Slide 1

REVIEW OF THE
ACCOUNTING CYCLE
CIA 1002 FOUNDATION IN FINANCIAL
ACCOUNTING AND REPORTING
SEMESTER 1, 2019/2020
 Slide 2

Outline

•  The basic accounting equation

•  Steps in the recording process
•  Basics of adjusting entries
•  The reporting phase
•  Accrual versus cash-basis accounting
 Slide 3

Accounting Information System

Debits and Credits

u  An account shows the effect of transactions on a given
asset, liability, equity, revenue, or expense account.

u  Double-entry accounting system (two-sided effect).

u  Recording done by debiting at least one account and

crediting another.

u  DEBITS must equal CREDITS.

 Slide 4

Debits and Credits

u  An arrangement that shows the

Account
effect of transactions on an
account.
u  Debit = “Left”
u  Credit = “Right”

An Account can be Account Name

illustrated in a T-
Debit / Dr. Credit / Cr.
Account form.
 Slide 5

Debits and Credits

If the sum of Debit entries are greater than the sum of

Credit entries, the account will have a debit balance.

Account Name
Debit / Dr. Credit / Cr.

Transaction #1 $10,000 $3,000 Transaction #2

Transaction #3 8,000

Balance $15,000
 Slide 6

Debits and Credits

If the sum of Debit entries are less than the sum of

Credit entries, the account will have a credit balance.

Account Name
Debit / Dr. Credit / Cr.

Transaction #1 $10,000 $3,000 Transaction #2

8,000 Transaction #3

Balance $1,000
 Slide 7

Debits and Credits Summary

Liabilities
Debit / Dr. Credit / Cr.
Normal Normal
Balance Balance
Debit Credit Normal Balance

Chapter
3-24

Assets Equity
Debit / Dr. Credit / Cr. Debit / Dr. Credit / Cr.

Normal Balance Normal Balance

Chapter Chapter
3-23

Expense
3-25
Revenue
Debit / Dr. Credit / Cr.
Debit / Dr. Credit / Cr.

Normal Balance
Normal Balance

Chapter
Chapter 3-26
3-27
 Slide 8

The Accounting Equation

A = L + OE
+ Revenue - Expenses
+ Owner Investments - Owner Withdrawals
+ Gains - Losses

•  The accounting equation underlies

the process used to capture the
effects of economic events.
•  Assets equal liabilities plus owners’
equity.
•  Each event, or transaction, has a dual
effect on the accounting equation.
McGraw-Hill /Irwin
 Slide 9

Accounting Equation for a Corporation

A = L + SE
+ Issued Capital + Retained Earnings

+ Revenues - Expenses - Dividends

+ Gains - Losses

•  Owners’ equity for a corporation, called

shareholders’ equity, is classified by source as
either issued capital or retained earnings.
•  Retained earnings equals net income less
distributions to shareholders (primarily
dividends) since the inception of the
McGraw-Hill /Irwin
corporation.
 Slide 10

Account Relationships
Debits and credits affect the Statement of
Financial Position Model as follows:

A = L + IC + RE
Issued Retained
Assets Liabilities Capital Earnings
Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
+ - - + - + - +

Permanent Accounts Revenues Expenses

and Gains and Losses
Temporary Accounts Dr. Cr. Dr. Cr.
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- + + -
 Slide 11

Account Relationships

•  The double-entry system is used to process

transactions.
•  In the double-entry system, debit means left side
of an account and credit means right side of an
account.
•  Whether a debit or a credit represents an increase
or decrease depends on the type of account.

McGraw-Hill /Irwin
 Slide 12

Account Relationships – con’t

•  Accounts on the left side of the accounting
equation (assets) are increased by debit entries
and decreased by credit entries.
•  Accounts on the right side of the equation
(liabilities and shareholders’ equity) are
increased by credit entries and decreased by
debit entries.
•  This arbitrary, but effective, procedure ensures that
for each transaction the net impact on the left
sides of the accounts always equals the net
impact on the right sides of accounts.

McGraw-Hill /Irwin
 Slide 13

Account Relationships – con’t

•  Notice that increases and decreases in retained
earnings are recorded indirectly in revenue, gain,
expense, and loss accounts.
•  For example, an expense represents a decrease
in retained earnings, which requires a debit.
•  That debit, however, is recorded in an appropriate
expense account rather than in retained earnings itself.
•  This allows the company to maintain a separate record
of expenses incurred during an accounting period.

McGraw-Hill /Irwin
 Slide 14

Account Relationships – con’t

•  The debit to retained earnings for the expense is
recorded in a closing entry (reviewed later) at the end
of the period, only after the expense total is reflected
in the income statement.
•  Similarly, an increase in retained earnings due to a
revenue is recorded indirectly with a credit to a
revenue account, which is later reflected as a credit to
retained earnings.

McGraw-Hill /Irwin
 Slide 15

Account Relationships – con’t

•  Permanent accounts (assets, liabilities, issued
capital and retained earnings) represent the basic
financial position elements of the accounting
equation.
•  Temporary accounts (revenues, gains, expenses
and losses) keep track of the changes in the
retained earnings component of shareholders’
equity.

McGraw-Hill /Irwin
 Slide 16

Account relationships-con’t

1.  Owners invest $40,000 in exchange for ordinary

shares.

= Liabilities + Equity
Assets

+ 40,000 + 40,000

McGraw-Hill /Irwin
 Slide 17

Account relationships-con’t

4. Received $4,000 cash for services performed.

Assets = Liabilities + Equity

+ 4,000 + 4,000
(revenue)

McGraw-Hill /Irwin
 During the Accounting Period Slide 18

Source Transaction Record in Post to

documents Analysis Journal Ledger

At the End of the Accounting Period

Financial Adjusted Record & Post Unadjusted

Statements Trial Balance Adjusting Trial Balance
Entries

The
At the End Accounting
of the Year Processing
Close Temporary Post-Closing
Cycle
McGraw-Hill /Irwin Accounts Trial Balance
 10 Steps in the Accounting Processing Cycle

•  Steps 1-4 take place during
the accounting period.
•  Step one: Obtain information
about external transactions from
source documents.
•  Step two: Analyze the
transaction.
•  Step three: Record the
transaction in a journal.
•  Step four: Post from the journal
to the general ledger.
•  Steps 5-8 occur at the end
of the accounting period.
•  Step five: Prepare an unadjusted
trial balance.
•  Step six: Record adjusting
entries and post to the general
ledger accounts.
•  Step seven: Prepare an adjusted
trial balance.
•  Step eight: Prepare financial
statements.

—  Steps 9 and 10 are required only at the end of the year.

◦  Step nine: Close the temporary accounts to retained earnings (at year-end
only).
◦  Step ten: Prepare a post-closing trial balance (at year-end only).

McGraw-Hill /Irwin © 2013 The McGraw-Hill Companies, Inc..

Journalizing

Recording transactions and events that effect particular asset,

liability, equity, revenue, and expense accounts.

September 1: Shareholders invested RM15,000 cash in the

corporation in exchange for ordinary shares.

McGraw-Hill /Irwin
Posting Journal Entries
Posting – The process of transferring amounts from the
journal to the ledger accounts.
ILLUSTRATION 3.7

McGraw-Hill /Irwin
 ILLUSTRATION 3.8
Posting a Journal
Entry

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After recording all entries for the period, Dress Right’s
Unadjusted Trial Balance would be as follows:

Dress Right Clothing Corporation

Unadjusted Trial Balance A Trial Balance
July 31, 2013
is a listing of all
Account Title Debits Credits
Cash $ 68,500
accounts and
Accounts receivable 2,000 their balances
Supplies 2,000 at a point in
Prepaid rent 24,000
Inventory 38,000 time.
Furniture and fixtures 12,000 Purpose: to check for
Accounts payable $ 35,000 completeness and to prove
Notes payable 40,000 that the sum of the
Unearned rent revenue 1,000 accounts with debit
Ordinary share capital 60,000 balances equals the sum of
the accounts with credit
Retained earnings 1,000
balances.
Sales revenue 38,500
Cost of goods sold 22,000
Salaries expense 5,000
Total $ 174,500 $ 174,500 Debits = Credits
McGraw-Hill /Irwin
 Slide 24

Adjusting Entries

Prepayments Accruals Estimates

(Deferrals)

Transactions where Transactions where

cash is paid or received cash is paid or received
before a related after a related expense
expense or revenue is or revenue is
recognized. recognized.

•  At the end of the period, some transactions or events remain

unrecorded.
•  Because of this, several accounts in the ledger need adjustments
before their balances appear in the financial statements.
•  Adjusting entries are necessary for three situations as above.
McGraw-Hill /Irwin
 Adjusting Entries for Prepayments/Deferrals

Prepayments are to record

u  Prepaid expenses: Expenses paid in cash before they are
used or consumed.

u  Unearned revenues: Cash received before services are

performed.

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Prepaid expenses

Prepaid Expenses. Assets paid for and recorded before a

company uses them.

Cash Payment BEFORE Expense Recorded

Prepayments often occur in regard to:

u  Insurance u  Rent
u  Supplies u  Buildings and equipment
u  Advertising

McGraw-Hill /Irwin
 Slide 27

Prepaid Expenses
For example, a company may pay $60,000 for rent for the next 6
months. In this case, the cash payment precedes the expense
recognition.
•  The entry at the payment date: debit to the Prepaid Rent
(asset), and a credit to Cash.
•  At the end of the period, an adjusting entry is required to
record the amount of rent used during the period.
•  The adjusting entry: debit to Rent Expense and a credit to
Prepaid Rent for the amount of the rent used during the
period.

McGraw-Hill /Irwin
 Slide 28

Prepaid Expenses
Asset Expense
Unadjusted Credit Debit
Balance Adjustment Adjustment

Today, I will
pay
for my first
6 months’ rent.
Prepaid Expenses
Items paid for in advance
of receiving their benefits

McGraw-Hill /Irwin
Prepaid expenses

Insurance. On Oct. 4th, Yazici Advertising paid RM6,000 for a

one-year fire insurance policy, beginning October 1. Show the
entry to record the purchase of the insurance.

Oct. 4 Prepaid Insurance 6,000

Cash 6,000

Prepaid Insurance Cash

Debit Credit Debit Credit
6,000 6,000

McGraw-Hill /Irwin
Adjusting Entries for prepaid expenses

Insurance. An analysis of the policy reveals that RM500

("6,000 ÷ 12) of insurance expires each month. Thus,
Yazici makes the following adjusting entry.
Oct. 31 Insurance Expense 500
Prepaid Insurance 500

Prepaid Insurance Insurance Expense

Debit Credit Debit Credit
6,000 500 500

5,500
McGraw-Hill /Irwin
ILLUSTRATION 3.24
Adjustment for Insurance

McGraw-Hill /Irwin
Adjusting Entries for
prepaid expenses

Statement
Presentation:
Prepaid Insurance
represents the
unexpired cost for the
remaining 11 months
of coverage.

ILLUSTRATION 3.37
McGraw-Hill /Irwin
 Adjusting Entries for prepaid expenses

Statement
Presentation:
Insurance
expense identifies
that portion of the
asset’s cost that
expired in
October.

ILLUSTRATION 3.36

McGraw-Hill /Irwin
Unearned revenues

Receipt of cash before the services are performed is recorded

as a liability called unearned revenues.

Cash Receipt BEFORE Revenue Recorded

Unearned revenues often occur in regard to:

u  Rent
u  Airline tickets
u  Magazine subscriptions
u  Customer deposits

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 Slide 35

Unearned Revenues

Liability Revenue
Debit Unadjusted Credit
Adjustment Balance Adjustment

McGraw-Hill /Irwin
Adjusting Entries for unearned revenue

Unearned Revenue. Yazici Advertising received "12,000 on

October 2 from KC for advertising services expected to be
completed by December 31. Show the journal entry to record
the receipt on Oct. 2nd.

Oct. 2 Cash 12,000

Unearned Service Revenue 12,000

Cash Unearned Service Revenue

Debit Credit Debit Credit
12,000 12,000

McGraw-Hill /Irwin
Adjusting Entries for unearned revenue

Unearned Revenues. An evaluation of the service Yazici

performed for KC during October, the company determines that
it should recognize "4,000 of revenue in October.

Oct. 31 Unearned Service Revenue 4,000

Service Revenue 4,000

Service Revenue Unearned Service Revenue

Debit Credit Debit Credit
100,000 4,000 12,000
4,000
104,000 8,000
McGraw-Hill /Irwin
ILLUSTRATION 3.27
Adjustment for Unearned Service Revenue

McGraw-Hill /Irwin
Adjusting Entries for
Unearned Revenue

Statement
Presentation:
Unearned service
revenue represents the
remaining advertising
services expected to be
performed in the future.

ILLUSTRATION 3.37
McGraw-Hill /Irwin
 Adjusting Entries for Unearned Revenue

Statement
Presentation:
Service revenue
shows total revenue
recognized in
October.

ILLUSTRATION 3.36

McGraw-Hill /Irwin
 Slide 41

Alternative Approach to Record Prepayments

Prepaid Expenses Unearned Revenue
Record initial cash Record initial cash receipts
payments as follows: as follows:
Expense $$$ Cash $$$
Cash $$$ Revenue $$$
Adjusting Entry Adjusting Entry
Record the amount for the Record the amount for the
prepaid expense as unearned liability as
follows: follows:
Prepaid expense $$$ Revenue $$$
Expense $$$ Unearned revenue $$$
The same end result can be achieved for prepayments by recording the external transaction directly into an
expense or revenue account. The adjusting entry then records the unexpired prepaid expense (asset)
or unearned revenue (liability) as of the end of the period. Under either approach, the net effect of the
transactions are the same.
McGraw-Hill /Irwin
 Slide 42

Example Alternative Approach

•  Advertising expense listed on the unadjusted trial balance
is RM12,000.This amount included RM2,000 of
advertising expense that was paid in advance. What is the
adjusting entry required for this item:

Dt Prepaid advertising RM2,000

Ct Advertising expense RM2,000

McGraw-Hill /Irwin
 Adjusting Entries for Accruals

Accruals are made to record

u  Accrued revenues: revenues for services performed but
not yet received in cash or recorded and

u  Accrued expenses: expenses incurred but not yet paid in

cash or recorded in the in the current accounting period.

Without an accrual adjustment, the

u  revenue account (and the related asset account) or the

u  expense account (and the related liability account) are

understated.

McGraw-Hill /Irwin
Adjusting Entries for Accruals

Revenues recorded for services performed for which cash has

yet to be received at statement date are accrued revenues.

Adjusting entry results in:

Revenue Recorded BEFORE Cash Receipt

Accrued revenues often occur in regard to:

u  Rent
u  Interest
u  Services performed

McGraw-Hill /Irwin
Adjusting Entries for Accruals

Accrued Revenues. In October Yazici Advertising performed

services worth RM2,000 that were not billed to clients on or
before October 31. Yazici makes the following adjusting entry.
Oct. 31 Accounts Receivable 2,000
Service Revenue 2,000

Accounts Receivable Service Revenue

Debit Credit Debit Credit
72,000 100,000
2,000 4,000
2,000
74,000 106,000
McGraw-Hill /Irwin
 ILLUSTRATION 3.29
Accrual Adjustment for Receivable and Revenue Accounts
McGraw-Hill /Irwin
 Adjusting Entries
for Accruals

ILLUSTRATION 3.36

ILLUSTRATION 3.37
McGraw-Hill /Irwin
Adjusting Entries for Accrued expenses

Expenses incurred but not yet paid in cash or recorded.

Adjusting entry results in:

Expense Recorded BEFORE Cash Payment

Accrued expenses often occur in regard to:

u  Rent
u  Interest
u  Taxes
u  Salaries

McGraw-Hill /Irwin
 Slide 49

Accrued expenses
Expense Liability
Debit Credit
Adjustment Adjustment

I won’t pay you Accrued Liabilities

until the job is done! Liabilities recorded when an
expense has been incurred
prior to cash payment (e.g.
salaries owed at the end of
an accounting period).

McGraw-Hill /Irwin
Adjusting Entries for accrued expenses

Accrued Salaries. At October 31, the salaries and wages for

these days represent an accrued expense and a related liability to
Yazici. The employees receive total salaries of ″10,000 for a five-
day work week, or ″2,000 per day.

ILLUSTRATION 3.32
Accrued Salaries and Wages
McGraw-Hill /Irwin
Adjusting Entries for a accrued expenses

Accrued Salaries. Employees receive total salaries of "10,000

for a five-day work week, or "2,000 per day. Prepare the
adjusting entry on Oct. 31 to record accrual for salaries.

Oct. 31 Salaries and Wages Expense 6,000

Salaries and Wages Payable 6,000

Salaries and Wages Expense Salaries and Wages Payable

Debit Credit Debit Credit
40,000 6,000
6,000

46,000
LO 3
McGraw-Hill /Irwin
ILLUSTRATION 3.33
Adjustment for Salaries and Wages Expense
LO 3
McGraw-Hill /Irwin
 Slide 53

Estimates
•  Uncollectible accounts
and depreciation of
fixed assets are
estimated.
•  Why? To comply with the accrual
accounting model.

•  An estimated item is a
function of future $
events and
developments.

McGraw-Hill /Irwin
 Slide 54

Estimates
The estimate of bad debt expense at the end of the
period is an example of an adjusting entry that requires
an estimate.
Assume that Dress Right’s management determines
that of the $2,000 of accounts receivable recorded at
July 31, only $1,500 will ultimately be collected. Prepare
the adjusting entry for July 31.

GENERAL JOURNAL Page 30

Post.
Date Description Ref. Debit Credit
July 31 Bad Debt Expense 500
Allowance for Uncollectible
Accounts 500
McGraw-Hill /Irwin
 Slide 55

Depreciation
Depreciation is the process of computing expense by
allocating the cost of plant and equipment over their
expected useful lives.

Straight-Line Asset Cost - Salvage Value

Depreciation =
Expense Useful Life

McGraw-Hill /Irwin
 Slide 56

Depreciation
Recall the Furniture and Fixtures for $12,000 listed on
Dress Right’s unadjusted trial balance. Assume the
following:

Asset Cost $ 12,000

Salvage Value -
Useful Life 60 months

Let’s calculate the depreciation expense for the month

ended July 31, 2013.

McGraw-Hill /Irwin
 Slide 57

Depreciation
Recall the Furniture and Fixtures for $12,000 listed on
Dress Right’s unadjusted trial balance.
Asset Cost $ 12,000
Salvage Value -
Useful Life 60 months

July $12,000 - $0
Depreciation = = $200 per month
Expense 60 months
GENERAL JOURNAL Page 2
Da te De scription PR De bit Cre dit
July 31 De pre cia tion Ex pe nse 200
Accumula te d De pr. -
Furniture & Fix ture s 200
To r ecor d depr eci a ti on

Accumulated Depreciation is a contra asset account to the asset account Furniture and
Fixtures. The normal balance in a contra asset account will be a credit, that is, “contra,”
or opposite, to the normal debit balance in an asset account.
McGraw-Hill /Irwin
 Slide 58

Depreciation
After posting, the accounts look like this:

Furniture and Fixtures Depreciation Expense

Beg. bal. - Beg. bal. -
12,000 200
Bal. 12,000 Bal. 200

Accumulated Depreciation
- Beg. bal.
200
200 Bal.

•  After posting the depreciation adjusting entry, the Depreciation

Expense account has a $200 debit balance and the
Accumulated Depreciation account has a $200 credit balance.
•  Notice that the balance in the Furniture and Fixtures account is
unchanged by the adjusting entry.
McGraw-Hill /Irwin
 DRESS RIGHT CLOTHING CORPORATION
Adjusted Trial Balance
July 31, 2013
Account Title Debits Credits This is the Adjusted
Cash $ 68,500 Trial Balance for
Accounts receivable 2,000
Allowance for uncollectible accounts $ 500 Dress Right after all
Supplies 1,200
Prepaid rent 22,000
adjusting entries have
Inventory 38,000 been recorded and
Furniture and fixtures 12,000
Accumulated depr.-furniture & fixtures 200 posted.
Accounts payable 35,000
Note payable 40,000
Unearned rent revenue 750
Salaries payable 5,500 Dress Right will use
Interest payable
Ordinary share capital
333
60,000
these balances to
Retained earnings 1,000 prepare the financial
Sales revenue 38,500
Rent revenue 250 statements.
Cost of goods sold 22,000
Salaries expense 10,500
Supplies expense 800
Rent expense 2,000
Depreciation expense 200
Interest expense 333
Bad debt expense 500
Totals $ 181,033 $ 181,033
McGraw-Hill /Irwin
Preparing Financial Statements

Financial Statements are prepared directly from the

Adjusted Trial Balance.

Statement of Statement of
Income
Changes in Financial
Statement
Equity Position

McGraw-Hill /Irwin
 Statement of Changes in Equity For the month ended 31 October,
2019

ILLUSTRATION 3.36 Preparation of the Income

Statement and Retained Earnings Statement from
the Adjusted Trial Balance
McGraw-Hill /Irwin
 ILLUSTRATION 3.37
Preparation of the Statement of Financial Position from the Adjusted Trial Balance

McGraw-Hill /Irwin
 Closing

Closing Process
u  Reduce the balance of nominal (temporary) accounts to zero
in preparation for the next period’s transactions.

u  Transfer all revenue and expense account balances (income

statement accounts) to an account called Income Summary.

u  Income Summary balance is then transferred Retained

Earnings.

u  Statement of financial position (asset, liability, and equity)

accounts are not closed.

u  Dividends are closed directly to Retained Earnings.

McGraw-Hill /Irwin
 Closing Journal Entries
Closing Entries
Service Revenue 106,000
Income Summary 106,000

Income Summary 73,000

Salaries & Wages Expense 46,000
Supplies Expense 15,000
Rent Expense 9,000
Insurance Expense 500
Interest Expense 500
Depreciation Expense 400
Bad Debt Expense 1,600

Income Summary 33,000

Retained Earnings 33,000

Retained Earnings 5,000

Dividends 5,000
ILLUSTRATION 3.35

McGraw-Hill /Irwin
 ILLUSTRATION 3.39
Posting of Closing Entries

McGraw-Hill /Irwin
Post-Closing Trial Balance
After the closing entries are posted to the ledger accounts, a post-closing trial
balance is prepared. The purpose of this trial balance is to verify that the
closing entries were prepared and posted correctly and that the accounts are
now ready for next year’s transactions.
Lists
permanent
accounts and
their balances.

McGraw-Hill /Irwin
 Slide 67

Statement of comprehensive income

•  All items of income and expense recognised in an
accounting period must be presented in either:
a) a single statement of comprehensive income, or
(b) two separate statements, comprising:
(i) a statement showing the components of profit or loss, and
(ii) a second statement beginning with the profit or loss for the period
and showing the entity's "other comprehensive income".

McGraw-Hill /Irwin
 Slide 68

Dress Right Clothing Corporation

Income Statement
For Month Ended July 31, 2013
Sales revenue $ 38,500
Cost of goods sold 22,000
Gross profit 16,500
Other expenses:
Salaries $ 10,500
Supplies 800
Rent 2,000
Depreciation 200
Bad debt 500
Total operating expenses 14,000
Operating income 2,500
Other income (expense):
Rent revenue 250
Interest expense (333) (83)
Net income $ 2,417

The income statement summarizes the results

of operating activities of the company.
McGraw-Hill /Irwin
 Slide 69

Dress Right Clothing Corporation

Statement of Financial Position
At July 31, 2013
Assets
Current assets:
Cash $ 68,500
Accounts receivable $ 2,000
Less: Allowance for uncollectible accounts 500 1,500
Supplies 1,200
Inventory 38,000
Prepaid rent 22,000
Total current assets 131,200
Property and equipment:
Furniture and fixtures 12,000
Less: Accumulated depreciation 200 11,800
Total assets $ 143,000

The Statement of Financial Position presents the

financial position of the company on a particular date.
McGraw-Hill /Irwin
 Slide 70

Dress Right Clothing Corporation

Statement of Financial Position
At July 31, 2013
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable $ 35,000
Salaries payable 5,500
Unearned rent revenue 750
Interest payable 333
Note payable 10,000
Total current liabilities 51,583
Long-term liabilities:
Note payable 30,000
Shareholders' equity:
Ordinary share captal $ 60,000
Retained earnings 1,417
Total shareholders' equity 61,417
Total liabilities and shareholders' equity $ 143,000

Notice that assets of $143,000 equal total

liabilities plus shareholders’ equity of $143,000.
McGraw-Hill /Irwin
 Slide 71

Dress Right Clothing Corporation

Statement of Cash Flows
For the Month of July 2013
Cash flows from operating activities:
Cash inflows:
From customers $ 36,500
From rent 1,000
Cash outflows:
For rent (24,000)
For supplies (2,000)
To suppliers for merchandise (25,000)
To employees (5,000)
Net cash used by operating activities $ (18,500)
Cash flows from investing activities:
Purchase of furniture and fixtures (12,000)
Cash flows from financing activities:
Issue of ordinary shares $ 60,000
Increase in notes payable 40,000
Payment of cash dividend (1,000)
Net cash provided by financing activities 99,000
Net increase in cash $ 68,500

The statement of cash flows discloses

the changes in cash during a period.
McGraw-Hill /Irwin
 Slide 72

Statement of changes in equity

•  shows how each component of equity has changed
during an accounting period
•  items presented include:
•  total comprehensive income for the period;
•  effects of any changes in accounting policies;
•  share issues; and
•  dividends paid.
•  provides a reconciliation of the opening and closing
balance on each component of equity

McGraw-Hill /Irwin
 Slide 73

Dress Right Clothing Corporation

Statement of Changes in Equity
For the Month of July 2013
Total
Ordinary Share Retained Shareholders'
Capital Earnings Equity
Balance at July 1, 2013 $ - $ - $ -
Issue of ordinary shares 60,000 60,000
Net income for July 2013 2,417 2,417
Less: Dividends (1,000) (1,000)
Balance at July 31, 2013 $ 60,000 $ 1,417 $ 61,417

The statement of changes in equity presents

the changes in permanent shareholder
accounts.

McGraw-Hill /Irwin
 Slide 74

Temporary and Permanent Accounts

Revenues Assets

Sharehold
Liabilities
Dividends
Expenses

Equity
ers’
Temporary Permanent
Accounts Accounts

Income The closing process applies

Summary only to temporary accounts.
•  Recall that step 9 of the accounting processing cycle is to close temporary
accounts to retained earnings.
•  The closing process serves a dual purpose.
Ø  First, the temporary accounts are reduced to zero balances, ready to measure activity in
the upcoming accounting period.
Ø  Second, these temporary account balances are closed (transferred) to retained earnings
to reflect the changes that have occurred in that account during the period.
McGraw-Hill /Irwin
 Slide 75

Accrual versus cash-basis accounting

•  Accrual-basis accounting

Ø Revenues are recognized when they earned and realizable, not wait until
cash is collected.
Ø Expenses are recognized when they occur or are consumed, not wait until
they are paid for.

Ø Measurement of revenues and expenses, regardless of when cash is

received or paid.
Ø Difference is net profit or net loss
•  Cash-basis accounting

Ø record revenue only when they receive cash, and record expenses only
when they disperse cash
Ø Difference is net operating cash flow.

•  IFRS and GAAP mandate the use of accrual method for recording all
revenue and expenses.
Ø The accrual accounting concept is rooted in matching principle.

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Cash Versus Accrual Accounting

•  Carter Company has sales on account totaling $100,000
per year for three years.
•  Carter collected $50,000 in the first year and $125,000 in
the second and third years.
•  The company prepaid $60,000 for three years’ rent in the
first year.
•  Utilities are $10,000 per year, but in the first year only
$5,000 was paid.
•  In the second year, the total of $15,000 was paid for the
utilities.
•  Payments to employees are $50,000 per year.
•  Let’s look at the cash flows.

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Slide 77

Cash Basis Example

•  Carter company paid $60,000 for 3 years’ rent at the
beginning of year 1.
•  Under cash basis accounting, the rent payment is
shown when paid.
Year 1 Year 2 Year 3 Total
Sales (on credit) $100,000 $100,000 $100,000 $300,000
Net Operating Cash Flows
Cash receipts from customers $ 50,000 $125,000 $125,000 $300,000
Cash disbursements:
Prepayment of three years’ rent (60,000) –0– –0– (60,000)
Salaries to employees (50,000) (50,000) (50,000) (150,000)
Utilities (5,000) (15,000) (10,000) (30,000)
Net operating cash flow $(65,000) $ 60,000 $ 65,000 $ 60,000

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Slide 78

Accrual Basis Example

•  Carter company paid $60,000 for three years’ rent at
the beginning of year 1.
•  Under accrual basis accounting, rent is recognized
as an expense in all three years even though it
was paid in year 1.
CARTER COMPANY
Statements of Profit or Loss
Year 1 Year 2 Year 3 Total

Revenues $100,000 $100,000 $100,000 $300,000

Expenses:
Rent 20,000 20,000 20,000 60,000
Salaries 50,000 50,000 50,000 150,000
Utilities 10,000 10,000 10,000 30,000
Total expenses 80,000 80,000 80,000 240,000
Net profit $ 20,000 $ 20,000 $ 20,000 $ 60,000

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Cash Basis Accounting

Summary of Cash Flows

Year 1 Year 2 Year 3 Total
Cash receipts from
customers $ 50,000 $ 125,000 $ 125,000 $ 300,000
Payment of 3
years' rent (60,000) - - (60,000)
Salaries to
employees (50,000) (50,000) (50,000) (150,000)
Payments for
utilities (5,000) (15,000) (10,000) (30,000)
Net cash flow $ (65,000) $ 60,000 $ 65,000 $ 60,000

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Accrual Accounting
Summary of Operations
Year 1 Year 2 Year 3 Total

Revenue $ 100,000 $ 100,000 $ 100,000 $ 300,000

Rent expense (20,000) (20,000) (20,000) (60,000)

Salary expense (50,000) (50,000) (50,000) (150,000)

Utility expense (10,000) (10,000) (10,000) (30,000)

Income $ 20,000 $ 20,000 $ 20,000 $ 60,000

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Cash Basis vs. Accrual Basis Accounting

•  Looking at the cash-basis and the accrual-basis
results for Carter Company, which method would
you want to use if you were asked to make
predictions about future years’ operating
performance?

Accrual-basis earnings is a more accurate

measure of performance than cash- basis
earnings.

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END OF LECTURE