Chapter 9
Completing the
Accounting Cycle
Created by D. Gilroy
Heart Lake Secondary School
1
The Adjustment
Process
The Adjusting Process
We now know that financial
statements are used extensively to
assist in making business decisions.
It is the accountants responsibility to
ensure that these financial
statements are accurate, up-to-date,
and consistent from year to year.
3
The Adjusting Process
When preparing the financial
statements, the accountant must
ensure:
All accounts are brought up to date;
All late transactions are taken into
account;
All calculations have been made
correctly; and
All GAAPs have been complied with.
4
The Adjusting Process
Bringing the account data up-to-date
at statement time is known as
“making the adjustments”.
The accounting entries produced by
this process are known as adjusting
entries.
In most cases adjusting entries
assign amounts of revenue or
expense to the appropriate
accounting period before the books
are finalized for the fiscal
period.
5
The Adjusting Process
Adjusting entries are necessary
because the books of account are
allowed to become inaccurate
between statements dates.
Some accounts do not need to be
perfectly accurate at the end of each
business day BUT do need to be
adjusted in order to determine the
correct net income of net loss for the
period.
6
The Adjusting Process
The first three adjusting entries are:
Adjusting entries for Supplies;
Adjusting entries for Prepaid
Expenses; and
Adjusting entries for Late-Arriving
Purchase Invoices.
7
Adjusting Entries for Supplies
When supplies are purchased, their cost is
debited correctly to the Supplies account.
As supplies are used, which is usually
daily, no accounting entries are made to
record this usage.
During the accounting period, the balance
of the Supplies account represents the
balance at the beginning of the period plus
any new supplies purchased.
8
Adjusting Entries for Supplies
The balance of Supplies Expense is zero.
In order to satisfy the Matching Principle,
both of these accounts must be adjusted
to reflect the usage (i.e. expense) during
the fiscal period.
To book the adjusting entry, you must first
determine the supplies inventory (by
counting the remaining supplies).
You then determine the cost of the
supplies used (i.e. difference between the
inventory count and the balance of
the supplies account).
9
Adjusting Entries for Supplies
Assume the Supplies on hand at December 31,
2007 are $1,386 (i.e. the supplies inventory).
2007
2007
6,514
1,386
6,514
6,514
2007
10
Adjusting Entries for
Prepaid Expense
There are times in business when expense
items are paid for in advance.
This presents no problem if the expense
item falls entirely within the fiscal period .
If the expense item affects more than the
current fiscal period, then it must be
treated as a prepaid expense.
A prepaid expense is an item paid for in
advance, but one where the benefits
extend into the future.
11
Adjusting Entries for
Prepaid Expense
Insurance is the most common prepaid
expense.
A business can purchase insurance to
cover possible losses on automobiles,
buildings, contents, crops, etc.
When you purchase insurance, you
usually pay for one year’s coverage in
advance. ( Note: occasionally, the period
can be greater than one year.)
12
Adjusting Entries for
Prepaid Expense
When prepaid expenses are purchased,
they are usually debited to a prepaid
expense account.
Prepaid expenses accounts have value
and are therefore classified as assets.
If, for example you were to cancel an
insurance policy, all (or a portion) of the
prepaid insurance expense would be
refunded by the insurance broker /
company.
13
Adjusting Entries for
Prepaid Expense
Prepaid annual insurance premium on
September 1, 2007.
2007
2007
600
1,200
600
600
$1,800
x 4/12
14
Adjusting Entries for
Late-Arriving Purchase Invoices
Goods and services are often bought
and received toward the end of an
accounting period.
The invoices for these items may not
arrive until the subsequent fiscal
period.
The Matching Principle states that
expenses are to be recognized in the
same period as the revenue that they
help to earn.
15
Adjusting Entries for
Late-Arriving Purchase Invoices
The financial statements are not
“typically” prepared until two or three
weeks after the fiscal year end.
During this waiting period, the
accounting department must analyze
all purchase invoices in order to find
those that affect the fiscal period that
just ended.
16
Adjusting Entries for
Late-Arriving Purchase Invoices
Prior to financial statement preparation, the
accountant discovers there were two latearriving invoices:
telephone $212 and utilities $315.
17
Class / Homework
Students should complete questions in
section 9-1 and start questions and
exercises section 9-2 in workbook
18
Adjusting Entries
and the
Work Sheet
Adjusting Entries and the
Work Sheet
The first place that adjusting entries
are recorded is on the work sheet.
As the work sheet is prepared,
adjusting entries are calculated and
recorded in a section headed
Adjustments.
20
1 954.90
2 2494.00
3 626.00
3
85.00
3
45.00
3 496.00
Supplies Expense
Insurance Expense
1 954.90
2 2494.00
An analysis of prepaid
A clerk discovered
The
insurance
physical
determined
inventory
three “late” purchase
ofthat
supplies
the balance
at Dec.at31
invoices belonging to
Dec.
totaled
31 should
$526.
2007…telephone $45,
What be
adjusting
$4,070. entry
truck repair $496 &
Whatisadjusting
required?entry
printer repair $85.
is required?
Extending
Balancingthe
theWork
Work
Balancing
Sheet
Sheet…
the
… add
determine
Work
or Sheet
subtract
the…diff.
thebetween
adjustments
the
Balance
the
Adjustments
Columns.
twofrom
income
the trial
statement
total
balance
each
columns
and
of the
record
last
the four
two
in the
balance
columns
last four
sheet
columns.
columns
1
2
3
3
3
3
1
2
Net Income
526.00
4,070.00
3,136.00
Journalize Adjusting Entries
So far, the adjusting entries have
been recorded only on the work sheet
Once the work sheet is complete /
balanced, the adjusting entries must
be recorded in the books of accounts.
Journalize and post all entries that
appear in the adjustments section of
the work sheet.
23
Journalize Adjusting Entries
24
Class work and homework
Students should complete up to end
of section 9-2 questions and exercises
25
Closing Entries
Closing Entries Concepts
The Time Period Concept states that
financial reporting, or net income in
particular, is done in equal period of
time.
After you do your adjusting entries
and prepare your formal income
statements, the accounts must be
made ready for the next accounting
cycle.
27
Closing Entries Concepts
Determine which accounts have
balances that continue from one
period to the next and which do not.
There are two types of accounts …
real accounts and nominal accounts.
All asset and liability accounts, as
well as the owner’s capital account,
are considered to be real accounts.
28
Closing Entries Concepts
Real accounts have balances that
continue into the next fiscal period.
Nominal accounts (revenue, expense
and drawings accounts) have
balances that do not continue into the
next fiscal period.
Nominal accounts, with the exception
of drawings, are related to the income
statement.
29
Closing Entries Concepts
A special nominal account, called the
Income Summary account, is used
only during the closing entry process.
Once the income statement for a
period has been completed, the
balances in the nominal accounts are
no longer useful … their balance
must be taken to zero in preparation
for the next accounting cycle.
30
Closing Entries Concepts
Closing an account means to cause it
to have no balance.
Any changes in equity during the
period are contained in the Revenue,
Expense, and Drawings accounts.
Closing these nominal accounts
moves the values collected in these
accounts into the one real equity
account, the Capital account.
31
Complete Accounting Cycle
Performed
by
accounting
clerks
Performed
daily
Transactions occur.
Source documents.
Accounting entries
recorded in the journal.
Performed
monthly
Ledger balanced by
means of a trial balance.
Journal entries posted
to the ledger accounts.
Work sheet prepared.
Formal income stmt. &
balance sheet prepared.
Closing entries
journalized & posted.
Adjusting entries
journalized & posted.
Performed
Performed
at end of
by
each fiscal
accountants
period
Post-closing
trial balance.
Class / Homework
p. 324, Exercises 1
p. 326, Exercises 4
33
Journalizing and
Posting the
Closing Entries
Closing
Closing
Closing
Entry
Entry
Entry
3: 2:
1:
transfer
4:transfer
transfer
thethe
balances
thebalances
balances
in Income
ininthe
Drawings
expense
revenue
Summary
account(s)
accounts
Account
account
to a newto
to
nominal
the
the Income
owner’s
account
Summary
Capital
called
account.
account.
Income Summary.
1
2
3
3
3
3
1
2
Net Income
Summary of Closing Entries
Post-Closing
Trial Balance
Extending the Work
Balancing
Sheet …
theadd
Work
or Sheet
subtract
… the adjustments
Balance
the
Adjustments
Columns.
from the trial
total
balance
each and
of the
record
last four
in the
columns
last four columns.
Post-Closing Trial Balance
1
2
3
3
3
3
1
2
526.00
4,070.00
3,136.00
Capital Account
Calculating your Post-Closing Balance
4
P. Marshall, Capital
$42,000.00 $28,895.42
66,836.09
$42,000.00
3
$95,731.51
$53,731.51
39
Post-Closing Trial Balance
P. Marshall, Capital
$42,000.00 $28,895.42
66,836.09
$42,000.00 $95,731.51
$53,731.81
40
Class / Homework
Students should complete section 9-3
questions and exercises
41
Adjusting for
Depreciation
Adjusting for Depreciation
Assets that are used to produce
revenue over several fiscal periods
are known as fixed assets.
Fixed assets are also known as
“long-lived assets”, “capital
equipment”, and “plant and
equipment”.
Except for land, all fixed assets will
be used up in the course of
time and activity.
43
Adjusting for Depreciation
Fixed assets decrease or depreciate
in value.
Depreciation refers to an allowance
made for the decrease in value of an
asset over time.
It is not possible to calculate
depreciation until the end of the
asset’s life … only then, can you say
how many years it was used
and determine its final worth.
44
Adjusting for Depreciation
The matching principle dictates that
depreciation must be included on
every year-end income statement.
To do this, accountants must
estimate depreciation while the asset
is still in use.
The two most common methods of
calculating depreciation are the:
Straight-Line method and
Declining-balance method.
45
Straight-Line Depreciation
The simplest way to estimate
depreciation.
The Straight-Line method of
depreciation divides up the net cost
of the asset equally over the years of
the asset’s life.
Straight-Line
Depreciation
for one year
=
Original Cost
Estimated
of Asset - Salvage Value
Estimated Number of Periods
in the Life of the Asset
46
Straight-Line Depreciation
You purchased a truck for $78,000 on
January 1, 2007. It is estimated that the
truck will be used for six years, and at the
end of that time, could be sold for $7,800.
What is the annual depreciation?
Straight-Line
Depreciation
for one year
=
=
=
Original Cost
Estimated
of Asset - Salvage Value
Estimated Number of Periods
in the Life of the Asset
$78,000
-
$7,800
6
$11,700
47
Straight-Line Depreciation
You purchased furniture for $5,120 on
January 1, 2007. It is estimated that the
furniture will be used for 10 years, and at
the end of that time, could be sold for
$500. What is the annual depreciation?
Straight-Line
Depreciation
for one year
=
=
=
Original Cost
Estimated
of Asset - Salvage Value
Estimated Number of Periods
in the Life of the Asset
$5,120
-
$500
10
$462
48
Adjusting Depreciation
When adjusting for depreciation you
would expect to
DR Depreciation Expense
CR Asset
In order to show the value of the
Asset at cost, you would not
CR Asset for the depreciation …
rather you
CR Accumulated Depreciation.
49
Accumulated Depreciation
Accumulated depreciation is a valuation or
contra account.
A contra account is one that is displayed
alongside an associated account and has
a balance that is opposite to the account it
is associated with.
Accumulated depreciation is also known
as a valuation account … an account that
is used, together with an asset account, to
show the true net value (or net
book value) of the asset.
50
Adjusting Entry for Depreciation
In the truck example, the adjusting
entry would be:
DR Depreciation Expense
11,700
CR Accumulated Amortization
11,700
In the furniture example, the
adjusting entry would be:
DR Depreciation Expense
CR Accumulated Amortization
462
462
51
Financial Statement
Presentation
Income Statement
 Depreciation expense is shown on the income
statement.
 Each depreciation expense item is shown separately
(e.g. Depreciation Expense – Truck).
Balance Sheet
 Accumulated depreciation is deducted from its
respective fixed asset account on the balance sheet.
 Each asset, with its related accumulated depreciation,
is shown separately. For example:
Truck
$78,000
Less: Accumulated Depreciation
11,700 $66,300
52
Depreciation for Part Year
Sometimes an asset is used for only part
of a year.
 For example, you purchase a building on May 1,
2007 for $120,000. The building is expected to
be used for 30 years, after which it will be worth
$30,000. Your company issued financial
statements quarterly (i.e. every 3 months).
Annual depreciation = (120,000 – 30,000) / 30
= $3,000
Monthly depreciation = 3,000 / 12 = $250 per month
The depreciation expense would be
1st quarter $ 0 and
53
2nd quarter $500.
Declining-Balance Depreciation
The declining-balance method is an
alternative to the straight-line method of
calculating depreciation.
The declining-balance method is common
because the government of Canada
requires a variation of this method for
income tax purposes.
This method calculates the annual
depreciation by multiplying the remaining
undepreciated cost (i.e. net book value)
by a fixed percentage.
54
Declining-Balance Depreciation
Some of the percentage rates set by the
government are as follows:
Canada Customs and Revenue Agency
Rates of Capital Cost Allowance (Depreciation)
Class
Description
Rate
3
6
8
10
12
Buildings of brick, stone, or cement
Buildings of frame, lot, or stucco
Office furniture and equipment
Automobiles, trucks, tractors, computer
equipment
Computer software (except system
software)
5%
10%
20%
30%
100%
55
Declining-Balance Depreciation
Example: you purchase computers on
January 1, 2006 for $22,000. The rate, per
the previous slide, is 30%.
Depreciation expense would be calculated
as follows:
2006: Original Cost
$22,000
Less: Depreciation ($22,000 x 30%)
6,600
Undepreciated cost (net book value) $15,400
2007: Undepreciated Cost
$15,400
Less: Depreciation ($15,400 x 30%)
4,620
Undepreciated cost (net book value) $10,780
56
Comparison of the Two
Methods of Depreciation
 For straight-line, assume the computers have an
8 year life with an ending value of $2,000.
The straight-line
method produces
depreciation figures
that are the same each year.
The net book value (NBV)
or undepreciated cost
gradually reduces until
it reaches the estimated
Salvage value.
$22,000 - $2,000
8
= $2,500 / year
57
Comparison of the Two
Methods of Depreciation
The decliningbalance method
produces depreciation
figures that are the larger in
the early years and smaller
in the later years. The
estimated final value is
ignored using this
method.
58
Tax Regulations
Canada Customs and Revenue Agency
(CCRA) requires businesses to use the
declining-balance method when
calculating depreciation for tax purposes.
In addition, the CCRA generally allows
50% of the asset’s cost to be eligible for
depreciation in its first year of use …
regardless of the month it was purchased.
The CCRA refers to this as the “50% Rule”
59
Tax Regulations
How would the “50% Rule” look?
60
Class / Homework
p. 348, Exercise 1
p. 349, Exercise 2 (do all the parts,
plus in part B, calculate with and
without the “50% rule”)
p. 350, Exercise 3 … prepare the
adjusting entries and an adjusted trial
balance.
61
Comprehensive Exercise
p. 361, Exercise 1
62