Question

Discuss the accounting cycle including transaction analysis, the accounting equation, journalizing transactions, and posting transactions to the general ledger. Discuss the importance of the unadjusted trial balance, the need for adjusting journal entries and explain deferrals and accruals. What is the purpose of the adjusted trial balance? How is it used to help prepare the financial statements? Compare and contrast permanent and temporary accounts and the process of closing the temporary accounts.

Answer 1

Accounting Cycle

An Accounting cycle start with a transaction and ends when books of account gets closed.The accounting cycle runs within the accounting period.The goal of accounting cycle is to produce financial statements for the company.

Eight Steps in Accounting Cycle

• Analyze transaction by examining source documents(example:- Invoice).
• Journalize transactions in the journal.
• Post journal entries to the accounts in the ledger.
• Prepare a trial balance of accounts(includes Adjusting entries).
• Prepare financial statements.
• Journalize and post adjusting entries.
• Journalize and post closing entries.
• Prepare a post-closing trial balance

Accounting Equation

The Accounting Equation is considered to be the foundation of Double entry accounting system.Based on this Double-entry system,the accounting equation ensures that the balance sheet remains "balanced," and each entry made on debit side should have a corresponding entry on the credit side.

The accounting equation Formula is given below :

Assets = Liability + Capital

Importance of unadjusted trial balance

The unadjusted trial balance is the listing of general ledger account balances at the end of a reporting period, before any adjusting entries are made to the balances to create finanacial statements.It is used as a starting point for analyzing account balances and making adjustment entries.

Adjusting journal entries: accruals and deferrals

Adjusting entries are required at the end of each accounting period to align the revenues and expenses to the "right" period,in accordance with the Matching principle in accounting.Adjusting entries generally occur before Financial statements are released.In general there are two types of adjusting journal entries: accruals and deferrals.

• Accruals: Revenues or expenses that should be reported now, but have not yet been recorded.
• Deferrals: Receipts of assets or payments of cash in advance of revenue or expense recognition.

Purpose of Adjusted trial balance

An adjusted trial balance is a listing of all the company accounts that will be reported on the financial statements after the adjusting journal entries have been made for an accounting period.This is not considered as a financial statement, because it is only used as an internal document.It is used to verify that the total of the debit balance in all accounts equals the the total of all credit balances in all accounts and to prepare financial statements.

Permanent and Temporary accounts

Permanent accounts are also called real accounts because they do not get closed up at the end of financial year.These accounts stay open as long as the company remains in business.Real accounts are all assets accounts, liabilities and equity accounts.

Temporary accounts are also called Nominal accounts.Temporary accounts are accounts that go into your income statements(Profit and Loss Account) plus drawings account.These accounts get closed at the end of the financial year because they do not carry any balance into the following year.

Process of closing Temporary accounts:

• closing the revenue accounts-transferring the credit balances in the revenue account to a clearing account called Income summary.
• closing the expense accounts-transferring the debit balances in the expense account to a clearing account called Income summary.
• closing the Income summary account-transferring the balance of Income Summary account to the Retained Earnings account.

Accountants may perform the closing process monthly or annually.Only revenue and expense account are closed-Not asset and liability accounts.