Completing the Accounting Cycle Chapter 4

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

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

Learning Objective 1 Describe the flow of accounting information from the unadjusted trial balance into the adjusted trial balance and financial statements.

Flow of Accounting Information

Flow of Accounting Information End-of-Period Spreadsheet (Work Sheet) Unadjusted TB Adjustments Adjusted TB Accounts Dr Cr Dr Cr Dr Cr Account balances are listed in the Unadjusted Trial Balance column using the ending balances found in the general ledger. (continued)

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

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

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

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

Learning Objective 2 Prepare financial statements from adjusted account balances.

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.

Financial Statement Preparation from End-of-Period Spreadsheet – Income Statement to statement of owner’s equity

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.

from the income statement Financial Statement Preparation from End-of-Period Spreadsheet – Statement of Owner’s Equity from the income statement to the balance sheet

Balance Sheet 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.

from the statement of owner’s equity Financial Statement Preparation from End-of-Period Spreadsheet – Balance Sheet from the statement of owner’s equity

Classified Balance Sheet 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.

Current Assets Cash Accounts Receivable Notes Receivable Supplies 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 Notes receivable are written promises by the customer to pay the amount of the note and possibly interest at an agreed rate.

Fixed Assets Equipment Machinery Buildings Land 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

Accounts payable Wages payable Interest payable Unearned fees Current Liabilities 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

Long-Term Liabilities 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 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.

Learning Objective 3 Prepare closing entries.

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

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

Closing Entries

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

Journalizing and Posting Closing Entries

Journalizing and Posting Closing Entries

Journalizing and Posting Closing Entries

Journalizing and Posting Closing Entries

Closing Entries Step 1 Step 2 Step 3 Step 4

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

Ledger (continued)

Ledger (continued)

Ledger (continued)

Ledger

Ledger (concluded)

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

Learning Objective 4 Describe the accounting cycle.

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

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

to the financial statements Accounting Cycle to the financial statements

From the adjusted trial balance Accounting Cycle From the adjusted trial balance

Learning Objective 5 Illustrate the accounting cycle for one period.

Accounting Cycle (continued)

Accounting Cycle (continued)

Accounting Cycle (concluded)

Accounting Cycle

Unadjusted Trial Balance

End-of-Period Spreadsheet

Adjusting Entries

Adjusted Trial Balance

Income Statement (continued)

Statement of Owner’s Equity (continued)

Balance Sheet (concluded)

Closing Entries

Post-Closing Trial Balance

Ledger (continued)

(continued)

Ledger (continued)

Ledger (concluded)

Learning Objective 6 Explain what is meant by the fiscal year and the natural business year.

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

Accounting Period

Financial History of a Business

Learning Objective 7 Describe and illustrate the use of working capital and the current ratio in evaluating a company’s financial condition.

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

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

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

Working Capital and Current Ratio 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 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.

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

End-of-Period Spreadsheet Appendix: End-of-Period Spreadsheet

The unadjusted trial balance is checked for equality. Trial Balance Adjustments Trial Balance Adjusted Account Title Debit Credit Debit Credit Debit Credit 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Cash 2,065 Accounts Receivable 2,220 Supplies 2,000 Prepaid Insurance 2,400 Land 20,000 Office Equipment 1,800 Accumulated Depr. Accounts Payable 900 Wages Payable Unearned Rent 360 Chris Clark, Capital 25,000 Chris Clark, Drawing 4,000 Fees Earned 16,340 Rent Revenue Wages Expense 4,275 Rent Expense 1,600 Depreciation Expense Utilities Expense 985 Supplies Expense 800 Insurance Expense Miscellaneous Exp. 455 42,600 42,600 The unadjusted trial balance is checked for equality.

Supplies needs adjusting Trial Balance Adjustments Trial Balance Unadjusted Adjusted Account Title Debit Credit Debit Credit Debit Credit 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Cash 2,065 Accounts Receivable 2,220 Supplies 2,000 Prepaid Insurance 2,400 Land 20,000 Office Equipment 1,800 Accumulated Depr. Accounts Payable 900 Wages Payable Unearned Rent 360 Chris Clark, Capital 25,000 Chris Clark, Drawing 4,000 Fees Earned 16,340 Rent Revenue Wages Expense 4,275 Rent Expense 1,600 Depreciation Expense Utilities Expense 985 Supplies Expense 800 Insurance Expense Miscellaneous Exp. 455 42,600 42,600 Supplies needs adjusting

(a) Cost of supplies on hand at December 31 is $760. Trial Balance Adjustments Trial Balance Unadjusted Adjusted Account Title Debit Credit Debit Credit Debit Credit 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Cash 2,065 Accounts Receivable 2,220 Supplies 2,000 Prepaid Insurance 2,400 Land 20,000 Office Equipment 1,800 Accumulated Depr. Accounts Payable 900 Wages Payable Unearned Rent 360 Chris Clark, Capital 25,000 Chris Clark, Drawing 4,000 Fees Earned 16,340 Rent Revenue Wages Expense 4,275 Rent Expense 1,600 Depreciation Expense Utilities Expense 985 Supplies Expense 800 Insurance Expense Miscellaneous Exp. 455 42,600 42,600 (a) 1,240 (a) Cost of supplies on hand at December 31 is $760. (a) 1,240

(b) The insurance expense for December is $200 ($2,400 ÷ 12). Trial Balance Adjustments Trial Balance Unadjusted Adjusted Account Title Debit Credit Debit Credit Debit Credit 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Cash 2,065 Accounts Receivable 2,220 Supplies 2,000 Prepaid Insurance 2,400 Land 20,000 Office Equipment 1,800 Accumulated Depr. Accounts Payable 900 Wages Payable Unearned Rent 360 Chris Clark, Capital 25,000 Chris Clark, Drawing 4,000 Fees Earned 16,340 Rent Revenue Wages Expense 4,275 Rent Expense 1,600 Depreciation Expense Utilities Expense 985 Supplies Expense 800 Insurance Expense Miscellaneous Exp. 455 42,600 42,600 (a) 1,240 (b) 200 (b) The insurance expense for December is $200 ($2,400 ÷ 12). (a) 1,240 (b) 200

(c) Rent revenue earned during December was $120 ($360 ÷ 3). Trial Balance Adjustments Trial Balance Unadjusted Adjusted Account Title Debit Credit Debit Credit Debit Credit 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Cash 2,065 Accounts Receivable 2,220 Supplies 2,000 Prepaid Insurance 2,400 Land 20,000 Office Equipment 1,800 Accumulated Depr. Accounts Payable 900 Wages Payable Unearned Rent 360 Chris Clark, Capital 25,000 Chris Clark, Drawing 4,000 Fees Earned 16,340 Rent Revenue Wages Expense 4,275 Rent Expense 1,600 Depreciation Expense Utilities Expense 985 Supplies Expense 800 Insurance Expense Miscellaneous Exp. 455 42,600 42,600 (a) 1,240 (b) 200 (c) Rent revenue earned during December was $120 ($360 ÷ 3). (c) 120 (c) 120 (a) 1,240 (b) 200

Trial Balance Adjustments Trial Balance Unadjusted Adjusted Account Title Debit Credit Debit Credit Debit Credit 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Cash 2,065 Accounts Receivable 2,220 Supplies 2,000 Prepaid Insurance 2,400 Land 20,000 Office Equipment 1,800 Accumulated Depr. Accounts Payable 900 Wages Payable Unearned Rent 360 Chris Clark, Capital 25,000 Chris Clark, Drawing 4,000 Fees Earned 16,340 Rent Revenue Wages Expense 4,275 Rent Expense 1,600 Depreciation Expense Utilities Expense 985 Supplies Expense 800 Insurance Expense Miscellaneous Exp. 455 42,600 42,600 (d) 500 (a) 1,240 (b) 200 (d) Fees accrued at the end of December, but not recorded, totaled $500. (c) 120 (d) 500 (c) 120 (a) 1,240 (b) 200

(e) Wages accrued, but not paid, at the end of December totaled $250. Trial Balance Adjustments Trial Balance Unadjusted Adjusted Account Title Debit Credit Debit Credit Debit Credit 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Cash 2,065 Accounts Receivable 2,220 Supplies 2,000 Prepaid Insurance 2,400 Land 20,000 Office Equipment 1,800 Accumulated Depr. Accounts Payable 900 Wages Payable Unearned Rent 360 Chris Clark, Capital 25,000 Chris Clark, Drawing 4,000 Fees Earned 16,340 Rent Revenue Wages Expense 4,275 Rent Expense 1,600 Depreciation Expense Utilities Expense 985 Supplies Expense 800 Insurance Expense Miscellaneous Exp. 455 42,600 42,600 (d) 500 (a) 1,240 (b) 200 (e) Wages accrued, but not paid, at the end of December totaled $250. (e) 250 (c) 120 (d) 500 (c) 120 (e) 250 (a) 1,240 (b) 200

(f) Depreciation of office equipment is $50 for December. Trial Balance Adjustments Trial Balance Unadjusted Adjusted Account Title Debit Credit Debit Credit Debit Credit 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Cash 2,065 Accounts Receivable 2,220 Supplies 2,000 Prepaid Insurance 2,400 Land 20,000 Office Equipment 1,800 Accumulated Depr. Accounts Payable 900 Wages Payable Unearned Rent 360 Chris Clark, Capital 25,000 Chris Clark, Drawing 4,000 Fees Earned 16,340 Rent Revenue Wages Expense 4,275 Rent Expense 1,600 Depreciation Expense Utilities Expense 985 Supplies Expense 800 Insurance Expense Miscellaneous Exp. 455 42,600 42,600 (d) 500 (a) 1,240 (b) 200 (f) Depreciation of office equipment is $50 for December. (f) 50 (e) 250 (c) 120 (d) 500 (c) 120 (e) 250 (f) 50 (a) 1,240 (b) 200

Summed and ruled Cash 2,065 Accounts Receivable 2,220 Supplies 2,000 Trial Balance Adjustments Trial Balance Unadjusted Adjusted Account Title Debit Credit Debit Credit Debit Credit 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Cash 2,065 Accounts Receivable 2,220 Supplies 2,000 Prepaid Insurance 2,400 Land 20,000 Office Equipment 1,800 Accumulated Depr. Accounts Payable 900 Wages Payable Unearned Rent 360 Chris Clark, Capital 25,000 Chris Clark, Drawing 4,000 Fees Earned 16,340 Rent Revenue Wages Expense 4,275 Rent Expense 1,600 Depreciation Expense Utilities Expense 985 Supplies Expense 800 Insurance Expense Miscellaneous Exp. 455 42,600 42,600 (d) 500 (a) 1,240 (b) 200 (f) 50 (e) 250 (c) 120 (d) 500 (c) 120 (e) 250 (f) 50 (a) 1,240 (b) 200 Summed and ruled 2,360 2,360

Add / Subtract Adjustments 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.

Chris Clark, Capital 25,000 25,000 Chris Clark, Drawing 4,000 4,000 Trial Balance Adjustments Trial Balance Unadjusted Adjusted Account Title Debit Credit Debit Credit Debit Credit 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Cash 2,065 2,065 Accounts Receivable 2,220 2,720 Supplies 2,000 760 Prepaid Insurance 2,400 2,200 Land 20,000 20,000 Office Equipment 1,800 1,800 Accumulated Depr. 50 Accounts Payable 900 900 Wages Payable 250 Unearned Rent 360 240 Chris Clark, Capital 25,000 25,000 Chris Clark, Drawing 4,000 4,000 Fees Earned 16,340 16,840 Rent Revenue 120 Wages Expense 4,275 4,525 Rent Expense 1,600 1,600 Depreciation Expense 50 Utilities Expense 985 985 Supplies Expense 800 2,040 Insurance Expense 200 Miscellaneous Exp. 455 455 42,600 42,600 43,400 43,400 (d) 500 (a) 1,240 (b) 200 (f) 50 (e) 250 (c) 120 (d) 500 (c) 120 (e) 250 (f) 50 (a) 1,240 (b) 200 2,360 2,360

Spreadsheet 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 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.

Chris Clark, Capital 25,000 25,000 Chris Clark, Drawing 4,000 4,000 Trial Balance Income Statement Balance Sheet Adjusted Account Title Debit Credit Debit Credit Debit Credit 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Cash 2,065 2,065 Accounts Receivable 2,720 2,720 Supplies 760 760 Prepaid Insurance 2,200 2,200 Land 20,000 20,000 Office Equipment 1,800 1,800 Accumulated Depr. 50 50 Accounts Payable 900 900 Wages Payable 250 250 Unearned Rent 240 240 Chris Clark, Capital 25,000 25,000 Chris Clark, Drawing 4,000 4,000 Fees Earned 16,840 16,840 Rent Revenue 120 120 Wages Expense 4,525 4,525 Rent Expense 1,600 1,600 Depreciation Expense 50 50 Utilities Expense 985 985 Supplies Expense 2,040 2,040 Insurance Expense 200 200 Miscellaneous Exp. 455 455 43,400 43,400

The four columns are summed. Trial Balance Income Statement Balance Sheet Adjusted Account Title Debit Credit Debit Credit Debit Credit 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Cash 2,065 2,065 Accounts Receivable 2,720 2,720 Supplies 760 760 Prepaid Insurance 2,200 2,200 Land 20,000 20,000 Office Equipment 1,800 1,800 Accumulated Depr. 50 50 Accounts Payable 900 900 Wages Payable 250 250 Unearned Rent 240 240 Chris Clark, Capital 25,000 25,000 Chris Clark, Drawing 4,000 4,000 Fees Earned 16,840 16,840 Rent Revenue 120 120 Wages Expense 4,525 4,525 Rent Expense 1,600 1,600 Depreciation Expense 50 50 Utilities Expense 985 985 Supplies Expense 2,040 2,040 Insurance Expense 200 200 Miscellaneous Exp. 455 455 43,400 43,400 9,855 16,960 33,545 26,440 The four columns are summed.

Determining Net Income (Net Loss) Income Statement Balance Sheet 9,855 16,960 33,545 26,440 7,105 7,105 16,960 16,960 33,545 33,545 Net Income The difference between the Income Statement column totals and Balance Sheet column totals is net income (or net loss) for the period.

Chris Clark, Capital 25,000 25,000 Chris Clark, Drawing 4,000 4,000 Trial Balance Income Statement Balance Sheet Adjusted Account Title Debit Credit Debit Credit Debit Credit 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Cash 2,065 2,065 Accounts Receivable 2,720 2,720 Supplies 760 760 Prepaid Insurance 2,200 2,200 Land 20,000 20,000 Office Equipment 1,800 1,800 Accumulated Depr. 50 50 Accounts Payable 900 900 Wages Payable 250 250 Unearned Rent 240 240 Chris Clark, Capital 25,000 25,000 Chris Clark, Drawing 4,000 4,000 Fees Earned 16,840 16,840 Rent Revenue 120 120 Wages Expense 4,525 4,525 Rent Expense 1,600 1,600 Depreciation Expense 50 50 Utilities Expense 985 985 Supplies Expense 2,040 2,040 Insurance Expense 200 200 Miscellaneous Exp. 455 455 43,400 43,400 9,855 16,960 33,545 26,440 Net income 7,105 7,105 16,960 16,960 33,545 33,545

Completing the Accounting Cycle The End