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 comparable 

Accrual Accounting

Accrual: to grow or accumulate over time 

• Accrual accounting means to attempt to record revenues and expenses when they happen, regardless of whether cash is received or paid 

Financial Statement Comparability

Time Period Concept: Assumes accounting will take place in fiscal periods 

• Ensures that comparability objectivity is met 

• Financial statements from a business/ businesses will be compared over the same amount of time

Adjusting the Accounts

• Fixing the accounts according to what financial information pertains to certain fiscal periods 

Adjusting Entry: A journal entry that assigns an amount of revenue or expense to the appropriate accounting period, bringing the balance sheet to it’s true value.

• Year end financial statements are superior to interim financial statements

Adjusting entries help to ensure 

1. Accounts are brought up to date 

2. Late transactions are taken into account

3. Calculations have been made correctly 

4. Accounting principles and standards have been followed 

In the Income Statement

Revenue Recognition Principle: Record revenue as soon as it is earned. 

Matching Principle: Matching the expenses to the revenue it helps earn.

In the Balance Sheet 

Cost Principle: Assets are recorded at the historical cost (record the original cost, even if the value increases).

Principle of Conservatism: Assets cannot be overstated or understated, it is always better to err on the side of caution 

TO NOTE:

Every adjusting entry will always affect a balance sheet and an income statement account.

Adjusting Entry Classifications 

2 Classifications: 

1. Accruals- accumulate over time 

2. Prepayments- items paid in cash prior to being used/ earned

Accrual Adjusting Entries

1. Accrued Expenses: Late Purchase Invoice

2. Accrued Revenue: Revenue earned but not yet recorded 

Prepayment Adjusting Entries

1. Prepaid (Unearned) Revenue: Received payment prior to being earned 

2. Prepaid Expenses: Supplies, Prepaids and Amortization 

Adjusting Entries- Supplies 

• Supplies are used daily during the fiscal period 

Taking Inventory: At the end of the fiscal period, supplies that are left over by the business are counted and valued 

Example; 

• Office supplies had a beginning balance of $6,000

• Over the fiscal period, 3 purchases were made bringing the balance to $15,000 

• 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 used 

$15,000-3,000= 12,000

Adjusting Entry (Dec 31, 2021)

Supplies Expense $12,000

        Supplies $12,000

To adjust for the inventory count of $3,000

Adjusting Entries- Prepaid Expenses 

• Some expenses are paid in advance and have benefits that exceed beyond the fiscal year

• This can include things like prepaid insurance

Example; 

• 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 insurance 

Beginning balance-Ending balance = Usage 

$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 $600 

Prepaid Insurance $600

To adjust for the four months of expired insurance

Adjusting Entries- Late Arriving Purchases 

• Financial statements are prepared after the fiscal period has ended 

• Late Invoices or bills that arrive must be taken into account for the fiscal period that it affects 

Example; 

• Jan 15 2020, several late arriving invoices have been received that are applicable to the previous fiscal year 

• Telephone Expense $212 

• Utilities Expense $315 

Adjusting Entry (December 31, 2019)

Telephone Expense $212

Utilities Expense $315 

Accounts Payable $527

To record the 2019 invoices that arrived in 2020

Adjusting Entries-Unearned Revenue 

Unearned Revenue: Revenue for which the cash has been received, but the good/service has not yet been provided (pending good/service) (Unearned revenue is a liability)

1. Record the revenue as earned when it is first received 

2. Record the revenue as unearned when it is first received 

Example; 

• 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

        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

        Unearned Revenue $5,000 

To adjust for the cash advance payment received

8.2- Adjusting the Entries and the Worksheet 

8 columns on the worksheet: 

• Trial Balance (DR and CR) 

• Adjustments (DR and CR)

• Income Statement (DR and CR) 

• Balance Sheet (DR and CR) 

When writing the adjustments, write them in the adjustment column as follows: 

Eg; Insurance Expense $2494 (in the Adjustment DR column)

        Prepaid Insurance $2494 (in the Adjustment CR column)

To complete the worksheet: 

Complete the balance sheet and Income Statement column 

Balance Sheet: Assets, Liabilities, Capital, Drawings 

Income Statement: Revenue and Expenses

A completed worksheet: 

8.3- Closing Entries Concepts 

Real Accounts and Nominal Accounts

Real Accounts (Permanent Account): Accounts that have balances that continue into the next fiscal period 

• Asset and Liability and Owner’s Capital Account 

Nominal accounts (Temporary Account): Accounts that have balances that do not continue into the next fiscal period 

• Revenue, Expense and Drawing accounts 

• All nominal accounts begin each fiscal period with a zero or nil balance 

• Nominal accounts (except Drawings) are related to the income statement 

Income Summary Account:

• Special type of nominal account 

• Used during the closing entry process

• Summarizes the revenue and expenses of the fiscal period 

• The temporary balance of this account represents the net income or net loss 

Closing the Accounts: means to cause it to have no balance. 

The nominal accounts are closed at the end of the fiscal period. 

End-of-the Year Procedure 

1. Bring the accounts up-to-date by journalizing and posting the adjusting entries 

2. Close the nominal accounts to prepare them for the next fiscal period

Transfer the balances of the revenue accounts to the new Income Summary Account 

• These figures are found on the income statement credit column 

• Revenue accounts have credit balances, debit balances are needed to close them out

Dec 31 Revenue 

                Income Summary 

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 them 

Dec 31 Income Summary 

                Expenses

Transfer the balances of the Income Summary to the Capital Account 

• If the Income summary account has a credit balance, a debit entry is needed to close it 

• If the Income summary account has a debit balance, a credit entry is needed to close it 

Net Income 

Dec 31          Income Summary 

                 Capital 

Net Loss 

Dec 31 Capital 

         Income Summary 

Transfer the balances of the Drawings account to the capital account 

• Drawings account always has a debit balance, a credit balance is needed to close the account

Dec 31 Capital 

                Drawings 

R-evenue 

E-xpense 

I-ncome 

D-rawings

• When the above procedure is completed, all the nominal accounts will have a zero balance 

• 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) 

3. Take off a post-closing trial balance 

A trial balance is taken off to ensure that the ledger is still in balance 

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) 

Depreciation: Refers to an allowance made for the decrease in the value of an asset over time. Also referred to as amortization of an asset.

Amortization: Means to transfer value. 

• All long term assets except for land are amortized over their useful life so that the balance sheet won’t be overstated 

Prepayments- Amortization Expense 

DR Amortization Expense 

         CR Accumulated Amortization 

Accumulated Amortization: the total amount of amortization expense over the life of an asset. 

HOW TO CALCULATE AMOUNT OF DEPRECIATION

1. Straight-line Method 

2. Declining Balance Method 

3. Canada Revenue Agency Method 

Cost: amount paid for the assets 

EUL: Estimated useful life (how long the asset will last) 

RV/SV: Residual value/salvage value (what the asset will be worth at the end of its useful life)

Net Book Value: Cost-Accumulated Amortization 

Straight-line Method

Formula: (Cost-RV/SV) / EUL = Amortization per year 

+For a shorter year, the amortization needs to be adjusted 

Accumulated Depreciation Account: known as a valuation or contra account

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Adjusting Entry for Depreciation

Depreciation Expense  (seen on income statement)

        Accumulated Depreciation (deducted from the fixed asset on the balance sheet) 

Declining Balance Method

Formula: NBV x Rate  = Amortization/Year 

Rate: Predetermined by CRA as shown below