rule #2) the accounting cycle · rule #2) the accounting cycle. financial statement preparation...
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Rule #2) The Accounting Cycle
Financial Statement Preparation
Based on our Adjustments and the Worksheet we prepared, we are ready to create the Financial Statements
The Financial Statements must be:
- Complete – all accounts are included
- Up to Date – all period ending adjustments have been made
- In the correct Format – to be understandable
Financial Statement Preparation
We will prepare an Income Statement and a Balance Sheet using the Worksheet information
Both include a Heading – Name, statement title and period
Income Statement – “For the period ended ______”
Balance Sheet – “As of ______”, or just the date
Financial Statement Preparation
The Income Statement has three sections in the following order:
Revenues (Sales)
Expenses
Net Income
Financial Statement Preparation
In addition to showing each account, there are subtotals to show:
Total IncomeTotal Expenses
And the final results:
Net Income or (Loss)
Financial Statement Preparation
All of the amounts, including Net Income, have already been computed on the worksheet
What we are doing is:
- Formatting to make the information more readable and useful
- Adding % which might be useful to the reader
- Adding underlines, which will mean something to the reader
- Adding comparisons (vs. prior year)
Financial Statement Preparation
Balance Sheet format differs:
- Resembles the accounting Equation
- Left side is Asset accounts
- Right side is Liabilities and Owner’s Equity accounts
Financial Statement Preparation
In addition to showing each Balance Sheet account, there are subtotals to show:
Total AssetsTotal Liabilities Total Owner’s EquityTotal Liabilities and Owner’s Equity
Financial Statement PreparationAll of the Balance Sheet amounts have already been computed on the worksheet, but;
We must complete one step to get all the correct amounts onto the Balance Sheet
Final Step: Take owner’s equity per the worksheet and update it for the net income (loss) for the period
Essentially:
Owner’s Equity +/- Net Income (Loss)
Financial Statement Preparation
In this way all of the Balance Sheet accounts are now up to date.
What we are doing is:
- Using the Net Income (Loss) to update the Owner’s Equity
- Formatting to make the information more readable and useful
- Adding underlines, which will mean something to the reader
- Adding comparisons (vs. prior year)
Financial Statement Preparation
Again, all the information is available from the Worksheet
Worksheet Owner’s Equity +/- Net Income (Loss) = End of period Adjusted Owner’s Equity
By making this adjustment we should see that the accounting equation still is in balance:
Assets = Liabilities + Owner’s Equity
Rule #2) The Accounting Cycle
Updating the Ledger for the Closing Entries
Journal/General Ledger
Worksheet + Adjustments
Financial Statements
Even though we have created the Financial Statements we need to include the worksheet adjustments on the Journal & General Ledger
Adjusting and Closing EntriesLet’s go back to our General Ledger again.
What adjustments did we make to the ledger accounts in closing the books?
Supplies InsuranceNet Income
Adjusting and Closing EntriesBefore we can start our Accounting for the next month, we have to do two things to the ledger:
1) Record the adjustments we made on the worksheet in the ledger (Adjusting Entries)
2) Close out the income statement accounts so we can start the transactions for the next month. Income Statement accounts are Temporary Accounts used to hold the activity until I move it to Owner’s Equity (Closing Entries)
Adjusting and Closing Entries
Adjusting Entries – Bring the general ledger accounts up to date at the end of the fiscal period
Closing Entries – 1) Reduce the Temporary Accounts to Zero so they can begin again in the next fiscal period
2) Close the Owner’s Drawing account into Owner’s Equity
The net impact of the Closing entries is to move the Net Income (Loss) and the Owner’s Drawing Account into the Owner’s Equity Account
Adjusting and Closing Entries
At this point we should be able to create a Post-Closing Trial Balance
This Trial Balance will:
1) Be in Balance (Debits = Credits)
2) Have updated all Balance Sheet Accounts for Adjusting Entries
3) Have updated the Owner’s Equity for Net Income (Loss)
4) Adjusted the Owner’s Drawing Account to zero
5) Adjusted the Income and Expense Accounts to zero