Accounting Cycle for Service Business - Cash Basis PDF

ACCOUNTING CYCLE FOR THE SERVICE BUSINESS – CASH BASIS  Class Agenda * FINANCIAL STATEMENTS - Income Statement - The Accounting Cycle - Temporary Accounts - Closing Entries  FINANCIAL STATEMENTS The goal of journalizing, posting to the ledgers, and preparing the trial ba...

ACCOUNTING CYCLE FOR THE SERVICE BUSINESS – CASH BASIS  Class Agenda * FINANCIAL STATEMENTS - Income Statement - The Accounting Cycle - Temporary Accounts - Closing Entries  FINANCIAL STATEMENTS The goal of journalizing, posting to the ledgers, and preparing the trial balance is to gather the information necessary to produce the financial statements. The time period concept requires companies produce the financial statements on a regular basis over the same time interval, such as a month or year. Most of the amounts on these statements are copied directly from the trial balance, and then appropriate calculations and summary amounts are also displayed.  FINANCIAL STATEMENTS Income Statement The net income from a business’s operations for a period of time is so important to business people and investors that one financial statement — the income statement — is dedicated to showing what that amount is and how it was determined. Income Statement  FINANCIAL STATEMENTS Income Statement The income statement is a report that lists and summarizes revenue, expense, and net income information for a period of time, usually a month or a year. Equation: ✓ Revenue – Expenses = Net Income (or Net Loss)  FINANCIAL STATEMENTS Income Statement Revenue is shown first; a list of expenses follows, and their total is subtracted from revenue. If the difference is positive, there is a profit, or net income. If the difference is negative, there is a net loss that is typically presented in parentheses a negative number.  FINANCIAL STATEMENTS Income Statement The income statement answers a business’s most important question: How much profit is it making? It is limited to a specific period of time (month or year) from beginning to end. The income statement relies on the matching principle in that it only reports revenue and expenses in a specified window of time. It does not include any revenue or expenses from before or after that block of time. Accounting Cycle  FINANCIAL STATEMENTS The Accounting Cycle Accounting is practiced under a guideline called the time period assumption, which allows the ongoing activities of a business to be divided up into periods of a year, quarter, month, or other increment of time. The precise time period covered is included in the headings of the income statement, the retained earnings statement, and the statement of cash flows.  FINANCIAL STATEMENTS The Accounting Cycle Therefore, the accounting process is cyclical. A cycle is a period of time in which a series of accounting activities are performed. As was just stated, the typical accounting cycle is a year, a month, or perhaps a quarter. Once the current cycle is completed, the same recording and reporting activities are then repeated in the next period of time of equal length.  The Accounting Cycle In accounting, journalizing and posting transactions to the ledgers are done every day in the cycle. Financial statements are typically prepared only on the last day of the cycle. Once the financial statements are complete, the process continues on into the next accounting period, where again the financial statements are the goal of the recordkeeping process. Temporary Accounts  FINANCIAL STATEMENTS Temporary Accounts The accounts on the income statement are called temporary accounts. They are used to record operational transactions for a specific period of time. Once the income statement is prepared to report the temporary account balances at the end of the period, these account balances are set back to zero by transferring them to another account. When the next accounting period begins, the beginning balances of the temporary accounts are zero, for a fresh start. Closing Entries FINANCIAL STATEMENTS Closing Entries The financial statements are the goal of all that is done in the accounting cycle. However, there are some steps that need to be taken once those reports are completed to set up the ledgers for the next cycle. These steps involve closing entries. FINANCIAL STATEMENTS Closing Entries Closing entries are special journal entries made at the end of the accounting period (month or year) after the financial statements are prepared but before the first transaction in the next month is recorded in the journal.  FINANCIAL STATEMENTS Closing Entries The purpose of closing entries is to set the balances of income statement accounts back to zero so you can start fresh and begin accumulating new balances for the next month. This process ensures that the balances on the second month’s income statement do not include amounts from transactions in the first month.  FINANCIAL STATEMENTS Closing Entries Profit at the end of the accounting period is transferred into a new account called Retained Earnings when the revenue and expense accounts are closed out. The Retained Earnings account is only used for closing entries.  FINANCIAL STATEMENTS Closing Entries Closing entries transfer the balances from the revenue and expense accounts into Retained Earnings in preparation for the new month. Retained Earnings is an account where profit is “stored.” Think of the retained earnings balance as “accumulated profit,” or all the net income that the business has ever generated since it began operations.  FINANCIAL STATEMENTS Closing Entries Assume a business’s accounting period is a month. For the first month in which the business operates, the beginning retained earnings balance is zero since there were no previous periods and therefore no previous profits. At the end of the first month, the retained earnings balance equals the net income for the month.  FINANCIAL STATEMENTS Closing Entries After the first month, when closing entries for the current month are journalized and posted, the additional net income for the next month is added to any net income already in Retained Earnings from previous months. Since Revenue - Expenses = Net Income, moving revenue and expense balances into Retained Earnings is the same as moving the net income.  FINANCIAL STATEMENTS Closing Entries The Retained Earnings account is not closed out; instead, revenue and expense accounts are closed out into it. The effects are that the credit balance in Retained Earnings increases each month by the month’s net income amount, and the balances of Fees Earned and all the expense accounts become zero.  FINANCIAL STATEMENTS Closing Entries Closing entries are entered in the same journal that was used for the general entries during the month. The first closing entry is journalized right after the last general entry. Closing entries must be posted to the ledgers to impact the revenue, expense, and Retained Earnings account balances.  FINANCIAL STATEMENTS Closing Entries As an example, assume that on 6/30 Fees Earned has a credit ledger balance of $2,100 and Rent Expense (the only expense account) has a debit ledger balance of $500. Net income is therefore $1,600. The closing entry process would be as follows: FINANCIAL STATEMENTS Closing Entries 1. Zero out the Fees Earned account (and any other revenue accounts, if there are others.) Debit Fees Earned for its credit balance of $2,100 to close it out and bring its balance to zero.  FINANCIAL STATEMENTS Closing Entries 2. Zero out the Rent Expense account (and any other expense accounts, if there are others.) Credit Rent Expense for its debit balance of $500 to close it out and bring the balance to zero. Debit Retained Earnings for the same amount.  FINANCIAL STATEMENTS Closing Entries Once posted, these two closing entries above increase the Retained Earnings balance by $1,600, which is $2,100 - $500. The balances in Fees Earned and Rent Expense are now both zero. FINANCIAL STATEMENTS Closing Entries: Example 1 FINANCIAL STATEMENTS Closing Entries: Example 2 Thank you.