Accounting

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Financial & Managerial Accounting

Fifteenth Edition

Chapter 4

The Accounting Cycle

Learning Objectives (1 of 2)

Obj. 1: Describe the flow of accounting information from the unadjusted trial balance into the adjusted trial balance and financial statements.

Obj. 2: Prepare financial statements from adjusted account balances.

Obj. 3: Prepare closing entries.

Obj. 4: Describe the accounting cycle.

Obj. 5: Illustrate the accounting cycle for one period.

Learning Objectives (2 of 2)

Obj. 6: Describe and illustrate the use of working capital and the current ratio in evaluating a company’s financial condition.

Obj. App 1: Describe and illustrate the end-of-period spreadsheet.

Obj. App 2: Describe and illustrate the use of reversing entries.

End-of-Period Spreadsheet and Flow of Accounting Data—NetSolutions

Flow of Accounting Information: End-of-Period Spreadsheet—Unadjusted Trial Balance Columns

The end-of-period spreadsheet on the previous slide begins with the unadjusted trial balance.

The unadjusted trial balance verifies that the total of the debit balances equals the total of the credit balances.

If the trial balance totals are unequal, an error has occurred.

Any errors must be found and corrected before the end-of-period process can continue.

Flow of Accounting Information: End-of-Period Spreadsheet—Adjustments Columns

The adjustments are normally entered in the order in which the data are assembled.

If the titles of the accounts to be adjusted do not appear in the unadjusted trial balance, the accounts are inserted in the proper order in the Account Title column.

The total of the Adjustments columns verifies that the total debits equal the total credits for the adjusting entries.

The total of the Debit column must equal the total of the Credit column.

Flow of Accounting Information: End-of-Period Spreadsheet—Adjusted Trial Balance Columns

The adjustments in the spreadsheet are added to or subtracted from the amounts in the Unadjusted Trial Balance columns to arrive at the amounts inserted in the Adjusted Trial Balance columns.

The totals of the Adjusted Trial Balance columns verify that the totals of the debit and credit balances are equal after adjustment.

Flow of Accounting Information: Financial Statements

As shown on the “End-of-Period Spreadsheet slide,” the accounts from the adjusted trial balance flow into the financial statements as follows:

The revenue and expense accounts (spreadsheet lines 20–28) flow into the income statement.

The dividends account (spreadsheet line 19) and net income amount (from the income statement) flow into the Retained Earnings column of the statement of stockholders’ equity.

The asset, liability, and common stock accounts (spreadsheet lines 8–18) and end-of-period retained earnings amount (from the statement of stockholders’ equity) flow into the balance sheet.

Income Statement (1 of 2)

Income Statement (2 of 2)

The income statement is prepared directly from the Adjusted Trial Balance columns of the end-of-period spreadsheet, beginning with fees earned.

The expenses in the income statement are listed in order of size, beginning with the larger items.

Miscellaneous expense is the last item, regardless of its amount.

Statement of Stockholders’ Equity (1 of 3)

Statement of Stockholders’ Equity (2 of 3)

The first items normally presented on the statement of stockholders’ equity are the balances of common stock and the retained earnings accounts at the beginning of the period.

The amount of dividends is deducted from the net income to determine the ending retained earnings account balance.

The amount of common stock issued is added to the Common Stock column.

Statement of Stockholders’ Equity (3 of 3)

Entries in each row are added across and the total is entered in the Total column.

All columns are totaled to arrive at the ending balances for Common Stock and Retained Earnings and the total of stockholders’ equity as of December 31, 20Y3.

Balance Sheet (1 of 3)

Balance Sheet (2 of 3)

The balance sheet is prepared directly from the Adjusted Trial Balance columns of the end-of-period spreadsheet, beginning with Cash.

The asset and liability amounts are taken from the spreadsheet.

The common stock and retained earnings amounts are taken from the statement of stockholders’ equity.

Balance Sheet (3 of 3)

A balance sheet that shows subsections for assets and liabilities is a classified balance sheet.

Assets are commonly divided into two sections on the balance sheet: (1) current assets and (2) property, plant, and equipment.

Liabilities are commonly divided into two sections on the balance sheet: (1) current liabilities and (2) long-term liabilities.

Current Assets (1 of 2)

Cash and other assets that are expected to be converted to cash or sold or used up usually within one year or less, through the normal operations of the business, are called current assets.

Current assets include:

Cash

Notes receivable

Accounts receivable

Supplies

Other prepaid expenses

Current Assets (2 of 2)

Notes receivable are written promises by the customer to pay the amount of the note and interest. Like accounts receivable, notes receivable are amounts that customers owe, but they are more formal than accounts receivable.

Notes receivable and accounts receivable are current assets because they are usually converted to cash within one year or less.

Property, Plant, and Equipment

Property, plant, and equipment (also called fixed assets or plant assets) include land and assets that depreciate over a period of time.

Assets that depreciate over time include:

Equipment

Machinery

Buildings

Current Liabilities

Amounts the business owes to creditors that will be due within a short time (usually one year or less) and that are to be paid out of current assets are called current liabilities.

Current liabilities include:

Notes payable

Accounts payable

Wages payable

Interest payable

Taxes payable

Unearned fees

Long-Term Liabilities

Amounts the business owes to creditors that will not be due for a long time (usually more than one year) are called long-term liabilities.

Stockholders’ Equity

Stockholders’ equity is the stockholders’ right to the assets of the business.

It is presented on the balance sheet below the liabilities section.

Stockholders’ equity is added to the total liabilities, and this total must be equal to the total assets.

Check Up Corner: Financial Statements from Adjusted Trial Balance (1 of 2)

The following account balances were taken from the adjusted trial balance for Laser Corrective Vision Company, a health care company, for the fiscal year ended December 31, 20Y2:

Common Stock	$175,000	Miscellaneous Expense	$8,500
Depreciation Expense	25,000	Rent Expense	20,000
Dividends	6,000	Salaries Expense	165,000
Fees Earned	312,000	Supplies Expense	15,500

On January 1, 20Y2, Retained Earnings had a balance of $100,000. During 20Y2, common stock of $50,000 was issued.

Prepare an income statement and Statement of stockholders’ equity for Laser Corrective Vision.

Check Up Corner: Financial Statements from Adjusted Trial Balance (2 of 2)

Permanent Accounts

Balances of the accounts reported on the balance sheet are carried forward from year to year.

Because they are relatively permanent, they are called permanent accounts or real accounts.

Temporary Accounts

Accounts that report amounts for only one period are called temporary accounts or nominal accounts.

Temporary accounts are not carried forward from year to year because they relate to only one period.

This includes all accounts reported on the income statement as well as the dividends account, which is reported on the statement of stockholders’ equity.

Closing Entries (1 of 3)

At the beginning of the next accounting period, temporary accounts should have zero balances.

To achieve this, temporary account balances are transferred to permanent accounts at the end of the accounting period through journal entries.

The entries that transfer these balances are called closing entries. The transfer process is called the closing process and is sometimes referred to as closing the books.

After the closing entries are posted, all of the temporary accounts have zero balances.

Closing Entries (2 of 3)

The closing process involves the following two steps:

Step 1. Revenue and expense account balances are transferred to the retained earnings account.

Step 2. The balance of the dividends account is transferred to the retained earnings account.

Closing Entries (3 of 3)

The two closing entries required in the closing process are as follows:

Debit each revenue account for its balance, credit each expense account for its balance, and credit (net income) or debit (net loss) the retained earned earnings account.

Debit the retained earnings account for the balance of the dividends account and credit the dividends account for its balance.

Closing entries are recorded immediately following the adjusting entries.

Flowchart of Closing Entries for NetSolutions

Closing Entries, NetSolutions

Ledger with Closing Entries—NetSolutions (1 of 2)

Ledger with Closing Entries—NetSolutions (2 of 2)

Check Up Corner: Closing Entries (1 of 2)

After the accounts have been adjusted at December 31, the end of the fiscal year, the following balances are taken from the ledger of Wyatt Services Co.:

Journalize the closing entries.

Check Up Corner: Closing Entries (2 of 2)

Post-Closing Trial Balance

A post-closing trial balance is prepared after the closing entries have been posted.

The purpose of the post-closing (after closing) trial balance is to verify that the ledger is in balance at the beginning of the next period.

Post-Closing Trial Balance, NetSolutions

Accounting Cycle (1 of 3)

The accounting process that begins with analyzing and journalizing transactions and ends with the post-closing trial balance is called the accounting cycle.

Accounting Cycle Steps (1 of 2)

The steps in the accounting cycle are as follows:

Step 1. Transactions are analyzed and recorded in the journal.

Step 2. Transactions are posted to the ledger.

Step 3. An unadjusted trial balance is prepared.

Step 4. Adjustment data are assembled and analyzed.

Step 5. An optional end-of-period spreadsheet is prepared.

Accounting Cycle Steps (2 of 2)

Step 6. Adjusting entries are journalized and posted to the ledger.

Step 7. An adjusted trial balance is prepared.

Step 8. Financial statements are prepared.

Step 9. Closing entries are journalized and posted to the ledger.

Step 10. A post-closing trial balance is prepared.

Accounting Cycle (2 of 3)

Accounting Cycle (3 of 3)

Illustration of the Accounting Cycle (1 of 2)

The following slides will provide an illustration of the accounting cycle for Kelly Consulting.

Chart of Accounts

Journal Entries

Unadjusted Trial Balance

End-of-Period Spreadsheet

Illustration of the Accounting Cycle (2 of 2)

Adjusting Entries

Adjusted Trial Balance

Financial Statements

Closing Entries

Post-Closing Trial Balance

Ledger

Chart of Accounts for Kelly Consulting (1 of 2)

11 Cash

12 Accounts Receivable

14 Supplies

15 Prepaid Rent

16 Prepaid Insurance

18 Office Equipment

19 Accumulated Depreciation

21 Accounts Payable

22 Salaries Payable

23 Unearned Fees

Chart of Accounts for Kelly Consulting (2 of 2)

31 Common Stack

32 Retained Earnings

33 Dividends

41 Fees Earned

51 Salary Expense

52 Rent Expense

53 Supplies Expense

54 Depreciation Expense

55 Insurance Expense

59 Miscellaneous Expense

Journal Entries for April, Kelly Consulting (1 of 3)

Journal Entries for April, Kelly Consulting (2 of 3)

Journal Entries for April, Kelly Consulting (3 of 3)

Unadjusted Trial Balance, Kelly Consulting

End-of-Period Spreadsheet, Kelly Consulting

Adjusting Entries, Kelly Consulting

Adjusted Trial Balance, Kelly Consulting

Financial Statements, Kelly Consulting (1 of 2)

Financial Statements, Kelly Consulting (2 of 2)

Closing Entries, Kelly Consulting

Post-Closing Trial Balance, Kelly Consulting

Ledger, Kelly Consulting (1 of 3)

Ledger, Kelly Consulting (2 of 3)

Ledger, Kelly Consulting (3 of 3)

Analysis for Decision Making: Working Capital and Current Ratio

The ability to convert assets into cash is called liquidity.

The ability of a business to pay its debts is called solvency.

Two financial measures for evaluating a business’s short-term liquidity and solvency are working capital and the current ratio.

Analysis for Decision Making: Working Capital (1 of 2)

Working capital is the excess of the current assets of a business over its current liabilities.

Working capital is computed as follows:

Working Capital = Current Assets – Current Liabilities

A positive working capital implies that the business is able to pay its current liabilities and is solvent.

Analysis for Decision Making: Working Capital (2 of 2)

NetSolutions’ working capital at the end of 20Y3 is computed as follows:

Working Capital = Current Assets – Current Liabilities

= $ 7,745 - $1,390

= $ 6,355

Analysis for Decision Making: Current Ratio (1 of 2)

The current ratio is another means of expressing the relationship between current assets and current liabilities.

The current ratio is computed by dividing current assets by current liabilities, as follows:

Analysis for Decision Making: Current Ratio (2 of 2)

The current ratio for NetSolutions at the end of 20Y3 is computed as follows:

Appendix 1: End-of-Period Spreadsheet

Spreadsheets are usually prepared by using a computer program such as Microsoft’s Excel®.

Some accountants prefer to expand the end-of-period spreadsheet to include financial statement columns.

Appendix 1: Steps in Preparing an Expanded End-of-Period Spreadsheet

Step 1. Enter the title.

Step 2. Enter the unadjusted trial balance.

Step 3. Enter the adjustments.

Step 4. Enter the adjusted trial balance.

Step 5. Extend the accounts to the Income Statement and Balance Sheet columns.

Step 6. Total the Income Statement and Balance Sheet columns, compute the net income or net loss, and complete the spreadsheet.

Spreadsheet with Unadjusted Trial Balance Entered

Spreadsheet with Unadjusted Trial Balance and Adjustments

Spreadsheet with Unadjusted Trial Balance, Adjustments, and Adjusted Trial Balance Entered

Spreadsheet with Amounts Extended to Income Statement and Balance Sheet Columns

Completed Spreadsheet with Net Income Shown

Appendix 1: Preparing the Financial Statements from the Spreadsheet

The spreadsheet can be used to prepare the income statement, the statement of stockholders’ equity, and the balance sheet.

When a spreadsheet is used, the adjusting and closing entries are normally not journalized or posted until after the spreadsheet and financial statements have been prepared.

Appendix 2: Reversing Entries (1 of 4)

Reversing entries are journal entries recorded on the first day of the next period that are the exact opposite of the related adjusting entry from the last day of the prior period.

Accrued Wages

Appendix 2: Reversing Entries (2 of 4)

Accrued wages for December 30 and 31 of $250 were recorded with the following adjusting entry:

Wages Expense and Wages Payable After Adjustment

Appendix 2: Reversing Entries (3 of 4)

Since a reversing entry is the opposite of the adjusting entry to which it relates, the reversing entry for the accrued payroll for NetSolutions is as follows:

Wages Expense and Wages Payable After Reversing Entry

Appendix 2: Reversing Entries (4 of 4)

On January 1, Wages Payable has a zero balance and Wages Expense has a credit balance of $250.

The Wages Expense credit balance of $250 is only temporary; it will have a debit balance of $1,025 ($1,275 – $250) as soon as the first payroll is paid on January 10.

The debit balance of $1,025 is the correct wages expense for January 1–10.

Accounting

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