UNIVERSITY OF TECHNOLOGY, JAMAICA

SCHOOL OF BUSINESS ADMINISTRATION

FUNDAMENTALS OF ACCOUNTING
THE ACCOUNTING CYCLE

The accounting cycle is the sequence in which data is recorded and processed until it becomes a
part of the financial statements at the end of accounting period. It begins with the analysis and
journalizing of business transactions and ends with the preparation of a post closing trial balance.

The primary purpose of the procedures is the preparation of the Statement of profit or loss and
the statement of financial position.

It is critical that one understands fully all stages of the accounting cycle for later studies in
accounting. The following are the primary stages in the accounting cycle:

1. Transactions are analysed from source documents (a source document is primary

document used originally to analyse and record transactions in the journal e.g. invoices
and vouchers)
2. Transactions are recorded in a journal
3. Transactions are posted to the ledger (from the journal).
4. The Trial balance is prepared, data needed to adjust accounts determined
5. Adjusting and closing entries are journalized and posted to the ledger
6. Adjusted trial balance
7. Prepare financial statements
8. Close accounts
9. Post- closing trial balance is prepared.
Even though to journalize is a part of the first phase in the accounting cycle, one
must fully understand double entry in order to journalize. Therefore we will look
first at the double entry system of recording information in the ledgers. After we
have mastered the double entry system we will then return to the journal.

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THE FUNDAMENTAL ELEMENTS OF ACCOUNTING

The fundamental elements of accounting are:

1. Assets
2. Liabilities
3. Equity

The elements are defined in the International Accounting Standards Board’s (IASB) “Framework
for the presentation of financial statements" as follows”:

Assets: a resource controlled by the enterprise as a result of past events, from which future
economic benefits can be derived. (IASB framework)

In simple terms assets can be defined as economic resources owned or controlled by the
business.

Jason Riley decides to start a fresh fruits shop with a motor van valued at $350,000, a shop
valued at $1,000,000 and a loan in bank of $450,000.

Jason Riley’s assets at the start of the business are as follows:

Motor van $350,000

Shop $1,000,000
Cash in bank $450,000
Total Assets $1,800,000

The calculated total assets of Jason’s Fresh Fruit Stop is $1,800,000 and is made up of three
different items.

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Liabilities: a present obligation of the enterprise arising from past events, the settlement of
which is expected to result in an outflow of resources embodying economic benefits. (IASB
framework)

In simple terms, liabilities can be defined as the debts owed by the business entity. These include
loans, bank overdraft, and other accounts payable. In the above case the only liability existing at
the start of Jason Riley’s business was the loan for $450,000.

Total Liabilities $450,000

Equity:is the residual interest in the assets of the enterprise after deducting all its liabilities.
(IASB)

It can also be defined as the investment of economic resources, belonging to the investor in a
business entity owned by the investor.

We can analyse his equity as follows:

Motor van $350,000

Shop $1,000,000
Equity $1,350,000

Note that the economic resources invested in the business by Jason Riley and which belong to
him constitute his equity. Hence his equity is comprised of only the value of motor van and the
value of the shop. Total equity is therefore $1,350,000. The cash in bank of $450,000, represents
resources borrowed by the owner and is therefore classified as a liability.

From the above example it will be seen that the assets of Jason Riley total $1,800,000, his
liabilities $450,000 and equity $1,350,000.

What is the relationship among these three items?

ASSETS = LIABILITIES + EQUITY

$1,800,000 = $450,000 + $1,350,000

This equation commonly referred to as the accounting equation.

Equity plus liabilities must always be equal to assets, and this is the principle upon which an
entity’s balance sheet is prepared. This equation may also be expressed in the form:

Assets – Liabilities = Equity

This form of the equation shows the residual effect and the definition of equity.

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Lecture Example 1:

JoniBenton started a furniture business on July 5 2014. At this date he invested $300,000 cash,
inventory of lumber $200,000 and a truck valued at $800,000. During the period July 5 to July
31 2014 the following transactions took place:

July 6 Bought office furniture by cash $40 000.

July 15 Received a loan from BIBC Bank $450,000, the cash is in bank
July 20 Bought machinery paying by cheque $200 000
July31 Bought more lumber by cash $10 000

Calculate the equity of JoniBenton at July 31, 2014.

It is critical that you know from this early stage that equity is only increased if:

a) the business makes a profit

b) more resources are is invested

And in reverse, equity is only decreased if the business:

a) makes a loss
b) resources are taken from the business for private use (drawings)

The above information can be written in the form of two equations:

1. Opening equity + Net income – Drawings + additional investment = Closing equity

2. Opening equity - Net loss – Drawings+ additional investment = Closing equity

Or one extended version

1. Opening equity + net income – net loss +additional investment by owner – drawings
= Closing equity

Note

Drawings are defined as resources taken from the business for private use by the owner.

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TUTORIAL QUESTIONS
PROBLEM SET 1

1. Answer true or false to the following statements

a) Equity is decreased if an entity uses cash to buy machinery

b) Assets+ Equity = Liabilities
c) Equity can be termed a liability
d) Assets – Liabilities= Equity
e) Equity is increased if the owner takes goods from the business for personal use

2. If total assets increased by $60,000 during a period of time and total liabilities increased
by $36,000 during the same period, the amount and direction (increase or decrease) of the
periods change in equity is:

a) $96 000 increase

b) $96 000 decrease
c) $24 000 increase
d) $24 000 decrease

3. The starting equity of a business was $300,000. During the year the business incurred a
net loss of $40,000 and closing equity was $200,000. Calculate the drawings for the
period.

4. _____________ are resources controlled by the enterprise as a result of past events and
from which future economic benefits are expected to flow to the enterprise

5. Miss Muffet is a sole trader and had assets of $659,100 and liabilities of $398,840 on 1
September 2012. During the year ended 31 August 2013 she paid $7,500 capital into the
business and she paid herself wages of $500 per month.At 31 August 2013, Miss Muffet
had assets of $660,130 and liabilities of $469,770.

What is Miss Muffet’s profit/loss for the year ended 31 August 2013?

a) $71,400 Loss
b) $71,400 Profit
c) $76,900 Loss
d) $76,900 Profit

6. The starting equity of Baryon Enterprise was $250,000. During the year the $56,000 was
taken as drawings. If the closing equity is $367,000, what is the profit or loss for the
year?

7. The net income earned by a business in the year ended 31 December 2012 was $10,600.
Equity at January1 2012 was $183,400 and at 31 December 2012 equity was $169,700.

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 The proprietor took merchandise costing $2,800 for personal use during the year. He also
withdrew a regular amount of cash to cover his living expenses
What is the amount of cash drawings for the year?

a) $22,400
b) $21,500
c) $11,800
d) $ 5,900

8. Jennifer Young started a dress making business on April 1, 2014 with the following:

Sewing machines $310,000

Stock of fabrics and threads $80,000
Cash in bank $60,000
Loan from BNF Bank $150,000
Amount owing to Pings Fabric $34,000
Motor Car $65,000

What was her Equity on April 1 2014?

9. Sophia Campbell started a tuck shop business on March 1, 2013. At that date she had the
following assets and liabilities.
Cash at bank $65,000
Motor van $450,000
The following transactions took place during the month of March 2013.

 Purchased fixtures and fittings by cheque $12,000

 Additionally invested $10,000 in the business
 Received loan by cash from RolandInnes $60,000
 Bought office equipment on credit from Courts $20,000
 Took $3,000 out of the bank to pay for a new dress for her birthday

Calculate the equity of Sophia Campbell at March 31, 2013.

10. Classify the following items into assets and liabilities:

a) Motor van
b) Premises
c) Account payable for goods
d) Inventory
e) Water bill owing to NWC
f) Prepaid insurance
g) Cash at bank
h) Patents and copyrights
i) Bank overdraft
j) Account Receivable for goods