Chapter # 4

Completion of Accounting Cycle

Accounting Period & Financial Statements

For the purpose of measuring net income and preparing financial statements, the life of a business is divided into accounting periods of equal length.

Because accounting periods are equal in length, we can compare of the income of the current period with the prior periods to see if operating results are improving or declining.

Accounting Period & Financial Statements

The usual accounting period for which complete financial statements are prepared and distributed to investors, bankers, and government agencies in one year.

However , most businesses also prepare quarterly and monthly financial statements so that management will be informed on the profitability of the business from month to month.

Transaction affecting more than One Accounting Period

Dividing the life of a business into relatively short accounting periods requires the use of adjusting entries at the end of each accounting period.

Those transaction which affect the revenues and expenses of more than one accounting period requires adjusting entries.

Adjusting Entries: A Closer Look

Recall The Realization Concept The Matching Concept

Related terminologies

Expenses:

1. Prepaid Expenditures

2. Out-standing Expenses/ Accrued expenses

Revenues:

1. Pre-received Revenue

2. Out-standing Revenue/ Accrued revenue

Prepaid Expenses

That expenses which is paid but the benefits are not yet acquired from such expenditures.

They are assets of the business and recorded in the balance sheet.

At the end of each accounting period such expenditures need adjusting entries.

For example,

1. Prepaid salaries

2. Prepaid rent

3. Prepaid commission etc

Out-standing Expenses

Those expenses that occurred but not yet paid

We have to pay such expenses and hence these are the liabilities for the business and to be recorded in Balance Sheet. Out-standing expenses also called Accrued expenses.

Such expenses required adjusting entries at the end of Accounting Period.

For example:1. Out-standing salaries2. Out-standing rent of the building etc

Pre-received Revenue

That revenue which we received in advance, means prior to the supply of good or services provided.

Such revenues are liabilities for the business until goods are provided or services rendered. Therefore we have to record such revenue in our balance sheet’s liability side.

Pre-received revenues also required some adjustment at the end of accounting period.

Examples are:1. Pre-received sales’ amount2. Pre-received commission’s amount etc

Out-standing revenue/ Accrued revenue

That revenue which we have already earned but still we haven’t received.

Such revenue is our asset just like Account Receivable and we have to mention it on assets side in balance sheet.

Such revenues requires adjustment at the end of accounting period.

Examples are:1. Out-standing commission2. Out-standing sales amount etc

Types of Adjusting Entries

1. Entries to apportion recorded cost(for pre-paid expenses)

2. Entries to apportion un-earned revenue(for pre-received revenues)

3. Entries to record un-recorded expenses(for out-standing expenses)

4. Entries to record un-recorded revenues(for out-standing revenues)

Entries to apportion recorded cost(for pre-paid expenses)

On August 1st 2009:

Rent is paid to the owner of the building $ 12,000.

The journal entry would on 1st August:

Date Description R/No Dr. Cr.

Aug

1st

Prepaid rent Cash

(Rent paid for one year)

…..

$ 12,000$ 12,000

Entries to apportion recorded cost(for pre-paid expenses)

On August 31st 2009:

An adjusting entry is required to apportion the pre-paid expense.Rent paid for one year (means 12 months)….$ 12,000 Per month rent: $12,000/12 = $ 1,000.Rent for August…… $ 1,000

Date Description R/No Dr. Cr.

August

31st

Rent Expenses Prepaid rent

(adjusting the pre-paid rent)

…..

$ 1,000$ 1,000

Entries to apportion un-earned revenue(for pre-received revenues)

On 1st March 2009:

Commission received $ 24,000 for providing guidance for one year.

The journal entry would me made on 1st March.

Date Description R/No Dr. Cr.

March

1st

Cash Un-earned commission

(commission received in advance)

…..

$ 24,000$ 24,000

Entries to apportion un-earned revenue(for pre-received revenues)

On 31st March 2009:An adjusting entry is required to adjust the apportion the un-earned revenue.Commission received on march 1st $ 24,000 for one year (means 12 months)Per month commission: $24,000/12 = $2,000Commission of March, 2009…………$2,000

Date Description R/No Dr. Cr.

March

31st

Un-earned commission Commission earned

(adjusting commission account)

…..

$ 2,000$ 2,000

Entries to record un-recorded expenses(for out-standing expenses)

This is 31st March 2009 but salaries is to be paid to employees on every 4th date of next month as per company’s policy. Salaries of employees is amounting $ 1600 for the month.

4th of next month means salaries are to be paid on April 4th 2009.An adjusting entry is required to record such un-paid salaries.

Date Description R/No Dr. Cr.

March

31st

Salaries expenses Salary payable

(adjusting entry for out-standing salaries)

…..

$ 1600$ 1600

Entries to record un-recorded revenues(for out-standing revenues)

This is 31st August 2009. We have provided services to our customers but the commission is not yet received from them. Commission amount is $ 2,560.

An adjusting entry is required to record such out-standing revenue of the commission earned.

Date Description R/No Dr. Cr.

Aug

31st

Commission Receivable Commission earned

(adjusting entry for out-standing salaries)

…..

$ 2,560$ 2,560

The Work Sheet

In a manual accounting system, a Work Sheet is a large columnar sheet of paper, specially designed to arrange in a convenient systematic form, all the accounting data required at the end of the accounting period.

Work Sheet is not a permanent part of accounting records; it is just prepared by accountants for their own convenience.