The Accounting CycleThe Accounting CycleTransactionsTransactions

1. Journalization1. Journalization

6. Financial Statements6. Financial Statements

7. Closing entries7. Closing entries

8. Post-closing trail balance

8. Post-closing trail balance

9. Reversing entries9. Reversing entries

3. Trial balance3. Trial balance

2. Posting2. Posting

5. Adjusted trial balance5. Adjusted trial balance

4. Adjustments4. AdjustmentsWork SheetWork Sheet

Chapter 3-23

AssetsAssets

Debit / Dr. Credit / Cr.

Normal BalanceNormal Balance

Chapter 3-27

Debit / Dr. Credit / Cr.

Normal BalanceNormal Balance

ExpenseExpense

Chapter 3-24

LiabilitiesLiabilities

Debit / Dr. Credit / Cr.

Normal BalanceNormal Balance

Chapter 3-25

Debit / Dr. Credit / Cr.

Normal BalanceNormal Balance

EquityEquity

Chapter 3-26

Debit / Dr. Credit / Cr.

Normal BalanceNormal Balance

RevenueRevenue

Normal Balance Credit

Normal Balance Credit

Normal Balance Debit

Normal Balance Debit

Debits and CreditsDebits and Credits

Transactions and EventsTransactions and EventsWhat to Record?What to Record?

FASB states, “transactions and other events and circumstances that affect a business enterprise.”

Types of Events:Types of Events:

External – between a business and its environment.

Internal – event occurring entirely within a business.

1. A supplier of a company‘s raw material is paid an amount owed on account.

External

Not Recorded

2. A customer pays its open account. External

3. A new chief executive officer is hired. Not Recorded

4. The biweekly payroll is paid.

5. Raw materials are entered into production. Internal

External

6. A new advertising agency is hired. Not Recorded

7. The accountant determines the federal income taxes owed based on the income earned.

Internal

Review “Transactions and Events”

Review “Transactions and Events”External Internal

Revenue Recognition Principle

• Dictates that revenue be recognized in the accounting period in which it is earned

• Revenue is considered earned when the service has been provided or when the goods are delivered

Matching Principle

• Requires that expenses be recorded in the same period in which the revenues they helped produce are recorded

Cash Basis of Accounting

• Revenue is recorded only when cash is received

• Expense is recorded only when cash is paid

Accrual Basis Accounting

• Adheres to the time period assumption and revenue recognition and matching principles

• Revenue is recorded when earned, rather than when cash is received

• Expense recorded when incurred, rather than when cash is paid

• Accrual accounting records events when the economic event occurs

Adjusting Entries

• Adjusting entries are made to adjust or update accounts at the end of the accounting period

• Adjusting entries can be categorized as– Prepayments– Accruals

Types of Adjusting Entries

– Prepayments• Prepaid expenses

• Unearned revenues

– Accruals• Accrued revenues

• Accrued expenses

• Cash has been spent but the item acquired has not been used or consumed (prepaid expenses)

• Cash has been collected but the revenue has not been earned (unearned revenues)

Prepayments

Accruals

• Revenue has been earned, but not collected (accrued revenues)

• Expenses were incurred, but not yet paid (accrued expenses)

Note: Entry has not yet been recorded!

Adjusted Trial Balance

• Adjusted trial balance proves the equity of total debit balances and total credit balances after the adjusting entries have been made

• Financial statements can be easily prepared from the adjusted trial balance

Closing the Books

• Closing entries– Transfer the temporary account balances to

update the retained earnings account– Reduce the balances in the temporary

accounts to zero to prepare for the next period’s postings

TemporaryTemporary PermanentPermanent

All revenue accounts All asset accounts

All expense accounts All liability accounts

Dividends accountShareholders’ equity

accounts

Required Steps in the Accounting Cycle

1. Analyze business transactions

2. Journalize the transactions

3. Post to general ledger accounts

4. Prepare a trial balance

5. Journalize and post adjusting entries

(prepayments and accruals)

Required Steps in the Accounting Cycle

6. Prepare an adjusted trial balance

7. Prepare financial statements

8. Journalize and post closing entries

9. Prepare a post-closing trial balance

General JournalGeneral Journal – a chronological record of transactions. Journal Entries are recorded in the journal.

Account Title Ref. Debit Credit

J an. 3 Cash 100 100,000

Common stock 300 100,000

10 Building 130 150,000

Note payable 220 150,000

Date

1. Journalizing1. Journalizing

General Journal

Posting Posting – the process of transferring amounts from the journal to the ledger accounts.

Cash Acct. No. 100

Date Explanation Ref. Debit Credit Balance

General Ledger

Account Title Ref. Debit Credit

J an. 3 Cash 100,000

Common stock 100,000

Date

General Journal

Jan. 3 Sale of stock GJ1 100,000 100,000

100

GJ1

2. Posting2. Posting

Trial BalanceTrial Balance – a list of each account and its balance; used to prove equality of debit and credit balances.

Acct. No. Account Debit Credit

100 Cash 140,000$ 105 Accounts receivable 35,000 110 I nventory 30,000 130 Building 150,000 200 Accounts payable 60,000$ 220 Note payable 150,000 300 Common stock 100,000 330 Retained earnings400 Sales 75,000 500 Cost of goods sold 30,000

385,000$ 385,000$

3. Trial Balance3. Trial Balance

4. Adjusting Entries4. Adjusting Entries

RevenuesRevenues - recorded in the period in which - recorded in the period in which they are earnedthey are earned.

Expenses Expenses - recognized in the period in which - recognized in the period in which they are incurredthey are incurred.

Adjusting entriesAdjusting entries - needed to ensure that - needed to ensure that the the revenue recognitionrevenue recognition and and matching matching principlesprinciples are followed. are followed.

Classes of Adjusting EntriesClasses of Adjusting Entries

1. Prepaid Expenses. Expenses paid in cash and recorded as assets before they are used or consumed.

Prepayments

3. Accrued Revenues. Revenues earned but not yet received in cash or recorded.

4. Accrued Expenses. Expenses incurred but not yet paid in cash or recorded.

2. Unearned Revenues. Revenues received in cash and recorded as liabilities before they are earned.

Accruals

Payment of cash that is recorded as an asset because service or benefit will be received in the future.

Adjusting Entries – “Prepaid Expenses”Adjusting Entries – “Prepaid Expenses”

insurancesuppliesadvertising

Cash PaymentCash Payment Expense RecordedExpense RecordedBEFORE

rentmaintenance on equipmentfixed assets

Prepayments often occur in regard to:

Example:Example: On Jan. 1On Jan. 1stst, Phoenix Corp. paid $12,000 for , Phoenix Corp. paid $12,000 for 12 months of insurance coverage. Show the journal 12 months of insurance coverage. Show the journal entry to record the payment on Jan. 1entry to record the payment on Jan. 1stst. .

Adjusting Entries – “Prepaid Expenses”Adjusting Entries – “Prepaid Expenses”

Cash 12,000

Prepaid insurance 12,000

Jan. 1

Debit Credit

Prepaid Insurance

12,00012,000 12,00012,000

Debit Credit

Cash

Example:Example: On Jan. 1On Jan. 1stst, Phoenix Corp. paid $12,000 for , Phoenix Corp. paid $12,000 for 12 months of insurance coverage. Show the 12 months of insurance coverage. Show the adjusting adjusting journal entryjournal entry required at Jan. 31 required at Jan. 31stst. .

Adjusting Entries – “Prepaid Expenses”Adjusting Entries – “Prepaid Expenses”

Prepaid insurance 1,000

Insurance expense 1,000Jan. 31

Debit Credit

Prepaid Insurance

12,00012,000 1,0001,000

Debit Credit

Insurance expense

1,0001,000

11,00011,000

Receipt of cash that is recorded as a liability because the revenue has not been earned.

Adjusting Entries – “Unearned Revenues”Adjusting Entries – “Unearned Revenues”

rentairline ticketsschool tuition

Cash ReceiptCash Receipt Revenue RecordedRevenue RecordedBEFORE

magazine subscriptionscustomer deposits

Unearned revenues often occur in regard to:

Example:Example: On Nov. 1On Nov. 1stst, Phoenix Corp. received $24,000 , Phoenix Corp. received $24,000 from Arcadia High School for 3 months rent in advance. from Arcadia High School for 3 months rent in advance. Show the journal entry to record the receipt on Nov. 1Show the journal entry to record the receipt on Nov. 1stst. .

Unearned rent revenue

24,000

Cash 24,000

Nov. 1

Debit Credit

Cash

24,00024,000 24,00024,000

Debit Credit

Unearned Rent Revenue

Adjusting Entries – “Unearned Revenues”Adjusting Entries – “Unearned Revenues”

Example:Example: On Nov. 1On Nov. 1stst, Phoenix Corp. received $24,000 , Phoenix Corp. received $24,000 from Arcadia High School for 3 months rent in advance. from Arcadia High School for 3 months rent in advance. Show the Show the adjusting journal entryadjusting journal entry required on Nov. 30 required on Nov. 30thth. .

Rent revenue 8,000

Unearned rent revenue 8,000Nov. 30

Debit Credit

Rent Revenue

8,0008,000 24,00024,000

Debit Credit

Unearned Rent Revenue

Adjusting Entries – “Unearned Revenues”Adjusting Entries – “Unearned Revenues”

8,0008,000

16,00016,000

Revenues earned but not yet received in cash or recorded.

Adjusting Entries – “Accrued Revenues”Adjusting Entries – “Accrued Revenues”

rentinterestservices performed

BEFORE

Accrued revenues often occur in regard to:

Cash ReceiptCash ReceiptRevenue RecordedRevenue Recorded

Adjusting entry results in:

Example:Example: On July 1On July 1stst, Phoenix Corp. invested $300,000 , Phoenix Corp. invested $300,000 in securities that return 5% interest per year. Show the in securities that return 5% interest per year. Show the journal entry to record the investment on July 1journal entry to record the investment on July 1stst. .

Cash 300,000

Investments 300,000

July 1

Debit Credit

Investments

300,000300,000 300,000300,000

Debit Credit

Cash

Adjusting Entries – “Accrued Revenues”Adjusting Entries – “Accrued Revenues”

Example:Example: On July 1On July 1stst, Phoenix Corp. invested $300,000 , Phoenix Corp. invested $300,000 in securities that return 5% interest per year. Show the in securities that return 5% interest per year. Show the adjusting journal entryadjusting journal entry required on July 31 required on July 31stst. .

Interest revenue 1,250

Interest receivable 1,250July 31

Debit Credit

Interest Receivable

1,2501,250 1,2501,250

Debit Credit

Interest Revenue

Adjusting Entries – “Accrued Revenues”Adjusting Entries – “Accrued Revenues”

Expenses incurred but not yet paid in cash or recorded.

Adjusting Entries – “Accrued Expenses”Adjusting Entries – “Accrued Expenses”

rentinteresttaxes

BEFORE

Accrued expenses often occur in regard to:

Cash Payment, if any*

Cash Payment, if any*

Expense RecordedExpense Recorded

salariesbad debts*

Adjusting entry results in:

Notes payable 200,000

Cash 200,000

Feb. 2

Debit Credit

Cash

200,000200,000 200,000200,000

Debit Credit

Notes Payable

Adjusting Entries – “Accrued Expenses”Adjusting Entries – “Accrued Expenses”

Example:Example: On Feb. 2On Feb. 2ndnd, Phoenix Corp. borrowed $200,000 , Phoenix Corp. borrowed $200,000 at a rate of 9% per year. Interest is due on first of each at a rate of 9% per year. Interest is due on first of each month. Show the journal entry to record the borrowing on month. Show the journal entry to record the borrowing on Feb. 2Feb. 2ndnd..

Example:Example: On Feb. 2On Feb. 2ndnd, Phoenix Corp. borrowed $200,000 , Phoenix Corp. borrowed $200,000 at a rate of 9% per year. Interest is due on first of each at a rate of 9% per year. Interest is due on first of each month. Show the month. Show the adjusting journal entryadjusting journal entry required on Feb. required on Feb. 2828thth..

Interest payable 1,500

Interest expense 1,500Feb. 28

Debit Credit

Interest Expense

1,5001,500 1,5001,500

Debit Credit

Interest Payable

Adjusting Entries – “Accrued Expenses”Adjusting Entries – “Accrued Expenses”

Shows the balance of all accounts, after adjusting entries, at the end of the accounting period.

5. Adjusted Trial Balance5. Adjusted Trial Balance

6. Preparing Financial Statements6. Preparing Financial Statements

Financial Statements are prepared directly from the Adjusted Trial Balance.

Financial Statements are prepared directly from the Adjusted Trial Balance.

Balance Sheet

Income Statemen

t

Statement of Cash

Flows

Statement of

Retained Earnings

Adjusted Trial Balance Debit Credit

Cash 140,000$ Accounts receivable 35,000 Building 190,000 Note payable 150,000$ Common stock 100,000 Retained earnings 38,000 Dividends declared 10,000 Sales 185,000 I nterest income 17,000 Cost of goods sold 47,000 Salary expense 25,000 Depreciation expense 43,000

490,000$ 490,000$

Balance Sheet

Assets

Cash 140,000$ Accounts receivable 35,000 Building 190,000

Total assets 365,000$

Liabilities

Note payable 150,000 Stockholders' equity

Common stock 100,000 Retained earnings 115,000

Total liab. & equity 365,000$

6. Preparing Financial Statements6. Preparing Financial Statements

Balance SheetAssume the following Adjusted Trial Balance

Adjusted Trial Balance Debit Credit

Cash 140,000$ Accounts receivable 35,000 Building 190,000 Note payable 150,000$ Common stock 100,000 Retained earnings 38,000 Dividends declared 10,000 Sales 185,000 I nterest income 17,000 Cost of goods sold 47,000 Salary expense 25,000 Depreciation expense 43,000

490,000$ 490,000$

I ncome Statement

Revenues:

Sales 185,000$ I nterest income 17,000

Total revenue 202,000 Expenses:

Cost of goods sold 47,000 Salary expense 25,000 Depreciation expense 43,000

Total expenses 115,000 Net income 87,000$

6. Preparing Financial Statements6. Preparing Financial Statements

Income Statement

Assume the following Adjusted Trial Balance

Adjusted Trial Balance Debit Credit

Cash 140,000$ Accounts receivable 35,000 Building 190,000 Note payable 150,000$ Common stock 100,000 Retained earnings 38,000 Dividends declared 10,000 Sales 185,000 I nterest income 17,000 Cost of goods sold 47,000 Salary expense 25,000 Depreciation expense 43,000

490,000$ 490,000$

Statement of Retained Earnings

Beginning balance 38,000$ + Net income 87,000 - Dividends (10,000) Ending balance 115,000

6. Preparing Financial Statements6. Preparing Financial Statements

Statement of Retained Earnings

Assume the following Adjusted Trial Balance

7. Closing Entries7. Closing Entries

To reduce the balance of the income To reduce the balance of the income statement (statement (revenuerevenue and and expenseexpense) accounts ) accounts to zero. to zero.

To transfer net income or net loss to owner’s To transfer net income or net loss to owner’s equity.equity.

Balance sheet (Balance sheet (assetasset, , liabilityliability, and , and equityequity) ) accounts are not closed.accounts are not closed.

Dividends are closed directly to the Retained Dividends are closed directly to the Retained Earnings account.Earnings account.

7. Closing Entries7. Closing EntriesExampleExample: Assume the following Adjusted Trial : Assume the following Adjusted Trial

BalanceBalanceAcct. No. Account Debit Credit

100 Cash 140,000$ 105 Accounts receivable 35,000 130 Building 190,000 220 Note payable 150,000$ 300 Common stock 100,000 330 Retained earnings 38,000 380 Dividends declared 10,000 400 Sales 185,000 430 I nterest income 17,000 500 Cost of goods sold 47,000 520 Salary expense 25,000 550 Depreciation expense 43,000

490,000$ 490,000$

Example:Example: Prepare the Prepare the Closing journal entryClosing journal entry from the from the adjusted trial balance on the previous slide.adjusted trial balance on the previous slide.

7. Closing Entries7. Closing Entries

Sales 185,000

Income summary 202,000Interest income 17,000

Income summary 115,000Cost of goods sold 47,000Salary expense 25,000Depreciation expense 43,000

Income summary 87,000Retained earnings 87,000

Retained earnings 10,000Dividends declared 10,000

8. Post-Closing Trial Balance8. Post-Closing Trial BalanceExample Example continued:continued:

Acct. No. Account Debit Credit

100 Cash 140,000$ 105 Accounts receivable 35,000 130 Building 190,000 220 Note payable 150,000$ 300 Common stock 100,000 330 Retained earnings 115,000 380 Dividends declared - 400 Sales - 430 I nterest income - 500 Cost of goods sold - 520 Salary expense - 550 Depreciation expense -

365,000$ 365,000$

9. Reversing Entries9. Reversing Entries

Reversing entries is an Reversing entries is an optional stepoptional step that a company may perform at the that a company may perform at the beginning of the next accounting beginning of the next accounting period.period.