In Chapter 2, we introduced Overnight AutoService, a small auto repair shop formed on November I, 200 I. Early in jhis chapter, we journalized and posted all of Overnight’s balance sheet transactions through November 26. We intentionally chose not to illustrate how revenue’ and expense transactions were journalized and posted. However, we may safely assume that the November 30 revenue and expense transactions discussed in were recorded properly in Overnight’s accounting system.
Overnight’s transactions-in December are described on the following pages, along with an analysis of each transaction. and illustrations of the entries made in the company’s accounting records.
Dec. 1 Paid Daily Tribune $360 cash for newspaper advertising to be tun during December.
Dec. 2 Purchased radio advertising from KRAM to be aired in December. The cost. was $470. payable within 30 days
Dec. 4 Purchased various shop supplies (such as grease. solvents, nuts, and bolts) . from NAPA Auto Parts; cost $1,400, due in 30 days. These supplies are expected to meet Overnight’s needs for three or four month
Dec. 15 Collected $4,980’cash for repairs made to vehicles of Airport Shuttle Service.
In our illustration, journal entries were shown in a very abbreviated form. The ‘actual entries made in Overnight’s journal appear below. Notice that these formal journal entries ‘ include short explanations of the transaction, which include such details as the terms of credit transactions and the names of customers and creditors.
DECEMBER’S LEDGER BALANCES
Alter the posting of these December transactions. Overnight’s ledger accounts appear as shown on the following page. To conserve space, we illustrate these aCCOUIllS in “1 He- (,P”I~C rorm. But for convenience. we show in red the December 3!’bolana of each m;- count ilJehit balances appear to the left of the account; credit balances appear to the riZhl. we do notinclude the balances withill the accounts. because some of them will he udjusted in the next step in the accounting cycle.)
The accounts in this illustration appear ui financia! statement urder~that is. balance sheet accounts first (assets, liabilities, and owner’s equity). followed by income statement accounts (revenue and expenses).
THE ACCOUNTING CYCLE
The sequence of accounting procedures used to record, classify, and summarize counting information is often termed the accounting cycle. The accounting cycle begins with the initial recording of business transactions and concludes with the preparation of formal financial statements. The term cycle, indicates that these procedures must be repeated continuously to enablethe business to prepare new, up-to-date financial state- ments at reasonable intervals.
Thus far, we have (1) journalized (recorded) transactions and (2) posted each journal entry to appropriate ledger accounts. The steps in the cycle that remain include (3) preparing a trial balance, (4) making end-of-year adjustments, (5) preparing an adjusted trial balance, (6) preparing financial statements,”(7) journalizing and posting closing entries, and (8)’ preparing an after-closing trial balance. We will now address each of the re- ” ‘ maining aspects of the accounting cycle
THE TRIAL BALANCE
Since equal dollar amounts of debits and credits are entered in the, accounts for every transaction recorded, the sum of all the debits in the ledger must be equal to the sum of , all the credits. If the computation of account balances has been accurate, it follows that the total of the accounts with debit balances must be equal to the total of the accounts with credit balances .
Before using the account balances to prepare a balance sheet, it is desirable to prove ,that the total of accou ts with debit balances is in fact equal to the total of accounts with credit balances. This proof of the equality of debit and credit balances is called a trial balance. A trial balance is a two-column schedule listing the names and balances of all , , the accounts in the order in which they appear in the ledger; the debit balances are listed in the left-hand column and the credit balances in the right-hand column. The totals of the two columns should agree. A trial balance taken from Overnight’s ledger follows
Uses and Limitations of the Trial Balance
The trial balance provides proof that the ledger is in balance. The agreement of the debit and credit totals of the trial balance gives assurance that:
I. Equal debits and credits have been recorded for all transactions.
2. The debit or credit balance of each account has been correctly computed.
3. The addition of the account balances in the trial balance has been correctly performed.
Suppose that the debit and credit totals of the trial balance do not agree. This situation indicates that one or more errors have been made; Typical of such errors are (I) the posting of a debit as a credit, or vice versa; (2) .arithmetic mistakes in determining account balances; (3)’c1erical errors in copying account balances into the trial balance; (4) listing a debit balance in the credit column ofthe trial balance, or vice versa; and (5) errors in addition of the trial balance
The preparation of a trial balance does not prove that transactions have been correctly analyzed and recorded in the proper accounts. If, for. example, areceipt of cash were erroneously recorded by debiting the Land account instead of the Cash account, the trial balance would still balance. Also, if a transaction were completely omitted from the ledger, the error would not be disclosed by the trial balance. In brief, the trial balance proves only one aspect of the ledger; and that is the equality of debits and credits.