This looks much easier if I can send as a document. I have this test due before midnight tomorrow for…

This looks much easier if I can send as a document. I have this test due before midnight tomorrow for ACCT 100. I have to plug these numbers in to the balance sheet, income statement, general journal, general ledger, work sheet, statement of owners equity, adjusting entries and post closing trial balance. I have a lot of assignments like these and if you can help with this one I would greatly appreciate and continue to send work your way! If you can send me an email I can forward the documents to you to explain better. Miller Design Studio Post-Closing Trial Balance July 31, 2011 Cash $22,480 Accounts Receivable 5,000 Offi ce Supplies 3,660 Prepaid Rent 1,600 Offi ce Equipment 16,320 Accumulated Depreciation–Offi ce Equipment $ 300 Accounts Payable 6,280 Unearned Design Revenue 600 Wages Payable 720 J. Miller, Capital 41,160 $49,060 $49,060 During August, the studio engaged in these transactions: Aug. 1 Received an additional investment of cash from J. Miller, $20,000. 2 Purchased additional office equipment with cash, $4,700. 7 Purchased additional office supplies for cash, $540. 8 Completed the series of designs that began on July 31 and billed for the total design services performed, including the accrued revenues of $800 that had been recognized in an adjusting entry in July, $1,400. 12 Paid the amount due for the office equipment purchased last month, $3,000. 13 Accepted an advance in cash for design work to be done, $2,400. 15 Performed design services and received a cash fee, $2,900. 16 Received payment on account for design services performed last month, $2,800. 19 Made a partial payment on the utilities bill that was received and recorded at the end of July, $140. 20 Performed design services for Rave Department Stores and agreed to accept payment next month, $3,200. 21 Performed design services for cash, $1,160. 22 Received and paid the utilities bill for August, $900. 23 Paid the assistant for four weeks’ wages, $4,800. 26 Paid the rent for September in advance, $1,600. 30 Paid cash to J. Miller as a withdrawal for personal expenses, $2,800. Required 1. Record entries in journal form and post to the ledger accounts the optional reversing entries on August 1 for Wages Payable and Accounts Receivable (see adjustment for unrecorded wages on page 116 and adjustment for design revenue on page 119). (Begin the general journal on page 5.) 2. Record the transactions for August in journal form. 3. Post the August transactions to the ledger accounts. 4. Prepare the Trial Balance columns of a work sheet. Miller Design Studio Post-Closing Trial Balance July 31, 2011 Cash $22,480 Accounts Receivable 5,000 Offi ce Supplies 3,660 Prepaid Rent 1,600 Offi ce Equipment 16,320 Accumulated Depreciation–Offi ce Equipment $ 300 Accounts Payable 6,280 Unearned Design Revenue 600 Wages Payable 720 J. Miller, Capital 41,160 $49,060 $49,060 Copyright 2010 Cengage Learning, Inc. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. 5. Prepare adjusting entries and complete the work sheet using the information below. a. One month’s prepaid rent has expired, $1,600. b. An inventory of supplies reveals $2,020 still on hand on August 31. c. Depreciation on equipment for August is calculated to be $300. d. Services performed for which payment had been received in advance totaled $1,300. e. Services performed that will not be billed until September totaled $580. f. Wages accrued by the end of August, $720. 6. From the work sheet, prepare an income statement, a statement of owner’s equity, and a balance sheet for August 31, 2011. 7. Record the adjusting entries on August 31, 2011, in journal form, and post them to the ledger accounts. 8. Record the closing entries on August 31, 2011, in journal form, and post them to the ledger accounts. 9. Prepare a post-closing trial balance at August 31, 2011.

C H A P T E R

3 Measuring Business Income
I ncome, or earnings, is the most important measure of a com-pany’s success or failure. Thus, the incentive to manage, or mis-
state, earnings by manipulating the numbers can be powerful, and

because earnings are based on estimates, manipulation can be easy.

For these reasons, ethical behavior is extremely important when

measuring business income.

L E A R N I N G O B J E C T I V E S

LO1 Define net income, and explain the assumptions underlying
income measurement and their ethical application. (pp. 100–104)

LO2 Define accrual accounting, and explain how it is
accomplished. (pp. 104–106)

LO3 Identify four situations that require adjusting entries, and
illustrate typical adjusting entries. (pp. 107–116)

LO4 Prepare financial statements from an adjusted trial
balance. (pp. 116–119)

LO5 Use accrual-based information to analyze cash flows.
(pp. 119–120)

Making a
Statement

Revenues

– Expenses

= Net Income

INCOME STATEMENT

STATEMENT OF
OWNER’S EQUITY

Beginning Balance

+ Net Income

– Withdrawals

= Ending Balance

BALANCE SHEET

Assets

Liabilities

Owner’s
Equity

A = L + OE

STATEMENT OF CASH FLOWS

= Ending Cash Balance

Operating activities
+ Investing activities
+ Financing activities
= Change in Cash

+ Beginning Balance

Adjusting entries affect the
balance sheet and income
statement but not the
statement of cash flows.

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� What assumptions must Reliable
Answering Service make to
account for transactions that
span accounting periods?

� How does Reliable assign its
revenues and expenses to the
proper accounting period so
that net income is properly
measured?

� Why are the adjustments that
these transactions require
important to Reliable’s financial
performance?

DECISION POINT � A USER’S FOCUS
RELIABLE ANSWERING
SERVICE

Reliable Answering Service takes telephone messages for doctors,
lawyers, and other professionals and relays them immediately when
they involve an emergency. At the end of any accounting period,
Reliable has many transactions that will affect future periods. Exam-
ples appear in the company’s trial balance on the following page.
They include office supplies and prepaid expenses, which, though paid
in the period just ended, will benefit future periods and are there-
fore recorded as assets. Another example is unearned revenue, which
represents receipts for services the company will not perform and
earn until a future period. If prepaid expenses and unearned revenue
are not accounted for properly at the end of a period, the company’s
income will be misstated. Similar misstatements can occur when a
company fails to record (accrue) expenses that it incurred or revenue
that it has earned but not yet received. Knowing the answers to the
questions at right will help prevent such misstatements.

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Profitability
Measurement:
Issues and Ethics

LO1 Define net income, and
explain the assumptions under-
lying income measurement and
their

ethical application.

As you know, profitability and liquidity are the two major goals of a business. For
a business to succeed, or even to survive, it must earn a profit. Profit, however,
means different things to different people. Accountants prefer to use the term net
income because it can be precisely defined from an accounting point of view as
the net increase in owner’s equity that results from a company’s operations.

Net income is reported on the income statement, and management, owners,
and others use it to measure a company’s progress in meeting the goal of profitabil-
ity. Readers of income statements need to understand what net income means and
be aware of its strengths and weaknesses as a measure of a company’s performance.

Net Income
Net income is accumulated in the owner’s Capital account. In its simplest form,
it is measured as the difference between revenues and expenses when revenues
exceed expenses:

Net Income � Revenues � Expenses

When expenses exceed revenues, a net loss occurs.
Revenues are increases in owner’s equity resulting from selling goods, render-

ing services, or performing other business activities. When a business delivers a
product or provides a service to a customer, it usually receives cash or is prom-
ised that it will receive cash in the near future. The amount of cash promised is
recorded in either Accounts Receivable or Notes Receivable. The total of these
accounts and the total cash received from customers in an accounting period are
the company’s revenues for that period.

i
p
i
r
a
t

Study Note
The essence of revenue is that
something has been earned
through the sale of goods
or services. That is why cash
received through a loan does
not constitute revenue.

100 CHAPTER 3 Measuring Business Income

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Profitability Measurement: Issues and Ethics 101

Expenses are decreases in owner’s equity resulting from the cost of selling
goods or rendering services and the cost of the activities necessary to carry on a
business, such as attracting and serving customers. In other words, expenses are
the cost of the goods and services used in the course of earning revenues. Exam-
ples include salaries expense, rent expense, advertising expense, utilities expense,
and depreciation (allocation of cost) of a building or office equipment. These
expenses are often called the cost of doing business or expired costs.

Not all increases in owner’s equity arise from revenues, nor do all decreases in
owner’s equity arise from expenses. Owner’s investments increase owner’s equity but
are not revenues, and withdrawals decrease owner’s equity but are not expenses.

Income Measurement Assumptions
Users of financial reports should be aware that estimates and assumptions play a
major role in the measurement of net income and other key indicators of perfor-
mance. The management of Netflix, the online movie rental company, acknowl-
edges this in its annual report, as follows:

The preparation of . . . financial statements in conformity with generally
accepted accounting principles in the United States requires management to
make estimates and assumptions that affect the reported amounts of assets
and liabilities, . . . and the reported amount of revenues and expenses.1

The major assumptions made in measuring business income have to do with con-
tinuity, periodicity, and matching.

Continuity Measuring business income requires that certain expense and reve-
nue transactions be allocated over several accounting periods. Choosing the num-
ber of accounting periods raises the issue of continuity. What is the expected life
of the business? Many businesses last less than five years, and in any given year,
thousands of businesses go bankrupt. The majority of companies present annual
financial statements on the assumption that the business will continue to oper-
ate indefinitely—that is, that the company is a going concern. The continuity
assumption is as follows:

Unless there is evidence to the contrary, the accountant assumes that the
business will continue to operate indefinitely.

Justification for all the techniques of income measurement rests on the
assumption of continuity. Consider, for example, the value of assets on the bal-
ance sheet. The continuity assumption allows the cost of certain assets to be held
on the balance sheet until a future accounting period, when the cost will become
an expense on the income statement.

When a firm is facing bankruptcy, the accountant may set aside the assump-
tion of continuity and prepare financial statements based on the assumption that
the firm will go out of business and sell all of its assets at liquidation value—that
is, for what they will bring in cash.

Periodicity Measuring business income requires assigning revenues and
expenses to a specific accounting period. However, not all transactions can be eas-
ily assigned to specific periods. For example, when a company purchases a build-
ing, it must estimate the number of years the building will be in use. The portion
of the cost of the building that is assigned to each period depends on this estimate
and requires an assumption about periodicity. The assumption is as follows:

Although the lifetime of a business is uncertain, it is nonetheless useful to
estimate the business’s net income in terms of accounting periods.

g
b
t
p
a

Study Note
The primary purpose of an
expense is to generate revenue.

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102 CHAPTER 3 Measuring Business Income

Study Note
Accounting periods are of equal
length so that one period can
be compared with the next.

FOCUS ON BUSINESS PRACTICE

Fiscal Years Vary

The fiscal years of many schools and governmental agen-
cies end on June 30 or September 30. The table at the right
shows the last month of the fiscal year of some well-known
companies.

Company Last Month of Fiscal Year

Apple Computer September
Caesars World July
Fleetwood Enterprises April
H.J. Heinz March
Kelly Services December
MGM-UA Communications August
Toys “R” Us January

Financial statements may be prepared for any time period, but generally, to
make comparisons easier, the periods are of equal length. A 12-month account-
ing period is called a fiscal year; accounting periods of less than a year are called
interim periods. The fiscal year of many organizations is the calendar year, Janu-
ary 1 to December 31. However, retailers often end their fiscal years during a
slack season, and in this case, the fiscal year corresponds to the yearly cycle of
business activity.

Matching To measure net income adequately, revenues and expenses must be
assigned to the accounting period in which they occur, regardless of when cash is
received or paid. This is an application of the matching rule:

Revenues must be assigned to the accounting period in which the goods are
sold or the services performed, and expenses must be assigned to the account-
ing period in which they are used to produce revenue.

In other words, expenses should be recognized in the same accounting period
as the revenues to which they are related. However, a direct cause-and-effect rela-
tionship between expenses and revenues is often difficult to identify. When there is
no direct means of connecting expenses and revenues, costs are allocated in a sys-
tematic way among the accounting periods that benefit from the costs. For example,
a building’s cost is expensed over the building’s expected useful life, and interest on
investments is recorded as income even though it may not have been received.

The cash basis of accounting differs from the matching rule in that it is the
practice of accounting for revenues in the period in which cash is received and
for expenses in the period in which cash is paid. Some individuals and businesses
use this method to account for income taxes. With this method, taxable income
is calculated as the difference between cash receipts from revenues and cash pay-
ments for expenses.

Although the cash basis of accounting works well for some small businesses
and many individuals, it does not meet the needs of most businesses.

Ethics and the Matching Rule
As shown in Figure 3-1, applying the matching rule involves making assumptions.
It also involves exercising judgment. Consider the assumptions and judgment
involved in estimating the useful life of a building. The estimate should be based

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Profitability Measurement: Issues and Ethics 103

on realistic assumptions, but management has latitude in making that estimate,
and its judgment will affect the final net income that is reported.

The manipulation of revenues and expenses to achieve a specific outcome is
called earnings management. Research has shown that companies that manage
their earnings are much more likely to exceed projected earnings targets by a little
than to fall short by a little. Why would management want to manage earnings to
keep them from falling short? It may want to

� Meet a previously announced goal and thus meet the expectations of
the market.

� Keep the company’s stock price from dropping.

� Meet a goal that will enable it to earn bonuses.

� Avoid embarrassment.

Earnings management, though not the best practice, is not illegal. However,
when the estimates involved in earnings management begin moving outside a
reasonable range, the financial statements become misleading. For instance, net
income is misleading when revenue is overstated or expenses are understated by
significant amounts. As noted earlier in the text, the preparation of financial state-
ments that are intentionally misleading constitutes fraudulent financial reporting.

Most of the enforcement actions that the Securities and Exchange Com-
mission has brought against companies in recent years involve misapplications
of the matching rule resulting from improper accrual accounting. For example,

NET INCOME

Revenues Expensesminus

MATCHING RULE

ASSUMPTIONS

Periodicity Going Concern

FIGURE 3-1
Assumptions and the Matching Rule

FOCUS ON BUSINESS PRACTICE

Are Misstatements of Earnings Always Overstatements?

for understating its income. Microsoft, a very successful
company, accomplished this by overstating its unearned
revenue on the balance sheet. The company’s motive in
trying to appear less successful than it actually was may
have been that it was facing government charges of being
a monopoly.2

Not all misstatements of earnings are overstatements. For
instance, privately held companies, which do not have to
be concerned about the effect of their earnings announce-
ments on owners or investors, may understate income to
reduce or avoid income taxes. In an unusual case involv-
ing a public company, the SEC cited and fined Microsoft

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104 CHAPTER 3 Measuring Business Income

Dell Computer had to restate four years of its financial results because senior
executives improperly applied accrual accounting to give the impression that the
company was meeting quarterly earnings targets. After the SEC action, the com-
pany conducted an internal investigation that resulted in many changes in its
accounting controls.3 In the rest of this chapter, we focus on accrual accounting
and its proper application.

Accrual
Accounting

LO2 Define accrual account-
ing, and explain how it is

accomplished.

Accrual accounting encompasses all the techniques accountants use to apply the
matching rule. In accrual accounting, revenues and expenses are recorded in the peri-
ods in which they occur rather than in the periods in which they are received or paid.

Accrual accounting is accomplished in the following ways:

1. Recording revenues when they are earned.

2. Recording expenses when they are incurred.

3. Adjusting the accounts.

Recognizing Revenues
As you may recall, the process of determining when revenue should be recorded is
called revenue recognition. The Securities and Exchange Commission requires
that all the following conditions be met before revenue is recognized:4

� Persuasive evidence of an arrangement exists.

� A product or service has been delivered.

� The seller’s price to the buyer is fixed or determinable.

� Collectibility is reasonably assured.

For example, suppose Miller Design Studio has created a brochure for a cus-
tomer and that the transaction meets the SEC’s four criteria: Miller and the

STOP & APPLY

_____ 1. Increases in owner’s equity resulting
from selling goods, rendering ser-
vices, or performing other business
activities

_____ 2. Manipulation of revenues and
expenses to achieve a specific
change in owner’s equity

_____ 3. Increase in owner’s equity that
results from a company’s operations.

_____ 4. Decreases in owner’s equity result-
ing from the cost of selling goods,
rendering services, and other busi-
ness activities.

a. Net income b. Revenues c. Expenses d. Earnings management

SOLUTION
1. b; 2. d; 3. a; 4. c

Match the assumptions or actions with the concepts below:

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Accrual Accounting 105

customer agree that the customer owes for the service, the service has been
rendered, both parties understand the price, and there is a reasonable expec-
tation that the customer will pay the bill. When Miller bills the customer, it
records the transaction as revenue by debiting Accounts Receivable and credit-
ing Design Revenue. Note that revenue can be recorded even though cash has
not been collected; all that is required is a reasonable expectation that cash will
be received.

Recognizing Expenses
Expenses are recorded when there is an agreement to purchase goods or ser-
vices, the goods have been delivered or the services rendered, a price has been
established or can be determined, and the goods or services have been used to
produce revenue. For example, when Miller Design Studio receives its utility
bill, it recognizes the expense as having been incurred and as having helped pro-
duce revenue. Miller records this transaction by debiting Utilities Expense and
crediting Accounts Payable. Until the bill is paid, Accounts Payable serves as a
holding account. Note that recognition of the expense does not depend on the
payment of cash.

Adjusting the Accounts
Accrual accounting also involves adjusting the accounts. Adjustments are neces-
sary because the accounting period, by definition, ends on a particular day. The
balance sheet must list all assets and liabilities as of the end of that day, and the
income statement must contain all revenues and expenses applicable to the period
ending on that day. Although operating a business is a continuous process, there
must be a cutoff point for the periodic reports. Some transactions invariably span
the cutoff point, and some accounts therefore need adjustment.

As you can see in Exhibit 3-1, some of the accounts in Miller Design Studio’s
trial balance as of July 31 do not show the correct balances for preparing the
financial statements. The trial balance lists prepaid rent of $3,200. At $1,600 per
month, this represents rent for the months of July and August. So, on July 31,
one-half of the $3,200 represents rent expense for July, and the remaining $1,600
represents an asset that will be used in August. An adjustment is needed to reflect
the $1,600 balance in the Prepaid Rent account on the balance sheet and the
$1,600 rent expense on the income statement.

As you will see, several other accounts in Miller Design Studio’s trial balance
do not reflect their correct balances. Like the Prepaid Rent account, they need to
be adjusted.

Study Note
Even though certain revenues
and expenses theoretically
change during the period,
there usually is no need to
adjust them until the end of
the period, when the financial
statements are prepared.

FOCUS ON BUSINESS PRACTICE

Revenue Recognition: Principles Versus Rules

the other hand, has one broad IFRS for revenue recognition
and leaves it to companies and their auditors to determine
how to apply the broad principle. As a result, revenue recog-
nition is an issue that will provide a challenge to achieving
international convergence of accounting practices.

Revenue recognition highlights the differences between
international and U.S. accounting standards. Although U.S.
standards are referred to as generally accepted accounting
principles, the FASB has issued extensive rules for revenue
recognition in various situations and industries. The IASB, on

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106 CHAPTER 3 Measuring Business Income

Adjustments and Ethics
Accrual accounting can be difficult to understand. The account adjustments take time
to calculate and enter in the records. Also, adjusting entries do not affect cash flows
in the current period because they never involve the Cash account. You might ask,
“Why go to all the trouble of making them? Why worry about them?” For one thing,
the SEC has identified issues related to accrual accounting and adjustments as an area
of utmost importance because of the potential for abuse and misrepresentation.5

All adjustments are important because of their effect on performance measures
of profitability and liquidity. Adjusting entries affect net income on the income
statement, and they affect profitability comparisons from one accounting period
to the next. They also affect assets and liabilities on the balance sheet and thus
provide information about a company’s future cash inflows and outflows. This
information is needed to assess management’s performance in achieving sufficient
liquidity to meet the need for cash to pay ongoing obligations. The potential for
abuse arises because considerable judgment underlies the application of adjusting
entries. When this judgment is misused, performance measures can be misleading.

EXHIBIT 3-1
Trial Balance Miller Design Studio

Trial Balance

July 31, 2011

Cash $22,480
Accounts Receivable 4,600
Office Supplies 5,200
Prepaid Rent 3,200
Office Equipment 16,320
Accounts Payable $ 6,280
Unearned Design Revenue 1,400
J. Miller, Capital 40,000
J. Miller, Withdrawals 2,800
Design Revenue 12,400
Wages Expense 4,800
Utilities Expense 680

$60,080 $60,080

STOP & APPLY

Four conditions must be met before revenue can be recognized. Identify which of these conditions
applies to the following actions:

a. Determines that the firm has a good credit rating.

b. Agrees to a price for services before it performs
them.

SOLUTION
a. Collectibility is reasonably assured.
b. The seller’s price to the buyer is fixed or determinable.

c. A product or service has been delivered.
d. Persuasive evidence of an arrangement exists.

c. Performs services.

d. Signs a contract to perform
services.

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The Adjustment Process 107

The Adjustment
Process

LO3 Identify four situations
that require adjusting entries,
and illustrate typical adjusting
entries.

When transactions span more than one accounting period, accrual accounting
requires the use of adjusting entries. Figure 3-2 shows the four situations in
which adjusting entries must be made. Each adjusting entry affects one balance
sheet account and one income statement account. As we have already noted,
adjusting entries never affect the Cash account.

The four types of adjusting entries are as follows:

Type 1. Allocating recorded costs between two or more accounting periods.
Examples of these costs are prepayments of rent, insurance, and supplies and the
depreciation of plant and equipment. The adjusting entry in this case involves an
asset account and an expense account.

Type 2. Recognizing unrecorded, incurred expenses. Examples of these expenses
are wages and interest that have been incurred but are not recorded during an
accounting period. The adjusting entry involves an expense account and a liabil-
ity account.

Type 3. Allocating recorded, unearned revenues between two or more account-
ing periods. Examples include cash received in advance and deposits made on
goods or services. The adjusting entry involves a liability account and a revenue
account.

Type 4. Recognizing unrecorded, earned revenues. An example is revenue that a
company has earned for providing a service but for which it has not billed or col-
lected a fee by the end of the accounting period. The adjusting entry involves an
asset account and a revenue account.

Adjusting entries are either deferrals or accruals.

� A deferral is the postponement of the recognition of an expense already paid
(Type 1 adjustment) or of revenue received in advance (Type 3 adjustment).
The cash payment or receipt is recorded before the adjusting entry is made.

� An accrual is the recognition of a revenue (Type 4 adjustment) or expense
(Type 2 adjustment) that has arisen but not been recorded during the
accounting period. The cash receipt or payment occurs in a future account-
ing period, after the adjusting entry has been made.

Type 1 Adjustment: Allocating Recorded Costs
(Deferred Expenses)
Companies often make expenditures that benefit more than one period. These
costs are debited to an asset account. At the end of an accounting period, the

BALANCE SHEET

Asset

Liability

Expense

Revenue

1. Allocating recorded
costs between two
or more accounting
periods.

2. Recognizing
unrecorded, incurred
expenses.

4. Recognizing
unrecorded,
earned revenues.

3. Allocating recorded,
unearned revenues
between two or more
accounting periods.

I
N
C
O
M
E

S
T
A
T
E
M
E
N
T

FIGURE 3-2
The Four Types of Adjustments

Study Note
Adjusting entries provide
information about past or future
cash flows but never involve an
entry to the Cash account.

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108 CHAPTER 3 Measuring Business Income

amount of the asset that has been used is transferred from the asset account to an
expense account. Two important adjustments of this type are for prepaid expenses
and the depreciation of plant and equipment.

Prepaid Expenses Companies customarily pay some expenses, including
those for rent, supplies, and insurance, in advance. These costs are called pre-
paid expenses. By the end of an accounting period, a portion or all of prepaid
services or goods will have been used or have expired. The required adjust-
ing entry reduces the asset and increases the expense, as shown in Figure 3-3.
The amount of the adjustment equals the cost of the goods or services used or
expired.

Study Note
The expired portion of a
prepayment is converted to an
expense; the unexpired portion
remains an asset.

BALANCE SHEET

Asset

Expense
Revenue
Liability
2. Recognizing
unrecorded, incurred
expenses.
4. Recognizing
unrecorded,
earned revenues.
3. Allocating recorded,
unearned revenues
between two or more
accounting periods.
I
N
C
O
M
E

S
T
A
T
E
M
E
N
T

Asset Account Expense Account

Adjusting
Entry
Credit

Adjusting
Entry
Debit

Amount equals cost
of goods or services
used up or expired.

1. Allocating recorded costs between two or more accounting periods.

FIGURE 3-3
Adjustment for Prepaid (Deferred) Expenses

When transactions span more than
one accounting period, an adjusting
entry is necessary. Depreciation of
plant and equipment, such as that
found in this warehouse, is a type of
transaction that requires an adjusting
entry. In this case, the adjusting entry
involves an asset account and an
expense account.

Courtesy of Timothy Babasade/
istockphoto.com.

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The Adjustment Process 109

If adjusting entries for prepaid expenses are not made at the end of an
accounting period, both the balance sheet and the income statement will present
incorrect information. The company’s assets will be overstated, and its expenses
will be understated. Thus, owner’s equity on the balance sheet and net income on
the income statement will be overstated.

To illustrate this type of adjusting entry and the others discussed below, we
refer again to the transactions of Miller Design Studio.

At the beginning of July, Miller Design Studio paid two months’ rent in
advance. The advance payment resulted in an asset consisting of the right to
occupy the office for two months. As each day in the month passed, part of
the asset’s cost expired and became an expense. By July 31, one-half of the
asset’s cost had expired and had to be treated as an expense. The adjustment
is as follows:

Adjustment for Prepaid Rent

July 31: Expiration of one month’s rent, $1,600.

Analysis: Expiration of prepaid rent decreases the asset account Prepaid Rent with
a credit and increases the owner’s equity account Rent Expense with a debit.

Application of Double Entry:

Assets � Liabilities � Owner’s Equity
PREPAID RENT RENT EXPENSE
Dr. Cr. Dr. Cr.
July 3 3,200 July 31 1,600 July 31 1,600

Bal. 1,600

Entry in Journal Form:
Dr. Cr.

July 31 Rent Expense 1,600
Prepaid Rent 1,600

Comment: The Prepaid Rent account now has a balance of $1,600, which rep-
resents one month’s rent that will be expensed during August. The logic in this
analysis applies to all prepaid expenses.

Miller Design Studio purchased $5,200 of office supplies in early July. A care-
ful inventory of the supplies is made at the end of the month. It records the
number and cost of supplies that have not yet been consumed and are thus still
assets of the company. Suppose the inventory shows that office supplies costing
$3,660 are still on hand. This means that of the $5,200 of supplies originally
purchased, $1,540 worth were used (became an expense) in July. The adjustment
is as follows:

Adjustment for Supplies

July 31: Consumption of supplies, $1,540

Analysis: Consumption of office supplies decreases the asset account Office Supplies
with a credit and increases the expense account Office Supplies Expense with a debit.

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110 CHAPTER 3 Measuring Business Income

Study Note
In accounting, depreciation
refers only to the allocation
of an asset’s cost, not to any
decline in the asset’s value.

Study Note
The difficulty in estimating
an asset’s useful life is further
evidence that the net income
figure is, at best, an estimate.

Comment: The asset account Office Supplies now reflects the correct balance of
$3,660 of supplies yet to be consumed. The logic in this example applies to all
kinds of supplies.

Depreciation of Plant and Equipment When a company buys a long-term
asset—such as a building, truck, computer, or store fixture—it is, in effect,
prepaying for the usefulness of that asset for as long as it benefits the com-
pany. Because a long-term asset is a deferral of an expense, the accountant must
allocate the cost of the asset over its estimated useful life. The amount allocated
to any one accounting period is called depreciation, or depreciation expense.
Depreciation, like other expenses, is incurred during an accounting period to
produce revenue.

It is often impossible to tell exactly how long an asset will last or how much
of the asset has been used in any one period. For this reason, depreciation must
be estimated. Accountants have developed a number of methods for estimat-
ing depreciation and for dealing with the related complex problems. (In the
discussion that follows, we assume that the amount of depreciation has been
established.)

To maintain historical cost in specific long-term asset accounts, separate
accounts—called Accumulated Depreciation accounts—are used to accu-
mulate the depreciation on each long-term asset. These accounts, which are
deducted from their related asset accounts on the balance sheet, are called con-
tra accounts. A contra account is a separate account that is paired with a related
account—in this case, an asset account. The balance of a contra account is shown
on a financial statement as a deduction from its related account. The net amount
is called the carrying value, or book value, of the asset. As the months pass, the
amount of the accumulated depreciation grows, and the carrying value of the
asset declines.

Adjustment for Plant and Equipment

July 31: Depreciation of office equipment, $300

Analysis: Depreciation decreases the asset account Office Equipment by increas-
ing the contra account Accumulated Depreciation–Office Equipment with a credit
and increasing the owner’s equity account Depreciation Expense–Office Equip-
ment with a debit.

Application of Double Entry:

Assets � Liabilities � Owner’s Equity
OFFICE SUPPLIES OFFICE SUPPLIES EXPENSE

Dr. Cr. Dr. Cr.
July 5 5,200 July 31 1,540 July 31 1,540
Bal. 3,660

Entry in Journal Form:
Dr. Cr.

July 31 Office Supplies Expense 1,540
Office Supplies 1,540

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The Adjustment Process 111

Application to Netflix, Inc. Netflix has prepaid expenses and property and
equipment similar to those in the examples we have presented. Among Netflix’s
prepaid expenses are payments made in advance to movie companies for rights
to DVDs. By paying in advance, Netflix is able to negotiate lower prices. These
fixed payments are debited to Prepaid Expense. When the movies produce reve-
nue, the prepaid amounts are transferred to expense through adjusting entries.6

Type 2 Adjustment: Recognizing Unrecorded,
Incurred Expenses (Accrued Expenses)
Usually, at the end of an accounting period, some expenses incurred during the
period have not been recorded in the accounts. These expenses require adjust-
ing entries. One such expense is interest on borrowed money. Each day, interest
accumulates on the debt. As shown in Figure 3-4, at the end of the account-
ing period, an adjusting entry is made to record the accumulated interest, which
is an expense of the period, and the corresponding liability to pay the interest.
Other common unrecorded expenses are wages and utilities. As the expense and
the corresponding liability accumulate, they are said to accrue—hence, the term
accrued expenses.

To illustrate how adjustments are made for unrecorded, incurred wages, sup-
pose Miller Design Studio has two pay periods a month rather than one. In July,
its pay periods end on the 12th and the 26th, as indicated in the calendar on the
next page.

Study Note
Remember that in accrual
accounting, an expense must be
recorded in the period in which
it is incurred regardless of when
payment is made.

Application of Double Entry:

Assets � Liabilities � Owner’s Equity
OFFICE EQUIPMENT DEPRECIATION EXPENSE–

Dr. Cr. OFFICE EQUIPMENT
Dr. Cr.July 6 16,320

July 31 300

ACCUMULATED DEPRECIATION–
OFFICE EQUIPMENT

Dr. Cr.
July 31 300

Entry in Journal Form:
Dr. Cr.

July 31 Depreciation Expense–Office
Equipment 300

Accumulated Depreciation–
Office Equipment 300

Comment: The carrying value of Office Equipment is $16,020 ($16,320 � $300)
and is presented on the balance sheet as follows:

PROPERTY, PLANT, AND EQUIPMENT
Office equipment $16,320
Less accumulated depreciation 300 $16,020

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112 CHAPTER 3 Measuring Business Income

By the end of business on July 31, Miller’s assistant will have worked three days
(Monday, Tuesday, and Wednesday) beyond the last pay period. The employee
has earned the wages for those days but will not be paid until the first payday in
August. The wages for these three days are rightfully an expense for July, and
the liabilities should reflect that the company owes the assistant for those days.
Because the assistant’s wage rate is $2,400 every two weeks, or $240 per day
($2,400�10 working days), the expense is $720 ($240 � 3 days).

Adjustment for Unrecorded Wages

July 31: Accrual of unrecorded wages, $720

Analysis: Accrual of wages increases the owner’s equity account Wages Expense
with a debit and increases the liability account Wages Payable with a credit.

BALANCE SHEET
3. Allocating recorded,
unearned revenues
between two or more
accounting periods.
4. Recognizing
unrecorded,
earned revenues.
1. Allocating recorded
costs between two
or more accounting
periods.
Expense
Revenue
Asset
Liability
Adjusting
Entry
Credit
Adjusting
Entry
Debit

2. Recognizing unrecorded, incurred expenses.

Liability Account Expense Account

Amount equals cost
of expense incurred.

I
N
C
O
M
E

S
T
A
T
E
M
E
N
T
Application of Double Entry:

Assets � Liabilities � Owner’s Equity
WAGES PAYABLE WAGES EXPENSE

Dr. Cr. Dr. Cr.
July 31 720 July 26 4,800

31 720
Bal. 5,520

Entry in Journal Form:
Dr. Cr.

July 31 Wages Expense 720
Wages Payable 720

FIGURE 3-4
Adjustment for Unrecorded
(Accrued) Expenses

JULY

SUN M T W TH F SAT
1 2 3 4 5 6

7 8 9 10 11 12 13
14 15 16 17 18 19 20
21 22 23 24 25 26 27
28 29 30 31

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The Adjustment Process 113

Comment: Note that the increase in Wages Expense will decrease owner’s equity
and that total wages for the month are $5,520, of which $720 will be paid next
month.

Application to Netflix, Inc. In 2008, Netflix had accrued expenses of
$31,394,000.7 If the expenses had not been accrued, Netflix’s liabilities would be
significantly understated, as would the corresponding expenses on Netflix’s income
statement. The end result would be an overstatement of the company’s earnings.

Type 3 Adjustment: Allocating Recorded,
Unearned Revenues (Deferred Revenues)
Just as expenses can be paid before they are used, revenues can be received before
they are earned. When a company receives revenues in advance, it has an obli-
gation to deliver goods or perform services. Unearned revenues are therefore
shown in a liability account.

For example, publishing companies usually receive cash in advance for maga-
zine subscriptions. These receipts are recorded in a liability account, Unearned
Subscriptions. If the company fails to deliver the magazines, subscribers are enti-
tled to their money back. As the company delivers each issue of the magazine, it
earns a part of the advance receipts. This earned portion must be transferred from
the Unearned Subscriptions account to the Subscription Revenue account, as
shown in Figure 3-5.

During July, Miller Design Studio received $1,400 from another firm as
advance payment for a series of brochures. By the end of the month, it had com-
pleted $800 of work on the brochures, and the other firm had accepted the work.

Adjustment for Unearned Revenue

July 31: Performance of services for which cash was received in advance, $800

Analysis: Performing the services for which cash was received in advance increases
the owner’s equity account Design Revenue with a credit and decreases the liability
account Unearned Design Revenue with a debit.

Study Note
Unearned revenue is a liability
because there is an obligation
to deliver goods or perform
a service, or to return the
payment. Once the goods have
been delivered or the service
performed, the liability is
transferred to revenue.

BALANCE SHEET

Asset Liability

Expense
Revenue
1. Allocating recorded
costs between two
or more accounting
periods.
2. Recognizing
unrecorded, incurred
expenses.
4. Recognizing
unrecorded,
earned revenues.
I
N
C
O
M
E

S
T
A
T
E
M
E
N
T

3. Allocating recorded, unearned revenues between two or more
accounting periods.

Liability Account

Adjusting
Entry
Debit

Amount equals price
of services performed

or goods delivered.

Adjusting
Entry
Credit

Revenue Account

FIGURE 3-5
Adjustment for Unearned (Deferred) Revenues

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114 CHAPTER 3 Measuring Business Income

Application to Netflix, Inc. Netflix has a current liability account called
Deferred (Unearned) Revenue. Deferred revenue consists of subscriptions
(monthly payments) billed in advance to customers for which revenues have not
yet been earned. Subscription revenues are recognized by prorating them over
each subscriber’s monthly subscription period. As time passes and customers use
the service, the revenue is transferred from Netflix’s Deferred Revenue account
to its Subscription Revenue account.

Type 4 Adjustment: Recognizing Unrecorded,
Earned Revenues (Accrued Revenues)
Accrued revenues are revenues that a company has earned by performing
a service or delivering goods but for which no entry has been made in the
accounting records. Any revenues earned but not recorded during an account-
ing period require an adjusting entry that debits an asset account and credits a
revenue account, as shown in Figure 3-6. For example, the interest on a note

Application of Double Entry:

Assets � Liabilities � Owner’s Equity
UNEARNED DESIGN REVENUE DESIGN REVENUE

Dr. Cr. Dr. Cr.
July 31 800 July 19 1,400 July 10 2,800
Bal. 600 15 9,600
31 800
Bal. 13,200

Entry in Journal Form:
Dr. Cr.

July 31 Unearned Design Revenue 800
Design Revenue 800

Comment: Unearned Design Revenue now reflects the amount of work still to be
performed, $600.

Asset Liability
1. Allocating recorded
costs between two
or more accounting
periods.
2. Recognizing
unrecorded, incurred
expenses.
3. Allocating recorded,
unearned revenues
between two or more
accounting periods.
BALANCE SHEET
Expense
Revenue
I
N
C
O
M
E

S
T
A
T
E
M
E
N
T

4. Recognizing unrecorded, earned revenues.

Asset Account Revenue Account

Adjusting
Entry
Debit
Adjusting
Entry
Credit

Amount equals price
of services performed.

FIGURE 3-6
Adjustment for Unrecorded
(Accrued) Revenues

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The Adjustment Process 115

receivable is earned day by day but may not be received until another account-
ing period. The Interest Receivable account should be debited and the Interest
Income account should be credited for the interest accrued at the end of the
current period.

When a company earns revenue by performing a service—such as designing
a series of brochures or developing marketing plans—but will not receive the
revenue for the service until a future accounting period, it must make an adjust-
ing entry. This type of adjusting entry involves an asset account and a revenue
account.

During July, Miller Design Studio agreed to create two advertisements for
Maggio’s Pizza Company. It also agreed that the first advertisement would be
finished by July 31. By the end of the month, Miller had earned $400 for com-
pleting the first advertisement. The client will not be billed until the entire proj-
ect has been completed.

Adjustment for Design Revenue

July 31: Accrual of unrecorded revenue, $400

Analysis: Accrual of unrecorded revenue increases the owner’s equity account
Design Revenue with a credit and increases the asset account Accounts Receivable
with a debit.

Application of Double Entry:

Assets � Liabilities � Owner’s Equity
ACCOUNTS RECEIVABLE DESIGN REVENUE

Dr. Cr. Dr. Cr.
July 15 9,600 July 22 5,000 July 10 2,800
31 400 15 9,600
Bal. 5,000 31 800
31 400
Bal. 13,600

Entry in Journal Form:
Dr. Cr.
July 31 Accounts Receivable 400
Design Revenue 400

Comment: Design Revenue now reflects the total revenue earned during July,
$13,600. Some companies prefer to debit an account called Unbilled Accounts
Receivable. Other companies simply flag the transactions in Accounts Receivable
as “unbilled.” On the balance sheet, they are usually combined with accounts
receivable.

Application to Netflix, Inc. Since Netflix’s subscribers pay their subscrip-
tions in advance by credit card, Netflix does not need to bill customers for ser-
vices provided but not paid. The company is in the enviable position of having no
accounts receivable and thus a high degree of liquidity.

A Note About Journal Entries
Thus far, we have presented a full analysis of each journal entry. The analyses
showed you the thought process behind each entry. By now, you should be fully

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116 CHAPTER 3 Measuring Business Income

Using the
Adjusted Trial
Balance to
Prepare Financial
Statements

LO4 Prepare financial
statements from an adjusted

trial balance.

STOP & APPLY

Type 1. Allocating recorded costs between two
or more accounting periods

Type 2. Recognizing unrecorded, incurred
expenses

Type 3. Allocating recorded, unearned revenues
between two or more accounting periods

Type 4. Recognizing unrecorded, earned revenues

SOLUTION
a. Type 4; b. Type 2; c. Type 1; d. Type 1

For each of the following items, identify the type of adjusting entry required:
___ a. Revenues earned but not yet collected or billed to customers
___ b. Interest incurred but not yet recorded
___ c. Unused supplies
___ d. Costs of plant and equipment

After adjusting entries have been recorded and posted, an adjusted trial balance
is prepared by listing all accounts and their balances. If the adjusting entries have
been posted to the accounts correctly, the adjusted trial balance will have equal
debit and credit totals. The adjusted trial balance for Miller Design Studio is
shown in Exhibit 3-2.

Some accounts in Exhibit 3-2, such as Cash and Accounts Payable, have the
same balances as in the trial balance in Exhibit 3-1 because no adjusting entries
affected them. The balances of other accounts, such as Office Supplies and Pre-
paid Rent, differ from those in the trial balance because adjusting entries did affect
them. The adjusted trial balance also has some new accounts, such as depreciation
accounts and Wages Payable, that are not in the trial balance.

The adjusted trial balance facilitates the preparation of the financial state-
ments. As shown in Exhibit 3-2, the revenue and expense accounts are used to
prepare the income statement.

aware of the effects of transactions on the accounting equation and the rules
of debit and credit. For this reason, in the rest of the book, we present journal
entries without full analysis.

The four types of adjusting entries are as follows:

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Using the Adjusted Trial Balance to Prepare Financial Statements 117

EXHIBIT 3-2 Relationship of the Adjusted Trial Balance to the Income Statement

Then, as shown in Exhibit 3-3, the statement of owner’s equity and the bal-
ance sheet are prepared. Notice that the net income from the income statement
is combined with the Withdrawals account on the statement of owner’s equity to
give the net change in the J. Miller, Capital account.

The resulting balance of J. Miller, Capital at July 31 is used in preparing the
balance sheet, as are the asset and liability account balances in the adjusted trial
balance.

Study Note
The adjusted trial balance is a
second check that the ledger
is still in balance. Because it
reflects updated information
from the adjusting entries, it is
used in preparing the formal
financial statements. It does not
mean there are no accounting
errors.

Miller Design Studio
Adjusted Trial Balance

July 31, 2011

Cash $22,480
Accounts Receivable 5,000
Office Supplies 3,660
Prepaid Rent 1,600
Office Equipment 16,320
Accumulated Depreciation–
Office Equipment $ 300
Accounts Payable 6,280
Unearned Design Revenue 600
Wages Payable 720
J. Miller, Capital 40,000
J. Miller, Withdrawals 2,800
Design Revenue 13,600
Wages Expense 5,520
Utilities Expense 680
Rent Expense 1,600
Office Supplies Expense 1,540
Depreciation Expense–
Office Equipment 300

$61,500 $61,500

Miller Design Studio
Income Statement

For the Month Ended July 31, 2011

Revenues
Design revenue $13,600
Expenses
Wages expense $5,520
Utilities expense 680
Rent expense 1,600
Office supplies expense 1,540
Depreciation expense–
office equipment 300

Total expenses 9,640

Net income $ 3,960

Study Note
The net income figure from the
income statement is needed to
prepare the statement of owner’s
equity, and the bottom-line figure of
that statement is needed to prepare
the balance sheet. This dictates the
order in which the statements are
prepared.

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118 CHAPTER 3 Measuring Business Income

EXHIBIT 3-3 Relationship of the Adjusted Trial Balance to the Balance Sheet and Statement of Owner’s Equity

Miller Design Studio
Adjusted Trial Balance
July 31, 2011

$61,500 $61,500

Miller Design Studio
Balance Sheet
July 31, 2011

Assets

Cash $22,480
Accounts receivable 5,000
Office supplies 3,660
Prepaid rent 1,600
Office equipment $16,320
Less accumulated
depreciation 300 16,020

Total assets $48,760

Liabilities

Accounts payable $ 6,280
Unearned design revenue 600
Wages payable 720

Total liabilities $ 7,600

Owner’s Equity
J. Miller, Capital 41,160

Total liabilities and owner’s equity $48,760

Miller Design Studio
Statement of Owner’s Equity

For the Month Ended July 31, 2011

J. Miller, Capital, July 1, 2011 $ 0
Investment by J. Miller 40,000

Net income 3,960

Subtotal $43,960

Less withdrawals 2,800

J. Miller, Capital, July 31, 2011 $41,160

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Cash Flows from Accrual-Based Information 119

Cash Flows
from Accrual-
Based
Information

LO5 Use accrual-based
information to analyze cash flows.

Management has the short-range goal of ensuring that its company has sufficient
cash to pay ongoing obligations—in other words, management must ensure the
company’s liquidity. To plan payments to creditors and assess the need for short-
term borrowing, managers must know how to use accrual-based information to
analyze cash flows.

Almost every revenue or expense account on the income statement has one
or more related accounts on the balance sheet. For instance, Office Supplies
Expense is related to Office Supplies, Wages Expense is related to Wages Payable,
and Design Revenue is related to Unearned Design Revenue. As we have shown,
these accounts are related by making adjusting entries, the purpose of which is to
apply the matching rule to the measurement of net income.

The cash inflows that a company’s operations generate and the cash outflows
that they require can also be determined by analyzing these relationships. For exam-
ple, suppose that after receiving the financial statements in Exhibits 3-2 and 3-3,
management wants to know how much cash was expended for office supplies. On
the income statement, Office Supplies Expense is $1,540, and on the balance sheet,
Office Supplies is $3,660. Because July was the company’s first month of operation,
there was no prior balance of office supplies, so the amount of cash expended for
office supplies during the month was $5,200 ($1,540 � $3,660 � $5,200).

Thus, the cash flow used in purchasing office supplies—$5,200—was much
greater than the amount expensed in determining income—$1,540. In planning
for August, management can anticipate that the cash needed may be less than
the amount expensed because, given the large inventory of office supplies, the
company will probably not have to buy office supplies in the coming month.
Understanding these cash flow effects enables management to better predict the
business’s need for cash in August.

The general rule for determining the cash flow received from any revenue
or paid for any expense (except depreciation, which is a special case not covered

STOP & APPLY

The adjusted trial balance for Carroll Company on December 31, 2010, contains the follow-
ing accounts and balances: D. Carroll, Capital, $300; D. Carroll, Withdrawals, $100; Service
Revenue, $1,000; Rent Expense, $300; Wages Expense, $400; and Telephone Expense, $100.
Compute net income and prepare a statement of owner’s equity in proper form for the month
of December.

SOLUTION
Net income � $1,000 � $300 � $400 � $100
� $1,000 � $800
� $200

Carroll Company
Statement of Owner’s Equity

For the Month Ended

December 31, 2010

D. Carroll, Capital, Dec. 1, 2010 $ 300
Net income 200
Subtotal $ 500
Less withdrawals 100
D. Carroll, Capital, Dec. 31, 2010 $ 400

Study Note
Income as determined by
accrual accounting is important
to a company’s profitability.
Cash flows are related to a
company’s liquidity. Both are
important to a company’s
success.

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120 CHAPTER 3 Measuring Business Income

here) is to determine the potential cash payments or cash receipts and deduct the
amount not paid or not received. As shown below, the application of the general
rule varies with the type of asset or liability account:

Potential Payment or
Receipt Not Paid or
Type of Account Received Result

Prepaid Expense Ending Balance � Expense � Cash Payments for
for the Period � Beginning Expenses
Balance

Unearned Revenue Ending Balance � Revenue � Cash Receipts from
for the Period � Beginning Revenues
Balance

Accrued Expense Beginning Balance � � Cash Payments for
Expense for the Period � Expenses
Ending Balance

Accrued Revenue Beginning Balance � � Cash Receipts from
Revenue for the Period � Revenues
Ending Balance

For instance, suppose that on May 31, a company had a balance of $480 in
Prepaid Insurance and that on June 30, the balance was $670. If the insurance
expense during June was $120, the amount of cash expended on insurance dur-
ing June can be computed as follows:

Prepaid Insurance at June 30 $670

Insurance Expense during June 120

Potential cash payments for insurance $790

Less Prepaid Insurance at May 31 480

Cash payments for insurance during June $310

The beginning balance is deducted because it was paid in a prior accounting
period. Note that the cash payments equal the expense plus the increase in the
balance of the Prepaid Insurance account [$120 � ($670 � $480) � $310]. In
this case, the cash paid was almost three times the amount of insurance expense.
In future months, cash payments are likely to be less than the expense.

STOP & APPLY

Supplies had a balance of $400 at the end of May and $360 at the end of June. Supplies Expense
was $550 for the month of June. How much cash was received for services provided during June?

SOLUTION
Supplies at June 30 $360
Supplies Expense during June 550
Potential cash payments for supplies $910
Less Supplies at May 31 400
Cash payments for supplies during June $510

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Reliable Answering Service: Review Problem 121

RELIABLE ANSWERING SERVICE: REVIEW PROBLEM
In the Decision Point at the beginning of the chapter, we noted that Reliable Answering
Service has many transactions that span accounting periods. We asked these questions:

• What assumptions must Reliable Answering Service make to account for
transactions that span accounting periods?

• How does Reliable assign its revenues and expenses to the proper accounting
period so that net income is properly measured?

• Why are the adjustments that these transactions require important to Reliable’s
financial performance?

Two of the assumptions Reliable must make are that it will continue as a going con-
cern for an indefinite time (the continuity assumption) and that it can make useful esti-
mates of its income in terms of accounting periods (the periodicity assumption). These
assumptions enable the company to apply the matching rule—that is, revenues are
assigned to the accounting period in which goods are sold or services are performed, and
expenses are assigned to the accounting period in which they are used to produce rev-
enue. These adjustments are important in order to measure net income adequately.

In addition to Reliable’s trial balance, which appears at the beginning of the chapter,
the following information is also available for the company on December 31, 2011:

• Why are the adjustments that these transactions require important to Reliable’s
financial performance?

a. Insurance that expired during December amounted to $40.

b. Office supplies on hand on December 31 totaled $75.

c. Depreciation for December totaled $100.

d. Accrued wages on December 31 totaled $120.

e. Revenues earned for services performed in December but not billed by the
end of the month totaled $300.

f. Revenues received in December in advance of services yet to be performed
totaled $160.

Required
1. Prepare T accounts for the accounts in the trial balance, and enter the balances.

2. Determine the required adjusting entries, and record them directly in the
T accounts. Open new T accounts as needed.

3. Prepare an adjusted trial balance.

4. Prepare an income statement, a statement of owner’s equity, and a balance
sheet for the month ended December 31, 2011.

5. User insight: Which accounts on Reliable’s income statement are potentially
affected by adjusting entries? Which account on Reliable’s balance sheet is
never affected by an adjusting entry?

�

Posting to T Accounts,
Determining Adjusting

Entries, and Using an
Adjusted Trial Balance

to Prepare Financial
Statements

LO3

LO4

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122 CHAPTER 3 Measuring Business Income

1. T accounts set up and amounts from trial balance entered
2. Adjusting entries recorded

Answers to
Review Problem

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Reliable Answering Service: Review Problem 123

3. Adjusted trial balance prepared

4. Financial statements prepared

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124 CHAPTER 3 Measuring Business Income

5. All accounts on the income statement are potentially affected by adjusting
entries. Cash on the balance sheet is never affected by an adjusting entry.

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Stop & Review 125

STOP & REVIEW

Net income is the net increase in owner’s equity that results from a company’s
operations. Net income equals revenues minus expenses; when expenses exceed
revenues, a net loss results. Revenues equal the price of goods sold or services
rendered during a specific period. Expenses are the costs of goods and services
used in the process of producing revenues.

The continuity assumption recognizes that even though businesses face
an uncertain future, without evidence to the contrary, accountants must
assume that a business will continue to operate indefinitely. The periodicity
assumption recognizes that although the lifetime of a business is uncertain, it
is nonetheless useful to estimate the business’s net income in terms of account-
ing periods. The matching rule holds that revenues must be assigned to the
accounting period in which the goods are sold or the services performed, and
expenses must be assigned to the accounting period in which they are used to
produce revenue.

Because applying the matching rule involves making assumptions and exercis-
ing judgment, it can lead to earnings management, which is the manipulation of
revenues and expenses to achieve a specific outcome. When the estimates involved
in earnings management move outside a reasonable range, financial statements
become misleading. Financial statements that are intentionally misleading consti-
tute fraudulent financial reporting.

LO1 Defi ne net income, and
explain the assump-

tions underlying income
measurement and their

ethical application.

LO2 Defi ne accrual account-
ing, and explain how it is

accomplished.

Accrual accounting consists of all the techniques accountants use to apply the
matching rule. It is accomplished by recognizing revenues when they are earned,
by recognizing expenses when they are incurred, and by adjusting the accounts.

LO3 Identify four situations
that require adjusting
entries, and illustrate

typical adjusting entries.

Adjusting entries are required when (1) recorded costs must be allocated between
two or more accounting periods, (2) unrecorded expenses exist, (3) recorded,
unearned revenues must be allocated between two or more accounting periods,
and (4) unrecorded, earned revenues exist. The preparation of adjusting entries is
summarized as follows:

Type of Account

Type of Adjusting Entry Debited Credited Examples of Balance Sheet Accounts

1. Allocating recorded costs
(previously paid, expired)

Expense Asset (or
contra-asset)

Prepaid rent
Prepaid insurance
Office supplies
Accumulated depreciation–office
equipment

2. Accrued expenses (incurred,
not paid)

Expense Liability Interest payable
Wages payable

3. Allocating recorded, unearned
revenues (previously received,
earned)

Liability Revenue Unearned design revenue

4. Accrued revenues (earned, not
received)

Asset Revenue Accounts receivable
Interest receivable

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126 CHAPTER 3 Measuring Business Income

LO4 Prepare fi nancial state-
ments from an adjusted

trial balance.

An adjusted trial balance is prepared after adjusting entries have been posted to the
accounts. Its purpose is to test whether the adjusting entries have been posted cor-
rectly before the financial statements are prepared. The balances in the revenue and
expense accounts in the adjusted trial balance are used to prepare the income state-
ment. The balances in the asset and liability accounts in the adjusted trial balance
and in the statement of owner’s equity are used to prepare the balance sheet.

LO5 Use accrual-based infor-
mation to analyze cash

fl ows.

To ensure a company’s liquidity, managers must know how to use accrual-based
information to analyze cash flows. The general rule for determining the cash flow
received from any revenue or paid for any expense (except depreciation) is to
determine the potential cash receipts or cash payments and deduct the amount
not received or not paid.

The following concepts and terms
were introduced in this chapter:
Accrual 107 (LO3)
Accrual accounting 104 (LO2)
Accrued expenses 111 (LO3)
Accrued revenues 114 (LO3)
Accumulated Depreciation

accounts 110 (LO3)
Adjusted trial balance 116 (LO4)
Adjusting entries 107 (LO3)
Carrying value 110 (LO3)

Cash basis of accounting 102 (LO1)
Continuity 101 (LO1)
Contra account 110 (LO3)
Deferral 107 (LO3)
Depreciation 110 (LO3)
Earnings management 103 (LO1)
Expenses 101 (LO1)
Fiscal year 102 (LO1)
Going concern 101 (LO1)
Interim periods 102 (LO1)

Matching rule 102 (LO1)
Net income 100 (LO1)
Net loss 100 (LO1)
Periodicity 101 (LO1)
Prepaid expenses 108 (LO3)
Profit 100 (LO1)
Revenue recognition 104 (LO2)
Revenues 100 (LO1)
Unearned revenues 113 (LO3)

REVIEW of Concepts and Terminology

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Chapter Assignments 127

CHAPTER ASSIGNMENTS
BUILDING Your Basic Knowledge and Skills

Short Exercises

Accrual Accounting Concepts
SE 1. Match the concepts of accrual accounting on the right with the assumptions
or actions on the left:

___ 1. Assumes expenses should be assigned
to the accounting period in which they
are used to produce revenues

___ 2. Assumes a business will last indefinitely
___ 3. Assumes revenues are earned at a point

in time
___ 4. Assumes net income that is measured

for a short period of time, such as one
quarter, is a useful measure

Adjustment for Prepaid Insurance
SE 2. The Prepaid Insurance account began the year with a balance of $920. Dur-
ing the year, insurance in the amount of $2,080 was purchased. At the end of the
year (December 31), the amount of insurance still unexpired was $1,400. Prepare
the year-end entry in journal form to record the adjustment for insurance expense
for the year.

Adjustment for Supplies
SE 3. The Supplies account began the year with a balance of $760. During the year, sup-
plies in the amount of $1,960 were purchased. At the end of the year (December 31),
the inventory of supplies on hand was $880. Prepare the year-end entry in journal
form to record the adjustment for supplies expense for the year.

Adjustment for Depreciation
SE 4. The depreciation expense on office equipment for the month of March is
$100. This is the third month that the office equipment, which cost $1,900, has
been owned. Prepare the adjusting entry in journal form to record depreciation
for March and show the balance sheet presentation for office equipment and
related accounts after the March 31 adjustment.

Adjustment for Accrued Wages
SE 5. Wages are paid each Saturday for a six-day workweek. Wages are currently
running $1,380 per week. Prepare the adjusting entry required on June 30,
assuming July 1 falls on a Tuesday.

Adjustment for Unearned Revenue
SE 6. During the month of August, deposits in the amount of $2,200 were
received for services to be performed. By the end of the month, services in the
amount of $1,520 had been performed. Prepare the necessary adjustment for
Service Revenue at the end of the month.

LO1

LO2

a. Periodicity
b. Continuity
c. Matching rule
d. Revenue recognition

LO3

LO3
LO3
LO3
LO3

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128 CHAPTER 3 Measuring Business Income

Preparation of an Income Statement and Statement of Owner’s Equity
from an Adjusted Trial Balance
SE 7. The adjusted trial balance for Shimura Company on December 31, 2010,
contains the following accounts and balances: J. Shimura, Capital, $4,300;
J. Shimura, Withdrawals, $175; Service Revenue, $1,300; Rent Expense, $200;
Wages Expense, $450; Utilities Expense, $100; and Telephone Expense, $25.
Prepare an income statement and statement of owner’s equity in proper form for
the month of December.

Determination of Cash Flows
SE 8. Unearned Revenue had a balance of $650 at the end of November and $450
at the end of December. Service Revenue was $2,550 for the month of December.
How much cash was received for services provided during December?

Exercises
Discussion Questions
E 1. Develop a brief answer to each of the following questions.
1. When a company has net income, what happens to its assets and/or to its

liabilities?
2. Is accrual accounting more closely related to a company’s goal of profitability

or liquidity?
3. Will the carrying value of a long-term asset normally equal its market value?

Discussion Questions
E 2. Develop a brief answer to each of the following questions.
1. If, at the end of the accounting period, you were looking at the T account for

a prepaid expense like supplies, would you look for the amounts expended in
cash on the debit or credit side? On which side would you find the amount
expensed during the period?

2. Would you expect net income to be a good measure of a company’s liquid-
ity? Why or why not?

Applications of Accounting Concepts Related to Accrual Accounting
E 3. The accountant for Ronaldo Company makes the assumptions or per-
forms the activities listed below. Tell which of the following concepts of accrual
accounting most directly relates to each assumption or action: (a) periodicity,
(b) continuity, (c) matching rule, (d) revenue recognition, (e) deferral, and (f)
accrual.
1. In estimating the life of a building, assumes that the business will last

indefinitely
2. Records a sale when the customer is billed
3. Postpones the recognition of a one-year insurance policy as an expense by

initially recording the expenditure as an asset
4. Recognizes the usefulness of financial statements prepared on a monthly basis

even though they are based on estimates
5. Recognizes, by making an adjusting entry, wages expense that has been

incurred but not yet recorded
6. Prepares an income statement that shows the revenues earned and the

expenses incurred during the accounting period

LO4

LO5

LO1 LO2
LO3

LO4
LO1 LO2
LO3

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Chapter Assignments 129

Application of Conditions for Revenue Recognition
E 4. Four conditions must be met before revenue should be recognized. In each
of the following cases, tell which condition has not been met.
a. Company A accepts a contract to perform services in the future for $2,000.
b. Company B ships products worth $3,000 to another company without an

order from the other company but tells the company it can return the prod-
ucts if it does not sell them.

c. Company C performs $10,000 of services for a firm with financial problems.
d. Company D agrees to work out a price later for services that it performs for

another company.

Adjusting Entry for Unearned Revenue
E 5. Fargo Voice of Fargo, North Dakota, publishes a monthly magazine featur-
ing local restaurant reviews and upcoming social, cultural, and sporting events.
Subscribers pay for subscriptions either one year or two years in advance. Cash
received from subscribers is credited to an account called Magazine Subscriptions
Received in Advance. On December 31, 2009, the end of the company’s fiscal
year, the balance of this account is $840,000. Expiration of subscriptions revenue
is as follows:

During 2009 $175,000
During 2010 415,000
During 2011 250,000

Prepare the adjusting entry in journal form for December 31, 2009.

Adjusting Entries for Prepaid Insurance
E 6. An examination of the Prepaid Insurance account shows a balance of $16,845
at the end of an accounting period, before adjustment. Prepare entries in journal
form to record the insurance expense for the period under the following indepen-
dent assumptions:
1. An examination of the insurance policies shows unexpired insurance that cost

$8,270 at the end of the period.
2. An examination of the insurance policies shows insurance that cost $2,150

has expired during the period.

Adjusting Entries for Supplies: Missing Data
E 7. Each of the following columns represents a Supplies account:

a b c d
Supplies on hand at July 1 $264 $346 $196 $ ?
Supplies purchased during the month 113 ? 174 1,928
Supplies consumed during the month 194 972 ? 1,741
Supplies on hand at July 31 ? 436 85 1,118

1. Determine the amounts indicated by the question marks.
2. Make the adjusting entry for column a, assuming supplies purchased are deb-

ited to an asset account.

Adjusting Entry for Accrued Salaries
E 8. Hugo Company has a five-day workweek and pays salaries of $35,000 each
Friday.
1. Prepare the adjusting entry required on May 31, assuming that June 1 falls

on a Wednesday.
2. Prepare the entry to pay the salaries on June 3, including the amount of sala-

ries payable from requirement 1.

LO2
LO3
LO3
LO3
LO3

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130 CHAPTER 3 Measuring Business Income

Revenue and Expense Recognition
E 9. Optima Company produces computer software that Tech Company sells.
Optima receives a royalty of 15 percent of sales. Tech Company pays royalties
to Optima Company semiannually—on May 1 for sales made in July through
December of the previous year and on November 1 for sales made in January
through June of the current year. Royalty expense for Tech Company and royalty
income for Optima Company in the amount of $6,000 were accrued on Decem-
ber 31, 2008. Cash in the amounts of $6,000 and $10,000 was paid and received
on May 1 and November 1, 2009, respectively. Software sales during the July to
December 2009 period totaled $150,000.
1. Calculate the amount of royalty expense for Tech Company and royalty

income for Optima during 2009.
2. Record the adjusting entry that each company made on December 31, 2009.

Preparation of Financial Statements
E 10. Prepare the monthly income statement, monthly statement of owner’s
equity, and the balance sheet at August 31, 2011, for Alvin Cleaning Company
from the data provided in the adjusted trial balance below. The owner made no
investments during the period.

LO3
LO4

Alvin Cleaning Company
Adjusted Trial Balance

August 31, 2011

Cash $ 4,750
Accounts Receivable 2,592
Prepaid Insurance 380
Prepaid Rent 200
Cleaning Supplies 152
Cleaning Equipment 3,875
Accumulated Depreciation–Cleaning Equipment $ 320
Truck 7,200
Accumulated Depreciation–Truck 720
Accounts Payable 420
Wages Payable 295
Unearned Janitorial Revenue 1,690
A. Wish, Capital 15,034
A. Wish, Withdrawals 2,000
Janitorial Revenue 14,620
Wages Expense 5,680
Rent Expense 1,350
Gas, Oil, and Other Truck Expenses 580
Insurance Expense 380
Supplies Expense 2,920
Depreciation Expense–Cleaning Equipment 320
Depreciation Expense–Truck 720

$33,099 $33,099

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Chapter Assignments 131

Adjusting Entries
E 11. Prepare year-end adjusting entries for each of the following:
1. Office Supplies has a balance of $336 on January 1. Purchases debited to

Office Supplies during the year amount to $1,660. A year-end inventory
reveals supplies of $1,140 on hand.

2. Depreciation of office equipment is estimated to be $2,130 for the year.
3. Property taxes for six months, estimated at $1,800, have accrued but have

not been recorded.
4. Unrecorded interest income on U.S. government bonds is $850.
5. Unearned Revenue has a balance of $1,800. Services for $750 received in

advance have now been performed.
6. Services totaling $800 have been performed; the customer has not yet been

billed.

Accounting for Revenue Received in Advance
E 12. Robert Shapiro, a lawyer, received $84,000 on October 1 to represent a cli-
ent in real estate negotiations over the next 12 months.
1. Record the entries required in Shapiro’s records on October 1 and at the end

of the fiscal year, December 31.
2. How would this transaction be reflected on the income statement and bal-

ance sheet on December 31?

Determination of Cash Flows
E 13. After adjusting entries had been made, the balance sheets of Ramiro’s Com-
pany showed the following asset and liability amounts at the end of 2009 and
2010:

2010 2009
Prepaid insurance $2,400 $2,900
Wages payable 1,200 2,200
Unearned fees 4,200 1,900

The following amounts were taken from the 2010 income statement:

Insurance expense $ 3,800
Wages expense 19,500
Fees earned 8,900

Calculate the amount of cash paid for insurance and wages and the amount of
cash received for fees during 2010.

Relationship of Expenses to Cash Paid
E 14. The income statement for Sahan Company included the following expenses
for 2011:

Rent expense $ 75,000
Interest expense 11,700
Salaries expense 121,000

LO3
LO3
LO5
LO5

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132 CHAPTER 3 Measuring Business Income

Listed below are the related balance sheet account balances at year end for
last year and this year.

Last Year This Year
Prepaid rent — $ 1,350
Interest payable $1,500 —
Salaries payable 7,500 114,000

1. Compute the cash paid for rent during the year.
2. Compute the cash paid for interest during the year.
3. Compute the cash paid for salaries during the year.

Problems
Determining Adjustments
P 1. At the end of the first three months of operation, the trial balance of City
Answering Service appears as shown below. Tim Bass, the owner of City Answer-
ing Service, has hired an accountant to prepare financial statements to determine
how well the company is doing after three months. Upon examining the account-
ing records, the accountant finds the following items of interest:
a. An inventory of office supplies reveals supplies on hand of $150.
b. The Prepaid Rent account includes the rent for the first three months plus a

deposit for April’s rent.
c. Depreciation on the equipment for the first three months is $416.
d. The balance of the Unearned Answering Service Revenue account represents

a 12-month service contract paid in advance on February 1.
e. On March 31, accrued wages total $105.

LO3

Required
All adjustments affect one balance sheet account and one income statement
account. For each of the above situations, show the accounts affected, the amount

City Answering Service
Trial Balance

March 31, 2010

Cash $ 3,582
Accounts Receivable 4,236
Office Supplies 933
Prepaid Rent 800
Equipment 4,700
Accounts Payable $ 2,673
Unearned Answering Service Revenue 888
T. Bass, Capital 5,933
T. Bass, Withdrawals 2,100
Answering Service Revenue 9,102
Wages Expense 1,900
Office Cleaning Expense 345

$18,596 $18,596

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Chapter Assignments 133

of the adjustment (using a � or – to indicate an increase or decrease), and the
balance of the account after the adjustment in the following format:

Balance Amount of Income Amount of
Sheet Adjustment Balance After Statement Adjustment Balance After

Account (� or �) Adjustment Account (� or �) Adjustment

Preparing Adjusting Entries
P 2. On November 30, the end of the current fiscal year, the following infor-
mation is available to assist Caruso Company’s accountants in making adjusting
entries:
a. Caruso Company’s Supplies account shows a beginning balance of $2,350.

Purchases during the year were $4,218. The end-of-year inventory reveals
supplies on hand of $1,397.

b. The Prepaid Insurance account shows the following on November 30:

Beginning balance $4,720
July 1 4,200
October 1 7,272

The beginning balance represents the unexpired portion of a one-year
policy purchased in September of the previous year. The July 1 entry repre-
sents a new one-year policy, and the October 1 entry represents additional
coverage in the form of a three-year policy.

c. The following table contains the cost and annual depreciation for buildings
and equipment, all of which Caruso Company purchased before the current
year:

Account Cost Annual Depreciation

Buildings $298,000 $16,000
Equipment 374,000 40,000

d. On September 1, the company completed negotiations with a client and
accepted an advance of $18,600 for services to be performed monthly in the
next year. The $18,600 was credited to Unearned Services Revenue.

e. The company calculated that as of November 30, it had earned $7,000 on
an $11,000 contract that would be completed and billed in January.

f. Among the liabilities of the company is a note payable in the amount of
$300,000. On November 30, the accrued interest on this note amounted to
$18,000.

g. On Saturday, December 2, the company, which is on a six-day workweek,
will pay its regular employees their weekly wages of $15,000.

h. On November 29, the company completed negotiations and signed a con-
tract to provide services to a new client at an annual rate of $23,000.

Required
1. Prepare adjusting entries for each item listed above.
2. Explain how the conditions for revenue recognition are applied to transac-

tions e and h.

LO2 LO3

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134 CHAPTER 3 Measuring Business Income

Determining Adjusting Entries, Posting to T Accounts, and Preparing
an Adjusted Trial Balance
P 3. The trial balance for Prima Consultants Company on December 31, 2010,
appears below.

The following information is also available:

a. Ending inventory of office supplies, $97
b. Prepaid rent expired, $500
c. Depreciation of office equipment for the period, $720
d. Interest accrued on the note payable, $600
e. Salaries accrued at the end of the period, $230
f. Service revenue still unearned at the end of the period, $1,410
g. Service revenue earned but not billed, $915

Required
1. Open T accounts for the accounts in the trial balance plus the following: Inter-

est Payable; Salaries Payable; Office Supplies Expense; Depreciation Expense–
Office Equipment; and Interest Expense. Enter the account balances.

2. Determine the adjusting entries and post them directly to the T accounts.
3. Prepare an adjusted trial balance.
4. Which financial statements do each of the above adjustments affect? What

financial statement is not affected by the adjustments?

LO3 LO4

Prima Consultants Company
Trial Balance

December 31, 2010
Cash $ 13,786
Accounts Receivable 24,840
Offi ce Supplies 991
Prepaid Rent 1,400
Offi ce Equipment 7,300
Accumulated Depreciation–Offi ce
Equipment $ 2,600
Accounts Payable 1,820
Notes Payable 10,000
Unearned Service Revenue 2,860
M. Sirot, Capital 30,387
M. Sirot, Withdrawals 15,000
Service Revenue 58,500
Salaries Expense 33,400
Utilities Expense 1,750
Rent Expense 7,700
$106,167 $106,167

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Chapter Assignments 135

The following information is also available:
a. To obtain space at the airport, VIP Limo paid two years’ rent in advance

when it began the business.
b. An examination of insurance policies reveals that $1,800 expired during the year.
c. To provide regular maintenance for the vehicles, VIP Limo deposited

$12,000 with a local garage. An examination of maintenance invoices reveals
charges of $10,944 against the deposit.

d. An inventory of spare parts shows $2,016 on hand.
e. VIP Limo depreciates all of its limousines at the rate of 12.5 percent per

year. No limousines were purchased during the year.
f. A payment of $10,500 for one full year’s interest on notes payable is now due.
g. Unearned Passenger Service Revenue on June 30 includes $17,815 for tick-

ets that employers purchased for use by their executives but which have not
yet been redeemed.

Required
1. Determine the adjusting entries and enter them in the general journal (Page 14).
2. Open ledger accounts for the accounts in the trial balance plus the following:

Interest Payable (213); Rent Expense (514); Insurance Expense (515); Spare
Parts Expense (516); Depreciation Expense–Limousines (517); Maintenance
Expense (518); and Interest Expense (519). Record the balances shown in
the trial balance.

VIP Limo Service
Trial Balance

June 30, 2010
Cash (111) $ 9,812
Accounts Receivable (113) 14,227
Prepaid Rent (117) 12,000
Prepaid Insurance (118) 4,900
Prepaid Maintenance (119) 12,000
Spare Parts (140) 11,310
Limousines (148) 220,000
Accumulated Depreciation–Limousines (149) $ 35,000
Notes Payable (211) 45,000
Unearned Passenger Service Revenue (213) 30,000
A. Pham, Capital (311) 88,211
A. Pham, Withdrawals (313) 20,000
Passenger Service Revenue (411) 428,498
Gas and Oil Expense (510) 89,300
Salaries Expense (511) 206,360
Advertising Expense (516) 26,800
$626,709 $626,709

Determining Adjusting Entries and Tracing Their Effects
to Financial Statements
P 4. VIP Limo Service was organized to provide limousine service between the
airport and various suburban locations. It has just completed its second year of
business. Its trial balance is below.

LO3 LO4

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136 CHAPTER 3 Measuring Business Income

3. Post the adjusting entries from the general journal to the ledger accounts,
showing proper references.

4. Prepare an adjusted trial balance, an income statement, a statement of owner’s
equity, and a balance sheet. The owner made no investments during the period.

Alternate Problems
Determining Adjustments
P 5. At the end of its fiscal year, the trial balance for Andy’s Cleaners appears as
shown below:

LO3

Andy’s Cleaners
Trial Balance

September 30, 2010
Cash $ 11,788
Accounts Receivable 26,494
Prepaid Insurance 3,400
Cleaning Supplies 7,374
Land 18,000
Building 186,000
Accumulated Depreciation–Building $ 45,600
Accounts Payable 18,400
Unearned Cleaning Revenue 1,700
Mortgage Payable 110,000
A. Kopec, Capital 56,560
A. Kopec, Withdrawals 9,000
Cleaning Revenue 159,634
Wages Expense 101,330
Cleaning Equipment Rental Expense 6,100
Delivery Truck Expense 4,374
Interest Expense 11,000
Other Expenses 7,034

$391,894 $391,894

The following information is also available:

a. A study of the company’s insurance policies shows ssssthat $680 is unexpired at
the end of the year.

b. An inventory of cleaning supplies shows $1,150 on hand.
c. Estimated depreciation on the building for the year is $12,800.
d. Accrued interest on the mortgage payable is $1,000.
e. On September 1, the company signed a contract, effective immediately, with

Hope County Hospital to dry clean, for a fixed monthly charge of $425, the
uniforms used by doctors in surgery. The hospital paid for four months’ ser-
vice in advance.

f. Sales and delivery wages are paid on Saturday. The weekly payroll is $3,060.
September 30 falls on a Thursday, and the company has a six-day pay week.

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Chapter Assignments 137

Required
All adjustments affect one balance sheet account and one income statement
account. For each of the above situations, show the accounts affected, the amount
of the adjustment (using a � or � to indicate an increase or decrease), and the
balance of the account after the adjustment in the following format:
Balance Amount of Income Amount of

Sheet Adjustment Balance After Statement Adjustment Balance After
Account (� or �) Adjustment Account (� or �) Adjustment

Preparing Adjusting Entries
P 6. On June 30, the end of the current fiscal year, the following information is
available to Conti Company’s accountants for making adjusting entries:
a. Among the liabilities of the company is a mortgage payable in the amount of

$260,000. On June 30, the accrued interest on this mortgage amounted to
$13,000.

b. On Friday, July 2, the company, which is on a five-day workweek and pays
employees weekly, will pay its regular salaried employees $18,700.

c. On June 29, the company completed negotiations and signed a contract to
provide monthly services to a new client at an annual rate of $7,200.

d. The Supplies account shows a beginning balance of $1,615 and purchases
during the year of $4,115. The end-of-year inventory reveals supplies on
hand of $1,318.

e. The Prepaid Insurance account shows the following entries on June 30:

Beginning balance $1,620
January 1 2,900
May 1 3,366

The beginning balance represents the unexpired portion of a one-year policy
purchased in April of the previous year. The January 1 entry represents a new
one-year policy, and the May 1 entry represents the additional coverage of a
three-year policy.

f. The following table contains the cost and annual depreciation for buildings
and equipment, all of which were purchased before the current year:

Account Cost Annual Depreciation

Buildings $170,000 $ 7,300
Equipment 218,000 20,650

g. On June 1, the company completed negotiations with another client and
accepted an advance of $21,600 for services to be performed in the next
year. The $21,600 was credited to Unearned Service Revenue.

h. The company calculates that as of June 30 it had earned $4,500 on a $7,500
contract that will be completed and billed in August.

Required
1. Prepare adjusting entries for each item listed above.
2. Explain how the conditions for revenue recognition are applied to transac-

tions c and h.

LO2 LO3
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138 CHAPTER 3 Measuring Business Income

Determining Adjusting Entries, Posting to T Accounts, and Preparing
an Adjusted Trial Balance
P 7. The trial balance for Best Advisors Service on December 31, 2011, is as
follows:

LO3
The following information is also available:

a. Ending inventory of office supplies, $300
b. Prepaid rent expired, $610
c. Depreciation of office equipment for the period, $526
d. Accrued interest expense at the end of the period, $570
e. Accrued salaries at the end of the period, $330
f. Service revenue still unearned at the end of the period, $1,166
g. Service revenue earned but unrecorded, $3,100

Required
1. Open T accounts for the accounts in the trial balance plus the following:

Interest Payable; Salaries Payable; Office Supplies Expense; Depreciation
Expense–Office Equipment; and Interest Expense. Enter the balances shown
on the trial balance.

2. Determine the adjusting entries and post them directly to the T accounts.
3. Prepare an adjusted trial balance.
4. Which financial statements do each of the above adjustments affect? Which

financial statement is not affected by the adjustments?
User insight �

Best Advisors Service
Trial Balance

December 31, 2011

Cash $ 18,500
Accounts Receivable 8,250
Offi ce Supplies 2,662
Prepaid Rent 1,320
Offi ce Equipment 9,240
Accumulated Depreciation–
Offi ce Equipment $ 1,540
Accounts Payable 5,940
Notes Payable 11,000
Unearned Service Revenue 2,970
M. Dabrowska, Capital 26,002
M. Dabrowska, Withdrawals 22,000
Service Revenue 72,600
Salaries Expense 49,400
Rent Expense 4,400
Utilities Expense 4,280
$120,052 $120,052

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Chapter Assignments 139

Determining Adjusting Entries and Tracing Their Effects to Financial
Statements
P 8. Helen Ortega opened a small tax-preparation service. At the end of its
second year of operation, Ortega Tax Service had the trial balance that appears
below.

LO3 LO4
User insight �

Ortega Tax Service
Trial Balance

December 31, 2010

Cash $ 3,700
Accounts Receivable 1,099
Prepaid Insurance 240
Offi ce Supplies 780
Offi ce Equipment 7,100
Accumulated Depreciation–
Offi ce Equipment $ 770
Accounts Payable 635
Unearned Tax Fees 219
H. Ortega, Capital 6,939
H. Ortega, Withdrawals 6,000
Tax Fees Revenue 21,926
Offi ce Salaries Expense 8,300
Advertising Expense 650
Rent Expense 2,400
Telephone Expense 220
$30,489 $30,489

The following information is also available:

a. Office supplies on hand, December 31, 2010, $225.
b. Insurance still unexpired, $100.
c. Estimated depreciation of office equipment, $795.
d. Telephone expense for December, $21; the bill was received but not recorded.
e. The services for all unearned tax fees had been performed by the end of the year.

Required
1. Open T accounts for the accounts in the trial balance plus the following:

Office Supplies Expense; Insurance Expense; and Depreciation Expense–
Office Equipment. Record the balances shown in the trial balance.

2. Determine the adjusting entries and post them directly to the T accounts.
3. Prepare an adjusted trial balance, an income statement, a statement of owner’s

equity, and a balance sheet. The owner made no investments during the period.
4. Why is it not necessary to show the effects of the above transactions on the

statement of cash flows?

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140 CHAPTER 3 Measuring Business Income

Importance of Adjustments
C 1. Never Flake Company, which operated in the northeastern part of the United
States, provided a rust-prevention coating for the underside of new automobiles.
The company advertised widely and offered its services through new car dealers.
When a dealer sold a new car, the salesperson attempted to sell the rust-preven-
tion coating as an option. The protective coating was supposed to make cars last
longer in the severe northeastern winters. A key selling point was Never Flake’s
warranty, which stated that it would repair any damage due to rust at no charge
for as long as the buyer owned the car.

For several years, Never Flake had been very successful in generating enough
cash to continue operations. But in 2011, the company suddenly declared bank-
ruptcy. Company officials said that the firm had only $5.5 million in assets against
liabilities of $32.9 million. Most of the liabilities represented potential claims
under the company’s lifetime warranty. It seemed that owners were keeping their
cars longer now than previously. Therefore, more damage was being attributed
to rust. Discuss what accounting decisions could have helped Never Flake survive
under these circumstances.

Earnings Management and Fraudulent Financial Reporting
C 2. In recent years, the Securities and Exchange Commission (SEC) has been
waging a public campaign against corporate accounting practices that manage or
manipulate earnings to meet the expectations of Wall Street analysts. Corpora-
tions engage in such practices in the hope of avoiding shortfalls that might cause
serious declines in their stock price. For each of the following cases that the SEC
challenged, tell why each is a violation of the matching rule and how it should be
accounted for:
a. Lucent Technologies sold telecommunications equipment to companies

from which there was no reasonable expectation of payment because of the
companies’ poor financial condition.

b. America Online (AOL) recorded advertising as an asset rather than as an
expense.

c. Eclipsys recorded software contracts as revenue even though it had not yet
rendered the services.

d. KnowledgeWare recorded revenue from sales of software even though it
told customers they did not have to pay until they had the software.

Analysis of an Asset Account
C 3. The Walt Disney Company is engaged in the financing, production,
and distribution of motion pictures and television programming. In Disney’s
2008 annual report, the balance sheet contained an asset called “film and tele-
vision costs.” Film and television costs, which consist of the costs associated
with producing films and television programs less the amount expensed, were
$5,394,000,000. The estimated amount of film and television costs expensed
(amortized) during the next year were $3,500,000,000. The amount estimated
to be spent for new film productions was $2,900,000,000.
1. What are film and television costs, and why would they be classified as an

asset?
2. Prepare an entry in T account form to record the amount the company spent

on new film and television productions during 2010 (assume all expenditures
are paid for in cash).

LO1 LO2
LO3

LO1

LO2 LO3

ENHANCING Your Knowledge, Skills, and Critical Thinking

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Chapter Assignments 141

3. Prepare an adjusting entry in T account form to record the expense for film
and television productions during 2009. Show the balance of the Film and
Television Costs account at the end of the next year.

4. Suggest a method by which The Walt Disney Company might have deter-
mined the amount of the expense in 3 in accordance with the matching rule.

Importance of Adjustments
C 4. Main Street Service Co. has achieved fast growth in the St. Louis area by sell-
ing service contracts on large appliances, such as washers, dryers, and refrigera-
tors. For a fee, Main Street agrees to provide all parts and labor on an appliance
after the regular warranty runs out. For example, by paying a fee of $200, a person
who buys a dishwasher can add two years (years 2 and 3) to the regular one-year
(year 1) warranty on the appliance. In 2009, the company sold service contracts
in the amount of $1.8 million, all of which applied to future years. Management
wanted all the sales recorded as revenues in 2009, contending that the amount
of the contracts could be determined and the cash had been received. Discuss
whether you agree with this logic. How would you record the cash receipts?
What assumptions do you think Main Street should make? Would you consider
it unethical to follow management’s recommendation? Who might be hurt or
helped by this action?

Real-World Observation of Business Activities
C 5. Visit a company with which you are familiar and observe its opera-
tions. (The company can be where you work, where you eat, or where you
buy things.) Identify at least two sources of revenue for the company and
six types of expenses. For each type of revenue and each type of expense,
determine whether it is probable that an adjusting entry is required at the
end of the accounting period. Then specify the adjusting entry as a deferred
revenue, deferred expense, accrued revenue, or accrued expense. Design a
table with columns and rows that summarizes your results in an easy-to-
understand format.

Analysis of Balance Sheet and Adjusting Entries
C 6. In CVS Corporation’s annual report in the Supplement to Chapter 5, refer
to the balance sheet and the Summary of Significant Accounting Policies in the
notes to the financial statements.
a. Examine the accounts in the current assets, property and equipment, and

current liabilities sections of CVS’s balance sheet. Which are most likely to
have had year-end adjusting entries? Describe the nature of the adjusting
entries. For more information about the property and equipment section,
refer to the notes to the financial statements.

b. Where is depreciation (and amortization) expense disclosed in CVS’s finan-
cial statements?

c. CVS has a statement on the “Use of Estimates” in its Summary of Signifi-
cant Accounting Policies. Read this statement and tell how important esti-
mates are to the determination of depreciation expense. What assumptions
do accountants make that allow these estimates to be made?

LO1 LO2
LO3
LO3
LO3

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142

Making a Statemen

C H A P T E R

4 Completing the Accounting Cycl

A ll companies prepare financial statements annually, and whether required by law or not, preparing them every quar-
ter, or even every month, is a good idea because these interim

reports give management an ongoing view of a company’s financial

performance. The preparation of financial statements requires not

only adjusting entries, which we described in the last chapter, but

also closing entries, which we explain in this chapter

L E A R N I N G O B J E C T I V E S

LO1 Describe the accounting cycle and the role of closing entries in
the preparation of financial statements. (pp. 144–146)

LO2 Prepare closing entries. (pp. 147–151)

LO3 Prepare reversing entries. (pp. 152–153)

LO4 Prepare and use a work sheet. (pp. 154–158)

Revenue

– Expenses

= Net Income

INCOME STATEMEN

STATEMENT OF
OWNER’S EQUITY

Beginning Balance

+ Net Income

– Withdrawals

= Ending Balance

BALANCE SHEET

Assets Liabilities

Owner’s
Equity

A = L + OE

STATEMENT OF CASH FLOWS

= Ending Cash Balance

Operating activities
+ Investing activities
+ Financing activities
= Change in Cash

+ Beginning Balance

Closing entries set the
accounts on the income
statement to zero and transfer
the resulting balance of net
income or loss to the owner’s
Capital account on the
balance sheet. Closing entries
do not affect cash flow

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14314

� What steps must a company
follow to prepare its accounts for
the next accounting period?

� After following these steps,
how is the ending balance of
the owner’s Capital account
determined?

DECISION POINT � A USER’S FOCUS
WESTWOOD MOVERS

Westwood Movers provides moving and storage services for the local
college and its students and employees. Westwood’s business tends
to be seasonal; its busiest times are generally in the late spring and
early fall. Thus, to keep a careful eye on fluctuations in earnings and
cash flows, Westwood prepares financial statements each quarter.

As you know from Chapter 3, before a company prepares financial
statements, it must make adjusting entries to the income statement
and owner’s equity accounts. After those entries have been made,
an adjusted trial balance listing all the accounts and balances is pre-
pared. Accounts from the adjusted trial balance are then used to pre-
pare the financial statements. For example, in preparing its income
statement, Westwood Movers would use the revenue and expense
accounts from its adjusted trial balance, which appear on the follow-
ing page. (This adjusted trial balance is “partial” in that it omits all
balance sheet accounts except the owner’s equity accounts.) In addi-
tion, Westwood, like all other companies, must prepare its accounts
for the next accounting period by making closing entries. Doing all
this takes time and effort, but the results benefit both management
and external users of the company’s financial statements by provid-
ing important information about revenues and operating income.

To accomplish these tasks, Westwood Movers needs to be able
to answer the questions on the right.

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144 CHAPTER 4 Completing the Accounting Cyc

To interpret and analyze a company’s performance requires an understanding
of how transactions are recognized and eventually end up in financial state-
ments. Two concepts that foster this understanding are the accounting cycle
and closing entries.

The Accounting Cycle
As Figure 4-1 shows, the accounting cycle is a series of steps whose ultimate pur-
pose is to provide useful information to decision makers. These steps are as follows:

1. Analyze business transactions from source documents.

2. Record the transactions by entering them in the general journa

3. Post the journal entries to the ledger, and prepare a trial balance.

4. Adjust the accounts, and prepare an adjusted trial balance.

5. Prepare financial

statements.

6. Close the accounts, and prepare a post-closing trial balance.

You are already familiar with Steps 1 through 5 from previous chapters. In the
next section, we describe Step 6, which may be performed before or after Step 5.

Closing Entries
Balance sheet accounts, such as Cash and Accounts Payable, are considered
permanent accounts, or real accounts, because they carry their end-of-period
balances into the next accounting period. In contrast, revenue and expense
accounts, such as Revenues Earned and Wages Expense, are considered tempo-
rary accounts, or nominal accounts, because they begin each accounting period
with a zero balance, accumulate a balance during the period, and are then cleared
by means of closing entries.

Closing entries are journal entries made at the end of an accounting period.
They have two purposes:

1. They set the stage for the next accounting period by clearing revenue and
expense accounts and the Withdrawals account of their balances.

From Transactions
to Financial
Statements

LO1 Describe the accounting
cycle and the role of closing
entries in the preparation of
financial statements.

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From Transactions to Financial Statements 145

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# 103261 Cust: CENGAGE Au: Needles Pg. No. 145
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146 CHAPTER 4 Completing the Accounting Cycle

Expense Accounts Revenue Accounts

xxx xxx

Step 2:
To close the

expense
accounts

Step 1:
To close the

revenue
accounts

Income Summary

CapitalWithdrawals

Step 3:
To close

Income Summary

Step 4:
To close

Withdrawals
xx

xxxxxx

xx
xx

FIGURE 4-2 Overview of the Closing Process

& APPLY

In each of the following pairs of activities, tell which activity is done first in the accounting cycle:

1. Close the accounts or adjust the accounts
2. Analyze the transactions or post the entries

to the ledger

3. Record the transactions in the journal or
prepare the initial trial balance

4. Prepare the post-closing trial balance or
prepare the adjusted trial balance

STOP

SOLUTION
1. Adjust the accounts
2. Analyze the transactions

3. Record the transactions in the journal
4. Prepare the adjusted trial balance

2. They summarize a period’s revenues and expenses by transferring the bal-
ances of revenue and expense accounts to the Income Summary account.
The Income Summary account is a temporary account that summarizes all
revenues and expenses for the period. It is used only in the closing process—
never in the financial statements. Its balance equals the net income or loss
reported on the income statement. The net income or loss is then transferred
to the owner’s Capital account.

Figure 4-2 shows an overview of the closing process. The net income or loss is
transferred from the Income Summary account to the owner’s Capital account
because even though revenues and expenses are recorded in individual accounts,
they represent increases and decreases in owner’s Capital. Closing entries transfer
the net effect of increases (revenues) and decreases (expenses) to owner’s Capi-
tal. For corporations like Netflix, the net income or loss is transferred from the
Income Summary account to the Retained Earnings account, which is part of the
stockholders’ (owner’s) equity of a corporation.

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Preparing Closing Entries 147

Preparing
Closing Entries

LO2 Prepare closing entries.

The steps involved in making closing entries are as follows:

Step 1. Close the credit balances on the income statement accounts to the
Income Summary account.

Step 2. Close the debit balances on the income statement accounts to the
Income Summary account.

Step 3. Close the Income Summary account balance to the owner’s Capital
account.

Step 4. Close the Withdrawals account balance to the owner’s Capital account.

As you will learn in later chapters, not all revenue accounts have credit bal-
ances and not all expense accounts have debit balances. For that reason, when
referring to closing entries, we often use the term credit balances instead of rev-
enue accounts and the term debit balances instead of expense accounts.

An adjusted trial balance provides all the data needed to record the closing
entries. Exhibit 4-1 shows the relationships of the four kinds of closing entries to
Miller Design Studio’s adjusted trial balance.

Step 1: Closing the Credit Balances
On the credit side of the adjusted trial balance in Exhibit 4-1, Design Revenue shows
a balance of $13,600. To close this account, a journal entry must be made debiting
the account in the amount of its balance and crediting it to the Income Summary
account. Exhibit 4-2 shows how the entry is posted. Notice that the entry sets the
balance of the revenue account to zero and transfers the total revenues to the credit
side of the Income Summary account.

Step 2: Closing the Debit Balances
Several expense accounts show balances on the debit side of the adjusted trial bal-
ance in Exhibit 4-1. A compound entry is needed to credit each of these expense
accounts for its balance and to debit the Income Summary account for the total.
Exhibit 4-3 shows the effect of posting the closing entry. Notice how the entry
reduces the expense account balances to zero and transfers the total of the account
balances to the debit side of the Income Summary account.

Step 3: Closing the Income Summary
Account Balance
After the entries closing the revenue and expense accounts have been posted, the
balance of the Income Summary account equals the net income or loss for the
period. A credit balance in the Income Summary account represents a net income
(i.e., revenues exceed expenses), and a debit balance represents a net loss (i.e.,
expenses exceed revenues).

At this point, the balance of the Income Summary account, whatever its nature,
is closed to the owner’s Capital account, as shown in Exhibit 4-1. Exhibit 4-4
shows how the closing entry is posted when a company has a net income. Notice
the dual effect of closing the Income Summary account and transferring the bal-
ance to owner’s Capital.

Step 4: Closing the Withdrawals Account Balance
The Withdrawals account shows the amount by which owner’s Capital decreased
during an accounting period. The debit balance of the Withdrawals account is
closed to the owner’s Capital account, as illustrated in Exhibit 4-1. Exhibit 4-5

Study Note
Although it is not absolutely
necessary to use the Income
Summary account when
preparing closing entries, doing
so simplifies the procedure.

Study Note
After Step 3 has been completed,
the credit balance of the Income
Summary account ($3,960)
represents net income—the key
measure of performance. When a
net loss occurs, debit the owner’s
Capital account (to reduce it)
and credit the Income Summary
account (to close it).

Study Note
After Step 1 has been completed,
the Income Summary account
reflects the account balance of
the Design Revenue account
before it was closed.

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148 CHAPTER 4 Completing the Accounting Cycle

EXHIBIT 4-1 Preparing Closing Entries from the Adjusted Trial Balance

shows the posting of the closing entry and the transfer of the balance of the With-
drawals account to the owner’s Capital account. In a corporation like Netflix,
payments to owners are called dividends, and they are closed to the Retained
Earnings account.

The Accounts After Posting
After all the steps in the closing process have been completed and all closing
entries have been posted, everything is ready for the next accounting period.

Miller Design Studio
Adjusted Trial Balance

July 31, 2011

Entry 1:

July 31 Design Revenue 411 13,600
Income Summary 314 13,600
To close the
revenue
account

Entry 2:

July 31 Income Summary 314 9,640
Wages Expense 511 5,520
Utilities Expense 512 680
Rent Expense 514 1,600
Office Supplies
Expense 517 1,540
Depreciation
Expense–Office
Equipment 520 300
To close the
expense
accounts

INCOME SUMMARY
July 31 9,640 July 31 13,600

July 31 3,960

Bal. —

Entry 3:

July 31 Income Summary 314 3,960
J. Miller, Capital 312 3,960
To close the
Income Summary
account

Entry 4:

July 31 J. Miller, Capital 312 2,800
J. Miller,
Withdrawals 313 2,800
To close the
Withdrawals
account

$61,500 $61,500

Study Note
Note that the Withdrawals
account is closed to the owner’s
Capital account, not to the
Income Summary account.

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Preparing Closing Entries 149

EXHIBIT 4-2
Posting the Closing Entry of a
Credit Balance to the Income
Summary Account

The revenue, expense, and Withdrawals accounts (temporary accounts) have zero
balances. The owner’s Capital account has been increased or decreased to reflect
net income or net loss (net income in our example) and has been decreased for
withdrawals. The balance sheet accounts (permanent accounts) show the correct
balances, which are carried into the next

period.

EXHIBIT 4-3 Posting the Closing Entry of Debit Balances to the Income Summary Account

Wages Expense Account No. 511

Post. Balance

Date Item Ref. Debit Credit Debit Credit

July 26 J2 4,800 4,800
31 Adj. J3 720 5,520
31 Closing J4 5,520 —

Utilities Expense Account No. 512

Post. Balance
Date Item Ref. Debit Credit Debit Credit

July 30 J2 680 680
31 Closing J4 680 —

Rent Expense Account No. 514

Post. Balance
Date Item Ref. Debit Credit Debit Credit

July 31 Adj. J3 1,600 1,600
31 Closing J4 1,600 —

Office Supplies Expense Account No. 517

Post. Balance
Date Item Ref. Debit Credit Debit Credit

July 31 Adj. J3 1,540 1,540
31 Closing J4 1,540 —

Depreciation Expense–Office
Equipment Account No. 520

Post. Balance
Date Item Ref. Debit Credit Debit Credit

July 31 Adj. J3 300 300
31 Closing J4 300 —

Income Summary Account No. 314

Post. Balance
Date Item Ref. Debit Credit Debit Credit

July 31 Closing J4 13,600 13,600

31 Closing J4 9,640* 3,960

*Total of all credit closing entries to expense accounts is debited to the Income Summary account.

Design Revenue Account No. 411

Post. Balance
Date Item Ref. Debit Credit Debit Credit

July 10 J2 2,800 2,800
15 J2 9,600 12,400
31 Adj. J3 800 13,200
31 Adj. J3 400 13,600
31 Closing J4 13,600 —

Income Summary Account No. 314
Post. Balance
Date Item Ref. Debit Credit Debit Credit
July 31 Closing J4 13,600 13,600

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150 CHAPTER 4 Completing the Accounting Cycle

The Post-Closing Trial Balance
Because errors can be made in posting closing entries to the ledger accounts, it is
necessary to prepare a post-closing trial balance. As you can see in Exhibit 4-6,
a post-closing trial balance contains only balance sheet accounts because the
income statement accounts and the Withdrawals account have been closed
and now have zero balances. It is a final check that total debits equal total
credits.

EXHIBIT 4-4 Posting the Closing Entry of the Income Summary Account Balance to the Owner’s Equity Account

EXHIBIT 4-5 Posting the Closing Entry of the Withdrawals Account Balance to the Owner’s Capital Account

J. Miller, Withdrawals Account No. 313

Post. Balance

Date Item Ref. Debit Credit Debit Credit

July 31 J2 2,800 2,800
31 Closing J4 2,800 —

J. Miller, Capital Account No. 312

Post. Balance
Date Item Ref. Debit Credit Debit Credit

July 1 J1 40,000 40,000
31 Closing J4 3,960 43,960
31 Closing J4 2,800 41,160

Miller Design Studio
Post-Closing Trial Balance

July 31, 2011

$49,060

EXHIBIT 4-6
Post-Closing Trial Balance

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Income Summary Account No. 314
Post. Balance
Date Item Ref. Debit Credit Debit Credit

July 31 Closing J4 13,600 13,600
31 Closing J4 9,640 3,960
31 Closing J4 3,960 —

J. Miller, Capital Account No. 312
Post. Balance
Date Item Ref. Debit Credit Debit Credit

July 1 J1 40,000 40,000
31 Closing J4 3,960 43,960

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Preparing Closing Entries 151

STOP & APPLY

Prepare the necessary closing entries from the following partial adjusted trial balance for Fountas
Recreational Park, and compute the ending balance of the owner’s Capital account. (Except for K.
Fountas, Capital, balance sheet accounts have been omitted.)

SOLUTION
Closing entries prepared:

June 30 Campsite Rentals 88,200
Income Summary 88,200
To close the credit balance account
30 Income Summary 36,754
Wages Expense 23,850
Insurance Expense 3,784
Utilities Expense 1,800
Supplies Expense 1,320
Depreciation Expense–Building 6,000
To close the debit balance accounts
30 Income Summary 51,446
K. Fountas, Capital 51,446
To close the Income Summary account
$88,200 � $36,754 � $51,446
30 K. Fountas, Capital 36,000
K. Fountas, Withdrawals 36,000
To close the Withdrawals account

Ending balance of the K. Fountas, Capital account computed:

K. FOUNTAS, CAPITAL
June 30 36,000 Beg. Bal. 93,070
June 30 51,446
End. Bal. 108,516

Fountas Recreational Park
Partial Adjusted Trial Balance

June 30, 2010

K. Fountas, Capital $93,070
K. Fountas, Withdrawals $36,000
Campsite Rentals 88,200
Wages Expense 23,850
Insurance Expense 3,784
Utilities Expense 1,800
Supplies Expense 1,320
Depreciation Expense–Building 6,000

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152 CHAPTER 4 Completing the Accounting Cycle

Reversing Entries:
An Optional
First Step

LO3 Prepare reversing
entries.

A reversing entry is an optional journal entry made on the first day of an account-
ing period. It has the opposite effect of an adjusting entry made at the end of the
previous period—that is, it debits the credits and credits the debits of an ear-
lier adjusting entry. The sole purpose of reversing entries is to simplify routine
bookkeeping procedures, and they apply only to certain adjusting entries. Defer-
rals should not be reversed because doing so would not simplify bookkeeping in
future accounting periods. As used in this text, reversing entries apply only to
accruals (accrued revenues and expenses).

To see how reversing entries can be helpful, consider this adjusting entry
made in the records of Miller Design Studio to accrue wages expense:Study Note

Reversing entries are the
opposite of adjusting entries
and are dated the first day of
the new period. They apply only
to certain adjusting entries and
are never required.

When the company pays its assistant on the next regular payday, its accountant
would make this entry:

Assets � Liabilities � Owner’s Equity
WAGES PAYABLE WAGES EXPENSE

Dr. Cr. Dr. Cr.
July 31 720 July 31 720

Entry in Journal Form:
Dr. Cr.

July 31 Wages Expense 720
Wages Payable 720
Accrued unrecorded wages

Entry in Journal Form:
Dr. Cr.

Aug. 23 Wages Payable 720
Wages Expense 4,080
Cash 4,800
Paid four weeks wages to assistant, $720
of which accrued in the previous period

Assets � Liabilities � Owner’s Equity
CASH WAGES PAYABLE WAGES EXPENSE
Dr. Cr. Dr. Cr. Dr. Cr.
Aug. 23 4,800 Aug. 23 720 Aug. 23 4,080

If no reversing entry is made at the time of payment, the accountant would
have to look in the records to find out how much of the $4,800 applies to the
current accounting period and how much applies to the previous period. That
may seem easy in our example, but think how difficult and time-consuming it
would be if a company had hundreds of employees working on different sched-
ules. A reversing entry helps solve the problem of applying revenues and expenses
to the correct account

ing period.

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Reversing Entries: An Optional First Step 153

For example, consider the following sequence of entries and their effects on
the Wages Expense account:

1. Adjusting Entry Dr. Cr.
July 31 Wages Expense 720
Wages Payable 720
2. Closing Entry
July 31 Income Summary 5,520
Wages Expense 5,520
3. Reversing Entry
Aug. 1 Wages Payable 720
Wages Expense 720
4. Payment Entry
Aug. 23 Wages Expense 4,800
Cash 4,800

Wages Expense Account No. 511

Post. Balance

Date Ref. Debit Credit Debit Credit

July 26 J2 4,800 4,800
31 J3 720 5,520
31 J4 5,520 —

Aug. 1 J5 720 720
23 J6 4,800 4,080

Entry 1 adjusted Wages Expense to accrue $720 in the July accounting period.

Entry 2 closed the $5,520 in Wages Expense for July to Income Summary, leav-
ing a zero balance.

Entry 3, the reversing entry, set up a credit balance of $720 on August 1 in
Wages Expense, which is the expense recognized through the adjusting entry
in July (and also reduced the liability account Wages Payable to a zero balance).
The reversing entry always sets up an abnormal balance in the income statement
account and produces a zero balance in the balance sheet account.

Entry 4 recorded the $4,800 payment of wages as a debit to Wages Expense,
automatically leaving a balance of $4,080, which represents the correct wages
expense to date in August. The reversing entry simplified the process of making
the payment entry on August 23.

Reversing entries apply to any accrued expenses or revenues. Miller Design Stu-
dio’s only accrued expense was wages expense. An adjusting entry for the company’s
accrued revenue (Design Revenue) would require the following reversing entry:

Dr. Cr.
Aug. 1 Design Revenue 400
Accounts Receivable 400
Reversed the adjusting entry
for accrued revenue earned

& APPLY

Which of the following accounts after adjustment will most likely require reversing entries:

a. Salaries Payable
b. Accumulated Depreciation
c. Interest Payable

d. Supplies
e. Taxes Payable

SOLUTION
a., c., and e.

STOP

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154 CHAPTER 4 Completing the Accounting Cycle

The Work Sheet:
An Accountant’s
Tool

LO4 Prepare and use a work
sheet.

To organize data and avoid omitting important information that might affect the
financial statements, accountants use working papers. Because working papers
provide evidence of past work, they enable accountants to retrace their steps when
they need to verify information in the financial statements.

A work sheet is a special kind of working paper. The work sheet is extremely
useful when a company prepares financial statements on both an annual and seasonal
basis, as Netflix does, and when an accountant must make numerous adjustments.
It is often used as a preliminary step in preparing financial statements. Using a work
sheet lessens the possibility of omitting an adjustment and helps the accountant check
the arithmetical accuracy of the accounts. The work sheet is never published and is
rarely seen by management. It is a tool for the accountant. Because preparing a work
sheet is a mechanical process, many accountants use a computer for this purpose.

Preparing the Work Sheet
A work sheet often has one column for account names and multiple columns with
headings like the ones shown in Exhibit 4-7. A heading that includes the name of the
company and the period of time covered (as on the income statement) identifies the
work sheet. As Exhibit 4-7 shows, preparation of a work sheet involves five steps.

Step 1. Enter and Total the Account Balances in the Trial Balance
Columns The debit and credit balances of the accounts on the last day of an
accounting period are copied directly from the ledger into the Trial Balance col-
umns (the green columns in Exhibit 4-7). When accountants use a work sheet,
they do not have to prepare a separate trial balance.

Step 2. Enter and Total the Adjustments in the Adjustments Columns
The required adjustments are entered in the Adjustments columns of the work
sheet (the purple columns in Exhibit 4-7). As each adjustment is entered, a let-
ter is used to identify its debit and credit parts. For example, in Exhibit 4-7,
the letter (a) identifies the adjustment made for the rent that Miller Design
Studio prepaid on July 3, which results in a debit to Rent Expense and a credit
to Prepaid Rent. These identifying letters may be used to reference supporting
computations or documentation for the related adjusting entries and can sim-
plify the recording of adjusting entries in the general journal.

A trial balance includes only accounts that have balances. If an adjustment
involves an account that does not appear in the trial balance, the new account is
added below the accounts listed on the work sheet. For example, Rent Expense
has been added to Exhibit 4-7. Accumulated depreciation accounts, which have a
zero balance only in the initial period of operation, are the sole exception to this
rule. They are listed immediately after their associated asset accounts. For exam-
ple, in Exhibit 4-7, the Accumulated Depreciation–Office Equipment account is
listed immediately after Office Equipment.

When all the adjustments have been made, the two Adjustments columns
must be totaled. This procedure proves that the debits and credits of the adjust-
ments are equal, and it generally reduces errors in the work sheet.

Step 3. Enter and Total the Adjusted Account Balances in the
Adjusted Trial Balance Columns The adjusted trial balance in the work sheet
is prepared by combining the amount of each account in the Trial Balance columns
with the corresponding amount in the Adjustments columns and entering each
result in the Adjusted Trial Balance columns (the yellow columns in Exhibit 4-7).

Exhibit 4-7 contains examples of crossfooting, or adding and subtracting
a group of numbers horizontally. The first line shows Cash with a debit balance

Study Note
The work sheet is not a financial
statement, it is not required, and
it is not made public.

Study Note
The Trial Balance columns of a
work sheet take the place of a
trial balance.

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The Work Sheet: An Accountant’s Tool 155

EXHIBIT 4-7 The Work Sheet

of $22,480. Because there are no adjustments to the Cash account, $22,480
is entered in the debit column of the Adjusted Trial Balance columns. On the
second line, Accounts Receivable shows a debit of $4,600 in the Trial Balance
columns. Because there is a debit of $400 from adjustment f in the Adjustments
columns, it is added to the $4,600 and carried over to the debit column of the
Adjusted Trial Balance columns at $5,000. On the next line, Office Supplies
shows a debit of $5,200 in the Trial Balance columns and a credit of $1,540

Miller Design Studio
Work Sheet

For the Month Ended July 31, 2011

Adjusted Income
Trial Balance Adjustments Trial Balance Statement Balance Sheet

Account Name Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit

Cash 22,480 22,480 22,480
Accounts Receivable 4,600 (f ) 400 5,000 5,000
Office Supplies 5,200 (b) 1,540 3,660 3,660
Prepaid Rent 3,200 (a) 1,600 1,600 1,600
Office Equipment 16,320 16,320 16,320
Accumulated
Depreciation–Office
Equipment (c) 300 300 300
Accounts Payable 6,280 6,280 6,280
Unearned Design
Revenue 1,400 (e) 800 600 600
J. Miller, Capital 40,000 40,000 40,000
J. Miller, Withdrawals 2,800 2,800 2,800
Design Revenue 12,400 (e) 800 13,600 13,600
(f ) 400
Wages Expense 4,800 (d) 720 5,520 5,520
Utilities Expense 680 680 680

60,080 60,080

Rent Expense (a) 1,600 1,600 1,600
Office Supplies
Expense (b) 1,540 1,540 1,540
Depreciation Expense–
Office Equipment (c) 300 300 300
Wages Payable (d) 720 720 720

5,360 5,360 61,500 61,500 9,640 13,600 51,860 47,900
Net Income 3,960 3,960

13,600 13,600 51,860 51,860

Note: The columns of the work sheet are prepared in the following order: (1) Trial Balance, (2) Adjustments, (3) Adjusted Trial
Balance, and (4) Income Statement and Balance Sheet columns. In the fifth step, the Income Statement and Balance Sheet
columns are totaled.

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156 CHAPTER 4 Completing the Accounting Cycle

from adjustment b in the Adjustments columns. Subtracting $1,540 from $5,200
results in a $3,660 debit balance in the Adjusted Trial Balance columns. This
process is followed for all the accounts, including those added below the trial bal-
ance totals. The Adjusted Trial Balance columns are then footed (totaled) to check
the accuracy of the crossfooting.

Step 4. Extend the Account Balances from the Adjusted Trial Bal-
ance Columns to the Income Statement or Balance Sheet Columns
Every account in the adjusted trial balance is an income statement account or a
balance sheet account. Each account is extended to its proper place as a debit
or credit in either the Income Statement columns or the Balance Sheet col-
umns (the blue columns in Exhibit 4-7). As shown in Exhibit 4-7, revenue and
expense accounts are extended to the Income Statement columns, and asset,
liability, Capital, and Withdrawals accounts are extended to the Balance Sheet
columns.

To avoid overlooking an account, the accounts are extended line by line,
beginning with the first line (Cash) and not omitting any subsequent lines. For
instance, the Cash debit balance of $22,480 is extended to the debit column
of the Balance Sheet columns; then, the Accounts Receivable debit balance of
$5,000 is extended to the debit column of the Balance Sheet columns; and
so forth.

Step 5. Total the Income Statement Columns and the Balance Sheet
Columns. Enter the Net Income or Net Loss in Both Pairs of Columns
as a Balancing Figure, and Recompute the Column Totals This fifth
and last step, shown in the brown columns at the bottom of Exhibit 4-7, is neces-
sary to compute net income or net loss and to prove the arithmetical accuracy of
the work sheet.

Net income (or net loss) is equal to the difference between the total debits
and credits of the Income Statement columns. It is also equal to the difference
between the total debits and credits of the Balance Sheet columns.

Revenues (Income Statement credit column total) $13,600
Expenses (Income Statement debit column total) (9,640)
Net Income $ 3,960

In this case, revenues (credit column) exceed expenses (debit column). Thus,
Miller Design Studio has a net income of $3,960. The same difference occurs
between the total debits and credits of the Balance Sheet columns.

The $3,960 is entered in the debit side of the Income Statement columns
and in the credit side of the Balance Sheet columns to balance the columns.
Remember that the excess of revenues over expenses (net income) increases own-
er’s equity and that increases in owner’s equity are recorded by credits.

When a net loss occurs, the opposite rule applies. The excess of expenses over
revenues—net loss—is placed in the credit side of the Income Statement columns
as a balancing figure. It is then placed in the debit side of the Balance Sheet col-
umns because a net loss decreases owner’s equity, and decreases in owner’s equity
are recorded by debits.

As a final check, the four columns are totaled again. If the Income Statement
columns and the Balance Sheet columns do not balance, an account may have
been extended or sorted to the wrong column, or an error may have been made
in adding the columns. Of course, equal totals in the two pairs of columns are not
absolute proof of accuracy. If an asset has been carried to the Income Statement
debit column (or an expense has been carried to the Balance Sheet debit column)

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The Work Sheet: An Accountant’s Tool 157

or a similar error with revenues or liabilities has been made, the work sheet will
balance, but the net income figure will be wrong.

Using the Work Sheet
Accountants use the completed work sheet in performing three principal tasks.
These tasks are as follows:

1. Recording the adjusting entries in the general journal. Because the
information needed to record the adjusting entries can be copied from
the work sheet, entering the adjustments in the journal is an easy step,
as shown in Exhibit 4-8. The adjusting entries are then posted to the
general ledger.

Study Note
Theoretically, adjusting
entries can be recorded in the
accounting records before
the financial statements are
prepared or even before the
work sheet is completed.
However, they always precede
the preparation of closing
entries.

EXHIBIT 4-8
Adjustments from the Work
Sheet Entered in the General
Journal

General Journal Page 3

Post.
Date Description Ref. Debit Credit

2011
(a) July 31 Rent Expense 514 1,600
Prepaid Rent 117 1,600
To recognize expiration of one
month’s rent
(b) 31 Office Supplies Expense 517 1,540
Office Supplies 116 1,540
To recognize office supplies used
during the month
(c) 31 Depreciation Expense–Office
Equipment 520 300
Accumulated Depreciation–Office 147 300
Equipment
To record depreciation of office
equipment for a month
(d) 31 Wages Expense 511 720
Wages Payable 214 720
To accrue unrecorded wages
(e) 31 Unearned Design Revenue 213 800
Design Revenue 411 800
To recognize payment
for services not yet
performed
(f ) 31 Accounts Receivable 113 400
Design Revenue 411 400
To accrue design fees
earned but unrecorded

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158 CHAPTER 4 Completing the Accounting Cycle

� WESTWOOD MOVERS: REVIEW PROBLEM
In the Decision Point at the beginning of the chapter, we pointed out that at the end
of an accounting period, Westwood Movers, like all other companies, must prepare its
accounts for the next accounting period. We posed these questions:

• What steps must a company follow to prepare its accounts for the next
accounting period?

• After following these steps, how is the ending balance of the owner’s Capital
account determined?

1. Prepare the necessary closing entries from the partial adjusted trial balance
for Westwood Movers that appears in the Decision Point. (As we noted earlier,
this adjusted trial balance omits all balance sheet accounts except the owner’s
equity accounts.)

2. Compute the ending balance of the owner’s Capital account.

3. User insight: In the closing process, why is it unnecessary to consider balance
sheet accounts other than owner’s equity accounts?

Preparation of
Closing Entries

LO2

& APPLY

Place the following columns of a work sheet in the proper order:

a. Balance Sheet columns
b. Trial Balance columns
c. Income Statement columns

d. Adjusted Trial Balance columns
e. Adjustments columns

SOLUTION
b., e., d., c., a.

STOP

2. Recording the closing entries in the general journal. The Income State-
ment columns of the work sheet show all the accounts that need to be closed,
except for the Withdrawals account. Exhibits 4-1 through 4-5 show how the
closing entries are entered in the journal and posted to the ledger.

3. Preparing the financial statements. Once the work sheet has been completed,
preparing the financial statements is simple because the account balances have
been sorted into the Income Statement and Balance Sheet columns.

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Westwood Movers: Review Problem 159

1. Closing entries prepared:
Answers to
Review Problem

2. Ending balance of the J. Thomas, Capital account computed:

3. The reason other balance sheet accounts are not considered in the closing
process is that the balances of all asset and liability accounts carry over to the
next accounting period. Thus, they do not need to be set to zero, as do the
income statements accounts and the Withdrawals account. Also, they do not
need to be updated, as does the owner’s Capital account.

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160 CHAPTER 4 Completing the Accounting Cycle

The steps in the accounting cycle are as follows: (1) analyze business transac-
tions from source documents; (2) record the transactions by entering them in
the general journal; (3) post the entries to the ledger, and prepare a trial bal-
ance; (4) adjust the accounts, and prepare an adjusted trial balance; (5) prepare
financial statements; and (6) close the accounts, and prepare a post-closing trial
balance. (Step 6 may occur before or after Step 5.)

Closing entries have two purposes: (1) They clear the balances of all tem-
porary accounts (revenue, expense, and Withdrawals accounts) so that they
have zero balances at the beginning of the next accounting period, and (2)
they summarize a period’s revenues and expenses in the Income Summary
account so that the net income or loss for the period can be transferred as a
total to owner’s Capital.

STOP & REVIEW

LO1 Describe the accounting
cycle and the role of

closing entries in the
preparation of fi nancial

statements.

The first two steps in preparing closing entries are to transfer the balances of the
revenue and expense accounts to the Income Summary account. The balance of
the Income Summary account is then transferred to the owner’s Capital account.
Finally, the balance of the Withdrawals account is transferred to owner’s Capital.
After the closing entries have been posted to the ledger accounts, a post-closing
trial balance is prepared as a final check on the balance of the ledger and to ensure
that all temporary (nominal) accounts have been closed.

LO2 Prepare closing entries.

LO3 Prepare reversing
entries.

Reversing entries are optional journal entries made on the first day of an
accounting period. Reversing entries have the opposite effect of adjusting
entries made at the end of the previous period—that is, a reversing entry
debits the credits and credits the debits of an earlier adjusting entry. The sole
purpose of reversing entries is to simplify routine bookkeeping procedures,
and they apply only to certain adjusting entries. As used in this text, reversing
entries apply only to accruals.

The five steps in preparing a work sheet are (1) enter and total the account
balances in the Trial Balance columns; (2) enter and total the adjustments in
the Adjustments columns; (3) enter and total the adjusted account balances in
the Adjusted Trial Balance columns; (4) extend the account balances from the
Adjusted Trial Balance columns to the Income Statement or Balance Sheet col-
umns; and (5) total the Income Statement and Balance Sheet columns, enter
the net income or net loss in both pairs of columns as a balancing figure, and
recompute the column totals.

A work sheet is useful in recording both adjusting and closing entries and in
preparing the financial statements. The income statement and balance sheet can
be prepared directly from the Income Statement and Balance Sheet columns of
the completed work sheet. The statement of owner’s equity is prepared using
owner’s Withdrawals, net income, additional investments, and the beginning bal-
ance of the owner’s Capital account.

LO4 Prepare and use a
work sheet.

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Stop & Review 161

REVIEW of Concepts and Terminology

The following concepts and terms
were introduced in this chapter:

Accounting cycle 144 (LO1)
Closing entries 144 (LO1)

Crossfooting 154 (LO4)
Income Summary account 146 (LO1)
Permanent accounts 144 (LO1)
Post-closing trial balance 150 (LO2)

Reversing entry 152 (LO3)
Temporary accounts 144 (LO1)
Working papers 154 (LO4)
Work sheet 154 (LO4)

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162 CHAPTER 4 Completing the Accounting Cycle

Short

Exercises

Accounting Cycle
SE 1. Resequence the following activities to indicate the usual order of the
accounting cycle:
a. Close the accounts.
b. Analyze the transactions.
c. Post the entries to the ledger.
d. Prepare the financial statements.
e. Adjust the accounts.
f. Record the transactions in the journal.
g. Prepare the post-closing trial balance.
h. Prepare the initial trial balance.
i. Prepare the adjusted trial balance.

Closing Revenue Accounts
SE 2. Assume that at the end of the accounting period there are credit balances
of $6,800 in Patient Services Revenues and $3,600 in Laboratory Fees Revenues.
Prepare the required closing entry in journal form. The accounting period ends
December 31.

Closing Expense Accounts
SE 3. Assume that debit balances at the end of the accounting period are $2,800
in Rent Expense, $2,200 in Wages Expense, and $1,000 in Other Expenses.
Prepare the required closing entry in journal form. The accounting period ends
December 31.

Closing the Income Summary Account
SE 4. Assuming that total revenues were $10,400 and total expenses were $6,000,
prepare the entry in journal form to close the Income Summary account to the R.
Shah, Capital account. The accounting period ends December 31.

Closing the Withdrawals Account
SE 5. Assuming that withdrawals during the accounting period were $1,600,
prepare the entry in journal form to close the R. Shah, Withdrawals account to
the R. Shah, Capital account. The accounting period ends December 31.

Posting Closing Entries
SE 6. Show the effects of the transactions in SE 2, SE 3, SE 4, and SE 5 by enter-
ing beginning balances in appropriate T accounts and recording the transactions.
Assume that the R. Shah, Capital account had a beginning balance of $1,300.

LO1

LO2
LO2
LO2
LO2
LO2

CHAPTER ASSIGNMENTS
BUILDING Your Basic Knowledge and Skills

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Chapter Assignments 163

Preparation of Reversing Entries
SE 7. Below, indicated by letters, are the adjusting entries at the end of March.

LO3

Account Name Debit Credit

Prepaid Insurance (a) 180
Accumulated Depreciation–Office Equipment (b) 1,050
Salaries Expense (c) 360
Insurance Expense (a) 180
Depreciation Expense–Office Equipment (b) 1,050
Salaries Payable (c) 360

1,590 1,590

Prepare the required reversing entry in journal form.

Effects of Reversing Entries
SE 8. Assume that prior to the adjustments in SE 7, Salaries Expense had a
debit balance of $1,800 and Salaries Payable had a zero balance. Prepare a
T account for each of these accounts. Enter the beginning balance; post the
adjustment for accrued salaries, the appropriate closing entry, and the reversing
entry; and enter the transaction in the T accounts for a payment of $480 for
salaries on April 3.

Preparation of Closing Entries
SE 9. The adjusted trial balance for Mendoza Company on December 31, 2011,
contains the following accounts and balances: C. Mendoza, Capital, $4,300; C.
Mendoza, Withdrawals, $175; Service Revenue, $1,300; Rent Expense, $200;
Wages Expense, $450; Utilities Expense, $100; and Telephone Expense, $25.
Prepare the closing entries.

Preparation of Closing Entries from a Work Sheet
SE 10. Prepare the required closing entries in journal form for the year
ended December 31, using the following items from the Income State-
ment columns of a work sheet and assuming that withdrawals by the owner,
T. Jameson, were $7,000:

LO3
LO2

LO2

LO4

Account Name Debit Credit

Repair Revenue 35,860
Wages Expense 13,260
Rent Expense 2,800
Supplies Expense 6,390
Insurance Expense 1,370
Depreciation Expense–Repair Equipment 3,020
26,840 35,860
Net Income 9,020
35,860 35,860

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164 CHAPTER 4 Completing the Accounting Cycle

SUPPLIES SUPPLIES EXPENSE
Dr. Cr. Dr. Cr.
9/1 Bal. 860 9/30 Adj. 1,280 9/30 Adj. 1,280 9/30 Closing 1,280
Sept. purchases 940 Bal. —
Bal. 520

WAGES PAYABLE WAGES EXPENSE
Dr. Cr. Dr. Cr.
9/30 Adj. 640 Sept. wages 3,940 9/30 Closing 4,580
Bal. 640 9/30 Adj. 640
Bal. —

Exercises

Discussion Questions
E 1. Develop brief answers to each of the following questions:
1. Why is the accounting cycle called a “cycle”?
2. Could closing entries be made without using the Income Summary account?
3. Why does the post-closing trial balance contain only balance sheet accounts?

Discussion Questions
E 2. Develop brief answers to each of the following questions:
1. Why are reversing entries helpful?
2. Under what circumstances would the Income Statement and Balance Sheet

columns on a work sheet balance when they are initially totaled?

Preparation of Closing Entries
E 3. The income statement accounts for the Monroe Realty Company at the end
of its fiscal year are shown below. Prepare the required closing entries in journal
form. Chris Ross is the owner.

Reversing Entries
E 4. Selected September T accounts for Hubbord Company are presented below.

LO1 LO2

LO3 LO4

LO2
LO3

1. In which of the accounts would a reversing entry be helpful? Why?
2. Prepare the appropriate reversing entry.
3. Prepare the entry to record a payment on October 25 for wages totaling

$3,140. How much of this amount represents wages expense for October?

Account Name Debit Credit

Commission Revenue $26,620
Wages Expense $9,110
Rent Expense 1,300
Supplies Expense 4,160
Insurance Expense 915
Depreciation Expense–Office Equipment 1,345
Total Expenses 16,830
Net Income $ 9,790

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Preparation of a Trial Balance
E 5. The following alphabetical list presents the accounts and balances for Sally’s
Cleaners on June 30, 2011. All the accounts have normal balances.

Accounts Payable $15,420
Accounts Receivable 7,650
Accumulated Depreciation–Office Equipment 1,350
Advertising Expense 1,800
Cash 7,635
Office Equipment 15,510
Prepaid Insurance 1,680
Rent Expense 7,200
Revenue from Commissions 57,900
S. Nash, Capital 30,630
S. Nash, Withdrawals 27,000
Supplies 825
Wages Expense 36,000

Prepare the trial balance by listing the accounts in the correct order, with the bal-
ances in the appropriate debit or credit column.

Completion of a Work Sheet
E 6. The following is a highly simplified alphabetical list of trial balance accounts
and their normal balances for the month ended March 31, 2011:

Accounts Payable $ 4
Accounts Receivable 7
Accumulated Depreciation–Office Equipment 1
Cash 4
J. Wells, Capital 12
J. Wells, Withdrawals 6
Office Equipment 8
Prepaid Insurance 2
Service Revenue 23
Supplies 4
Unearned Revenues 3
Utilities Expense 2
Wages Expense 10

1. Prepare a work sheet, entering the trial balance accounts in the order in which
they would normally appear and entering the balances in the correct debit or
credit column.

2. Complete the work sheet using the following information: expired insurance,
$1; estimated depreciation on office equipment, $1; accrued wages, $1; and
unused supplies on hand, $1. In addition, $2 of the unearned revenues bal-
ance had been earned by the end of the month.

Preparation of Statement of Owner’s Equity
E 7. The Capital, Withdrawals, and Income Summary accounts for Eva’s Hair
Salon are shown in T account form at the top of the next page. The closing
entries have been recorded for the year ended December 31, 2010.

LO2
LO4
LO4

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166 CHAPTER 4 Completing the Accounting Cycle

Preparation of Adjusting and Reversing Entries from Work Sheet Columns
E 8. The items that appear below are from the Adjustments columns of a work
sheet dated June 30, 2011.

1. Prepare the adjusting entries in journal form.
2. Where required, prepare appropriate reversing entries in journal form.

Preparation of Closing Entries from the Work Sheet
E 9. The items that follow are from the Income Statement columns of the
work sheet for Ben’s Repair Shop for the year ended December 31, 2011.
Prepare entries in journal form to close the revenue, expense, Income Summary,
and Withdrawals accounts. The owner, Ben Junkus, withdrew $6,000 during
the year.

LO3 LO4

LO2 LO4

Prepare a statement of owner’s equity for Eva’s Hair Salon.

E. KRISTEN, CAPITAL
Dr. Cr.
12/31/10 4,500 12/31/09 13,000

12/31/10 9,500
Bal. 18,000

INCOME SUMMARY
Dr. Cr.
12/31/10 21,500 12/31/10 31,000
12/31/10 9,500

Bal. —

E. KRISTEN, WITHDRAWALS
Dr. Cr.
4/1/10 1,500 12/31/10 4,500
7/1/10 1,500
10/1/10 1,500

Bal. —

Adjustments

Account Name Debit Credit

Prepaid Insurance (a) 240
Office Supplies (b) 630
Accumulated Depreciation–Office Equipment (c) 1,400
Accumulated Depreciation–Store Equipment (d) 2,200
Office Salaries Expense (e) 240
Store Salaries Expense (e) 480
Insurance Expense (a) 240
Office Supplies Expense (b) 630
Depreciation Expense–Office Equipment (c) 1,400
Depreciation Expense–Store Equipment (d) 2,200
Salaries Payable (e) 720

5,190 5,190

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Chapter Assignments 167

Adjusting Entries and Preparation of a Balance Sheet
E 10. In the partial work sheet for L. Wung Company that follows, the Trial
Balance and Income Statement columns have been completed. All amounts are
in dollars.

1. Show the adjustments that have been made in journal form without giving an
explanation.

2. Prepare a balance sheet for December 31, 2010.

LO4

Income Statement

Account Name Debit Credit

Repair Revenue 25,620
Wages Expense 8,110
Rent Expense 1,200
Supplies Expense 4,260
Insurance Expense 915
Depreciation Expense–Repair Equipment 1,345
15,830 25,620
Net Income 9,790
25,620 25,620

Trial Balance Income Statement

Account Name Debit Credit Debit Credit

Cash 14
Accounts Receivable 24
Supplies 22
Prepaid Insurance 16
Building 50
Accumulated
Depreciation–Building 16
Accounts Payable 8
Unearned Revenues 4
L. Wung, Capital 64
Revenues 88 92
Wages Expense 54 60
180 180
Insurance Expense 8
Supplies Expense 16
Depreciation Expense–
Building 4
Wages Payable
88 92
Net Income 4
92 92

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168 CHAPTER 4 Completing the Accounting Cycle

Problems
Preparation of Closing Entries
P 1. Affordable Trailer Rental rents small trailers by the day for local moving jobs.
This is its adjusted trial balance at the end of the current fiscal year:

Required
1. From the information given, record closing entries in journal form.
2. If closing entries were not prepared at the end of the accounting period, what

problems would result in the next accounting period?

Closing Entries Using T Accounts and Preparation of Financial Statements
P 2. The adjusted trial balance for Settles Tennis Club at the end of the company’s
fiscal year appears at the top of the next page.

Required
1. Prepare T accounts and enter the balances for B. Settles, Capital; B. Settles,

Withdrawals; Income Summary, and all revenue and expense accounts.
2. Enter the four required closing entries in the T accounts, labeling the com-

ponents a, b, c, and d, as appropriate.
3. Prepare an income statement, a statement of retained earnings, and a balance

sheet for Settles Tennis Club.
4. Explain why it is necessary to make closing entries at the end of an account-

ing period.
LO1 LO2

User insight �

LO1 LO2

Aff ordable Trailer Rental
Adjusted Trial Balance

June 30, 2011

Cash $ 692
Accounts Receivable 972
Supplies 119
Prepaid Insurance 360
Trailers 12,000
Accumulated Depreciation–Trailers $ 7,200
Accounts Payable 271
Wages Payable 200
A. Tropp, Capital 5,694
A. Tropp, Withdrawals 7,200
Trailer Rentals Revenue 45,546
Wages Expense 23,400
Insurance Expense 720
Supplies Expense 266
Depreciation Expense–Trailers 2,400
Other Expenses 10,782
$58,911 $58,911

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Chapter Assignments 169

Preparation of Closing Entries
P 3. Robert Half International, Inc. is a global specialized staffing firm. Infor-
mation adapted from the statement of earnings (in thousands, without earnings
per share information) in its annual report for the year ended December 31,
2005, follows.1 The firm reported distributing cash (dividends) in the amount of
$47,781,000 to the owners in 2005.

Revenues
Service revenues $3,338,439
Interest income 10,948
Total revenues $3,349,387
Expenses
Employee compensation and benefits $1,965,390
Selling, general, and administrative expenses 991,823
Income taxes 154,304
Total expenses $3,111,517
Net income $ 237,870

LO2

Settles Tennis Club
Adjusted Trial Balance

June 30, 2011

Cash $ 26,200
Prepaid Advertising 9,600
Supplies 1,200
Land 100,000
Building 645,200
Accumulated Depreciation–Building $ 260,000
Equipment 156,000
Accumulated Depreciation–Equipment 50,400
Accounts Payable 73,000
Wages Payable 9,000
Property Taxes Payable 22,500
Unearned Revenue–Locker Fees 3,000
B. Settles, Capital 471,150
B. Settles, Withdrawals 54,000
Revenue from Court Fees 678,100
Revenue from Locker Fees 9,600
Wages Expense 351,000
Maintenance Expense 51,600
Advertising Expense 39,750
Utilities Expense 64,800
Supplies Expense 6,000
Depreciation Expense–Building 30,000
Depreciation Expense–Equipment 12,000
Property Taxes Expense 22,500
Miscellaneous Expense 6,900
$1,576,750 $1,576,750

6,900

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170 CHAPTER 4 Completing the Accounting Cycle

Required
1. Enter the trial balance amounts in the Trial Balance columns of a work sheet

and complete the work sheet using the information that follows:
a. Expired insurance, $3,060.
b. Inventory of unused delivery supplies, $1,430.
c. Inventory of unused office supplies, $186.
d. Estimated depreciation on the building, $14,400.
e. Estimated depreciation on the trucks, $15,450.
f. Estimated depreciation on the office equipment, $2,700.
g. The company credits the lockbox fees of customers who pay in advance

to the Unearned Lockbox Fees account. Of the amount credited to this
account during the year, $5,630 had been earned by August 31.

Required
1. Prepare in journal form the closing entries Robert Half would have made on

December 31, 2005. Treat income taxes as an expense and cash distributions
to owners as withdrawals.

2. Based on your handling of requirement 1 and the effect of expenses and cash
distributions on owner’s capital, what theoretical reason can you give for not
including expenses and cash distributions in the same closing entry?

Preparation of a Work Sheet, Financial Statements, and Adjusting, Closing,
and Reversing Entries
P 4. At the end of the fiscal year, the trial balance of Reed Delivery Service
appeared as shown below.

LO2 LO3 LO4

Reed Delivery Service
Trial Balance

August 31, 2010

Cash $ 10,072
Accounts Receivable 29,314
Prepaid Insurance 5,340
Delivery Supplies 14,700
Offi ce Supplies 2,460
Land 15,000
Building 196,000
Accumulated Depreciation–Building $ 53,400
Trucks 103,800
Accumulated Depreciation–Trucks 30,900
Offi ce Equipment 15,900
Accumulated Depreciation–Offi ce Equipment 10,800
Accounts Payable 9,396
Unearned Lockbox Fees 8,340
Mortgage Payable 72,000
N. Reed, Capital 128,730
N. Reed, Withdrawals 30,000
Delivery Service Revenue 283,470
Lockbox Fees Earned 28,800
Truck Drivers’ Wages Expense 120,600
Offi ce Salaries Expense 44,400
Gas, Oil, and Truck Repairs Expense 31,050
Interest Expense 7,200
$625,836 $625,836

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h. Lockbox fees earned but unrecorded and uncollected at the end of the
accounting period, $816.

i. Accrued but unpaid truck drivers’ wages at the end of the year, $1,920.

2. Prepare an income statement, a statement of owner’s equity, and a balance
sheet for the company. Assume the owner, Natalie Reed, made no additional
investments.

3. Prepare adjusting, closing, and, when necessary, reversing entries from the
work sheet.

4. Can the work sheet be used as a substitute for the financial statements?
Explain your answer.

The Complete Accounting Cycle Without a Work Sheet: Two Months (second
month optional)
P 5. On May 1, 2011, Conrad Sayer opened Conrad’s Repair Service. During the
month, he completed the following transactions for the company:

May 1 Began business by depositing $5,000 in a bank account in the
name of the company.

1 Paid the rent for the store for current month, $425.
1 Paid the premium on a one-year insurance policy, $480.
2 Purchased repair equipment from Chmura Company, $4,200.

Terms were $600 down and $300 per month for one year. First
payment is due June 1.

5 Purchased repair supplies from Brown Company on credit,
$468.

8 Paid cash for an advertisement in a local newspaper, $60.
15 Received cash repair revenue for the first half of the month,

$400.
21 Paid Brown Company on account, $225.
31 Received cash repair revenue for the last half of May, $975.
31 Made a withdrawal, $300.

Required for May
1. Prepare journal entries to record the May transactions.
2. Open the following accounts: Cash (111); Prepaid Insurance (117);

Repair Supplies (119); Repair Equipment (144); Accumulated Depreciation–
Repair Equipment (145); Accounts Payable (212); C. Sayer, Capital (311);
C. Sayer, Withdrawals (313); Income Summary (314); Repair Revenue
(411); Store Rent Expense (511); Advertising Expense (512); Insurance
Expense (513); Repair Supplies Expense (514); and Depreciation Expense–
Repair Equipment (515). Post the May journal entries to the ledger
accounts.

3. Using the following information, record adjusting entries in the general
journal and post to the ledger accounts:
a. One month’s insurance has expired.
b. The remaining inventory of unused repair supplies is $169.
c. The estimated depreciation on repair equipment is $70.

4. From the accounts in the ledger, prepare an adjusted trial balance.
(Note: Normally, a trial balance is prepared before adjustments but is omitted
here to save time.)

5. From the adjusted trial balance, prepare an income statement, a statement of
owner’s equity, and a balance sheet for May.

6. Prepare and post closing entries.
7. Prepare a post-closing trial balance.

User insight �
LO1 LO2

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172 CHAPTER 4 Completing the Accounting Cycle

(Optional)
During June, Conrad Sayer completed these transactions for Conrad’s Repair
Service:

June 1 Paid the monthly rent, $425.
1 Made the monthly payment to Chmura Company, $300.
6 Purchased additional repair supplies on credit from Brown Com-

pany, $863.
15 Received cash repair revenue for the first half of the month,

$914.
20 Paid cash for an advertisement in the local newspaper, $60.
23 Paid Brown Company on account, $600.
30 Received cash repair revenue for the last half of the month,

$817.
30 Recorded a withdrawal by owner, $300.

8. Prepare and post journal entries to record the June transactions.
9. Using the following information, record adjusting entries in the general jour-

nal and post to the ledger accounts:
a. One month’s insurance has expired.
b. The inventory of unused repair supplies is $413.
c. The estimated depreciation on repair equipment is $70.

10. From the accounts in the ledger, prepare an adjusted trial balance.
11. From the adjusted trial balance, prepare the June income statement, state-

ment of owner’s equity, and balance sheet.
12. Prepare and post closing entries.
13. Prepare a post-closing trial balance.

Alternate Problems
Preparation of Closing Entries
P 6. The adjusted trial balance for Patch Consultant Company at the end of its
fiscal year is shown below.

LO1 LO2

Patch Consultant Company
Adjusted Trial Balance

December 31, 2011

Cash $ 7,275
Accounts Receivable 2,325
Prepaid Insurance 585
Offi ce Supplies 440
Offi ce Equipment 6,300
Accumulated Depreciation–Offi ce Equipment $ 765
Automobile 6,750
Accumulated Depreciation–Automobile 750
Accounts Payable 1,700
Unearned Consulting Fees 1,500
S. Patch, Capital 14,535
S. Patch, Withdrawals 7,000
Consulting Fees Earned 31,700
Offi ce Salaries Expense 13,500
Advertising Expense 2,525
Rent Expense 2,650
Telephone Expense 1,600
$50,950 $50,950

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Required
Prepare in journal form the required closing entries.

Preparation of a Work Sheet, Financial Statements,
and Adjusting and Closing Entries
P 8. Pierot Theater Company’s trial balance at the end of its current fiscal year is
shown at the top of the next page.

LO2 LO4

Required
1. Prepare the required closing entries.
2. Explain why closing entries are necessary at the end of the accounting

period.

Preparation of Closing Entries
P 7. The adjusted trial balance for Greg Painting Company at December 31,
2011, is provided below. The owner made no investments during the period.

User insight �
LO2

Chapter Assignments 173

Greg Painting Company
Adjusted Trial Balance

December 31, 2011

Cash $ 4,750
Accounts Receivable 2,592
Prepaid Insurance 380
Prepaid Rent 200
Painting Supplies 152
Painting Equipment 3,875
Accumulated Depreciation–Painting Equipment $ 320
Truck 7,200
Accumulated Depreciation–Truck 720
Accounts Payable 420
Wages Payable 295
Unearned Painting Revenue 1,690
G. Rak, Capital 15,034
G. Rak, Withdrawals 2,000
Painting Revenue 14,620
Wages Expense 5,680
Rent Expense 1,350
Gas, Oil, and Other Truck Expenses 580
Insurance Expense 380
Supplies Expense 2,920
Depreciation Expense–Painting Equipment 320
Depreciation Expense–Truck 720

$33,099 $33,099

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174 CHAPTER 4 Completing the Accounting Cycle

Required
1. Enter Pierot Theater Company’s trial balance amounts in the Trial Balance

columns of a work sheet and complete the work sheet using the following
information:
a. Expired insurance, $17,400.
b. Inventory of unused office supplies, $244.
c. Inventory of unused cleaning supplies, $468.
d. Estimated depreciation on the building, $14,000.
e. Estimated depreciation on the theater furnishings, $36,000.
f. Estimated depreciation on the office equipment, $3,160.
g. The company credits all gift books sold during the year to the Gift

Books Liability account. A gift book is a booklet of ticket coupons
that is purchased in advance as a gift. The recipient redeems the coupons
at some point in the future. On June 30 it was estimated that $37,800
worth of the gift books had been redeemed.

h. Accrued but unpaid usher wages at the end of the accounting period,
$860.

2. Prepare an income statement, a statement of owner’s equity, and a balance
sheet. Assume no additional investments by the owner, Pierot Rieu.

3. Prepare adjusting and closing entries from the work sheet.
4. Can the work sheet be used as a substitute for the financial statements?

Explain your answer.
User insight �

Pierot Theater Company
Trial Balance

June 30, 2010

Cash $ 31,800
Accounts Receivable 18,544
Prepaid Insurance 19,600
Offi ce Supplies 780
Cleaning Supplies 3,590
Land 20,000
Building 400,000
Accumulated Depreciation–Building $ 39,400
Theater Furnishings 370,000
Accumulated Depreciation–Theater Furnishings 65,000
Offi ce Equipment 31,600
Accumulated Depreciation–Offi ce Equipment 15,560
Accounts Payable 45,506
Gift Books Liability 41,900
Mortgage Payable 300,000
P. Rieu, Capital 312,648
P. Rieu, Withdrawals 60,000
Ticket Sales Revenue 411,400
Theater Rental Revenue 45,200
Usher Wages Expense 157,000
Offi ce Wages Expense 24,000
Utilities Expense 112,700
Interest Expense 27,000

$1,276,614 $1,276,614

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Preparation of Closing Entries
P 9. The adjusted trial balance for Burke Consultants Company at the end of its
fiscal year is shown below.

LO2

Chapter Assignments 175

Burke Consultants Company
Adjusted Trial Balance

December 31, 2010

Cash $ 7,575
Accounts Receivable 2,625
Prepaid Insurance 585
Offi ce Supplies 440
Offi ce Equipment 6,300
Accumulated Depreciation–Offi ce Equipment $ 765
Automobile 6,750
Accumulated Depreciation–Automobile 750
Accounts Payable 1,700
Unearned Consulting Fees 1,500
D. Burke, Capital 14,535
D. Burke, Withdrawals 7,000
Consulting Fees Earned 32,550
Offi ce Salaries Expense 13,500
Advertising Expense 2,525
Rent Expense 2,650
Telephone Expense 1,850
$51,800 $51,800

Required
Prepare in journal form the required closing entries for Burke Consultants
Company.

Preparation of Closing Entries
P 10. The adjusted trial balance for Van Rental Service at the end of its fiscal year
is shown on the next page.

Required
Prepare in journal form the required closing entries for Van Rental Service.

LO2

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176 CHAPTER 4 Completing the Accounting Cycle

ENHANCING Your Knowledge, Skills, and Critical Thinking

Interim Financial Statements
C 1. Offshore Drilling Company provides services for drilling operations off the coast
of Louisiana. The company has a significant amount of debt to Southern National
Bank in Baton Rouge. The bank requires the company to provide it with quarterly
financial statements. Explain what is involved in preparing financial statements every
quarter.

Purpose of Closing Entries
C 2. Maury Jacobs, owner of Jacobs Furniture Company, notices the amount
of time it takes the company’s accountant to prepare closing entries. He sug-
gests that the company could save time and money by not doing closing
entries. He argues that only adjusting entries are needed to determine the
company’s earnings. Explain the purposes of closing entries and why they are
worth doing.

Accounting Efficiency
C 3. Way Heaters Company manufactures industrial heaters used in making candy.
It sells its heaters to some customers on credit with generous terms specifying pay-
ment six months after purchase and an interest rate based on current bank rates.
Because the interest on the loans accrues a little every day but is not paid until the

LO1
LO1
LO1

Van Rental Service
Adjusted Trial Balance

December 31, 2010

Cash $ 10,215
Accounts Receivable 12,100
Prepaid Rent 13,000
Prepaid Insurance 4,700
Prepaid Maintenance 10,350
Spare Parts 11,520
Vans 310,000
Accumulated Depreciation–Vans $ 55,000
Notes Payable 48,730
Unearned Rental Revenue 35,500
R. Krazel, Capital 115,305
R. Krazel, Withdrawals 18,000
Rental Revenue 523,498
Gas and Oil Expense 87,100
Salaries Expense 202,710
Advertising Expense 36,800
Rent Expense 12,000
Insurance Expense 1,800
Spare Parts Expense 9,294
Depreciation Expense–Vans 27,500
Maintenance Expense 10,944
$778,033 $778,033

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note’s due date, an adjusting entry must be made at the end of each accounting
period to debit Interest Receivable and credit Interest Income for the amount
of the interest accrued but not received to date. The company prepares financial
statements every month. Keeping track of what has been accrued in the past is
time-consuming because the notes carry different dates and interest rates.

Form in-class groups to determine what the accountant can do to simplify the
process of making the adjusting entry for accrued interest each month. Compare
the groups’ solutions in a class discussion.

Ethics and Time Pressure
C 4. James Bear, an accountant for Rosa Company, has made adjusting entries
and is preparing the adjusted trial balance for the first six months of the year.
Financial statements must be delivered to the bank by 5 P.M. to support a criti-
cal loan agreement. By noon, Bear has been unable to balance the adjusted
trial balance. The figures are off by $1,320, so he increases the balance of the
owner’s Capital account by $1,320. He closes the accounts, prepares the state-
ments, and sends them to the bank on time. Bear hopes that no one will notice
the problem and believes that he can find the error and correct it by the end
of next month. Are Bear’s actions ethical? Why or why not? Did he have other
alternatives?

Fiscal Year, Closing Process, and Interim Reports
C 5. Refer to the notes to the financial statements in the CVS annual report in the
Supplement to Chapter 5. When does CVS end its fiscal year? For what reasons
might it have chosen this date? From the standpoint of completing the account-
ing cycle, what advantage does this date have? Does CVS prepare interim finan-
cial statements? What are the implications of interim financial statements for the
accounting cycle?

Interim Financial Reporting and Seasonality
C 6. Both CVS and Southwest Airlines provide quarterly financial informa-
tion in their financial statements. Quarterly financial reports provide impor-
tant information about the “seasonality” of a company’s operations. Seasonality
refers to how dependent a company is on sales during different seasons of the
year, and how that affects a company’s need to plan for cash flows and inven-
tory. From the quarterly financial information for CVS in the Supplement to
Chapter 5, determine the effects of seasons on CVS’s net revenues and net
earnings by calculating for the most recent year the percentage of quarterly net
sales and net earnings to annual net sales and net earnings. Discuss the results.
How do you think the effect of seasons might differ for Southwest’s operating
revenues and income?

LO1
LO1
LO1

This comprehensive problem involving Miller Design Studio covers all the learn-
ing objectives in this chapter and in the chapters on measuring business transac-
tions and measuring business income. To complete the problem, you may some-
times have to refer to this material.

The July 31, 2011, post-closing trial balance for the Miller Design Studio is
on the next page.

COMPREHENSIVE Problem: Miller Design Studio

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Title: Principles of Accounting Server: Jobs

C/M/Y/K
Short / Normal / Long
DESIGN SERVICES OF
S4CARLISLE
Publishing Services

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178 CHAPTER 4 Completing the Accounting Cycle

During August, the studio engaged in these transactions:

Aug. 1 Received an additional investment of cash from J. Miller,
$20,000.

2 Purchased additional office equipment with cash, $4,700.
7 Purchased additional office supplies for cash, $540.
8 Completed the series of designs that began on July 31 and billed

for the total design services performed, including the accrued rev-
enues of $800 that had been recognized in an adjusting entry in
July, $1,400.

12 Paid the amount due for the office equipment purchased last
month, $3,000.

13 Accepted an advance in cash for design work to be done,
$2,400.

15 Performed design services and received a cash fee, $2,900.
16 Received payment on account for design services performed last

month,

$2,800.

19 Made a partial payment on the utilities bill that was received and

recorded at the end of July, $140.
20 Performed design services for Rave Department Stores and

agreed to accept payment next month, $3,200.
21 Performed design services for cash, $1,160.
22 Received and paid the utilities bill for August, $900.
23 Paid the assistant for four weeks’ wages, $4,800.
26 Paid the rent for September in advance, $1,600.
30 Paid cash to J. Miller as a withdrawal for personal expenses,

$2,800.

Required
1. Record entries in journal form and post to the ledger accounts the optional

reversing entries on August 1 for Wages Payable and Accounts Receivable
(see adjustment for unrecorded wages on page 116 and adjustment for design
revenue on page 119). (Begin the general journal on page 5.)

2. Record the transactions for August in journal form.
3. Post the August transactions to the ledger accounts.
4. Prepare the Trial Balance columns of a work sheet.

Miller Design Studio
Post-Closing Trial Balance
July 31, 2011

$49,060 $49,060

# 103261 Cust: CENGAGE Au: Needles Pg. No. 178
Title: Principles of Accounting Server: Jobs

C/M/Y/K
Short / Normal / Long
DESIGN SERVICES OF
S4CARLISLE
Publishing Services

37744_04_ch04_p142-179.indd 17837744_04_ch04_p142-179.indd 178 12/2/09 5:39:54 PM12/2/09 5:39:54 PM

5. Prepare adjusting entries and complete the work sheet using the information
below.
a. One month’s prepaid rent has expired, $1,600.
b. An inventory of supplies reveals $2,020 still on hand on August 31.
c. Depreciation on equipment for August is calculated to be $300.
d. Services performed for which payment had been received in advance

totaled $1,300.
e. Services performed that will not be billed until September totaled $580.
f. Wages accrued by the end of August, $720.

6. From the work sheet, prepare an income statement, a statement of owner’s
equity, and a balance sheet for August 31, 2011.

7. Record the adjusting entries on August 31, 2011, in journal form, and post
them to the ledger accounts.

8. Record the closing entries on August 31, 2011, in journal form, and post
them to the ledger accounts.

9. Prepare a post-closing trial balance at August 31, 2011.

Chapter Assignments 179

# 103261 Cust: CENGAGE Au: Needles Pg. No. 179
Title: Principles of Accounting Server: Jobs

C/M/Y/K
Short / Normal / Long
DESIGN SERVICES OF
S4CARLISLE
Publishing Services

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>Ch4 CP

Date

Aug. 1

Name:

Course:

Date

Chapter 4, Comprehensive Problem

General Journal

Page 5

Post.

Description

Ref.

Debit

Credit

Reversing entries:

Aug.

Entries:

2011

Ch4 CP 2

General Journal

Post.
Date Description Ref. Debit Credit
2011

Aug.

			Chapter 4, Comprehensive Problem (Continued)
Page 6
	15
	16
		19
	21
	22
	23
	26
	30

Ch4 CP 3

Chapter 4, Comprehensive Problem (Continued)

Post.

Date

Ref. Debit Credit Debit Credit

2011

Aug. 1
2
7
12
13

16
19
21
22
23
26
30

Post. Balance
Date Item Ref. Debit Credit Debit Credit
2011

July 31

Aug. 1
8
16
20

Reversing entries prepared and posted

Transactions for August journalized and posted

7 and 8.

Adjusting and closing entries prepared and posted

General Ledger

Cash

Account No. 111

Balance

Item

July

800

22,480

Accounts Receivable

Account No. 113

400

5,000

Ch4 CP 4

Chapter 4, Comprehensive Problem (Continued)

Post. Balance
Date Item Ref. Debit Credit Debit Credit
2011

July 31

Aug. 7

Post. Balance
Date Item Ref. Debit Credit Debit Credit
2011

July 31

1,600

Aug. 26

Post. Balance
Date Item Ref. Debit Credit Debit Credit
2011

July 31

16,320

Aug. 2

Office Equipment

Post. Balance
Date Item Ref. Debit Credit Debit Credit
2011

July 31

300

Aug. 31

Post. Balance
Date Item Ref. Debit Credit Debit Credit
2011

July 31

Aug. 12

	Office Supplies	Account No. 115
3,660
	Prepaid Rent	Account No. 117
	1,	600
				Office Equipment	Account No. 146
			16,320
		Accumulated Depreciation—		Account No. 147
			300
		Accounts Payable		Account No. 212
	6,280

Ch4 CP 5

Chapter 4, Comprehensive Problem (Continued)
Office Equipment Account No. 146
Post. Balance
Date Item Ref. Debit Credit Debit Credit
2011
July 31 16,320 16,320
Aug. 2
Accumulated Depreciation—Office Equipment Account No. 147
Post. Balance
Date Item Ref. Debit Credit Debit Credit
2011
July 31 300 300
Aug. 31
Accounts Payable Account No. 212
Post. Balance
Date Item Ref. Debit Credit Debit Credit
2011
July 31 6,280
Aug. 12
19

Post. Balance
Date Item Ref. Debit Credit Debit Credit
2011

July 31 800 600
Aug. 13

Post. Balance
Date Item Ref. Debit Credit Debit Credit
2011

July 31

720

Aug. 1
31

Unearned		Design	Revenue	Account No. 213
	Wages Payable	Account No. 214
	720

Ch4 CP 6

Chapter 4, Comprehensive Problem (Continued)

Post. Balance
Date Item Ref. Debit Credit Debit Credit
2011

July 31

Aug. 1
31
31

Post. Balance
Date Item Ref. Debit Credit Debit Credit
2011

Aug. 30

Summary

Post. Balance
Date Item Ref. Debit Credit Debit Credit
2011
Aug. 31
31
31

Design Revenue

Post. Balance
Date Item Ref. Debit Credit Debit Credit
2011
Aug. 1
8
15
20
21
31
31
31

	J. Miller, Capital	Account No. 311
41,160
	J. Miller, Withdrawals	Account No. 312
	Income	Account No. 313
Account No. 411

Ch4 CP 7

Chapter 4, Comprehensive Problem (Continued)

Post. Balance
Date Item Ref. Debit Credit Debit Credit
2011
Aug. 1
23
31
31

Post. Balance
Date Item Ref. Debit Credit Debit Credit
2011

Aug. 22

Post. Balance
Date Item Ref. Debit Credit Debit Credit
2011
Aug. 31
31

Office Equipment

Post. Balance
Date Item Ref. Debit Credit Debit Credit
2011
Aug. 31
31

	Wages Expense	Account No. 511
	Utilities Expense	Account No. 512
	Rent Expense	Account No. 514
	Office Supplies Expense	Account No. 517
	Depreciation Expense—	Account No. 519

Ch4 CP 8

Chapter 4, Comprehensive Problem (Continued)

Income Balance

Trial Balance

Sheet

Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit

Cash
Accounts Receivable
Office Supplies
Prepaid Rent
Office Equipment
Accumulated Depreciation—

Office Equipment

Accounts Payable
J. Miller, Capital
J. Miller, Withdrawals
Design Revenue
Wages Expense
Utilities Expense
Rent Expense
Depreciation Expense—

Office Equipment

Wages Payable
Office Supplies Expense

`
4. Trial balance amounts entered on the work sheet
				Miller Design Studio
Work	Sheet
		For the Month Ended		August 31, 2011
Adjusted
	Trial Balance	Adjustments	Statement
Account Name
Unearned Design Revenue
Net Income

&C&”Helvetica,Bold”&12&A
&”Times New Roman,Regular”&9© 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Ch4 CP 9

Chapter 4, Comprehensive Problem (Continued)

Miller Design Studio

For the Month Ended August 31, 2011

Revenue

Miller Design Studio

For the Month Ended August 31, 2011

6.	Income statement, statement of owner’s equity, and balance sheet prepared
Income Statement
Expenses
Total expenses
Net income
Statement of	Owner’s Equity
J. Miller, capital, August 1, 2011
Subtotal
J. Miller, capital, August 31, 2011

Ch4 CP 10

Chapter 4, Comprehensive Problem (Continued)
Miller Design Studio

August 31, 2011
Owner’s Equity

Balance Sheet

Assets

Total assets

Liabilities

Total liabilities

Total owner’s equity

Total liabilities and owner’s equity

Ch4 CP 11

Chapter 4, Comprehensive Problem (Continued)

Post.
Date Description Ref. Debit Credit

2011

Aug. 31

31
31
31
31

Page 7
Adjusting entries:
–	=

Ch4 CP 12

Chapter 4, Comprehensive Problem (Continued)

General Journal

Post.

Date Description Ref. Debit Credit

2011
Aug. 31
31
31
31

Page 8

Closing entries:

Ch4 CP 13

Chapter 4, Comprehensive Problem (Continued)

Miller Design Studio

August 31, 2011

9.	Post-closing trial balance prepared
Post-Closing Trial Balance

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