Presentation on theme: "Chapter 6 Completing the Accounting Cycle for a Service Business."— Presentation transcript:
Chapter 6 Completing the Accounting Cycle for a Service Business
Adjustments End of period ledger is not accurate Need to bring accounts up to date Accounts needing updating: –Prepaid Expenses, e.g., Prepaid Rent and Insurance (current assets) –Fixed Assets, e.g., they decline in value, known as depreciation
Prepaid Rent Company prepays for six months rent on November 1, $12000 –Dr Prepaid Rent 12000 –Cr Cash12000 Adjusting entry at December 31, 2006 Dr Rent Expense4000 Cr Prepaid Rent 4000 2/6 x $12000
Supplies The ledger shows a balance for Supplies of $500 A check of the supplies cupboard shows only $350 worth of supplies remaining Adjusting entry: Dr Supplies Expense150 Cr Supplies150
Prepaid Insurance Buy insurance for one year on April 1, 2004 Dr Prepaid Insurance24000 Cr Cash24000 Adjustment at December 31, 2004 Dr Insurance Expense18000 Cr Prepaid Insurance18000 9/12 x $24000
Depreciation Two methods: 1.Straight-line: record decrease in value of fixed asset evenly Dep = Cost – Salvage Value Years of Useful Life 2.Declining Balance: accelerated decrease in value in early years where greater use Dep = Book value x CCA allowance % Where Book value = Cost – Accumulated Dep’n CCA = Capital Cost % allowed by government, e.g., Autos 30%, Equipment 20%, Buildings (brick 5%), Buildings (wood) 10%, etc.
Depreciation Adjustment: Straight Line Automobile cost $20000, salvage (residual) value $4000, 8 useful years Calculate first year’s depreciation and adjusting entry: Dr. Depreciation Expense, Auto 2000 Cr. Accumulated Depreciation, Auto* 2000 (20000-4000)/8 * A contra account – see two slides later
Depreciation Adjustment: Declining Balance Automobile with cost $20000 and accumulated depreciation of $4000 is adjusted for a six month period: Dr. Depreciation Expense, Auto 2400 Cr. Accumulated Depreciation, Auto 2400 (20000-4000) x 30% x 6/12
Contra Accounts Accumulated Depreciation is an asset with a credit balance which is shown opposite its associated asset on Balance Sheet: Fixed Assets Automobile20000 Less: Accumulated Depreciation 6400 13600 Ledger account numbers follow the main accounts, e.g., if Auto is 140, Acc. Dep’n, Auto is 141
Closing Entries All revenues and expenses must be reduced to zero to allow new entries next period Use the REID formula: –R: close revenues to Income Summary –E: close expenses to Income Summary –I: close Income Summary to Capital –D: close Drawings to Capital
Close Revenues Dr Fees Income30000 Dr Management Revenue20000 Cr Income Summary50000 Close Expenses Dr Income Summary40000 Cr Advertising Expense10000 Wages15000 General Expense15000
Close Income Summary Dr Income Summary10000 Cr J. Schmoo, Capital 10000 Close Drawings Dr J. Schmoo, Capital5000 Cr J. Schmoo, Drawings5000
GAAP Matching Principle re adjustments Materiality Principle – include all information that affects decisions by users of financial statements Conservatism Principle – when faced with choices, select the treatment resulting in lower net income and net assets
Notes All adjusting entries must be journalized and posted to the ledger! Ten column worksheets include two adjusted trial balance columns: –Add the adjustments to the trial balance accounts then move to is and bs After all adjusting and closing entries have been posted “take off” a post-closing trial balance to ensure readiness for next period … capital account should be last!