Completing the accounting cycle

Financial statements are the main product of an accounting system. We move from our: opening balance sheet through transactions (in our general journal) posting their amounts to our ledger and using those amounts to prepare a trial balance, income statement, and final balance sheet.

The Adjustment Process It is important for financial statements to be up to date, so they can be comparable from year to year. Bringing accounts up to date is also called ‘making the adjustments.’

Adjusting Entries The journal entries needed to bring accounts up to date are called ‘Adjusting Entries.’ It is necessary to make these adjustments so the correct net income or loss can be determined.

Adjusting for Supplies The ‘Supplies’ account is allowed to become inaccurate from day to day (as supplies are used up). When supplies are purchased, their cost is debited directly to the Supplies account. Cash Supplies 200 200

Journal Entry The journal entry would have been: Supplies 200 Bank 200 Purchased supplies for cash

As supplies are used (usually daily) no accounting entry is made. Thus, when we get to the end of our fiscal period, we must make an ‘adjustment’ to the supplies account.

How do we figure out how much we’ve used? We do a physical count: Let’s say there’s $125 worth of supplies left. (so we must have used $75)

We make the adjustment by…. deducting the amount from the supplies account (CR) and turning it into an expense (DR) Supplies Expense 75 Supplies 75 Adjusting entry for supplies

Adjustment 2: Prepaid Expenses Let’s say, on July 1, we paid an entire year’s worth of rent. ($12,000) We would not want to make an expense of the whole thing, because we technically haven’t used it yet. (But we need to keep track of the $12,000)

‘Prepaid Rent’ Prepaid Rent $12,000 Bank $12,000

Adjusting entry… At the end of each month we would make an adjusting entry: Rent Expense $1000 Prepaid Rent $1000 reduces this account

This way, we would be expensing our rent each month, and decreasing the amount in the ‘prepaid rent’ account!

Prepaid expenses Prepaid expenses might also be in the form of insurance: Let’s say we bought an insurance policy for $600 on August 1, 2012. If we only made an adjustment at year-end, what would the journal entries be on August 1 and Dec 31?

Aug 1 Prepaid Insurance $600 Bank $600 Dec 31 Insurance Expense $250 Prepaid Insurance $250 Why? $600 / 12 months = $50 / month (August – Dec = 5 months)

Homework Page 308 Exercise 1 (Do the adjusting entries for each on a separate piece of journal paper.) Exercise 3 Exercise 5