CH 9 COMPLETING THE ACCOUNTING CYCLE

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CH 9 COMPLETING THE ACCOUNTING CYCLE
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9.1 The Adjustment Process

• It is important that financial statements are
  up-to date, accurate and consistent from year to
  year.
• Accountants must make sure that
• 1) All accounts are brought up-to date
• 2) All late transactions are taken into account
• 3) All calculations have been made correctly
• 4) All GAAPs have been complied with

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Adjusting entries

• To do this we make adjustments to such things as
  insurance, supplies,
• An adjusting entry assigns amounts of revenue or
  expense to the appropriate accounting period
  before finalizing the books for the financial
  period.
• This is necessary because accounting books become
  inaccurate between statements dates.
• Why is this allowed?
• Saves time, effort and money.
• Imagine having to correct supplies every time you
  or someone in your company used a pen!

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Adjusting entries for supplies

• When supplies are purchased they are debited
  correctly
• But, as they are used no accounting entries are
  made to record the usage at the time
• Thus you will have 2 accounts
• Supplies
• Supplies expense

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Adjusting entries continued

• Supplies will have a balance of what you paid
  (full purchase price)
• Supplies expense will have a balance of zero
• Until an adjustment is made to correct this
• This is done at the end of the accounting cycle

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How do you count what you dont have?

• At the end of the cycle you would take inventory
  of what supplies you have and subtract it from
  what you thought you had.
• An adjustment to this would
• Debit the supplies expense account and
• Credit the supplies account

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Adjusting entries for prepaid expenses

• Some expense items are paid for in advance.
• This usually presents no special problem because
  the item (rent) falls within the fiscal period
• But sometimes we have special expenses
  (insurance) where that are paid for and extend
  beyond the fiscal period

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A prepaid expanse

• A prepaid expanse is an item paid for in advance,
  but one where the benefits extend into the future
• Insurance is the most common example because we
  pay upfront for one years insurance before we
  actually use it.

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When it is bought we

• Debit the prepaid insurance account and credit
  the bank account.
• Prepaid insurance has value and therefore we
  consider it an asset.
• If we cancelled it after 3 months we would get
  money back.

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At the end of the fiscal period

• you need to figure out how much insurance has
  been used and debit insurance expense this amount
  and credit prepaid insurance.
• Say you bought the insurance on March 1st for a
  year. You paid 1800 for it.
• How many months of use did you have this year?

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How many months?

• 9?
• 10?
• 10!
• So 1800 / 12 150
• Right?
• Therefore, 10 X 150 1500
• This is how much (in ) was used on this
  insurance policy.

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Adjusting Entries for Late-Arriving Purchase
Invoices

• Goods and services are often bought towards the
  end of an accounting period.
• Bills for these purchases may not arrive until
  the next fiscal period.
• Remember the matching principal
• Expenses are to be recognised in the same period
  as the revenue that they helped to earn!

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Late Arriving continued

• Luckily, financial statements are not prepared
  for 2 or 3 weeks after the accounting period.
• This gives enough time for all invoices from the
  last period to come in.
• Ex telephone bill arrives 2 weeks after the
  fiscal period endsdebit telephone expense
• Credit accounts payable

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9.2 Adjusting Entries and the Work Sheet

• We will now add 2 columns to our work sheet.
• It will now have 8 columns

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And it will look like this
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For this example we find after taking inventory
that supplies on hand at the end of the fiscal
period is 526.00.
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Example continued

• Our supplies account balance was 1480.90
• Therefore our adjustment for this is 954.90
• Notice that we number or letter each entry for
  ease of identifying them later

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Adjusting for insurance expense

• From our example we know that our Prepaid
  Insurance 6564.00

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Prepaid insurance listing
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Total used 2494.00
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Late purchase invoices

• Telephone 45
• Truck repair 496
• Printer repair 85
• Total 626

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Extending the worksheet

• The worksheet steps are the same except for the
  following 2 steps
• Step 1) Evaluate each item in the first 4 columns
  (trial balance and adjustments). You may need to
  add or subtract (if an adjustment was made) This
  will result in one number for each entry
• Step 2) Transfer the value found in step one to
  one of the last 4 columns (income statement or
  balance sheet)
• Note make sure that debits balances remain debit
  balances and credit balances remain credit
  balances.

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Balancing the work sheet

• Again everything is the same except for the
  following steps
• 1) Total each of the last 4 columns
• 2) Determine the difference between the two
  income statement columns and the two balance
  sheet columns
• 3) Ensure that the two differences are the same.
  If not, the worksheet does not balance and
  therefore contains errors.

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Journalizing and posting adjusting entries

• All adjusting entries must be formally
  journalized.

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Closing Entries Concepts

• The final stage of the accounting cycle is to
  prepare the accounts for the next fiscal period.
• To do this you must understand which accounts
  have balances that continue from one period to
  the next and which do not

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Real Accounts and Nominal Accounts

• Real Accounts have balances that continue into
  the next fiscal period. All assets, liabilities
  and Owners capital accounts. Ex Bank, Truck,
  accounts payable
• Nominal Accounts have balances that do not
  continue into the next fiscal period. Revenue,
  Expense and Drawing accounts. All nominal
  accounts start each fiscal period with a zero
  balance.
• A special nominal account called the Income
  summary account is used only during the closing
  entry process. It summarizes the revenue and
  expenses for the period. The temporary balance in
  this account represents either the net income or
  net loss.

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Closing out the Nominal Accounts

• There must be no balances left in any of the
  nominal accounts at the end of the accounting
  period.
• Closing an account means to cause it to have no
  balance.
• The total equity of a business is not contained
  in one account.
• It is contained in the equity section of the
  ledger.

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Closing out the Nominal Accounts continued

• The capital account shows the equity balance at
  the beginning of the period.
• Any changes are contained in the revenue, expense
  and drawing accounts.
• Closing the nominal equity accounts involves
  moving the values collected in those accounts
  into one real equity account the capital
  account

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Steps for Closing out the Nominal Account

• Step 1) Bring the accounts up-to-date by
  journalizing and posting the adjusting entries.
  Remember, some accounts were allowed to become
  inexact. These need to be corrected first.
• Step 2) Close the nominal accounts and prepare
  them for the next fiscal period. This involves
  journalizing and posting the closing entries
• a) transfer the balances of the revenue and
  expense accounts to the new income summary
  account.

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Steps for Closing out the Nominal Account

• Step 2 -- b) transfer the balances of the income
  summary and drawings accounts to the capital
  account.
• When this is done all of the nominal accounts
  will have zero balances.
• Step 3) Take off a post closing trial balance.
  There is a lot of potential for making errors in
  the process of journalizing and posting the
  adjusting and closing entries. A trial balance is
  taken off to ensure that the ledger is still in
  balance. A post closing trail balance is taken as
  soon as the closing entries have been posted.

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You have now completed the accounting cycle!!!
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9.4 Journalizing and posting the closing entries

• This section is extremely well explained in you
  text pgs 327 332

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Closing Entries Summary

• The four closing entries do the following
• 1. Close out the revenue accounts to the income
  summary account
• 2. Close out the expense accounts to the income
  summary account
• 3. Close out the income summary account to the
  capital account
• 4. Close out the drawings account to the capital
  account.

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Post-Closing Trial Balance

• Always do this after you have finished
  journalizing and posting the adjusting and
  closing entries.

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Uses of the work sheet

• 1. Provides a method of organising the figures
  for the financial statements. It contains all of
  the up-to-date figures for the statements in one
  convenient place.
• 2. Lets the accounts see the effects of adjusted
  entries before they are recorded in the accounts.
  Accountants sometimes have choices as to how to
  handle the adjustments.
• 3. It proves the arithmetic accuracy of the
  figures before they are used in the financial
  statements.
• 4. Is the source for all of the information for
  recording the adjusting and closing entries.

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9.5 Adjusting for Depreciation

• Depreciation refers to an allowance made for the
  decrease in value of an asset over time. All
  assets (with the exception of land) are expected
  to do this.
• Again this section is very thoroughly explained
  in your text pgs 336 - 348