BAF3M Accounting Chapter 8 – Completing the Accounting Cycle

BAF3M Accounting

Chapter 8 – Completing the Accounting Cycle

8.1 The Adjustment Process• Accountants need to ensure that the statements

they produce are:

• Up to Date, Accurate, Consistent

Adjustments are necessary to ensure

• Accounts are brought up to date

• All late transactions are taken into account

• All calculations are correct

• All accounting standards have been complied with

• During the course of the fiscal period, things are allowed to get out of date

• Adjusting entries get everything up-to-date and accurate again

• Why allowed to go inaccurate?– Saves time, money, effort

8.1 The Adjustment Process

• We will look at the adjusting entries for four main areas– Supplies– Prepaid Expenses – Late Arriving Invoices– Unearned Revenue

8.1 The Adjustment Process

Adjusting Entries

Adjustment #1: Supplies

The Supplies balance shows the total supplies purchased in the year

What is the Balance?

What the balance is

What Should The Balance Be?

What the balance should be?

What the balance “should be” is determined from someone counting the supplies that remain in the business at the end of the year

The Adjustment

The required adjustment

Introducing a New Account

What the balance is

The income statement account related to Supplies is shown above

The accounting clerk has not used this account during the year

Expense: What Should the Balance Be?

What the balance should be

What the balance “should be” is equal to the amount of supplies “used up” during the year

What the Adjustment Would Be

The adjusting entry as it would appear in the general journal

What that Looks Like in the Journal

Adjusting Entries

The Prepaid Insurance balance shows the total cost of insurance bought in the year

Adjustment #2: Prepaid Expenses

What the balance is

What Should the Balance Be?

What the balance “should be” is determined from someone calculating the portion of the insurance policy that is “unexpired” or “not used up yet, but paid for”

How did you Get $1200?

• An Insurance policy was purchased on September 1st for one year. The fiscal period expires Dec. 31.

As of Dec. 31, how many months of insurance have been used ?

- 4 months have been used

Each month costs:$1800 / 12mo. = $150

4 months have been used:$150*4 = $600

The Adjustment

Introducing Your 2nd New Account

What the balance is

The income statement account related to Prepaid Insurance is shown above

The accounting clerk has not used this account during the year

Expense: What Should the Balance Be?

What the balance “should be” is the amount of the insurance policy that has expired at year’s end

What the Adjustment Should Be?

What it Looks Like in the Journal

The adjusting entry for insurance as it would appear in the general journal

Adjusting Entries

Adjustment #3: Late Arriving Invoices

The Accounts Payable balance does not include two invoices that arrived late

• Two late invoices have arrived

–$212 for the Telephone Bill

–$315 for the Utilities Bill

Little analysis is needed for this adjustment

The Adjustment

Simply enter the late invoices

The Adjustment contd.

Simply enter the late invoices

What Should the Balance Be?

And calculate the adjusted balance

Expense: What is the Balance?

The Adjustments

The What Should the Balance Be?

What that Looks Like in the Journal

The adjusting entry for late invoices as it would appear in the general journal

The adjusting entries have brought balance sheet accounts up to date

Summary 1

Adjusting Entries—Summary

Balance Sheet

And have recorded expenses in related accounts on the income statement

Summary 2Adjusting Entries—Summary

Balance Sheet Income Statement

Adjusting for Unearned Revenue

• Unearned Revenue is a liability – it occurs when you are paid in advance of providing a service.

• If the accounting department puts advance payments into Revenue, this is an error that needs to be corrected:

• DR Revenue (to reduce it); CR Unearned Revenue (to increase it)

Check your Understanding

• See Textbook Tracker Sheet for the required Questions and Exercises for section 8.1

8.2 Adjusting Entries and the Work Sheet

• The work sheet is an informal accounting form used to help organize all of the financial data

• There are 8 columns– Trial Balance DR/CR– Adjustments DR/CR– Income Statement DR/CR– Balance Sheet DR/CR

ADJUSTING FOR SUPPLIES

• According to Global Logistics’ trial balance they have $1480.90 worth of supplies

• However, once a physical inventory was completed on December 31, 2008 they discovered that they only had $526.00 worth of supplies on hand

Global Logistics Work Sheet

Balance SheetDr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.520.51

Accounts Receivable 18475.001480.906564.004196.00

54600.0052510.00

1240.00720.00

25000.0028895.42

Drawings 42000.00213821.00

3500.001951.65

24000.001800.00

41951.163750.00

65957.20296466.42 296466.42

Account Payable

Account Titles

Year ended: Dec. 31, 20--

CapitalBank LoanGST RecoverableGST Payable

Automotive EquipmentFurniture & EquipmentPrepaid InusranceSupplies

Wages EspenseUtitlies ExpenseTruck ExpenseTelephone ExpenseRent ExpenseMiscellaneious ExpenseBank Charges ExpenseShipping Revenue

IncomeTrial Balance Adjustments Statement

ADJUSTING FOR SUPPLIES

Dec. 31 Supplies Expense 964.90

Supplies 964.90

Account Receivable 18475.001480.90 954.906564.004196.00

54600.002510.001240.00

720.0025000.0028895.42

Drawings 42000.00213821.00

3500.001951.65

24000.001800.00

41951.163750.00

65957.20271466.42 271466.42

Supplies Expense 954.90

Trial Balance Adjustments Statement

Prepaid InsuranceSupplies

Wages ExpenseUtitlies ExpenseTruck ExpenseTelephone ExpenseRent ExpenseMiscellaneous ExpenseBank Charges ExpenseShipping Revenue

Account Payable

Account Titles

Automotive EquipmentFurniture & Equipment

ADJUSTING FOR INSURANCE USED

• According to Global Logistics’ trial balance they have $6564 in prepaid insurance

• They have$4070 remaining in unused insurance

ADJUSTING FOR INSURANCE USED

Dec. 31 Insurance Expense 2494

Prepaid Insurance 2494

Account Receivable 18475.001480.90 954.906564.00 2494.004196.00

54600.002510.001240.00

720.0025000.0028895.42

Drawings 42000.00213821.00

3500.001951.65

24000.001800.00

41951.163750.00

65957.20271466.42 271466.42

Supplies Expense 954.90Insurance Expense 2494

Account Payable

Account Titles

Year ended: Dec. 31, 2008

Automotive EquipmentFurniture & EquipmentPrepaid InsuranceSupplies

ADJUSTING FOR LATE ARRIVING INVOICES

• Three late invoices in this exampleTelephone $ 45

Truck Repair 496

Printer Repair 85

Total $626

20--Dec. 31 Telephone expense 45

Truck expense 496

Miscellaneous expense 85

Accounts Payable 626

Account Receivable 18475.001480.90 954.906564.00 2494.004196.00

54600.002510.00 626.001240.00

720.0025000.0028895.42

Drawings 42000.00213821.00

3500.001951.65 85.00

24000.001800.00 45.00

41951.16 496.003750.00

65957.20271466.42 271466.42

Supplies Expense 954.90Insurance Expense 2494

Account Payable

Account Titles

COMPLETING THE SHEET

• From this point you complete the 8-column worksheet just as you completed the 6-column worksheet– Except as you transfer numbers to the correct column

you may need to add or subtract the adjustments into the totals as necessary

• Balance the columns using the “magical” number

• Underline where necessary

Balance SheetDr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.520.51 520.51

Account Receivable 18475.00 18475.001480.90 954.90 526.006564.00 2494.00 4070.004196.00 4196.00

54600.00 54600.002510.00 626.00 3136.001240.00 1240.00

720.00 720.0025000.00 25000.0028895.42 28895.42

Drawings 42000.00 42000.00213821.00 213821.00

3500.00 3500.001951.65 85.00 2036.65

24000.00 24000.001800.00 45.00 1845.00

41951.16 496.00 42447.163750.00 3750.00

65957.20 65957.20271466.42 271466.42

Supplies Expense 954.90 954.90Insurance Expense 2494 2494

4074.90 4074.90 146984.91 213821.00 125107.51 58271.4266836.09 66836.09

213821.00 213821.00 125107.51 125107.51

Account Payable

Account Titles

• Journalizing and Posting the Adjusting Entries– All the adjusting entries need to be properly

journalized and posted to the ledger

8.3 Preparing for New Fiscal Years

• REAL ACCOUNTS – balances that continue into the next fiscal periodex. Bank, trucks, accounts payable etc.

• NOMINAL ACCOUNTS – have balances that do not continue into the next fiscal periodONLYONLY Expenses, drawing and revenue

• CLOSING OUT AN ACCOUNT – means to make it have no balance. Nominal accounts are closed out at the end of the fiscal period.

• INCOME SUMMARY ACCOUNT – – summarizes the revenues and expenses of the period. Represents either the net income or net loss for the fiscal period

WHY DO WE CLOSE OUT ACCOUNTS?WHY DO WE CLOSE OUT ACCOUNTS? Closing these accounts allows us to plainly observe the previous year's effect on our revenue, expense, and drawings accounts. You can well imagine that if we did not close these accounts, their balances would build to outrageous amounts.

HOW DO WE DO THIS?HOW DO WE DO THIS? The Order in Which we Close Out Accounts (p293)1. Close out the revenue account(s) to the

Income Summary account2. Close out the expense account(s) to the

Income Summary account3. Close out the Income Summary account to the

Capital account4. Close out the Drawing account to the Capital

account

• Closing Entry #1: Close out the revenue account(s) to the Income Summary account

JournalDec 31 Shipping Revenue 213821

Income Summary213821

Because revenue is a CR balance account, a DR entry is needed to close it off

• Closing Entry #2: Close out the expense account(s) to the Income Summary account

JournalDec 31 Income Summary 146984.91

Bank Charges Exp3500

…(all exp listed here)

Insurance Exp2494Because expenses are a DR balance account, a CR entry

is needed to close them off

• Closing Entry #3: Close out the Income Summary account to the Capital account

JournalDec 31 Income Summary 66836.09

P. Marshall, Capital66836.09

If the Income Summary account has a CR balance, then a DR entry is needed to close it. (profit capital increases)

If the Income Summary account has a DR balance, then a CR entry is needed to close it. (loss capital decreases)

• Closing Entry #4: Close out the Drawing account to the Capital account

JournalDec 31 P. Marshall, Capital 42000

P. Marshall, Drawings42000

Because Drawings is a DR balance account, a CR entry is needed to close it

• Post-Closing Trial Balance– Checks the accuracy of the ledger after the

adjusting and closing entries have been done– Example shown in Fig 8-10, Page 290

8.4 Adjusting for Depreciation

• What is it?• First let’s remember our definition for an

expense– Something that we spend money on to make

• Based on this definition shouldn’t things like equipment or cars be expenses? We use these things to make money do we not?

• However, items such as a car don’t suddenly become worthless – it loses some of it’s value each year

• So a portion of the cost of the equipment should be allocated as an expense in each year of the item’s life

• This process meets the matching principle

Depreciation an allowance made for the decrease in value of an asset over time

Depreciation is an expense so it appears on the INCOME STATEMENT

• An anecdotal example– Read p. 301-302 about the depreciation of a

company’s delivery van

• Methods– 2 most common are:

– Straight Line– Declining Balance

• Straight Line Method– Divides up the net cost of the asset equally

over the years of the assets life

Straight Line for 1 yr =

(orig cost - estimated salvage value)

Estimated # of periods in the asset’s life

• Straight line Example• Tip Top Trucking purchased a truck for

$78000 on Jan 1. 20--. Truck could be used for 6 years, and be sold at that time for $7800.

• Therefore:Estimated Annual Depreciation is($78000 – $7800) / 6 = $11700The truck will depreciate $11700 each year.

• Recording DepreciationJournalDepreciation Expense – Truck 11700

Truck 11700

The above work is correct, but not used by larger, computerized businesses…they use a new account called “Accumulated Depreciation”

• So the entry will look like this:

JournalDepreciation Expense – Truck 11700

Accumulated Depreciation - Truck11700

The use of the accumulated depreciation account provides 2 types of information:

1) By not taking the depreciation right off of the asset account we can still find the original cost of the asset2) We can quickly calculate the total amount of depreciation recorded over the years

• Accumulated Depreciation is a CONTRA account– A contra account is one that is displayed

alongside an associated account and has a balance that is opposite to that account

• Accumulated Depreciation is also a VALUATION account– One that is used together with an asset

account to show the true net value of an asset

• Adjusting Entry for Depreciation1) records the depreciation for the period in

the depreciation expense account2)Increases the appropriate accumulated

depreciation account for the asset, which reduces the asset’s net book value

Journalized as…Depreciation Exp $$$$

Acc. Dep. (Asset) $$$$

Declining-balance Method• Allocates a greater amount of depreciation to the first

years of an asset’s life

• This is the method the government requires for income tax purposes

• To find the depreciated amount you take the undepreciated cost of the asset and multiply it by a fixed %– This % is set by the gov’t – See schedule on p. 308

BAF3M Accounting Chapter 8 – Completing the Accounting Cycle

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