Introduction to Accounting:

The Language of Business

Lesson 4: Accounting Cycle Part 2
Supplemental Textbook

Business Learning Software, Inc

Adjustments for financial reporting

A career as a tax specialist

While most students are aware that accountants frequently assist their clients with tax returns and other tax
issues, few are aware of the large number of diverse and challenging careers available in the field of taxation. Nearly
all public accounting firms, ranging from the “Big 4” international firms to the sole practitioner, generate a
significant portion of their fees through tax compliance, planning and consulting. With over 155 million individual
tax returns filed in the US every year, it is not surprising that many individuals and most businesses need assistance
in dealing with the incredibly complex US and international tax laws. This complexity also provides tremendous tax
planning opportunities. As a tax specialist, you will show individual clients how to reduce their taxes while
simultaneously helping them make decisions about investing, buying a house, funding their children’s education,
and planning their retirement. For your business clients, careful planning and structuring of business investments
and transactions can save millions of dollars in taxes. In fact, it is safe to say that very few significant business
transactions take place without the careful guidance of a tax specialist.

A career in taxation is by no means limited to public accounting. Because there are so many types of taxes
impacting so many aspects of our lives, tax specialists act as consultants in a large number of fields. For example,
many companies offer deferred compensation or stock bonus plans to their executives. Nearly all companies
provide some sort of pension or other retirement plan for their employees, as well as health care benefits.
Significant tax savings can be generated for both the company and their employees if these benefits are structured
correctly. In response to the amazing complexity of our tax laws, many schools offer masters degrees specializing in
tax. Such a degree is not required to specialize in tax, but does offer students a significant advantage if they want to
pursue a career in taxation. In a recent survey of 1,400 chief financial officers, the top two responses to the question
“which one of the following areas of specialization would you recommend to someone just beginning his or her
career in accounting?” were personal financial planning and tax accounting. These responses reflect the
indisputable fact that as the US demographic includes more wealthy, and older, Americans than ever before,
professional tax guidance will be in ever-increasing demand.

The career paths outlined above do not nearly cover all of the many professional options available to tax
specialists. For example, are you concerned that a traditional tax accounting job may be too tame for you? Special
agents of the IRS routinely participate in criminal investigations and arrests, working closely with other federal law
enforcement agencies. Are you interested in law? Accounting offers an ideal undergraduate degree for aspiring
business and tax attorneys. If you think you may be interested in a career as a tax specialist, be sure to consult with
one of your school’s tax professors about the many job opportunities this field provides.

Earlier you were introduced to the accounting process of analyzing, classifying, and summarizing business
transactions into accounts. You learned how these transactions are entered into the journal and posted to the ledger
accounts. You also know how to use the trial balance to test the equality of debits and credits in the journalizing and
posting process. The purpose of the accounting process is to produce accurate financial statements so they may be

Introduction to Accounting : The Language of Business – Supplemental Textbook 1

used for making sound business decisions. At this point in your study of accounting, you are concentrating on three
financial statements—the income statement, the statement of retained earnings, and the balance sheet.

When you began to analyze business transactions, you saw that the evidence of the transaction is usually a
source document. It is any written or printed evidence that describes the essential facts of a business transaction.
Examples are receipts for cash paid or received, checks written or received, bills sent to customers, or bills received
from suppliers.

The journal entries we discuss in this chapter are adjusting entries. The arrival of the end of the accounting
period triggers adjusting entries. Accountants use adjusting entries to bring accounts to their proper balances
before preparing financial statements. In this chapter, you learn the difference between the cash basis and accrual
basis of accounting. Then you learn about the classes and types of adjusting entries and how to prepare them.

Cash versus accrual basis accounting

Professionals such as physicians and lawyers and some relatively small businesses may account for their
revenues and expenses on a cash basis. The cash basis of accounting recognizes revenues when cash is received
and recognizes expenses when cash is paid out. For example, under the cash basis, a company would treat services
rendered to clients in 2010 for which the company collected cash in 2011 as 2011 revenues. Similarly, under the
cash basis, a company would treat expenses incurred in 2010 for which the company disbursed cash in 2011 as 2011
expenses. Under the “pure” cash basis, even the purchase of a building would be debited to an expense. However,
under the “modified” cash basis, the purchase of long-lived assets (such as a building) would be debited to an asset
and depreciated (gradually charged to expense) over its useful life. Normally the “modified” cash basis is used by
those few individuals and small businesses that use the cash basis.

Cash Basis Accrual Basis

Revenues are recognized As cash is received As earned (goods are
delivered or services are
performed)
Expenses are recognized As cash is paid As incurred to produce
revenues

Exhibit 1: Cash basis and accrual basis of accounting compared

Because the cash basis of accounting does not match expenses incurred and revenues earned, it is generally
considered theoretically unacceptable. The cash basis is acceptable in practice only under those circumstances
when it approximates the results that a company could obtain under the accrual basis of accounting. Companies
using the cash basis do not have to prepare any adjusting entries unless they discover they have made a mistake in
preparing an entry during the accounting period. Under certain circumstances, companies may use the cash basis
for income tax purposes.

Throughout the text we use the accrual basis of accounting, which matches expenses incurred and revenues
earned, because most companies use the accrual basis. The accrual basis of accounting recognizes revenues
when sales are made or services are performed, regardless of when cash is received. Expenses are recognized as
incurred, whether or not cash has been paid out. For instance, assume a company performs services for a customer
on account. Although the company has received no cash, the revenue is recorded at the time the company performs

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the service. Later, when the company receives the cash, no revenue is recorded because the company has already
recorded the revenue. Under the accrual basis, adjusting entries are needed to bring the accounts up to date for
unrecorded economic activity that has taken place. In Exhibit 1, shown below, we show when revenues and
expenses are recognized under the cash basis and under the accrual basis.

The need for adjusting entries

The income statement of a business reports all revenues earned and all expenses incurred to generate those
revenues during a given period. An income statement that does not report all revenues and expenses is incomplete,
inaccurate, and possibly misleading. Similarly, a balance sheet that does not report all of an entity’s assets,
liabilities, and stockholders’ equity at a specific time may be misleading. Each adjusting entry has a dual purpose:
(1) to make the income statement report the proper revenue or expense and (2) to make the balance sheet report
the proper asset or liability. Thus, every adjusting entry affects at least one income statement account and one
balance sheet account.
January 30
February 9
March 16
April 8
May 18
June 49
July 8
August 14
September 42
October 17
November 13
Subtotal 224
December 376
Total Companies 600
Source' American Institute of Certified Public Accountants Accounting Trends & Techniques (New York' AICPA, 2004) p39

Exhibit 2: Summary-fiscal year ending by month

Since those interested in the activities of a business need timely information, companies must prepare financial
statements periodically. To prepare such statements, the accountant divides an entity’s life into time periods. These
time periods are usually equal in length and are called accounting periods. An accounting period may be one
month, one quarter, or one year. An accounting year, or fiscal year, is an accounting period of one year. A fiscal
year is any 12 consecutive months. The fiscal year may or may not coincide with the calendar year, which ends
on December 31. As we show in Exhibit 2, 63 per cent of the companies surveyed in 2004 had fiscal years that
coincide with the calendar year. In 2008, the comparable figure for publicly-traded companies in the US was 65 per
cent. Companies in certain industries often have a fiscal year that differs from the calendar year. For instance many
retail stores end their fiscal year on January 31 to avoid closing their books during their peak sales period. Other
companies select a fiscal year ending at a time when inventories and business activity are lowest.

Periodic reporting and the matching principle necessitate the preparation of adjusting entries. Adjusting
entries are journal entries made at the end of an accounting period or at any time financial statements are to be
prepared to bring about a proper matching of revenues and expenses. The matching principle requires that
expenses incurred in producing revenues be deducted from the revenues they generated during the accounting
period. The matching principle is one of the underlying principles of accounting. This matching of expenses and
revenues is necessary for the income statement to present an accurate picture of the profitability of a business.
Adjusting entries reflect unrecorded economic activity that has taken place but has not yet been recorded. Why has
the company not recorded this activity by the end of the period? One reason is that it is more convenient and

Introduction to Accounting : The Language of Business – Supplemental Textbook 3

economical to wait until the end of the period to record the activity. A second reason is that no source document
concerning that activity has yet come to the accountant’s attention.

Adjusting entries bring the amounts in the general ledger accounts to their proper balances before the company
prepares its financial statements. That is, adjusting entries convert the amounts that are actually in the general
ledger accounts to the amounts that should be in the general ledger accounts for proper financial reporting. To
make this conversion, the accountants analyze the accounts to determine which need adjustment. For example,
assume a company purchased a three-year insurance policy costing USD 600 at the beginning of the year and
debited USD 600 to Prepaid Insurance. At year-end, the company should remove USD 200 of the cost from the
asset and record it as an expense. Failure to do so misstates assets and net income on the financial statements.

Exhibit 3: Two classes and four types of adjusting entries

Companies continuously receive benefits from many assets such as prepaid expenses (e.g. prepaid insurance and
prepaid rent). Thus, an entry could be made daily to record the expense incurred. Typically, firms do not make the
entry until financial statements are to be prepared. Therefore, if monthly financial statements are prepared,
monthly adjusting entries are required. By custom, and in some instances by law, businesses report to their owners
at least annually. Accordingly, adjusting entries are required at least once a year. Remember, however, that the
entry transferring an amount from an asset account to an expense account should transfer only the asset cost that
has expired.

An accounting perspective:

Uses of technology

Eventually, computers will probably enter adjusting entries continuously on a real-time basis so
that up-to-date financial statements can be printed at any time without prior notice. Computers
will be fed the facts concerning activities that would normally result in adjusting entries and

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 instructed to seek any necessary information from their own databases or those of other computers
to continually adjust the accounts.

Classes and types of adjusting entries

Adjusting entries fall into two broad classes: deferred (meaning to postpone or delay) items and accrued
(meaning to grow or accumulate) items. Deferred items consist of adjusting entries involving data previously
recorded in accounts. These entries involve the transfer of data already recorded in asset and liability accounts to
expense and revenue accounts, respectively. Accrued items consist of adjusting entries relating to activity on
which no data have been previously recorded in the accounts. These entries involve the initial, or first, recording of
assets and liabilities and the related revenues and expenses (see Exhibit 3).

Deferred items consist of two types of adjusting entries: asset/expense adjustments and liability/revenue
adjustments. For example, prepaid insurance and prepaid rent are assets until they are used up; then they become
expenses. Also, unearned revenue is a liability until the company renders the service; then the unearned revenue
becomes earned revenue.

Accrued items consist of two types of adjusting entries: asset/revenue adjustments and liability/expense
adjustments. For example, assume a company performs a service for a customer but has not yet billed the customer.
The accountant records this transaction as an asset in the form of a receivable and as revenue because the company
has earned a revenue. Also, assume a company owes its employees salaries not yet paid. The accountant records
this transaction as a liability and an expense because the company has incurred an expense.
MICROTRAIN COMPANY
Trial Balance
2010 December 31
Acct.
No. Account Title Debits Credits
100 Cash $ 8,250
103 Accounts Receivable 5,200
107 Supplies on Hand 1,400
108 Prepaid Insurance 2,400
112 Prepaid Rent 1,200
150 Trucks 40,000
200 Accounts Payable $ 730
216 Unearned Service Fees 4,500
300 Capital Stock 50,000
320 Dividends 3,000
400 Service Revenue 10,700
505 Advertising Expense 50
506 Gas and Oil Expense 680
507 Salaries Expense 3,600
511 Utilities Expense 150 $65,930
$65,930

Exhibit 4: Trial balance

In this chapter, we illustrate each of the four types of adjusting entries: asset/expense, liability/revenue,
asset/revenue, and liability/expense. Look at Exhibit 4, the trial balance of the MicroTrain Company at 2010

Introduction to Accounting : The Language of Business – Supplemental Textbook 5

December 31. As you can see, MicroTrain must adjust several accounts before it can prepare accurate financial
statements. The adjustments for these accounts involve data already recorded in the company’s accounts.

In making adjustments for MicroTrain Company, we must add several accounts to the company’s chart of
accounts shown in an earlier chapter. These new accounts are:
Type of Account Acct. Account Title Description
Asset No. Interest Receivable The amount of interest earned but not
Contra asset* 121 Accumulated yet received. The total depreciation
Liability Revenue 151 Deprecation—Trucks expense taken on trucks since the
Expenses 206 Salaries Payable acquisition date. The balance of this
418 Interest Revenue account is deducted from that of Trucks
512 Insurance Expense on the balance sheet.
515 Rent Expense The amount of salaries earned
518 Supplies Expense by employees but not yet paid
521 Depreciation Expense— by the company.
Trucks The amount of interest earned
in the current period.
The cost of insurance incurred
in the current period.
The cost of rent incurred in
the current period.
The cost of supplies used in
the current period.
The portion of the cost of the
trucks assigned to expense
during the current period.
*Accountants deduct the balance of a contra asset from the balance of the related reasons for using a asset account on the balance sheet. We explain the
contra asset account later in the chapter.

Now you are ready to follow as MicroTrain Company makes its adjustments for deferred items. If you find the
process confusing, review the beginning of this chapter so you clearly understand the purpose of adjusting entries.

An accounting perspective:

Uses of technology

It is difficult to name a publicly owned company that does not provide an extensive website. In fact,
websites have become an important link between companies and their investors. Most websites
will have a link titled investor relations or merely company information which provides a wealth of
financial information ranging from audited financial statements to charts of the company's stock
prices. As an example, check out the Gap, Incs website at:

http://www.gapinc.com

Browse the Gap site and see for yourself the comprehensiveness of the financial information
available there.

Adjustments for deferred items

This section discusses the two types of adjustments for deferred items: asset/expense adjustments and
liability/revenue adjustments. In the asset/expense group, you learn how to prepare adjusting entries for prepaid
expenses and depreciation. In the liability/revenue group, you learn how to prepare adjusting entries for unearned
revenues.

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 MicroTrain Company must make several asset/expense adjustments for prepaid expenses. A prepaid expense
is an asset awaiting assignment to expense, such as prepaid insurance, prepaid rent, and supplies on hand. Note
that the nature of these three adjustments is the same.

Prepaid insurance When a company pays an insurance policy premium in advance, the purchase creates the
asset, prepaid insurance. This advance payment is an asset because the company will receive insurance coverage in
the future. With the passage of time, however, the asset gradually expires. The portion that has expired becomes an
expense. To illustrate this point, MicroTrain Company purchased for cash an insurance policy on its trucks for the
period 2010 December 1, to 2011 November 30. The journal entry made on 2010 December 1, to record the
purchase of the policy was:
2010
Dec. 1 Prepaid Insurance 2,400

Cash 2400

Purchased truck insurance to cover a one-year period.

The two accounts relating to insurance are Prepaid Insurance (an asset) and Insurance Expense (an expense).
After posting this entry, the Prepaid Insurance account has a USD 2,400 debit balance on 2010 December 1. The
Insurance Expense account has a zero balance on 2010 December 1, because no time has elapsed to use any of the
policy’s benefits.
(Dr.) Prepaid Insurance (Cr) (Dr.) Insurance Expense (Cr)
2010 2010
Dec. 1 Dec. 1
Bal. 2,400 Bal. -0-

By 2010 December 31, one month of the year covered by the policy has expired. Therefore, part of the service
potential (or benefit obtained from the asset) has expired. The asset now provides less future services or benefits
than when the company acquired it. We recognize this reduction by treating the cost of the services received from
the asset as an expense. For the MicroTrain Company example, the service received was one month of insurance
coverage. Since the policy provides the same services for every month of its one-year life, we assign an equal
amount (USD 200) of cost to each month. Thus, MicroTrain charges 1/12 of the annual premium to Insurance
Expense on 2010 December 31. The adjusting journal entry is:
2010
Dec. 31 Insurance Expense 200 Adjustment

Prepaid Insurance 200 1—Insurance

To record insurance expense for December.

After posting these two journal entries, the accounts in T-account format appear as follows:
(Dr.) Prepaid Insurance (Cr)
2010 2010
Dec. 1 Purchased Dec. 31 Adjustment 1 200
on account 2,400
Decreased by $200
2,200
Bal. After adjustment
(Dr.) Insurance Expense (Cr.)

Introduction to Accounting : The Language of Business – Supplemental Textbook 7

Increased by 2010
$200 31 Adjustment 1 200

In practice, accountants do not use T-accounts. Instead, they use three-column ledger accounts that have the
advantage of showing a balance after each transaction. After posting the preceding two entries, the three-column
ledger accounts appear as follows:
Prepaid Insurance
Date Explanation Post Ref. Debit Credit Balance

Dec. 2010 1 Purchased on Account G1 2400 2400 Dr.

31 Adjustment G3* 200 2200 Dr.

Insurance Expense
Date Explanation Post Ref. Debit Credit Balance

Dec. 2010 31 Adjustment G3* 200 200 Dr.

*Assumed page number

Before this adjusting entry was made, the entire USD 2,400 insurance payment made on 2010 December 1, was
a prepaid expense for 12 months of protection. So on 2010 December 31, one month of protection had passed, and
an adjusting entry transferred USD 200 of the USD 2,400 (USD 2,400/12 = USD 200) to Insurance Expense. On
the income statement for the year ended 2010 December 31, MicroTrain reports one month of insurance expense,
USD 200, as one of the expenses it incurred in generating that year’s revenues. It reports the remaining amount of
the prepaid expense, USD 2,200, as an asset on the balance sheet. The USD 2,200 prepaid expense represents 11
months of insurance protection that remains as a future benefit.

Prepaid rent Prepaid rent is another example of the gradual consumption of a previously recorded asset.
Assume a company pays rent in advance to cover more than one accounting period. On the date it pays the rent, the
company debits the prepayment to the Prepaid Rent account (an asset account). The company has not yet received
benefits resulting from this expenditure. Thus, the expenditure creates an asset.

We measure rent expense similarly to insurance expense. Generally, the rental contract specifies the amount of
rent per unit of time. If the prepayment covers a three-month rental, we charge one-third of this rental to each
month. Notice that the amount charged is the same each month even though some months have more days than
other months.

For example, MicroTrain Company paid USD 1,200 rent in advance on 2010 December 28, to cover a three-
month period beginning on that date. The journal entry would be:
2010
Dec. 1 Prepaid Rent 1,200
Cash 1,200
Paid three months' rent on a building.

The two accounts relating to rent are Prepaid Rent (an asset) and Rent Expense. After this entry is posted, the
Prepaid Rent account has a USD 1,200 balance and the Rent Expense account has a zero balance because no part of
the rent period has yet elapsed.
(Dr.) Prepaid Rent (Cr) (Dr.) Rent Expense (Cr)
2010 2010
Dec. 1 Dec. 1

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Bal. Cash Paid 1,200 Bal. -0-

On 2010 December 31, MicroTrain must prepare an adjusting entry. Since one third of the period covered by the
prepaid rent has elapsed, it charges one-third of the USD 1,200 of prepaid rent to expense. The required adjusting
entry is:
2010
Dec.
Adjustment 31 Rent Expense 400

2—Rent Prepaid Rent To record rent expense for December 400

After posting this adjusting entry, the T-accounts appear as follows:

(Dr.) Prepaid Rent (Cr)
2010 1,200 2010 Dec. 31 Decreased
Dec. 1 Cash Paid Adjustment 2 400
Bal. after adjustment 800 by $400
(Dr.) Rent Expense (Cr)
Increased by 2010 400
$400 Dec.
31 Adjustment 2

The USD 400 rent expense appears in the income statement for the year ended 2010 December 31. MicroTrain
reports the remaining USD 800 of prepaid rent as an asset in the balance sheet on 2010 December 31. Thus, the
adjusting entries have accomplished their purpose of maintaining the accuracy of the financial statements.

Supplies on hand Almost every business uses supplies in its operations. It may classify supplies simply as
supplies (to include all types of supplies), or more specifically as office supplies (paper, stationery, floppy diskettes,
pencils), selling supplies (gummed tape, string, paper bags, cartons, wrapping paper), or training supplies
(transparencies, training manuals). Frequently, companies buy supplies in bulk. These supplies are an asset until
the company uses them. This asset may be called supplies on hand or supplies inventory. Even though these terms
indicate a prepaid expense, the firm does not use prepaid in the asset’s title.

On 2010 December 4, MicroTrain Company purchased supplies for USD 1,400 and recorded the transaction as
follows:
2010
Dec. 4 Supplies on Hand 1,400
Cash 1,400
To record the purchase of supplies for future use.

MicroTrain’s two accounts relating to supplies are Supplies on Hand (an asset) and Supplies Expense. After this
entry is posted, the Supplies on Hand account shows a debit balance of USD 1,400 and the Supplies Expense
account has a zero balance as shown in the following T-accounts:
(Dr.) Supplies On Hand (Cr.) (Dr.) Supplies Expense (Cr.)
2010 2010
Dec. 4 Dec. 4
Bal. Cash Paid 1,400 Bal. -0-

An actual physical inventory (a count of the supplies on hand) at the end of the month showed only USD 900 of
supplies on hand. Thus, the company must have used USD 500 of supplies in December. An adjusting journal entry
brings the two accounts pertaining to supplies to their proper balances. The adjusting entry recognizes the
reduction in the asset (Supplies on Hand) and the recording of an expense (Supplies Expense) by transferring USD

Introduction to Accounting : The Language of Business – Supplemental Textbook 9

500 from the asset to the expense. According to the physical inventory, the asset balance should be USD 900 and
the expense balance, USD 500. So MicroTrain makes the following adjusting entry:
2010
Dec. 31 Supplies Expense 500 Adjustment
Supplies on Hand 500 3—Supplies
To record supplies used during December.

After posting this adjusting entry, the T-accounts appear as follows:

(Dr.) Supplies on Hand (Cr)
2010 2010 Decreased by $500
Dec. 4 Cash Paid 1,400 Dec. 31 Adjustment 3 500
Bal. after 900
adjustment
(Dr.) Supplies Expense (Cr.)
Increased by 2010 500
$500 Dec 31 Adjustment 3

The entry to record the use of supplies could be made when the supplies are issued from the storeroom.
However, such careful accounting for small items each time they are issued is usually too costly a procedure.

Accountants make adjusting entries for supplies on hand, like for any other prepaid expense, before preparing
financial statements. Supplies expense appears in the income statement. Supplies on hand is an asset in the balance
sheet.

Sometimes companies buy assets relating to insurance, rent, and supplies knowing that they will use them up
before the end of the current accounting period (usually one month or one year). If so, an expense account is
usually debited at the time of purchase rather than debiting an asset account. This procedure avoids having to make
an adjusting entry at the end of the accounting period. Sometimes, too, a company debits an expense even though
the asset will benefit more than the current period. Then, at the end of the accounting period, the firm’s adjusting
entry transfers some of the cost from the expense to the asset. For instance, assume that on January 1, a company
paid USD 1,200 rent to cover a three-year period and debited the USD 1,200 to Rent Expense. At the end of the
year, it transfers USD 800 from Rent Expense to Prepaid Rent. To simplify our approach, we will consistently debit
the asset when the asset will benefit more than the current accounting period.

Depreciation Just as prepaid insurance and prepaid rent indicate a gradual using up of a previously recorded
asset, so does depreciation. However, the overall time involved in using up a depreciable asset (such as a building)
is much longer and less definite than for prepaid expenses. Also, a prepaid expense generally involves a fairly small
amount of money. Depreciable assets, however, usually involve larger sums of money.

A depreciable asset is a manufactured asset such as a building, machine, vehicle, or piece of equipment that
provides service to a business. In time, these assets lose their utility because of (1) wear and tear from use or (2)
obsolescence due to technological change. Since companies gradually use up these assets over time, they record
depreciation expense on them. Depreciation expense is the amount of asset cost assigned as an expense to a
particular period. The process of recording depreciation expense is called depreciation accounting. The three
factors involved in computing depreciation expense are:

• Asset cost. The asset cost is the amount that a company paid to purchase the depreciable asset.

• Estimated residual value. The estimated residual value (scrap value) is the amount that the
company can probably sell the asset for at the end of its estimated useful life.

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 • Estimated useful life. The estimated useful life of an asset is the estimated time that a company can
use the asset. Useful life is an estimate, not an exact measurement, that a company must make in advance.
However, sometimes the useful life is determined by company policy (e.g. keep a fleet of automobiles for three
years).

Accountants use different methods for recording depreciation. The method illustrated here is the straight-line
method. Straight-line depreciation assigns the same amount of depreciation expense to each accounting period over
the life of the asset. The depreciation formula (straight-line) to compute straight-line depreciation for a one-
year period is:

Asset cost – Estimated residual value

Annual deprecation=
Estimated years of useful life

To illustrate the use of this formula, recall that on December 1, MicroTrain Company purchased four small
trucks at a cost of USD 40,000. The journal entry was:
2010
Dec. 1 Trucks 40,000
Cash 40,000
To record the purchase of four trucks.

The estimated residual value for each truck was USD 1,000, so MicroTrain estimated the total residual value for
all four trucks at USD 4,000. The company estimated the useful life of each truck to be four years. Using the
straight-line depreciation formula, MicroTrain calculated the annual depreciation on the trucks as follows:

USD 40,000 – USD 4,000

Annual deprecation = = USD 9,000
4 years

The amount of depreciation expense for one month would be 1/12 of the annual amount. Thus, depreciation
expense for December is USD 9,000 ÷ 12 = USD 750.

The difference between an asset’s cost and its estimated residual value is an asset’s depreciable amount. To
satisfy the matching principle, the firm must allocate the depreciable amount as an expense to the various periods
in the asset’s useful life. It does this by debiting the amount of depreciation for a period to a depreciation expense
account and crediting the amount to an accumulated depreciation account. MicroTrain’s depreciation on its
delivery trucks for December is USD 750. The company records the depreciation as follows:
2010
Dec. 31 Depreciation Expense – Trucks 750
Accumulated Depreciation - Trucks 750 Adjusted 4-
Depreciation
To record depreciation expense for December.

After posting the adjusting entry, the T-accounts appear as follows:

(Dr.) Depreciation Expense—Trucks (Cr)
Increased by 2010
$750 Dec 31 Adjustment 4 750

(Dr.) Accumulated Depreciation—Trucks (Cr.) Increased by $750

(book value of asset
decreased)

Introduction to Accounting : The Language of Business – Supplemental Textbook 11

 2010
Dec. 31 Adjustment 4 750

MicroTrain reports depreciation expense in its income statement. And it reports accumulated depreciation in
the balance sheet as a deduction from the related asset.

The accumulated depreciation account is a contra asset account that shows the total of all depreciation
recorded on the asset from the date of acquisition up through the balance sheet date. A contra asset account is a
deduction from the asset to which it relates in the balance sheet. The purpose of a contra asset account is to reduce
the original cost of the asset down to its remaining undepreciated cost or book value. The accumulated
depreciation account does not represent cash that is being set aside to replace the worn out asset. The
undepreciated cost of the asset is the debit balance in the asset account (original cost) minus the credit balance in
the accumulated depreciation contra account. Accountants also refer to an asset’s cost less accumulated
depreciation as the book value (or net book value) of the asset. Thus, book value is the cost not yet allocated to an
expense. In the previous example, the book value of the equipment after the first month is:
Cost USD 40,000
Less: Accumulated depreciation 750
Book value (or cost not yet allocated to as an expense) 39,250

MicroTrain credits the depreciation amount to an accumulated depreciation account, which is a contra asset,
rather than directly to the asset account. Companies use contra accounts when they want to show statement readers
the original amount of the account to which the contra account relates. For instance, for the asset Trucks, it is useful
to know both the original cost of the asset and the total accumulated depreciation amount recorded on the asset.
Therefore, the asset account shows the original cost. The contra account, Accumulated Depreciation—Trucks,
shows the total amount of recorded depreciation from the date of acquisition. By having both original cost and the
accumulated depreciation amounts, a user can estimate the approximate percentage of the benefits embodied in the
asset that the company has consumed. For instance, assume the accumulated depreciation amount is about three-
fourths the cost of the asset. Then, the benefits would be approximately three-fourths consumed, and the company
may have to replace the asset soon.

Thus, to provide more complete balance sheet information to users of financial statements, companies show
both the original acquisition cost and accumulated depreciation. In the preceding example for adjustment 4, the
balance sheet at 2010 December 31, would show the asset and contra asset as follows:
Assets
Trucks USD 40,000
Less: Accumulated deprecation 750
USD 39,250

As you may expect, the accumulated depreciation account balance increases each period by the amount of
depreciation expense recorded until the remaining book value of the asset equals the estimated residual value.

A liability/revenue adjustment involving unearned revenues covers situations in which a customer has
transferred assets, usually cash, to the selling company before the receipt of merchandise or services. Receiving
assets before they are earned creates a liability called unearned revenue. The firm debits such receipts to the
asset account Cash and credits a liability account. The liability account credited may be Unearned Fees, Revenue
Received in Advance, Advances by Customers, or some similar title. The seller must either provide the services or
return the customer’s money. By performing the services, the company earns revenue and cancels the liability.

12
 Companies receive advance payments for many items, such as training services, delivery services, tickets, and
magazine or newspaper subscriptions. Although we illustrate and discuss only advanced receipt of training fees,
firms treat the other items similarly.

Unearned service fees On December 7, MicroTrain Company received USD 4,500 from a customer in
payment for future training services. The firm recorded the following journal entry:
2010
Dec. 7 Cash 4,500
Unearned Service Fees
To record the receipt of cash from a customer in payment 4,500
for future training services.

The two T-accounts relating to training fees are Unearned Service Fees (a liability) and Service Revenue. These
accounts appear as follows on 2010 December 31 (before adjustment):
(Dr.) Unearned Service Fees (Cr.)
2010
Dec. 7 Cash received
in advance 4,500

(Dr.) Service Revenue (Cr.)

2010
Bal. before adjustment 10,700*
*The $10,700 balance came .

The balance in the Unearned Service Fees liability account established when MicroTrain received the cash will
be converted into revenue as the company performs the training services. Before MicroTrain prepares its financial
statements, it must make an adjusting entry to transfer the amount of the services performed by the company from
a liability account to a revenue account. If we assume that MicroTrain earned one-third of the USD 4,500 in the
Unearned Service Fees account by December 31, then the company transfers USD 1,500 to the Service Revenue
account as follows:
2010
Dec.
Adjustment 5— 31 Unearned Service Fees 1,500
Revenue earned Service Revenue
To transfer a portion of training fees from the liability 1,500
account to the revenue account.

After posting the adjusting entry, the T-accounts would appear as follows:
Decreased by (Dr.) Unearned Service Fees (Cr.)
$1,500
2010 2010

2010 Dec. 31 Adjustment 5 1,500 Dec. 7 Cash received

in advance 4,500
Bal. after adjustment 3,000
(Dr.) Service Revenue (Cr.)
2010 10,700 Increased — by
Bal. before adjustment Dec. 31 1,500 $1,500
Adjustment 5
Bal. after adjustment 12,200

MicroTrain reports the service revenue in its income statement for 2010. The company reports the USD 3,000
balance in the Unearned Service Fees account as a liability in the balance sheet. In 2011, the company will likely
earn the USD 3,000 and transfer it to a revenue account.

Introduction to Accounting : The Language of Business – Supplemental Textbook 13

 If MicroTrain does not perform the training services, the company would have to refund the money to the
training service customers. For instance, assume that MicroTrain could not perform the remaining USD 3,000 of
training services and would have to refund the money. Then, the company would make the following entry:
Unearned Service Fees 3,000
Cash 3,000
To record the refund of unearned training fees.

Thus, the company must either perform the training services or refund the fees. This fact should strengthen your
understanding that unearned service fees and similar items are liabilities.

Accountants make the adjusting entries for deferred items for data already recorded in a company’s asset and
liability accounts. They also make adjusting entries for accrued items, which we discuss in the next section, for
business data not yet recorded in the accounting records.

An accounting perspective:

Business insight

According to the National Association of Colleges and Employers, the average offer to an
accounting major in 2009 was USD 48,334 and tends to increase each year. According to recent
surveys, the market for accounting graduates remains brisk. Often, one of the chief problems for
graduates is how to handle multiple job offers. As a result of the low unemployment rate,
employers—especially small accounting firms with limited recruiting budgets—are doing whatever
they can to grab qualified candidates.

Adjustments for accrued items

Accrued items require two types of adjusting entries: asset/revenue adjustments and liability/expense
adjustments. The first group—asset/revenue adjustments—involves accrued assets; the second group—
liability/expense adjustments—involves accrued liabilities.

Accrued assets are assets, such as interest receivable or accounts receivable, that have not been recorded by
the end of an accounting period. These assets represent rights to receive future payments that are not due at the
balance sheet date. To present an accurate picture of the affairs of the business on the balance sheet, firms
recognize these rights at the end of an accounting period by preparing an adjusting entry to correct the account
balances. To indicate the dual nature of these adjustments, they record a related revenue in addition to the asset.
We also call these adjustments accrued revenues because the revenues must be recorded.

Interest revenue Savings accounts literally earn interest moment by moment. Rarely is payment of the
interest made on the last day of the accounting period. Thus, the accounting records normally do not show the
interest revenue earned (but not yet received), which affects the total assets owned by the investor, unless the
company makes an adjusting entry. The adjusting entry at the end of the accounting period debits a receivable
account (an asset) and credits a revenue account to record the interest earned and the asset owned.

14
 For example, assume MicroTrain Company has some money in a savings account. On 2010 December 31, the
money on deposit has earned one month’s interest of USD 600, although the company has not received the interest.
An entry must show the amount of interest earned by 2010 December 31, as well as the amount of the asset, interest
receivable (the right to receive this interest). The entry to record the accrual of revenue is:
2010
Adjustment Dec. 31 Interest Receivable 600
6—Interest Interest Revenue 600
revenue accrued To record one month's interest revenue.

The T-accounts relating to interest would appear as follows:

(Dr.) Interest Receivable (Cr.)
Increased by 2010
$600 Dec 31 Adjustment 6 600

(Dr.) Interest Revenue (Cr.)

2010 Increased by $600
Dec. 31 Adjustment 6 600.

MicroTrain reports the USD 600 debit balance in Interest Receivable as an asset in the 2010 December 31,
balance sheet. This asset accumulates gradually with the passage of time. The USD 600 credit balance in Interest
Revenue is the interest earned during the month. Recall that in recording revenue under accrual basis accounting, it
does not matter whether the company collects the actual cash during the year or not. It reports the interest revenue
earned during the accounting period in the income statement.

Unbilled training fees A company may perform services for customers in one accounting period while it bills
for the services in a different accounting period.

MicroTrain Company performed USD 1,000 of training services on account for a client at the end of December.
Since it takes time to do the paper work, MicroTrain will bill the client for the services in January. The necessary
adjusting journal entry at 2010 December 31, is:
Adjustment 7—Unbilled 2010
Dec. 31 Accounts Receivable (or Service Fees Receivable) 1,000
Service Revenue
1,000
To record unbilled training services performed in
December.

After posting the adjusting entry, the T-accounts appear as follows:

(Dr.) Accounts Receivable (Cr.)
2010
Previous bal. 5,200*
Dec. 31 Adjustment 7 1,000*_
Bal. after adjustment 6,200
*This previous balance came from transactions discussed in an earlier chapter
(Dr.) Service Revenue (Cr.)
2010
Bal. before adjustment 10,700
Dec. 31 Adjustment
5—previously

Introduction to Accounting : The Language of Business – Supplemental Textbook 15

 unearned
revenue. 1,500
Dec. 31 Adjustment 7 1,000
Bal. after both adjustments 13200

The service revenue appears in the income statement; the asset, accounts receivable, appears in the balance
sheet.

Accrued liabilities are liabilities not yet recorded at the end of an accounting period. They represent
obligations to make payments not legally due at the balance sheet date, such as employee salaries. At the end of the
accounting period, the company recognizes these obligations by preparing an adjusting entry including both a
liability and an expense. For this reason, we also call these obligations accrued expenses.

Salaries The recording of the payment of employee salaries usually involves a debit to an expense account and
a credit to Cash. Unless a company pays salaries on the last day of the accounting period for a pay period ending on
that date, it must make an adjusting entry to record any salaries incurred but not yet paid.

MicroTrain Company paid USD 3,600 of salaries on Friday, 2010 December 28, to cover the first four weeks of
December. The entry made at that time was:
2010
Dec. 28 Salaries Expense 3,600
Cash 3,600
Paid training employee salaries for the first four weeks of
December.

Assuming that the last day of December 2010 falls on a Monday, this expense account does not show salaries
earned by employees for the last day of the month. Nor does any account show the employer’s obligation to pay
these salaries. The T-accounts pertaining to salaries appear as follows before adjustment:
(Dr.) Salaries Expense (Cr) (Dr.) Salaries Payable (Cr)
2010 Dec. 3,600 2010 -0-
28 Dec. 28 Bal.

If salaries are USD 3,600 for four weeks, they are USD 900 per week. For a five-day workweek, daily salaries are
USD 180. MicroTrain makes the following adjusting entry on December 31 to accrue salaries for one day:
2010
Dec. 31 Salaries Expense 180
Salaries Payable 180
To accrue one day's salaries that were earned but not paid.

After adjustment, the two T-accounts involved appear as follows:

(Dr.) Salaries Expense (Cr)
2010
Dec. 28 Bal. 3,600
Dec. 31 Adjustment 8 180

Bal. after adjustment 3,780

(Dr.) Salaries Payable (Cr.)
2010 180 Increased by
Dec. 31 Adjustment 8 $180

16
 Failure to Recognize Effect on Net Income Effect on Balance Sheet Items
1. Consumption of the benefits of an asset Overstates net income Overstates assets Overstates retained earnings
(prepaid expense)
2. Earning of previously unearned revenues Understates net income Overstates liabilities Understates retained
earnings
3. Accrual of assets Understates net income Understates assets Understates retained
earnings
4. Accrual of liabilities Overstates net income Understates liabilities Overstates retained
earnings

Exhibit 5: Effects of failure to recognize adjustments

The debit in the adjusting journal entry brings the month’s salaries expense up to its correct USD 3,780 amount
for income statement purposes. The credit to Salaries Payable records the USD 180 salary liability to employees.
The balance sheet shows salaries payable as a liability.

Another example of a liability/expense adjustment is when a company incurs interest on a note payable. The
debit would be to Interest Expense, and the credit would be to Interest Payable.

Effects of failing to prepare adjusting entries

Failure to prepare proper adjusting entries causes net income and the balance sheet to be in error. You can see
the effect of failing to record each of the major types of adjusting entries on net income and balance sheet items in
Exhibit 5.

Using MicroTrain Company as an example, this chapter has discussed and illustrated many of the typical entries
that companies must make at the end of an accounting period. Later chapters explain other examples of adjusting
entries.

Analyzing and using the financial results—trend percentages

It is sometimes more informative to express all the dollar amounts as a percentage of one of the amounts in the
base year rather than to look only at the dollar amount of the item in the financial statements. You can calculate
trend percentages by dividing the amount for each year for an item, such as net income or net sales, by the
amount of that item for the base year:

Current year amount

Trend percentage=
Base year amount

To illustrate, assume that ShopaLot, a large retailer, and its subsidiaries reported the following net income for
the years ended 2001 January 31, through 2010. The last column expresses these dollar amounts as a percentage of
the 2001 amount. For instance, we would calculate the 125 per cent for 2002 as:

[(USD 1,609,000/USD 1,291,000)5 100]

Dollar Amount
of Net Income Percentage of
(millions) 1991 Net Income
1991 $1,291 100 %
1992 1.609 125
1993 1,995 155
1994 2,333 181
1995 2,681 208
1996 2,740 212
1997 3,056 237
1998 3,526 273
1999 4,430 343
2000 5,377 416
2001 6,295 488

Introduction to Accounting : The Language of Business – Supplemental Textbook 17

 Examining the trend percentages, we can see that ShopaLot's s net income has increased steadily over the 10-
year period. The 2010 net income is over 4 times as much as the 2001 amount. This is the kind of performance that
management and stockholders seek, but do not always get.

In the first three chapters of this text, you have learned most of the steps of the accounting process.

An accounting perspective:

Uses of technology

The Internet sites of the Big-4 accounting firms are as follows:

Ernst & Young http://www.ey.com

Deloitte Touche Tohmatsu http://www.deloitte.com

KPMG http://www.kpmg.com

PricewaterhouseCoopers http://www.pwcglobal.com

You might want to visit these sites to learn more about a possible career in accounting.

Understanding the learning objectives

• The cash basis of accounting recognizes revenues when cash is received and recognizes expenses when cash
is paid out.

• The accrual basis of accounting recognizes revenues when sales are made or services are performed,
regardless of when cash is received; expenses are recognized as incurred, whether or not cash has been paid
out.

• The accrual basis is more generally accepted than the cash basis because it provides a better matching of
revenues and expenses.

• Adjusting entries convert the amounts that are actually in the accounts to the amounts that should be in the
accounts for proper periodic financial reporting.

• Adjusting entries reflect unrecorded economic activity that has taken place but has not yet been recorded.

• Deferred items consist of adjusting entries involving data previously recorded in accounts. Adjusting entries
in this class normally involve moving data from asset and liability accounts to expense and revenue accounts.
The two types of adjustments within this deferred items class are asset/expense adjustments and
liability/revenue adjustments.

• Accrued items consist of adjusting entries relating to activity on which no data have been previously recorded
in the accounts. These entries involve the initial recording of assets and liabilities and the related revenues
and expenses. The two types of adjustments within this accrued items class are asset/revenue adjustments
and liability/expense adjustments.

• This chapter illustrates entries for deferred items and accrued items.

18
 • Failure to prepare adjusting entries causes net income and the balance sheet to be in error.

• For a particular item such as sales or net income, select a base year and express all dollar amounts in other
years as a percentage of the base year dollar amount.
Demonstration problem
Among other items, the trial balance of Korman Company for 2010 December 31, includes the following account
balances:
Debits Credits

Supplies on Hand $ 6,000

Prepaid Rent 25,200
Buildings 200,000
Accumulated Depreciation—Buildings $33,250
Salaries Expense 124,000
Unearned Delivery Fees 4,000

Some of the supplies represented by the USD 6,000 balance of the Supplies on Hand account have been
consumed. An inventory count of the supplies actually on hand at December 31 totaled USD 2,400.

On May 1 of the current year, a rental payment of USD 25,200 was made for 12 months’ rent; it was debited to
Prepaid Rent.

The annual depreciation for the buildings is based on the cost shown in the Buildings account less an estimated
residual value of USD 10,000. The estimated useful lives of the buildings are 40 years each.

The salaries expense of USD 124,000 does not include USD 6,000 of unpaid salaries earned since the last
payday.

The company has earned one-fourth of the unearned delivery fees by December 31.

Delivery services of USD 600 were performed for a customer, but a bill has not yet been sent.

a. Prepare the adjusting journal entries for December 31, assuming adjusting entries are prepared only at year-
end.

b. Based on the adjusted balance shown in the Accumulated Depreciation—Buildings account, how many years
has Korman Company owned the building?
Solution to demonstration problems
KORMAN COMPANY General Journal
Date Account Titles and Explanation Post. Debit Credit
Ref.
2010 Dec. 31 Supplies Expense 3 6 0 0
Supplies on Hand 3 6 0 0
To record supplies expense ($6,000 - $2,400).

31 Rent Expense 1 6 8 0 0
Prepaid Rent 1 6 8 0 0
To record rent expense ($25,200 X 8/12).

31 Depreciation Expense—Buildings 4 7 5 0

Introduction to Accounting : The Language of Business – Supplemental Textbook 19

 Accumulated Deprecation—Buildings 4 7 5 0
To record depreciation ($200,000 - $10,000 / 40 years).

31 Salaries Expense 6 0 0 0
Salaries Payable 6 0 0 0
To record accrued salaries.

31 Unearned Delivery Fees 1 0 0 0

Service Revenue 1 0 0 0
To record delivery fees earned.

31 Accounts Receivable 6 0 0
Service Revenue 6 0 0
To record delivery fees earned.

Eight years; computed as:

Total accumulated deprecation USD 33,250#USD 4,750

=
Annual deprecation expense USD 4,750

Key terms
Accounting period A time period normally of one month, one quarter, or one year into which an entity’s
life is arbitrarily divided for financial reporting purposes.
Accounting year An accounting period of one year. The accounting year may or may not coincide with the
calendar year.
Accrual basis of accounting Recognizes revenues when sales are made or services are performed,
regardless of when cash is received. Recognizes expenses as incurred, whether or not cash has been paid out.
Accrued assets and liabilities Assets and liabilities that exist at the end of an accounting period but have
not yet been recorded; they represent rights to receive, or obligations to make, payments that are not legally
due at the balance sheet date. Examples are accrued fees receivable and salaries payable.
Accrued items Adjusting entries relating to activity on which no data have been previously recorded in the
accounts. Also, see accrued assets and liabilities.
Accrued revenues and expenses Other names for accrued assets and liabilities.
Accumulated depreciation account A contra asset account that shows the total of all depreciation
recorded on the asset up through the balance sheet date.
Adjusting entries Journal entries made at the end of an accounting period to bring about a proper
matching of revenues and expenses; they reflect economic activity that has taken place but has not yet been
recorded. Adjusting entries are made to bring the accounts to their proper balances before financial
statements are prepared.
Book value For depreciable assets, book value equals cost less accumulated depreciation.
Calendar year The normal year, which ends on December 31.
Cash basis of accounting Recognizes revenues when cash is received and recognizes expenses when cash
is paid out.
Contra asset account An account shown as a deduction from the asset to which it relates in the balance
sheet; used to reduce the original cost of the asset down to its remaining undepreciated cost or book value.
Deferred items Adjusting entries involving data previously recorded in the accounts. Data are transferred
from asset and liability accounts to expense and revenue accounts. Examples are prepaid expenses,
depreciation, and unearned revenues.
Depreciable amount The difference between an asset’s cost and its estimated residual value.
Depreciable asset A manufactured asset such as a building, machine, vehicle, or equipment on which
depreciation expense is recorded.
Depreciation accounting The process of recording depreciation expense.

20
 Depreciation expense The amount of asset cost assigned as an expense to a particular time period.
Depreciation formula (straight-line):
Estimated residual value (scrap value) The amount that the company can probably sell the asset for at
the end of its estimated useful life.
Estimated useful life The estimated time periods that a company can make use of the asset.
Fiscal year An accounting year of any 12 consecutive months that may or may not coincide with the
calendar year. For example, a company may have an accounting, or fiscal, year that runs from April 1 of one
year to March 31 of the next.
Matching principle An accounting principle requiring that expenses incurred in producing revenues be
deducted from the revenues they generated during the accounting period.
Prepaid expense An asset awaiting assignment to expense. An example is prepaid insurance. Assets such
as cash and accounts receivable are not prepaid expenses.
Service potential The benefits that can be obtained from assets. The future services that assets can render
make assets “things of value” to a business.
Trend percentages Calculated by dividing the amount of an item for each year by the amount of that item
for the base year.
Unearned revenue Assets received from customers before services are performed for them. Since the
revenue has not been earned, it is a liability, often called revenue received in advance or advances by
customers.
Self-test
True-false

Indicate whether each of the following statements is true or false:

Every adjusting entry affects at least one income statement account and one balance sheet account.

All calendar years are also fiscal years, but not all fiscal years are calendar years.

The accumulated depreciation account is an asset account that shows the amount of depreciation for the current
year only.

The Unearned Delivery Fees account is a revenue account.

If all of the adjusting entries are not made, the financial statements are incorrect.
Multiple-choice
Select the best answer for each of the following questions.

An insurance policy premium of USD 1,200 was paid on 2010 September 1, to cover a one-year period from that
date. An asset was debited on that date. Adjusting entries are prepared once a year, at year-end. The necessary
adjusting entry at the company’s year-end, 2010 December 31, is:
a. Prepaid insurance 400
Insurance expense 400
b. Insurance expense 800
Prepaid insurance 800
c. Prepaid insurance 800
Insurance expense 800
d. Insurance expense 400
Prepaid insurance 400

The Supplies on Hand account has a balance of USD 1,500 at year-end. The actual amount of supplies on hand
at the end of the period was USD 400. The necessary adjusting entry is:
a. Supplies expense 1,100
Supplies on hand 1,100
b. Supplies expense 400

Introduction to Accounting : The Language of Business – Supplemental Textbook 21

 Supplies on hand 400
c. Supplies on hand 1,100
Supplies expense 1,100
d. Supplies on hand 400
Supplies expense 400

A company purchased a truck for USD 20,000 on 2010 January 1. The truck has an estimated residual value of
USD 5,000 and is expected to last five years. Adjusting entries are prepared only at year-end. The necessary
adjusting entry at 2010 December 31, the company’s year-end, is:
a. Deprecation expense – Trucks 4,000
Accumulated 4,000
b. Deprecation expense – Trucks 3,000
Trucks 3,000
c. Deprecation expense – Trucks 3,000
Accumulated deprecation – Trucks 3,000
d. Accumulated deprecation trucks 3,000
Deprecation expense – Trucks 3,000

A company received cash of USD 24,000 on 2010 October 1, as subscriptions for a one-year period from that
date. A liability account was credited when the cash was received. The magazine is to be published by the company
and delivered to subscribers each month. The company prepares adjusting entries at the end of each month because
it prepares financial statements each month. The adjusting entry the company would make at the end of each of the
next 12 months would be:
a. Unearned subscription fees 6,000
Subscription fee revenue 6,000
b. Unearned subscription fees 2,000
Subscription fee revenue 2,000

c. Unearned subscription feeds 18,000

Subscription fee revenue 18,000

d. Subscription fee revenue 2,000

Unearned subscription fees 2,000

When a company earns interest on a note receivable or on a bank account, the debit and credit are as follows:
Debit Credit
a. Accounts receivable Interest revenue
b. Interest receivable Interest revenue
c. Interest revenue Accounts receivable
d. Interest revenue Interest receivable

If USD 3,000 has been earned by a company’s workers since the last payday in an accounting period, the
necessary adjusting entry would be:

a. Debit an expense and credit a liability.

b. Debit an expense and credit an asset.

c. Debit a liability and credit an asset.

d. Debit a liability and credit an expense.

Now turn to “Answers to self test” at the back of the book to check your answers.

22
 Questions
➢ Which events during an accounting period trigger the recording of normal journal entries? Which
event triggers the making of adjusting entries?

➢ Describe the difference between the cash basis and accrual basis of accounting.

➢ Why are adjusting entries necessary? Why not treat every cash disbursement as an expense and
every cash receipt as a revenue when the cash changes hands?

➢ “Adjusting entries would not be necessary if the ‘pure’ cash basis of accounting were followed
(assuming no mistakes were made in recording cash transactions as they occurred). Under the cash
basis, receipts that are of a revenue nature are considered revenue when received, and expenditures
that are of an expense nature are considered expenses when paid. It is the use of the accrual basis of
accounting, where an effort is made to match expenses incurred against the revenues they create,
that makes adjusting entries necessary.” Do you agree with this statement? Why?

➢ Why do accountants not keep all the accounts at their proper balances continuously throughout the
period so that adjusting entries would not have to be made before financial statements are prepared?

➢ What is the fundamental difference between deferred items and accrued items?

➢ Identify the types of adjusting entries included in each of the two major classes of adjusting entries.

➢ Give an example of a journal entry for each of the following:

➢ Equal growth of an expense and a liability.

➢ Earning of revenue that was previously recorded as unearned revenue.

➢ Equal growth of an asset and a revenue.

➢ Increase in an expense and decrease in an asset.

➢ A fellow student makes the following statement: “You can easily tell whether a company is using the
cash or accrual basis of accounting. When an amount is paid for future rent or insurance services, a
firm that is using the cash basis debits an expense account while a firm that is using the accrual basis
debits an asset account.” Is the student correct?

➢ You notice that the Supplies on Hand account has a debit balance of USD 2,700 at the end of the
accounting period. How would you determine the extent to which this account needs adjustment?

➢ Some assets are converted into expenses as they expire and some liabilities become revenues as they
are earned. Give examples of asset and liability accounts for which this statement is true. Give
examples of asset and liability accounts to which the statement does not apply.

➢ Give the depreciation formula to compute straight-line depreciation for a one-year period.

➢ What does the term accrued liability mean?

➢ What is meant by the term service potential?

Introduction to Accounting : The Language of Business – Supplemental Textbook 23

 ➢ When assets are received before they are earned, what type of an account is credited? As the amounts
are earned, what type of account is credited?

➢ What does the word accrued mean? Is there a conceptual difference between interest payable and
accrued interest payable?

➢ Matching expenses incurred with revenues earned is more difficult than matching expenses paid
with revenues received. Do you think the effort is worthwhile?

➢ Real world question Refer to the financial statements of The Limited, Inc., in the Annual report
appendix. Approximately what percentage of the depreciable assets under property, plant, and
equipment has been depreciated as of the end of the most recent year shown?
Exercises
Exercise A Select the correct response for each of the following multiple-choice questions:

The cash basis of accounting:

(a) Recognizes revenues when sales are made or services are rendered.

(b) Recognizes expenses as incurred.

(c) Is typically used by some relatively small businesses and professional persons.

(d)Recognizes revenues when cash is received and recognizes expenses when incurred.

The accrual basis of accounting:

(a) Recognizes revenues only when cash is received.

(b) Is used by almost all companies.

(c) Recognizes expenses only when cash is paid out.

(d)Recognizes revenues when sales are made or services are performed and recognizes expenses only
when cash is paid out.

Exercise B Select the correct response for each of the following multiple-choice questions:

The least common accounting period among the following is:

(a) One month.

(b) Two months.

(c) Three months.

(d)Twelve months.

The need for adjusting entries is based on:

(a) The matching principle.

(b) Source documents.

(c) The cash basis of accounting.

24
 (d)Activity that has already been recorded in the proper accounts.

Exercise C Select the correct response for each of the following multiple-choice questions:

Which of the following types of adjustments belongs to the deferred items class?

(a) Asset/revenue adjustments.

(b) Liability/expense adjustments.

(c) Asset/expense adjustments.

(d)Asset/liability adjustments.

Which of the following types of adjustments belongs to the accrued items class?

(a) Asset/expense adjustments.

(b) Liability/revenue adjustments.

(c) Asset/liability adjustments.

(d)Liability/expense adjustments.

Exercise D A one-year insurance policy was purchased on August 1 for USD 2,400, and the following entry was
made at that time:
Prepaid Insurance 2,400
Cash 2,400

What adjusting entry is necessary at December 31, the end of the accounting year?

Show how the T-accounts for Prepaid Insurance and Insurance Expense would appear after the entries are
posted.

Exercise E Assume that rent of USD 12,000 was paid on 2010 September 1, to cover a one-year period from
that date. Prepaid Rent was debited. If financial statements are prepared only on December 31 of each year, what
adjusting entry is necessary on 2010 December 31, to bring the accounts involved to their proper balances?

Exercise F At 2010 December 31, an adjusting entry was made as follows:

Rent Expense 1,500
Prepaid Rent 1,500

You know that the gross amount of rent paid was USD 4,500, which was to cover a one-year period. Determine:

a. The opening date of the year to which the USD 4,500 of rent applies.

b. The entry that was made on the date the rent was paid.

Exercise G Supplies were purchased for cash on 2010 May 2, for USD 8,000. Show how this purchase would
be recorded. Then show the adjusting entry that would be necessary, assuming that USD 2,500 of the supplies
remained at the end of the year.

Introduction to Accounting : The Language of Business – Supplemental Textbook 25

 Exercise H Assume that a company acquired a building on 2010 January 1, at a cost of USD 1,000,000. The
building has an estimated useful life of 40 years and an estimated residual value of USD 200,000. What adjusting
entry is needed on 2010 December 31, to record the depreciation for the entire year 2010?

Exercise I On 2010 September 1, Professional Golfer Journal, Inc., received a total of USD 120,000 as payment
in advance for one-year subscriptions to a monthly magazine. A liability account was credited to record this cash
receipt. By the end of the year, one-third of the magazines paid for in advance had been delivered. Give the entries
to record the receipt of the subscription fees and to adjust the accounts at December 31, assuming annual financial
statements are prepared at year-end.

Exercise J On 2010 April 15, Rialto Theater sold USD 90,000 in tickets for the summer musicals to be
performed (one per month) during June, July, and August. On 2010 July 15, Rialto Theater discovered that the
group that was to perform the July and August musicals could not do so. It was too late to find another group
qualified to perform the musicals. A decision was made to refund the remaining unearned ticket revenue to its
ticket holders, and this was done on July 20. Show the appropriate journal entries to be made on April 15, June 30,
and July 20. Rialto has a June 30th year-end.

Exercise K Guilty & Innocent, a law firm, performed legal services in late December 2010 for clients. The USD
30,000 of services would be billed to the clients in January 2011. Give the adjusting entry that is necessary on 2010
December 31, if financial statements are prepared at the end of each month.

Exercise L A firm borrowed USD 30,000 on November 1. By December 31, USD 300 of interest had been
incurred. Prepare the adjusting entry required on December 31.

Exercise M Convenient Mailing Services, Inc., incurs salaries at the rate of USD 3,000 per day. The last payday
in January is Friday, January 27. Salaries for Monday and Tuesday of the next week have not been recorded or paid
as of January 31. Financial statements are prepared monthly. Give the necessary adjusting entry on January 31.

Exercise N State the effect that each of the following independent situations would have on the amount of
annual net income reported for 2010 and 2011.

a, No adjustment was made for accrued salaries of USD 8,000 as of 2010 December 31.

b. The collection of USD 5,000 for services yet unperformed as of 2010 December 31, was credited to a revenue
account and not adjusted. The services are performed in 2011.

Exercise O In the following table, indicate the effects of failing to recognize each of the indicated adjustments
by writing “O” for overstated and “U” for understated.
Effect on Balance Sheet Items
Effect on Stockholders'
Failure to Recognize Net Income Assets Liabilities Equity
1. Depreciation on a building
2. Consumption of supplies on hand
3. The earning of ticket revenue
received in advance
4. The earning of interest on a bank
account

26
5. Salaries incurred by unpaid

Exercise P The following data regarding net income (loss) are for Perkins Parts, a medium-sized automotive
supplier, for the period 2004–2009.
Net Income Net Income
(Earnings) (Earnings)
($ millions) ($ millions)
1989 ...... ........... $ 860 1995 ........ .............. $ 4,139
1990 ...... ........... 3,835 1996 ........ .............. 4,446
1991 ...... ........... (2,258) 1997 ........ .............. 6,920
1992 ...... ........... (7,385) 1998 ........ .............. 22,071
1993 ...... ........... 2,529 1999 ........ .............. 7,237
1994 ...... ........... 5,308 2000 ........ .............. 3,467

Using 1989 as the base year, calculate the trend percentages, and comment on the results.
Problems
Problem A Among other items, the trial balance of Filmblaster, Inc., a movie rental company, at December 31
of the current year includes the following account balances:
Debits

Prepaid Insurance USD 10,000

Prepaid Rent USD 14,400

Supplies on Hand USD 2,800

Examination of the records shows that adjustments should be made for the following items:

a. Of the prepaid insurance in the trial balance, USD 4,000 is for coverage during the months after December 31
of the current year.

b. The balance in the Prepaid Rent account is for a 12-month period that started October 1 of the current year.

c. USD 300 of interest has been earned but not received.

d. Supplies used during the year amount to USD 1,800.

Prepare the annual year-end adjusting journal entries at December 31.

Problem B Marathon Magazine, Inc., has the following account balances, among others, in its trial balance at
December 31 of the current year:
Debits Credits
Supplies on Hand.................. $3,720
Prepaid Rent ......................... 7,200
Unearned Subscription Fees ... $15,000
Subscriptions Revenue........... 261,000
Salaries Expense ................... 123,000

• The inventory of supplies on hand at December 31 amounts to USD 720.

• The balance in the Prepaid Rent account is for a one-year period starting October 1 of the current year.

• One-third of the USD 15,000 balance in Unearned Subscription Fees has been earned.

• Since the last payday, the employees of the company have earned additional salaries in the amount of USD
5,430.

Introduction to Accounting : The Language of Business – Supplemental Textbook 27

 a. Prepare the year-end adjusting journal entries at December 31.

b. Open ledger accounts for each of the accounts involved, enter the balances as shown in the trial balance, post
the adjusting journal entries, and calculate year-end balances.

Problem C Hillside Apartments, Inc., adjusts and closes its books each December 31. Assume the accounts for
all prior years have been properly adjusted and closed. Following are some of the company’s account balances prior
to adjustment on 2010 December 31:

HILLSIDE APARTMENTS, INC.

Partial Trial Balance

2010 December 31
Debits Credits
Prepaid insurance $ 7,500
Supplies on hand 7,000
Buildings 255,000
Accumulated deprecation – Buildings $ 96,000
Unearned rent 2,700
Salaries expense 69,000
Rent revenue 277,500

The Prepaid Insurance account balance represents the remaining cost of a four-year insurance policy dated 2011
June 30, having a total premium of USD 12,000.

The physical inventory of the office supply stockroom indicates that the supplies on hand cost USD 3,000.

The building was originally acquired on 1994 January 1, at which time management estimated that the building
would last 40 years and have a residual value of USD 15,000.

Salaries earned since the last payday but unpaid at December 31 amount to USD 5,000.

Interest earned but not collected on a savings account during the year amounts to USD 400.

The Unearned Rent account arose through the prepayment of rent by a tenant in the building for 12 months
beginning 2010 October 1.

Prepare the annual year-end adjusting entries indicated by the additional data.

Problem D The reported net income amounts for Gulf Coast Magazine, Inc., for calendar years 2010 and 2011
were USD 200,000 and USD 222,000, respectively. No annual adjusting entries were made at either year-end for
any of the following transactions:

A fire insurance policy to cover a three-year period from the date of payment was purchased on 2010 March 1 for
USD 3,600. The Prepaid Insurance account was debited at the date of purchase.

Subscriptions for magazines in the amount of USD 72,000 to cover an 18-month period from 2010 May 1, were
received on 2010 April 15. The Unearned Subscription Fees account was credited when the payments were received.

A building costing USD 180,000 and having an estimated useful life of 50 years and a residual value of USD
30,000 was purchased and put into service on 2010 January 1.

28
 On 2011 January 12, salaries of USD 9,600 were paid to employees. The account debited was Salaries Expense.
One-third of the amount paid was earned by employees in December of 2010.

Calculate the correct net income for 2010 and 2011. In your answer, start with the reported net income. Then
show the effects of each correction (adjustment), using a plus or a minus to indicate whether reported income
should be increased or decreased as a result of the correction. When the corrections are added to or deducted from
the reported net income amounts, the result should be the correct net income amounts. The answer format should
appear as follows:
Explanation of corrections 2010 2011
Reported net income $200,000 $222,000
To correct error in accounting for:
Fire insurance policy premium:
Correct expense in 2010 -1,000
Correct expense in 2011 -1,200

Problem E Jupiter Publishing Company began operations on 2010 December 1. The company’s bookkeeper
intended to use the cash basis of accounting. Consequently, the bookkeeper recorded all cash receipts and
disbursements for items relating to operations in revenue and expense accounts. No adjusting entries were made
prior to preparing the financial statements for December.

Dec. 1 Issued capital stock for USD 300,000 cash.

3 Received USD 144,000 for magazine subscriptions to run for two years from this date. The magazine is
published monthly on the 23rd.

4 Paid for advertising to be run in a national periodical for six months (starting this month). The cost was
USD 36,000.

7 Purchased for cash an insurance policy to cover a two-year period beginning December 15, USD 24,000.

12 Paid the annual rent on the building, USD 36,000, effective through 2011 November 30.

15 Received USD 216,000 cash for two-year subscriptions starting with the December issue.

15 Salaries for the period December 1–15 amounted to USD 48,000. Beginning as of this date, salaries will be
paid on the 5th and 20th of each month for the preceding two-week period.

20 Salaries for the period December 1–15 were paid.

23 Supplies purchased for cash, USD 21,600. (Only USD 1,800 of these were subsequently used in 2010.)

27 Printing costs applicable equally to the next six issues beginning with the December issue were paid in
cash, USD 144,000.

31 Cash sales of the December issue, USD 84,000.

31 Unpaid salaries for the period December 16–31 amounted to USD 22,000.

31 Sales on account of December issue, USD 14,000.

a. Prepare journal entries for the transactions as the bookkeeper prepared them.

Introduction to Accounting : The Language of Business – Supplemental Textbook 29

 b. Prepare journal entries as they would have been prepared under the accrual basis. Where the entry is the
same as under the cash basis, merely indicate “same”. Where possible, record the original transaction so that no
adjusting entry would be necessary at the end of the month. Ignore explanations.

Alternate problems
Alternate problem A The trial balance of Caribbean Vacation Tours, Inc., at December 31 of the current year
includes, among other items, the following account balances:

Debits Credits
Prepaid Insurance ........................................ $24,000
Prepaid Rent ................................................ 24,000
Buildings...................................................... 188,000
Accumulated Depreciation—Buildings............. $31,600
Salaries Expense .......................................... 200,000

The balance in the Prepaid Insurance account is the advance premium for one year from September 1 of the
current year.

The buildings are expected to last 25 years, with an expected residual value of USD 30,000.

Salaries incurred but not paid as of December 31 amount to USD 8,400.

The balance in Prepaid Rent is for a one-year period that started March 1 of the current year.

Prepare the annual year-end adjusting journal entries at December 31.

Alternate problem B Among the account balances shown in the trial balance of Dunwoody Mail Station, Inc.,
at December 31 of the current year are the following:
Debits Credits
Supplies on hand $10,000
Prepaid insurance 6,000
Buildings 168,000
Accumulated deprecation and buildings $ 39,000

The inventory of supplies on hand at December 31 amounts to USD 3,000.

The balance in the Prepaid Insurance account is for a two-year policy taken out June 1 of the current year.

Depreciation for the buildings is based on the cost shown in the Buildings account, less residual value estimated
at USD18,000. When acquired, the lives of the buildings were estimated at 50 years each.

a. Prepare the year-end adjusting journal entries at December 31.

b. Open ledger accounts for each of the accounts involved, enter the balances as shown in the trial balance, post
the adjusting journal entries, and calculate year-end balances.

Alternate problem C Nevada Camping Equipment Rental Company occupies rented quarters on the main
street of Las Vegas. To get this location, the company rented a store larger than needed and subleased (rented) a
portion of the area to Max’s Restaurant. The partial trial balance of Nevada Camping Equipment Rental Company
as of 2010 December 31, is as follows:
NEVEDA CAMPING EQUIPMENT RENTAL COMPANY
Trial Balance

30
2010 December 31
Debits Credits
Cash $100,000
Prepaid Insurance 11,400
Supplies on Hand 20,000
Camping Equipment 176,000
Accumulated Depreciation—Camping Equipment $ 19,200
Notes Payable 40,000
Equipment Rental Revenue 1,500,000
Sublease Rental Revenue 8,800
Building Rent Expense 14,400
Salaries Expense 196,000

a. Salaries of employees amount to USD 300 per day and were last paid through Wednesday, December 27.
December 31 is a Sunday. The store is closed Sundays.

b. An analysis of the Camping Equipment account disclosed:

Balance, 2010 January 1 $128,000
Addition, 2010 July 1 48,000
Balance, 2010 December 31, per trial balance $176,000

The company estimates that all equipment will last 20 years from the date they were acquired and that the
residual value will be zero.

c. The store carries one combined insurance policy, which is taken out once a year effective August 1. The
premium on the policy now in force amounts to USD 7,200 per year.

d. Unused supplies on hand at 2010 December 31, have a cost of USD 9,200.

e. December’s rent from Max’s Restaurant has not yet been received, USD 800.

f. Interest accrued on the note payable is USD 700.

Prepare the annual year-end entries required by the preceding statement of facts.

Alternate problem D The reported net income amounts for Safety Waste Control Company were 2010, USD
200,000; and 2011, USD 230,000. No annual adjusting entries were made at either year-end for any of these
transactions:

a. A building was rented on 2010 April 1. Cash of USD 14,400 was paid on that date to cover a two-year period.
Prepaid Rent was debited.

b. The balance in the Office Supplies on Hand account on 2010 December 31, was USD 6,000. An inventory of
the supplies on 2010 December 31, revealed that only USD 3,500 were actually on hand at that date. No new
supplies were purchased during 2011. At 2011 December 31, an inventory of the supplies revealed that USD 800
were on hand.

c. A building costing USD 1,200,000 and having an estimated useful life of 40 years and a residual value of USD
240,000 was put into service on 2010 January 1.

Introduction to Accounting : The Language of Business – Supplemental Textbook 31

 d. Services were performed for customers in December 2010. The USD 24,000 bill for these services was not
sent until January 2011. The only transaction that was recorded was a debit to Cash and a credit to Service Revenue
when payment was received in January.

Calculate the correct net income for 2010 and 2011. In your answer, start with the reported net income amounts.
Then show the effects of each correction (adjustment) using a plus or a minus to indicate whether reported income
should be increased or decreased as a result of the correction. When the corrections are added to or deducted from
the reported net income amounts, the result should be the correct net income amounts. The answer format should
be as follows:
Explanation of Corrections 2010 2011
Reported net income $200,000 $230,000
To correct error in accounting for:
Prepaid rent:
Correct expense in 2010 -5,400
Correct expense in 2011 -7,200

Alternate problem E On 2010 June 1, Richard Cross opened a swimming pool cleaning and maintenance
service, Cross Pool Company. He vaguely recalled the process of making journal entries and establishing ledger
accounts from a high school bookkeeping course he had taken some years ago. At the end of June, he prepared an
income statement for the month of June, but he had the feeling that he had not proceeded correctly. He contacted
his brother, John, a recent college graduate with a major in accounting, for assistance. John immediately noted that
his brother had kept his records on a cash basis.

June 1 Received cash of USD 28,000 from various customers in exchange for service agreements to clean and
maintain their pools for June, July, August, and September.

5 Paid rent for automotive and cleaning equipment to be used during the period June through September, USD
8,000. The payment covered the entire period.

8 Purchased a two-year liability insurance policy effective June 1 for USD 12,000 cash.

10 Received an advance of USD 9,000 from a Florida building contractor in exchange for an agreement to help
service pools in his housing development during October through May.

16 Paid salaries for the first half of June, USD 8,400.

17 Paid USD 900 for advertising to be run in a local newspaper for two weeks in June and four weeks in July.

19 Paid the rent of USD 24,000 under a four-month lease on a building rented and occupied on June 1.

26 Purchased USD 5,400 of supplies for cash. (Only USD 900 of these supplies were used in June.)

29 Billed various customers for services rendered, USD 16,000.

30 Unpaid employee services received in the last half of June amounted to USD 12,600.

30 Received a bill for USD 600 for gas and oil used in June.

a. Prepare the entries for the transactions as Richard must have recorded them under the cash basis of
accounting.

32
 b. Prepare journal entries as they would have been prepared under the accrual basis. Where the entry is the
same as under the cash basis, merely indicate “same”. Where possible, record the original transaction so that no
adjusting entry would be necessary at the end of the month. Ignore explanations.
Beyond the numbers—Critical thinking
Business decision case A You have just been hired by Top Executive Employment Agency, Inc., to help
prepare adjusting entries at the end of an accounting period. It becomes obvious to you that management does not
seem to have much of an understanding about the necessity or adjusting entries or which accounts might possibly
need adjustment. The first step you take is to prepare the following unadjusted trial balance from the general
ledger. Only those ledger accounts that had end-of-year balances are included in the trial balance.
Debits Credits
Cash $ 80,000
Accounts Receivable 28,000
Supplies on Hand 3,000
Prepaid Insurance 2,700
Office Equipment 120,000
Accumulated Depreciation—Office Equipment $ 45,000
Buildings 360,000
Accumulated Depreciation—Buildings 105,000
Accounts Payable 9,000
Loan Payable (Bank) 15,000
Unearned Commission Fees 30,000
Capital Stock 160,000
Retained Earnings 89,300
Commissions Revenue 270,000
Advertising Expense 6,000
Salaries Expense 112,500
Utilities Expense 7,500
Miscellaneous Expense 3,600
$723,300 $723,300

a. Explain to management why adjusting entries in general are made.

b. Explain to management why some of the specific accounts appearing in the trial balance may need adjustment
and what the nature of each adjustment might be (do not worry about specific dollar amounts).

Business decision case B A friend of yours, Jack Andrews, is quite excited over the opportunity he has to
purchase the land and several miscellaneous assets of Drake Bowling Lanes Company for USD 400,000. Andrews
tells you that Mr and Mrs Drake (the sole stockholders in the company) are moving due to Mr Drake’s ill health.
The annual rent on the building and equipment is USD 54,000.

Drake reports that the business earned a profit of USD 100,000 in 2010 (last year). Andrews believes an annual
profit of USD 100,000 on an investment of USD 400,000 is a really good deal. But, before completing the deal, he
asks you to look it over. You agree and discover the following:

Drake has computed his annual profit for 2010 as the sum of his cash dividends plus the increase in the Cash
account: Dividends of USD 60,000 + Increase in Cash account of USD 40,000 = USD 100,000 profit.

Introduction to Accounting : The Language of Business – Supplemental Textbook 33

 As buyer of the business, Andrews will take over responsibility for repayment of a USD 300,000 loan (plus
interest) on the land. The land was acquired at a cost of USD 624,000 seven years ago.

An analysis of the Cash account shows the following for 2010:

Rental revenues received $465,000
Cash paid out in 2010 for—
Salaries paid to employees $260,000
Utilities paid 18,000
Advertising expenses paid 15,000
Supplies purchased and used 24,000
Interest paid on loan 18,000
Loan principal paid 30,000
Cash dividends 60,000 425,000
In crease in cash balance for the year $ 40,000

You also find that the annual rent of USD 54,000, a December utility bill of USD 4,000, and an advertising bill
of USD 6,000 have not been paid.

a. Prepare a written report for Andrews giving your appraisal of Drake Bowling Lanes Company as an
investment. Comment on Drake’s method of computing the annual profit of the business.

b. Include in your report an approximate income statement for 2010.

Group project C In teams of two or three students, go to the library to locate one company’s annual report for
the most recent year. Identify the name of the company and the major products or services offered, as well as gross
revenues, major expenses, and the trend of profits over the last three years. Calculate trend percentages for
revenues, expenses, and profits using the oldest year as the base year. Each team should write a memorandum to
management summarizing the data and commenting on the trend percentages. The heading of the memorandum
should contain the date, to whom it is written, from whom, and the subject matter.

Group project D With one or two other students and using library and internet sources, write a paper on
Statement of Accounting Standards No. 106, “Accounting for Postretirement Benefits Other Than Pensions”. This
standard resulted in some of the largest adjusting entries ever made. Companies had to record an expense and a
liability to account for these costs on an accrual basis. In the past they typically had recorded this expense on a cash
basis, recognizing the expense only when cash was paid to retirees. Be sure to cite your sources and treat direct
quotes properly.

Group project E With one or two other students and using library sources, write a paper on human resource
accounting. Generally accepted accounting principles do not allow “human assets” to be included among assets on
the balance sheet. Why is this? Be sure to cite your sources and to treat direct quotes properly.
Using the Internet—A view of the real world
Visit the website:

http://www.pwcglobal.com

Click on the Sarbanes-Oxley Act. Write a brief report to your instructor summarizing your findings.
Answers to self-test
True-false

34
 True. Every adjusting entry involves either moving previously recorded data from an asset account to an
expense account or from a liability account to a revenue account (or in the opposite direction) or simultaneously
entering new data in an asset account and a revenue account or in a liability account and an expense account.

True. A fiscal year is any 12 consecutive months, so all calendar years are also fiscal years. A calendar year,
however, must end on December 31, so it does not include fiscal years that end on any date other than December 31
(such as June 30).

False. The accumulated depreciation account is a contra asset that shows the total of all depreciation recorded
on an asset from its acquisition date up through the balance sheet date.

False. The Unearned Delivery Fees account is a liability. As the fees are earned, the amount in that account is
transferred to a revenue account.

True. If an adjusting entry is overlooked and not made, at least one income statement account and one balance
sheet account will be incorrect.

Multiple-choice

d. One-third of the benefits have expired. Therefore, USD 400 must be moved from the asset (credit) to an
expense (debit).

a. USD 1,100 of the supplies have been used, so that amount must be moved from the asset (credit) to an
expense (debit).

c. The amount of annual depreciation is determined as (USD 20,000 – USD 5,000) divided by 5 = USD 3,000.
The debit is to Depreciation Expense—Trucks, and the credit is to Accumulated Depreciation—Trucks, a contra
asset account.

b. Each month USD 2,000 would be transferred from the liability account (debit), Unearned Subscription Fees,
to a revenue account (credit).

b. An asset, Interest Receivable, is debited, and Interest Revenue is credited.

a. The debit would be to Salaries Expense, and the credit would be to Salaries Payable.

Introduction to Accounting : The Language of Business – Supplemental Textbook 35

Completing the accounting cycle

A career in information systems

Have you ever heard the sayings "knowledge is power" or "information is money"? When people talk about
accounting, what they are really talking about is information. The information used by businesses, as well as the
technology that supports that information, represents some of the most valuable assets for organizations around
the world. Very often, the success of a business depends on effective creation, management, and use of information.

As companies become ever more reliant on technology, the need for well-educated Management Information
Systems (MIS) auditors and control professionals increases. Improved technology has the potential to dramatically
improve business organizations and practices, reduce costs and exploit new business and investment opportunities.
At the same time, companies face constant challenges in selecting and implementing these new technologies.
Because of their high value and inherent complexity, the development, support, and auditing of information
systems has become one of the fastest growing specialties in accounting.

Graduates with special interests and skills in computing and technology have expansive opportunities. In
addition to traditional accounting and auditing functions, MIS professionals perform evaluations of technologies
and communications protocols involving electronic data interchange, client servers, local and wide area networks,
data communications, telecommunications, and integrated voice/data/video systems. In public accounting,
technology has impacted the auditing profession by extending the knowledge required to draw conclusions and the
skills required to audit advanced accounting and information systems.

With management consulting practices growing and information systems becoming a larger percentage of public
accounting revenue, MIS professionals are in high demand. If you are considering a degree in computer or
information systems, you should consider the advantages that an accounting major or minor can give you in
working closely with businesses and consulting firms. A dual major in accounting and MIS is one of the most
desirable undergraduate degree combinations in the workforce.

This chapter explains two new steps in the accounting cycle—the preparation of the work sheet and closing
entries. In addition, we briefly discuss the evolution of accounting systems and present a classified balance sheet.
This balance sheet format more closely resembles actual company balance sheets. After completing this chapter,
you will understand how accounting begins with source documents that are evidence of a business entity's
transactions and ends with financial statements that show the solvency and profitability of the entity.

The accounting cycle summarized

In Chapter 1, you learned that when an event is a measurable business transaction, you need adequate proof of
this transaction. Then, you analyze the transaction's effects on the accounting equation, Assets = Liabilities +
Stockholders' equity. In earlier chapters, you performed other steps in the accounting cycle. As a review, study the
diagram of the eight steps in the accounting cycle in Exhibit 11. Remember that the first three steps occur during
the accounting period and the last five occur at the end. The next section explains how to use the work sheet to
facilitate the completion of the accounting cycle.

Introduction to Accounting : The Language of Business – Supplemental Textbook 36

 The work sheet
The work sheet is a columnar sheet of paper or a computer spreadsheet on which accountants summarize
information needed to make the adjusting and closing entries and to prepare the financial statements. Usually, they
save these work sheets to document the end-of-period entries. A work sheet is only an accounting tool and not part
of the formal accounting records. Therefore, work sheets may vary in format; some are prepared in pencil so that
errors can be corrected easily. Other work sheets are prepared on personal computers with spreadsheet software.
Accountants prepare work sheets each time financial statements are needed—monthly, quarterly, or at the end of
the accounting year.

This chapter illustrates a 12-column work sheet that includes sets of columns for an unadjusted trial balance,
adjustments, adjusted trial balance, income statement, statement of retained earnings, and balance sheet. Each set
has a debit and a credit column. (See Exhibit 12.)

Accountants use these initial steps in preparing the work sheet. The following sections describe the detailed
steps for completing the work sheet.

• Enter the titles and balances of ledger accounts in the Trial Balance columns.

• Enter adjustments in the Adjustments columns.

• Enter adjusted account balances in the Adjusted Trial Balance columns.

• Extend adjusted balances of revenue and expense accounts from the Adjusted Trial Balance columns to the
Income Statement columns.

• Extend any balances in the Retained Earnings and Dividends accounts to the Statement of Retained
Earnings columns.

• Extend adjusted balances of asset, liability, and capital stock accounts from the Adjusted Trial Balance
columns to the Balance Sheet columns.

Instead of preparing a separate trial balance as we did earlier, accountants use the Trial Balance columns on a
work sheet. Look at Exhibit 12 and note that the numbers and titles of the ledger accounts of MicroTrain Company
are on the left portion of the work sheet. Usually, only those accounts with balances as of the end of the accounting
period are listed. (Some accountants do list the entire chart of accounts, even those with zero balances.) Assume
you are MicroTrain's accountant. You list the Retained Earnings account in the trial balance even though it has a
zero balance to (1) show its relative position among the accounts and (2) indicate that December 2010 is the first
month of operations for this company. Next, you enter the balances of the ledger accounts in the Trial Balance
columns. The accounts are in the order in which they appear in the general ledger: assets, liabilities, stockholders'
equity, dividends, revenues, and expenses. Then, total the columns. If the debit and credit column totals are not
equal, an error exists that must be corrected before you proceed with the work sheet.

As you learned in earlier, adjustments bring the accounts to their proper balances before accountants prepare
the income statement, statement of retained earnings, and balance sheet. You enter these adjustments in the
Adjustments columns of the work sheet. Also, you cross-reference the debits and credits of the entries by placing a
key number or letter to the left of the amounts. This key number facilitates the actual journalizing of the adjusting

37
entries later because you do not have to rethink the adjustments to record them. For example, the number (1)
identifies the adjustment debiting Insurance Expense and crediting Prepaid Insurance. Note in the Account Titles
column that the Insurance Expense account title is below the trial balance totals because the Insurance Expense
account did not have a balance before the adjustment and, therefore, did not appear in the trial balance.

Work sheet preparers often provide brief explanations at the bottom for the keyed entries as in Exhibit 12.
Although these explanations are optional, they provide valuable information for those who review the work sheet
later.

The adjustments for MicroTrain Company are:

Exhibit 6: Steps in the accounting cycle

• Entry (1) records the expiration of USD 200 of prepaid insurance in December.

• Entry (2) records the expiration of USD 400 of prepaid rent in December.

• Entry (3) records the using up of USD 500 of supplies during the month.

• Entry (4) records USD 750 depreciation expense on the trucks for the month. MicroTrain acquired the
trucks at the beginning of December.

MicroTrain acquired the trucks at the beginning of December

• Entry (5) records the earning of USD 1,500 of the USD 4,500 in the Unearned Service Fees account.

• Entry (6) records USD 600 of interest earned in December.

Introduction to Accounting : The Language of Business – Supplemental Textbook 38

 • Entry (7) records USD 1,000 of unbilled training services performed in December.

• Entry (8) records the USD 180 accrual of salaries expense at the end of the month.

Often it is difficult to discover all the adjusting entries that should be made. The following steps are helpful:

• Examine adjusting entries made at the end of the preceding accounting period. The same types of entries
often are necessary period after period.

• Examine the account titles in the trial balance. For example, if the company has an account titled Trucks,
an entry must be made for depreciation.

• Examine various business documents (such as bills for services received or rendered) to discover other
assets, liabilities, revenues, and expenses that have not yet been recorded.

• Ask the manager or other personnel specific questions regarding adjustments that may be necessary. For
example: "Were any services performed during the month that have not yet been billed?"

39
 MICROTRAIN COMPANY Work Sheet For the Month Ended 2010 December 31

Acc Account Titles

t.
Statement of
Adjusted Trail Income Balance
Trial Balance Adjustments Retained
Balance Statement Sheet
Earnings

No. Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit Debit

100 Cash 8,250 8,250 8,250

103 Accounts 5,200 (7) 1,000 6,200 6,200
Receivable
107 Supplies on Hand 1,400 (3) 500 900 900
108 Prepaid Insurance 2,400 n) 200 2,200 2,200
112 Prepaid Rent 1,200 (2) 400 BOO 800
150 Trucks 40,0 0 0 40,000 40,000
200 Accounts Payable 730 730
216 Unearned Service 4,500 (5) 1,500 3,000
Fees
300 Capital Stock 50,000 50,000
310 Retained Earnings —0- —0— -0-
2010 December
31
320 Dividends 3,000 3,000 3,000
400 Service (5)
1,500
Revenue 10,700 (7) 13,200 13,200
1,000
505 Advertising 50 SO 50
Expense
506 Gas and Oil 690 660 680
Expense
507 Salaries Expense 3,600 (3) 130 3,7S0 3,780
511 Utilities Expense 150 ISO 150
65,930 65,930
512 Insurance Expense (1) 200 200 200
SIS Rent Expense (Z) 400 400 400
518 Supplies Expense (3) 500 500 500
521 Depreciation
Expense-
Trucks (t) 750 750 750
151 Accumulated
Depreciation-
Trucks (t) 750 750
121 Interest 600 600
Receivable m 6O0
418 Interest Revenue (6) 500 600 GOO
206 Salaries Payable (S) 180 ISO
5,130 5,130 53,400 6S,4G0 6,510 13,800
Net Income 7,290 7,290
13,800 13,800 3,000 7,29C
Retained Earnings, 4,290
2010 December
31
7,290 7,29C 53,950

Exhibit 7: Completed worksheet

(1) To record insurance expenses for December.

(2) To record rent expenses for December.

(3) To record supplies expenses for December.

(4) To record depreciation expenses for December.

Introduction to Accounting : The Language of Business – Supplemental Textbook 40

 (5) To transfer fees for service provided in December from the liability account to the revenue account.

(6) To record one month's interest revenue.

(7) To record unbilled training services performed in December.

(8) To accrue one day's salaries that were earned but are unpaid.

After all the adjusting entries are entered in the Adjustments columns, total the two columns. The totals of these
two columns should be equal when all debits and credits are entered properly.

After MicroTrain's adjustments, compute the adjusted balance of each account and enter these in the Adjusted
Trial Balance columns. For example, Supplies on Hand (Account No. 107) had an unadjusted balance of USD 1,400.
Adjusting entry (3) credited the account for USD 500, leaving a debit balance of USD 900. This amount is a debit in
the Adjusted Trial Balance columns.

Next, extend all accounts having balances to the Adjusted Trial Balance columns. Note carefully how the rules of
debit and credit apply in determining whether an adjustment increases or decreases the account balance. For
example, Salaries Expense (Account No. 507) has a USD 3,600 debit balance in the Trial Balance columns. A USD
180 debit adjustment increases this account, which has a USD 3,780 debit balance in the Adjusted Trial Balance
columns.

Some account balances remain the same because no adjustments have affected them. For example, the balance
in Accounts Payable (Account No. 200) does not change and is simply extended to the Adjusted Trial Balance
columns.

Now, total the Adjusted Trial Balance debit and credit columns. The totals must be equal before taking the next
step in completing the work sheet. When the Trial Balance and Adjustments columns both balance but the Adjusted
Trial Balance columns do not, the most probable cause is a math error or an error in extension. The Adjusted Trial
Balance columns make the next step of sorting the amounts to the Income Statement, the Statement of Retained
Earnings, and the Balance Sheet columns much easier.

Begin by extending all of MicroTrain's revenue and expense account balances in the Adjusted Trial Balance
columns to the Income Statement columns. Since revenues carry credit balances, extend them to the credit column.
After extending expenses to the debit column, subtotal each column. MicroTrain's total expenses are USD 6,510 and
total revenues are USD 13,800. Thus, net income for the period is USD 7,290 (USD 13,800—USD 6,510). Enter this
USD 7,290 income in the debit column to make the two column totals balance. You would record a net loss in the
opposite manner; expenses (debits) would have been larger than revenues (credits) so a net loss would be entered
in the credit column to make the columns balance.

Next, complete the Statement of Retained Earnings columns. Enter the USD 7,290 net income amount for
December in the credit Statement of Retained Earnings column. Thus, this net income amount is the balancing
figure for the Income Statement columns and is also in the credit Statement of Retained Earnings column. Net
income appears in the Statement of Retained Earnings credit column because it causes an increase in retained
earnings. Add the USD 7,290 net income to the beginning retained earnings balance of USD 0, and deduct the
dividends of USD 3,000. As a result, the ending balance of the Retained Earnings account is USD 4,290.

41
 Now extend the assets, liabilities, and capital stock accounts in the Adjusted Trial Balance columns to the
Balance Sheet columns. Extend asset amounts as debits and liability and capital stock amounts as credits.

Note that the ending retained earnings amount determined in the Statement of Retained Earnings columns
appears again as a credit in the Balance Sheet columns. The ending retained earnings amount is a debit in the
Statement of Retained Earnings columns to balance the Statement of Retained Earnings columns. The ending
retained earnings is a credit in the Balance Sheet columns because it increases stockholders' equity, and increases
in stockholders' equity are credits. (Retained earnings would have a debit ending balance only if cumulative losses
and dividends exceed cumulative earnings.) With the inclusion of the ending retained earnings amount, the Balance
Sheet columns balance.

When the Balance Sheet column totals do not agree on the first attempt, work backward through the process
used in preparing the work sheet. Specifically, take the following steps until you discover the error:
MICROTRAIN COMPANY
Income Statement
For the Month Ended 2010 December 31
Revenues:
Service Revenue $13,200
Interest Revenue 600
Total Revenue $13,800
Expenses:
Advertising Expense $ 50
Gas and Oil Expense 680
Salaries Expense 3,780
Utilities Expense 150
Insurance Expense 200
Rent Expense 400
Supplies Expense 500
Depreciation Expense—Trucks 750
Total Expense 6,510
Net Income $ 7,290

Exhibit 8: Income statement

• Re-total the two Balance Sheet columns to see if you made an error in addition. If the column totals do not
agree, check to see if you did not extend a balance sheet item or if you made an incorrect extension from the
Adjusted Trial Balance columns.

• Re-total the Statement of Retained Earnings columns and determine whether you entered the correct
amount of retained earnings in the appropriate Statement of Retained Earnings and Balance Sheet
columns.

• Re-total the Income Statement columns and determine whether you entered the correct amount of net
income or net loss for the period in the appropriate Income Statement and Statement of Retained Earnings
columns.

Introduction to Accounting : The Language of Business – Supplemental Textbook 42

 An accounting perspective:

Uses of technology

Electronic spreadsheets have numerous applications in accounting. An electronic spreadsheet is

simply a large blank page that contains rows and columns on the computer screen. The blocks
created by the intersection of the rows and columns are cells; each cell can hold one or more words,
a number, or the product of a mathematical formula. Spreadsheets are ideal for creating large work
sheets, trial balances, and other schedules, and for performing large volumes of calculations such
as depreciation calculations. The most popular spreadsheet program is Microsoft Excel®. Free
spreadsheet programs are also available from companies such as Google and Zoho.

Preparing financial statements from the work sheet

When the work sheet is completed, all the necessary information to prepare the income statement, statement of
retained earnings, and balance sheet is readily available. Now, you need only recast the information into the
appropriate financial statement format.

The information you need to prepare the income statement in Exhibit 8 is in the work sheet's Income Statement
columns in Exhibit 12.

The information you need to prepare the statement of retained earnings is taken from the Statement of Retained
Earnings columns in the work sheet. Look at Exhibit 9, MicroTrain Company's statement of retained earnings for
the month ended 2010 December 31. To prepare this statement, use the beginning Retained Earnings account
balance (Account No. 310), add the net income (or deduct the net loss), and then subtract the Dividends (Account
No. 320). Carry the ending Retained Earnings balance forward to the balance sheet. Remember that the statement
of retained earnings helps to relate income statement information to balance sheet information. It does this by
indicating how net income on the income statement relates to retained earnings on the balance sheet.
MICROTRAIN COMPANY
Statement of Retained Earnings
For the Month Ended 2010 December 31,
Retained earnings, 2010 December 1 $ —0—
Net income for the December 7,290
Total $ 7,290
Less: Dividends 3,000
Retained earnings, 2010 December 31 $ 4,290

Exhibit 9: Statement of retained earnings

43
 MICROTRAIN COMPANY
Balance Sheet
2010 December 31
Assets
Cash $ 8,250
Accounts receivable 6,200
Supplies on hand 900
Prepaid insurance 2,200
Prepaid rent 800
Interest receivable 600
Trucks $ 40,000
Less: Accumulated depredation 750 39,250
Total assets $ 58,200
Liabilities and Stockholders' Equity
Liabilities:
Accounts payable $ 730
Unearned service fees 3,000
Salaries payable 180
Total liabilities $ 3,910
Stockholders' equity:
Capital stock $ 50,000
Retained earnings 4,290
Total stockholders' equity 54,290
Total liabilities and stockholders' equity $ 58,200

Exhibit 10: Balance sheet

The information needed to prepare a balance sheet comes from the Balance Sheet columns of MicroTrain's work
sheet (Exhibit 12). As stated earlier, the correct amount for the ending retained earnings appears on the statement
of retained earnings. See the completed balance sheet for MicroTrain in Exhibit 10.

Journalizing adjusting entries

After completing MicroTrain's financial statements from the work sheet, you should enter the adjusting entries
in the general journal and post them to the appropriate ledger accounts. You would prepare these adjusting entries
as you learned earlier, except that the work sheet is now your source for making the entries. The preparation of a
work sheet does not eliminate the need to prepare and post adjusting entries because the work sheet is only an
informal accounting tool and is not part of the formal accounting records.

The numerical notations in the Adjustments columns and the adjustments explanations at the bottom of the
work sheet identify each adjusting entry. The Adjustments columns show each entry with its appropriate debit and
credit. MicroTrain's adjusting entries as they would appear in the general journal after posting are:
MICROTRAIN COMPANY
General Journal page3

Date Account Titles and Explanation Post. Debit Credit

Ref.
2010 Adjusting Entries
Dec. 31 Insurance Expense (-SE) 512 2 0 0
Prepaid Insurance (-A) 108 2 0 0
To record insurance expense for December.

31 Rent Expense (-SE) 515 4 0 0

Prepaid Rent (-A) 112 4 0 0
To record rent expense for December.

Introduction to Accounting : The Language of Business – Supplemental Textbook 44

 31 Supplies Expense (-SE) 518 5 0 0
Supplies on Hand (-A) 107 5 0 0
To record supplies used during December.

31 Depreciation Expense—Trucks (-SE) 521 7 5 0

Accumulated Depredation—Trucks (-A) 151 7 5 0
To record depreciation expense for December.

31 Unearned Service Fees (-L) 216 1 5 0 0

Service Revenue (+SE) 400 1 5 0 0
To transfer a potion of training fees from the liability account
to the revenue account.

31 Interest Receivable (+A) 121 6 0 0

Interest Revenue (+SE) 418 6 0 0
To record one month's interest revenue.

31 Accounts Receivable (+A) 103 1 0 0 0

Service Revenue (+SE) 400 1 0 0 0
To record unbilled training services performed in December.

31 Salaries Expense (-SE) 507 1 8 0

Salaries Payable (+L) 206 1 8 0
To accrue one day's salaries that were earned by are unpaid.

The closing process

Earlier you learned that revenue, expense, and dividends accounts are nominal (temporary) accounts that are
merely subclassifications of a real (permanent) account, Retained Earnings. You also learned that we prepare
financial statements for certain accounting periods. The closing process transfers (1) the balances in the revenue
and expense accounts to a clearing account called Income Summary and then to Retained Earnings and (2) the
balance in the Dividends account to the Retained Earnings account. The closing process reduces revenue, expense,
and Dividends account balances to zero so they are ready to receive data for the next accounting period.
Accountants may perform the closing process monthly or annually.

The Income Summary account is a clearing account used only at the end of an accounting period to
summarize revenues and expenses for the period. After transferring all revenue and expense account balances to
Income Summary, the balance in the Income Summary account represents the net income or net loss for the
period. Closing or transferring the balance in the Income Summary account to the Retained Earnings account
results in a zero balance in Income Summary.

Also closed at the end of the accounting period is the Dividends account containing the dividends declared by
the board of directors to the stockholders. We close the Dividends account directly to the Retained Earnings
account and not to Income Summary because dividends have no effect on income or loss for the period.

In accounting, we often refer to the process of closing as closing the books. Remember that only revenue,
expense, and Dividend accounts are closed—not asset, liability, Capital Stock, or Retained Earnings accounts. The
four basic steps in the closing process are:

45
 • Closing the revenue accounts—transferring the balances in the revenue accounts to a clearing account
called Income Summary.

• Closing the expense accounts—transferring the balances in the expense accounts to a clearing account
called Income Summary.

• Closing the Income Summary account—transferring the balance of the Income Summary account to
the Retained Earnings account.

• Closing the Dividends account—transferring the balance of the Dividends account to the Retained
Earnings account.

Revenues appear in the Income Statement credit column of the work sheet. The two revenue accounts in the
Income Statement credit column for MicroTrain Company are service revenue of USD 13,200 and interest revenue
of USD 600 (Exhibit 12). Because revenue accounts have credit balances, you must debit them for an amount equal
to their balance to bring them to a zero balance. When you debit Service Revenue and Interest Revenue, credit
Income Summary (Account No. 600). Enter the account numbers in the Posting Reference column when the
journal entry has been posted to the ledger. Do this for all other closing journal entries.
MICROTRAIN COMPANY
General Journal Page 4
Date Account Titles and Explanation Post. Debit Credit
Ref.
2010 Closing Entries
Dec. 31 Service Revenue 400 1 3 2 0 0
Interest Revenue 418 6 0 0
Income Summary 600 1 3 8 0 0
To close the revenue accounts in the Income Statement credit
column to Income Summary.

After the closing entries have been posted, the Service Revenue and Interest Revenue accounts (in T-account
format) of MicroTrain appear as follows. Note that the accounts now have zero balances.
Service Revenue
(Dr) Account No. 400 (Cr.)
2010 Bal. before 13,200
closing
Dec. 31 To close to
Decreased Income
by $13,200 Summary13,20
0
Bal. after closing —0—
Interest Revenue
Account No. 418 (Cr.)
2010 Bal. before 600
closing
Dec. 31 To close to
Decreased Income
by $600 Summary 600
Bal. after closing —0—
As a result of the previous entry, you would credit the Income Summary account for USD 13,800. We show the
Income Summary account in Step 3.

Introduction to Accounting : The Language of Business – Supplemental Textbook 46

 Expenses appear in the Income Statement debit column of the work sheet. MicroTrain Company has eight
expenses in the Income Statement debit column. As shown by the column subtotal, these expenses add up to USD
6,510. Since expense accounts have debit balances, credit each account to bring it to a zero balance. Then, make the
debit in the closing entry to the Income Summary account for USD 6,510. Thus, to close the expense accounts,
MicroTrain makes the following entry:
MICROTRAIN COMPANY
General Journal Page 4

Date Account Titles and Explanation Post. Ref. Debit Credit

31 Income Summary 600 6 5 1 0
2010 Dec.
Advertising Expense 505 5 0
Gas and Oil Expense 506 6 8 0
Salaries Expense 507 3 7 8 0
Utilities Expense 511 1 5 0
Insurance Expense 512 2 0 0
Rent Expense 515 4 0 0
Supplies Expense 518 5 0 0
Depreciation Expense—Trucks 521 7 5 0
To close the expense accounts appearing in the Income

The debit of USD 6,510 to the Income Summary account agrees with the Income Statement debit column
subtotal in the work sheet. This comparison with the work sheet serves as a check that all revenue and expense
items have been listed and closed. If the debit in the preceding entry was made for a different amount than the
column subtotal, the company would have an error in the closing entry for expenses.

After they have been closed, MicroTrain's expense accounts appear as follows. Note that each account has a zero
balance after closing.
Advertising Expense
(Dr) Account No. 505 (Cr.)
Bal. before closing ■ 50 2010 ■ ■
Dec. 31 To close to
Income

Decreased
Summary 50 by $50

Bal. after closing —0—

Gas and Oil Expense
(Dr.) Account No. 506 (Cr.)
Bal. before closing 680 2010
Dec. 31 To close to
Income Decreased
Summary 680 by $680

Bal. after closing —0—

Salaries Expense
(Dr.) Account No. 507 (Cr.)
Bal. before closing 3,780 2010
Dec. 31 To close to
Income

Decreased
Summary 3,780 by $3,780

47
Bal. after closing —0—
Utilities Expense
(Dr.) Account No. 511 (Cr.)
Bal. before closing 150 2010
Dec. 31 To close to
Income Decreased
Summary 150 by $150

Bal. after closing —0—

Insurance Expense
(Dr.) Account No. 512 (Cr.)
Bal. before closing 200 2010
Dec. 31 To close to
Income Decreased
Summary 200 by $200

Bal. after closing —0—

Rent Expense
(Dr.) Account No. 515 (Cr.)
Bal. before closing 400 2010
Dec. 31 To close to
Income Decreased
Summary 400 by $400

Bal. after closing —0—

Supplies Expense
(Dr.) Account No. 518 (Cr.)
Bal. before closing 500 2010
Dec. 31 To close to
Income Decreased
Summary 500 by $500

Bal. after closing —0—

Depreciation Expense-Trucks
(Dr.) Account No. 521 (Cr.)
Bal. before closing ■ 750' 2010 "
Dec. 31 To close to
Income Decreased
Summary 750 by $750

Bal. after closing —0—

The expense accounts could be closed before the revenue accounts; the end result is the same.

As the result of closing the revenues and expenses of MicroTrain, the total revenues and expenses have been
transferred to the Income Summary account.
Income Summary
If total expenses exceed Total expenses Total revenues If total revenues exceed
total revenues, w total expenses,
the account has a debit the account has a credit
balance, which is the net balance, which is the net
loss for the period income for the period.

MicroTrain's Income Summary account now has a credit balance of USD 7,290, the company's net income for
December.
(Dr)
Income Summary (Cr.)

2010 From closing 6,510 2010 13,800

Dec. 31 the expense Dec. 31 From closing
accounts the revenue
accounts
Bal. before closing this
account (net income) 7,290

Introduction to Accounting : The Language of Business – Supplemental Textbook 48

 Next, close MicroTrain's Income Summary account to its Retained Earnings account. The journal entry to do
this is:
MICROTRAIN COMPANY
General Journal Page 4

Date Account Titles and Explanation Post. Ref. Debt Credit

31 Income Summary 600 7 2 9 0
2010 Dec.
Retained Earnings 310 7 2 9 0
To close the Income Summary account to the Retained
Earnings account.

After its Income Summary account is closed, the company's Income Summary and Retained Earnings accounts
appear as follows:
Income Summary
(Dr.) Account No. 600 (Cr.)
"2010 Dec. 31 From
2010 closing
Dec. 31 From closing the The revenue
expense accounts 6,510 accounts 13,800
Bal. before closing this
account (net income) 7,290
Dec. 31 To close this
account to Retain ed
Earnings 7,290
Bal. after closing —0—

Retained Earnings
(Dr) Account No. 310 (Cr.)

Bal. before closing -0-

Process
2010
Dec. 31 From Income 7,290 Decreased by
Summary $7,290

The last closing entry closes MicroTrain's Dividends account. This account has a debit balance before closing. To
close the account, credit the Dividends account and debit the Retained Earnings account. The Dividends account is
not closed to the Income Summary because it is not an expense and does not enter into income determination. The
journal entry to close MicroTrain's Dividends account is:
MICROTRAIN COMPANY
General Journal Page 4

Date Account Titles and Explanation Post. Ref. Debit Credit

31 Retained Earnings (-SE) 310 3 0 0 0
2010 Dec.
Dividends (+SE) 320 3 0 0 0
To close the Dividends account to the Retained Earnings
account.

After this closing entry is posted, the company's Dividends and Retained Earnings accounts appear as follows:
Dividends
(Dr.) Account No. 320 (Cr.)
Bal. before closing 3,000 2010 3000
Dec. 31 To close to
Retained
Earning

Decreased
by $3,000

Bal. after closing —0—

Retained Earnings
(Dr.) Account No. 310 (Cr.)

49
2010 Bal. before closing
process -0-
2010
Dec. 31 From dividends 3,000 Dec. 31 From Income
Summary 7,290
Bal. after closing
process is complete 4,290

After you have completed the closing process, the only accounts in the general ledger that have not been closed
are the permanent balance sheet accounts. Because these accounts contain the opening balances for the coming
accounting period, debit balance totals must equal credit balance totals. The preparation of a post-closing trial
balance serves as a check on the accuracy of the closing process and ensures that the books are in balance at the
start of the new accounting period. The post-closing trial balance differs from the adjusted trial balance in only two
important respects: (1) it excludes all temporary accounts since they have been closed; and (2) it updates the
Retained Earnings account to its proper ending balance.

A post-closing trial balance is a trial balance taken after the closing entries have been posted. The only
accounts that should be open are assets, liabilities, capital stock, and Retained Earnings accounts. List all the
account balances in the debit and credit columns and total them to make sure debits and credits are equal.

Look at Exhibit 6, a post-closing trial balance for MicroTrain Company as of 2010 December 31. The amounts in
the post-closing trial balance are from the ledger after the closing entries have been posted.

The next section briefly describes the evolution of accounting systems from the one-journal, one-ledger manual
system you have been studying to computerized systems. Then, we discuss the role of an accounting system.

An accounting perspective:

Uses of technology

If you are studying in the US, you may want to visit the American Institute of Certified Public
Accountants website at:

http://www.aicpa.org

You will find information about the CPA exam, about becoming a CPA, hot accounting topics, and
various other topics, such as the US states that have passed a 150-hour requirement to sit for the
CPA exam. You can also learn such things as the states that have approved limited liability
companies (LLCs) and limited liability partnerships (LLPs). These forms of organization serve to
place limits on accountants' liability. You can also find the phone numbers and mailing addresses
of State Boards of accountancy and State Societies of CPAs. Browse around this site to investigate
anything else that is of interest. Similar sites are available in other countries as well.

Accounting systems: From manual to computerized

The manual accounting system with only one general journal and one general ledger has been in use for
hundreds of years and is still used by some very small companies. Gradually, some manual systems evolved to
include multiple journals and ledgers for increased efficiency. For instance, a manual system with multiple journals
and ledgers often includes: a sales journal to record all credit sales, a purchases journal to record all credit

Introduction to Accounting : The Language of Business – Supplemental Textbook 50

purchases, a cash receipts journal to record all cash receipts, and a cash disbursements journal to record all cash
payments. Still recorded in the general journal are adjusting and closing entries and any other entries that do not fit
in one of the special journals. Besides the general ledger, such a system normally has subsidiary ledgers for
accounts receivable and accounts payable showing how much each customer owes and how much is owed to each
supplier. The general ledger shows the total amount of accounts receivable and accounts payable, but the details in
the subsidiary ledgers allow companies to send bills to customers and pay bills to suppliers.

Another innovation in manual systems was the "one write" or pegboard system. By creating one document and
aligning other records under it on a pegboard, companies could record transactions more efficiently. These systems
permit the writing of a check and the simultaneous recording of the check in the cash disbursements journal. Even
though some of these systems are still in use today, computers make them obsolete.

During the 1950s, companies also used bookkeeping machines to supplement manual systems. These machines
recorded recurring transactions such as sales on account. They posted transactions to the general ledger and
subsidiary ledger accounts and computed new balances. With the development of computers, bookkeeping
machines became obsolete. They were quite expensive, and computers easily outperformed them. In the mid-1950s,
large companies began using mainframe computers. Early accounting applications were in payroll, accounts
receivable, accounts payable, and inventory. Within a few years, programs existed for all phases of accounting,
including manufacturing operations and the total integration of other accounting programs with the general ledger.
Until the 1980s, small and medium-sized companies either continued with a manual system, rented time on
another company's computer, or hired a service bureau to perform at least some accounting functions.
MICROTRAIN COMPANY
Trial Balance
2010 December 31
Acct.
No. Account Title Debits Credits
100 Cash $ 8,250
103 Accounts Receivable 6,200
107 Supplies on Hand 900
108 Prepaid Insurance 2,200
112 Prepaid Rent 800
121 Interest Receivable 600
150 Trucks 40,000
151 Accumulated Depreciation—Trucks $ 750
200 Accounts Payable 730
206 Salaries Payable 180
216 Unearned Service Fees 3,000
300 Capital Stock 50,000
310 Retained Earnings 4,290
$ 58,950 $ 58,950

Exhibit 11: Post closing trial balance

51
 An accounting perspective:

Business insight

Imagine a company with an Accounts Receivable account and an Accounts Payable account in its
general ledger and no Accounts Receivable Subsidiary Ledger or Accounts Payable Subsidiary
Ledger. How would this company know to whom to send bills and in what amounts? Also, how
would employees know for which suppliers to write checks and in what amounts? Such subsidiary
records are necessary either on paper or in a computer file.

Here is how the general ledger and subsidiary ledgers might look:

Subsidiary General Ledger Subsidiary Accounts

Accounts Payable Ledger
Receivable
Ledger
JOHN JONES ACCOUNTS RECEIVABLE BELL CORPORATION

200 1 900 100

SYLVIA SMITH GRANGER CORPORATION

300 1 ACCOUNTS PAYABLE 600

1,000
JAMES WELLS WONG CORPORATION

400 1 300

When a sale on account is made to John Jones, the debit is posted to both the control account,
Accounts Receivable, in the General Ledger and the subsidiary account, John Jones, in the
Subsidiary Accounts Receivable Ledger. Likewise, when a purchase on account is made from Bell
Corporation, the credit is posted to both the control account, Accounts Payable, in the General
Ledger and to the subsidiary account, Bell Corporation, in the Subsidiary Accounts Payable Ledger.
At the end of the accounting period, the balances in each of the control accounts in the General
Ledger must agree with the totals of the accounts in their respective subsidiary ledgers as shown
above. A given company could have hundreds or even thousands of accounts in their subsidiary
ledgers that show the detail not supplied by the totals in the control accounts.

A broader perspective:

Skills for the long haul

The decision has been made: You [Tracy] have opted to start your career by joining an
international accounting firm. But you can not help wondering if you have the right skills both for
short and long-term success in public accounting.

Introduction to Accounting : The Language of Business – Supplemental Textbook 52

Most students understand that accounting knowledge, organizational ability and interpersonal
skills are critical to success in public accounting. But it is important for the beginner to realize that
different skills are emphasized at different points in a public accountant's career.

Let us examine the duties and skills needed at each level—Staff Accountant (years 1-2), Senior
Accountant (years 3-4), Manager/ Senior Manager (years 5-11) and Partner (years 11+).

Staff accountant—Enthusiastic learner

Let us travel with Tracy as she begins her career at the staff level. At the outset, she works directly
under a senior accountant on each of her audits and is responsible for completing audits and
administrative tasks assigned to her. Her duties include documenting work papers, interacting
with client accounting staff, clerical tasks and discussing questions that arise with her senior. Tracy
will work on different audit engagements during her first year and learn the firm's audit approach.
She will be introduced to various industries and accounting systems.

The two most important traits to be demonstrated at the staff level are (1) a positive attitude and
(2) the ability to learn quickly while adapting to unfamiliar situations.

Senior accountant—Organizer and teacher

As a senior accountant, Tracy will be responsible for the day-to-day management of several audit
engagements during the year. She will plan the audits, oversee the performance of interim audit
testing and direct year-end field work. She will also perform much of the final wrap-up work, such
as preparing checklists, writing the management letter and reviewing or drafting the financial
statements. Throughout this process, Tracy will spend a substantial amount of time instructing and
supervising staff accountants.

The two most critical skills needed at the senior level are (1) the ability to organize and control an
audit and (2) the ability to teach staff accountants how to audit.

Manager/senior manager—General manager and salesperson

Upon promotion to manager, Tracy will begin the transformation from auditor to executive. She
will manage several audits at one time and become active in billing clients as well as negotiating
audit fees. She will handle many important client meetings and closing conferences. Tracy will also
become more involved in the firm's administrative tasks. Finally, outside of her client service and
administrative duties, Tracy will be evaluated to a large extent on her community involvement and
ability to assist the partners in generating new business for the firm.

The two skills most emphasized at the manager level are (1) general management ability and (2)
sales and communication skills.

Partner—Leader and expert

As a partner in the firm, Tracy will have many broad responsibilities. She will engage in high-level
client service activities, business development, recruiting, strategic planning, office administration

53
 and counseling. Besides serving as the engagement partner on several audits, she will have
ultimate responsibility for the quality of service provided to each of her clients. Although a certain
industry or administrative function will become her specialty, she will often be called upon to
perform a wide variety of audit and administrative duties when other partners have scheduling
conflicts. She will be expected to serve as a positive example to those who work for her and will
train others in her areas of expertise.

At the partnership level, what is looked for is leadership ability plus the ability to become an expert
in a specific industry or administrative function.

In the meantime

Those planning on a public accounting career should do more than just learn accounting. To
develop the needed skills, a broad education background in business and nonbusiness courses is
required plus participation in extracurricular activities that promote leadership and
communication skills. It is never too early to start building the skills for long-term success.

Source: Dana R. Hermanson and Heather M. Hermanson, New Accountant, January 1990, pp. 24-
26, © 1990, New DuBois Corporation.

The development of the personal computer (PC) in 1976 and its widespread use a decade later drastically
changed the accounting systems of small and medium-sized businesses. The number and quality of accounting
software packages for PCs and the power of PCs quickly increased. Soon small and medium-sized businesses could
maintain all accounting functions on a PC. By the 1990s, the cost of PCs and accounting software packages had
decreased significantly, accounting software packages had become more user-friendly, and computer literacy had
increased so much that many very small businesses converted from manual to computerized systems. However,
some small business owners still use manual systems because they are familiar and meet their needs, and the
persons keeping the records may not be computer literate.

Your knowledge of the basic manual accounting system described in previous chapters enables you to better
understand a computerized accounting system. The computer automatically performs some of the steps in the
accounting cycle, such as posting journal entries to the ledger accounts, closing the books, and preparing the
financial statements. However, if you understand all of the steps in the accounting cycle, you will better understand
how to use the resulting data in decision making.

An accounting perspective:

The impact of technology

Results from a recent survey of 1,400 chief financial officers (CFOs) indicate that tomorrow's
accounting professionals will be called upon to bridge the gap between technology and business.
With the rise of integrated accounting and information systems, technical expertise will go hand in
hand with general business knowledge.

Introduction to Accounting : The Language of Business – Supplemental Textbook 54

 As we show in Exhibit 7, an accounting system is a set of records and the procedures and equipment used to
perform the accounting functions. Manual systems consist of journals and ledgers on paper. Computerized
accounting systems consist of accounting software, computer files, computers, and related peripheral equipment
such as printers.

Regardless of the system, the functions of accountants include: (1) observing, identifying, and measuring
economic events; (2) recording, classifying, and summarizing measurements; and (3) reporting economic events
and interpreting financial statements. Both internal and external users tell accountants their information needs.
The accounting system enables a company's accounting staff to supply relevant accounting information to meet
those needs. As internal and external users make decisions that become economic events, the cycle of information,
decisions, and economic events begins again.

The primary focus of the beginning chapters has been on how you can use an accounting system to prepare
financial statements. However, we also discussed how to use that information in making decisions. Later chapters
also show how to prepare information and how that information helps users to make informed decisions. We have
not eliminated the preparation aspects because we believe that the most informed users are ones who also
understand how the information was prepared. These users understand not only the limitations of the information
but also its relevance for decision making.

The next section discusses and illustrates the classified balance sheet, which aids in the analysis of the financial
position of companies. One example of this analysis is the current ratio and its use in analyzing the short-term debt-
paying ability of a company.

Exhibit 12: The role of an accounting system

55
 An accounting perspective

Uses of technology

Accounting software packages are typically menu driven and organized into modules such as
general ledger, accounts payable, accounts receivable, invoicing, inventory, payroll, fixed assets,
job cost, and purchase order. For instance, general journal entries are made in the general ledger
module, and this module contains all of the company's accounts. The accounts payable module
records all transactions involving credit purchases from suppliers and payments made to those
suppliers. The accounts receivable module records all sales on credit to various customers and
amounts received from customers.

A classified balance sheet

The balance sheets we presented so far have been unclassified balance sheets. As shown in Exhibit 10, an
unclassified balance sheet has three major categories: assets, liabilities, and stockholders' equity. A classified
balance sheet contains the same three major categories and subdivides them to provide useful information for
interpretation and analysis by users of financial statements.

Exhibit 13, shows a slightly revised classified balance sheet for The Home Depot, Inc., and subsidiaries. 1 Note
that The Home Depot classified balance sheet is in a vertical format (assets appearing above liabilities and
stockholders' equity) rather than the horizontal format (assets on the left and liabilities and stockholders' equity on
the right). The two formats are equally acceptable.

The Home Depot classified balance sheet subdivides two of its three major categories. The Home Depot
subdivides its assets into current assets, property and equipment, long-term investments, long-term notes
receivable, intangible assets (cost in excess of the fair value of net assets acquired), and other assets. The company
subdivides its liabilities into current liabilities and long-term liabilities (including deferred income taxes). A later
chapter describes minority interest. Stockholders' equity is the same in a classified balance sheet as in an
unclassified balance sheet. Later chapters describe further subdivisions of the stockholders' equity section.

We discuss the individual items in the classified balance sheet later in the text. Our only purpose here is to
briefly describe the items that can be listed under each category. Some of these items are not in The Home Depot's
balance sheet.

1 Founded in 1978, The Home Depot is America's largest home improvement retailer and ranks among the
nation's 30 largest retailers. The company has more than 1,000 full-service warehouse stores. Their primary
customers are do-it-yourselfers.

Introduction to Accounting : The Language of Business – Supplemental Textbook 56

 THE HOME DEPOT, INC. AND SUBSIDIARIES
Consolidated Balance Sheet
2001 January 28
(amounts in millions, except share data)
January 28,
2001
Assets
Current Assets:
Cash and Cash Equivalents $ 167
Short-Term Investments, including current maturities of long-term investments 10
Receivables, net 835
Merchandise Inventories 6,556
Other Current Assets 209
Total Current Assets $ 7,777
Property and Equipment, at cost:
Land $ 4,230
Buildings 6,167
Furniture, Fixtures and Equipment 2,877
Leasehold Improvements 665
Construction in Progress 1,032
Capital Leases 261
$ 15,232
Less: Accumulated Depreciation and Amortization 2,164
Net Property and Equipment $ 13,068
Long-Term Investments 15
Notes Receivable 77
Cost in Excess of Fair Value of Net Assets Acquired, net of accumulated amortization
of $41 at January 25, 2001 and $33 at January 30, 2000 314
Other 134 13,608
Total assets $ 21,385
Liabilities and Stockholders' Equity
Current Liabilities:
Accounts Payable $ 1,976
Accrued Salaries and Related Expenses 627
Sales Taxes Payable 298
Other Accrued Expenses 1,402
Income Taxes Payable 78
Current Installments of Long-Term Debt 4
Total Current Liabilities $4,385
Long-Term Debt, excluding current installments $ 1,545
Other Long-Term Liabilities 245
Deferred Income Taxes 195 1,985
Minority Interest 11
Stockholders' equity:
Common Stock, par value $0.05. Authorized: 10,000,000,000 shares; issued and
outstanding-
2,323,747,000 shares at 2001 January 28 and 2,304,317,000 shares at 2000 January 30 116
Paid-In Capital 4,810
Retained Earnings 10,151

57
Accumulated Other Comprehensive Income (67)
15,010
Less: Shares Purchased for Compensation Plans 6
Total Stockholders' Equity 15,004
Total Liabilities and Stockholders' Equity $ 21,385

Exhibit 13: A classified balance sheet

Current assets are cash and other assets that a business can convert to cash or uses up in a relatively short
period—one year or one operating cycle, whichever is longer. An operating cycle is the time it takes to start with
cash, buy necessary items to produce revenues (such as materials, supplies, labor, and/or finished goods), sell
services or goods, and receive cash by collecting the resulting receivables. Companies in service industries and
merchandising industries generally have operating cycles shorter than one year. Companies in some manufacturing
industries, such as distilling and lumber, have operating cycles longer than one year. However, since most operating
cycles are shorter than one year, the one-year period is usually used in identifying current assets and current
liabilities. Common current assets in a service business include cash, marketable securities, accounts receivable,
notes receivable, interest receivable, and prepaid expenses. Note that on a balance sheet, current assets are in order
of how easily they are convertible to cash, from most liquid to least liquid.

Cash includes deposits in banks available for current operations at the balance sheet date plus cash on hand
consisting of currency, undeposited checks, drafts, and money orders. Cash is the first current asset to appear on a
balance sheet. The term cash normally includes cash equivalents.

Cash equivalents are highly liquid, short-term investments acquired with temporarily idle cash and easily
convertible into a known cash amount. Examples are Treasury bills, short-term notes maturing within 90 days,
certificates of deposit, and money market funds.

Marketable securities are temporary investments such as short-term ownership of stocks and bonds of other
companies. Such investments do not qualify as cash equivalents. These investments earn additional money on cash
that the business does not need at present but will probably need within one year.

Accounts receivable (also called trade accounts receivable) are amounts owed to a business by customers. An
account receivable arises when a company performs a service or sells merchandise on credit. Customers normally
provide no written evidence of indebtedness on sales invoices or delivery tickets except their signatures. Notice the
term net in the balance sheet of The Home Depot (Exhibit 13). This term indicates the possibility that the company
may not collect some of its accounts receivable. In the balance sheet, the accounts receivable amount is the sum of
the individual accounts receivable from customers shown in a subsidiary ledger or file.

Merchandise inventories are goods held for sale.

A note is an unconditional written promise to pay another party the amount owed either when demanded or at
a certain specified date, usually with interest (a charge made for use of the money) at a specified rate. A note
receivable appears on the balance sheet of the company to which the note is given. A note receivable arises (1) when
a company makes a sale and receives a note from the customer, (2) when a customer gives a note for an amount due
on an account receivable, or (3) when a company loans money and receives a note in return.

Introduction to Accounting : The Language of Business – Supplemental Textbook 58

 Other current assets might include interest receivable and prepaid expenses. Interest receivable arises when
a company has earned but not collected interest by the balance sheet date. Usually, the amount is not due until
later. Prepaid expenses include rent, insurance, and supplies that have been paid for but all the benefits have not
yet been realized (or consumed) from these expenses. If prepaid expenses had not been paid for in advance, they
would require the future disbursement of cash. Furthermore, prepaid expenses are considered assets because they
have service potential.

Long-term assets are assets that a business has on hand or uses for a relatively long time. Examples include
property, plant, and equipment; long-term investments; and intangible assets.

Property, plant, and equipment are assets with useful lives of more than one year; a company acquires
them for use in the business rather than for resale. (These assets are called property and equipment in The Home
Depot's balance sheet.) The terms plant assets or fixed assets are also used for property, plant, and equipment. To
agree with the order in the heading, balance sheets generally list property first, plant next, and equipment last.
These items are fixed assets because the company uses them for long-term purposes. We describe several types of
property, plant, and equipment next.

Land is ground the company uses for business operations; this includes ground on which the company locates
its business buildings and that is used for outside storage space or parking. Land owned for investment is not a
plant asset because it is a long-term investment.

Buildings are structures the company uses to carry on its business. Again, the buildings that a company owns
as investments are not plant assets.

Office furniture includes file cabinets, desks, chairs, and shelves.

Office equipment includes computers, copiers, FAX machines, and phone answering machines.

Leasehold improvements are any physical alterations made by the lessee to the leased property when these
benefits are expected to last beyond the current accounting period. An example is when the lessee builds room
partitions in a leased building. (The lessee is the one obtaining the rights to possess and use the property.)

Construction in progress represents the partially completed stores or other buildings that a company such
as The Home Depot plans to occupy when completed.

Accumulated depreciation is a contra asset account to depreciable assets such as buildings, machinery, and
equipment. This account shows the total depreciation taken for the depreciable assets. On the balance sheet,
companies deduct the accumulated depreciation (as a contra asset) from its related asset.

Long-term investments A long-term investment usually consists of securities of another company held
with the intention of (1) obtaining control of another company, (2) securing a permanent source of income for the
investor, or (3) establishing friendly business relations. The long-term investment classification in the balance sheet
does not include those securities purchased for short-term purposes. For most businesses, long-term investments
may be stocks or bonds of other corporations. Occasionally, long-term investments include funds accumulated for
specific purposes, rental properties, and plant sites for future use.

59
 Intangible assets Intangible assets consist of the noncurrent, nonmonetary, nonphysical assets of a
business. Companies must charge the costs of intangible assets to expense over the period benefited. Among the
intangible assets are rights granted by governmental bodies, such as patents and copyrights. Other intangible assets
include leaseholds and goodwill.

A patent is a right granted by the federal government; it gives the owner of an invention the authority to
manufacture a product or to use a process for a specified time.

A copyright granted by the federal government gives the owner the exclusive privilege of publishing written
material for a specified time.

Leaseholds are rights to use rented properties, usually for several years.

Goodwill is an intangible value attached to a business, evidenced by the ability to earn larger net income per
dollar of investment than that earned by competitors in the same industry. The ability to produce superior profits is
a valuable resource of a business. Normally, companies record goodwill only at the time of purchase and then only
at the price paid for it. The Home Depot has labeled its goodwill "cost in excess of the fair value of net assets
acquired".

Accumulated amortization is a contra asset account to intangible assets. This account shows the total
amortization taken on the intangible assets.

Current liabilities are debts due within one year or one operating cycle, whichever is longer. The payment of
current liabilities normally requires the use of current assets. Balance sheets list current liabilities in the order they
must be paid; the sooner a liability must be paid, the earlier it is listed. Examples of current liabilities follow.

Accounts payable are amounts owed to suppliers for goods or services purchased on credit. Accounts payable
are generally due in 30 or 60 days and do not bear interest. In the balance sheet, the accounts payable amount is
the sum of the individual accounts payable to suppliers shown in a subsidiary ledger or file.

Notes payable are unconditional written promises by the company to pay a specific sum of money at a certain
future date. The notes may arise from borrowing money from a bank, from the purchase of assets, or from the
giving of a note in settlement of an account payable. Generally, only notes payable due in one year or less are
included as current liabilities.

Salaries payable are amounts owed to employees for services rendered. The company has not paid these
salaries by the balance sheet date because they are not due until later.

Sales taxes payable are the taxes a company has collected from customers but not yet remitted to the taxing
authority, usually the state.

Other accrued expenses might include taxes withheld from employees, income taxes payable, and interest
payable. Taxes withheld from employees include federal income taxes, state income taxes, and social security
taxes withheld from employees' paychecks. The company plans to pay these amounts to the proper governmental
agencies within a short period. Income taxes payable are the taxes paid to the state and federal governments by
a corporation on its income. Interest payable is interest that the company has accumulated on notes or bonds but
has not paid by the balance sheet date because it is not due until later.

Introduction to Accounting : The Language of Business – Supplemental Textbook 60

 Dividends payable, or amounts the company has declared payable to stockholders, represent a distribution of
income. Since the corporation has not paid these declared dividends by the balance sheet date, they are a liability.

Unearned revenues (revenues received in advance) result when a company receives payment for goods or
services before earning the revenue, such as payments for subscriptions to a magazine. These unearned revenues
represent a liability to perform the agreed services or other contractual requirements or to return the assets
received.

Companies report any current installment on long-term debt due within one year under current liabilities. The
remaining portion continues to be reported as a long-term liability.

Long-term liabilities are debts such as a mortgage payable and bonds payable that are not due for more than
one year. Companies should show maturity dates in the balance sheet for all long-term liabilities. Normally, the
liabilities with the earliest due dates are listed first.

Notes payable with maturity dates at least one year beyond the balance sheet date are long-term liabilities.

Bonds payable are long-term liabilities and are evidenced by formal printed certificates sometimes secured by
liens (claims) on property, such as mortgages. Maturity dates should appear on the balance sheet for all major long-
term liabilities.

The deferred income taxes on The Home Depot's balance sheet result from a difference between income tax
expense in the accounting records and the income tax payable on the company's tax return.

Stockholders' equity shows the owners' interest in the business. This interest is equal to the amount
contributed plus the income left in the business.

The items under stockholders' equity in The Home Depot's balance sheet are paid-in capital (including common
stock) and retained earnings. Paid-in capital shows the capital paid into the company as the owners' investment.
Retained earnings shows the cumulative income of the company less the amounts distributed to the owners in
the form of dividends. Cumulative translation adjustments result from translating foreign currencies into US
dollars (a topic discussed in advanced accounting courses).

The next section shows how two categories on the classified balance sheet relate to each other. Together they
help reveal a company's short-term debt-paying ability.

Analyzing and using the financial results — the current ratio

The current ratio indicates the short-term debt-paying ability of a company. To find the current ratio, we
divide current assets by current liabilities. For instance, Exhibit 13 shows that The Home Depot's current assets as
of 2001 January 28, were USD 7,777,000,000 and its current liabilities were USD 4,385,000,000. Thus, its current
Current assets USD 7,777,000,000
ratio was: Current ratio= =1.77 : 1
Current liabilities USD 4,385,000,000

The current ratio of 1.77:1 for The Home Depot means that it has almost twice as many current assets as current
liabilities. Because current liabilities are normally paid with current assets, the company appears to be able to pay
its short-term obligations easily.

61
 In evaluating a company's short-term debt-paying ability, you should also examine the quality of the current
assets. If they include large amounts of uncollectable accounts receivable and/or obsolete and unsalable inventory,
even a 2:1 current ratio may be inadequate to allow the company to pay its current liabilities. The Home Depot
undoubtedly does not have such a problem.

The current assets, current liabilities, and current ratios of some other companies as of the third quarter of 2001
were:
Current Current Current Ratio
Company Assets Liabilities
Wal-Mart Stores, Inc. $ 32,620,000,000 $ 32,869,000,000 .99:1
Hewlett-Packard Company 15,782,000,000 13,950,000,000 1.13:1
3M Corporation 6,556,000,000 5,006,000,000 1.31:1
General Electric Company 313,050,000,000 168,788,000,000 1.85:1
Johnson & Johnson 19,079,000,000 7,504,000,000 2.54:1

We described each of these companies earlier in the text.

As you can see from these comparisons, the current ratios vary a great deal. An old rule of thumb is that the
current ratio should be at least 2:1. However, what constitutes an adequate current ratio depends on available lines
of credit, the cash-generating ability of the company, and the nature of the industry in which the company operates.
For instance, companies in the airline industry are able to generate huge amounts of cash on a daily basis and may
be able to pay their current liabilities even if their current ratio is less than 1:1. Comparing a company's current
ratio with other companies in the same industry makes sense because all of these companies face about the same
economic conditions. A company with the lowest current ratio in its industry may be unable to pay its short-term
obligations on a timely basis, unless it can borrow funds from a bank on a line of credit. A company with the highest
current ratio in its industry may have on hand too many current assets, such as cash and marketable securities,
which could be invested in more productive assets.

In an upcoming chapter describes the assumptions, concepts, and principles that constitute the accounting
theory underlying financial accounting. Thus, accounting theory dictates the standards and procedures applied to
the reporting of financial information in the financial statements.
Understanding the learning objectives
• Analyze transactions by examining source documents.

• Journalize transactions in the journal.

• Post journal entries to the accounts in the ledger.

• Prepare a trial balance of the accounts and complete the work sheet.

• Prepare financial statements.

• Journalize and post adjusting entries.

• Journalize and post closing entries.

• Prepare a post-closing trial balance.

• The work sheet is a columnar sheet of paper on which accountants summarize information needed to make
the adjusting and closing entries and to prepare the financial statements.

Introduction to Accounting : The Language of Business – Supplemental Textbook 62

 • Work sheets may vary in format. The work sheet illustrated in the chapter has 12 columns—two each for
trial balance, adjustments, adjusted trial balance, income statement, statement of retained earnings, and
balance sheet.

• The information needed to prepare the income statement is in the Income Statement columns of the work
sheet. Net income for the period is the amount needed to balance the two Income Statement columns in the
work sheet.

• The information needed to prepare the statement of retained earnings is in the Statement of Retained
Earnings columns of the work sheet. The ending Retained Earnings balance is carried forward to the
balance sheet.

• The information needed to prepare the balance sheet is in the Balance Sheet columns of the work sheet.

• As explained in above, adjusting entries are necessary to bring the accounts to their proper balances before
preparing the financial statements. Closing entries are necessary to reduce the balances of revenue,
expense, and Dividends accounts to zero so they are ready to receive data for the next accounting period.

• Revenue accounts are closed by debiting them and crediting the Income Summary account.

• Expense accounts are closed by crediting them and debiting the Income Summary account.

• The balance in the Income Summary account represents the net income or net loss for the period.

• To close the Income Summary account, the balance is transferred to the Retained Earnings account.

• To close the Dividends account, the balance is transferred to the Retained Earnings account.

• Only the balance sheet accounts have balances and appear on the post-closing trial balance.

• All revenue, expense, and Dividends accounts have zero balances and are not included in the post-closing
trial balance.

• Manual systems and computerized systems perform the same accounting functions.

• The ease of accounting with a PC has encouraged even small companies to convert to computerized
systems.

• A classified balance sheet subdivides the major categories on the balance sheet. For instance, a classified
balance sheet subdivides assets into current assets; long-term investments; property, plant, and equipment;
and intangible assets. It subdivides liabilities into current liabilities and long-term liabilities. Later chapters
show more accounts in the stockholders' equity section, but the subdivisions remain basically the same.

• The current ratio gives some indication of the short-term debt-paying ability of a company.

• To find the current ratio, divide current assets by current liabilities.

Demonstration problem
This problem involves using a work sheet for Green Hills Riding Stable, Incorporated, for the month ended 2010
July 31, and performing the closing process. The trial balance for Green Hills Riding Stable, Incorporated, as of
2010 July 31, was as follows:

63
 GREEN HILLS RIDING STABLE, INCORPORATED
Trial Balance
2010 July 31
Acct.
No. Account Title Debits Credits
100 Cash $ 10,700
103 Accounts Receivable 8,100
130 Land 40,000
140 Buildings 24,000
200 Accounts Payable $ 1,100
201 Notes Payable 40,000
300 Capital Stock 35,000
310 Retained Earnings, 2010 July 1 3,100
320 Dividends 1,000
402 Horse Boarding Fees Revenue 4,500
404 Riding Lesson Fees Revenue 3,600
507 Salaries Expense 1,400
513 Feed Expense 1,100
540 Interest Expense 200
568 Miscellaneous Expense 800
$ 87,300 $87,300

Depreciation expense for the month is USD 200. Accrued salaries on July 31 are USD 300.

a. Prepare a 12-column work sheet for the month ended 2010 July 31.

b. Journalize the adjusting entries.

c. Journalize the closing entries.

Solution to demonstration problem
a. See the work sheet below.
GREEN HILLS RIDING STABLE, INCORPORATE
Work Sheet
For the Month Ended 2010 July 31
Acct Account Titles Statement of
Adjusted Income
. Trial Balance Adjustments Retained Balance Sheet
Balance Statement
Earnings
No. Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit

100 Cash 10,700 10,700 10,700

103 Accounts Receivable S,100 3,100 8,100
130 Land 40,000 40,000 40,000
140 Buildings 24,000 24,000 24,000
200 Accounts Payable 1,100 1,100 1,100
201 Notes Payable 40,000 40,0 0 0 40,000
300 Capital Stock 35,000 35,000 35,000
310 Retained Earnings 3,100 3,100 3,100
2010 July 1
320 Dividends 1,000 1,000 1,000
402 Horse Boarding Fees 4,500 4,500 4,500
Revenue
404 Riding and Lesson 3,500 3,600 3,600
Fees Revenue
507 Salaries Expense 1,400 (2) 300 1,700 1,700
513 Feed Expense 1,100 1,100 1,100
540 Interest Expense 200 200 200
563 Miscellaneous 300 SOO SOO
Expense
87,300 37,300
520 Depreciation Expense (1) 200 200 200
—Buildings
141 Accumulated
Depreciation-
Buildings (1) 200 200 200

Introduction to Accounting : The Language of Business – Supplemental Textbook 64

206 Salaries Payable (2) 300 300 300
EOO 5oo 87,500 37,300
4,000 8,100
Net Income 4,100 4,100
8,100 8,100 1,000 7,200 82,300 76,600
Retained Earnings, 6,200 6,200
2010 July 31
7,200 7,200 S2,S00 32,800

Adjustments:
(i) To record depreciation of
building for July.
(2) To record accrued
salaries of $300.

b.
GREEN HILLS RIDING STABLE, INCORPORATED
General Journal Page 4
Date Account Titles and Explanation Post. Ref. Debt Credit
2010 Adjusting Entries
July 31 Depredation Expense—Buildings (- 520 2 0 0
SE)
Accumulated Depreciation—Buildings 141 2 0 0
(-A)
To record depreciation expense.

31 Salaries Expense (-SE) 507 3 0 0

Salaries Payable (+L) 206 3 0 0
To record accrued salaries.

c.
GREEN HILLS RIDING STABLE, INCORPORATED
General Journal Page 4

Date Account Titles and Explanation Post. Debt Credit

Ref.
2010 Closing Entries
July 31 Horse Boarding Fees Revenue 402 4 5 0 0
Riding Lesson Fees Revenue 404 3 6 0 0
Income Summary 600 8 1 0 0
To close revenue accounts.

31 Income Summary 600 4 0 0 0

Salaries Expense 507 1 7 0 0
Feed Expense 513 1 1 0 0
Interest Expense 540 2 0 0
Miscellaneous Expense 568 8 0 0
Depreciation Expense—Buildings 520 2 0 0
To close expense accounts.

31 Income Summary 600 4 1 0 0

Retained Earnings 310 4 1 0 0
To close Income Summary account.

31 Retained Earnings 310 1 0 0 0

Dividends 320 1 0 0 0
To close dividends account.

65
 Key terms*
Accounting cycle Series of steps performed during the accounting period to analyze, record, classify,
summarize, and report useful financial information for the purpose of preparing financial statements. The
steps include analyzing transactions, journalizing transactions, posting journal entries, taking a trial balance
and completing the work sheet, preparing financial statements, journalizing and posting adjusting entries,
journalizing and posting closing entries, and taking a post-closing trial balance.
Accounting system A set of records and the procedures and equipment used to perform accounting
functions.
Accounts payable Amounts owed to suppliers for goods or services purchased on credit.
Accounts receivable Amounts due from customers for services performed or merchandise sold on credit.
Accumulated amortization A contra account to intangible assets.
Accumulated depreciation A contra account to depreciable assets such as buildings, machinery, and
equipment.
Bonds payable Written promises to pay a definite sum at a certain date as evidenced by formal printed
certificates that are sometimes secured by liens on property, such as mortgages.
Buildings Structures used to carry on the business.
Cash Includes deposits in banks available for current operations at the balance sheet date plus cash on hand
consisting of currency, undeposited checks, drafts, and money orders.
Cash equivalents Highly liquid, short-term investments acquired with temporarily idle cash.
Classified balance sheet Subdivides the three major balance sheet categories (assets, liabilities, and
stockholders' equity) to provide more information for users of financial statements. Assets may be divided
into current assets; long-term investments; property, plant, and equipment; and intangible assets. Liabilities
may be divided into current liabilities and long-term liabilities.
Closing process The act of transferring the balances in the revenue and expense accounts to a clearing
account called Income Summary and then to the Retained Earnings account. The balance in the Dividends
account is also transferred to the Retained Earnings account.
Construction in progress Represents the partially completed stores or other buildings that a company
plans to occupy when completed.
Copyright Grants the owner the exclusive privilege of publication of written material for a specific time.
Current assets Cash and other assets that a business can convert into cash or use up in one year or one
operating cycle, whichever is longer.
Current liabilities Debts due within one year or one operating cycle, whichever is longer. The payment of
current liabilities normally requires the use of current assets.
Current ratio Calculated by dividing current assets by current liabilities.
Dividends payable Amounts declared payable to stockholders and that represent a distribution of income.
Goodwill An intangible value attached to a business, evidenced by the ability to earn larger net income per
dollar of investment than that earned by competitors in the same industry.
Income Summary account A clearing account used only at the end of an accounting period to summarize
revenues and expenses for the period.
Income taxes payable Are the taxes payable to the state and federal governments by a corporation based
on its income.
Intangible assets Noncurrent, nonmonetary, nonphysical assets of a business.
Interest payable Interest that has accumulated on debts, such as notes or bonds. This accrued interest has
not been paid at the balance sheet date because it is not due until later.
Interest receivable Arises when interest has been earned but not collected at the balance sheet date.
Land Ground the company uses for business operations. Land could include ground on which the company
locates its business buildings and that used for outside storage space or a parking lot.
Leasehold improvements Are any physical alterations made by the lessee to the leased property when
these benefits are expected to last beyond the current accounting period.
Leaseholds Rights to use rented properties.
Long-term assets Assets that are on hand or used by a business for a relatively long time. Examples
include long-term investments; property, plant, and equipment; and intangible assets.

Introduction to Accounting : The Language of Business – Supplemental Textbook 66

 Long-term investment Usually securities of another company held with the intention of (1) obtaining
control of another company, (2) securing a permanent source of income for the investor, or (3) establishing
friendly business relations.
Long-term liabilities Debts such as a mortgage payable and bonds payable that are not due for more than
one year.
Marketable securities Temporary investments that a company makes to earn a return on idle cash.
Merchandise inventory Goods held for sale.
Note An unconditional written promise to pay to another party the amount owed either when demanded or
at a certain date.
Notes payable Unconditional written promises by a company to pay a specific sum of money at a certain
future date.
Office equipment Includes computers, copiers, FAX machines, and phone answering machines.
Office furniture Includes file cabinets, desks, chairs, and shelves.
Operating cycle The time it takes to start with cash, buy necessary items to produce revenues (such as
materials, supplies, labor, and/or inventories), sell services or goods, and receive cash by collecting the
resulting receivables.
Paid-in capital Shows the capital paid into the company as the owners' investment.
Patent A right granted by the federal government authorizing the owner of an invention to manufacture a
product or to use a process for a specific time.
Post-closing trial balance A trial balance taken after the closing entries have been posted.
Prepaid expenses Assets awaiting assignment to expense. Items such as rent, insurance, and supplies that
have been paid for but from which all of the benefits have not yet been realized (or consumed). Prepaid
expenses are classified as current assets.
Property, plant, and equipment Assets with useful lives of more than one year that a company acquired
for use in a business rather than for resale; also called plant assets or fixed assets.
Retained earnings Shows the cumulative income of the company less the amounts distributed to the
owners in the form of dividends.
Salaries payable Amounts owed to employees for services rendered.
Sales taxes payable Are taxes a company has collected from customers but has not remitted to the taxing
authority, usually the state.
Stockholders' equity Shows the owners' interest (equity) in the business.
Taxes withheld from employees Items such as federal income taxes, state income taxes, and social
security taxes withheld from employees' paychecks.
Unclassified balance sheet A balance sheet showing only three major categories: assets, liabilities, and
stockholders' equity.
Unearned revenues (revenues received in advance) Result when payment is received for goods or
services before revenue has been earned.
Work sheet A columnar sheet of paper on which accountants have summarized information needed to
make the adjusting and closing entries and to prepare the financial statements.
*Some of these terms have been defined in earlier chapters but are included here for your convenience.
Self-test
True-false

Indicate whether each of the following statements is true or false.

At the end of the accounting period, three trial balances are prepared.

The amounts in the Adjustments columns are always added to the amounts in the Trial Balance columns to
determine the amounts in the Adjusted Trial Balance columns.

If a net loss occurs, it appears in the Income Statement credit column and Statement of Retained Earnings debit
column.

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 After the closing process is complete, no balance can exist in any revenue, expense, Dividends, or Income
Summary account.

The post-closing trial balance may contain revenue and expense accounts.

All accounting systems currently in use are computerized.

Multiple-choice

Select the best answer for each of the following questions.

Which of the following accounts is least likely to be adjusted on the work sheet?

a. Supplies on Hand.

b. Land.

c. Prepaid Rent.

d. Unearned Delivery Fees.

If the Balance Sheet columns do not balance, the error is most likely to exist in the:

a. General journal.

b. General ledger.

c. Last six columns of the work sheet.

d. First six columns of the work sheet.

Net income for a period appears in all but which one of the following?

a. Income Statement debit column of the work sheet.

b. Statement of Retained Earnings credit column of the work sheet.

c. Statement of retained earnings.

d. Balance sheet.

Which of the following statements is false regarding the closing process?

a. The Dividends account is closed to Income Summary.

b. The closing of expense accounts results in a debit to Income Summary.

c. The closing of revenues results in a credit to Income Summary.

d. The Income Summary account is closed to the Retained Earnings account.

Which of the following statements is true regarding the classified balance sheet?

a. Current assets include cash, accounts receivable, and equipment.

b. Plant, property, and equipment is one category of long-term assets.

c. Current liabilities include accounts payable, salaries payable, and notes receivable.

Introduction to Accounting : The Language of Business – Supplemental Textbook 68

d. Stockholders' equity is subdivided into current and long-term categories.

Now turn to “Answers to self-test” at the end of the chapter to check your answers.

Questions
➢ At which stage of the accounting cycle is a work sheet usually prepared?

➢ Why are the financial statements prepared before the adjusting and closing entries are journalized
and posted?

➢ Describe the purposes for which the work sheet is prepared.

➢ You have taken over a set of accounting books for a small business as a part-time job. At the end of
the first accounting period, you have partially completed the work sheet by entering the proper
ledger accounts and balances in the Trial Balance columns. You turn to the manager and ask, "Where
is the list of additional information I can use in entering the adjusting entries?" The manager
indicates there is no such list. (In all the text problems you have done, you have always been given
this information.) How would you obtain the information for this real-life situation? What are the
consequences of not making all of the required adjustments at the end of the accounting period?

➢ How are the amounts in the Adjusted Trial Balance columns of a work sheet determined?

➢ The work sheet for Bridges Company shows net income of USD 40,000. The following four
adjustments were ignored:

➢ Subscriptions Fees earned, USD 1,200.

➢ Depreciation of equipment, USD 4,000.

➢ Depreciation of building, USD 10,000.

➢ Salaries accrued, USD 3,000. What is the correct net income?

➢ After the Adjusted Trial Balance columns of a work sheet have been totaled, which account balances
are extended to the Income Statement columns, which account balances are extended to the
Statement of Retained Earnings columns, and which account balances are extended to the Balance
Sheet columns?

➢ How is the statement of retained earnings prepared?

➢ What is the purpose of closing entries? What accounts are not affected by closing entries?

➢ A company has net income of USD 50,000 for the year. In which columns of the work sheet would
net income appear?

➢ Is it possible to prepare monthly financial statements without journalizing and posting adjusting and
closing entries? How?

➢ What is the purpose of a post-closing trial balance?

➢ Describe some of the ways in which the manual accounting system has evolved.

69
 ➢ When did computerized accounting systems come into use?

➢ Define an accounting system.

➢ How is a classified balance sheet different than an unclassified balance sheet?

➢ Real world question Refer to "A broader perspective: Skills for the long haul" to answer the
following true-false questions:

➢ The same skills are needed at each level in a CPA firm.

➢ The two most important traits at the staff accountant level are a positive attitude and the ability
to learn quickly while adapting to unfamiliar situations.

➢ The senior accountant needs management skills in addition to technical skills.

➢ Partners become increasingly involved in technical matters and have less and less interaction
with people.

➢ Real world question Referring to the Annual report appendix in your text, identify the
classifications (or categories) of assets used by The Limited in its balance sheet.

➢ Real world question Referring to the Annual report appendix in your text, identify the
classifications (or categories) of liabilities used by The Limited in its balance sheet.
Exercises
Exercise A List the steps in the accounting cycle. Would the system still work if any of the steps were
performed out of order?

Exercise B Three of the major column headings on a work sheet are Trial Balance, Income Statement, and
Balance Sheet. Determine under which major column headings each of the following items would appear and
whether it would be a debit or credit. (For example, Cash would appear on the debit side of the Trial Balance and
Balance Sheet columns.)
Statement of
Trial Income Retained Balance
Balance Statement Earnings Sheet
Account Titles Debit Credit Debit Credit Debit Credit Debit Credit
a. Accounts Receivable
b. Accounts Payable
c. Interest Revenue
d. Advertising Expense
e. Capital Stock
f. Retained Earnings (Beg.)
g. Net income for the month
h. Retained Earnings (End)

Exercise C Assume a beginning balance in Retained Earnings of USD 84,000 and net income for the year of
USD 36,000. Illustrate how these would appear in the Statement of Retained Earnings columns and Balance Sheet
columns in the work sheet.

Exercise D In the previous exercise, if there was a debit balance of USD 216,000 in the Retained Earnings
account as of the beginning of the year and a net loss of USD 192,000 for the year, show how these would be treated
in the work sheet.

Introduction to Accounting : The Language of Business – Supplemental Textbook 70

 Exercise E Damon Davis was preparing the work sheet for Drano Plumbing Company. He calculated the net
income to be USD 50,000. When he totaled the Balance Sheet columns, the column totals were debit, USD
400,000; and credit, USD 300,000. What was the probable cause of this difference? If this was not the cause, what
should he do to find the error?

Exercise F The Trial Balance of the Printer Repair Company at 2010 December 31, contains the following
account balances listed in alphabetical order to increase your skill in sorting amounts to the proper work sheet
columns.
Printer Repair Company
Trial Balance Account Balances
2010 December 31
Accounts Payable $ 41,000
Accounts Receivable 92,000
Accumulated Depreciation—Buildings 25,000
Accumulated Depreciation—Equipment 9,000
Buildings 140,000
Capital Stock 65,000
Cash 60,000
Equipment 36,000
Prepaid Insurance 3,600
Retained Earnings, 2010 January 1 4,800
Salaries Expense 96,000
Service Revenue 290,000
Supplies on Hand 4,000
Utilities Expense 3,200

Using these account balances and the following additional information, prepare a work sheet for Printer Repair
Company. Arrange the accounts in their approximate usual order.

• Supplies on hand at 2010 December 31, have a cost of USD 2,400.

• The balance in the Prepaid Insurance account represents the cost of a two-year insurance policy covering
the period from 2010 January 1, through 2011 December 31.

• The estimated lives of depreciable assets are buildings, 40 years, and equipment, 20 years. No salvage
values are anticipated.

Exercise G Texban Corporation had a 2010 January 1, balance in its Retained Earnings account of USD
90,000. For the year 2010, net income was USD 50,000 and dividends declared and paid were USD 24,000.
Prepare a statement of retained earnings for the year ended 2010 December 31.

Exercise H Rubino Company reported net income of USD 100,000 for the current year. Examination of the
work sheet and supporting data indicates that the following items were ignored:

• Accrued salaries were USD 6,000 at December 31.

• Depreciation on equipment acquired on July 1 amounted to USD 4,000.

Based on this information, (a) what adjusting journal entries should have been made at December 31, and (b)
what is the correct net income?

Exercise I Refer to the work sheet prepared in the Printer Repair Company exercise. Prepare the adjusting and
closing journal entries.

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 Exercise J The Income Statement column totals on a work sheet prepared at 2010 December 31, are debit,
USD 500,000; and credit, USD 900,000. In T-account format, show how the postings to the Income Summary
account would appear as a result of the closing process. Identify what each posting represents.

Exercise K After adjustment, these selected account balances of Cold Stream Campground are:
Debits Credits
Retained earnings $540,000.00
Rental revenue 960000
Salaries expense $336,000.00
Depreciated expense – Buildings 64000
Utilities expense 208000
Dividends 32000

In T-account format, show how journal entries to close the books for the period would be posted. (You do not
need to show the closing journal entries.) Enter these balances in the accounts before doing so. Key the postings
from the first closing entry with the number (1), the second with the number (2), and so on.

Exercise L The following account balances appeared in the Income Statement columns of the work sheet
entries prepared for Liu Company for the year ended 2010 December 31:
Account Titles Income Statement
Debit Credit

Service Revenue 330,000

Advertising Expense 1,350
Salaries Expense 130,000
Utilities Expense 2,250
Insurance Expense 900
Rent Expense 6,750
Supplies Expense 2,250
Depreciation Expense—Equipment 4,500
Interest Expense 562
Interest Revenue 1,125
148,552 331,125
Net Income 182,553
331,125 331,125

Prepare the closing journal entries.

Exercise M Which of the following accounts are likely to appear in the post-closing trial balance for the Blake
Company?

• Accounts Receivable

• Cash

• Service Revenue

• Buildings

• Salaries Expense

• Capital Stock

Introduction to Accounting : The Language of Business – Supplemental Textbook 72

 • Dividends

• Accounts Payable

• Income Summary

• Unearned Subscription Fees

Exercise N Using the legend at the right, determine the category (number) into which you would place each of
these items.
Item Legend
a. Land. 1. Current assets.
b. Marketable securities. 2. Long-term investments.
c. Notes payable, due in three years. 3. Property, plant, and equipment.
d. Taxes withheld from employees. 4. Intangible assets.
e. Patents. 5. Current liabilities.
f. Retained earnings. 6. Long-term liabilities.
g. Unearned subscription fees. 7. Stockholders' equity.
h. Bonds of another corporation (a 20-year
investment).
i. Notes payable, due in six months.
j. Accumulated depreciation.

Exercise O The following data are from the 2001 annual report of The Procter & Gamble Company and its
subsidiaries. This company markets a broad range of laundry, cleaning, paper, beauty care, health care, food, and
beverage products in more than 140 countries around the world. Leading brands include Ariel, Crest, Pampers,
Pantene, Crisco, Vicks, and Max Factor. The dollar amounts are in millions.
June 30
2001 2000
Current assets $10,889 $10,146
Current liabilities 9,846 10,141

Calculate the current rations for the two years. Comment on whether the trend is favorable or unfavorable.
Problems
Problem A The following adjusted trial balance is for Jasper Appliance Repair Company:
JASPER APPLIANCE REPAIR COMPANY
Adjusted Trial Balance
2010 June 30
Debits Credits
Cash $ 63,000
Accounts Receivable 42,000
Trucks 110,000
Accumulated Depreciation—Trucks $ 30,000
Accounts Payable 10,800
Notes Payable 20,000
Capital Stock 50,000
Retained Earnings, 2009 July 1 5,500
Dividends 10,000
Service Revenue 230,000
Rent Expense 12,000
Advertising Expense 5,000
Salaries Expense 90,000
Supplies Expense 1,500

73
Insurance Expense 1,200
Depreciation Expense—Trucks 10,000
Interest Expense 1,000
Miscellaneous Expense 600
$346,300 $346,300

Prepare the closing journal entries at the end of the fiscal year, 2010 June 30.

Problem B The adjusted trial balance for Denver Architects , Inc., follows:
DENVER ARCHITECTS, INC.
Adjusted Trial Balance
2010 December 31
Debits Credits
Cash $ 90,000
Accounts Receivable 20,000
Interest Receivable 200
Notes Receivable 4,000
Prepaid Insurance 960
Prepaid Rent 2,400
Supplies on Hand 600
Equipment 60,000
Accumulated Depreciation—Equipment $ 12,500
Buildings 140,000
Accumulated Depreciation—Buildings 15,000
Land 56,240
Accounts Payable 60,000
Notes Payable 10,000
Interest Payable 750
Salaries Payable 7,000
Capital Stock 100,000
Retained Earnings, 2010 January 1 20,200
Dividends 40,000
Service Revenue 360,000
Insurance Expense 1,920
Rent Expense 9,600
Advertising Expense 1,200
Depreciation Expense—Equipment 2,500
Depreciation Expense—Buildings 3,000
Supplies Expense 2,280
Salaries Expense 150,000
Interest Expense 750
Interest Revenue 200
$ 585,650 $ 585,650

a. Prepare an income statement.

b. Prepare a statement of retained earnings.

c. Prepare a classified balance sheet.

d. Prepare the closing journal entries.

Introduction to Accounting : The Language of Business – Supplemental Textbook 74

 e. Show the post-closing trial balance assuming you had posted the closing entries to the general ledger.

Problem C The following trial balance and additional data are for Sure Sale Reality Company
SURE SALE REALTY COMPANY
Trial Balance
2010 December 31
Debits Credits
Cash $ 62,800
Accounts Receivable 117,120
Prepaid Rent 46,080
Equipment 173,760
Accumulated Depreciation—Equipment $ 21,120
Accounts Payable 62,400
Capital Stock 96,000
Retained Earnings, 2010 January 1 49,920
Dividends 46,080
Commissions Revenue 653,200
Salaries Expense 321,600
Travel Expense 96,480
Miscellaneous Expense 18,720
$ 882,640 $ 882,640

The prepaid rent is for the period 2010 July 1, to 2011 June 30.

The equipment has an expected life of 10 years with no salvage value.

Accrued salaries are USD 11,520.

Travel expenses accrued but unreimbursed to sales staff at December 31 were USD 17,280

a. Prepare a 12-column work sheet for the year ended 2010 December 31. You need not include account numbers
or explanations of adjustments.

b. Prepare adjusting journal entries.

c. Prepare closing journal entries.

Problem D The following trial balance and additional data are for South Sea Tours, Inc.:
SOUTH SEA TOURS, INC.
Trial Balance
2010 December 31
Debits Credits
Cash $ 109,050
Accounts Receivable 133,750
Prepaid Insurance 4,350
Prepaid Advertising 18,000
Notes Receivable 11,250
Land 90,000
Buildings 165,000
Accumulated Depreciation—Buildings $ 49,500
Office Equipment 83,400
Accumulated Depreciation—Office Equipment 16,680

75
Accounts Payable 56,850
Notes Payable 75,000
Capital Stock 240,000
Retained Earnings, 2010 January 1 47,820
Dividends 30,000
Service Revenue 368,350
Salaries Expense 96,000
Travel Expense 111,000
Interest Revenue 600
Interest Expense 3,000
$ 854,800 $ 854,800

The company consistently followed the policy of initially debiting all prepaid items to asset accounts.

The buildings have an expected life of 50 years with no salvage value.

The office equipment has an expected life of 10 years with no salvage value.

Accrued interest on notes receivable is USD 450.

Accrued interest on the notes payable is USD 1,000.

Accrued salaries are USD 2,100.

Expired prepaid insurance is USD 3,750.

Expired prepaid advertising is USD 16,500.

a. Prepare a 12-column work sheet for the year ended 2010 December 31. You need not include account
numbers. Briefly explain the entries in the Adjustments columns at the bottom of the work sheet, as was done in
Exhibit 12.

b. Prepare the required closing entries.

Problem E The following trial balance and additional data are for Florida Time-Share Property Management
Company:
FLORIDA TIME-SHARE PROPERTY MANAGEMENT COMPANY
Trial Balance
2010 December 31
Debits Credits
Cash $ 424,000
Prepaid Rent 28,800
Prepaid Insurance 7,680
Supplies on Hand 2,400
Office Equipment 24,000
Accumulated Depreciation—Office Equipment $ 5,760
Automobiles 64,000
Accumulated Depreciation—Automobiles 16,000
Accounts Payable 2,880
Unearned Management Fees 12,480
Capital Stock 360,000
Retained Earnings, 2010 January 1 120,640
Dividends 28,000

Introduction to Accounting : The Language of Business – Supplemental Textbook 76

Commissions Revenue 260,000
Management Fee Revenue 19,200
Salaries Expense 199,840
Advertising Expense 2,400
Gas and Oil Expense 14,240
Miscellaneous Expense 1,600
$ 796,960 $ 796,960

Insurance expense for the year, USD 3,840.

Rent expense for the year, USD 19,200.

Depreciation expense: office equipment, USD 2,880; and automobiles, USD 12,800.

Salaries earned but unpaid at December 31, USD 26,640.

Supplies on hand at December 31, USD 1,000.

The unearned management fees were received and recorded on 2010 November 1. The advance payment
covered six months' management of an apartment building.

a. Prepare a 12-column work sheet for the year ended 2010 December 31. You need not include account numbers
or explanations of adjustments.

b. Prepare an income statement.

c. Prepare a statement of retained earnings.

d. Prepare a classified balance sheet.

e. Prepare adjusting and closing entries.

Alternate problems
Alternate problem A The following adjusted trial balance is for Dream Home Realty Company:
DREAM HOME REALTY COMPANY
Adjusted Trial Balance
2010 June 30
Debits Credits
Cash $ 98,000
Accounts Receivable 40,000
Office Equipment 35,000
Accumulated Depreciation—Office Equipment $ 14,000
Automobiles 40,000
Accumulated Depreciation—Automobiles 20,000
Accounts Payable 63,000
Capital Stock 75,000
Retained Earnings, 2009 July 1 54,700
Dividends 5,000
Commissions Revenue 170,000
Salaries Expense 25,000
Commissions Expense 120,000
Gas and Oil Expense 4,000
Rent Expense 14,800

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Supplies Expense 1,400
Utilities Expense 2,000
Depreciation Expense—Office Equipment 3,500
Depreciation Expense—Automobiles 8,000
$ 396,700 $ 396,700

Prepare the closing journal entries at the end of the fiscal year, 2010 June 30.

Alternate problem B The adjusted trial balance for Penrod Insurance Consultants, Inc., follows:
Penrod Insurance Consultants, Inc.
Adjusted Trial Balance
2010 December 31

Debits Credits
Cash $ 107,200
Accounts Receivable 68,000
Interest Receivable 400
Notes Receivable 20,000
Prepaid Insurance 2,400
Supplies on Hand 1,800
Land 32,000
Buildings 190,000
Accumulated Depreciation—Buildings $ 40,000
Office Equipment 28,000
Accumulated Depreciation—Office Equipment 8,000
Accounts Payable 48,000
Salaries Payable 8,500
Interest Payable 900
Notes Payable (due 2011) 64,000
Capital Stock 120,000
Retained Earnings, 2010 January 1 42,800
Dividends 40,000
Commissions Revenue 392,520
Advertising Expense 24,000
Commissions Expense 75,440
Travel Expense 12,880
Depreciation Expense—Buildings 8,500
Salaries Expense 98,400
Depreciation Expense—Office Equipment 2,800
Supplies Expense 3,800
Insurance Expense 3,600
Repairs Expense 1,900
Utilities Expense 3,400
Interest Expense 1,800
Interest Revenue 1,600
$ 726,320 $ 726,320

a. Prepare an income statement for the year ended 2010 December 31.

b. Prepare a statement of retained earnings.

Introduction to Accounting : The Language of Business – Supplemental Textbook 78

 c. Prepare a classified balance sheet.

d. Prepare the closing journal entries.

e. Show the post-closing trial balance assuming you had posted the closing entries to the general ledger.

Alternate problem C The following trial balance and additional data are for Ramon Data Processing
Company:
RAMON DATA PROCESSING COMPANY
Trial Balance
2010 December 31
Debits Credits
Cash $ 76,000
Accounts Receivable 98,000
Prepaid Rent 7,200
Prepaid Insurance 2,400
Equipment 80,000
Accumulated Depreciation—Equipment $ 40,000
Accounts Payable 30,000
Capital Stock 100,000
Retained Earnings, 2010 January 1 65,600
Dividends 24,000
Service Revenue 370,000
Commissions Expense 270,000
Travel Expense 36,000
Miscellaneous Expense 12,000
$ 605,600 $ 605,600

The prepaid rent is for the period 2010 January 1, to 2011 December 31.

The equipment is expected to last 10 years with no salvage value.

The prepaid insurance was for the period 2010 April 1, to 2011 March 31.

Accrued commissions payable total USD 3,000 at December 31.

a. Prepare a 12-column work sheet for the year ended 2010 December 31. You need not include account numbers
or explanations of adjustments.

b. Prepare the adjusting journal entries.

c. Prepare the closing journal entries.

Alternate problem D The following trial balance and additional data are for Best-Friend Pet Hospital, Inc.
BEST-FRIEND PET HOSPITAL, INC.
Trial Balance
2010 December 31 Debits Credits
Cash $ 16,490
Accounts Receivable 54,390
Supplies on Hand 900
Prepaid Fire Insurance 1,800
Prepaid Rent 21,600

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Equipment 125,000
Accumulated Depreciation —Equipment $ 25,000
Accounts Payable 29,550
Notes Payable 9,000
Capital Stock 150,000
Retained Earnings, 2010 January 1 20,685
Service Revenue 179,010
Interest Expense 225
Salaries Expense 142,200
Advertising Expense 29,250
Supplies Expense 2,135
Miscellaneous Expense 3,705
Legal and Accounting Expense 13,750
Utilities Expense 1,800
$ 413,245 $ 413,245

The company consistently followed the policy of initially debiting all prepaid items to asset accounts.

Prepaid fire insurance is USD 600 as of the end of the year.

Supplies on hand are USD 638 as of the end of the year.

Prepaid rent is USD 2,625 as of the end of the year.

The equipment is expected to last 10 years with no salvage value.

Accrued salaries are USD 2,625.

a. Prepare a 12-column work sheet for the year ended 2010 December 31. You need not include account
numbers. Briefly explain the entries in the Adjustments columns at the bottom of the work sheet, as was done in
Exhibit 12.

b. Prepare the 2010 December 31, closing entries.

Alternate problem E The following trial balance and additional data are for Roswell Interior Decorators, Inc.:
ROSWELL INTERIOR DECORATORS, INC
Trial Balance
2010 December 31
Debits Credits
Cash $ 85,400
Accounts Receivable 81,600
Supplies on Hand 4,000
Prepaid Rent 12,240
Prepaid Advertising 2,880
Prepaid Insurance 4,400
Office Equipment 7,600
Accumulated Depreciation—Office Equipment $ 2,760
Office Furniture 29,200
Accumulated Depreciation—Office Furniture 8,280
Accounts Payable 25,200
Notes Payable (due 2011) 4,000
Capital Stock 100,000

Introduction to Accounting : The Language of Business – Supplemental Textbook 80

Retained Earnings, 2010 January 1 22,400
Dividends 45,520
Service Revenue 250,000
Salaries Expense 98,800
Utilities Expense 20,000
Miscellaneous Expense 24,000
$ 412,640 $ 412,640

Supplies on hand at 2010 December 31, are USD 1,000.

Rent expense for 2010 is USD 10,000.

Advertising expense for 2010 is USD 2,304.

Insurance expense for 2010 is USD 2,400.

Depreciation expense is office equipment, USD 912, and office furniture, USD 3,000.

Accrued interest on notes payable is USD 150.

Accrued salaries are USD 4,200.

a. Prepare a 12-column work sheet for the year ended 2010 December 31. You need not include account numbers
or explanations of adjustments.

b. Prepare an income statement.

c. Prepare a statement of retained earnings.

d. Prepare a classified balance sheet.

e. Prepare adjusting and closing entries.

Beyond the numbers—Critical thinking
Business decision case A Heather and Dan Holt met while both were employed in the interior trim and
upholstery department of an auto manufacturer. After their marriage, they decided to earn some extra income by
doing small jobs involving canvas, vinyl, and upholstered products. Their work was considered excellent, and at the
urging of their customers, they decided to go into business for themselves, operating out of the basement of the
house they owned. To do this, they invested USD 120,000 cash in their business. They spent USD 10,500 for a
sewing machine (expected life, 10 years) and USD 12,000 for other miscellaneous tools and equipment (expected
life, 5 years). They undertook only custom work, with the customers purchasing the required materials, to avoid
stocking any inventory other than supplies. Generally, they required an advance deposit on all jobs.

The business seemed successful from the start, as the Holts received orders from many customers. But they felt
something was wrong. They worked hard and charged competitive prices. Yet there seemed to be barely enough
cash available from the business to cover immediate personal needs. Summarized, the checkbook of the business
for 2010, their second year of operations, showed:
Balance, 2010 January 1 $ 99,200
Cash received from customers:
For work done in 2009 $ 36,000
For work done in 2010 200,000

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For work to be done in 2011 48,000 284,000
$ 383,200
Cash paid out:
Two-year insurance policy dated 2010 January 1 $ 19,200
Utilities 48,000
Supplies 104,000
Other Expenses 72,000
Taxes, including sales taxes 26,400
Dividends 40,000 309,600
Balance, 2010 December 31 $ 73,600

Considering how much they worked, the Holts were concerned that the cash balance decreased by USD 25,600
even though they only received dividends of USD 40,000. Their combined income from the auto manufacturer had
been USD 45,000. They were seriously considering giving up their business and going back to work for the auto
manufacturer. They turned to you for advice. You discovered the following:

Of the supplies purchased in 2010, USD 24,000 were used on jobs billed to customers in 2010; no supplies were
used for any other work.

Work completed in 2010 and billed to customers for which cash had not yet been received by year-end
amounted to USD 40,000.

Prepare a written report for the Holts, responding to their belief that their business is not sufficiently profitable.
(Hint: Prepare an income statement for 2010 and include it in your report.)

Annual report analysis B Using the Annual report appendix, calculate the current ratios for the two years
shown for The Limited, Inc. Write a summary of the results of your calculations. Also, look at some of the other
data provided by the company in preparing your comments. For instance, look at the net income for the last three
years.

Broader perspective – Writing experience C Read the "A broader perspective: Skills for the long haul".
Write a description of a career in public accounting broader perspective at each level within the firm. Discuss the
skills needed and how you could develop these skills.

Group project D In teams of two or three students, interview a management accountant. Management
accountants may have the title of chief financial officer (CFO), controller, or some other accounting title within a
company. Seek information on the advantages and disadvantages of working as a management accountant. Also
inquire about the nature of the work and any training programs offered by the company. As a team, write a
memorandum to the instructor summarizing the results of the interview. The heading of the memorandum should
contain the date, to whom it is written, from whom, and the subject matter.

Group project E With a small group of students, obtain an annual report of a company in which you have
some interest. You may obtain the annual report from your instructor, the library, the Internet, or the company.
Describe the nature of each item on the classified balance sheet. You may have to do library research on some of the
items. Also, calculate the current ratio for the most recent two years and comment. Write a report to your instructor
summarizing the results of the project.

Introduction to Accounting : The Language of Business – Supplemental Textbook 82

 Group project F With a small group of students and using library sources, write a paper comparing the
features of three different accounting software packages (such as Peachtree Complete, Quikbooks Pro, DacEasy,
MYOB Business Essentials, NetSuite Small Businee and Cougar Mountain ). Give the strengths and weaknesses of
each. Cite sources for the information and treat direct quotes properly.
Using the Internet—A view of the real world
Visit the following Internet site:

http://www.merck.com

Pursue choices you are offered on the screen under Investor Relations until you locate the most recent
consolidated balance sheet. In a short report to your instructor, describe how you got to the balance sheet and
identify the major headings used in the balance sheet. For instance, the first such heading is Assets. Also, calculate
the current ratio.

Visit the following Internet site:

http://www.kodak.com

Type in "Annual report" in the search box to locate the most recent annual report and then find the consolidated
statement of financial position. Identify the major headings within the balance sheet and calculate the current ratio
for the most recent year. Write a memo to your instructor summarizing your findings.
Answers to self-test
True-false

True. The three trial balances are the unadjusted trial balance, the adjusted trial balance, and the post-closing
trial balance. The first two trial balances appear on the work sheet.

False. If a debit-balance account (such as Prepaid Rent) is credited in the adjustment, the amount in the
Adjustments columns is deducted from the amount in the Trial Balance columns to determine the amount for that
item in the Adjusted Trial Balance columns.

True. The net loss appears in the Income Statement credit column to balance the Income Statement columns.
Then the loss appears in the Statement of Retained Earnings debit column because it reduces Retained Earnings.

True. All of these accounts are closed, or reduced to zero balances, as a result of the closing process.

False. All revenue and expense accounts have zero balances after closing.

False. Some manual accounting systems are still in use.

Multiple-choice

b. The other accounts are very likely to be adjusted. The Land account would be adjusted only if an error has
been made involving that account.

c. The Adjusted Trial Balance columns should balance before items are spread to the Income Statement,
Statement of Retained Earnings, and Balance Sheet columns. Therefore, if the Balance Sheet columns do not
balance, the error is likely to exist in the last six columns of the work sheet.

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 d. The net income for the period does not appear in the balance sheet. It does appear in all of the other places
listed.

a. The Dividends account is closed to the Retained Earnings account rather than to the Income Summary
account.

b. Plant, property, and equipment is one of the long-term asset categories. Response (a) should not include
equipment. Response (c) should not include notes receivable. Stockholders' equity is not subdivided into current
and long-term categories.
Comprehensive review problem
Lopez Delivery Service Company has the following chart of accounts:
Acct. Acct.
No. Account Title No. Account Title
100 Cash 310 Retained Earnings
103 Accounts Receivable 320 Dividends
107 Supplies on Hand 400 Service Revenue
108 Prepaid Insurance 507 Salaries Expense
112 Prepaid Rent 511 Utilities Expense
140 Buildings 512 Insurance Expense
141 Accumulated Depreciation—Buildings 515 Rent Expense
150 Trucks 518 Supplies Expense
151 Accumulated Depreciation—Trucks 520 Depreciation Expense—Buildings
200 Accounts Payable 521 Depreciation Expense—Trucks
206 Salaries Payable 568 Miscellaneous Expense
300 Capital Stock 600 Income Summary

The post-closing trial balance as of 2010 May 31, was as follows:

LOPEZ DELIVERY SERVICE COMPANY
Post-Closing Trial Balance
2010 May 31
Acct.
No. Account Title Debits Credits
100 Cash $ 80,000
103 Accounts Receivable 30,000
107 Supplies on Hand 14,000
108 Prepaid Insurance 4,800
112 Prepaid Rent 12,000
140 Buildings 320,000
141 Accumulated Depreciation —Buildings $ 36,000
150 Trucks 80,000
151 Accumulated Depreciation—Trucks 30,000
200 Accounts Payable 24,000
300 Capital Stock 300,000
310 Retained Earnings 150,800
$ 540,800 $ 540,800

The transactions for June 2010 were as follows:

June 1 Performed delivery services for customers on account, USD 60,000.

3 Paid dividends, USD 10,000.

4 Purchased a USD 20,000 truck on account.

7 Collected USD 22,000 of the accounts receivable.

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 8 Paid USD 16,000 of the accounts payable.

11 Purchased USD 4,000 of supplies on account. The asset account for supplies was debited.

17 Performed delivery services for cash, USD 32,000.

20 Paid the utilities bills for June, USD 1,200.

23 Paid miscellaneous expenses for June, USD 600.

28 Paid salaries of USD 28,000 for June.

• Depreciation expense on the buildings for June is USD 800.

• Depreciation expense on the trucks for June is USD 400.

• Accrued salaries at June 30 are USD 4,000.

• A physical count showed USD 12,000 of supplies on hand on June 30.

• The prepaid insurance balance of USD 4,800 applies to a two-year period beginning 2010 June 1.

• The prepaid rent of USD 12,000 applies to a one-year period beginning 2010 June 1.

• Performed USD 12,000 of delivery services for customers as of June 30 that will not be billed to those
customers until July.

a. Open three-column ledger accounts for the accounts listed in the chart of accounts.

b. Enter the 2010 May 31, account balances in the accounts.

c. Journalize the transactions for June 2010.

d. Post the June journal entries and include cross-references (assume all journal entries appear on page 10 of the
journal).

e. Prepare a 12-column work sheet as of 2010 June 30.

f. Prepare an income statement, a statement of retained earnings, and a classified balance sheet.

g. Prepare and post the adjusting entries (assume they appear on page 11 of the general journal).

h. Prepare and post the closing entries (assume they appear on page 12 of the general journal).

i. Prepare a post-closing trial balance.

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