Chapter 4

 Process by which companies produce their financial statements  Use of a work sheet summarizes needed data in one place Copyright © 2009 Prentice Hall. All rights reserved 2

Journalize Transaction Post to Accounts Adjust Accounts Prepare Financial Statements Close Accounts 3 During the period End of the period Copyright © 2009 Prentice Hall. All rights reserved

Prepare an accounting work sheet 4 Copyright (c) Prentice Hall. All rights reserved.

 Internal summary device  NOT: ◦ A journal ◦ A ledger ◦ A financial statement  Computerized spreadsheets work well 5 Copyright (c) Prentice Hall. All rights reserved.

 Enter account titles and their unadjusted balances in the Trial Balance columns  Total the amounts 6Copyright (c) Prentice Hall. All rights reserved.

 Enter the adjusting entries in the Adjustments columns  Total the amounts 7 Copyright (c) Prentice Hall. All rights reserved.

 Compute each account’s adjusted balance by combining the trial balance and adjustment figures  Enter each account’s adjusted amount in the Adjusted trial balance columns  See following slide 8 Copyright (c) Prentice Hall. All rights reserved.

9 Work Sheet Steps Copyright (c) Prentice Hall. All rights reserved.

 Draw an imaginary line above the first revenue account  Every account above goes to the Balance sheet columns  Every account below goes to the Income Statement columns 10Copyright (c) Prentice Hall. All rights reserved.

11Copyright (c) Prentice Hall. All rights reserved.

 On the income statement, compute net income ◦ Revenues minus expenses  Enter net income as the balancing amount 12 Net Income Copyright (c) Prentice Hall. All rights reserved.

 Also enter net income as a balancing amount on the balance sheet 13 Net Income Copyright (c) Prentice Hall. All rights reserved.

14Copyright (c) Prentice Hall. All rights reserved.

Use the work sheet to prepare financial statements 15 Copyright (c) Prentice Hall. All rights reserved.

 Both work sheet and financial statements have the same account balances and the same net income(or loss)  Work sheet is an internal document  Financial statements are for external users  Adjusting entries from work sheet need to be recorded in journal and posted 16 Copyright (c) Prentice Hall. All rights reserved.

17 Net Income Any Company Income Statement Month ended May 31, 2010 Revenue: Service revenue $ 6,500 Expenses: Salary expense $1,000 Depreciation expense 1,000 Supplies expense 500 Utilities expense 400 Total expenses 2,900 Net Income $ 3,600 Work Sheet Financial Statement Copyright (c) Prentice Hall. All rights reserved.

18 Any Company Statement of Owner’s Equity Month ended May 31, 2010 Josie Smith, Capital May 1, 2010 $13,200 Add: Net Income 3,600 16,800 Less: Withdrawals (1,000) Josie Smith, Capital, May 31, 2010 $15,800 Copyright (c) Prentice Hall. All rights reserved.

19 Copyright (c) Prentice Hall. All rights reserved.

?Review Question? ??

1. Which of the following steps of the accounting cycle takes place during the period? A. Posting to the accounts B. Adjusting the accounts C. Closing the accounts D. Preparing financial statements 21Copyright (c) 2009 Prentice Hall. All rights reserved.

1.Which of the following steps of the accounting cycle takes place during the period? A.Posting to the accounts B.Adjusting the accounts C.Closing the accounts D.Preparing financial statements 22Copyright (c) 2009 Prentice Hall. All rights reserved.

2. The work sheet: A. replaces the financial statements. B. is similar to the journal. C. summarizes data for the financial statements. D. makes posting adjusting entries unnecessary. 23Copyright (c) 2009 Prentice Hall. All rights reserved.

2.The work sheet: A.replaces the financial statements. B.is similar to the journal. C.summarizes data for the financial statements. D.makes posting adjusting entries unnecessary. 24Copyright (c) 2009 Prentice Hall. All rights reserved.

Close the revenue, expense, and dividend accounts 25 Copyright (c) Prentice Hall. All rights reserved.

 Occurs at the end of the period ◦ Gets accounts ready for next period  Zeroes out revenue and expense accounts 26 Copyright (c) Prentice Hall. All rights reserved.

Temporary  Closed at the end of the period ◦ Revenues ◦ Expenses ◦ Withdrawals  Start next period with a zero balance Permanent  Not closed at the end of the period ◦ Assets ◦ Liabilities ◦ Capital  Ending balance carries forward to next period 27 Copyright (c) Prentice Hall. All rights reserved.

 Transfer temporary accounts to Capital  Income summary account used in closing process ◦ Summarizes net income ◦ Temporary holding tank ◦ Closed into Capital 28 Copyright (c) Prentice Hall. All rights reserved.

 1. Close revenues  2. Close expenses 29

30 6,500 Service Revenue 6,5002,900 Expenses 2,900 Income summary 6,500 Bal. 3,600 Revenues – Expenses = Net Income #1 #2 Copyright (c) Prentice Hall. All rights reserved.

 3. Close Income summary  4. Close Withdrawals 31 Copyright (c) Prentice Hall. All rights reserved.

32 2,900 Income summary 6,500 Bal. 3,600 1,000 Josie Smith, W/D 1,000 Josie Smith, Capital 3,600 13,200 Beginning balance 15,800 Ending balance 3,600 #3 #4 Copyright (c) Prentice Hall. All rights reserved.

33 Any Company Statement of Owner’s Equity Month ended May 31, 2010 Josie Smith, Capital, May 1, 2010 $13,200 Add: Net income 3,600 16,800 Less: Withdrawals (1,000) Josie Smith, Capital, May 31, 2010 $15,800 Josie Smith, Capital 13,200 Beginning balance 1,0003,600 15,800 Ending balance Copyright (c) Prentice Hall. All rights reserved.

34 GENERAL JOURNAL DATEDESCRIPTION REF DEBITCREDIT Service revenue110,900 Income summary110,900 To close revenues

Copyright (c) Prentice Hall. All rights reserved. 35 GENERAL JOURNAL DATEDESCRIPTION REF DEBITCREDIT Income Summary35,000 Salary expense26,100 Supplies expense2,500 Depreciation exp. – furniture 900 Depreciation exp. - building5,500 To close expenses

36 110,900 Service Revenue 110,900 35,000 Expenses 35,000 Income summary 110,900 Bal. 75,900 Revenues – Expenses = Net Income #1 #2 Copyright (c) Prentice Hall. All rights reserved.

37 GENERAL JOURNAL DATEDESCRIPTION REF DEBITCREDIT Income summary75,900 C. Pipeline, Capital75,900 To close Income summary

Copyright (c) Prentice Hall. All rights reserved. 38 GENERAL JOURNAL DATEDESCRIPTION REF DEBITCREDIT C. Pipeline, Capital59,000 C. Pipeline, W/D59,000 To close withdrawals

39 35,000 Income summary 100,900 Bal. 75,900 59,000 C. Pipeline, W/D 59,000 C. Pipeline, Capital 75,900 46,000 Beginning balance 62,900 Ending balance 75,900 #3 #4 Copyright (c) Prentice Hall. All rights reserved.

Review  ?Questions?

3. The purpose of closing entries is: A. to apply the revenue and matching principles. B. to update asset and liability accounts. C. to zero out revenues, expenses and the withdrawals account. D. all of the above. 41Copyright (c) 2009 Prentice Hall. All rights reserved.

3.The purpose of closing entries is: A.to apply the revenue and matching principles. B.to update asset and liability accounts. C.to zero out revenues, expenses and the withdrawals account. D.all of the above. 42Copyright (c) 2009 Prentice Hall. All rights reserved.

4. Which of the following is a temporary account? A. Brad Juarez, capital B. Accumulated depreciation C. Supplies D. Rent expense 43Copyright (c) 2009 Prentice Hall. All rights reserved.

4.Which of the following is a temporary account? A.Brad Juarez, capital B.Accumulated depreciation C.Supplies D.Rent expense 44Copyright (c) 2009 Prentice Hall. All rights reserved.

4.Which of the following is a temporary account? A.Brad Juarez, capital B.Accumulated depreciation C.Supplies D.Rent expense 45Copyright (c) 2009 Prentice Hall. All rights reserved.

5. Which of the following is a permanent account? A. Unearned revenue B. Service revenue C. Withdrawals D. Depreciation expense 46Copyright (c) 2009 Prentice Hall. All rights reserved.

5.Which of the following is a permanent account? A.Unearned revenue B.Service revenue C.Withdrawals D.Depreciation expense 47Copyright (c) 2009 Prentice Hall. All rights reserved.

6. The Income summary: A. is an account used only in the closing process. B. temporarily holds the amount of net income for the period. C. is closed into owner’s capital. D. is all of the above. 48Copyright (c) 2009 Prentice Hall. All rights reserved.

Prepare postclosing trial balance 49 Copyright (c) Prentice Hall. All rights reserved.

 List of permanent accounts and their balances after posting closing entries  Total debits and credits must be equal  Same accounts as on the Balance Sheet 50 Copyright (c) Prentice Hall. All rights reserved.

Classify assets and liabilities as current or long-term 51 Copyright (c) Prentice Hall. All rights reserved.

 Measure of how quickly an item can be converted into cash  A classified balance sheet lists assets in order of their liquidity 52 Copyright (c) Prentice Hall. All rights reserved.

53 Cash used to buy goods & services Goods & services sold to customers Business collects cash from customers Copyright (c) Prentice Hall. All rights reserved.

 Will be converted to cash, sold, or used up during the next year or operating cycle, whichever is longer  Examples: ◦ Cash ◦ Accounts receivable ◦ Supplies ◦ Prepaid expenses 54 Copyright (c) Prentice Hall. All rights reserved.

 Not converted to cash within the current year or operating cycle  Categories ◦ Plant assets  Land  Building  Furniture  Equipment ◦ Long-term investments ◦ Other assets 55 Copyright (c) Prentice Hall. All rights reserved.

 Must be paid either with cash or goods & services within one year or operating cycle  Examples: ◦ Accounts payable ◦ Notes payable due within one year ◦ Salary payable ◦ Interest payable ◦ Unearned revenue 56 Copyright (c) Prentice Hall. All rights reserved.

 Are not due within the current year or operating cycle  Examples: ◦ Notes payable with due dates over one year ◦ Mortgages 57 Copyright (c) Prentice Hall. All rights reserved.

58 Copyright (c) Prentice Hall. All rights reserved.

Account Format  Side-by-side ◦ Assets on left ◦ Liabilities & Equity on right Report Format  Top and bottom ◦ Assets on top ◦ Liabilities & Equity on bottom 59Copyright (c) Prentice Hall. All rights reserved.

Use the current ratio and the debt ratio to evaluate a company 60 Copyright (c) Prentice Hall. All rights reserved.

61 Current assets Current liabilities  Measures a company’s ability to pay its current liabilities  Rule of thumb ◦ Strong current ratio is 1.5 Copyright (c) Prentice Hall. All rights reserved.

 Indicates the proportion of a business’s assets that are financed with debt  Measures business’s ability to pay its debts  Rule of thumb: ◦ Below 60% is considered safe 62 Total liabilities Total assets Copyright (c) Prentice Hall. All rights reserved.

Review  ?Questions?

7. The entry to close Withdrawals includes a: A. debit to Withdrawals. B. debit to Owner’s capital. C. credit to Income summary. D. credit to Retained earnings. 64Copyright (c) 2009 Prentice Hall. All rights reserved.

7.The entry to close Withdrawals includes a: A.debit to Withdrawals. B.debit to Owner’s capital. C.credit to Income summary. D.credit to Retained earnings. 65Copyright (c) 2009 Prentice Hall. All rights reserved.

8. Which of the following accounts would NOT appear on a postclosing trial balance? A. Owner’s capital B. Accounts receivable C. Prepaid rent D. Rent expense 66Copyright (c) 2009 Prentice Hall. All rights reserved.

8.Which of the following accounts would NOT appear on a postclosing trial balance? A.Owner’s capital B.Accounts receivable C.Prepaid rent D.Rent expense 67Copyright (c) 2009 Prentice Hall. All rights reserved.

9. Which of the following assets is most liquid? A. Accounts receivable B. Supplies C. Furniture D. Land 68Copyright (c) 2009 Prentice Hall. All rights reserved.

9.Which of the following assets is most liquid? A.Accounts receivable B.Supplies C.Furniture D.Land 69Copyright (c) 2009 Prentice Hall. All rights reserved.

10. Indicate in which section of a classified balance sheet each account will appear. CA = Current assets PA = Plant assets CL = Current liabilities LTL = Long-term liabilities OE = Owner’s equity Prepaid expenses Accumulated depreciation Note payable due in five years Mary Shull, capital Salaries payable 70Copyright (c) 2009 Prentice Hall. All rights reserved.

10. Indicate in which section of a classified balance sheet each account appear. CA = Current assets PA = Plant assets CL = Current liabilities LTL = Long-term liabilities OE = Owner’s equity Prepaid expenses Accumulated depreciation Note payable due in five years Mary Shull, capital Salaries payable 71 CA PA LTL OE CL Copyright (c) 2009 Prentice Hall. All rights reserved.