CHAPTER TWO

2. ACCOUNTING CYCLE FOR SERVICE-GIVING BUSINESS

2.1. Characteristics of an accounts

The simplest form of an account has three parts.

First, each account has a title, which is the name of the item recorded in the account. Second,
each account has a space for recording increases in the amount of the item. Third, each account
has a space for recording decreases in the amount of the item. The account form presented below
is called a T account because it is similar to the letter T.
Title

Left hand Side Right Hand Side

Debit Credit
The left side of the account is called the debit side, and the right side is called the credit side.
Amounts entered the left side of an account, regardless of the account title, are called Debit or
charges to the account and the account is said to be Debited, Amounts entered on the right side
of an account are called Credits, and the account is said to be credited. Debit and credits are
sometimes abbreviated as Dr, and Cr.

2.2. Classification of accounts

Account is items of financial statements. That is, the two root categories:-
- Balance sheet
- Income statement

Balance sheet accounts are classified as assets, liabilities or owners equity. And income
statement accounts are classified as revenues and expenses.

1. Asset Account
Assets include any physical (tangible) items or rights (intangibles) that have money value and
owned by the enterprise. When we are referring tangible and intangible it means the following:

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 Tangible – can be touched and seen e.g. building, machinery etc
Intangible- can not be touched and seen e.g. Accounts receivable, copyright etc

Assets are divided in to two classes.

I. Current assets are cash and other assets that are expected to be converted in to cash, or sold
, used in business activities with in a relatively short period of time usually a year or less
includes:-
Cash is a medium of exchange- includes coins and paper money.
Receivables claims are against customers.
Account receivable – claims based on oral promise.
Notes receivable – claims supported by written promise
Inventories- goods held for sale.
Prepaid expense/asset- asset purchased for use in business activities but not used.

II. Plant Asset- tangible assets used in the business that are of a permanent or relatively fixed
nature are called plant assets or fixed assets. Plant asset include – Equipment, machinery,
building, land etc.

 All plant assets, with the exception of land gradually wear out or other wise lose
their use fullness with the passage of time. They are subject to depreciation.

2. Liabilities Accounts: Are debts of the business entity owed to outsiders or creditors. The two
most common classes of liabilities are:-

I. Current liabilities

These are liabilities that will be due with in a short time (usually one year or less) and
that are to be paid out of current assets. it includes the following items: Accounts payable, Notes
payable, wages payable, Taxes payable etc.

II. Long term liabilities these are liabilities that will be due for a long time (usually more than
one year). Includes – bonds payable, mortgage payable

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3. Owners Equity Accounts

Owner’s equity is the residual claim of the owners against the assets of the enterprise.

Assets – Liabilities = Owners Equity

An owners’ equity account consists the following sub classifications. These are:
I, Capital: is an accumulated investment by the owner
II. Drawing: is accumulated withdraws by the owner
III. Income summary – used to summarize effects of revenues and expense on
capital.
Balance sheet accounts are called real (permanent) accounts. This is because these accounts
transfer their balances from one accounting period to the other accounting period.
A. Income Statement Accounts
1. Revenue Accounts
Revenues – are increases in owner’s equity as a result of rendering services or selling
products to customers.
Revenues resulted from of sale of merchandise inventories is called sales revenue.
Revenues resulted from performing service is called service income.
Revenues resulted from letting others to use one’s own property is termed as Rent income.

Expenses – are assets used up or services consumed in the process of generating revenues.

Examples
Usage of supplies is termed as supplies expense
- Expiry of insurance policy is termed as insurance expense
- Payment of cash for employment service is termed as salary/wage expense
- Payment for charge service is termed as Repair and maintenance expense
 Income statement accounts are called temporary accounts. This is because income
statement accounts transfer their balances to the permanent or real or balance
sheet accounts at the end of the accounting period.

2.3. Chart of accounts

A list of the account in the ledger is called chart of accounts. The order of the accounts in the

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chart of accounts should agree with the order of the items in the balance sheet and the income
statement. The accounts are identified with numbers for the purpose of indexing and also for use
as reference.

In the chart of account stated above, each account has two digits. The first digit indicates the
major classification of the ledger in which the account is located. Accounts beginning with
1. Represents assets, 4. Revenue and
2. Liabilities, 5. Expense
3. Owners Equity,
The second digit indicates the location of the account with in its class. For example:
11. Cash: Indicates it is an asset with a first class in its category
14. Supplies: Shows that supplies account is an asset account in which it
has a fourth position
52. Rent Expenses: Rent Expense is categorized as second position in the
expense category.
The chart of accounts of one organization may look like below
Balance Sheet Accounts 32 Owner, Drawing
1. Assets 33 Income summary
11 Cash Income Statement Accounts
12 Account Receivable 4. Revenue
14 Supplies 41 Fees Earned
16 Prepaid Insurance 5. Expenses
17 Land 51 Wages Expenses
18 Office Equipment 52 Rent Expenses
2. Liabilities
21 Accounts Payable 54 Utilities Expenses
23 Unearned Rent
59 Supplies Expenses
3. Owner’s Equity
59 Miscellaneous Expenses
31 Owner, Capital

2.4Rules of debit and credit

The rule of debit and the normal balances of the various types of accounts are summarized as
follows:-

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 Increase (Normal Balance) Decrease
Balance Sheet Account
Asset Debit Credit
Liability Credit Debit
Owner’s Equity
Capital Credit Debit
Drawing Debit Credit
Income Statements accounts
Revenue Credit Debit
Expense Debit Credit
2.5 Normal balances of accounts

The sum of the increases recorded in an account is usually equal to or greater than the sum of the
decreases recorded in the account. For this reason, the normal balances of all accounts are
positive rather than negative. For example, the total debits (increases) in an asset account will
ordinarily be greater than the total credits (decreases). Thus, asset accounts normally have debit
balances. Note that a normal balance of an account is its increase side.

2.6Analyzing and recording transactions

Periodically the journal entries are transferred to the accounts in the ledger. This process of
transferring the debits and credits from the journal entries to the accounts is called posting.
Business Business Business Entry Entry
TRANSACTIO TRANSACTION DOCUMENT RECORDED in POSTED to
N Occurs Prepared Journal Ledger
Authorized

Using this system to analyze transactions can be summarized as follows:

1. Determine whether an asset, a liability, owner’s equity, revenue or expense account is
affected by the transaction.
2. For each account affected by the transaction, determine whether the account increases or
decreases
3. Determine whether each increase or decrease should be recorded as a debit or credit.

Illustration of Analyzing and Summarizing Transactions

On Nov. 1, Samuel the owner of Sammy trading deposits Br.15, 000 in a bank account in the
name of Sammy trading.
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On Nov. 5, Sammy trading bought land for Br.10,000, paying cash.
On Nov. 10, Sammy trading purchased supplies on account for Br. 1,350.
On Nov. 18,Sammy trading received fees of Br.7,500 from customers for services.
On Nov. 30, Throughout the month, Sammy trading incurred the following expenses wages,
Br.2, 125; rent, Br.450; and miscellaneous, Br.275.
On Nov. 30, Sammy trading paid creditors on account, $950
On Nov. 30, Sammy trading recorded the amount of supplies used in the operations during the
month is Birr 800.
On Nov. 30, Samuel withdrew $2,000 in cash from Sammy trading for personal use.

Dec. 1 Sammy trading paid premium of Birr 2,400 for a comprehensive insurance policy
covering liability, theft, and fire.
Dec. 1 Sammy trading.paid rent for December, Birr 800.00
Dec. 1 Sammy trading received an offer from a local retailer to rent the land purchased on
November 5. Sammy trading received Birr 360 for three months’ rent in advance, beginning
December 1.
Dec 4. Purchased office equipment on account from ABC Supply Co.
for Birr 1,800
Dec 6. Paid Birr 180 for a newspaper advertisement.
Dec 11. Paid creditors Birr 400.00
Dec 13. Paid for twoWeeks’ wages Birr 950.
Dec 16. Received Birr 3,100 from fee earned for the first half of December.
Dec 16. Fees earned on account totaled Birr 1,750 for the first half of December.
Dec 20. Paid Birr 900 to ABC Supply Company on the Birr 1,800 debt owed
from the December 4 transaction.
Dec 21. Received Birr 650 from customers in payment of their accounts
Dec 23. Paid Birr 1,450 for supplies.
Dec 27. Paid for two Weeks’ wages Birr 1,200.
Dec 31. Paid Birr 310 telephone bill for the month.
Dec 31. Paid Birr 225 electric bill for the month.
Dec 31. Received Birr 2,870 from fees earned for the second half of December.
Dec 31. Fees Earned on account totaled Birr 1,120 for the second half of December.

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Dec 31. Samuel withdrew Birr 2,000 for personal use.

The journal for Sammy trading since it was organized on November 1 is shown below. It also
shows the ledger after the transactions for both November and December have been posted.

Journal Page 1
Date Description Post Ref. Debit Credit
2000 1 Cash 11 15000.00
Nov. Samuel Capital 31 15000.00

5 Land 17 10000.00
Cash 11 10000.00

10 Supplies 14 1350.00
Accounts Payable 21 1350.00

18 Cash 11 7500.00
Fees Earned 41 7500.00

30 Wages Expenses 51 2125.00

Rent Expense 52 800.00
Utilities Expense 54 450.00
Miscellaneous Expense 59 275.00
Cash 11 3650.00

30 Accounts Payable 21 950.00

Cash 11 950.00

30 Supplies Expense 55 800.00

Supplies 14 800.00
30 Samuel, Drawing 32 2000.00
Cash 11 2000.00
Dec. 1 Prepaid Insurance 15 2400.00
Cash 11 2400.00
1 Rent Expense 52 800.00
Cash 11 800.00

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 Journal Page 2
Date Description Post Debit Credit
Ref.
Dec. 1 Cash 11 360.00
Unearned Rent 23 360.00

4 Office Equipment 18 1800.00

Accounts Payable 21 1800.00

6 Miscellaneous Expense 59 180.00

Cash 11 180.00

11 Accounts Payable 21 400.00

Cash 11 400.00

13 Wages Expenses 51 950.00

Cash 11 950.00

16 Cash 11 3100.00
Fees Earned 41 3100.00

16 Account Receivable 12 1750.00

Fees Earned 41 1750.00

20 Accounts Payable 21 900.00

Cash 11 900.00

21 Cash 11 650.00
Accounts Receivable 12 650.00

23 Supplies 14 1450.00
Cash 11 1450.00

27 Wages Expense 51 1200.00

Cash 11 1200.00

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 Journal Page 3
Date Description Post Ref. Debit Credit
2000
Dec. 31 Utilities Expense 54 310.00
Cash 11 310.00

31 Utilities Expense 54 225.00

Cash 11 225.00

31 Cash 11 2870.00
Fees Earned 41 2870.00

31 Accounts Receivable 12 1120.00

Fees Earned 41 1120.00

31 Samuel, Drawing 32 2000.00

Cash 11 2000.00

Posting to Ledger
Accounts: Cash Ledger Account No. 11
Date Item Post Ref Debit Credit Balance
Debit Credit
2000
Nov. 1 1 15000.00 15000.00
5 1 10000.00 5000.00
18 1 7500.00 12500.00
30 1 3650.00 8850.00
30 1 950.00 7900.00
30 1 2000.00 5900.00
Dec. 1 1 2400.00 3500.00
1 1 800.00 2700.00
1 2 360.00 3060.00
6 2 180.00 2880.00
11 2 400.00 2480.00
13 2 950.00 1530.00
16 2 3100.00 4630.00

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Accounts: Cash Ledger Account No. 11
Date Item Post Ref Debit Credit Balance
Debit Credit
2000
Dec. 20 2 900.00 3730.00
21 2 650.00 4380.00
23 2 1450.00 2930.00
27 2 1200.00 1730.00
31 3 310.00 1420.00
31 3 225.00 1195.00
31 3 2870.00 4065.00
31 3 2000.00 2065.00

Accounts: Accounts Receivable Account No. 12

Date Item Post Ref Debit Credit Balance
Debit Credit
2000
Dec. 16 2 1750.00 1750.00
21 2 650.00 1100.00
31 3 1120.00 2220.00

Accounts: Supplies Account No. 14

Date Item Post Ref Debit Credit Balance
Debit Credit
2000
Nov. 10 1 1350.00 1350.00
30 1 800.00 550.00
23 2 1450.00 2000.00

Accounts: Prepaid Insurance Account No. 15

Date Item Post Ref Debit Credit Balance
Debit Credit
2000
1 2400.00 2400.00
Dec. 1

Accounts: Land Account No. 17

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 Date Item Post Ref Debit Credit Balance
Debit Credit
2000
Nov. 5 1 10,000 10,000

Accounts: Office Equipment Account No. 14

Date Item Post Ref Debit Credit Balance
Debit Credit
2000
Nov. 4 2 1800.00 1800.00

Accounts: Accounts Payable Account No. 21

Date Item Post Ref Debit Credit Balance
Debit Credit
2000
Nov. 10 1 1350.00 1350.00
30 1 950.00 400.00
4 2 1800.00 2200.00
11 2 400.00 1800.00
20 2 900.00 900.00

Accounts: Unearned Rent Account No. 23

Date Item Post Ref Debit Credit Balance
Debit Credit
2000
Nov. 1 2 360.00 360.00

Accounts: Samuel, Capital Account No. 31

Date Item Post Ref Debit Credit Balance
Debit Credit
2000
Nov. 1 1 15000.00 15000.00

Accounts: Samuel, Drawing Account No. 32

Date Item Post Ref Debit Credit Balance
Debit Credit
2000
Nov. 30 1 2000.00 2000.00
Dec. 31 3 2000.00 4000.00

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Accounts: Fees Earned Account No. 32
Date Item Post Ref Debit Credit Balance
Debit Credit
2000
Nov. 18 1 7500.00 75000.00
Dec. 16 2 3100.00 10600.00
16 2 1750.00 12350.00
31 3 2870.00 15220.00
31 3 1120.00 16340.00

Accounts: Wages Expense Account No. 51

Date Item Post Ref Debit Credit Balance
Debit Credit
2000
Nov. 30 1 2125.00 2125.00
Dec. 13 2 950.00 3075.00
27 2 1200.00 4275.00
a re
Accounts: Rent Expense Account No. 52
Date Item Post Ref Debit Credit Balance
Debit Credit
2000
Nov. 30 1 800.00 800.00
Dec. 1 1 800.00 1600.00

Accounts: Utility Expense Account No. 54

Date Item Post Ref Debit Credit Balance
Debit Credit
2000
Nov. 30 1 450.00 450.00
Dec. 31 3 310.00 760.00
31 3 225.00 985.00

Accounts: Supplies Expense Account No. 55

Date Item Post Ref Debit Credit Balance
Debit Credit

Nov. 30 1 800.00 800.00

Accounts: Miscellaneous Expense Account No. 59

Date Item Post Ref Debit Credit Balance
Debit Credit

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 2000
1 275.00 275.00
2 180.00 455.00

2.7 Preparing a trial balance

The equality of debits and credits in the ledger must be proved at the end of each accounting
period. This is made by preparing a trial balance. Trial balance is a summary listing of the titles
and balances of the accounts in the ledger.

Trial Balance of Samuel trading is shown below

Samuel trading
Trail Balance
December 31, 2000
Cash 2,065.00
Accounts Receivable 2,220.00
Supplies 2,000.00
Prepaid Insurance 2,400.00
Land 10,000.00
Office Equipment 1,800.00
Accounts Payable 900.00
Unearned Rent 360.00
Habte, Capital 15,000.00
Habte, Drawing 4,000.00
Fees Earned 16,340.00
Wages Expense 4,275.00
Rent Expense 1,600.00
Utilities Expense 985.00
Supplies Expense 800.00
Miscellaneous Expense 455.00
32,600.00 32,600.00

2.8 The usefulness and limitations of a trial balance

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The trail balance does not provide complete proof of accuracy of the ledger. It indicates only that
the debits and credits are equal.
Discovery and Correction of Errors
Errors will sometimes occur in journalizing and posting transactions. In the following
paragraphs, we describe and illustrate how errors may be discovered and corrected.
Discovery of Errors
As motioned previously, the trail balance is one of the primary ways of discovering errors in the
ledger. However, it indicates only that the debits and credits side are equal. If the two total of the
trial balance are not equal, it is probably due to one or more of the following types of errors.
1. Trial balance preparation errors
a. Columns incorrectly added
b. Amount incorrectly entered on trial balance
c. Balance entered in wrong column or omitted
2. Error in determine the account balances, such as:
a. A balance was incorrectly computed
b. A balance was entered in the wrong balance column
3. Errors in posting transaction in the ledger, such as:
a. An erroneous amount was posted to the account
b. A debit entry was posted as a credit, or vice versa
c. A debit or a credit posting was omitted
Among the types of errors that will not cause an inequality in the trail balance totals are the
following:
1. Failure to record a transaction or to post a transaction
2. Recording the same erroneous amount for both the debit and the credit parts of a
transaction
3. Recording the same transaction more than once
4. Posting a part of a transaction correctly as a debit or credit but to the wrong accounts

Errors in the accounts may be discovered in various ways (1) through audit procedure (2) by
chance (3) by looking at the trial balance.
Correction of errors

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 1. Prove the accuracy of the trial balance totals by re-adding the columns
2. Compare the listings in the trail balance with the balance shown in the ledger. Make
certain that no accounts have been omitted
3. Recomputed the balance of each account in the ledger
4. Trace the postings in the ledger back to the journal. Place a small check mark beside each
item in the ledger and also in the journal. If the error is not found, examine each account
to see if there is an entry without a check mark. Do the same with the entries in the
journal.
5. Prove the equality of the debit and the credits in the journal
Entry in which error occurred
Supplies Accounts Payable

12,500 12,500

Entry that should have been recorded:

Office Equipment Accounts Payable

12,500 12,500

Comparing the two sets of T accounts shows that the incorrect debit of 12,500 to Supplies may
be corrected by debiting Office Equipment for 12,500 and crediting Supplies for 12,500. The
following correcting entry is then journalized and posted.

Journal Page 30
Date Description Post Ref. Debit Credit
2000
May. 5 Office Equipment 18 12500.00

Supplies 14 12500.00
To correct erroneous debit
to Supplies on May 5

The procedures for correcting errors are summarized below

Error Correction Procedure
Journal entry incorrect but not Draw line through the error and insert correct title
posted or amount
Journal entry correct but posted Draw line through the error and post correctly
incorrectly
Journal entry incorrect and posted Journalize and post a correcting entry

2.9 The adjusting process-accrual vs. cash basis of accounting

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When accountants prepare financial statements, they are assuming that the economic life of the
business can be divided into time periods. Using this accounting period concept, accountants
must determine in which period the revenue and expenses of the business should be reported. To
determine the appropriate period, accountants will use either:

(1) The cash basis of accounting or

(2) The accrual basis of accounting.

Under the cash basis, revenues and expenses are reported in the income statement in the period
in which cash is received or paid. For example, fees are recorded when cash is received form
clients, and wages are recorded when cash is paid to employees. The net income (or net loss) is
the difference between the cash receipts (revenue) and the cash payments (expense).

Under the accrual basis, the revenue recognition principle leads to reporting revenue in the
income statement in the period in which they are earned. For example, revenue is normally
reported in the period in which the services are provided to customers or goods are delivered to
customers. Cash may or may not be received from customers during this period.

Under accrual basis, expenses are reported in the same period as the revenues to which they
related. For example, employees provided services to customers and not when the wages are
paid. That is expenses are recorded in the period in which it is incurred (when assets are sold,
used, consumed or expired)

The accounting principle that requires the matching of revenues and expense is called the
matching concept or matching principle. Under this concept the income statement will match
the revenues earned and the expenses incurred and it will report the resulting income or loss for
the period.

Nature of the Adjusting Process

At the end of an accounting period, many of the balances of accounts in the ledger can be
reported, with out change, in the financial statements. For example, the balance of the cash
account is normally the amount reported on the balance sheet as the cash on hand at the end of
the accounting period.

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Some accounts in the ledger, however, require updating. For example, the balances listed for
prepaid expenses are normally overstated because the use of these assets is not recorded on a
day-to-day basis. The balance of the supplies account usually represents the cost of supplies at
the beginning of the period plus the cost of supplies acquired during the period. This does not
indicate the amount of supplies on hand at the end of the period.

Te journal entries at the end of an accounting period to bring the accounts up to date and to
properly match revenues and expenses are called adjusting entries. By their nature, all adjusting
entries affect at least one income statement account and one balance sheet account. Thus, an
adjusting entry will always involve a revenue or an expense account and an asset or a liability
account.

Basic Concepts for Adjustments

Before starting adjusting entries, let’s discuss the following terms and concepts.

Deferred expenses Are items that have been initially recorded as assets but are expected to
become expenses over time or through the normal operations of the business. The supplies and
prepaid discusses in the preceding paragraphs are examples of deferred expenses. The supplies
become an expense as they are used, and the prepaid insurance becomes an expense as time
passes and the insurance expires. Deferred expenses are often called prepaid expenses.

Deferred revenue: - Are items that have been initially recorded as liabilities but are expected to
become revenues over time or through the normal operations of the business. Examples of
deferred revenues include tuition received by University of Gondar at the beginning of the
semester and magazine subscriptions received in advance by a publisher. The tuition is earned
throughout the semester as students attend class. Deferred revenues are often called unearned
revenues.

The second class of items that give rise to adjusting entries is accruals. Accruals are created by
the failure to record an expense that has been incurred or revenue that has been earned. Accruals
may be either accrued expenses or accrued revenues, as described below.

Accrued Expense: - Are expenses that have been incurred but have not been recorded in the
accounts. Examples of accrued expense include unrecorded wages owed to employees at the end

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of a period and unrecorded interest owed on loans. Accrued expenses are often called Accrued
liabilities.

Accrued Revenues: - Are revenues that have been earned but have not been recorded in the
accounts. Examples of accrued revenues included unrecorded fees earned by an attorney or
unrecorded commissions earned by a real estate agent. Accrued revenues are often called
accruedassets.
How do you tell the difference between deferrals and accruals? Deferrals normally arise when
cash is received or paid in the current period but the related revenue or expense is to be recorded
in a future period. Accruals normally arise when a revenue or expense is recorded in the current
period but the related cash is received or paid in a future period.

These differences are illustrated in below.

Current Period Future Period

Deferral Cash received or paid Revenue or expenses recorded
Accrual Revenue or expense recorded Cash received or paid
Recording Adjusting Entries

Deferred Expenses (Prepaid Expenses)

The balance in Sammy trading supplies account in December 31 is 2,000. Some of these
supplies (computer diskettes, paper, envelopes, etc) were used during December, and some are
still on hand. Assuming that the inventory of supplies on December 31 is 760, the amount to be
transferred from the asset account to the expense account is 1,240, computed as follows.

Supplies available (balance of account) Birr 2,000

Supplies on hand (inventory) 760
Supplies used (amount of adjustment) Birr 1,240
Increases in expense accounts are recorded as debits and decreases in assets accounts are
recorded as credits. Hence, at the end of December, the expense account should be debited for
birr 1,240 and the supplies account should be credited for birr 1,240 to record the supplies and
supplies expense are as follows:

Dec. 31 Supplies Expense …………………………… 1,240

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 Supplies ……………………………………………. 1.240
The debit balance of birr 2,400 in Sammy trading prepaid insurance account represents a
December, 1 prepayment of insurance of 24 months. At the end of December, the insurance
expense account should be increased (debited) and the prepaid insurance account should be
decreased (credited) by birr 100, the insurance for one month ( 2400/24month). The adjusting journal
entry and the T accounts for Prepaid Insurance and Insurance Expense are as follows:
Dec. 31 Insurance Expense …………………………… 100
Prepaid insurance…………………………………. 100
Balance Sheet
 Because net income increased owner’s equity, an overstated net income will overstate
capital account by ………….. 1340
 Prepayments (prepaid insurance and supplied) overstated by ….. 1340
Deferred Revenue (Unearned Revenue)

According to Sheba Computers trial balance on December 31, the balance in the unearned rent
account is $360. This balance represents the receipts of three months’ rent in December 1 for
December, January and February. At the end of December, the unearned rent account should be
decreases by $120 (debited) and /the rent income account should be increased by $120(credited).
The $120 represents the rental income for one month ($360÷3). The adjusting journal entry and
T accounts are shown below.

Dec. 31 Unearned Rent …………………………… 120

Rent Income ………………………………. 120
Unearned Rent Rent Income
Accrued Expense (Accrued Liabilities)

At the end of December, accrued wages for Sheba Computer were $250. This amount is an
additional expense of December and is debited to the wages expense account. It is also a liability
as December 31 and is credited to wages payable. The adjusting journal entry and T accounts are
shown below.
Dec. 31 Wage Expense …………………………… 250
Wage Payable……………………………………. 250
Accrued Revenues (Accrued Assets)

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At the end of an accounting period, there may be items of revenue that have been earned but
have not been recorded. In such cases, the amount of the revenue should be recorded by debiting
an asset account and crediting a revenue account. Because of the dual nature of such accruals,
they are called revenues or accrued assets.

To illustrate assume Sheba Computers provided service of Birr 500 in December. The revenue
earned in December but it will be collected in January. The adjusting journal entry and T
accounts to record the claim against the customer (an account receivable) and the revenue earned
in December are shown below.
Dec. 31 Accounts Receivable ………………………… 500
Fees Earned ……………………………………… 500
Plant Assets

Tangible assets that are owned by a business, are permanent or have a long life, and are used in
the business are called Plant asset or fixed assets.

Sheba Computer’s plant assets include office equipment that is used much like the supplies are
used to generate revenue. As time passes, the equipment losses its ability to provide useful
services. This decrease in usefulness is called depreciation.

All plant assets, except land, lose their usefulness. Any decrease in an asset used to generate
revenue is an expense. Depreciation in accounting is the systematic allocation of plant asset’s
cost to expense.

To record the adjusting entry to record depreciation, an expense account is debited. The account
debited is a depreciation expense account. However, the asset account Office Equipment is not
credited because both the original cost of a plant asset and the amount of depreciation recorded
since its purchase are normally reported on the balance sheet. The account credited is an
accumulatedDepreciation account, which is reported on the balance as a deduction from the
asset account. Accumulated depreciation accounts are called contra accounts or contra asset
accounts because they are reported as deductions from the related asset accounts.

Normal titles for plant asset accounts and their related contra asset accounts are as follows:

Plant Asset Contra Asset

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 Land None – Land is not depreciated
Buildings Accumulated Depreciation - Buildings
Equipment Accumulated Depreciation - Equipment
The adjusting entry to record depreciation for December for Sheba Computer is illustrated in the
following journal entry and T accounts. The estimated amount of depreciation for the month is
assumed to be $50.
Depreciation Expense 50
Accumulated Depreciation Office Equipment 50
The $50 increase in the accumulated depreciation account is subtracted from the $1,800 cost
recorded in the related plant asset account. The difference between the two balanc is the
unexpired, undepreciated, or, unallocated cost. This amount ($1,750) is called the book value of
the asset. The book value may be presented on the balance sheet in the following manner.
Office Equipment $1,800
Less accumulated depreciation 50 $1,750

2.10 Preparing a worksheet

Supplies used, $1240 ($2000-$760) Wages accrued but not paid, $250
Insurance expired, $100 Fees earned but not received, $500
Rent earned from amount received in Depreciation of office equipment, $50
advance, $120
The worksheet is completed by extending the adjusted trial balance amounts to be the income
statement and balance sheet columns, the amounts for revenue and expense are extended to the
income statement columns. The amounts for asset, liabilities, owner’s capital, and drawing are
extended to the balance sheet columns.

Sheba Computers
Work Sheet
For the Two months ended December 31, 2000

Trial Balance Adjustment Adjusted Trial Income Balance

Account Title Balance Statement Sheet

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 Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
Cash 2,065 2,065 2,065

Accounts Receivable 2,220 (e) 500 2,720 2,720

Supplies 2,000 (a) 1240 760 760

Prepaid Insurance 2,400 (b) 100 2,300 2,300

Land 10,000 10,000 10,00

0
Office equipment 1,800 1,800 1,800

Accounts Payable 900 900 900

Unearned Rent 360 (c)120 240 240

Habte, Capital 15,000 15000 15000

Habte, Drawing 4,000 4,000 4,000

Fees Earned 16,340 (e) 500 16840 16840

Wages Expense 4,275 (d)250 4,525 4,525

Rent Expense 1,600 1,600 1,600
Utilities Expense 985 985 985
Supplies Expense 800 (a)1240 2,040 2,045
Miscellaneous expense 455 455 455
32,600 32,600
Insurance Expense (b)100 100 100
Rent Income (c) 120 120 120

Wages payable (d) 250 250 250

Depreciation Expense (f)50 50 50

Accumulated Depreciation (f) 50 50 50
7205 7205

Net Income 2260 2260 33400 33400 16960 23645 23645

2.11 Preparing financial statements from a worksheet

The worksheet is an aid in preparing the income statements, the statement of owner’s equity, and
the balance sheet.
Income Statements
The income statement is normally prepared directly from the work sheet. However, the order of
the expense may be changed.

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 Sheba computer
Income Statement
For the Two Months ended December 31, 2000
Fees earned $16 8 4 0
Rent revenue 1 2 0
Total revenues 16 9 6 0
Expenses
Wages expense 4 5 2 5
Supplies expense 2 0 4 0
Rent expense 1 6 0 0
Utilities expense 9 8 5
Insurance expense 1 0 0
Depreciation expense 5 0
Miscellaneous expense 4 5 5
Total expenses 9 7 5 5
Net Income 7 2 0 5

Statement of owner’s equity

The first item normally presented on the statements of owner’s equity is the balance of the
owner’s capital account at the beginning of the period. On the worksheet, however, the amount
listed as capita is not always the account balance at the beginning of the period. The owner’s
may have invested additional asset in the business during the period. Hence for the beginning
balance and any additional investment, it is necessary to refer to the capital account in the ledger.
These amounts, along with the net income (or net loss) and the drawing amount show in the
worksheet, are used to determine the ending capital account balance.

Sheba computer
Statement of Owner’s equity
For the Two Months ended 2000
Habte capital, November 1,2000
Investment on November & December 15 0 0 0 0 0
Net income for November and December 7 2 0 5 0 0
$22 2 0 5 0 0
Less withdrawal 4 0 0 0 0 0
Increase I owner’s equity 18 2 0 5 0 0
Habte Capital December 31,2000 18 2 0 5 0 0

Balance Sheet
Balance sheet as shown below it has different subsection i.e. current asset, property, plant,
equipment, and current liabilities and owner’s equity. The balances of the accounts reported on
the balance sheet are carried forward from year to year. Because they are relatively permanent
these account are called real account. The balance of the account reported in the income

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 statement is not forward from year to year. Likewise, the balance of owner’s withdrawal account,
which is reported on the statement of owner’s equity, is not carried forward. Because these
accounts report amounts for only one period, they are called temporary accounts or nominal
accounts.
Sheba computer
Balance Sheet
December 31, 2000
Asset Liabilities
Current Assets Current
liabilities
Cash $ 0 6 5 Accounts $ 9 0 0 0
2 Payable 0
Account Receivable 2 7 2 0 Wages 2 5 0 0
Payable 0
Supplies 7 6 0 Unearned rent 2 4 0 0
0
Prepaid Insurance 2 3 0 0 Total liabilities $1 3 9 0 00
Total current assets $7 8 4 5
Property, plant, and
equipment
Land 1 0 0 0
0
Office equipment 1800
Less accum. Deprc. 50 1 7 5 0 Owner’s
equity
Total property / Pat king 18 2 0 5 00
capital
And equipment 11 7 5 0 Total liabilities
and
Total Assets 19 5 9 5 Owner’s $19 5 9 5 00
equity

2.12 Adjusting and closing entries

After the financial statement have been prepared, the income statement account balance in the
ledger must be closed (reduced to zero); so that, these account can be use to collect revenue and
expense transaction for the subsequent accounting period, this procedure is called closing the
account (closing entry).
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 1. To bring revenue, expense, and owner’s drawing accounts with a zero balance.
2. To bring the capital account to its ending balance
The closing process has four steps
a. To close revenue, debit each revenue account for its balance and credit income
summery, for totals revenues.
b. To close expense accounts, debit income summery for total expense account and
credit each expense account for its balance
c. To close income summery account debit income summery account and credit
owner’s capital when the balance is net income or credit income summery and debit
owner’s capital when the balance is net loss
d. To close owner’s drawing, debit owner’s capital and credit owner’s drawing
account.
JOURNAL PAGE
Date
2 2000 31 Fees, Earned 41 16 8 4 0 00
Dec.
3 Rent 42
4 Income Summary 33 1 6 9 6 0 00
31 Income Summary 33
Wages Expense 51 4 5 2 5 00
Rent Expense 52 1 6 0 0 00
Depreciation Expense 53 5 0 00
Utilities Expense 54 9 8 5 00
Supplies Expense 55 2 0 4 0
Insurance Expense 56 1 0 0 00
Miscellanoeus Expense 59 4 5 5 00
31 Income Summary 33 7 2 0 5 00
Habte Capital 31 7 2 0 5 00
31 Habte, capital 31
Habte, Drawing 32 4 0 0 0 00

2.13 Post-closing trial balance

The last accounting procedure for a period is to prepare a trail balance after the closing entries
have been posted. The purpose of the post-closing trail balance is to make sure that the ledger is
in balance at the beginning of the next period.

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 Samuel trading

Post-closing trial balance

December 31, 2000

Asset Liabilities

Cash 2,065.00 Accounts Payable 900.00

Accounts Receivable 2,720.00 Wages Payable 250.00
Supplies 760.00 Unearned rent 240.00
Prepaid Insurance 2,300.00 Owners equity
Land 10,000.00 Pat king capital 18,205.00
Office Equipment 1,750.00
Total Assets 19,595.00 Total liabilities and Owner’s equity $19,595.00

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