Accounting Cycle and Financial Statement Preparation
What you must know
Follow the cycle: source documents → journals → ledger → unadjusted trial balance → adjusting entries → adjusted trial balance → financial statements → closing entries → post-closing trial balance. Master adjusting entries for accruals (accrued revenue, accrued expenses), deferrals (prepaid expenses, unearned revenue), estimates (depreciation, bad debts, inventory write-downs) and reclassifications (current/non-current). Know the structure of the statement of financial position (current vs non-current), the statement of profit or loss (function or nature of expense), other comprehensive income, the statement of changes in equity, and the statement of cash flows (operating, investing, financing).
Traps candidates fall into
- Reversing the direction of an accrual: an accrued expense increases a liability and an expense, not a prepayment.
- Forgetting that depreciation is an estimate, not a deferral, and that it affects both profit or loss and accumulated depreciation.
- Confusing closing entries (which zero temporary accounts) with adjusting entries.
- Misclassifying a bank overdraft repayable on demand as non-current.
- Omitting the tax effect when adjusting profit for the statement of changes in equity.
- Treating dividends declared but unpaid as an expense rather than a reduction of retained earnings and a liability.
Rule of thumb
Match every adjusting entry to the framework question: which element is unrecognised or misstated at year-end? Then record the minimum entry that fixes it and check that debits equal credits and that the cash flow statement reconciles opening to closing cash.
Worked example
Unearned revenue of 120,000 was received on 1 October for 12 months. At 31 December, three months are earned: debit unearned revenue 30,000, credit revenue 30,000. The remaining liability of 90,000 is current because it will be settled within twelve months.