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					Chapter 9

   Completing the
  Accounting Cycle

The Adjustment
  Process 9.1
       The Adjusting Process

We now know that financial statements are used
extensively to assist in making business

It is the accountants responsibility to ensure that
these financial statements are accurate, up-to-
date, and consistent from year to year.

       The Adjusting Process
When preparing the financial statements,
     the accountant must ensure:
                All late
                          calculations   All GAAPs
All accounts transactions
                           have been     have been
are brought    are taken
                             made        complied
 up to date;      into
                           correctly;       with.

       The Adjusting Process

Bringing the account data       The accounting entries
  up-to-date at statement      produced by this process
time is known as “making        are known as adjusting
    the adjustments”.                  entries.

                In most cases adjusting
              entries assign amounts of
              revenue or expense to the
                appropriate accounting
                period before the books
               are finalized for the fiscal
                                 period.             5
        The Adjusting Process

                               Some accounts do not need
    Adjusting entries are     to be perfectly accurate at the
necessary because the books     end of each business day
  of account are allowed to   BUT do need to be adjusted in
 become inaccurate between    order to determine the correct
      statements dates.       net income of net loss for the

     The Adjusting Process
The first three adjusting entries are:

              Adjusting      Adjusting
Adjusting     entries for    entries for
entries for    Prepaid      Late-Arriving
Supplies;     Expenses;      Purchase
                 and          Invoices.

 Adjusting Entries for Supplies

                                              During the
                      As supplies are     accounting period,
When supplies are                         the balance of the
                      used, which is
 purchased, their                          Supplies account
                     usually daily, no
  cost is debited                           represents the
                    accounting entries      balance at the
 correctly to the
                    are made to record     beginning of the
Supplies account.
                        this usage.      period plus any new
                                         supplies purchased.

Adjusting Entries for Supplies

                                            In order to satisfy the
                                         Matching Principle, both of
       The balance of Supplies            these accounts must be
          Expense is zero.             adjusted to reflect the usage
                                      (i.e. expense) during the fiscal

                                      You then determine the cost of
       To book the adjusting entry,
                                          the supplies used (i.e.
       you must first determine the
                                          difference between the
          supplies inventory (by
                                         inventory count and the
         counting the remaining
                                          balance of the supplies

Adjusting Entries for Supplies
 Assume the Supplies on hand at December 31,
  2007 are $1,386 (i.e. the supplies inventory).

  2007                     2007

                 6,514            6,514
         1,386                    6,514


Adjusting Entries for
 Prepaid Expense

  There are times in         This presents no
   business when          problem if the expense
  expense items are          item falls entirely
 paid for in advance.     within the fiscal period

  If the expense item     A prepaid expense is
 affects more than the      an item paid for in
 current fiscal period,     advance, but one
then it must be treated     where the benefits
as a prepaid expense.     extend into the future.

        Adjusting Entries for
         Prepaid Expense
                             A business can purchase
                                insurance to cover
  Insurance is the most
                                possible losses on
common prepaid expense.
                              automobiles, buildings,
                               contents, crops, etc.

                 When you purchase
             insurance, you usually pay
              for one year’s coverage in
                   advance. ( Note:
               occasionally, the period
               can be greater than one
                        year.)                    12
        Adjusting Entries for
         Prepaid Expense

 When prepaid expenses             Prepaid expenses
 are purchased, they are       accounts have value and
   usually debited to a        are therefore classified as
prepaid expense account.                 assets.

              If, for example you were to
                   cancel an insurance
               policy, all (or a portion) of
                  the prepaid insurance
                    expense would be
              refunded by the insurance
                     broker/company.                   13
         Adjusting Entries for
          Prepaid Expense
       Prepaid annual insurance premium on
                September 1, 2007.

2007                      2007

                600              600
        1,200                    600

                                       x 4/12

     Adjusting Entries for
Late-Arriving Purchase Invoices
  Goods and services
                          The invoices for these
  are often bought and
                           items may not arrive
   received toward the
                           until the subsequent
  end of an accounting
                               fiscal period.

             The Matching Principle
               states that expenses
             are to be recognized in
             the same period as the
              revenue that they
                       help to earn.

     Adjusting Entries for
Late-Arriving Purchase Invoices

                           During this waiting period,
The financial statements         the accounting
   are not “typically”     department must analyze
 prepared until two or      all purchase invoices in
 three weeks after the      order to find those that
     fiscal year end.        affect the fiscal period
                                 that just ended.

     Adjusting Entries for
Late-Arriving Purchase Invoices
  Prior to financial statement preparation, the
   accountant discovers there were two late-
                arriving invoices:
       telephone $212 and utilities $315.

Adjusting Entries
    and the
  Work Sheet
   Adjusting Entries and the
       Work Sheet 9.2

                         As the work sheet is
 The first place that    prepared, adjusting
adjusting entries are   entries are calculated
 recorded is on the       and recorded in a
    work sheet.            section headed

                                            An analysis of prepaid
                                1 954.90       A clerk discovered
                                            insurance determined
                                            The physical inventory
                                2 2494.00
                                             three “late” purchase
                                              that the balance at
                                            of supplies at Dec. 31
                                            invoices belonging to
                                                  totaled $526.
                                                 Dec. 31 should
                                            2007…telephone $45,
                                3 626.00
                                             What be $4,070. entry
                                              truck repair $496 &
                                                  is required?
                                             What adjusting entry
                                                  printer repair $85.
                                                  is required?

                    3   85.00

                    3  45.00
                    3 496.00

Supplies Expense    1 954.90
Insurance Expense   2 2494.00
 Balancing the Work Sheet thedetermine the diff. adjustments
                  Balancing … Work subtract
Extending the Work Sheet … add or Sheet … thebetween the
               total each Adjustments Columns.
          Balance theand recordfour balance sheet columns
  from the statement columns the in the last four
two income trial balance of the last two columns columns.

                              1                   526.00
                              2                 4,070.00

                              3                            3,136.00




Net Income
 Journalize Adjusting Entries
                         Once the work sheet is
So far, the adjusting
                          complete / balanced,
  entries have been
                          the adjusting entries
recorded only on the
                           must be recorded in
     work sheet
                         the books of accounts.

            Journalize and post all
             entries that appear in
               the adjustments
              section of the work
Journalize Adjusting Entries

Closing Entries 9.3
    Closing Entries Concepts

                                After you do your
The Time Period Concept       adjusting entries and
   states that financial       prepare your formal
reporting, or net income     income statements, the
 in particular, is done in   accounts must be made
  equal period of time.         ready for the next
                                accounting cycle.

    Closing Entries Concepts
   Determine which
                          There are two types of
    accounts have
                            accounts … real
balances that continue
                          accounts and nominal
from one period to the
next and which do not.

             All asset and liability
             accounts, as well as
              the owner’s capital
                  account, are
             considered to be real
                   accounts.                 26
    Closing Entries Concepts
                            Nominal accounts
 Real accounts have      (revenue, expense and
balances that continue     drawings accounts)
  into the next fiscal    have balances that do
        period.           not continue into the
                            next fiscal period.

              Nominal accounts,
             with the exception of
             drawings, are related
                 to the income
     Closing Entries Concepts

                                 Once the income statement
                                    for a period has been
 A special nominal account,      completed, the balances in
called the Income Summary       the nominal accounts are no
account, is used only during       longer useful … their
 the closing entry process.    balance must be taken to zero
                                 in preparation for the next
                                      accounting cycle.

  Closing Entries Concepts
                          Any changes in equity
Closing an account         during the period are
means to cause it to         contained in the
 have no balance.         Revenue, Expense, and
                           Drawings accounts.

             Closing these nominal
              accounts moves the
           values collected in these
             accounts into the one
            real equity account, the
                Capital account.              29
       Complete Accounting Cycle
             Performed      Transactions occur.         Accounting entries
               daily        Source documents.         recorded in the journal.
             Performed     Ledger balanced by         Journal entries posted
              monthly     means of a trial balance.   to the ledger accounts.

                                                       Formal income stmt. &
                           Work sheet prepared.
                                                      balance sheet prepared.

             at end of        Closing entries            Adjusting entries
            each fiscal    journalized & posted.       journalized & posted.

                               trial balance.
 Journalizing and
   Posting the
Closing Entries 9.4
   Closing Entry 1: transfer balances in in the expense
     Closing Entrytransfer the the balances in Drawings
                   4:                            revenue
 Closing Entry 3: 2: transfer the balances Income Summary
         accounts to the owner’s Capital account. Summary.
           account nominal account called Income
account(s) Accountto the Income Summary account.
           to a new






Net Income
Summary of Closing Entries
Trial Balance
                  Balancing the Work subtract
Extending the Work Sheet … add or Sheet … the adjustments
        Post-Closing Trial Balance
               total each Adjustments Columns.
          Balance theand recordfour columns columns.
  from the trial balance of the last in the last four

                             1                  526.00
                             2                4,070.00

                             3                           3,136.00



          Capital Account
Calculating your Post-Closing Balance
       P. Marshall, Capital
 4   $42,000.00 $28,895.42
                  66,836.09       3
       $42,000.00    $95,731.51


        Post-Closing Trial Balance
 P. Marshall, Capital
$42,000.00 $28,895.42
$42,000.00 $95,731.51


        Class / Homework
p. 334, Exercises 1
p. 335, Exercises 2 – A, B & D
p. 335-6, Exercises 3

 Adjusting for
Depreciation 9.5
   Adjusting for Depreciation
                          Fixed assets are also
Assets that are used
                          known as “long-lived
 to produce revenue
                            assets”, “capital
  over several fiscal
                            equipment”, and
periods are known as
                               “plant and
     fixed assets.

              Except for land, all
            fixed assets will
                    be used up in
            the course of
                      time and
                   activity.                 40
   Adjusting for Depreciation

                               Depreciation refers to an
Fixed assets decrease or       allowance made for the
   depreciate in value.         decrease in value of an
                                   asset over time.

                  It is not possible to
                 calculate depreciation
              until the end of the asset’s
              life … only then, can you
              say how many years it was
                used and determine its
                        final worth.                 41
    Adjusting for Depreciation
 The matching principle
                               To do this, accountants
dictates that depreciation
                                   must estimate
must be included on every
                                depreciation while the
     year-end income
                                 asset is still in use.

                 The two most common
                 methods of calculating
                 depreciation are the:
                 Line method and
                    balance method.                  42
    Straight-Line Depreciation

The simplest way to estimate depreciation.

The Straight-Line method of depreciation divides
up the net cost of the asset equally over the years
of the asset’s life.

                         Original Cost      Estimated
                            of Asset - Salvage Value
     Depreciation    =   Estimated Number of Periods
     for one year
                            in the Life of the Asset

    Straight-Line Depreciation
You purchased a truck for $78,000 on January 1,
2007. It is estimated that the truck will be used
for six years, and at the end of that time, could be
sold for $7,800. What is the annual depreciation?

                         Original Cost      Estimated
                            of Asset - Salvage Value
     Depreciation    =   Estimated Number of Periods
     for one year
                            in the Life of the Asset
                            $78,000   -    $7,800
                     =                6
                     =   $11,700                        44
    Straight-Line Depreciation
You purchased furniture for $5,120 on January 1,
2007. It is estimated that the furniture will be used
for 10 years, and at the end of that time, could be
sold for $500. What is the annual depreciation?

                         Original Cost      Estimated
                            of Asset - Salvage Value
     Depreciation    =   Estimated Number of Periods
     for one year
                            in the Life of the Asset
                            $5,120   -      $500
                     =               10
                     =   $462                           45
Adjusting Depreciation
            When adjusting for
 depreciation you would expect
   to DR Depreciation Expense

In order to show the value of
the Asset at cost, you would
not CR Asset for the
depreciation … rather you
CR Accumulated Depreciation.     46
    Accumulated Depreciation
                                  A contra account is one that is
                                     displayed alongside an
Accumulated depreciation is a
                                  associated account and has a
 valuation or contra account.
                                  balance that is opposite to the
                                  account it is associated with.

                  Accumulated depreciation is
                   also known as a valuation
                account … an account that is
                  used, together with an asset
                account, to             show the
                 true net value (or net
                           book value) of the
                             asset.                          47
Adjusting Entry for Depreciation

In the truck example, the adjusting entry would be:
 • DR Depreciation Expense            11,700
 • CR Accumulated Amortization         11,700

In the furniture example, the adjusting entry would be:

 • DR Depreciation Expense             462
   • CR Accumulated Amortization         462

          Financial Statement

   Income Statement                   Balance Sheet

                   Each       Accumulated     Each asset, with
                                              its related
               depreciation   depreciation    accumulated
Depreciation   expense item    is deducted    depreciation, is
 expense is      is shown         from its    shown separately.
shown on the    separately      respective    For example Truck
   income           (e.g.       fixed asset   $78,000
 statement.    Depreciation    account on              Less:
                Expense –      the balance    Depreciation
                  Truck).          sheet.     11,700 $66,300

     Depreciation for Part Year
Sometimes an asset is used for only part of a year.

For example, you purchase a building on May 1, 2007 for
$120,000. The building is expected to be used for 30
years, after which it will be worth $30,000. Your company
issued financial statements quarterly (i.e. every 3
 • Annual depreciation = (120,000 – 30,000) / 30
                        = $3,000
 • Monthly depreciation = 3,000 / 12 = $250 per month
   •    The depreciation expense would be
                       1st quarter $ 0 and
                       2nd quarter $500.                50
Declining-Balance Depreciation
                                 The declining-balance
  The declining-balance            method is common
method is an alternative to   because the government of
the straight-line method of   Canada requires a variation
 calculating depreciation.     of this method for income
                                      tax purposes.

               This method calculates the
                 annual depreciation by
                multiplying the remaining
                        undepreciated cost
                 (i.e. net book value)
                             by a fixed
Declining-Balance Depreciation
Some of the percentage rates set by the
 government are as follows:
  Canada Customs and Revenue Agency
 Rates of Capital Cost Allowance (Depreciation)
Class              Description             Rate
  3    Buildings of brick, stone, or cement       5%
  6    Buildings of frame, lot, or stucco        10%
  8    Office furniture and equipment            20%
  10   Automobiles, trucks, tractors, computer   30%
  12   Computer software (except system          100%
Declining-Balance Depreciation
Example: you purchase computers on January 1, 2006 for $22,000. The
rate, per the previous slide, is 30%.

Depreciation expense would be calculated as follows:

2006: Original Cost                           $22,000    Less:
Depreciation ($22,000 x 30%)    6,600       Undepreciated cost
(net book value) $15,400

2007:    Undepreciated Cost                  $15,400
          Less: Depreciation ($15,400 x 30%)   4,620
          Undepreciated cost (net book value) $10,780

          Comparison of the Two
          Methods of Depreciation
  For straight-line, assume the computers have an
   8 year life with an ending value of $2,000.

        The straight-line
        method produces
       depreciation figures    $22,000 - $2,000
that are the same each year.          8
  The net book value (NBV)
     or undepreciated cost     = $2,500 / year
    gradually reduces until
   it reaches the estimated
         Salvage value.                           54
Comparison of the Two
Methods of Depreciation

            The declining-
          balance method
       produces depreciation
    figures that are the larger in
    the early years and smaller
       in the later years. The
       estimated final value is
          ignored using this
               method.               55
Tax Regulations

         Tax Regulations
How would the “50% Rule” look?


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