Chapter 4
Adjusting entries of journals/ trial balance is done to close the books of accounts into the retained earnings; retained earnings is the basis of preparing the income statement and subsequent financial statements. For the most part, the process is complicated, however accounting software easily captures and automates the entire process. Nonetheless, it is essential to have an understanding of the underlying process that is involved in adjusting entries. The accounting cycle entails;
transactions are recorded in the journal
journal entries are posted to appropriate ledger accounts
a trial balance is constructed
adjusting entries are prepared and posted
an adjusted trial balance is prepared
formal financial statements are produced (perhaps with the assistance of a worksheet)
A worksheet can be used for adjustment; the worksheet contains columns for the trial balance, column reflecting adjustments to the trial balance, the final trial balance, the income statement, retained earnings and the statement of financial position (B sheet).
The trial balance contains credit and debit balances of the company, any adjustments are made under the adjustment column, and an updated version of the same is presented in the adjusted trial balance and extended to the income statement, retained earnings account, and the balance sheet.
In essence, the entire process primarily seeks to update the retained earnings balances in the ledger account to be equivalent to those at the end of period balances. Temporary accounts (dividends, expenses, and retained earnings are zeroed out while items in real accounts are carried forward to the next accounting period in the b/sheet.
All expenses and incomes are represented in the income statement with a positive balance (profit), and a negative one is a loss.
A net profit is an income and therefore credited to the income account and debited to retained earnings accounts. The profit is carried to the balance sheet under the equity section.
Income statement XXX
Retained Earnings XXX
A net loss is treated oppositely such that
Net loss is credited to the income statement and debited to retained earnings, and corresponding adjustments are made to the b/sheet. In sum;
Retained Earnings XXX
Incomes Statement XXX
Other assets and liabilities are closed off to the balance sheet. The balance sheet contains the assets, liabilities, and equity.
Important metrics for measuring a company’s liquidity are the quick ratio and the current ratio (can be easily manipulated because of the inclusion of inventory) and the quick ratio.
Financial statements should be accompanied by notes.
Chapter Five
Merchant Operations; these are online-based stores
The layout of the income statement begins with revenues minus the operating expenses, which is equal to a profit or a loss.
Recognition of sales is pegged on the nature of sales; credit sales are treated as follows;
A/C receivables XXX
Sales A/c XXX
Cash sales
Sales XXX
Sales returns and allowances have the effect of reducing debtors (credit sales) and the sales increase such that
Sales A/C XXX
Debtors A/C XXX
Trade discounts are given to promote customers to purchase in bulk and also pay promptly. Trade discounts reduce the amount the customer would pay and is, therefore, an expense to the business. Sales are recognized net trade discounts.
Online stores typically require credit cards for payments. Customers using the same are charged a given interest. The benefit is that the merchant is able to receive an immediate payment of the goods and services. Sales are recognized in full and the accompanying interest charge on the credit card is billed as an expense.
Merchants give their suppliers cash discounts to encourage them to pay promptly within a stipulated period. The discount is an expense to the company that reduces the amount the customer (the debtor) would have paid.
To stay afloat, companies, need to have a proper inventory system in place. Inventory management starts from acquisition of the inventory for resale. Recording of the same can be done periodically or immediately that is following acquisition, then resale. Purchase a/c keeps track of inventory purchases. At purchases the inventory a/c is debited as stock has increased while the purchase a/c is credited under cost of goods sold.
Similar to returns on sales, purchases made ca also be returned. Purchase returns and allowances reduce the amount the company would have paid to its suppliers such that;
Account payables XXX
Purchase ReturnsXXX
Purchase discounts
Just like the business gives its customers discounts, the company’s suppliers also offer trade discounts to encourage prompt payments. The company may recognize the same as under gross or net valuations.Most important to note is that purchase discounts are an income to the business as they reduce the amount payable to the creditors.
Freight in charges are mostly covered by the company, and therefore a company takes in the freight charge (an expense too) as part of the total purchase cost. To this point the net purchases are calculated as;
To get the total cost of goods sold; Opening Stock + Purchases+ Freight in Charges- Purchase discounts + Purchase Returns – closing stock
There is no point of maintaining a purchase account as accounting systems automatically adjusts the inventory.
Following all these introductions, ie the purchase account; the P&L A/c is prepared to meet reflect on additional items; this can be done on a multiple or singular format.
Most importantly, it is crucial to have in place an accounting system that can trace all the processes within a platform of accountability. A control system is put in place to ensure reliability as well as to safeguard a company’s assets. They include all the processes that accompany accounting transactions. For instance, a company’s physical assets can be safeguarded by locks or CCTV cameras.
Purchases of assets should follow a laid down procedure from a purchase requisition such that a requisition for supply is made after analyzing several quotations. After a requisition, then comes delivery, how will the items be tracked? A delivery note should accompany all the items and staff should be put in place to ensure that the items meet the terms of sale. Items should then be entered into the inventory system and updated. The subsequent trail should be in paper as well as on the online system. Payment of the invoices should also follow strict controls.
As to cash control, cash should be safely secured from the bank to the company’s safe.Only one or two personnel should have the key to the safe should, and CCTV cameras should be put to monitor movements in and out of the safe house. The cashier in charge of distributing money to the company say for petty cash should do so after approval from the finance head. In most cases, the accountant asks for a specified amount of petty cash. The amount should be documented with signatures from all those that are responsible for approving to such payments. Once the cashier receives the petty cash, all payments say travel reimbursements or medical should be accompanied by receipts, such that the cashier will give a specified sum and attach the receipt as proof of the payment. The party receiving the payment should also sign after accepting payment. For cash wages, the supervisor should include a list of all the names of the employees, their ID, and corresponding signatures. The laborers may have to collect money physically with their IDS and then sign after receiving payments. Lastly, the cashier should reconcile all the cash payments and ensure that the balance in hand equals what she has in the petty cash box. Essentially, this process seeks to document the trail of cash throughout the company as well as provide accountability to how the company’s cash is spent.
Chapter six_ Cash and Highly-Liquid Investments
In accounting cash is not only presented in coins and currency but also comprise of money orders and deposits with banks. Generally, cash is treated as a liquid current asset. However, cash and cash equivalent cannot be easily transferred and is thus recognized as a long term investment to the company.
With this said, a company needs to manage its cash such that it has enough in store to meet its day to day obligation and invest the excess amounts to generate income for the company. A company resorts to internal and external strategies to manage its cash flows. Internal policies comprise of several activities within the company such as delaying payments, putting in place cash controls and accelerating collection points such as using credit cards for collection.
Movement of cash in and out of business is reasonable. Cash may thus come in as physical cash from cash receipts and through banks as credit sales from credit cards or customers making cheque deposits.It becomes crucial to manage cash flows to see, thus how much the company has. Bank reconciliation is a process that attempts to reconcile the differences in bank statements to those in the company’s cash ledger accounts. For the most part, differences are inevitable as the business may have recognized cheques that are yet to be presented to the bank and the bank may charge bank charges and interest that the company has not recognized. Companies that deal with huge cash disbursements and receipts perform a proof in cash reconciliation in addition to the bank reconciliation to eliminate periodic differences in cash and bank balances.
Petty cash is needed for daily company expenditures. The control system for cash discussed above have tackled this discussion. However, the entries for petty cash has not been discussed. Even though the journal entry represents easily debiting the petty cash a/c and crediting the corresponding bank balance where the money has been withdrawn from it is important to note that journal entries to this transaction involve debiting the appropriate expense account as is represented by the receipts to replenish the cash account. Therefore, at the end of the day we have the expense accounts which will be closed off to the income statement and the cash balances which will be closed off to cash/bank in the b/sheet.
Petty cash balances may also differ such that there are differences in the cash and receipt balances. This could be as a result of errors in giving change or an amount that was paid off without a corresponding receipt of proof. When this happens, there is need to reconcile the differences by debiting the petty cash a/c with a shortage and crediting it with an over excess amount. Debiting and crediting corresponding balances will offset the differences in the receipt and cash balances. To this end I realize that an accountant may be required to pay in case of an undercharge or isn’t so?
As earlier said, a business may seek avenues such as stock market, hedge funds, derivatives, futures, forwards, and so on to invest the extra cash from the business to generate income. This happens as with time; the value of the investment grows to surpass its fair value. Unfortunately, the investment may also fail to grow and instead generate losses.The journal entry below help understands the process.

  • When the company makes short term investments they withdraw cash from the bank ac to the short term investments (both are assets) an increase in assets, therefore;
  • An increase in fair value results to gains such that there is an increase in short term investment (increases in assets are always debited), and an increase in incomes (credited)
  • On the contrary, realized losses have an opposite effect such that
  • Investment may also earn dividends or interest charges all which represent incomes to the company such that dividends/ interest received from the company are credited and the amount received debited to bank/cash

Short term investment Dr
Bank A/cCr
Short term investment XXX
Realized gains from investmentsXXX
Realized losses XXX
Short Term investment XXX
Cash/Bank XXX
Dividend/ interest income XXX
Other companies choose to maintain the changes in short term investment using a valuation account. The valuation account primarily highlights the changes in the investment reflecting on the gains or losses.Losses are debited on the income statement and gains credited, the realized gain or loss is netted to the cash/bank in the b/sheet.