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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