Completing The Accounting Cycle: ACCT 111 Financial Accounting Week 3

ACCT 111 Financial Accounting Week 3
Completing the Samuel Tan
Accounting Cycle
Assistant Professor of Accounting
End of the
The Accounting Cycle
^
Adjusted Financial
Trial balance
trial balance statements
❖ Learning objectives this week

❖ Accrual accounting and time periods in accounting
❖ Revenue and expense recognition principles
❖ Adjusting entries and correcting errors
❖ Preparing financial statements and closing the books
This week: the end of the accounting cycle
Prepare the unadjusted trial balance
Adjusting entries & error-correction
Prepare the adjusted trial balance
Prepare the financial statements
Close the books

Accrual accounting
This is what we're doing!
Accrual Accounting Cash-basis Accounting
Records
Records
impact of transactions in the
only cash transactions
period in which they occur
Accrual accounting
❖ WishyWashy cleans FedEx delivery trucks and FedEx
promises to pay WishyWashy $3,000 in full within 30 days.
Transaction is recorded Transaction is not recorded

since WishyWashy has since there was
provided the service no change in cash
Accrual accounting
❖ WishyWashy buys supplies on account from SupplyCo,
agreeing to pay $3,700 in full within 30 days.
Transaction is recorded Transaction is not recorded

since WishyWashy has since there was
received the supplies no change in cash
Accrual accounting
Accounting standards Fails to capture the underlying
require accrual accounting! economics of transactions
Records
Records
impact of transactions in the
only cash transactions
period in which they occur
How exactly do we do this?

What are these "periods"?
Time periods in accounting
❖ We record transactions in the period in which they occur
❖ Example 1: company performs service, customer pays later
Company performs service Customer pays cash later
Time Period 1 Time Period 2
Only accrual accounting Both accrual and cash-basis

records the sale in the period the accounting record the change in cash
service is performed (Revenue)
Time periods in accounting
❖ We record transactions in the period in which they occur
❖ Example 2: company pays in advance to rent a building
Company pays in advance Company uses the building
Time Period 1 Time Period 2
Both accrual and cash-basis Only accrual accounting records

accounting record the change in cash the rent in the period it benefited
the company (Rent Expense)
Remember this
from Week 1?
The reporting period assumption

❖ Financial statements are prepared for specific periods!
Annual • B/S as of the end of the year

reports • I/S for the year
Semi-annual • B/S as of the end of the half-year

reports • I/S for the half-year
Quarterly • B/S as of the end of the quarter

reports • I/S for the quarter
"Interim reports"
https://www.dbs.com/investors/financials/quarterly-financials
Time Periods in Accounting
❖ Many companies use the calendar year as their fiscal year, e.g. DBS:
The Annual Report has the Balance Sheet as of 31 Dec 2019,

and the Income Statement for the year ended 31 Dec 2019
Annual Report
1 Jan 2019 31 March 2019 30 June 2019 30 Sep 2019 31 Dec 2019
Quarterly Report Quarterly Report Quarterly Report Quarterly Report
The Quarterly Report for Q1 has the Balance Sheet as of 31 March 2019,
and the Income Statement for the quarter ended 31 March 2019
Time Periods in Accounting
❖ But other companies use other end-dates, e.g. Apple:
The Annual Report has the Balance Sheet as of 28 Sep 2019,

and the Income Statement for the year ended 28 Sep 2019
Annual Report
29 Sep 2018 29 Dec 2018 30 March 2019 29 June 2019 28 Sep 2019
Quarterly Report Quarterly Report Quarterly Report Quarterly Report
The Quarterly Report for Q1 has the Balance Sheet as of 29 Dec 2018,
and the Income Statement for the quarter ended 29 Dec 2018
Revenue and Expense Recognition
❖ We've learned two key concepts:
Accrual accounting Reporting period assumption

Transactions are recorded in Financial statements are
the period in which they occur prepared for specific periods
❖ Let's apply this to two key elements:

❖ When do we record revenues for a certain period?
❖ When do we record expenses for a certain period?
When should revenue be recognised?
❖ The revenue recognition principle

❖ Recognise revenue when it is earned, and not before
❖ i.e. when good or services have been transferred to the customer
❖ For consumer sales, this is usually at the point of the sale

❖ i.e. when the company hands the goods to the customer
❖ Not just when an order is placed!
Revenue recognition: technical guidelines
FRS 115 guidelines (effective 2018): 5-step method
1. Identify the contract with a customer

2. Identify the performance obligations in the contract:
promises to transfer goods or services to the customer
Just know the basic
3. Determine the transaction price: expected amount principle: recognise
received for transferring the goods or services revenue when goods
or services have been
4. Allocate the transaction price to the performance transferred to the
obligations in the contract customer
5. Recognise revenue when a performance obligation is
satisfied by transferring a promised good or service
to a customer
Revenue recognition: unearned revenue example
❖ On 15 Jan, ServiceCo received $1,000 from a customer

for service to be completed in February
❖ Do we recognise $1,000 revenue on 15 Jan?
January February
Advance Payment Performed Work
The revenue has not The work has been

been earned, so don't performed, so
recognise revenue recognise revenue
❖ Journal entry for advanced payment for future work

❖ E.g. On 15 Jan ServiceCo received $1,000 from a customer
for service to be completed in February
Revenue has not been earned

Instead, recognise an Unearned Revenue liability
Debit Credit
Unearned Revenue
Cash 1,000
(15 Jan) 1,000
Unearned Revenue 1,000
Received payment for future work Bal. 1,000
❖ Journal entry when the company performs the work

❖ E.g. On 20 February, ServiceCo completed the work for the
customer
Revenue has been earned, so recognise it!

Reduce the liability since we no longer owe the customer service
Debit Credit Unearned Revenue

(20 Feb) 1,000 (15 Jan) 1,000
Revenue 1,000
Recognizing revenue Bal. 0
When should expenses be recognised?
❖ The Expense recognition principle
❖ "Matching of costs with revenues"
Identify
Measure the
expenses
expenses
incurred
Recognise expenses in the same

period as related revenues
When should expenses be recognised?
❖ Why match expenses to related revenues in the same period?
❖ The idea: businesses incur cost to generate revenue
❖ Matching expenses lets us compute the profitability for each period
2018 2019
Revenues for 2018 Revenues for 2019
Related to Related to
Expenses for 2018 Expenses for 2019

Matching expenses: inventory example
❖ BookSeller purchased 100 books for $10 each on 15 Jan
❖ Do we recognise a $1,000 expense on 15 Jan?
January February
Purchased 100 books Sold 20 books
The inventory is not related The 20 books have generated

to any revenue, so don't revenue, so recognise an
recognise an expense expense for the 20 books
❖ Journal entry for purchase of inventory
❖ E.g. BookSeller purchased 100 books for $10 each on 15 Jan:
No expense is recognised on purchasing inventory

Because revenue hasn't been generated yet!
Debit Credit
Inventory (100 x $10) 1,000
Cash 1,000
Purchased inventory
❖ Journal entries for sale of inventory
❖ E.g. BookSeller sells 20 books costing $10 each for $15 each:
Debit Credit
Cash (20 x $15) 300 Recognise the revenue
Revenue 300 from selling the 20 books
Sold inventory
Debit Credit
Cost of goods sold (20 x $10) 200 Recognise the expense
Inventory 200 from selling the 20 books
Sold inventory
Inventory declines
after we sold some of it
Matching expenses: prepayment example
❖ The relationship between the expense & the revenue may be indirect!
❖ On 15 Jan, BookSeller paid $1,000 for bookshop rent for February
❖ Do we recognise a $1,000 expense on 15 Jan?
January February
Prepaid for Rent Used the Bookshop
The prepayment is not The company used the

related to any revenue yet, so bookshop in February to
don't recognise an expense help generate revenue, so
recognise an expense
❖ Journal entry for prepaying for an expense
❖ E.g. On 15 Jan, BookSeller paid $1,000 for bookshop rent for February:
No expense is recognised on prepaying for rent

Debit Credit
Prepaid Rent 1,000
Cash 1,000
Prepaid for February rent
❖ Journal entry for incurring expense that was previously prepaid

❖ E.g. BookSeller incurs rent in February that was prepaid in January
Debit Credit
Rent Expense 1,000 Recognise the expense
Prepaid Rent 1,000 from using the bookstore
Incurring rent expense
The Prepaid Rent is
"used up"
Continuing with last week's Practice Case!
WishyWashy Car Wash
This week: on Google Docs at tinyurl.com/fa-wk3 (save a copy!)

WishyWashy's new transactions
❖ The Google doc is at tinyurl.com/fa-wk3

❖ Save a copy & bookmark! We'll come back to this a few times
❖ Journalise the transactions in November and December

❖ ... and post the transactions to the ledger
❖ Think about when to recognise revenue and expenses

WishyWashy's transactions: 1 Nov
1 Nov: UPS pays WishyWashy $20,000 in advance for
washing services for its trucks over the next two months
(December and January).
Debit Credit
Cash 20,000
Recording unearned revenue
Cash Unearned Revenue

... ... (1 Nov) 20,000
(1 Nov) 20,000
WishyWashy's transactions: 2 & 7 Nov
2 Nov: FedEx pays WishyWashy the remaining amount

that it owes.
7 Nov: WishyWashy pays SupplyCo the remaining
amount that it owes.
WishyWashy's transactions: 20 Nov & 1 Dec
20 Nov: WishyWashy pays $3,000 in advance to rent a

carwash lot from December to February, at $1,000 per
month.
1 Dec: WishyWashy hires an employee at a salary of $4,000
a month. Each month's salary is paid in cash on the 15th of
the next month.
WishyWashy's transactions: 12-23 Dec
12 Dec: WishyWashy purchases carwash equipment for

$30,000 in cash.
20 Dec: WishyWashy purchases more supplies for $1,300

in cash.
23 Dec: SingPost pays WishyWashy $20,000 in advance for
washing services for its trucks over two months
(December to January).
WishyWashy's unadjusted trial balance at the end of December
WishyWashy Unadjusted Trial Balance on 31 December

Account Balance
Account Title Debit Credit
Cash
Supplies
Prepaid Rent
Equipment
Land
Unearned Revenue
Share Capital
Dividends
Revenue
Gain on Sale of Land
Advertising expense
Total
Adjusting entries and error-correction
Close the books

Why "adjust" stuff...?
❖ Journal entry for prepaying for an expense
❖ E.g. On 15 Jan, BookSeller paid $1,000 for bookshop rent for February:
Debit Credit
Prepaid Rent 1,000
Cash 1,000
Prepaid for February rent
No expense is recognised on prepaying for rent

❖ Journal entry for incurring expense that was previously prepaid

❖ E.g. BookSeller incurs rent in February that was prepaid in January
Debit Credit
Rent Expense 1,000 Recognise the expense
Prepaid Rent 1,000 from using the bookstore
Incurring rent expense
The Prepaid Rent is
"used up"
But wait... BookSeller incurs rent every day as it uses its store...
So should BookSeller recognise a little rent expense every day?
Adjusting entries
or how we avoid making certain journal entries every day...
❖ Some transactions are only recorded at the end of a period

❖ Much less costly than recording in real time!
❖ So... we "adjust the accounts" at the end of a period
❖ Record the transactions that have not been recorded
❖ May be done at the end of each month, or quarter, etc
❖ These are cases where cash timing ≠ revenue or expense timing
❖ Adjusting entries always affect a revenue or expense account
❖ They don't affect the cash! (Unless there are errors to correct...)
Situations with adjusting entries
❖ Deferrals: incurring revenue or expense after cash changes
Cash Received Revenue Earned "Unearned Revenue"
or Cash Paid Expense Incurred "Prepaid Expenses"
❖ Accruals: incurring revenue or expense before cash changes

Revenue Earned Cash Received "Accounts Receivable"
or Expense Incurred Cash Paid "Accrued Expenses"
❖ Depreciation: expensing an asset over time as it is used

Asset Purchased Expensed over time
Deferrals Type 1: Unearned Revenue
Cash Received Revenue Earned
❖ Unearned Revenue: collecting cash before earning the revenue

❖ Unearned Revenue is a liability
❖ Because you owe the customer a good or a service
Deferrals Type 1: Unearned Revenue
❖ 1 Dec: A customer pays $1,000 up front for services to be
performed over the next two months:
Unearned Revenue
Debit Credit
Cash 1,000
1,000
Received cash for revenue in advance
❖ 31 Dec (Adjusting entry): Half the service has been performed
Debit Credit Unearned Revenue

Unearned Revenue 500 500 1,000
Revenue 500
Unearned revenue that has been earned
Deferrals Type 2: Prepaid Expenses
Cash Paid Expense Incurred
❖ Prepaid Expenses: paying cash before incurring an expense

❖ Prepaid Expense is an asset
❖ Because you can use the expense to generate revenue
Deferrals Type 2: Prepaid Expenses
❖ 1 Dec: The company prepays $10,000 for insurance coverage for its
employees over the next 12 months
Prepaid Insurance
Debit Credit
Prepaid Insurance 10,000 10,000
Cash 10,000
Prepayment for employee insurance
❖ 31 Dec (Adjusting entry): By the end of the period, employees have

recorded $1,000 premium on insurance as insurance expense
Debit Credit Prepaid Insurance
Insurance Expense 1,000
10,000 1,000
Prepaid Insurance 1,000
Recording insurance expense
Accruals Type 1: Accounts Receivable
Revenue Earned Cash Received
❖ Accounts Receivable: earning revenue before collecting the cash

❖ Accounts receivable is an asset
❖ Because you will receive the cash in future
Accruals Type 1: Accrued Revenue
❖ 31 Dec (Adjusting entry): During December, the company
performed $2,000 of services for a customer, but the customer has
not paid yet. The revenue has not yet been recorded in the books.
Debit Credit Accounts Receivable
Accounts Receivable 2,000 2,000
Revenue 2,000
Recording accounts receivable
❖ 16 Jan: The customer pays $1,500 on account

Debit Credit Accounts Receivable
Cash 1,500 2,000 1,500
Accounts Receivable 1,500
Received payment on account
Accruals Type 2: Accrued Expenses
Expense Incurred Cash Paid
❖ Accrued Expense: incurring an expense before paying cash

❖ Accrued Expenses are liabilities
❖ Because you will pay the cash in future
❖ AKA "Accrued Liability"
Accruals Type 2: Accrued Expense
❖ 31 Dec (Adjusting entry): The company employs staff at a total
salary of $10,000 per month, to be paid on the 15th of the following
month. Salary expense for December has not been recorded.
Debit Credit Salary Payable
Salary expense 10,000 10,000
Salary Payable 10,000
Accruing salary expense
❖ 15 Jan: The company pays the salary for December.
Debit Credit Salary Payable

Salary Payable 10,000 10,000 10,000
Cash 10,000
Paying salary
Depreciation
Asset Purchased Expensed over time
❖ Depreciation: expensing an asset over time as it is used

❖ More details on depreciation at Week 6
❖ For now we'll only cover the simplest case...
Depreciation
❖ 1 Dec: The company purchases a truck for $24,000 in cash and determined that it
would have a useful life of 10 years with no residual value. The company
depreciates vehicles on a straight-line basis.
Debit Credit Vehicles

Vehicles 24,000
24,000
Cash 24,000
Purchase of a truck in cash
❖ 31 Dec (Adjusting entry): The accounting department records depreciation of the

truck for the month of December
Straight-line depreciation: expense (cost - residual value) evenly over time

Annual Depreciation = $24,000 / 10 = $2,400
December Depreciation = $2,400 / 12 = $200
Depreciation
❖ 1 Dec: The company purchases a truck for $24,000 in cash and determined that it
would have a useful life of 10 years with no residual value. The company
depreciates vehicles on a straight-line basis.
Debit Credit Vehicles

Vehicles 24,000
24,000
Cash 24,000
Purchase of a truck in cash
❖ 31 Dec (Adjusting entry): The accounting department records depreciation of the

truck for the month of December ???
Debit Credit Acc. Dep. - Vehicles
Depreciation Expense 200 200
Accumulated Depreciation - Vehicles 200
Accumulated depreciation for the truck
Depreciation
❖ Accumulated depreciation is a contra-asset account
❖ "Contra" accounts are offset against a companion account
Vehicles
24,000 Balance Sheet at 31 Dec
Vehicles (at cost) 24,000
Accumulated Less: Acc. Depreciation (200)

Depreciation:
Vehicles, net of depreciation 23,800
Vehicles
200
Importance of when adjusting is done
❖ Always check the period you are adjusting for!
❖ On 12 March 2020, Tents4Rents prepaid $9,000 for rent for the
next three months (April to June), and will incur $3,000 of
rent expense per month.
Debit Credit
Prepaid Rent 9,000
Cash 9,000
Prepayment for rent
What will the company record on 30 June?

❖ If Tents4Rents records adjusting entries every month:

❖ The previous adjusting entry was done at __________
❖ Rent expense to be recorded on 30 June:
Debit Credit
❖ If Tents4Rents records adjusting entries every quarter:

❖ The previous adjusting entry was done at __________
❖ Rent expense to be recorded on 30 June:
Debit Credit
Some practice with the WishyWashy Case
❖ WishyWashy adjusts its accounts at the end of each quarter
❖ At the end of December, the company's accountants

gathers additional information to make the adjustments...
❖ Prepare the adjusting entries and post them to the ledger

WishyWashy's adjusting entries
31 Dec: WishyWashy has completed all the washing
services that UPS paid for on 1 Nov.
Can WishyWashy recognise revenue now?
Debit Credit
Revenue 20,000
Unearned revenue that has been earned
Unearned Revenue Revenue

(31 Dec) 20,000 (1 Nov) 20,000 (9 Oct) 3,000
(23 Dec) 20,000 (14 Oct) 7,000
(31 Dec) 20,000
31 Dec: WishyWashy completed half the washing services

that SingPost paid for on 23 Dec.
31 Dec: WishyWashy estimates that $200 of depreciation
has been incurred for the carwash equipment.
31 Dec: WishyWashy has not recorded salary expense for

the employee hired on 1 Dec.
31 Dec: WishyWashy used the carwash lot in December
but has not recorded rent expense.
31 Dec: Based on a manual count, WishyWashy has $2,000

of supplies remaining.
Summary of the Adjustment Process
❖ What were we doing in the previous examples?

❖ Assigning revenues & expenses to the right period!
❖ Two purposes of the adjusting process:
❖ Measure income during an accounting period
❖ Update the trial balance
Summary of the Adjustment Process
❖ Every adjusting entry affects both of the following:
❖ Either revenue or expense — to measure income
❖ Either assets or liabilities — to update the balance sheet
Type of Account Affected

Type of Adjusting Entry
Debit Credit
Unearned Revenue Liability Revenue
Deferrals
Prepaid Expenses Expense Asset
Accounts Receivable Asset Revenue
Accruals
Accrued Expenses Expense Liability
Depreciation Expense Contra-asset
Correcting errors
❖ Errors may be discovered & corrected at the end of a period
❖ Watch out for these in our tests and exams!
❖ You need to spot the error & write a journal entry to correct it
❖ Easy method when you spot an error:

1. Write down the journal entry the company actually recorded
2. Write down the journal entry it should have recorded
3. Write down the journal entry to get from #1 to #2
Correcting errors: example 1
❖ On 31 Dec, the company discovers that $3,000 of credit
sales during the month were recorded as cash sales
Step 1: what it recorded Step 2: what it should have recorded

Debit Credit Debit Credit
Cash 3,000 Accounts Receivable 3,000
Revenue 3,000 Revenue 3,000
Step 3: correcting the error

Debit Credit
Accounts Receivable 3,000
Cash 3,000
This is the answer you will write in the tests and exam
And note that these will also be posted to the T-accounts
Correcting errors: example 2
❖ On 31 Dec, the company discovers that $300 of credit sales
during the month were recorded as $3,000 of credit sales
Step 1: what it recorded Step 2: what it should have recorded

Debit Credit Debit Credit
Accounts Receivable 3,000 Accounts Receivable 300
Revenue 3,000 Revenue 300
Step 3: correcting the error

Debit Credit
This is the answer you will write in the tests and exam
And note that these will also be posted to the T-accounts
Then what?
❖ We update the trial balance to include the adjustments

and corrections!
Unadjusted Adjusted
Adjusting Entries
Trial Balance Trial Balance
❖ And after that we can prepare the financial statements!

Adjusting the trial balance
Close the books

Adjusting the trial balance
❖ Prepare a new trial balance using the updated T-accounts!

❖ This is called the "adjusted trial balance"
❖ We'll try this with WishyWashy...

❖ I've copied the unadjusted trial balance for reference
WishyWashy: Adjusting the Trial Balance
WishyWashy Trial Balance on 31 December
Unadjusted Balances Adjusted Balances
Account Title Debit Credit Debit Credit
Cash 40,700
Supplies 5,000
Prepaid Rent 3,000
Equipment 30,000
Acc. Depreciation
Land 20,000
Salary Payable
Share Capital 50,000
Dividends 2,100
Revenue 10,000
Gain on Sale of Land 2,000
Advertising Expense 1,200
Salary Expense
Rent Expense
Supplies Expense
Depreciation Expense
Total 102,000 102,000
WishyWashy: Adjusting the Trial Balance
Unadjusted Balances Adjustments Adjusted Balances
Account Title Debit Credit Debit Credit Debit Credit
Cash 40,700
Supplies 5,000
Prepaid Rent 3,000
Equipment 30,000
Acc. Depreciation
Land 20,000
Salary Payable
Share Capital 50,000
...
You may see "adjustments" columns – this

records the impact of all the adjustments
There's no need to do this, but you can try it

at Workbook 1 Question 1 for practice
Preparing the financial statements
Close the books

Trial Balance → Income Statement
Cash 40,700 40,700
Supplies 5,000 2,000
Prepaid Rent 3,000 2,000
Equipment 30,000 30,000
Acc. Depreciation 200
Land 20,000 20,000
Unearned Revenue 40,000 10,000
Share Capital 50,000 50,000
Income Statement Items
Dividends 2,100 2,100
Revenue 10,000 40,000
Gain on Sale of Land 2,000 2,000
Advertising Expense 1,200 1,200
Salary Expense 4,000
Rent Expense 1,000
Supplies Expense 3,000
Depreciation Expense 200
Total 102,000 102,000 106,200 106,200
Trial Balance → Income Statement
WishyWashy Income Statement
for the quarter ended 31 December
Revenue
Expenses and gains:
Gain on sale of land
Advertising expense
Salary expense
Rent expense
Supplies expense
Depreciation expense
Net Income
Trial Balance → Statement of Changes in Equity
Cash 40,700 40,700
Equipment 30,000 30,000
Land 20,000 20,000
Equity Items
Retained Earnings??
Revenue 10,000 40,000
Rent Expense 1,000
Total 102,000 102,000 106,200 106,200
Trial Balance → Statement of Changes in Equity
WishyWashy Statement of Changes in Equity

for the quarter ended 31 December
Beginning of the quarter

Issuance of New Shares
Net Profit for the year
Less Dividends Paid
End of the quarter
Trial Balance → Balance Sheet
Balance Sheet Items
Cash 40,700 40,700
Equipment 30,000 30,000
Land 20,000 20,000
Revenue 10,000 40,000
Rent Expense 1,000
Total 102,000 102,000 106,200 106,200
Trial Balance → Balance Sheet
WishyWashy Balance Sheet as at 31 December
Assets
Cash
Supplies
Prepaid Rent
Equipment, net of Acc. Dep.
Fill in the assets Land
and liabilities first, Total Assets
from the balances
in the trial balance!
Liabilities
Unearned Revenue If you did it
Salary Payable correctly,
Total Liabilities A=L+E
Shareholders' Equity
Share Capital
Retained Earnings
Total Shareholders' Equity
Closing the books
Close the books

At the end of the period, we close the books
❖ To prepare the accounts for the next period's transactions
❖ Temporary accounts: set to zero, transferred to retained earnings
❖ Permanent accounts: not changed, carry balances to next period
Temporary Accounts Permanent Accounts
Accounts that relate to a Other accounts

specific time period
Assets
Revenue & gains Liabilities
Expenses & losses Equity
Dividends
AKA"nominal accounts" AKA "real accounts"

Closing the temporary accounts
Simply transfer the items to retained earnings!
❖ Close revenues and gains for the period to retained earnings

❖ Just make revenue and gains accounts zero!
Debit Credit
Revenue or Gain 1 x
Revenue or Gain 2 x
Revenue or Gain 3 x
... etc x
Retained Earnings x
Closing revenue and gains to retained earnings
This increases
Retained Earnings
❖ Close expenses and losses for the period to retained earnings

❖ Just make the expense and loss accounts zero!
Debit Credit
Retained Earnings x
Expense or Loss 1 x
Expense or Loss 2 x
Expense or Loss 3 x
--- etc x
Closing expense and losses to retained earnings
This decreases
Retained Earnings
❖ Close dividends during the period to retained earnings

❖ Just make the Dividends account zero!
Debit Credit
Retained Earnings x
Dividends x
Closing dividends to retained earnings
This decreases
Retained Earnings
Wrapping up WishyWashy (phew!)
❖ Write the closing entries for WishyWashy
❖ Post the closing entries to the affect T-accounts

What happens next period after closing?
❖ Temporary accounts: the T-accounts restart from zero
❖ Permanent accounts: the T-accounts continue!
❖ E.g. if WishyWashy makes a cash sale of $1,000 on 2 Jan next year...
Debit Credit
Cash 1,000
Revenue 1,000
Cash Revenue
Bal. 40,700 (2 Jan) 1,000
(2 Jan) 1,000
Last year's ending balance

Summarising closing entries
❖ Why do we close the income statement accounts?

❖ They track performance for a given period, so the
next period should start with zero
❖ We need Net Profit less Dividends to flow into the
balance sheet (as part of Retained Earnings)
Post-closing trial balance
❖ An updated trial balance after the closing entries are done
❖ The temporary accounts will be zero (or omitted)
❖ Retained Earnings will be updated
❖ This is optional, and done for internal checking
❖ For your own practice:

❖ Try creating WishyWashy's post-closing trial balance!
❖ The RE number should tally with the RE in the balance sheet
Under Armour Under Investigation
https://www.wsj.com/articles/under-armour-is-subject-of-federal-accounting-probe-11572819835
❖ Channel stuffing: a few of the possible methods:

❖ Persuading customers to receive goods early
❖ Offering customers very long payment terms
❖ Delivering more goods than the customer ordered
❖ Last week we discussed how Under Armour used A/R to artificially
increase Sales, and how this caused an obvious increase in A/R:
Accounts Receivable / Revenue % growth in Revenue (blue) & A/R (green)
0.13 60
51
0.12
42
0.11
33
0.1
24
0.09 15
2011 2012 2013 2014 2015 2016 2011 2012 2013 2014 2015 2016
Let's apply what we learned this week to answer a few questions...

❖ Why do companies do this? If UA is "creating" revenue anyway, why
not just create a fictitious credit sale without delivering goods?
❖ If the customer has ordered the goods, UA is going to recognise revenue

eventually. Why go through the trouble to recognise revenue early?
So... what happens next period?

❖ What happens next period? Assuming the best-case scenario for UA:
❖ Customers are persuaded to receive a lot of goods early, i.e. this
quarter instead of next quarter
Debit Credit
This quarter:
Accounts Receivable X
↑A/R & ↑Sales
Revenue X
❖ The customers decide to keep all the goods, and manage pay back in
full for the purchase (What if they can't pay back? Covered at Week 5!)
Debit Credit
Next quarter:
Cash Y
↓A/R & ↓Sales
Accounts Receivable Y
Needs more and more channel
stuffing to avoid a decline:
can't maintain forever!
❖ Checking UA's change in revenue & A/R during & after channel stuffing:
% growth in Revenue (blue) & A/R (green)
60
47
34
21
-5
2011 2012 2013 2014 2015 2016 2017 2018 2019
“We have auditors here in the end of the July
looking at the books. No more emails on this.”
–An Executive Vice President of MiMedx (DOJ Indictment)
https://www.wsj.com/articles/mimedx-ex-senior-executives-indicted-on-fraud-charges-11574789916
The Accounting Cycle (1/2)
Transaction occurs
Transactions analysed
Transactions entered in the journal
Amounts posted to the ledger

The Accounting Cycle (2/2)
Close the books

After class...
❖ Go over the WishyWashy case again if necessary
❖ Make sure you understand each of the steps
❖ Solutions will be uploaded on eLearn
❖ Homework is due before next class!
❖ Only E 4-11 and P 4-14 from the textbook
❖ Try Workbook 1, Qns 1-3 (focus on adjusting & closing entries)
❖ I recommend trying these after you try the HW questions
❖ We'll go over parts of questions 1-3 next week
That's all!
Next time: cash and receivables

Completing The Accounting Cycle: ACCT 111 Financial Accounting Week 3

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Completing The Accounting Cycle: ACCT 111 Financial Accounting Week 3

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ACCT 111 Financial Accounting Week 3

Completing the Samuel Tan

❖ Learning objectives this week

Prepare the unadjusted trial balance

Adjusting entries & error-correction

Prepare the adjusted trial balance

Prepare the financial statements

Close the books

Accrual Accounting Cash-basis Accounting

Accrual Accounting Cash-basis Accounting

Transaction is recorded Transaction is not recorded

Accrual Accounting Cash-basis Accounting

Transaction is recorded Transaction is not recorded

Accrual Accounting Cash-basis Accounting

How exactly do we do this?

Company performs service Customer pays cash later

Time Period 1 Time Period 2

Only accrual accounting Both accrual and cash-basis

Company pays in advance Company uses the building

Time Period 1 Time Period 2

Both accrual and cash-basis Only accrual accounting records

The reporting period assumption

Annual • B/S as of the end of the year

Semi-annual • B/S as of the end of the half-year

Quarterly • B/S as of the end of the quarter

The Annual Report has the Balance Sheet as of 31 Dec 2019,

Quarterly Report Quarterly Report Quarterly Report Quarterly Report

The Annual Report has the Balance Sheet as of 28 Sep 2019,

Quarterly Report Quarterly Report Quarterly Report Quarterly Report

Accrual accounting Reporting period assumption

❖ Let's apply this to two key elements:

❖ The revenue recognition principle

❖ For consumer sales, this is usually at the point of the sale

1. Identify the contract with a customer

❖ On 15 Jan, ServiceCo received $1,000 from a customer

Advance Payment Performed Work

The revenue has not The work has been

❖ Journal entry for advanced payment for future work

Revenue has not been earned

❖ Journal entry when the company performs the work

Revenue has been earned, so recognise it!

Debit Credit Unearned Revenue

Recognise expenses in the same

Revenues for 2018 Revenues for 2019

Expenses for 2018 Expenses for 2019

Purchased 100 books Sold 20 books

The inventory is not related The 20 books have generated

No expense is recognised on purchasing inventory

Prepaid for Rent Used the Bookshop

The prepayment is not The company used the

No expense is recognised on prepaying for rent

❖ Journal entry for incurring expense that was previously prepaid

WishyWashy Car Wash

This week: on Google Docs at tinyurl.com/fa-wk3 (save a copy!)

❖ The Google doc is at tinyurl.com/fa-wk3

❖ Journalise the transactions in November and December

❖ Think about when to recognise revenue and expenses

Cash Unearned Revenue

2 Nov: FedEx pays WishyWashy the remaining amount

20 Nov: WishyWashy pays $3,000 in advance to rent a

12 Dec: WishyWashy purchases carwash equipment for

20 Dec: WishyWashy purchases more supplies for $1,300