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.