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f160 Part 1 Completing The Accounting Cycle
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Taxes Payable for the appropriate amount. When the taxes are actually paid, Income Taxes
Payable is debited, and Cash is credited.
The adjustment for income taxes presents a minor problem on the work sheet because the
amount of income taxes to be paid cannot be determined until net income (net loss) has been
computed. One way to solve this problem is to subtotal the work sheet columns, determine the
balancing figure for pretax income, multiply that figure by the tax rate to determine the amount
of the tax, and then make the adjusting entry for Income Tax Expense and Income Taxes Payable
the same way as other adjustments are made.
With this approach, both income tax accounts Income Tax Expense and Income Taxes
Payable are added on the work sheet following the column subtotals. To illustrate, we assume
that ITEC, Inc., is subject to a tax rate of 25%. The work sheet shown in Exhibit 4-13 would
be completed as follows:


Adjustments Income Statement Balance Sheet

Debits Credits Debits Credits Debits Credits

Subtotals 5,380 5,380 23,780 34,800 35,220 24,200
Income Tax Expense 2,755 2,755
Income Taxes Payable 2,755 2,755
Totals 8,135 8,135 26,535 34,800 35,220 26,955
Net Income (to balance) 08,265* 8,265
Totals 34,800 34,800 35,220 35,220


*[$34,800 $23,780 $11,020 to balance the income statement columns: $11,020 0.25 $2,755 Income
Tax Expense and Income Taxes Payable; the balance ($11,020 $2,755 $8,265) is net income.]



We have explained and
REPORTING THE ENDING RETAINED EARNINGS BALANCE
illustrated how the financial statements can be prepared from the income statement and balance
sheet columns on the work sheet. To simplify the illustration (Exhibit 4-13), we assumed that
ITEC, Inc., was organized on January 1, 2003, and therefore had no previous retained earnings
balance. Normally, a work sheet will show the beginning retained earnings on the trial balance,
which will be extended as a credit to the balance sheet columns. In addition, if a corporation
has paid its stockholders dividends during the period, the dividends account will be shown on
the trial balance and extended as a debit to the balance sheet columns. When preparing the bal-
ance sheet, these amounts must be considered in determining the ending retained earnings bal-
ance. The net income balancing figure on the work sheet is added to the beginning retained
earnings amount; any amount shown for dividends is subtracted. The resulting figure is the
amount of ending retained earnings to be reported on the balance sheet; thus:

Beginning Retained Earnings
Net Income
Dividends

Ending Retained Earnings


For the ITEC illustration, the beginning Retained Earnings balance was zero since the com-
pany had just been established. There also were no dividends paid. Therefore, the ending bal-
ance for retained earnings ($8,265) was simply the amount of net income for the period. For
the next accounting period, ITEC would start with a balance of $8,265 in its retained earnings
account, add the net income balancing figure for that period, and subtract any dividends to de-
termine the ending retained earnings balance to report on the balance sheet.
The income statement and balance sheet for ITEC, Inc., as prepared from the work sheet,
are shown in Exhibits 4-14 and 4-15, respectively.
160 f161
Completing The Accounting Cycle Chapter 4
Completing the Accounting Cycle



Income Statement for ITEC, Inc.
exhibit 4-14


ITEC, Inc.
Income Statement
For the Year Ended December 31, 2003

Sales revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $34,700
Rent revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100
Total revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $34,800
Less cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21,000
Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $13,800
Less operating expenses:
Salaries expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $02,200
Truck rental expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 400
Insurance expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40
Supplies expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 140 2,780
Income before income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . $11,020
Income tax expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,755
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $08,265




exhibit 4-15 Balance Sheet for ITEC, Inc.


ITEC, Inc.
Balance Sheet
December 31, 2003

Assets
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $24,270
Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,000
Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,000
Supplies on hand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 110
Prepaid insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 440
Prepaid truck rental . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,400
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $35,220

Liabilities and Owners Equity
Liabilities:
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $03,000
Unearned rent revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 500
Salaries payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 700
Income taxes payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,755 $06,955
Owners equity:
Capital stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $20,000
Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,265* 28,265
Total liabilities and owners equity . . . . . . . . . . . . . . . . . . . . . $35,220

*Beginning Retained Earnings Net Income Dividends Ending Retained Earnings.
161
f162 Part 1 Completing The Accounting Cycle
Financial Reporting and the Accounting Cycle



APPENDIX B: SPECIAL JOURNALS
So far we have shown all journal entries in general journal format, as explained in Chapter 3. With
many businesses having hundreds or even thousands of transactions every day, it is impractical and
inefficient to use only one journal. Instead, they group transactions into similar classes and use a
special journal for each. These special journals can be maintained on paper or in a computerized
special journal A book of
original entry for recording system; the basic principles are the same. In this appendix, we refer to a manual system.
similar transactions that oc-
cur frequently.
The Sales Journal
One of the most frequently occurring business transactions involves the sale of goods or services,
either for cash or on credit. Cash sales are generally recorded in a cash receipts journal. When
merchandise is sold on credit, a prenumbered sales invoice is prepared. This invoice specifies the
date of the sale, the amount and kinds of merchandise sold, and the price. One copy of the in-
voice is sent to the accounting department to be used as the basis for an entry in the sales jour-
sales journal A special jour-
nal in which credit sales are nal. This journal is a chronological listing of all credit sales, as shown in Exhibit 4-16.
recorded. This sales journal page has no columns for sales discounts (reductions in price offered to cus-
tomers who pay within a specified period), sales returns, or sales taxes. Antler Corporation records
all credit sales at their gross amounts and notes sales discounts at the time of collection (in the Cash
Receipts Journal). Sales returns, which involve a debit to Sales Returns and Allowances and a credit
to Accounts Receivable, are recorded by Antler in the general journal. Many companies include sales
discounts and returns in the sales journal, but we have omitted them here for the sake of simplic-
ity. (The concepts of sales discounts and returns are covered more fully in Chapter 6.) If Antler were
operating in a state with sales taxes, the taxes would be entered in a Sales Taxes Payable (credit) col-
umn, with the total posted to the sales taxes payable account at the same time Accounts Receivable
and Sales Revenue are posted. (The concept of sales taxes is covered more fully in Chapter 8.)


A Sample Page in a Sales Journal for Antler Corporation
exhibit 4-16


SALES JOURNAL

Invoice Post.
Date Customer No. Ref. Amount

2003
Jan. 2 Lee Smith 125 105.7 600

Jan. 5 Roger Jameson 126 105.5 250

Jan. 6 Ralph Smith 127 105.8 315

Jan. 8 John Anderson 128 105.1 216

Jan. 9 Carl Hartford 129 105.4 822

Jan. 12 Mike Taylor 130 105.9 610

Jan. 16 Marvin Brinkerhoff 131 105.3 507

Jan. 23 Roy Avondet 132 105.2 125

Jan. 27 Jay Rasmussen 133 105.6 350

Jan. 28 Jerry Woolsey 134 105.11 816

4,611

(105) (400)
162 f163
Completing The Accounting Cycle Chapter 4
Completing the Accounting Cycle


The sales journal differs from the general journal in several respects. First, because all
transactions are similar, the entries do not require separate explanations. Second, there are
no debit and credit columns because the total is always posted as a debit to Accounts Re-
ceivable (account 105) and a credit to Sales Revenue (account 400). Third, the sales journal
includes a column for the sales invoice number for easy reference to a source of additional
information.
Having a single total posted to Accounts Receivable saves time and keeps the general ledger
in manageable form. However, it does make it difficult, if not impossible, for a company to
monitor the activity of individual accounts. Maintaining a separate account for each customer
within the general ledger creates a different sort of problem a voluminous general ledger with
many accounts receivable accounts, plus Cash, Inventory, and so forth. The same problem ex-
ists for Accounts Payable.
To handle this problem, companies generally keep at least three ledgers: the general ledger,
which contains all the balance sheet and income statement accounts; the accounts receivable sub-
sidiary ledger; and the accounts payable subsidiary ledger. The subsidiary ledgers contain sep-
subsidiary ledger A group-
ing of individual accounts arate accounts (in alphabetical order) for each customer and creditor, showing all debits, cred-
that in total equal the bal-
its, and a balance. They are called subsidiary ledgers because they back up, or support, the account
ance of a control account in
balances in the general ledger. The total of all accounts in the accounts receivable subsidiary
the general ledger.
ledger, for example, equals the balance in Accounts Receivable in the general ledger. Accounts
Receivable is called a control account because it summarizes the individual accounts in the ac-
control account A summary
account in the general counts receivable subsidiary ledger. Exhibit 4-17 illustrates the relationship between the general
ledger that is supported by
and subsidiary ledgers.
detailed individual accounts
As the sales journal entries are posted to the accounts receivable subsidiary ledger accounts,
in a subsidiary ledger.
the individual account numbers are entered in the sales journal posting reference column. The
number of the sales journal page and the date of the transaction are similarly entered as a post-
ing reference in the subsidiary accounts. These cross-references quickly direct accountants to the
source of additional information, while serving as a means of checking their work. Exhibit 4-18
shows the posting of the sales transactions to the general ledger. Note that the total posted to
Accounts Receivable in the general ledger equals the total of all postings to the accounts receiv-
able subsidiary ledger.



The Purchases Journal
A second frequently occurring transaction involves the purchase of merchandise for resale, ei-
ther for cash or on credit. Cash purchases are recorded in a cash disbursements journal and will
be discussed later. Credit purchases are chronologically recorded in a purchases journal. The
purchases journal A special
journal in which credit pur- individual entries are posted to accounts in the accounts payable subsidiary ledger throughout
chases are recorded.
the accounting period. At the end of the period, the total is posted to both Accounts Payable
and Purchases.
The purchases and sales journals are similar, except that the sales journal includes invoice
numbers and the purchases journal includes invoice dates. The date is useful for identifying the
beginning of a discount period. A sample page from a purchases journal is shown in Exhibit
4-19 on page 166. As with the sales journal, Antler Corporation handles discounts at the time
of payment. (The concept of purchase discounts is covered more fully in Chapter 7.)
This purchases journal is used for recording credit purchases of inventory only. Credit pur-
chases of equipment, supplies, other such items, and purchase returns would be recorded in the
general journal. Exhibit 4-20 on page 167 illustrates the posting of the purchases journal to the
accounts payable subsidiary ledger and to the general ledger.
Each purchase is posted to the individual creditor s account in the accounts payable sub-
sidiary ledger; the total of $4,851 is posted to Accounts Payable (202) and Purchases (450) in
the general ledger. Like the sales journal, the purchases journal is cross-referenced to the general
and subsidiary ledgers. The cumulative total of all balances in the accounts payable subsidiary
ledger equals the balance in the accounts payable account.
163
f164 Part 1 Completing The Accounting Cycle
Financial Reporting and the Accounting Cycle



The General and Subsidiary Ledgers
exhibit 4-17

Accounts Payable Subsidiary Ledger
General Ledger
Land White
Incorporated
Notes United
Payable Company
Tool
Accounts
Design Co.
Payable
Capital Stock Palmer
Supply Co.
Mayberry
Inventory
Marketing
Accounts Jackson
Receivable Wholesale
Cash Equipment
Supply
Davies
Wholesale




Accounts Receivable Subsidiary Ledger
Jerry Woolsey
105.11
Mike Taylor
105.9
Ralph Smith
105.8
Lee Smith
105.7
Jay Rasmussen
105.6
Roger Jameson
105.5
Carl Hartford
105.4
Marvin Brinkerhoff
105.3
Roy Avondet
105.2
John Anderson
105.1




The Cash Receipts Journal
Another special journal is the cash receipts journal, which includes all cash received from sales,
cash receipts journal A spe-
cial journal in which all interest, rent, or other sources. Exhibit 4-21 on page 168 shows a typical page from a cash re-
cash received, from sales, ceipts journal and the posting of its entries.
interest, rent, or other
The cash receipts journal usually includes columns for Cash (DR), Sales Discounts (DR),
sources, is recorded.
Accounts Receivable (CR), and Sales Revenue (CR). In addition, an Other Accounts (CR) col-
umn is used to record all irregular cash transactions, that is, all items that do not fall natu-
rally into a labeled column such as Cash or Accounts Receivable. Examples are collections of in-
164 f165
Completing The Accounting Cycle Chapter 4
Completing the Accounting Cycle



Posting from the Sales Journal
exhibit 4-18


ACCOUNTS
RECEIVABLE
LEDGER

Lee Smith (105.7)

1/2 600


Roger Jameson (105.5)

1/5 250


Ralph Smith (105.8)
SALES JOURNAL 1/6 315
Invoice Post.
Date Customer No. Ref. Amount John Anderson (105.1)
2003
Jan. 2 Lee Smith 125 105.7 600 1/8 216
5 Roger Jameson 126 105.5 250
6 Ralph Smith 127 105.8 315
Carl Hartford (105.4)
8 John Anderson 128 105.1 216
9 Carl Hartford 129 105.4 822 1/9 822
12 Mike Taylor 130 105.9 610
16 Marvin Brinkerhoff 131 105.3 507 Mike Taylor (105.9)
23 Roy Avondet 132 105.2 125
1/12 610
27 Jay Rasmussen 133 105.6 350
28 Jerry Woolsey 134 105.11 816
4,611 Marvin Brinkerhoff
(105.3)
(105) (400)
1/16 507


Roy Avondet (105.2)

1/23 125


Jay Rasmussen (105.6)
GENERAL LEDGER
1/27 350

Accounts Receivable
Jerry Woolsey (105.11)
(105) Sales Revenue (400)

1/28 816
1/31 4,611 1/31 4,611




terest, rents, or notes receivable. The Other Accounts column is added for cross-checking pur-
poses. A check mark ( ) is placed below the total to indicate that the individual items have been
posted.
Exhibit 4-21 shows that on January 7, $588 was received from Lee Smith in payment of a
$600 bill (debit Cash, credit Accounts Receivable). The $12 difference is a 2% discount ($600
0.02 $12) offered by Antler to customers who pay within 10 days (debit Sales Discounts).
The $125 cash sale on January 12 was debited to Cash and credited to Sales Revenue. The in-
165
f166 Part 1 Completing The Accounting Cycle
Financial Reporting and the Accounting Cycle



A Sample Page in a Purchases Journal for Antler Corporation
exhibit 4-19


PURCHASES JOURNAL

Invoice Post.
Date Supplier Date Ref. Amount

2003 2003

Jan. 2 Mayberry Marketing Jan. 1 202.4 300

Jan. 5 Jackson Wholesale Jan. 4 202.3 616

Jan. 6 Equipment Supply Jan. 5 202.2 485

Jan. 12 Davies Wholesale Jan. 11 202.1 690

Jan. 14 Jackson Wholesale Jan. 12 202.3 150

Jan. 15 Palmer Supply Co. Jan. 14 202.5 810

Jan. 22 White Incorporated Jan. 22 202.8 800

Jan. 29 United Company Jan. 28 202.7 600

Jan. 30 Tool Design Co. Jan. 29 202.6 400

J 4,851

(202) (450)




terest revenue collected on January 18 was credited to Other Accounts. Mike Taylor did not re-
ceive a sales discount because he did not pay within the 10-day discount period.
In posting the entries from the cash receipts journal to the general ledger, only those amounts
in the Other Accounts (CR) column are handled individually; the number of each ledger ac-
count appears in the Post. Ref. column. For example, when the $150 payment was collected on
January 9 and posted to Notes Receivable, the account number 103 was entered in the Post.
Ref. column. All other columns are posted to the general ledger as totals at the end of each ac-
counting period. The total of the debit columns is compared with the total of the credit columns
to make sure that total debits equal total credits. As the totals are posted, their account num-
bers are entered just below the column totals. The individual entries in the Accounts Receivable
(CR) column are posted to the customers accounts in the accounts receivable subsidiary ledger.
Subsidiary account numbers are placed in the Post. Ref. column to indicate that these subsidiary
postings have been made.

The Cash Disbursements Journal
The cash payments of a business are usually recorded in a separate cash disbursements journal
cash disbursements journal
A special journal in which (shown in Exhibit 4-22 on page 169). The cash disbursements journal contains Other Accounts
all cash paid out for sup- (CR), Cash (CR), Purchase Discounts (CR), Accounts Payable (DR), Sales Salaries Expense
plies, merchandise, salaries,
(DR), General and Administrative Salaries Expense (DR), and Other Accounts (DR) columns.
and other items is
The Purchase Discounts and Accounts Payable columns are used to account for payments for
recorded.
merchandise previously purchased. The Sales and the General and Administrative Salaries Ex-
pense columns are used to record the payment of salaries (if a separate payroll journal is not
kept). The Other Accounts (DR) column is used to record cash purchases of merchandise and
other payments for which there are no special columns. As with the other journals, the paren-
thetical numbers at the bottoms of the columns mean those column totals have been posted to
their respective general ledger accounts.
166 f167
Completing The Accounting Cycle Chapter 4
Completing the Accounting Cycle



Posting from the Purchases Journal
exhibit 4-20


ACCOUNTS PAYABLE
LEDGER

Mayberry Marketing
(202.4)

300 1/2


Jackson Wholesale
(202.3)

616 1/5


Equipment Supply
(202.2)

485 1/6


Davies Wholesale
PURCHASES JOURNAL
(202.1)
Invoice Post.
Date Supplier Date Ref. Amount 690 1/12
2003 2003
Jan. 2 Mayberry Marketing Jan. 1 202.4 300
Jackson Wholesale
5 Jackson Wholesale 4 202.3 616
(202.3)
6 Equipment Supply 5 202.2 485
12 Davies Wholesale 11 202.1 690 616 1/5
150 1/14
14 Jackson Wholesale 12 202.3 150
15 Palmer Supply Co. 14 202.5 810
22 White Incorporated 22 202.8 800 Palmer Supply Co.
(202.5)
29 United Company 28 202.7 600
30 Tool Design Co. 29 202.6 400
810 1/15
4,851

(202) (450)
White Incorporated
(202.8)

800 1/22


United Company
(202.7)

600 1/29
GENERAL LEDGER

Tool Design Co. (202.6)
Accounts Payable (202) Purchases (450)

400 1/30
4,851 1/31 1/31 4,851




In reading Exhibit 4-22, notice that on February 1 the company made a $588 payment to
satisfy the $600 payable to United Company. The 2% discount of $12 was taken because pay-
ment was made within 10 days of purchase. The payments to Equipment Supply and Mayberry
Marketing were for the full amounts because they were not made within the 10-day discount
period (see the purchases journal in Exhibit 4-20).
167
f168 Completing The Accounting Cycle
Part 1 EOC Financial Reporting and the Accounting Cycle



The Cash Receipts Journal
exhibit 4-21



CASH RECEIPTS JOURNAL
Other Accounts
Sales Accounts Sales
Cash Discounts Receipt Post. Receivable Revenue Post.
DR DR Date No. Account Name Ref. CR CR Ref. Amount CR
2003
588.00 12.00 Jan. 7 621 Lee Smith 105.7 600.00
150.00 9 622 Notes Receivable 103 150.00
125.00 12 623 Cash Sales 125.00
805.56 16.44 15 624 Carl Hartford 105.4 822.00
50.00 18 625 Interest Revenue 513 50.00
30.00 22 626 Cash Sales 30.00
122.50 2.50 29 627 Roy Avondet 105.2 125.00
610.00 29 628 Mike Taylor 105.9 610.00
2,481.06 30.94 2,157.00 155.00 200.00
(101) (404) (105) (400) (”)



GENERAL LEDGER

Accounts Receivable
Notes Receivable
(105)
Cash (101) (103)

1/31 2,157.00
1/31 2,481.06 1/31 150.00


Interest Revenue
(513)
Sales Revenue (400) Sales Discounts (404)

1/31 50.00
1/31 155.00 1/31 30.94


ACCOUNTS RECEIVABLE SUBSIDIARY LEDGER

Lee Smith (105.7) Mike Taylor (105.9)
Roy Avondet (105.2) Carl Hartford (105.4)

1/7 600.00 1/29 610.00
1/29 125.00 1/15 822.00




review of learning objectives

Describe how accrual accounting allows for timely re- The necessity for periodic reporting further requires that
1 porting and a better measure of a company s eco- accrual accounting be used to provide accurate statements of
nomic performance. Accounting information is needed on a financial position and results of operations for an accounting
timely basis for decision-making purposes. This requires that period. Accrual-basis accounting means that revenues are rec-
the total life of a business be divided into accounting periods, ognized as they are earned, not necessarily when cash is re-
generally a year or less, for which reports are prepared. Some ceived; expenses are recognized as they are incurred, not nec-
of the data presented in the periodic reports must be tentative essarily when cash is paid. Accrual-basis accounting provides
because dividing a company s life into relatively short report- a more accurate picture of a company s financial position and
ing periods requires that allocations and estimates be made. operating results than does cash-basis accounting. The cash
168 f169
Completing The Accounting Cycle EOC Chapter 4
Completing the Accounting Cycle



The Cash Disbursements Journal
exhibit 4-22




CASH DISBURSEMENTS JOURNAL
Other Accounts Salaries Expense Other Accounts
Purchase Accounts
Post. Amount Cash Discounts Check Account Post. Payable Sales Gen. & Post. Amount
Ref. CR CR CR Date No. Name Ref. DR DR Admin. DR Ref. DR

2003
6,588.00 12.00 Feb. 1 176 United Company 202.7 1,600.00
6,225.00 6 177 First Federal Co. 201 3,225.00

3,000.00 8 178 Bell Telephone 569 3,000.00
6,485.00 17 179 Equipment Supply 202.2 1,485.00
2,100.00 24 180 Payroll 1,400.00 700.00

6,300.00 28 181 Mayberry Marketing 202.4 1,300.00
6,698.00 12.00 1,385.00 1,400.00 700.00 3,225.00

(101) (452) (202) (501) (550) (”)




GENERAL LEDGER

Accounts Payable (202) Purchase Discounts (452)
Cash (101) Notes Payable (201)

2/28 1,385.00 2/28 12.00
2/28 6,698.00 2/6 225.00



General and
Telephone Expense
Sales Salaries Expense Administrative Salaries
(569)
(501) Expense (550)

2/8 3,000.00
2/28 1,400.00 2/28 700.00



ACCOUNTS PAYABLE SUBSIDIARY LEDGER

United Company
Equipment Supply Mayberry Marketing
(202.7)
(202.2) (202.4)

2/1 600.00
2/17 485.00 2/28 300.00




flow statement is also very important in the financial position receivables, unrecorded liabilities, prepaid expenses, and un-
analysis. earned revenues. The analysis process involved in making an
adjusting entry involves two steps. First, determine whether an
Explain the need for adjusting entries and make ad- asset or liability has been recorded for the proper amount and,
2 justing entries for unrecorded receivables, unrecorded if not, correct it (fix the balance sheet). Second, determine
liabilities, prepaid expenses, and unearned revenues. At the what revenue or expense adjustment is needed because of the
end of an accounting period, there are potentially many im- asset or liability adjustment just made (fix the income state-
portant events that have as yet not been recorded. Some im- ment).
portant events occur outside the normal accounting process,
while other events occur slowly over time. An important part Explain the preparation of the financial statements,
3
of the accounting process is to review the financial condition the explanatory notes, and the audit report. After the
and operating activities of the company for the period to make adjusting entries have been posted to the accounts, an adjusted
sure that all assets, liabilities, revenues, and expenses have been trial balance is prepared. This adjusted trial balance provides
recorded. These year-end adjustments are called adjusting en- the raw data for the preparation of the balance sheet and the
tries and may be classified under four headings: unrecorded income statement; preparation of the statement of cash flows
169
f170 Completing The Accounting Cycle
Part 1 EOC Financial Reporting and the Accounting Cycle



requires more detailed information about cash receipts and counts. Revenue accounts are closed by being debited; expense
cash disbursements. The notes to the financial statements pro- accounts and the dividends account are closed by being cred-
vide further information about the methods and assumptions ited. Revenues, expenses, and dividends are closed to Retained
used in preparing the financial statements as well as further Earnings.
detail about certain financial statement items. The audit is con-
ducted by a CPA from outside the company who reviews the Understand how all the steps in the accounting cy-
6
adjusting entries, performs tests to check the balances of se- cle fit together. The accounting cycle consists of spe-
lected accounts, and reviews the condition of the accounting cific steps to analyze, record, classify, summarize, and report
systems. the exchange transactions of economic entities. By way of re-
view, Exhibit 4-12 identifies the steps in the accounting cycle.
Perform a systematic analysis of financial statements.
4 Financial statements are prepared in order to be used.
Two general techniques for financial statement analysis are the
DuPont framework and common-size financial statements. Make adjusting entries for prepaid expenses and un-
7
The DuPont framework involves the decomposition of return earned revenues when the original cash amounts are
on equity into three components: profitability, efficiency, and recorded as expenses and revenues. Prepayments are some-
leverage. Preparation of common-size financial statements in- times initially recorded as expenses instead of as prepaid ex-
volves dividing all financial statement amounts by total rev- penses (assets); cash receipts for revenue in advance are some-
enue for the period. times initially recorded as revenues instead of as unearned
revenues (liabilities). However, the concepts governing the ad-
Complete the closing process in the accounting cy- justing process are the same: use the first part of the adjusting
5 cle. Once adjusting entries have been journalized and entry to fix the balance sheet and the second part to fix the
posted to the accounts and the financia l statements have been income statement. The end result (the updated balances re-
prepared, the accounting records should be made ready for the ported on the balance sheet and income statement, respec-
next accounting cycle. This is accomplished by journalizing tively) is the same regardless of which approach is used, as-
and posting closing entries for all nominal (temporary) ac- suming that adjusting entries are made correctly.




key terms and concepts

Appendix A:
nominal accounts 151
accrual-basis accounting 133
post-closing trial balance 152 work sheet 157
adjusting entries 136
prepaid expenses 139
asset turnover 148
Appendix B:
profit margin 148
assets-to-equity ratio 148
cash disbursements journal 166
real accounts 151
calendar year 133
cash receipts journal 164
return on equity 148
cash-basis accounting 136
control account 163
revenue recognition principle 134
closing entries 152
purchases journal 163
time-period concept 133
common-size financial statements
sales journal 162
149 unearned revenues 141
special journal 162
DuPont framework 148 unrecorded liabilities 138
unrecorded receivables 137 subsidiary ledger 163
fiscal year 133
matching principle 134




review problem

The Accounting Cycle This review problem provides a useful summary of the entire accounting cycle. The following
post-closing trial balance is for Sports Haven Company as of December 31, 2002.
170 f171
Completing The Accounting Cycle EOC Chapter 4
Completing the Accounting Cycle



Sports Haven Company
Post-Closing Trial Balance
December 31, 2002

Debits Credits

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $17,500
Accounts Receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17,000
Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28,800
Supplies on Hand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,200
Prepaid Building Rental . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24,000
Accounts Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $18,000
Capital Stock (3,600 shares outstanding) . . . . . . . . . . . . . . . . . . . . . . . 54,000
Retained Earnings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16,500
Totals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $88,500 $88,500


Following is a summary of the company s transactions for 2003.
a. At the beginning of 2003, the company issued 1,500 new shares of stock at $20 per share.
b. Total inventory purchases were $49,500; all purchases were made on credit and are recorded
in the inventory account.
c. Total sales were $125,000; $102,900 were on credit, the rest were for cash. The cost of
goods sold was $47,500; the inventory account is reduced at the time of each sale.
d. In December, a customer paid $3,500 cash in advance for merchandise that was temporarily
out of stock. The advance payments received from customers are initially recorded as lia-
bilities. The $3,500 is not included in the sales figures in (c) above.
e. The company paid $66,500 on accounts payable during the year.
f. The company collected $102,000 of accounts receivable during the year.
g. The company purchased $600 of supplies for cash during 2003, debiting Supplies on Hand.
h. The company paid $850 for advertising during the year, debiting Prepaid Advertising.
i. Total salaries paid during the year were $45,000.
j. The company paid $650 during the year for utilities.
k. Dividends of $7,500 were paid to stockholders in December.
On December 31, 2003, the company s accountant gathers the following information to adjust
the accounts:
l. As of December 31, salaries of $750 had been earned by employees but will not be paid
until January 3, 2004.
m. A count at December 31 shows $800 of supplies still on hand.
n. The prepaid advertising paid during 2003 includes $400 paid on December 1, 2003, for a
series of radio advertisements to be broadcast throughout December 2003 and January 2004.
The balance in the account, $450, represents advertisements that were broadcast during
2003.
o. On December 31, 2002, the company rented an office building for two years and paid
$24,000 in cash (the full rental fee for 2003 and 2004). The payment was recorded with a
debit to Prepaid Building Rental. No entries have been made for building rent in 2003.
p. On December 20, 2003, a bill for $150 was received for utilities. No entry was made to
record the receipt of the bill, which is to be paid on January 4, 2004.
q. As of December 31, 2003, the merchandise paid for in advance [transaction (d)] was still
out of stock. The company expects to receive the merchandise and fill the order by Janu-
ary 15, 2004.
r. The company s income is taxed at a rate of 15%.

1. Make entries in the general journal to record each of the transactions [items (a) through (k)].
Required:
2. Using T-accounts to represent the general ledger accounts, post the transactions recorded
in the general journal. Enter the beginning balances in the accounts that appear in the De-
171
f172 Completing The Accounting Cycle
Part 1 EOC Financial Reporting and the Accounting Cycle


cember 31, 2002, post-closing trial balance before posting 2003 transactions. When all trans-
actions have been posted to the T-accounts, determine the balance for each account.
3. Prepare a trial balance as of December 31, 2003.
4. Record adjusting entries [items (l) through (r)] in the general journal; post these entries to
the general ledger (T-accounts).
5. Prepare an income statement and balance sheet for 2003.
6. Record closing entries [label (s) and (t)] in the general journal; post these entries to the gen-
eral ledger (T-accounts).
7. Prepare a post-closing trial balance.

Solution 1. Following are the journal entries to record the transactions for the year. Several of these are
summary entries representing numerous individual transactions.
(a) Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30,000
Capital Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30,000

The company issued additional shares of stock, so Capital Stock must be credited to reflect
the increase in owners equity. Since the company received cash of $30,000 (1,500 shares
at $20 per share), Cash is also increased.
(b) Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49,500
Accounts Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49,500

The company purchased $49,500 of goods on credit. Inventory is increased (debited) for
this amount. Accounts Payable is credited to show the increase in liabilities.
(c) Accounts Receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102,900
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22,100
Sales Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 125,000

Total sales were $125,000, so Sales Revenue must be increased (credited) by that amount.
Of this amount, $102,900 were on credit, and $22,100 were cash sales. We increase the
asset accounts, Accounts Receivable and Cash, by debiting them.
(c) Cost of Goods Sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47,500
Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47,500

The cost of the merchandise sold during the year was $47,500. Cost of Goods Sold (ex-
pense) must be increased (debited) by this amount. Since the goods were sold, Inventory
(asset) must be reduced by a credit of $47,500.
(d) Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,500
Unearned Sales Revenue . . . . . . . . . . . . . . . . . . . . . . . . . 3,500

Cash is debited (increased) by the amount received from the customer. The company
recorded the advance payments for merchandise by crediting a liability account, Unearned
Sales Revenue.
(e) Accounts Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66,500
Cash. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66,500

The company s payments on its accounts reduce the amount of its obligation to creditors,
so Accounts Payable (liability) is debited to decrease it by the amount paid. Cash must also
be decreased (credited).
(f) Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102,000
Accounts Receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . 102,000

Since the company has collected some of its receivables from customers, Accounts Receiv-
able is credited to show a decrease. Cash is increased (debited).
(g) Supplies on Hand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 600
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 600
172 f173
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Completing the Accounting Cycle


The company purchased $600 of supplies. By debiting Supplies on Hand, an increase is
shown in that asset account. Cash must be credited to show a decrease.
(h) Prepaid Advertising . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 850
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 850

The company purchased $850 of advertising and chose to initially debit an asset account,
Prepaid Advertising. Since cash was paid, it must be reduced by a credit.
(i) Salaries Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45,000
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45,000


(j) Utilities Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 650
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 650

For transactions (i) and (j), an expense account must be debited to show that expenses have
been incurred. Cash must be credited (reduced).
(k) Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,500
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,500

Dividends must be debited to show a decrease in owners equity resulting from a distribu-
tion of earnings. Cash must be reduced by a credit.
2. T-accounts with the beginning balances and journal entries posted are shown here. (Note
that accounts with more than one entry must be balanced by drawing a rule and enter-
ing the debit or credit balance below it.)

Cash Accounts Receivable Inventory

Beg. (e) 66,500 Beg. (f) 102,000 Beg. (c) 47,500
bal. 17,500 (g) 600 bal. 17,000 bal. 28,800
(a) 30,000 (h) 850 (c) 102,900 (b) 49,500
(c) 22,100 (i) 45,000 Updated Updated
(d) 3,500 (j) 650 bal. 17,900 bal. 30,800
(f) 102,000 (k) 7,500
Updated
bal. 54,000

Supplies on Hand Prepaid Building Rental Prepaid Advertising

Beg. Beg. (h) 850
bal. 1,200 bal. 24,000
(g) 600
Updated
bal. 1,800

Accounts Payable Unearned Sales Revenue Capital Stock

(e) 66,500 Beg. (d) 3,500 Beg.
bal. 18,000 bal. 54,000
(b) 49,500 (a) 30,000
Updated Updated
bal. 1,000 bal. 84,000

Retained Earnings Dividends Sales Revenue

Beg. (k) 7,500 (c) 125,000
bal. 16,500

Cost of Goods Sold Salaries Expense Utilities Expense

(c) 47,500 (i) 45,000 (j) 650
173
f174 Completing The Accounting Cycle
Part 1 EOC Financial Reporting and the Accounting Cycle


3. The balance of each account is entered in a trial balance. Each column in the trial balance
is totaled to determine that total debits equal total credits.


Sports Haven Company
Trial Balance
December 31, 2003
Debits Credits

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $054,000
Accounts Receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17,900
Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30,800
Supplies on Hand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,800
Prepaid Building Rental . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24,000
Prepaid Advertising . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 850
Accounts Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $001,000
Unearned Sales Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,500
Capital Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84,000
Retained Earnings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16,500
Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,500
Sales Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 125,000
Cost of Goods Sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47,500
Salaries Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45,000
Utilities Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 650
Totals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $230,000 $230,000




4. The adjusting entries for Sports Haven Company are presented in journal form and ex-
plained. Updated T-accounts are provided showing the posting of the adjusting entries.
(l) Salaries Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 750
Salaries Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 750

As of December 31, there is an unrecorded liability and expense of $750 for salaries owed
to employees. Because the salaries were earned in 2003, the liability and related expense
must be recorded in 2003.
(m) Supplies Expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,000
Supplies on Hand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,000

Supplies on Hand (asset) has a debit balance before adjustment of $1,800 [beginning bal-
ance of $1,200 plus $600 of supplies purchased during the year, transaction (g)]. Since $800
of supplies are on hand at the end of the year, Supplies on Hand should be reduced (cred-
ited) by $1,000. Supplies Expense must be debited to show that $1,000 of supplies were
used during the period.
(n) Advertising Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 650
Prepaid Advertising . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 650

Prepaid Advertising has a debit balance before adjustment of $850, the total amount paid
for advertising during the year [transaction (h)]. This amount includes $400 that was paid
for radio advertising throughout December 2003 and January 2004. Only that portion that
applies to 2004 should be shown as Prepaid Advertising, $200 ($400 2 months), since
it is not an expense of the current year. The remainder, $650, is advertising expense for the
period. Thus, the asset account, Prepaid Advertising, must be credited for $650, and Ad-
vertising Expense must be increased by a debit of $650.
174 f175
Completing The Accounting Cycle EOC Chapter 4
Completing the Accounting Cycle


(o) Building Rent Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,000
Prepaid Building Rental . . . . . . . . . . . . . . . . . . . . . . . . . . 12,000

The original entry at the end of 2002 was a debit to the asset account, Prepaid Building
Rental, and a credit to Cash. An adjusting entry is needed to record rent expense of $12,000
for 2003 ($24,000 2 years). The expense account must be debited and the asset account
must be reduced by a credit. The remaining $12,000 in Prepaid Building Rental reflects
the portion of the total payment for building rent expense in 2004.
(p) Utilities Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 150
Utilities Payable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 150

As of December 31, 2003, there is an unrecorded liability and expense of $150 for utili-
ties. Because the expense was incurred in 2003, an adjusting entry is needed to record the
liability and related expense.
(q) No entry required.

The original entry to record the advance payment from a customer was made by crediting
a liability [transaction (d)]. As of December 31, no revenue has been earned. The company
still has an obligation to deliver goods or refund the advanced payment. Therefore, no ad-
justment is required, since the liability is already properly recorded.
(r) Income Tax Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,595
Income Taxes Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,595

The remaining adjustment is for income taxes. The difference between total revenues and
total expenses is the amount of income before taxes, $17,300. This amount is multiplied
by the applicable tax rate of 15% to determine income taxes for the period. The expense
account is debited to show the income taxes incurred for the year and the liability account
is credited to show the obligation to the government.



Cash Accounts Receivable Inventory

Beg. (e) 66,500 Beg. (f) 102,000 Beg. (c) 47,500
bal. 17,500 (g) 600 bal. 17,000 bal. 28,800
(a) 30,000 (h) 850 (c) 102,900 (b) 49,500
(c) 22,100 (i) 45,000 Updated Updated
(d) 3,500 (j) 650 bal. 17,900 bal. 30,800
(f) 102,000 (k) 7,500
Updated
bal. 54,000


Supplies on Hand Prepaid Building Rental Prepaid Advertising

Beg. (m) 1,000 Beg. (o) 12,000 (h) 850 (n) 650
bal. 1,200 bal. 24,000 Updated
(g) 600 Updated bal. 200
Updated bal. 12,000
bal. 800


Accounts Payable Salaries Payable Utilities Payable

(e) 66,500 Beg. (l) 750 (p) 150
bal. 18,000
(b) 49,500
Updated
bal. 1,000
175
f176 Completing The Accounting Cycle
Part 1 EOC Financial Reporting and the Accounting Cycle


Income Taxes Payable Unearned Sales Revenue Capital Stock

(r) 2,595 (d) 3,500 Beg.
bal. 54,000
(a) 30,000
Updated
bal. 84,000


Retained Earnings Dividends Sales Revenue

Beg. (k) 7,500 (c) 125,000
bal. 16,500


Cost of Goods Sold Salaries Expense Utilities Expense

(c) 47,500 (i) 45,000 (j) 650
(l) 750 (p) 150
Updated Updated
bal. 45,750 bal. 800


Advertising Expense Supplies Expense Building Rent Expense

(n) 650 (m) 1,000 (o) 12,000



Income Tax Expense

(r) 2,595




5. Data for the financial statements may be taken from the adjusted ledger accounts and re-
ported as follows:


Sports Haven Company
Income Statement
For the Year Ended December 31, 2003

Sales revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $125,000
Less cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47,500
Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $77,500
Less operating expenses:
Salaries expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $045,750
Utilities expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 800
Advertising expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 650
Supplies expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,000
Building rent expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,000 60,200
Income before income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $17,300
Income tax expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,595
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $14,705

Earnings per share:
$14,705 5,100 shares $2.88 (rounded)
176 f177
Completing The Accounting Cycle EOC Chapter 4
Completing the Accounting Cycle



Sports Haven Company
Balance Sheet
December 31, 2003

Assets
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $54,000
Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17,900
Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30,800
Supplies on hand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 800
Prepaid building rental . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,000
Prepaid advertising. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 200
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $115,700

Liabilities and Owners Equity
Liabilities:
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $01,000
Salaries payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 750
Utilities payable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 150
Income taxes payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,595
Unearned sales revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,500
Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $007,995
Owners equity:
Capital stock (5,100 shares outstanding) . . . . . . . . . . . . . . . . . . . . . $84,000
Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23,705*
Total owners equity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 107,705
Total liabilities and owners equity . . . . . . . . . . . . . . . . . . . . . . . . . . . $115,700

*Note that in preparing the balance sheet, net income must be added to the beginning balance in Retained Earn-
ings and dividends must be subtracted ($16,500 $14,705 $7,500 $23,705).




6. The next step is to record the closing entries in the general journal and then post those en-
tries to the general ledger (T-accounts). T-accounts are shown with all previous entries and
the closing entries [items (s) and (t)] posted.
The first entry is to close the revenue account and each of the expense accounts.
Sales Revenue has a credit balance; it is debited to reduce the balance to zero. The ex-
pense accounts are closed by crediting them. The difference in total revenues and total
expenses is $14,705 (net income for the period). Net income represents an increase in
retained earnings. All of this is captured in the single, compound closing entry (s), as
follows:
(s) Sales Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 125,000
Cost of Goods Sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47,500
Salaries Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45,750
Utilities Expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 800
Advertising Expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . 650
Supplies Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,000
Building Rent Expense . . . . . . . . . . . . . . . . . . . . . . . . . . 12,000
Income Tax Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,595
Retained Earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14,705

Second, Dividends, a nominal account, must also be closed to Retained Earnings.
(t) Retained Earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,500
Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,500
177
f178 Completing The Accounting Cycle
Part 1 EOC Financial Reporting and the Accounting Cycle


Cash Accounts Receivable Inventory

Beg. (e) 66,500 Beg. (f) 102,000 Beg. (c) 47,500
bal. 17,500 (g) 600 bal. 17,000 bal. 28,800
(a) 30,000 (h) 850 (c) 102,900 (b) 49,500
(c) 22,100 (i) 45,000 Updated Updated
(d) 3,500 (j) 650 bal. 17,900 bal. 30,800
(f) 102,000 (k) 7,500
Updated
bal. 54,000


Supplies on Hand Prepaid Building Rental Prepaid Advertising

Beg. (m) 1,000 Beg. (o) 12,000 (h) 850 (n) 650
bal. 1,200 bal. 24,000 Updated
(g) 600 Updated bal. 200
Updated bal. 12,000
bal. 800


Accounts Payable Salaries Payable Utilities Payable

(e) 66,500 Beg. (l) 750 (p) 150
bal. 18,000
(b) 49,500
Updated
bal. 1,000


Income Taxes Payable Unearned Sales Revenue Capital Stock

(r) 2,595 (d) 3,500 Beg.
bal. 54,000
(a) 30,000
Updated
bal. 84,000


Retained Earnings Dividends Sales Revenue

(t) 7,500 Beg. (k) 7,500 (t) 7,500 (s) 125,000 (c) 125,000
bal. 16,500
(s) 14,705
Updated
bal. 23,705


Cost of Goods Sold Salaries Expense Utilities Expense

(c) 47,500 (s) 47,500 (i) 45,000 (s) 45,750 (j) 650 (s) 800
(l) 750 (p) 150




Advertising Expense Supplies Expense Building Rent Expense

(n) 650 (s) 650 (m) 1,000 (s) 1,000 (o) 12,000 (s) 12,000




Income Tax Expense

(r) 2,595 (s) 2,595
178 f179
Completing The Accounting Cycle EOC Chapter 4
Completing the Accounting Cycle


7. The final (optional) step in the accounting cycle is to prepare a post-closing trial balance.
This procedure is a check on the accuracy of the closing process. It is a listing of all ledger
account balances at year-end. Note that only real accounts appear because all nominal ac-
counts have been closed to a zero balance in preparation for the next accounting cycle.


Sports Haven Company
Post-Closing Trial Balance
December 31, 2003
Debits Credits

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $054,000
Accounts Receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17,900
Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30,800
Supplies on Hand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 800
Prepaid Building Rental . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,000
Prepaid Advertising . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 200
Accounts Payable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $001,000
Salaries Payable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 750
Utilities Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 150
Income Taxes Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,595
Unearned Sales Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,500
Capital Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84,000
Retained Earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23,705
Totals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $115,700 $115,700




discussion questions

1. Why are financial reports prepared on a periodic basis? 13. Of what value are the notes to the financial statements
2. Distinguish between reporting on a calendar-year and and the audit report, both of which are usually included
on a fiscal-year basis. in the annual report to shareholders?
3. When are revenues generally recognized (recorded)? 14. Describe the DuPont framework for analysis of finan-
4. What is the matching principle? cial statements.
5. Explain why accrual-basis accounting is more appropri- 15. What is a common-size financial statement? What are
ate than cash-basis accounting for most businesses. its advantages?
6. Why are accrual-based financial statements considered 16. What is the most informative section of the common-
somewhat tentative? size balance sheet? Explain.
7. Why are adjusting entries necessary? 17. Distinguish between real and nominal accounts.
8. Since there are usually no source documents for adjust- 18. What is the purpose of closing entries?
ing entries, how does the accountant know when to 19. What is the purpose of the post-closing trial balance?
make adjusting entries and for what amounts? Explain where the information for the post-closing trial
9. The analysis process for preparing adjusting entries in- balance comes from.
volves two basic steps. Identify the two steps and ex-
plain why both are necessary.
10. Why are supplies not considered inventory? What type
of account is Supplies on Hand?
11. Cash is not one of the accounts increased or decreased
20. Explain why there are alternative ways of recording cer-
in an adjusting entry. Why?
tain transactions, either as assets or expenses, or as lia-
12. Which are prepared first: the year-end financial state-
bilities or revenues.
ments or the general journal adjusting entries? Explain.
179
f180 Completing The Accounting Cycle
Part 1 EOC Financial Reporting and the Accounting Cycle




discussion cases

CASE 4-1 USING FINANCIAL STATEMENTS FOR INVESTMENT
DECISIONS
Several doctors are considering the purchase of a small real estate business as an investment. Be-
cause you have some training in the mechanics of the accounting cycle, they have hired you to
review the real estate company s accounting records and to prepare a balance sheet and an in-
come statement for their use. In analyzing various business documents, you verify the following
data.
The account balances at the beginning of the current year were as follows:
Cash in Bank . . . . . . . . . . . . . . . . . . . . . . . . . $07,800
Notes Receivable (from Current Owner) . . . . . 10,000
Supplies on Hand . . . . . . . . . . . . . . . . . . . . . . 750
Prepaid Office Rent. . . . . . . . . . . . . . . . . . . . . 4,500
Accounts Payable . . . . . . . . . . . . . . . . . . . . . . 450
Owners Equity . . . . . . . . . . . . . . . . . . . . . . . . 22,600

During the current year, the following summarized transactions took place:
a. The owner paid $1,200 to the business to cover the interest on the note receivable ($10,000
0.12 1 year). Nothing was paid on the principal.
b. Real estate commissions earned during the year totaled $45,500. Of this amount, $1,000
has not been received by year-end.
c. The company purchased $500 of supplies during the year. A count at year-end shows $300
worth still on hand.
d. The $4,500 paid for office rental was for 18 months, beginning in January of this year.
e. Utilities paid during the year amounted to $1,500.
f. During the year, $400 of accounts payable were paid; the balance in Accounts Payable at
year-end is $300, with the adjustment being debited to Miscellaneous Office Expense.
g. The owner paid himself $1,500 a month as a salary and paid a part-time secretary $2,400
for the year. (Ignore payroll taxes.)
On the basis of the above data, prepare a balance sheet and an income statement for the real es-
tate business. Does the business appear profitable? Does the balance sheet raise any questions or
concerns? What other information might the doctors want to consider in making this invest-
ment decision?

ACCOUNTING AND ETHICAL ISSUES INVOLVING THE
CASE 4-2
CLOSING PROCESS
Silva and Wanita Rodriques are the owners of Year-Round Landscape, Inc., a small landscape
and yard service business in southern California. The business is three years old and has grown
significantly, especially during the past year. To sustain this growth, Year-Round Landscape must
expand operations.
In the past, the Rodriques have been able to secure funds for the business from personal
resources. Now those resources are exhausted, and the Rodriques are seeking a loan from a lo-
cal bank.
To satisfy bank requirements, Year-Round Landscape, Inc., must provide a set of financial
statements, including comparative income statements showing the growth in earnings over the
past three years. In analyzing the records, Silva notices that the nominal accounts have not yet
been closed for this year. Furthermore, Silva is aware of a major contract that is to be signed on
January 3, only three days after the December 31 year-end for the business. Silva suggests that
the closing process be delayed one week so that this major contract can be included in this year s
operating results. Silva estimates that this contract will increase current year earnings by 20%.
What accounting issues are involved in this case? What are the ethical issues?
180 f181
Completing The Accounting Cycle EOC Chapter 4
Completing the Accounting Cycle



CASE 4-3 WRESTLING WITH YOUR CONSCIENCE AND GAAP
You are the controller for South Valley Industries. Your assistant has just completed the finan-
cial statements for the current year and has given them to you for review. A copy of the state-
ments also has been given to the president of the company. The income statement reports a net
income for the year of $50,000 and earnings per share of $2.50.
In reviewing the statements, you realize the assistant neglected to record adjusting entries.
After making the necessary adjustments, the company shows a net loss of $10,000. The differ-
ence is due to an unusually large amount of unrecorded expenses at year-end. You realize that
these expenses are not likely to be found by the independent auditors.
You wonder if it would be better to delay the recording of the expenses until the first part
of the subsequent year in order to avoid reporting a net loss on the income statement for the
current year. A significant increase in revenues is expected in the coming year, and the expenses
in question could be absorbed by the higher revenues.
What issues are involved in this case? What course of action would you take?


CASE 4-4 MAKING SURE OPERATING RESULTS ARE ACCURATE
Dian Karen and Kathy Gillen are considering forming a company to purchase a small business
that specializes in interior decoration services. The business records show a modest profit over
each of the past five years (approximately $5,000 net income per year). However, the past year s
operating results appear to be much better, as shown by the unaudited income statement.


Fashion Design, Inc.
Income Statement
For the Year Ended December 31, 2003

Revenues:
Consulting revenues. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $51,000
Commissions on furnishings sold. . . . . . . . . . . . . . . . . . . . . . . . . . . 18,000
Total revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $69,000
Expenses:
Advertising expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,200
Rent expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,800
Salaries expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36,000
Supplies expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 500
Utilities expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,800
Other expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,500 45,800
Income before taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $23,200
Income taxes (estimated at 25%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,800
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $17,400
EPS: $17,400 1,000 shares $17.40 per share



In an attempt to verify what appears to be unusually high net income for 2003, Karen and
Gillen hire a CPA to audit the records. The CPA discovers the following:
a. The company pays salaries on the 1st and 15th of each month. Salaries amounting to $2,500
have been earned by employees by December 31 but will not be paid until January 1. No
adjusting entry has been made.
b. Of the $18,000 in commissions received by December 31, 30% will not be earned until
completion of a job in mid-February of 2004. All commissions received have been recorded
as revenues.
c. A $10,000 payment was received on November 1 for a consulting assignment that is only
one-half earned at December 31. The total amount was credited to Consulting Revenues
when received.
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f182 Completing The Accounting Cycle
Part 1 EOC Financial Reporting and the Accounting Cycle


d. The rent is $400 per month and must be paid in advance on a one-year lease. A check for
$4,800 was given to the landlord on March 1, 2003, and recorded as rent expense on that
date.
According to the CPA, except for these data, the income statement appears to accurately
reflect the operating results of Fashion Design, Inc.
Answer the following questions:
1. Do the 2003 operating results offer encouragement to Karen and Gillen as potential in-
vestors? Explain.
2. What adjustments (if any) are required to make the income statement more accurately re-
flect the results of operations for the year?
3. What is the impact on the balance sheet (if any) of the data discovered by the CPA?




exercises

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