1. Completing the Accounting Cycle4
Completing the Accounting Cycle
Chapter
Corporate Financial Accounting
14e
Warren
Reeve
Duchac

2. Learning Objectives
Obj. 1: Describe the flow of accounting information from the unadjusted trial balance into the adjusted trial balance and financial statements.
Obj. 2: Prepare financial statements from adjusted account balances.
Obj. 3: Prepare closing entries.
Obj. 4: Describe the accounting cycle.
Obj. 5: Illustrate the accounting cycle for one period.
Obj. 6: Explain what is meant by the fiscal year and the natural business year.
ADM: Describe and illustrate the use of working capital and the current ratio in evaluating a company’s financial condition.

3. Flow of Accounting Information: End-of-Period Spreadsheet—Unadjusted Trial Balance Columns
The end-of-period spreadsheet begins with the unadjusted trial balance.
The unadjusted trial balance verifies that the total of the debit balances equals the total of the credit balances.
If the trial balance totals are unequal, an error has occurred.
Any errors must be found and corrected before the end-of- period process can continue.

4. Flow of Accounting Information: End-of-Period Spreadsheet—Adjustments Columns
The adjustments are normally entered in the order in which the data are assembled.
If the titles of the accounts to be adjusted do not appear in the unadjusted trial balance, the accounts are inserted in the proper order in the Account Title column.
The total of the Adjustments columns verifies that the total debits equal the total credits for the adjusting entries.
The total of the Debit column must equal the total of the Credit column.

5. Flow of Accounting Information: End-of-Period Spreadsheet—Adjusted Trial Balance Columns
The adjustments in the spreadsheet are added to or subtracted from the amounts in the Unadjusted Trial Balance columns to arrive at the amounts inserted in the Adjusted Trial Balance columns.
The totals of the Adjusted Trial Balance columns verify that the totals of the debit and credit balances are equal after adjustment.

6. Flow of Accounting Information: Financial Statements
The accounts from the adjusted trial balance flow into the financial statements as follows:
The revenue and expense accounts flow into the income statement.
The dividends account and net income amount (from the income statement) flow into the retained earnings statement.
The asset, liability, and common stock accounts and end-of-period retained earnings amount (from the retained earnings statement) flow into the balance sheet.

7. Financial Statements—NetSolutions

8. Income Statement
The income statement is prepared directly from the Adjusted Trial Balance columns of the end- of-period spreadsheet, beginning with fees earned.
The expenses in the income statement are listed in order of size, beginning with the larger items.
Miscellaneous Expense is the last item, regardless of its amount.

9. Retained Earnings Statement
The first item normally presented on the retained earnings statement is the balance of the retained earnings account at the beginning of the period.
The amount of dividends is deducted from the net income to determine the ending retained earnings account balance.

10. Balance Sheet (slide 1 of 2)
The balance sheet is prepared directly from the Adjusted Trial Balance columns of the end-of-period spreadsheet, beginning with Cash.
The asset and liability amounts are taken from the spreadsheet.
The retained earnings amount is taken from the retained earnings statement.
A balance sheet that shows subsections for assets and liabilities is a classified balance sheet.
Assets are commonly divided into two sections on the balance sheet: (1) current assets and (2) property, plant, and equipment.
Liabilities are commonly divided into two sections on the balance sheet: (1) current liabilities and (2) long-term liabilities.

11. Current Assets (slide 1 of 2)
Cash and other assets that are expected to be converted to cash or sold or used up usually within one year or less, through the normal operations of the business, are called current assets.
Current assets include: Cash Notes receivable Accounts receivable Supplies and Other prepaid expenses
Notes receivable are written promises by the customer to pay the amount of the note and interest. Like accounts receivable, notes receivable are amounts that customers owe, but they are more formal than accounts receivable.
Notes receivable and accounts receivable are current assets because they are usually converted to cash within one year or less.

12. Property, Plant, and Equipment
Property, plant, and equipment (also called fixed assets or plant assets) include land and assets that depreciate over a period of time.
Assets that depreciate over time include:
Equipment
Machinery
Buildings

13. Current & Long Term Liabilities
Amounts the business owes to creditors 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.
Current liabilities include:
Notes payable
Accounts payable
Wages payable
Interest payable
Taxes payable
Unearned fees
Amounts the business owes to creditors that will not be due for a long time (usually more than one year) are called long-term liabilities.

14. Stockholders’ Equity
Stockholders’ equity is the stockholders’ right to the assets of the business.
It is presented on the balance sheet below the liabilities section.
Stockholders’ equity is added to the total liabilities, and this total must be equal to the total assets.

15. Permanent Accounts
Accounts that are relatively permanent from year to year are called permanent accounts or real accounts.
The balances of these accounts are carried forward from year to year.
This includes accounts reported on the balance sheet.

16. Temporary Accounts
Accounts that report amounts for only one period are called temporary accounts or nominal accounts.
Temporary accounts are not carried forward from year to year because they relate to only one period.
This includes all accounts reported on the income statement as well as the dividends account, which is reported on the retained earnings statement.

17. Closing Entries (slide 1 of 4)
At the beginning of the next period, temporary accounts should have zero balances.
To achieve this, temporary account balances are transferred to permanent accounts at the end of the accounting period through journal entries.
The entries that transfer these balances are called closing entries. The transfer process is called the closing process and is sometimes referred to as closing the books.
After the closing entries are posted, all of the temporary accounts have zero balances.

18. Closing Entries (slide 2 of 4)
The closing entries involves the following four steps:
Step 1. Revenue account balances are transferred to an account called Income Summary.
Step 2. Expense account balances are transferred to an account called Income Summary.
Step 3. The balance of Income Summary (net income or net loss) is transferred to the retained earnings account.
Step 4. The balance of the dividends account is transferred to the retained earnings account.

19. Closing Entries (slide 3 of 4)
Income Summary is a temporary account that is only used during the closing process.
At the beginning of the closing process, Income Summary has no balance.
During the closing process, revenue and expense accounts are cleared by debiting or crediting Income Summary for their amounts.
Because it has the effect of clearing the revenue and expense accounts of their balances, Income Summary is sometimes called a clearing account.

20. Closing Entries (slide 4 of 4)
The four closing entries required in the closing process are as follows:
Debit each revenue account for its balance and credit Income Summary for the total revenue.
Credit each expense account for its balance and debit Income Summary for the total expenses.
Debit Income Summary for its balance (net income) and credit the retained earnings account. (In the case of a net loss, credit Income Summary for the amount of its balance and debit the retained earnings account for the amount of the net loss.)
Debit the retained earnings account for the balance of the dividends account and credit the dividends account.

21. Closing Entries, NetSolutions

22. Ledger with Closing Entries—NetSolutions (slide 1 of 2)

23. Ledger with Closing Entries—NetSolutions (slide 2 of 2)

24. 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.

25. Accounting Cycle
The accounting process that begins with analyzing and journalizing transactions and ends with the post-closing trial balance is called the accounting cycle.
The steps in the accounting cycle are as follows:
Step 1. Transactions are analyzed and recorded in the journal.
Step 2. Transactions are posted to the ledger.
Step 3. An unadjusted trial balance is prepared.
Step 4. Adjustment data are assembled and analyzed.
Step 5. An optional end-of-period spreadsheet is prepared.
Step 6. Adjusting entries are journalized and posted to the ledger.
Step 7. An adjusted trial balance is prepared.
Step 8. Financial statements are prepared.
Step 9. Closing entries are journalized and posted to the ledger.
Step 10. A post-closing trial balance is prepared.

26. Fiscal Year
The annual accounting period adopted by a business is known as its fiscal year.
Fiscal years begin with the first day of the month selected and end on the last day of the following twelfth month.
When a corporation adopts a fiscal year that ends when business activities have reached the lowest point in its annual operating cycle, such a fiscal year is called the natural business year.

27. Analysis for Decision Making: Working Capital and Current Ratio
The ability to convert assets into cash is called liquidity.
The ability of a business to pay its debts is called solvency.
Two financial measures for evaluating a business’s short-term liquidity and solvency are working capital and the current ratio.

28. Analysis for Decision Making: Working Capital (slide 1 of 2)
Working capital is the excess of the current assets of a business over its current liabilities.
Working capital is computed as follows:
Working Capital = Current Assets – Current Liabilities
A positive working capital implies that the business is able to pay its current liabilities and is solvent.
NetSolutions’ working capital at the end of is computed as follows:

29. Analysis for Decision Making: 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, as follows:
Current Assets
Current Ratio = Current Liabilities
The current ratio for NetSolutions at the end of is computed as follows:

30. Appendix 1: Steps in Preparing an Expanded End-of-Period Spreadsheet
Step 1. Enter the title.
Step 2. Enter the unadjusted trial balance.
Step 3. Enter the adjustments.
Step 4. Enter the adjusted trial balance.
Step 5. Extend the accounts to the Income Statement and Balance Sheet columns.
Step 6. Total the Income Statement and Balance Sheet columns, compute the net income or net loss, and complete the spreadsheet.

31. Spreadsheet with Unadjusted Trial Balance Entered

32. Spreadsheet with Unadjusted Trial Balance and Adjustments

33. Spreadsheet with Unadjusted Trial Balance, Adjustments, and Adjusted Trial Balance Entered

34. Spreadsheet with Amounts Extended to Income Statement and Balance Sheet Columns

35. Completed Spreadsheet with Net Income Shown

36. Appendix 1: Preparing the Financial Statements from the Spreadsheet
The spreadsheet can be used to prepare the income statement, the retained earnings statement, and the balance sheet.
When a spreadsheet is used, the adjusting and closing entries are normally not journalized or posted until after the spreadsheet and financial statements have been prepared.

37. Appendix 2: Reversing Entries (slide 1 of 4)
Reversing entries are journal entries recorded on the first day of the next period that are the exact opposite of the related adjusting entry from the last day of the prior period.

38. Accrued Wages

39. Appendix 2: Reversing Entries (slide 2 of 4)
Accrued wages for December 30 and 31 of $250 were recorded with the following adjusting entry:

40. Appendix 2: Reversing Entries (slide 3 of 4)
Since a reversing entry is the opposite of the adjusting entry to which it relates, the reversing entry for the accrued payroll for NetSolutions is as follows:

41. Wages Expense and Wages Payable After Reversing Entry

42. Appendix 2: Reversing Entries (slide 4 of 4)
On January 1, Wages Payable has a zero balance and Wages Expense has a credit balance of $250.
The Wages Expense credit balance of $250 is only temporary; it will have a debit balance of $1,025 ($1,275 – $250) as soon as the first payroll is paid on January 10.
The debit balance of $1,025 is the correct wages expense for January 1–10.