Chapter 4 Lecture Notes

The Accounting Cycle is the steps involved in the accounting process during a fiscal
period.
A fiscal year is 12 consecutive months. It does not have to line up with a calendar year.
We are now starting the Step 4 of the Accounting Cycle: the Worksheet.
Lets review the steps we have completed of the Accounting Cycle:
o Step 1: Analysis of Business Transactions and Journal Entries
o Step 2: Post the journal entries to the General Ledger Accounts
o Step3: Prepare the Trial Balance

The Worksheet

The Worksheet is used to summarize all the information needed to prepare the financial
statements.
It can be made up of 10 or 12 accounting columns. We will use a 10 column worksheet
in this course.
This is not a formal statement so you do not use dollar ($) signs on the worksheet.
It is not required and not all accountants use a worksheet.
The purpose of the worksheet is to make it easier for the bookkeeper or accountant to
balance the numbers in a list or column.
From the final worksheet you will be able to prepare the formal financial statements.
If you are using a computerized system you will not have a worksheet.
The Steps to Completing the Work Sheet are located on page 155 in the textbook.

Sections of the Worksheet

1. Trial Balance Columns copy the accounts and numbers directly from either the
accounts in the General Ledger or from the formal Trial Balance completed in Step 3 of
the Accounting Cycle.
2. Adjustments Columns this is where you make corrections and/or updates to the
numbers in the Trial Balance Columns.
3. Adjusted Trial Balance To get the numbers in these columns you will add/subtract the
numbers in the Trial Balance and Adjustments Columns. Now the numbers are the
correct totals for the end of the accounting period.
4. Income Statement Columns Bring over the Revenues and Expenses from the Adjusted
Trial Balance Columns. At the bottom of the columns you will be able to determine the
companys net income or loss.
5. Balance Sheet Columns Bring over the Assets, Liabilities, Owners Capital, and
Owners Withdrawal. You will also bring over the amount of Net Income or Loss from
the Income Statement Columns to balance the last columns.

Hints on the Worksheet

Always do a worksheet in pencil!

Always total your columns making sure they equal BEFORE going to the next step!
As you do adjustments you will generally have to add new account titles. Add these
under the total figures of the Trial Balance Columns (see Figure 3 on page 179).
If the company has a Net Income then the figure will be in the Debit Column of the
Income Statement. A Net Loss will be in the Credit Column of the Income Statement.
The Net Income or Net Loss is then carried to the Balance Sheet Columns. They will be
in the opposite column on the Balance Sheet from what they are in the Income Statement.
So a Net Income is in the Credit Column and Net Loss in the Debit Column. See the
Worksheet at the bottom of page 176 for an example of a Net Income and the top of page
177 for a Net Loss.
The Net Income/Loss figure in the Balance Sheet Columns should make the Debit and
Credit Columns balance. If they do not then there is an error somewhere.
Finding errors on the worksheet In the textbook you will find some hints on what to do
to help find errors on the worksheet.

Adjustments

Adjustments are corrections or updates to the accounts to allow for more accurate
reporting on the financial statements at the end of the accounting period.
They are internal transactions and do not affect outside parties.
There are only a few accounts that we deal with when doing adjustments.
All adjustments have to be 1) entered on the worksheet, 2) prepared as a journal entry,
and 3) posted to the General Ledger Account.
Most textbooks, including this one, tell you to do the entry into the worksheet first.
However I find it easier to do the journal entry first and then enter the numbers into the
worksheet. This is due to the fact that I can think through the entry in words (the
journal entry) all in one place before I have to input numbers in a line (the worksheet).
Either way is correct and you can do whichever way is the easiest for you.
Lets go over various adjustments starting on page 171, the worksheet entries are shown
on Figure 2 on page 178, and the adjusting journal entries are on page 182 in Figure 5.

Supplies

As we have been purchasing supplies we have posted them to the Supplies account which
is an Asset. At the end of the year we need to determine if we still have all of the supplies
in this account or in other words, in inventory.
Ask yourself two questions: What is the value of the supplies that have been used?
What is the value of the supplies that are left or remain?
The supplies used need to be moved to the Supplies Expense account and the supplies
that are left will stay in the Supplies account (Asset account).
The adjusting journal entry and the amount in the Adjustment Column of the Worksheet
will be for the amount used for that period of time. You want the value of the Supplies
Asset account in the Adjusted Trial Balance Column to end up being the amount
remaining in inventory or on hand.
The terms left, remaining, or on hand all mean the same thing.
KEY HINT: When doing a problem, determine if it gives you the amount left/remaining
or the amount used? If it gives you the amount used then that is the figure to use in the
adjusting journal entry and on the worksheet. If it gives you the amount left then you
have to subtract that figure from the figure in the account to obtain the amount used.

Prepaid Insurance

This adjustment can be for any type of expense the business pays for in advance
(prepays), not only insurance. Rent is another good example of a prepaid business item.
The adjustment is to move the amount that has been used at the end of the period.
Example: On October 1st the business pays $5,000 for 5 months of insurance or $1,000
per month. The business has paid the insurance premiums in advance since the business
could get part of the month back if the policy was canceled before the end of the 5
months. The payment is considered an asset, which has value, until it is used up so the
cost is put in the asset account Prepaid Insurance when it is paid. The adjusting journal
entry is made at the end of the accounting period for the amount used to that point. At the
end of the business year, December 31st, you need to move 3 months (Oct-Dec) of the
payment to an expense account since it has been used up. You will do an adjusting
journal entry to move $3,000 ($1,000 per month for 3 months) from Prepaid Insurance to
Insurance Expense.
If you do not do this adjustment then you are overstating your assets and overstating net
income.

Depreciation of Assets

Depreciation is an adjustment made to show the using up of an asset spread over the
expected tax life of the asset.
Note that it says the tax life not the real life of the asset. For example a truck may be
used in the business for 10 years but it can only be depreciated for 5 years which is the
tax life.
Assets that can be depreciated are equipment, vehicles, and buildings. Land cannot be
depreciated since land is never really used up.
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There are various methods allowed by the IRS to depreciate assets, however the simplest
method is known as the Straight-line Depreciation Method.
Straight-line Depreciation is based on three factors: 1) the historical cost of the asset, 2)
the residual or salvage value of the asset, and 3) the estimated useful life of the asset.
The straight-line method allows the business to calculate the annual depreciation amount
one time and equal amounts are depreciated each year.
Historical Cost this is the original cost of the asset on the Balance Sheet. It is what
you purchased the asset for on the original purchase date.
Residual or Salvage Value this is the estimated value of the asset at the end of its tax
life. An asset cannot be depreciated below the salvage value.
Estimated Useful Life of the asset this figure is given to you by the IRS based on
which method of depreciation is being used and what type of asset it is.
A new account that you will use in the adjusting journal entries will be Accumulated
Depreciation which is a Contra-Asset Account.
A Contra-Asset means that its balance is opposite the normal balance of regular asset
accounts. Since Assets have a normal balance of a Debit, Contra-Assets have a normal
balance of a Credit.
Accumulated Depreciation is the amount of depreciation that has been assigned to that
asset each year. It is a running total of yearly depreciation. It lowers the value of the
asset.
The Book Value of the Asset is the value of the asset on the companys accounting
records. The book value and the actual value, what you can sale it for, are not the same
thing. Book Value is more of a tax value. Another term for Book Value is Carrying Value.
Book Value = Historical Cost of the Asset Accumulated Depreciation of the Asset
Straight-line Depreciation Formula to determine the annual depreciation amount:
Historical Cost Salvage Value
Estimated Years of Useful Life

Note: See the additional problems and example on how to calculate straight-line
depreciation posted on Moodle.

Wages or Salaries Expense

This adjustment applies the amount of wages that have been earned at the end of the
accounting period but have not been paid. We have to show these wages as payable so
the businesss liabilities and expenses are correct in the financial statements at the end of
the period.
Example: It is Dec 31st which ends on Wed. The employees do not get paid until Friday,
Jan 3rd. This check will include Dec 29th, 30th, and 31st so we will have to make the
adjustment showing the amount payable to the employees on Dec 31st.
There are a couple of diagrams in this section of the textbook that go over this concept.

The adjusting journal entry will enter the amount owed at the end of the accounting
period as a debit to the Salaries/Wages Expense account and a credit to the
Salaries/Wages Payable account.
You will most likely have to add the Salaries/Wages Payable account. This is a Liability
account. You can call it Salaries or Wages Payable.
While this example discusses salaries/wages, you could have the same type of situation
requiring an adjusting entry for insurance and taxes. This is especially true for payroll
taxes owed by the business that will be paid in the next accounting period.

Completing the Financial Statements from the Worksheet

Basically you have done all the numerical work on the worksheet. Now you can
concentrate on formatting the financial statements.
Remember that the columns on the financial statements do not represent Debits and
Credits.
Also remember that the last column to the right is a total column and the next column in
to the left is a subtotal column.
Income Statement bring over the numbers from the Income Statement columns on the
worksheet. If there is more than one revenue account then you will list them and then
get a total, just like we do with the expense accounts.
Statement of Owners Equity The key thing to remember here is that the beginning
capital is going to be the number listed as capital in the Balance Sheet column unless this
is a new company that started with zero capital in the beginning. Practice Exercise 5
(page 199-200) is an example of continuous company and Figure 6 (page 185) is an
example of a brand new company. The owner can also add an additional investment in
the company that month.
Balance Sheet here you will need to be sure to show the accumulated depreciation and
deduct it from the historical cost of the asset.