CHAPTER 2

ACCOUNTING CYCLE
INTRODUCTION
In order for businesses to look back on how they did in the past, they need to
follow a certain set of steps to verify that their financials are accurate. These
steps are commonly referred to as the accounting cycle because, after each
accounting period has ended, businesses repeat the same basic steps.
A series of steps are completed during each accountings period to record,
store, and report the accounting information contained in the recorded
transactions. These steps are referred to as the accounting cycle. The major
steps include:
1. Analyzing the transaction.
2. Journalizing the transaction.
3. Posting from the Journals to General Ledger.
4. Preparing the Unadjusted Trial Balance.
5. Recording Adjusting Entries.
6. Preparing the Adjusted Trial Balance.
7. Preparing Financial Statements.
8. Recording Closing Entries.
9. Preparing a Closing Trial Balance.

10. Reversing Entries

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NATURE OF AN ACCOUNT
Within the accounting system, accounts are used to store the recorded
monetary information from the transactions or events. Separate accounts
are maintained for each asset, liability, revenue, expense, and other
stockholders‟ equity items. Examples of these accounts include Cash, Accounts
Receivable (that is, amounts due from customers), Building, Accounts Payable
(that is, amounts owed to suppliers), Mortgage Payable, Sales revenue, Salaries
Expense, Purchases, Capital Stock, Retained Earnings, and Dividends
distributed.
 An account is an individual record of increases and decreases
in a specific asset, liability, stockholders' equity, revenue, or expense
item.
In its simplest form, an account consists of three parts:
 A title,
 A left or debit side, and
 A right or credit side.
Because the format of an account resembles the letter T, we refer to it as a T-
account.
Example

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CLASSIFICATIONS OF ACCOUNTS
Accounts are classified into five: assets, liabilities, capital, and revenue and,
expenses. The first three are called balance sheet accounts and the other two
are called income Statement accounts. Balance Sheet accounts are those
reported on the balance sheet at the end of the reporting period and Income
Statement accounts are reported on the Income Statement.
The five groups of account are discussed below

1. Assets: Resources owned by a business or individual are called assets.

Assets could be tangible or intangible. Tangible assets are assets having
physical existence, like cash, land, computer, stationery materials. Intangible
assets do not have physical existence. Example: Goodwill, Copyright, patent
right.
On the balance sheet assets are classified into two current assets and non –
current assets.
Current Assets – are those assets, which can be used, sold, or converted into
cash within one accounting year. Example: cash, supplies, prepayments,
receivables etc.
Non-current Asset: All assets other than current assets are called non-current
assets. Example: land, patent right, office equipment, vehicles.

2. Liabilities: Creditors‟ claims to the assets of a business; amounts owed to

creditors are called liabilities. Like assets, liabilities are classified in to two as
current liabilities and non – current liabilities

Current liabilities: The liabilities that are payable within the next (one)
accounting year are known as current liability. Example: Accounts Payable,
Rent Payable, Salary Payable.

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Non – Current Liabilities: Debts that are not required to be paid within the next
accounting period. Example long term notes payable.
3. Capital: The excess of the assets of a business over its liabilities is referred to
as capital. It is the equity of the owner in the business.
4. Revenue: Are increases in owner‟s equity resulting from the main operations
of the business. Examples of revenue accounts are sales, interest income,
tuition fee, and sales commission.
5. Expenses: are decreases in owner‟s equity in the process of earning revenue.
For example, a hotel has to pay salary to its workers for the services rendered to
clients in order to get the income form customers (revenue) the Hotel has pay
salary to the employees (expense). Example of expenses: Salary, insurance,
depreciation, supplies, utilities, rent etc.
CHART OF ACCOUNTS
The number and name of accounts used by an organization depends on the
nature of its operation. The list of accounts used by an organization and their
codes is called the chart of accounts. Look at the following chart of accounts of
Gion Transport.

Gion Transport
Chart of Accounts

Asset Account number

Cash--------------------------------------------------------------------------11
Accounts Receivable------------------------------------------------------ 12
Supplies----------------------------------------------------------------------13
Prepaid Insurance-----------------------------------------------------------14
Equipment------------------------------------------------------------------- 15
Accumulated Depreciation –Equipment---------------------------------16

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Truck--------------------------------------------------------------------------17
Accumulated depreciation – Truck----------------------------------------18

Liabilities
Accounts Payable-------------------------------------------------------------21
Notes Payable-----------------------------------------------------------------22

Owners Equity
EyobAdem, Capital----------------------------------------------------------31
EyobAdem Drawing-------------------------------------------------------32
Income Summary-------------------------------------------------------------33

Revenue
Service income----------------------------------------------------------------41

Expense
Salaries Expense --------------------------------------------------------------51
Rent Expense ------------------------------------------------------------------52
Utilities Expense---------------------------------------------------------------53
Supplies Expense--------------------------------------------------------------54
Insurance Expense-------------------------------------------------------------55
Maintenance Expense---------------------------------------------------------56
Depreciation Expense---------------------------------------------------------57
Truck Expense-----------------------------------------------------------------58
Miscellaneous expense--------------------------------------------------------59

In the chart of accounts, the asset accounts are listed according to their
liquidity. Liquidity is the ease with which an asset can be converted in to cash.
Cash is the most liquid asset so it is listed first. Accounts other than cash will be
listed in their frequency of use
The account number is a code to identify accounts. The number could be a two
digit, three digit or more digits.

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 RULES DEBITS AND CREDITS

As shown above every account has three parts. These parts are discussed below:

Title – The name of the account.

 This is written at the top of the account.

Debit – is the left hand side of an account

 Debit is abbreviated as „Dr.‟
 When an amount is entered on the left side of an account we say the
account is debited or charged.
Credit – is the right hand side of an account.
 Credit is abbreviated as Cr.
 An account is said to be credited when an amount is entered on the
right hand side of the account.

An account may increase or decrease on the debit side or on the credit side
depending on the nature of the account. In general, accounts appearing on the
left hand side of the accounting equation increase on their left side (Dr. side) and
decrease on their right side (Cr. Side); whereas accounts on the right side of the
equation increase on their right side and decrease on their left side.

The above general rule will be expanded as follows

Debit Credit
-Increase in assets -Decrease in assets
-Increase in expenses -Decrease in expenses
-Decrease in capital -Increase in Liabilities
-Decrease in liabilities -Increase in liabilities
-Decrease in revenue -Increase in revenue.

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The normal balance of an Account
Normal balance refers to the side of an account (Dr. or Cr.), which will have
greater entries than the other. The increasing side will be the normal balance for
accounts.

Example: The normal balance of all asset accounts is debit

STEP 1 – ANALYSING THE BUSINESS TRANSACTIONS

The accounting process starts with the analysis of business transactions. A
business transaction is any financial event that changes the resources of a firm.
For example, purchases, sales, payments, and receipts of cash are all business
transactions. The accountant analyzes each business transaction to decide what
information to record and where to record it.

STEP 2 - JOURNALIZING BUSINESS TRANSACTIONS

A journal is often called a “document of original entry” because a

Company’s transactions (and events) are initially recorded here. All
transactions could be recorded in a single journal, called the general journal.
However, most corporations have a number of different special journals, each
designed for the recording of a particular type of business transaction.

The focus in this section is on the general journal. This journal consists of a
date column, a column to list the accounts affected by each transactions, a
column to list the account numbers, and a debit column and a credit column for
listing the amounts to be recorded as a debit or credit to each account.

Just below the listing of the accounts a written explanation of the transaction is
presented. The process of recording the transaction in the journal is called
Journalizing. The resulting entry is referred to as a Journal entry.

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A number of advantages result from the use of a general journal (and special
journals). First, use of this journal helps in preventing errors. The accounts and
debit and credit amounts for each transaction are initially recorded on a single
journal page rather than directly in the numerous accounts. This makes it easier
to verify the equality of the debits and credits. Second, all the transactional
information (including the explanation) is recorded in one place, thereby
providing a complete “picture” of the transaction. This second advantage is
especially useful during the auditing process or if an error is discovered later in
the accounting cycle because reference can be made back to the general journal
to determine the nature of the original transaction. Finally, since the transactions
are recorded in chronological order, the journal also provides a chronological
record of the Company‟s financial transactions.

The process of recording a business transaction in the accounting record is

called journalizing.
The Journal commonly used to record all types of transactions is the General
Journal. This Journal includes the following parts, entered step by step.
1. The date of the transaction
2. The title of the account debited
3. The title of the account credited
4. The amount of debit and credit
5. Brief explanation of the entry or reference to the source document.

Look at the following General Journal and notice where each of the above
information is found.

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 Journal page
Date Description P.R Debit Credit
Year
Month day Debited account title XX
XXX
Credited account title X XX
XX
Explanation

There are also other types of Journals like, known as special journals that are
used to record specific types of transactions. The cash Journal, for instance, is
used to record only transactions affecting cash.
Steps in Journalizing a Transaction
The following steps should be followed in recording a transaction in the journal.

1. Record the date - Insert the year, the month, and the date as shown above.
2. Record the Debit- Insert the account debited in the description column
and the amount of debit in the debit column.
3. Record the credit- Insert the account credited below the debited account
and indented to the right in the description column and the amount of
credit in the credit column.
4. Explanation- Write a brief explanation or reference to source document
in the description column, when necessary.
Each one set of debits and credits for a transaction is called a journal entry.
In recording a business transaction answer the following questions based on the
transaction to be recorded may help you.
a) Which accounts are affected?
b) Is each account increased or decreased?
c) Which account is debited and which is credited?

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 d) Prepare the complete journal entry.

Example. On January 10,2013 Yordanos P.L.C paid Birr 6,000 to its

employees as a salary for the first week of the year.

This business transaction will be analyzed and recorded as follows.

a) Which accounts are affected? Answer: Cash and Salary Expense.
b) Is each account increased or decreased?
 Answer: cash is decreased and
 Salary expense is increased.
c) Which account is debited and which is credited?
 Answer: Salary Expense is debited because increase in expenses is
recorded on the debit side.
 Cash is credited because decrease in assets is recorded on the
debit side.
d) Prepare the complete Journal entry.

2013 Description
Jan. 10 Salary expense 00
6000
Cash 6000 00
Payment of salary

Note: A journal entry is the complete presentation of the record in the journal.

Illustration
To illustrate the complete accounting cycle, we will consider the following list
of selected transactions. The transactions were completed by Gion Transport in
the month of January 2013 .

January 1. Ato Eyobtook Birr 450,000 from his personal savings and deposited
it in the name of Gion transport.
January 2. Gion Transport purchased two used trucks for Birr 150,000 each, on
cash.

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January 4. Gion Transport received a check for Birr 650 for services given to
Hana Trading.
January 4. Received an invoice for truck expenses Birr 90.
January 11. Paid Birr 600 for Awash Insurance Company to buy an insurance
policy for its trucks.
January 16. Ato Eyobissued a check for Birr 9,400 to the workers as a salary for
two weeks.
January 20. Gion trading Billed Muradu Supermarket for goods transported
from Djibouti to Gondar Birr 2,650
January 21. Ato Eyobwrote a check for birr 450 to have one of the trucks
repainted
January 21. Gion trading purchased stationary materials and other supplies of
Birr 740 on account
January 22. Office equipment of Birr 11,600 is bought on account.
January 23. Purchased an additional truck for Birr 250,000 paying birr 100,000
in cash and issuing a note for the difference.
January 23. Recorded services billed to customers on account birr 14,600.
January 25. Received cash from customers on account Birr 15,000.
January 27. The owner withdrew Birr 500 in cash for his personal use.
January 28. Paid Birr 9,400 to workers as a salary for the last two weeks of the
month.
January 30. Paid telephone expense of Birr 95 and electric expenses of Birr 125
for the month.
January 30. Paid other miscellaneous expenses Birr 50.
January 31. Paid Birr 4,000 as a rent for a building used for office space.

These transactions are journalised as follows:

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Date Description Debit Credit
2013 Cash 450,000
Jan.1 EyobCapital 450,000
To record investment by owner
2 Truck 300,000
Cash 300,000
Purchase of trucks
4 Cash 650
Service Income 650
Cash received from customers
4 Truck Expenses 90
Accounts Payable 90
Service received in advance
11 Prepaid Insurance 600
Cash 600
Purchase of insurance policy
16 Salary Expense 9,400
Cash 9,400
Payment of salary
20 Accounts Receivable 2,650
Service Income 2,650
Provision of service
21 Truck Expense 450
Cash 450
Cash paid to repaint truck
21 Supplies 740
Accounts Payable 740
Purchase of supplies of account
22 Office Equipment 11,600
Accounts Payable 11,600
Purchase of equipment
23 Truck 250,000
Cash 100,000
Notes Payable 150,000
Purchase of truck
23 Accounts Receivable 14,600
Service Income 14,600
Provision of service on account

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25 Cash 15,000
Accounts Receivable 15,000
Collection of cash
27 Drawings 500
Cash 500
Owner withdrawals
28 Salary Expense 9,400
Cash 9,400
Payment of salary
30 Utilities Expense 220
Cash 220
Payment for telephone, electricity
30 Miscellaneous Expenses 50
Cash 50
Payment for various expenses
31 Rent Expense 4,000
Cash 4,000
Payment of Rent

STEP 3-POSTING FROM THE JOURNAL TO THE LEDGER

In a manual system each account is listed on a separate standardized business
paper. A general ledger is the entire group of accounts for a Company. It
might take several forms, such as a computer storage location on a tape or disk,
or in the case of our manual system a loose-leaf binder with a page for each T-
account.
 Once a Company‟s transactions and events have been journalized in a
general journal, each account (that is, financial information storage
record) within the general ledger must be updated.
 This is accomplished through the process of posting. Posting entails
transferring the date and debit and credit amounts from the journal entries
in the general journal to the appropriate debit and credit sides of the
applicable accounts in the general ledger. Thus, after posting, the general

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 ledger accounts contain the same information as in the general journal,
just in a different format.
An account could be of two types; the two-column account and the four-column
account. We will use the four-column account for our illustration. The two
forms of accounts are given below.
The two-column account:
Account Account number
Date It e m P.R Debit Date Item P.R Credit

STEP 4 – PREPARING TRIAL BALANCE

After the journal entries have been prepared and posted for the accounting
period, the balance in each account is determined. Then a trial balance is often
prepared.
 A trial balance is an accounting working paper that lists all the
general ledger accounts and their account balances.
These account balances are listed in either the debit or the credit column. The
trial balance is used to verify that the total of the debit balances is equal to the
total of the credit balances.
If a trial balance does not balance, an error has been made. To find the error,
the debit and credit columns of the trial balance should be re added. If the
column totals do not agree, the amounts in the debit and credit columns should
be checked to be sure that a debit or credit account balance was not mistakenly
listed in the wrong column.

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 Gion Transport
Trial Balance
January 31, 2013

Cash 41,030 00
Accounts Receivable 2,250 00
Supplies 740 00
Prepaid Insurance 600 00
Office equipment 11,600 00
Truck 550,000 00
Accounts payable 12,430 00
Notes payable 150,000 00
Eyobcapital 450,000 00
Eyobdrawing 500 00
Service income 17,900 00
Salary expense 18,800 00
Rent expense 4,000 00
Utilities expense 220 00
Maintenance expense 450 00
Truuck expense 90 00
Miscellaneous expense 50 00
Total 630,330 00 630,330 00

Proof Provided by the Trial Balance

The trial balance debit totals and credit totals are equal implies that the
accounting work is more likely to be free from any one or more of the following
errors.

1. Error in preparing the trial balance including

-Addition error
-The amount of an account balance was in correctly listed on the trial
balance
- A debit balance was recorded as a credit or vice versa
- A balance was entirely omitted.

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 2. Error in posting, including
- An erroneous amount was posted to the account.
- A debit amount was posted as a credit or vice versa
- A debit or credit posting was omitted
Limitations of the Trial Balance
The trial balance amounts are equal doesn‟t mean that the accounting work is
free from error. That is, there are errors that may take place without affecting
the trial balance totals. Some examples are mentioned below:
- Failure to record a transaction or to post a transaction
- Recording the same erroneous amount for both the debit and the credit
parts of a transaction.
- Recording the same transaction more than once.
- Posting part of a transaction to the correct side but the wrong account.
Note: All these errors have the same affect (increasing or decreasing) on the
debit totals and credit totals
STEP 5-ADJUSTMENTS
All the transactions recorded above in the journalizing step are the result of daily
transactions. Other transactions result from the passage of time or from the
internal operations of the business. For example, insurance premiums are paid
for a certain period of time and expire during that time period. Another example
is office supplies such as paper, pens & pencils.
At the end of the period the balances in accounts such as supplies and prepaid
insurance must be brought up to date. The supplies account balance, for
example, must be credited by the consumed part of the supplies, debiting
supplies expense.

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Example. Stationary materials totaling Birr 1,900.00 were purchased and
recorded during the year. At the end of the year, only Birr 150 of the supplies
are left in hand.
The adjusting entry prepared at the end of the year to adjust the supplies account
will be

2013 Supplies expense 1,750

Dec 31 Supplies 1,750
Note: 1. Adjustments are dated as the last day of the year.
2. The accounting year here – we assume, runs from January 1- December 31.

Additional examples on adjustments will be given below under the topic

„worksheet‟

The Accrual Basis and the Cash Basis of Accounting

1. The cash basis of accounting – In this basis of accounting revenues are

reported in the period in which cash is received and expenses are reported
in the period in which cash is paid. Net in come will, therefore, be the
difference between the cash receipts (Revenues) and cash payments
(expenses). This method will be used by organizations that have very few
receivables and payables. For most businesses, however, the cash basis is
not an acceptable method.

2. The accrual basis of accounting – Under this method revenues are reported
in the period in which they are earned, and expenses are reported in the
period in which they are incurred. For example, revenue will be recognized
as services are provided to customers or goods sold and not when cash is
collected. Most organizations use this method of accounting and we will
apply this method in this course.

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The Matching Principle

This principle states that the expense of a period have to be matched with the
revenue of that period regardless of when payment is made. In order to do this,
the accrual basis of accounting requires the use of an adjusting process at the
end of the period so that revenues and expenses of the period will be determined
properly.

Worksheet for Financial Statements

Most of the data required to prepare the accounting reports (financial
statements) is now gathered. The data will now be presented in a convenient
form. The worksheet is a large columnar sheet prepared to arrange in a
convenient form all the accounting data required to prepare financial statements.
The worksheet has a heading and a body.
The heading has three parts:
i) Name of the Organization
ii) Name of the form (worksheet)
iii) Period of time covered.
The body contains five main parts each of them with two main columns. These
parts are
1. The trial balance
2. The adjustment
3. The adjusted trial balance
4. The income statement
5. The balance sheet.
The worksheet for Gion Transport is given below. The five parts of the body are
discussed as follows. You are advised to read and understand the discussions
before you look at the respective columns of the worksheet.

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 Gion Transport
Work Sheet
For the month ended jan.31, 2013
Account Title Trial Balance Adjustment Adjusted Trial Income Balance sheeet
balance statement
1 Cash 41,030 41,030 41,030
©
2 Accounts 2,250 7,400 9,650 9,650
receivable
(a)
3 Supplies 740 340 400 400
(b)
4 Prepaid 600 450 150 150
Insurance
5 Office equipment 11,600 11,600 11,600
6 Truck 550,000 550,000 550,00
0
7 Accounts payable 12,430 12,430 12,430
8 Notes payable 150,000 150,000 150,00
0
9 EyobCapital 450,000 450,000 450,00
0
10 Eyobdrawing 500 500 500
©
11 Service income 17,900 7,40 25,300 2530
0 0
12 Salary expense 18,800 18,800 18,800
13 Rent expense 4,000 4,000 4,000
14 Utilities expense 220 220 220
15 Maintenance 450 450 450
expense
16 Truck expense 90 90 90
17 Miscellaneous 50 50 50
Expense
18 630,330 630,330

19 Supplies (a)
340 340 340
expense
20 Insurance (b)
450 450 450
expense
21 8190 8190 637,730 637,730

22 Net income ` 900 900

23 25300 2530 613,33 613,33
0 0 0

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1. The trial balance column – this is the same trial balance we have prepared
before. The trial balance column of the work sheet can be brought direct from
the ledger or from a separate trial balance.
2. The Adjustment column – As mentioned previously, some account balances
have to be adjusted at the end of the year.

The accounts in the ledger of our illustration that require adjustment and the
adjusting entry for the accounts are presented below.
a) Supplies – The supplies account has a debit balance of Birr 740. The cost of
supplies in hand on July 31 is determined to be Birr 400. The following
adjusting entry is required to bring the balance of the account up to date:

Supplies expense…………………………….340
Supplies……………………………………..340
b) Prepaid insurance – Analysis of the policy showed that three – fourth
of the policy is expired. That is only Birr 150 of the policy is applicable to
future periods. The adjusting entry to transfer the expired part of the insurance
to expense will be.
Insurance expense ……………………….450
Prepaid insurance………………………..450
c) Service Income – At the end of the month unbilled fees for services
performed to clients totaled Birr 7,400.

This amount refers to an income earned but to be collected in the future. The
journal entry to record it will be
Accounts receivable………………………….7400
Service income………………………………7,400

All the above adjusting entries will be inserted in the adjustment column of the
worksheet in front of the accounts affected.

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Note – The letters a, b & c are used to cross-reference the debits and credits to
help future review of the worksheet.
3. The Adjusted Trial Balance Column – The accounts that require
adjustment are now adjusted. Transferring the trial balance column amounts
combined with the adjustment column amounts will complete the adjusted trial
balance column of the worksheet.
4. The income statement and the balance sheet columns – Transfer the
income statement account balances (revenue &expenses) to the income
statement and balance sheet account balances (Asset, Liability & owners‟
equity) to the balance sheet columns. Note that what we have to transfer is the
adjusted trial balance column amounts, to the corresponding columns.
STEP 6- PREPARATION FINANCIAL STATEMENT PREPARATION
After the work sheet is completed financial statements could be prepared easily.
In chapter one we have discussed four basic financial statements prepared by
most organizations. Here, we will prepare three of these statements for Gion
Transport form the worksheet.

1. Income statement -all the data required to prepare the income

statement is brought from the worksheet.

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 Gion Transport
Income statement
For the month ended. Jan 31, 2013

Service Income ……………………………………………………Birr 25,300

Operating expenses
Salary expense………………………..Birr 18,800
Rent……..…………………………………….4,000
Maintenance expense ……………………… 450
Insurance “ ……………………………450
Supplies “ …………………………….340
Utilities “……………………………..220
Truck “ …………………………….. .90
Miscellaneous “………………………………50
Total operating expense…………………………………24,400
Net Income………………………………………………Birr 900
2. Statement of owner’s equity – This statement shows the beginning balance
of capital and the changes that affected it.
The balance of the owners equity account (Eyobcapital) in the worksheet may
not be the beginning one. Therefore, the ledger has to be reviewed to see if there
was an additional investment during the priod or not. In our illustration there is
no additional investment.
Gion Transport
Statement of Owner’s equity
For the month ended January 31, 2013

Eyobcapital January 1, 2013 ………………………………Birr 450,000

Net income for the month………………….birr 900
Less: Withdrawal…………………………...500 400
Eyob capital, January 31, 2013 …………………….Birr 450,400

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 3. Balance sheet – The data to prepare this statement will be taken from the
worksheet and the other financial statements. Note that assets and
liabilities are classified as current and non – current
Gion Transport
Balance sheet
January 31, 2013
Assets
Current Assets:

Cash…………………………………………Birr 41, 030

Accounts Receivable…………………………….. 9,650
Supplies…………………………………………… 400
Prepaid insurance…………………………………….150
Total current assets……………………………………………Birr 51,230
Plant Asset (None-Current Assets):

Office equipment……………………………..Birr 110,600

Truck……………………………………………550,000 561,600
Total asset………………………………………………………Birr 612,830

Liabilities
Current liabilities
Accounts payable……………………………..Birr 12,430

Non-current liabilities
Notes payable……………………………………..150,000

Total liabilities……………………………………………………Birr 162,430

Owner’s equity

Ato Eyob Capital……………………………………………………….. 450,400

Total liability and owners equity………………………………….Birr 612,830

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STEP 8- CLOSING PROCESS
 Some of the accounts in the ledger are temporary accounts used to classify
and summarize the transactions affecting capital (owner‟s equity). These
accounts will be closed after financial statements are prepared. That is, their
balances will be transferred to the Capital account. The temporary
accounts that have to be closed are revenue, expense and withdrawal
accounts.

Steps in closing:

a. Closing revenue accounts - Debit each revenue account by its balance and
credit the „Income Summary‟ account by the total revenue for the period.
Note: Income summary is an account used to close revenue and expense
accounts. This account will immediately be closed to the capital account at the
end of the closing process.
b. Closing expense accounts – Debit the income summary account by the total
of expenses for the period and credit each expense account by its balance.

c. Closing the income summary account – Income summary will be closed to

the capital account. The balance of his account depends on the nature of
operation; credit if result is profit and debit if result is loss.
d. Closing Withdrawal – Debit the owners equity account by the total of
drawings for the period and credit the drawing account.
The temporary accounts of Gion transport are closed as follows.

2013 Income summary………………….25,300

January Service income…………………………………25,300
31 Closing revenue

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 31 Salary expense………………………..18,800
Rent expense……………………………4,000
Maintenance expense………………….. 450
Insurance expense………………………..450
Supplies expense…………………………340
Utilities expense………………………….220
Truck expense …………………………… 90
Miscellaneous expense…………………….50
Income expense…………………………………24,400
Closing expenses

2013 Income summary………………900

January 31 Eyob Capital………………………..900
Closing income summary
31 Eyob capital…………………...500
Eyob drawing………………………..500
Closing withdrawal

The above closing entries have transferred the balance of the temporary
accounts to the permanent capital account.
STEP 9- POST CLOSING TRIAL BALANCE
After the closing entries have been journalized and posted, a trial balance is
prepared to prove the equality of the general ledger before recording the New
Year’s transactions. It should be noted that this trial balance includes only
balance sheet accounts. This is because the temporary income statement
accounts are closed during the closing process. This trial balance is called the
post – closing trial balance.

In practice the ledger balance after closing may be checked by a simple

calculator print out rather than a formal trial balance. The post-closing trial
balance for Gion Transport is presented below.
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 Gion Transport
Post – Closing trial balance
Jan 31, 2013

Cash……………………………………………Birr 41,030
Accounts Receivable ………………………………...9,650
Supplies…………………………………………………400
Prepaid insurance……………………………………….150
Office equipment……………………………………11,600
Truck……………………………………………….550, 000
Accounts payable…………………………………………………….Birr 12,430
Note payable……………………………………………………………..150,000
Eyob capital……………………………………………………………..450,400
Total……………………………………Birr 612,830 Birr 612,830

STEP 10-REVERSING ENTRIES

After the accounts have been adjusted and closed for the current period, a new
accounting cycle is begun for the next accounting period. Prior to journalizing
the daily transactions of the new accounting period in the general journal, most
major companies will prepare reversing entries. A reversing entry is the exact
reverse (accounts and amounts) of an adjusting entry. Reversing entries are
usually made at the same time as closing entries but are dated the first day of the
next accounting period.
They are optional and have one purpose: to simplify the recording of a
subsequent transaction related to the adjusting entry.
Reversing entries enable the subsequent transaction to be recorded in a routine
fashion, without the need to consider the possible impact of the related adjusting
entry.

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As a general guideline, reversing entries should be made for any adjusting entry
that establishes a new balance sheet account. Consequently, reversing entries
should be made for:
Adjusting entries that establish accrued revenues or expenses to be collected or
paid in the next accounting period.
Adjusting entries related to prepayments of costs initially recorded as expenses
or receipts in advance initially recorded as revenues.
Reversing entries should not be made for:
1. Adjusting entries related to prepayments of costs initially recorded
as assets or receipts in advance initially recorded as liabilities.
2. Adjusting entries related to estimated items such as depreciation or
bad debts
These guidelines are just that, guidelines. They are no substitute for good
accounting judgment.
To summarize, reversing entries are not necessary but, if used, do reduce the
analyses related to subsequent transactions and increase operational
efficiency. If reversing entries are prepared, they are usually made to
eliminate the accrued items-that is, assets (such as Interest Receivable)
established as a result of recording accrued revenues, and liabilities (such as
Salaries Payable) established as a result of recording accrued expenses in the
adjusting entries. Reversing entries are also made if a Company initially records
a payment in advance as an expense instead of an asset and when a Company
initially records a receipt in advance as revenue instead of a liability and then
makes subsequent adjustments to establish an asset and a liability, respectively.

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