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CHAPTER 4

COMPLETING THE

ACCOUNTING CYCLE

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OUTLINE

Adjusting EntriesPreparing the Adjusted Trial BalanceClosing EntriesPreparing the Financial Statements

Income StatementStatement of Owner’s EquityBalance Sheet

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The Accounting Cycle

SourceDocuments

Journal

LedgerTrial BalanceAdjustments

AdjustedTrial Balance

Financial Statements

Closing Entries

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Fiscal year Vs Calendar year

Fiscal year

Calendar year

1st day of a month and ends

twelve months later on the

last day of a month.

1st January to 31st December

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Accrual Vs Cash-basis accounting

Accrual

Cash-basisrevenue is recorded when cashis received, and expenses are recorded when cash is paid.

revenue and expenses arerecognized at the time theytake place, and not at thetime they are actually paid.

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Recognition of Revenue & Expenses

REVENUE RECOGNITION

PRINCIPLE

THE MATCHING PRINCIPLE

revenue be recognized in the accounting period in which itis earned.

efforts (expenses) be matched

with accomplishments (revenues).

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The Need for Adjusting Entries

1 Revenues to be recorded in the period in which they are earned, and for......

2 Expenses to be recognized in the period in which they are incurred.

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The Basics of Adjusting Entries

Prepayments

Prepaid Expenses

Expenses paid in cash and

recorded as assets before

they are used or consumed

Unearned Revenues Cash received and recorded as

liabilities before revenue is earned

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The Basics of Adjusting Entries

Accruals

Accrued Revenues

Revenues earned but not yet

received in cash or recorded

Accrued Expenses

Expenses incurred but not yet

paid in cash or recorded

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Prepaid Expenses

Prior to adjustment, assets are overstated and

expenses are understated.

The adjusting entry results in a debit to an expense

account and a credit to an asset account.

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Prepaid Expenses

Asset Expense

Unadjusted balance

Credit Adjustment

Debit Adjustment

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Prepaid Expenses

Supplies

Insurance

Depreciation

Examples

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SuppliesAn inventory count reveals that RM1,000 of RM2,500 of supplies are still on hand.Adjustment:

Dr. Supplies Expense 1,500

Cr. Office Supplies 1,500

Dr. Office Supplies 2,500

Cr. Cash 2,500

Entries before adjustment:

Adjustingentries:

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Supplies

Office Supplies

Supplies ExpenseCash 2,500 Supp. Exp 1,500

Off. Supp. 1,500

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InsuranceInsurance premium paid for one year amounting to RM1,200; Expires every month RM100.

Adjustment:

Dr. Insurance Expense 100

Cr. Prepaid Insurance 100

Entries before adjustment:

Adjustingentries:

Dr. Prepaid Insurance 1,200

Cr. Cash 1,200

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Insurance

Prepaid Insurance

Insurance ExpenseCash 1,200 Ins. Exp 100

Pre. Insurance 100

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DepreciationDepreciation is the allocation of the cost of an asset to

expense over its useful life in a rational and systematic

manner.

Depreciation is an estimate rather than a factual measurement of the cost that has expired.

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Depreciation

In recording depreciation, Depreciation Expense is debited and a contra asset account, Accumulated Depreciation, is credited

The difference between the cost of any depreciable

asset and its related accumulated depreciation is

referred to as the book value of the asset.

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Depreciation

DepreciationMethods

Straight Line Method

Reducing Balance Method

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Depreciation

Straight-line depreciation allocates equal amount of anassets net cost to depreciation during the estimateduseful life.

Eg: Equipment costing RM26,000, estimated to have a useful life of 4 years and expected to be sold for RM8,000 at the end of the 4th year.

Formula: Cost - Scrap Value

Estimated useful life

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Depreciation

Calculation: RM26,000 - RM8,000

4 years

= RM4,500 per year

Adjustingentries:

Dr. Depreciation Expense 4,500

Cr. Accumulated Depn. 4,500

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Depreciation

Depreciation Expense

Accumulated Depn.Off. Eqpt. 4,500

Depn. Exp. 4,500

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Depreciation

Reducing Balance depreciation :

Eg: Equipment costing RM35,000, accumulated depreciation RM5,250. The depreciation rate is 15% on book value.

Formula: Net Book Value x Depreciation rate

(Cost - Accumulated Depn) x Depreciation rate

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Depreciation

Calculation: (RM35,000 - RM5,250) x 15%

= RM4,463 per year

Adjustingentries:

Dr. Depreciation Expense 4,463

Cr. Accumulated Depn. 4,463

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Unearned Revenues

Prior to adjustment, liabilities are overstated and

revenues are understated.

The adjusting entry results in a debit to a liability account

and a credit to a revenue account.

Examples of unearned revenues include rent, magazine

subscriptions, and customer deposits for future services.

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Unearned Revenues

Liability Revenue

Unadjusted balance

Credit Adjustment

Debit Adjustment

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Unearned Revenues

RM2,000 subscription fees has been earned, out of RM5,000 unearned subscription fees that has been received last month.

Adjustment:

Dr. Unearned Subscription Fees 2,000Cr. Subscription Fees 2,000

Dr. Cash 5,000Cr. Unearned

Subscription Fees 5,000

Entries before adjustment:

Adjustingentries:

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Unearned Revenues

Unearned Subscription Fees

Suscription FeesSubscriptionFees 2,000

Balance 5,000

UnearnedSubscriptionFees 2,000

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Accrued Revenues

Prior to adjustment, assets and revenues are understated.

Accrued revenues may accumulate with the passing of time

or through services performed but not billed or collected.

The adjusting entry requires a debit to an asset account

and a credit to a revenue account.

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Accrued Revenues

Asset Revenue

Debit Adjustment Credit

Adjustment

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Accrued Revenues

The company has completely performed the audit service but has not bill the customer yet, RM7,000.

Adjustment:

Dr. Account Receivable 7,000

Cr. Audit Fees 7,000

Adjustingentries:

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Accrued Revenues

Account Receivable 7,000

Audit Fees

Audit Fees 7,000

Account Receivable

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Accrued Expenses

Prior to adjustment, liabilities and expenses

are understated.

The adjusting entry results in a debit to an expense

account and a credit to a liability account.

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Accrued Expenses

Expense Liability

Debit Adjustment Credit

Adjustment

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Accrued Expenses

Salaries accrued at the end of the month RM4,000.Adjustment:

Dr. Salary Expense 4,000

Cr. Salary Payable 4,000

Adjustingentries:

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Accrued Expenses

Salary Exp. 4,000

Salary payable

Salary Payable 4,000

Salary Expense

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Summary of Adjusting Entries

Types of Accounts Before AdjustingEntriesAdjustments Adjustments

Prepaid Expenses

Assets overstatedExpenses understated

Dr. Expense Cr. Asset

UnearnedRevenues

Liabilities overstatedRevenues understated

Dr. Liability Cr. Revenue

AccruedRevenues

Dr. Asset Cr. Revenue

Dr. Expense Cr. Liability

Assets understatedRevenues understated

AccruedExpenses

Liabilities understatedExpenses understated

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The adjusted trial balance An Adjusted Trial Balance is prepared after all

adjusting entries have been journalized and posted.

Its purpose is to prove the equality of the total debit

and credit balances in the ledger after all adjustments

have been made.

Financial statements can be prepared directly from

the adjusted trial balance.

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Closing Entries

Temporary /Nominal Accounts

Permanent /Real Accounts

All revenue accounts

All expense accounts

Owner’s drawings

All asset accounts

All liability accounts

Owner’s capital account

CLOSE

CN LO OT S E

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Closing Entries

Revenues

Expenses

IncomeSummary

Drawings

Owner’sCapital

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Closing Entries

Revenues

Expenses

Dr. Revenue Account

Cr. Income Summary

Dr. Income Summary

Cr. Expense Account

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Closing Entries

Drawings Dr. Owner’s Capital

Cr. Drawings Account

IncomeSummary

Loss

ProfitDr. Income Summary

Cr. Owner’s Capital

Dr. Owner’s Capital

Cr. Income Summary

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Preparing the Financial Statements

~ The income statement is prepared from the revenue

and expense accounts.

~ The owner’s equity statement is derived from the owner’s capital and drawing accounts and the net income (or net loss) from the income statement.

~ The balance sheet is then prepared from the asset

and liability accounts and the ending owner’s capital

balance as reported in the owner’s equity statement.

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