4 Completing the Accounting Cycle and Classifying Accounts CHAPTER PowerPoint Slides to accompany Fundamental Accounting Principles, 14ce Prepared by Joe Pidutti, Durham College

© 2013 McGraw-Hill Ryerson Limited. Learning Objectives Describe and prepare a worksheet and explain its usefulness. (LO1) Describe the closing process and explain why temporary accounts are closed each period. (LO2) Prepare closing entries. (LO3) Explain and prepare a post-closing trial balance. (LO4) © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. Learning Objectives Complete the steps in the accounting cycle. (LO5) Explain and prepare a classified balance sheet. (LO6) Prepare reversing entries and explain their purpose. (Appendix 4A) (LO7) Calculate the current ratio and describe what it reveals about a company’s financial condition. (Appendix 4B) (LO8) © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. The Accounting Cycle Prepare post-closing trial balance Analyze transactions 1 9 Journalize 2 Close 8 Post 3 Prepare statements 7 Prepare unadjusted trial balance 4 Prepare adjusted trial balance 6 Adjust 5 LO 1 © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. The Worksheet An optional working paper that can be used to simplify the preparation of financial statements. It is: Prepared before adjusting entries are made. Not distributed to decision makers. Helpful in preventing errors. Often used by auditors. LO 1 © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. A Blank Worksheet Steps: Enter unadjusted trial balance. Enter adjustments. Prepare adjusted trial balance. Extend adjusted trial balance columns. Enter net income (or loss) and balance financial statement columns. Prepare financial statements. LO 1 © 2013 McGraw-Hill Ryerson Limited.

Prepare Unadjusted Trial Balance Step 1 Prepare Unadjusted Trial Balance © 2013 McGraw-Hill Ryerson Limited. LO 1

© 2013 McGraw-Hill Ryerson Limited. Step 2 Enter Adjustments © 2013 McGraw-Hill Ryerson Limited. LO 1

Prepare Adjusted Trial Balance Step 3 Prepare Adjusted Trial Balance © 2013 McGraw-Hill Ryerson Limited. LO 1

Extend Adjusted Amounts to Statement Columns Step 4 Extend Adjusted Amounts to Statement Columns © 2013 McGraw-Hill Ryerson Limited. LO 1

Enter net income (or loss) and balance financial statement columns. Step 5 Enter net income (or loss) and balance financial statement columns. LO 1 © 2013 McGraw-Hill Ryerson Limited.

Prepare financial statements from worksheet information. Step 6 Prepare financial statements from worksheet information. © 2013 McGraw-Hill Ryerson Limited. LO 1

© 2013 McGraw-Hill Ryerson Limited. The Closing Process The closing process occurs at the end of an accounting period after financial statements are prepared. Closing entries: Reset revenue, expense and withdrawal account balances to zero at the end of the period. Update the capital account to reflect net income (or loss) and drawings from the period just ending. LO 2 © 2013 McGraw-Hill Ryerson Limited.

Four-Step Closing Process (REID) Close Revenue accounts to Income Summary account. Close Expense accounts to Income Summary account. Close Income Summary account to Owner’s Capital account. Close Drawings (Withdrawals) account to the Capital account. LO 3 © 2013 McGraw-Hill Ryerson Limited.

Four-Step Closing Process (REID) Example Please see the Adjusted Trial Balance illustration in the textbook. LO 3 © 2013 McGraw-Hill Ryerson Limited.

Step 1: Close Revenue accounts to Income Summary Teaching Revenue 5,850 Equip. Rental Revenue 300 Income Summary 66,150 LO 3 © 2013 McGraw-Hill Ryerson Limited.

Step 2: Close Expense Accounts to Income Summary Depreciation Expense 200 Salaries Expense 1,470 Interest Expense 35 Insurance Expense 100 Rent Expense 1,000 Supplies Expense 1,050 Utilities Expense 230 © 2013 McGraw-Hill Ryerson Limited. LO 3

Step 3: Close Income Summary to Capital Virgil Klimb, Capital 2,065 LO 3 © 2013 McGraw-Hill Ryerson Limited.

Step 4: Close Drawings to Capital Virgil Klimb, Capital 600 Virgil Klimb, Withdrawals 600 LO 3 © 2013 McGraw-Hill Ryerson Limited.

Account Balances after Closing All temporary accounts (revenue, expense, and withdrawal accounts will have zero balances. The capital account will be updated to reflect net income (or loss) and withdrawals from the period just ending. All other accounts will be unchanged. LO 4 © 2013 McGraw-Hill Ryerson Limited.

Post-Closing Trial Balance A list of permanent accounts and their balances after closing entries are journalized and posted. It verifies that: Total debits = total credits for permanent accounts. All temporary accounts have zero balances. LO 4 © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. The Accounting Cycle Prepare post-closing trial balance Analyze transactions 1 9 Journalize 2 Close 8 Post 3 Prepare statements 7 Prepare unadjusted trial balance 4 Prepare adjusted trial balance 6 Adjust 5 LO 2 © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. Mini-Quiz Closing the temporary accounts at the end of each accounting period:    A) Serves to transfer the effects of these accounts to the proper equity account on the balance sheet.  B)Prepares the withdrawals account for use in the next period.  C)Gives the revenue and expense accounts zero balances.  D)Both A and C.  E)All of the above. © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. Mini-Quiz Closing the temporary accounts at the end of each accounting period:    A) Serves to transfer the effects of these accounts to the proper equity account on the balance sheet.  B)Prepares the withdrawals account for use in the next period.  C)Gives the revenue and expense accounts zero balances.  D)Both A and C.  E)All of the above. © 2013 McGraw-Hill Ryerson Limited.

Classified Balance Sheet A classified balance sheet: Organizes assets and liabilities into important subgroups. Provides users with more useful information for decision making.   LO 6 © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. Current assets are assets that are expected to be sold, collected, or used within the longer of one year or the company’s operating cycle. LO 6 © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. Long-term investments are held for more than one year or the operating cycle. LO 6 © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. Property, plant and equipment are tangible assets used for more than one accounting period to produce or sell products and services. LO 6 © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. Intangible assets are long-term resources used to produce or sell products and services. They lack physical form. LO 6 © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. Current liabilities are obligations due to be paid or settled within the longer of one year or the company’s operating cycle. LO 6 © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. Long-term liabilities are obligations due beyond the longer of one year or the company’s operating cycle. LO 6 © 2013 McGraw-Hill Ryerson Limited.

Equity is the owner’s claim on the assets of a company. © 2013 McGraw-Hill Ryerson Limited. LO 6

© 2013 McGraw-Hill Ryerson Limited. Review What classes of assets and liabilities are shown on a typical classified balance sheet? Current assets, long-term investments, PP&E, intangible assets, current liabilities, long-term liabilities LO 6 © 2013 McGraw-Hill Ryerson Limited.

Appendix 4A Reversing Entries Optional entries used to simplify record keeping. They are: Prepared on the first day of the new accounting period. Prepared for adjusting entries that created accrued assets and liabilities. LO 7 © 2013 McGraw-Hill Ryerson Limited.

Reversing Entries - Example DP Company rents unused office space to a tenant for $2,400 per month. The company had not received October’s rent payment from the tenant by October 31. Payment is expected on November 3. The entry to record the accrued revenue would be: Oct.31 Accounts Receivable 2,400 Rent Revenue 2,400 LO 7 © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. Appendix 4A Reversing Entries are Not used Reversing Entries are Used Oct.31 Accounts Receivable 2,400 Accounts Receivable 2,400 Rent Revenue 2,400 Rent Revenue 2,400 LO 7 © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. Appendix 4A Reversing Entries are Not used Reversing Entries are Used Nov. 1 No entry Rent Revenue 2,400 Accounts Receivable 2,400 Nov.3 Cash 2,400 Cash 2,400 Accounts Receivable 2,400 Rent Revenue 2,400 LO 7 © 2013 McGraw-Hill Ryerson Limited.

Appendix 4B Using the Information Current ratio: A ratio that is used to evaluate a company’s ability to pay its short-term obligations. Current ratio = Current assets Current liabilities LO 8 © 2013 McGraw-Hill Ryerson Limited.

Appendix 4B Using the Information Current ratio = Current assets Current liabilities This ratio: Should not be used in isolation as a measure of liquidity. Will vary from industry to industry. May be tracked over time to spot trends. May be used to compare to industry norms. LO 8 © 2013 McGraw-Hill Ryerson Limited.

© 2013 McGraw-Hill Ryerson Limited. End of Chapter © 2013 McGraw-Hill Ryerson Limited.