Chapter Two
2. Accounting cycle for service-giving business
Introduction:
The accounting cycle is process or a series of activities that begins with a transaction and ends
with the closing of the books. Because this process is repeated each reporting period, it is
referred to as the accounting cycle and includes the following major steps:
1. Identify and analyze the transaction and events.
2. Recording transactions and events in a journal.
3. Classifying transactions by posting from the journal to accounts in the ledger.
4. Summarizing transactions from the ledger to an unadjusted trial balance.
5. Prepare necessary adjusting entries.
6. Prepare the adjusted trial balance (completion of the work sheet).
7. Summarize worksheet data in the form of financial statement.
8. Closing the accounting records (nominal accounts) to summarize operations of the
accounting period.
9. Preparation of post-closing trial balance.
10. Reversing certain adjusting entries (optional)
The steps from 1-4 are performed throughout the accounting period as transactions occur
or in periodic batch processes. The steps from 5-10 are performed at the end of the
accounting period.
2.1. Service giving companies and characteristics of an account
A service giving companies produces and sells intangible benefits or utilities to customers.
Though tangible goods may also sell together with services, the dominant portions in service
transactions are intangible. The products of service giving companies cannot be stored in most
cases and shall be consumed by the receipt of the service at the service center. Accounting
systems are designed to show the increases and decreases in each financial statement item in a
separate record. This record is called an account.
For example, since cash appears on the balance sheet, a separate record is kept of the increases
and decreases in cash. A group of accounts for a business entity is called a ledger. A list of the
accounts in the ledger is called a chart of account.
The accounts are normally listed in the order in which they appear in the financial statements. An
account, in its simplest form, 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 resembles the
letter T.
The terms debit and credit mean left and right sides respectively. The left side of an account
is called the debit side and the right side of an account is called the credit side. The word
charge is sometimes is used in similar fashion for the term debit. Amounts entered on the left
side of an account, regardless of the account title, are called debits or charges to the account, and
the account is said to be debited or charged. Amounts entered on the right side of an account are
called credits and the account is said to be credited. Debits and credits are sometimes abbreviated
as Dr. and Cr.
Title
Left side Right Side
Debit Credit
The illustration that follows, receipts of cash during a period of time has been listed vertically
on the debit side of the cash account. The cash payments for the same period have been listed
in similar fashion on the credit side of the account.
A memorandum total of the cash receipts for the period to date, Birr 20,500 may be inserted
below the last debit at any time whenever the information is desired. The figures should be
small and written in pencil in order to avoid any mistakes while additional amount is debited.
Such a procedure referred to as Pencil footing.
The total of the cash payments, birr 16,800 may be inserted on the credit side in a similar
fashion.
Deduction of the smaller sum from the larger, Birr 20,500- Birr 16,400, produces cash
on hand amount, which is called the balance of the account. The cash account, as per this
illustration is Birr 3, 700. This amount may be inserted in pencil figures next to the larger
pencil footing, which identifies it as a debit balance. The debit balance of Birr 3,700 would
have been taken if balance sheet were prepared.
Title
7,200 2,000
8,800 6,450
4,500 1,900
3, 500
2,950
20500 16,800
3,700
2.1. Characteristics of an account
2.2. Classification of accounts
2.3. Chart of accounts
2.4. Rules of debit and credit
2.5. Normal balances of accounts
2.6. Analyzing and recording transactions
2.7. Preparing a trial balance
2.8. The usefulness and limitations of a trial balance
2.9. The adjusting process-accrual vs. cash basis of accounting
2.10. Preparing a worksheet
2.11. Preparing financial statements from a worksheet
2.12. Adjusting and closing entries
2.13. Post-closing trial balance
