CHAPTER 1

Accounting Principles & Practices

An Overview
Definition:
Accounting is the process of identifying, measuring, recording, summarizing, reporting/communicating/ & interpreting the
Business Transactions to different users for decision making purposes.
Business Transactions are the financial occurrences of an event that must be recorded in the accounting records.
As businesses & society have become complex over years, accounting has developed new concepts & techniques to meet the
ever increasing needs for financial information. Without such information, many complex economic developments social
programs might never been undertaken.
Account as Information System
Accounting enables inter & intra businesses organization financial communication through financial statements. Accounting is
thus often called BUSINESS LANGUAGE.
Users of Accounting Information:
1. External Users
INVESTORS: need the accounting information to know the financial status of the organization to make a decision whether to
invest their capital in the entity.
BANKERS/LENDERS/ & SUPPLIERS: appraise the financial of soundness a business organization & assess the risks involved
just before they make a loan & grant credits .
GOVERNMENT AGENCIES: are concerned with the financial activities of a business organization for taxation purposes &
regulations.
EMPLOYEES & LABOR UNION: are also interested in the stability & profitability of the business organization that hires them
in negotiating labor contract.
2. Internal Users
THE MANAGEMENT: these are the responsible people for directing the operation of enterprises, demand the accounting
information to accelerate favorable trends & to reduce those unfavorable, to evaluate the employees’ current performance &
appraise them accordingly, to plan the future.
Accounting Equation
Assets: A resource controlled by the entity as a result of past events and from which future economic benefits are expected
to flow to the entity.
Equity: the right/claim of the owner against the properties
Example: XYZ Company acquired an automobile of $100,000
Asset = Equity 100,000 = 100,000

Equity may be categorized to two broad principal subdivisions as:

1. The right of the creditors/ Liabilities
2. The right of the owner/ owner’s equity
Liabilities A present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow
from the entity of resources embodying economic benefits. So we can say that:
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 Asset = Liabilities + Owner`s Equity
Further consider the above example that $45,000 of the total amount is borrowed from someone else to purchase an
automobile & remaining is contributed by the business itself. So we can it in accounting equation as:

Asset = Liability + Owner`s Equity $45,000 + $55,000

Key Terms
Accounts Payable: a liability that is created from purchase on account and/or raising funds through loan
Prepaid Expenses: purchase of consumable goods or advance a\cash payment for unused services
Revenues: income generated from sales of goods & services
Accounts Receivable: claim of the business organization against the customer that is created as a result of sales on account or
performing a certain services at not for cash.
Expenses: Decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or
incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants. Note
connection with assets and liabilities.
Analyzing Transactions
Assume that Mr. John established a Sole Proprietorship to be known as Long Taxi, and completed the following transactions
during the month of August:
August 1: Mr. John deposited $10,000 at bank in the name of his business
5: Mr. John purchased land for future building site, $7,500for cash
8: Mr. John purchased gasoline, oil & other supplies agreeing to pay the amount on the near future, $850
12: The business earned fares of $4,500 & received the amount for cash
18: Paid creditors on account for purchase of August 8, $400
27: Long taxi incurred & paid the following expenses for the month of August: wages expense = $1,125, rent
expense = $850, utilities expense = $150 & miscellaneous expense = $75
30: Withdrew $1,000 for personal use
31: determined the cost of supplies on hand to be $250. Supplies of $600 have been used in the operation

Assets Liabilities Owner`s Equity Description

August

Cash Land A/P John, Capital

1 + 10,000 + 10,000 Investment
5 (7,500) + 7,500
8 + 850 +850
12 + 4,500 + 4,500 Fares earned
18 (400) (400)
27 (2,200) (1,125) Wages expense
(850) Rent expense
(150) Utilities expense
(75) Misc. expense
30 (1000) (1000) Withdrawal
31 (600) (600) Supplies expense

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 $3,400 $25 0 $7,500 $450 $10,700

Note: The effect of every transaction I stated in terms of increase and/or decrease in one or more accounting equation
elements. The equality of the two sides is always maintained; & the owner`s equity increases by additional investment &
revenues and decreases by expenses & withdrawals.

Financial Statements for Sole proprietorship

There are four principal financial statements namely Income Statement, Statement of Owner`s Equity, Statements of financial
position & Statement of Cash flows.
Income Statement: is the summary of all revenues & expenses for the specific period such as a month, a quarter, a semi annual,
and a year. The excess of the revenue over the expenses incurred to earn the revenues is called Net Income or profit, whereas
the excess of expenses over revenues are said to be Net Loss.
Statement of Owner`s Equity: the summary of the changes in the owner`s equity that have occurred during the specific period
such as a year. Owner`s equity is affected by additional investment, revenues, expenses & withdrawals.
Statements of financial position: is the list of assets, liabilities & owner`s equity as of a specific date, usually at the close of the
last date of month or the year. The preparation of the balance sheets takes either a report form or account/equation form.
Statement of Cash flows: the summary of cash receipts & payments of a business entity for specific period such as a year. It is
customary to report cash flows in three sections:
a. Cash Flows from operating activities: includes cash transactions that enter into the determination of the net income.
b. Cash Flows from investing activities: the section reports the cash transaction for the acquisition & sale of relatively
permanent assets such as land, equipment, building…
c. Cash Flows from financing activities: this section reports the cash transaction related to cash investment by the owner
& borrowed funds, and cash withdrawn by the owner for personal use.
Note: the preparation of all financial statements is identified by the name of the business, the title of the financial statement &
the date/period of preparation. The use of indentions, captions, dollar signs & rulings are much more necessary because they
aid the reader by emphasizing the various distinct sections of the statement. Below are the financial statements of Long Taxi.

Long Taxi
Income Statement
For the month ended, August 31, 2009
Revenues:
Fares Earned $4,500
Expenses:
Wages expense $1,125
Rent expense 850
Supplies expense 600
Utilities expense 150
Miscellaneous expense 75
Total expense
Net Income (2,800)
$1,700

Long Taxi

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 Statement of Owner`s Equity
For the month ended, August 31, 2009
Mr. John, Capital as of August 1, 2009 $ 0
Beginning investment $10,000
Add: Net Income 1,700
Less: Withdrawal (1000)
Increase in owner`s equity 10,700
Mr. John, Capital as of August 31, 2009 $10,700

The sequential order of the Net Income & Withdrawal will be reversed if withdrawal exceeds the net income; and
said to be decrease in owner`s equity, the difference will then be deducted from the beginning capital.
Long Taxi
Balance Sheet
August 31, 2009
 Assets
Cash $3,400
Supplies 250
Land 7,500
Total assets $11,150
 Liabilities
Accounts Payable $450
 Owners Equity
John, Capital $10,700
Total Liabilities & Owner`s Equity $11,150

Long Taxi
Statement of Cash Flows
For the month ended, August 31, 2009
 Cash Flows from operating activities:
Cash received from customers $4,500
Less: cash payments for expenses & to creditors (2,600)
Net cash flow from operating activities $1,900
 Cash flows from investing activities:
Less: cash payments for acquisition of land (7,500)
 Cash flows from financing activities:
Cash received from owner as investment $10,000
Less: Withdrawal (1,000)
Net cash flow from financing activities 9,000
 Net cash flow $3,400

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Activity
Enmesh Business Center, which is owned Mr. Erik, at the beginning of Year 2009, has the following beginning
balance accounts:
Cash= $25,000, Accounts Receivable= $8,000, Supplies= $7,500, Building= $150,000 & Accounts= $32000
Enmesh Business Center completed the following transactions since January, 2009:
January 1. Mr. Erik invested additional cash of $10,000 in the business
2. Purchased equipments $5,000 on account
5. Performed service for cash $5,200
9. Billed customers for fees earned $2,000
13. paid suppliers on account $ 3,200
16. Received customers on account $5,200
21. Purchased supplies $800 paying a half amount
24. Paid telephone, power & water expense $750
29. Determined supplies used in the operation process $2,300
30. Paid salary expense $800, trucks expense $650, & rent expense $980
30. Withdrew$1,750 for personal use
31. Paid miscellaneous expense of $320

Instruction:
 Analyze these transactions
 Prepare the four principal financial statements for the month of January, 2009

The analyses of transactions completed by Enmesh Business Center during the Month of
January are presented as follows:
Assets Liability Owner`s Equity
January

Description

Cash A/ R Supplies Equipment Building A/P Capital

$25,000 $8,000 $7,500 $150,000 $32,000 $158,500 Beginning Balance
1 + 10,000 + 10,000 Additional Investment
2 + $5,000 + 5,000
5 + 5,200 + 5,200 service fees
9 + 2,000 + 2,000 fees earned
13 (3,200) (3,200)
16 + 5,200 (5,200)
21 (400) + 800 + 400
24 (750) (750) utilities expense
29 (2,300) (2,300) supplies expense
30 (2,430) (980) rent expense
(800) salary expense

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 (650) trucks expense
30 (1,750) (1,750) withdrawal
31 (320) (320) misc. expense
$36,550 $4,800 $6,000 $5,000 $150,000 $34,200 $168,150

The preparation of the four principal financial statements is presented below:

Enmesh Business Center
Income Statement
For the month ended, January 31, 2009
 Revenues:
Service fees $5,200
Fees earned 2,000 $7,200
 Expenses:
Supplies expense $2,300
Rent expense 980
Salary expense 800
Utilities expense 750
Trucks expense 650
Miscellaneous expense 320
Total expenses (5,800)
 Net Income
$1,400

Enmesh Business Center

Statement of Owner`s Equity
For the month ended, January 31, 2009
Erik, Capital as of January 1, 2009 $23,500
Add: Additional Investment $10,000
Net Income 1,400 $11,400
Less: withdrawal (1,750)
Increase in capital 9,650
Erik, Capital as of January 31, 2009 $33,150

Enmesh Business Center

Balance Sheet
January 31, 2009
Assets
Cash $36,550
Accounts Receivable 4,800
Supplies 5,800
Equipment 5,000
Building 150,000
Total Asset $202,350

Liabilities
Accounts Payable $34,200
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 Owner`s Equity
Erik, Capital 32,950
Total Liabilities & owner`s Equity $168,150

Enmesh Business Center

Statement of Cash Flows
For the month ended, January 31, 2009
 Cash flows from Operating Activities:
Cash received from customers $10,400
Less: Cash payments to creditors & suppliers (7,400)
Net cash flow from operating activities $3,300
 No Cash flows from Investing Activities
 Cash flows from Financing Activities:
Cash received from the owner $10,000
Less: Cash withdrawn by the owner (1,750)
Net Cash from Financing Activities 8,250
Add beginning cash balance 25,000
 Net Cash flow $36,550

CHAPTER 2
The Accounting Cycle
Account: is the type of traditionally used for the purpose of recording the individual transactions .
Ledger/general ledger/: is a group of related accounts that compromise a complete unit, such as all of the accounts of a
specific business enterprise. It is a complete collection of all the accounts of a business unit.
Accounts fall into two general broad categories:
1. Balance Sheet Accounts
2. Income Statement Accounts
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  The balance sheet accounts are called real or permanent accounts & classified as assets, liabilities & owner`s equity.
ASSETS: are any physical/tangible and/or right/intangible properties that have monetary value. Assets are customarily further
classified as current assets & plant assets to ease the presentation of the balance sheet.
Current Assets: include cash & other assets that may reasonably expected to be realized/ converted to cash or used up or
sold usually within a year or less through the normal business operation. Example: notes receivable, accounts receivable,
supplies, prepaid expenses etc.
Cash: is any medium of exchange that a bank will accept at a face value, and includes bank deposits, currencies, checks, etc.
Notes Receivable: are claims against the debtors evidenced by a written promise to pay the sum of money at definite time
to the order of the specific person or to the bearer.
Accounts Receivable: are also claims against the debtor, but less formal than notes receivable.
Prepaid Expenses: supplies on hand & advance cash payments for unused services .
Property, plant, and equipment are assets of a durable nature. Other terms commonly used are plant assets, fixed assets,
and capital assets. Those are long term assets which possess physical substance and used in the operation of the entity.
LIABILITIES: are debts owed to the outsiders/ creditors, described on the statements of financial position as payables, &
classified as current & long term.
Current Liabilities: are those liabilities which due/mature within a year or less, those are to be paid out of the current
assets. Example: accounts payable, salaries payable, interest payable, taxes payable, etc .
Long term Liabilities: liabilities those will not be due within a year. If a part of the liability is paid within a year, the portion
paid becomes current liability.
OWNER`S EQUITY: the residual claim/right against the assets of the business after the total liabilities are deducted. Capital
is the owner`s equity in a sole proprietorship & partnership, sometimes called Net Worth.
Withdrawal: represent the amount of money that is taken by the owner for personal use.
 The income statement accounts are classified as revenues & expenses
Revenues: the gross increase in owner`s equity as a result of the sales of goods, performance of services, rental of properties,
provision of loans, etc. Below are some types of revenues:
Fees: professional revenues
Fares: transportation revenues
Commission: revenues for brokers
Interest: revenues from provision of loans
Expenses: are costs of generating a certain revenue.
Charts of Accounts
The charts of accounts are the complete listing of the titles & numbers of the accounts in the ledger, and can be compared to
the table of contents. The group of accounts for sole proprietorship & partnership usually appear in the order of:
1. Assets
2. Liabilities
3. Owner`s equity
4. Revenues &
5. Expenses; and every account have two digits: the first digit indicates the major subdivision of the ledger in which the
account is placed and the second digit indicates the position of the account within its subdivision. This numbering
system permits the later insertion of new accounts in their proper sequence.

Statements of financial position accounts Income statement accounts

1. Assets 4. Revenues
1.1. Cash 4.1. Sales
1.2. Accounts receivable 4.2. Fees earned
1.3. 4.3. Interest income
1.4. Supplies 5. Expenses

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 1.5. Prepaid rents 5.1. Supplies expense
1.6. 5.2. Salary expense
1.7. Equipment 5.3. Rent expense
1.8. 5.4. Depreciation expense
1.9. Land 5.9. Miscellaneous expense
2. Liabilities
2.1. Accounts payable
2.2. Salaries payable
3. Owner`s equity
3.1. Capital
3.2. Drawing
3.3. Income summary

Nature of an Account
The simplest form of an account is the T account, and the T account has three parts:
Title: the space reserved for the name of an account
Debit/Charge: the left side of the T account
Credit: the right side of the T account
The debit side signifies:
 An increase of asset & expense accounts
 A decrease of liabilities, owner`s equity & revenues
The credit side signifies:
 A decrease of asset & expense accounts
 An increase of liability, owner`s equity & revenue accounts
The transactions before they are recorded in the T account initially will be recorded in Journal through the process of
Journalizing in the form of Journal entries.
Example:
1. Mr. John earned interest of $5,000 and collected the amount.
Cash----------------------------$5,000
Interest income----------------------------$5,000

2. Mr. John purchased supplies of $1,500 on account

Supplies-----------------------------------$1,500
Accounts payable---------------------------------------$1,500

3. Mr. John purchased equipment of $2,500paying $1,800 and agreeing to pay the remaining $1,00 within a month
Equipment---------------------------------$2,800
Cash---------------------------------------------------$1,800
Accounts payable---------------------------------- 1,000

The process of transferring accounts from to appropriate ledger is called Posting

Cash Interest Income Supplies Accounts Payable Equipment

$5,000 $1,800 $5,000 $1,500 $1,500 $2,500
1,000

The duality system: is the procedure that keeps the equality of the debut & credit sides or the equality of the two sides of the
accounting equation.
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Normal Balances of the Accounts
All asset, expense & drawing accounts have a normal debit balance; to be credited whenever they decrease. Their increase will
have the reverse direction.
All liability, owner`s equity & revenue accounts have a normal credit balance; to be debited whenever they decrease. Their
increase will have the reverse direction.

Journals & Accounts

Business transaction occurs→Business documents→Journal Entry →
posting
 The initial records of
transactions are evidenced by business documents such as sales tickets, bills, cash register tape, etc.
 Based on these evidences, the transactions entered/recorded in their chronological order in the book of journals.
 The debits & the credits are then transferred/ posted to the right ledger.
Two Columns Journal
A transaction, before it is entered into the two column journal,
- Determine the account affected
- Determine whether it is decreased or increased
- Determine whether to debit or credit the account
Further consider the illustration of Long Taxi:

Journal Page 22
Date Description P/R Debit Credit
2009

Januar 1 cash $10,000

y Capital $10,000
(to record investment)

The process of recording transaction in the two column journal:

1. Record the date:
a. Insert the year at the top only of the date column of page, except when the year date changes
b. Insert the month on the first line only of the date column of each page, except when the month date changes
c. Insert the day in the date column on the first line used for each transaction, regardless of the number of
transactions during the day
2. Record the debit:
Insert the title of the account to be debited at the extreme left of the description column & enter the amount in the
debit column
3. Record the credit:
Insert the title of the account to be credited below the account debited, moderately indented, & enter the amount in
the credit column.
4. Write explanation: a brief explanation moderately indented

Transactions, after they are recorded in the two column journal, they will be transferred to a four column journal by a process
called POSTING, under an appropriate account.

Account Name: Cash Account Number: 11

Date Description P/R Debit Credit Balance
Debit Credit

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 2009

Januar 1 Balance  $25,000 $25,000

y 1 10,000 10,000
22
The posting process takes the following process:
 record the date
 insert the number of the journal page in the post reference column, make a tick for the beginning balance
 compute the final balance after each entry
Trial Balance
A trial balance is the listing of the ledger accounts & their debit & credit balances to determine the equality of the two sides. The
accounts appear on the trial balance in the following order:
 asset accounts
 liability accounts
 owner`s equity accounts/ capital
 revenue accounts
 expense accounts
Note that the most liquid assets are listed first & the least liquid assets are listed last, liabilities with short due date appear first
& expenses are to be listed in their ascending order

Enmesh Business Center

Trial Balance
January 31, 2009
Cash $36,550
Accounts Receivable 4,800
Supplies 6,000
Equipment 5,000
Building 150,000
Accounts Payable $34,200
Erik, Capital 168,500
Erik, Drawing 1,750
Sales 5,200
Fees earned 2,000
Supplies expense 2,300
Rent expense
980
Salary expense
800
Utilities expense
750
Trucks expense
650
Miscellaneous expense
320
$209,900 $209,900

Note that the trial balance doesn`t provide the accuracy of the ledger, rather it merely indicates the equality of the debit & the
credit sides.
The inequality of the two sides arises from:
1. error in preparing the trial balance
a. if either column incorrectly added
b. if the amount incorrectly entered
c. if the Debit is recorded as Credit or vice versa
2. error in recording a transaction in the ledger
a. if the erroneous amount is posted
b. if the Debit is posted as Credit or vice versa

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 c. if either column is omitted
Below are some types of that will not affect the equality of the debit & the credit sides:
i. failure to record the transaction or to post the transaction
ii. posting the same erroneous amount to both sides
iii. to record the same transaction more than once
iv. to post a part of the transaction correctly, but to the wrong account
The common two types of errors are:
1. transposition error: erroneous rearrangement of the digits: e.g. $3,200 as $2,300
2. slide error: if the entire number is erroneously moved one or more spaces to the right or left: e.g. $ 45,200 as $45.20 or
as $452.00

ILLUSTRATION: Lake View has the following balances as of September 30, 2008
Lake View
Trial Balance
September 30.2008
Cash $8,800
Accounts receivable 17,825
Supplies 1,800 The debit & the credit sides are
Prepaid Insurance 400 not equal as a result of the
Equipment 22,500
Notes Payable
following errors:
$25,000
Accounts Payable 1. the balance of cash
5,000
Joan Key, Capital was understated by
36,720
Joan Key, Drawing $700
8,000
Sales 59,750 2. a cash receipt of $470
Wages expense was posted as a debit
31,500
Rent expense to cash $740
1,800
Advertising expense 3. a credit of $325 to
5,700
Utility expense
5,650 accounts receivable
$103,975 $126,470 was not posted
4. a return of $245 of
defective supplies was erroneously posted as $425 credit to supplies
5. an insurance premium acquired at cost of $400 was posted as a credit to prepaid insurance
6. the balance of notes payable was overstated by $5,000
7. a credit of $890 in accounts payable was over looked when to determine the balance of the account
8. a debit of $1,000 for withdrawal by the owner was posted as a debit to wages expense
9. the balance of $18,000 in rent expense was entered as $1,800 in the trial balance
10. miscellaneous expense with the balance of $1,100 was omitted from the trial balance
The corrected trial balance is presented below:
Lake View
Trial Balance
September 30.2008
Cash $8,800+700-270
Accounts receivable 17,825-325
Supplies 1,800+180
Prepaid Insurance 400+400+400
Equipment 22,500
Notes Payable $25,000-5,000
Accounts Payable 5,000+890
Joan Key, Capital 36,720
Joan Key, Drawing 8,000+1,000
Sales
59,750
Wages expense
31,500-1,000

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 Rent expense 1,800+16,200
Advertising expense 5,700
Utility expense 5,650
Misc. expense 1,100
$122,360 $122,360

Nature the Adjusting process

 Definition: - adjustment is the process of updating the accounts & assuring the proper matching of revenues &
expenses at the end of an accounting period; adjusting entries are required entries to record the adjustment process.
Deferrals & Accruals
Deferred items: - consist of adjusting entries involving data previously recorded in accounts. These entries involve the transfer
of data already recorded in the assets & liabilities account to expense & revenues account, respectively. Deferred items consist
two types of adjustments:
a. Assets/Expenses Adjustment: called deferred expenses or prepaid expenses. All prepayments remain asset until
they are used up or expired, & deferred to be recorded as expense.
E.g. supplies, prepaid insurance, prepaid rents, etc
There are two types of recording prepaid expenses: as asset & as expense
- If the original transaction is recorded as asset, the adjusting entry at the end of the accounting period is needed to
transfer the amount expired from asset account to expense account.
- If the original transaction is recorded as expense, the adjusting entry at the end of the accounting period is needed to
transfer the amount that is not expired from expense account to asset account.
Assume Mendacity ltd rented a building on September 1, 2003paying $48,000 for a period of one year. Assume also
that the accounting period of the business or4ganization ends on December 31. The adjusting entry will be recorded as
follows:
 If recorded as asset:
September 1, 2003: Prepaid Rent---------------------------$48,000
Cash-----------------------------------------$48,000
(To record the original transaction)

December 31, 2003: Rent Expense---------------------------$16,000

Prepaid Rent---------------------------------$16,000
(To record adjustment)

 If recorded as expense:
September 1, 2003: Rent Expense--------------------------$48,000
Cash-------------------------------------------$48,000
(To record the original transaction)

December 31, 2003: Prepaid Rent---------------------------$32,000

Rent Expense-----------------------------------$32,000
(To record adjustment)

Activity: Supplies provided for use during year 2 was $1,800, & at the end of the year only supplies of $890 are available on
hand. Pass a necessary journal entry!!

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 b. Liability/Revenue Adjustment: called deferred revenues, & arise from advance cash receipts/collection. They remain
liability till they are earned.
- If the original transaction is recorded as liability, the adjusting entry at the end of the accounting period is
needed to transfer the amount earned from liability account to revenue account.
- If the original transaction is recorded as revenue, the adjusting entry at the end of the fiscal period is needed
to transfer the unearned amount from revenue account to liability account.
E.g. Assume that on November 30, 2008, Cox ltd received cash in advance for rent of machinery, $36,000 for three months, and
its fiscal year ends on December 31. Pass a necessary adjusting entry!!
 the original transaction is recorded as liability:
November 30, 2008: Cash-------------------------------------$36,000
Unearned Revenue------------------------------------$36,000
(To record the original transaction)

December 31, 2008: Unearned Revenue-------------------------$12,000

Rent Revenue-----------------------------------------$12,000
(To record adjustment)

 the original transaction is recorded as revenue:

November 30, 2008: Cash---------------------------------------------$36,000
Rent Revenue------------------------------------$36,000
(To record the original transaction)

December 31, 2008: Rent Revenue---------------------------------------$24,000

Unearned Rent------------------------------------------------$24,000
(To record adjustment)
Note: Adjustment for all deferrals decrease either an item/side_ Debit or Credit

Accrued Items: - involves the initial record of assets & liabilities; and the related revenues & expenses.
They consist of two types of adjusting entries:
1. Assets/ Revenues Adjustments : called accrued revenues. A company performs services for customers & bills them.
This transaction then will be recorded as assets/receivables & as revenues because the Company earned the revenues.
Example: PQR business loaned $20,000on November 1, 2009 at 12% interest rate. Pass a necessary adjusting entry if
the Business`s accounting period ends on December 31.
December 31, 2009: Interest Receivable-----------------------$400
Interest Revenue----------------------------------$400
(To record interest revenue earned)
Activity: USP Business Concern, on October 1, 2009, agreed to perform an accounting Consultancy service for $96,000 for
a period of one yea r starting from that date. The full payment will be made after a full discharge of all responsibilities,
(i.e. after a year), the accounting period ends on December 31. Pass a ne3cessry adjusting entry on the last date of the
accounting period.

2. Liabilities/Expenses Adjustment: called accrued or post paid expenses. These are accumulated expenses that are
unpaid & unrecorded. They are already incurred, but not yet recorded & paid .

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 Example: DSAE Inc pays wages of $20,000 for five work days each Friday. The current year accounting period ends on
March 31, Wednesday. Pass ea necessary adjusting entry.
March 31: Wage Expense----------------------$12,000
Wages Payable---------------------------------$12,000
(To record wages expense incurred)
Activity: DDFC borrowed $200,000 from DDCB at 12% interest rate on July 1, 2002. Pass a necessary adjusting entry
on December 31, 2002 for DDFC.
Note: All accrual adjustments increase both sides_ the debit & the credit
Depreciation: is a decrease in usefulness of plant assets with a time passage. As time passes, all plant assets, except land,
loose their capacity to provide useful service, however, there is no visible reduction in quantity. Depreciation is another type of
prepaid/deferred expense.
Accumulated Depreciation is a contra/offset account for depreciable plant assets [deductible from the cost of plant assets].
Example: Micro Train Co reported depreciation of $750 on December 31, 2009, on its tucks. The original cost of the trucks was
$10,000.
December 31, 2009: Depreciation Expense-trucks----------------------------$750
Accumulated Depreciation-trucks------------------------$750
(To record depreciation Expense)
Book Values: Are the recorded cost of plant assets less accumulated depreciation, [unexpired cost of plant assets].
Book value= cost-accumulated depreciation
9,250=10,000-750
Worksheet – is a columnar sheet of paper or a computer spreadsheet on which accountants summarize information
needed to make the adjusting and closing entries, and to prepare the financial statements. It is only an accounting tool & not
the formal accounting record.
The major purpose of the worksheet is to organize data into a convenient form prior to the preparation of the financial
statements. The worksheet has five main money columns with their respective debit & credit sides, each; in general there exist
ten columns of worksheet for sole proprietorship & partnership businesses:
 The trial balance column
 Adjustment column
 The adjusted trial balance column
 The income statement column &
 The balance sheet column
The heading of worksheet should fulfill/satisfy the www requirements, & its date of preparation is similar with that of the
balance sheet. Below is the illustration of Joan Miller Advertising Agency

Joan Miller Advertising Agency

Worksheet
ILLUSTRATION:
For the Month Ended, January 31, 2008

Account Name Trial Balance Adjustment Adjusted Income Statement Balance Sheet
Trial Balance
Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit
Cash 1,720 1,720 1,720
Accounts Receivable 2,800 2,800 2,800

Art Supplies 1,800 c 500 1,300 1,300

Office Supplies 800 d 200 600 600

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 Prepaid Rent 800 a 400 400 400
Prepaid Insurance 480 b 40 440 440
Art Equipment 4,200 4,200 4,200
Office Equipment 3,000 3,000 3,000
Accumulated Depreciation-
 Art Equipment e 70 70 70
 Office f 50 50 50
Equipment
Accounts Payable 3,170 3,170 3,170
Unearned Art Fees 1,000 h 400 600 600
Joan Miller, Capital 10,000 10,000 10,000
Joan Miller, Drawing 1,400 1,400 1,400
Advertising Fees Earned 4,200 i 200 4,400 4,400
Wages Expense 1,200 g 180 1,380 1,380
Utilities Expense 100 100 100
Telephone Expense 70 70 70
18,370 18,370

Rent Expense a 400 400 400

Insurance Expense b 40 40 40
Art Supplies Expense c 500 500 500
Office Supplies Expense d 200 200 200
Depreciation Expense-
 Art Equipment e 70 70 70
 Office Equipment f 50 50 50
Wages Payable g 180 180 180
Art Fees Earned h 400 400 400
Fees Receivable i 200 200 200
2,040 2,040 18,870 18,870 2,810 4,800 16,060 14,070
1,990 1,990
Net Income 4,800 4,800 16,060 16,060

Journalizing the Adjusting Entries

a. Rent expense------------------400
Prepaid rent---------------------------400

b. Insurance expense------------40
Prepaid insurance---------------------40

c. Art supplies expense-----500

Art supplies-------------------------500
d. Office supplies expense-------200
Office supplies-------------------200

e. Depreciation expense-Art equipment----70

Accumulated Depreciation-Art equipment----70

f. Depreciation expense-Office equipment----50

Accumulated Depreciation-Office equipment-----50

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 g. Wages expense---------------180
Wages payable-----------------180

h. Unearned Art fees --------------400

Art fees earned-----------------400

i. Fees receivable-------------------200
Advertising fees earned---------200

The Nature of the Closing process

 The net effect of all temporary/nominal accounts will be summarized to the capital account at the end of the
accounting period.
 These nominal accounts must have a zero balance at the end of the fiscal year, so that they will be ready for use in
the following accounting period. These two activities take place through the closing entries.
All expense & revenue accounts are first closed to Income Summary account, & then the Income Summary account to the
capital account; whereas the drawing account directly closed to the capital account.
Note that the Income summary account has NO NORMAL BALANCE, and it is only opened & closed during the closing process.
The accounts title & the amounts for journalizing the closing entries are obtained from:
- The worksheet
- Income Statement
- The Statement of Owner`s Equity &
- The ledger
All nominal accounts in the Adjusted Trial Balance column are closed to Income Summary as follows:

Advertising Fees earned-----------------4,400

Income Summary--------------------------4,400
(To close Advertising Fees earned)

Income Summary----------------1,380
Wages Expense-----------------1,380
(To close wages Expense)

Income Summary----------------100
Utilities Expense-----------------100
(To close Utilities expense)

Income Summary --------------70

Telephone Expense---------------70
(To close telephone expense)

Income Summary------------------400
Rent expense--------------------400
(To close rent expense)

Income summary----------------40
Insurance expense----------------40
(To close Insurance expense)
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 Income Summary --------------------500
Art supplies expense----------------500
(To close Art supplies expense)

Income Summary----------------200
Office supplies expense---------200
(To close office supplies expense)

Income Summary --------------------70

Depreciation Expense-Art equipment ----70
(To close Depreciation Expense-Art equipment)

Income Summary-------------------50
Depreciation Expense-office equipment ----50
(To close Depreciation Expense-office equipment)

Art Fees Earned---------------400

Income Summary----------------400
(To close Art Fees Earned)

 Finally when to close the Income Summary Drawing Accounts to the Capital Account, it will have the
following format:
Joan Miller, Capital----------------------1,400
Joan Miller, Drawing--------------------------1,400
(To close the drawing account)

Income Summary--------------------4,800
Cash $ 1,720
Accounts ReceivableJoan Miller, Capital----------------4,800
2,800
Fees Receivable (To close Income Summaries with credit 200 balance/Revenues)
Art SuppliesJoan Miller, Capital---------------------------2,810
1,300
Office Supplies Income Summary---------------------------2,810
600
Prepaid Rent (To close Income Summaries with debit 400 balance/Expenses)
From the above entries, we can summarize that the Income Summary440
Prepaid Insurance Account has the debit & credit balance of $ 4,800 &
$2,810, respectively.Art
TheEquipment
debit side of the Income Summary signifies 4,200 the summary of all Revenues whereas the credit signifies
Office Equipment 3,000
the summary of all expenses. So we can say that the Company generated the Net Income of $1,990(4,800-2,810 ).
Accumulated Depreciation-
 Art Equipment $ 70
Post Closing Trial Balance Office Equipment 50
Accounts Payable 3,170
The last procedure of the accounting cycle is the preparation of the post closing trial balance; after all nominal accounts are
closed, to make sureUnearned Art Fees
that the ledger is in balance at the beginning of the new accounting600 period . The post closing trial
Wages Payable 180
balance incorporates only the balance sheet accounts & contra plant assets accounts_ accumulated depreciation.
Joan Miller, Capital _____ 10,590
$ 14,660 $ 14,660

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Post Closing Trial Balance Admas University
January 31, 2008
 Chapter 4

CHAPTER 4
Accounting for Merchandising Enterprises
Merchandising enterprises are those business concerns which are established in order to purchase/acquire merchandise only
for resale purpose rather than for further processing or consumption purpose.

Accounting for purchases & sales

Purchases of merchandise are usually identified in the ledger as ‘purchase’ whereas sales as ‘sales’. Merchandising enterprises
accumulate all the cost of merchandise in the purchase account.
Purchase------------------------------------------XXX
Cash/Accounts Payable-----------------------------XXX
(To record purchases)

Cash/Accounts Receivable---------------------------------XXX
Sales------------------------------------------------------------XXX
(To record sales)

Purchases/Sales Discount
The arrangements agreed upon by the buyer & the seller as to when payments for merchandise are to be made are called Credit
Terms. If the payment for merchandise is made immediately, the arrangement o the agreement is said to be CASH/NET CASH.
Otherwise the buyer is allowed a certain time of payment, known as the Credit Period. The credit period begins with the date of
the sales as shown by the date of the invoice/bill.

 If the payment is due within the stated number of days after the date of the invoice, say 30 days, the terms are said to
be Net 30 days_ ‘n/30’
 If the payment is due at the end of the month, in which the sales was made, it may be expressed as ‘n/eom’

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As a means of encouraging payment before the end of the credit period, the sellers may offer a discount for early payments of
cash. For example, if the seller offers 2% discount for payment within 10 days, even if the credit period is 30 days, can be
expressed as ‘2/10, n/30’. This is known as a cash discount.
 2/10, n/30 Credit term
 2 Discount rate
 10 Discount period
 30 Credit period

Example: Zimmer Company sold merchandise of $180,000 on account to Minco ltd_ term 2/10, n/30, Minco paid the amount
within the discount period.
Purchase Discount- Minco ltd Sales Discount- Zimmer Co
Purchase---------------------$180,000 Accounts Receivable----------------$180,000
Accounts Payable------------$180,000 Sales-----------------------------$180,000
(To record Purchase) (To record Sales)

Accounts Payable------------$180,000 Cash--------------------------------$176,400

Cash------------------------------$176,400 Sales Discount-------------------- 3,600
Purchase Discount------------- 3,600 Accounts Receivable----------------$180,000
(To record cash payment) (To record cash collection)

Purchase/Sales Return & Allowance

In some special cases, part of merchandise purchased or sold might be returned & the price adjustment is requested. The buyer
asks for purchase return & allowance writing the Debit Memorandum. The Debit Memorandum is the convenient medium to
inform the seller/creditor/ the amount of the buyer/debtor/ & the purposes to debit accounts payable or cash.
The seller gives a Credit Memorandum that shows the amount the amount for which it is going to Credit its Accounts
Receivable or cash. Purchase Return & Allowance is a deduction/a contra (offsetting account of)/ to purchase account, whereas
Sales Return & Allowance is a deduction/a contra (offsetting account of)/ to Sales Account .
Illustration
On July 3, year 3, ABC ltd purchased supplies of $5,000 on account from XYZ Company; unfortunately supplies of $450 were
defective & ABC wrote a Debit Memorandum to XYZ on July 11, year 3. Record the original transaction & the return on the
behalf of the buyer & the seller.
ABC ltd XYZ Company
July 3, year: Purchase--------------$5,000 Accounts Receivable-----------$5,000
Accounts Payable--------$5,000 Sales -------------------------------------$5,000
(To record purchase) (To record sales)

July 11, year 3: Accounts Payable------$450 Sales Return & Allowance-----$450

Purchase Return & Allowance---$450 Accounts Receivable----$450
(To record Purchase Return & Allowance) (To record Sales Return & Allowance)

Activity
On July 4, 2000, Pinkie Company purchased items of $20,000, term 2/10, n/45 from Rainbow ltd & paid the amount within the
discount period. Three days after the last date of the discount period, items of $1,280 were returned for some defects.
Instruction
1. Record the original transaction on the behalf of the seller & the buyer
2. Record the payment on the last date of the discount period for both the seller & the buyer
3. Record the return of the items for both the buyer & the seller specifying the date of the transaction.

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 Transportation Costs
The terms of agreement between the buyer & the seller include provisions concerning:
a. When the ownership title of the merchandise transfers to the buyer
b. Which party is to bear the cost of delivering the merchandising to the buyer (transportation cost).
There are two terms: FOB shipping point
FOB destination
FOB (Free On Board) Shipping point: - the ownership title transfers to the buyer at the shipping point, & the
transportation costs are to be covered by the buyer itself. The transportation costs paid by the buyer are then debited to
Transportation/Freight In & credited to cash.
But in some special cases, the seller may repay the transportation costs & adds the amount to the invoice by debiting to
Accounts Receivable & crediting to cash; and the buyer will debit Transportation In & credit Accounts Payable.
FOB (Free On Board) Destination: - the seller places merchandise free on board to its destination paying all
transportation/delivery costs, & the ownership title is transferred to the buyer at the destination of the merchandise/at the
address of the buyer/.

Illustration
On June 10, 2002, Durban Company purchased merchandise from Bell Corporation $900, term FOB shipping point, 2/10, n/30,
with the prepaid transportation cost of $50 that is added to the invoice. Pass necessary entries for both the entities.

Durban Company Bell Corporation

June 10, 2002: Purchase---------$900 Accounts Receivable-------$950
Freight In --------- 50 Sales------------------------------$900
Accounts Payable-------------$950 Cash----------------------------------50
(To record Purchase) (To record Sales)

June 20, 2002: Accounts Payable-----$950 Cash-----------------------------$932

Cash--------------------------$932 Sales Discount--------------------18
Purchase Discount----------- 18 Accounts Receivable-----------$950
(To record the cash payment) (To record the cash collection)
Note that the discount rate is not applicable to the prepaid transportation cost.
When the agreement term is FOB destination, the transportation cost paid by the buyer will be debited to Transportation out/
Delivery Expense, & reported on the seller`s Income Statement as selling expense. And no entry is needed by the buyer to
record the transportation cost paid by the seller.
Example: GTY Company sold merchandise of $400, FOB destination paying $12 to RABS ltd.

GTY: Accounts Receivable---------$400 RABS: Purchase-------------$400

Sales------------------------------$400 Accounts Payable-------------$400
(To record sales) (To record Purchase)

Transportation out-------------$12 (No Entry)

Cash----------------------------$12
(To record transportation cost)

Sales Taxes
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Taxing units (states) levy (impose) tax on retail sales of merchandise. The liability for sales tax is ordinarily incurred regardless of
the terms of the sales. Sellers add the percent of the tax on the normal selling price of the commodities.
Example: A sale on account of $100 is subject to sales tax of 4%
Accounts Receivable ------------------104
Sales-----------------------------------$100
Sales tax payable--------------------- 4

Periodically, the appropriate amount of sales tax is paid to the taxing unit & the sales tax payable is debited.
Sales tax payable-------------------$4
Cash--------------------------------$4
Activity: Record the following transactions
a. Purchased merchandise on account $15,000, 2/10, n/30
b. Sold $3,000of merchandise on account, subject to tax of 6%
c. Paid the amount owed in ‘a’ within the discount period
d. Paid $1,650 to the State Revenue Department for sales tax collected

Cost of Merchandises Sold

Merchandising Enterprises determine cost of merchandise sold as follows:

Cost of merchandise sold:

Beginning Inventory xxx
Add: Purchases Xxx
Less: Purchase discount (xx)
Purchase return & allowance (xx)
Net Purchase xx
Add: Transportation cost xx
Cost of merchandise purchased xxx
Cost of merchandise available for sale xxx
Less: Ending Inventory
(xx)
Cost of merchandise sold
xxx

Activity: Based on the following data, prepare statement of cost of merchandise sold for the fiscal year ended on June
30, 1991 for ABC Limited Company.

Merchandise Inventory:
 June 30, 1991 $ 236,000
 June 30, 1990 127,000
Purchase 760,000
Purchase return and allowance 8,200
Purchase discount 4,800
Transportation cost 3,000

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