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Chapter 4

Accrual Accounting and Completing the Accounting Cycle. Chapter 4. Characteristics of the Accounting Model. Periodic Reporting Accrual-Basis Accounting Adjusting Entries Closing Entries. Periodic Reporting.

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Chapter 4

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  1. Accrual Accounting and Completing the Accounting Cycle Chapter 4

  2. Characteristics of theAccounting Model • Periodic Reporting • Accrual-Basis Accounting • Adjusting Entries • Closing Entries

  3. Periodic Reporting Time Period Concept--The life of a business is divided into distinct and short time periods so the accounting information can be summarized each period.

  4. Periodic Reporting Time Period Concept--The life of a business is divided into distinct and short time periods so the accounting information can be timely. Fiscal Year--An accounting period that lasts 12 months.

  5. Periodic Reporting Time Period Concept--The life of a business is divided into distinct and short time periods so the accounting information can be timely. Fiscal Year--An accounting period that lasts 12 months. Calendar Year—A fiscal year that lasts 12 months and ends on December 31.

  6. Periodic Reporting Fiscal Year-- For publicly traded companies, the period covered by annual financial statements which are prepared for the public (Annual Report), and the SEC (Form 10K ).

  7. Periodic Reporting Time Periods are often further divided into Quarters and Months Quarter--An accounting period that lasts 3 months. For publicly traded companies quarterly financial reports are prepared and sent to the SEC (Form 10Q). Month--May be a calendar month or a series of periods lasting 4 and 5 weeks.

  8. Life Cycle of a Business Entity Accounting Period 1 Accounting Period 2 Accounting Period 3 Inc Statement, Statement of RE, Cash Flow Statement Inc Statement, Statement of RE, Cash Flow Statement Inc Statement, Statement of RE, Cash Flow Statement Balance Sheet Balance Sheet Balance Sheet

  9. Accrual Accounting • Accrual-basis accounting is a concept in which revenues and expenses are recorded when earned or incurred, not when cash is received or paid. • Revenues and expenses must be assigned to the proper accounting period. • “Revenue recognition principle” and the “matching principle” determine the accounting period items are recorded in.

  10. Revenue Recognition Revenue is recognized when two criteria are met: • The earning process is “substantially complete.” • An exchange has taken place.

  11. The Matching Principle All expenses incurred to generate revenues must be recognized in the same period as the related revenues. Example: The cost of goods sold for an item must be matched with the sales revenue generated in any time period.

  12. Determining Accrual Income Recognized Revenues of 2009 - Matched Expenses of 2009 = Net Income for 2009

  13. Steps in the Accounting Cycle • Analyze transactions and business documents. • Journalize transactions. • Post journal entries to the general ledger. • Determine account balances and prepare a trial balance. • Journalize and post adjusting entries. • Prepare the adjusted trial balance. • Prepare financial statements. • Journalize and post the closing entries. • Balance the accounts and prepare a post-closing trial balance.

  14. Step 5 - Adjusting Entries Adjusting entries are required at the end of each accounting period for accrual-basis accounting, prior to preparing the financial statements. The purpose for adjusting entries are to: • Bring Balance Sheet accounts current. • Reflect proper amounts of revenues and expenses on the Income Statement.

  15. Tips Regarding Adjusting Entries • Analytical Process. You must determine what original entry was made (if any) and what the ending balances should be before you know what adjusting entry to make. You cannot memorize adjusting entries. • Adjusting entries always include a Balance Sheet account and an Income Statement account. • Adjusting entries never involve a CASH account.

  16. 3-Step Process forAdjusting Entries • Identify the original entries that were made, if any. (Original entries were only made for unearned revenues and prepaid expenses.) • Determine what the correct balances should be at this point in time. • Make the adjustments needed to correct the balances.

  17. Most Common Adjusting Entries • Prepaid Expenses--Expenses that have been recorded (paid) but not yet incurred. • Unearned Revenues--Revenues that have been recorded (received) but not yet earned. • Accrued Revenues--Revenues that have been earned but not yet recorded. • Accrued Expenses--Expenses that have been incurred but not yet recorded.

  18. Example: Prepaid Expenses On July 1, 2008 XYZ Company pays $3,600 for one year’s rent in advance, covering July 1, 2008 to June 30, 2009. On December 31, 2008, an adjustment will be needed. What is the adjusting entry?

  19. Example: Prepaid Expenses On July 1, 2008 XYZ Company pays $3,600 for one year’s rent in advance, covering July 1, 2008 to June 30, 2009. On December 31, 2008, an adjustment will be needed. What is the adjusting entry? Rent Expense Prepaid Rent Cash Original Entry 3,600 3,600 Correct Balances1,800 1,800

  20. Example: Prepaid Expenses On July 1, 2008 XYZ Company pays $3,600 for one year’s rent in advance, covering July 1, 2008 to June 30, 2009. On December 31, 2008, an adjustment will be needed. What is the adjusting entry? Rent Expense Prepaid Rent Cash Original Entry 3,600 3,600 Correct Balances1,800 1,800 Adjusting Entry 1,800 1,800 Adjusting Entry: 12/31 Rent Expense 1,800 Prepaid Rent 1,800

  21. Prepaid Expenses On July 1, 2008, XYZ Company pays $3,600 for one year’s rent in advance, covering July 1, 2008, to June 30, 2009. On December 31, 2008, an adjustment will be needed. What is the adjusting entry using the expense approach?

  22. Prepaid Expenses On July 1, 2008, XYZ Company pays $3,600 for one year’s rent in advance, covering July 1, 2008, to June 30, 2009. On December 31, 2008, an adjustment will be needed. What is the adjusting entry using the expense approach? Prepaid Rent Cash Rent Expense Original Entry 3,600 3,600 Correct Balances1,800 1,800

  23. Prepaid Expenses On July 1, 2008, XYZ Company pays $3,600 for one year’s rent in advance, covering July 1, 2008, to June 30, 2009. On December 31, 2008, an adjustment will be needed. What is the adjusting entry using the expense approach? Prepaid Rent Cash Rent Expense Original Entry 3,600 3,600 Correct Balances1,800 1,800 • Adjusting Entry 1,800 1,800 Adjusting Entry: 12/31 Prepaid Rent 1,800 Rent Expense 1,800

  24. Example: Unearned Revenue On July 1 XYZ Company receives $5,000 for season tickets to a trade show they will put on every month for the next 12 months. On December 31 an adjustment will be needed. What is it?

  25. Example: Unearned Revenue On July 1 XYZ Company receives $5,000 for season tickets to a trade show they will put on every month for the next 12 months. On December 31 an adjustment will be needed. What is it? Cash Show Rev Unearned Rev Original Entry 5,000 5,000 Correct Balances 2,500 2,500

  26. Example: Unearned Revenue On July 1 XYZ Company receives $5,000 for season tickets to a trade show they will put on every month for the next 12 months. On December 31 an adjustment will be needed. What is it? Cash Show Rev Unearned Rev Original Entry 5,000 5,000 Correct Balances 2,500 2,500 • Adjusting Entry 2,500 2,500 Adjusting Entry: 12/31 Unearned Rev 2,500 Show Rev 2,500

  27. Example: Accrued Revenue The XYZ Company earns a rent revenue of $500 in 2008 but did not send out an invoice nor receive the payment until January 3, 2009. An adjustment will be needed. What is the adjusting entry?

  28. RentReceivable Rent Revenue Original Entry none none Correct Balances 500 500 Example: Accrued Revenue The XYZ Company earns a rent revenue of $500 in 2008 but did not send out an invoice nor receive the payment until January 3, 2009. An adjustment will be needed. What is the adjusting entry?

  29. RentReceivable Rent Revenue Original Entry none none Correct Balances 500 500 Example: Accrued Revenue The XYZ Company earns a rent revenue of $500 in 2008 but did not send out an invoice or receive the payment until January 3, 2009. An adjustment will be needed. What is the adjusting entry? Adjusting Entry: 12/31 Rent Receivable 500 Rent Revenue 500

  30. Example: Accrued Expense The XYZ Company is assessed property taxes of $1,000 for 2008, but will not make this payment until January 5, 2009. An adjustment will be needed. What is the adjusting entry?

  31. Example: Accrued Expense The XYZ Company is assessed property taxes of $1,000 for 2008, but will not make this payment until January 5, 2009. An adjustment will be needed. What is the adjusting entry? Property Tax Expense Property Tax Payable Original Entry none none Correct Balances 1,000 1,000

  32. Example: Accrued Expense The XYZ Company is assessed property taxes of $1,000 for 2008, but will not make this payment until January 5, 2009. An adjustment will be needed. What is the adjusting entry? Property Tax Expense Property Tax Payable Original Entry none none Correct Balances 1,000 1,000 Adjusting Entry: 12/31 Property Tax Expense 1,000 Property Tax Payable 1,000

  33. AccruedExpense • Which of the following is not a True statement? • Accumulated depreciation is a contra-asset. • Depreciation expense is a contra-expense. • Accumulated depreciation has a normal credit balance. • Depreciation expense has a normal debit balance.

  34. There are 9 steps in the Accounting Cycle. List them in order. (Hint: Three of them contain the words “Trial Balance”) • __________________________ • __________________________ • __________________________ • __________________________ • __________________________ • __________________________ • __________________________ • __________________________ • __________________________

  35. Steps in the Accounting Cycle • Analyze transactions and business documents. • Journalize transactions. • Post journal entries to the general ledger. • Determine account balances and prepare a trial balance. • Journalize and post adjusting entries. • Prepare the adjusted trial balance. • Prepare financial statements. • Journalize and post the closing entries. • Balance the accounts and prepare a post-closing trial balance.

  36. Record Trans-actions Prepare Trial Balance Make Adjusting Entries Prepare Financial Statements Step 7 Preparing Financial Statements • After all transactions have been recorded, a trial balance prepared, and adjusting entries made . . . the financial statements can be prepared.

  37. Step 8The Closing Process • Nominal Accounts (temporary accounts) are closed to a zero balance at the end of each accounting period. • Real Accounts (permanent accounts) are not closed to a zero balance at the end of the accounting period. These accounts are carried forward to the next period. • Closing Entries reduce all nominal accounts to a zero balance.

  38. Examples Real Accounts Assets Liabilities Owners’ Equity (Balance Sheet Accounts)

  39. Examples Real Accounts Assets Liabilities Owners’ Equity (Balance Sheet Accounts) Nominal Accounts Revenues Expenses Dividends (Income Statement Accounts)

  40. This is not the actual entry! Closing Entries The Goal: Move all Revenue and Expense items (Net Income) into Retained Earnings. Dec 31 Sales Revenue....................... 1,500 Rent Revenue........................ 100 Cost of Goods Sold............ 1,100 Salaries Expense............... 200 Other Expenses................. 150 Retained Earnings............. 150

  41. Closing Entries Closing the books ALWAYS requires 4 closing entries

  42. Closing Entries Closing Entry 1. Close all revenue accounts by debiting them. Dr. Cr. Sales Revenue............ 13,000 Rent Revenue………... 2,000 Income Summary... 15,000

  43. The Closing Process Income Summary Revenues xxx Bal. xxx xxx Revenues Since the revenue account is a nominal account, it is closed at the end of the period to Income Summary.

  44. The Closing Process Closing Entry 2. Close all expense accounts by crediting them. Dr. Cr. Income Summary…............. 13,600 Cost of Goods Sold….... 12,800 Insurance Expense........ 500 Supplies Expense.......... 300

  45. The Closing Process Income Summary xxx Rev. Exp. YYY Expenses The expense accounts are credited in order to close the account at the end of the period. Bal. YYY YYY

  46. The Closing Process Closing Entry 3. Close Income Summary. Dr. Cr. Income Summary…............. 1,400 Retained Earnings.….... 1,400

  47. The Closing Process Income Summary Retained Earnings xxx Rev. Exp. YYY Net Income Net Income The Income Summary account is closed with a debit orcredit depending on its balance.

  48. The Closing Process Closing Entry 4. Close Dividends (if any). Dr. Cr. Retained Earnings…............ 500 Dividends………….….... 500

  49. About Dividends • Dividends are not expenses. They are distributions to stockholders of part of the corporation’s earnings. • Dividends reduce Retained Earnings. For example: If a company earns $1,400 of Net Income, paying dividends to shareholders does not change Income.

  50. Example: Dividends Declaration of Dividends: Dividends...................... 500 Dividends Payable.... 500

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