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The Cycle

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  1. The Cycle 5 Unit 5 • Learning Objectives • Describe the accounting cycle and fiscal period and the steps necessary to complete the accounting cycle. • Explain the accrual basis of accounting and use it to identify and journalize necessary adjusting entries to complete the accounting cycle. • Complete the end of fiscal period worksheet and close temporary accounts. • Analysis: Calculate and explain Gross Profit and Gross Profit percentage

  2. Objective 5.1: Accounting Cycle and Fiscal Period Accounting information is divided into distinct time periods (fiscal periods) according to the information needs of the firm The Accounting Cycle refers to the process that is used repeatedly to divide accounting Information into time periods O5.1

  3. Accounting Cycle END OF FISCAL PERIOD BEGINNING OF FISCAL PERIOD INCOME STATEMENT INCOME STATEMENT 10 0 Revenue Revenue At the end of the cycle, the $3 in net income is moved (closed) to the equity section of the balance sheet. Expenses Expenses 7 0 Income statement accounts start at zero then add activity through the fiscal period. Profit Profit or or Loss Loss INCOME STATEMENT INCOME STATEMENT 2 Revenue 7 Revenue Expenses 1 Expenses 5 Profit or Loss Profit or Loss INCOME STATEMENT Revenue 4 Expenses 2 Profit or Loss O5.1

  4. Steps to complete the cycle 1. Transactions are journalized and posted. TRANSACTIONS JOURNAL ACCOUNTLEDGERS O5.1

  5. Steps to complete the cycle 2. End of fiscal period adjustments are journalized and posted ADJUSTMENTS JOURNAL ACCOUNTLEDGERS O5.1

  6. Steps to complete the cycle 3. Financial Statements are prepared ACCOUNT LEDGERS O5.1

  7. Steps to complete the cycle 5. Temporary accounts are closed Move Profit or Loss to Equity and set Revenue and Expense accounts to zero 10 0 7 0 5. The process is repeated for the next cycle. O5.1 0

  8. Objective 5.2: Accrual basis & Adjusting entries Accrual is the process of recording financial activity based on whether a transaction has occurred as opposed to recording financial activity on whether cash has been exchanged (cash basis accounting). O5.2

  9. We must stop at the end of the fiscal period and ask if any adjusting entries (AJE) need to be made to remain consistent with the accrual basis of accounting. The idea of accrual during the adjusting process focuses on Income and Expense accounts for the fiscal period just ended. All adjusting entries (AJE) affect at least one income statement account and one balance sheet account.

  10. Why do we need to make adjusting entries? • Revenue Recognition Concept • Matching Concept Revenue is recorded when it is earned and receivable, whether cash is paid or not. Expenses must be matched (recorded) in the same period in which they where incurred to generate the revenues recorded in that period (whether they have been paid for with cash or not.

  11. Adjusting Entries Deferrals (Items previously recorded) Cash paid or received before the revenue or expense is recognized Accruals (Items not previously recorded) Cash paid or received after the revenue or expense is recognized Prepaid Expenses Prepaid Insurance Prepaid Supplies Accrued Expenses Interest Expense Consulting Expense Wages Expense Unearned Revenue Customer Deposits Tickets Paid in Advance Accrued Revenues Fee Income Consulting Income Interest Income Depreciation Equipment Buildings

  12. In this course of study, all adjusting entries (AJE) affect at least one income statement account and one balance sheet account. No cash is involved.

  13. December 31 Nisanov Distributors is completing their fiscal year end. At the beginning of the year, the firm had $2,350 of office supplies on hand. The physical count at the end of the year is $550. Which accounts are involved? O5.2

  14. Nisanov Distributors Balance Sheet Income Statement Assets Liabilities + Equity Cash Accounts Receivable Office Supplies Inventory Prepaid Insurance Office Equipment Accounts Payable Wages Payable Taxes Payable Unearned Revenue Notes Payable Frieda, Capital Frieda, Drawing Sales Consulting Revenue Cost of Goods Sold Wages Expense Rent Expense Utilities Expense Insurance Expense Interest expense Supplies expense Profit Supplies should go down, Supplies expense should go up OR Loss O5.2

  15. December 31 The balance in the Office Supplies (asset) account after the adjusting entry should be the same as the physical count. Therefore, the adjusting entry should be $2,350 - $550 = $1,800. O5.2

  16. Adjusting Entries O5.2

  17. December 31 We finished $8,500 worth of consulting! At the beginning of the year, Nisanov Distributors had $16,000 Unearned Consulting Revenue recorded. At year end, $8,500 of that amount had been earned. Which accounts are involved? O5.2

  18. Nisanov Distributors Balance Sheet Income Statement Assets Liabilities + Equity Cash Accounts Receivable Office Supplies Inventory Prepaid Insurance Office Equipment Accounts Payable Wages Payable Taxes Payable Unearned Revenue Notes Payable Frieda, Capital Frieda, Drawing Sales Consulting Revenue Cost of Goods Sold Wages Expense Rent Expense Utilities Expense Insurance Expense Interest expense Supplies expense Profit Unearned Revenue should go down, Consulting Revenue should go up OR Loss O5.2

  19. December 31 We finished $8,500 worth of consulting! The balance in the Unearned Revenue (liability) account before the adjusting entry is $16,000; if $8,500 of this amount has been earned, the adjusting entry should be $8,500. O5.2

  20. Adjusting Entries O5.2

  21. December 31 Nisanov Distributors purchased a $50,000 twoyear certificate of deposit at the beginning of the year earning 4% annually. An adjusting entry is required for interest earned. Which accounts are involved? O5.2

  22. Nisanov Distributors Balance Sheet Income Statement Assets Liabilities + Equity Cash Accounts Receivable Interest Receivable Office Supplies Inventory Prepaid Insurance Office Equipment Accounts Payable Wages Payable Taxes Payable Unearned Revenue Notes Payable Frieda, Capital Frieda, Drawing Sales Consulting Revenue Interest Income Cost of Goods Sold Wages Expense Rent Expense Utilities Expense Insurance Expense Interest expense Supplies expense Profit Both accounts should increase OR Loss O5.2

  23. December 31 Interest earned is $50,000 x 4% = $2,000 Therefore, the adjusting entry is $2,000 which will increase revenue for the fiscal period just ending even though the interest will not be received until maturity of the CD at the end of the 2nd year. O5.2

  24. Adjusting Entries O5.2

  25. December 31 Nisanov Distributors has seven employees with daily payroll costs of $135 each. Employees work Monday through Friday and are paid in full on Friday of each week. Year end (Dec 31) falls on Wednesday this year. An adjusting entry is required for accrued but unpaid payroll. Which accounts are involved? O5.2

  26. Nisanov Distributors Balance Sheet Income Statement Assets Liabilities + Equity Cash Accounts Receivable Interest Receivable Office Supplies Inventory Prepaid Insurance Office Equipment Accounts Payable Wages Payable Taxes Payable Unearned Revenue Notes Payable Frieda, Capital Frieda, Drawing Sales Consulting Revenue Interest Income Cost of Goods Sold Wages Expense Rent Expense Utilities Expense Insurance Expense Interest expense Supplies expense Profit Both accounts should increase OR Loss O5.2

  27. December 31 Unpaid payroll daily is 7 x $135 = $945. There are 3 days accrued but unpaid, Monday, Tuesday and Wednesday. Total adjusting entry is 3 x $945 = $2,835 O5.2

  28. Adjusting Entries O5.2

  29. December 31 Nisanov Distributors purchased office equipment at the beginning of the current year at a cost of $25,000; salvage value 0; useful life 5 years. Complete the adjusting entry to record the first year’s depreciation. Which accounts are involved? O5.2

  30. Nisanov Distributors Balance Sheet Income Statement Assets Liabilities + Equity Cash Accounts Receivable Interest Receivable Office Supplies Inventory Prepaid Insurance Office Equipment Accumulated Depreciation -Office Equipment Accounts Payable Wages Payable Taxes Payable Unearned Revenue Notes Payable Frieda, Capital Frieda, Drawing Sales Consulting Revenue Interest Income Cost of Goods Sold Wages Expense Rent Expense Utilities Expense Insurance Expense Depreciation Expense Supplies expense Profit Both accounts should increase OR Loss O5.2

  31. The net effect or “weight” on the balance sheet is often called the Book Value. Example Equipment 850 Accumulated Depreciation (150) Book Value –Equipment 700 Contra Account O2.3

  32. December 31 Cost – Salvage value = Depreciable amount divided by useful life = annual depreciation. $25,000 - $0 = $25,000 $25,000/ 5 = $5,000 O5.2

  33. Adjusting Entries O5.2

  34. Objective 5.3: Worksheet At the end of the fiscal period a worksheet is often used to schedule adjusting entries, prepare financial statements and schedule closing entries. The process starts with a Trial Balance O5.3

  35. Trial Balance • The Trial Balance is simply a report that lists all of the account balances in the accounting system • debit balance on the left and • credit balances on the right. Total debits must = Total credits O5.3

  36. Trial Balance Except for CONTRA accounts, the Trial Balance follows this picture. Contra accounts must be listed according to their balance, debits left – credits right Owner, Drawing O5.3

  37. Worksheet & the Trial Balance The worksheet begins with a Trial Balance O5.3

  38. Completing the Worksheet Adjusting entries are entered into the next column O5.3

  39. Completing the Worksheet An Adjusted Trial Balance is prepared in the next column by updating the Trial Balance with the effects of the adjusting entries O5.3

  40. Completing the Worksheet The adjusted account Balances are then separated into Income Statement and Balance Sheet columns O5.3

  41. Completing the Worksheet Financial statements are prepared directly from the Worksheet O5.3

  42. Worksheet The completed Worksheet can be used to prepare the end of fiscal period financial statements EXAMPLE O5.3

  43. Excess of debits O5.3 Excess of credits

  44. Notice the net income is transferred to the Equity section to properly reflect the new Equity balance. O5.3

  45. Recall that the Income Statement is a temporary collection of eventual changes to Equity O5.3

  46. Income Statement accounts are temporary accounts We need to follow a careful process to insure the correct transfer of Income Statement activity to the Equity section of the Balance Sheet. This is referred to as the Closing process. O5.3

  47. Closing Temporary Accounts The closing process involves a step by step procedure to empty out the Income Statement accounts to prepare for the next fiscal period. To close an account simply means to select an entry that forces the account to a zero balance. O5.3

  48. Closing Temporary Accounts The first step in closing an account is to determine the ending balance in the account Once you know the ending balance, you can determine the closing entry required O5.3

  49. Example -Closing Entry Account Balance Closing Entry Resulting balance O5.3

  50. Example -Closing Entry But how do we balance this entry in the Journal? Account Balance Closing Entry Resulting balance O5.3