1. Completing the Accounting Cycle for a Service Business
Chapter 6

2. Adjustments End of period ledger is not accurate
Need to bring accounts up to date
Accounts needing updating:
Prepaid Expenses, e.g., Prepaid Rent and Insurance (current assets)
Fixed Assets, e.g., they decline in value, known as depreciation

3. Adjustments 1. Late Invoices
2. Accruals - a. Prepaid Expenses, b. Unearned Revenue, c. Interest, d. Salaries & Wages
3. Allocations & Amortization (Depreciation) - a. Bad Debt, b. Supplies, c. Straight Line, d. Declining Balance

4. Prepaid Rent Company prepays for six months rent on November 1, $12000
Dr Prepaid Rent
Cr Cash
Adjusting entry at December 31, 2006
Dr Rent Expense 4000
Cr Prepaid Rent
2/6 x $12000

5. Supplies Adjusting entry: Dr Supplies Expense 150 Cr Supplies 150
The ledger shows a balance for Supplies of $500
A check of the supplies cupboard shows only $350 worth of supplies remaining
Adjusting entry:
Dr Supplies Expense 150
Cr Supplies

6. Prepaid Insurance Adjustment at December 31, 2004
Buy insurance for one year on April 1, 2004
Dr Prepaid Insurance
Cr Cash
Adjustment at December 31, 2004
Dr Insurance Expense
Cr Prepaid Insurance 18000
9/12 x $24000

7. Depreciation Two methods:
Straight-line: record decrease in value of fixed asset evenly
Dep = Cost – Salvage Value
Years of Useful Life
Declining Balance: accelerated decrease in value in early years where greater use
Dep = Book value x CCA allowance %
Where Book value = Cost – Accumulated Dep’n
CCA = Capital Cost % allowed by government, e.g., Autos 30%, Equipment 20%, Buildings (brick 5%), Buildings (wood) 10%, etc.

8. Depreciation Adjustment: Straight Line
Automobile cost $20000, salvage (residual) value $4000, 8 useful years
Calculate first year’s depreciation and adjusting entry:
Dr. Depreciation Expense, Auto 2000
Cr. Accumulated Depreciation, Auto* 2000
( )/8
* A contra account – see two slides later

9. Depreciation Adjustment: Declining Balance
Automobile with cost $20000 and accumulated depreciation of $4000 is adjusted for a six month period:
Dr. Depreciation Expense, Auto 2400
Cr. Accumulated Depreciation, Auto 2400
( ) x 30% x 6/12

10. Contra Accounts
Accumulated Depreciation is an asset with a credit balance which is shown opposite its associated asset on Balance Sheet:
Fixed Assets
Automobile
Less: Accumulated Depreciation
Ledger account numbers follow the main accounts,
e.g., if Auto is 140, Acc. Dep’n, Auto is 141

11. Worksheet

12. Adjustments on the Worksheet and Closing the Books
Entering the Adjustments on the Worksheet is no different then what we have already done
You enter the Debit & Credit to their respective accounts using the “Adjustments Column” of the worksheet.

13. Adjustments on the Worksheet and Closing the Books
Is the process of reducing Revenue & Expense accounts to a zero (0) balance.
It serves 2 purposes
To prepare the Revenue & Expense accounts for the next period by reducing them to zero (0)
To update the Owner’s Equity account

14. Closing Entries
All revenues and expenses must be reduced to zero to allow new entries next period
Use the REID formula:
R: close revenues to Income Summary
E: close expenses to Income Summary
I: close Income Summary to Capital
D: close Drawings to Capital

15. Adjustments on the Worksheet and Closing the Books
Updating the Owner’s Equity Account
Current Owner’s Equity =
Capital – Drawings + Revenue – Expenses
Net Income
Equity at start of Accounting period
Change in Equity for Period

16. Adjustments on the Worksheet and Closing the Books
Which Accounts are going to be closed?
Cash  Capital are known as Permanent Accounts
Revenues, Expenses, and Drawings are known as Temporary Accounts
The Income Summary Account!
This is only a “holding” account used to journalize the Closing Entries for Revenues & Expenses
Revenue will have a Credit balance, therefore to close (make the account zero, we must debit this account) and Credit the Income Summary account

17. Adjustments on the Worksheet and Closing the Books
Expenses will have a Debit balance, therefore to close, we must Credit this Account & Debit the Income Summary Account
It will Look like this
Income Summary
You will then close the Income Summary account into Capital
Expense Balance
Revenue Balance

18. Adjustments on the Worksheet and Closing the Books
Finally, Drawings will have a Debit balance, therefore you must Credit this account (to close it) and Debit Owner’s Equity

19. Steps in Closing the Books
Step 1: Close Revenue Accounts into the Income Summary Account
Step 2: Close Expense Accounts into the Income Summary Account
Step 3: Close the Income Summary Account into Capital
Step 4: Close the Drawings Account into Capital

20. Adjustments on the Worksheet and Closing the Books
A Post-Closing Trial Balance
Once you have closed all the temporary accounts (Revenue, Expenses, and Drawings) into Capital.
You must preform a Post-Closing Trial Balance to make sure that all your Debits = your Credits

21. Close Expenses Close Revenues Cr Income Summary 50000
Dr Fees Income
Dr Management Revenue 20000
Cr Income Summary
Close Expenses
Dr Income Summary
Cr Advertising Expense Wages General Expense

22. Close Income Summary Close Drawings
Dr Income Summary Cr J. Schmoo, Capital 10000
Close Drawings
Dr J. Schmoo, Capital 5000
Cr J. Schmoo, Drawings 5000

23. Principles Matching Principle re adjustments
Materiality Principle – include all information that affects decisions by users of financial statements
Conservatism Principle – when faced with choices, select the treatment resulting in lower net income and net assets

24. Notes
All adjusting entries must be journalized and posted to the ledger!
Ten column worksheets include two adjusted trial balance columns:
Add the adjustments to the trial balance accounts then move to is and bs
After all adjusting and closing entries have been posted “take off” a post-closing trial balance to ensure readiness for next period … capital account should be last!