Chapter 4 Completing the Accounting Cycle © 2009 The McGraw-Hill Companies, Inc.

Chapter 4

Completing the Accounting Completing the Accounting CycleCycle

© 2009 The McGraw-Hill Companies, Inc.

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The solution for this timing difference is to record adjusting entries at the end of the period to get the amounts reported

as revenues and expenses up to date.

Accounting systems are designed to record most

recurring daily transactions, particularly any involving

cash.

The problem is that cash is not always received or paid

in the period when the revenue is earned or when

the expense is incurred.

Reasons for Adjustments

Slide 3

Types of Adjustments

Unearned Revenues

Previously recorded liabilities that were created when cash was received in advance, and that must be adjusted for the amount of revenue

actually earned during the period.

Accrued Revenues

Revenues that were earned but not recorded because cash was received after the services

were performed or goods were delivered.

Prepaid Expenses

Previously recorded assets that must be adjusted for the amount of expense actually

incurred during the period through the use of the asset.

Accrued Expenses

Expenses that were incurred but were not recorded because cash was paid after the goods

or services were used.

Slide 4

Analysis of Adjustments

Debit CreditCash 9,100$ Investments 6,000 Accounts Receivable 700 Supplies 5,000 Prepaid Rent 4,800 Prepaid Insurance 2,400 Equipment 36,000 Accounts Payable 4,800$ Unearned Revenue 600 Notes Payable 20,000 M. Rosa, Capital 30,000 M. Rosa, Drawing 3,000 Pizza Revenue 14,000 Wages Expense 1,000 Telephone Service Expense 600 Advertising Expense 800 Total 69,400$ 69,400$

Pizza AromaUnadjusted Trial Balance

On May 31, 2009 Analyzing Adjustments1.Identify the type of adjustment.2.Determine the amount.3.Record the adjusting entry.

Slide 5

Unearned Revenues

Delivers pizza; earns $400.

May

Month End5/31/09

When cash was received:Cash (+A) 600

Unearned Revenue (+L) 600

Adjusting entry 5/31/09:Unearned Revenue (-L) 400

Pizza Revenue (+R, +OE) 400

600 Unadj. Bal.(AJE 1) 400

200 Bal.

Unearned Revenue14,000 Unadj. Bal.

400 (AJE 1)14,400 Bal.

Pizza Revenue

Slide 6

Accrued Revenues

Time passes; earns $30.

May

Month End5/31/09

When cash was received:Cash (+A) 180

Interest Receivable (-A) 180

Adjusting entry 5/31/09:Interest Receivable (+A) 30

Investment Revenue (+R, +OE) 30

Beg. Bal. - (AJE 2) 30

Bal. 30

Interest ReceivableBeg. Bal.

30 (AJE 2)30 Bal.

Investment Revenue

June – Oct.

Slide 7

Prepaid Expenses

Use the store; incur $800 expense

May

Month End5/31/09

When cash was paid:Prepaid Rent (+A) 4,800

Cash (-A) 4,800

Adjusting entry 5/31/09:Rent Expense (+E, -OE) 800

Prepaid Rent (-A) 800

Unadj. Bal. 4,800 800 (AJE 4)

Bal. 4,000

Prepaid RentBeg. Bal. -

(AJE 4) 800 Bal. 800

Rent Expense

Slide 8

Prepaid Expenses

Use the equipment; incur $300 expense

May

Month End5/31/09

When equipment was purchased:Equipment (+A) 36,000

Cash (-A) 33,000 Accounts Payable (+L) 3,000

Adjusting entry 5/31/09:Depreciation Expense (+E, -OE) 300

Accumulated Depreciation (+XA, -A) 300

- Beg. Bal.300 (AJE 5)300 Bal.

Accumulated DepreciationBeg. Bal. -

(AJE 5) 300 Bal. 300

Depreciation Expense

Slide 9

Prepaid Expenses

Use the equipment; incur $300 expense

May

Month End5/31/09

When equipment was purchased:Equipment (+A) 36,000

Cash (-A) 33,000 Accounts Payable (+L) 3,000

Adjusting entry 5/31/09:Depreciation Expense (+E, -OE) 300

Accumulated Depreciation (+XA, -A) 300

- Beg. Bal.300 (AJE 5)300 Bal.

Accumulated DepreciationBeg. Bal. -

(AJE 5) 300 Bal. 300

Depreciation ExpenseMay June July

Equipment 36,000$ 36,000$ 36,000$ Accumulated Depreciation 300 600 900 Net Book Value 35,700$ 35,400$ 35,100$

Slide 10

Accrued Expenses

Use employee labor; incur $100 expense.

May

Month End5/31/09

When cash is paid:Wages Payable (-L) 100

Cash (-A) 100

Adjusting entry 5/31/09:Wages Expense (+E, -OE) 100

Wages Payable (+L) 100

June

- Beg. Bal.100 (AJE 6)100 Bal.

Wages PayableBeg. Bal. 1,000

(AJE 6) 100 Bal. 1,100

Wages Expense

Slide 11

Here is a summary of

all eight adjusting entries for

Pizza Aroma.

Debit Credit(AJE 1) Unearned Revenue (-L) 400

Pizza Revenue (+R, +OE) 400

(AJE 2) Interest Receivable (+A) 30 Investment Revenue (+R, +OE) 30

(AJE 3) Supplies Expense (+E, -OE) 4,400 Supplies (-A) 4,400

(AJE 4) Rent Expense (+E, -OE) 800 Prepaid Rent (-A) 800

(AJE 5) Depreciation Expense (+E, -OE) 300 Accumulated Depreciation (+XA, -A) 300

(AJE 6) Wages Expense (+E, -OE) 100 Wages Payable (+L) 100

(AJE 7) Utilities Expense (+E, -OE) 1,000 Utilities Payable (+L) 1,000

(AJE 8) Interest Expense (+E, -OE) 200 Interest Payable (+L) 200

Adjusting Journal Entries

Summary of Pizza Aroma’s Adjusting Entries

Slide 12

Debit CreditCash 9,100$ Investments 6,000 Interest Receivable 30 Accounts Receivable 700 Supplies 600 Prepaid Rent 4,000 Prepaid Insurance 2,400 Equipment 36,000 Accumulated Depreciation 300$ Accounts Payable 4,800 Unearned Revenues 200 Wages Payable 100 Utilities Payable 1,000 Interest Payable 200 Notes Payable 20,000 M. Rosa, Capital 30,000 M. Rosa, Drawing 3,000 Pizza Revenue 14,400 Investment Revenue 30 Supplies Expense 4,400 Wages Expense 1,100 Utilities Expense 1,000 Telephone Service Expense 600 Rent Expense 800 Insurance Expense - Advertising Expense 800 Interest Expense 200 Depreciation Expense 300 Total 71,030$ 71,030$

Pizza AromaAdjusted Trial Balance

On May 31, 2009The adjusted trial

balance is a list of all accounts and their

adjusted balances to check on the equality of

recorded debits and credits.

Here is the adjusted trial balance for Pizza Aroma. The amounts were taken from the

balances in the ledger accounts after all

adjusting entries were recorded.

Slide 13

Revenue minus expenses yields net income on the Income Statement.

Net income, withdrawals by the owner, and any additional contributions made by the owner during the period affect the balance in the owner’s capital account on the Statement of Owner’s Equity.

The owner’s capital account is a component of the Balance Sheet.

Relationships among Financial Statements

Thus, if a number on the income statement changes or is in error, it will impact the other statements.

Slide 14

Relationships among Financial Statements

Temporary accounts accumulate balances for a period, but start with a zero balance at the beginning of

the next period.

Temporary accounts accumulate balances for a period, but start with a zero balance at the beginning of

the next period.

Revenues

Exp

ense

s Draw

ing

TemporaryAccounts

Permanent Accounts

Assets

Lia

bili

ties E

qu

ity

Permanent accounts retain their balances from the end of one

period to the beginning of the

next.

Permanent accounts retain their balances from the end of one

period to the beginning of the

next.

Slide 15

Debit CreditCash 9,100$ Investments 6,000 Interest Receivable 30 Accounts Receivable 700 Supplies 600 Prepaid Rent 4,000 Prepaid Insurance 2,400 Equipment 36,000 Accumulated Depreciation 300$ Accounts Payable 4,800 Unearned Revenues 200 Wages Payable 100 Utilities Payable 1,000 Interest Payable 200 Notes Payable 20,000 M. Rosa, Capital 30,000 M. Rosa, Drawing 3,000 Pizza Revenue 14,400 Investment Revenue 30 Supplies Expense 4,400 Wages Expense 1,100 Utilities Expense 1,000 Telephone Service Expense 600 Rent Expense 800 Insurance Expense - Advertising Expense 800 Interest Expense 200 Depreciation Expense 300 Total 71,030$ 71,030$

Pizza AromaAdjusted Trial Balance

On May 31, 2009

Now let’s prepare the financial statements for

Pizza Aroma.

Let’s prepare the financial statements

in this order:

1. Income Statement

2. Statement of Owner’s Equity

3. Balance Sheet

Slide 16

Debit CreditCash 9,100$ Investments 6,000 Interest Receivable 30 Accounts Receivable 700 Supplies 600 Prepaid Rent 4,000 Prepaid Insurance 2,400 Equipment 36,000 Accumulated Depreciation 300$ Accounts Payable 4,800 Unearned Revenues 200 Wages Payable 100 Utilities Payable 1,000 Interest Payable 200 Notes Payable 20,000 M. Rosa, Capital 30,000 M. Rosa, Drawing 3,000 Pizza Revenue 14,400 Investment Revenue 30 Supplies Expense 4,400 Wages Expense 1,100 Utilities Expense 1,000 Telephnoe Service Expense 600 Rent Expense 800 Insurance Expense - Advertising Expense 800 Interest Expense 200 Depreciation Expense 300 Total 71,030$ 71,030$

Pizza AromaAdjusted Trial Balance

On May 31, 2009

Operating RevenuesPizza Revenue 14,400$ Total Operating Revenue 14,400

Operating ExpensesSupplies Expense 4,400 Wages Expense 1,100 Utilities Expense 1,000 Rent Expense 800 Advertising Expense 800 Telephone Service Expense 600 Depreciation Expense 300 Total Operating Expenses 9,000 Operating Income 5,400 Other ItemsInvestment Revenue 30 Interest Expense (200) Net Income 5,230$

Pizza AromaIncome Statement

For the Month Ended May 31, 2009

Slide 17

Debit CreditCash 9,100$ Investments 6,000 Interest Receivable 30 Accounts Receivable 700 Supplies 600 Prepaid Rent 4,000 Prepaid Insurance 2,400 Equipment 36,000 Accumulated Depreciation 300$ Accounts Payable 4,800 Unearned Revenues 200 Wages Payable 100 Utilities Payable 1,000 Interest Payable 200 Notes Payable 20,000 M. Rosa, Capital 30,000 M. Rosa, Drawing 3,000 Pizza Revenue 14,400 Investment Revenue 30 Supplies Expense 4,400 Wages Expense 1,100 Utilities Expense 1,000 Telephone Service Expense 600 Rent Expense 800 Insurance Expense - Advertising Expense 800 Interest Expense 200 Depreciation Expense 300 Total 71,030$ 71,030$

Pizza AromaAdjusted Trial Balance

On May 31, 2009

M. Rosa, Capital, May 1, 2009 -$ Additional Contributions 30,000 Net Income 5,230 M. Rosa, Drawing (3,000) M. Rosa, Capital, May 31, 2009 32,230$

Pizza AromaStatement of Owner's Equity

For the Month Ended May 31, 2009

From the Income Statement

Slide 18

Debit CreditCash 9,100$ Investments 6,000 Interest Receivable 30 Accounts Receivable 700 Supplies 600 Prepaid Rent 4,000 Prepaid Insurance 2,400 Equipment 36,000 Accumulated Depreciation 300$ Accounts Payable 4,800 Unearned Revenues 200 Wages Payable 100 Utilities Payable 1,000 Interest Payable 200 Notes Payable 20,000 M. Rosa, Capital 30,000 M. Rosa, Drawing 3,000 Pizza Revenue 14,400 Investment Revenue 30 Supplies Expense 4,400 Wages Expense 1,100 Utilities Expense 1,000 Telephone Service Expense 600 Rent Expense 800 Insurance Expense - Advertising Expense 800 Interest Expense 200 Depreciation Expense 300 Total 71,030$ 71,030$

Pizza AromaAdjusted Trial Balance

On May 31, 2009

Current Assets

Cash 9,100$

Investments 6,000

Accounts Receivable 700

Interest Receivable 30

Supplies 600

Prepaid Rent 4,000

Prepaid Insurance 2,400

Total Current Assets 22,830

Equipment 36,000$

Accumulated Depreciation (300)

Equipment, net 35,700

Total Assets 58,530$

Current Liabilities

Accounts Payable 4,800$

Wages Payable 100

Utilities Payable 1,000

Interest Payable 200

Unearned Revenue 200

Total Current Liabilities 6,300

Notes Payable 20,000

Total Liabilities 26,300

M. Rosa, Capital 32,230

Total Liabilities and Owner's Equity 58,530$

Owner's Equity

Pizza Aroma

Balance Sheet

May 31, 2009

Assets

Liabilities

Slide 19

Completing the Accounting Cycle

1. Debit Revenue accounts and credit Income Summary.

2. Debit Income Summary and credit Expense accounts.

3. Close the balance in Income Summary to “Owner’s Name,” Capital.

4. Debit “Owner’s Name,” Capital and credit “Owner’s Name,” Drawing.

1. Debit Revenue accounts and credit Income Summary.

2. Debit Income Summary and credit Expense accounts.

3. Close the balance in Income Summary to “Owner’s Name,” Capital.

4. Debit “Owner’s Name,” Capital and credit “Owner’s Name,” Drawing.

Slide 20

Completing the Accounting Cycle

Debit Credit(CE 1) Pizza Revenue (-R, -OE) 14,400

Interest Revenue (-R, -OE) 30 Income Summary (+OE) 14,430

(CE 2) Income Summary (-OE) 9,200 Wages Expense (-E, +OE) 1,100 Supplies Expense (-E, +OE) 4,400 Utilities Expense (-E, +OE) 1,000 Telephone Service Expense (-E, +OE) 600 Rent Expense (-E, +OE) 800 Advertising Expense (-E, +OE) 800 Depreciation Expense (-E, +OE) 300 Interest Expense (-E, +OE) 200

(CE 3) Income Summary (-OE) 5,230 M. Rosa, Capital (+OE) 5,230

(CE 4) M. Rosa, Capital ( -OE) 3,000 M. Rosa, Drawing (+OE) 3,000

Closing Journal Entries

Slide 21

Post-Closing Trial Balance

Debit Credit

Cash 9,100$

Investments 6,000

Interest Receivable 30

Accounts Receivable 700

Supplies 600

Prepaid Rent 4,000

Prepaid Insurance 2,400

Equipment 36,000

Accumulated Depreciation 300$

Accounts Payable 4,800

Unearned Revenues 200

Wages Payable 100

Utilities Payable 1,000

Interest Payable 200

Notes Payable 20,000

M. Rosa, Capital 32,230

Total 58,830$ 58,830$

Pizza Aroma

Post-Closing Trial Balance

On May 31, 2009Final check that all debits still equal credits and that

all temporary accounts have been closed.

Contains only permanent accounts.

Is the last step in the accounting process.

Slide 22

Net Profit Margin (NPM)

Net ProfitMargin =

$5,230$14,400

= 36.3%

Net Profit

MarginNet Income

Total Sales Revenues= × 100

× 100

Net profit margin provides information on managers’ relative success at generating revenues and

controlling costs. Because managers’ sales growth strategies and cost control measures impact this

ratio, a rising net profit margin signals more effective management of sales and/or control of expenses.

Slide 23

Making Comparisons to Benchmarks

Comparing a company’s ratio (1) over time and (2) to its competition provides additional useful information

on the effectiveness of management.

Papa John's 6.3%Domino's 7.4%Yum! Brands 8.6%All companies in industry 13.3%

Auto/Truck Manufacturers 8.2%Footwear 14.3%Pharmaceuticals (Diversified) 17.5%

Average Net Profit Margin Ratios by IndustryRestaurant Industry

Other Industries

Papa John’s Net Profit Margin

2004 2005 2006

McGraw-Hill/Irwin Slide 24

Supplement 4-A: Using an Accounting Worksheet

An accounting worksheet may be

prepared to facilitate end-of-period

accounting activities.

The final worksheet provides all the data needed to complete the remaining end-of-period steps, bringing together in one place (1) the unadjusted trial balance, (2) the amounts for adjusting entries, (3) the income statement, (4) the statement of owner’s equity, and

(5) the balance sheet.

End of Chapter 4

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