Problem 4-1A due in 18 hours

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WRD27e_IEPPT_Ch04.pptx

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Warren

Reeve

Duchac

Accounting

27e

Completing the Accounting Cycle

C H A P T E R

human/iStock/360/Getty Images

Learning Objectives

LO1: Describe the flow of accounting information from the unadjusted trial balance into the adjusted trial balance and financial statements.

LO2: Prepare financial statements from adjusted account balances.

LO3: Prepare closing entries.

LO4: Describe the accounting cycle.

LO5: Illustrate the accounting cycle for one period.

LO6: Explain what is meant by the fiscal year and the natural business year.

LO7: Describe and illustrate the use of working capital and the current ratio in evaluating a company’s financial condition.

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

Flow of Accounting Information (slide 1 of 5)

Account balances are listed in the Unadjusted Trial Balance columns using the ending balances found in the general ledger.

End-of-Period Spreadsheet (Work Sheet)

Unadjusted Trial Balance

Dr Cr Dr Cr Dr Cr

Adjustments

Adjusted Trial Balance

Accounts

Flow of Accounting Information (slide 2 of 5)

Adjustments are entered here. Two possibilities:

Deferrals – Existing balances are changed.

Accruals – New information is entered.

End-of-Period Spreadsheet (Work Sheet)

Adjustments

Adjusted Trial Balance

Unadjusted Trial Balance

Accounts

Dr Cr Dr Cr Dr Cr

Flow of Accounting Information (slide 3 of 5)

Adjustments are added to or subtracted from the amounts in the Unadjusted Trial Balance columns. Account balances are now adjusted.

Adjustments

Adjusted Trial Balance

End-of-Period Spreadsheet (Work Sheet)

Unadjusted Trial Balance

Dr Cr Dr Cr Dr Cr

Accounts

Flow of Accounting Information (slide 4 of 5)

Amounts for revenues and expenses in the Adjusted Trial Balance columns are extended to the Income Statement columns.

Adjusted Trial Balance

Income Statement

Balance Sheet

End-of-Period Spreadsheet (Work Sheet)

Accounts

Dr Cr Dr Cr Dr Cr

Flow of Accounting Information (slide 5 of 5)

The amounts for assets, liabilities, owner’s capital, and drawing in the Adjusted Trial Balance columns are extended to the Balance Sheet columns.

Adjusted Trial Balance

Income Statement

Balance Sheet

End-of-Period Spreadsheet (Work Sheet)

Dr Cr Dr Cr Dr Cr

Accounts

The balances for the accounts that follow appear in the Adjusted Trial Balance columns of the end-of-period spreadsheet. Indicate whether each account would flow into the income statement, statement of owner’s equity, or balance sheet.

Office Equipment

Utilities Expense

Accumulated Depreciation—Equipment

Unearned Rent

Fees Earned

Doug Johnson, Drawing

Rent Revenue

Supplies

Flow of Accounts into Financial Statements (slide 1 of 2)

Example Exercise

Flow of Accounts into Financial Statements (slide 2 of 2)

Example Exercise

Income Statement

The income statement is prepared directly from the Income Statement or Adjusted Trial Balance columns of the end-of-period spreadsheet (work sheet), beginning with fees earned of $16,840.

The expenses in the income statement are listed in order of size, beginning with the larger items. However, Miscellaneous Expense is always the last account listed, regardless of its amount.

Financial Statements, NetSolutions: Income Statement

to statement of owner’s equity

The first item presented on the statement of owner’s equity is the balance of the owner’s capital account at the beginning of the period.

Any investments, the net income (or net loss), and the drawing account balance are used to determine the ending owner’s capital account balance.

Statement of Owner’s Equity

Financial Statements, NetSolutions: Statement of Owner’s Equity

from the income statement

to the balance sheet

Zack Gaddis owns and operates Gaddis Employment Services. On January 1, 2018, Zack Gaddis, Capital had a balance of $186,000. During the year, Zack invested an additional $40,000 and withdrew $25,000. For the year ended December 31, 2018, Gaddis Employment Services reported a net income of $18,750. Prepare a statement of owner’s equity for the year ended December 31, 2018.

Statement of Owner’s Equity

Example Exercise

Balance Sheet

The balance sheet is prepared directly from the Balance Sheet or Adjusted Trial Balance columns of the end-of-period spreadsheet, beginning with Cash of $2,065.

A classified balance sheet is a balance sheet that is expanded by adding subsections for assets and liabilities.

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.

Financial Statements, NetSolutions: Balance Sheet

from the

statement of

owner’s equity

Current Assets (slide 1 of 2)

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

Cash

Accounts receivable

Notes receivable

Supplies

Other prepaid expenses

Current Assets (slide 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.

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.

Accounts payable

Notes payable

Wages payable

Interest 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.

Owner’s Equity

Owner’s equity is the owner’s right to the assets of the business.

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

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

The following accounts appear in an adjusted trial balance of Hindsight Consulting. Indicate whether each account would be reported in the (a) current asset; (b) property, plant, and equipment; (c) current liability; (d) long-term liability; or (e) owner’s equity section of the December 31, 2018, balance sheet of Hindsight Consulting.

Jason Corbin, Capital

Notes Receivable (due in six months)

Notes Payable (due in 10 years)

Land

Cash

Unearned Rent (three months)

Accumulated Depreciation—Equipment

Accounts Payable

Classified Balance Sheet (slide 1 of 2)

Example Exercise

Classified Balance Sheet (slide 2 of 2)

Example Exercise

Permanent Accounts

Accounts that are relatively permanent from year to year are called permanent accounts or real accounts.

The balances of these accounts are carried forward from year to year.

This includes accounts reported on the balance sheet.

Temporary Accounts

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

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

This includes all accounts reported on the income statement as well as the owner’s drawing account, which is reported on the statement of owner’s equity.

The Closing Process

Closing Entries (slide 1 of 3)

To report amounts for only one period, temporary accounts should have zero balances at the beginning of the next period.

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 (or closing the books).

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

Closing Entries (slide 2 of 3)

The closing process involves the following two closing journal entries:

First Closing Entry

Revenue and expense account balances are transferred to the owner’s capital account.

Second Closing Entry

The balance of the owner’s drawing account is transferred to the owner’s capital account.

Closing Entries (slide 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 owner’s capital account.

Debit the owner’s capital account for the balance of the drawing account and credit the drawing account.

Note: It is possible to close the temporary revenue and expense accounts using a clearing account such as Income Summary, Revenue and Expense Summary, or Profit and Loss Summary. In this case, four closing entries are made. The first entry closes the revenue accounts to Income Summary. The second entry closes the expense accounts to Income Summary. The third entry closes the income summary account to owner's equity. The fourth entry closes the owner's drawing account to owner's equity.

Flowchart of Closing Entries for NetSolutions

Closing Entries, NetSolutions

Ledger, NetSolutions (slide 1 of 4)

Ledger, NetSolutions (slide 2 of 4)

Ledger, NetSolutions (slide 3 of 4)

Ledger, NetSolutions (slide 4 of 4)

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

Journalize the two entries required to close the accounts.

Closing Entries (slide 1 of 2)

Example Exercise

Closing Entries (slide 2 of 2)

Example Exercise

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 (slide 1 of 2)

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 (slide 2 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 (work sheet) is prepared.

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.

From the following list of steps in the accounting cycle, identify what two steps are missing:

Transactions are analyzed and recorded in the journal:

Transactions are posted to the ledger.

Adjustment data are assembled and analyzed.

An optional end-of-period spreadsheet is prepared.

Adjusting entries are journalized and posted to the ledger.

Financial statements are prepared.

Closing entries are journalized and posted to the ledger.

A post-closing trial balance is prepared.

Accounting Cycle

Example Exercise

Accounting Cycle (slide 1 of 2)

Accounting Cycle (slide 2 of 2)

Illustration of the Accounting Cycle

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

Adjusting Entries

Adjusted Trial Balance

Financial Statements

Closing Entries

Post-Closing Trial Balance

Ledger

Chart of Accounts for Kelly Consulting

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

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

Journal Entries for April, Kelly Consulting (slide 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: Income Statement

Financial Statements, Kelly Consulting: Statement of Owner’s Equity

Financial Statements, Kelly Consulting: Balance Sheet

Closing Entries, Kelly Consulting

Post-Closing Trial Balance, Kelly Consulting

Ledger, Kelly Consulting (slide 1 of 4)

Ledger, Kelly Consulting (slide 2 of 4)

Ledger, Kelly Consulting (slide 3 of 4)

Ledger, Kelly Consulting (slide 4 of 4)

Fiscal Year

The annual accounting period adopted by a business is known as its fiscal year.

Fiscal years begin with the first day of the month selected and end on the last day of the following twelfth month.

When a corporation adopts a fiscal year that ends when business activities have reached the lowest point in its annual operating cycle, such a fiscal year is called the natural business year.

Financial History of a Business

Financial Analysis and Interpretation: 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.

Financial Analysis and Interpretation: Working Capital (slide 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:

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

Working Capital = Current Assets – Current Liabilities

Financial Analysis and Interpretation: Working Capital (slide 2 of 2)

NetSolutions’ working capital at the end of 2018 is computed as follows:

Financial Analysis and Interpretation: Current Ratio (slide 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:

Current Ratio =

Current Assets

Current Liabilities

Financial Analysis and Interpretation: Current Ratio (slide 2 of 2)

The current ratio for NetSolutions at the end of 2018 is computed as follows:

Working Capital and Current Ratio

Current assets and current liabilities for Fortson Company follow:

Determine the working capital and current ratio for 2019 and 2018.

Does the change in the current ratio from 2018 to 2019 indicate a favorable or an unfavorable change?

Example Exercise

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.

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 owner’s 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

Some adjusting entries recorded at the end of an accounting period affect how transactions are recorded in the next period.

For this reason, some companies add another step to the accounting cycle, called reversing entries.

This additional step records journal entries 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.

Reversing Entries – Accrued Wages

Reversing Entries – Wages Expense and Wages Payable (After Adjustment)

Reversing Entries – Wages Expense and Wages Payable (After Reversing Entry)