Accounting1 Chapter 8 (Completing the Accounting Cycle)
Accounting1 Chapter 8 (Completing the Accounting Cycle)
Grade 11 Accounting
Textbook: Accounting 1 (7th edition) By: George Syme, Tim Ireland and Colin Dodds.
8.1-The Adjustment Process
- Adjusting entries are completed prior to preparing financial statements (financial statements need to be reliable, relevant and comparableĀ
Accrual Accounting
Accrual:Ā to grow or accumulate over timeĀ
- Accrual accounting means to attempt to record revenues and expenses when they happen, regardless of whether cash is received or paidĀ
Financial Statement Comparability
Time Period Concept:Ā Assumes accounting will take place in fiscal periodsĀ
- Ensures that comparability objectivity is metĀ
- Financial statements from a business/ businesses will be compared over theĀ sameĀ amount of time
Adjusting the Accounts
- Fixing the accounts according to what financial information pertains to certain fiscal periodsĀ
Adjusting Entry:Ā A journal entry that assigns an amount of revenue or expense to the appropriate accounting period, bringing the balance sheet to itās true value.
- Year end financial statements are superior to interim financial statements
Adjusting entries help to ensureĀ
- Accounts are brought up to dateĀ
- Late transactions are taken into account
- Calculations have been made correctlyĀ
- Accounting principles and standards have been followedĀ
In the Income Statement
Revenue Recognition Principle:Ā Record revenue as soon as it is earned.Ā
Matching Principle:Ā Matching the expenses to the revenue it helps earn.
In the Balance SheetĀ
Cost Principle:Ā Assets are recorded at the historical cost (record the original cost, even if the value increases).
Principle of Conservatism:Ā Assets cannot be overstated or understated, it is always better to err on the side of cautionĀ
TO NOTE:
Every adjusting entry will always affect a balance sheet and an income statement account.
Adjusting Entry ClassificationsĀ
2 Classifications:Ā
- Accruals- accumulate over timeĀ
- Prepayments- items paid in cash prior to being used/ earned
Accrual Adjusting Entries
- Accrued Expenses: Late Purchase Invoice
- Accrued Revenue: Revenue earned but not yet recordedĀ
Prepayment Adjusting Entries
- Prepaid (Unearned) Revenue: Received payment prior to being earnedĀ
- Prepaid Expenses: Supplies, Prepaids and AmortizationĀ
Adjusting Entries- SuppliesĀ
- Supplies are used daily during the fiscal periodĀ
Taking Inventory:Ā At the end of the fiscal period, supplies that are left over by the business are counted and valuedĀ
Example;Ā
- Office supplies had a beginning balance of $6,000
- Over the fiscal period, 3 purchases were made bringing the balance to $15,000Ā
- At the end of the fiscal period, it is discovered that there are actually $3,000 worth of supplies left (inventory count)
Account balance-Inventory count = Amount usedĀ
$15,000-3,000= 12,000
Adjusting Entry (Dec 31, 2021)
Supplies Expense $12,000
Ā Ā Ā Ā Supplies $12,000
To adjust for the inventory count of $3,000
Adjusting Entries- Prepaid ExpensesĀ
- Some expenses are paid in advance and have benefits that exceed beyond the fiscal year
- This can include things like prepaid insurance
Example;Ā
- Your company paid auto insurance for one year, starting September 1st 2020 at a cost of $1,800
- At the end of the fiscal period, the balance of the prepaid insurance is $1,800
(Months not used/ Months paid) x Monthly rate = Ending balance in prepaid insurance
(8/12) x $1,800 =1,200 ending balance in prepaid insuranceĀ
Beginning balance-Ending balance = UsageĀ
$1,800-$1,200= $600
OR
(Months used/ Months paid) x Monthly Rate = Usage
(4/12) x $1,800 =$600
Adjusting Entry (December 31, 2021)
Insurance Expense $600Ā
Prepaid Insurance $600
To adjust for the four months of expired insurance
Adjusting Entries- Late Arriving PurchasesĀ
- Financial statements are prepared after the fiscal period has endedĀ
- Late Invoices or bills that arrive must be taken into account for the fiscal period that it affectsĀ
Example;Ā
- Jan 15 2020, several late arriving invoices have been received that are applicable to the previous fiscal yearĀ
- Telephone Expense $212Ā
- Utilities Expense $315Ā
Adjusting Entry (December 31, 2019)
Telephone Expense $212
Utilities Expense $315Ā
Accounts Payable $527
To record the 2019 invoices that arrived in 2020
Adjusting Entries-Unearned RevenueĀ
Unearned Revenue:Ā Revenue for which the cash has been received, but the good/service has not yet been provided (pending good/service) (Unearned revenue is aĀ liability)
- Record the revenue as earned when it is first receivedĀ
- Record the revenue as unearned when it is first receivedĀ
Example;Ā
- Deposited a cheque for $5,000 on December 23, 2020 for work that is to be done in January and February of 2021
Journal Entry (December 23, 2020)
Bank $5,000
Ā Ā Ā Ā Revenue $5,000
To record a cheque deposited for service to be done at a later date, revenue recognized
Adjusting Entry (December 30, 2020)
Revenue $5,000
Ā Ā Ā Ā Unearned Revenue $5,000Ā
To adjust for the cash advance payment received
8.2- Adjusting the Entries and the WorksheetĀ
8 columns on the worksheet:Ā
- Trial Balance (DR and CR)Ā
- Adjustments (DR and CR)
- Income Statement (DR and CR)Ā
- Balance Sheet (DR and CR)Ā
When writing the adjustments, write them in the adjustment column as follows:Ā
Eg; Insurance Expense $2494 (in the Adjustment DR column)
Ā Ā Ā Ā Prepaid Insurance $2494 (in the Adjustment CR column)
To complete the worksheet:Ā
Complete the balance sheet and Income Statement columnĀ
Balance Sheet:Ā Assets, Liabilities, Capital, DrawingsĀ
Income Statement:Ā Revenue and Expenses
A completed worksheet:Ā
8.3- Closing Entries ConceptsĀ
Real Accounts and Nominal Accounts
Real Accounts (Permanent Account):Ā Accounts that have balances that continue into the next fiscal periodĀ
- Asset and Liability and Ownerās Capital AccountĀ
Nominal accounts (Temporary Account):Ā Accounts that have balances that do not continue into the next fiscal periodĀ
- Revenue, Expense and Drawing accountsĀ
- All nominal accounts begin each fiscal period with a zero or nil balanceĀ
- Nominal accounts (except Drawings) are related to the income statementĀ
Income Summary Account:
- Special type of nominal accountĀ
- Used during the closing entry process
- Summarizes the revenue and expenses of the fiscal periodĀ
- The temporary balance of this account represents the net income or net lossĀ
Closing the Accounts:Ā means to cause it to have no balance.Ā
The nominal accounts are closed at the end of the fiscal period.Ā
End-of-the Year ProcedureĀ
- Bring the accounts up-to-date by journalizing and posting the adjusting entriesĀ
- Close the nominal accounts to prepare them for the next fiscal period
Transfer the balances of the revenue accounts to the new Income Summary AccountĀ
- These figures are found on the income statement credit columnĀ
- Revenue accounts have credit balances, debit balances are needed to close them out
Dec 31 RevenueĀ
Ā Ā Ā Ā Ā Ā Ā Ā Income SummaryĀ
Transfer the balances of the expense accounts to the new Income Summary Account
- The figures for this closing entry are found in the debit column of the Income Statement
- Expense accounts have debit balances, credit balances are needed to close themĀ
Dec 31 Income SummaryĀ
Ā Ā Ā Ā Ā Ā Ā Ā Expenses
Transfer the balances of the Income Summary to the Capital AccountĀ
- If the Income summaryĀ accountĀ has a credit balance, a debit entry is needed to close itĀ
- If the Income summaryĀ accountĀ has a debit balance, a credit entry is needed to close itĀ
Net IncomeĀ
Dec 31 Ā Ā Ā Ā Ā Income SummaryĀ
Ā Ā Ā Ā Ā Ā Ā Ā Ā CapitalĀ
Net LossĀ
Dec 31 CapitalĀ
Ā Ā Ā Ā Ā Income SummaryĀ
Transfer the balances of the Drawings account to the capital accountĀ
- Drawings account always has a debit balance, a credit balance is needed to close the account
Dec 31 CapitalĀ
Ā Ā Ā Ā Ā Ā Ā Ā DrawingsĀ
R-evenueĀ
E-xpenseĀ
I-ncomeĀ
D-rawings
- When the above procedure is completed, all the nominal accounts will have a zero balanceĀ
- The Capital account will continue to the next fiscal period and will have an updated balance (this represents the beginning capital for the next fiscal period)Ā
- Take off a post-closing trial balanceĀ
A trial balance is taken off to ensure that the ledger is still in balanceĀ
A post closing trial balance is taken as soon as the closing entries have been posted
8.4- Amortization
- Depreciation is also called fixed assets, capital equipment and plant and equipment
- Every long term asset is expected to be used up in the course of time (except land)Ā
Depreciation:Ā Refers to an allowance made for the decrease in the value of an asset over time. Also referred to asĀ amortization of an asset.
Amortization:Ā Means to transfer value.Ā
- All long term assets except for land are amortized over their useful life so that the balance sheet wonāt be overstatedĀ
Prepayments- Amortization ExpenseĀ
DR Amortization ExpenseĀ
Ā Ā Ā Ā Ā CR Accumulated AmortizationĀ
Accumulated Amortization:Ā the total amount of amortization expense over the life of an asset.Ā
HOW TO CALCULATE AMOUNT OF DEPRECIATION
- Straight-line MethodĀ
- Declining Balance MethodĀ
- Canada Revenue Agency MethodĀ
Cost:Ā amount paid for the assetsĀ
EUL:Ā Estimated useful life (how long the asset will last)Ā
RV/SV:Ā Residual value/salvage value (what the asset will be worth at the end of its useful life)
Net Book Value:Ā Cost-Accumulated AmortizationĀ
Straight-line Method
Formula: (Cost-RV/SV) / EUL = Amortization per yearĀ
+For a shorter year, the amortization needs to be adjustedĀ
Accumulated Depreciation Account: known as a valuation orĀ contra account
---
Adjusting Entry for Depreciation
Depreciation Expense Ā (seen on income statement)
Ā Ā Ā Ā Accumulated Depreciation (deducted from the fixed asset on the balance sheet)Ā
Declining Balance Method
Formula: NBV x Rate Ā = Amortization/YearĀ
Rate: Predetermined by CRA as shown belowĀ
Accounting1 Chapter 8 (Completing the Accounting Cycle)
Grade 11 Accounting
Textbook: Accounting 1 (7th edition) By: George Syme, Tim Ireland and Colin Dodds.
8.1-The Adjustment Process
- Adjusting entries are completed prior to preparing financial statements (financial statements need to be reliable, relevant and comparableĀ
Accrual Accounting
Accrual:Ā to grow or accumulate over timeĀ
- Accrual accounting means to attempt to record revenues and expenses when they happen, regardless of whether cash is received or paidĀ
Financial Statement Comparability
Time Period Concept:Ā Assumes accounting will take place in fiscal periodsĀ
- Ensures that comparability objectivity is metĀ
- Financial statements from a business/ businesses will be compared over theĀ sameĀ amount of time
Adjusting the Accounts
- Fixing the accounts according to what financial information pertains to certain fiscal periodsĀ
Adjusting Entry:Ā A journal entry that assigns an amount of revenue or expense to the appropriate accounting period, bringing the balance sheet to itās true value.
- Year end financial statements are superior to interim financial statements
Adjusting entries help to ensureĀ
- Accounts are brought up to dateĀ
- Late transactions are taken into account
- Calculations have been made correctlyĀ
- Accounting principles and standards have been followedĀ
In the Income Statement
Revenue Recognition Principle:Ā Record revenue as soon as it is earned.Ā
Matching Principle:Ā Matching the expenses to the revenue it helps earn.
In the Balance SheetĀ
Cost Principle:Ā Assets are recorded at the historical cost (record the original cost, even if the value increases).
Principle of Conservatism:Ā Assets cannot be overstated or understated, it is always better to err on the side of cautionĀ
TO NOTE:
Every adjusting entry will always affect a balance sheet and an income statement account.
Adjusting Entry ClassificationsĀ
2 Classifications:Ā
- Accruals- accumulate over timeĀ
- Prepayments- items paid in cash prior to being used/ earned
Accrual Adjusting Entries
- Accrued Expenses: Late Purchase Invoice
- Accrued Revenue: Revenue earned but not yet recordedĀ
Prepayment Adjusting Entries
- Prepaid (Unearned) Revenue: Received payment prior to being earnedĀ
- Prepaid Expenses: Supplies, Prepaids and AmortizationĀ
Adjusting Entries- SuppliesĀ
- Supplies are used daily during the fiscal periodĀ
Taking Inventory:Ā At the end of the fiscal period, supplies that are left over by the business are counted and valuedĀ
Example;Ā
- Office supplies had a beginning balance of $6,000
- Over the fiscal period, 3 purchases were made bringing the balance to $15,000Ā
- At the end of the fiscal period, it is discovered that there are actually $3,000 worth of supplies left (inventory count)
Account balance-Inventory count = Amount usedĀ
$15,000-3,000= 12,000
Adjusting Entry (Dec 31, 2021)
Supplies Expense $12,000
Ā Ā Ā Ā Supplies $12,000
To adjust for the inventory count of $3,000
Adjusting Entries- Prepaid ExpensesĀ
- Some expenses are paid in advance and have benefits that exceed beyond the fiscal year
- This can include things like prepaid insurance
Example;Ā
- Your company paid auto insurance for one year, starting September 1st 2020 at a cost of $1,800
- At the end of the fiscal period, the balance of the prepaid insurance is $1,800
(Months not used/ Months paid) x Monthly rate = Ending balance in prepaid insurance
(8/12) x $1,800 =1,200 ending balance in prepaid insuranceĀ
Beginning balance-Ending balance = UsageĀ
$1,800-$1,200= $600
OR
(Months used/ Months paid) x Monthly Rate = Usage
(4/12) x $1,800 =$600
Adjusting Entry (December 31, 2021)
Insurance Expense $600Ā
Prepaid Insurance $600
To adjust for the four months of expired insurance
Adjusting Entries- Late Arriving PurchasesĀ
- Financial statements are prepared after the fiscal period has endedĀ
- Late Invoices or bills that arrive must be taken into account for the fiscal period that it affectsĀ
Example;Ā
- Jan 15 2020, several late arriving invoices have been received that are applicable to the previous fiscal yearĀ
- Telephone Expense $212Ā
- Utilities Expense $315Ā
Adjusting Entry (December 31, 2019)
Telephone Expense $212
Utilities Expense $315Ā
Accounts Payable $527
To record the 2019 invoices that arrived in 2020
Adjusting Entries-Unearned RevenueĀ
Unearned Revenue:Ā Revenue for which the cash has been received, but the good/service has not yet been provided (pending good/service) (Unearned revenue is aĀ liability)
- Record the revenue as earned when it is first receivedĀ
- Record the revenue as unearned when it is first receivedĀ
Example;Ā
- Deposited a cheque for $5,000 on December 23, 2020 for work that is to be done in January and February of 2021
Journal Entry (December 23, 2020)
Bank $5,000
Ā Ā Ā Ā Revenue $5,000
To record a cheque deposited for service to be done at a later date, revenue recognized
Adjusting Entry (December 30, 2020)
Revenue $5,000
Ā Ā Ā Ā Unearned Revenue $5,000Ā
To adjust for the cash advance payment received
8.2- Adjusting the Entries and the WorksheetĀ
8 columns on the worksheet:Ā
- Trial Balance (DR and CR)Ā
- Adjustments (DR and CR)
- Income Statement (DR and CR)Ā
- Balance Sheet (DR and CR)Ā
When writing the adjustments, write them in the adjustment column as follows:Ā
Eg; Insurance Expense $2494 (in the Adjustment DR column)
Ā Ā Ā Ā Prepaid Insurance $2494 (in the Adjustment CR column)
To complete the worksheet:Ā
Complete the balance sheet and Income Statement columnĀ
Balance Sheet:Ā Assets, Liabilities, Capital, DrawingsĀ
Income Statement:Ā Revenue and Expenses
A completed worksheet:Ā
8.3- Closing Entries ConceptsĀ
Real Accounts and Nominal Accounts
Real Accounts (Permanent Account):Ā Accounts that have balances that continue into the next fiscal periodĀ
- Asset and Liability and Ownerās Capital AccountĀ
Nominal accounts (Temporary Account):Ā Accounts that have balances that do not continue into the next fiscal periodĀ
- Revenue, Expense and Drawing accountsĀ
- All nominal accounts begin each fiscal period with a zero or nil balanceĀ
- Nominal accounts (except Drawings) are related to the income statementĀ
Income Summary Account:
- Special type of nominal accountĀ
- Used during the closing entry process
- Summarizes the revenue and expenses of the fiscal periodĀ
- The temporary balance of this account represents the net income or net lossĀ
Closing the Accounts:Ā means to cause it to have no balance.Ā
The nominal accounts are closed at the end of the fiscal period.Ā
End-of-the Year ProcedureĀ
- Bring the accounts up-to-date by journalizing and posting the adjusting entriesĀ
- Close the nominal accounts to prepare them for the next fiscal period
Transfer the balances of the revenue accounts to the new Income Summary AccountĀ
- These figures are found on the income statement credit columnĀ
- Revenue accounts have credit balances, debit balances are needed to close them out
Dec 31 RevenueĀ
Ā Ā Ā Ā Ā Ā Ā Ā Income SummaryĀ
Transfer the balances of the expense accounts to the new Income Summary Account
- The figures for this closing entry are found in the debit column of the Income Statement
- Expense accounts have debit balances, credit balances are needed to close themĀ
Dec 31 Income SummaryĀ
Ā Ā Ā Ā Ā Ā Ā Ā Expenses
Transfer the balances of the Income Summary to the Capital AccountĀ
- If the Income summaryĀ accountĀ has a credit balance, a debit entry is needed to close itĀ
- If the Income summaryĀ accountĀ has a debit balance, a credit entry is needed to close itĀ
Net IncomeĀ
Dec 31 Ā Ā Ā Ā Ā Income SummaryĀ
Ā Ā Ā Ā Ā Ā Ā Ā Ā CapitalĀ
Net LossĀ
Dec 31 CapitalĀ
Ā Ā Ā Ā Ā Income SummaryĀ
Transfer the balances of the Drawings account to the capital accountĀ
- Drawings account always has a debit balance, a credit balance is needed to close the account
Dec 31 CapitalĀ
Ā Ā Ā Ā Ā Ā Ā Ā DrawingsĀ
R-evenueĀ
E-xpenseĀ
I-ncomeĀ
D-rawings
- When the above procedure is completed, all the nominal accounts will have a zero balanceĀ
- The Capital account will continue to the next fiscal period and will have an updated balance (this represents the beginning capital for the next fiscal period)Ā
- Take off a post-closing trial balanceĀ
A trial balance is taken off to ensure that the ledger is still in balanceĀ
A post closing trial balance is taken as soon as the closing entries have been posted
8.4- Amortization
- Depreciation is also called fixed assets, capital equipment and plant and equipment
- Every long term asset is expected to be used up in the course of time (except land)Ā
Depreciation:Ā Refers to an allowance made for the decrease in the value of an asset over time. Also referred to asĀ amortization of an asset.
Amortization:Ā Means to transfer value.Ā
- All long term assets except for land are amortized over their useful life so that the balance sheet wonāt be overstatedĀ
Prepayments- Amortization ExpenseĀ
DR Amortization ExpenseĀ
Ā Ā Ā Ā Ā CR Accumulated AmortizationĀ
Accumulated Amortization:Ā the total amount of amortization expense over the life of an asset.Ā
HOW TO CALCULATE AMOUNT OF DEPRECIATION
- Straight-line MethodĀ
- Declining Balance MethodĀ
- Canada Revenue Agency MethodĀ
Cost:Ā amount paid for the assetsĀ
EUL:Ā Estimated useful life (how long the asset will last)Ā
RV/SV:Ā Residual value/salvage value (what the asset will be worth at the end of its useful life)
Net Book Value:Ā Cost-Accumulated AmortizationĀ
Straight-line Method
Formula: (Cost-RV/SV) / EUL = Amortization per yearĀ
+For a shorter year, the amortization needs to be adjustedĀ
Accumulated Depreciation Account: known as a valuation orĀ contra account
---
Adjusting Entry for Depreciation
Depreciation Expense Ā (seen on income statement)
Ā Ā Ā Ā Accumulated Depreciation (deducted from the fixed asset on the balance sheet)Ā
Declining Balance Method
Formula: NBV x Rate Ā = Amortization/YearĀ
Rate: Predetermined by CRA as shown belowĀ