BAF 3M0 Unit 4 Review

Everyone please contribute to the document, this is a COLLECTIVE effort

The Worksheet:
● A worksheet is not a formal financial statement
● A tool accountants can use to complete the last stages of the accounting cycle. That
means the public never sees a company's worksheets. It is the rough copy used to help
prepare the formal financial statements.
● It shows all the accounts on one page and calculates the net income or (net loss) of the
company and proves that everything balances.
● It's useful because it contains information for all of the last steps of the accounting cycle,
all in one place. This simplifies the completion of the cycle, and makes finding errors and
discrepancies even easier.
● If you look at the completed worksheet shown below, you can see that there are four
sections (two columns in each). From left to right they are:
○ Trial Balance
○ Adjustments
○ Income Statement
○ Balance Sheet

Adjusting Entries:

Adjustments: Adjustments made to the accounting records of a company at the end of the
accounting cycle. Adjustments are made to ensure that financial information adheres to GAAP
and are accurate for the users of the financial statements.

● Without adjustments, accounting for many companies would not adhere to GAAP,
and therefore would not reflect the actual performance of a business. The
revenue recognition and matching principles state that revenues and expenses
that are earned in one period should be recorded in that period, regardless of
whether payment is made or invoices are received!

● Late Invoices:
○ In the real world, transactions that take place in one accounting period
sometimes are not invoiced until the next period, or an invoice may arrive late.
■ An example of the late invoices is: On January 10th, of this year, we
received an invoice from J. Simmons Inc. for $750 repair services that
were done on December 29th of last year. Our year-end is December
31st.
 Accruals
Accruals are expenses or revenues that build up or accumulate. We will examine the following
four (4) types of accounting accruals and one type of personal accrual:
■ Prepaid Expenses
■ Unearned Revenues
■ Interest
■ Salaries and Wages
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● Prepaid Expenses:
○ In a few cases, paying for expense accounts in advance saves time and money.
An example of these accounts can be rent and insurance expenses. The prepaid
rent or insurance is considered an asset when the amount is paid because the
expense has not occurred yet.
○ The accounts that would be affected would be: The prepaid expense account and
the expense account
■ A company that pays rent of $1,000 a month pays for its rent for a full
year in advance on January 1st of this year
● Prepaid rent - DR (12000)
● Cash - CR (12000)
● Unearned revenue:
○ Unearned revenue is very similar to prepaid expenses. For every revenue item
that is prepaid by a customer, a business will also have two accounts:
■ The unearned revenue account:
● This is a current liability account because if you end up not
providing the service to the customer by the end of the fiscal
period, you still owe them your service in the next fiscal period,
which means that it is a liability.
■ The revenue account:
● where the liability goes once the revenue has been earned
● Interest:
○ Interest is the price of money; it is the cost of borrowing funds. It is stated as a
percentage cost on a yearly basis; however, it is usually paid monthly. For
example, 4% interest means to borrow $100 it would cost you $4 per year.
○ Formula for simple interest - Principal amount of loan X annual interest rate X
number of months / 12 months.
● Salaries and Wages:
○ Note: Salaries and wages are not the same thing. Wages are based on how
many hours an employee works and salaries are generally a fixed amount paid
out every payday.
○ However, salaries and wages work in a similar fashion to interest. As employees
earn their pay, a company accumulates a salaries or wages expense. If
employees have earned money but haven't been paid on the last day of the
accounting period, an adjustment must be made.
 ■ Ex: If the salaries expense every two weeks is $10,000, then the journal
entry on July 31st would recognize one half of the regular salary expense.
It's half way through the pay period. (Only $5,000 or $10,000 divide by 2)

Allocations
The following three areas will be examined:
○ Bad Debt (debt owed to a business that is never paid.)
○ Supplies (day-to-day items used by the business, such as stationery, and listed
as an asset.)
○ Amortization (the decrease in value of fixed assets) – We will look at two
methods:
■ Straight-line method (amortizing an asset's value equally over the life if
the asset).
■ Declining balance method (amortizing an asset more quickly at the
beginning and less and less as it ages).
● Bad Debt:
○ Part of the cost of selling on credit is acquiring bad debt – that is – customers
who do not pay. To ignore that some of your accounts receivable will not be
collected is to mislead the users of your financial statements.
○ There are two (2) steps in the bad debt process:
■ Make an allowance (estimate) as soon as there is a possibility that the
customer may not pay.
■ Remove the accounts receivable when you are sure they will not pay.
○ Bad Debt is an account that appears as an expense on the Income Statement.
This ensures that the portion of the accounts receivable that is considered a bad
debt is recorded in the period with the sales from which the bad debt originated;
this adheres to the Matching Principle.
○ The allowance for doubtful accounts is a contra asset account and it allows
the user of the financial statement to see how much of the accounts receivable
are considered uncollectible. Remember that this is just an estimate and that no
one specific accounts receivable has been deemed uncollectible at this point.
● Supplies:
○ A count is made of the value of supplies remaining in the storeroom at the end of
the accounting cycle. What is missing is allocated to supplies expense.
■ Example: an organization started this year with $1,500 of supplies. It
purchased $800 and $700 of supplies at two points during the year. By
the end of the year, the supplies account shows a balance of $3,000.
■ A count of supplies was made of the supply storeroom and found that
only $1,200 of supplies remained. The journal entry to record the
adjustment will be ($3,000 - $1,200 = $1,800)
● Amortization:
○ Amortization is the allocation of an expense related to the decrease in value of a
fixed asset at a predetermined rate over time. Amortization takes value away
 from the asset and turns it into an expense. This is done to reflect the wearing
out of the asset over time.
○ WHY?: If we waited until the day a piece of equipment broke down for good
before we recorded the loss of that asset's total value, we would show an
enormous loss in that period, rather than showing the wearing out of the asset
over time, which is what really happens (We do this to ensure that the matching
principle is followed).
○ Every fixed asset is amortized (except land, which is NOT). Each fixed asset has
two amortization accounts associated with it:
1. an amortization expense account
2. an accumulated amortization account (which is a contra asset account)
○ On the balance sheet, the accumulated amortization amount for each fixed asset
will be subtracted from the corresponding asset account. NOTE: in a journal the
original asset account is NOT TOUCHED!
○ The Straight-line method:

○ The Declining Balance method:

● Note for declining balance that the amortization expense will change every year. This is
because it is based on a rate. That rate is multiplied by a continuously falling net book
value balance. (Hence the name: declining balance). Note though, that to record the
journal entry the process is the same. Only the amount changes.

Classified Financial Statements:

● WHY? Three reasons:
1. We have several contra-accounts that we need to show and sub-total on the
balance sheet. This requires a balance sheet with multiple columns;
2. We need to categorize, and classify certain accounts into particular groups for
analysis and reporting;
3. Lastly, we can't balance anymore using this old method! Remember the “Capital”
account is the balance from the beginning of the period. All changes 00to
Owner's Equity have been channeled into the Drawings, Revenue, and Expense
accounts.
● 4 Big Changes
1. The Balance Sheet is vertical.
2. Accounts are presented more clearly categorized and classified.
3. There are three (3) columns.
4. The Owner's Equity section is expanded and includes a line for Net Income and
Drawings
 ● The 3 sections in a Classified Balance Sheet are sorted like this:

Closing Entries:
● Closing entries are journal entries that close off the accounts for an accounting period.
These accounts, which are related to income and expenses of a business, are used to
track information for a specific period of time. They are then set back to zero in order to
prepare them to run through a brand new accounting cycle in the next accounting period.
● Not all accounts are closed. There are 2 types of accounts:
1. Permanent Accounts (Assets, Liabilities, and the Capital accounts).
These are NOT closed.
2. Temporary Accounts (Drawings, Revenues, and Expenses). These ARE
closed.
● WHY?: The Capital account does not tell us the current value of total Owner's Equity. It
only gives us the value for the first day in the accounting cycle. All day-to-day equity
transactions have been recorded in their own accounts. To find the current total Owner's
Equity, we must put them all together. This is exactly what closing entries do. They
combine all drawings, revenues, and expenses, and put the net value back into the
Capital account for the start of the next accounting period.
4 steps for closing:
1. Debit all revenue accounts with a credit balance (and credit any revenue accounts with a
debit balance like sales discounts) AND credit Income Summary.
2. Credit all expense accounts with a debit balance AND debit Income Summary.
3. Debit Income Summary* account AND credit Capital.
4. Credit Drawings AND Debit Capital.
Note: the Income Summary account is a holding account. It is only used in the closing entry
process. The balance in the Income Summary account will be the net income or (loss) from the
Income Statement.)
● After you close the temporary accounts, the post-closing trial balance is prepared in
order to ensure that the closing entries were completed properly.
● Closing Entries Concepts:
 ○ Permanent accounts ( also called Real accounts) have balances that continue
into the next fiscal period. (Assets, Liabilities, Capital)
○ Temporary accounts (also called Nominal accounts) have balances that do not
continue into the next fiscal period. (Revenue, Expenses, Drawings)
○ Income Summary Account summarizes the revenues and expenses of the
period. The balance represents either net income or net loss.
● All of the necessary amounts for the closing journal entries exist on the
worksheet.

Post Closing trial balance:

● The accounts that are present within the closing trial balance are All Assets, All
Liabilities, and only Capital.

Accounting Cycle:

0.Transactions occur. Source documents gathered.

1.Accounting entries recorded in the journal.

2.Journal entries posted to the ledger accounts.

3.Ledger balanced by means of a trial balance.

4.Worksheet prepared.

5.Formal income statement and balance sheet prepared.

6.Adjusting entries journalized and posted.

7.Closing entries journalized and posted.

7.Post-closing trial balance