Chapter 3

The Accounting Cycle

Steps in the accounting cycle

There are several steps that are usually followed in the accounting process within an accounting
period. These are repeated every accounting period during the 'life' of the business. They make
up what is known as an accounting cycle. The figure below presents a graphic illustration of the
accounting circle.

Source Documents of
Accounting Transactions

Recording in the Journal

[Books of Prime Entry]

Posting to the Ledger

[periodically]
Repeatingtheprocess

Preparation of the
Trial Balance

Recording and Posting

Adjusting Journal Entries

Preparation of
Financial Statements

Recording and Posting

Closing Journal Entries

The successive steps that make up the accounting cycle are:

(a) Journalizing - From source documents the dual effect of each transaction is analyzed and
recorded in chronological order in books of prime entry or journals.

(b) Posting – This is the process of transferring the debit and credit entries from the journals
to the respective accounts in the ledgers.

(c) Preparing a Trial Balance - A list of the balances of all accounts in the ledger is
extracted at a particular date in order to check the arithmetic equality of the debit and
credit balances and to provide a summary of the data from the ledger.

(d) Preparing Adjusting Entries - End-of-period adjustments are made by journalizing and
posting events which need to be included at the end of the period in order to update the
accounts. An adjusted trial balance is normally prepared after adjusting entries have been
22 Introductory Financial Accounting

made.

(e) Preparing Financial Statements - Usually an income statement (profit and loss account)
and balance sheet are prepared from the adjusted trial balance. A cash flow statement is
prepared from details of the income statement and the balance sheet.

(f) Preparing Closing Entries - Entries are made to close temporary accounts like revenue
and expense accounts. Closing entries reduce the balance of these accounts to zero.

Journals or books of prime entry

The primary function of journals is to provide a chronological history of the transactions of a
business. Journals serve as a formal connecting link between the source document of a
transaction and the appropriate ledger accounts. Journals provide more information regarding a
transaction than the ledger accounts, and they show clearly the dual effect of each transaction.
The term 'journalize' is used to describe the process of recording the various aspects of a
transaction in one or more books of prime entry.

A journal entry should include the following information:

(a) Date of the transaction

(b) Titles of the accounts to be debited and credited
(c) Amounts to be debited or credited
(d) A brief narration or explanation of the transaction, where relevant.

The journals will also contain a column for posting reference or folio. This column will show to
which account numbers in the ledger the various journal entries have been posted. A firm will
have a number of books of prime entry or journals. The most basic starting point is however, the
General Journal, sometimes also known as the Journal Proper. The general journal is the simplest
form of a journal and uses a two-column format. In a small business organization a general
journal may serve the purpose of recording all accounting transactions.

General Journal page no.

Date Details Folio Debit Credit

As shown above, the general journal contains the following columns:

(a) Date - The date of the transaction is entered in this column; the year, month and day. It
is not necessary to repeat the year and month on the same journal page.

(b) Details - This column contains the titles of accounts to be debited and credited and a
brief narration of the transaction. The account debited is written first and the account
credited is written on the following line, indented a little bit so as to distinguish it from
the debit account. On the next lines a concise narration of the transaction is written.

(c) Folio - This is a posting reference column. It contains the ledger pages or reference
numbers of the accounts to which the journal entry has been posted. This column is left
blank at the time of journalizing and is filled only when the posting is done from the
journal to the ledger accounts.
 The Accounting Cycle 23

(d) Debit - This column is for the amount debited.

(e) Credit - This column is for the amount credited.

Example

In July 200X, A. Raisi started a tailoring shop. Following are his transactions for the first week.

July 1 He opened the shop with capital consisting of a sewing machine costing shs.
50,000 and shs. 3,000 in cash.
2 He bought thread, needles and other sewing supplies costing shs. 500.
3 He completed a shirt for a customer and received shs. 400 for his services.
4 His neighbour M. Jumanne asked him to repair two pairs of trousers which he
has done. He was promised to be paid shs. 300 at the end of the month.
5 He sewed a baby's dress and was paid shs. 200 by the baby's mother.
6 He bought chairs for his shop from Mwenge Furniture Mart for shs. 2,000 on
credit.

These transactions are recorded as follows:

General Journal page 1

Date Description Folio Debit Credit
200X
July 1 Cash 3,000
Sewing Equipment 50,000
A. Raisi, Capital 53,000
Owner's initial investment in the
business
2 Sewing Supplies 500
Cash 500
Bought sewing supplies for cash
3 Cash 400
Sewing Income 400
Payment received for services
rendered.
4 M. Jumanne 300
Sewing Income 300
Amount receivable for services
rendered
5 Cash 200
Sewing Income 200
Amount received for sewing a
dress
6 Shop Furniture 2,000
Mwenge Furniture Mart 2,000
Bought chairs for the shop on credit
24 Introductory Financial Accounting

Posting to ledger accounts

Posting of journal entries to ledger accounts is aided by the use of a chart of accounts. A chart of
accounts is a list by classification of all accounts in the ledger. There are different ways of
classifying accounts, the most commonly used classification is one that categorizes between
Assets, Liabilities, Capital, Revenues and Expenses. These could further be broken down into
sub categories. Assets for example, could be broken into fixed and current; liabilities between
current and long term, etc..

A. Raisi Tailoring Shop uses the following Chart of Accounts for its General Ledger.

Chart of Accounts
Account title Account number
Assets:
Fixed Assets
Sewing Equipment 01
Shop Furniture 02
Current Assets
Debtors - M. Jumanne 11
Cash 12
Liabilities:
Creditors – Mwenge Furniture Mart 21
A. Raisi, Capital 31
Sewing Income 41
Sewing Supplies 51

The journal entry of 1st July will be posted to the respective ledger accounts as follows:

General Journal page 1

Date Description Folio Debit Credit
200X
July 1 Cash GL 12 3,000

Sewing Equipment GL 01 50,000

A. Raisi, Capital GL 31 53,000

Owner's initial investment in the

business.

Sewing Equipment Account no. 01

Date Details Fol. Debit Date Details Fol. Credit

200X
Jul 1 Capital GJ1 50,000

Cash Account no. 12

Date Details Fol. Debit Date Details Fol. Credit

200X
Jul 1 Capital GJ1 3,000
 The Accounting Cycle 25

A. Raisi, Capital Account no. 31

Date Details Fol. Debit Date Details Fol. Credit

200X
Jul 1 Cash GJ1 3,000
1 Equipment GJ1 50,000

It is noticed that the same date in the journal entry is used in posting to the accounts. The debits
of shs. 3,000 to cash and shs. 50,000 to sewing equipment in the journal are posted to the debit
sides of the Sewing Equipment Account and Cash account; whereas the total credit of shs.
53,000 to A. Raisi, Capital in the journal was transferred to the credit side of that account in the
ledger.

During the posting procedure, the folio column is filled after each amount in the journal is
transferred to the ledger account. The folio column of the journal contains the ledger account
reference numbers for Cash (GL 12), Sewing Equipment (GL 01) and A. Raisi Capital (GL 31).
On the other hand, the folio columns of these accounts in the ledger show “GJ 1” which is the
page number of the journal where the transaction was originally recorded. A transaction can
always be traced from the ledger to the journal or from the journal to the ledger. This is what
cross-referencing is all about, the ease with which one can keep track of a transaction.

The details column of each ledger account shows the corresponding account where the particular
entry has been recorded. For example, the debit entry in cash account has a corresponding credit
entry in the capital account.

After all the journal entries of the first week of July have been posted, the general ledger will
look as shown below:

General ledger

Sewing Equipment Account no. 01

Date Details Fol. Debit Date Details Fol. Credit

200X
Jul 1 Capital GJ1 50,000

Shop Furniture Account no. 02

Date Details Fol. Debit Date Details Fol. Credit

200X
Jul 6 Mwenge Furniture GJ1 2,000
Mart
26 Introductory Financial Accounting

M. Jumanne Account no. 11

Date Details Fol. Debit Date Details Fol. Credit

200X
Jul 4 Sewing Income GJ1 300

Cash Account no. 12

Date Details Fol. Debit Date Details Fol. Credit

200X 200X
Jul 1 Capital GJ1 3,000 Jul 2 Sewing Supply GJ1 500
Jul 3 Sewing Income GJ1 400
Jul 5 Sewing Income GJ1 200

Creditor Mwenge Furniture Mart Account no. 21

Date Details Fol. Debit Date Details Fol. Credit

200X
Jul 6 Shop Furniture GJ1 2,000

A. Raisi, Capital Account no. 31

Date Details Fol. Debit Date Details Fol. Credit

200X
Jul 1 Cash GJ1 3,000
Jul 1 Equipment GJ1 50,000

Sewing Income Account no. 41

Date Details Fol. Debit Date Details Fol. Credit

200X
Jul 3 Cash GJ1 400
Jul 4 M. Jumanne GJ1 300
Jul 5 Cash GJ1 200

Sewing Supply Account no. 51

Date Details Fol. Debit Date Details Fol. Credit

200X
Jul 2 Cash GJ1 500
 The Accounting Cycle 27

At this point A. Raisi could check the equality of debits and credits to ensure that the double
entry system has been followed by preparing a trial balance, the third step in the accounting
cycle. A Trial balance is a list of all balances extracted from the ledger. Depending on the nature
of the accounts some will have debit balances and others credit balances. An account is balanced
by summing separately each of the debit and credit amount columns. If debit column amount
total exceeds the credit column total, the difference is known as a debit balance. If the credit
amount column exceeds the debit amount column, the difference is known as a credit balance.
The trial balance for the illustration on 6th July, 200X is as seen below:

A. Raisi Tailoring Shop

Trial Balance as at 6th July, 200X

Account title Debit Credit

Sewing Equipment 50,000
Shop Furniture 2,000
Debtor - M. Jumanne 300
Cash 3,100
Creditor - Mwenge Furniture Mart 2,000
A. Raisi, Capital 53,000
Sewing Income 900
Sewing Supply 500
Total 55,900 55,900

The trial balance shows that the debit total equals the credit total. However, this does not
guarantee that no error has been committed. The intricacies related to errors in the trial balance
will be discussed in depth in a later chapter.

A. Raisi could also find out how much profit he made in the first week of operation by preparing
an income statement or a profit and loss account. Adjusting entries are ordinarily prepared at the
end of an accounting period. Therefore this step in the accounting cycle is not illustrated here. A
simple Income Statement for A. Raisi Tailoring Shop is shown below:

A. Raisi Tailoring Shop

Income Statement
For the week July 1-6-200X

Shs.
Sewing Income 900
less: Sewing Supply expense 500
Net Profit 400

The Net profit of shs. 400 will increase A. Raisi's net worth or equity in the business. At the end
of the first week on 6th July, 200X, the assets, liabilities and owner's equity of the Tailoring
Shop may be summarized in a balance sheet as follows:
28 Introductory Financial Accounting

A. Raisi Tailoring Shop

Balance Sheet
As at 6th July, 200X

Shs. Shs.
Assets:
Fixed Assets
Sewing Equipment 50,000
Shop Furniture 2,000
Total Fixed Assets 52,000
Current Assets:
Cash 3,100
Debtor - M. Jumanne 300
Total Current Assets 3,400
Less: Current Liabilities:
Creditor - Mwenge Furniture Mart 2,000
Net Current Assets 1,400
Long term Debt 0
Total Net Assets 53,400
Financed by:
Owner' Equity
A. Raisi, Capital 53,000
add: Net Profit 400
Total Owner's Equity 53,400

This balance sheet shows the financial position of A. Raisi Tailoring Shop at 6th July, 200X.
Although it is possible to prepare financial statements anytime, these statements are required at
least once, at the end of an accounting period.

The foregoing example illustrated a business which offers services. Business firms engaged in
trading, manufacturing or other business lines follow the same steps in the accounting cycle.
 The Accounting Cycle 29

Review questions
1. What is the ledger and how does one balance the accounts in the ledger?

2. Why is it necessary to prepare a trial balance before financial statements are finalized?

3. If you were actually to inspect the accounts maintained by a business, would you expect
to find ‘T’ - accounts? Why?

4. Briefly explain the nature of a journal entry.

5. What are the main differences between an account and a journal entry?

6. Could entries to the general ledger accounts be made directly from the source
documents? What do you think are advantages of this approach? And what would be the
disadvantages?

7. List the steps of the accounting cycle described in this chapter.

Exercises
1. I. Jaha extracted the following balances from his ledger on 31st December. Present them
in a form of a Trial Balance.

Account titles Amount (Shs).

Cash in hand 25,000
Cash at bank 625,000
Sales 7,265,000
Purchases 2,350,000
Motor vehicles 1,250,000
Rent and rates 125,000
Light and electricity 60,000
Carriage inward 50,000
Carriage outward 35,000
Opening stock, 1st January 1,825,000
Miscellaneous income 130,000
Capital 8,000,000
Drawings 850,000
Laborers wages 1,520,000
Office salaries 980,000
Debtors 2,365,000
Creditors 565,000
Furniture 800,000
Land and buildings 4,600,000
Loan from NBC 1,500,000

2. Heri started business on 1 July 200X. The following transactions took place during the
month of July.
30 Introductory Financial Accounting

July

1 Introduced shs. 4,000,000 and a car valued at shs. 1,750,000.

2 Bought goods for cash at a cost of shs. 1,130,000.

8 Paid wages of shs. 13,000 and miscellaneous expenses of shs. 2,000.

9 Sold goods on credit to Vishindo for shs. 190,000.

14 Sold goods on credit to Somo for shs. 240,000.

18. Bought goods on credit from Walei for shs. 85,000.

22 Bought office furniture at a cost of shs. 350,000 cash.

25 Paid wages of shs. 38,000 cash.

26 Paid drawings to himself of shs. 80,000.

31 Vishindo paid the full amount owing.

31 Paid rent of shs. 50,000 cash.

Required:

(a) Prepare journal entries to record the above transactions for the month of July.

(b) Post the journal entries to the relevant ledger accounts.

(c) Balance off the accounts and extract a trial balance at 31st July 200X.

Problems
1. Emma owns a shop and had been in business for two months when her balance sheet at
30th June 200X was as shown below:

shs shs
Assets:
Fixed Assets
Buildings 3,000
Shop Furniture 3,000
Total Fixed Assets 6,000
Current Assets:
Cash 700
Debtor - Perry 300
Total Current Assets 1,000
Less: Current Liabilities
Creditor - Gro-fit 1,000
Creditor - Super-fit 1,500
Total Current Liabilities 2,500
Net Current Assets (1,500)
 The Accounting Cycle 31

shs shs
Total Net Assets 4,500
Financed by:
Owner' Equity: 4,500

Following are Emma’s business transactions for the month of July:

July 1 Purchased goods on credit from Gro-fit for shs. 500,000

2 Cash Sales shs. 1,000,000.
3 Sold items of shs. 300,000 on credit to Lea.
4 Paid Gro-fit shs. 300,000.
5 Perry paid shs. 300,000.
8 Cash sales shs. 900,000.
9 Purchased furniture shs. 350,000 cash.
10 Sold goods on credit to Perry for shs. 400,000.
11 Sold goods on credit to Maneno for shs. 150,000.
16 Purchased goods on credit from Super-fit for shs. 2,000,000.
17 Purchased items from Gro-fit on credit for shs. 1,000,000.
19 Paid Super-fit shs. 3,300,000.
21 Maneno paid shs. 150,000 in settlement of his account.
28 Made cash sales shs. 2,300,000.
31 Paid Gro-fit shs. 900,000.

Required:

(a) Record the above transactions in the journal and post to the ledger accounts.

(b) Balance off the accounts in the ledger.

(c) Extract a trial balance as at 31st July 200X.

2. Write up all the accounts necessary to record the following transactions in the books of
G. Tembo, and show the balance sheet at the end of December.

200X
Dec. 1 Started business with shs. 2,500,000 cash.
2 Bought office furniture cash shs. 15,000.
3 Bought machinery shs. 75,000 on credit from Mipango & Co.
5 Bought a motor van paying shs. 600,000.
8 Bought goods for resale from Adela Enterprises shs. 200,000 on credit.
15 Sold goods on credit to Kelia shs. 300,000.
17 Paid the amount owing to Mipango & Co. shs. 750,000 by cheque.
23 Received the amount due from Kelia shs. 300,000 in cash.
31 Bought more machinery by cash shs. 280,000.
31 Drew out shs. 100,000 for own use.

3. Using a general journal, record the following transactions and post the entries to
appropriate accounts in the general ledger.

Mar. 1 Invested shs. 50,000 cash in the business.

3 Bought merchandise on credit, shs. 18,000.
6 Paid cash for shop supplies, shs. 3,000.
7 Sold merchandise for cash, shs. 10,000.
32 Introductory Financial Accounting

10 Paid shs. 5,000 to a trade creditor.

11 Sold merchandise on credit, shs. 16,000.
14 Bought merchandise for cash shs. 7,000.
17 B. Asha took shs. 2,500 for personal use.
25 Collected shs. 6,000 from trade debtors.
30 Received and paid electricity bill shs. 1,500.

4. Record the following transactions as journal entries:

(a) Purchase of shs. 100,000 of goods on credit.

(b) Withdrawal of shs. 10,000 cash by the owner for his daughter’s birthday party.
(c) Collection of shs. 10,000 from Imamu Jones who is a credit customer of the
firm.
(d) Return of shs. 10,000 of goods to a supplier because they are faulty. The
original purchase was on credit terms and has not been settled.
(e) Payment of shs. 150,000 by the business to a supplier on account of an amount
due.
(f) Purchase of machinery for shs. 300,000 on credit.
(g) Additional cash of shs. 100,000 invested in the business by the proprietor.
(h) Payment of shs. 120,000 in cash for goods supplied.
(i) Obtained a loan of shs. 1,000,000 from NBC through a bank account at Ubungo
Branch.

5. Daktari Jaribu, DDS has her own dental practice. Her books had the following accounts
and balances as of 1st October.

Cash shs. 341,200, Debtors shs. 597,500, Office Supplies shs. 39,000, Equipment shs.
3,012,500, Surgery Supplies shs. 155,000, Creditors shs. 96,500 and Capital shs.
4,048,700.

Following are transactions in the practice of her profession during October.

Oct. 1 Paid office rent for October shs. 80,000.

2 Purchased equipment on credit shs. 290,000.
3 Purchased X-ray film and other surgery supplies on credit shs. 25,000.
5 Received cash on account from patients shs. 472,500.
9 Paid cash to creditors shs. 175,000.
14 Paid cash for renewal of insurance policy shs. 51,000.
17 Paid from the business shs. 170,000 being personal and family
expenses.
20 Received and paid October invoices for laboratory analyses shs. 31,500.
22 Cash received from cash paying patients shs. 295,000.
24 Paid miscellaneous expenses shs. 11,200.
26 Received and paid October electricity bill shs. 32,500.
30 Recorded all fees charged to credit patients for services performed
during October shs. 571,500.
30 Recorded use of shs. 55,000 worth of surgery supplies.

Required:

(a) Open ledger accounts and insert opening balances.

(b) Record the above transactions in a two-column journal.
(c) Post the journal to the ledger.
 The Accounting Cycle 33

(d) Balance off the ledger.

(e) Extract a trial balance.