The Accounting Cycle

The process by which data about economic events are entered into an
accounting system, processed, organized and used to produce
information such as financial statatements
Cash vs. Accrual Accounting Revisited & the Timing of Revenue and
Expense Recognition
Recognition refers to when revenues/expenses are recorded in the
accounting system and reported on the income statement

Accrual accounting is based on the concept of MATCHING

expenses should be recorded in the same period in which the revenues
are recognized
For example, under accrual accounting concepts it is not necessary to
wait until cash is received to record a sale unless significant
uncertainty exists as to whether it will be collected.
Unlike cash accounting, where only transactions that involve cash are
recorded, choices exist with accrual accounting and therefore
exercising judgment and a look at the facts of the situation are
necessary

 These recognition choices have big impact on F/S (ie. I/S and B/S)
Keep in mind that the underlying economic events and transactions
are the same under both methods but the issue is that of TIMING of
the recognition of these events. At the end of the day eventually all
economic events are reflected in the F/S.
Revenue and Expense recognition will be explored in greater depth in
Chapter 4
The Accounting Cycle Process
During the year on a daily basis:
1. Economic event or transaction happens
2. Prepare a Journal entry (Debits must equal credits)
3. Journal entry is posted into the general ledger to specific accounts
using either T-accounts or spreadsheet
At the end of the accounting period:
4.
5.
6.
7.

Identify, prepare and post any adjusting entries

Create Trial Balance
Prepare Financial statements (Assets = Liabilities + OE)
Prepare and post closing entries (resets I/S accounts to zero)

Process begins anew in next year or period

Things to consider when preparing a journal entry:
Which element is affected?
Which specific account is affected?
How are the accounts affected (ie. Up/down)?
How much are the accounts affected?

Format of Journal Entries

Date DR Account Name
CR Account Name
Explanation of transaction

$$$$
$$$$

Journal Entries and the Double Entry Bookkeeping System

Journal entries are the method by which we translate economic events
into the accounting system
Using a journal entry, the transaction or economic event is recorded in
two or more places in the general ledger. General ledger or
spreadsheet is basically the location where all the accounting
information and accounts are stored.
The journal entry and the recorded transaction should always be in
balance (ie. Debits=Credits) as should the accounting equations
A=L+OE
Posting a journal entry to the general ledger is the process of
transferring each line of a journal entry to the corresponding account
in the general ledger
When posting journal entries manually, a spreadsheet or T-account can
be used to represent the general ledger accounts

Other General Notes on Journal Entries

Under ASPE and IFRS, items are recorded at their cost or transaction
value, write-ups of assets are not allowed under ASPE but may be
allowed under IFRS if certain conditions are met
Sometimes assumptions and explanations are needed for your entries
where choices exist (ie. revenue and expense recognition) these
choices will impact the financial statements. Generally we will see
that where choice exists preparers will try to cater to their main
objectives of accounting
DRs increase asset and expense accounts and decrease liability,
owners equity and revenue accounts
CRs decrease asset and expense accounts and increase liability,
owners equity and revenue accounts

Adjusting Entries
Entries made at the end of the period or event which are not triggered
by exchanges with outside entities
At the end of the period before financial statements prepared,
managers must identify economic changes that occurred during the
period but that have not been reflected in the accounting system
Do not involve cash and therefore would not be necessary under a
cash basis system of accounting. Only exist under an accrual
accounting system
Necessary in accrual accounting system because recognition of
revenues and expenses do not always correspond with cash flows (ie.
depreciation, insurance, wages).
Accrual accounting attempts to measure economic changes not just
cash changes. Concept of matching revenues and expenses is
important and is basis for adjusting entries.
Always involve one balance sheet and one income statement account
4 Types of Adjusting Entries
1. Deferred Expense/Prepaid Expense
Record the consumption of assets that provide benefits for greater
then one period
Not triggered by an exchange with another entity and do not
involve cash
Examples (prepaid insurance, prepaid rent, amortization)
Depreciaton/Amortization
reflects the consumption of capital assets (buildings,
equipment, etc.)
it is a contra-asset account (ie. shown on the balance sheet as a
credit or reduction from assets)
Cost of asset less depreciation/amortization referred to as net
book value (NBV) this usually does not reflect and is totally
separate from assets market value

 many different ways to amortize

-straight line method (even amount of depreciation over
asset life)
-declining balance (more depreciation in earlier years)
-units of production (mining companies, manufacturing)
o each method produces different results and each method is
allowable under IFRS/ASPE
o depreciation/amortization is an arbitrary allocation (estimate)
which does not involve cash
o sophisticated bankers generally uninterested in this since mostly
concerned with cash and market values
o note that Canada Revenue Agency (CRA) generally has its own
method of depreciation for tax purposes called CCA (Capital
cost allowance) where each class of assets have a different CCA
rate. This method is similar to the declining balance method.
2. Deferred Revenue
o When an entity receives payment for goods or services before it
recognizes the revenue (ie. Deposits or advances)
o Liability is credited (increased) for unearned revenue when
payment received and cash is debited (increased)
o When the service is performed the liability is debited
(decreased) and revenue is credited (increased)
o Adjusting entries occurs usually at time service completed or at
end of reporting period to reflect revenue earned
3. Accrued Expense/Accrued Liability
o When the entity has incurred an expense but it is not triggered
by an external event (ie. utilities expense, accrued wages,
interest expense, etc.)
o Liability such as accounts payable is credited (increased) and
expense is debited (increased) when expense is incurred
o In subsequent period, when payment is issued liability is
debited (decreased) and cash is credited (decreased)
o Adjusting entry is required due to the matching concept ie all
expenses should be matched to the revenue it helped create

4. Accrued Assets/Accrued Revenue

o An asset which is recorded before cash is received
o Needed when an entity has earned revenue but no external
transaction has triggered the recording of the revenue (ie.
interest revenue)
o Most often a receivable is debited (increased) and revenue is
credited (increased)
o When cash is received in subsequent period, cash is debited
(increased) and receivable is credited (decreased)
NOTE:

The goal with adjusting entries is to have the account balances

properly reflected at the end of the period.
Look at:
1) What is now in the ledger accounts?
2) What should be in the ledger accounts?
3) What entry is needed to go from now to should?
Adjusting entries may differ depending on the original journal
entry made

Trial Balance
The trial balance is a listing of all the accounts in the general ledger
with their balances
Main purpose is:
o 1. to ensure debits equal credits (if not an error exists)
o 2. to provide a summary of the balances in each account to
facilitate the preparation of the financial statements

Closing Entries
Happens at end of accounting period after F/S prepared
o Any income statement related accounts (ie. revenue and
expense accounts) are temporary accounts because they are
reset to zero at the end of each period
o Balances in these accounts are not carried forward since the
income statement reports results over a period of time. Once the
period of time (usually one year) is over the balances are reset
to zero to begin anew
o Simply involves reversing the balances in each income
statement and expense account so that account balance at end of
period is equal to zero
o When the accounts are closed the difference (usually net
income or net loss) is transferred to the retained earnings
account. If there is a net income then there will be a credit to
the retained earnings account (increase). If there is a net loss
there will be a debit to the retained earnings account (decrease).
Homework Prepare and Complete Child First Safety on page 142 on your
own