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Chapter 4
The Accounting Cycle
Adjusting Entries
Closing Process Net Profit Margin Ratio
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The Accounting Cycle
Accounting cycle process
Records individual transactions
Produces the four basic financial statements
Gets the general ledger ready for the next
accounting period
Made up of eight steps
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Accounting Cycle Steps
Record journal entries from transactions
Post journal entries to the general ledger
Prepare unadjusted trial balance
Adjust the accounts
Prepare an adjusted trial balance
Prepare the financial statements
Close the temporary accounts
Prepare a post-closing trial balance
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Unadjusted Trial Balance
A listing of individualaccounts, usually in financial
statement order.
Ending debit or creditbalances are listed in two
separate columns.
Total debit account balances
shouldequal total creditaccount balances.
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Matrix, Inc.
Unadjusted Trial Balance
At December 31, 2006
Description Debit Credit
Cash 3,900$
Accounts receivable 4,985
Inventory 3,300
Equipment 4,800Accumulated depreciation - Equip. 1,440$
Furniture and fixtures 6,600
Accumulated depreciation - furn. & fix. 2,200
Accounts payable 2,985
Notes payable 4,000
Common stock 10,000
Retained earnings, 12/31/05 1,760
Sales revenue 35,000
Cost of goods sold 27,500
Operating expenses 6,300
Totals 57,385$ 57,385$
Unadjusted Trial Balance Example
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Problem
Following unadjusted account balances for Delilahs Deluxe Doggie Dayspa:
Delilah's Deluxe Doggie Dayspa
Unadjusted Trial Balance
December 31, 2005
Cash 13,500
Accounts Receivable 14,000
Supplies 3,500
Prepaid Rent 24,000
Prepaid Insurance 12,000Notes Receivable (due 3/31/04) 30,000
Equipment 245,000
Accounts Payable 12,500
Unearned Service Revenue 20,000
Notes Payable (due 5/1/07) 100,000
Common Stock 50,000
Dividends 12,000
Service Revenue 367,500
Salary Expense 165,000
Rent Expense 20,000
Income Tax Expense 11,000
Required: Prepare a trial balance in good form.
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The Unadjusted Trial Balance
If total debits do not equal total credits on thetrial balance, errors have occurred . . .
in preparing balanced
journal entries,
in posting the correct dollareffects of a transaction,
or in copying ending balancesfrom the ledger to the
trial balance.
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Adjusting Entries
There are two types of adjustingentries.ACCRUALS
Revenues
earned orexpenses
incurred thathave not been
previouslyrecorded.
DEFERRALS
Receipts of
assets orpayments of
cash in advanceof revenue or
expenserecognition.
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End ofaccounting period.
Cash received. Revenues earned.
Example includes rent received inadvance (an unearned revenue).
Deferred Revenue
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End ofaccounting period.
Cash receivedRevenues earned
Example includes interest earnedduring the period (accrued revenue).
Accrued Revenue
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End ofaccounting period.
Cash paid.
Examples include prepaid rent, advertising,and insurance.
Deferred Expense
Expense incurred.
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End ofaccounting period.
Cash paid.
Examples include salaries and wagesincurred but not recorded.
Accrued Expense
Expense incurred.
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Certain circumstances require
adjusting entries to record
accounting estimates. Examples include . . .
Depreciation
Bad debts
Income taxes
$$$
Adjustments Involving
Estimates
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Depreciation Adjustment
The accountingconcept of
depreciation involvesthe systematicandrationalallocation of
the cost of a long-lived asset over
multiple accountingperiods it is used togenerate revenue.
This is a cost
allocation concept,
not a valuation
concept.
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Prepare the Adjusted Trial
Balance After weve completed and posted the
adjusting entries to the general ledger
accounts, we prepare another trial balance
We confirm again that the debit balances equal
the credit balances
Basis for preparing the financial statements
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Prepare adjusting entries from the following information:
a) An inventory of supplies reveals that $1,300 of supplies are on hand. (deferred expense/ asset)
b) Delilahs has a 6 day work week, Monday through Saturday. (accrued expense/ liability)
Employees are paid every Friday. 12/31 is on a Tuesday. Delilahs weekly payroll is $3,600.
c) The equipment was purchased 1/1/05. (deferred expense/ asset)It has an expected life of 10 years and no salvage value.
d) The note receivable was issued by a client on 10/31/05. (accrued revenue/ asset)The annual interest rate is 7%.
e) The note payable was issued 4/1/05. The annual interest rate is 5%. (accrued expense/ liability)
f) Unearned service revenue represents gift certificates purchased. (Deferred revenue/ liability)At year end, $8,000 of the certificates have been used.
g) Prepaid insurance represents a payment of $12,000 for 2 years coverage. (deferred expense/ asset)The payment was made 7/1/05.
h) Prepaid rent represents a payment of $24,000 for 12 months rent. (deferred expense/ asset)
The payment was made 9/1/05.
Problem
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Post these journal entries to the t-accounts and prepare an adjusted trial balance.
Problem
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Prepare the Financial Statements
Goal of the whole process
Financial statements that reflect the financialcondition and transactions of the company
Income Statement
Statement of Changes of Owners Equity
Balance Sheet
Statement of Cash Flows
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From the adjusted trial balance for Delilahs, prepare an income statement,
statement of stockholders equity, & classified balance sheet.
For computing the EPS, assume 10,000 shares are outstanding.
Problem
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Closing the Books
Even though the
balance sheet
account balances
carry forward
from period to
period, the
income statementaccounts do not.
Closing entries:
1. Transfer net income
(or loss) to Retained
Earnings.
2. Establish a zero
balance in each of the
temporaryaccounts tostart the next
accounting period.
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Closing the Books
The following accounts are calledtemporary or nominal accounts and
are closed at the end of the period .
. . Revenues. Expenses.
Gains.
Losses.
Dividends declared.
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Closing the Books
Assets, liabilities, and stockholdersequity are permanent, or real
accounts, and are neverclosed.
Assets.
Liabilities.
Stockholders
Equity.
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Closing the Books
Two steps are used in
the closing process .
. .1. Close revenues and
gains to Retained
Earnings.2. Close expenses and
losses to Retained
Earnings.
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Post-Closing Trial Balance
Prepared after the temporary accounts are
closed
Serves as a final check that debits = credits
Confirms that we start the next accounting
period with only permanent accounts
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Post-Closing Trial BalanceMatrix, Inc.
Adjusted Trial BalanceAt December 31, 2004
Description Debit Credit
Cash 3,900$
Accounts receivable 4,985
Inventory 3,300
Equipment 4,800Accumulated depreciation - Equip. 1,440$
Furniture and fixtures 6,600
Accumulated depreciation - furn. & fix. 2,200
Accounts payable 2,985
Notes payable 4,000
Common stock 10,000
Retained earnings, 1/1/04 1,760Sales revenue 35,000
Cost of goods sold 27,500
Operating expenses 6,300
Totals 57,385$ 57,385$
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Post-Closing Trial BalanceMatrix, Inc.
Post-Closing Trial BalanceAt December 31, 2004
Description Debit Credit
Cash 3,900$
Accounts receivable 4,985
Inventory 3,300
Equipment 4,800Accumulated depreciation - Equip. 1,440$
Furniture and fixtures 6,600
Accumulated depreciation - furn. & fix. 2,200
Accounts payable 2,985
Notes payable 4,000
Common stock 10,000
Retained earnings, 12/31/04 2,960Sales revenue -
Cost of goods sold -
Operating expenses -
Totals 23,585$ 23,585$
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Key Ratio Analysis
Net Profit Margin indicates how effectivemanagement is at generating profit on every
dollar of sales.
Net IncomeNet Sales
Net ProfitMargin
=
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Prepare closing entries and post-closing trial balance for Delilahs.
Prepare net profit margin for Delilahs.
Problem