c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Completing the Accounting Cycle Chapter 4

Learning Objectives 1. Describe the flow of accounting information from the unadjusted trial balance into the adjusted trial balance and financial statements. 2. Prepare financial statements from adjusted account balances. 3. Prepare closing entries. 4. Describe the accounting cycle. 5. Illustrate the accounting cycle for one period.

Learning Objectives 6. Explain what is meant by the fiscal year and the natural business 7. Describe and illustrate the use of working capital and the current ratio in evaluating a company’s financial condition.

c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Learning Objective Describe the flow of accounting information from the unadjusted trial balance into the adjusted trial balance and financial statements. 1

F LOW OF A CCOUNTING I NFORMATION

Flow of Accounting Information o Account balances are listed in the Unadjusted Trial Balance column using the ending balances found in the general ledger. End-of-Period Spreadsheet (Work Sheet) Unadjusted TB AccountsDrCrDrCrDrCr AdjustmentsAdjusted TB (continued)

Flow of Accounting Information o Adjustments are entered here. Two possibilities:  Deferrals – Existing balances are changed  Accruals – New information is entered End-of-Period Spreadsheet (Work Sheet) AccountsDrCrDrCrDrCr AdjustmentsAdjusted TB (continued) Unadjusted TB

Flow of Accounting Information  Adjustments are combined with the unadjusted trial balance amounts. Account balances are now adjusted. AccountsDrCrDrCrDrCr AdjustmentsAdjusted TB End-of-Period Spreadsheet (Work Sheet) (continued) Unadjusted TB

Flow of Accounting Information o Revenue and expense balances in the Adjusted Trial Balance column are extended to the Income Statement column. Adjusted TB AccountsDrCrDrCrDrCr Income State.Balance Sheet End-of-Period Spreadsheet (Work Sheet) (continued)

Flow of Accounting Information o Asset, liability, owner’s equity, and drawing balances in the Adjusted Trial Balance column are extended to the Balance Sheet column. Adjusted TB AccountsDrCrDrCrDrCr Income State.Balance Sheet End-of-Period Spreadsheet (Work Sheet) (concluded)

c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Learning Objective Prepare financial statements from adjusted account balances. 2

Income Statement o 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.

F INANCIAL S TATEMENT P REPARATION FROM E ND - OF -P ERIOD S PREADSHEET – I NCOME S TATEMENT to statement of owner’s equity

Statement of Owner’s Equity o 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.

F INANCIAL S TATEMENT P REPARATION FROM E ND - OF - P ERIOD S PREADSHEET – S TATEMENT OF O WNER ’ S E QUITY from the income statement to the balance sheet

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

F INANCIAL S TATEMENT P REPARATION FROM E ND - OF -P ERIOD S PREADSHEET – B ALANCE S HEET from the statement of owner’s equity

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

C URRENT A SSETS Cash and other assets that are expected to be converted into cash, sold, or used up usually within a year or less, through the normal operations of the business, are called current assets.  Cash  Accounts Receivable  Notes Receivable  Supplies

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

F IXED A SSETS Property, plant, and equipment (also called fixed assets or plant assets) include assets that depreciate over a period of time. Land is an exception, since it is not subject to depreciation.  Equipment  Machinery  Buildings  Land

C URRENT L IABILITIES Liabilities 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  Wages payable  Interest payable  Unearned fees

L ONG -T ERM L IABILITIES Liabilities not due for a long time (usually more than one year) are called long-term liabilities.  Long-term notes payable  Mortgage payable  Bond payable

Owner’s Equity o 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.

c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Learning Objective Prepare closing entries. 3

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

Closing Entries o 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.

Closing Entries o To report amounts for only one period, temporary accounts should have zero balances at the beginning of the next period. o To achieve this, the revenue and expense account balances are transferred to Income Summary at the end of the period.

Closing Entries o The balance of Income Summary (net income or net loss) is then transferred to the owner’s capital account. o The balance of the owner’s drawing account is also transferred to the owner’s capital account. o The entries that transfer these balances are called closing entries.

C LOSING E NTRIES

Closing Entries o Income Summary is a temporary account that is only used during the closing process. o At the end of the closing process, the Income Summary account will have a zero balance. o Income Summary is sometimes called a clearing account.

J OURNALIZING AND P OSTING C LOSING E NTRIES

C LOSING E NTRIES Step 1 Step 2 Step 3 Step 4

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

(continued) L EDGER

(continued)

L EDGER

( concluded ) L EDGER

Post-Closing Trial Balance o 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.

P OST -C LOSING T RIAL B ALANCE

c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Learning Objective Describe the accounting cycle. 4

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

Accounting Cycle 1. Transactions are analyzed and recorded in the journal. 2. Transactions are posted to the ledger. 3. An unadjusted trial balance is prepared. 4. Adjustment data are assembled and analyzed. 5. An optional end-of-period spreadsheet (work sheet) is prepared. (continued)

Accounting Cycle 6. Adjusting entries are journalized and posted to the ledger. 7. An adjusted trial balance is prepared. 8. Financial statements are prepared. 9. Closing entries are journalized and posted to the ledger. 10. A post-closing trial balance is prepared.

to the financial statements A CCOUNTING C YCLE

From the adjusted trial balance A CCOUNTING C YCLE

c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Learning Objective Illustrate the accounting cycle for one period. 5

A CCOUNTING C YCLE (continued)

A CCOUNTING C YCLE (continued)

A CCOUNTING C YCLE (concluded)

A CCOUNTING C YCLE

U NADJUSTED T RIAL B ALANCE

E ND - OF -P ERIOD S PREADSHEET

A DJUSTING E NTRIES

A DJUSTED T RIAL B ALANCE

I NCOME S TATEMENT (continued)

S TATEMENT OF O WNER ’ S E QUITY (continued)

B ALANCE S HEET (concluded)

C LOSING E NTRIES

P OST -C LOSING T RIAL B ALANCE

(continued) L EDGER

(continued)

L EDGER

(concluded) L EDGER

c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Learning Objective Explain what is meant by the fiscal year and the natural business year. 6

Accounting Period o The annual accounting period adopted by a business is known as its fiscal year. o When a business adopts a fiscal year that ends when business activities have reached the lowest point in its annual operation, such a fiscal year is also called the natural business year.

A CCOUNTING P ERIOD

F INANCIAL H ISTORY OF A B USINESS

c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Learning Objective Describe and illustrate the use of working capital and the current ratio in evaluating a company’s financial condition. 7

Working Capital and Current Ratio o The ability to convert assets into cash is called liquidity.

Working Capital and Current Ratio o The ability of a business to pay its debts is called solvency.

Working Capital and Current Ratio o Working capital is the excess of the current assets of a business over its current liabilities.

Working Capital and Current Ratio o NetSolutions’ working capital at the end of 2013 is $6,355 as computed below. This amount of working capital implies that NetSolutions is able to pay its current liabilities. Working Capital = Current Assets – Current liabilities = $7,745 – $1,390 = $6,355

Working Capital and Current Ratio o 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.

Current Ratio = Current Assets Current Liabilities = $7,745 $1,390 = 5.6 (Rounded) Working Capital and Current Ratio o The current ratio for NetSolutions at the end of 2013 is 5.6, computed as follows:

c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Appendix: End-of-Period Spreadsheet

81 Account TitleDebitCreditDebitCreditDebitCredit Unadjusted Trial Balance Adjustments Trial Balance Adjusted Cash2,065 Accounts Receivable2,220 Supplies2,000 Prepaid Insurance2,400 Land20,000 Office Equipment1,800 Accumulated Depr. Accounts Payable900 Wages Payable Unearned Rent360 Chris Clark, Capital25,000 Chris Clark, Drawing4,000 Fees Earned16,340 Rent Revenue Wages Expense4,275 Rent Expense1,600 Depreciation Expense Utilities Expense985 Supplies Expense800 Insurance Expense Miscellaneous Exp.45542,600 The unadjusted trial balance is checked for equality.

82 Account TitleDebitCreditDebitCreditDebitCredit Trial Balance Adjustments Trial Balance Adjusted Supplies needs adjusting Cash2,065 Accounts Receivable2,220 Supplies2,000 Prepaid Insurance2,400 Land20,000 Office Equipment1,800 Accumulated Depr. Accounts Payable900 Wages Payable Unearned Rent360 Chris Clark, Capital25,000 Chris Clark, Drawing4,000 Fees Earned16,340 Rent Revenue Wages Expense4,275 Rent Expense1,600 Depreciation Expense Utilities Expense985 Supplies Expense800 Insurance Expense Miscellaneous Exp.45542,600 Unadjusted

83 Account TitleDebitCreditDebitCreditDebitCredit Trial Balance Adjustments Trial Balance Adjusted Cash2,065 Accounts Receivable2,220 Supplies2,000 Prepaid Insurance2,400 Land20,000 Office Equipment1,800 Accumulated Depr. Accounts Payable900 Wages Payable Unearned Rent360 Chris Clark, Capital25,000 Chris Clark, Drawing4,000 Fees Earned16,340 Rent Revenue Wages Expense4,275 Rent Expense1,600 Depreciation Expense Utilities Expense985 Supplies Expense800 Insurance Expense Miscellaneous Exp.45542,600 (a) Cost of supplies on hand at December 31 is $760. Unadjusted (a) 1,240

84 Account TitleDebitCreditDebitCreditDebitCredit Trial Balance Adjustments Trial Balance Adjusted (a) 1,240 Cash2,065 Accounts Receivable2,220 Supplies2,000 Prepaid Insurance2,400 Land20,000 Office Equipment1,800 Accumulated Depr. Accounts Payable900 Wages Payable Unearned Rent360 Chris Clark, Capital25,000 Chris Clark, Drawing4,000 Fees Earned16,340 Rent Revenue Wages Expense4,275 Rent Expense1,600 Depreciation Expense Utilities Expense985 Supplies Expense800 Insurance Expense Miscellaneous Exp.45542,600 (a) 1,240 (b) The insurance expense for December is $200 ($2,400 ÷ 12). Unadjusted (b) 200

85 Account TitleDebitCreditDebitCreditDebitCredit (c) 120 Trial Balance Adjustments Trial Balance Adjusted (b) 200 (a) 1,240 (b) 200 Cash2,065 Accounts Receivable2,220 Supplies2,000 Prepaid Insurance2,400 Land20,000 Office Equipment1,800 Accumulated Depr. Accounts Payable900 Wages Payable Unearned Rent360 Chris Clark, Capital25,000 Chris Clark, Drawing4,000 Fees Earned16,340 Rent Revenue Wages Expense4,275 Rent Expense1,600 Depreciation Expense Utilities Expense985 Supplies Expense800 Insurance Expense Miscellaneous Exp.45542,600 (a) 1,240 (c) Rent revenue earned during December was $120 ($360 ÷ 3). Unadjusted

86 Account TitleDebitCreditDebitCreditDebitCredit Trial Balance Adjustments Trial Balance Adjusted (b) 200 (a) 1,240 (b) 200 (c) 120 (d) 500 Cash2,065 Accounts Receivable2,220 Supplies2,000 Prepaid Insurance2,400 Land20,000 Office Equipment1,800 Accumulated Depr. Accounts Payable900 Wages Payable Unearned Rent360 Chris Clark, Capital25,000 Chris Clark, Drawing4,000 Fees Earned16,340 Rent Revenue Wages Expense4,275 Rent Expense1,600 Depreciation Expense Utilities Expense985 Supplies Expense800 Insurance Expense Miscellaneous Exp.45542,600 (a) 1,240 (d) Fees accrued at the end of December, but not recorded, totaled $500. Unadjusted

87 Account TitleDebitCreditDebitCreditDebitCredit (e) 250 Trial Balance Adjustments Trial Balance Adjusted (b) 200 (a) 1,240 (d) 500 (b) 200 (c) 120 Cash2,065 Accounts Receivable2,220 Supplies2,000 Prepaid Insurance2,400 Land20,000 Office Equipment1,800 Accumulated Depr. Accounts Payable900 Wages Payable Unearned Rent360 Chris Clark, Capital25,000 Chris Clark, Drawing4,000 Fees Earned16,340 Rent Revenue Wages Expense4,275 Rent Expense1,600 Depreciation Expense Utilities Expense985 Supplies Expense800 Insurance Expense Miscellaneous Exp.45542,600 (d) 500 (e) 250 (a) 1,240 ( (e) Wages accrued, but not paid, at the end of December totaled $250. Unadjusted

88 Account TitleDebitCreditDebitCreditDebitCredit Trial Balance Adjustments Trial Balance Adjusted (b) 200 (a) 1,240 (d) 500 (c) 120 (d) 500 (f) 50 (b) 200 Cash2,065 Accounts Receivable2,220 Supplies2,000 Prepaid Insurance2,400 Land20,000 Office Equipment1,800 Accumulated Depr. Accounts Payable900 Wages Payable Unearned Rent360 Chris Clark, Capital25,000 Chris Clark, Drawing4,000 Fees Earned16,340 Rent Revenue Wages Expense4,275 Rent Expense1,600 Depreciation Expense Utilities Expense985 Supplies Expense800 Insurance Expense Miscellaneous Exp.45542,600 (e) 250 (a) 1,240 (e) 250 (f) Depreciation of office equipment is $50 for December. Unadjusted

89 Account TitleDebitCreditDebitCreditDebitCredit ,360 Trial Balance Adjustments Trial Balance Adjusted (b) 200 (a) 1,240 (d) 500 (c) 120 (f) 50 (b) 200 (a) 1,240 (e) 250 (d) 500 Cash2,065 Accounts Receivable2,220 Supplies2,000 Prepaid Insurance2,400 Land20,000 Office Equipment1,800 Accumulated Depr. Accounts Payable900 Wages Payable Unearned Rent360 Chris Clark, Capital25,000 Chris Clark, Drawing4,000 Fees Earned16,340 Rent Revenue Wages Expense4,275 Rent Expense1,600 Depreciation Expense Utilities Expense985 Supplies Expense800 Insurance Expense Miscellaneous Exp.45542,600 Summed and ruled (f) 50 Unadjusted

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

91 Account TitleDebitCreditDebitCreditDebitCredit Trial Balance Adjustments Trial Balance Adjusted 2,360 (b) 200 (a) 1,240 (d) 500 (c) 120 (d) 500 (f) 50 (b) 200 (a) 1,240 (e) 250 Cash2,0652,065 Accounts Receivable2,2202,720 Supplies2, Prepaid Insurance2,4002,200 Land20,00020,000 Office Equipment1,8001,800 Accumulated Depr.50 Accounts Payable Wages Payable250 Unearned Rent Chris Clark, Capital25,00025,000 Chris Clark, Drawing4,0004,000 Fees Earned16,34016,840 Rent Revenue120 Wages Expense4,2754,525 Rent Expense1,6001,600 Depreciation Expense50 Utilities Expense Supplies Expense8002,040 Insurance Expense200 Miscellaneous Exp ,60042,600 43,40043,400 (f) 50 Unadjusted (e) 250

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

Extending Amounts to Statement Columns o The next step is to extend amounts in the Adjusted Trial Balance columns to the Income Statement and Balance Sheet columns. Because of space limitations, the unadjusted trial balance and the adjustments columns have been removed for the remainder of this slide presentation.

95 Account TitleDebitCreditDebitCreditDebitCredit Trial Balance Income Statement Balance Sheet Adjusted Cash2,0652,065 Accounts Receivable2,7202,720 Supplies Prepaid Insurance2,2002,200 Land20,00020,000 Office Equipment1,8001,800 Accumulated Depr.5050 Accounts Payable Wages Payable Unearned Rent Chris Clark, Capital25,00025,000 Chris Clark, Drawing4,0004,000 Fees Earned16,84016,840 Rent Revenue Wages Expense4,5254,525 Rent Expense1,6001,600 Depreciation Expense5050 Utilities Expense Supplies Expense2,0402,040 Insurance Expense Miscellaneous Exp ,400

96 Account TitleDebitCreditDebitCreditDebitCredit Trial Balance Income Statement Balance Sheet Adjusted The four columns are summed. Cash2,0652,065 Accounts Receivable2,7202,720 Supplies Prepaid Insurance2,2002,200 Land20,00020,000 Office Equipment1,8001,800 Accumulated Depr.5050 Accounts Payable Wages Payable Unearned Rent Chris Clark, Capital25,00025,000 Chris Clark, Drawing4,0004,000 Fees Earned16,84016,840 Rent Revenue Wages Expense4,5254,525 Rent Expense1,6001,600 Depreciation Expense5050 Utilities Expense Supplies Expense2,0402,040 Insurance Expense Miscellaneous Exp ,40043,4009,85516,96033,54526,440

Determining Net Income (Net Loss) o The difference between the Income Statement column totals and Balance Sheet column totals is net income (or net loss) for the period. 9,85516,96033,54526,4407,105 16,96016,96033,54533,545 Income Statement Balance Sheet Net Income

98 Account TitleDebitCreditDebitCreditDebitCredit Trial Balance Income Statement Balance Sheet Adjusted Cash2,0652,065 Accounts Receivable2,7202,720 Supplies Prepaid Insurance2,2002,200 Land20,00020,000 Office Equipment1,8001,800 Accumulated Depr.5050 Accounts Payable Wages Payable Unearned Rent Chris Clark, Capital25,00025,000 Chris Clark, Drawing4,0004,000 Fees Earned16,84016,840 Rent Revenue Wages Expense4,5254,525 Rent Expense1,6001,600 Depreciation Expense5050 Utilities Expense Supplies Expense2,0402,040 Insurance Expense Miscellaneous Exp ,40043,4009,85516,96033,54526,440 Net income7,105 7,105 16,96016,96033,54533,545

c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Completing the Accounting Cycle The End