36,
000
Year
lyexpi
rat
ion= =Br
.12,
000pery
ear
.Ther
efor
e,af
teroney
earonl
y
3Yea

1/3(12,000)expires,theremai ningbalanceBr .24,

000(=Br.36,000– 12,000)is
unexpir
edandr eportedasanasset .
Thisalt
ernati
vemet hodleadst ot hesamer esult
sinthebalancesheetandincome
stat
ement ,
asdoest heassetmet hodofrecording.Her
ealso,thebalanceofpr
epaid
rentthatwillappearont hebal ancesheeti sBr .24,
000andt heamountofr ent
expensefortheyeari sBr
.12,000.
1.
1. Ef
fectofOver
looki
ngAdj
ust
ment
sforDef
err
edExpenses

Whati
stheef
fectofov
erl
ooki
ngt
headj
ust
mentont
hef
inanci
alst
atement
s?
I
ncomeSt
atement
:
 Theexpenseswouldbeov erstat
edbyBr .24,000.Becauseiti
st hr
oughthe
adjust
ingentryt
hatweappor t
ionedtheunexpi r
edportionf
rom theexpense
accountandtransf
err
edtot heassetaccount.
 Theov er
stat
ementofexpensel eadstoanunder st
atementofneti ncome
(oroverst
atementofnetl
ossi ft
hereisnetloss).
Bal
ancesheet
:
 Theunder statementofneti ncomewi l
lber efl
ectedont heowner sequi ty
(capital)t hati scapi talwi llbeunder stated.Becauset hroughthecl osing
processt heunder statedi ncomebal ancewi l
lbet ransferr
edt othecapi tal
account ,hencet heunder st atementofcapi t
al.
 The asset s( Prepaid Rent )woul d be af fected and under st
ated,i fthe
adjustmentwasov erl ooked.Becausei tist hr
oughadj ustmentt hatwe
transfert heunexpi r
edpor tiont otheassetaccount .Buti fnoadjustment ,
theunexpi redpor tionr emai nsint heexpenseaccountt hanbeingi nt he
assetaccount .
Therefor
e,wesaynev er,nev erov erl ookanadj ustment,f orfaili
ngt odosowi l
l
misstateallfinanci alst atement s.Andmi sstatedf i
nancialst at
ement swi l
lleadt o
WRONGDECI SIONS.
CheckYourPr ogr essExer cise-1
AnbessaCo.pur chasedsuppl i
eswor thbr .
5000onMar ch12,20x2. Atthebeginningof
thefi
scaly earthecompanyhadbr .
3500wor thofsuppl i
esonhand.Aphy sicalcount
attheendoft hey earDecember 31,20x2showedt hatthereisbr .
1500wor thof
46
suppl i
esonhand.Recor dt henecessar yadj ust mentj our nalent ryonDecember 31,
20x2i f
A.Thecompanyhasapol icyofr ecor di
ngsuppl iesasanexpensei niti
all
ywhen
theyar ebought .
B. Thecompanyhasapol icyofr ecor dingsuppl i
esasanasseti niti
all
ywhen
theyar ebought
I
I.Def er redRev enues( Unear nedRev enues)
Justasexpensescanbepai dbef or et heyar eused, rev enuescanber eceivedbefor e
theyar eear ned,i .e.,bef oret heser vicehasbeengi v en.Uni tyUni v ersit
yCol l
ege
coll
ect edmoneyf rom y oui nadv anceofgi v i
ngser vice.Suchadv ancecol l
ecti
ons
madebef oregi vingser vi
cear ecal ledUnear nedRevenues.
Whencashi sr ecei vedi nadv ance,t hecompanyent er si ntoanobl igat i
ont odeliver
goodsorper f orm ser vi
ces.Ther efor e,unear nedr ev enuesar eshowni nal i
abili
ty
account ,andwi llappearont heBal anceSheet .
Unear nedRev enuesdi fferf rom ot herl i
abili
tiesbecauseunl i
keAccount spayable,
theyar eusual lyset tledbyr ender i
ngser vices, thanpay menti ncash.Wecansayi tis
awor kof frathert hanapai dof fliabi lity.Ofcour se,ifthecompanyf ailstodel iv
erthe
servicesaspr omi sedi tmustr efundt hecust omer sthei rmoneyf ort hepor ti
onithas
notr ender edt heser vice.
Each t ime t he companyr ender s ser vices i ti s ear ning t he revenues.No cash
coll
ect i
onwi l
lbemadeatt hispoi nt,why ?Becauset hecashhasal readybeen
coll
ect edi nadv ance.
Concer ningt her ecor dingofDef er r edRev enues, wehav et woal ternativemet hods:
1. Recor dingadv ancecol lect ionsdi r
ectlyinal iabi l
it
yaccount
2. Recor dingadv ancecol lect iondi rectlyinar ev enuesaccount
Thef inanci alst at ement sprepar edusi ngt heset womet hodsar eoneandt hesame.I t
i
sl i
ket wor oadsl eadi ngt othesamepl ace.
Tohel pusunder st andt hedi f
fer encebet weent heal ternativemet hods,consi derthe
foll
owi ngi l
lust ration:
OnJanuar y1, 2001, Oceani cAdv er tisementCompanycol lectedBr .18,600i nadvance
from ZOOM Companybypr omi si ngt o adv er ti
set hepr oduct sofZOOM Co.on
EthiopianTel ev isionandononeoft hel ocalnewspaper sfort hecomi ng20mont hs.
Assumeadv ertisementser vicesgi v eneachmont hareequal .
1. TheLiabi
li
tyMethod:Recor
dingUnear
nedRevenuesDi
rect
ly(
ini
ti
all
y)i
na
Liabi
li
tyAccount
Amount st hatarecol l
ectedi nadv ancefrom customersarenotr ev
enuesoft he
businessent er
prise,asfarasser viceisnotprovi
ded.Asar esul
t,oneapproachto
recordtheadv ancecollect
ionsistor ecor
dthem dir
ectl
yinal i
abil
i
tyaccount;evenif
partorallofitmightbeear nedduringtheperi
od.
OnJan.1,2001,Oceani cAdv ert
isementCompanywi l
lrecor
dt headvancecoll
ecti
on
as:
47
 Cash………………………………………18, 600
Unear nedAdv ertisementRev enues………………………18, 600
Remembert hatt heunear nedadv erti
sementRev enuesi sal iabili
tyaccount ,nota
revenueaccount .TheAdv er tisementRev enueswi llbeear nedgr aduallyasOceanCo.
givest heser v icesaspr omi sed.Becausei twil
lnotbepr act i
calt orecor dweeklyor
mont hlyear ningsofr ev enues, whatwedoi stodel ayweekl yormont hlyearningunti
l
the end oft he f iscalper iod.By whi ch t i
me we wi llt ransf ert he amountof
Adv erti
sementRev enuesear nedf orthey earf rom t heliabi l
ityaccountt otherevenue
account .Theadj ust mentj our nalent r
yf ort hi
sdebi tsthel iabili
tyaccountandcr edi
ts
ther evenuesaccountf ort heear nedpor tion(thepor ti
onf orwhi chser v
icehasbeen
rendered) .
OnDec.31, 2001,t hef ollowi ngadj ustingent r
ywi l
lbemadei nt hecaseofOceani c
Adv erti
sementCompany :
Unear nedAdv er t
isementRev enues…………………. 11,160
Adv ertisementRev enues……………………. .11,160
Tor ecor dadj ust ment
Theamountt hati sear nedcanbecomput edas:
Mont hly=Br .18, 600/ 20mont hs=Br .930permont hear nings.
i
.e.each mont ht hecompanyear nsBr .930. 00.Ther efor e,f ortheper iod fr
om
Jan.1,2001,t o Dec. 31,2001,Br .11, 160 ( =12 x 930)i s ear ned by Oceani c
Adv erti
sementCompany .
Aftertheadj ust i
ngent ryhasbeenpost ed, unearnedAdv ertisementRev enuewi l
lhave
aBr .7440endbal anceandAdv er ti
sementRev enuewi llhav eaBr .11, 160balance.
Thebal ancei nunear nedAdv er ti
sementr epresent st heobl igationoft hecompanyt o
renderadv ertisementser vicesi nt hef utur eperiods.Thi scanbest at edusinga“ T”
accountasf ol lows:
Unear nedAdv er tisementRev enue Adv erti
sementRev enue
Br .18, 600 Jan.1, 2001
Br.11, 160 Br .7, 440 Br .11,160

Tot ransfertheearnedpor ti
onBr .11,
160
from theliabil
i
tytot herevenueaccount
Whatwoul
dbetheef f
ectofov erlookingtheadj ust
ment ?
Onthei
ncomestatement :
- Rev enueswoul dbeunder stat
ed.Thisisbecause;i
tisthr
ough
adjustmentt hatwet ransfertheearnedpor ti
onf
rom theli
abil
i
tytot
he
revenueaccount .
- Neti ncomewoul dbeunder stated;ornetlosswouldbeoverstat
ed.
Becauset herewouldbeanunder st
atementofrevenue.
48
Ont
hebal
ancesheet
- Capitalwouldbeunder st
ated,becauset heunder statednetincome
wouldbecl osedfi
nall
ytothecapi t
alaccount.
- Thel i
abil
it
ywouldbeov erstat
edi ntheBal ancesheetbecauset he
adjustmenthas transfer
red outf rom the liabi
l
ityaccountt othe
revenueaccountt hepor t
iont hatisear ned.But ,ifther
ewasno
adjustmentthisearnedpor t
ionremainsi nt heli
abili
tyaccountand
overstat
esit.
2. TheRevenueMet
hod:Recor
dingAdvanceCol
lect
ionsI
nit
ial
lyi
naRevenue
Account
Wehav est ressedt hatamount scol lectedf rom cust omersi nadv ancear eli
abil
iti
es
notrevenuebecauseaccor dingt other ev enuer ealizati
onprinciple,rev
enueisear ned
whenser vicei sgi v
ent ot hecust omer .
Howev er,weknowt hateacht imeser v i
cei sgiv enweear nrevenue.Asar esul
t,some
compani espr ef ertor ecor dadv ancecol lectionsi niti
all
yinar ev enueaccountthough
i
tisnotear ned.
Here,theexpect ati
oni st hat ,inthef utureal loft headv ancecollectionswil
lbeear ned
andbeconv ertedint or ev enue.Not icet hat,ev eni fwer ecordt headv ancecoll
ect i
on
i
nr evenueaccount sitdoesn’ tmeant hati ti
sr ev enue.Itsti
llremai nstobeal iabil
it
y
asfarasser vi
cei snotgi v en.
OnJan.1, 2001, t
hedat eofadv ancecol lecti
on, OceanicAdv erti
sementCompanywi ll
recor
dt hef oll
owi ngj our nal entry:
Cash- ----
--
----
--
----
----
---
---
---
--
--
---
---
---
---
-18,600
Adv ertisementRev enue- -
--
---
-----
--
---
--
--
--
--
--
18,600
Tor ecor dadv ancecol lectionsf oradv erti
sementf or20mont hs

Recor dingtheadv ancecol l

ecti
oni nrev enueaccountdoesnotnecessar il
yimplyt hat
i
twi llbeearnedt otal
lyintheper iod.
Apor ti
onofi tmightremai nunear ned.Whent her eisunear nedr evenueatt heendof
they earanadj ustmenti snecessar yt ot r
ansf ert hisunear nedpor ti
onf r
om t he
revenueaccountt otheliabil
it
yaccount .
Iny ear2001, OceanicAdv erti
sementCompanyr ender edser vi
cesonl yfor12mont hs
from t hetotal20-mont hser vi
cesi tpromi sedt ogi ve.Sincet he8mont hsserv i
cei s
notr enderedi tshouldNOTber eportedasr ev enue.Asar esult,usi
nganadj usti
ng
entry,whichdebi tsther evenueaccountandcr edi t
st hel i
abi l
i
tyaccount ,wet ransfer
theunear nedpor ti
ont otheliabil
ityaccount .
On Dec.31,2001,t he f oll
owi ng adj usti
ng ent ryi s necessar yf or oceani c
adv erti
sementcompany :
Adverti
sementRev enue- -
---
---
--
---
---
--
------
--
----
--7440
UnearnedAdv erti
sementRev enue- ---
--
---
--
---
--
---
---
--
---
--
--
--
--
-7440
Af t
ert headjustingent r
yispost ed,theAdv erti
sementRev enueaccountwi l
lhav ea
49
bal
anceofBr.11,
160andunear
nedAdver
ti
sementRevenuewi
llhaveabalanceofBr
.
7,
440.Noti
cethat
,iti
soneandthesametothebal
ancethatr
esult
edintheprevi
ous
al
ter
nati
ve.
2.
1. Ef
fectofOver
looki
ngAdj
ust
ment
sforDef
err
edRevenues
Whatwoul dbet heef fectofov er l
ooki ngt headj ustment ?
Ont heincomest atement
- Rev enueswoul dbeov erstatedbyt heamountoft headj ustment, becausei tis
throught headj ustmentt hatt heunear nedpor ti
oni sappor ti
onedf rom r evenue
account .
- Neti ncomewoul dbeov er st
at ed
Ont heBal anceSheet :
- Li abili
ty( =unear nedAdv erti
sementRev enue)woul dhav ebeenunderst ated
becausei tist hrought headj ust ingent rythatwet r
ansf ertheunear nedpor t
ion
tot hel iabi l
i
tyaccount .Thati s,i fnoadj ustment ,nothingwoul dhav ebeen
transferredt ot heliabil
it
yaccount .
- Ov erstatementofowner ’sequi tyt husr esultsf r
om t heov erst atementof
revenueorneti ncome.
CheckYourPr ogr essExer cise-2
NebirPubl ishingCo.r eceivedbr .
5600i nadv ancef rom cust omer swhosubscr i
bet o
themagazi net hatt hecompanypubl ishes.Att hebegi nningoft hefiscaly eart he
companyhadbr .3200ofunear nedr ev enues.Andatt heendoft hecurrentf iscaly ear
December 31,20x2 t here wer e st i
llbr .
4300 unear ned rev enues from magazi ne
subscri
pt i
onsr eceiv edi nadv ance.
Recordt henecessar yadj ustmentj our nal entryonDecember 31, 20x2assumi ng
A-Thecompanyr ecor dsadv ancer eceiptsasal iabil
i
tywhent heyarecol lect ed
B-Thecompanyr ecordsadv ancer eceiptsasar evenuewhent heyarecol lected
2.ACCOUNTI NGFORACCRUALS

Def
ini
ti
on:anaccr
uali
sther
ecogni
ti
onofr
evenueoranexpenset
hathasar
isenbut
hasnoty etbeenr ecorded.
Thewor d“accrue”meanst oaccumul ateorgr owi nsi
ze.Inaccount i
ng,anaccrualis
therecogniti
onofr evenueoranexpenset hathasaccumul at
edov erti
mebuthasnot
yetbeenr ecorded.Inor dertoreportacompany ’sfi
nancialposi
tionandpr of
itabi
li
ty
accurately
,theaccr ual
sshoul dber ecogni zed(recor
ded)int heaccountingperiodi
n
whichtheyoccur .
Asy oucannot i
cef r
om t hedefinit
ion,wehav ebasicall
yt wot ypesofaccr ualsi
n
accounting.Thesear e:
I–Accr uedExpense/Accr uedLi abili
ty/
II
–Accr uedRev enue/ AccruedAsset s/
I
. AccruedExpenses/ AccruedLiabil
it
y/
Accruedexpensesr efertoexpensest hatar eincurr
edbutar ebot hunpai dand
50
unrecor ded.Whenwesayt heexpensei sincur r
ed;itmeans,“t heser vi
cehasbeen
receivedbutt hepaymentf orithasnoty etbeenmade. ”Sincet hei ncurr
edexpensei s
notpai dt her
eisasenseofal i
abil
it
y,hencet henameaccr uedl i
abili
ty.
Mostexpenses i n accounti
ng are paid whenev ertheyar eincurred.Ther e are,
howev er ,somebusi nessexpensest hataccrue( accumul ate)dai l
ybutar eusuall
y
recordedwhent heyar epaid.Suchexpensesi nclude,sal ar
yandwagespai dto
empl oyees,andi nt
erestpaidonbor rowedmoney .Asy ouknow,empl oyeeswor kon
aday -to-daybasisbuttheyarenotpai donadai l
ybasis.Rat herthereisani nter
valon
whicht hepay mentismade.Ther efore,wesayt heseexpensesaccr ue,thatis,grow
oraccumul ateoverti
me.
Accrual( bothaccruedexpensesandaccr uedr evenues)ingener alneedanadj usti
ng
entrywhent heendoft hef i
scalperi
odcomesbef orethedat eonwhi chtheexpense
i
st obepai d.
I
ll
ust
rat
ion
MamushBaker ypay
st hesalar
iesofitsemployeesev er
yFr i
day,f
orafiveworki
ng
daysfrom MondaytoFr i
day
.(Thatis,t
heempl oyeesarepaidoneveryFr
idayfort
he
worktheyperformfr
om Mondayt oFr
iday.Thesalaryf
orfiveworki
ngdaysamounts
toBr.2500.
Forthey ear1998,theendoft hefi
scalyear,Dec.31,fall
sonWednesday .What
adj
ustmentisneededonDecember31i nrel
ati
ont osal
aryexpense.
Answer
:
Byt heendofDec.31,1998,t heempl oyeeshav ealreadywor kedfort hreedays
(Monday ,Tuesday ,
andWednesday )butt heywi llnotbepai dunti
ltheregularpayday
onFr i
day ,whichliesonJan.2, 1999inanot herfiscalperiod.
Thesal ariesfort het hr
eeday sar erightfull
yanexpensef or1998.Asar esul
t,t
he
expensemustber ecordedandr epor tedin1998,i nthey earinwhi chitisincurr
ed
(Accordingt otheexpenser ecogniti
onpr incipl
e).
Sinceitisnotpai donDec.31, 1998,ther eisal i
abili
tythatt hecompanyowest opay.
Thesal aryrateisBr .2,500f orthewor kdays,then,ther at eperdaywi l
lbeBr .500(=
Br.2500/ 5).Therefore,theexpensef orthet hreeday sisBr .500x3=Br .1,500.
fand
thefoll
owi ngadj ustingentryshoul dbemadet or ecogni zet heaccr
uedexpenseon
Dec.31, 1998:
SalaryExpense- --
--
---
--
---
---
-1500
SalaryPay able----
--
---
--
---
---
--
--
--
--
---
--1500

Thebal anceinsalari
espay ablethatwil
lber eportedasal iabil
it
yonMamushBaker ’
s
balancesheeti sBr.1,500.Andt heSalaryExpenseoft hethreeday sBr .1500willbe
reportedtogetherwiththesalaryexpensesoft hey earonthei ncomest atement.
Ef f
ectofOv erlooki
ngAdj ustmentofAccr uedExpenses
Aswest atedearli
er,
adjustmentisamandat orystepi ntheaccount i
ngcy clebecause
fai
lingtodosowi l
laffecttheamount sr eportedont hefinancialst
atement s.Asa
51
result,theadj ust mentf orr ecogni zingaccr uedexpensesmustbemadeal way sbyt he
endoft hef iscal year.
Inourcase,i ft headj ust mentonDec.31,1998wasov er looked,t hef ollowi ngwi l
lbe
refl
ect edont hef i
nanci al stat ement s:
Ont heI ncomeSt atement
- Expenses woul d hav e been under stat ed,because i nt he adj ustmentan
expenseaccounthasbeeni ncr eased.
- Under stat ementofexpensel eadst oanov erst atementofneti ncome( oran
under st at ementofnetl oss, ifther ei snetl oss)
Ont heBal anceSheet
- Capi talwoul dhav ebeenov er statedbecauseoft heov er statementofnet
income.
- Li abi l
ity( salaries pay able)woul d hav e been under stated,because i nt he
adj ust ing
ent r
yal abi alit
yaccounthasbeeni ncreased.
II
.Accr uedRev enues( Accr uedAsset s)
Accr uedr ev enuesar er ev enuesf orwhi chaser v icehasbeenper formedorgoods
deli
v eredbutf orwhi chnoent ryhasbeenr ecor ded.
Thati s, ther ev enueshav ebeenear nedbutnotbot hy etr ecor dedandr ecei v
ed.
Anyr evenuest hathav ebeenear nedbutnotr ecor deddur ingt heaccount ingper i
od
callforanadj ust ingent ryt hatdebi tsanassetaccount( =speci f
icallyar ecei vable)
andcr edi tsar ev enueaccount .
2.11. REVERSI NGENTRI ES:THEOPTI ONALFI RSTSTEPI NTHENEXT
ACCOUNTI NGPERI OD
Att heendofeachaccount ingper iod,adj ustingent riesar emadet obr ingr ev enues
andexpensesi nt oconf ormi tywi tht hemat chingr ule.Thati s, usi
ngadj ust i
ngent ries
attheendoft heaccount i
ngper iod,wet rytoupdat et heaccount soft hebusi ness
enterpr i
se.
Ar ev er sing ent ryi sa gener aljour nalent rymadeon t hef ir
stdayoft henew
account ingper iodt hati st heexactr ev erseofanadj ust ingent r
ymadeatt heendof
thepr ev iousper iod.Unl ikeadj ust i
ng ent ri
es,r ever sing ent ri
esar eopt ional ,i.e.,
withoutt heuseofr ever singent r
ieswecanpr epar ecor rectf i
nancial statement s.
Ar ev ersingent ry,ast henamei mpl ies,i stheexactr ev erseoft headj ust i
ngent r
y
madeatt heendoft hepr eviousper iod.I tcont ainst hesameaccountt it
lesanddol l
ar
amount sast her elatedadj ust ingent r y,butt hedebi tsandcr edit
sar et her ev erseof
thosei nt headj ust ingent ryandt hedat ei sthef i
rstdayoft henextaccount i
ngper iod.
Rev ersing ent ries si mpl if
yt he r ecor ding ofcer tainr outine cash r eceipt s and
payment sandmi nimizet hepossi bili
tyofmaki nger rors.
Notal ladj ustingent ri
escanber ev ersed.I naccount ing,whent hepol icyofusi ng
reversingent riesi sadopt edt headj ust i
ngent ri
est or ecor dt hef oll
owi ngadj ust ment s
canber ev ersed:
52
 - Adjustment stor ecordbot hty pesofaccr ualscanber ev er
sed.
- Pr epai
dexpensesi niti
allyrecordedasanexpensecanber ever sed
- Unear nedr evenuesi nit
iall
yrecor dedasar evenuecanber eversed
N.B Deferral
st hatar er ecordedi niti
all
yasanassetandasr ev enuecannotbe
rev
ersed.
Toshowhowr eversingentriescanbehel pful,
considerthefollowingexampl e.
- SAMRACOMPANYpay sthesal aryofi tsempl oyeeseachFr idayf orafi
ve-
day
wor kweek.Assumesal aryperdayi sBr .300.00,orBr.1500f oraf ive-
dayweek.
Thr oughoutt hey ear,thecompany ’
saccount antmakesaj our nalentr
yeach
Fridayasf oll
ows:
SalaryExpense- --
--
---
---
--
--
-1500
Cash- -
--
--
---
--
---
--
---
--
--
---
--
--1500
Tor ecordpay mentofsal aryfortheweek.

Next ,l
etusassumet hatDecember31,endoft hey ear2002f al l
sonWednesday .Al l
expensesoft hey earmustber ecor dedbef oret heaccount sarecl osedandf i
nanci al
statement sar epr epar edonDecember31.Ther eforeanadj ust i
ngent rymustbe
madet or ecor dthesal ar iesexpenseandt her elatedl i
abil
ityf ort het hreeday s
(Monday t o Wednesday )t hey hav e wor ked.The adj usti
ng ent ryfor$ 900. 00
(comput edas3x300dai lysal aryexpenses)i s:
Dec.31, 2002
Salar yExpense 900
Salar yPay abl e 900
Tor ecordaccr uedsal aryforthet hreeday swor ked
inDecember
Ther ev ersingent rywoul dbe:
Jan.1, 2003 Salar yPay abl e 900
Sal ar yExpense 900
Torev er seadj ustmentmadeatt heendofpr eviousy ear.
Afterther ev ersingent rysal arypay ablewi l
l hav ezer obalanceandsal aryexpensewi l
l
hav eacr edi tbal anceof900bi rr.OpenT- account sf orbot hthesal aryexpenseand
salarypay abl eaccount sandr ecor dadj ustment ,closingandr ev ersingent ri
esintheT
-account s; youwoul dgett hef orement i
onedbal ances.
Thepay mentofsal ar yont hef oll
owi ngFr idaywoul dsimpl yber ecor dedasf oll
ows:
Januar y2 SalaryExpense…………. .
1500
Cash……………………………. 1500
CheckYourPr ogressExer ci se- 3
Howwoul dt hepay menthav ebeenr ecordedi ftheadj ust mentwer enotr eversed?
TheChoi ceofMet hodofRecor dingDef er rals
Asy oucanr ecall,f orbot ht ypesofdef erralst herear etwomet hodsofr ecording.
Thati s,int hecaseofpr epai dexpensest heassetandexpensemet hodsandi nt he
53
caseofunear nedr ev enuest hel i
abili
tyandr ev enuemet hodsofr ecor ding.Bot h
alt
ernat i
v emet hodsofr ecor dingdef erralsresul
ti nthesameef f
ectsont hef inanci al
statement s.Then,t henextl ogi calquest i
ont oaski swhi chmet hodofr ecor dingt o
use.
Thechoi cebet weent het womet hodsofr ecordingpr epaidexpensesandunear ned
revenuesdependsuponwhi chmet hodwoul dnor mal l
yresulti nfewerent riesand
woul dbel eastl ikelyt ocreat eer r
orsint herecordingpr ocess.
Itisbet tertor ecor dt hosepr epai dexpensest hatwi llbeused( consumed)dur ingt he
account ingper i
odi nitial
lyasanexpense.Thi sway ,onlyoneent rywoul dber equired,
andnoadj ustingent ryisnecessar y.Ont heotherhand,t hosepr epaidexpensest hat
willnotbe t otallyused orconsumed dur i
ng t he account ing period ar e usual ly
recordedi niti
allyasasset sandanadj ustingentryismadeatt heendoft heper i
odf or
theamountconsumed.
Recor dingpr epai dexpensest hatlastf ormor et hanoneper i
odr equi r
esonl yan
adjustingent ry, butr ecordingi ti ni
ti
allyasanexpensewoul dnor mall
yr equirebot han
adjustingent ryandr ev ersingent ry.
Similarly,forunear nedr ev enuest hatwi llbeearnedi nt hecur r
entaccount ingper iod,
ther evenuemet hodofr ecor dingi spr eferabl
e.I ncont r
ast,forunear nedr ev enues
thatwi llbeear nedi nmor et hanoneper i
odt hel abial
it
ymet hodofr ecor dingi s
preferable.
2.12.ANSWERSTOCHECKYOURPROGRESSQUESTI ONSOFADJUSTMENTS
CheckYourPr
ogr
essExer
cise-1
A-December31,
20x2 Suppl
i
es…………. 1,
500
Suppl
i
esExpense………1,
500
B-December31,
20x2 Suppl
i
esExpense………7,000
Suppli
es………….
7,000
CheckYourPr
ogr
essExer
cise-2
A-December31,
20x2 Unear
nedSubscr
ipt
ionRev
enue………4,
500

Subscri
pti
onRevenue……………4,500
B-December31,
20x2 Subscr
ipt
ionRevenue…………..4,
300
Unear
nedSubscri
pti
onRevenue………4,
300
CheckYourPr
ogr
essExer
cise-3
January2Sal ar
yExpense………………. 600
Salar
yPay able………………..
900
Cash……………………………. 1,
500
2.13.MODELEXAMI NATI ONQUESTIONS
PartI.Mul t
ipl
eChoice
1.Rev enueswhichareear nedbutnotcol
l
ect
edresul
ti
ng:
A.AccruedAsset s
B.AccruedLiabi
lit
ies
54
 C.Accr uedRev enues
D.Di f
f eredRev enues
E. “ A”and“ C”
2.Rev ersingent riesar e
A.madeatt hebegi nni ngoft henewaccount ingper i
od
B.di r
ectr everseoft headj ust ingent ri
esmadeatt heendoft heprevi
ousy ear.
C.ar eopt i
onal
D.Al l
E.None
3.Theadj ustingent ryt or ecor daccr uedexpenseswi l
l:
A.debi tanassetaccountandcr editaliabi li
tyaccount
B.debi tal i
abi l
ityaccountandcr editar ev enueaccount
C.debi tanexpenseaccountandcr edi
tal iabil
ityaccount
D.debi tanexpenseaccountandcr edi
tanassetaccount .
E.None
3.Unear nedr ev enuesar eclassifi
edas:
A.l iabilit
y
B.anasset
C.ar ev enue
D.anexpense
E.None
Par tII.Exer cise
MAMOGASHACompanypay sthesal aryofi t
sempl oy eesonev erySaturdayforasi x
wor kingday sf rom Mondayt oSat urday .Thet ot alsal aryfort hesi xday
samountt o
Br .4,
200.
Fort hey ear2002, thef iscaly earendedonThur sday ,Dec.31, 2002.
Instruct i
on:Ont hebasi soft heabov edat a:
1-Recor dt headj ustmentneededon1Thur sdayDec.31, 2002.
2-Recor dt hepay mentofsal ar yonSat ur day ,Jan.2, 2002.( Assumet he
companyf ollowst hepol icyofusi ngr ev ersingentries)
3-Repeati nstruct i
on“ 2”assumi ngt hecompanydoesnotuser ev
ersing
ent ries.
OnJul y1, 2000
SELAM CONPANYr ent edOf ficeroomsf rom BUDENApl cfor4y ear
sbypay i
ngBr .
72000.TheSELAM COMPANYagr eedt ouset heof fi
ceroomsasashowr oom f or
i
t sproduct si tmanuf act ur
esati tsf act oryaroundkal i
ty.
Bot hCompani esuseaf iscaly earthatendsonDec.31.
I
nst
ruct
ion:
1.Passthejour
nalentr
yt or
ecor
d
a)Thepay mentofcashbySelam companyonJul
y1,
2000,
assumi
ng
thecompanyr ecor
dsprepaymentsasanasset
.
55
 b) Theadj ust i
ngent ri
esent r
yrepairedonDec.31, 2000and2001i n
ther ecor dsof
SELAM COMPANY.
2. Passt hej our nal ent ryint her ecor dsofBUDENACompanyt orecord:
a)Thecashcol lect i
onmadeonJul y1,2000,assumi ngthecompany
recor dsadv ancecol lect i
onsasal iabil
it
y .
b)Theadj ust ingent ryr equiredonDec.31,2000and2001i nt he
recor dsofBudenacompany
c)Whati st heef fectoff ai l
ingt opasst headj ustmentonDec.31, 2000
2.14. WORKSHEETFORFI NANCI ALSTATEMENTS
Mostoft hedat ar equiredt opr eparet heaccount ingrepor ts(fi
nancialstatements)is
nowgat her
ed.Thedat awi llnowbepr esent edinaconv eni
entform.Thewor ksheet
i
sal argecol umnarsheetpr epar edt oar r
angei naconv enientform alltheaccounting
datar equir
edt opr epar ef inanci alst atement s.Thewor ksheethasaheadi nganda
body .
Theheadi nghast hreepar t
s:
i
) Nameoft heOr gani zation
i
i)Nameoft hef orm( wor ksheet )
i
ii
)Per i
odoft imecov er ed.
Thebodycont ainsf i
vemai npar t
seachoft hem wi t
ht womai ncolumns.Thesepar ts
are
1.Thet ri
al balance
2.Theadj ustment
3.Theadj ustedt rial bal ance
4.Thei ncomest at ement
5.Thebal ancesheet .
Thewor ksheetf orBat iTr anspor tisgi venbel ow. Thef i
vepar tsoft hebodyar e
discussedasf ollows.Youar eadv i
sedt or eadandunder standthedi scussionsbefore
youlookatt her espect i
vecol umnsoft hewor ksheet.
Bat iTr ansport
Wor kSheet
Fort h3emont hendedj an.31,2003
AccountTi
tl
e Tr
ialBal
ance Adj
ust
ment Adjust
edTrial I
ncome Bal
ancesheeet
bal
ance st
atement
1 Cash 41,
030 41,
030 41,
030
2 Accounts 2,
250 ©
7,
400 9,
650 9,
650
recei
vabl
e
3 Suppli
es 740 (
a)
340 400 400
4 Pr
epai
dInsur
ance 600 (
b)
450 150 150
5 Of
ficeequi
pment 11,
600 11,
600 11,
600
6 Tr
uck 550,
00 550,
00 550,
00
0 0 0

56
7 Account
spayabl
e 12,
430 12,
430 12,
430
8 Notespayabl
e 150,
00 150,
00 150,
00
0 0 0
9 Yi
merCapi
tal 450,
00 450,
00 450,
00
0 0 0
10 Yi
merdrawing 500 500 500
11 Ser
vicei
ncome 17,
900 ©
7,
400 25,
300 2530
0
12 Salaryexpense 18,
800 18,
800 18,
800
13 Rentexpense 4,
000 4,
000 4,
000
14 Util
iti
esexpense 220 220 220
15 Mai ntenance 450 450 450
expense
16 Truckexpense 90 90 90
17 Miscel l
aneous 50 50 50
Expense
18 630,
33 630,
33
0 0
19 Suppl
i
esexpense (
a)
340 340 340
20 I
nsur
anceexpense (
b)
450 450 450
21 7290 7290 636,
83 636,
83
0 0
22 Neti
ncome
23 25300 2530 613,
33 613,
33
0 0 0

1.Thet rialbal ancecol umn–t hisisthesamet ri

albal ancewehav epreparedbef ore.
Thet r
ialbal ancecol umnoft hewor ksheetcanbebr oughtdi r
ectf r
om thel edgeror
fr
om asepar at etrialbalance.
2.TheAdj ust mentcol umn–Asment i
onedpr evi
ousl y,someaccountbal anceshav e
tobeadj ust edatt heendoft hey ear.
The account si nt he ledgerofouri ll
ustrati
on t hatr equi
re adjustmentand t he
adjust
ingent ryf ort heaccount sar epresentedbel ow.
a)Suppl ies–Thesuppl iesaccounthasadebi tbal anceofBi r
r740.Thecostof
suppli
esi nhandonJul y31i sdet erminedt obeBi rr400.Thef oll
owingadj usti
ng
entryi
sr equi redt obr i
ngthebal anceoft heaccountupt odate:
Suppl i
esexpense……………………………. 340
Suppl i
es……………………………………. .340
b) Prepai di nsur ance–Anal ysisofthepol icyshowedt hatthree–f ourthoft he
poli
cyi sexpi r ed.Thati sonl yBi r
r150oft hepol i
cyi sapplicabletof ut
ureper iods.
Theadj ustingent ryt otransfertheexpi r
edpar toft heinsurancet oexpensewi l
lbe.
Insur anceexpense………………………. 450
Pr epaidinsur ance………………………. .450
c)Ser viceI ncome–Att heendoft hemont hunbi ll
edf eesforservicesperformedt o
cli
entstot aledBi r
r7, 400.
57
Thisamountr eferst oani ncomeear nedbutt obecol l
ect
edi nthef utur
e.Thej ournal
entrytor ecor ditwi l
lbe
Account sr eceiv able…………………………. 7,
400
Servicei ncome………………………………7, 400
Allt heabov eadj ust i
ngent ri
eswi llbei nsertedi ntheadj ustmentcol umnoft he
wor ksheetinf rontoft heaccount saf f
ected.
Not e–Thel etter
sa, b&car eusedt ocr oss-referencethedebi t
sandcr edit
st ohelp
futurerev i
ewoft hewor ksheet .
3.TheAdj ust edTr ialBal anceCol umn–Theaccount sthatr equireadjustmentar e
now adj usted. Tr ansf erringt hetr i
albal ancecol umnamount scombi nedwi t
ht he
adjustmentcol umnamount swi llcompl etet headj ust
edt r
ialbalancecol umnoft he
wor ksheet .
4.Thei ncomest atementandt hebal ancesheetcol umns–Tr ansfert heincome
statementaccountbal ances( r
ev enue&expenses)t othei ncomest atementand
balancesheetaccountbal ances( Asset ,Liabi l
it
y&owner sequi ty)tot hebal ance
sheetcol umns. Not et hatwhatwehav et ot r
ansferistheadj ustedtrialbalance
columnamount s,tot hecor respondi ngcol umns.

Lookatt he22nd row.Itshowst heneti ncomef orthemont handi ti

saddedt othe
twocol umns(Incomest at
ementDr .andbalancesheetcr .
)asabalancingf i
gure.
2.15. FINANCI ALSTATEMENTPREPARATI ON
Afterthewor ksheetiscompl et
edf i
nancialstatement scouldbepreparedeasi l
y.In
chapteronewehav ediscussedf ourbasi cfinancialstatement
spr eparedbymost
organizat
ions.Her e,wewi llpr
epar ethr eeoft hesest at
ementsf orBatiTr anspor
t
formthewor ksheet.
1. Incomest at
ement Al lthedat arequiredt opr eparetheincomest atementis
brought
fr
om thewor ksheet.

BatiTransport
Incomest at
ement
Fort
hemont hended.Jan31, 2003
Ser
viceIncome…………………………………………………………Bi rr25,300
Operat
ingexpenses
Salaryexpense………………………. .
Birr18,800
Rent “ ……………………………………. 4,000
Mai ntenanceexpense……………………… 450
Insurance “……………………………450
Supplies “……………………………. 340
Util
iti
es “……………………………. .
220
Truck “……………………………. ..90
58
 Miscell
aneous “ ………………………………50
Totaloper
atingexpense………………………………………24, 400
NetIncome…………………………………………………Bi rr900
2.Statementofowner ’sequi t
y–Thi sstatementshowst hebegi nni
ngbal anceof
capi
talandt hechangesthataf fectedit
.
Thebal anceoft heownersequi t
yaccount(Yimercapit
al)i
nt hewor ksheetmaynot
bethebegi nningone.Therefore,theledgerhastoberevi
ewedt oseeiftherewasan
addi
tionalinvestmentduri
ngt hepr iodornot.Inouri
ll
ustr
ationthereisnoaddi t
ional
i
nvestment .

BatiTr
anspor
t
Stat
ementofOwner’
sequit
y
ForthemonthendedJanuar
y31,2003

Yi mercapi t
al January1, 2003………………………………Bi r
r450,
000
Neti ncomef orthemont h…………………. bi
rr900
Less: Wi t
hdr awal …………………………………. .
.500 400
Yi mercapi t
al,Januar y31, 2003………………. ……………. Bir
r450,
400
3. Balancesheet– Thedat at opr eparet hi
sst atementwi llbetakenfrom the
worksheetandt heot herf i
nancialstat ement s.Not et hatassetsandliabi
l
iti
esare
cl
assifi
edascur rentandnon–cur rent .
Bat iTransport
Bal ancesheet
Januar y31, 2003
Asset s
CurrentAsset s:
Cash…………………………………………Bi rr41,030
AccountsRecei vabl e……………………………. .9, 650
Suppli
es…………………………………………… 400
Prepai
di nsur ance……………………………………. 150
Total currentasset s……………………………………………Bi rr51,230
PlantAsset( None- Cur r
entAsset s):
Offi
ceequi pment ……………………………. .Birr110, 600
Truck………………………………………………550, 000 561,600
Total asset ………………………………………………………Bi rr612, 830
Liabiliti
es
Currentl iabili
ties
Accountspay able……………………………. .
Birr12, 430
Non- cur r
entl iabil
ities
Notespay abl e……………………………………. .
150, 000
Total l
iabilit
ies……………………………………………………Bi rr162,430
59
 Owner ’
sequi ty
AtoYi merCapi t
al……………………………………………………………. .450,400
Total liabi l
ityandowner sequi ty…………………………………………. Birr612,830
2.16. THECLOSI NGPROCESS
Someoft heaccount si nt hel edgerar et empor aryaccount susedt ocl assi
fyand
summar izet het r
ansact i
onsaf fect i
ngcapi t
al( owner sequi ty
).Theseaccount swi l
l
becl osedaf t
erf i
nancialst atement sar epr epar ed.Thati s,theirbalanceswi llbe
tr
ansf erredt ot heCapi talaccount .Thet empor ar yaccount st hathavet obecl osed
arer ev enue, expenseandwi thdr awal account s.
Stepsi ncl osing:
1.Cl osi ngr evenueaccount s-Debi teachr ev enueaccountbyi t
sbalanceandcr edit
the‘ IncomeSummar y ’
accountbyt het otal rev enuef ortheper i
od.
Not e:I ncomesummar yisanaccountusedt ocl oser evenueandexpenseaccount s.
Thisaccountwi l
limmedi atel ybecl osedt ot hecapi talaccountatt heendoft he
cl
osi ngpr ocess.
2.Cl osi ngexpenseaccount s–Debi tthei ncomesummar yaccountbyt hetotalof
expensesf ortheper iodandcr editeachexpenseaccountbyi tsbal
ance.
3.Cl osi ngt hei ncomesummar yaccount–I ncomesummar ywi l
lbecl osedtot he
capi talaccount .Thebal anceofhi saccountdependsont henatureofoper ation;
cr edi tifr esultisprofitanddebi tifresul tisloss.
4.Cl osi ngWi thdrawal–Debi ttheowner sequi t yaccountbyt hetotalofdr awings
fort heper iodandcr editthedr awi ngaccount .
Thet empor aryaccount sofBat itr
anspor tarecl osedasf ol
lows.
2003 Ser vi
ceincome…………………………………25, 300
Incomesummar y
…………………. 25,300
Januar y
31 Closi ngr ev enue
31 Incomesummar y……………24, 400
Salaryexpense………………………. .
18, 800
rentexpense……………………………4, 000
Mai ntenanceexpense…………………. .450
Insuranceexpense………………………. .450
Suppl i
esexpense…………………………340
Utili
ti
esexpense…………………………. 220
Truckexpense……………………………90
Mi scell
aneousexpense……………………. 50
Cl osingexpenses
2003 Incomesummar y………………900
Januar y31 YemerCapi t
al ………………………. .900
Closi ngi ncomesummar y
31 Yi mercapi tal…………………. .
.500
60
 Yimerdr owi ng………………………. .500
Closingwi thdr owal
Theabov ecl osingent ri
eshav etransf erredt hebal anceoft het empor aryaccount sto
theper manentcapi talaccount .
CheckYourPr ogr essExer cise-4
Postal lt heabov ecl osingent r
iesandr ecomput et hebal anceofal ltheaccount s
aff ected.
2.17. POSTCLOSI NGTRI ALBALANCE
Af tert hecl osingent ri
eshav ebeenj our nal i
zedandpost ed, at ri
albal ancei sprepared
to pr ov et he equal i
ty oft he gener all edgerbef orer ecor ding t he new year ’s
transact ions.I tshoul dbenot edt hatt hi st ri
albal ancei ncludesonl ybal ancesheet
account s. Thi si sbecauset het empor ar yi ncomest atementaccount sarecl osed
dur ingt hecl osingpr ocess. Thi st rialbal ancei scal ledt hepost– cl osi
ngt r
ial
bal ance.
Inpr acticet hel edgerbal anceaf tercl osi ngmaybecheckedbyasi mpl ecalculat
or
printoutr athert hanaf ormalt ri
albal ance.Thepostcl osi ngt ri
albal ancef orBai t
Tr anspor tispr esent edbel ow. Bat iTr anspor t
Post–Cl osi ngt r
ial balance
Jan31, 2003
Cash……………………………………………Bi r
r41, 030
Account sRecei vabl e………………………………. ..
9, 650
Suppl i
es…………………………………………………400
Pr epai di nsurance………………………………………. 150
Of ficeequi pment ……………………………………11, 600
Tr uck………………………………………………. 550,000
Account spay able……………………………………………………. Birr12, 430
Not spay able……………………………………………………………. .
150, 000
Yimercapi t
al……………………………………………………………. .
450, 400
Tot al……………………………………Bi rr612, 830 Bir
r612, 830
2.18. SUMMARY
Account ant sgot hroughanumberofst ep- by -steppr ocedur est or ecordt r
ansact i
ons
andt osummar izet her ecor dsi nt ousef ulr epot rsi nasy stemat i
cmanner .These
procedur est hataccount antsgot hroughf rom t het imeat ransact ioni sidentif
iedunt i
l
thet i
mef i
nanci alst atement sar epr epar edar et oget hercal l
edt heaccount i
ngcy cle.
Theaccount ingcy cleissummar izedbel ow:
I
nput Process Output

61
1.Whenat r
ansact
i
2o
.n
Transact i
onsar erecor dedi nthej
ournal 7.
Prepar
ingf
inanci
alst
atement
s
happens,source 3
d.o
Pc
ous
me
t
ingt
ntsoindiv
idual account s
areprepar
ed. 4.Prepar i
ngat ri
albal anceaf t
erdetermining
thebalanceofeachl edgeraccount
6.preparing and compl et i
ng the work sheet
withadj ustments
8.Adjustment sarejour nalizedandposted
9.Closingent ri
esarej ournalizedandposted
10.Apostcl osi
ngt r
ial balanceisprepared
2.19. ANSWERSTOCHECKYOURPROGRESSQUESTI ONS
CheckYourPr ogressExer
cise-1
Expensesar efoundont her i
ghthandsideoftheaccountingequati
on;theyare
el
ement s ofthe owners equi
tyaccount. When expenses i
ncr
ease capi
talwil
l
decreaseandv i
cev er
sa.Becauseofthi
srever
seeff
ectofexpensesoncapitalt
hey
i
ncreaseont heDr .si
dedanddecreaseontheCr.si
de,unli
keotherr
ighthandside
accounts.
CheckYourPr
ogr
essExer
cise-2
a)Buildi
ngandAccount spay abl
e
b)Bothaccountsar ei
ncreased.
c)Buildi
ngisdebitedandaccount spayablei
scr edit
ed
d)Jour nalent
ry:
2003, Buil
ding……………………………150, 000
Jan11 Accountspayable…………………………. .
150,
000
Pur chaseofbuildi
ngoncr edit
.
CheckYourPr ogressExer ci
se-3
Prepareafour–col umnaccountf oreachaccountandposttherespect
iveent
ri
esto
theaccounts.Compar etheendi ngbalanceofeachaccounti
ny ouranswerwit
hthei
r
balanceinthetri
albal
ance.
CheckYourPr ogressExer ci
se-4

Af
teral
ltheclosingent r
iesarepostedal
ltemporar
yaccountswil
lhavezer
obal ances.
Ontheot herhand,per manentaccount swillhavenon-zerobalances. Exampl e:
Yi
merCapi t
al =Birr450,
400,suppli
esBir
r400.
Acompletelistoft hepermanentaccountsandthei
rbalancesi
sgivenonthepost–
cl
osi
ngtrialbalance.
2.
20.MODELEXAM QUESTI ONS

1.Indi
catewhethereachofthefol
lowi
ngi
temsbelowisanasset
,li
abil
i
ty,r
evenue,
expense,gainorlossaccountandwhetheri
tappear
sinthebalancesheetor
i
ncomest atement.
a)Offi
cefurni
tur
e
62
 b)Incomef rom ser vices
c)Sal ar i
espai dt owor ker s
d)Suppl iesonhand
e)Sal ar ypay abl etowor ker s
f)Cash
g)Incomef orm sal eofausedt r
uck
h)Goodsdamagedbyf irei nthest ore
2.Gi venbel owi sal i
stofsel ectedt ransact i
onsper formedbyJohnDécordur ingthe
mont hofSept ember2002, thef i
rstmont hofoper ation.
a)Recor dt het ransact ionsi nGener al Jour nal
b)Posteachent ryt ot heper spect iveaccount .Uset hef our–col umnaccount.
c)Pr epar eat ri
al balance
d)Pr epar eawor ksheet .Assumet hef ollowi ngadj ustmentf ort
heaccounts
andj our nalizet hem.
e)Pr epar eaBal ancesheet ,I
ncomest atementandst atementofowner ’
sequity
f)closet het empor ar yaccount s.
Sept.10 Mr .Johnt r
ansf erredcashf orm hi sper sonalaccountt obeusedi nthe
business,
Bi rr10,000.
“ 10 Pai dr entf ort hemont h, Birr500
“ 11 Pur chasedat ruckf orBi rr12, 000bypay ingBi rr3,000Cashandgi vi
nga
notespay ablef ort hedi ffer ence.
“ 12 Pur chasedequi pmentonaccountBi rr1,460.
“ 13 Pur chasedsuppl i
esonaccountBi r
r240.
“ 14 Pai di nsur ancepr emi umsofBi rr170( Dr .prepai dinsur ance)
“ 15 Recei vedcashf orser vicescompl etedBi rr360.
“ 16 Pur chasedSuppl iesonaccountBi rr240.
“ 18 Pai dsal ar i
esofBi rr900.
“ 21 Pai di tsliabili
tiesf orthepur chaseofequi pment
“ 24 Recor dedsal esonaccountBi rr2,080
“ 26 Recei vedani nv oicef ort ruckexpenseBi rr115
“ 27 Pai dut il
itiesexpenseBi r
r205.
“ 27 Pai dmi scellaneousexpensesBi rr73.
“ 28 Recei vedcashf r
om cust omer sonaccountbi r
r1, 420
“ 30 Pai dsal ar i
est oempl oy eesBi r
r950
“ 30.Theownerwi t
hdr ewBi r
r1, 750f orper sonal use.
3.Thet ri
albal anceofBet tyBeaut ySal oondoesnotbal ance. Theerror
si nthe
account ingwor kar egi venbel ow.Det ermi net hecor rectbal anceofeachaccount
andpr epar et hecor r
ect edt ri
al balance.
BettyBeaut ySal oon
Trialbal ance
63
 April30
Cach 5,902. 00
Account sRecei vable 6,300. 00
Suppl i
es 1,600. 00
Equipment 5,200. 00
Account spay able 4,300.00
Bettycapi tal 10, 000.00
Servicei ncome 4,700.00
Operat ingexpenses 1,980. 00
Tot al 20,982. 00 19, 200.00
Theer rorsar et hef ollowi ng:
 Cashr eceivedf or m acust omeronaccountwasr ecor ded( bot hdebitand
credi t)asbi rr
 1, 400i nsteadofBi r
r1,120
 Thepur chaseonaccountofanequi pmentcost ingBi rr780wasr ecordedasa
debi tto
 oper at i
ngexpenseandcr edittoaccount spay abl e.
 Ser vicewasper f ormedt oclient sBi rr1, 780f orwhi chaccount sRecei vabl
e
was
 debi tedbi rr1,780andser viceincomewascr edi tbirr178
 Apay mentofBi rr80f ortelephonechar geswasdebi tedt oOper atingExpense
andi twasal sodebi tedtocash
 Thel edgerbal anceoft heser vicei ncomeaccounti sbi rr4, 700r atherthanBir
r
4,720.
4.AsofSene301994,t heendoft hecur rentf iscaly ear,t heaccount antforAbay
Gener alTr adingcompl etedt hewor ksheetbef orej our nal i
zingandpost i
ngthe
adjustment s.
Required:( a)Compar et headj ustedandunadj ust edt ri
albal ancesandpr eparethe
eightj
our nal entr i
est hatwer erequiredt oadj ustt heaccount s.
(b)Prepar et hejour nal entriesthatwer erequi redt ocl oset empor ar yaccount s.
AbayGener alTr adi ng
TrialBal ance
Sene30, 1994
Unadj ust ed Adjusted
Cash 12, 825.00 12, 825.00
Supplies 8,950. 00 3,635.00
Prepaidrent 19, 500.00 1,500.00
Prepaidinsur ance 3,750. 00 1,250.00
Equipment 92, 150.00 92, 150.00
Accumul ated depr eciat
ion 53,480. 00 66,
270.
00
64
equi pment
Aut omobi l
e 56,
500.
00 56,
500.
00
Accumul ated depreci
ati
on 28,
250.
00 36,
900.
00
aut omobi l
e
Account spay able 8,
310.
00 8,
730.
00
Salar ypay able 3,
400.
00
TaxPay able 1,
225.
00
AtoAbaycapi t
al 41,
245.
00 41,
245.
00
AtoAbaydr awing 18,
600.
00 18,
600.
00
Ser viceincome 261,
200.
00 261,
200.
00
Salar yExpense 172,
300 175,
700.00
RentExpense 18,
000.00
Suppl i
esExpense 5,
315.00
Depr eciat i
onExpenseEquipment 12,
790.00
Depr eciat i
onExpenseAutomobile 8,
650.00
Utili
tiesExpense 4,
700.00 5,
120.00
TaxesExpense 1,
500 2,
725.00
Insur anceExpense 2,
500.00
Mi scellaneousExpense 1,
710.00 __
__ 1,
710.00 __
__
Tot al 392,
485.00 392,
487.
00 418,
970.00 418,
970.
00
2.20.GLOSSARYOFTERMS
Account–ar ecordshowi ngsepar atelythei ncreasesanddecr easesofaf inancial
statementi tem dur ingaper iod.
Taccount -thesi mpl estformatofanaccount ,whi chresemblesthel etter‘T’.
Char tofAccount s-al i
stoft heaccountsusedbyanor gani
zati
onandt heircodes.
Debi t-thel eftsideofanaccount .
Credi t-ther i
ghtsi deofanaccount .
Sour ceDocument s-document ssuchasani nvoiceoracashr eceiptv ouchert hat
evidencet heoccur renceofat r
ansaction.
Jour nal-abookorr ecordwher eat ransacti
on’sf ulldebi
tsandcr editsandot her
detailsar ef i
rstrecor ded.
Jour nalEnt r
y -
thedebi t
sandcr edit
srecor dedi nthejournalforonet ransact i
on.
Ledger - abook,wher ei ncreasesanddecr easesi neachaccountar esepar ately
recorded.I tist heref orethecol lect
ionoft heindividualaccountsofanor ganizati
on.
TrialBal ance–af orm showi ngthefinalbalanceofeachl edgeraccount .Iti
susedt o
somehowchecki fanyer rorswer emadedur ingtheper i
od.
Wor kSheet–awor kingpapert hataccount antsuset ocoll
ectadjustmentdat aandt o
easlypr epar et hef i
nanci alstatements.
Adjust ment s–ent riesrequi redtoup- datesomeaccount sbeforepr epar i
ngf inancial
statement s.

65
PostCl
osi
ngTr
ialBal
ance-at
ri
albal
ancepr
epar
edaf
teral
ltheaccount
shav
ebeen
cl
osed.

CHAPTER3:
3. 1INTRODUCTI ON
Int hepr eviouschapt er
s,y ousawhowt or ecor dt r
ansact ionsofaser vicebusi ness.
Thest epst hatwegot hrought opr epar et hef inanci alstat ement sofot hert ypesof
busi nesses ( such as a mer chandi si
ng busi ness) ar e basi callyt he same.
Tr ansact ionsar ef i
rstjour nal
ized,andt henpost edt ot hel edger ;awor ksheeti s
prepar ed and compl et
ed…. But ,ther e ar e some t ransact ionsi n mer chandisi
ng
compani est haty oudon’ tf indinaser vicegi vi
ngbusi ness, liket hepur chaseofgoods
forsal eandt hesal eoft hosegoods.Thef irstsect i
onoft hi schapt er ,theref
ore,
discussest henat ureofamer chandi singbusi nessandhowt or ecordmer chandisi
ng
transact ions.The nextsect i
on di scusses aboutt he pr epar ation of f i
nancial
statement sformer chandisingcompani es.
SECTI ON- ONE:RECORDI NGMERCHANDI SINGTRANSACTI ONS
3.2NATUREOFAMERCHANDI SI NGBUSI NESS
3.2.1Whati saMer chandi singBusi ness?
Amer chandi singbusi nessbuy sgoodsi nf ini
shedf ormf orresal et ocust omer s.
Amer chandi singbusi nesssel l
st angiblegoodst oi tscust omer s.Whenwesaygoods
i
tcanbeany thingt hathasphy sicalchar acteristi
cst haty oucanseeandt ouch( i
.e.
,
tangi ble).Thesecanbegoodsr angingf rom t elevisionset s,car s,of ficet ableand
chai r( furniture),t o chewi ng gums,t oot hbrushesand v ar i
ousst ationer y
. These
goodst hatamer chandisingcompanysel lst oitscust omer sar ecal ledmer chandise
i
nvent ory. ( A cust omeri sani ndividualoraf irmt owhom abusi nesssel lsits
product s.)
Onef i
nalt hingt haty oushoul dknow aboutamer chandi singbusi nessi st hata
mer chandi singcompanydoesnotpr oducet hegoodst hati tsel l
s.I nst ead,itbuy s
thesegoodsf rom manuf act ur
er s, whichpr oducet hegoodsusi ngr awmat eri
als.
Thef ol l
owi ngdi agr am canhel py out obet t
erv i
sual izet hef low ofgoodsf rom a
manuf act urert ot hef i
nalconsumer :

sel
l
s Merchandi
singcompani es
Manufacturer wholesal
e sell Retail
e f
inal
s rs r consumer
goods goods
Awhol esaleri
sat rader
,whichbuysgoodsf rom manuf acturersandsel
lsthem toa
retai
l
eroranot herwholesaler
.I tisther et
ailerwhosel l
st hegoodst othef inal
consumerbybuy ingthem fr
om wholesal
ers(orsomet i
mesf r
om amanuf act
urer).
Wheny ouwantt obuyasoapt owashy ourclothes,wheredoy oubuyit
?Whoi sthe
manuf actur
eroft hesoap?Ar ethereanywhol esal
ersoft hatsoapinyourarea?Can
66
thewholesal
erbet akenast hecust
omerofthemanufactur
er?Andfinal
l
y,canwe
saytheshopfrom whichyoubuythesoapisamer
chandi
singbusi
ness?
3.2.
2 Compar ison of Financi
al St
atement
sf or Merchandi
sing and Ser
vice
Businesses
I
ncomeSt
atement
A modeli ncomest atementf oramer chandi singbusi nessandanot heronef ora
servicebusi nessar eshownbel ow.Compar ethem car efully.
ABCser v i
cecompany XYZmer chandi sing
Incomest atement I
ncomest atement
Fort hey earendedDec. 31,200x Fort hey earendedDec. 31, 200x
Rev enue: Rev enue:
Serv i
cef ee…………………. Bi
rr23,200 NetSal es…………………Bi rr360, 000
Costofgoodssol d……………. (256,
000)
GrossPr of i
t……………………. 104,000
Expenses: VariousOper ati
ng
VariousOper ati
ngExpenses ( 7120) Expenses………………………. (79,400)
NetI ncome 16080 NetI ncome……………………. .24,600
Asy oucanseef rom theabov eIncomeSt atement s,mer chandisingcompani eshav e
topayt obuyt hegoodst hatt heysell.Ther efor e,theyhav etodeductt hiscostof
goodssol di naddi ti
ont oot heroper atingexpensesf rom theirsal esrevenuet o
deter minet heirnetincome.
Thedi f
ferencebet weensalesr evenueandcostofgoodssol disr eferredtoasgr oss
profit.Why‘ gross’
?Becauseot herexpenseshav ey ett obededuct edt oarri
veatt he
netpr ofitorneti ncomeoft hebusi ness.
Bal
anceSheet
TheBal anceSheetofaser vi
cebusi nessandt hatofamer chandisingbusi nessar e
simil
ari nev eryaspectexceptonet hi ng.Thecur rentassetssectionoft heBal ance
Sheetofamer chandisingbusinessi ncl udesoneassett hatservi
cecompani esdonot
have.Thati smer chandiseinventor y.Mer chandiseinventoryreferst ogoodsbought
byamer chandi si
ng businessf orr esalet o customer s. So,i famer chandising
businesshassomeunsol dgoods( mer chandise)onhandatt heendoft hey eart hi
s
wouldber epor tedasoneassetont heBal anceSheet .
3.3THEPERI ODI CANDTHEPERPETUALI NVENTORYSYSTEMS
Thev alueofgoods( mer chandise)onhandatt heendoft heyearf orresal ewoul dbe
reportedont heBal anceSheetasoneassetasdescr i
bedabov e.Thi smeanst hatwe
needt oopenasepar ateledgeraccounti nwhi cht or ecor
dmer chandi sei nventory
i
nformat ion.
Thet woal ternat i
vesindealingwi tht hisaccountar e:
1. Toupdat ethisaccountev eryt imegoodsar eboughtandsol d( cont i
nuousl y=
perpet ually
)or
2. Toupdat ethisaccountonl yatt heendoft heper i
od(peri
odi call
y).
67
3.3. 1ThePer i
odi cInv ent or ySy stem
Undert hi ssy stem,ast henameper iodi csuggest s,t hei nvent oryaccounti supdat ed
onlyper iodi callyi.e.,onl yatt heendofaper iod.
Whengoodsar ebought ,at empor ar ypur chasesaccounti sdebi tedi nsteadoft he
i
nv ent oryaccounti t
sel f.Li kewi se,whengoodsar esol dr evenuei sr ecor ded,butt he
factt hatt her eisar educt i
oni nmer chandi sei nv ent or yisnotr ecogni zed. Thisi s
becauset heMer chandi seI nv entor yaccounti snotcr editedev er yt imegoodsar e
sold.
Ther efor e,i fonewant st oknow t hecostofgoodsonhand,i ti samustt hata
phy sicali nv ent orybeconduct edf irst.Theaccountdoesn’ tr eflectt hev alueofgoods
onhandbecausei twasnotupdat edwhenmer chandi sewasboughtandsol d.
Physi cali nvent or ymeanscount i
ngt hequant ityofgoodsonhand.Oncet hequant ity
ofgoodsonhandhasbeendet er mi ned,i ti smul tipliedbyt heuni tpr i
ceoft hose
goodst odet ermi net hecostofgoodsonhand.
Inconcl usi on, undert heper iodi csy st em, sincet hemer chandi sei nv ent oryaccounti s
notcont i
nual lyupdat ed,t hecostofmer chandi seonhandi sdet er mi nedonl yatt he
endoft heper i
odaf tercar ryingoutaphy sical inv ent or y .
Compani essuchasdepar tmentst oresor‘ supermar ket s’,
whi chsel l smal li
tems, use
periodi csy stems.
3.3.2 Per pet ualI nvent orySy stems
Aper pet uali nv ent orysy stem cont inuousl yr ecor dst heamountofi nv ent oryonhand
(perpet ual=cont inuous) .Undert hissy stem,t hemer chandi sei nv ent oryaccounti s
debi t
edorcr edi tedev eryt ime( goods)ar eboughtorsol d.Whenani tem issold,i ts
costi sr ecor dedi nasepar atecostofgoodssol daccounti naddi tiont orecording
sales.
Thecostofmer chandi seonhandcanbel ookedupf rom t hemer chandi seInventor y
accountanyt ime, withoutconduct ingaphy si cal inv ent or y.
CheckYourPr ogr essExer cise- 1
Ifyouhav easuper mar ketbusi ness, woul dy ouuset heper pet ualorper iodicsystem?
Whati fy oursy stem i scomput eri
zed?Expl ain.
3.4RECORDI NGPURCHASESANDSALESTRANSACTI ONS
Thef ollowi ngdi scussi onsi nt her emai nderoft hi schapt eral lassumet heuseofa
periodi ci nv entor ysy stem.Theper pet ualsy st em wi llbedi scussedi npar ttwooft his
cour se.
3.4. 1.ACCOUNTI NGFORPURCHASE
Purchasesofmer chandi sei dent i
fied( r ecor ded)i nt hel edgeraspur chases.
Mer chandi si ngent erprisecanaccumul atei nt hepur chasesaccountt hecostofal l
mer chandi sepur chasedf orr esaledur ingt heaccount i
ngper i
od. Whenpur chasesar e
madef orcash, t
het ransact ioncoul dber ecor dedasf ollows:
Pur chases…………………………………. .
510
Cash…. .……………………………………………. 510
68
Whenpur chasesar emadeonaccount ,t
hetransact ioncoul dberecordedasf oll
ows:
Pur chases…………………………………. .
510
AP……………………………. ……………………. 510
3.4.1.1. Pur chaseDi scounts
Theagr eementbyt hebuy erandsel lerastowhenpay ment stobemadef ort he
mer chandisepur chasedandsol darecalledcreditt erms.I fpaymentisrequiredf or
themer chandi sesol d,upont hedeliveryofmer chandi setothebuyer,t
het erm ar e
saidtobecashor netcash.Ot her
wise, t
hebuy erisal lowedanamountoft ime, known
asthecr editper iod, inwhicht opay .Forexampl e, HabeshaCompanypur chased
mer chandiseonaccountf rom ABCCompany :
Thecr editperiodusual l
ybeginswi ththedateoft hesal easshownont hei nvoice
(i
nvoiceisabi l
l thatt hesellersendst othebuy erwhent r
ansactwithonaccount )
preparedbyt hesel ler.Ifpaymenti sduewi thi
nast at ednumberofday safterthe
dateoft heinv oice, suchas30day s,theter
msar enet30day s.Thesetermsmaybe
writ
tenasn/ 30.I fpay mentisduebyt heendoft hemont hi nwhichthesalewas
made, thetermsar ewr i
tt
enasn/ eom.

I
finvoi
ceispai
dwit
hin I
nvoicefor$1,
500 Ifi
nvoi
ceisNOTpai
dwi
thi
n10
10day sofinvoi
ce Ter
ms: daysofinvoi
cedat
e
2/10,n/
30

2%ofinvoi
ce $1,
470 $1,
500
Ful
lamounti
sdue
amount i
sall
owed Pai
d Pai
d
wit
hin30day
sofi
n
asacashdiscount
voi
cedate

Asmeansofencour agingpay mentbef or etheendoft hecr editper iod,thesel l

ermay
offeradiscountf ortheear l
ypay mentofcash.Thus, t
heexpr essi on“2/ 10,n/30”
means, thecreditper iodis30day s,t
hebuy ermaydeduct2%oft heamountof
purchaseifpay menti smadewi thi
n10day softhepur chaseddat e.Ref erthi
s
diagram:
Discounttakenbyt hebuy erf orear l
ypay mentofani nv oice(li
abi li
ty)arecal l
ed
purchasesdi scount .Itisrecor dedbycr editingthepur chasesdi scount saccountand
vi
ewedasadeduct i
onf r
om t hei ni
ti
al(or i
ginal)r
ecordedofpur chases.Pur chase
discountisacont ra( orof fsetting)accountt opurchases.Taket hisil
lustrati
on:
Il
lustrat
ion1: HabeshaCompanyonOct ober11, 2012pur chased$1, 500of
mer chandiseonaccount ,
wi thacr edittermsof2/ 10,n/ 30f r
om ABCCompany .The
j
our nalentrytorecor dthepur chaseofmer chandi seonaccounti st hefollowing.
October11, 2012 Pur chases 1,
500
AP 1,500
Il
lustrat
ion2: OnOct ober21, 2012, HabeshaCompanymadecashpay mentt ot he
ABCCompanyf orthemer chandi sepurchasedonOct ober11, 2012.Thej ournal ent
ry
torecordthepay mentofcashi sasf oll
ow:
69
 Oct
ober21,
2012 AP 1,
500
Cash 1,470
PurchasesDi scount 30
3. 4.1.2. Pur chasesRet urnsandAl l
owances
Ifthemer chandi sepur chasedhasdef ects,outoft hev al
ueorduet oot herr eason,
thebuy ercompanymi ghtr eturnt hemer chandiset othesel l
ercompany( pur chases
return)orpr iceadj ustment sarer equest edbyt hebuy er(purchaseall
owances)f or
themer chandi set hathasdef ectorot herr easons.I nthesecases,thebuy erandt he
sellercommuni catewi thadocumentcal eddebi
l tmemor andum.Pur chasesr etur
ns
andal lowancesaccount sarededuct ionf rom theamounti ni
ti
all
yrecor dedin
purchasesandi tisacont r
a( offsetti
ng)account s.
Il
lustration3: HabeshaCompanysentadebi tmemor andum forABCCompanyf or
thepur chasesr eturnofmer chandi sethatamount edto$62.Thej ournal entr yto
recordt histransact ionisasf ollow:
AP 62
PurchasesRet urns&Al lowances 62
Bearinmindthat
,whenbuyerretur
nsmerchandi
sepri
ort
othepaymentoft
he
i
nvoice(
li
abil
it
y),
theamountofdebitmemorandum i
sdeduct
edfrom t
hei
nvoi
ce
amountbefor
epur chasedi
scounti
scomputed.
Thefol
lowi
ngTaccount ssummar i
zethethreepurchases-
rel
atedtr
ansact
ionsof
HabeshaCompanyandshowt heircombinedeffectonnetsales.
Pur
chases PurchasesDi
scountPurchasesReturns&Allowances
1,500 30 62

NetPur
chases
1408
3.4.2.RecordingSales
Whenamer chandisi
ngcompanyt r
ansfer
sgoodst othebuyer,inexchangeforcash
orapromiset opatalaterdate,r
evenueisproducedt
ot hecompany .Thisr
evenueis
recor
dedinaSal esaccount.Howev er,t
hesalesrevenue,whichisreport
edont he
I
ncomeSt atementisNetSal es.Thatis,
NetSales=Gr ossSales–Sal esDiscounts-Sal
esReturnsandAl l
owances
Recor
dingGr
ossSal
es
Thegrosssalesamountisobt ai
nedf rom sal
esi nv
oi ces.Ani nvoi
ceisadocument ,
prepar
edbyt hesell
erofmer chandisetonotifytot hebuy ert
hedet ai
lsofthesale.
Thesedetail
scanincl
udenumberofi temssold,unitpr i
ceofit
ems, tot
alpr
ice,
terms
ofsaleandmannerofshi pment .Whengoodsar edel iv
eredtot hecust
omer ,t
he
Salesaccounti
scredi
tedbecauser evenuesareincreasedbycr edit
s.
Acompanycansel lgoodsei
therforcashoronaccount .
Recor
dingCashSal
es
Whenmer
chandi
sei
ssol
doncash,t
heCashaccounti
sdebi
tedandt
her
evenue
70
accountSalesiscr
edit
ed.
Example–I kaCompanybasedinBahi
rDar,buysandsell
susedcommodit
ies.On
January14.2001.Ikasol
dgoodsforBi
rr20,
000.Recor
dthetr
ansact
ion.
Answer
:
Januar
y14, Dr
.Cash………………………………..
20,
000.
00
Cr.Sal
es……………………………………20,
000.
00
34.
2.1.Recor
dingCr
edi
tSal
es
TheAccount
sRecei
vabl
eaccounti
sdebi
tedwhengoodsar
esol
donaccount(
for
cr
edi
t)
.
Exampl
e-
I
kasol dgoodswor
thBi
rr35,
000onaccountonJanuar
y15,2001. Recor
dthe
t
ransact
ion.
Sol
uti
on
Januar
y15. Account
sRecei
vabl
e………………….
.35,
000.
00
Sal
es…………………………………………35,
000.00
Det
ermi
ningGrossSal
eswhentherearetradedi
scount
s
Atr
adediscounti
sapercent
agededucti
onf r
om t
hespeci
fi
edl
i
stpr
iceorcat
alogue
pri
ceofmer chandise.
Tradediscount sallowus:
- Toav oi
dpubl ishinganewcat alogueseveryti
mepr i
ceschange.
- Togr antquant i
tydiscounts
- Quot ati
onofdi f
ferentpri
cest odi f
fer
enttypesofcustomer s.
Tradediscount sar enotr ecordedi nt hesell
er’
saccountingr ecords;t
heyareonl y
usedtocal culatethegr osssel l
ingprice.
Example:IKAsol d500T. V.sets,eachwi thali
stpr i
ceofBirr80,onJanuary17,2001
forcash.Itgav ethecust omera30%t r
adediscount,ast
hecust omerwasav eryloyal
one.Recor dt hesal e.
Answer
:
Li
stpr i
ceofgoods(80X500) Bi rr40, 000
Less:Tr adediscount(30%of40, 000)( 12,000)
I
nvoicepr i
ce 28,000
Journalentry:
Cash……………………. .28,
000
Sale………………………28, 000
CheckYourPr ogressExer cise–2
1.Recordthej ournalentryifIKaCompanyabov esol
dgoodswit
halistpr
iceofBi
rr
52,
000t oacust omeronaccount .I kaof feredthecust
omeratr
adediscountof
20%f orpurchasesabov eBirr40,
000asi tusuall
ydoes.
Recor
dingDeduct
ionsf
rom Gr
ossSal
es
Gobacktoi l
l
ustrat
ion1-andhavealookatthemodelIncomeStatementofa
mer
chandi
sing company.You wi
l
lsee thatt
he sal
es r
eport
ed on t
he i
ncome
71
statementi snetsal es,i .
e.,af t erdeduct i
onofsal esdi scount sandsal esr eturnsand
all
owances.
Grosssal es( from inv oi ce)…………………. .
XXX
Less:Sal esdi scount s……………………………. (XX)
Sal esr etur nsandal lowances…………. …..(XX)
Netsal es………………………………. XX
Sof arwehav eseent heaccount i
ngsy stemsont hesi deoft hebuy er ,thust he
opposi teofbuy errecor dswi l
l beusedi nr ecor dingont hesi deoft hesel ler
company .Mer chandi sesal esar ei
dent ifi
edi nthesel lercompany ’sl edgerassal es.
Salesofmer chandi sei ncashshoul dber ecor dedasf oll
ows:
Cash…………………………………………510
Sal es……………………………………………510
Whent hebusi nesssel l
smer chandi seonaccount ,thesal esr ecor dedasf ollow.
AR…………………………………………510
Sal es……………………………………………510
3. 4.2.2.Sal esDi scount s
Discountt akenbyt hebuy erf orear lypay menti scal l
edsal esdi scount s.Sal es
discount sar er ecor dedasdebi ttosal esdi scount sandi ti sar educt i
oni nt heamount
init
ial l
yrecor dedi nsal es.
Ill
ust rati
on1: OnDecember1, 2012, HabeshaCompanyhassol dmer chandi seof
$500onaccountt oXYZCompanywi thcr edi tter msof2/ 10,n/ 30.Thej our nal entry
tor ecor dsal eofmer chandi seonaccounti sasf ollow:
AR 500
Sal es 500
Ill
ust rati
on2: OnDecember9, 2012, HabeshaCompanyr eceivedcashf rom XYZ
Companyf orDecember1, 2012t ransact ion.Thej ournal entryt or ecor dt her eceiptof
cashi sasf ollow:
Cash 490
Sal esDi scount s 10
AR 500
3.4.3.Sal esRet urnsandAl l
owance
Mer chandi sesol dmayber etur nedbyt hebuy er( salesr eturn)or ,becauseofdef ect
s
orot herreasons, thebuy ermaybeal l
owedar educt i
onf rom theor iginal pr i
ceat
whi cht hegoodswer esol d( sal esal l
owance) .Sal esr eturnsandal lowancesi sa
reduct ioni nsal esr ev enueandar educt i
oni ncashoraccount sr ecei vable.Sal es
retur nsandal lowancesar eacont ra(orof fsetting)account stosal es.Thesel l
erand
thebuy ercommuni cat ether et urnofmer chandi seorr educt ioni nt heor iginal price
withadocumentcal ledcr edi tmemor andum.
Ill
ust rati
on: HabeshaCompanyr eceivedcr editmemor andum f orsal esr etur nsand
all
owancesof$110.
Sal esRet urns&Al l
owances……………110
72
 AR…………………………………………….
110
Bearinmindthat
,whenbuyerreturnsmer
chandi
sepri
ortothepaymentofthe
i
nvoice(
li
abil
it
y),
theamountofcr edi
tmemorandum i
sdeductedf
rom t
heinvoi
ce
amountbefor
epur chasedi
scountiscomput
ed.
Thefol
l
owingTaccount
ssummari
zethethr
eesales-r
elat
edt
ransact
ionsofHabesha
Companyandshowthei
rcombi
nedef
fectonnetsales.
Sal
es SalesDi
scount SalesRetur
nand
All
wowance
500 10 110

NetSales
380
3.5.Transport
ationCost s
Thetermsofasal eshoul dindicatewhent heownershi
p( t
it
le)ofthemer chandise
passestothebuy er.Thispointdeter
mineswhi chparty,t
hebuy erorthesell
er,must
paythetr
ansportationcosts.Thus, t
heterm oftheagreementbet weenbuy erand
sell
eri
ncludeprovisionsconcer ni
ng:
1. Whent heowner shi
p(tit
le)ofthemer chandisepassest othebuy er
;
and

2. Whichpar
tyi
stobeart
hecostofdel
i
ver
ing(
costoft
ranspor
tat
ion)
themer
chandi
setot
hebuyer
.

Ifowner shippassest othebuy erwhensellerdeli

versthemer chandi
setotheshipper,
thebuy erabsor bstr
anspor tat
ioncostandt heter
mi ssaidt obeFOBShippingPoi nt.
FOBShi ppi
ngPoi ntmeanst hesellerpl
acethemer chandise“fr
eeonboard”andt he
buy erresponsiblef
ort hetransportati
oncostbeyondt hatpoint
.
Ifowner shippassest obuy erwhent hemerchandiseisreceivedbythebuyer,
the
sell
erassumecostoft ransportat
ionandthet er
mi ssaidt obeFOBDest i
nati
on.The
shippingpoi nti
spresent edasf ol
low:
FOBShi ppingPoint FOBDest i
nati
on
Ownership(tit
le)passestot hebuy erwhen Deli
veredtoshipper Del iver
edt obuyer
merchandiseis
Tr
ansportationcostar eborne( pai
d)by… Buyer Sel
ler
Whenmer chandiseispurchasedont er
msofFOBshi ppi
ngpoint,t
ransport
ati
oncost
paidbyt hebuy ershouldbedebi tedt oTranspor t
ati
onInorFreightInaccountand
credit
edt ocash. Thebalanceoftr ansportat
ioninaccountshouldbeaddedt onet
purchasest odet erminethetotalcostofmer chandi
sepurchased.I
fthesell
erprepay
thetranspor tat
ioncostandaddt hem t othei nvoi
ce,thebuy
erwi l
ldebit
transportati
oni nfortr
ansportati
oncost .
Il
lustr
ation: OnJune10, DurbanCo.pur chasedmer chandi
seof$900f rom Bell
Corp.

73
onaccount
,ter
msofFOBshi ppingpoint,2/
10,n/
30,wit
hprepai
dtranspor
tat
ioncost
of$50addedtothei
nvoi
ce.Theent r
ybyDur banCo.coul
dbeasf ol
lows:
Purchases 900
Transport
ationIn 50
AP 950
Beari
nmindthat
,whenthet
ermsprovi
deforadi
scountforearl
ypayment,
the
di
scounti
sbasedontheamountofsal
erat
hert
hanont heinvoi
cetot
al.
Whent heagr eementst at est hatt hesel l
eri st obeart hedel iver
ycost s( FOB
destinat ion) ,theamount spai dbyt hesel lerf ordel iv eryaredebi tedt ot ranspor tation
out( itisexpenseaccountandpr esent edassel l
ingexpense) .
3.6.Sal esTaxes
Almostal lcount ri
est hroughoutt hewor ldl evyat axonsal esofmer chandi se.Thus,
unlesst hemer chandi singcompanyr emi tst hecol lect edtaxest ot hegov ernment ,
l
iabilityfort hesal est axi si ncur redatt het imewhensal eismade, regar dlessoft he
termsoft hesal e.Atthet imeofacashsal e,thesel lercol l
ect sthesal est ax.Whena
salei smadeonaccount , thesel l
erchar gest het axt ot hebuy erbydebi tingAccount s
Recei vabl e.Thesel l
ercr edi tst hesal esaccountf ort heamountoft hesal eand
creditst het axt oSal esTaxPay abl e.
Il
lustrat i
on: Sal eof$100onaccount ,subj ectt oat axr ateof4%.
AR………………………………………………104
Sal es…………………………………………………100
Sal esTaxPay abl e…………………………………4
Periodi cally,theappr opr iateamountoft hesal est axi spai dt othet axinguni t
, and
salest axpay menti sdebi ted.
3.7.Account ingt r
eat mentf ori nv ent orysy stem
Invent oryr efer stopr oduct sacompanyownsandexpect st osellini t
snor mal
oper ationsofbusi ness( Mer chandi sei nv ent oryr efer st opr oductst hatacompany
ownsandi nt endst osel l).Ther ear et wosy stemsofaccount i
ngf ormer chandi se:
periodi candper petualsy stem.
Periodi cSy stem:Manymer chandi singent er pr
iseuset hissy st
em.Rev enuesf rom
salesar er ecor dedwhensal esar emade, butnoat t empti smadeont hesal esdat eto
recor dt hecostofmer chandi sesol d.
Perpet ualSy stem:I nt hissy stem bot hsal esamountandt hecostofmer chandi se
soldamountar erecor dedwheneachi temsofi nvent oryaresol d.
CostofMer chandi seSol d
Costofmer chandi sesol di sthecostofmer chandi sesol dtocust omer sdur inga
period.I nper iodicinv ent orysy stem, thecostofmer chandisesol ddur ingaper i
odi s
repor tedi nasepar atesect i
oni nt hei ncomest atement .
Il
lustrat i
on: ABCCor por ationbeguni tsoper ati
ononJanuar y3,2011, andpur chased
$340, 000ofmer chandi sedur ingt hey ear.I finvent or yatDecember31, 2011i s
$59,700; thecostofmer chandi sesol ddet ermi ned( comput ed)asf oll
ows:
74
Costofmerchandisesol
d:
Purchases………………………………………………………………. …$340,000
Less:Merchandisei
nventoryDec.31,2011.
……………. .59,
700
Costofmerchandisesol
d……………………………………………………. .
280,300
Assume,duri
ng2012ABCCor porat
ionpurchasedadditi
onalmerchandiseof
$521,
980,r
eceivedcredi
tmemor andum ofpurchasedretur
nsandal lowancesof
$9,
100,i
nadditi
onABCt akepurchasesdiscountof$2,525,andpayst r
ansport
ati
on
cost
sof$17,400forFOBShi ppi
ngPointagreement .
Thepur chasesreturnsandal
lowancesanddiscountsar edeductedfr
om thet
otal
purchasestoyieldthenetpurchases,
andthetransportati
oncostsareaddedtothe
netpurchasestoyi el
dthecostofmerchandi
sepur chased.Thefoll
owingi
scostof
mer chandisepur chasedf or2012.
Pur chases………………………………………………………………$521, 980
less: Pur chasesr et urnsandal lowances……………………$9, 100
Pur chasesdi scount ……………………………………. 2,52511, 625
NetPur chases…………………………………………………. .
.……..$510, 355
Add: Tr anspor tationI n……………………………………………………. .
17, 400
CostofMer chandi sePur chased………………………………………$527, 755
Theendi ngi nv ent oryofABCCor por ationonDec.31, 2011, $59,700, becomest he
beginninginv ent or yf or2012.I nt hecostofmer chandisesol dsect i
onofi ncome
statementf or2012, thisbegi nni nginv entoryisaddedt othecostofmer chandise
purchasedt oy ieldt hemer chandi seav ai
lableforsale.Theendi ngi nv ent ory,
whi chis
assumedt obe$62, 150, i
st hensubt ractedf rom themer chandi seav ail
abl eforsale
toy i
eldthecostofmer chandi sesol d.
Costofmer chandi sesol d:
Mer chandisei nv ent or yJan.1, 2012………………………………………………. 59,700
Pur chases………………………………………………………………521, 980
Less: Pur chasesr etur nsandal l
owances……. .…..9,
100
Pur chasesdi scount ………………………. .
2,52511,400
NetPur chases…………………………………………………………. 510,355
Add: Transpor tationI n……………………………………………. …..
.17, 400
Costofmer chandi sepur chased……………………………………. .
…………527, 755
Mer chandi seav ai l
abl ef orsal e……………………………………………. .
..587, 455
Less: Mer chandi sei nv entoryDec.31, 2012………………………………. .
...
62,150
Costofmer chandi sesol d………………………………………………525, 305
3.8.MERCHANDI SEI NVENTORYADJUSTMENTS
Thebestmet hodst or epor tthecostofmer chandisesol dismai ntainingasepar ate
accountent itledmer chandi sei nvent ory.Attheendoft heper iod, t
heamountof
i
nv entoryatt hebegi nningoft heper iodshoul dber eplacedbyt heamountof
i
nv entoryatt heendoft heper iod.Thi sisadjustedbyt woent ries:
Entry1:Tr ansf ert hebegi nni ngi nvent orytoincomesummar y.ForABCCor porationit
75
 i
sil
lust
rat
edasf
oll
ows:
I
ncomeSummary…………………………………………. 59,
700
Mer
chandi
seI
nvent
ory
…………………………………………59,
700
N.B.Thisinventor
yispar
tofcostofmer
chandi
sesol
d.I
tisal
sosubt
ract
ed
from assetsaccount
.
Ent
ry2:Debitt
hecostofmerchandi
seinv
ent
oryatt
heendoft
heperi
odt
otheasset
account
,i.
e.merchandiseinv
ent
ory
:
Merchandi
seInv
ent or
y ……………………………………62,
500
IncomeSummary……………………………………………….
62,
500
Beari
nmi nd,t
hecredi
tporti
onoftheentr
yeff
ect
sisadeductionoftheunsol
d
merchandisef
rom t
hetotalcostofmer
chandi
seavai
labl
eforsaleduri
ngtheper
iod.
3.
9.
ADJUSTMENTFORDEFERRALSANDACCRUALS
Adjust i
ngEnt riesforDef er rals( pr epai dexpenses)
Prepai dexpensesar et hecostofgoodsorser vi
cest hathav ebeenpur chasedbutnot
usedatt heendoft heaccount ingper iod.Thepor ti
onoft heassetst hathasbeen
useddur ingt heper iodbecomesanexpense.Pr epaidexpensei ncludesaspr epaid
i
nsur ance, prepai dr ent, prepai di nt erest ,et c.
Il
lustration: assumet hatABCCor por ationof fi
cesuppl i
esaccounthasbal anceof
$1,090onDec.31, 2012.Of fi
cesuppl iesonhandamount edto$480onDec.31, 2012.
Officesuppl iesexpensei s610i .
e.( 610=1090- 480) .
Of fi
ceSuppl iesExpense……………………………………. .610
OfficeSuppl ies…………………………………………………. .
610
ABCCor por at i
onpr epai dinsur ancebal ancewas$4, 560atDec.31, 2012.$1, 910of
i
nsur ancepr emi umshasexpi r eddur i
ngt hey ear .
I
nsur anceExpense……………………………………. .……1, 910
Pr epai dI nsur ance………………………………………………1, 910
Adjust i
ngEnt riesforUnear nedRev enue( Def errals)
Rev enuer ecei veddur i
ngapar ticul arper iodmaybeonl ypar tlyearnedbyt heendof
theper iod.I temsofr evenuet hatar erecei vedi nadv ancer epresental iabi
lit
ythatare
receivedi nadv ancer epresental i
abi li
tyt hatmaybet ermedunear nedr evenue.
Il
lustration: assumeABCCor por at iononOct .1, 2012r entsapor tionofbui l
dingthat
i
thasbeenl easedf oraper iodofoney ear ,receiv i
ng$2, 400inpay mentf ortheentire
year’srent al.Thet ransact ionwasor iginal lyrecor dedasdebi ttocashandcr editto
l
iabili
tyaccountofunear nedr ent .OnDec.31, 2012, onef our
thoft heamounthas
beenear nedandt hr eef our thoft heamountr emai nsal i
abili
ty.
Unear nedRent …………………………………………. .600
RentI ncome………………………………………………. ..
600
Adjust i
ngEnt riesforAccr uedLi abi li
ties( Accr uedExpense)
Someexpensesaccr uef rom dayt odaybutar eusual lyrecordedonl ywhent heyar e
paidsuchassal ari
espai df orempl oyeesandi nterestpai donnot espay able.The
amountofsuchaccr uedbutunpai di t
emsatt heendoft hefiscalperiodarebot h
76
expenseandl iability.
Il
lustration: OnDec.31, 2012, t
heendoft hef i
scalyear ,thesal essal ari
esexpense
accountf orABCCor por ationhasabal anceof$59, 250andt heof f
icesal aries
expenseaccounthasadebi tbalanceof$20, 660.Fort hisf iscal year, t
her ecordsof
thebusi nessshowt hatt heaccr ualsf orsal essal ari
esandof fi
cesal ar
iesar e$780
and$360, respect ively ,att heendoft hey ear.
SalesSal aryExp…………………………………………780
OfficeSal aryExp……. .…………………………………360
Salar yPay abl e………………………………………. .
.1,140
Adjust i
ngEnt ri
esf orAccr uedAsset s(accr uedRev enue)
Duringaf i
scal per i
odi tiscommont orecor dsomet ypesofr evenueonl yast hecash
i
sr eceiv ed; consequent ly, attheendoft heper i
odther emaybei temsofr evenuethat
hav enotbeenr ecor ded.I nsuchcases, theamountofaccr uedr evenuemustbe
recordedbydebi ti
nganassetaccountandcr editi
ngar ev enueaccount .
Il
lustration: onDec.31, 2012, ABCCor por ationhasani nterestbear ingnot e
receivabl e.Al li
nter esti ncomewi llbecol l
ectedi n2013, whenpay menti sdueont he
note.Thei nterestear nedbutnotcol l
ect edasofDec.31, 2012i s$200.
I
nt erestRecei vabl e……………………………………. .
.200
InterestI ncome………………………………………. .……. 200
WORKSHEETFORMERCHANDI SINGENTERPRI SE
Aftery ear endpost ingoft hej ournal siscompl eted,wor ksheeti susedt oassi stin
prepar i
ngt headj ust ingent r
ies,cl osingent r
ies,andf i
nanci alstat ement s.Thepr i
mary
diff
erencebet weent hewor ksheetofmer chandi seent erpr i
seandser vi
ceent erpr
ise
i
st hatoft hebegi nni ngandendi ngmer chandi seinvent ories, whi char eshowni nthe
i
ncomesummar yaccount , appeari nbot ht hedebi tandcr editincomest at ement
columnsoft hewor ksheet .
Adjust ment sont heWor kSheet
Thedat aneededf oradj ust i
ngt heaccount sofABCCor por ationar esummar i
zedas
foll
ows:
- I nter estaccr uedonnot er eceivabl e
$200

- Merchandi
sei
nvent
oryasofDec.31,
2012
62,
150

- Of
fi
cesuppl
i
esasofDec.31,
2012 480

- I
nsur
anceexpi
reddur
ing2012 1910

- Depr
eci
ati
ondur
ing2012on:

 St
oreequi
pment 3100

77
  Of
fi
ceequi
pment 2490

- Sal
ari
esaccr
uedonDec.31,
2012

 Sal
essal
ary
…………………………780

 Of
fi
cesal
ary
……………………… 360

 Sal
arypay
abl
e 1,
140

- Renti
ncomeear
neddur
ing2012 600

Thebal ancesoft heaccount sinthetri

albalancecol umnsandt heamountofany
adjustment sareaddedordeduct edasappr opriat
e.Theadj ustedbalancesaret hen
extendedi nt ot
headj ustedtr
ialbal
ancecol umns, whi charet otal
edtopr ovethe
equali
tyofdebi tsandcr edit
s.Boththedebi tandcr editamount sfort
heincome
summar yar eextended.
Aft
eral loftheitemshav ebeenext endedi ntothest atementsect i
onsoft hewor k
sheet,thefourcol umnsar etotal
edandt heneti ncomeornetl ossisdetermined.The
fol
lowingwor ksheetisforABCCor por
ationill
ustration:
(a)Interestearnedbutnotr ecei
vedonnot esrecei vabl
e,200

(
b)Begi
nni
ngmer
chandi
sei
nvent
ory
,59,
700

(
c)Endi
ngmer
chandi
sei
nvent
ory
,62,
150

(
d)Of
fi
cesuppl
i
esused,
510=1090-480

(
e)I
nsur
anceexpi
red,
1910

(
f)Depr
eci
ati
onofst
oreequi
pment
,3,
100

(
g)Depr
eci
ati
onofof
fi
ceequi
pment
,2,
490

(
h)Sal
ari
esaccr
uedbutnotpai
d(sal
essal
ary
,780andof
fi
cesal
ary360)t
otal
1,
140

(
i)Rentear
nedf
rom amountr
ecei
vedi
nadv
ance,
600

ABCCorporat
ion
WorkSheet
ForYearEndedDec.31,2012
AccountTi
tl
e Tr
ialBal
ance Adj
ust
ment
s Adjust
ed I
ncome Balance
Tri
alBalance St
atement Sheet
Dr. Cr
. Dr
. Cr
. Dr. Cr
. Dr
. Cr
. Dr. Cr
.
Cash 62,
950 62,
950 62,
950
Notesr
ecei
vabl
e 40,
000 40,
000 40,
000

78
AR 60,
880 60,
880 60,
880
I
nter est (
a)200 200 200
Recei v abl
e
Mer chandi seI nv. 59,
700 (
c)62,
150 (
b)59,
700 62,
150 62,
150
Offi
ceSuppl i
es 1,
090 (
d)610 480 480
Prepai d 4,
560 (
e)1,
910 2,650 2,
650
I
nsur ance
StoreEqui pment 27,
100 27,
100 27,
100
Accum. DepSt.Eq 2,
600 (
f)3,
100 5,
700 5,
700
.
Offi
ce 15,
570 15,
570 15,
570
Equipment
Accum. Depof.Eq 2,
230 (
g)2,
490 4,
720 4,
720
AP 22,
420 22,
420 22,
420
SalariesPay able (
h)1,
140 1,
140 1,
140
Unear nedRent 2,
400 (
i)
600 1,
800 1,
800
NotePay abl
e 25,
000 25,
000 25,
000
Capit al St
ock 100,
00 100,
000 100,
00
0 0
Retai
nedEar
ning 53,
800 53,
800 53,
800
Div
idends 18,
000 18,
000 18,
000
I
ncome (
b)59,
700 (
c)62,
150 59,
700 62,
150 59,
700 62,
150
Summar y
Sal
es 720,
18 720,
185 720,
18
5 5
Sal
esR&A 6,
140 6,
140 6,
140
Sal
esDiscount 5,
790 5,
790 5,
790
Pur
chases 521,
98 521,
980 521,
98
0 0
PurchasesR&A 9,
100 9,
100 9,
100
Purchas 2,
525 2,
525 2,
525
Discount
Transpor tati
onI n 17,
400 17,
400 17,
400
SalesSal aryEx p. 59,
250 (
h)780 60,
030 60,
030
Adv erti
singExp. 10,
860 10,
860 10,
860
Depn. Exp. St . (
f)3,
100 3,
100 3,
100
Eq.
Misce Sell
ing 630 630 630
Exp
Offi
ceSal aryExp 20,
660 (
h)360 21,
020 21,
020
RentExp 8,
100 8,
100 8,
100
Depn.Exp. Of.Eq. (
g)2,
490 2,
490 2,
490
I
nsur anceExp (
e)1,
910 1,
910 1,
910
Offi
ce Supply (
d)610 610 610
Exp
MisceAdmi nExp 760 760 760
RentI ncome (
i)
600 600 600
I
nter estIncome 3,
600 (
a)200 3,
800 3,
800

79
I
nter
estExpense 2,
440 2,
440 2,
440
943,
86 943,
86 131,
000 131,
900 1,
012,
940 1,
012,
94 722,
96 798,
36 289,
98 214,
58
0 0 0 0 0 0 0
NetI
ncome 75,
400 75,
400
798,
36 798,
36 289,
98 289,
98
0 0 0 0

3.10. PREPARATI ONOFFI NANCI ALSTATEMENT

Thebasi cfinanci alstatementf ormer chandisingenterprisei ncludesi ncome
stat ement ,bal ancesheet ,statementofowner ’
sequity,andst atementofcashf low,
aresi milartot hoseofser viceent er pri
se.Forcor porati
ont y
peofmer chandise
ent erpriset hef i
nanci al statementi ncludesst atementofr etainedear ningsr at her
thanst atementofowner ’sequi ty
.
Thebasi cdi f
f erencebet weent hef inancialstatementofmer chandi seent erpr i
seand
serv iceent erpr isei sthei ncomest atementsect i
onofcostofmer chandi sesol dand
thebal ancesheetsect ionofmer chandi sei nventory.
IncomeSt at ement
Ther earet wowi delyusedf ormsf ort heincomest at
ement :mul tiple–st epand
singl e–st ep.
Mul ti
ple–St epf orofI ncomeSt at ement
Themul ti
ple–st epi ncomest atementi ssocal ledbecauseofi t
smanysect ions, sub
sect ionsandi nter medi atebal ances.Suchas:
1.Rev enuef r om sal es:t het otalofal lchargest ocust omer sf ormer chandi sesold,
bot honaccountandcash, i
sr epor tedint hi
ssect i
on.Sal esr eturnandal lowances
andsal esdi scount sar ededuct edf rom thegr ossamountt oy iel
dnetsal es.

2.CostofMer chandise Sol

d:thi
s sect
ion i
sforthe det
ermi
nat
ion ofcostof
merchandi
sesold.Theothernameofcostofmerchandi
sesol
discostofgoods
sol
dorcostofsales.

3.Gross Profi
t:the excess oft he netrevenue f
rom sal
es overthe costof
merchandisesol
discalledgrossprofi
torgrossmargi
n.I
tiscal
ledgr
ossbecause
operat
ingexpensesmustbededuct edfrom i
t.

4.Operati
ngExpenses:f orr et
ailbusiness,operati
ngexpensescanbesubdi videin
totwo categories:sel l
ing andadmi nist
rati
veexpenses.Sel li
ng expensesar e
i
ncurreddir
ectlyandent irelyi
nconnect ionwithsaleofmer chandise.Theyinclude
suchexpensessuchas:sal ari
esf orsalesman,st oresuppli
esused,depr eciati
on
ofthe store equipmentand adv erti
sementcost .Administrat
ive expenses or
generalexpensesi ncurredi ntheadmi ni
str
ationofthebusi ness,suchas:of fi
ce
sal
ari
es,depreciati
onofof fi
ceequi pment,andof f
icesuppl
iesusedr entexpenses,
i
nsuranceexpenseset c.

5.I
ncomef
rom Oper
ati
ons:t
heexcessofgr
osspr
ofi
tov
ert
otaloper
ati
ngexpenses
80
 i
scall
edincomefrom operat
ion.Ifoperat
ingexpensesar
egr
eat
ert
hangr
oss
pr
ofi
t,t
heexcessi
scal
ledlossfrom oper
ati
ons.

6.OtherIncome:r evenuesourcesot
herthantheprincipalact
ivi
ti
esoft
hebusi
ness
areclassi
fiedasot herincome,ornon-oper
ati
ngi ncome.Suchas:incomefr
om
rent
,int
erestincomeandgai nfr
om sal
esofplantassets.

7.Otherexpenses:expensest
hatarenotassoci
atedwit
hoper
ati
onsofthebusi
ness,
suchasi nt
erestexpensesandlossfrom di
sposal
s(sal
es)ofthebusi
nessplant
asset
s.

Thetwocat egor
iesofnon- operat
ingit
emsar eoffsetagainsteachot heront he
i
ncome st atement .Ifthe tot
alofot herincome exceeds t he tot
alofot her
expenses,thedifferenceisaddedt oi
ncomef r
om oper at
ions.Ifthetotalofother
expensesexceedst hedif
fer
enceissubtract
edfrom incomef rom operations.

8.NetIncomeornetl
oss:t
hef
inalf
igur
eont
hei
ncomest
atementi
sneti
ncome(
or
netl
oss).

Single–St epf orm ofI ncomeSt atement

Insingle–st epi ncomest atementt het otal expensesdeduct edfrom thetot
alsof
revenues.Anobj ect i
on( disadvantage)oft hesi ngle–st epform ofincomestatement
i
st her elationshi psasofgr osspr ofi
ttosal esandi ncomef rom operationst
osales
arenotasr eadi lydet erminableast heyar ewhent hemul ti
ple–st epform ofi
ncome
statement
Inthef ollowi ngpagest hemul t
iple–st epi ncomest at ementandsi ngle–step
i
ncomest atementf orABCCor porationi l
lust r
at i
oni spr esentedasf ol
lows
respect i
v ely :
Mul ti
ple–st epi ncomest at
ementf orABCCor poration
ABCCor por ation
I
ncomeSt atement
Fort heYearEndedDecember31, 2012
Rev enuesf rom Sal es:
Sal e………………………………………………………………………. .
.….$720, 185
Less: Sal esr eturnsandal lowances………. ………. ..
..
.$6,140
Salesdi scount s……………………………. ...
…..5,79011, 930
NetSal es………………………………………………………………. …. $708,255
CostofMer chandi seSol d:
Mer chandi seI nventor y
, Jan.1,2012……………………………. .…………. ….
..
.59,
700
Purchases………………………………………………………. .
..521,980
Less: Pur chasesr eturnsandal l
owances……………9, 100
Pur chasesdi scount……………………. ……2, 52511, 625
NetPur chases…………………………………………………. ….510, 355
81
 Add: Tr anspor tati
onin…………………………………………. .…17,400
CostofMer chandisePur chased…………………………………………………527, 755
Mer chandi seAv ail
ableforSale………………………………………………. .…. .
..
587,455
Less: Mer chandi seInvent ory
,Dec.31, 2012…………………………………. .
62,150
Costofmer chandi seSol d……………………………………………………………………525, 305
GrossPr ofit……………………………………………………………………. .
182, 950
Oper atingExpenses:
Sel l
ingExpenses:
Sal esSal aryExp………………………………………………………60, 030
Adv ertisingExp………………………………………………………. 10,860
Depr eciat ionExp.St oreEquipment ………………………………. .…..
3, 100
Mi scel laneousSel l
ingExp……………………………………………630
Tot al Sel lingExp……………………………………………………………. .
…74, 620
Admi ni strat i
v eexpenses:
Of fi
cesal ar yExp……………………………………………………. .
.21,020
RentExp……………………………………………………………. .
…8,100
Depr eciat ionExp.Of fi
ceEqui pment …………………………………. .2,490
Insur anceExp…………………………………………………………. .1,
910
Mi scel laneousAdmi nist
rati
veExp………………………………. .…760
Tot al Admi ni
strati
veExp…………………………………………………34, 890
Tot al Oper atingExp…………………………………………. .
……………, ,
109, 510
I
ncomef rom Oper ati
on………………………………………………………. ..
.73,440
OtherI ncome:
InterestI ncome……………………………………………………………3, 800
RentI ncome……………………………………………………………….600
Tot al Ot herI ncome……………………………………………………………. .4,400
OtherExpenses:
InterestExpense……………………………………………………………. 2, 4401, 960
NetI ncome………………………………………. ……………………………. ..
.75,400
Single–st epi ncomest atementf orABCCor porati
on
ABCCor porati
on
IncomeSt at
ement
FortheYearEndedDecember31, 2012
Rev enues:
NetSal es……………………………………………………………………. 708,255
Int erestI ncome………………………………………………………………. ..
3,800
RentI ncome……………………………………………………………. 600
Tot al Revenue…………………………………………………………712, 655
Expenses:
CostofMer chandi seSold………………………………………………. .525,305
Sel lingExpenses……………………………………………………. .
……74, 620
82
 Admi ni strativeEx penses…………………………………………………. 34,890
I
nterestExpenses……………………………………………………. .
……. 2,
440
Tot al Expenses………………………………………………………. .637,255
NetI ncome……………………………………………………………. ……75,400
RetainedEar ni ngsSt atement
Retainedear ningsst atementsummar i
zesthechangeswhi chhav eoccur r
edinthe
ret
ainedear ningsaccountdur ingthef i
scalperi
od.Itserv
esasal i
nkbet weenthe
i
ncomest atementandt hebal ancesheet .
ABCCor porati
on
Ret ai
nedEar ni
ngsStatement
Fort heYearEndedDecember31, 2012
RetainedEar nings, Januar y31,2012…………………………………………. 53,800
NetI ncomef ortheYear ………………………………………………………. 75,400
Less: Di vidends………………………………………………………………. .…18, 000
Increasei nRet ai nedEar nings…………………………………………………. 57,400
RetainedEar nings, December31, 2012………………………………………111, 200
BalanceSheet
Thear rangementofasset sont helefthandsideoft hebalancesheetand, l
iabi
l
iti
es
andowner ’sequi tyont her ighthandsi deofthebalancesheeti scalledaccountform.
Thear rangementoft het hreesect ionofthebalancesheeti nt hedownwar d
sequencecal l
edr epor tfor m.

ABCCorporati
on
Bal
anceSheet
December31,2012
Asset s
CurrentAsset s:
Cash………………………………………………………………………. .
62,950
Not esRecei v
abl e………………………………………………………. .40,000
Account sRecei vable………………………………………………. .
…..60,880
InterestReceiv able…………………………………………………. ..
……. 200
Mer chandiseI nv entory
………………………………………………... 62,150
Of fi
ceSuppl i
es…………………………………………………………. ….480
Pr epaidI
nsur ance……………………………………………………. .
…2, 650
TotalCur rentAssets…………………………………………. .
.229,310
Pl
antAsset s:
Stor eEquipment ………………………………………. …27,
100
Less:Accumul atedDepreci
ati
on……………………..…5,700
21,400
Of fi
ceEqui pment ……………………………………. …..
15,
570
Less:Accumul atedDepreci
ati
on…………………….…4,720
83
 10,850
Tot alPlantAsset s…………………………………………. …....32,250
TotalAsset s………………………………………………………. …….261,560
Li
abi l
iti
es
Cur r
entLi abilit
ies:
AccountPay abl e………………………………………………………22, 420
NotePay able( Cur r
entPor t
ion)
………………………………………. .
5,000
SalaryPay able………………………………………………………. ..
..
1,140
Unear nedRent ……………………………………………………………. 1,800
Total CurrentLi abil
it
ies…………………… …………. …..
.…..30,360
Long–Ter m Li abi li
ti
es:
NotePay able……………………………………………………. .
…….20,000
TotalLi abil
iti
es………………………………… ……………. .
………50, 360
Stockhol ders’ Equi ty
Capital Stock………………………………………………………. .
……100,000
RetainedEar nings……………………………………………………. ….111, 200
TotalSt ockhol der s’Equit
y………………………………………. .
..
..
..
211, 200
TotalLi abil
ityandSt ockholders’
Equi
ty………………………. ……. 261,560

3.
11. ADJUSTI NGENTRI ES
Thef ollowingsareadjust i
ngent rieswhi chwer eprev i
ousl
ydi scussedforABC
Corpor ati
onasofDecember31, 2012.
I
nterestRecei vabl
e………………………………………………. 200
I
nterestI ncome……………………………………………………. .200
I
ncomeSummar y……………………………………………. .59700
Mer chandi seI nventory………………………. ……………. .
..
.59700
Merchandi seInventory…………………………………………62150
I
ncomeSummar y………………………. .……………………. …62150
Off
iceSuppl i
esExpense……………………………………. …...
.610
Of fi
ceSuppl ies……………………………………. ……………. ..
610
I
nsur anceExpense……………………………………………. …1910
Pr epaidI nsur ance……………………………………………. .….
1910
Depreci ati
onExpense-St oreEqui pment ………………………. .
3100
Accumul atedDepr eciati
on–St oreEquipment ………………. ….
3100
Depreci ati
onExpense-Of f
iceEqui pment ………………. .……2490
Accumul atedDepr eciation–Of fi
ceEquipment …………. ……….
2490
Sal
esSal aryExpense…………………………………………. …780
OfficeSal ari
esExpense………………………………. ..
….…….360
Salar yPay able…………………………………. .
………. ……...
1140
Unear nedRent ………………………………………………. ...
.600
RentI ncome…………………………………. ………………. .
…600

84
 3.12.CLOSI NGENTRI ES
Theclosingent r
iesar er ecor dedint hej ournalimmedi atelyfoll
owi ngt headj usti
ng
entri
es.Closingent ri
escl earedalloft het empor aryowner ’
sequi tyaccount s,
reducingthem t ozer obal ance.Thef i
nal effectofclosingent ri
esi saneti ncreaseor
anetdecr easei nt her etai nedearnings.Thecl osingent r
iesforABCCor porati
onasof
December31, 2012ar et hef ol
lowings:
Sales………………………………………………………. ..….
..720,185
Pur chasesRet ur nsAndAl lowances……………………………. .
…9100
Pur chasesDi scount s…………………………………………. ...
…..2525
InterestI ncome……………………………………………. ..
...
..
…. .
3800
RentI ncome…………………………………………………………600
IncomeSummar y………………………………………………………736, 210
I
ncomeSummar y ………………………………………………663, 260
SalesRet urnsAndAl l
owances………. …………………………………. $6,140
SalesDi scount s……………………………. …………………. .……...
...
..5,790
Purchases………………………………………………………………. 521, 980
Transpor tat ionIn……………………………………………………. .
..
...
17,400
SalesSal ar yExp……………………………………………………. ..
….60,030
Adv erti
singExp………………………………………. .
.…….……. ..
…..10,860
Depr eciationExp.St oreEqui pment …………………………. .…………. .3,100
Miscel l
aneousSel li
ngExp………………………………………. .
.……. ….630
Offi
ceSal ar yExp………………………………………………………. .
21, 020
RentExp………………………………………………………………. ..
...
8,100
Depr eciationExp.Of fi
ceEqui pment …………………………………. .
..
..2,
490
I
nsur anceExp……………………………………………………………. 1,910
Offi
ceSuppl iesExpense……………………………………………………610
Miscel l
aneousAdmi nistrati
veExp………………………………………. .
.760
I
nter estEx pense…………………………………………………………. .2,440

I
ncomeSummary …………………………………………………75400
Ret
ainedEarni
ngs………………………………………………….
………75400

Ret
ainedEarni
ngs………………………………………………..18000
Div
idends…………………………………………………………..
..
…….
.18000

Theef
fectsofthefourcl
osingentr
iesare:
1. Thef i
rstentryclosesallincomestatementaccountwi
thcr
edi
t
balancebytr
ansferr
ingtothecredi
tsideofthei
ncomesummar y.

2. Thesecondentr
yclosesalli
ncomest
atementaccountwi
thdebi
t
bal
ancebytot
hedebitsi
deoft
hei ncomesummar
y.

85
 3. Thethi
rdentrycl
osesi
ncomesummar
ybyt
ransf
err
ingi
tsbal
ance
t
other
etai
nedear
nings.

4. Thefourt
hent
rycl
osesdi
vi
dendsbyt
ransf
err
ingi
tsbal
ancet
othe
r
etai
nedearni
ngs.

Aft
erallt
emporaryowner’
sequityaccount
shavebeenclosed,t
heonl
yaccount
wit
hbalancesaretheasset
s,contraasset
s(e.
g.accumul
ateddepr
eci
ati
on)
,li
abi
li
ty,
capi
talst
ockandretai
nedearnings.

3.13. REVERSI NGENTRI ES

Tosi mpl i
fytheanal ysi
sandrecordingofsubsequenttransacti
onsr el
atedtosuch
adjust i
ngent r
ies,anoptional
procedureistheuseofr eversi
ngent r
iesmaybeused.
Rev ersingent ryistheexactreverseoftheadjust
ingent r
ytowhi chitrel
ates.The
amount sandt heaccount sar
et hesameast headjustingentry
;thedebitsandcr edi
ts
mer elyr eversed.
Il
lust r
ation:theadj usti
ngentryforABCCor porat
ionrecordedonDec.31, 2012for
accr uedsal aryexpenseandsal arypayablewasasf oll
ows:

Sal
esSalaryExp……………………………………………..……780
Offi
ceSalaryExp………………………………………………….360
Sal
aryPay
abl
e………………………………………………….
.1140

Ther
ever
singent
rycoul
dber
ecor
dedonJan.1,
2013i
sasf
oll
ows:

Sal
aryPayabl
e……………………………………………………1140
Sal
esSalaryExp………………………………………………….
….780
Offi
ceSalar
yExp………………………………………..
.……….
…360

I
ll
ust
rat
ion:
ABCCorpor
ati
onr
ecor
dedt
headj
ust
ingent
ryf
oraccr
uedi
nter
est
r
ecei
vabl
esasf
oll
ows:

I
nter
estRecei
vabl
e……………………….
.…………………….
200
I
nter
estI
ncome…………………………………………….……..
..
..
.200

Ther
ever
singent
ryf
oraccr
uedi
nter
estr
ecei
vabl
eisasf
oll
ows:

I
nter
estI
ncome…………………………. …………………….
.200
I
nter
estRecei
vabl
e……………………………….
…………….
……200

3.
14. I
NTERIM STATEMENTS
Businessent
erpr
isesf
requentl
yprepar
efi
nancialst
atementsati
nter
valswi
thi
nthe
fi
scalyear
,suchasmonthly,quar
ter
ly,
orsemiannual
ly.St
atement
sissuedf
or
86
periodscov eri
nglesst hanaf i
scalyeararecall
edinteri
m stat
ement s.Theanalysis
andr ecordi
ngoft ransactionisperf
ormedonacont inuousbasisthroughoutthe
fi
scal year,
regardlessofwhenf i
nancialstat
ementsar etobeprepared.Wheni nt
erim
fi
nanci alst
atement saretobepr epared,theadj
ustmentdat aareassembl edand
wor ksheetiscompl et
edasoft heendoft heint
erim peri
od.Howev er,adj
usti
ngand
closingentriesarenotr ecordedintheaccount s.Theseentri
esarer ecordedonlyat
theendoft hefiscalyear.

3.15.CORRECTI ONOFERRORS
Occasionalerr
orsinjournali
zi
ngandpost i
ngt r
ansacti
onsareanav oidabl
e.Procedur
esused
tocorrecter
rorsinthejournalandledgerv
ariesinaccordancewiththenatur
eoft heerr
or
andthephaseoft heaccount ingcy
cleinwhichtheerrorisdiscov
ered.

Whenaner rori
naccountt
it
leoramountinthejour
nal
isdiscov
eredbef
oret
heentr
yis
posted,
thecorr
ecti
onmaybemadebydr awingali
nethr
oughtheerr
orandi
nser
ti
ngthe
corr
ectti
tl
eoramountimmediatel
yabove.

Whenanent ryint
hejournal
ispreparedcorr
ectl
y,butt
hedebitpor
ti
oni
sincorr
ect
lypost
ed
t
ot heaccountascredi
t(orvi
ceversa),t
heincor
rectpost
ingmaybecor
rectedbydrawi
nga
l
inethr
ought heer
rorandposti
ngt heit
em corr
ectl
y

Whenaner roneousaccountti
tleappearsinajournalentr
yandt heerr
ori
snotdiscover
ed
unti
laf
terpostingiscomplet
ed, t
heprefer
ableprocedureistojournal
i
zeandposta
corr
ecti
ngent r
y.Forexample,purchaseofoffi
ceequipmentwhi chwaspaidincash,was
err
oneouslyjournal
izedandpostedasa$500t oof fi
cesuppli
esofdebitbutcor
rect
ly
j
ournal
izedandpostas$500t ocredit
tocash.Thecor r
ecti
ngent r
yshoul
dbeasf ol
lows:

Of
fi
ceEquipment
……………………………………..500
Of
fi
ceSuppli
es………………………………………………500

CHAPTER4
ACCOUNTINGSYSTEMSDESI
GN
6.
1. I
ntr
oduct
ion
Thewayi nwhi chmanagementisgi ventheinf
or mationforusei nconduct i
ngthe
aff
airsoft hebusinessand reporti
ng to owners,credit
ors,and otheri nt
erest
ed
part
ies is cal
led t
he account
ing system.I tincludes the enti
re networki
ng of
communi cati
on.Anaccounti
ngsystem isthemet hodsandpr ocedur
esf orcoll
ecti
ng,
cl
assify
ing,summar izi
ng,and r eporti
ng a business’sf i
nancialand oper ati
ng
i
nformation.
6.
2. Pr
inci
plesofSy
stemsDesi
gn
Account ingsy stemsar edif
f er
entfr
om businesstobusi ness.Accountingsyst
ems
forlargebusi nessesmustbeabl etocoll
ect,accumul at
e,andr eportmanytypesof
transactions.Ev enthought hedif
fer
encesint hebusinesst hatrel
atedtothenumber
oft ransacti
onst obepr ocessedandt heusesmadeofaccount ingdatather
earea
numberofbr oadpr inci
pleswhi chcanapplytoallsystems.Thosear e:
a)Costef fect
ivebalance

87
 b)Fl
exi
bil
i
tyt
omeetf
utur
eneeds

c)Adequat
eint
ernal
cont
rol

d)Ef
fect
iver
epor
ti
ng

e)Adapt
iont
oor
gani
zat
ional
str
uct
ure

6.
3. Account
ingSy
stem I
nst
all
ati
onandRev
isi
on
Beforedesigningtheaccount i
ngsy stem thedesi gnermusthav eacompl et
e
knowledgeoft hebusi ness’soper ati
ons.
Accountingsy st
emsev olvethroughat hree-steppr ocessasabusi nessgr owsand
changes.Thef i
rstst
epi nt hi
spr ocessisanal ysi
s,whi chconsist
sof( 1)identifying
theneedsoft hosewhouset hebusi ness’
sf inancialinformat
ionand( 2)determi ning
how thesy st
em shoul dpr ovi
det hisinformat i
on.I nthesecondst ep,thesy stem i s
designedsot hatitwillmeett heuser s’needs.Fi nall
y,thesyst si
em i mpl ementedand
used.Ingener al
,manyl argebusi nessescont i
nuallyrev i
ew t
heiraccounti
ngsy stem
andmayconst antl
ybei nvol
v edinchangi ngpar tofi t
.Thej obofi nstal
li
ngand
changingismadeupoft hreephases:
i
. Anal ysis
ii
. Desi gn
i
ii
. I mplement at
ion

6.
4. I
nter
nal
Cont
rolSt
ruct
ure
An enterpri
se internalcont rolst ructur
e consi sts of pol
icies and procedures
est
abl
ished to pr ovide reasonable assur ance thatt he enterpr
iser’
s goals and
obj
ect
iveswi l
lbeachi eved.Thisinternalcontrolstr
ucturecanbedi videdintothree
el
ements.
1.Cont r
olenvironment :i
saffect edbymanagement ’
sphil
osophyandoper ati
ng
style,organizationalstructure oft he enterpr
ise,personnelpol i
cies and
practi
ces.

2.Cont
rolpr
ocedur
es:Thef
oll
owi
ngar
egener
alcont
rol
procedur
es

a)Compet
entper
sonnel
andRot
ati
onofdut
ies

b)Assi
gnmentofr
esponsi
bil
i
ties

c)Separ
ati
onofr
esponsi
bil
i
tiesf
orr
elat
edoper
ati
ons

d)Separ
ati
onofoper
ati
onsandAccount
ing

e)Pr
oofandsecur
it
ymeasur
es

f
)Independentr
evi
ewbyi
nter
nal
audi
tor
\

3.Accounti
ngsy
stem:I
sani
ntegr
alpar
toft
hei
nter
nal
cont
rol
str
uct
ureofan
ent
erpri
se.

88
 6.
5. Dat
aPr
ocessi
ngMet
hods
Theenti
reamountofdata(infor
mat i
on)neededbyanenterpr
isei
scall
eddatabase.
Asthedatabasei
ncreases,manual processi
ngbecomestoocostl
yandtakesmuch
ti
me.Insuchacase,themanual system canbechanged,
orrepl
acedor
suppl
ementedbycomput er
izedsystem.
6.
6. Subsi
diar
yLedger
sandSpeci
alJour
nal
s
SubsidiaryLedger :Ast henumberofpur chaseandsalesonaccountsi ncrease,the
needf ormai ntai
ningasepar at
eaccountf oreachcredi
toranddebt
oriscl ear.When
ther
ei slargenumberofi ndi
vidualaccount swi t
hcommonchar acteri
stics,itis
commont oplacet hem i nseparateledgercall
edsubsidiar
yledger
.Eachsubsi di
ary
l
edgeri scont r
olledbysummar i
zingaccountcal l
edcontrol
li
ngaccount.Thesum of
thebal ancesoft heaccount sinasubsi diar
yledgermustagr eewi
ththebal anceof
therelatedcont r
oll
ingaccount .
Subsidiaryledgerincludes:
 Accountpay ableledger:
cont r
oll
edbyaccountpay able

 Cust
omer
s’l
edger(
accountr
ecei
vabl
e):
cont
rol
l
edbyaccountr
ecei
vabl
e

SpecialJournals:Specialjournalswouldbeneededonl yfortheki ndoft ransact

ions
thatoccurfr
equent l
y.Thef oll
owingaretypi
caltr
ansacti
onswhi choccurmostof ten
i
namedi um-sizemer chandisingfir
m andthespecial
journal
sempl oyed.
Ty pesofTr ansacti
on Recordedi n
1.Pur chaseofmer chandi
seorotheri
temson PurchasesJour nal
account
2.Pay mentofcashf oranypurpose Cash pay ment
Jour nal
3.Salesofmer chandiseonaccount SalesJour nal
4.Recei ptofcashf rom anysour
ce Cash r
eceipts
journal

PurchaseJour nal
Thepur chasej ournalusedonlytorecor
dpurchasedmateri
alsonaccount .Sal
es
j
ournalisal so used tor ecor
d goodsormateri
alssold on accountbases.The
materi
alspur chasedorsol doncashbasesar
etreatedonspecialj
ournalknownas
cashjournal
Dat
e Accountcr
edi
ted Post Account Pur
ch St
ore Offi
ce Sundr
y P.
R Amount
Ref. payabl
e ases suppl
y Suppl
y account
sDr e
Cr Dr Dr Dr
Jan. 2 BedruCo.  11448 11448
2008 3 Masr eshaand Sons  14812 14812
Pl
c.
9 PaulosSuppl yCo.  514 262 252
11 Dir
ibchocor porat
ion  7186 7186
11 Masr eshaand Sons  6416 6416
Pl
c. 30250
17 Robesuppl y  3000 3000
20 WalelignCo.  30250 St
or pment 121
eEqui
23 Paulossuppl yCo.  264 150 114

89
27 Dir
ibi
choCor
por
ati
on  12750 12750 00 00 00
30 Total  86640(2 55612 412(
11 366(
11  30250
11) (
511) 5) 6)

Exampl e:
toshowshowt opostanaccountfr
om pur
chasej
ournal
tosubsi
diar
y
l
edgers.
Ayele
Ayele 200200
Beyene 800Beyene
Chalachew 600 800
Deri
be400chalachew
2000 600
Deri
be
GeneralLedger 400
Accountpayable
2000

90
 CHAPTERFI VE
Accounti
ngforcash
Cashisanymedi um ofexchangethatabankwillacceptatfacev al
ue.I
notherterms
Cashisanassetwhi chincl
udescoin,bankdeposit
,currency(papermoney),checks,
bankdrafts(incomingmoneyv i
abank)andmoneyor ders(incomingcheckorcash
fr
om customerbymai l
erbank.)
Cont
rol ofcash
Themanagementofcashi sofmaj ori
mportanceinanybusi nessent
erpr
isesince
cashi
sav
italf
act
ori
ntheoper
ati
onofabusi
nessandmanybusi
nesst
ransact
ions
i
nvol
vecash.I
naddi
ti
on,
cont
rol
l
ingofcashi
simpor
tantsi
ncei
tist
hemostl
i
qui
dof
al
lasset
sthati
svul
ner
abl
etot
hef
tormi
sappr
opr
iat
ion.To pr
otecti
ts cash
compani
esshoul
d:
1. accountf
oral
lcasht
ransact
ionsaccur
atel
ysot
hatcor
recti
nfor
mat
ionwi
l
l
beav
ail
abl
eregar
dingcashf
lowsandbal
ances.
2. makecer
tai
nthatenoughcashi
sav
ail
abl
etopaybi
l
last
heycomedue.
3. av
oidhol
dingt
oomuchi
dlecash,becauseexcesscashcoul
dbei
nvest
edt
o
gener
atei
ncomesuchasi
nter
est
.
4. pr
eventl
ossofcashduet
othef
torf
raud
3.2.
1CONTROLLI NGCASHRECEIPTS
Businessesor
dinar
il
yrecei
vecashf
rom t
womai
nsour
ce (
1)ov
ert
hecount
erf
rom
cashcust
omer
s:and(
2)f
orm char
gecust
omer
smaki
ngpay
ment
sonaccount
.The
casht
hati
srecei
vedi
mmedi
atel
yov
ert
hecount
eri
susual
l
yrecor
dedandpl
acedi
na
cashr
egi
ster
.Att
heendofeachday
,thecashi
neachcashr
egi
steri
sreconci
l
ed
wi
tht
hecashr
egi
stert
apeorcomput
erpr
int
outf
ort
hatr
egi
ster
.Thecashi
sthen
t
aken t
othe cashi
er'
s of
fi
ce and t
he t
apes ar
efor
war
ded t
othe account
ing
depar
tment
,wher
etheybecomet
hebasi
sforent
ri
esi
nthecashr
ecei
ptsj
our
nal
.
Whencashi
srecei
vedl
ater
,usual
l
yint
hef
orm ofchecks,ar
ecor
doft
hechecks
r
ecei
ved shoul
d bepr
epar
ed assoon ast
heyar
erecei
ved. Then t
hecash i
s
combi
nedwi
tht
her
ecei
ptsf
rom cashsal
esandshoul
dbedeposi
tedi
mmedi
atel
y.
I
ngener
al,
thougheachbusi
nessv
ari
esi
nit
sspeci
fi
cpr
ocedur
esf
orcont
rol
l
ingcash
91
r
ecei
pts,
thef
oll
owi
ngbasi
cpr
inci
plesar
eused:
1.Ar
ecor
dofal
lcashr
ecei
ptsshoul
dbepr
epar
edassoonascashi
srecei
ved
mostt
hef
tsofcashoccurbef
orear
ecor
dismadeoft
her
ecei
pt.
2.Al
lcashr
ecei
ptsshoul
dbedeposi
tedi
nabankont
hedayt
heyar
erecei
vedor
on t
he next busi
ness day
.Undeposi
ted cash i
s mor
e suscept
ibl
eto
mi
sappr
opr
iat
ion.
3.Theempl
oyeewhohandl
escashr
ecei
ptsshoul
dnotal
sobet
heempl
oyee
whor
ecor
dst
her
ecei
ptsi
ntheaccount
ingr
ecor
ds.
4.I
tpossi
ble,t
heempl
oyeewho r
ecei
vest
hecash shoul
d notal
so bet
he
empl
oyeet
odi
sbur
set
hecash.Thi
scont
rolmeasur
eispossi
blei
nal
lbutt
he
smal
l
estcompani
es.
I
ll
ust
rat
ion7-
1-cashr
ecei
ptscy
clef
orat
ypi
cal
mer
chandi
singcommonl
y
Ini
ti
alsour
cesofcash Excesscashisusedfor
areownerinvest
ment purposesot
herthan
andborrowing repl
acingi
nvent
ory

Cash

Account
s I
nvent
or
Recei
vabl
e y

CashShor
tandOv
er
Theamountofcashact
ual
l
yrecei
veddur
ingadayof
tendoesnotagr
eewi
tht
he
r
ecor
dofcashr
ecei
pts.Whenev
ert
her
eisadi
ff
erencebet
weent
her
ecor
dandt
he
act
ualcashandnoer
rorcanbef
oundi
nther
ecor
d,i
tmustbeassumedt
hatt
he
mi
stakeoccur
redi
nmaki
ngchanget
hecashshor
tageorov
eragei
srecor
dedi
nan
accountent
it
ledcashshor
tandov
er.Thus,
ift
heact
ualcashr
ecei
vedf
rom sal
esi
s
l
esst
hant
her
ecor
dedamount
,cashshor
tandov
eraccounti
sdebi
ted,wher
easi
f
t
heact
ualcashi
sgr
eat
ert
hant
her
ecor
dedt
hecashshor
tandov
eraccounti
s
cr
edi
tedf
ort
hedi
ff
erence.
Forexampl
e,assumet
hatacl
erkacci
dent
all
yshor
tchangeacust
omerBi
rr1and
t
hatt
otal
cashsal
esf
ort
hedayar
eBi
rr740.
50.Att
heendoft
heday
,act
ual
cashwi
l
l
beBi
rr1ov
ert
hesum oft
hesal
est
icket
sort
het
otaloft
hecashr
egi
stert
ape.The
92
Jour
nal
ent
ryt
orecor
dtheday
’scashsal
esi
s;
Cash…………………………741.
50
Sal
es…………………………….
..
.740.
50
Cashshor
tandov
er……………….
..
.1.
00
Attheendoft hefiscalperi
odifther
eisadebitbal
anceinthecashshor tandover
accountitisanexpenseandmaybei ncl
udedin“Miscel
laneousadmi ni
str
ati
ve
expense”ontheincomest atement.Whereasifi
thasacreditbalance,i
tisr
evenue
andmay bel
istedinthe“otheri
ncome”secti
on.
CashChangeFund
Businessesthatreceivecashdirectl
yfr om cust
omersmustmai nt
ainafundof
curr
encyandcoi nsinor dertomakechange. Theamountoft hechangefundis
deductedfrom t
hetotalcashonhandatt hecloseofbusinesseachdaytodeter
mine
thedailycashcoll
ecti
ons.Changef undmaybeest abl
i
shedbydr awi
ngacheckfor
therequir
edamount ,
debiti
ngtheaccountcashonhandandcr edi
ti
ngcashinBank.

CheckYourProgressExercise-1
1.Whatarethefourobjecti
vessoughti
nef
fect
ivecashmanagement
?
………………………………………………………………………………………………
2.Li
stf
ouressent
ial
feat
uresofasy
stem ofi
nter
nal
cont
rol
overcashr
ecei
pts?
………………………………………………………………………………………………
3.
3.2CONTROLLI
NGCASHDI
SBURSEMENTS

Cont
rol
sar
eal
soneededov
ercashdi
sbur
sement
s.Si
ncemostofacompany
’scash
i
sspentbycheck,
manyoft
hei
nter
nal
cont
rol
sforcashdi
sbur
sement
sdeal
wit
h
checksandaut
hor
izat
ionsf
orcashpay
ment
s.
Thef
oll
owi
ngar
esomebasi
ccont
rol
procedur
esf
orcashdi
sbur
sement
s.
1.Al
lpay
ment
sofcashshoul
dbeev
idencedbyachecksi
gnedbyadesi
gnat
ed
of
fi
cial
ift
heyar
enotpay
ment
sfr
om pet
tycash.
2.Al
lchecksshoul
dbeser
ial
l
ynumber
ed,andaccesst
ochecksshoul
dbe
l
i
mit
edt
oempl
oyeesaut
hor
izedt
owr
it
echecks.
3.Pr
efer
abl
y,t
wosi
gnat
uresshoul
dber
equi
redoneachchecksot
hatone
per
sonal
onecannotwi
thdr
awf
undsf
rom t
hebankaccount
4.Ther
esponsi
bil
i
tyf
ori
ssui
ngpur
chaseor
der
s,i
nspect
inggoodsr
ecei
ved,
and
v
eri
fyi
ngcont
ract
ualandar
it
hmet
icaldet
ail
sofi
nvoi
cesshoul
dbedi
vi
ded
among t
he empl
oyees ofsev
eraldepar
tment
s (Thati
s appl
ythe basi
c
pr
inci
pleofsegr
egat
ionofdut
ies)
93
 5.Appr
oveddocument
sshoul
dber
equi
redt
osuppor
tal
lchecksi
ssued.
I
ngener
ali
tisdesi
rabl
etocoor
dinat
etheser
elat
edact
ivi
ti
esandt
oli
nkt
hem wi
th
t
hef
inali
ssuanceofcheckst
ocr
edi
tor
s. Oneoft
hebestsy
stemsusedf
ort
his
pur
posei
sthev
ouchersy
stem.
3.3.3TheVoucherSy stem
Av ouchersystem ismadeupofr ecords,methodsandproceduresusedinproving
andr ecordi
ngl i
abil
it
iesandi nmaki ngandr ecordi
ngcashpay ments.A voucher
system uses(1)v ouchers(2)avoucherregist
er(3)afi
l
ef orunpaidvoucher
s(4)a
checkregist
erand( 5)af i
l
eforpai
dv oucher
s.
Av oucherisaf orm withspacesprovidedfordat
aaboutli
abil
it
yt hatmustbepai d.
Thedat
aincl
udei
temssuchascr
edi
tor
’snameandaddr
ess,
descr
ipt
ionofgoodsor
ser
vicesr
ecei
ved,
inv
oicenumber
,ter
msofpay
ment
,duedat
e,amountdueandof
ten
showst
hel
edgeraccount
sandamount
stobedebi
ted.Thev
oucheral
sohasspaces
f
orsi
gnat
uresoft
hoseappr
ovi
ngt
hel
i
abi
l
ityf
orpay
ment
.
I
ll
ust
rat
ion7-
2Av
oucher

SKYsuppl
ycompany
Texas666

VOUCHER VoucherNO 111

Ourp.
o.No 2002
Vendor
’si
nvoi
ce516
Pai
dbychedkNo1000

Pay
abl
eTo:MoonCor
por
ati
on Dat
ePai
d 11/
1/2003
Downt
own
Mi
thi
gan777
Dat
e Acct
.No Descr
ipt
ion Quant
it
y Uni
tpr
ice Tot
al
Jan 5 53 Sony 10 Bi
rr2000.
00 Bi
rr200,
000.
00
t
elev
isi
on Bi
rr200,
000.
00
Tot
al 2% 4,
000.
00
di
scount
Netpay
abl
e 196,
000.
00

Ter
ms2/
10,
N/30
94
Expl
anat
ions:Duedat
eisFebr
uar
y4,
2003
Audi
tedTo Approvedf
or Ent
eredinvoucher Dat
eent
ered
cor
rect
ness payment Regi
ster
5/
1/2003

Voucher
sar
ecust
omar
il
ypr
epar
edbyt
heaccount
ingdepar
tmentont
hebasi
sofan
i
nvoi
ceoramemor
andum t
hatser
vesaspr
oofofexpendi
tur
e.Thi
sisusual
l
ydone
onl
yaf
tert
hef
oll
owi
ngcompar
isonsandv
eri
fi
cat
ionshav
ebeencompl
etedand
not
edont
hei
nvoi
ce;
1.Compar
ison oft
he i
nvoi
ce wi
th a copyoft
he pur
chase or
dert
over
if
y
quant
it
ies,
pri
cesandt
erms.
2.Compar
isonoft
hei
nvoi
cewi
tht
her
ecei
vi
ngr
epor
ttov
eri
tyr
ecei
ptoft
he
i
temsbi
l
led
3.Ver
if
icat
ionoft
hear
it
hmet
ical
accur
acyoft
hei
nvoi
ce.
Af
teral
ldat
aexceptdet
ail
sofpay
menthav
ebeeni
nser
ted,t
hei
nvoi
ceorot
her
suppor
ti
ngev
idencei
sat
tachedt
othev
oucher
.Thev
oucheri
sthengi
vent
othe
desi
gnat
edof
fi
ci
alorof
fi
cial
sforf
inal
appr
oval
.
 VoucherRegi
ster-Af
terappr
ovalbyt
hedesi
gnat
edof
fi
cial
,eachv
oucheri
s
r
ecor
dedi
naJour
nalknownasv
oucherr
egi
ster
.Iti
ssi
mil
art
oandr
epl
aces
t
hepur
chasej
our
nal
.
 Unpai
dVoucherFi
le -Af
terav
oucherhasbeenr
ecor
dedi
nthev
oucher
r
egi
ster
,iti
sfi
l
edi
nanunpai
dvoucherf
il
e,wher
eitr
emai
nsunt
ili
tispai
d.
Theamountdueoneachv
oucherr
epr
esent
sthecr
edi
tbal
anceofanaccount
pay
abl
eandt
hev
oucheri
tsel
fisl
i
keani
ndi
vi
dualaccounti
nasubsi
diar
y
account
spay
abl
eledger
. Accor
dingl
y,asepar
atesubsi
diar
yledgeri
snot
needed.
 CheckRegi
ster-Thepaymentofavoucheri
srecor
dedi
nacheckr
egi
ster
.
Thecheckr
egi
steri
samodi
fi
edf
orm oft
hecashpay
ment
sjour
nalandi
sso
cal
l
edbecausei
tisacompl
eter
ecor
dofal
lchecks.
 Pai
dvoucherf
il
e–Af
terpay
mentv
oucher
sar
eusual
l
yfi
l
edi
nnumer
ical
order
i
napai
dvoucherf
il
e. Theyar
ethenr
eadi
l
yav
ail
abl
eforexami
nat
ionby
empl
oyeesori
ndependentaudi
tor
sneedi
ngi
nf.Aboutacer
tai
nexpendi
tur
e.
Thet
wocont
rol
l
ingov
ercashdev
icesf
orcashar
e:
95
I)Thebankaccount&
II
)Pet tycash
I) Thebankaccount :Itisoneoft hemaj ordev i
cesf ormai nt
ainingcont rolover
cash.Togett hemostbenef itfrom t hebankaccount ,allcashr eceivedmustbe
deposi t
edi nthebankandal lpayment smustbemadebychecksdr awnont hebank
orfrom speci alcashfunds.Whensuchsy stem isstri
ctl
yf ollowed,ther eisadoubl e
recordofcash,onemai ntai
nedbyt hebusi nessandt heot herbyt hebank.I nsome
casesabankmayr equireabusi nesst omai ntainami nimum cashbal ancecall
ed
compensat ingbalance.
Formsusedi nabankaccount
A)Si gnaturecar d:Whenanaccounti sopened, eachpersonwhoi saut horizedto
wr i
techecksont hataccountmustsi gnasi gnaturecard.Thebankkeepst he
signaturecar donf i
leandcompar esi twhenchecksar esubmi t
ted.
B)Deposi tti
cket(sli
p):Usedbyt hebusi nessasar ecei
ptt or ecordthecashdeposi t.
C)Check:i sawr i
tt
endocumentsi gnedbyt hedeposi t
or,or deringthebankt opaya
sum ofmoneyt oani ndividualorbusi nessent it
y .
Threepar tiesinvolv
edi nacheck:
1)Maker( drawer):thef i
rmt hatwr it
est hecheck.

2)Pay
er(
drawee)
:thebankonwhi
cht
hechecki
sdr
awn.

3)Pay
ee:t
hepersonorcompanyt
owhom t
hechecki
spai
d.
Maker check pay
ee checkBank

Money
D)Checkr
egi
ster
:Af
orm whi
chusedtor
ecordal
ltr
ansact
ionspai
dbycheck.
 Adocumentwhichisatt
achedwit
hcheckst
hatt
ell
sthepayeet
her
easonf
or
t
hepaymentiscal
ledremit
tanceadvi
ce
Bankst
atement

 I tist hemonthl
yst at
ement /
schedul
esendbythebanktothedeposi
tor
.
Bankreconci
liati
on
Thepr ocessofcompar ingt hebank’sbal
anceofanaccountwi
ththecompany’
s
balanceandexpl aini
nganydi ff
erencestomakethem agr
eeiscal
ledbank
reconcil
iation.
 Reasonswhyt
hebank&deposi
torbal
ancesar
enotequalar
e:
a)I
temsr
ecor
dedbyt
hecompanybutnoty
etr
ecor
dedbyt
hebank.

1)Depositi
ntr
ansi
t:i
sthedeposi
tthatt
hecompanyhasr
ecor
dedbutnot
recor
dedbyt
hebank.

2)Out
standi
ng checks:These hav
e been issued by t
he company and
r
ecordedoni
tsbookbuthavenotyetbeenpai
dbythebank.

b)I
temsr
ecor
dedbyt
hebankonl
y.

1)Bank col
lect
ion:not
es r
ecei
vabl
e and i
nter
estaccr
ued on not
es
96
 receiv
ablemaybecoll
ectedbyt
hebank.Thebankwi
llnoti
fy(
remi
nd)
theamountofcol l
ecti
onwhenevert hebankissendingthebank
statementt
othedeposi
tor.

2)Servi
cecharge:t
heamountofbanksf
eeforpr
ocessi
ngandpri
nti
ng
check.Whenthebankpr
ovi
dest
hebankst
atementt
othedeposi
tor
.

3)I
nter
estr
evenueonchecki
ngaccount
.

c)Notsuff
ici
entf
und(NSF)recei
vedfrom cust
omer.
d)Checkscol
lect
ed,
deposi
tedandr et
urnedtopay
eebyt
hebankf
orr
easonot
her
thanNSF
 Thebankr
etur
ncheckst
othepayeei
f:
 Themakeraccounthascl
osed.

 Thesi
gnat
urei
snotaut
hor
ized.

 Thecheckf
ormi
simpr
oper
/changed.

 Account
ingf
oral
lret
urnedchecki
sthesamef
orNSF.
e)Err
orbyeitherthecompanyort hebankorboth.
E.g.1)Acheckwr i
ttenfor$225i sdrawnbyt hebankas$252.
2)Acheckwr it
tenfor$225i sjournali
zedbythedeposi
tor
sas$522.
Itwi
l
lunder
stat
e
thecashledgerbalanceoft hedepositor.
A/p--
---
--
---
--
--
--
---
522
Cash----
--
--
--
--
--
---
--
--
--
---
--
--
---
--
522
Tor ecor
dthebalanceofcash
Cash--
--
---
--
--
---
--
--
---
--
--
--
--
-297
A/p---
--
---
--
--
--
--
--
--
---
--
--
--
--
--
-297

 Bankcr edi tmemor andums: areadditionsbybanknotr ecor dedbydeposi t

or.
 Bankdebi tmemor andums:ar et hededuct ionsbybanknotr ecor dedbythe
deposi tor .
For matf orbankr econcili
at i
on
XxCompany
BankReconci liation
Sep.30, xx
Cashbal anceaccor dingt obankr ecord----
--
--
---
---
--
---
--
---
---
--
--
--
---
--
------
--
--
--
xxx
Add:Addi ti
onsofdeposi tornotonbankst atement( deposi ti
nt ransi t
)---
-xx
Banker r
ort hatunderst atebankbal ance- -
---
--
--
---
---
--
---
--
--
--
---
----xx xxx
Ded:deduct ionbyt hedeposi tornotbybank( outstandingChecks)- --
--
--
-xx
Banker rort hatov erstatebankbal ance- ---
--
---
--
--
----
--
--
---
--
--
---
-----
xx xxx
Adjustedcashbal ance- --
---
---
----
---
--
---
--
--
----
--
--
---
---
--
--
---
---
--
---
--
--
--
---
-----xxx
Cashbal anceaccor dingt odeposi torrecords- -
--
--
--
---
----
--
--
--
---
--
--
------
--
--
---
--
--xxx
Add:addi ti
onsbybanknotr ecor dedbydeposi tor(creditmemor andum :
Notes&i nterestcol l
ection, i
nter estrevenueonchecki ngaccount s) --
--
--
--
xx
Deposi t
orer rorthatunder statethedeposi torcashl edgerbal ance--
---
--xx xxx
Subtotal--
--
---
-----
----
--
---
---
--
---
----
----
---
--
--
---
---
--
---
---
--
--
---
--
----
--
--
--
---
--
--
---xxx
97
Ded: Deduct i
onbybanknotr ecor dedbyt hedeposi tor
( debi tmemor andum: NSFchecks, servicechar ges)- --
----
-----
--
---
--
---
--
--xx
Deposi torer rort hatov erstatecashl edgerbal ance- --
-----
--
---
--
---
--
----
xx xxx
Adj ust edcashbal ance- ---
--
------
--
----
----
--
---
----
---
---
---
----
--
---
----
-----
--
---
--
---
--
xxx
Exampl e: Thebankst atementf orABCCompanyi ndicat esabal anceof$3359. 78as
ofJul y31.Thebal ance
Incashi nABCCompanyl edgerofsamedat ei s$2549. 99.
Addi tionali nf ormat ion:
-Deposi tofJul y31, notr ecor dedonbankst atement- -----
--816.20
-Out standi ngchecks: #812- ----
---
---
-----
--
-1061. 00
#878- ---
------
--
----
--435. 39
#883- ---
------
--
----
---48.60
-Not epl usi nterestof$8col l
ect edbybank( credi tmemor andum)notr ecordedi n
cashr ecei ptjour nal 408. 00.
-Bankser vicechar ge( debi tmemor andum)notr ecordedi ncashpay mentj ournal--
--
--
18.
-Check#879f or$732. 26t o“ X”companyonaccount ,recor dedi ncashpay ment
j
our nal as$723. 26.
-NSFchecks- --
---
------
--
----
---
--$300.
Instruct i
on
a)Pr epar ebankr econci l
iation
b)Jour nal i
zet henecessar yj ournal entr
ies.
ABCCompany
A.Bankr econci li
ation: Bankr econci liation
July31, 2000
Cashbal anceaccor di
ngt obankr ecor d-----
----
--
-----
--
---
--
-----
----
--
---
--
---
---
---
-3359.78
Add: Addi tionsofdeposi tornotonbankst atement( deposi tintransit)---
--
-816.20
Ded: Out standi ngChecks- ----
-#812- ---
--
--
----
---
---
-1061. 00
#878- ---
------
--
----
--435. 39
#883- ---
------
--
----
----48. 60
Tot al outst andi ng (1,544.99)
Adj ust edcashbal ance- - -
--
-----
---
---
-----
--
---
---
---
---
----
---
---
--
-----
-----
--
---
--
---
2630. 99
Cashbal anceaccor di
ngt odeposi t
orr ecor ds---
-----
---
--
-----
----
--
--
---
----
--
---
--
---
--
2549. 99
Add: addi ti
onsbybanknotr ecor dedbydeposi tor( Notepl usinterestcol l
ection)--
-
408
Subt ot al-----
--
----
------
---
--
---
----
----
----
---
-----
--
--
----
---
---
---
----
---
--
-----
----
--
--2957.99
Ded: NSFchecks- ----
--
----
---
---
-----
---
---
----
---
--
-----
---
--
300
Ser v i
cechar ge- -
--
---
----
----
----
---
-----
--
--
----
---
---
----
18
Deposi torer rort hatov erstatecashl edgerbal ance- --
--
-----
9. 00327
Adj ust edcashbal ance- -
---
----
----
---
---
----
---
--
-----
---
--
-----
--
---
-----
---
---
--
---
---
---
-2630.99
B)Jour nal ent ries
Jul y31/ Cash- --
----
---
---
----
---
--
-408
Not esr eceivabl e---
--
-----
-400
Int erestr evenue- ---
--
-----
---
-8
Account sr ecei vable----
----
----
-300
Cash- ---
---
----
---
--
-300
Mi scel laneousadmi nistrativeexpense- --
--18
98
 Cash-
--
--
--
--
--
--
--
--
18
Account spay able--
---
--
--9
Cash- --
--
---
----
--
--
---
9
II
) Pet tycashf und
Pettycashi st hesmal lfundusedt omakepay mentforsmal lexpendit
ur es.Thereare
thr
eest epsi nvolvedint heoper at i
onoft hepet t
ycashasment i
onedbel ow:
1)Est ablishingt hepet tycash:I nest ablishi
ngt hepettycashf und,thef i
rststepisto
esti
mat et heamountofcashneededf ordisbursementofr el
ati
velysmal lamount s
duringcer tainper iod,suchasweekoramont handappoi nti
ngt he pettycash
custodi an,theonewhoi sr esponsi blefortheoper ati
onoft hepettycashf undandf or
maki ngdi sbur sement sfrom t hepet tycashf und.
Noent réewi llbemadet ot hepet tycashaccountunl esst hepet t
ycashf undis
changed( increasedordecr eased) .
Ift he Companydeci des t oi ncrease t he size oft he fund fr
om $100 ( ini
ti
all
y
established) to$250( newdeci sion),itwoulddebi tPettyCash$150andcr editCash
$150asshowni ntheex ampl ebel ow.
2)Maki ngpay mentf rom thepet tycash:
Pettycashr eceipt:Theempl oyeewhor equestf orpaymentandt hepettycash
custodi anwi llsignoni t
.Thepet tycashcust odianwillmakepay mentf orthe
specifiedempl oy eewhor equestdi sbursement .

Eachpay mentf rom t hef undmustbedocument edonapr enumber edpet tycash

receipt( orpet tycashv oucher ).Thesi gnaturesofbot ht hef undcust odianandt he
personr ecei v i
ngpay mentar er equiredont her eceipt.
NB:Noj our nalent rywi l
lbemadeatt hetimeofdi sbur sement( pay ment )f rom t he
pettycashf und.I ti sconsi deredbot hinadv i
sabl eandunnecessar yt odoso.I nstead,
thecompanyr ecogni zest heaccount ingef fectsofeachpay mentwheni treplenishes
thef und.
3)Repl eni shi ng( reimbur sing)t hepet tycash:Whent hemoneyi nt hepet t
ycashf und
reachesami nimum l ev el t
hef undi sr eplenished( reimbur sed) .Repl enishingt hepet t
y
cashf undr est orest oitsor i
ginalamount .Ther equestf ort hisi si nitiatedbyt hepet t
y
cashcust odi an.Thecust odianwi l
lpr ovidethesummer yoft hepet tycashpay ment
witht hepet tycashr ecei pttot het reasur er
.Thent het r
easur erappr ovest her equest
andchecki spr epar edt or estoret hef undt oitsestabl ishedamount .
Jour nalent rywi llbemadet or estoret hepet tycashf undt opr ev iousl yestabl i
shed
amountandt or ecor dal lexpendi tures.
Occasi onal ly ,inr epl enishi ngapet t
ycashf und,acompanyusesaCashOv erand
Shor taccountwhent hepet tycashf undf ailst opr oveout .Thati s,aner r
oroccur s
suchasi ncor rectchange, ov erpay mentofexpense, orlostr ecei pt.I fcashpr ov esout
shor t(i.e.,t hesum oft her ecei pt
sandcashi nt hef undi sl esst hant hei mpr est
amount ),t hecompanydebi tst heshor taget ot heCashOv erandShor taccount .If
cashpr ov esoutov er,itcr editstheov eraget oCashOv erandShor t.
NB:A companyr eportsadebi tbal anceofCashOv erandShor ti nt hei ncome
statementasot herexpense.I tr eportsacr edi tbalanceofcashov erandshor tint he
accountasot herr evenue.Thecompanycl osesCashOv erandShor ttoI ncome
Summar yatt heendoft hey ear .
.
Exampl e:
99
 A.Jul
y1.ABCest
abl
i
shedpet
tycashf
undbywr
it
ingacheckf
or$100.

B.July5.ABCIncreasedt
heamountoft
hepet
tycashf
undt
o$150bywr
it
inga
checkfor$50.

C.Jul y25.ABCRepl eni

shedthepet t
ycashfundbywri
tingacheckf or$137.On
thi
sdat e,thef undconsistedof$13i ncashandthef ol
lowingpettycash
recei
pts:fr
eight-
in$74,postageexpense$43andMiscell
aneousexpense$17.
D.Jul y28.ABCRepl eni
shedthepet t
ycashfundbywri
tingacheckf or$135.On
thi
sdat e,thef undconsistedof$15i ncashandthef ol
lowingpettycash
recei
pts:fr
eight-
in$76,postageexpense$45andMiscell
aneousexpense$20.
Requi
r ed:Journal
izethepettycasht r
ansact
ions.
Sol
ution:
A.Pet t
ycash---
--
---
--
--
-100
Cashi nbank---
--
---
--
--
---
100
B.Pet t
ycash---
--
---
--
--
-50
Cashi nbank--
--
--
---
--
--
--
50
C.Fr eighti
n………………74

Post
ageexpense………43

Mi
scel
l
aneousexpense.
..
17

Cashov
er&shor
t……3

Cashi
nbank…………….
.137

{
Cashover&shor tshowsthatther
eisanoverpaymenterr
or/l
ostr
ecei
ptandwi
ll
takenasot
herexpenseonincomestat
ementi.e.t
heavai
labl
efundonhandi
s
$13inst
eadof$16=( 150–74-43-
17)}
D.Fr
eighti
n………………76

Post
ageexpense………45

Mi
scel
l
aneousexpense.
..
20

Cashi
nbank…………….
.135

Cashov
er&shor
t…………6
{Cashover&shortshowsthatthereisanexpensewhi chissavedornotpai
d
becauseoferr
orsandtakenasot herrevenueonincomest at
ementi.
e.the
avail
abl
efundonhandi s$15insteadof$9=( 150-76-
45-20)}

100
 CHAPTER- 6
ACCOUNTI NGFORRECEI VABLE
Recei v abl esar eal lcl aimsagai nsti ndi vidual s,or gani zat ionorot herdebt orsi nt he
salesofmer chandi seorser vicesonacr edi tbasi s.
Recei v abl es t hatar e based on or alagr eement s ar e known as open account s
(accountr ecei vabl e) .Recei vabl est hatar ebasedonf or mal( wr i
tten)i nstrument sar e
call
edpr omi ssor ynot es( not esr ecei v abl e).
Thesal esofequi pmentont hei nst al lmentpl ani nv olv i
ngal argeamountofmoney
alsocomeundernot er ecei v abl es.Pr omi ssor ynot esmayal sobeusedi nstal l
mentof
anopenaccountandi nbor rowi ngandl endi ng.
From t he poi ntv iew oft he cr edi tor ,a cl aim ev i
denced bya not e has same
adv ant agesov eracl aimi nt hef or m ofaccountr ecei vabl es.Bysi gninganot e,t he
debt oracknowl edgest hedebt sandagr eest opayi naccor dancewi tht het erms
speci fied.Thenot ei st heref or est rongl egalcl aimi nt heaccountofcour tact ion.I tis
alsomor el iqui dt hananopenaccountbecauset hehol dercansusual l
yt ransf er
si t
mor er eadi lyt oabankorot herf inanci alagencyi nexchangef orcash.
Account sandnot esr ecei v abl esor igi nat i
ngf rom sal est ransact ionsar ecal ledTr ade
Recei v abl es.Recei v abl esor iginat ingf rom suchsour cesasi nterestonN/ R,l oanst o
theof ficerorempl oy eesandl oanst oaf filiatedcompani esar er ef erredt oasot her
receiv abl es.
Allrecei vabl est hatar ecol lect iblei ncashwi t hinay earar ecl assi fi
edundercur rent
asset sont hebal ancesheet .I ftheper iodofcol l
ect ioni slongert hanay earsuchl ong
terml oanar el i
stedunderi nv est ment s.
Cont rolov erRecei v abl es
Themanagementofabusi nessent erpriseshoul dar ranget hemeansofi nternal
cont rolov ert heirr ecei v ables.Thuscont rolsi ncludet hesepar ationoft hebusi ness
oper ationsandt heaccount i
ngf orr ecei v abl es,sot hatt heaccount i
ngr ecor dscan
serv easani ndependentcheckonopt ions.Thust heempl oy eewhohandl est he
account i
ngf ornot esandaccountr ecei v abl esshoul dnotbei nv ol
v edwi t
hcr edit
appr ov alsorcol l
ect ionofr ecei vabl es.Separ ationoft hesef unct i
onsr educest he
possi bi l
ity ofer ror s and embezzl ement .The cont rols woul d al so i ncl ude t he
separ at ionofr esponsi bili
tiesf orr el at edf unct ions, sot hatt hewor kofoneempl oy ee
canser veasacheckont hewor kofanot herempl oy ee.
Formostbusi nesses,t hepr incipalr ecei v abl esar enot esr eceiv ableandaccount
receiv abl e.Gener al l
y ,not esr ecei v abl esar er ecor ded i n a si ngl e gener all edger
account .Ift her ear enumer ousnot es,t hegener all edgeraccountcanbesuppor t ed
byanot esr ecei vabl er egi ster .
Adequat econt rolov eraccountr ecei vabl ebegi nswi tht heappr ovaloft hesal ebya
responsi bl ecompanyof f
icialort hecr edi tdepar tment ,aftert hecust omer ’
scr edit
rati
nghasbeenr ev i
ewed.Li kewi se,adj ust ment sofaccountr ecei vable,suchasf or
salesr etur nsandal lowancesandsal esdi scount sshoul dbeaut hor i
zedorr ev i
ewed
byar esponsi bl epar ty.Ef fect iv ecol lect i
onpr ocedur esshoul dal sobeest abl ishedt o
ensur et imel y col lect ion ofaccountr ecei v able and t o mi nimi ze l osses f r
om
uncol lect ibleaccount s.
Char act er isticsofNot esRecei v abl es
Anot ei sawr i
t t
enpr omi set opayasum ofmoneyonademandoratadef initet i
me.
101
Anot eispayabletot heor derofapar t
icul
arperson,fi
rm orbearer
.Anot emustbe
si
gnedbyt heper sonwhomakesi t.Theonet owhoseor derthenoteispay ableisa
payeeandtheonemaki ngthepromi sei
samaker
Notes have sev eralchar acter
ist
ics thathav e accounti
ng impli
cati
ons.These
charact
eri
sti
csar edescr i
bedasf ol
lows
 Duedat e:thedat eanot eistobepai discall
edtheduedat eormaturi
tydat e.The
peri
odoft i
mebet weent heissuancedateandt heduedat eofashor tterm note
maybest atedineitherdaysormont hs.

NB:Whent heter
m ofanoteisstat
edi
ndays,t
heduedatei
sthespeci
fi
ednumberofdaysaft
er
i
tsissuance.I
ncount
ingthedays,omi
tthedat
ethenot
eisi
ssuedbuti
ncludet
heduedate.
Example:Zamraconstr
uct
ionmakesanoterecei
vabl
efrom sunshi
neconst r
ucti
on
onOctober2,2008of60days$2500pay
abl
eatDashenbankwithint
erestat7%.The
duedatefort
henoteis

Ter
m oft
henot
e--
--
--
--
--
--
--
--
--
--
--
--
--
--
--
--
--
-60day
s

Oct
ober(
day
s)-
--
--
--
--
--
--
--
-31

Dat
eofnot
e--
--
--
--
--
--
--
--
--
- 2,
29

Numberofday
sremai
ning-
--
--
--
--
--
--
--
--
--
--
-31

Nov
ember(
day
s)-
--
--
--
--
--
--
--
--
--
--
--
--
--
--
--
--
-30

Duedat
e(December
)--
--
--
--
--
--
--
--
--
--
--
--
--
--
-1
Whent het
erm ofanot
eisstatedascert
ainnumberofmont
hsaf
terthei
ssuance
dat
e,theduedat eisdet
ermined bycounti
ng t
henumberofmonthsfrom the
i
ssuancedat
e.
Exampl
e:a3mont
hnot
edat
edJune5woul
dbedueonSept
ember5.

NB: i
fther
eisnodatei
nt hemonthofmatur
it
ythatcor
respondst
othei
ssuancedate,
theduedat ebecomesthelastdayofthemonth.Forexample2monthnotedated
July31wouldbedueonSept ember30.

 Int
erestbear
ingnot
esandnon-
int
erestbear
ingnot
es:t
her
ear
etwot
ypesof
notes.

 Int
erestbear
ingnot
e:anotethatprov
idesfort
hepaymentofi
nter
estf
ort
he
peri
odbetweenthei
ssuancedateandtheduedate.

 Non-i
nter
estbear
ingnot
e:anot
ethatdoesnotpr
ovi
def
ort
hepay
mentof
i
nter
est.

 Maturit
yValue:theamountthatisdueonanot eondat eofmat uri
tyorduedat
e
i
smat uri
tyv
alue.Thematurit
yvalueofnon-i
nter
estbearingnot
ei sthesamewit
h
t
hef aceamountorpr i
nci
palofthenote.Themat uri
tyofanint
erestbeari
ngnot
e
i
sthesum oft hepri
nci
palandtheint
erestdueont henot
e.

102
 Exampl
e:t
hemat
uri
tyv
alueoft
henot
erecei
vabl
eforsunshi
neconst
ruct
ioni
s

Mat
uri
tyv
alue=pr
inci
pal
+int
erest
=2500+(
2500x7%x60/
360)=$2529.
17

Account
ingf
orNot
esRecei
vabl
e

Thety pi
calr et
ailenter
pri
semakesmostofi t
ssalesforcashoronaccount .Ifthe
accountofacust omerbecomesdeli
nquent,thecr
edit
ormayi nsi
stthattheaccount
beconv ertedintoanot e.Int
hisway,t
hedebt ori
sgivenmor etime,ifthecredi
tor
needsmor ef und,thenotemaybeendor sedandt r
ansfer
redtoabankorot her
fi
nancialagency .Notesmayalsober
eceivedbyretai
lfi
rmsthatsellmerchandi
seon
l
ongt erm credit
.

Whenanot ei
srecei
vedfrom acust
omertoappl
yonaccount
,thef
act
sar
erecor
ded
bydebiti
ngthenotereceiv
ableaccountoft
hecust
omerf r
om whom t
henoteis
recei
ved.

Example:Assumethatt
heaccountofBM co.,
whichhasadebitbalanceof$900is
pastduea20day,8%notef
orthatamount,datedApr
il23,
isaccept
edi nset
tl
ement
oftheaccount
.

Theent
ryf
ort
heacqui
si
ti
onoft
henot
eisasf
oll
ows

Apr
il23Not
esRecei
vabl
e--
--
--
--
--
--
--
--
900

Account
sRecei
vabl
e--
--
--
--
--
-900

Af
ter20day
smay13t
henot
emat
ures.Thenecessar
yent
ri
esont
hisdat
eis

May13 Cash-
--
--
--
--
--
--
--
--
--
-904
NotesRecei
vabl
e--
--
--
--
--
--
--
-900

I
nter
estI
ncome-
--
--
--
--
--
--
--
--
4

I
ftheabov
einf
ormat
ioni
snoni
nter
estbear
ingnot
etheent
ryonmat
uri
tydat
eis:

May13 Cash-
--
--
--
--
--
--
--
--
--
-900

Not
esr
ecei
vabl
e--
--
--
--
--
--
--
-900

Example:A30day ,12% not

edat
edDec.21,2008,isaccept
edinset
tlementofthe
accountofAmbasselCompanywhichhasabal anceof$4000.Theentr
ytorecord
thetr
ansact
ionon

1.December21set
tl
ementoft
heaccount

2.Adj
ust
ingent
ryf
oraccr
uedones,
Dec.
31,
2008

3.Rever
singent
ryJan.1,
2009
4.Thenecessaryent
ryonthemat ur
it
ydat
e
Dec21Not er
eceivabl
e--
--
--
--
--
4000

103
 Income---
--
--
--
-4000
Dec31I
nter
estr
ecei
vable-
--
--
--
13.3

I
nter
estI
ncome(
4000x10/
360x12%)-
--
--
--
--
--
--
--
-13.
3

Jan.1 I
nter
estr
ecei
vabl
e--
--
--
--
--
--
13.
3

I
nter
estr
evenue-
--
--
--
--
--
--
--
13.
3

Jan20Cash-
--
--
--
--
--
--
--
--
--
--
--
--
--
4040

Not
eRecei
vabl
e--
--
--
--
--
--
--
-4000

I
nter
estr
ecei
vabl
e--
--
--
--
--
--
--
--
--
-40

DiscountingNotesRecei vable
Abusi nessmaykeept henot eithasr eceivedunti
ltheduedat eort r
ansferittoa
bankbyendor sement .Ifanot ei stransf err
edtoabank,i tissai
dtobedi scounted
andbankchar gesinterestfordiscountingt henote.Thediscount(
int
erest)chargedis
comput edonthemat uri
tyvalueofthenot efort
heperiodoftimethebankmusthol d
thenot e.Theamountpai dt otheendor seristheexcessoft hematurit
yv al
ueov er
thediscountorint
erestchar gedbyt hebank.Thi samounti sknownaspr oceeds.

Example:Assumethata90daynon-
int
erestbeari
ngnotefor$1,
350,
dat
edaugust21
i
sdiscountedatLi
onBankonSeptember20att herat
eof7%.

Whati
sthemat
uri
tyv
alueoft
henot
e?

Whati
sthenumberofday
sint
hedi
scountper
iod?

Whati
stheamountoft
hedi
scount
?

Whati
stheamountoft
hepr
oceeds?

Pr
epar
etheent
ryonSep.20

Sol
uti
on:

Facev
alueoft
henot
edat
edaug.
21-
--
--
--
--
--
--
--
--
--
--
--
--
--
--
-$1350

Mat
uri
tyv
alueoft
henot
edueNov
.19-
--
--
--
--
--
--
--
--
--
--
--
--
--
1350

Di
scountper
iod(
sep.
20-
Nov
.19)-
--
--
--
--
--
--
--
-60day
s

Di
scountonmat
uri
tyv
alue(
1350x7%x60/
360)-
--
--
--
--
--
--
15.
75

Pr
oceeds(
1,350–15.
75)
--
--
--
--
--
--
--
--
--
--
--
--
--
--
--
--
--
--
--
--
-$1334.
25

Theent
ryf
ort
het
ransact
ioni
s

Sep.20 Cash-
--
--
--
--
--
--
--
--
--
--
--
1334.
25

I
nter
estexpense-
--
--
--
--
--
-15.
75

104
Not
esRecei
vabl
e--
--
--
--
--
--
--
--
--
--
--
1350
Exampl
e:Misr
akenter
pri
sewhichhasa90day,9% not
esr
ecei
vabl
efor$2000,dat
ed
Nov.
8isdi
scount
edatabankonDec.3att
her
ateof10%.

Whati
sthemat
uri
tyv
alueoft
henot
e?

Whati
sthenumberofday
sint
hedi
scountper
iod?

Whati
stheamountoft
hedi
scount
?

Whatistheamountoftheproceeds?
Pr
eparetheent
ryonDec.
Faceval
ueofthenotedatedNov .
8--
--
--
--
--
--
--
--
--
--
--
--
--
--
--
$2000

I
nter
estonnot
e(2000x90/
360x9%) 45

Mat
uri
tyv
alueoft
henot
edueFeb6-
--
--
--
--
--
--
--
--
--
--
--
--
--2045

Di
scountper
iod(
Dec3-
Feb6)-
--
--
--
--
--
--
--
--
--
--
--
--
-65day
s

Di
scountonmat
uri
tyv
alue(
2045x65/
360x
10%)-
--
--
--
--
--
--
36.
92

Pr
oceeds-
--
--
--
--
--
--
--
--
--
--
--
--
--
--
--
--
--
--
--
--
--
--
--
--
--
--
--
--
--
-$2008.
08

Theent
ryf
ort
hetransacti
onis:
Dec3 Cash-
--
--
--
--
--
---
--
--
--
-2008.
08

Not
esr
ecei
vabl
e--
--
--
--
--
--
--
--
2000

I
nter
esti
ncome-
--
--
--
--
--
--
--
--
-8.
08

Whent heproceedsf r
om di scountednoteislessthant
hef acev al
ueisrecordedas
i
nterestexpenseandt ot her eversethefacev al
ueislesst hant heproceedthe
di
fferenceisrecordedasi nterestincome.
Di
shonor ednot esreceiv
abl e

Ifthemakeroft henot efai

l
stopaytheobli
gat
ionont heduedat e,thenoteissaidto
bedi shonored.Adi shonor
ednoteisnotnegoti
able,andfort hi
sr easontheholder
usuallytransfer
st heclaimincl
udi
nganyi nt
erestduet otheaccount sreceiv
able
account.Thisact i
onisnecessar
yinordert
omaket hesubsi
diaryledgerdi
sclosethe
dishonorofthenote.

Exampl e:I
fthe$900,20day,8%not erecei
vedandrecor
ded onApri
l23hadbeen
dishonoredatmaturi
ty,t
heentr
yt o char
gethenote,i
ncl
udi
ngtheint
erest
,backt
o
thecustomersaccountwoul
dhav ebeenasfoll
ows:

May13 Accountr
ecei
vabl
eB.
M co-
--
--
--
--
--
904

Not
esr
ecei
vabl
e--
--
--
--
--
--
--
--
--
--
--
--
--
-900

I
nter
esti
ncome -
--
--
--
--
--
--
--
--
--
--
--
--
--
--
4

105
 Whent hedi scountedN/Risdishonored,t
heholderusual
lynotifi
estheendorserof
suchfactandasksf orpayment.I
frequestpaymentandnotif
icationofdi
shonorare
ti
mely,theendor seri
slegal
lyobli
gedtopayt heamountdueont henote.Theenti
re
amountpai dtot hehol
derbytheendorserincl
udi
ngtheint
erest,shoul
dbedebitedto
accountreceivableoft
hemaker.

Insomecases,t heholderoft hedishonorednot egivestheendorseranot arized

stat
ementoft hefactsofthedishonor.Thefeefort hi
sstat
ementknownasapr otest
feeischargedtotheendorser,
whoi nternchargesittothemakerofthenote.I
ft here
hadbeenapr ot
estfeeinconnectionwi t
hthedi shonorandthepaymentisrecor ded
asdebittothemaker ’
sA/Randcr edittocash.

Example:Assumethatthe$2000,90day,9%notedi
scount
edonDec3isdi
shonor
ed
atmaturi
tybythemaker,thebankchargesaprot
estf
eeof$5theent
ryt
orecordt
he
paymentbytheendorser,
ingener
aljour
nalf
orm,wouldbeasf
oll
ows:

Feb6 A/
R--
--
--
--
--
--
--
--
--2,
050

Cash-
--
--
--
--
--
--
--
--
--
--
-2,
057
(
Pai
ddi
shonor
ed,
discount
ednot
e:mat
uri
tyval
ueof$2,
045pl
uspr
otestf
eeof$5)
.

Uncol
lect
ibl
erecei
vabl
es

Whenmer chandi
seorser vi
cesaresol
dwi thouttheimmediat
ereceiptofcash,a
porti
onofcl ai
msagai nstcust
omersordinari
lyprovestobeuncoll
ecti
ble.Thisis
usuall
ythecaseregardlessoft
hecareusedi ngrant
ingcr
edi
tandtheeffecti
veness
ofthecoll
ecti
onproceduresemploy
ed.

Theoperati
ng expensei
ncur
red becauseoft hefai
lur
eto col
l
ectrecei
vabl
esi
s
var
iousl
yter
medasexpenseorlossfrom uncol
l
ect
ibl
eaccount
sorbaddebt
s.

Therei
snogener alrul
eforwhenanaccountbecomesuncoll
ect
ibl
e.Some
i
ndicat
ionsthatanaccountmaybeuncol l
ect
ibl
eincl
udethef
oll
owing:
1.Therecei
vableispastdue.
2.Thecustomerdoesnotr espondtothecompany’
satt
emptstocoll
ect
.
3.Thecustomerfil
esforbankruptcy
.
4.Thecustomerclosesitsbusi
ness.
5.Thecompanycannotl ocatethecust
omer.

Ther
earegener
allyaccept
edmet
hodsofaccount
ingf
orr
ecei
vabl
est
hatar
edeemed
tobeuncol
l
ecti
ble.

1)Theallowancemet hodort hereservemethod,whi chmakesadvanceprovi

sionf
or
uncoll
ectibl
erecei
v abl
esbyest i
mat i
ng uncol
lecti
bleaccount
satt heend ofthe
accountingper
iod.
2)Thedi rectwri
teof fmet hodordi r
ectchargeof fmethod,whichrecogni
zesthe
expenseonlywhenspeci f
icaccount sar
ebeliev
edt obeworthl
ess.
All
owancemet hodofAccount i
ngf orUncol
lecti
ble
Theallowancemet hodest i
matestheuncollect
ibl
eaccountsrecei
vabl
eattheendof
106
theaccount
ingperi
od.Basedont hi
sestimate,uncol
l
ectibl
eaccountsexpensei
s
recor
dedbyanadjust
ingentry
.
Example:Abusi
nessenterpri
sehasabalanceofrecei
vables$45,
000attheendof
theyear.$2,
500isesti
mat edtobeuncol
lect
ibl
e.Theadjusti
ngentr
yattheendof
theyeari
s:

Uncol
lect
ibl
eaccount
sexpense-
--
--
--
--
--
--
--
-2500

Al
lowancef
ordoubt
fulaccount
s--
--
--
--
--
-2500

 Netr
eal
izabl
eval
ueofA/
R=45,
000–2,
500=42,
500
 Al
lowancef
orDoubt
fulAccount
sisacont
raaccountt
oAccount
sRecei
vabl
e.
The balance in accountr ecei
vableist he amountoft he totalclaims agai nst
customersonopenaccount ,andthecreditbal
anceof$2500i nal l
owancef ordoubt ful
accountsistheamountt o bededuct ed fr
om accountr ecei
vablet o determinet he
expectedreal
i
zablev al
ue,f
requentl
ycalledthenetreal
izabl
ev alue.$2500r educti
oni n
theassetwastransferr
edtouncoll
ecti
bleaccountsexpense,whichwi l
lintur
nbecl osed
toincomesummar y.

Uncoll
ecti
bleaccountexpenseisgenerall
yrepor
tedontheincomest at
ementasan
administ
rat
ive expense because the cr
editgrant
ing and coll
ect
ion dut
ies ar
e
responsi
bil
i
tiesofdepar
tmentwi t
hinthegener
aladmini
str
ati
veframework.

Wr
it
e–of
fst
otheAl
lowanceAccount

Whenanaccounti sbelievedtobeuncol lecti

ble,i
tiswrit
tenoffagainsttheallowance
accountasi nthef ol
lowi ngentr
y :
Example:On Januar y21,2010,ABC’ s accountr eceivabl
e of$6, 000 from XYZ
Companyi swr ittenoffasf ol
lows:
All
owancef orDoubt fulAccount s………6, 000
Account sRecei vable………………6, 000
Duringthey ear ,asmor eaccount sorpor t
ionsofaccount sar edet er
minedt obe
uncoll
ecti
ble,theyar ewr it
tenof fagai nstal l
owancef ordoubt f
ulaccount si nthe
samemanner .Instructionsforwr i
te-offsshoul dori
ginat
ewi ththecreditmanageror
otherdesi
gnat edof fi
cial.Theaut horizations,whichshoul dalwaysbewr i
tt
en,serve
asobjecti
veev idencei nsupportoft heaccount i
ngentry.

Naturall
yenough,thetot
alamountwri
tt
enoffagainsttheall
owanceaccountduring
theperiodwil
lrarelybeequalt
otheamountint heaccountatthebeginningofthe
peri
od.Theal l
owanceaccountwil
lhaveacreditbal
anceatt heendoft heperi
odif
thewr i
teof
fduringtheper
iodamountt
olessthanthebeginni
ngbalance.

Af
tert
hey ear–endadj
ust
ingent
ryi
srecor
dedt
heal
l
owanceaccountwi
l
lhav
ea
cr
edi
tbal
ance.

Anaccountrecei
vabl
ethathasbeenwr
it
tenoffagiantt
heall
owanceaccountmay
l
atercol
lect
ed.Insuchcases,t
heaccountshoul
dber ei
nst
atedthati
st heexact

107
rever
seofthewr i
te-offentr
y.
Example:Assumet hatNancySmi t
h’saccountof$5,000whi chwaswr it
tenoffon
April
2iscoll
ectedlateronJune10.Preparethenecessar yentr
ies.
June10. Account sReceivabl
e………….5, 000
All
owancef orDoubtfulAccount s…5, 000
June10. Cash……………………………5, 000
AccountsReceivable………………5, 000
Thecashr ecei
vedi npay mentwouldber ecordedinthecashr eceiptsjournalasa
recei
ptonaccount .Al t
houghitispossibl
et ocombi net hereinstatementandt he
recei
ptofcashint oasi ngl
edebi
tandcredit,
theentri
esint hecustomer ’saccounti
s
appropr
iat
e.

Est
imatingUncol
lect
able
Theall
owancemethodrequi
resanest
imat
eofuncol
l
ect
ibl
eaccount
satt
heendoft
he
per
iod.
Thet
womet
hodsusedt
oest
imat
euncol
lect
ibl
eaccount
sar
easf
oll
ows:

1.Esti
mat
eBasedonper
cent
ageofSal
es:Account
srecei
vabl
ear
eacqui
redasa
resultofsal esonaccount .Thevol umeofsuchsal esdur i
ngt hey eart her ef orused
asani ndicat ionoft hepr obabl eamountoft heaccountt hatwi llbeuncol lectabl e.
Exampl e:I ti s known f rom pastexper ience t hatabout1% ofchar ge sal l
ies
uncol l
ect able and t he credi tsal ef orpar ticul ary earamounti s $300, 000.The
adjust i
ngent ryforuncol l
ect ibleaccount satt heendoft hey earwoul dbeasf ollow:
Dec31.Uncol lectabl eAccountExpense- -
--
--
---
-------
-- -
---
--
---
3,000
Allowancef orDoubt fulAccount s- --
---
--
----
--
---
-----
--3,000
Insteadofcr edi tsales,t otalsal es( includingt hosemadef orcash)maybeusedi n
dev elopingt heper cent age.Tot alsal esar eobt ainabl ef r
om t hel edgerwi thoutt he
necessi tytheanal ysist hatmayber equi redtodet er minechar gesal es.I ft her at i
oof
thesal esonaccountt ocashsal esdoesnotchangemat eriall
yf rom y eart oy ear ,t
he
resul tobt ainedwi llbeequal lysat isfact ory.Iftheabov eexampl et hatbal anceoft he
salesaccountatt heendoft hey eari sassumedt obebi rr400, 000t heappl icat ionof
¾oft hatamountwoul dbeal soy i
eldanest i
mat eofbi r
r3,000.
Theest i
mat ebasedonsal esmet hodofdet ermi ninguncol lectibleaccountexpense
widel yused.I naddi t
iont oi tssi mpl i
city,itpr ov idest hebestbasi suncol lectible
accountexpenset ot heper iodi nwhi cht herelat edsal eswer emade.
Exampl e2:Att heendoft hecur renty ear,Account sRecei vablehasabal anceof
$800, 000;Al lowancef orDoubt f
ulAccount shasacr editbalanceof$7, 500;andnet
salesf orthey eart ot al$3,500, 000.Baddebtexpensei sestimat edat1⁄ 2of1%ofnet
sales.
Requi red:Det er mine
(a)Theamountoft headj ustingent r
yf oruncol lect ibleaccount s;
(b)Theadj ust edbal ancesofAccount sRecei vabl e, Allowancef orDoubt ful Account s,
andBadDebtExpense; and
(c)Thenetr ealizablev alueofaccount sr eceivabl e.
Sol ution
a.$17, 500( $3, 500,000x0. 005) Adj ustedBal ance
b.Account sRecei vable..........................................$800, 000
108
All
owancef orDoubt
ful
Accounts( $7,
500+$17, 500)..........……..25,000
BadDebtExpense.............................................17,500
c.$775,000($800,
000--$25,
000)
Esti
mat ebasedonAnal ysi
sofRecei vabl
e( agingmet hodsofr ecei
vable):Underthi
s
method,managementestimateswhatper centageofr eceivabl
eswi l
lresulti
nl osses
fr
om uncollect
ibl
eaccounts.Thecompanypr eparesanagi ngschedul einwhi chit
cl
assifi
escustomerbalancesbythelengthoft i
met heyhav ebeenunpai dasshown
bel
ow:
Group1:Notpastdue,Group2:1–30dayspastdue,Group3:31–60dayspast
due,Gr
oup4:61–90dayspastdue,Group5:91–180dayspastdue,
Group6:
181–365dayspastdue,
Group7:Over365dayspastdue
 Thet ot alsf oreachagedcl assar edet ermi ned.
 Thet ot alforeachagedcl assi smul tipli
edbyanest i
mat edper centageof
uncol l
ect i
bleaccount sf ort hatcl ass.
 Theest i
mat edt ot alofuncol l
ect ibleaccount si sdet erminedast hesum oft he
uncol l
ect i
bleaccount sf oreachagedcl ass&j our nal
izedasf oll
ows:
Uncol lectabl eaccountexpense………………. .XX
Al lowancef ordoubt fulaccount s……….XX
Exampl e1:Att heendoft hecur renty ear,Account sRecei vablehasabal anceof
$800, 000;Al lowancef orDoubt fulAccount shasacr edi tbalanceof$7, 500;andnet
salesf ort hey eart ot al $3, 500, 000.Usi ngt heagi ngmet hod,thebal anceofAl l
owance
forDoubt ful Account si sest imat edas$30, 000.
Requi red:Det ermi ne;
(a)Theamountoft headj ust ingent ryf oruncol lectibleaccount sandr ecordt he
j
our nal;
(b)Theadj ust edbal ancesofAccount sRecei vabl e,Allowancef orDoubt f
ulAccounts,
andBadDebtExpense; and
(c)Thenetr eal i
zabl ev alueofaccount sr ecei vabl e.
Solut i
on
a.$22, 500( $30, 000–7, 500)
Uncol lect ableaccountex pense……. .22, 500
Allowancef ordoubt ful account……….22, 500
b.Account sRecei vabl e..........................................$800, 000
Allowancef orDoubt ful Account s( $7,500+$17, 500)..........……..30, 000
BadDebtExpense.............................................17, 500
C.$770, 000( $800, 000- -$30, 000)
Occasi onal ly,t heal lowanceaccountwi llhav eadebi tbalancepr iortoadj ustment.
Thisoccur swhenwr i
te- of f
sdur ingt hey earhav eexceededpr eviouspr ovisi
onsf or
baddebt s.I nsuchacase,t hecompanyaddst hedebi tbal ancet ot her equir
ed
balancewheni tmakest headj ust ingent ry.
Exampl e2:Al lowancef ordoubt fulaccount shasadebi tbalanceof$1, 500att heend
oft hey ear ,bef oreadj ust ment .Af teradj ustmentanal ysisofr eceivableindicat
es
all
owancef ordoubt fulaccount sof$17, 000att heendoft hey ear,theamountoft he
appr opri
at eadj ustingent rywi llbewhat ?
Solut i
on
Theor i
ginal ent rytosetupt heal lowancef ordoubt fulaccount swoul dhav ebeen:
Baddebtexpense…………………. .1,500
109
 Al
l
owancef
ordoubt
ful
account…….
.1,
500

Theadjustmentis17,
000–1,500=15, 500
Baddebtexpense………………15, 500
All
owancefordoubtf
ul account……………………….15, 500
I
fmor eaccount sarewri
ttenoffthant heor iginalcredi
tbalanceintheall
owance
account,i
twil
lendupwithadebitbal
ance.I fthisdebitbalancegetst
oohigh,
it
Meansy oushouldadj
ustyourest
imatehi gherforuncol l
ectabl
eaccount
.
Exampl e3:Att heendoft hecur renty ear ,Account sReceivablehasabal anceof$1, 400,000;
Allowancef orDoubt fulAccount shasadebi tbal anceof$2, 250;andnetsal esf orthey ear
total$9, 500,000.Usi ngt heagi ngmet hod, t
hebal anceofAl lowancef orDoubt fulAccount sis
estimat edas$24, 000.
Requi red:Det ermi ne;
(a)Theamountoft headj ustingent ryforuncol lecti
bleaccount sandr ecordt hej ournal;
(b)Theadj ustedbal ancesofAccount sRecei v able, Al
lowancef orDoubt ful Account s,and
BadDebtExpense; and
(c)Thenetr eali
zabl ev alueofaccount sr eceiv able.
Sol uti
on
a.$26, 250( $24, 000+2, 250)
Uncollectableaccountexpense……. .26, 250
All
owancef ordoubt fulaccount……….26, 250Adj ustedBalance
b.Account sRecei vable..........................................$1, 400, 000
Al l
owancef orDoubt fulAccount s($26, 250- 2,250)..........……..…24, 000
BadDebtExpense.............................................26, 250
c.$1, 376,000( $1,400, 000- -$24, 000)
DirectWr it
e-offMet hodofaccount i
ngf orUncol l
ect i
ble
Undert hedi r
ectwr i
te-of fmet hod, uncol l
ect ableaccountexpensei snotr ecor dedunt ilt
he
cust omer ’saccounti sdet ermi nedt obewor t
hl ess.Att hatti
me, thecust omer ’saccount
receiv ableiswr it
tenof f.
Undert hismet hod, compani esdonotr ecogni zeuncol lect
ibleaccount sexpenseont hebasi s
ofest imat es.
Thedi rectwr i
te-offmet hodort hedi rectchar ge- offmet hodi sreasonabl eifacompanysel ls
allormostofi tsout putt of ewcompani eswhi chf inancial
lystrong.Because,

Insuchsi tuati
onsandi nmanysmal lbusi nessandpr ofessi
onalenter
prise,i
tissat i
sfactory
todeferr ecogniti
onofuncol lectibleunt i
ltheper i
odi nwhi chspecifi
caccount sar edeemed
tobewor t
hlessandar eact uallywr ittenof fasanexpense.
Accordingly,whent hedi rect-wr it
e-of fmet hodi sinuse,t heaccount sreceiv
abl ewi l
lbe
l
istedont hebal ancesheetatt hei rgr ossamount ,andnoev aluati
onallowancewi llbeused,
andther eisnonecessi tyf oranadj ustingent ryattheendoft heperi
od.
Exampl e:Assumet hatABChas$42accountr eceivabl
ef rom DL.Thisr
eceivableis
determinedt obeuncol lectible.Theent rytowr i
teofftheaccountonMay10i sasf oll
ows:
Uncollectibl
eAccount sExpense…………………. 42
A/Recei vabl e-Hor nCo…………………………………. 42
Ifanaccountt hathasbeenwr itt
enof fi scollecti
blelater,t
heaccountshoul dbereinstated.
Exampl e:Assumet hatt heaccountr eceivableof$4, 200wr i
tt
enof fonMay10i slater
coll
ectedonNov ember21.Ther einstat ementandr eceiptofcashisrecordedasf oll
ows:
Nov .
21 Account sRecei vabl e-Hor nCo………………………42
Uncol lectibleAccountExpense…………………………42
Nov21.Cash…………………………42
A/R……………………………. .
42
110
111