Completing the Accounting Cycle

1. 4 • C H A P T E R Completing the Accounting Cycle

2. Learning Objective 1 • Describe how accrual accounting allows for timely reporting and a better measure of a company's economic performance.

3. Why Use Accrual Accounting?

4. Define the Time Period Concept. Time Period

5. Financial Reports • Most companies report to stockholders at fiscal year-end. • Other reports are issued more frequently, perhaps monthly or quarterly. • This frequency of reports forces accountants to use data based on judgments and estimates. ABC Inc. Annual Report

6. Define Accrual Accounting

7. Revenue Recognition Revenues are recorded when two main criteria are met: What are they?

8. Define The Matching Principle

9. Define Cash-Basis Accounting

10. Example: Accrual- vs. Cash-Basis Accounting During 2006, Crown Consulting billed its client for $48,000. On December 31, 2006, it had received $41,000, with the remaining $7,000 to be received in 2007. Total expenses during 2006 were $31,000 with $3,000 of these costs not yet paid at December 31. Determine net income under both methods. Crown Consulting Reported Income for 2006

11. Learning Objective 2 • Explain the need for adjusting entries and make adjusting entries for unrecorded receivables, unrecorded liabilities, prepaid expenses, and unearned revenues.

12. What Are the Steps in the Accounting Cycle?

13. Why DO Adjusting Entries? WHY?

14. Adjusting Entries Tips • Each adjusting entry always involves at least one income statement account and one balance sheet account. Adjusting entries never involve cash.

15. Unrecorded Receivables Unrecorded Liabilities Prepaid Expenses Unearned Revenues Define Each of These Common Adjusting Entries

16. What Is the 3-Step Process for Adjusting Entries?

17. Example: Unrecorded Receivables Bullseye Management earns a rent revenue of $500 in 2006 but will not receive the payment until January 10, 2007. An adjustment will be needed. What is the adjusting entry? Rent Receivable Rent Revenue Original entry none none Correct balances 500 500

18. Example: Unrecorded Liabilities MoneyTree Inc. is assessed property taxes of $1,000 for 2006, but will not make this payment until January 5, 2007. 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

19. Example: Prepaid Expenses On July 1, 2006, I Think I Can Inc. pays $3,600 for one year’s rent in advance (covering July 1, 2006, to June 30, 2007). On December 31, 2006, an adjustment will be needed. What is the adjusting entry? Rent Expense Prepaid Rent Cash Original entry 3,600 3,600 Adjusting entry 1,800 1,800 Correct balances 1,800 1,800

20. Example: Unearned Revenues On July 1, 2006, Clean As A Whistle Co. received $3,600 for one year’s rent in advance (covering July 1, 2006, to June 30, 2007). On December 31, 2006, an adjustment will be needed. What is the adjusting entry? Unearned Rent Rent Revenue Cash Original entry 3,600 3,600 Adjusting entry 1,800 1,800 Correct balances 1,800 1,800

21. Learning Objective 3 • Explain the preparation of the financial statements, the explanatory notes, and the audit report.

22. Review The Steps in the Accounting Cycle

23. PreparingFinancial Statements • Prepared directly from the data in the adjusted ledger accounts. • Explanatory notes clarify the methods and assumptions. • The auditor reviews the statements with GAAP.

24. Describe the Preparation of Financial Statements

25. What Are The Notes and Why Have Them?

26. Tell Me About The Audit

27. Using a Work Sheet • What Is a Work Sheet? How Does It Work?

28. Learning Objective 4 • Complete the closing process in the accounting cycle.

29. Real Accounts Nominal Accounts Describe The Closing Process

30. nominal or temporary accounts real (permanent) account Closing Entries Identify Nominal and Real Accounts Dec. 31 Sales Revenue. . . . . . . . . . . 1,500 Rent Revenue. . . . . . . . . . . . 100 Cost of Goods Sold . . . . . 1,100 Salaries Expense. . . . . . . 200 Other Expenses . . . . . . . . 150 Retained Earnings . . . . . . 150

31. Closing Entries Describe Which Accounts Are Used For Each Entry Step 1. Close all revenue accounts by debiting them. Sales Revenue. . . . . . . . . 15,000 Retained Earnings . . . . 15,000 Step 2. Close all expense accounts by crediting them. Retained Earnings. . . . . . . 13,600 Cost of Goods Sold. . . . 12,800 Insurance Expense. . . . 500 Supplies Expense. . . . . 300

32. Closing Dividends Discuss the Dividends Account • Dividends

33. Make All Three Dividends Entries for $200 Declaration of Dividends: Payment of Dividends: Closing Entry for Dividends:

34. Revenues xxx Bal. xxx Revenues Since the revenues account is a nominal account, it is closed at the end of the period to Retained Earnings. Expenses Bal. xxx The Closing Process Revenues RetainedEarnings Beg. Bal. xxx Dividends Bal. xxx

35. Revenues xxx Bal. xxx Expenses The expenses account is also a nominal account and is debited to Retained Earnings to close it. Expenses xxx Bal. xxx The Closing Process Expenses RetainedEarnings Beg. Bal. xxx Revenues Dividends Bal. xxx

36. Revenues xxx Bal. xxx The dividends account, which is also nominal, is credited to close out the balance. Dividends Expenses Bal. xxx xxx xxx The Closing Process Dividends RetainedEarnings Beg. Bal. xxx Revenues Expenses Dividends Bal. xxx

37. Revenues xxx Bal. xxx Retained Earnings is a real account and always carries a balance. End. Bal. xxx Net income for the period is determined by these two entries. Expenses Bal. xxx xxx The Closing Process RetainedEarnings Beg. Bal. xxx Revenues Expenses Dividends Dividends Bal. xxx xxx

38. Post-Closing Trial Balance • Optimal last step. • Information taken from the General Ledger after all closing entries are posted. • Lists all real account balances at the end of the closing process. • Assures that total debits equal total credits prior to the beginning of the new accounting period. • Only real accounts will have a balance at this time.

39. Example: Post-ClosingTrial Balance Three Monkeys Inc. Post-Closing Trial Balance December 31, 2006 Debits Credits Cash $ 8,200 Accounts Receivable 4,000 Inventory 3,000 Supplies 1,000 Accounts Payable $ 5,000 Capital Stock 10,000 Retained Earnings ______ 1,200 Totals $16,200 $16,200

40. Learning Objective 6 • Understand how all the steps in the accounting cycle fit together.

41. Summary of theAccounting Cycle • Financial statements: • Result from the accounting cycle. • Provide useful information to investors, creditors, and other users. • Are included in the annual reports provided to stockholders. • Can be analyzed and compared to statements of similar firms to detect strengths and weaknesses.

42. Learning Objective 7Expanded Material • Make adjusting entries for prepaid expenses and unearned revenues when the original cash amounts are recorded as expenses and revenues.

43. Example: Prepaid Expenses On July 1, 2006, Time Flies Company pays $3,600 for one year’s rent in advance (covering July 1, 2002, to June 30, 2007). On December 31, 2006, 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 Adjusting entry 1,800 1,800 Correct balances 1,800 1,800

44. Unearned Rent Rent Revenue Cash Example: Prepaid Expenses On July 1, 2006, Pot Of Gold Inc. pays the Rainbow Company $3,600 for one year’s rent in advance (covering July 1, 2006, to June 30, 2007). On December 31, 2006, an adjustment will be needed. Use the revenue approach. Original entry 3,600 3,600 Adjusting entry 1,800 1,800 Correct balances 1,800 1,800

45. END CHAPTER 4 "Things which matter most must never be at the mercy of things which matter least."