A Review of A Review of the the

Accounting Accounting CycleCycle

2

Learning Objectives

Identify and explain the basic steps in the accounting process (accounting cycle).

Analyze transactions and make and post journal entries.

Make adjusting entries, produce financial statements, and close nominal accounts.

Distinguish between accrual and cash-basis accounting.

3

Learning Objectives

Discuss the importance and expanding role of computers to the accounting process.

EXPANDED MATERIAL Use special journals and subsidiary

ledgers to process accounting information more efficiently and to provide additional useful information.

4

The purpose of this chapter is to review the

basic steps of the accounting process.

The purpose of this chapter is to review the

basic steps of the accounting process.

5

Double-Entry Accounting

A system of recording transactions in a way that maintains the equality of the accounting equation.

Assets = Liabilities + Owners’ Equity

or

A = L + OE

6

For every transaction, there must be at least one debit and one credit.

Debits must always equal credits for each transaction.

Debits are always entered on the left side of an account and credits are always entered on the right side.

Double-Entry Accounting Facts

7

Assets = Liabilities + Owners’ Equity

DR CR

+ -

DR CR

- +

DR CR

- +

The Accounting Equation with T-Accounts

8

How Accounts Affect Owners' Equity

Capital StockDR CR- +

Retained EarningsDR CR- +

Owners' EquityDR CR

- +

ExpensesDR CR+ -

RevenuesDR CR- +

DividendsDR CR+ -

9

JournalizingIdentify the accounts involved with an event or

transaction.Determine whether each account increased or

decreased.Determine the amount by which each account

was affected.

This process is used whether the This process is used whether the accounting is being done manually or accounting is being done manually or

with a computer.with a computer.

This process is used whether the This process is used whether the accounting is being done manually or accounting is being done manually or

with a computer.with a computer.

101. Analyze Transactions and 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.

11

2. Journalize Transactions

A journal is an accounting record in which business transactions are entered in chronological order.

Journal entries record transaction information; debits equal credits.

12

General Journal Entry Format

Date Debit Entry.................................. xx

Credit Entry............................. xx

Explanation.

Journal Entries

A journal is an accounting record in which business transactions are entered in chronological order.

Journal entries record transaction information; debits equal credits.

13

Date DescriptionPostRef. Debits Credits

Journal Page 1

Jan 1 Cash 5Revenue 5

Received cash forservices provided.

4 Supplies 12Accounts Payable 12

Purchased supplieson account.

10 Accounts Payable 12Cash 12

Paid for supplies.

14

Example: Journal Entry

Merchandise is sold to a customer on account for $75. The cost of the product to

the firm is $60. Make the journal entry.

15

Example: Journal Entry

Jan. 1 Accounts Receivable..................... 75 Sales Revenue.......................... 75

Sold merchandise on account.

Merchandise is sold to a customer on account for $75. The cost of the product is $60. Make the journal entry.

1 Cost of Goods Sold...................... 60 Inventory................................. 60

To record cost and reduce inventory.

Merchandise is sold to a customer on account for $75. The cost of the product to

the firm is $60. Make the journal entry.

16

3. Post Journal Entries to Accounts

Posting is the process of transferring amounts from the journal to the general ledger.

A ledger is a book 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.

17

Chart of Accounts

ASSETS (100-199)Current Assets (100-150)101 Cash105 Accounts Receivable107 Inventory

Long-Term Assets (151-199)151 Land152 Building

LIABILITIES (200-299)Current Liabilities (200-219)201 Notes Payable202 Accounts Payable

Long-Term Liabilities (220-239)222 Mortgage Payable

OWNERS’ EQUITY (300-399)301 Capital Stock330 Retained Earnings

SALES (400-499)400 Sales Revenue

EXPENSES (500-599)500 Cost of Goods Sold523 Rent Expense528 Advertising Expense573 Utility Expense

18

The Reporting Phase

A trial balance is prepared. Adjusting entries are recorded. Financial statements are prepared. Closing entries are made. Post-closing trial balance may be

taken.

194. Determine Account Balances and Prepare a Trial BalanceDetermine the account balance for each

T-Account.A Trial Balance is a listing of all

account balances. It provides a means to assure that debits equal credits.

20XYZ CompanyTrial Balance

December 31, 2002

Debits CreditsCash $ 21Accounts Receivable 15Inventory 12Land 200Accounts Payable $ 30Capital Stock 150Retained Earnings 24Sales Revenue 919Cost of Goods Sold 850Advertising Expense 10Misc. Expenses 15 ______ Total $ 1,123 $ 1,123

21

5. 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

and expenses on the income statement.

22

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.

23

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.

24Three-Step Process forAdjusting Entries

Identify the original entries that were made, if any. (Original entries are only made for unearned revenues and prepaid expenses.)

Determine what the correct balances should be at this point in time.

Make the adjustments needed to correct the balances.

25

Example: Depreciation

Rosi, Inc., purchased buildings in 1997 at a cost of $156,000. Each year, 5% of the cost is depreciated. At the end of 2002, the following adjusting entry is made:

Adjusting Entry 12/31 Depreciation Expense--Buildings 7,800

Accumulated Depr.--Buildings 7,800To record depreciation on building at 5% per year.

26

Example: Doubtful Accounts

An estimation of bad debts based on the ending receivables balance reveals that the allowance account needs to be increased by $1,100.

Adjusting Entry 12/31 Doubtful Accounts Expense 1,100

Allowance for Doubtful Accounts 1,100 To adjust for estimated doubtful accounts expense.

27

Example: Doubtful Accounts

Later, assume on March 19 that a $150 receivable is deemed to be uncollectible. Using the allowance account, the uncollectible account is written off the books.

3/19 Allowance for Doubtful Accounts 150Accounts Receivable 150

To write off an uncollectibleaccount.

28

Example: 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 Payable 2,150To record accrued salaries andwages.

29

Example: Accrued Revenues

Rosi, Inc., holds a note receivable from a customer on which interest totaling $250 has accrued.

Adjusting Entry 12/31 Interest Receivable 250

Interest Revenue 250To record accrued interest on anote receivable.

30

Example: 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 4,200To record expired insurance.

$8,000 - $3,800$8,000 - $3,800$8,000 - $3,800$8,000 - $3,800

31

Example: 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.

Adjusting Entry 12/31 Rent Revenue 475

Unearned Rent Revenue 475To record unearned rent revenue.

Original credit to a revenue account.Original credit to a revenue account.Original credit to a revenue account.Original credit to a revenue account.$2,550 - $2,075$2,550 - $2,075$2,550 - $2,075$2,550 - $2,075

32

Example: Deferred Revenues

Adjusting Entry 12/31 Unearned Rent Revenue 2,075

Rent Revenue 2,075To record rent revenue ($2,550 - $475).

Original credit to a liability account.Original credit to a liability account.Original credit to a liability account.Original credit to a liability account.

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.

33

Example: Inventory

Refer to Rosi, Inc.’s trial balance in this chapter. Note that the firm

has $45,000 in inventory. The year-end count shows that $51,000 is on hand. Assume that the firm

uses a periodic system.

Refer to Rosi, Inc.’s trial balance in this chapter. Note that the firm

has $45,000 in inventory. The year-end count shows that $51,000 is on hand. Assume that the firm

uses a periodic system.

34

Example: InventoryThe XYZ Company earns a rent revenue of $500 in 19x8 but will not receive the payment until January 10, 19x9. An adjustment will be needed. What is the adjusting entry?

Adjusting Entry 12/31 Inventory 6,000

Purchases Discounts 3,290Cost of Goods Sold 153,310

Purchases 162,500To adjust inventory, cost ofgoods sold, and related accounts.

Purchases, Purchase Discounts, and Cost of Goods Sold are affected by the adjusting entry to update the inventory account.

$51,000 - $45,000$51,000 - $45,000$51,000 - $45,000$51,000 - $45,000To closeTo closeTo closeTo close

To closeTo closeTo closeTo close

35

Record Trans-actions

Prepare Trial

Balance

Make Adjusting

Entries

• After all transactions have been recorded, a trial balance prepared, and adjusting entries made, the financial statements are prepared.

6. Preparing Financial Statements

Prepare Financial

Statements

36

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.

37

Revenues

Bal. xxx

Retained Earnings

Beg. Bal. xxx Revenues

The Closing Process

xxx

Since the revenue account is Since the revenue account is a nominal account, it is a nominal account, it is closed at the end of the closed at the end of the

period to period to Retained Earnings.Retained Earnings.

Since the revenue account is Since the revenue account is a nominal account, it is a nominal account, it is closed at the end of the closed at the end of the

period to period to Retained Earnings.Retained Earnings.

38

Expenses

Bal. xxx xxxThe expense account is The expense account is

credited in order to close credited in order to close the account at the end of the account at the end of

the period.the period.

The expense account is The expense account is credited in order to close credited in order to close the account at the end of the account at the end of

the period.the period.

The Closing Process

Expenses

Retained Earnings

Beg. Bal. xxx Revenues

39

Dividends

Bal. xxx

The Closing Process

xxx

The dividends The dividends account, which is account, which is also nominal, is also nominal, is credited to close credited to close out the balance.out the balance.

The dividends The dividends account, which is account, which is also nominal, is also nominal, is credited to close credited to close out the balance.out the balance.

Expenses

Retained Earnings

Beg. Bal. xxx Revenues

Dividends

40

The Closing Process

Retained EarningsRetained Earnings is a real account is a real account

and always carries and always carries a balance.a balance.

Retained EarningsRetained Earnings is a real account is a real account

and always carries and always carries a balance.a balance.

Net Income for the Net Income for the period is determined period is determined by these two entries.by these two entries.

Net Income for the Net Income for the period is determined period is determined by these two entries.by these two entries.

ExpensesDividends

Retained Earnings

Beg. Bal. xxx Revenues

End. Bal. xxx

41

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.

42

Jim Brewster, Inc.Post-Closing Trial Balance

December 31, 2002Debits Credits

Cash $ 8,200Accounts Receivable 4,000Inventory 3,000Supplies 1,000Accounts Payable $ 5,000Capital Stock 10,000Retained Earnings 1,200 Totals $16,200 $16,200

Example: Post-Closing Trial Balance

43

Summary of the Accounting Cycle Analyze transactions and business documents. Journalize transactions. Post journal entries to accounts. Determine account balances and prepare a trial

balance. Journalize and post adjusting entries. Prepare financial statements. Journalize and post closing entries. Balance the accounts and prepare a post-

closing trial balance.

44

Special Journals

• A special journal is a book for recording similar transactions that occur frequently.

• Sales Journal--A record where credit sales are recorded.

• Subsidiary Ledger--A grouping of individual accounts that equal the balance of a control account in the general ledger.

45

• Voucher Register--A book of original entry which takes the place of a purchases journal and provides a record of all authorized payments to be made by check. Charges on each voucher are classified by the appropriate accounting in the financial records.

• Cash Receipts Journal--A record in which all cash received from sales, interest, rent, or other sources is recorded.

• Cash Disbursements Journal--A record of all checks issued during the period in payment of properly approved vouchers.

Special Journals

46

The EndThe End