The Accounting Cycle Overview of the Accounting Process

The Accounting Cycle

Overview of the Accounting Process Step 1 Business documents analyzed Step 2 Transactions recorded in journals Recording Process Continued Step 3 Transactions posted to ledgers 2

Overview of the Accounting Process Continued from previous slide Steps in the Reporting Phase Step 4 Trial balance Step 5 Adjustments Continued Work sheet (optional) 3

Overview of the Accounting Process Step 6 Financial statements Steps in the Reporting Phase Step 7 Adjustments Step 8 Post-closing trial balance (optional) 4

Recording Phase A system of recording transactions in a way that maintains the equality of the accounting equation. Assets = Liabilities + Owners’ Equity or A = L + OE 5

1. Analyzing Business Documents Transactions are the exchange of goods or services between entities, as well as other events that have an economic impact on a business. § Business documents are records that are evidence of transactions. § 6

2. Journalizing Transactions ù A journal is an accounting record in which business transactions are entered in chronological order. ù Journal entries record transaction information; debits equal credits. General Journal Entry Format Date Debit Entry. . . . xx Credit Entry. . . . xx Explanation. 7

2. Journalizing Transactions Every journal entry involves a three-step process: 1. Identify the accounts involved with an event or transaction. 2. Determine whether each account increased or decreased. 3. Determine the amount by which each account was affected. 8

9 Debits and Credits Assets = DR CR (+) (–) Liabilities + Owners’ Equity DR CR (–) (+) Capital Stock DR CR (–) (+) Continued Retained Earnings DR CR (–) (+)

10 Debits and Credits Retained Earnings DR CR (–) (+) Expenses DR CR Revenues DR CR (+) (–) Dividends DR CR (+) (–) (+)

11 General Journal Date 2005 July Description 1 Dividends Payable Declared semiannual cash dividend on common stock. 10 Equipment Notes Payable Issued note for new equipment Page 24 Post Ref. Debits 330 260 25, 000 180 220 7, 500 . Credits 25, 000 7, 500

Example: Journal Entry On January 2, sold merchandise costing $60 to a customer on account for $75. Make the journal entry. 12

Example: Journal Entry On January 2, sold merchandise costing This entry assumes that the $60 to a customer on account for $75. perpetual system is used. Make the journal entry. Jan. 2 Accounts Receivable. . . . . 75 Sales Revenue. . . 75 Sold merchandise on account. 2 Cost of Goods Sold. . . . . 60 Inventory. . . . 60 To record cost and reduce inventory. 13

14 3. Posting to the Ledger Accounts Posting is the process of transferring amounts from the journal to the general ledger. § A ledger is a collection of accounts in which data from transactions recorded in the journals are posted, classified, and summarized. § A chart of accounts lists all accounts used by the company. §

15 3. Posting to the Ledger Accounts The Equipment account in the general ledger after the purchase of July 10 (Slide 14) has been posted would appear as follows: Account Date EQUIPMENT Item Account No: 180 PR 2005 July 1 Balance 10 Purchase Equipment J 24 Debit 7, 500 Credit Balance 10, 550 18, 050 To examine the journal entry, click this button to go to Slide 14. To return, click on the word “July” in the entry on Slide 14.

Typical Chart of Accounts ASSETS (100 -199) Current Assets (100 -150) 101 Cash 105 Accounts Receivable 107 Inventory Long-Term Assets (151 -199) 151 Land 152 Building LIABILITIES (200 -299) Current Liabilities (200 -219) 201 Notes Payable 202 Accounts Payable 16 Long-Term Liabilities (220 -239) 222 Mortgage Payable OWNERS’ EQUITY (300 -399) 301 Capital Stock 330 Retained Earnings SALES (400 -499) 400 Sales Revenue EXPENSES (500 -599) 500 Cost of Goods Sold 523 Rent Expense 528 Advertising Expense 573 Utility Expense

17 Illustration 1. October 1, C. R Byrd invests $10, 000 cash in an advertising venture to be known as the Pioneer Advertising Agency Oct. 1 Cash C. R. Byrd, Capital (Invested cash in business) 1 40 10, 000 2. October 1, office equipment costing $5, 000 is purchased by signing a 3 -month, 12%, $5, 000 note payable. Oct. 1 Office equipment Notes payable (Issued 3 -month, 12%, note for office equipment) 15 25 5, 000 3. October 2, a $1, 200 cash advance is received from R. Knox, a client, for advertising services that are expected to be completed.

18 Illustration Oct. 2 Cash Unearned Fees (Received advance from R. Knox for future service) 1 28 1, 200 4. October 3, office rent for October is paid in cash, $900 Oct. 3 Rent Expense Cash (Paid October Rent) 62 1 900 5. October 4, $600 is paid for a one-year insurance policy that will expire next year on September 30. Oct. 4 Prepaid Insurance Cash (Paid one-year policy; effective date October 1) 10 1 600

19 Illustration 6. October 5, an estimated 3 -month supply of advertising materials is purchased on account from Aero Supply for $2, 500 Oct. 5 Advertising Supplies Account Payable (Purchased supplies on account from Aero Supply) 8 26 2, 500 7. October 9, hire four employees to begin work on October 15. each employee is to receive a weekly salary of $500 for a 5 -day work week, payable every 2 weeks – first payment made on October 26. A business transaction has not occurred. There is only an agreement between the employer and the employees to enter into a business. 8. October 20, C. R. Byrd withdraw $500 cash for personal use. Oct. 20 C. R. Byrd, Drawing 41 Cash 1 (Withdraw cash for personal use) 500

20 Illustration 9. October 26, employee salaries of $4, 000 are owed and paid in cash. (See October 9 transaction) Oct. 26 Salaries Expense Cash (Paid salaries to date) 60 1 4, 000 10. October 31, received $10, 000 in cash from Copa Company for advertising services rendered in October. Oct. 31 Cash Fees Earned (Received cash for fees earned) 41 1 500

21 GENERAL LEDGER CASH Date Explanation Oct. 1 2 3 4 20 26 31 Ref J 1 J 1 Debit 10, 000 1, 200 10, 000 Credit 900 600 500 4, 000 Balance 10, 000 11, 200 10, 300 9, 700 9, 200 5, 200 15, 200 ADVERTISING SUPPLIES Date Explanation Oct. 5 Ref J 1 Debit NO 8 Credit 2, 500 Balance 2, 500 Prepaid Insurance Date Oct. 4 Explanation Ref J 1 Debit 600 NO 10 Credit B 3 alance 600

22 GENERAL LEDGER Office Equipment Date Explanation Oct. 1 Ref J 1 Debit No. 15 Credit 5, 000 Notes Payable Date Explanation Oct. 1 Ref Debit J 1 NO 25 Credit 5, 000 Account Payable Date Explanation Oct. 5 Ref Debit J 1 Oct. 2 Explanation Ref Credit 2, 500 J 1 Debit Balance 5, 000 NO 26 Unearned Fees Date Balance 2, 500 NO 28 Credit 1, 200 Balance 1, 200

23 GENERAL LEDGER C. R. Byrd, Capital Date Explanation Oct. 1 Ref Debit J 1 No. 40 Credit 10, 000 Balance 10, 000 C. R. Byrd, Drawing Date Explanation Oct. 20 Ref J 1 Debit NO 41 Credit 500 Fees Earned Date Explanation Oct. 31 Ref Debit J 1 NO 50 Credit 10, 000 Salaries Expense Date Oct. 26 Explanation Ref J 1 Balance Debit 4, 000 Balance 10, 000 NO 60 Credit Balance 4, 000

24 GENERAL LEDGER Rent Expense Date Oct. 3 Explanation Ref J 1 Debit NO 62 Credit 900 PIONEER ADVERTISING AGENCY ACCOUNTS 1 -19 = Assets Accounts 20 – 39 = Liabilities 40 – 49 = Owner’s Equity 50 – 59 = Revenues 60 – 69 = Expenses Balance 900

Reporting Phase 4. 5. 6. 7. 8. A trial balance is prepared. Adjusting entries are recorded. Financial statements are prepared. Closing entries are made. A post-closing trial balance is prepared (optional). 25

4. Preparing a Trial Balance ü Determine the account balance for each T -Account. ü A trial balance is a list of all accounts and their balances. It provides a means to assure that debits equal credits. 26

27 PIONEER ADVERTISING AGENCY TRIAL BALANCE OCTOBER 31, 2010 DEBIT Cash Advertising Supplies CREDIT $ 15, 200 2, 500 Prepaid Insurance 600 Office Equipment 5, 000 Notes Payable $ 5, 000 Accounts Payable 2, 500 Unearned Fees 1, 200 C. R. Byrd, Capital C. R. Byrd, Drawing 10, 000 500 Fees Earned Salaries Expense Rent Expense 10, 000 4, 000 900 $28, 700 =======

5. Preparing 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, costs, and expenses on the income statement. 28

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. ü Adjusting entries always incorporate a balance sheet account and an income statement account. ü Adjusting entries never involve a cash account. ü 29

Most Common Adjusting Entries 30 • Unrecorded Revenues—Revenues that have been earned but not yet recorded. • Unearned Revenues—Revenues that have been recorded but not yet earned. • Unrecorded Expenses—Expenses that have been incurred but not yet recorded. • Prepaid Expenses—Expenses that have been recorded but not yet incurred.

Three-Step Process for Adjusting Entries 1. Identify the original entries that were made, if any. Original entries are only made for unearned revenues and prepaid expenses. 2. Determine what the correct balances should be at this point in time. 3. Make the adjustments needed to bring the balances to the desired amounts. 31

Asset Depreciation Rosi, Inc. purchased buildings in 2000 at a cost of $156, 000, an expected life of 20 years, and no anticipated residual value. Each year, 5% of the cost is depreciated. At the end of 2005, the following adjusting entry is made: Adjusting Entry 12/31 Depreciation Expense—Buildings 7, 800 Accumulated Depr. —Buildings 7, 800 To record depreciation on building at 5% per year. 32

Accrued Expenses 33 At the end of the fiscal period, Rosi, Inc. had accrued salaries and wages totaling $2, 150. Adjusting Entry 12/31 Salaries and Wages Expense 2, 150 Salaries and Wages Payable 2, 150 To record accrued salaries and wages.

34 Accrued Revenues Rosi, Inc. holds a note receivable from a customer on which interest total $250 has accrued. Adjusting Entry 12/31 Interest Receivable Interest Revenue To record accrued interest on a note receivable. 250

Prepaid Expenses 35 Rosi, Inc. ’s trial balance shows that the asset account Prepaid Insurance has a balance of $8, 000. By December 31, only $3, 800 applies to future periods. Adjusting Entry 12/31 Insurance Expense 4, 200 Prepaid Insurance 4, 200 To record expired insurance. $8, 000 – $3, 800 Original debit to an asset account

Prepaid Expenses 36 Rosi, Inc. ’s trial balance shows that the asset account Insurance Expense has a balance of $8, 000. By December 31, $3, 800 applies to future periods. Adjusting Entry 12/31 Prepaid Insurance 3, 800 Insurance Expense 3, 800 To record expired insurance. $8, 000 – $4, 200 Original debit to an expense account

Deferred Revenues 37 Rosi, Inc. receives a payment of $2, 550 from a customer prior to the services being rendered. By December 31, $2, 075 in $2, 550 – $2, 075 services have been provided. Adjusting Entry 12/31 Rent Revenue 475 Unearned Rent Revenue To record unearned rent revenue. Original credit to a revenue account 475

38 Deferred Revenues Rosi, Inc. receives a payment of $2, 550 from a customer prior to the services being rendered. By December 31, $2, 075 in $2, 550 – $475 services have been provided. Adjusting Entry 12/31 Unearned Rent Revenue To record rent revenue. 2, 075 Original credit to a liability account 2, 075

39 Illustration 1. At the end of October 31, it reveals that $1, 000 of supplies are still on hand. Oct. 31 Advertising Supplies Expense Advertising Supplies (To record supplies used) 1, 500 Advertising Supplies 10/5 2, 500 10/31 Adj. 1, 500 10/31 Bal. 1, 000 Advertising Supplies Expense 10/31 Adj. 1, 500

40 Illustration 2. At the end of October 31, it reveals that $50 of insurance expires. ($600 ÷ 12 = $50 each month) Oct. 31 Insurance Expense Prepaid Insurance (To record insurance expired) 50 50 Prepaid Insurance 10/4 600 10/31 Bal. 550 10/31 Adj. Insurance Expense 10/31 Adj. 50 50

41 Illustration 3. Depreciation on the office equipment is estimated to be $480 a year, or $40 per month. Oct. 31 Depreciation Expense Accumulated Depreciation Equip (To record monthly depreciation) 40 40 Accumulated Depreciation - OE 10/31 Adj. 10/31 Bal. 40 Depreciation Expense 10/31 Adj. 40 40

42 Illustration 4. At the end of October 31, it reveals that $400 of fees from R. Knox has been earned. Oct. 31 Unearned Fees Earned (To record fees earned) 400 Unearned Fees 10/31 Adj. 400 10/2 10/31 Bal. Fees Earned 1, 200 800 10/31 Bal. 10, 000 10/31 Adj. 400

43 Illustration 5. In October, Company earned $200 in fees for advertising service that were not billed to clients before October 31. Oct. 31 Accounts Receivable Fees Earned (To accrue fees earned but not billed or collected) 200 Accounts Receivable 10/31 Adj. 200 Fees Earned 10/31 10, 000 10/31 400 10/31 Adj. 200 10/31 Bal. 10, 600 200

44 Illustration 6. Interest due on October 31 is $50. Oct. 31 Interest Expense Interest Payable (To accrue interest on notes payable) 50 Interest Expense 10/31 50 Fees Earned 10/31 50 50

45 Illustration 7. Employees receive total salaries of $2, 000 for a five-day work weeks, or $400 per day. Thus, accrued salaries at October 31, are $1, 200 (3 X$400). Oct. 31 Salaries Expense Salaries Payable (To record accrued salaries) 1, 200 Salaries Expense 10/26 4, 000 10/31 Adj. 1, 200 10/31 Bal. 5, 200 Salaries Payable 10/31 Adj. 1, 200

46 GENERAL LEDGER CASH Date Explanation Oct. 1 2 3 4 20 26 31 Ref J 1 J 1 Debit 10, 000 1, 200 10, 000 Credit 900 600 500 4, 000 Balance 10, 000 11, 200 10, 300 9, 700 9, 200 5, 200 15, 200 Accounts Receivable Date Oct. 31 Explanation Adj. Entry Ref J 2 Debit 200 NO 6 Credit Balance 200

47 GENERAL LEDGER ADVERTISING SUPPLIES Date Explanation Oct. 5 31 Adj. Entry Ref J 1 J 2 NO 8 Debit 2, 500 Credit 1, 500 Prepaid Insurance Date Oct. 4 31 Explanation Adj. Entry Ref J 1 J 2 2, 500 1, 000 NO 10 Debit 600 Balance Credit 50 B 3 alance 600 550

48 GENERAL LEDGER Office Equipment Date Explanation Oct. 1 Ref J 1 Debit No. 15 Credit 5, 000 Balance 5, 000 Acc. Dep. - OE Date Oct. 31 Explanation Adj. Entry Ref J 12 NO 16 Debit Credit 40 Balance 40

49 GENERAL LEDGER Notes Payable Date Explanation Oct. 1 Ref NO 25 Debit J 1 Credit 5, 000 Account Payable Date Explanation Oct. 5 Ref Debit J 1 Balance 5, 000 NO 26 Credit 2, 500 Balance 2, 500 Interest Payable Date Explanation Oct. 31 Ref NO 27 Debit J 2 Credit 50 Unearned Fees Date Explanation Oct. 2 31 Adj. Entry Ref J 1 J 2 Debit 400 Balance 50 NO 28 Credit 1, 200 Balance 1, 200 800

50 GENERAL LEDGER Salaries Payable Date Oct. 31 Explanation Adj. Entry No. 29 Ref Debit J 2 Credit 1, 200 Balance 1, 200 C. R. Byrd, Capital Date Explanation Oct. 1 Ref Debit J 1 No. 40 Credit 10, 000 Balance 10, 000 C. R. Byrd, Drawing Date Explanation Oct. 20 Ref J 1 Debit NO 41 Credit 500 Fees Earned Date Oct. 31 31 31 Explanation Adj. Entry Ref J 1 J 2 Debit Balance NO 50 Credit 10, 000 400 200 Balance 10, 000 10, 400 10, 600

51 GENERAL LEDGER Salaries Expense Date Oct. 26 Oct. 31 Explanation Adj. Entry Ref J 1 J 2 No. 60 Debit Credit 4, 000 1, 200 Balance 4, 000 5, 200 Adv. Supplies Exp Date Oct. 31 Explanation Adj. Entry Ref J 12 Debit No. 61 Credit 1, 500 Balance 1, 500 Rent Expense Date Oct. 31 Explanation Adj. Entry Ref J 2 NO 62 Debit Credit 900 Oct. 31 Explanation Adj. Entry Ref J 2 Debit 50 Balance 900 NO 63 Insurance Expense Date NO 41 Credit Balance 50

52 GENERAL LEDGER Interest Expense Date Oct. 31 Explanation Adj. Entry Ref J 2 NO 64 Debit Credit 50 50 Depreciation Expense Date Oct. 31 Explanation Adj. Entry Ref J 2 Balance Debit NO 65 Credit 40 PIONEER ADVERTISING AGENCY ACCOUNTS 1 -19 = Assets Accounts 20 – 39 = Liabilities 40 – 49 = Owner’s Equity 50 – 59 = Revenues 60 – 69 = Expenses Balance 40

53 6. Preparing Financial Statements After all transactions have been recorded, a trial balance is prepared, adjusting entries are made, and the financial statements are prepared. Record Transactions Prepare Trial Balance Make Adjusting Entries Prepare Financial Statements

7. The Closing Process q Real accounts are permanent accounts not closed to a zero balance at the end of the accounting period. These accounts are carried forward to the next period. q Nominal accounts are temporary accounts that are closed to a zero balance at the end of each accounting period. q Closing entries reduce all nominal accounts to a zero balance. 54

7. The Closing Process Revenues xxx Bal. xxx 55 Retained Earnings Beg. Bal. xxx Revenues Since the revenue account is a nominal account, it is closed at the end of the period to Retained Earnings.

7. The Closing Process Retained Earnings Expenses Bal. xxx Beg. Bal. xxx Revenues The expense account is credited in order to close the account at the end of the period. 56

7. The Closing Process Retained Earnings The dividends account, which is also nominal, is credited to close out the balance. Expenses Dividends Bal. xxx Beg. Bal. xxx Revenues 57

7. The Closing Process Retained Earnings is a real account and always carries a balance. Expenses Dividends Beg. Bal. xxx Revenues End. Bal. xxx Net Income for the period is determined by these two items. Dividends reduce Retained Earnings 58

8. Post-Closing Trial Balance 59 • Provides a listing of all real account balances at the end of the closing balance. • The trial balance 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.

60 Example: Post-Closing Trial Balance Jim Brewster, Inc. Post-Closing Trial Balance as of December 31, 2004 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

Summary of the Accounting Cycle 1. Analyze transactions and business documents. 2. Journalize transactions. 3. Post journal entries to accounts. 4. Determine account balances and prepare a trial balance. 5. Journalize and post adjusting entries. 6. Prepare financial statements. 7. Journalize and post closing entries. 8. Prepare a post-closing trial balance. 61

Summary of the Accounting Cycle An accountant must thoroughly understand the intricacies of the accounting cycle. That means you! 62

Accrual Accounting Accrual accounting recognizes revenues as they are earned, not necessarily when cash is received. 63

Accrual Accounting That’s true. And, accrual accounting recognizes expenses as they are incurred, not necessarily when cash is paid. 64

Cash-Basis Accounting Cash-basis accounting is focused on cash receipts and cash disbursements. 65

Computers and the Accounting Process There has been a rapid increase in the use of computers to assist in performing many of the tasks found in the accounting cycle. 66

Computers and the Accounting Process Computers are well suited to perform many accounting cycle tasks. Report Generation Recall Mathematical Recording Storage Computations 67

Computers and the Accounting Process Computers will never replace the accountant. 68

chapter 2 The End 69