Chapter 4
Completing the
Accounting Cycle
Albrecht, Stice, Stice, Swain
COPYRIGHT © 2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are
trademarks used herein under license.
1
Periodic Reporting
Beginning
of Year
End of
Year
• Fiscal Year
– 12-month accounting period.
• Calendar Year
– When an entity closes its books on December
31.
2
Accrual Accounting
• What do we do when transactions span
more than one period?
• Accrual Accounting!
– Revenues and expenses are recorded as they
are earned and incurred, not necessarily
when cash is received or paid.
– Better measures a firm’s performance than
does cash flow data (?).
3
Revenue Recognition
Recognize revenue when:
1.
The earning process is
substantially complete.
2.
Cash has either been
collected or collection
is reasonably assured.
4
The Matching Principle
• All costs and expenses incurred in
generating revenues must be recognized
in the same reporting period as the related
revenues.
If revenues are
recognized.
Related costs and
expenses should
be recognized.
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Example: Accrual- vs. CashBasis Accounting
During 2009, Bond Consulting billed its client for $48,000. On
December 31, 2009, it had received $41,000, with the
remaining $7,000 to be received in 2010. Total expenses
during 2009 were $31,000 with $3,000 of these costs not yet
paid at December 31. Determine net income under both
methods.
Bond Consulting
Reported Income for 2009
Cash-Basis Accounting
Cash receipts
$41,000
Cash disbursement
28,000
Income
$13,000
Accrual-Basis Accounting
Revenues earned
$48,000
Expenses incurred 31,000
Income
$17,000
6
Adjusting Entries
• Entries required at the end of each
accounting period to adjust the accounts
to their proper amounts.
– Unrecorded receivables.
– Unrecorded liabilities.
– Prepaid expenses.
– Unearned revenues.
• Each adjusting entry involves at least one
income statement account and one
balance sheet account.
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Example: Unrecorded
Receivables
Precision Management earns rent revenue of $500 in
2009 but will not receive the payment until January 10,
2010. An adjustment will be needed. What is the
adjusting entry?
Rent Receivable
Original entry
Correct balances
Rent Revenue
none
none
500
500
12/31/09 Rent Receivable
Rent Revenue
500
500
8
Example: Unrecorded
Liabilities
Protege Inc. is assessed property taxes of $1,000 for
2009, but will not make this payment until January 5,
2010. An adjustment will be needed. What is the
adjusting entry?
Property Tax
Expense
Original entry
Property Tax
Payable
none
none
Correct balances 1,000
1,000
12/31/09 Property Tax Expense 1,000
Property Tax Payable
1,000
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Example: Prepaid Expenses
On July 1, 2009, Apex Inc. pays $3,600 for one year’s
rent in advance (covering July 1, 2009, to June 30,
2010). On December 31, 2009, an adjustment will be
needed. What is the adjusting entry?
Prepaid Rent
Original entry
3,600
Adjusting entry
Correct balances
Cash
Rent
Expense
3,600
1,800
1,800
1,800
12/31/09 Rent Expense
Prepaid Rent
1,800
1,800
1,800
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Example: Unearned Revenues
On July 1, 2009, Dahl House Co. received $3,600 for one
year’s rent in advance (covering July 1, 2009, to June 30,
2010). On December 31, 2009, an adjustment will be needed.
What is the adjusting entry?
Rent Revenue
Original entry
Cash
Unearned
Rent
3,600
Adjusting entry
1,800
Correct balances
1,800
12/31/09 Unearned Rent
1,800
Rent Revenue
3,600
1,800
1,800
1,800
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The Closing Process
• The Closing Process
– Record entries that reduce all nominal accounts to a
zero balance at the end of the accounting period.
– Nominal accounts are closed to retained earnings.
Income Statement
Revenues
xxx
Beg. Bal. xxx
Bal. xxx
Revenues
Expenses
Expenses
Bal. xxx
xxx
Balance sheet
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Net R. Earning
Closing Entries
• Step 1: Close all revenue accounts by debiting
them.
• Step 2: Close all expense accounts by crediting
them.
• Step 3: The difference between revenues and
expenses (net income) should be credited to
retained earnings.
Revenues . . . . . . . . . . . . . . . . . . . . . . . XXX
Cost of Goods Sold . . . . . . . . .
Other Expenses . . . . . . . . . . . .
Retained Earnings . . . . . . . . . .
XXX
XXX
XXX
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Review of the Accounting Cycle
Step
Step
Step
1
2
3
Analyze transactions.
Record the effects of the transactions.
Summarize the effects of transactions.
1. Posting journal entries.
2. Preparing a trial balance.
Prepare reports.
Step
4
1. Adjusting entries.
2. Preparing financial statements.
3. Closing the books.
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