The Accounting Cycle (So Far)

The Accounting Cycle(So Far) • Analyze transactions • Record transactions in journal entries • Post journal entries to general ledger • Trial balance

Basic Elements of Accrual Accounting • Revenue recognition principle • Revenue is recognized when earned, rather than when collected • Matching principle • Expenses are incurred to generate revenues and are recognized in the same period that the revenues are recognized

Adjusting Entries • Recorded prior to preparation of financial statements • Needed to bring accounts into conformity with accrual accounting • Purpose of adjusting entries • Recognize revenues in the period earned • Match expenses with revenues

Types of Adjusting Entries

Prepayments – Unearned Revenues • Have been collected but not earned • Reported as liabilities until earned • Example: • On Dec 1, 2004, Alpha Co. collects $6,000 in rent revenue for the next 6 months • At Dec 31, 2004, $1,000 (1 month) is earned (revenue); $5,000 (5 months) is unearned (liability)

Prepayments – Prepaid Expenses • Have been paid but not incurred • (not used to generate revenues) • Reported as assets until used or consumed • Example: • On Jun 1, 2004, Beta Co. pays a 12 month insurance premium for $1,200 • At Jun 30, 1 month ($100) is incurred (expense); 11 months ($1,100) is prepaid (asset)

Prepayments – Long-lived Assets • Have been purchased (paid for) but will be used to generate revenues for several future reporting periods • Reported as assets (Plant & Equipment) • Cost is matched with revenues generated through Depreciation Expense

Accrued Revenues (Receivables) • Have been earned but not collected • Reported as assets until received • Example: • Gamma Co. rents space in its warehouse during May; at May 31, they have not collected the $500 May rent • At May 31, $500 is earned (revenue) and collectible/receivable (asset)

Accrued Expenses (Payables) • Have been incurred (used to generate revenues) but not paid • Reported as liabilities until paid • Example: • On Jan 1, Delta Co. borrowed $10,000 at a 12% interest rate; at the end of Jan no interest has been paid on the loan • At Jan 31, interest of $100 (1 month) is incurred (expense) but not paid (liability/payable)

Examples ofAdjusting Entries

The Accounting Cycle(Continued) • Record adjusting entries • Post to general ledger • Adjusted trial balance • List of general ledger accounts and balances, after posting of adjusting entries • Prepare financial statements

Completing theAccounting Cycle • Record closing entries • Temporary accounts closed to Income Summary • Income Summary and Dividends closed to Retained Earnings • Post to general ledger • Post-closing trial balance • Start over again for the next period

The Accounting Cycle (So Far)