CHAPTER 4

COMPLETING THE ACCOUNTING CYCLE

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OUTLINE
Adjusting Entries Preparing the Adjusted Trial Balance Closing Entries Preparing the Financial Statements
Income Statement Statement of Owners Equity Balance Sheet
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The Accounting Cycle

Closing Entries Financial Statements Source Documents

Adjusted Trial Balance

Journal

Adjustments

Trial Balance
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Ledger
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Fiscal year Vs Calendar year Fiscal year

1st day of a month and ends twelve months later on the last day of a month.

Calendar year

1st January to 31st December

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Accrual Vs Cash-basis accounting Accrual

revenue and expenses are recognized at the time they take place, and not at the time they are actually paid.
(Recognized when the benefit Transferred)

Cash-basis

revenue is recorded when cash is received, and expenses are recorded when cash is paid (Recognized based on cash movement)
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Recognition of Revenue & Expenses

REVENUE RECOGNITION PRINCIPLE

revenue be recognized in the accounting period in which it is earned.

THE MATCHING PRINCIPLE

efforts (expenses) should be matched with accomplishments (revenues).

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Adjusting Entries
Entries that required to make sure all the revenues and expenses are clearly measured and recognized (realise) Prepared at the end of the period Do not involved cash account

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The Need for Adjusting Entries

1 Revenues to be recorded in the period in which they are earned, and for...... 2 Expenses to be recognized in the period in which they are incurred.

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The Basics of Adjusting Entries

Prepaid Expenses Expenses paid in cash and recorded as assets before they are used or consumed

Prepayments
Unearned Revenues Cash received and recorded as liabilities before revenue is earned

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The Basics of Adjusting Entries

Accrued Revenues Revenues earned but not yet received in cash or recorded

Accruals
Accrued Expenses Expenses incurred but not yet paid in cash or recorded

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Prepaid Expenses
Prior to adjustment, assets are overstated and expenses are understated. The adjusting entry results in a debit to an expense account and a credit to an asset account.

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Prepaid Expenses
Asset Unadjusted balance Credit Adjustment Debit Adjustment Expense

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Prepaid Expenses
Supplies

Examples

Insurance

Depreciation

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Supplies
Adjustment: An inventory count reveals that RM1,000 of RM2,500 of supplies are still on hand.

Entries before adjustment:

Dr.

Office Supplies
Cr. Cash

2,500
2,500

Adjusting entries:

Dr. Supplies Expense

Cr. Office Supplies
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1,500
1,500
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Supplies
Office Supplies Cash 2,500 Supp. Exp 1,500 Supplies Expense

Off. Supp. 1,500

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Insurance
Adjustment: Insurance premium paid for one year amounting to RM1,200; Expires every month RM100.

Entries before adjustment:

Dr. Prepaid Insurance

Cr. Cash

1,200
1,200

Adjusting entries:

Dr. Insurance Expense

100
100
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Cr. Prepaid Insurance

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Insurance
Prepaid Insurance Cash 1,200 Ins. Exp 100 Insurance Expense Pre. Insurance 100

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Depreciation
Depreciation is the allocation of the cost of an asset to expense over its useful life in a rational and systematic manner.
Depreciation is an estimate rather than a factual measurement of the cost that has expired.

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Depreciation
In recording depreciation, Depreciation Expense is debited and a contra asset account, Accumulated Depreciation, is credited

The difference between the cost of any depreciable asset and its related accumulated depreciation is referred to as the book value of the asset.

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Depreciation
Depreciation Methods

Straight Line Method Unit of productions Method

Reducing Balance Method

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Depreciation
Straight-line depreciation allocates equal amount of an
assets net cost to depreciation during the estimated useful life.
Formula: Cost - Scrap Value Estimated useful life Eg: Equipment costing RM26,000, estimated to have a useful life of 4 years and expected to be sold for RM8,000 at the end of the 4th year.

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Depreciation
Calculation: RM26,000 - RM8,000 4 years

= RM4,500 per year

Adjusting entries:

Dr. Depreciation Expense 4,500 Cr. Accumulated Depn. 4,500

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Depreciation
Depreciation Expense Off. Eqpt. 4,500 Accumulated Depn. Depn. Exp. 4,500

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Depreciation
Reducing Balance depreciation :
Formula: Net Book Value x Depreciation rate Depreciation rate

(Cost - Accumulated Depn) x

Eg: Equipment costing RM35,000, accumulated depreciation RM5,250. The depreciation rate is 15% on book value.

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Depreciation
Calculation: (RM35,000 - RM5,250) x 15% = RM4,463 per year

Adjusting entries:

Dr. Depreciation Expense 4,463 Cr. Accumulated Depn. 4,463

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Unearned Revenues
Prior to adjustment, liabilities are overstated and revenues are understated. The adjusting entry results in a debit to a liability account and a credit to a revenue account. Examples of unearned revenues include rent, magazine subscriptions, and customer deposits for future services.

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Unearned Revenues
Liability
Unadjusted balance

Revenue

Debit Adjustment

Credit Adjustment

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Unearned Revenues
Adjustment:

RM2,000 subscription fees has been earned, out of RM5,000 unearned subscription fees that has been received last month.
Dr. Cash 5,000 Cr. Unearned Subscription Fees 5,000

Entries before adjustment:

Adjusting entries:

Dr.

Unearned Subscription Fees 2,000 Cr. Subscription Fees 2,000

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Unearned Revenues
Unearned Subscription Fees Subscription Fees 2,000 Balance 5,000 Suscription Fees Unearned Subscription Fees 2,000

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Accrued Revenues
Accrued revenues may accumulate with the passing of time or through services performed but not billed or collected. Prior to adjustment, assets and revenues are understated.

The adjusting entry requires a debit to an asset account and a credit to a revenue account.

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Accrued Revenues
Asset Revenue

Debit Adjustment

Credit Adjustment

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Accrued Revenues
Adjustment: The company has completely performed the audit service but has not bill the customer yet, RM7,000.

Adjusting entries:

Dr.

Account Receivable 7,000 Cr. Audit Fees 7,000

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Accrued Revenues
Account Receivable Audit Fees 7,000 Audit Fees
Account Receivable 7,000

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Accrued Expenses
Prior to adjustment, liabilities and expenses are understated.

The adjusting entry results in a debit to an expense account and a credit to a liability account.

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Accrued Expenses
Expense Liability

Debit Adjustment

Credit Adjustment

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Accrued Expenses
Salaries accrued at the end of the month RM4,000.

Adjustment:

Adjusting entries:

Dr.

Salary Expense Cr. Salary Payable

4,000 4,000

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Accrued Expenses
Salary Expense
Salary Payable 4,000

Audit Fees
Salary Exp. 4,000

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Summary of Adjusting Entries

Types of Adjustments Prepaid Expenses Unearned Revenues Accrued Revenues Accrued Expenses Accounts Before Adjustments Assets overstated Expenses understated Liabilities overstated Revenues understated Assets understated Revenues understated Liabilities understated Expenses understated
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AdjustingEntries Dr. Expense Cr. Asset Dr. Liability Cr. Revenue Dr. Asset Cr. Revenue Dr. Expense Cr. Liability
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The adjusted trial balance

An Adjusted Trial Balance is prepared after all adjusting entries have been journalized and posted.
Its purpose is to prove the equality of the total debit and credit balances in the ledger after all adjustments have been made. Financial statements can be prepared directly from the adjusted trial balance.

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Closing Entries
All revenue accounts

Temporary / Nominal Accounts

All expense accounts Owners drawings

C L O S E

All asset accounts

Permanent / Real Accounts

All liability accounts

Owners capital account

C N L O O T S E
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Closing Entries
Revenues
Income Summary

Expenses
Owners Capital

Drawings

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Closing Entries
Dr. Revenue Account

Revenues

Cr.

Income Summary

Expenses

Dr.

Income Summary Cr. Expense Account

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Closing Entries
Income Summary Profit

Dr. Income Summary Cr. Owners Capital Dr. Owners Capital

Cr. Income Summary

Loss

Drawings

Dr.

Owners Capital Cr. Drawings Account

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BKAL 1013 Chapter 4

Preparing the Financial Statements

~ The income statement is prepared from the revenue and expense accounts. ~ The owners equity statement is derived from the owners capital and drawing accounts and the net income (or net loss) from the income statement.

~ The balance sheet is then prepared from the asset and liability accounts and the ending owners capital balance as reported in the owners equity statement.
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The Income Statement

The statement that reports the profitability of a business organization for a stated period of time Content of the statement
Title Revenues Expenses Net profit/(loss) difference between revenues and expenses
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The income statement .. cont

Format
Single
Did not classified the revenues and expenses based on their category

Multiple
More detailed and classified all the revenues and expenses based on their nature/function

Summary
Reports the important/significant item and support with the notes

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The owners equity statement

The statement that reports the changes in owners equity for a period of time. Must be prepared after the income statement Connect the link between IS and BS

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The owners equity statement - Cont

Format
Title Beginning balance Additional investment during period (if any) Net income of the period (from IS) Withdrawals Ending balance

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The Balance Sheet

The statement that list all the assets, liabilities and equities of a specific moment in time Purpose to show the financial position of the organization Assets classified into current and noncurrent assets Liabilities classified into current and long term liabilities
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The balance sheet .. cont

Format
Report form Account form Working capital form

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