The accounting process

The chapter describes the main steps of accounting process and explains the essence   of double-entry bookkeeping system.

After studying this unit you should be able to:

1. Define accounting terms related to starting an accounting system.

2. Analyze accounting equation.

3. Use T accounts to analyze transactions showing which accounts are debited or credited for each transaction.

4. Enumerate all the steps of the accounting cycle.

5. Understand the purpose of double-entry bookkeeping system.

Active vocabulary:

accounting equation – бухгалтерське (балансове) рівняння

assets – активи

disbursement– виплата

dual aspect – подвійний аспект

entry – запис

equity – частка власності

general ledger –головна бухгалтерська книга

generally accessible–загальнодоступний

inventory – товарні запаси

invoice – рахунок-фактура, накладна

liabilities – пасиви

liability account – рахунок пасивів.

nominal account – номінальний рахунок; тимчасовий рахунок, що показує нарахування доходів та витрат лише за звітній період

on a continual basis – постійно

posting – проводка

real accounts – реальні рахунки; рахунки балансу; рахунки, на яких залишки зберігаються і після закінченні звітного періоду

receipt – квитанція

source  document – первинний документ

to maintain the balance – підтримувати баланс

trial balance – пробний баланс.

Text a starting an accounting system

Business owners and managers need accounting records in order to properly manage a business and prepare financial reports. Accounting information may be recorded by hand or by using accounting machines or computers. The kind of business and its size usually determine how its accounting records are best kept. Regardless of the accounting records kept, the concepts and principles are the same.

The Accounting Equation

A business owns things, such as cash, equipment, and supplies, which it uses to conduct its activities. Anything of value that is owned is called an asset. Financial rights to the assets of a business are called equities. A business owns the assets with which it conducts business. A business' owner has a financial interest in the business and therefore has rights to its assets. Individuals or other businesses to whom a business owes money also have rights to the business’ assets.

A business' accounting records are kept separate from records of indi­viduals or businesses that have equities in that business. Thus, a business' owner keeps one set of accounting records for the business and another set of records for personal finances. (CONCEPT: Business Entity)

There are two kinds of equities. (1) Equity of persons to whom a business owes money. An amount owed by a business is called a liability. (2) Equity of the owner. The value of the owner's equity is called capital. The value of an owner's equity is the amount remaining after the value of all liabilities is subtracted from the value of all assets.

An equation showing the relationship among assets, liabilities, and capi­tal is called an accounting equation. An accounting equation is most often written as:

Assets = Liabilities + Capital

Implementation of this equation begins with the recording of raw data – that is, the firm’s day-to-day financial transactions. It is accomplished through the double-entry system of bookkeeping.

The Double-Entry Bookkeeping System

Double-entry bookkeeping is a system in which each financial transaction is recorded as two separate accounting entries to maintain the balance shown in the accounting equation. Most often one entry changes the left (asset) side of the equation, and the other entry changes the right (liabilities + owners’ equity) side. However, for the few types of transactions the two entries change only one side of the equation. This occurs, for example, when cash (an asset) is used to purchase equipment (another asset).

How the Double-Entry Bookkeeping System Works

Suppose that John Thompson and Mark Martin each invest $25,000 in cash to start a new business. Before they make these investments, both sides of accounting equation are equal to zero. The firm has no assets no liabilities, and no owners’ equity. The results of their investments are shown as transaction A in Illustration 2-1. Cash (an asset) is increased by $50,000; owners’ equity is also increased by a total of $50,000 to balance the increase in assets.

Note that the entries for this transaction are not lumped together as one asset increase and the owners’ equity increase. Instead the entries are placed in separate accounts, which show exactly what is being increased. Here the investments are cash, so the Cash account is increased. Similarly, under owners’ equity, there is one account for Thompson and one for Martin.

Three additional transactions are shown in Illustration 2-1:

In transaction B, A bank loan of $10,000 was used to purchase equipment. The loan is a liability, and the equipment is an asset.

In transaction C, inventory worth $5,000 was purchased on credit. The inventory is an asset, and the amount owed is a liability.

In transaction D, $5,000 in cash was used to pay off part of the bank loan. The payoff decreases cash, an asset; the reduction of the loan amount decreases a liability.

	A ssets			Liabilities		Owrner's Equity
	Cash	Equipment	Inventory	Bank Loans	Suppliers	Tompson	Martin
Transaction A (cash investment)	+50000$	0	0	0	0	+25000$	+25000$
	50000$	0	0	0	0	+25000$	+25000$
Transaction B (equipment purchase via bank loan)	0	+10000$	0	+10000	0	0	0
	50000$	10000$	0	10000$	0	+25000$	+25000$
Transaction C (credit purchase of inventory)	0	0	+5000	0	+5000$	0	0
	50000$	10000$	+5000$	10000$	5000$	+25000$	+25000$
Transaction D (partial payoff of loan)	50000$	0	0	-5000$	0	0	0
	45000$	10000$	5000$	5000$	5000$	+25000$	+25000$

Four Business transactions are recorded using the double-entry system.

Double-entry bookkeeping is used to balance the accounting equation:

Assets = Liabilities + Owner's Equity

Follow through each of these transactions in Illustration 2-1 to make sure you understand why each entry is recorded as shown. Also note that, after all four transactions, assets total $60,000 and liabilities and owners’ equity total $60,000. Thus the books are still balanced. That is assets are indeed equal to liabilities plus owners’ equity.

The Accounting Cycle

In the typical accounting system, raw data are transformed into financial statements in five steps. The first three – analysis, journalizing, and posting – are performed on a continual basis throughout the accounting period. The last two – preparation of the trial balance and of the financial statements – are performed at the end of the accounting period.

Analyzing Source Documents The basic accounting data are contained in source documents, which are the receipts, invoices, cash register tapes, sales slips, and other documents that show the dollar values of day-to-day business transactions. The accounting cycle begins with the analysis of each of these documents. The purpose of the analysis is to determine which accounts are affected by the documents and how are they affected. Journalizing the Transactions Every financial transaction is next recorded in a journal – a process that is called journalizing. Transactions must be recorded in the firm’s general journal or in specialized journals. The general journal is a book of original entry in which typical transactions are recorded in order of their occurrence. An accounting system may also include specialized journals for specific types of transactions that occur frequently. Thus a retail store might have cash receipts, cash disbursements, purchases, and sales journals in addition to its general journal.

* When all the details of the transaction are finalised, the transactions should be posted. Once posted, the accounting information in the transaction cannot be modified—if you need to change it use the Cancel command. Transactions need to be posted to be credited or debited against the accounts that are assigned to them, and (where appropriate) to update the stock and/or the debtor's or creditor's balances. For this reason it is not possible to close a period which contains unposted transactions.

Next the information recorded in the general journal or specialized journals is transferred to the general ledger. The general ledger is a book of accounts that contains a separate sheet or section for each account. An account is a form used to sort and summarize changes in a specific item. Separate accounts for each item may be kept on cards, sheets, or in bound book form. Ledger accounts are a means of accumulating in one place all the information about changes in specific assets, liabilities, and owner’s equity. In its simplest form, an account has only three elements: (1) a title, consisting of the name of a particular asset, liability, or owner’s equity; (2) a left side, which is called a debit side; and (3) a right side, which is called a credit side. This form of account is called a T account because of its resemblance to the letter T.

Title of Account
Left or debit side	Right or credit side

An amount recorded on the left or debit side of an account is called a debit, or a debit entry; an amount entered on the right or credit side is called a credit, or a credit entry. Accountants also use the words debit and credit as verbs. The act of recording a debit in an account is called debiting the account; the recording of credit is called crediting the account. A debit to an account is sometimes called a charge to the account; an account is debited or charged when an amount is entered on the left side of the account.

Students beginning a course in accounting often have a preconceived but erroneous opinion about the meanings of the terms debit and credit. For example, to some people unacquainted with accounting, the word credit may carry a more favourable connotation than does the word credit. Such connotations have no validity in the field of accounting. Accountants use debit to mean an entry on the left-hand side of an account, and credit to mean an entry on the right-hand side. The students should therefore regard debit and credit as simple equivalents of left and right, without any hidden or subtle implication.

The process of transferring journal entries to the general ledger is called posting.

Accounts are usually arranged in the ledger in financial statement order, that is, assets first, followed by liabilities, owner’s equity, revenue, and expenses. The number of accounts needed by a business will depend on its size, the nature of its operations, and the extend to which management and regulatory agencies want detailed classification of information. An identification number is assigned to each account. A chart of accounts is a list of the accounts titles and account numbers being used by a given business.

Preparing the Trial Balance The trial balance is a summary of the balances of all general ledger accounts at the end of the accounting period. After all transactions for the period have been posted to the ledger accounts, the balance for each account is determined. Every account will have either a debit, credit or zero balance. A trial balance is a list of each account balance and it, therefore, indicates whether in total the debits equal the credits. Thus a trial balance helps provide a check on the accuracy of the recording and posting. It does not, however, guarantee that the recording and posting have been done correctly. Errors, such as posting an amount to the wrong account, are of course possible even though the trial balance does balance.

Preparing Financial Statements and Closing Books The firm’s financial statements are prepared from the information contained in the trial balance. This information is

presented in a standardized format to make the statements as generally accessible as possible to the various parties who may be interested in the firm’s financial affairs.

Once these statements have been prepared and checked, the firm’s books are “closed” for the accounting period. A new accounting cycle is then begun for the next period.

Key terms.

Account – рахунок – a record used to summarize all increases and decreases in a particular asset, such as Cash or any other type of asset, liability, owner’s equity, revenue, or expense.

Account balance – сальдо – the difference in dollars between the total debits and total credit of the account.

Accounting equation – бухгалтерське рівняння (балансове рівняння) – assets equal liabilities plus owner’s equity.

Assets – активи – economic resources (things of value) owned by a business which are expected to benefit future operations.

Chart of accounts – план рахунків – a listing of the ledger accounts titles and numbers being used by a given business.

Credit – кредит, права сторона рахунку – an amount entered on the right-hand side of an account. A credit is used to record a decrease in an asset and an increase in a liability or owner’s equity.

Credit balance – кредитове сальдо – the balance of an account in which the total amount of credits exceeds the total amount of debits.

Debit – дебет, ліва сторона рахунку – an amount entered on the left-hand side of an account. A credit is used to record an increase in an asset and a decrease in a liability or owner’s equity.

Debit balance – дебетове сальдо – the balance of an account in which the total amount of debits exceeds the total amount of credits.

Double-entry bookkeeping system – система подвійного запису – in recording transactions the total dollar amount of debits must be equal the total dollar amount of credits.

Entry – запис господарської операції – a record made in a book of account, register, or computer file of a financial transaction, event, proceeding, etc.

Equity – частка власності – a share of owner’s capital in a company.

Financial Statements – фінансові звіти – reports which summarize the financial position and operating results of a business (balance sheet and income statement).

Financial statement order – порядок запису статей у фінансовуму звіті – the usual sequence of accounts in a ledger; that is, assets first, followed by liabilities, owner’s equity, revenue, and expenses.

Journal (book of original entry) – журнал обліку господарських операцій – A chronological record of transactions, showing for each transaction the debits and credits to be entered in specific ledger accounts. The simplest type of journal is called a general journal.

Journalizing – фіксація трансакції в журналі обліку – the process of recording a transaction in a journal. To journalize means to prepare an entry in a journal.

Ledger – головна бухгалтерська книга – a loose-leaf book, file, or other record containing all the separate accounts of a business.

Liabilities – пасиви; залучені кошти – debts or obligations of a business. The claims of creditors against the assets of a business.

Owner’s equity – власний капітал – the excess of assets over liabilities. The amount of an owner’s net investment in a business plus profits from successful operations which have been retained in a business and minus losses.

Posting – проводка –the process of transferring information from the journal to individual accounts in the ledger.

Source (business) document – первинний документ – original evidence of transactions, as for example, cheque, sales tickets, and cash register tapes.

Trial balance – пробний баланс – a two-column schedule listing the names and the debit or credit balances of all accounts in the ledger.