completing the accounting cycle

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Completing the

Completing the

Accounting Accounting

CycleCycle

Chapter 4Chapter 4Chapter 4Chapter 4

Learning ObjectivesLearning Objectives

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

2.2. Prepare financial statements from adjusted Prepare financial statements from adjusted account balances.account balances.

3.3. Prepare closing entries.Prepare closing entries.

4.4. Describe the accounting cycle.Describe the accounting cycle.

5.5. Illustrate the accounting cycle for one Illustrate the accounting cycle for one period.period.

Learning ObjectivesLearning Objectives

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

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


Learning Learning Objective

ObjectiveDescribe the flow of accounting

Describe the flow of accounting

information from the unadjusted

information from the unadjusted

trial balance into the adjusted trial

trial balance into the adjusted trial

balance and financial statements.

balance and financial statements.

11

FLOW OF ACCOUNTING FLOW OF ACCOUNTING INFORMATIONINFORMATION

Flow of Accounting InformationFlow of Accounting Information

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

End-of-Period Spreadsheet (Work Sheet)End-of-Period Spreadsheet (Work Sheet)

Unadjusted TB

Accounts Dr Cr Dr Cr Dr Cr

Adjustments Adjusted TB

(continued)


o Adjustments are entered here. Two possibilities:Adjustments are entered here. Two possibilities: Deferrals – Existing balances are changedDeferrals – Existing balances are changed Accruals – New information is enteredAccruals – New information is entered




(continued)

Unadjusted TB


Adjustments are combined with the unadjusted Adjustments are combined with the unadjusted trial balance amounts. Account balances are trial balance amounts. Account balances are now adjusted.now adjusted.




(continued)

Unadjusted TB


o Revenue and expense balances in Revenue and expense balances in the Adjusted Trial Balance column are the Adjusted Trial Balance column are extended to the Income Statement column.extended to the Income Statement column.

Adjusted TB


Income State. Balance Sheet


(continued)


o Asset, liability, owner’s equity, and drawing Asset, liability, owner’s equity, and drawing balances in the Adjusted Trial Balance column balances in the Adjusted Trial Balance column are extended to the Balance Sheet column.are extended to the Balance Sheet column.

Adjusted TB


Income State. Balance Sheet


(concluded)



ObjectivePrepare financial statements

Prepare financial statements

from adjusted account balances.

from adjusted account balances.

22

Income StatementIncome Statement

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

FINANCIAL STATEMENT FINANCIAL STATEMENT PREPARATION FROM PREPARATION FROM

END-OF-PERIOD END-OF-PERIOD SPREADSHEET – INCOME SPREADSHEET – INCOME

STATEMENTSTATEMENT

to statement of owner’s equity

Statement of Owner’s EquityStatement of Owner’s Equity

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

FINANCIAL STATEMENT FINANCIAL STATEMENT PREPARATION FROM END-PREPARATION FROM END-

OF-PERIODOF-PERIODSPREADSHEET – SPREADSHEET –

STATEMENT OF OWNER’S STATEMENT OF OWNER’S EQUITYEQUITY

from the income statement

to the balance sheet

Balance SheetBalance Sheet

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

FINANCIAL STATEMENT FINANCIAL STATEMENT PREPARATION FROM PREPARATION FROM

END-OF-PERIOD END-OF-PERIOD SPREADSHEET – BALANCE SPREADSHEET – BALANCE

SHEETSHEET from the statement of owner’s equity

Classified Balance SheetClassified Balance Sheet

o A A classified balance sheetclassified balance sheet is a balance is a balance sheet that was expanded by adding sheet that was expanded by adding subsections for (1) current assets, (2) subsections for (1) current assets, (2) property, plant, and equipment, (3) property, plant, and equipment, (3) current liabilities, and (4) long-term current liabilities, and (4) long-term liabilities.liabilities.

CURRENT ASSETSCURRENT ASSETS

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

CashCash

Accounts Accounts ReceivableReceivable

Notes Notes ReceivableReceivable

SuppliesSupplies

Notes ReceivableNotes Receivable

o Notes receivable Notes receivable are written promises by are written promises by the customer to pay the amount of the the customer to pay the amount of the note and possibly interest at an agreed note and possibly interest at an agreed rate.rate.

FIXED ASSETSFIXED ASSETS

Property,Property, plant, andplant, and equipmentequipment (also called (also called fixed assetsfixed assets or or plant plant assetsassets) include assets ) include assets that depreciate over a that depreciate over a period of time. Land is period of time. Land is an exception, since it is an exception, since it is not subject to not subject to depreciation.depreciation.

EquipmentEquipment

MachineryMachinery

BuildingsBuildings

LandLand

CURRENT LIABILITIESCURRENT LIABILITIES

Liabilities that will be Liabilities that will be due within a short due within a short time (usually one time (usually one year or less) and that year or less) and that are to be paid out of are to be paid out of current assets are current assets are called called current current liabilitiesliabilities..

Accounts Accounts payablepayable

Wages payableWages payable

Interest payableInterest payable

Unearned feesUnearned fees

LONG-TERM LIABILITIESLONG-TERM LIABILITIES

Liabilities not due for Liabilities not due for a long time (usually a long time (usually more than one year) more than one year) are called are called long-term long-term liabilitiesliabilities..

Long-term notes Long-term notes payablepayable

Mortgage Mortgage payablepayable

Bond payableBond payable

Owner’s EquityOwner’s Equity

o Owner’s equityOwner’s equity is the owner’s right to the is the owner’s right to the assets of the business. Owner’s equity is assets of the business. Owner’s equity is added to the total liabilities, and this added to the total liabilities, and this combined total must be equal to the total combined total must be equal to the total assets.assets.



ObjectivePrepare closing entries.

Prepare closing entries.

33

Closing EntriesClosing Entries

o Accounts that are relatively permanent Accounts that are relatively permanent from year to year are called from year to year are called permanent permanent accounts accounts or or real accountsreal accounts. These accounts . These accounts are carried forward from year to year.are carried forward from year to year.


o Accounts that report amounts for only one Accounts that report amounts for only one period are called period are called temporary accounts temporary accounts or or nominal accountsnominal accounts. Temporary accounts are . Temporary accounts are not carried forward because they relate to not carried forward because they relate to only one period. only one period.


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

o To achieve this, the revenue and expense To achieve this, the revenue and expense account balances are transferred to account balances are transferred to Income Summary at the end of the Income Summary at the end of the period.period.


o The balance of Income Summary (net The balance of Income Summary (net income or net loss) is then transferred to income or net loss) is then transferred to the owner’s capital account. the owner’s capital account.

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

o The entries that transfer these balances The entries that transfer these balances are called are called closing entriesclosing entries..

CLOSING CLOSING ENTRIESENTRIES


o Income Summary Income Summary is a temporary account is a temporary account that is only used during the closing that is only used during the closing process.process.

o At the end of the At the end of the closing processclosing process, the , the Income Summary account will have a zero Income Summary account will have a zero balance.balance.

o Income Summary is sometimes called a Income Summary is sometimes called a clearing accountclearing account..

JOURNALIZING JOURNALIZING AND POSTING AND POSTING

CLOSING ENTRIESCLOSING ENTRIES


Step 1

Step 2

Step 3

Step 4

Temporary Account BalancesTemporary Account Balances

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

(continued)

LEDGERLEDGER

LEDGERLEDGER

(continued)

(continued)

LEDGERLEDGER

LEDGERLEDGER

(concluded)

LEDGERLEDGER

Post-Closing Trial BalancePost-Closing Trial Balance

o A post-closing trial balance is prepared A post-closing trial balance is prepared after the closing entries have been after the closing entries have been posted. The purpose of the post-closing posted. The purpose of the post-closing (after closing) trial balance is to verify (after closing) trial balance is to verify that the ledger is in balance at the that the ledger is in balance at the beginning of the next period.beginning of the next period.

POST-CLOSING POST-CLOSING TRIAL BALANCETRIAL BALANCE



ObjectiveDescribe the accounting cycle.

Describe the accounting cycle.

44

Accounting CycleAccounting Cycle

o The accounting process that begins with The accounting process that begins with analyzing and journalizing transactions analyzing and journalizing transactions and ends with preparing the accounting and ends with preparing the accounting records for the next period’s transactions records for the next period’s transactions is called the is called the accounting cycleaccounting cycle. There are . There are ten steps in the accounting cycle.ten steps in the accounting cycle.


1.1. Transactions are analyzed and recorded Transactions are analyzed and recorded in the journal.in the journal.

2.2. Transactions are posted to the ledger.Transactions are posted to the ledger.

3.3. An unadjusted trial balance is prepared.An unadjusted trial balance is prepared.

4.4. Adjustment data are assembled and Adjustment data are assembled and analyzed.analyzed.

5.5. An optional end-of-period spreadsheet An optional end-of-period spreadsheet (work sheet) is prepared.(work sheet) is prepared.

(continued)


6.6.Adjusting entries are journalized and Adjusting entries are journalized and posted to the ledger.posted to the ledger.

7.7.An adjusted trial balance is prepared.An adjusted trial balance is prepared.

8.8.Financial statements are prepared.Financial statements are prepared.

9.9.Closing entries are journalized and posted Closing entries are journalized and posted to the ledger.to the ledger.

10.10. A post-closing trial balance is prepared.A post-closing trial balance is prepared.

to the financial

statements

ACCOUNTING ACCOUNTING CYCLECYCLE

From the adjusted trial balance




ObjectiveIllustrate the accounting cycle

Illustrate the accounting cycle for one period.

for one period.

55


(continued)


(concluded)

UNADJUSTED UNADJUSTED TRIAL BALANCETRIAL BALANCE

END-OF-PERIOD END-OF-PERIOD SPREADSHEETSPREADSHEET

ADJUSTING ADJUSTING ENTRIESENTRIES

ADJUSTED ADJUSTED TRIAL BALANCETRIAL BALANCE

INCOME INCOME STATEMENTSTATEMENT

(continued)

STATEMENT OF STATEMENT OF OWNER’S EQUITYOWNER’S EQUITY

(continued)

BALANCE BALANCE SHEETSHEET

(concluded)

POST-CLOSING POST-CLOSING TRIAL BALANCETRIAL BALANCE

(continued)

LEDGERLEDGER

(continued)

(continued)

LEDGERLEDGER

(concluded)

LEDGERLEDGER



ObjectiveExplain what is meant by the

Explain what is meant by the

fiscal year and the natural

fiscal year and the natural business year.

business year.

66

Accounting PeriodAccounting Period

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

o When a business adopts a fiscal year that When a business adopts a fiscal year that ends when business activities have ends when business activities have reached the lowest point in its annual reached the lowest point in its annual operation, such a fiscal year is also called operation, such a fiscal year is also called the the natural business yearnatural business year..

ACCOUNTING ACCOUNTING PERIODPERIOD

FINANCIAL FINANCIAL HISTORY OF A HISTORY OF A

BUSINESSBUSINESS



ObjectiveDescribe and illustrate the use of

Describe and illustrate the use of

working capital and the current

working capital and the current

ratio in evaluating a company’s

ratio in evaluating a company’s financial condition.

financial condition.

77

Working Capital and Current RatioWorking Capital and Current Ratio

o The ability to convert assets into cash is The ability to convert assets into cash is called called liquidityliquidity..


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


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


o NetSolutions’ working capital at the end of NetSolutions’ working capital at the end of 2013 is $6,355 as computed below. This 2013 is $6,355 as computed below. This amount of working capital implies that amount of working capital implies that NetSolutions is able to pay its current NetSolutions is able to pay its current liabilities.liabilities.

Working Capital = Current Assets – Current liabilities

= $7,745 – $1,390

= $6,355


o The The current ratio current ratio is another means of is another means of expressing the relationship between expressing the relationship between current assets and current liabilities. The current assets and current liabilities. The current ratio is computed by dividing current ratio is computed by dividing current assets by current liabilities.current assets by current liabilities.

Current Ratio = Current Assets

Current Liabilities

= $7,745

$1,390

= 5.6 (Rounded)


o The current ratio for NetSolutions at the The current ratio for NetSolutions at the end of 2013 is 5.6, computed as follows:end of 2013 is 5.6, computed as follows:


Appendix:Appendix:

End-of-Period

End-of-Period

Spreadsheet

SpreadsheetEnd-of-Period

End-of-Period

Spreadsheet

Spreadsheet

81

Account Title Debit Credit Debit Credit Debit Credit

12345678910111213141516171819202122232425

Unadjusted Trial Balance Adjustments Trial Balance

Adjusted

Cash 2,065Accounts Receivable 2,220Supplies 2,000Prepaid Insurance 2,400Land 20,000Office Equipment 1,800Accumulated Depr.Accounts Payable 900Wages PayableUnearned Rent 360Chris Clark, Capital 25,000Chris Clark, Drawing 4,000Fees Earned 16,340Rent RevenueWages Expense 4,275Rent Expense 1,600Depreciation ExpenseUtilities Expense 985Supplies Expense 800Insurance ExpenseMiscellaneous Exp. 455

42,600 42,600

The The unadjusted unadjusted trial balance trial balance is checked is checked

for equalityfor equality..

82


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Trial Balance Adjustments Trial Balance

Adjusted

Supplies Supplies needs needs adjusting adjusting


42,600 42,600

Unadjusted

83


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Adjusted


42,600 42,600

(a) Cost of supplies on hand at December 31 is $760.

Unadjusted

(a) 1,240

(a) 1,240

84


12345678910111213141516171819202122232425


Adjusted

(a) 1,240


42,600 42,600

(a) 1,240

(b) The insurance expense for December is $200 ($2,400 ÷ 12).

Unadjusted

(b) 200

(b) 200

85


12345678910111213141516171819202122232425

(c) 120

(c) 120


Adjusted

(b) 200(a) 1,240

(b) 200


42,600 42,600

(a) 1,240

(c) Rent revenue earned during December was $120 ($360 ÷ 3).

Unadjusted

86


12345678910111213141516171819202122232425


Adjusted

(b) 200(a) 1,240

(b) 200

(c) 120

(c) 120

(d) 500

(d) 500


42,600 42,600

(a) 1,240

(d) Fees accrued at the end of December, but not recorded, totaled $500.

Unadjusted

87


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(e) 250


Adjusted

(b) 200(a) 1,240

(d) 500

(b) 200

(c) 120

(c) 120


42,600 42,600

(d) 500

(e) 250

(a) 1,240

((e) Wages accrued, but not paid, at the end of December totaled $250.

Unadjusted

88


12345678910111213141516171819202122232425


Adjusted

(b) 200(a) 1,240

(d) 500

(c) 120

(c) 120(d) 500

(f) 50

(f) 50

(b) 200


42,600 42,600

(e) 250

(a) 1,240

(e) 250

(f) Depreciation of office equipment is $50 for December.

Unadjusted

89


12345678910111213141516171819202122232425

2,360 2,360


Adjusted

(b) 200(a) 1,240

(d) 500

(c) 120

(c) 120

(f) 50

(b) 200(a) 1,240

(e) 250

(e) 250

(d) 500


42,600 42,600 Summed and ruled

(f) 50

Unadjusted

Add / Subtract AdjustmentsAdd / Subtract Adjustments

o The next step is to add or subtract the The next step is to add or subtract the adjustments to (or from) the amounts adjustments to (or from) the amounts found in the Unadjusted Trial Balance found in the Unadjusted Trial Balance columns and enter the results in the columns and enter the results in the Adjusted Trial Balance columns.Adjusted Trial Balance columns.

91



12345678910111213141516171819202122232425

Adjusted

2,360 2,360

(b) 200(a) 1,240

(d) 500

(c) 120

(c) 120(d) 500

(f) 50

(b) 200(a) 1,240

(e) 250

Cash 2,065 2,065Accounts Receivable 2,220 2,720Supplies 2,000 760Prepaid Insurance 2,400 2,200Land 20,000 20,000Office Equipment 1,800 1,800Accumulated Depr. 50Accounts Payable 900 900Wages Payable 250Unearned Rent 360 240Chris Clark, Capital 25,000 25,000Chris Clark, Drawing 4,000 4,000Fees Earned 16,340 16,840Rent Revenue 120Wages Expense 4,275 4,525Rent Expense 1,600 1,600Depreciation Expense 50Utilities Expense 985 985Supplies Expense 800 2,040Insurance Expense 200Miscellaneous Exp. 455 455

42,600 42,600 43,400 43,400

(f) 50

Unadjusted

(e) 250

SpreadsheetSpreadsheet

o Preparing the work sheet as a spreadsheet Preparing the work sheet as a spreadsheet allows the computer to assist you in the allows the computer to assist you in the process. The spreadsheet illustrated in process. The spreadsheet illustrated in Exhibit 1 has been reproduced on the next Exhibit 1 has been reproduced on the next slide. slide.

Extending Amounts to Statement Extending Amounts to Statement ColumnsColumnso The next step is to extend amounts in the The next step is to extend amounts in the

Adjusted Trial Balance columns to the Adjusted Trial Balance columns to the Income Statement and Balance Sheet Income Statement and Balance Sheet columns. Because of space limitations, the columns. Because of space limitations, the unadjusted trial balance and the unadjusted trial balance and the adjustments columns have been removed adjustments columns have been removed for the remainder of this slide for the remainder of this slide presentation.presentation.

95


Trial Balance Income Statement Balance Sheet

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Adjusted

Cash 2,065 2,065Accounts Receivable 2,720 2,720Supplies 760 760Prepaid Insurance 2,200 2,200Land 20,000 20,000Office Equipment 1,800 1,800Accumulated Depr. 50 50Accounts Payable 900 900Wages Payable 250 250Unearned Rent 240 240Chris Clark, Capital 25,000 25,000Chris Clark, Drawing 4,000 4,000Fees Earned 16,840 16,840Rent Revenue 120 120Wages Expense 4,525 4,525Rent Expense 1,600 1,600Depreciation Expense 50 50Utilities Expense 985 985Supplies Expense 2,040 2,040Insurance Expense 200 200Miscellaneous Exp. 455 455

43,400 43,400

96



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Adjusted

The four columns are summed.


43,400 43,400 9,855 16,960 33,545 26,440

Determining Net Income (Net Loss)Determining Net Income (Net Loss)

o The difference between the Income Statement The difference between the Income Statement column totals and Balance Sheet column totals is column totals and Balance Sheet column totals is net income (or net loss) for the period.net income (or net loss) for the period.

9,855 16,960 33,545 26,4407,105 7,105

16,960 16,960 33,545 33,545

Income Statement Balance Sheet

Net IncomeNet IncomeNet IncomeNet Income

98



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Adjusted


43,400 43,400 9,855 16,960 33,545 26,440Net income 7,105 7,105

16,960 16,960 33,545 33,545


Completing the

Completing the

Accounting Accounting

CycleCycle

The EndThe EndThe EndThe End

completing the accounting cycle

Documents

adjusted trial balance

balance sheetend

balance sheet column

adjusted account balances

income statement column

accounting cycle

expense balances

ending balances