COURSE
:
ACC 232 - FINANCIAL ACCOUNTING I
CREDIT HOURS
:
3 CREDITS
SEMESTER/SESSION
:
2nd SEMESTER, 2024/2025 SESSION
PREPARED BY
:
ZEQUEL MICHAEL
STUDENT ID
:
998474209
REFERENCE
:
FINANCIAL ACCOUNTING by CHRISTINE JONICK, ED.D.
FINANCIAL STATEMENTS
The purpose of journalizing, posting to the ledgers, and preparing the trial balance is to
compile the essential information needed for the creation of financial statements. According to
the time period concept, companies are required to produce these statements consistently over
specified intervals, such as monthly or annually. Most of the figures presented in these
statements are taken directly from the trial balance, along with relevant calculations and
summary totals. In this discussion, we will focus on the first of the four financial statements.
Income Statement
For business professionals and investors, the income statement plays a crucial role by
providing a clear picture of a company's financial performance over a specific period. This
essential report details and summarizes revenue, expenses, and net income, generally covering
a month or a year. It is based on the straightforward equation: Revenue - Expenses = Net
Income (or Net Loss).
The income statement begins with revenue, followed by a comprehensive list of
expenses, the total of which is deducted from the revenue. When the resulting figure is positive,
it indicates a profit, or net income. Conversely, a negative result signifies a net loss, which is
typically presented in parentheses.
At its core, the income statement addresses a fundamental question for any business:
How much profit is being generated? Its focus is limited to a defined timeframe—either a
month or a year—ensuring that only revenue and expenses incurred during this period are
reported. This adherence to the matching principle means that any revenues or expenses outside
this timeframe are excluded.
Now that you’ve gained an understanding of the income statement, including its
components and structure, we will postpone discussions of the other three financial
statements—the retained earnings statement, the balance sheet, and the statement of cash
flows—until later.
The Accounting Cycle
Accounting operates under a guideline known as the time period assumption, which
enables businesses to break down their ongoing activities into distinct intervals—be it a year,
a quarter, a month, or another specified timeframe. The exact duration covered is clearly
COURSE
:
ACC 232 - FINANCIAL ACCOUNTING I
CREDIT HOURS
:
3 CREDITS
SEMESTER/SESSION
:
2nd SEMESTER, 2024/2025 SESSION
PREPARED BY
:
ZEQUEL MICHAEL
STUDENT ID
:
998474209
REFERENCE
:
FINANCIAL ACCOUNTING by CHRISTINE JONICK, ED.D.
indicated in the headings of key financial documents, such as the income statement, the retained
earnings statement, and the statement of cash flows.
As a result, the accounting process follows a cyclical pattern. Each cycle represents a
timeframe during which a series of accounting activities take place. Typically, these cycles span
a year, a month, or a quarter. Once one cycle concludes, the same recording and reporting tasks
are repeated in the subsequent period of equal length.
Throughout each cycle, transactions are journalized and posted to ledgers on a daily
basis. However, financial statements are generally prepared only at the end of the cycle. Once
these statements are finalized, the process transitions smoothly into the next accounting period,
where the creation of financial statements remains the central focus of the recordkeeping
endeavor.
Temporary Accounts
The accounts listed on the income statement are known as temporary accounts. These
accounts are utilized to document operational transactions over a designated period. After the
income statement is prepared and reflects the temporary account balances at the end of that
period, these balances are reset to zero by transferring them to a different account. As a new
accounting period commences, the temporary accounts start with zero balances, allowing for a
fresh beginning.
Closing Entries
Financial statements serve as the culmination of the entire accounting cycle. Once these
reports are finalized, several essential steps must be taken to prepare for the upcoming cycle,
primarily involving the process of closing entries.
Closing entries are specific journal entries made at the end of an accounting period—
whether it be a month or a year—after the financial statements have been generated but prior
to recording the first transaction of the new period. The primary aim of closing entries is to
reset the balances of the income statement accounts to zero, allowing for a clean slate to begin
accumulating new balances for the forthcoming month. This step ensures that the income
statement for the second month reflects only transactions relevant to that period, free from any
amounts carried over from the first month.
At the end of the accounting period, the profits earned are transferred into a new account
known as Retained Earnings when the revenue and expense accounts are closed out. This
Retained Earnings account is exclusively designated for closing entries. By moving the
balances from revenue and expense accounts into Retained Earnings, businesses prepare for
the next month’s financial activities. You can think of Retained Earnings as a repository for
profit—a place where accumulated profit, or all net income generated since the business
commenced, is stored.
For illustration, let’s consider a business whose accounting period is one month.
Initially, at the start of operations, the retained earnings balance is zero, as there have been no
COURSE
:
ACC 232 - FINANCIAL ACCOUNTING I
CREDIT HOURS
:
3 CREDITS
SEMESTER/SESSION
:
2nd SEMESTER, 2024/2025 SESSION
PREPARED BY
:
ZEQUEL MICHAEL
STUDENT ID
:
998474209
REFERENCE
:
FINANCIAL ACCOUNTING by CHRISTINE JONICK, ED.D.
previous periods or profits. By the end of the first month, the retained earnings balance will
reflect the net income earned during that month.
After the first month, when closing entries for the current month are documented and
recorded, any additional net income for the subsequent month will be added to the existing
balance in Retained Earnings from previous periods. This is consistent with the fundamental
equation of revenue minus expenses equals net income; thus, transferring the balances from
revenue and expense accounts into Retained Earnings effectively equates to moving the net
income itself.
Running In Circles
A timekeeper stands at the ready, stopwatch in hand, prepared to time each lap. With a
click of the “Start” button, the runner takes off. He races across the finish line in 50 seconds,
the stopwatch displaying this time when the “Stop” button is pressed.
After catching his breath and sipping some water, the runner decides to challenge
himself again to see if he can improve his time. The timekeeper clicks “Start” once more, and
the runner sprints even faster this time. He crosses the finish line, but the stopwatch now reads
95 seconds when the “Stop” button is clicked.
What went wrong here? Did the runner really become significantly slower? In reality,
he maintained a consistent pace; the issue lies with the timekeeper! The stopwatch was not
reset to zero before the second run, resulting in the first run's 50 seconds being added to the 45
seconds of the second attempt. While the runner could subtract the first time from the second,
who wants to do math on the track? That’s precisely why the reset button exists—to facilitate
a straightforward comparison of the results from both runs.
This concept applies similarly to financial statements, where income and expense
figures are reported for a specific period—be it a month or a year. Once one month has been
accounted for, the balances in the revenue and expense accounts must be reset to zero. This
ensures that the subsequent month’s income statement does not carry over figures from the
previous month. This process involves closing out the balances in these accounts and resetting
them to zero, facilitating clear and accurate reporting going forward.
The Retained Earnings account remains open and is not closed at the end of the
accounting period. Instead, revenue and expense accounts are transferred into it. As a result,
the credit balance in Retained Earnings increases each month by the amount of net income for
that month, while the balances for Fees Earned and all expense accounts reset to zero.
Closing entries are recorded in the same journal used for general entries throughout the
month, with the first closing entry made immediately after the final general entry. It is essential
that these closing entries are posted to the ledgers, as they directly affect the balances of the
revenue, expense, and Retained Earnings accounts.
To illustrate, let’s consider an example as of June 30. Fees Earned shows a credit
balance of $2,100, while Rent Expense (the sole expense account) has a debit balance of $500.
Consequently, the net income for this period is $1,600.
