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Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Chapter 4 1.

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1 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Chapter 4 1

2 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 2 Prepare an accounting worksheet Use the worksheet to prepare financial statements Close the revenue, expense, and dividend accounts Prepare the post-closing trial balance

3 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 3 Classify assets and liabilities as current or long-term Describe the effect of various transactions on the current ratio and the debt ratio

4 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Process used to produce financial statements A worksheet summarizes needed data Cycle begins with Assets = Liabilities + Equity and revenues and expenses set equal zero Accounting occurs: During the period At the end of the period 4

5 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Start with the beginning account balances. Analyze and journalize transactions as they occur. Post to the accounts. Compute the unadjusted balance in each account. Enter the trial balance and complete the worksheet. Journalize and post adjusting entries Prepare the financial statements. Journalize and post the closing entries. Prepare the post-closing trial balance. 5 During the period At the end of the period IPO anyone?

6 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Prepare an accounting worksheet 6 1 1

7 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. A tool used to summarize information It is not a: journal ledger financial statement Computerized spreadsheets & sensitivity analysis Contains heading similar to statements 7

8 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Enter account titles unadjusted balances Total the amounts 8

9 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Enter the adjusting entries Total the amounts Remember, these still need to be journalized and posted 9

10 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Compute each account’s adjusted balance Enter the adjusted balance in the adjusted trial balance column 10 $2,200 (Dr) + $400 (Dr) = $2,600 $600 (Cr) - $200 (Dr) = $400

11 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Draw an imaginary line above the first revenue account Every account above the line are Balance Sheet accounts Every account below the line are Income Statement accounts Copy the totals to the appropriate column 11 Assets Liabilities Equity Expenses Revenue

12 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Using the income statement columns, compute net income Revenues minus expenses Enter net income as the balancing amount 12 Expenses total = $3,900 Revenues total = $7,600 Net income = $3,700

13 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Also enter net income as a balancing amount on the balance sheet 13 Net income from previous columns

14 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 14 Complete Worksheet

15 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Data for the unadjusted trial balance of Mexican Riviera Tanning Salon at March 31, 2012 follow: Adjusting data for March 2012 are: Les Neeland, the principal stockholder, has received an offer to sell the company. He needs to know the net income for the month covered by these data. 1. Prepare the worksheet for Mexican Riviera Tanning Salon. 2. How much was the net income/net loss for March? 15 a. Accrued service revenue, $2,600 c. Accrued salary expense, $1,700 b. Supplies used in operations, $400 d. Depreciation expense, $4,100

16 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 16 ACCOUNT TITLE TRIAL BALANCEADJUSTMENTS ADJUSTED TRIAL BALANCE DEBITCREDITDEBITCREDITDEBITCREDIT Cash$13,000 Accounts receivable Supplies1,400 Equipment66,500 Accumulated depreciation $18,500 Accounts payable3,200 Salary payable Retained earnings1,500 Common stock10,000 Service revenue89,900 Salary expense42,200 Depreciation expense Supplies expense $123,100 Net income (a) 2,600 (b) 400 (d) 4,100 (c) 1,700 (a) 2,600 (c) 1,700 (d) 4,100 (b) 400 $ 8,800 $8,800 $13,000 2,600 1,000 66,500 $22,600 3,200 1,700 1,500 10,000 92,500 43,900 4, $131,500

17 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 17 ACCOUNT TITLE ADJUSTED TRIAL BALANCE INCOME STATEMENT BALANCE SHEET DEBITCREDITDEBITCREDITDEBITCREDIT Cash $13,000 Accounts receivable 2,600 Supplies 1,000 Equipment 66,500 Accumulated depreciation $22,600 Accounts payable 3,200 Salary payable 1,700 Retained earnings 1,500 Common stock 10,000 Service revenue 92,500 Salary expense 43,900 Depreciation expense 4,100 Supplies expense 400 $131,500 $131,500 Net income $ 92,500 $43,900 4, $ 48,400 $92,500 $ 44,100 $ 92,500 $ 13,000 2,600 1,000 66,500 $ 22,600 3,200 1,700 1,500 10,000 _ $ 83,100 $39,000 $ 44,100 $ 83,100 $ 83,100

18 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Draper Consulting, Inc. Just complete the instruction for completing the worksheet, not the rest of them. Draw a line between BS and IS accounts Move Income statement accounts Sub total each column Plug in net income to balance & finalize totals Move Balance sheet accounts Sub total each column Plug in net income to balance & finalize totals 18

19 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Use the worksheet to prepare financial statements

20 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. The worksheet contains the financial statement data. Income statement column equals the income statement The Net income total is for our retained earnings statement Connects the Net income to the balance sheet Balance sheet column equals the balance sheet Worksheet is an internal document Financial statements are for external users 20

21 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Compare the balances here with the Income Statement appearing next. 21 Worksheet Income Statement

22 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 22 Beginning Retained earnings is found in the balance sheet columns, along with Dividends Net income is found in the income statement columns Ending Retained earnings is computed here Carry the ending Retained earnings balance to the balance sheet

23 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Compare the balances on the worksheet with the Balance Sheet appearing next. 23 Worksheet Balance Sheet

24 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Liquidity measures quickness of cash How quickly an item can be converted into cash Classified Balance Sheet Lists assets in order of their liquidity Current Assets Converted to cash, sold, or used Most commonly within one year 24

25 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Examples: Cash Accounts receivable Supplies Prepaid expenses Inventory 25

26 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Not converted to cash within the current year Categories Plant assets Land Building Furniture Equipment Long-term investments Other assets 26

27 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Must be paid either with cash or goods and services within one year Examples: Accounts payable Notes payable due within one year Salary payable Interest payable Unearned revenue 27

28 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Are not due within the current year Examples: Notes payable with due dates over one year Mortgages 28

29 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 29

30 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Report form should be read top to bottom 30

31 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 1. Identify the assets (including contra assets) and liabilities 2. Classify each asset and each liability as current or long-term 31 AccountIdentificationClassification Buildings Accounts payable Total expenses Accumulated depreciation Accrued liabilities (Salary payable) Prepaid expenses Service revenue Cash Receivables Interest expense Equipment Assets Liabilities Neither Assets Liabilities Assets Neither Assets Neither Assets Long-term Current N/A Long-term Current N/A Current N/A Long-term

32 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Draper Consulting, Inc. Just complete instruction for preparing financial statements, not the rest. Prepare Income statement first Prepare Statement of retained earnings second Prepare Classified Balance sheet third Remember to update retained earnings balance! 32

33 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 33

34 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 34

35 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Close the revenue, expense, and dividend accounts

36 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Occurs at the end of the period Gets accounts ready for next period Zeroes out revenue and expense accounts Updates Retained earnings to the ending balance Four step process Close temporary accounts Closing entries do not capture new transactions like adjusting entries did. All closing entries do is transfer balances to their permanent destinations. 36

37 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Temporary Closed at the end of the period Revenues Expenses Dividends Start next period with a zero balance Permanent Not closed at the end of the period Assets Liabilities Common stock Retained earnings Ending balance carries forward to next period 37

38 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Step 1 – Close Revenues to Income summary account Step 2 – Close individual Expense accounts to Income summary account Step 3 – Close Income summary account to Retained earnings account Step 4 - Close Dividends account to retained earnings account 38

39 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. The closing process 39

40 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. The adjusted trial balance from the January worksheet of Silver Sign Company is shown: Requirement: 1. Journalize Silver’s closing entries at January

41 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 1. Journalize Silver’s closing entries at January Jan.31Service revenue$16,800 Income summary$16,800 31Income summary6,200 Salary expense3,600 Rent expense1,400 Depreciation expense400 Supplies expense200 Utilities expense600

42 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 2. How much net income or net loss did Silver earn for January? How can you tell? 42 31Income summary10,600 Retained earnings10,600 31Retained earnings800 Dividends800 Silver had net income of $10,600. We know this because service revenue exceeded total expenses.

43 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Draper Consulting, Inc. Just complete the instruction for closing entries and posting them Link to Draper Consulting, Inc. Adjusted trial balance 43

44 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Prepare post-closing trial balance

45 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 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 45

46 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. After closing its accounts at July 31, 2012, Goodrow Electric Company had the following account balances: 1. Prepare Goodrow’s post-closing trial balance at July 31,

47 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 47 Cash$ 100 Accounts receivable1,600 Supplies200 Equipment4,500 Accumulated depreciation$ 1,300 Land1,200 Accounts payable1,100 Unearned service revenue1,400 Long-term liabilities800 Common stock1,000 Retained earnings 2,000 Total$ 7,600 Goodrow Electric Company Post-Closing Trial Balance July 31, 2012

48 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Classify assets and liabilities as current or long-term

49 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Measures quickness of cash How quickly an item can be converted into cash Classified Balance Sheet Lists assets in order of their liquidity Current Assets Converted to cash, sold, or used Within one year or operating cycle 49

50 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 50 Cash used to buy goods & services Goods & services sold to customers Business collects cash from customers

51 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Convertible to cash or consumed within one year, or operating cycle Examples: Cash Accounts receivable Short term investments Supplies Prepaid expenses Inventory 51

52 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Not converted to cash within the current year or operating cycle Categories Plant assets Land Building Furniture Equipment Long-term investments Other assets 52

53 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Must be paid either with cash or goods and services within one year or operating cycle Examples: Accounts payable Notes payable due within one year Salary payable Interest payable Unearned revenue 53

54 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Are not due within the current year or operating cycle Examples: Notes payable with due dates over one year Mortgages Note: The current portion of a longer term liability is reported under current assets. 54

55 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 55

56 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Report form should be read top to bottom 56

57 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 1. Identify the assets (including contra assets) and liabilities 2. Classify each asset and each liability as current or long-term 57 AccountIdentificationClassification Buildings Accounts payable Total expenses Accumulated depreciation Accrued liabilities (Salary payable) Prepaid expenses Service revenue Cash Receivables Interest expense Equipment Assets Liabilities Neither Assets Liabilities Assets Neither Assets Neither Assets Long-term Current N/A Long-term Current N/A Current N/A Long-term

58 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Use the debt ratio, current ratio and the interest coverage ratio to evaluate a company

59 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. To measure the business’s financial position Decision makers use financial ratios Widely used debt analysis ratios: Debt ratio Current ratio Extra: Interest coverage ratio 59

60 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Fun to trouble ratio present performance. Other companies to your company. Along with dollar and percentage changes, trend percentages, and component percentages, ratios can be used to compare: A ratio is a mathematical expression of the relationship between two items. Miles per hour Defects per thousands Hundreds more uses Miles per gallon Odds of winning Risk to Reward ratio

61 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Debt exposure present performance. Other companies to your company. We can compare business ratios with company history, competitors, or another industry to learn several things about businesses. Along with dollar and percentage changes, trend percentages, and component percentages, ratios can be used to compare: Profitability Value Efficiency Hundreds more uses Strategy Impending doom Managerial effectiveness

62 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Debt exposure aka leverage present performance. Other companies to your company. Is the company borrowing responsibly? Along with dollar and percentage changes, trend percentages, and component percentages, ratios can be used to compare: Debt Ratio: debt ÷ assets Debt Ratio: debt ÷ assets Find a tool to measure responsible borrowing 50% is optimal, they have way too much debt and way too little equity. The #’s: 810 ÷900 = 90% The #’s: 810 ÷900 = 90% The story This is too much borrowing compared to the industry norm of equal liability and equity financing. They may be in danger of failing to make the associated interest payments and in paying back principle. If they can’t pay, the equity holders lose their entire investment. This is very risky. This is too much borrowing compared to the industry norm of equal liability and equity financing. They may be in danger of failing to make the associated interest payments and in paying back principle. If they can’t pay, the equity holders lose their entire investment. This is very risky.

63 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Indicates the proportion of a business’s assets that are financed with debt Measures business’s ability to pay its debts Rule of thumb: Above 60% is considered unsafe 50% is widely regarded as optimal Lower may suffer from unnecessarily high cost of capital 63 Total liabilities Total assets

64 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Measures a company’s ability to pay its current liabilities Rule of thumb Strong current ratio is 1.5 Ample cash on hand, with little wasteful excess 1.0 is either dangerously low, or well managed How to tell? 64 Current assets Current liabilities

65 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Interest Coverage Ratio Compares earnings to borrowing costs. If too much earnings are going to lenders, then the company isn’t handling their debt well. Rule of thumb Norm is between 2.0 and 3.0 Twice as much earnings as interest charges Lower than 2.0 means high interest is consuming over half of the company’s earnings Leaves little margin of performance safety 65 Earnings before interest & taxes Interest expense

66 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Debt ratio Liabilities ÷ Assets Current ratio Current Assets ÷ Current liabilities Interest coverage ratio EBIT ÷ Interest expense Compare each number against benchmark Judge each number and interpret 66

67 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Groups of up to 6 One laptop per team User name: default Password: mpcmpcmpc Follow the Yahoo Finance debt analysis procedure Report on the debt analysis reporting form 20 minutes of work, not enough to finish everyone Submit individual sheet for points next class 67

68 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Practice Set Page 250 Complete the worksheet. Prepare financials Prepare closing entries Prepare post-closing trial balance 68

69 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 69 Complete Worksheet

70 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Be on time or you will miss out on the action Be prepared to execute the entire accounting cycle at warp speed If you put maximum effort into it, you will master the accounting cycle and get the point of the financial statements This is a huge help toward your test preparation, but only if you are prepared

71 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Heart of Texas Telecom has these account balances at December 31, 2012: 1. Compute Heart of Texas Telecom’s current ratio and debt ratio. 2. How much in current assets does Heart of Texas Telecom have for every dollar of current liabilities that it owes? 71 Note payable, long-term $ 7,800 Accounts payable $ 3,700 Prepaid rent 2,300 Accounts receivable 5,700 Salary payable 3,000 Cash 3,500 Service revenue 29,400 Depreciation expense 6,000 Supplies 500 Equipment 15,000 Current ratio= Total current assets Total current liabilities = $12,000 6,700 =1.79 Debt ratio= Total liabilities Total assets = $14,500 $27,000 =0.54 Heart of Texas Telecom has $1.79 of current assets for every dollar of current liabilities that it owes.

72 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. The worksheet is a tool that puts the whole accounting process in one place. Remember that debits = credits in the first three columns. Columns 4 and 5 (Income Statement and Balance Sheet) debits do not equal credits until you post the net income or net loss for the period. The formal financial statements yield the same net income or loss that is shown on the worksheet. 72

73 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Closing the accounts is just like starting a new baseball game. The score is 0-0. All temporary account balances are zero after closing. The post-closing trial balance contains the same accounts that the balance sheet contains— assets, liabilities, Common stock, and Retained earnings. 73

74 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Classification means dividing assets and liabilities between those that will last less than a year (current) and those that will last longer than a year (long-term). The classified balance sheet still represents the accounting equation and must balance (Assets = Liabilities + Equity). 74

75 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. The current ratio measures liquidity within one year by comparing current assets to current liabilities. The debt ratio measures the ability to pay liabilities in the long term by comparing all liabilities to all assets. The different ratios give different views of a company’s financial health. 75

76 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 76

77 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 77 Copyright All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America.


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