Chapter 4

The Accounting Cycle: Preparing An Annual Report

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Preparing the Annual Report Preparing the Annual Report

Balance Sheet Income Statement
Statement of Owners Equity

PLUS . . . Additional information about the companys: Financial position Business operations Future prospects

Statement of Cash Flows

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Preparing the Annual Report Preparing the Annual Report

The financial statements must be audited.
Publicly owned companies must file their audited financial statements with the SEC.
SEC

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Certified Public Accountant

Securities and Exchange Commission

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Adjusting Entries: A Closer Look Adjusting Entries: A Closer Look

Adjusting entries are needed whenever revenue or expenses affect more than one accounting period. Every adjusting entry involves a change in either a revenue or expense and an asset or liability.

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Types of Adjusting Entries Types of Adjusting Entries

Apportion Apportion Unrecorded Unrecorded Costs Costs Apportion Apportion Unearned Unearned Revenue Revenue
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Record Record Unrecorded Unrecorded Revenue Revenue Record Record Unrecorded Unrecorded Expenses Expenses

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Entries to Apportion Unrecorded Entries to Apportion Unrecorded Costs Costs

End of Current Period Prior Periods Current Period Future Periods

Transaction Transaction Paid future Paid future expenses in expenses in advance advance (creates an (creates an asset). asset).
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Adjusting Entry Adjusting Entry Recognize portion Recognize portion of asset consumed as of asset consumed as expense, and expense, and Reduce balance of Reduce balance of asset account. asset account.

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Entries to Apportion Unrecorded Entries to Apportion Unrecorded Costs Costs

Examples Include: Depreciation Supplies Expiring Insurance Policies

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Entries to Apportion Unrecorded Entries to Apportion Unrecorded Costs Costs

$2,400 Insurance Policy Coverage for 12 Months $200 Monthly Insurance Expense

Jan. 1

Dec. 31

On January 1, Webb, Co. purchased a oneOn January 1, Webb, Co. purchased a oneyear insurance policy for $2,400. year insurance policy for $2,400.
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Entries to Apportion Unrecorded Entries to Apportion Unrecorded Costs Costs

Initially, costs that benefit more than one Initially, costs that benefit more than one accounting period are recorded as assets. accounting period are recorded as assets.
GENERAL JOURNAL
Date Jan. Account Titles and Explanation 1 Unexpired Insurance Cash Purchase a one-year insurance policy.
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P R Debit 2,400

Credit 2,400

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Entries to Apportion Unrecorded Entries to Apportion Unrecorded Costs Costs

The costs are expensed as they are used to The costs are expensed as they are used to generate revenue. generate revenue.
GENERAL JOURNAL
Date Account Titles and Explanation Monthly Adjusting Entry for Insurance Jan. 31 Insurance Expense Unexpired Insurance Insurance expense for January.
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P R Debit 200

Credit

200

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Entries to Apportion Unrecorded Entries to Apportion Unrecorded Costs Costs

Balance Sheet Balance Sheet Cost of assets Cost of assets that benefit that benefit future periods. future periods.
Unexpired Insurance 1/1 2,400 1/31 200 Bal. 2,200
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Income Statement Income Statement Cost of assets Cost of assets used this period to used this period to generate revenue. generate revenue.
Insurance Expense 1/31 200

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Entries to Apportion Unearned Entries to Apportion Unearned Revenue Revenue

End of Current Period Prior Periods Current Period Future Periods

Transaction Transaction Collected Collected from from customers in customers in advance advance (creates a (creates a liability). liability).
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Adjusting Entry Adjusting Entry Recognize portion Recognize portion earned as revenue, earned as revenue, and and Reduce balance of Reduce balance of liability account. liability account.

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Entries to Apportion Unearned Entries to Apportion Unearned Revenue Revenue

Examples Include: Airline Ticket Sales Sports Teams Sales of Season Tickets

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Entries to Apportion Unearned Entries to Apportion Unearned Revenue Revenue

$6,000 Rental Contract Coverage for 12 Months $500 Monthly Rental Revenue Jan. 1 Dec. 31

On January 1, Webb, Co. received $6,000 in On January 1, Webb, Co. received $6,000 in advance for a one-year rental contract. advance for a one-year rental contract.
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Entries to Apportion Unearned Entries to Apportion Unearned Revenue Revenue

Initially, revenues that benefit more than one Initially, revenues that benefit more than one accounting period are recorded as liabilities. accounting period are recorded as liabilities.
GENERAL JOURNAL
Date Jan. Account Titles and Explanation 1 Cash Unearned Rental Revenue Collected $6,000 in advance for rent.
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P R Debit 6,000

Credit 6,000

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Entries to Apportion Unearned Entries to Apportion Unearned Revenue Revenue

Over time, the revenue is recognized as it is Over time, the revenue is recognized as it is earned. earned.
GENERAL JOURNAL
Date Account Titles and Explanation Monthly Adjusting Entry for Rent Revenue Jan. 31 Unearned Rental Revenue Rental Revenue Rental revenue for January.
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P R Debit 500

Credit

500

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Entries to Apportion Unearned Entries to Apportion Unearned Revenue Revenue

Balance Sheet Balance Sheet Liability for Liability for future periods. future periods. Income Statement Income Statement Revenue earned Revenue earned this period. this period.

Unearned Rental Revenue

1/31

500

1/1 6,000 Bal. 5,500

Rental Revenue 1/31 500

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Entries to Record Unrecorded Entries to Record Unrecorded Expenses Expenses

End of Current Period Prior Periods Current Period Future Periods

Adjusting Entry Adjusting Entry Recognize expense Recognize expense incurred, and incurred, and Record liability for Record liability for future payment. future payment.
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Transaction Transaction Liability will Liability will be paid. be paid.

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Entries to Record Unrecorded Entries to Record Unrecorded Expenses Expenses

Examples Include: Interest Wages and Salaries Property Taxes

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Entries to Record Unrecorded Entries to Record Unrecorded Expenses Expenses

$3,000 Wages Expense

Monday, May 29

Wednesday, May 31

Friday, June 2

On May 31, Webb, Co. owes wages of On May 31, Webb, Co. owes wages of $3,000. Pay day is Friday, June 2. $3,000. Pay day is Friday, June 2.
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Entries to Record Unrecorded Entries to Record Unrecorded Expenses Expenses

Initially, an expense and a liability are Initially, an expense and a liability are recorded. recorded.
GENERAL JOURNAL
Date Account Titles and Explanation Wages Payable To accrue wages owed to employees.
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P R Debit 3,000

Credit 3,000

May 31 Wages Expense

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Entries to Record Unrecorded Entries to Record Unrecorded Expenses Expenses

Balance Sheet Balance Sheet Liability to be Liability to be paid in a future paid in a future period. period.
Wages Payable 5/31 3,000

Income Statement Income Statement Cost incurred this Cost incurred this period to generate period to generate revenue. revenue.
Wages Expense 5/31 3,000

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Entries to Record Unrecorded Entries to Record Unrecorded Expenses Expenses

$5,000 Weekly Wages $3,000 Wages Expense $2,000 Wages Expense

Monday, May 29

Wednesday, May 31

Friday, June 2

Lets look at the entry for June 2. Lets look at the entry for June 2.
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Entries to Record Unrecorded Entries to Record Unrecorded Expenses Expenses

The liability is extinguished when the debt is The liability is extinguished when the debt is paid. paid.
GENERAL JOURNAL
Date Account Titles and Explanation Wages Payable (accrued in May) Cash Weekly payroll for May 29-June 2.
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P R Debit 2,000 3,000

Credit

June 2 Wages Expense (for June)

5,000

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Entries to Record Unrecorded Entries to Record Unrecorded Revenue Revenue

End of Current Period Prior Periods Current Period Future Periods

Adjusting Entry Adjusting Entry Recognize revenue Recognize revenue earned but not yet earned but not yet recorded, and recorded, and Record receivable. Record receivable.
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Transaction Transaction Receivable Receivable will be will be collected. collected.

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Entries to Record Unrecorded Entries to Record Unrecorded Revenue Revenue

Examples Include: Interest Earned Work Completed But Not Yet Billed to Customer

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Entries to Record Unrecorded Entries to Record Unrecorded Revenue Revenue

$170 Interest Revenue

Saturday, Jan. 15

Monday, Jan. 31

Tuesday, Feb. 15

On Jan. 31, the bank owes Webb, Co. On Jan. 31, the bank owes Webb, Co. interest of $170. Interest is paid on the 15th interest of $170. Interest is paid on the 15th day of each month. day of each month.
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Entries to Record Unrecorded Entries to Record Unrecorded Revenue Revenue

Initially, the revenue is recognized and a Initially, the revenue is recognized and a receivable is created. receivable is created.
GENERAL JOURNAL
Date Account Titles and Explanation Interest Revenue To recognize interest revenue.
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P R Debit 170

Credit 170

Jan. 31 Interest Receivable

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Entries to Record Unrecorded Entries to Record Unrecorded Revenue Revenue

Balance Sheet Balance Sheet Receivable to Receivable to be collected in a be collected in a future period. future period.
Interest Receivable 1/31 170

Income Statement Income Statement Revenue earned Revenue earned this period. this period.

Interest Revenue 1/31 170

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Entries to Record Unrecorded Entries to Record Unrecorded Revenue Revenue

$320 Monthly Interest $170 Interest Revenue $150 Interest Revenue

Saturday, Jan. 15

Monday, Jan. 31

Tuesday, Feb. 15

Lets look at the entry for February 15. Lets look at the entry for February 15.
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Entries to Record Unrecorded Entries to Record Unrecorded Revenue Revenue

The receivable is collected in a future period. The receivable is collected in a future period.

GENERAL JOURNAL
Date Account Titles and Explanation Interest Revenue (for February) Interest Receivable (accrued Jan. 31) To record interest received.
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P R Debit 320

Credit 150 170

Feb. 15 Cash

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Adjusting Entries and Accounting Adjusting Entries and Accounting Principles Principles
Costs are matched with revenue Costs are matched with revenue in two ways: in two ways: Direct association of costs Direct association of costs with specific revenue with specific revenue transactions. transactions. Systematic allocation of costs Systematic allocation of costs over the useful life of the over the useful life of the expenditure. expenditure.
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The Concept of Materiality The Concept of Materiality

An item is material if knowledge of the An item is material if knowledge of the item might reasonably influence the item might reasonably influence the decisions of users of financial statements. decisions of users of financial statements.
Many companies immediately charge the cost of immaterial items to expense.
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Lightbulbs Supplies

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Effects of the Adjusting Entries Effects of the Adjusting Entries

Journalize transactions.

Post entries to the ledger accounts.

Prepare trial balance.

Make end-ofyear adjustments.

Prepare after closing Journalize and post closing trial balance. Irwin/McGraw-Hill entries.

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Closing the Accounts Closing the Accounts

Close Revenue accounts
to Income Summary. Remember these steps?

Close Expense accounts

to Income Summary.

Close Income Summary account to Owners Capital. Owners Capital.

Close Withdrawals to

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Preparing Financial Statements Preparing Financial Statements Covering Different Periods of Time Covering Different Periods of Time
Many companies prepare financial statements at Many companies prepare financial statements at various points throughout the year. various points throughout the year. Annually
Interim Financial Statements

Quarterly Monthly

Jan. 1
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Dec. 31

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