The Accounting Cycle Preparing an Annual Report Accounting Help

Courtesy Genyrne Corporation

Courtesy Genyrne Corporation

No one can accuse Genzyme Corp., the biotech giant based In Cambridge, Mass., of being a technolog icallaggard. Its scientists work at theforeiront of biological research, while computer-controlled production equipment churns out bundreds of different advanced compounds.

Cowie is right about the Year 2000-and there’s growing evidence that he Is-a lot of businesses are in for a nasty shock. Up to now, skeptics have been able to pooh-pooh Year 2000 as a’ relatively easy-to-fix bug, an example of overheated hyp~ by consultants looking for a quick buck. But ihere’s. growing alarm in Washington and elsewhere.

As the year 2000 fast approaches, the final months of 1999 are likaly to be extremely hectic for computer programmers as they scramble to make last-minute software code changes. In the accounting profession, the final months of every year mark. an extremely hectic period that is often referred to as the “busy season.” Accounting is an ongoing, year-round activity. Decision makers need-and accountants provide-up-todate financial information on a daily bas. But the end of a company’s fiscal year is an especially busy time. Most companies close their accounts once each year-at their fiscal year-end. While this task is not as


Publicly owned companies-those with shares listed on a stock exchange-have obligations to relea~e annual and quarterly information to their stockholders and to the public. These companies don’t just prepare financial statements-they publish annual reports.

An’ annual report includes comparative financial statements for several years and a wealth of other information about the company’s financial position, business operations, and future prospects. But before these reports are issued, the financial statements must be alldited by a firm of certified public accountants (ePAs). Thus both the company’s accountants and the CPAs arc under great time pressure ~o.get their work done and the annual report issued. A copy of the annual report , is .sent to each stockholder; copies also are available to the general public upon request. Publicly owned companies also must file their audited financial statements and detailed supporting schedules with the Securities and Exchange Commission (SEC). And then there are the income tax returnsmaybe lots of income tax ‘returns

Many businesses expect their accounting departments to develop comprehensive budgets for the coming fiscal year. These budgets show in detail the planned ‘financial operations of every department within the organization, usually on a month-by-month basis. They are used throughout the year-both to coordinate the activities of different departments and as a basis for evaluating departmental performance. Much of the planning involved in the budgeting process is done well before year-end. Nonetheless. the work generally becomes much more intense as the new year approaches. As explained in Chapter 3, a company’s fiscal year need 1I0t coincide with-the calendar year. Some companies, elect to end their fiscal year during a seasonal IDwpoint in


We introduced adjusting entries in Chapter 3, using as examples the entries to record supplies expense -and depreciation expense. We will now see that other types of expenses and also revenue-may require adjustment at the end of the accounting period. – But first let us review the role of adjusting entries in the accounting cycle

Types of Adjusting Entries

The exact number of adjustments needed at the end of each accounting period depends on the nature of the company’s business activities. However. most adjusting entries fall into one of four general categoriesr’

example, Supplies, Unexpired Insurance, and so on) and by crediting Cash. In each future period that benefits from the use of this asset, an adjusting entry is made to allocate a portion of the asset’s cost to expense. This adjusting entry is recorded by debiting
the appropriate expense account (for example, Supplies Expense, Insurance Expense) and crediting the asset account.

2. Entries to apportion unearned revenue. A business may collect cash in advance for services to be rendered in future accounting periods. Transactions of this nature arc usually recorded by debiting Cash and by crediting a liability account (tyically calledUnearned Revenue). In the period that services are actually rendered, an adjusting entry is made to record the portion of revenue actually earned during the period. The adjusting entry is recorded by debiting Unearned Revenue and by crediting Revenue Earned for the value of the services’ rendered.

3. Entries to record unrecorded expenses. An expense may be incurred in the current accounting period even though no bill has been received and no cash payment will occur until a future period. These accrued expenses are recorded by an adjusting entry made at the end of the accounting period. The adjusting entry is recorded by debiting the appropriate expense account (for example, Interest Expense or Salary Expense) and by crediting the related liability. ”
4. Entries to record unrecorded revenue. Revenue may be earned, or accrue, during the current period, but not yet be collected or recorded in the accounting records. Revenue earned”, for which no cash has been collected, is recorded by an adjusting entry made at the end of the accounting period. The adjusting entry is recorded by debiting Accounts Receivable and “by crediting Revenue Earned.

Each of these adjusting entry categories is described in the diagram that appears on page 147.

Cash Effects

In an accrual accounting system,” there are often “timing differences” between-cash 110 ws and the recognition of expenses or revenue. A company can pay cash In advance of incurring any expense, or it can receive cash before earning any revenue. likewise, it can incur an expense before it pays any cash, or it can earn revenue before it receives any cash. These timing differences and the related adjusting entries they require are summarized below

• “Adjusting entries to apportion recorded costs result from cash being paid prior to an expense being incurred. ”
• Adjusting entries to apportion unearned revenue result from cash being received prior to revenue being earned. .”
• Adjusting entries to record unrecorded expenses result from expenses being incurred before cash is paid.
• Adjusting entries to record unrecorded revenue result from revenue being earned before cash is received



Year·End at Overnight Auto Service

To {llustrate the various types of adjustingentries, we will again use our example involving Overnight Auto Service. We will skip ahead to Decembcr.Jf , 2002-the end uf the company’s first. complete year of operations, This will enable us to illustrate the preparation of annual financial statements, rather than statements thut cover only asingle month

we assumed that Overnight adjusted and closed its accounts at the emf of each month. This allowed us to keep our first Illustration short, but closing the accounts every month is 1101 a common business practice. Most companies adjust their accounts every month but make closing entries only at year-end. We will assume that Overnight has been following this approach throughout 2002 The company’s unadjusted trial balance as of December ~I, 2002, appears below

When temporary accounts

When temporary accounts

Because Overnight now closes its accounts only at year-end, the balances in the revenue, expense, and owner’s drawing accounts represent the activities of the entire year rather than those of a single month. But Overnight last adjusted its accounts on November
30; therefore, it is still necessary to make adjusting entries for the month of December. In the next few pages we illustrate several transactions, as well as the related adjusting entries. Both are shownin the format of general journal entries. To help distinguish’ between transactions and adjusting entries, transactions will be shown in blue, and adjusting entries will be printed in

Prepaid Expenses

Payments in advance are often made for such items us insurance, rent, and office supplies. If the advance payment (or prepayment) will benefit more than just the current accountlng period, the cost represents 011 asset rather than an expense .The cost of this asset will be allocated to expense in the accounting periods in which the .services or the supplies arc used. In summary, “repaid expenses are assets; they become expenses only as the goods or services arc used up.

Shop Supplies

To illustrate, consider Overnight’s accounting policies for shop supplies. As supplies are purchased, their cost is debited to the usset account Shop Supplies. It is not practical to make journal entries every few minutes as supplies are used. Inslcad; 1in estimate is made of the supplies remaining onhand at the end of each month; the supplies that are “missing” arc assumed to have been used. Prior to making adjusting entries at December 3 I. the balance in Overnight’s Shop Supplies account is $\,t{OO. Assume that at December 3\, Mcbryan estimates there arc about $\ ,200 worth of shop supplies remaining on hand. This suggests supplies costing about $60n have been used in December; thus the following adjusting entry is made

Recording Prepayments diractly In the Expense Accounts

In our illustration, payments for shop supplies and ‘for insurance covering more than one period were debited to asset accounts. However, some companies follow an alternative policy of debiting such prepayments directly to an expense account, such as Supplies Expense. At the end of the period, the adjusting entry then would be to debit Shop Supplies and credit Supplies Expense for the cost of supplies that had not been used.

This alternative method leads to the same’ results as does the procedure used by Overnight. Under either approach; the cost of supplies used during the current period is treated as an expense, ana the cost of supplies still on hand is carried forward ift the balnce sheet as an asset

Depreciation of Buildings

The recording of depreciation expense at the end of an aecounting period provides another example of an adjusting entry that apportions a recorded cost. The adjusting entry to record depreciation on Overnight’s building is the same every month throughout the building’s estimated useful life (20 years). This entry.
essentially the same as illustrated in Chapter 3, is

The monthly depreciation expense is based on. the following facts: the building cost $36,000 and has an estimated useful life of 20 years (240 months). Under the straight line method of depreciation, the cost assumed to expire each month is ~40 of $36.000, or $150.3

Apportioning Unearned Revenue

In some instances, customers may pay in advance for services to be rendered in later accounting periods. For example, a football team collects much of its revenue in advance through the sale of season tickets. Health clubs collect in advance by selling long-term membership contracts, Airlines sell many of their tickets well in advance of a scheduled night.

For accounting purposes, amounts collected in advance do not represent revenue, because these amounts have not yet been earned. Amounts collected from customers in advance are recorded by debiting the Cash account and crediting an unearned revenue account. Unearned revenue also may be called deferred revenue.

When a company collects money in advance from its customers, it has an obligation to render services in the future. Therefore, the balance of an unearned revenue account is considered to be a liability; it appears in the liability section of the balance sheet, not in the income statement. Unearned revenue differs from other liabilities because it usually will be settled by rendering services, rather than by making payment in cash. In short, it will be worked off rather than paid off. Of course if the business is unable to render the service, it must discharge this liability by refunding money to its customers

Recording Advance Collections Directly in the Revenue Accounts

We have stressed that amounts collected from customers in advance represents liabilities, not revenue. However, some companies follow an accounting policy of crediting theseadvance col·- lections directly to revenue accounts. The adjusting entry then should consist of a debit . to the revenue account and a credit to the unearned revenue account for the portion of the advance payments not yet earned. This alternative accounting practice leads to the same results as does the method used in our illustration, In this text, we will follow the originally described practice of crediting advance payments from customers to an unearned revenue account

Recording Unrecorded Expenses

This type of adjusting entry recognizes expenses that will be paid infuture transactions; therefore, no cost has yet been recorded in the accounting records. Salaries of employees and interest on borrowed money are common examples of expenses that accumulate from day to day but that usually are not recorded until they arc paid. These expenses arc said to accrue over time, that is, to grow or to accumulate. At the end of the accounting period; an adjusting entry should be made to record any expenses that have accrued but that have not yet been recorded. Since these expenses will be paid at a future date, the adjusting entry consists of a debit to an expense account and a credit to a liability account. We shall now use the example of Overnight Auto Service to illustrate this type of adjusting’ entry

Accrual of Wages (or Salaries) Expense

Overnight, like many businesses, pays its ernployees every other Friday. This month, however, ends on a Wednesday-two days before the next scheduled payday. Thus Overnight’s employees have worked for more than a week in December for which they have not yet been paid. ‘ Time cards indicate that since the last payroll date, Overnight’s employees have worked .:’ total of 130 hours. Including payroll taxes, Overnight’s wage expense averages about $15 per hour. Therefore. at December 31, the company owes its employees approximately $/,950 for work performed in December,” The following adjusting entry, should be made to record this amount both as wages expense of the current period and as a liability:

Accrual of Interest Expens

In November 2001, Overnight purchased its building, an old bus garage, from Metropolitan Transit District. Overnight issued a $30,000 shortterm note payable for much of the purchase price. Unfortunately, Overnight has never been able to arrange long-term financing on the old bus garage. Instead, it has had to arrange a series of short-term Ioans-s-usually only. three to six months in term. The proceeds of each new loan are used to rt~~”aythe previous loan that is coming due.

Recording, Unrecorded Revenue

A business may earn revenue during the current accounting period but not bill the customer until a future accounting period. This situation is likely to occur if additional services are being performed for the same customer. if’ which case the bill might not be prepared until 0,11 services are completed. Any revenue that has been earned but not recorded during the current accounting period should be recorded at the end of the period by means of an adjustirig entry. This adjusting entry consists of a debit to an account receivable and a credit to the. appropriate revenue account. The term accrued revenue often is used to describe revenue that has been earned during the period but that has not been recorded prior to-the closing date.

To illustrate this type of adjusting entry. assume that in December, Overnight entered into an agreement to perform routine maintenance on several vans owned by Airport Shuttle Service. Overnight agreed to maintain these vans for a flat fee of $1.500 per
month. payable on the fifteenth of each month.

No entry was made to record the signing of this agreement. because no services had. yet been .rendered. Overnight began rendering services on December 15, but the first monthly payment ‘will not be received until January IS. Therefore, Overnight should make the following adjusting entry at December 31 to record the revenue earned from Airport Shuttle during the month:

Recording, Unrecorded Revenue

Recording, Unrecorded Revenue


Posted on November 21, 2015 in The Accounting Cycle Preparing an Annual Report

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