1 chapter 9 completing the accounting cycle created by d. gilroy heart lake secondary school
TRANSCRIPT
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The Adjusting ProcessWe now know that financial
statements are used extensively to assist in making business decisions.
It is the accountants responsibility to ensure that these financial statements are accurate, up-to-date, and consistent from year to year.
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The Adjusting ProcessWhen preparing the financial
statements, the accountant must ensure:All accounts are brought up to date;All late transactions are taken into
account;All calculations have been made
correctly; andAll GAAPs have been complied with.
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The Adjusting ProcessBringing the account data up-to-date
at statement time is known as “making the adjustments”.
The accounting entries produced by this process are known as adjusting adjusting entriesentries.
In most cases adjusting entriesadjusting entries assign amounts of revenue or expense to the appropriate accounting period before the books
are finalized for the fiscal period.
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Adjusting entries are necessary because the books of account are allowed to become inaccurate between statements dates.
Some accounts do not need to be perfectly accurate at the end of each business day BUT do need to be adjusted in order to determine the correct net income of net loss for the
period.
The Adjusting Process
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The Adjusting ProcessThe first three adjusting entries are:
Adjusting entries for SuppliesSupplies;Adjusting entries for Prepaid Prepaid
ExpensesExpenses; andAdjusting entries for Late-Arriving Late-Arriving
Purchase InvoicesPurchase Invoices.
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Adjusting Entries for SuppliesWhen supplies are purchased, their cost is
debited correctly to the Supplies account.As supplies are used, which is usually
daily, no accounting entries are made to record this usage.
During the accounting period, the balance of the Supplies account represents the balance at the beginning of the period plus any new supplies purchased.
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Adjusting Entries for SuppliesThe balance of Supplies Expense is zero.In order to satisfy the Matching Principle,
both of these accounts must be adjusted to reflect the usage (i.e. expense) during the fiscal period.
To book the adjusting entry, you must first determine the supplies inventory (by counting the remaining supplies).
You then determine the cost of the supplies used (i.e. difference between the
inventory count and the balance of the supplies account).
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Adjusting Entries for Supplies
2007
2007 2007
6,514 6,514
1,386 6,514
Assume the Supplies on hand at December 31, 2007 are $1,386 (i.e. the supplies inventory).
6,514 6,514
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Adjusting Entries for Prepaid Expense
There are times in business when expense items are paid for in advance.
This presents no problem if the expense item falls entirely within the fiscal period .
If the expense item affects more than the current fiscal period, then it must be treated as a prepaid expenseprepaid expense.
A prepaid expenseprepaid expense is an item paid for in advance, but one where the benefits
extend into the future.
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Insurance is the most common prepaid expense.
A business can purchase insurance to cover possible losses on 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.)
Adjusting Entries for Prepaid Expense
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When prepaid expensesprepaid expenses are purchased, they are usually debited to a prepaid expense account.
Prepaid expensesPrepaid expenses accounts have value and are therefore classified as 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.
Adjusting Entries for Prepaid Expense
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2007 2007
600 600
1,200 600
Prepaid annual insurance premium on September 1, 2007.
600 600
Adjusting Entries for Prepaid Expense
$1,800 x 4/12
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Goods and services are often bought and received toward the end of an accounting period.
The invoices for these items may not arrive until the subsequent 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
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The financial statements are not “typically” prepared until two or three weeks after the fiscal year end.
During this waiting period, the accounting department must analyze all purchase invoices in order to find those that affect the fiscal period that just ended.
Adjusting Entries for Late-Arriving Purchase Invoices
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Prior to financial statement preparation, the accountant discovers there were two late-
arriving invoices: telephone $212 and utilities $315.
Adjusting Entries for Late-Arriving Purchase Invoices
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Students should complete questions in section 9-1 and start questions and exercises section 9-2 in workbook
Class / Homework
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The first place that adjusting entries are recorded is on the work sheet.
As the work sheet is prepared, adjusting entries are calculated and recorded in a section headed Adjustments.
Adjusting Entries and the Work Sheet
The physical inventoryof supplies at Dec. 31
totaled $526.What adjusting entry
is required?
Supplies Expense 954.901
954.901An analysis of prepaidinsurance determined
that the balance at Dec. 31 should
be $4,070.What adjusting entry
is required?
Insurance Expense 2494.002
2494.002
A clerk discoveredthree “late” purchaseinvoices belonging to2007…telephone $45,
truck repair $496 & printer repair $85.
45.003496.003
85.003
626.003
Balance the Adjustments Columns.Extending the Work Sheet … add or subtract the adjustments from the trial balance and record in the last four columns.
1
1
2
2
3
33
3
526.004,070.00
3,136.00
1
1
2
2
3
33
3
Balancing the Work Sheet … total each of the last four columns
1
1
2
2
3
33
3
Balancing the Work Sheet … determine the diff. between thetwo income statement columns the two balance sheet columns
1
1
2
2
3
33
3
Net Income
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So far, the adjusting entries have been recorded only on the work sheet
Once the work sheet is complete / balanced, the adjusting entries must be recorded in the books of accounts.
Journalize and post all entries that appear in the adjustments section of the work sheet.
Journalize Adjusting Entries
Class work and homework
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Students should complete up to end of section 9-2 questions and exercises
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The Time Period Concept states that financial reporting, or net income in particular, is done in equal period of time.
After you do your adjusting entries and prepare your formal income statements, the accounts must be made ready for the next accounting cycle.
Closing Entries Concepts
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Determine which accounts have balances that continue from one period to the next and which do not.
There are two types of accounts … real accountsreal accounts and nominal accountsnominal accounts.
All asset and liability accounts, as well as the owner’s capital account, are considered to be real accountsreal accounts.
Closing Entries Concepts
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Real accountsReal accounts have balances that continue into the next fiscal period.
Nominal accountsNominal accounts (revenue, expense and drawings accounts) have balances that do not continue into the next fiscal period.
Nominal accountsNominal accounts, with the exception of drawings, are related to the income statement.
Closing Entries Concepts
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A special nominal account, called the Income Summary accountIncome Summary account, is used only during the closing entry process.
Once the income statement for a period has been completed, the balances in the nominal accounts are no longer useful … their balance must be taken to zero in preparation for the next accounting cycle.
Closing Entries Concepts
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Closing an accountClosing an account means to cause it to have no balance.
Any changes in equity during the period are contained in the 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.
Closing Entries Concepts
Complete Accounting CycleTransactions occur.Source documents.
Accounting entriesrecorded in the journal.
Performeddaily
Ledger balanced bymeans of a trial balance.
Performedmonthly
Journal entries postedto the ledger accounts.
Performedby
accountingclerks
Formal income stmt. &balance sheet prepared.
Closing entriesjournalized & posted.
Adjusting entriesjournalized & posted.
Performedby
accountants
Work sheet prepared.
Post-closingtrial balance.
Performedat end of
each fiscalperiod
1
1
2
2
3
33
3
Net Income
Closing Entry 1Closing Entry 1: transfer the balances in the revenue account(s) to a new nominal account called Income Summary.
Closing Entry 2Closing Entry 2: transfer the balances in the expense accounts to the Income Summary account.
Closing Entry 3Closing Entry 3: transfer the balances in Income Summary Account to the owner’s Capital account.
Closing Entry 4Closing Entry 4: transfer the balances in Drawings account to the owner’s Capital account.
Balance the Adjustments Columns.Extending the Work Sheet … add or subtract the adjustments from the trial balance and record in the last four columns.
1
1
2
2
3
33
3
526.004,070.00
3,136.00
1
1
2
2
3
33
3
Balancing the Work Sheet … total each of the last four columns
1
1
2
2
3
33
3
Post-Closing Trial Balance
1
1
2
2
3
33
3
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Capital AccountCalculating your Post-Closing Balance
$28,895.42P. Marshall, Capital
66,836.09 3$42,000.004
$53,731.51
$42,000.00 $95,731.51
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Post-Closing Trial BalanceP. Marshall, Capital
$28,895.4266,836.09
$95,731.51
$53,731.81
$42,000.00
$42,000.00
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Assets that are used to produce revenue over several fiscal periods are known as fixed assetsfixed assets.
Fixed assets are also known as “long-lived assets”, “capital equipment”, and “plant and equipment”.
Except for land, all fixed assets will be used up in the course of time and activity.
Adjusting for Depreciation
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Fixed assets decrease or depreciate in value.
DepreciationDepreciation refers to an allowance made for the 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.
Adjusting for Depreciation
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The matching principle dictates that depreciationdepreciation must be included on every year-end income statement.
To do this, accountants must estimate depreciation while the asset is still in use.
The two most common methods of calculating depreciation are the:
Straight-LineStraight-Line method and Declining-balanceDeclining-balance method.
Adjusting for Depreciation
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The simplest way to estimate depreciation.
The Straight-Line method of Straight-Line method of depreciationdepreciation divides up the net cost of the asset equally over the years of the asset’s life.
Straight-Line Depreciation
Straight-Line Depreciation for one year
=
Original Cost of Asset -
Estimated Salvage Value
Estimated Number of Periods in the Life of the Asset
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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?
Straight-Line Depreciation
Straight-Line Depreciation for one year
=
Original Cost of Asset -
Estimated Salvage Value
Estimated Number of Periods in the Life of the Asset
=$78,000 - $7,800
6
= $11,700
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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?
Straight-Line Depreciation
Straight-Line Depreciation for one year
=
Original Cost of Asset -
Estimated Salvage Value
Estimated Number of Periods in the Life of the Asset
=$5,120 - $500
10
= $462
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When adjusting for depreciation you would expect to DR DR Depreciation Expense Depreciation Expense CR AssetCR Asset
In order to show the value of the Asset at cost, you would not CR CR AssetAsset for the depreciation … rather you CR CR Accumulated DepreciationAccumulated Depreciation.
Adjusting Depreciation
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Accumulated depreciation is a valuation or contra account.
A contra accountcontra account is one that is displayed alongside an associated account and has a balance that is opposite to the account it is associated with.
Accumulated depreciation is also known as a valuation accountvaluation account … an account that is used, together with an asset account, to
show the true net value (or net book value) of the asset.
Accumulated Depreciation
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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
Adjusting Entry for Depreciation
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Income StatementDepreciation expense is shown on the income
statement.Each depreciation expense item is shown separately
(e.g. Depreciation Expense – Truck).
Balance SheetAccumulated depreciation is deducted from its
respective fixed asset account on the balance sheet.Each asset, with its related accumulated depreciation,
is shown separately. For example: Truck $78,000
Less: Accumulated Depreciation Depreciation 11,700 $66,300
Financial Statement Presentation
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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 months).Annual depreciation = (120,000 – 30,000) / 30
= $3,000Monthly depreciation = 3,000 / 12 = $250 per month
The depreciation expense would be 1st quarter $ 0 and
2nd quarter $500.
Depreciation for Part Year
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The declining-balance methoddeclining-balance method is an alternative to the straight-line method of calculating depreciation.
The declining-balance method is common because the government of Canada requires a variation 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 percentage.
Declining-Balance Depreciation
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Some of the percentage rates set by the government are as follows:
Declining-Balance Depreciation
Canada Customs and Revenue AgencyCanada Customs and Revenue AgencyRates of Capital Cost Allowance (Depreciation)
Class Description Rate3 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 equipment 30%
12 Computer software (except system software) 100%
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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
Declining-Balance Depreciation
2007: Undepreciated Cost $15,400 Less: Depreciation ($15,400 x 30%) 4,620 Undepreciated cost (net book value) $10,780
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For straight-line, assume the computers have an 8 year life with an ending value of $2,000.
Comparison of the Two Methods of Depreciation
$22,000 - $2,0008
= $2,500 / year
The straight-line method produces
depreciation figuresthat are the same each year.
The net book value (NBV)or undepreciated cost
gradually reduces until it reaches the estimated
Salvage value.
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Comparison of the Two Methods of Depreciation
The declining- balance method
produces depreciationfigures that are the larger inthe early years and smaller
in the later years. Theestimated final value is
ignored using thismethod.
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Canada Customs and Revenue Agency (CCRA) requires businesses to use the declining-balance method when calculating depreciation for tax purposes.
In addition, the CCRA generally allows 50% of the asset’s cost to be eligible for depreciation in its first year of use … regardless of the month it was purchased.
The CCRA refers to this as the “50% Rule”
Tax Regulations
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p. 348, Exercise 1p. 349, Exercise 2 (do all the parts,
plus in part B, calculate with and without the “50% rule”)
p. 350, Exercise 3 … prepare the adjusting entries and an adjusted trial balance.
Class / Homework