1. Chapter 13
Skyline College

2. Classified Financial Statements
At the end of the period, Simpson Antiques
prepares three financial statements:
Income statement
Statement of owner's equity
Balance sheet
We will prepare three financial statements.

3. The the balance sheet is arranged in a classified format.
This makes the financial statement more useful to the readers.
A classified Balance Sheet is formatted where accounts are divided into groups of similar accounts and a subtotal is given for each group.
A newspaper’s classified section is similar to a business’s classified financial statements. Classifying like information together on financial statements makes them easier to interpret.

4. The Multiple-Step Income Statement
A multiple-step income statement is a type of income statement on which several subtotals are computed before the net income is calculated.
A classified income statement is sometimes called a multiple-step income statement.

5. The Single-Step Income Statement
A single-step income statement is a format in which only one computation is needed to determine the net income.
A single-step income statement is a format in which only one computation is needed to determine the net income.
(Total Revenue – Total Expenses = Net Income)

6. Single-step Income Statement
The format lists all revenues in one section and all expenses in another section.
JT Consulting Services
Income Statement
Month Ended December 31, 2007
Revenue
Fees Income ,000
Expenses
Salaries Expense ,000
Utilities Expense
Supplies Expense
Rent Expense ,000
Depreciation Expense - Equipment
Total Expenses ,683
Net Income for the Month ,317
Here is a single step income statement. Total expenses are subtracted from total revenues to get net income of $18,317.00

7. Operating Revenue
The first section of the multiple-step income statement contains the revenue from operations.
This is the revenue earned from normal business activities.
Other income is presented separately near the bottom of the statement.
Operating Revenue is the revenue earned from normal business activities.

8. Operating Revenue
The operating revenue for Simpson Antiques is net sales of merchandise.
Sales
<Sales Returns and Allowances>
<Sales Discounts>
Net Sales
The operating revenue for Simpson Antiques is net sales of merchandise.
This is an internal calculation which does not appear on the income statement

9. Operating Revenue Net sales for Simpson Antiques
Net sales for Simpson Antiques is $549,150.
Net sales for Simpson Antiques

10. Cost of Goods Sold
The Cost of Goods Sold section contains information about the cost of the merchandise that was sold during the period.
Three elements are needed to compute the cost of goods sold:
Beginning inventory
Net delivered cost of purchases
Ending inventory
Cost of Goods Sold section contains information about the cost of the merchandise that was sold during the period. Three elements are needed to compute the cost of goods sold: Beginning inventory, Net delivered cost of purchases and Ending inventory.

11. Net Delivered Cost of Purchases
+ Freight In
<Purchases Returns and Allowances>
<Purchases Discounts>
Net Delivered Cost of Purchases
To calculate the net delivered cost of purchases, you can follow the above calculation.

12. Schedule of Cost of Goods Sold
Beginning Merchandise Inventory
+ Net Delivered Cost of Purchases
Total Merchandise Available for Sale
<Ending Merchandise Inventory>
Cost of Goods Sold
Remember, the Cost of Goods Sold section contains information about the cost of the merchandise that was sold during the period.
This is usually footnoted in the financial statements rather than appearing on the income statement

13. Cost of Goods Sold Cost of goods sold
The net delivered cost of purchases was $325,120. When we add the beginning inventory to these purchases, we get total available inventory for sale of $377,120. After subtracting out the ending inventory still on hand, we get cost of goods sold of $330,120.
Cost of goods sold

14. Gross Profit on Sales
Gross profit is the difference between net sales and the cost of goods sold.
For Simpson Antiques net sales is the revenue earned from selling clothes.
Cost of goods sold is what Simpson Antiques paid for the clothes that were sold during the fiscal period.
Gross profit is what is left to cover operating expenses and provide a profit.
Gross profit is also what is left to cover operating expenses and provide a profit.

15. Gross profit on sales for Simpson Antiques
Net sales were $549,150. When we subtract the cost of goods sold of $330,120, Simpson Antiques will report gross profit of $219,030.

16. Operating Expenses
Operating expenses are expenses that arise from normal business activities.
Simpson Antiques separates operating expenses into two categories:
Selling Expenses
General and Administrative Expenses
Operating expenses are separated into two categories: (1) Selling Expenses and (2) General and Administrative Expenses.

17. Operating Expenses
Salaries for salespersons and advertising are examples of selling expenses.
Selling expenses include salesperson salaries and advertising expenses.

18. Operating Expenses
Rent, utilities, and salaries for office employees are examples of general and administrative expenses.
General and Administrative Expenses include Insurance Expense and office employees salaries.

19. Net Income or Net Loss from Operations
The format for determining net income (or net loss) from operations is:
Gross Profit on Sales
(Total Operating Expenses)
Net Income (or Net Loss) from Operations
Here you can see the formula for calculating net income or net loss from operations.

20. Net income from operations
Simpson Antiques is reporting $51, net income from operations.

21. Other Income and Other Expenses
Income that is earned from sources other than normal business activities appears in the Other Income section.
For Simpson Antiques other income includes interest on notes receivable and one miscellaneous income item.
Expenses that are not directly connected with business operations appear in the Other Expenses section.
Income that is earned from sources unrelated to the normal business activity is classified as “other income” and would appear in the Other Income section. Expenses which are incurred but not directly connected with business operations appear in the Other Expenses section. (ex. Interest expense).

22. Other Income and Other Expenses
Total other income was equal to $748 and other expenses totaled $770. The difference was net nonoperating expense of $22.

23. Net Income or Net Loss
Net income is all the revenue minus all the expenses.
If there is a net loss, it appears in parentheses.
Net income or net loss is used to prepare the statement of owner's equity.
Net income is all the revenue minus all the expenses.

24. Net income for Simpson Antiques
Simpson Antiques had $51, of net income.

25. The Statement of Owner's Equity
The statement of owner's equity reports the changes that occurred in the owner's financial interest during the period.
The ending capital balance for Patricia Simpson, $84,792.80, is used to prepare the balance sheet.
The statement of owner's equity reports the changes that occurred in the owner's financial interest during the period. At the end of the period, Patricia Simpson, Capital had a balance of $84,

26. Current Assets
Current assets are assets consisting of cash, items that normally will be converted into cash within one year, or items that will be used up within one year.
Current assets consist of cash, items that will normally be converted into cash within one year, and items that will be used within one year (cash, accounts receivables, merchandise inventory, etc.).

27. Current Assets Current assets are listed in the order of liquidity.
Liquidity is the ease with which an item can be converted into cash.
Current assets are usually listed in order of liquidity. Current assets are vital to the survival of a business because they provide the funds needed to pay bills and meet expenses.

28. Current Assets Current assets for Simpson Antiques
Total current assets for Simpson Antiques is $98,
Current assets for Simpson Antiques

29. Property, Plant & Equipment
Property, Plant & Equipment (PP&E) is property that will be used in the business for longer than one year.
The balance sheet shows three amounts for each category of plant and equipment :
Plant and Equipment is our next asset classification appearing on the classified balance sheet.
Asset
(Accumulated depreciation)
Book value

30. Plant and Equipment Total property, plant and equipment
Total plant and equipment for Simpson Antiques is $31,900.
Total property, plant and equipment

31. Current Liabilities
Current liabilities are debts that must be paid within one year using current assets.
Current liabilities are usually listed in order of priority of payment.
Management must ensure that funds are available to pay current liabilities when they become due in order to maintain the firm's good credit reputation.
The liabilities section comes next on the classified balance sheet. Liabilities are classified into two sections: current and long term.

32. Total current liabilities
Assets
Prepaid Interest
75.00
6,300.00
Total Current Assets
98,716.00
Total Plant and Equipment
31,900.00
Total Assets
130,616.00
Liabilities and Owner’s Equity
Current Liabilities
Notes Payable-Trade
2,000.00
Notes Payable-Bank
9,000.00
Accounts Payable
24,129.00
Interest Payable
20.00
Social Security Tax Payable
1,158.40
Medicare Tax Payable
267.40
Employee Income Tax Payable
990.00
Fed. Unemployment Tax Pay.
9.60
State Unemployment Tax Pay.
64.80
Salaries Payable
1,200.00
Sales Tax Payable
6,984.00
Total Current Liabilities
45,823.20
Simpson Antiques
Balance Sheet
Year Ended December 31, 2007
Total current liabilities
Total current liabilities for Simpson Antiques is $45,

33. Long-Term Liabilities
Long-term liabilities are any debts that are not considered current.
Although repayment of long-term liabilities might not be due for several years, management must make sure that periodic interest is paid promptly.
Long-term liabilities include mortgages, notes payable, and loans payable.
After current liabilities comes long-term liabilities.

34. Owner's Equity
After transferring the capital account balance from the statement of owner’s equity, we can complete the balance sheet. Total liabilities and owner’s equity is $130,
The ending balance from the statement of owner’s equity is transferred to the Owner's Equity section of the balance sheet.

35. Adjusting Entries All adjustments are shown on the worksheet.
After the financial statements have been prepared, the adjustments are made a permanent part of the accounting records.
They are recorded in the general journal as adjusting journal entries and are posted to the general ledger.
The adjustments shown on the worksheet need to be recorded in the general journal as adjusting journal entries. They are then posted to the general ledger.

36. Journalizing the Adjusting Entries
Each adjusting entry shows how the adjustment was calculated.
Supervisors and auditors need to understand, without additional explanation, why the adjustment was made.
It is important to leave a detailed explanation with each adjusting entry. The explanation should show how the adjustment was calculated.

37. Adjusting Entries Type of Adjustment Worksheet Reference Purpose
Inventory
(a – b)
Removes beginning inventory and adds ending inventory to the accounting records.
Expense
(c – e)
Matches expense to revenue for the period; the credit is to a contra asset account.
Accrued Expense
(f – i)
Matches expense to revenue for the period; the credit is to a liability account.
Prepaid Expense
(j – l)
Matches expense to revenue for the period; the credit is to an asset account.
The last adjustments were for interest receivable and to record accrued commission earned on sales tax owed.
Accrued Income
(m – n)
Recognizes income earned in the period. The debit is to an asset account (Interest Receivable) or a liability account (Sales Tax Payable).

38. GENERAL JOURNAL PAGE 25 DATE DESCRIPTION POST. DEBIT CREDIT REF.
Dec
Adjusting Entries
(Adjustment a)
Income Summary ,000.00
Merchandise Inventory ,000.00
To transfer beginning inventory to Income Summary
(Adjustment b) 31
Merchandise Inventory ,000.00
Here are the first two adjusting journal entries regarding merchandise inventory.
Income Summary ,000.00
To record ending inventory

39. GENERAL JOURNAL PAGE 25 DATE DESCRIPTION POST. DEBIT CREDIT REF.
Dec
Adjusting Entries
(Adjustment c)
Uncollectible Accounts Expense
Allowance for Doubtful Accounts
To record estimated loss from uncollectible amounts based on 0.8% of net credit sales of $100,000
(Adjustment d) 31
Depreciation Expense – Store Equip ,400.00
Accum. Depreciation - Store Equip ,400.00
Adjusting journal entries for adjustments c-e are shown here.
To record depreciation for 2007 as shown by schedule on file.
(Adjustment e) 31
Depreciation Expense – Office Equip
Accum. Depreciation - Office Equip
To record depreciation for 2007 as shown by schedule on file.

40. GENERAL JOURNAL PAGE 25 DATE DESCRIPTION POST. DEBIT CREDIT REF.
Dec
Adjusting Entries
(Adjustment f)
Salaries Expense - Sales ,200.00
Salaries Payable ,200.00
To record accrued salaries of part-time sales clerks for Dec
(Adjustment g) 31
Payroll Taxes Expense
Social Security Tax Payable
Here are the payroll related adjusting journal entries.
Medicare Tax Payable
To record accrued payroll tax on accrued salaries for Dec

41. GENERAL JOURNAL PAGE 25 DATE DESCRIPTION POST. DEBIT CREDIT REF.
Dec
Adjusting Entries
(Adjustment h)
Payroll Taxes Expense
Fed. Unemployment Tax Payable
State Unemployment Tax Payable
To record accrued payroll tax on accrued salaries for Dec
(Adjustment i) 31
Interest Expense
Interest Payable
Here are the next two adjusting entries h-i.
To record interest on a 2-month, $2,000, 12% note payable dated Dec. 1, 2007

42. GENERAL JOURNAL PAGE 26 DATE DESCRIPTION POST. DEBIT CREDIT REF.
Dec
Adjusting Entries
(Adjustment j)
Supplies Expense ,975.00
Supplies ,975.00
To record supplies used
(Adjustment k) 31
Insurance Expense ,450.00
Prepaid Insurance ,450.00
Here are those adjusting journal entries (adjustments j –l).
To record expired insurance on 3-year policy purchased for $7,350 on Jan. 2, 2007
(Adjustment l) 31
Interest Expense
Prepaid Interest
To record transfer of 2/3 of prepaid interest of $225 for a 3-month, 10% note payable issued to bank on Nov. 1, 2007

43. GENERAL JOURNAL PAGE 27 DATE DESCRIPTION POST. DEBIT CREDIT REF.
Dec
Adjusting Entries
(Adjustment m)
Interest Receivable
Interest Income
To record accrued interest earned on a 4-month, 15% note receivable dated Nov. 1, 2007 ($1,200 x 0.15 x 2/12)
(Adjustment n) 31
These are the last two adjustments.
Sales Tax Payable
Miscellaneous Income
To record accrued commission earned on sales tax owed for fourth quarter of 2007: Sales Tax Payable $7,200 Commission rate x Commission due $

44. Posting the Adjusting Entries
After the adjustments have been recorded in the general journal, they are promptly posted to the general ledger.
The word Adjusting is entered in the Description column of each general ledger account.
Remember to write the word Adjusting in the Description column of each general ledger account.

45. Journalizing and Posting the Closing Entries
At the end of the period, the temporary accounts are closed.
The temporary accounts are:
Revenue accounts
Cost of goods sold accounts
Expense accounts
Drawing account
The temporary accounts are: Revenue accounts, Cost of goods sold accounts, all expense accounts and the Drawing account.

46. There are four steps in the closing process.
Close revenue accounts and cost of goods sold accounts with credit balances to Income Summary.
Close expense accounts and cost of goods sold accounts with debit balances to Income Summary.
Close Income Summary, which now reflects the net income or loss for the period, to owner's capital.
Close the drawing account to owner's capital.
We will use the same four steps in the merchandiser’s closing process: close revenue accounts and cost of goods sold accounts with credit balances to Income Summary, close expense accounts and cost of goods sold accounts with debit balances to Income Summary, close Income Summary, which now reflects the net income or loss for the period, to owner's capital, and close the drawing account to owner's capital.

47. Step 1: Closing the Revenue Accounts and the Cost of Goods Sold Accounts with credit balances.
GENERAL JOURNAL PAGE
DATE DESCRIPTION POST DEBIT CREDIT
REF.
2007
Dec
Closing Entries
Income Summary ,578.00
Sales ,650.00
Interest Income
Miscellaneous Income
Purchases Returns and Allowances ,050.00
Purchases Discounts ,130.00
Step 1: Close the Revenue Accounts and the Cost of Goods Sold Accounts that have credit balances. Make a credit to the Income Summary account.
Debit each account, except Income Summary, for its balance. Credit Income Summary for the total.

48. Step 2: Closing the Expense Accounts and the Cost of Goods Sold Accounts with Debit Balances.
GENERAL JOURNAL PAGE
DATE DESCRIPTION POST DEBIT CREDIT
REF.
Dec
Sales Returns and Allowances ,000.00
Income Summary ,406.20
Purchases ,500.00
Salaries Expense – Sales ,990.00
Advertising Expense ,425.00
Cash Short or Over
Supplies Expense ,975.00
Depreciation Expense - Store Equip ,400.00
Rent Expense ,600.00
Freight In ,800.00
Salaries Expense - Office ,500.00
Telephone Expense ,875.00
Uncollectible Accounts Expense
Utilities Expense ,925.00
Depreciation Expense - Office Equip
Interest Expense
Payroll Taxes Expense ,371.20
Insurance Expense ,450.00
Credit each account, except Income Summary, for its balance. Debit Income Summary for the total.
Step 2: Closing the Expense Accounts and the Cost of Goods Sold Accounts with Debit Balances. Make a corresponding debit to the Income Summary account.

49. Step 3: Closing the Income Summary Account.
The third closing entry transfers the Income Summary balance to the owner's capital account.
This closes the Income Summary account, which remains closed until it is used in the end-of-period process for the next year.
For Simpson Antiques, the third closing entry is as follows:
Income Summary
Adjusting Entries (a-b) 12/ , Closing Entries 12/ , ,406.20
12/ ,000.00
12/31 568, , Bal. 51,171.80
GENERAL JOURNAL PAGE
DATE DESCRIPTION POST DEBIT CREDIT
REF.
Dec
Income Summary ,171.80
Patricia Simpson, Capital ,171.80
Step 3: Closing the Income Summary Account. Close the balance into the owner’s capital account.

50. Step 4: Closing the Drawing account.
This entry closes the drawing account and updates the capital account.
GENERAL JOURNAL PAGE
DATE DESCRIPTION POST DEBIT CREDIT
REF.
Dec
Patricia Simpson, Capital ,600.00
Patricia Simpson, Drawing ,600.00
Step 4: Closing the Drawing account. Close the balance into the owner’s capital account.

51. Posting the Closing Entries
The closing entries are posted from the general journal to the general ledger.
This process brings the temporary account balances to zero.
The word Closing is entered in the Description column.
This process brings the temporary account balances to zero. Remember to write the word Closing in the Description column.

52. Preparing a Postclosing Trial Balance
Prepare a postclosing trial balance to confirm that the general ledger is in balance.
Only the accounts that have balances – the asset, liability and owner's capital accounts – appear on the postclosing trial balance.
The postclosing trial balance matches the amounts reported on the balance sheet.
To verify this, compare the postclosing trial balance with the balance sheet.
Only the accounts that have balances – the asset, liability and owner's capital accounts – appear on the postclosing trial balance.

53. Only the accounts that have balances—the asset, liability and owner's capital accounts—appear on the postclosing trial balance.
Only the accounts that have balances—the asset, liability and owner's capital accounts—appear on the postclosing trial balance.
Asset Accounts

54. To verify this, compare the postclosing trial balance with the balance sheet.
The postclosing trial balance should match the amounts reported on the balance sheet.
Capital Account

55. Preparing a Postclosing Trial Balance
Temporary accounts do not appear on the postclosing trial balance.
Revenue
Cost of Goods Sold
Temporary accounts including revenues, expenses and withdrawals do not appear on the postclosing trial balance.
Expenses
Withdrawals

56. Two such measurements are used by Simpson Antiques:
Ratios and other measurements are used to analyze and interpret financial statements.
Two such measurements are used by Simpson Antiques:
Gross profit percentage
Current ratio
The basic procedure for calculating a ratio. One number is divided by another number. The result is the ratio of the numerator, or top number, to the denominator, or bottom number.

57. Gross Profit Percentage
The gross profit percentage is the amount of gross profit from each dollar of sales.
The gross profit percentage is calculated by dividing gross profit by net sales.
For Simpson Antiques, for every dollar of net sales, gross profit was almost 40 cents.
For Simpson Antiques, for every dollar of net sales, gross profit was almost 40 cents.
Gross profit $219,030 Net sales $549,150 =
= = %

58. Current Ratio
The current ratio provides a measure of a firm's liquidity or ability to pay its current debts.
Simpson Antiques has $2.15 in current assets for every dollar of current liabilities.
The current ratio is calculated in the following manner:
Simpson Antiques has $2.15 in current assets for every dollar of current liabilities.
= to 1
Current assets $98, Current liabilities $45,823.20 =

59. Only accruals are reversed.
Journalizing and Posting Reversing Entries
Reversing entries are journal entries made to reverse the effect of certain adjusting entries involving accrued income or accrued expenses.
Only accruals are reversed.
The last step in the accounting cycle which is actually an optional step is to prepare reversing journal entries.

60. Reversing Entry GENERAL JOURNAL PAGE 25 GENERAL JOURNAL PAGE 29
At the beginning of the year, a reversing entry is made. This will simplify recordkeeping when the paychecks are issued.
GENERAL JOURNAL PAGE
DATE DESCRIPTION POST DEBIT CREDIT
REF.
Dec
Salaries Expense—Sales ,200.00
Salaries Payable ,200.00
(Adjustment f)
Adjusting Entries
At the beginning of the year, a reversing entry is made which is the opposite of the adjusting journal entry. This will simplify recordkeeping when the paychecks are issued.
GENERAL JOURNAL PAGE
DATE DESCRIPTION POST DEBIT CREDIT
REF.
2008 Jan
Salaries Payable ,200.00
Salaries Expense—Sales ,200.00
Reversing Entries

61. On January 3 the payment of $1,700 of salaries is recorded in the normal manner.
GENERAL JOURNAL PAGE
DATE DESCRIPTION POST DEBIT CREDIT
REF.
2008 Jan
Salaries Expense ,700.00
Cash ,700.00
On January 3 the payment of $1,700 of salaries is recorded in the normal manner. There is no need to take into account the adjusting entry made on December 31.

62. Reversing Accrued Salaries Expense
Salaries Payable
12/ ,200
Closing 1,200
1/ ,200
12/ ,200
1/ ,200
Bal
Bal ,200
The credit balance in Salaries Expense is unusual because the normal balance of an expense account is a debit.
This is what the T accounts would look like. On January 1 the reversing entry is made.

63. December = $1,200 last period January = $ 500 this period
After this entry is posted, the expense is properly divided between two periods.
Salaries Expense
Salaries Payable
Cash
12/ ,200
Closing 1,200
1/ ,200
12/31 1,200
1/1 1,200
1/3 1,700
1/ ,700
Bal
December = $1,200 last period
January = $ this period
Total = $1,700
After this entry is posted, the expense is properly divided between two periods.

64. The Accounting Cycle Step 1 Analyze transactions
Step 2 Journalize the data about transactions
Step 3 Post the data about transactions
Step 4 Prepare a worksheet
Step 5 Prepare financial statements
Step Journalize and post adjusting entries
Step 7 Journalize and post closing entries
Step 8 Prepare a postclosing trial balance
Step 9 Interpret the financial information
Step 2 Journalize the data about transactions
Step 3 Post the data about transactions
Step 1 Analyze transactions
Step 4 Prepare a worksheet
Step 5 Prepare financial statements
Here are the nine steps. Since reversing entries are optional, they are not included as a formal step in the cycle.
Step 9 Interpret the financial information
Step Journalize and post adjusting entries
Step 7 Journalize and post closing entries
Step 8 Prepare a postclosing trial balance