©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Steps in the Accounting Cycle Prepare an adjusted trial balance Prepare financial statements Journalize and post adjusting entries Prepare a trial balance Journalize and post accounting transactions Journalize and post closing entries Prepare a post-closing trial balance 5 6 7

Accrual and Cash Bases of Accounting Cash BasisAccrual Basis Record revenues when: Cash is receivedRevenue is earned Record expenses when: Cash is paidExpense is incurred

GAAP Generally Accepted Accounting Principles require the accrual basis, thus income statements report accrual-based income.

Classification of Adjusting Entries Cash is received before revenue is earned Cash is received after revenue is earned Deferred Revenue Accrued Revenue

Classification of Adjusting Entries Cash is paid before expense is incurred Cash is paid after expense is incurred Deferred Expense Accrued Expense

Deferred Revenue Example Suppose that a company sells 12-month subscriptions to its monthly magazine. On October 1, the company receives a total of $1,200 for 20 subscriptions.

Accrued Revenue Example Assume a CPA firm agrees to provide a service to a client for a $1,000 fee. The firm completes its work on Sep. 23, bills the client on October 10, and receives payment on October 21. The CPA firm closes its own books on Sep. 30.

Deferred Expense Example Suppose that on March 1, a company purchases a 12- month general liability insurance policy for $36,000.

Deferred Expense Example (continued) Suppose further that the company prepares financial statements at the end of March. As of March 31, the company has been covered for one month and has therefore consumed one month of insurance, or $3,000 ($36,000 ÷ 12 months).

Deferred Expense Example (continued)

Accrued Expense Example Suppose that a company’s daily payroll is $1,000. The company pays its employees via direct deposit every Saturday for the work the employees have provided through Friday. Suppose further that the company prepares its financial statements on April 30, which is a Friday.

Accrued Expense Example (continued) When the company pays its employees, the following entry would be made:

Summary of Adjusting Entry Scenarios

Closing Process The closing process is the process of transferring all revenue, expense, and dividend account balances to the Retained Earnings account. Each revenue account is reduced to zero by debiting it and each expense account is reduced to zero by crediting it. The offset account- Retained Earnings- is credited for the amount of total revenues and debited for the amount of total expenses. Thus, the balance of ending Retained Earnings account for a period shows the difference between total revenues and total expenses.

Closing Process Example If we look at the Circle Films trial balance, the closing entries would be: Service Revenue 8,500 Retained Earnings 8,500 Retained Earnings 3,245 Advertising Expense 250 Depreciation Expense 600 Interest Expense 45 Salaries Expense 2,000 Supplies Expense 350 Retained Earnings 1,500 Dividends 1,

The Accounting Cycle: A Summary

End of Chapter 4