Accounting System

The Accounting Process/ Cycle

Analyze transactions Journalize original entries Post journal entries to ledger Identify, journalize and post adjusting entries Journalize and post closing entries Prepare financial statements

Double Entry System

Every business transaction has a receiving aspect and a giving aspect Thus, assets = liabilities Alternatively, every debit has an equivalent credit Ensures internal cross checking

Accounting Equation

Sources of funds = Applications of funds Assets = liabilities Assets = internal liabilities (capital/ equity) + external liabilities Hence A = L + E

Identification of Accounts

Personal accounts of:

natural persons artificial persons like companies/ organizations representative (of a group) personal accounts

Real accounts: tangible or intangible (assets) Nominal accounts: or impersonal accounts like expenses/ losses, incomes/ gains

Rules for Journalizing

For Personal accounts: debit the receiver and credit the giver For Real accounts: debit what comes in and credit what goes out For Nominal accounts: debit all expenses/ losses, and credit all incomes/ gains Thus identify the accounts affected by the transaction from business point of view, and then accordingly apply the rule for debit and credit

Ledger Accounts

T-shaped accounts Balancing the accounts (take balance as difference between debit totals and credit totals) Assets and expenses are debit balances (total debits > total credits) Liabilities and incomes are credit balances (total credits > total debits)

Temporary and Permanent Accounts

Permanent accounts:

Never closed Are B/S accounts (liabilities and assets) Ending balances appear on B/S Carried as opening balances to next year
Are closed at year end, not carried to next year Mainly for expenses and incomes Their balances at the year end are transferred to income statement Balance of income statement (profit/ loss) is transferred to retained earnings statement (a permanent account), whose balance is shown in B/S with share capital

Temporary accounts:

Trial Balance

Is a list of the account names and balances in each account as at the year end Shows debit and credit balances in two separate columns Totals of two sides must be equal (double entry system) However, tallying of two sides does not preclude possibility of errors Preparation of trial balance facilitates preparation of financial statements, as it shows a summary of account balances

The Adjusting and Closing Process

Adjusting Entries:

Events may be separate from transactions Need to pass adjusting entries for some events at the year end Eg. Depreciation, provision for bad debts, prepaid and outstanding expenses/ incomes..
To transfer balance of temporary accounts (incomes/ expenses) to income statement Balance of income statement (net profit/ loss) is transferred to retained earnings

Closing Entries:

Preparing the Financial Statements

Balance of retained earnings is transferred to B/S Closing balances of assets and liabilities = opening balances + adjustments during the year to these items Adjustments for adjusting entries like depreciation, prepaid/ outstanding items, provisions etc.