Completing the Accounting Cycle Completing the Accounting Cycle C H A P T E R 4

Learning Objective 1 Describe how accrual accounting allows for timely reporting and a better measure of a company's economic performance.

Why Use Accrual Accounting?

Define the Time Period Concept. Time Period

Financial Reports Most companies report to stockholders at fiscal year- end. Other reports are issued more frequently, perhaps monthly or quarterly. This frequency of reports forces accountants to use data based on judgments and estimates. ABC Inc. Annual Report

Define Accrual Accounting

Revenue Recognition Revenues are recorded when two main criteria are met: What are they?

Define The Matching Principle

Define Cash-Basis Accounting

Example: Accrual- vs. Cash-Basis Accounting Crown Consulting Reported Income for 2006 During 2006, Crown Consulting billed its client for $48,000. On December 31, 2006, it had received $41,000, with the remaining $7,000 to be received in Total expenses during 2006 were $31,000 with $3,000 of these costs not yet paid at December 31. Determine net income under both methods.

Learning Objective 2 Explain the need for adjusting entries and make adjusting entries for unrecorded receivables, unrecorded liabilities, prepaid expenses, and unearned revenues.

What Are the Steps in the Accounting Cycle?

Why DO Adjusting Entries?

Adjusting Entries Tips Each adjusting entry always involves at least one income statement account and one balance sheet account. Adjusting entries never involve cash.

Define Each of These Common Adjusting Entries Unrecorded Receivables Unrecorded Liabilities Prepaid Expenses Unearned Revenues

What Is the 3-Step Process for Adjusting Entries?

Bullseye Management earns a rent revenue of $500 in 2006 but will not receive the payment until January 10, An adjustment will be needed. What is the adjusting entry? Example: Unrecorded Receivables Original entry nonenone Correct balances Rent ReceivableRent Revenue

Original entry none none Correct balances 1,000 1,000 MoneyTree Inc. is assessed property taxes of $1,000 for 2006, but will not make this payment until January 5, An adjustment will be needed. What is the adjusting entry? Property Tax Expense Property Tax Payable Example: Unrecorded Liabilities

Example: Prepaid Expenses Rent Expense Prepaid Rent Original entry 3,600 3,600 Adjusting entry 1,800 1,800 Correct balances 1,800 1,800 Cash On July 1, 2006, I Think I Can Inc. pays $3,600 for one year’s rent in advance (covering July 1, 2006, to June 30, 2007). On December 31, 2006, an adjustment will be needed. What is the adjusting entry?

Example: Unearned Revenues On July 1, 2006, Clean As A Whistle Co. received $3,600 for one year’s rent in advance (covering July 1, 2006, to June 30, 2007). On December 31, 2006, an adjustment will be needed. What is the adjusting entry? Original entry 3,600 3,600 Adjusting entry 1,800 1,800 Correct balances 1,800 1,800 Unearned Rent Rent RevenueCash

Learning Objective 3 Explain the preparation of the financial statements, the explanatory notes, and the audit report.

Review The Steps in the Accounting Cycle

Preparing Financial Statements Prepared directly from the data in the adjusted ledger accounts. Explanatory notes clarify the methods and assumptions. The auditor reviews the statements with GAAP.

Describe the Preparation of Financial Statements

What Are The Notes and Why Have Them?

Tell Me About The Audit

Using a Work Sheet What Is a Work Sheet ? How Does It Work?

Learning Objective 4 Complete the closing process in the accounting cycle.

Describe The Closing Process Real AccountsNominal Accounts

Closing Entries Identify Nominal and Real Accounts Dec. 31 Sales Revenue ,500 Rent Revenue Cost of Goods Sold.....1,100 Salaries Expense Other Expenses Retained Earnings real (permanent) account nominal or temporary accounts

Step 1.Close all revenue accounts by debiting them. Sales Revenue ,000 Retained Earnings....15,000 Closing Entries Describe Which Accounts Are Used For Each Entry Step 2. Close all expense accounts by crediting them. Retained Earnings ,600 Cost of Goods Sold....12,800 Insurance Expense Supplies Expense

Dividends Closing Dividends Discuss the Dividends Account

Declaration of Dividends: Payment of Dividends: Closing Entry for Dividends: Make All Three Dividends Entries for $200

Dividends Bal. xxx Retained Earnings Revenues Bal. xxx Beg. Bal. xxx Expenses Bal. xxx The Closing Process Revenues Since the revenues account is a nominal account, it is closed at the end of the period to Retained Earnings. xxx Revenues

Dividends Bal. xxx Retained Earnings Beg. Bal. xxx Expenses Bal. xxx The Closing Process Expenses The expenses account is also a nominal account and is debited to Retained Earnings to close it. xxx ExpensesRevenues Bal. xxx xxx

Dividends Bal. xxx Retained Earnings xxx Revenues Bal. xxx Beg. Bal. xxx The Closing Process Dividends The dividends account, which is also nominal, is credited to close out the balance. xxx Dividends Expenses Revenues Expenses Bal. xxx xxx

Dividends Bal. xxx Retained Earnings xxx Revenues Bal. xxx Beg. Bal. xxx The Closing Process xxx Dividends Expenses Revenues Expenses Bal. xxx xxx End. Bal. xxx Net income for the period is determined by these two entries. Retained Earnings is a real account and always carries a balance.

Optimal last step. Information taken from the General Ledger after all closing entries are posted. Lists all real account balances at the end of the closing process. Assures that total debits equal total credits prior to the beginning of the new accounting period. Only real accounts will have a balance at this time. Optimal last step. Information taken from the General Ledger after all closing entries are posted. Lists all real account balances at the end of the closing process. Assures that total debits equal total credits prior to the beginning of the new accounting period. Only real accounts will have a balance at this time. Post-Closing Trial Balance

Three Monkeys Inc. Post-Closing Trial Balance December 31, 2006 Debits Credits Cash $ 8,200 Accounts Receivable 4,000 Inventory 3,000 Supplies 1,000 Accounts Payable $ 5,000 Capital Stock 10,000 Retained Earnings______ 1,200 Totals$16,200$16,200 Example: Post-Closing Trial Balance

Learning Objective 6 Understand how all the steps in the accounting cycle fit together.

Summary of the Accounting Cycle Financial statements: Result from the accounting cycle. Provide useful information to investors, creditors, and other users. Are included in the annual reports provided to stockholders. Can be analyzed and compared to statements of similar firms to detect strengths and weaknesses.

Learning Objective 7 Expanded Material Make adjusting entries for prepaid expenses and unearned revenues when the original cash amounts are recorded as expenses and revenues.

Original entry 3,600 3,600 Adjusting entry 1,800 1,800 Correct balances 1,800 1,800 Example: Prepaid Expenses Rent Expense Prepaid RentCash On July 1, 2006, Time Flies Company pays $3,600 for one year’s rent in advance (covering July 1, 2002, to June 30, 2007). On December 31, 2006, an adjustment will be needed. What is the adjusting entry using the expense approach?

Unearned Rent Rent RevenueCash Original entry 3,600 3,600 Adjusting entry 1,800 1,800 Correct balances 1,800 1,800 Example: Prepaid Expenses On July 1, 2006, Pot Of Gold Inc. pays the Rainbow Company $3,600 for one year’s rent in advance (covering July 1, 2006, to June 30, 2007). On December 31, 2006, an adjustment will be needed. Use the revenue approach.

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