These statements are the result of the company's accounting process, which we discuss throughout this book. Finally, the cycle is completed by reporting the information on one of the company's financial statements (in this case, its balance sheet).
Preparation of Adjusting Entries (Step 3)
The adjusting entry is a debit (decrease) to rental income for $300 and a credit (increase) to unearned rent for $300. The company records the depreciation at the end of the accounting period in an adjusting entry.
Preparation of the Financial Statements (Step 4)
This account is deducted from accounts receivable on the company's balance sheet to report the estimated collection amount. Note that for an estimated item, under the Accounts Credited column, we show the use of a contra account because a company typically credits (increases) such an account (for example, accumulated depreciation) to reduce the book value of the related active. An adjusted trial balance shows all accounts and account balances in a business after adjustments (but before closing) in either a debit or a credit column. The adjusted trial balance is used to verify that the sum of the debit balances equals the sum of the credit balances.
This working paper also helps in the preparation of the company's financial statements because all the accounts and amounts included in the financial statements are listed on the adjusted trial balance. Finally, the company prepares the income statement, statement of retained earnings and balance sheet in consecutive order directly from the information in the adjusted trial balance. The sum of the Other items section (for recurring items not directly related to ongoing operations) is deducted to determine pre-tax income.
Preparation of Closing Entries (Step 5)
This credit is closed to zero with a debit entry in Income Summary and a credit entry in Retained Earnings for the amount of net income. This debit balance is closed to zero with a debit entry to Retained Earnings and a credit entry to the Income Summary for the amount of the net loss. Finally, the amount necessary to reduce the balance to zero is credited to the distributed dividends account; the corresponding debit to retained earnings reduces it by the amount of dividends.
The result of closing entries is that (1) all of the company's income, expense, and dividend accounts are closed (have zero balances) and are ready to accumulate net income and dividend information for the next accounting period, (2) the ending balance in its retained earnings account increases by $900 because of the excess of net income over dividends and (3) only permanent balance accounts are open (have non-zero account balances). Deferred revenue and prepaid expenses result when cash inflows or outflows occur before the revenue or expense is recognized. Accrued income and expenses result when the recognition of income or expenses occurs before the inflow or outflow of cash.
Additional Issues
A post-closing trial balance is prepared to verify that the total debit balance equals the sum of the credit balances in all of the company's permanent accounts. This working paper is not shown here. Adjusting entries use accrual accounting concepts to ensure that all revenue earned and all expenses incurred during the period are recorded, regardless of cash inflows or outflows. Closing entries are required at the end of the accounting cycle to reduce the suspense accounts to zero and to update the retained earnings account for changes that occurred during the period.
However, she will need to examine the details of the sales revenue account to determine the sales revenues and allowances. Because the inventory was returned by the customer, Dapple Corporation would also "reverse" the original entry for cost of goods sold by debiting inventory and crediting cost of goods returned to cost of inventory returned. The company then subtracts its ending inventory from the cost of goods available for sale to determine the cost of goods sold.
W ORKSHEET (S PREADSHEET )
Each of the adjusting journal entries we show in Example 3-4 is initially prepared as shown on the worksheet. For example, the debit balance of $360 in Prepaid Insurance is combined with the credit adjustment of $270, and the new balance of $90 is transferred to the debit column of the balance sheet. The adjustment item for income taxes is registered and the amounts are entered in the correct columns in the accounts.
A total of $32,348 in the debit and credit columns means the system is in balance and the worksheet is complete. A brief overview of the Dapple Corporation worksheet shows how the worksheet helps in the accounting process. The total of $17,216 in the credit column of the income statement is credited to Income Summary, while individual accounts with credit balances are debited.
R EVERSING E NTRIES
The worksheet is prepared as a preliminary step, before the adjusting and closing entries are recorded in the general journal and the financial statements are prepared. A reversal entry allows a company to record the later transaction regularly, without considering the possible impact of the previous adjusting entry. If it does not make a reversal entry, when Dapple records this collection, it must determine what portion of the interest relates to 2007 ($66 of Interest Receivable) and what portion is Interest Income for 2008 ($33 for two months).
99 received in excess of the face value of the note is credited to interest income. If Dapple does not make a chargeback, when it pays the wages, it must determine what part of the wage payment relates to wages paid) and what part is salary expenses for 3 months). As we indicated in the discussion of the adjusting entry for deferred revenue, some companies initially record the receipt of revenue in advance of earnings as a revenue instead.
S UBSIDIARY L EDGERS
Because the individual customer accounts have a debit balance, this subledger has a total debit balance (calculated by preparing a schedule of the individual customer account balances). This account is called a control account because its debit balance must equal that of the subledger. In a computerized accounting system, each posting to the accounts receivable control account is also automatically posted to the appropriate subledger account.
Similarly, the accounts payable subsidiary ledger contains the individual accounts of all the company's credit providers. Since these accounts have credit balances, the credit total of this subsidiary ledger must match the credit total of the Accounts Payable control account in the general ledger. If the Dapple Corporation used a subsidiary ledger for the accounts receivable, the general ledger and control account balances at the end of 2007 would appear as we show in Example 3-12.
S PECIAL J OURNALS
When a company uses this subsidiary ledger, it still maintains a receivables account in the general ledger. It is used to record adjusting, closing and reversing entries and other transactions not recorded in special journals. The worksheet is a tool designed to minimize errors, simplify the recording of correcting and closing entries in the journal, and help in the preparation of financial statements.
A reversal entry is the exact counterpart of an adjusting entry and is used to simplify the recording of a later transaction related to the adjusting entry. A subledger is a group of accounts for one specific business activity that together form the total of the associated control account in the general ledger. Special journals such as sales journal, purchases journal, cash receipts journal, and cash payments journal are tools used to record business transactions with similar characteristics that allow greater efficiency and effectiveness in the accounting cycle.
C OMPUTER S OFTWARE
Because operating procedures and transactions vary from company to company, each company organizes its specialty journals in a way that best suits its business. Payroll software can be very complex due to the different federal, state and local tax laws. Payroll software can be designed to calculate each employee's salaries based on pay rates and overtime; distribute salaries across departments in the company; calculate federal, state, and local withholding taxes; calculate other voluntary deductions, such as for investments in pension plans; print paychecks; generate comparisons of actual with expected salaries; and preparing various tax withholding reports.
General ledger software is broader than the name suggests and includes many aspects of a company's accounting system. General ledger software usually includes all special journals and the general journal for recording transactions, a chart of accounts, and the ledger accounts on disks to store the recorded information. The general ledger software of a company is usually linked to its accounts receivable, accounts payable, inventory and payroll software.
A PPENDIX : C ASH -B ASIS A CCOUNTING
In Example 3-14, most of the amounts come from the initial information we presented about the company. To prepare a trial balance at the end of the accounting period, first calculate the balance in each account. Next, list each account and list its balance in the debit or credit column of the worksheet (trial balance).
7. Prepare closing entries. Closing entries are entries in the company's journal made at the end of the accounting period (1) to reduce the balance in each temporary account (revenue, expense, and dividend accounts) to zero and (2) to update the retained earnings account. 8. Fill in the worksheet (spreadsheet). To complete the worksheet, first list each account and indicate its balance in the debit or credit column of the trial balance. Based on the previous information, prepare the journal entries for adjusting the company's books as of December 31, 2007.
Prepare a year-end trial balance on a worksheet and complete the worksheet with the following information: (a) year-end accrued salaries totaling $1,200; (b) for simplicity, the building and equipment are depreciated on a straight-line basis over an estimated useful life of twenty years, with no residual value; c) the total stock at the end of the year. An analysis of the 2007 cash transactions recorded in the company's checkbook indicates the following deposits and checks:
