Question

Question 6

a). With the aid of relevant examples, explain the steps of the accounting cycle.
(10 marks)

b. Outline five (5) reasons for the discrepancy between the cash book and the bank
statement. (5 marks)

Answer 1

a. Following are the major steps involved in the accounting cycle. We will use a simple example problem to explain each step.

Lets follow an example to understand accounting cycle steps. Cynthia works as an accountant for a medium-sized company that manufactures toys. Cynthia's job is to process the financial information of her company and prepare financial statements. These financial statements will be reviewed by management to help make business decisions. In order to perform her work, Cynthia follows a series of steps for the collection, processing and reporting of financial transactions called the accounting cycle.

Step One: Collection and Analysis

Cynthia must first collect and analyze all of the financial transactions undertaken by her company. She analyzes each transaction in order to determine how it affects the financial health of the company. For example, Cynthia will review all the sales conducted each day and all payments made to suppliers.

Step Two: Journalizing the Transactions

After collecting all of the financial transactions, Cynthia records each transaction in the general journal. A general journal is a journal where all financial transactions are recorded in chronological order as they occur. For example, Cynthia will record all of the company's sales for each day in the general ledger.

Step Three: Post to General Ledger

Once all the entries have been recorded in the general journal, Cynthia will then post the transactions to the general ledger, which is organized by account. The company has a set of accounts where each type of transaction belongs. The list of accounts is called a chart of accounts. For example, she will record sales in the sales account and bills in expense accounts such as utilities, supplies and marketing. She may post to the general ledger at the end of the week or month.

Step Four: Unadjusted Trial Balance

After all the transactions have been posted to the general ledger in the appropriate accounts, Cynthia will prepare an unadjusted trial balance. Cynthia needs to ensure that the debits and credits in the general ledger are balanced. For every debit entry, there should be a credit entry that keeps the books in balance. For example, if Cynthia finds a receipt for some supplies purchased by her company, she'll debit the amount as an asset in the appropriate account and credit the vendor's account as the amount paid (or payable) to the supplier.

Debits are recorded on the left side of the account, and credits are recorded on the right side of the account. In order for the general ledger to be in balance, the total value of debits must be equal the total value of credits. If Cynthia finds that an account is not in balance, she'll need to find out why and correct the problem.

Step Five: Adjustments

Cynthia will next make any necessary adjustments to bring accounts and balances up to date. Since Cynthia's company utilizes an accrual accounting method, income is recognized when earned, and expenses are recognized when incurred. This means that Cynthia will record income even if the company hasn't received the money, and she will record expenses even if the company has yet to pay the bill. Cynthia needs to make sure that all income earned and expenses incurred are recorded before she proceeds to the next step.

Step Six: Adjusted Trial balance

An adjusted trial balance is a trial balance which is prepared after the preparation of adjusting entries. Adjusted trial balance contains balances of revenues and expenses along with those of assets, liabilities and equities. Cynthia will prepare the said adjusted trial balance which can be used directly in the preparation of the statement of changes in stockholders' equity, income statement and the balance sheet.

Step Seven: Preparation of closing entries

Closing entries are based on the account balances in an adjusted trial balance.Temporary accounts include

1. Revenue, Income and Gain Accounts
2. Expense and Loss Accounts
3. Dividend, Drawings or Withdrawals Accounts
4. Income Summary Account

Cynthia will pass closing entries are journal entries made at the end of an accounting period which transfer the balances of temporary accounts to permanent accounts.

Step Eight: Preparing post-closing trial balance

A post-closing trial balance is a list of balances of ledger accounts prepared after closing entries have been passed and posted to the ledger accounts. Since the closing entries transfer the balances of temporary accounts (i.e. expense, revenue, gain, dividend and withdrawal accounts) to the retained earnings account, the new balances of temporary accounts are zero and therefore they are not listed on a post-closing trial balance. However, all the other accounts having non-negative balances are listed including the retained earnings account.

The preparation of post-closing trial balance is the last step of the accounting cycle and its purpose is to be sure that sum of debits equal the sum of credits before the start of new accounting period. It provides the openings balances for the ledger accounts of the new accounting period.

b. Reasons for discrepancies between bank statement and cash book

Some of the reasons for a difference between the balance on the bank statement and the balance on the books include:

• Outstanding checks
• Deposits in transit
• Bank service charges and check printing charges
• Errors on the company's books
• Electronic charges and deposits that appear on the bank statement but are not yet recorded in the company's records