Chapter 4

• The Accounting Cycle

• Adjusting Entries

• Closing Process

• Net Profit Margin Ratio

The Accounting Cycle

• Accounting cycle process

– Records individual transactions

– Produces the four basic financial statements

– Gets the general ledger ready for the next

accounting period

– Made up of eight steps

Accounting Cycle Steps

• Record journal entries from transactions

• Post journal entries to the general ledger

• Prepare unadjusted trial balance

• Adjust the accounts

• Prepare an adjusted trial balance

• Prepare the financial statements

• Close the temporary accounts

• Prepare a post-closing trial balance

Unadjusted Trial Balance

• A listing of individual

accounts, usually in financial

statement order.

• Ending debit or credit

balances are listed in two

separate columns.

• Total debit account balances

should equal total credit

account balances.

Matrix, Inc.

Unadjusted Trial Balance

At December 31, 2006

Description Debit Credit

Cash 3,900$

Accounts receivable 4,985

Inventory 3,300

Equipment 4,800

Accumulated depreciation - Equip. 1,440$

Furniture and fixtures 6,600

Accumulated depreciation - furn. & fix. 2,200

Accounts payable 2,985

Notes payable 4,000

Common stock 10,000

Retained earnings, 12/31/05 1,760

Sales revenue 35,000

Cost of goods sold 27,500

Operating expenses 6,300

Totals 57,385$ 57,385$

Unadjusted Trial Balance Example

Problem

Following unadjusted account balances for Delilah’s Deluxe Doggie Dayspa:

Delilah's Deluxe Doggie Dayspa

Unadjusted Trial Balance

December 31, 2005

Cash 13,500

Accounts Receivable 14,000

Supplies 3,500

Prepaid Rent 24,000

Prepaid Insurance 12,000

Notes Receivable (due 3/31/04) 30,000

Equipment 245,000

Accounts Payable 12,500

Unearned Service Revenue 20,000

Notes Payable (due 5/1/07) 100,000

Common Stock 50,000

Dividends 12,000

Service Revenue 367,500

Salary Expense 165,000

Rent Expense 20,000

Income Tax Expense 11,000

Required: Prepare a trial balance in good form.

The Unadjusted Trial BalanceIf total debits do not equal total credits on the

trial balance, errors have occurred . . .

in preparing balanced

journal entries,

in posting the correct dollar

effects of a transaction,

or in copying ending balances

from the ledger to the

trial balance.

Adjusting EntriesThere are two types of adjusting

entries.ACCRUALS

Revenues

earned or

expenses

incurred that

have not been

previously

recorded.

DEFERRALS

Receipts of

assets or

payments of

cash in advance

of revenue or

expense

recognition.

End of accounting period.

Cash received. Revenues earned.

Example includes rent received in

advance (an unearned revenue).

Deferred Revenue

End of accounting period.

Cash receivedRevenues earned

Example includes interest earned

during the period (accrued revenue).

Accrued Revenue

End of accounting period.

Cash paid.

Examples include prepaid rent, advertising,

and insurance.

Deferred Expense

Expense incurred.

End of accounting period.

Cash paid.

Examples include salaries and wages

incurred but not recorded.

Accrued Expense

Expense incurred.

• Certain circumstances require

adjusting entries to record

accounting estimates.

• Examples include . . .

–Depreciation

–Bad debts

– Income taxes

$$$

Adjustments Involving

Estimates

Depreciation Adjustment

The accounting

concept of

depreciation involves

the systematic and

rational allocation of

the cost of a long-

lived asset over

multiple accounting

periods it is used to

generate revenue.

This is a “cost

allocation” concept,

not a “valuation”

concept.

Prepare the Adjusted Trial

Balance

• After we’ve completed and posted the

adjusting entries to the general ledger

accounts, we prepare another trial balance

• We confirm again that the debit balances equal

the credit balances

• Basis for preparing the financial statements

Prepare adjusting entries from the following information:

a) An inventory of supplies reveals that $1,300 of supplies are on hand. (deferred expense/ asset)

b) Delilah’s has a 6 day work week, Monday through Saturday. (accrued expense/ liability)

Employees are paid every Friday. 12/31 is on a Tuesday. Delilah’s weekly payroll is $3,600.

c) The equipment was purchased 1/1/05. (deferred expense/ asset)

It has an expected life of 10 years and no salvage value.

d) The note receivable was issued by a client on 10/31/05. (accrued revenue/ asset)

The annual interest rate is 7%.

e) The note payable was issued 4/1/05. The annual interest rate is 5%. (accrued expense/ liability)

f) Unearned service revenue represents gift certificates purchased. (Deferred revenue/ liability)

At year end, $8,000 of the certificates have been used.

g) Prepaid insurance represents a payment of $12,000 for 2 years coverage. (deferred expense/ asset)

The payment was made 7/1/05.

h) Prepaid rent represents a payment of $24,000 for 12 months rent. (deferred expense/ asset)

The payment was made 9/1/05.

Problem

Post these journal entries to the t-accounts and prepare an adjusted trial balance.

Problem

Prepare the Financial Statements

• Goal of the whole process

• Financial statements that reflect the financial condition and transactions of the company

– Income Statement

– Statement of Changes of Owners’ Equity

– Balance Sheet

– Statement of Cash Flows

From the adjusted trial balance for Delilah’s, prepare an income statement,

statement of stockholders’ equity, & classified balance sheet.

For computing the EPS, assume 10,000 shares are outstanding.

Problem

Closing the Books

Even though the

balance sheet

account balances

carry forward

from period to

period, the

income statement

accounts do not.

Closing entries:

1. Transfer net income

(or loss) to Retained

Earnings.

2. Establish a zero

balance in each of the

temporary accounts to

start the next

accounting period.

Closing the Books

The following accounts are called

temporary or nominal accounts and

are closed at the end of the period .

. .• Revenues.

• Expenses.

• Gains.

• Losses.

• Dividends declared.

Closing the Books

Assets, liabilities, and stockholders’

equity are permanent, or real

accounts, and are never closed.

• Assets.

• Liabilities.

• Stockholders’

Equity.

Closing the Books

Two steps are used in

the closing process .

. .

1. Close revenues and

gains to Retained

Earnings.

2. Close expenses and

losses to Retained

Earnings.

Post-Closing Trial Balance

• Prepared after the temporary accounts are

closed

• Serves as a final check that debits = credits

• Confirms that we start the next accounting

period with only permanent accounts

Post-Closing Trial BalanceMatrix, Inc.

Adjusted Trial Balance

At December 31, 2004

Description Debit Credit

Cash 3,900$

Accounts receivable 4,985

Inventory 3,300

Equipment 4,800

Accumulated depreciation - Equip. 1,440$

Furniture and fixtures 6,600

Accumulated depreciation - furn. & fix. 2,200

Accounts payable 2,985

Notes payable 4,000

Common stock 10,000

Retained earnings, 1/1/04 1,760

Sales revenue 35,000

Cost of goods sold 27,500

Operating expenses 6,300

Totals 57,385$ 57,385$

Post-Closing Trial BalanceMatrix, Inc.

Post-Closing Trial Balance

At December 31, 2004

Description Debit Credit

Cash 3,900$

Accounts receivable 4,985

Inventory 3,300

Equipment 4,800

Accumulated depreciation - Equip. 1,440$

Furniture and fixtures 6,600

Accumulated depreciation - furn. & fix. 2,200

Accounts payable 2,985

Notes payable 4,000

Common stock 10,000

Retained earnings, 12/31/04 2,960

Sales revenue -

Cost of goods sold -

Operating expenses -

Totals 23,585$ 23,585$

Key Ratio Analysis

Net Profit Margin indicates how effective

management is at generating profit on every

dollar of sales.

Net Income

Net Sales

Net Profit

Margin =

Prepare closing entries and post-closing trial balance for Delilah’s.

Prepare net profit margin for Delilah’s.

Problem