1. The Accounting Cycle Transactions 1. Journalization 6. Financial Statements 7. Closing entries 8. Post-closing trail balance 9. Reversing entries 3. Trial balance 2. Posting 5. Adjusted trial balance 4. Adjustments Work Sheet

2. Normal Balance Credit Normal Balance Debit Debits and Credits

3. Transactions and Events What to Record? FASB states, “transactions and other events and circumstances that affect a business enterprise.” Types of Events: External – between a business and its environment. Internal – event occurring entirely within a business.

4. 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” ExternalInternal

5. 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

6. Matching Principle Requires that expenses be recorded in the same period in which the revenues they helped produce are recorded

7. Cash Basis of Accounting Revenue is recorded only when cash is received Expense is recorded only when cash is paid

8. 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

9. 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

10. Types of Adjusting Entries –Prepayments Prepaid expenses Unearned revenues –Accruals Accrued revenues Accrued expenses

11. 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

12. 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!

13. 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

14. 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

15. TemporaryPermanent Temporary Permanent All revenue accountsAll asset accounts All expense accountsAll liability accounts Dividends account Shareholders’ equity accounts

16. 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)

17. 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

18. General Journal General Journal – a chronological record of transactions. Journal Entries are recorded in the journal. 1. Journalizing General Journal

19. Posting Posting – the process of transferring amounts from the journal to the ledger accounts. General Ledger General Journal Jan. 3Sale of stockGJ1100,000 100 GJ1 2. Posting

20. Trial Balance Trial Balance – a list of each account and its balance; used to prove equality of debit and credit balances. 3. Trial Balance

21. 4. Adjusting Entries Revenues - recorded in the period in which they are earned Revenues - recorded in the period in which they are earned. Expenses - recognized in the period in which they are incurred Expenses - recognized in the period in which they are incurred. Adjusting entries- needed to ensure that the revenue recognition and matching principles are followed. Adjusting entries - needed to ensure that the revenue recognition and matching principles are followed.

22. Classes 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

23. Payment of cash that is recorded as an asset because service or benefit will be received in the future. Adjusting Entries – “Prepaid Expenses ” insurance supplies advertising Cash Payment Expense Recorded BEFORE rent maintenance on equipment fixed assets Prepayments often occur in regard to:

24. Example: On Jan. 1 st, Phoenix Corp. paid $12,000 for 12 months of insurance coverage. Show the journal entry to record the payment on Jan. 1 st. Adjusting Entries – “Prepaid Expenses” Cash12,000 Prepaid insurance12,000Jan. 1 DebitCredit Prepaid Insurance 12,00012,000 DebitCredit Cash

25. Example: On Jan. 1 st, Phoenix Corp. paid $12,000 for 12 months of insurance coverage. Show the adjusting journal entry required at Jan. 31 st. Adjusting Entries – “Prepaid Expenses” Prepaid insurance1,000 Insurance expense1,000Jan. 31 DebitCredit Prepaid Insurance 12,0001,000 DebitCredit Insurance expense 1,000 11,000

26. Receipt of cash that is recorded as a liability because the revenue has not been earned. Adjusting Entries – “Unearned Revenues” rent airline tickets school tuition Cash Receipt Revenue Recorded BEFORE magazine subscriptions customer deposits Unearned revenues often occur in regard to:

27. Example: On Nov. 1 st, Phoenix Corp. received $24,000 from Arcadia High School for 3 months rent in advance. Show the journal entry to record the receipt on Nov. 1 st. Unearned rent revenue24,000 Cash24,000Nov. 1 DebitCredit Cash 24,00024,000 DebitCredit Unearned Rent Revenue Adjusting Entries – “Unearned Revenues”

28. Example: On Nov. 1 st, Phoenix Corp. received $24,000 from Arcadia High School for 3 months rent in advance. Show the adjusting journal entry required on Nov. 30 th. Rent revenue8,000 Unearned rent revenue8,000Nov. 30 DebitCredit Rent Revenue 8,00024,000 DebitCredit Unearned Rent Revenue Adjusting Entries – “Unearned Revenues” 8,000 16,000

29. Revenues earned but not yet received in cash or recorded. Adjusting Entries – “Accrued Revenues” rent interest services performed BEFORE Accrued revenues often occur in regard to: Cash Receipt Revenue Recorded Adjusting entry results in:

30. Example: On July 1 st, Phoenix Corp. invested $300,000 in securities that return 5% interest per year. Show the journal entry to record the investment on July 1 st. Cash300,000 Investments300,000July 1 DebitCredit Investments 300,000300,000 DebitCredit Cash Adjusting Entries – “Accrued Revenues”

31. Example: On July 1 st, Phoenix Corp. invested $300,000 in securities that return 5% interest per year. Show the adjusting journal entry required on July 31 st. Interest revenue1,250 Interest receivable1,250July 31 DebitCredit Interest Receivable 1,2501,250 DebitCredit Interest Revenue Adjusting Entries – “Accrued Revenues”

32. Expenses incurred but not yet paid in cash or recorded. Adjusting Entries – “Accrued Expenses” rent interest taxes BEFORE Accrued expenses often occur in regard to: Cash Payment, if any* Expense Recorded salaries bad debts* Adjusting entry results in:

33. Notes payable200,000 Cash200,000Feb. 2 DebitCredit Cash 200,000200,000 DebitCredit Notes Payable Adjusting Entries – “Accrued Expenses” Example: On Feb. 2 nd, Phoenix Corp. borrowed $200,000 at a rate of 9% per year. Interest is due on first of each month. Show the journal entry to record the borrowing on Feb. 2 nd.

34. Example: On Feb. 2 nd, Phoenix Corp. borrowed $200,000 at a rate of 9% per year. Interest is due on first of each month. Show the adjusting journal entry required on Feb. 28 th. Interest payable1,500 Interest expense1,500Feb. 28 DebitCredit Interest Expense 1,5001,500 DebitCredit Interest Payable Adjusting Entries – “Accrued Expenses”

35. Shows the balance of all accounts, after adjusting entries, at the end of the accounting period. 5. Adjusted Trial Balance

36. 6. Preparing Financial Statements Financial Statements are prepared directly from the Adjusted Trial Balance. Balance Sheet Income Statement Statement of Cash Flows Statement of Retained Earnings

37. 6. Preparing Financial Statements Balance Sheet Assume the following Adjusted Trial Balance

38. 6. Preparing Financial Statements Income Statement Assume the following Adjusted Trial Balance

39. 6. Preparing Financial Statements Statement of Retained Earnings Assume the following Adjusted Trial Balance

40. 7. Closing Entries To reduce the balance of the income statement (revenue and expense) accounts to zero. To transfer net income or net loss to owner’s equity. Balance sheet (asset, liability, and equity) accounts are not closed. Dividends are closed directly to the Retained Earnings account.

41. 7. Closing Entries Example : Assume the following Adjusted Trial Balance

42. Example: Prepare the Closing journal entry from the adjusted trial balance on the previous slide. 7. Closing Entries Sales185,000 Income summary202,000 Interest income17,000 Income summary115,000 Cost of goods sold47,000 Salary expense25,000 Depreciation expense43,000 Income summary87,000 Retained earnings87,000 Retained earnings10,000 Dividends declared10,000

43. 8. Post-Closing Trial Balance Example continued:

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