Chapter Two

Accounting Cycle
for Service-giving
Businesses
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1. Explain what an account is and how it helps in the
recording process.
2. Define debits and credits and explain their use in
recording business transactions.
3. Identify the basic steps in the recording process.
4. Explain what a journal, a ledger & posting is/are and
how they helps in the recording process.
5. Prepare a trial balance and explain its purposes.
6. Explain the time period assumption.
7. Explain the accrual basis of accounting.
 Cont’d
8. Explain the reasons for adjusting entries.
9. Identify the major types of adjusting entries.
10.Prepare adjusting entries for deferrals & accruals.
11.Describe the nature and purpose of an adjusted trial
balance.
12.Prepare a worksheet.
13.Explain the process of closing the books.
14.Describe the content & purpose of a Post-Closing TB.
15.State the required steps in the accounting cycle.
16.Explain the approaches to preparing correcting
entries.
 2. The Account
1.
 An account is an individual accounting record of
increases and decreases in a specific asset, liability,
stockholders’ equity, revenue, or expense item.
 In its simplest form, an account consists of three
parts: (1) a title, (2) a left or debit side, and (3) a
right or credit side.
 Because the format of an account resembles the
letter T, we refer to it as a T-account.
 Illustration 2-1 shows the basic form of an account.
 2.1.1. Classification of Accounts

Basically accounts are classified as balance

sheet accounts and income statement

accounts.

 Balance sheet statement is the list of assets,

liabilities and owner’s equity accounts.

 Income statement is also the combination of

1. Assets: are any physical things (tangible)

or intangible that have a monetary value and

expected to provide future benefits to the

organization.

• Depending on their duration or useful

economic life, assets are categorized as

current assets and plant assets.

Current assets: are assets that might be expected to be

realized in cash or sold or used up within one year or less in

business operation. It includes cash, accounts receivable, notes

receivable, prepaid expenses, etc

Plant assets- are an assets used in the business that are

permanent or relatively fixed nature. Sometimes it is called fixed

assets. It includes equipment, machinery, buildings, land, etc.

Except land, plant assets gradually wear out or lose their useful

life.
2. Liabilities – are debts owed to outsiders or
creditors.
 Current liabilities – are those liabilities that will be

due within one year or less. It includes account

payable, notes payable, salary payable, etc.
 Long term liabilities – are those liabilities that will

be due after long time. Example: Bond,mortgage

3. Owner’s Equity – it is the residual claim against

the assets of the business after the total liabilities are
deducted.
 Cont’d
DEBIT AND CREDIT PROCEDURES

Double-entry system
 Each transaction must affect two or more
accounts to keep the basic accounting
equation in balance.
 Recording done by debiting at least one
account and crediting at least one other
account.
 DEBITS must equal with CREDITS.
 Cont’d
If the sum of Debit entries are greater than
the sum of Credit entries, the account will
have a debit balance.
Account Name
Debit / Dr. Credit / Cr.
Transaction #1 $10,000 $3,000 Transaction #2
Transaction #3 8,000

Balance $15,000
 Cont’d
If the sum of Credit entries are greater than
the sum of Debit entries, the account will
have a credit balance.
Account Name
Debit / Dr. Credit / Cr.
Transaction #1 $10,000 $3,000 Transaction #2
8,000 Transaction #3

Balance $11,000
 Cont’d
Assets
Debit / Dr. Credit / Cr.  Assets - Debits should
exceed credits.

Normal Balance
 Liabilities – Credits
Chapter
should exceed debits.
3-23

 Normal balance is on
Liabilities
Debit / Dr. Credit / Cr. the increase side.

Normal Balance

Chapter
3-24
 Cont’d
Equity
Debit / Dr. Credit / Cr.  Issuance of share capital
and revenues increase
equity (credit).
Normal Balance

 Dividends and expenses

Chapter
3-25

decrease equity (debit).

Share Capital-Ordinary Retained Earnings Dividends

Debit / Dr. Credit / Cr. Debit / Dr. Credit / Cr. Debit / Dr. Credit / Cr.

Normal Balance Normal Balance Normal Balance

Chapter Chapter Chapter

3-25 3-25 3-23
 Cont’d
Revenues  The purpose of earning
Debit / Dr. Credit / Cr.
revenues is to benefit the
shareholders.
Normal Balance  The effect of debits and
Chapter
3-26
credits on revenue accounts
is the same as their effect
Expenses on equity.
Debit / Dr. Credit / Cr.
 Expenses have the
opposite effect: expenses
Normal Balance decrease equity.

Chapter
3-27
 Cont’d
Liabilities
Norm
Norm Norm
Norm Debit / Dr. Credit / Cr.

al
al al
al
Balan
Balan Balan
Balan
ce
ce Assets ce
ce
Normal Balance

Debit
Debit
Debit / Dr. Credit / Cr.
Credit
Credit Equity
Chapter
3-24

Debit / Dr. Credit / Cr.

Normal Balance

Normal Balance
Chapter
3-23

Expenses Chapter
3-25

Debit / Dr. Credit / Cr. Revenues

Debit / Dr. Credit / Cr.

Normal Balance

Normal Balance
Chapter
3-27

Chapter
3-26
Summary of Debit/Credit Rules
Statement of
Financial Position Income
Statement
Asset = Liability + Equity Revenue - Expense

Debit

Credit
 Cont’d
Question #1
Debits:
a. increase both assets and liabilities.
b. decrease both assets and liabilities.
c. increase assets and decrease liabilities.
d. decrease assets and increase liabilities.
 Cont’d
Question #2
Accounts that normally have debit balances are:
a. assets, expenses, and revenues.
b. assets, expenses, and equity.
c. assets, liabilities, and dividends.
d. assets, dividends, and expenses.
Equity
Relationshi
ps

Illustration 2-11
Equity relationships
Summary of Debit/Credit Rules
Relationship among the assets, liabilities,
and equity of a business: Illustration 2-12
Summary of debit/credit
rules

The equation must be in balance after every

transaction. Total Debits must equal total
Credits.
 > DO IT!
Kate Browne, president of Hair It Is Company SA, has just
rented space in a shopping mall in which she will open and
operate a beauty salon. A friend has advised Kate to set up
a double-entry set of accounting records in which to record
all of her business transactions. Identify the SoFP accounts
that Hair It Is Company will likely use to record the
transactions needed to establish and open the business.
Also, indicate whether the normal balance of each account
is a debit or a credit.
Assets Liabilities Equity

Cash (debit) Notes Payable (credit) Share Capital—

Supplies (debit) Accounts Payable (credit) Ordinary
(credit)
Equipment (debit)
 Steps in the Recording
2. Process
2.
 Although it is possible to enter transaction
information directly into the accounts without using
a journal, few businesses do so.
 Practically every business uses three basic steps
in the recording process:
1) Analyze each transaction for its effects on the
accounts.
2) Enter the transaction information in a journal.
3) Transfer the journal information to the
appropriate accounts in the ledger.
 The recording process begins with the transaction.
 Business documents, such as a sales receipt, a
check, or a bill, provide evidence of the transaction.
 Cont’d
 The company analyzes this evidence to determine the
transaction’s effects on specific accounts. The
company then enters the transaction in the journal.
 Finally, it transfers the journal entry to the designated
accounts in the ledger.
 Illustration 2-13 shows the recording process.
The Journal
 Book of original entry.
 Transactions recorded in chronological order.
 Companies may use various kinds of journals, but
every company has the most basic form of journal,
a general journal.
 Contributions to the recording process:
1. Discloses the complete effects of a
transaction.
2. Provides a chronological record of
transactions.
 Cont’d
JOURNALIZING - Entering transaction data in the
journal.
Illustration: On September 1, shareholders invested
€15,000 cash in the corporation in exchange for ordinary
shares, and Softbyte purchased computer equipment for
€7,000 cash. Illustration 2-
14
GENERAL JOURNAL
 Cont’d
SIMPLE AND COMPOUND ENTRIES
Illustration: On July 1, Tsai Company purchases a
delivery truck costing NT$420,000. It pays NT$240,000
cash now and agrees to pay the remaining NT$180,000
on account.
Illustration 2-15 Compound Journal
Entry
1. The date of the transaction is entered in the Date column.
2. The debit account title (that is, the account to be debited) is entered
first at the
extreme left margin of the column headed “Account Titles and
Explanation,”
and the amount of the debit is recorded in the Debit column.
3. The credit account title (that is, the account to be credited) is
indented and
entered on the next line in the column headed “Account Titles and
Explanation,” and the amount of the credit is recorded in the Credit
column.
4. A brief explanation of the transaction appears on the line below the
credit account title. A space is left between journal entries. The blank
space separates
individual journal entries and makes the entire journal easier to read.
5. The column titled Ref. (which stands for Reference) is left blank when
 > DO IT!
As president and sole shareholder, Kate Browne
engaged in the following activities in establishing her
salon, Hair It Is Company.
1. Opened a bank account in the name of Hair It Is
Company SA and deposited €20,000 of her own
money in this account in exchange for ordinary
shares.
2. Purchased equipment on account (to be paid in 30
days) for a total cost of €4,800.
3. Interviewed three applicants for the position of
beautician.
Cont’d
The Ledger
 The entire group of accounts maintained by a company is the
ledger.
 The ledger keeps in one place all the information about
changes in specific account balances.
 Companies may use various kinds of ledgers, but every
company has a general ledger. It contains all the asset,
liability, and equity accounts.
Illustration 2-16 The General
Ledger
The Standard form of Account
 The simple T-account form used in accounting
textbooks is often very useful for illustration
purposes.
 However, in practice, the account forms used in
ledgers are much more structured.
 Illustration 2-17 shows a typical form, using
assumed data from a cash account. This is called
the three-column form of account.
 It has three money columns—debit, credit, and
balance.
 The balance in the account is determined after each
transaction.
 Companies use the explanation space and reference
 Cont’d
Illustration 2-17 Three-Column Form of Account
Posting
 Transferring journal entries to the ledger accounts is
called posting.
 Posting involves the following steps.
1) In the ledger, enter, in the appropriate columns of the
account(s) debited, the date, journal page, and debit amount
shown in the journal.

2) In the reference column of the journal, write the account

number to which the debit amount was posted.

3) In the ledger, enter, in the appropriate columns of the

account(s) credited, the date, journal page, and credit
amount shown in the journal.

4) In the reference column of the journal, write the account

number to which the credit amount was posted.
Illustration 2-18 shows these four steps using Softbyte
Inc.’s first journal entry, the issuance of ordinary shares
for €18,000 cash
 Cont’d
Question #3
Posting:
a. normally occurs before journalizing.
b. transfers ledger transaction data to the
journal.
c. is an optional step in the recording
process.
d. transfers journal entries to ledger
accounts.
Chart of Accounts
 The number and type of accounts differ for each
company.
 The number of accounts depends on the amount of
detail management desires. For example, the
management of one company may want a single
account for all types of utility expense. Another may
keep separate expense accounts for each type of
utility, such as gas, electricity, and water.
 Most companies have a chart of accounts. This chart
lists the accounts and the account numbers that
identify their location in the ledger.
 The numbering system that identifies the accounts
Illustration 2-19 Chart of accounts for Pioneer Advertising
Agency Inc.
 The Recording Process
2.
Illustrated
3.
 Illustrations 2-20 through 2-29 show the basic
steps in the recording process, using the
October transactions of Pioneer Advertising
Agency Inc.
 Pioneer’s accounting period is a month. A basic
analysis and a debit-credit analysis precede the
journalizing and posting of each transaction.
 For simplicity, we use the T-account form in the
illustrations instead of the standard account form.
 The purpose of transaction analysis is first to
identify the type of account involved, and then to
Illustration 2-30 General Journal Entries,
Summary
Illustration 2-30 General Journal Entries,
Summery
Illustration 2-31 General
Ledger
 > DO IT!
Basel Company recorded the following transactions in a
general journal during the month of March. The
beginning balance in cash on March 1 was 600 Euro. Post
these
Mar. 4entries
Cashto the Cash account.2,280
Service Revenue 2,280
15 Salaries and Wages Expense 400
Cash 400
19 Utilities Expense 92
Cash 92
2. The Trial Balance
4.
 A Trial Balance is a list of accounts and their
balances at a given time.
 Customarily, companies prepare a trial balance at
the end of an accounting period.
 They list accounts in the order in which they
appear in the ledger.
 Debit balances appear in the left column and
credit balances in the right column.
 The trial balance proves the mathematical
equality of debits and credits after posting.
 Cont’d
 Under the double-entry system, this equality occurs
when the sum of the debit account balances equals
the sum of the credit account balances.
 A trial balance may also uncover errors in
journalizing and posting.
 In addition, a trial balance is useful in the
preparation of financial statements.
 The steps for preparing a trial balance are:
1. List the account titles and their balances.
2. Total the debit and credit columns.
3. Prove the equality of the two columns.
Illustration 2-32 A Trial Balance
Limitations of a Trial Balance
 A trial balance does not guarantee freedom
from recording errors, however.
 Numerous errors may exist even though the
totals of the trial balance columns agree.
Trial balance may balance even when:
1. A transaction is not journalized.
2. A correct journal entry is not posted.
3. A journal entry is posted twice.
4. Incorrect accounts are used in journalizing or posting.
5. Offsetting errors are made in recording the amount of a
transaction.
Locating Errors
 Errors in a trial balance generally result from
mathematical mistakes, incorrect postings, or
simply transcribing data incorrectly.
 What do you do if you are faced with a trial balance
that does not balance?
 First, determine the amount of the difference
between the two columns of the trial balance.
 After this amount is known, the following steps are
often helpful:
1) If the error is $1, $10, $100, or $1,000, re-add the
trial balance columns and re-compute the account
balances.
 Cont’d
2) If the error is divisible by 2, scan the trial balance to
see whether a balance equal to half the error has been
entered in the wrong column.
3) If the error is divisible by 9, re-trace the account
balances on the trial balance to see whether they are
incorrectly copied from the ledger. For example, if a
balance was $12 and it was listed as $21, a $9 error
has been made. Reversing the order of numbers is
called a transposition error.
4) If the error is not divisible by 2 or 9, scan the ledger to
see whether an account balance in the amount of the
error has been omitted from the trial balance, and
scan the journal to see whether a posting of that
amount has been omitted.
> DO IT!
 Adjusting Entries-
2. Timing Issues
5.
Accountants divide the economic life of a business into
artificial time periods (Time Period Assumption).

.....
Jan. Feb. Mar. Apr. Dec.

 Generally a month, a quarter, or a year.

 Also known as the “Periodicity Assumption”
Fiscal and Calendar Years
 Monthly and quarterly time periods are called
interim periods.
 Most large companies must prepare both
quarterly and annual financial statements.
 Fiscal Year = Accounting time period that is one
year in length.
 Calendar Year = January 1 to December 31.
 Cont’d
Question #4
The time period assumption states that:
a. Companies must wait until the calendar year is
completed to prepare financial statements.

b. Companies use the fiscal year to report financial

information.

c. The economic life of a business can be divided into

artificial time periods.

d. Companies record information in the time period in

which the events occur.
Accrual- Versus Cash-Basis of
Accounting
Accrual-Basis of Accounting
 Transactions recorded in the periods in
which the events occur.
 Companies recognize revenues when they
perform services (rather than when they
receive cash).
 Expenses are recognized when incurred
(rather than when paid).
Accrual- Versus Cash-Basis of
Accounting
Cash-Basis of Accounting
 Revenues are recorded when cash is
received.
 Expenses are recorded when cash is paid.
 Cash-basis of accounting is not in
accordance with International Financial
Reporting Standards (IFRS).
Recognizing Revenues and
Expenses
REVENUE RECOGNITION PRINCIPLE
Recognize revenue in
the accounting period in
which the performance
obligation is satisfied.
• To illustrate, assume that Soon’s
Dry Cleaning cleans clothing on
June 30, but customers do not
claim and pay for their clothes
until the first week of July, soo
should recognize revenue.
Recognizing Revenues and
Expenses
EXPENSE RECOGNITION PRINCIPLE
Match expenses with
revenues in the period
when the company makes
efforts to generate those
revenues.
“Let the expenses
follow the revenues.”
 Cont’d

• The critical issue in expense recognition is when

the expense makes its contribution to revenue.

• This may or may not be the same period in which

the expense is paid.

• If Soon’s does not pay the salary incurred on

June 30 until July, it would report salaries payable

on its June 30 statement of financial position.
Illustration 3-1
IFRS relationships
in Revenue &
Expense
Recognition
Recognizing Revenues and
Expenses
Question #5
The revenue recognition principle states that:
a. Revenue should be recognized in the accounting
period in which a performance obligation is
satisfied.
b. Expenses should be matched with revenues.
c. The economic life of a business can be divided
into artificial time periods.
d. The fiscal year should correspond with the
calendar year.
 > DO IT!
A list of concepts is provided in the left column below, with a
description of the concept in the right column below. There are
more descriptions provided than concepts. Match the description
of the concept to the concept.
(a) Monthly and quarterly time
1. ___ Accrual-basis
accounting. periods.
(b) Efforts (expenses) should be
2. ___ Calendar year.
matched with results (revenues).
3. ___ Time period (c) Accountants divide the economic
assumption. life of a business into artificial time
4. ___ Expense periods.
recognition principle. (d) Companies record revenues when
they receive cash and record
expenses when they pay out cash.
(e) An accounting time period that
starts on January 1 and ends on
December 31.
 The Basics of Adjusting
2. Entries
6.
Adjusting Entries
 Ensure that the revenue recognition and
expense recognition principles are followed.
 Necessary because the trial balance may
not contain up-to-date and complete data.
 Required every time a company prepares
financial statements.
 Will include one income statement account
and one SoFP account.
 Cont’d
Question #6
Adjusting entries are made to ensure that:
a. Expenses are recognized in the period in which
they are incurred.
b. Revenues are recorded in the period in which
services are performed.
c. Statement of financial position and income
statement accounts have correct balances at the
end of an accounting period.
d. All of the above.
Types of Adjusting Entries

Illustration 3-2
Categories of Adjusting
Entries
Illustration Each account is analyzed to determine
3-3 whether it is complete and up-to-date for
Trial Balance
FS purposes.
Adjusting Entries for Deferrals
Deferrals are expenses or revenues that
are recognized at a date later than the point
when cash was originally exchanged.
There are two types of deferrals:
 Prepaid Expenses and
 Unearned Revenues.
PREPAID EXPENSES
Payments of expenses that will benefit more
than one accounting period.

Cash BEFORE Expense Recorded

Payment
Prepayments often occur in regard to:
 Insurance  Rent
 Supplies  Buildings and Equipment
 Advertising
 Cont’d
 Expire either with the passage of time or through
use.
 Adjusting entry:
► Increase (debit) to an expense account and
Decrease (credit)
► 3-4
Illustration to an asset account.
Adjusting Entries for Prepaid
Expenses
 Cont’d
Illustration: Pioneer Advertising
Inc. purchased supplies costing
₺2,500 on October 5. Pioneer
recorded the purchase by increasing
(debiting) the asset Supplies. This
account shows a balance of ₺2,500
in the October 31 trial balance. An
inventory count at the close of
business on October 31 reveals that
₺1,000 of supplies
Oct. 31 are still on hand.
Supplies Expense 1,500
Supplies 1,500
Illustration 3-5
Adjustment for Supplies
 Cont’d
Illustration: On October 4,
Pioneer Advertising Inc. paid
₺600 for a one-year fire insurance
policy. Coverage began on October
1. Pioneer recorded the payment
by increasing (debiting) Prepaid
Insurance. This account shows a
balance of ₺600 in the Oct. 31 TB.
Insurance of ₺50 (₺600 ÷ 12)
expires each month.
Oct. 31 Insurance Expense 50
Prepaid Insurance 50
Illustration 3-6
Adjustment for Insurance
 Cont’d
DEPRECIATION
 Buildings, equipment, and motor vehicles
(assets that provide service for many years)
are recorded as assets, rather than an
expense, on the date acquired.
 Depreciation is the process of allocating
the cost of an asset to expense over its
useful life.
 Depreciation does not attempt to report the
actual change in the value of the asset.
 Cont’d
Illustration: For Pioneer
Advertising, assume that depreciation
on the equipment is ₺480 a year, or
₺40 per month.
Oct. 31
Depreciation Expense 40
Accumulated Depreciation 40

Accumulated Depreciation is
called a Contra Asset
•HELPFUL HINT
Account.
All Contra Accounts have increases,
decreases, and normal balances
opposite to the account to which they
relate.
Illustration 3-7
Adjustment for Depreciation
 Cont’d
Statement Presentation
 Accumulated Depreciation is a contra asset
account (credit).
 Appears just after the account it offsets
(Equipment) on the SOFP.
 Book Value is the difference between the cost of
any depreciable asset and its accumulated
depreciation.
Illustration 3-8: SoFP Presentation of Accumulated
Depreciation
 Cont’d
Illustration 3-9: Accounting for Prepaid
Expenses
UNEARNED REVENUES

Receipt of cash that is recorded as a liability

because the service has not been performed.

Cash Receipt BEFORE Revenue Recorded

Unearned revenues often occur in regard to:

 Rent  Magazine subscriptions
 Airline tickets  Customer deposits
 Cont’d
 Adjusting entry is made to record the revenue for
services performed during the period and to show
the liability that remains at the end of the
accounting period.
 Results in a decrease (debit) to a liability account
and an increase (credit) to a revenue account.
Illustration 3-10: Adjusting Entries for Unearned
Revenues
 Cont’d
Illustration: Pioneer Advertising Inc. received
₺1,200 on October 2 from R. Knox for advertising
services expected to be completed by December 31.
Unearned Service Revenue shows a balance of
₺1,200 in the October 31 trial balance. Analysis reveals
that the company performed ₺400 of services in
October.
Oct. 31 Unearned Service Revenue 400
Service Revenue 400
Illustration 3-11
Service Revenue Accounts for
Adjustment
 Cont’d
Illustration 3-12: Accounting for Unearned
Revenues
 > DO IT!
The ledger of Zhu Company on March 31, 2014, includes
these selected accounts before adjusting entries are
prepared.
(amounts in thousands) Debit Credit
Prepaid Insurance ¥ 3,600
Supplies 2,800
Equipment 25,000
Accumulated Depreciation—Equipment ¥ 5,000
Unearned Service Revenue 9,200
An analysis of the accounts shows the
following.
1. Insurance expires at the rate of ¥100 per month.
2. Supplies on hand total ¥800.
3. The equipment depreciates ¥200 a month.
Adjusting Entries for Accruals
Accruals are made to record
 Revenues for services performed but not yet
recorded at the statement date (accrued
revenues).

OR
 Expenses incurred but not yet paid or recorded at
the statement date (accrued expenses).
ACCRUED REVENUES
Revenues for services performed but not yet
received in cash or recorded.

Revenue BEFORE Cash

Recorded Receipt
Accrued revenues often occur in regard
to:
 Rent  Services performed
 Interest
 Cont’d
 Adjusting entry records the receivable that exists
and records the revenues for services
performed.
 Adjusting entry:
► Increases (debits) an asset account and
► Increases (credits) a revenue account.
Illustration 3-13: Adjusting Entries for Accrued
Revenues
 Cont’d
Illustration: In October, Pioneer
Advertising Inc. performed
services worth ₺200 that were not
billed to clients in October.
Oct. 31
Accounts Receivable 200
Service Revenue 200

On November 10, Pioneer receives cash of ₺200 for the

services performed.

Nov. 10 Cash 200

Accounts Receivable 200
Illustration 3-14
Adjustment for Accrued revenue
 Cont’d
Illustration 3-15: Accounting for Accrued
Revenues
ACCRUED EXPENSES
Expenses incurred but not yet paid in cash or
recorded.

Expense BEFORE Cash

Recorded Payment
Accrued expenses often occur in regard
to:
 Interest
 Taxes
 Salaries
 Cont’d
 Adjusting entry records the obligation and
recognizes the expense.
 Adjusting entry:
► Increase (debit) an expense account and
► Increase (credit) a liability account.
Illustration 3-16: Adjusting Entries for Accrued
Expenses
 Cont’d
Illustration: Pioneer Advertising Inc. signed a three-
month note payable in the amount of ₺5,000 on October
1. The note requires Pioneer to pay interest at an annual
rate of 12%.
Illustration 3-17: Formula for Computing
Interest

Oct. 31 Interest Expense 50

Interest Payable 50
Illustration 3-18
Adjustment for Accrued Interest
 Cont’d
Illustration: Pioneer paid salaries and wages on
October 26; the next payment of salaries will not occur
until November 9. The employees receive total salaries
of ₺2,000 for a five-day work week, or ₺400 per day.
Thus, accrued salaries at October 31 are ₺1,200 (₺400 x
3Illustration
days). 3-19: Calendar Showing Pioneer’s Pay
Periods
Illustration 3-20
Adjustment for Accrued Salaries &
Wages
 Cont’d
Illustration 3-21: Accounting for Accrued
Expenses
 > DO IT!
Micro Computer Services began operations on August 1,
2014. At the end of August 2014, management prepares
monthly financial statements. The following information
relates to August.
1. At August 31, the company owed its employees ¥8,000
in salaries and wages that will be paid on September 1.
2. On August 1, the company borrowed ¥300,000 from a
local bank on a 15-year mortgage. The annual interest
rate is 10%.
3. Revenue for services performed but unrecorded for
August totaled ¥11,000.
Prepare the adjusting entries needed at August 31, 2014.
Summary of Basic Relationships
Illustration 3-22: Summery of Adjusting
Entries
 Cont’d
 Illustrations 3-23 & 3-24 (on next slides) show
the journalizing and posting of adjusting entries
for Pioneer Advertising Agency Inc. on October
31.
 The ledger identifies all adjustments by the
reference J2 because they have been recorded on
page 2 of the general journal.
 The company may insert a center caption “Adjusting
Entries” between the last transaction entry and the
first adjusting entry in the journal.
 When you review the general ledger in Illustration 3-
24, note that the entries highlighted in color are
Illustration 3-23: General Journal Showing Adjusting
Entries
Cont’d
 The Adjusted Trial Balance
2. & FS’s
7.
Preparing the Adjusted Trial Balance
 Prepared after all adjusting entries are
journalized and posted.
 Purpose is to prove the equality of debit
balances and credit balances in the ledger.
 Is the primary basis for the preparation of
financial statements.
Illustration 3-25: Adjusted Trial
Balance
 Cont’d
Question #7
Which of the following statements is incorrect
concerning the adjusted trial balance?
a. An adjusted trial balance proves the equality of the
total debit balances and the total credit balances in
the ledger after all adjustments are made.
b. The adjusted trial balance provides the primary basis
for the preparation of financial statements.
c. The adjusted trial balance lists the account balances
segregated by assets and liabilities.
d. The adjusted trial balance is prepared after the
adjusting entries have been journalized and posted.
Preparing Financial Statements

Financial
Financial Statements
Statements are
are prepared
prepared directly
directly
from
from the
the Adjusted
Adjusted Trial
Trial Balance.
Balance.

Retaine
d Stateme
Income
Earning nt of
Stateme
s Financial
nt
Stateme Position
nt
Illustration 3-27: The Preparation of the SoFP from the Adjusted Trial
Balance
2. Completing the Accounting Cycle– Using
8. the Worksheet

Worksheet
 Multiple-column form used in preparing
financial statements.
 Not a permanent accounting record.
 May be a computerized worksheet using an
electronic spreadsheet program such as Excel.
 Prepared using a five step process.
 Use of worksheet is optional.
 Illustration 4-1
Steps in Preparing a Worksheet
Form &
Procedure
For A Worksheet
 Cont’d
1. PREPARE A TRIAL BALANCE ON THE Illustration
WORKSHEET 4-2
Adjusted Income Statement of
Trial Balance Adjustments Trial Balance Statement Financial Position
Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
Cash 15,200
Supplies 2,500
Prepaid Insurance 600
Equipment 5,000
Notes Payable 5,000
Accounts Payable 2,500
Unearned Revenue 1,200
Share Capital-Ordinary 10,000
Dividends 500
Service Revenue 10,000

Salaries and Wages Exp. 4,000

Rent Expense 900
Totals 28,700 28,700
Trial balance amounts
come directly from ledger
Include all accounts.
accounts with
balances.
Illustration 3-23: General Journal Showing Adjusting
Entries
 Cont’d
2. ENTER THE ADJUSTMENTS IN THE ADJUSTMENTS
COLUMNS Adjusted Income Statement of
Trial Balance Adjustments Trial Balance Statement Financial Position
Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
Cash 15,200
Supplies 2,500 (a) 1,500
Prepaid Insurance 600 50
(b)
Equipment 5,000
Notes Payable 5,000 Adjustments Key:
Accounts Payable 2,500
Unearned Revenue 1,200 (d) 400 (a) Supplies Used.
Share Capital-Ordinary 10,000 (b) Insurance Expired.
Dividends 500
Service Revenue 10,000 (d) 400
(c) Depreciation Expensed.
(e) 200
Salaries and Wages Exp. 4,000 (g) 1,200 (d) S/Revenue Recognized.
Rent Expense
Totals
900
28,700 28,700
(e) Service Revenue
Supplies Expense (a) 1,500 Accrued.
Insurance Expense 50
Accumulated Depreciation
(b)
(c) 40 (f) Interest Accrued.
Depreciation Expense (c) 40 (g) Salaries Accrued.
Accounts Receivable (e) 200
Interest Expense (f) 50 Enter adjustment
Interest Payable (f) 50 amounts, total
Salaries and Wages Payable (g) 1,200
Totals 3,440 3,440 adjustments columns,
and check for equality.
Add additional accounts as
needed.
 Cont’d
3. COMPLETE THE ADJUSTED TRIAL BALANCE COLUMNS
Illustration
Adjusted Income
4-2 Statement of
Trial Balance Adjustments Trial Balance Statement Financial Position
Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
Cash 15,200 15,200
Supplies 2,500 (a) 1,500 1,000
Prepaid Insurance 600 (b) 50 550
Equipment 5,000 5,000
Notes Payable 5,000 5,000
Accounts Payable 2,500 2,500
Unearned Revenue 1,200 400 800
(d)
Share Capital-Ordinary 10,000 10,000
Dividends 500 500
Service Revenue 10,000 (d) 400 10,600
(e)
200
Salaries and Wages Exp. 4,000 (g) 1,200 5,200
Rent Expense 900 900
Totals 28,700 28,700
(a)
Supplies Expense 1,500 1,500
Insurance Expense (b) 50 50
(c)
Accumulated Depreciation 40 40
Depreciation Expense (c) 40 40
Accounts Receivable (e) 200 200
Interest Expense (f) 50 50
Interest Payable (f) 50 50
(g)
Salaries and Wages Payable 1,200 1,200
Totals 3,440 3,440 30,190 30,190
Total the adjusted trial
balance columns and check
for equality.
 Cont’d
4. EXTEND AMOUNTS TO FINANCIAL STATEMENT Illus.: 4-
COLUMNS Adjusted Income
2
Statement of
Trial Balance Adjustments Trial Balance Statement Financial Position
Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
Cash 15,200 15,200
Supplies 2,500 (a) 1,500 1,000
Prepaid Insurance 600 50 550
(b)
Equipment 5,000 5,000
Notes Payable 5,000 5,000
Accounts Payable 2,500 2,500
Unearned Revenue 1,200 400 800
Share Capital-Ordinary 10,000 (d) 10,000
Dividends 500 500
Service Revenue 10,000 (d) 400 10,600 10,600
(e) 200
Salaries and Wages Exp. 4,000 1,200 5,200 5,200
(g)
Rent Expense 900 900 900
Totals 28,700 28,700
Supplies Expense (a) 1,500 1,500 1,500
Insurance Expense (b) 50 50 50
Accumulated Depreciation (c) 40 40
Depreciation Expense (c) 40 40 40
Accounts Receivable (e) 200 200
Interest Expense (f) 50 50 50
Interest Payable (f) 50 50
Salaries and Wages Payable (g) 1,200 1,200
Totals 3,440 3,440 30,190 30,190 7,740 10,600

Extend all revenue and expense

account balances to the IS
Columns.
 Cont’d
5. TOTAL COLUMNS, COMPUTE NET INCOME Illus.: 4-
(LOSS) Adjusted Income
2
Statement of
Trial Balance Adjustments Trial Balance Statement Financial Position
Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
Cash 15,200 15,200 15,200
Supplies 2,500 1,500 1,000 1,000
Prepaid Insurance 600 (a) 50 550 550
Equipment 5,000 (b) 5,000 5,000
Notes Payable 5,000 5,000 5,000
Accounts Payable 2,500 2,500 2,500
Unearned Revenue 1,200 400 800 800
Share Capital-Ordinary 10,000 (d) 10,000 10,000
Dividends 500 500 500
Service Revenue 10,000 400 10,600 10,600
(d)
200
Salaries and Wages Exp. 4,000 1,200(e) 5,200 5,200
(g)
Rent Expense 900 900 900
Totals 28,700 28,700
Supplies Expense 1,500 1,500 1,500
(a)
Insurance Expense 50 50 50
(b)
Accumulated Depreciation 40 40 40
(c)
Depreciation Expense (c) 40 40 40
Accounts Receivable (e) 200 200 200
Interest Expense (f) 50 50 50
Interest Payable (f) 50 50 50
Salaries and Wages Payable (g) 1,200 1,200 1,200
Totals 3,440 3,440 30,190 30,190 7,740 10,600 22,450 19,590
Net Income 2,860 2,860
Totals 10,600 10,600 22,450 22,450
Compute Net Income or Net
Loss.
Preparing FS’s from a
Worksheet
 Income statement is prepared from the income
statement columns.
 Statement of financial position and retained
earnings statement are prepared from the
statement of financial position columns.
 Companies can prepare financial statements
before they journalize and post adjusting entries.
 Cont’d
Illustration 4-3: Financial Statements from A
Worksheet
 Cont’d
Illustration 4-3: Financial Statements from A
Worksheet
 Cont’d
Illustration 4-3: Financial Statements from A
Worksheet
Preparing Adjusting Entries from a
Worksheet
 Adjusting entries are prepared from the
adjustments columns of the worksheet.
 Journalizing and posting of adjusting entries
follows the preparation of financial statements
when a worksheet is used.
 Cont’d
Question #8
Which of the following statements is incorrect
concerning the worksheet?
a. The worksheet is essentially a working tool of the
accountant.
b. The worksheet is distributed to management and
other interested parties.
c. The worksheet cannot be used as a basis for
posting to ledger accounts.
d. Financial statements can be prepared directly from
the worksheet before journalizing and posting the
adjusting entries.
 > DO IT!
Susan Elbe is preparing a worksheet. Explain to Susan
how she should extend the following adjusted trial balance
accounts to the financial statement columns of the
worksheet.
Cash Statement of financial position
(debit column)
Accumulated
Depreciation
Statement of financial position
Accounts Payable (credit column)

Dividends Income statement

Service Revenue (debit column)

Salaries and Income statement

Wages Expense (credit column)
 2. Closing the Books
At9.
the end of the accounting period, the company
makes the accounts ready for the next period.
Illustration 4-4: Temporary Versus Permanent
Accounts
Preparing Closing Entries

Closing entries formally recognize in the ledger

the transfer of
 net income (or net loss) and
 Dividends to Retained Earnings.

Companies generally journalize and post closing

entries only at the end of the annual accounting
period.
Closing entries produce a zero balance in each
temporary account.
 Illustration 4-5
• HELPFUL HINT Diagram of
The Dividends Closing Process—
account is Corporation
closed directly to
Retained RE’s is a
Earnings and not to permanent
Income Summary account. All
because other accounts
dividends are not an are temporary
expense. accounts.
Illustration 4-6: Closing Entries
Journalized
Posting
Closing
Entries

Illustration 4-7
Post Closing
Entries
 > DO IT!
The worksheet for Hancock Company shows the
following in the financial statement columns:
Dividends €15,000
Share Capital, Ordinary €42,000
Net income €18,000
Prepare the closing entries at Dec. 31 that affect
equity.
Income Summary 18,000
Retained Earnings 18,000
Retained Earnings 15,000
Dividends 15,000
 2.1 Post Closing Trial Balance
0.
Post-Closing Trial Balance
 Lists permanent accounts and their balances
after the journalizing and posting of closing
entries.
 Purpose is to prove the equality of the
permanent account balances carried forward into
the next accounting period.
 Only contains balances for permanent—
statement of financial position—accounts.
 All temporary accounts will have zero
balances.
 It is prepared from the permanent accounts in
Illustration 4-8: Post-Closing Trial Balance

Illustration 4-8
 Summary of the
2.1 Accounting Cycle
1.
Illustration 4-11: Steps in the Accounting
Cycle
1.
1. Analyze
Analyze
business
business transactions
transactions
9.
9. Prepare
Prepare a a 2.
2. Journalize
Journalize the
the
post-closing
post-closing trial
trial transactions
transactions
balance
balance
8.
8. Journalize
Journalize 3.
3. Post
Post to
to ledger
ledger
and
and post
post closing
closing accounts
accounts
entries
entries
7.
7. Prepare
Prepare 4.
4. Prepare
Prepare a
a trial
trial
financial
financial balance
balance
statements
statements
6.
6. Prepare
Prepare an an 5.
5. Journalize
Journalize and
and post
post
adjusted
adjusted trial
trial adjusting
adjusting entries
entries
balance
balance
Correcting Entries—An
Avoidable

Step
Unnecessary if accounting records are free of
errors.
 Made whenever an error is discovered.
 Must be posted before closing entries.
Instead of preparing a correcting entry, it is
possible to reverse the incorrect entry and
then prepare the correct entry.
 Cont’d
CASE 1: On May 10, Mercato Co. journalized and posted a
$50 cash collection on account from a customer as a debit
to Cash $50 and a credit to Service Revenue $50. The
company discovered the error on May 20, when the
customer paid the remaining balance in full.

Incorrect Cash 50
Entry
Service Revenue
50
Correct Cash 50
Entry
Accounts Receivable
50
Correcting Service Revenue 50
Entry Accounts Receivable
50
 Cont’d
CASE 2: On May 18, Mercato purchased on account
equipment costing $450. The transaction was journalized
and posted as a debit to Equipment $45 and a credit to
Accounts Payable $45. The error was discovered on June 3.

Incorrect Equipment 45
Entry
Accounts Payable
45
Correct Equipment 450
Entry
Accounts Payable
450
Correcting Equipment 405
Entry Accounts Payable
405
 > DO IT!
Sanchez Company discovered the following errors
made in January 2014.
1. A payment of Salaries and Wages Expense of $600
was debited to Supplies and credited to Cash, both for
$600.
2. A collection of $3,000 from a client on account was
debited to Cash $200 and credited to Service
Revenue $200.
3. The purchase of supplies on account for $860 was
debited to Supplies $680 and credited to Accounts
Payable $680.

Correct the errors without reversing the incorrect

 > DO IT!

Solutions
Salaries and Wages Expense 600
Supplies 600

Service Revenue 200

Cash 2,800
Accounts Receivable 3,000

Supplies ($860 - $680) 180

Accounts Payable 180
2.1 Reversing Entries
2.
 It is often helpful to reverse some of the adjusting

entries before recording the regular transactions

of the next period.
 Companies make a reversing entry at the
beginning of the next accounting period.
 Each reversing entry is the exact opposite of
the adjusting entry made in the previous period.
 The use of reversing entries does not change
the amounts reported in the financial statements.
Reversing Entries Example
Illustration: To illustrate the optional use of reversing
entries for accrued expenses, we will use the salaries
expense transactions for Pioneer Advertising Inc.
1. Oct. 26 (initial salary entry): Pioneer pays ₺4,000 of
salaries and wages earned between October 15 and
Oct. 26.
2. October 31 (adjusting entry): Salaries and wages
earned between October 29 and October 31 are
₺1,200. The company will pay these in the November 9
payroll.
3. November 9 (subsequent salary entry): Salaries
and wages paid are ₺4,000. Of this amount, ₺1,200
applied to accrued salaries and wages payable and
Reversing Entries Example
Illustration 4A-1: Comparative Entries
With Reversing Entries
(per appendix)

Initial Salary Entry

Oct. 26 Same entry

Adjusting Entry
Oct. 31 Same entry

Closing Entry
Oct. 31 Same entry

Reversing Entry
Nov. 1 Salaries and Wages Payable 1,200
Salaries and Wages Expense
1,200
Subsequent Salary Entry
Nov. 9 Salaries and Wages Expense 4,000
Cash 4,000
Reversing Entries Example
Illustration 4A-2: Posting With Reversing
Entries
The End of Chapter
2
Thank You!!!