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BAF3M Accounting
Chapter 8 – Completing the Accounting Cycle
8.1 The Adjustment Process• Accountants need to ensure that the statements
they produce are:
• Up to Date, Accurate, Consistent
Adjustments are necessary to ensure
• Accounts are brought up to date
• All late transactions are taken into account
• All calculations are correct
• All accounting standards have been complied with
• During the course of the fiscal period, things are allowed to get out of date
• Adjusting entries get everything up-to-date and accurate again
• Why allowed to go inaccurate?– Saves time, money, effort
8.1 The Adjustment Process
• We will look at the adjusting entries for four main areas– Supplies– Prepaid Expenses – Late Arriving Invoices– Unearned Revenue
8.1 The Adjustment Process
Adjusting Entries
Adjustment #1: Supplies
The Supplies balance shows the total supplies purchased in the year
What is the Balance?
What the balance is
What Should The Balance Be?
What the balance should be?
What the balance “should be” is determined from someone counting the supplies that remain in the business at the end of the year
The Adjustment
The required adjustment
Introducing a New Account
What the balance is
The income statement account related to Supplies is shown above
The accounting clerk has not used this account during the year
Expense: What Should the Balance Be?
What the balance should be
What the balance “should be” is equal to the amount of supplies “used up” during the year
What the Adjustment Would Be
The required adjustment
The adjusting entry as it would appear in the general journal
What that Looks Like in the Journal
Adjusting Entries
The Prepaid Insurance balance shows the total cost of insurance bought in the year
Adjustment #2: Prepaid Expenses
What is the Balance?
What the balance is
What Should the Balance Be?
What the balance should be
What the balance “should be” is determined from someone calculating the portion of the insurance policy that is “unexpired” or “not used up yet, but paid for”
How did you Get $1200?
• An Insurance policy was purchased on September 1st for one year. The fiscal period expires Dec. 31.
As of Dec. 31, how many months of insurance have been used ?
- 4 months have been used
Each month costs:$1800 / 12mo. = $150
4 months have been used:$150*4 = $600
The Adjustment
The required adjustment
Introducing Your 2nd New Account
What the balance is
The income statement account related to Prepaid Insurance is shown above
The accounting clerk has not used this account during the year
Expense: What Should the Balance Be?
What the balance should be
What the balance “should be” is the amount of the insurance policy that has expired at year’s end
What the Adjustment Should Be?
The required adjustment
What it Looks Like in the Journal
The adjusting entry for insurance as it would appear in the general journal
Adjusting Entries
Adjustment #3: Late Arriving Invoices
The Accounts Payable balance does not include two invoices that arrived late
• Two late invoices have arrived
–$212 for the Telephone Bill
–$315 for the Utilities Bill
What is the Balance?
Little analysis is needed for this adjustment
The Adjustment
Simply enter the late invoices
The Adjustment contd.
Simply enter the late invoices
What Should the Balance Be?
And calculate the adjusted balance
Expense: What is the Balance?
The Adjustments
The What Should the Balance Be?
What that Looks Like in the Journal
The adjusting entry for late invoices as it would appear in the general journal
The adjusting entries have brought balance sheet accounts up to date
Summary 1
Adjusting Entries—Summary
Balance Sheet
And have recorded expenses in related accounts on the income statement
Summary 2Adjusting Entries—Summary
Balance Sheet Income Statement
Adjusting for Unearned Revenue
• Unearned Revenue is a liability – it occurs when you are paid in advance of providing a service.
• If the accounting department puts advance payments into Revenue, this is an error that needs to be corrected:
• DR Revenue (to reduce it); CR Unearned Revenue (to increase it)
Check your Understanding
• See Textbook Tracker Sheet for the required Questions and Exercises for section 8.1
8.2 Adjusting Entries and the Work Sheet
• The work sheet is an informal accounting form used to help organize all of the financial data
• There are 8 columns– Trial Balance DR/CR– Adjustments DR/CR– Income Statement DR/CR– Balance Sheet DR/CR
ADJUSTING FOR SUPPLIES
• According to Global Logistics’ trial balance they have $1480.90 worth of supplies
• However, once a physical inventory was completed on December 31, 2008 they discovered that they only had $526.00 worth of supplies on hand
8.2 Adjusting Entries and the Work Sheet
Global Logistics Work Sheet
Balance SheetDr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.520.51
Accounts Receivable 18475.001480.906564.004196.00
54600.0052510.00
1240.00720.00
25000.0028895.42
Drawings 42000.00213821.00
3500.001951.65
24000.001800.00
41951.163750.00
65957.20296466.42 296466.42
Account Payable
Account Titles
Year ended: Dec. 31, 20--
CapitalBank LoanGST RecoverableGST Payable
Bank
Automotive EquipmentFurniture & EquipmentPrepaid InusranceSupplies
Wages EspenseUtitlies ExpenseTruck ExpenseTelephone ExpenseRent ExpenseMiscellaneious ExpenseBank Charges ExpenseShipping Revenue
IncomeTrial Balance Adjustments Statement
ADJUSTING FOR SUPPLIES
20--
Dec. 31 Supplies Expense 964.90
Supplies 964.90
8.2 Adjusting Entries and the Work Sheet
Balance SheetDr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.520.51
Account Receivable 18475.001480.90 954.906564.004196.00
54600.002510.001240.00
720.0025000.0028895.42
Drawings 42000.00213821.00
3500.001951.65
24000.001800.00
41951.163750.00
65957.20271466.42 271466.42
Supplies Expense 954.90
Trial Balance Adjustments Statement
Prepaid InsuranceSupplies
Wages ExpenseUtitlies ExpenseTruck ExpenseTelephone ExpenseRent ExpenseMiscellaneous ExpenseBank Charges ExpenseShipping Revenue
Account Payable
Account Titles
CapitalBank LoanGST RecoverableGST Payable
Bank
Automotive EquipmentFurniture & Equipment
ADJUSTING FOR INSURANCE USED
• According to Global Logistics’ trial balance they have $6564 in prepaid insurance
• They have$4070 remaining in unused insurance
8.2 Adjusting Entries and the Work Sheet
ADJUSTING FOR INSURANCE USED
20--
Dec. 31 Insurance Expense 2494
Prepaid Insurance 2494
8.2 Adjusting Entries and the Work Sheet
Global Logistics Work Sheet
Balance SheetDr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.520.51
Account Receivable 18475.001480.90 954.906564.00 2494.004196.00
54600.002510.001240.00
720.0025000.0028895.42
Drawings 42000.00213821.00
3500.001951.65
24000.001800.00
41951.163750.00
65957.20271466.42 271466.42
Supplies Expense 954.90Insurance Expense 2494
Account Payable
Account Titles
Year ended: Dec. 31, 2008
CapitalBank LoanGST RecoverableGST Payable
Bank
Automotive EquipmentFurniture & EquipmentPrepaid InsuranceSupplies
Wages ExpenseUtitlies ExpenseTruck ExpenseTelephone ExpenseRent ExpenseMiscellaneous ExpenseBank Charges ExpenseShipping Revenue
IncomeTrial Balance Adjustments Statement
8.2 Adjusting Entries and the Work Sheet
ADJUSTING FOR LATE ARRIVING INVOICES
• Three late invoices in this exampleTelephone $ 45
Truck Repair 496
Printer Repair 85
Total $626
8.2 Adjusting Entries and the Work Sheet
20--Dec. 31 Telephone expense 45
Truck expense 496
Miscellaneous expense 85
Accounts Payable 626
Global Logistics Work Sheet
Balance SheetDr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.520.51
Account Receivable 18475.001480.90 954.906564.00 2494.004196.00
54600.002510.00 626.001240.00
720.0025000.0028895.42
Drawings 42000.00213821.00
3500.001951.65 85.00
24000.001800.00 45.00
41951.16 496.003750.00
65957.20271466.42 271466.42
Supplies Expense 954.90Insurance Expense 2494
Account Payable
Account Titles
Year ended: Dec. 31, 2008
CapitalBank LoanGST RecoverableGST Payable
Bank
Automotive EquipmentFurniture & EquipmentPrepaid InsuranceSupplies
Wages ExpenseUtitlies ExpenseTruck ExpenseTelephone ExpenseRent ExpenseMiscellaneous ExpenseBank Charges ExpenseShipping Revenue
IncomeTrial Balance Adjustments Statement
COMPLETING THE SHEET
• From this point you complete the 8-column worksheet just as you completed the 6-column worksheet– Except as you transfer numbers to the correct column
you may need to add or subtract the adjustments into the totals as necessary
• Balance the columns using the “magical” number
• Underline where necessary
Global Logistics Work Sheet
Balance SheetDr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.520.51 520.51
Account Receivable 18475.00 18475.001480.90 954.90 526.006564.00 2494.00 4070.004196.00 4196.00
54600.00 54600.002510.00 626.00 3136.001240.00 1240.00
720.00 720.0025000.00 25000.0028895.42 28895.42
Drawings 42000.00 42000.00213821.00 213821.00
3500.00 3500.001951.65 85.00 2036.65
24000.00 24000.001800.00 45.00 1845.00
41951.16 496.00 42447.163750.00 3750.00
65957.20 65957.20271466.42 271466.42
Supplies Expense 954.90 954.90Insurance Expense 2494 2494
4074.90 4074.90 146984.91 213821.00 125107.51 58271.4266836.09 66836.09
213821.00 213821.00 125107.51 125107.51
Account Payable
Account Titles
Year ended: Dec. 31, 2008
CapitalBank LoanGST RecoverableGST Payable
Bank
Automotive EquipmentFurniture & EquipmentPrepaid InsuranceSupplies
Wages ExpenseUtitlies ExpenseTruck ExpenseTelephone ExpenseRent ExpenseMiscellaneous ExpenseBank Charges ExpenseShipping Revenue
IncomeTrial Balance Adjustments Statement
8.2 Adjusting Entries and the Work Sheet
• Journalizing and Posting the Adjusting Entries– All the adjusting entries need to be properly
journalized and posted to the ledger
8.3 Preparing for New Fiscal Years
• REAL ACCOUNTS – balances that continue into the next fiscal periodex. Bank, trucks, accounts payable etc.
• NOMINAL ACCOUNTS – have balances that do not continue into the next fiscal periodONLYONLY Expenses, drawing and revenue
8.3 Preparing for New Fiscal Years
• CLOSING OUT AN ACCOUNT – means to make it have no balance. Nominal accounts are closed out at the end of the fiscal period.
• INCOME SUMMARY ACCOUNT – – summarizes the revenues and expenses of the period. Represents either the net income or net loss for the fiscal period
8.3 Preparing for New Fiscal Years
WHY DO WE CLOSE OUT ACCOUNTS?WHY DO WE CLOSE OUT ACCOUNTS? Closing these accounts allows us to plainly observe the previous year's effect on our revenue, expense, and drawings accounts. You can well imagine that if we did not close these accounts, their balances would build to outrageous amounts.
HOW DO WE DO THIS?HOW DO WE DO THIS? The Order in Which we Close Out Accounts (p293)1. Close out the revenue account(s) to the
Income Summary account2. Close out the expense account(s) to the
Income Summary account3. Close out the Income Summary account to the
Capital account4. Close out the Drawing account to the Capital
account
8.3 Preparing for New Fiscal Years
• Closing Entry #1: Close out the revenue account(s) to the Income Summary account
JournalDec 31 Shipping Revenue 213821
Income Summary213821
Because revenue is a CR balance account, a DR entry is needed to close it off
8.3 Preparing for New Fiscal Years
• Closing Entry #2: Close out the expense account(s) to the Income Summary account
JournalDec 31 Income Summary 146984.91
Bank Charges Exp3500
…(all exp listed here)
Insurance Exp2494Because expenses are a DR balance account, a CR entry
is needed to close them off
8.3 Preparing for New Fiscal Years
• Closing Entry #3: Close out the Income Summary account to the Capital account
JournalDec 31 Income Summary 66836.09
P. Marshall, Capital66836.09
If the Income Summary account has a CR balance, then a DR entry is needed to close it. (profit capital increases)
If the Income Summary account has a DR balance, then a CR entry is needed to close it. (loss capital decreases)
8.3 Preparing for New Fiscal Years
• Closing Entry #4: Close out the Drawing account to the Capital account
JournalDec 31 P. Marshall, Capital 42000
P. Marshall, Drawings42000
Because Drawings is a DR balance account, a CR entry is needed to close it
8.3 Preparing for New Fiscal Years
• Post-Closing Trial Balance– Checks the accuracy of the ledger after the
adjusting and closing entries have been done– Example shown in Fig 8-10, Page 290
8.3 Preparing for New Fiscal Years
8.4 Adjusting for Depreciation
• What is it?• First let’s remember our definition for an
expense– Something that we spend money on to make
money
• Based on this definition shouldn’t things like equipment or cars be expenses? We use these things to make money do we not?
8.4 Adjusting for Depreciation
• However, items such as a car don’t suddenly become worthless – it loses some of it’s value each year
• So a portion of the cost of the equipment should be allocated as an expense in each year of the item’s life
• This process meets the matching principle
8.4 Adjusting for Depreciation
Depreciation an allowance made for the decrease in value of an asset over time
Depreciation is an expense so it appears on the INCOME STATEMENT
8.4 Adjusting for Depreciation
• An anecdotal example– Read p. 301-302 about the depreciation of a
company’s delivery van
8.4 Adjusting for Depreciation
• Methods– 2 most common are:
– Straight Line– Declining Balance
8.4 Adjusting for Depreciation
• Straight Line Method– Divides up the net cost of the asset equally
over the years of the assets life
Straight Line for 1 yr =
(orig cost - estimated salvage value)
Estimated # of periods in the asset’s life
8.4 Adjusting for Depreciation
• Straight line Example• Tip Top Trucking purchased a truck for
$78000 on Jan 1. 20--. Truck could be used for 6 years, and be sold at that time for $7800.
• Therefore:Estimated Annual Depreciation is($78000 – $7800) / 6 = $11700The truck will depreciate $11700 each year.
8.4 Adjusting for Depreciation
• Recording DepreciationJournalDepreciation Expense – Truck 11700
Truck 11700
The above work is correct, but not used by larger, computerized businesses…they use a new account called “Accumulated Depreciation”
8.4 Adjusting for Depreciation
• So the entry will look like this:
JournalDepreciation Expense – Truck 11700
Accumulated Depreciation - Truck11700
The use of the accumulated depreciation account provides 2 types of information:
1) By not taking the depreciation right off of the asset account we can still find the original cost of the asset2) We can quickly calculate the total amount of depreciation recorded over the years
8.4 Adjusting for Depreciation
• Accumulated Depreciation is a CONTRA account– A contra account is one that is displayed
alongside an associated account and has a balance that is opposite to that account
8.4 Adjusting for Depreciation
• Accumulated Depreciation is also a VALUATION account– One that is used together with an asset
account to show the true net value of an asset
8.4 Adjusting for Depreciation
• Adjusting Entry for Depreciation1) records the depreciation for the period in
the depreciation expense account2)Increases the appropriate accumulated
depreciation account for the asset, which reduces the asset’s net book value
Journalized as…Depreciation Exp $$$$
Acc. Dep. (Asset) $$$$
8.4 Adjusting for Depreciation
Declining-balance Method• Allocates a greater amount of depreciation to the first
years of an asset’s life
• This is the method the government requires for income tax purposes
• To find the depreciated amount you take the undepreciated cost of the asset and multiply it by a fixed %– This % is set by the gov’t – See schedule on p. 308