1

:2
: 22
Accounting Cycle

Due to the complexity of tabular analysis, in addition to the fact that companies are exposed to hundreds or
even thousands of daily transactions, which makes the previous tabular analysis discussed in the previous
lecture an impractical method to achieve the accountant’s goal of preparing financial statements.
This prompted accountants to set up a system consisting of 8 sequential steps to be implemented in each
accounting period called “Accounting Cycle”.

Now let's go through these steps in detail:

 2
1 Identify transactions
Here the accountant tries to answer two questions

Is the event an accounting transaction? Which accounts? & what is the direction of the changes?
You know that there are 3 conditions (discussed before) We have 5 accounts categories (A, L, O.E, R & E) and
to record a transaction: each category contains several accounts.
1- The company is a party of the transaction. Any transaction affects at least two accounts
2- To be monetary measurable. (sometimes more than two accounts). One of them
3- To be completed and accomplished (change in Accounts) increases and the other decreases, the important
thing is that the equation remains balanced.

Accountants have agreed to use two other terms (instead of increase & decrease):

You know that:

Assets = Liabilities + O.E + Revenue – Expenses – Drawings

If we transfer expenses & drawings to the other side, All accounts will be classified into two opposing groups:

DEBIT Assets Liabilities CREDIT

By nature Expenses O.E By nature
(Dr.) Drawings Revenue (Cr.)

+ Increase Dr. Cr. Increase +

(-) Decrease Cr. Dr. Decrease (-)
So:
When an accout increases, it takes the same nature. When an accout decreases, it takes the opposite nature.
Also:
Debit means increase in AED or decrease in LOR Credit means increase in LOR & decrease in AED
Now:
What will be happen if cash increased?
In this case you should remember that cash is an asset, which is Debit by nature, so an increase in cash makes it debit.
This is how you think about it (analyzing) and then go straight to the next step of recording that transaction in
your general journal (the next step in accounting cycle).
 3
These are most of the accounts that we'll deal with until the ninth lecture:

1- Land 20- Loan

2- Building 21- Accounts Payable (AP)
3- Equipment (Machines) + Dr. [Link]
+ 22- Notes Payable (NP)
4- Furniture salarieccccs 23- Expense Payable ☻
5- Cars (Trucks) 24- Unearned Revenue ☻
6- Cash (in cash or check)
7- Accounts Receivable (AR)
8- Notes Receivable (NR)
9- Inventory - Cr. Dr. -
10- Supplies 25- Capital
11- Prepaid expense ☻

12- wages and salaries 26- Sales revenue

13- Utilities expense 27- Fees revenue
14- Tax expense 28- Services revenue (SR)
15- Insurance expense 29- Commissions revenue
16- Interest expense + Dr. Cr. + 30- Interest revenue
17- Rent expense 31- Rent revenue
18- Used Supplies 32- Dividends revenue
19- Depreciation ☻ 33- Royalties revenue

Don’t miss (34- Drawings) which is always (Dr.)

☻ What is a prepaid expense? Why it is an asset?

☻ What is a Depreciation? Why it is an expense?
These accounts will be explained in detail after 2 lectures.
☻ What is an Expense Payable? Why it is a liability?
☻ What is an Unearned Revenue? Why it is a liability?

1) prepaid expense 2) Depreciation

Companies make prepayments for goods or services such The purpose of recording depreciation as an expense is to
as: paid rent (insurance) 2 years in advance. allocat the initial price of the asset over its useful life. Such
as: Truck depreciation, Equip. Depreciation …… etc.

3) Expense Payable 4) Unearned Revenue

Also called Accrued expenses, which are expenses not paid Here, we collect cash before providing services. It is
yet. treated as a liability because the revenue has still not been
earned and it represents products or services owed to a
customer.
 4
2 Record Journal Entries
After Analyzing the trnasaction in our mind (which accounts are affected? How much? which one is Dr. & which one is Cr.?), we record
it in the General Journal (Journalizing):
➢ The Journal : Book of original entry.
➢ Transactions recorded in the General Journal in a chronological order (sorted by time).
➢ Double-entry accounting system: Each transaction has two parties (sides), one is debit and the other is credit
with same value to keep the basic accounting equation in balance.
➢ Therefore, recording a journal entry is done by debiting at least one account and crediting another.
➢ Debit side must equal Credit side.

The General Journal is a table with 4 colmn:

Date Description Debit Credit
Debited Account XX
1/1
Credited Account XX

Applying to the previous example:

Transactions Analyzing (in your mind)
=
Date Description Debit Credit
1- Invested $
10,000 cash in Cash + 10,000 (A) Dr. Cash 10,000
2/1
business. Capital + 10,000 (O.E) Cr. Capital 10,000
2- Purchased used car for Car + 4,000 (A) Dr. Car 4,000
3/1
$
4,000 cash for use in business. Cash (-) 4,000 (A) Cr. Cash 4,000
3- Purchased supplies on Supplies + 500 (A) Dr. Supplies 500
9/1
account for $500. AP + 500 (L) Cr. AP 500
4- Billed customers $
1,800 for AR + 1,800 (A) Dr. AR 1,800
11/1
services performed. Service Revenue + 1,800 (R) Cr. Service Revenue 1,800
5- Paid $
200 cash for Ads. ex. + 200 (E) Dr. Ads. Espense 200
16/1
advertising. Cash (-) 200 (A) Cr. Cash 200
6- Received $700 cash from Cash + 700 (A) Dr. Cash 700
20/1
customers billed on Jan. 11 (4). AR (-) 700 (A) Cr. AR 700
7- Paid creditor $
300 cash on Cash (-) 300 (A) Cr. AP 300
23/1
balance owed. AP (-) 300 (L) Dr. Cash 300
8- Withdrew 1,000 cash for
$
Cash (-) 1,000 (A) Cr. Drawings 1,000
28/1
personal use by owner. Drawings + 1,000 (- O.E) Dr. Cash 1,000

Important Notes:
• All entries in this example are simple entries (only 1 account is debit & 1 account is credit), but there are compounded entries
which contain more than 1 account in the debit side or in the credit side or in both of them. In general, whatever the number of
accounts is in any side, the values must be balanced (total Dr. amount = total Cr. amount).
Simple entry Compound entry
Assume that on July 1, Butler Company purchased a delivery Assume that on July 1, Butler Company purchased a delivery
truck at a cost of $35,000 cash. truck at a cost of $35,000. It paid $15,000 cash now and
agreed to pay the remaining on account.

Truck 35,000 Truck 35,000

cash 35,000 cash 15,000
AP (complementary) 20,000

• Big companies use a Chart of Accounts which includes all the Accounts currently used or expected to be used in the Company’s
accounting system, those accounts are arranged in sequence, as presented in the financial statements. Every account takes a
reference number.
 5
3 Posting to Ledger

To understand what is the main purpose of this step assume that the beginning balance of was 20,000 and for
more simplicity, we will assume that the company experienced only two transactions during the year:

1- On 1/5 Provided service of 30,000 in cash 2-On 1/10 Paid salaries of 10,000 in cash
30,000 Salaries 10,000
SR 30,000 10,000

Now, can you determine the cash balance at the end of the year?
It’s very easy: ①
Cash beg. + Collected - Paid = Cash end.
② 20,000 + 30,000 - 10,000 = 40,000 ②

Unfortunately, the matter is not so easy in companies that deal in hundreds of transactions daily, which is what prompted
accountants to design a general ledger that takes the form of a letter (T) to classify all numbers in two sides, as shown in the
following figure:

Dr. Cr.
Beg. Balance 20,000 1/10 10,000
1/5 30,000
50,000 10,000
End. Balance 40,000 ③
You can notice that cash account is prepared according following steps:
1- Beginning Balance: if there is a beginning balance you have to put it in the nature side (here is Dr. because cash is an asset).
2- Posting entries to ledger: you write the date & value in the side which the account was used in the entry.
3- Ending Balance: you have to sum Dr. & Cr. then subtraction Dr. - Cr. to calculate ending balance (Dr. > Cr. because cash is an asset).
Previous steps are aplicaple for all accounts With the distinction between

Debit Accounts (AED) Credit Accounts (LOR)

Dr. Cr. Dr. Cr.
Beg. Balance XX Date XX Date XX Beg. Balance XX
Date XX Date XX Date XX Date XX
Total Dr. Total Cr. Total Dr. Total Cr.
End. Balance Dr. – Cr. End. Balance Cr. - Dr.

Posting: transfers journal entries to ledger accounts.

 6
Example (1)
Journalize the following transactions in general journal form and post to the appropriate accounts in the Ledger.
1- Sept. 1, Invested $10,000 cash in the business.
2- Sept. 5, Purchased Office Equipment for $12,000 paying $5,000 in cash and the balance on account.
3- Sept. 25, Paid $3,000 cash on balance owed for equipment.
4- Sept. 30, Withdrew $500 cash for personal use.

Journalizing Posting
Date Description Debit Credit Dr. ① Cr.
Cash 10,000 1/9 10,000 5/9 5,000
1/9
Capital 10,000 25/9 3,000
Equipment 12,000 30/9 500
5/9 cash 5,000 10,000 8,500
AP 7,000 End. Balance 1,500
AP 3,000
25/9
Cash 3,000 Dr. ② Cr.
Drawing 500 1/9 10,000
30/9
Cash 500 0 10,000
End. Balance 10,000
Dr. ③ Cr. Dr. ④ Cr.
5/9 12,000 25/9 3,000 1/9 7,000
12,000 0 3,000 7,000
End. Balance 12,000 End. Balance 4,000
Dr. ⑤ Cr.
30/9 500
500 0
End. Balance 500

s4 Unadjusted Trial Balance

➢ A list of accounts and their balances at a given time Accounts Debit Credit
usually in financial statement order.. Cash 1,500
➢ Ending debit or credit balances are listed in two A Equipment 12,000
separate columns. Capital 10,000
O.E Drawings 500
➢ Purpose is to prove that total debit account balances
AP 4,000
equal total credit account balances. L
14,000 14,000
R =
E

Business documents, such as a sales slip, a check, a bill, or a cash register tape, provide evidence of the transaction.
 7

5 Adjusted Entries

Adjustments
Is to determine the correct balances of A, L, E, & R by determining:
expense of the period paid or not paid yet & revenues of the period: received or not received yet

Assume that on 1/10/2019 Tom rented a house from Jerry of $100 monthly What is the appropriate
accounting treatment for each of them (Tom & Jerry) in these two situations: (“A” Asset, “L” Liability,
“E” Expense & “R” Revenue)

: If Tom Paid $400 (4 months) on 1/10/2019 will expire on 1/2/2020

1/10/2019 Journal entry: 1/10/2019 Journal entry:

Prepaid rent (A) 400 Cash 400
Cash 400 Unearned revenue (L) 400
31/12 Adjustment 31/12 Adjustment
3 3
Expired rent = 400 × = 300 Earned rent = 400 × = 300
4 4
Rent Ex. (E) 300 Unearned revenue (L) 300
Prepaid rent (A) 300 Rent revenue (R) 300
Until 31/12 there is unexpired prepaid rent balance = 100 Until 31/12 there is unearned rent balance = 100
 8
This type of adjustment called “Deferrals” which consists of:

Prepaid Expense (Expense – Asset) Unearned Revenues (Revenue - Liability)

Expenses paid and recorded as assets before they are : Revenues received in cash and recorded as liabilities
due, expired, used, or consumed. (cash paid in advance) before they are earned. (cash received in advance)

: If Tom didn’t pay any amount till 31/12/2019

31/12 Adjustment 31/12 Adjustment

Rent Ex. (E) 300 AR (A) 300
Rent Payable (L) 300 Rent revenue (R) 300
Until 31/12 there is accrued expense (Payable) = 300 Until 31/12 there is accrued revenue (AR) = 300

This type of adjustment called “Accruals” which consists of:

Accrued Expenses (Expense – Liability) Accrued Revenues (Revenue - Asset)
Expenses due or expired or used or consumed but not yet Revenues earned but not yet received in cash or recorded.
paid in cash or recorded. (cash not paid yet). (cash not received yet)

So, we have 4 types of adjusting entries concluded in the following figure:

 9
❑ A company must make adjusting entries every time it prepares financial statements or when
needed.
❑ Adjusting entries needed to ensure that balance sheet and income statement accounts have
correct balances at the end of an accounting period.
❑ Adjusting entries - needed to ensure that the revenue recognition and matching principles
are followed.
❑ Each adjusting entry will affect in “B.S.” account & “I.S.” account.

Balance Sheet Income Statement

d. f.
Prepaid
Expense

Payment of cash that is recorded as an asset because service or benefit will be received in the future.

(1) Supplies (2) Depreciation (3) Insurance

Used supplies. Depreciate assets with long useful life Also: Rent, Maintenance & Ads.
(2) Depreciation
Assets like: Buildings, Machines, Equipment, Cars, Trucks, Furniture & Computers (all long-term assets except land) have a useful life
(number of years). So, with the passage of time these assets become obsolete and depreciate.
We use these assets to earn revenue, according to matching principle, we have to expense (write off) a portion of their costs each
period. These expense called “depreciation” which is aimed to allocate the cost of a tangible or physical asset over its useful life.
Assume that on 1/1/2018, Mostafa company purchased a truck of $32,000 estimated useful life 3 years, estimated
salvage value (market value at the end of its life) $2,000.

As you see, annual depreciation ca be calculated as follows:

C–S 32,000 – 2,000
Annual Depreciation = = = 10,000
N 3
 10
Each year will depreciate 10,000 from truck vlue, so we should write off this depreciation from truck’ cost, but we cann’t
do that directly (because of historical cost principle) so we can do that by creat new account called:
“Accumulated Depreciation”
It is A Contra-Asset account (Cr. by nature) increased by the annual depreciation, and we subtracte its balance from
asset’s cost to calculat the net Book Value (BV). Each asset has its accumulated depreciation which offset its cost.
So the depreciation adjusting entry will be:
Dep. Ex. XX
Accum. Dep. XX

31/12/2018 31/12/2019 31/12/2020

adjusting entry adjusting entry adjusting entry
Dep. Ex. 10,000 Dep. Ex. 10,000 Dep. Ex. 10,000
Accum. Dep. 10,000 Accum. Dep. 10,000 Accum. Dep. 10,000
B.S. on 31/12/2018 B.S. on 31/12/2019 B.S. on 31/12/2020
: : :
Truck 32,000 C Truck 32,000 C Truck 32,000 C
(-) Accum. Dep. (10,000) (-) Accum. Dep. (20,000) (-) Accum. Dep. (30,000)
22,000 BV 12,000 BV 2,000 BV

Salvage
Because it is the end of its useful life
annually depreciation
Monthly depreciation =
12

Unearned
Revenue

Here we receive cash before provide service (or sellig goods) to the customer, therefore, we should record this amount
as a liability because the revenue has not been earned. When we provide the service we should record adjusting entry
which transfer liability (Unearned revenue) into revenue:
Unearned Revenue XX
Revenue XX Calculating like prepaid Ex.
Unearned revenues often occur in regard to:
Rent Airline Tickets School Tuition Magazine supscreptions Customer Dposits

Accrued
Expense
Here we took the service but we haven't paid (or recorded) for it yet, therefore we should record an expense (Dr.) &
recognize a liability (Cr.) by the following adjusting entry:
Ex. XX
Ex. Payable XX
Accrued expense often occur in regard to:
Rent Taxes Salaries Interest
 11
Accrued
Revenue

Here we performed a service but we haven't collected (or recorded) yet, therefore we should record an revenue (Cr.) &
recognize an asset (Dr.) by the following adjusting entry:
AR XX
R XX
Accrued revenue often occur in regard to:
Rent Interest Service redered

Used = B.B. + Purchases – E.B Supplies Ex. E

(1) Supplies
= Available – E.B. Supplies S
Assets

(2) Depreciation Annual C–S Dep. Ex. E

=
(Contra) Dep. N Accum Dep. A

EXPENSES always
Debit (Dr.)
(3) Prepaid Prepaid Past duration
× Ex. E
insurance Ex. Contract duration
= B. before adj. – unexpired B.
Prepaid Ex. P
(Rent, Ads, Maintenance)

(4) Accrued Interest Ex. E

Interest = PIN
interest Ex. Interest P. I
Liabilities

(5) Accrued 1- salary per day (week salary/5) Salaries Ex. E

Salaries Ex. 2- Unpaid salaries Salaries P. P
REVENUES always

(6) Unearned Unearned R. U

Like Prepaid insurance
Credit (Cr.)

Revenue R. R
Assets

(7) Accrued AR A
Given
Revenue R. R
 12

6
an Adjusted Trial Balance

▪ After all adjusting entries are journalized and posted the company prepares another trial balance from the ledger
accounts (Adjusted Trial Balance).

▪ An adjusted trial balance proves the equality of the total debit balances and the total credit balances in the ledger
after all adjustments are made.

▪ The adjusted trial balance provides the primary basis for the preparation of financial statements.

7 Financial Statements

8 Closing Entries

At the end of the accounting period, the company makes the accounts ready for the next period. We do that by closing
temporary accounts (Revenues, Expenses & Drawings) – which called nominal accounts – to make its balances = 0 by:

reverse its nature

1) Closing Expenses (Dr. Cr.) 2) Closing Revenues (Cr. Dr.)
Income Summary 645 (E) Service Revenue 7,000
Depreciation expense 375 Income Summary 7,000 (R)
Interest expenses 270

3) Closing net income (if R > E) 4) Closing Drawings (Dr. Cr.)

Income Summary (7,000 – 645) 6,355 Capital 2,000
Capital 6,355 Drawings 2,000
But if E > R this entry will reverse Drawing is closed directly to Capital (it isn’t ex.)
 13
As you see we can distinguish between two groups of accounts:

Also called: Nominal Accounts Also called: Real Accounts

3 Meters (RED) Balance Sheet Accounts
Don’t carry forword their balances from current period to the next period Carry forword their balances from current period to the next period
1- Expenses (Dr. Cr.) 1- Assets
2- Revenues (Cr. Dr.) 2- Liabilities
3- Income Summary (result) 3- O.E
4- Drawings (Dr. Cr.) Closing entries is the only step in the
Example (3) accounting cycle which is done annually only.
The Folllowing is Adjusted Trial Balance for Mostafa Company on December, 31, 2020 (Numbers is in Thousands) :
Accounts Debit Credit Required:
Cash 150 1- Prepare financial statements.
Prepaid Insurance 60 2- Prepare closing entries.
Capital 850 3- Prepare post-closing trial balance.
Salaries 50
AP 200
SR 370
AR 450
Salaries Payable 10
Insurance expense 30
Equipment 650
Ads expense 20
Equipment Dep. expense 20
Equipment Accum. Dep. 70
Drawings 70
1,500 1,500

1- Prepare financial statements

Mostafa Co. Mostafa Co. Mostafa Co.
Income Statement Owner’s Equity Balance Sheet
For the year ended Dec.,31,2020 For the year ended Dec.,31,2020 On Dec.,31,2020
Revenues: Capital Beg. 850 Cash 150
SR 370 + Net Income 250 Prepaid Insurance 60
Expenses: (-) Drawings (70) AR 450
Capital End. 1,030 Equip. 650
Salaries expense 50
(-) Accum. Dep. (70)
Insurance expense 30
580
Ads expense 20
1,240
Dep. expense 20
capital 1,030
(120)
AP 200
Net Income 250 Salaries Payable 10
1,240
 14
1. Financial statements can be prepared from the information provided by an adjusted trial balance. ✓
2. An adjusted trial balance should be prepared before the adjusting entries are made. X
2- Prepare closing entries
1) Closing Expenses (Dr. Cr.) 2) Closing Revenues (Cr. Dr.)
Income Summary 120 Service Revenue 370
Salaries expense 50 Income Summary 370
Insurance expense 30
Ads expense 20
Dep. expense 20

3) Closing net income (if R > E) 4) Closing Drawings (Dr. Cr.)

Income Summary 250 Capital 70
Capital 250 Drawings 70

3- Prepare post-closing trial balance

Purpose is to prove the equality of the permanent account balances after journalizing and posting of closing entries.
Accounts Debit Credit
Cash 150
Prepaid Insurance 60
AR 450
Equip. 650
(-) Accum. Dep. 70
capital 1,030
AP 200
Salaries Payable 10
1,310 1,310
It hasn’t any revenue, expenses & drawings because their balances = 0 (Therefore they are temporary).

Now you finished the whole accounting cycle (recall from Lecture 04 page 28):

• The steps in the accounting cycle are repeated in each

accounting period.
• The steps in the accounting cycle are performed in sequence.
• The accounting cycle includes the steps of analyze business
transactions, journalizing transactions, and posting to ledger
accounts generally be performed daily.
• The step in the accounting cycle that is performed on a periodic
basis (i.e., monthly, quarterly) is journalizing and posting
adjusting entries.
• The final step in the accounting cycle is to prepare a post-
closing trial balance which is prepared only annually.
 15
Exercise (8):
The adjusted trial balance of Mostafa company on December 31, 2020 includes the following accounts:
Accum. Dep. $
480 Dep. Expense 2,000
$
Note Payable $
5,800
Interest Expense $
150 Utilities Expense 300
$
Service Revenue $
19,600
Salaries Expense $
4,000 Supplies 1,160
$
Supplies Expense $
1,200
Wages Payable $
400 Rent Expense 500
$

Instructions: Prepare an income statement for the year ended on December 31, 2020.
Mostafa Co.
Income Statement
For the year ended Dec.,31,2020
Revenues:
SR 19,600
Take care:
Expenses:
Dep. Expense 2,000 These 4 accounts are B.S. accounts
Interest Expense 150
Utilities Expense 300
Salaries Expense 4,000
Supplies Expense 1,200
Rent Expense 500
(8,150)
Net Income 11,450

Exercise (9):
The adjusted trial balance of Mostafa company on December 31, 2020 includes the following accounts:
Capital $
12,600 Dep. Expense 2,000
$
Note Payable $
5,800
Interest Expense $
150 Utilities Expense 300
$
Service Revenue $
19,600
Salaries Expense $
4,000 Drawing 9,895
$
Supplies Expense $
1,200
Wages Payable $
400 Rent Expense 500
$

Instructions: Prepare an owner’s equity statement for the year ended on December 31, 2020.
Here we should begin with calculating net income as follow:
Net income = 19,600 – (2,000 + 150 + 300 + 4,000 + 1,200 + 500) = 11,450
Mostafa Co.
Owner’s Equity
For the year ended Dec.,31,2020
Capital Beg. 12,600
+ Net Income 11,450
(-) Drawings (9,895)
Capital End. 14,155
 16
Exercise (10):
The adjusted trial balance of Mostafa company on December 31, 2020 includes the following accounts:
Cash 8,680
$
Accum. Dep. $
840 Accounts Payable 1,140
$

Accounts Receivable 810

$
Supplies $
1,160 Salaries Payable 400
$

Notes Payable 5,800

$
Prepaid Rent $
865 Equipment 11,400
$

Unearned Revenues 580

$
Mostafa, Capital $
14,155 Service Revenues 13,635
$

Depreciation Expense 665

$
Supplies Expense $
190
Instructions: Prepare Balance Sheet on December 31, 2020.
Mostafa Co.
Balance Sheet
On Dec.,31,2020
Cash 8,680
Equipment 11,400
(-) Accum. Dep. (840)
10,560
AR 810
Supplies 1,160
Prepaid Rent 865
22,075
AP 1,140
Salaries Payable 400
NP 5,800
Unearned Revenues 580
Mostafa, Capital 14,155
22,075
 17
Exercise (11):
The adjusted trial balance of Mostafa company on December 31, 2020 appears below:
Accounts Dr. Cr.
Cash 5,400
Accounts Receivables 4,200
Office Supplies 3,800
Office Equipment 15,000
Accum. Depreciation 4,000
Mostafa, Capital 14,400
Mostafa, Drawing 2,500
Accounts Payable 3,300
Unearned Revenue 6,000
Service Revenue 8,200
Supplies Expense 600
Depreciation Expense 2,500
Rent Expense 1,900
35,900 35,900
Instructions: Prepare Financial Statements for the year ended on December 31, 2020.
Mostafa Co. Mostafa Co. Mostafa Co.
Income Statement Owner’s Equity Balance Sheet
For the year ended Dec.,31,2020 For the year ended Dec.,31,2020 On Dec.,31,2020
Revenues: Capital Beg. 14,400 Cash 5,400
SR 8,200 + Net Income 3,200 AR 4,200
Expenses: (-) Drawings (2,500) Supplies 3,800
600 Capital End. 15,100 Equip. 15,000
Supplies Expense
(-) Accum. Dep. (4,000)
Dep. Expense 2,500
11,000
Rent Expense 1,900
24,400
(5,000)
capital 15,100
Net Income 3,200 AP 3,300
Unearned R. 6,000
24,400
 18
Single Step Income Statement Multi steps

In the beginning, you know that income statement matching revenues with expenses, but you
should now learn two other important terms, namely Gains & losses:

If the company had a land and its cost is 1,000,000, and the company
sold this land by 1,500,000.

Here we don’t record the selling amount (1,500,000) as sales because land isn’t a merchandise
(so we record sales only for selling merchandising goods). Instead of that we record Gain from
selling this land = 500,000 (the difference between 1,500,000 & 1,000,000) because this
activity is Incidental not essential.
So, we have 4 terms used to calculate income:

+ Net Income Revenues Gains

(-) Net Income Expenses Losses

From usual activities From unusual activities

Sales & other revenues Results from disposal

COGS, Operating of assets. (gain or loss)
expenses & other ex. Or disaster losses.
 19
When preparing income statement, we have two approaches:

Single Step Multi steps

We prepare I/S in one step by calculating the Here we rearrange items in a more informative order
difference between two groups: which differentiate between operating & non-operating
• Revenues & Gains (R&G) activities. Not only that, but rather the operational
activities themselves are divided into two results:
• Expenses & Losses (E&L)
1- Gross profit (margin) = Sales – COGS
Regardless of its source.
2- Operating income = Gross profit – Operating ex.
Advantage:
(operating expenses are expenses for Selling goods and
Format is simpler and easier to read. Administrative activities “S&A”)
Disadvantages: Then:
No Additional information about the results of 3-1 Add any other (R&G).
merchandising activities non-operating activities
3-2 deduct any other (E&L).
No separation between operating (original, normal, And we can calculate gross profit rate which help users in
usual) activities and non-operating activities of the decision making as follow:
company. Gross profit
Gross profit rate = × 100
Net sales
: Net Sales S
Net Sales S (-) COGS (C)
Interest revenue XX Gross profit (1) G
Gain on Sales of fixed assets XX (-) operating expenses (S&A) :
Salaries expense XX
Total R & G A
Utilities expense XX
: Ads expense XX
COGS C Dep. Expense XX
Salaries expense XX Freight out XX
Utilities expense XX Insurance expense XX
Ads expense XX Miscellaneous expenses XX
Dep. Expense XX (XX)
Freight out XX Operating Income (2) OI
Insurance expense XX + Other R & G:

XX Interest revenue XX
Miscellaneous expenses
Gain on Sales of equipment XX
Interest expense XX
(-) Other E & L:
loss from vandalism (fire/flood) XX
Interest expense (XX)
Total E & L (B) loss from vandalism (fire/flood) (XX)
Net Income NI Net Income NI
G
Gross profit rate = × 100
S
 20
Example (1)
Given the following data which pertain to Mostafa Co. for the year ended 12/31/2020: (numbers are in thousands)
Net Sales 1,000 Dep. Expense 15
Interest revenue 400 Freight out 12
Gain on Sales of equipment 300 Insurance expense 11
COGS 700 Miscellaneous expenses 7
Salaries expense 40 Interest expense 250
Utilities expense 10 loss from vandalism 150
Advertising expense 5
Required:
1- Prepare Single step Income statement.
2- Prepare Multi steps Income statement.
3- Calculate gross profit rate.

Single Step Multi steps

Mostafa company Mostafa company
Income statement Income statement
For the year ended on Dec. 31, 2020 For the year ended on Dec. 31, 2020
: Net Sales 1,000
Net Sales 1,000 (-) COGS (700)
Interest revenue 400 Gross profit 300
Gain on Sales of equipment 300 (-) operating expenses (S&A) :
Salaries expense 40
Total R & G 1,700
Utilities expense 10
: Ads expense 5
COGS 700 Dep. Expense 15
Salaries expense 40 Freight out 12
Utilities expense 10 Insurance expense 11
Ads expense 5 Miscellaneous expenses 7
Dep. Expense 15 (100)
Freight out 12 Operating Income 200
Insurance expense 11 + Other R & G:
Interest revenue 400
Miscellaneous expenses 7
Gain on Sales of equipment 300
Interest expense 250
(-) Other E & L:
loss from vandalism 150
Interest expense (250)
Total E & L (1,200) loss from vandalism (150)
Net Income 500 Net Income 500
300
Gross profit rate = × 100 = 30%
1,000
 21
Example (2)
Data from the adjusted trial balance of Mostafa Company on December 31, 2020 is as follow:
Sales $
560,000 Sales R & A $
20,000
Sales Discounts $
7,000 Cost of Goods Sold $
386,000
Freight-out $
2,000 Advertising Expense $
15,000
Interest Expense $
18,000 Store Salaries Expense $
55,000
Utilities Expense $
28,000 Depreciation Expense $
7,000
Dividend revenue $
58,000 Loss from fire $
20,000
Instructions: Prepare
1. A single-step income statement
2. A multiple-step income statement

Single Step Multi steps

Mostafa company Mostafa company
Income statement Income statement
For the year ended on Dec. 31, 2020 For the year ended on Dec. 31, 2020
: Sales 560,000
Sales 560,000 (-) Sales R & A (20,000)
(-) Sales R & A (20,000) (-) Sales discount (7,000)

(-) Sales discount (7,000) Net Sales 533,000

(-) COGS (386,000)
Net Sales 533,000
Gross profit 147,000
Dividend revenue 58,000
(-) operating expenses (S&A) :
Total R & G 591,000 Freight out 2,000
: Ads expense 15,000
COGS 386,000 Salaries expense 55,000
Freight out 2,000 Utilities expense 28,000
Ads expense 15,000 Dep. Expense 7,000

Interest expense 18,000 (107,000)

Salaries expense 55,000 Operating Income 40,000
+ Other R & G:
Utilities expense 28,000
Dividend revenue 58,000
Dep. Expense 7,000
(-) Other E & L:
loss from fire 20,000
Interest expense (18,000)
Total E & L (531,000) loss from fire (20,000)
Net Income 60,000 Net Income 60,000
 22
Example (3)
Mostafa Company gathered the following condensed data for the year ended December 31, 2020:
Cost of goods sold $
690,000
Net sales $
1,250,000
Administrative expenses $
234,000
Interest expense $
8,000
Dividend revenue $
38,000
Selling expenses $
45,000
Loss from flood $
233,000
Instructions: Prepare
1- A single-step income statement
2- A multiple-step income statement

Single Step Multi steps

Mostafa company Mostafa company
Income statement Income statement
For the year ended on Dec. 31, 2020 For the year ended on Dec. 31, 2020
: Net Sales 1,250,000
Net Sales 1,250,000 (-) COGS (690,000)
Dividend revenue 38,000 Gross profit 560,000
(-) operating expenses (S&A) :
Total R & G 1,288,000
Administrative expenses 234,000
:
Selling expenses 45,000
COGS 690,000
(279,000)
Administrative expenses 234,000
Operating Income 281,000
Interest expense 8,000
+ Other R & G: -
Selling expenses 45,000 Dividend revenue 38,000
loss from flood 233,000 (-) Other E & L:

Total E & L (1,210,000) Interest expense (8,000)

loss from flood (233,000)
Net Income 78,000
Net Income 78,000
 23
Income statement
Accounting
Net Sales ×× Sales
(-) COGS )××( (-) Sales R. & A
Gross Profit ×× (-) Sales discount

(-) Selling Expenses: ×× Ne t sales

(-) Administrative Expenses: ××
(+/-) Other Income & Expenses: ×× )××(
Operating Income ××
(-) Interest Expense (Financing Costs) )××(
Net Income Before Tax ××
(-) Income Tax (Net Income X tax %) )××(
Income from cont. Operations After tax ××
➢ Discontinued Operations:
×× All of them X (1- Tax %)
Operating Income/ Loss
××
Gain /Loss from Disposal
Net Income ××
Example (1):
The accountant of Weather spoon Shoe Co. co. has extracted the following information from the
company's records as a basis for an income statement.

Rent revenue $29,000

Interest expense 1,860
Wages and salaries expenses - selling 114,800
Supplies expense- selling 17,600
Income tax 37,000
Wages and salaries- administrative 135,900
Other administrative expense 51,700
Cost of goods sold 496,000
Net sales 980,000
Depreciation on plant assets(70% selling; 30% 65,000
administrative) 16,000
Dividends declared 15,000
Gain on sale of plant assets 20,000
Loss on sale of plant assets

There were 20,000 ordinary shares outstanding during the year.

Required: Prepare an income statement for the year 2015.
 24
Weather spoon Company
Income statement
For the year ended December, 31, 2015
Net sales
(-) COGS ( )
Gross profit 484,000
(-) Selling Expenses:
Wages & salaries- selling
Supplies Exp.- selling
Dep. Exp. ( 65,000 X 70% selling)
(-) Administrative Expenses: (177,900 )
Wages & Salaries- Adm.
Other Admin. Exp.
Dep. Exp. (65,000 X 30% Adm.)

(+ /- ) Other Income & Expense: (207,100)

Rent Revenue
Gain on sale of assets
***Loss on sale of assets 24,000
Operating Income (Income From operations) 123,000
(-) Interest Expense ( )
Income before income tax 121,140
(-) Income Tax "Given" ( )
Net Income 84,140

Earnings per share {EPS} $4.2/ Share

= -

Example (2):
Sales revenue $ 180,000 Sales
Cost of goods sold 90,000 (-) Sales R. & A ( )
Salaries and wages expense 15,000 (-) Sales discount (0)
Net sales 163,500
Depreciation expense 30,000
(-) COGS ( )
Dividend revenue 6,000 Gross profit 73,500
Utilities expense 12,000 (-) Selling & Administrative Expenses:
Rent revenue 30,000 Salaries and wage expense
Interest expense 18,000 Dep. exp.
Sales returns 16,500 Utilities exp.
Advertising exp.
Advertising expense 19,500
(76,500)
What amount would Ortiz report as income (+/-) Other Income and Expense
from operations in its income statement? Divid. Rev,
Rent Rev.
Operating Income { Income from
operations}
33,000
 25
Earnings Per Share

Net Income – Preference Dividends(Given)

EPS =
Weighted average number of Ordinary shares(Given)

In 2015, Esther Corporation reported net income of $1,000,000. It declared and paid preference
dividends of $250,000 and ordinary share dividends of $100,000. During 2015, Esther had a
weighted average of 250,000 ordinary shares outstanding.
Required: Compute Esther's 2015 earnings per share.

Solution
Net Income – Preference dividends
$1,000,000 - $250,000
EPS = = $3 / share
No. of ordinary shares
250,000 shares

Discontinued operations

A discontinued operation is the sale or disposal of an entire segment (division or production line) of the company.

✓ Gains or losses from Discontinued Operations :

• Operating Income or Loss of the segment Should be NET
• Gain or loss from the Disposal. of Tax

Example (3):
On November 30, 2014, Cairo Corporation Income before Tax
disposed one of its production divisions at (-) Income tax (55,000 X 30%) ( )
a Pre-tax (before tax) Gain of $27,[Link] Income from continuing operations after tax
operating loss of this division during 2014
pre-tax was $ 10,000. The Pre-tax income Discontinued operations:
from continuing operation for the year Disposal Gain 27,000 x 70% ( net of tax)
totaled $ 55,000. The income tax rate is Operating Loss (10,000) x 70% ( net of tax) ( )
30%.
Required: Net income $50,400
Prepare a partial income statement for
2014 beginning with pretax income
 26
Example (4):
Presented below is selected ledger of McGraw Corporation as of December 31, 2015
Cash 50,000
Administrative expenses 100,000
Selling expenses 80,000
Net sales 540,000
Cost of goods sold 260,000
Cash dividends declared (2015) 20,000
Cash dividends paid (2015) 15,000
Discontinued operations (loss before income taxes) 40,000
Depreciation expense (not recorded in 2014) 30,000
Retained earnings, December 31, 2014 90,000
Effective tax rate = 30%
Required: Prepare an Income statement for 2015; Assume 20,000 ordinary shares were outstanding
during 2015.

McGraw Corporation
Income statement
For the year ended December 31, 2015
Net sales 540,000
(-) COGS (260,000 )
Gross Profit 280,000

(-) Selling Expenses (80,000 )

(-) Administrative Expenses
(100,000 )

(+/-) Other Income & Expense 0

Operating Income 100,000

(-) Interest Expense (0 )

Income before income tax
100,000

(-) Income tax (100,000 x 30%) (30,000 )

Income from cont. operations After Tax 70,000

**Discontinued operations:

Loss from Disc. Operation (40,000 X 70%) (28,000 )

Net Income $42,000

Net Income – Preference dividends

EPS = $ -0 = $2.1 / share
No. of shares