Chapter 4: financial and accounting

• Each adjusting entry involves at least one income statement account and one balance sheet account... Example: Unrecorded Receivables Original entry none none Correct balances 500 500

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Chapter 4

Completing the Accounting Cycle

Albrecht, Stice, Stice, Swain

LEARNING OBJECTIVES

• How accrual accounting allows for timely reporting and

a better measure of a company’s economic

performance?

• Explain the need for adjusting entries and make

adjusting entries for unrecorded receivables,

unrecorded liabilities, prepaid expenses, and

unearned revenues.

• Explain the preparation of the financial statements, the

explanatory notes, and the audit report.

• Complete the closing process in the accounting cycle

• Understand how all the steps in the accounting cycle

fit together.

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Foods for thought

• In 2011, you sign a contract of $100,000 for writing

a software The software is to be delivered in

2012.

• You have received $20,000 after signing the

contract, and expect $80,000 in 2012.

• How much is your revenue?

• When will you be able to answer the question with certainty?

• Can you wait until 2012 to prepare the financial

reports?

• Relevancy (Updated infor) vs accuracy

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– Revenues and expenses are recorded as they are

earned and incurred, not necessarily when cash is

received or paid

– Better measures a firm’s performance than does cash flow data

• Can you easily estimate the profit when

Honda sell a car?

• the deal is not done until many years

later

What should be recorded as

Revenue Recognition

Recognize revenue when:

The earning process is substantially complete.

Cash has either been collected or collection

is reasonably assured.

1.

2.

The Matching Principle

• All costs and expenses incurred in generating revenues must be recognized in the same reporting period as the related revenues

• You are running a computer store

– List major revenues and expenses

– What expenses will be recognized when you sell a

computer?

– How about the store rent? Wages of employees?

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Example: Accrual- vs Cash-Basis Accounting

Bond Consulting Reported Income for 2009

During 2009, Bond Consulting billed its client for $48,000 On December 31, 2009, it had received $41,000, with the remaining

$7,000 to be received in 2010 Total expenses during 2009

were $31,000 with $3,000 of these costs not yet paid at

December 31 Determine net income under both methods.

Accrual-Basis Accounting

Revenues earned $48,000 Expenses incurred 31,000 Income $17,000

Cash-Basis Accounting

Cash disbursement 28,000

Practice E4-25

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• Each adjusting entry involves at least one income

statement account and one balance sheet account

How do you report income?

• On November 1, you established a cleaning service firm.

• You signed a year-long contract to provide cleaning services for $100/month You provide services every week, but you bill your customer every 3 months

– When should you record A/R? How much?

• The office rent is $500/ month, but you pay at the end of each quarter.

– When should you recognize the A/P? How much?

• You bought the insurance of $100/month for the office, but

you already paid for the whole year.

– When should you recognize the expense? How much?

• A customer advanced $600 for the cleaning service during the next 3 months

– When should you recognize the revenue? How much?

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Precision Management earns rent revenue of $500 in

2009 but will not receive the payment until January 10,

2010 An adjustment will be needed What is the

adjusting entry?

Example: Unrecorded Receivables

Original entry none none Correct balances 500 500

Rent Receivable Rent Revenue

12/31/09 Rent Receivable 500

Rent Revenue 500

Original entry none none Correct balances 1,000 1,000

Protege Inc is assessed property taxes of $1,000 for

2009, but will not make this payment until January 5,

2010 An adjustment will be needed What is the

adjusting entry?

Property TaxExpense Property Tax Payable

Example: Unrecorded Liabilities

12/31/09 Property Tax Expense 1,000 Property Tax Payable 1,000

Unearned Rent

Rent Revenue Original entry 3,600 3,600 Adjusting entry 1,800 1,800

Correct balances 1,800 1,800

Example: Unearned Revenues

12/31/09 Unearned Rent 1,800

Rent Revenue 1,800

On July 1, 2009, Dahl House Co received $3,600 for one

year’s rent in advance (covering July 1, 2009, to June 30,

2010) On December 31, 2009, an adjustment will be needed What is the adjusting entry?

Cash

Practice E4-26/164

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Preparing Financial Statements

Four step process using the trial balance:

1 Identify all revenue and expense accounts and

prepare the income statement

2 Compute net income

3 Compute the ending retained earnings balance

4 Prepare a balance sheet using the balance sheet

accounts and the ending retained earnings balance computed from step 3

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The Notes

• Notes

– List assumptions and methods used in preparing the financial statements

– Give more detail about specific items

– Augment the summarized numerical information

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What Auditors do

• Check financial statements for conformity with GAAP.

• Review Adjustments

• What should the auditors be concerned?

• sample selected accounts

– How would you verify that the asset accounts are correct?

• review accounting systems.

– Would you trust the financial reports prepared in an accounting system that is haphazard, with many missing documents?

• Attaches audit report and distributes it with the financial statements

– Balances are carried

forward to next period

• Nominal Accounts

– Temporary

• Closed (brought to a zero balance) at year end.

– Income Statement accounts and

dividends– Balance are NOT carried forward to next period

The Closing Process

• The Closing Process

– Record entries that reduce all nominal accounts to a zero balance at the end of the accounting period

– Nominal accounts are closed to retained earnings

• Step 3: The difference between revenues and

expenses (net income) should be credited to

retained earnings.

Revenues XXX

Cost of Goods Sold XXX Other Expenses XXX Retained Earnings XXX

Dividends

• Nominal account but NOT an expense

• Distribution to shareholders

• Closed by crediting dividends and debiting retained

earnings (reduces retained earnings)

When dividends are first declared:

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Preparing a Post-Closing

Trial Balance

• List of all real accounts

• A check of whether total debits equal total credits for all

real accounts prior to beginning new accounting cycle

Rodman Industries Inc.

Post-Closing Trial Balance

December 31, 2009

Debits Credits Cash $ 8,200

Summarize the effects of transactions.

1 Posting journal entries

2 Preparing a trial balance.

Summarize the effects of transactions.

1 Posting journal entries.

2 Preparing a trial balance.

Prepare reports.

1 Adjusting entries.

2 Preparing financial statements.

3 Closing the books.

Prepare reports.

1 Adjusting entries.

2 Preparing financial statements.

3 Closing the books.

Analyze transactions.

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