The Accounting Cycle.

The Accounting Cycle

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

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

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

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

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. 24

2. Journalizing Transactions
A journal is an accounting record in which business transactions are entered in chronological order. Journal entries record transaction information; debits equal credits. General Journal Entry Format Date Debit Entry xx Credit Entry xx Explanation. 26

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

Debits and Credits Assets = Liabilities + Owners’ Equity
DR CR DR CR DR CR (+) (–) (–) (+) (–) (+) Capital Stock DR CR (–) (+) Retained Earnings DR CR (–) (+) Continued 16

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

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

Example: Journal Entry
On January 2, sold merchandise costing $60 to a customer on account for $75. Make the journal entry. 32

Example: Journal Entry
On January 2, sold merchandise costing $60 to a customer on account for $75. Make the journal entry. This entry assumes that the perpetual system is used. Jan. 2 Accounts Receivable Sales Revenue Sold merchandise on account. 2 Cost of Goods Sold Inventory To record cost and reduce inventory. 33

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. 35

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 EQUIPMENT Account No: 180 Date Item PR Debit Credit Balance 2005 July 1 Balance  10,550 10 Purchase Equipment J24 7, ,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
Long-Term Liabilities ( ) 222 Mortgage Payable OWNERS’ EQUITY ( ) 301 Capital Stock 330 Retained Earnings SALES ( ) 400 Sales Revenue EXPENSES ( ) 500 Cost of Goods Sold 523 Rent Expense 528 Advertising Expense 573 Utility Expense ASSETS ( ) Current Assets ( ) 101 Cash 105 Accounts Receivable 107 Inventory Long-Term Assets ( ) 151 Land 152 Building LIABILITIES ( ) Current Liabilities ( ) 201 Notes Payable 202 Accounts Payable 37

Illustration 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 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 October 2, a $1,200 cash advance is received from R. Knox, a client, for advertising services that are expected to be completed.

Illustration Oct. 2 Cash Unearned Fees (Received advance from R.Knox
for future service) 1 28 1,200 October 3, office rent for October is paid in cash, $900 Oct. 3 Rent Expense Cash (Paid October Rent) 62 1 900 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

Illustration 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 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. October 20, C.R. Byrd withdraw $500 cash for personal use. Oct. 20 C.R. Byrd, Drawing Cash (Withdraw cash for personal use) 41 1 500

Illustration 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 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

GENERAL LEDGER Date Explanation Ref Debit Credit Balance Oct. 1 2 3 4
CASH Date Explanation Ref Debit Credit Balance Oct. 1 2 3 4 20 26 31 J1 10,000 1,200 900 600 500 4,000 11,200 10,300 9,700 9,200 5,200 15,200 ADVERTISING SUPPLIES NO 8 Date Explanation Ref Debit Credit Balance Oct. 5 J1 2,500 Prepaid Insurance NO 10 Date Explanation Ref Debit Credit B3alance Oct. 4 J1 600

GENERAL LEDGER Date Explanation Ref Debit Credit Balance Oct. 1 J1
Office Equipment No. 15 Date Explanation Ref Debit Credit Balance Oct. 1 J1 5,000 Notes Payable NO 25 Date Explanation Ref Debit Credit Balance Oct. 1 J1 5,000 Account Payable NO 26 Date Explanation Ref Debit Credit Balance Oct. 5 J1 2,500 Unearned Fees NO 28 Date Explanation Ref Debit Credit Balance Oct. 2 J1 1,200

C.R. Byrd, Capital No. 40 Date Explanation Ref Debit Credit Balance Oct. 1 J1 10,000 C.R. Byrd, Drawing NO 41 Date Explanation Ref Debit Credit Balance Oct. 20 J1 500 Fees Earned NO 50 Date Explanation Ref Debit Credit Balance Oct. 31 J1 10,000 Salaries Expense NO 60 Date Explanation Ref Debit Credit Balance Oct. 26 J1 4,000

PIONEER ADVERTISING AGENCY ACCOUNTS
GENERAL LEDGER Rent Expense NO 62 Date Explanation Ref Debit Credit Balance Oct. 3 J1 900 PIONEER ADVERTISING AGENCY ACCOUNTS 1-19 = Assets Accounts 20 – 39 = Liabilities 40 – 49 = Owner’s Equity 50 – 59 = Revenues 60 – 69 = Expenses

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

4. Preparing a Trial Balance
Determine the account balance for each T-Account. A trial balance is a list of all accounts and their balances. It provides a means to assure that debits equal credits. 38

PIONEER ADVERTISING AGENCY
TRIAL BALANCE OCTOBER 31, 2010 DEBIT CREDIT Cash $ 15,200 Advertising Supplies 2,500 Prepaid Insurance 600 Office Equipment 5,000 Notes Payable $ 5,000 Accounts Payable Unearned Fees 1,200 C.R. Byrd, Capital 10,000 C.R. Byrd, Drawing 500 Fees Earned Salaries Expense 4,000 Rent Expense 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. 16

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. Adjusting entries always incorporate a balance sheet account and an income statement account. Adjusting entries never involve a cash account. 17

Most Common Adjusting Entries
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. 18

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. 19

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 ,800 To record depreciation on building at 5% per year.

Accrued Expenses 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.

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

Original debit to an asset account
Prepaid Expenses 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

Original debit to an expense account
Prepaid Expenses 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

Original credit to a revenue account
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 services have been provided. $2,550 – $2,075 Adjusting Entry 12/31 Rent Revenue 475 Unearned Rent Revenue 475 To record unearned rent revenue. Original credit to a revenue account 20

Original credit to a liability account
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 services have been provided. $2,550 – $475 Adjusting Entry 12/31 Unearned Rent Revenue 2,075 Rent Revenue 2,075 To record rent revenue. Original credit to a liability account

39 Illustration 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/ ,500 10/31 Adj. 1,500 10/31 Bal. 1,000 Advertising Supplies Expense 10/31 Adj. 1,500

40 40 Illustration 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 Prepaid Insurance 10/ 10/31 Adj 10/31 Bal Insurance Expense 10/31 Adj

41 41 41 Illustration 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 Accumulated Depreciation - OE 10/31 Adj d 10/31 Bal Depreciation Expense 10/31 Adj

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

Illustration 43 43 43 43 43 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 Fees Earned 10/ ,000 10/ 10/31Adj 10/31 Bal. 10,600

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

Illustration 45 45 45 45 45 45 45 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 (3X$400). Oct. 31 Salaries Expense Salaries Payable (To record accrued salaries) 1,200 Salaries Expense 10/ ,000 10/31 Adj. 1,200 10/31 Bal. 5,200 Salaries Payable 10/31 Adj ,200

GENERAL LEDGER Date Explanation Ref Debit Credit Balance Oct. 1 2 3 4
CASH Date Explanation Ref Debit Credit Balance Oct. 1 2 3 4 20 26 31 J1 10,000 1,200 900 600 500 4,000 11,200 10,300 9,700 9,200 5,200 15,200 Accounts Receivable NO 6 Date Explanation Ref Debit Credit Balance Oct. 31 Adj. Entry J2 200

GENERAL LEDGER Date Explanation Ref Debit Credit Balance Oct. 5 31
ADVERTISING SUPPLIES NO 8 Date Explanation Ref Debit Credit Balance Oct. 5 31 Adj. Entry J1 J2 2,500 1,500 1,000 Prepaid Insurance NO 10 Date Explanation Ref Debit Credit B3alance Oct. 4 31 Adj. Entry J1 J2 600 50 550

Office Equipment No. 15 Date Explanation Ref Debit Credit Balance Oct. 1 J1 5,000 Acc. Dep. - OE NO 16 Date Explanation Ref Debit Credit Balance Oct. 31 Adj. Entry J12 40

Notes Payable NO 25 Date Explanation Ref Debit Credit Balance Oct. 1 J1 5,000 Account Payable NO 26 Date Explanation Ref Debit Credit Balance Oct. 5 J1 2,500 Interest Payable NO 27 Date Explanation Ref Debit Credit Balance Oct. 31 J2 50 Unearned Fees NO 28 Date Explanation Ref Debit Credit Balance Oct. 2 31 Adj. Entry J1 J2 400 1,200 800

GENERAL LEDGER Date Explanation Ref Debit Credit Balance Oct. 31
Salaries Payable No. 29 Date Explanation Ref Debit Credit Balance Oct. 31 Adj. Entry J2 1,200 C.R. Byrd, Capital No. 40 Date Explanation Ref Debit Credit Balance Oct. 1 J1 10,000 C.R. Byrd, Drawing NO 41 Date Explanation Ref Debit Credit Balance Oct. 20 J1 500 Fees Earned NO 50 Date Explanation Ref Debit Credit Balance Oct. 31 31 Adj. Entry J1 J2 10,000 400 200 10,400 10,600

GENERAL LEDGER Date Explanation Ref Debit Credit Balance Oct. 26
Salaries Expense No. 60 Date Explanation Ref Debit Credit Balance Oct. 26 Oct. 31 Adj. Entry J1 J2 4,000 1,200 5,200 NO 41 Adv. Supplies Exp No. 61 Date Explanation Ref Debit Credit Balance Oct. 31 Adj. Entry J12 1,500 Rent Expense NO 62 Date Explanation Ref Debit Credit Balance Oct. 31 Adj. Entry J2 900 NO 63 Insurance Expense Date Explanation Ref Debit Credit Balance Oct. 31 Adj. Entry J2 50

PIONEER ADVERTISING AGENCY ACCOUNTS
GENERAL LEDGER Interest Expense NO 64 Date Explanation Ref Debit Credit Balance Oct. 31 Adj. Entry J2 50 Depreciation Expense NO 65 Date Explanation Ref Debit Credit Balance Oct. 31 Adj. Entry J2 40 PIONEER ADVERTISING AGENCY ACCOUNTS 1-19 = Assets Accounts 20 – 39 = Liabilities 40 – 49 = Owner’s Equity 50 – 59 = Revenues 60 – 69 = Expenses

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 Trans-actions Prepare Trial Balance Make Adjusting Entries Prepare Financial Statements 33

7. The Closing Process 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. Nominal accounts are temporary accounts that are closed to a zero balance at the end of each accounting period. Closing entries reduce all nominal accounts to a zero balance. 34

7. The Closing Process Retained Earnings Revenues Beg. Bal. xxx xxx Bal. xxx Revenues Since the revenue account is a nominal account, it is closed at the end of the period to Retained Earnings. 44

7. The Closing Process Retained Earnings Beg. Bal. xxx Revenues Expenses Expenses The expense account is credited in order to close the account at the end of the period. xxx Bal. xxx 45

7. The Closing Process Retained Earnings The dividends account, which is also nominal, is credited to close out the balance. Beg. Bal. xxx Revenues Expenses Dividends Dividends xxx Bal. xxx 46

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

8. Post-Closing Trial Balance
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. 48

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 ,200 Totals $16,200 $16,200 49

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. 50

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

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

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

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

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.

Computers are well suited to perform many accounting cycle tasks. Recall Report Generation Storage Recording Mathematical Computations

Computers will never replace the accountant.

chapter 2 The End

The Accounting Cycle.

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