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Financial Statements and Closing Procedures

4.Journalize and post the adjusting entries. 5.Journalize and post the closing entries. 6.Prepare a postclosing trial balance. 7.Journalize and post reversing entries. Completing the Accounting Cycle Section Objectives

Page 478 Journalizing and Posting the Adjusting Entries

Objective 4 Journalize and post the adjusting entries. Page 478

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. Page 478

Journalizing the Adjusting Entries Page 478

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. Page 478

Type of Adjustment Worksheet Reference Purpose Adjusting Entries Removes beginning inventory and adds ending inventory to the accounting records. Inventory(a – b) Page 478

GENERAL JOURNAL PAGE 25 DATE DESCRIPTION POST. DEBIT CREDIT REF. Income Summary 51, Merchandise Inventory 51, To transfer beginning inventory to Income Summary Merchandise Inventory 46, Income Summary 46, To record ending inventory (Adjustment a) (Adjustment b) Page Adjusting Entries 2004 Dec. 31

Adjusting Entries Type of Adjustment Worksheet Reference Purpose Inventory(a – b)Removes beginning inventory and adds ending inventory to the accounting records. Matches expense to revenue for the period; the credit is to a contra asset account. Expense(c – e) Page 478

GENERAL JOURNAL PAGE 25 DATE DESCRIPTION POST. DEBIT CREDIT REF. Uncollectible Accounts Expense Allowance for Doubtful Accounts To record estimated loss from uncollectible amounts based on 0.75% of net credit sales of $100,000 Depreciation Expense – Store Equip. 2, Accum. Depreciation - Store Equip. 2, To record depreciation for 2004 as shown by schedule on file. (Adjustment c) (Adjustment d) Depreciation Expense – Office Equip. 1, Accum. Depreciation - Office Equip. 1, To record depreciation for 2004 as shown by schedule on file. (Adjustment e) 31 Page 479 Adjusting Entries 2004 Dec. 31

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. Matches expense to revenue for the period; the credit is to a liability account. Accrued Expense(f – i) Page 478

GENERAL JOURNAL PAGE 25 DATE DESCRIPTION POST. DEBIT CREDIT REF. Salaries Expense - Sales 1, Salaries Payable 1, To record accrued salaries of part- time sales clerks for Dec Payroll Taxes Expense Social Security Tax Payable To record accrued payroll tax on accrued salaries for Dec (Adjustment g) Medicare Tax Payable (Adjustment f) 31 Page 479 Adjusting Entries 2004 Dec. 31

GENERAL JOURNAL PAGE 25 DATE DESCRIPTION POST. DEBIT CREDIT REF. Page 480 Adjusting Entries Interest Expense Interest Payable (Adjustment i) (Adjustment h) Payroll Taxes Expense Fed. Unemployment Tax Payable To record accrued payroll tax on accrued salaries for Dec State Unemployment Tax Payable Dec. 31 To record interest on a 2-month, $2,000, 12% note payable dated Dec. 1, 2004

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. Matches expense to revenue for the period; the credit is to an asset account. Prepaid Expense(j – l) Page 478

GENERAL JOURNAL PAGE 26 DATE DESCRIPTION POST. DEBIT CREDIT REF Dec. 31 Supplies Expense 4, Supplies 4, To record supplies used Insurance Expense 3, Prepaid Insurance 3, To record expired insurance on 2-year policy purchased for $7,200 on Jan. 1, 2004 (Adjustment j) (Adjustment k) (Adjustment l) 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, Page 480/481 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. Accrued Income(m – n) Page 478 Recognizes income earned in the period. The debit is to an asset account (Interest Receivable) or a liability account (Sales Tax Payable).

GENERAL JOURNAL PAGE 27 DATE DESCRIPTION POST. DEBIT CREDIT REF Dec. 31 (Adjustment m) Interest Receivable Interest Income To record accrued interest earned on a 4-month, 12% note receivable dated Nov. 1, 2004 ($1,200 x 0.12 x 2/12) Sales Tax Payable Miscellaneous Income To record accrued commission earned on sales tax owed for fourth quarter of 2004: Sales Tax Payable $7,200 Commission rate x 0.02 Commission due $ 144 (Adjustment n) 31 Page 481 Adjusting Entries

Posting the Adjusting Entries Page 478

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. Page 478

Page 481 Journalizing and Posting the Closing Entries

Objective 5 Journalize and post the closing entries. Page 481

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 Journalizing and Posting the Closing Entries Page 481

Journalizing the Closing Entries Page 481

There are four steps in the closing process. 1.Close revenue accounts and cost of goods sold accounts with credit balances to Income Summary. 2.Close expense accounts and cost of goods sold accounts with debit balances to Income Summary. 3.Close Income Summary, which now reflects the net income or loss for the period, to owner's capital. 4.Close the drawing account to owner's capital. Page 481

GENERAL JOURNAL PAGE 28 DATE DESCRIPTION POST. DEBIT CREDIT REF Dec. 31 Closing Entries Income Summary 566, Sales 559, Interest Income Miscellaneous Income Purchases Returns and Allowances 3, Purchases Discounts 3, Page 482 Step 1: Closing the Revenue Accounts and the Cost of Goods Sold Accounts with credit balances. Debit each account, except Income Summary, for its balance. Credit Income Summary for the total.

GENERAL JOURNAL PAGE 28 DATE DESCRIPTION POST. DEBIT CREDIT REF. Dec. 31 Sales Returns and Allowances 13, Income Summary 512, Purchases 320, Salaries Expense – Sales 79, Advertising Expense 7, Cash Short or Over Supplies Expense 4, Depreciation Expense - Store Equip 2, Rent Expense 27, Freight In 8, Salaries Expense - Office 26, Telephone Expense 1, Uncollectible Accounts Expense Utilities Expense 5, Depreciation Expense - Office Equip. 1, Interest Expense Payroll Taxes Expense 7, Insurance Expense 3, Page 482 Step 2: Closing the Expense Accounts and the Cost of Goods Sold Accounts with Debit Balances. Credit each account, except Income Summary, for its balance. Debit Income Summary for the total.

Income Summary 12/31 46, /31566, , Bal. 48, Adjusting Entries (a-b)12/31 51, Closing Entries 12/31 512, , GENERAL JOURNAL PAGE 28 DATE DESCRIPTION POST. DEBIT CREDIT REF. Dec. 31 Income Summary 48, Sonia Sanchez, Capital 48, Page 483 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 Modern Casuals, the third closing entry is as follows: Step 3: Closing the Income Summary Account.

GENERAL JOURNAL PAGE 28 DATE DESCRIPTION POST. DEBIT CREDIT REF. Dec. 31 Sonia Sanchez, Capital 27, Sonia Sanchez, Drawing 27, Page 483 Step 4: Closing the Drawing account. This entry closes the drawing account and updates the capital account.

Posting the Closing Entries Page 483

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. Page 483

Page 483 Preparing a Postclosing Trial Balance

Objective 6 Prepare a postclosing trial balance. Page 483

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. Page 483

Page 484 Only the accounts that have balances—the asset, liability and owner's capital accounts—appear on the postclosing trial balance. Asset Accounts

Page 484 The postclosing trial balance matches the amounts reported on the balance sheet. Liability Accounts

Page 484 To verify this, compare the postclosing trial balance with the balance sheet. Capital Account

Revenue Preparing a Postclosing Trial Balance Page 484 Cost of Goods Sold Expenses Withdrawals Temporary accounts do not appear on the postclosing trial balance.

Page 484 Interpreting the Financial Statements

Gross profit percentage Current ratio Inventory turnover Ratios and other measurements are used to analyze and interpret financial statements. Page 484 Three such measurements are used by Modern Casuals:

The gross profit percentage is the amount of gross profit from each dollar of sales. ANSWER: QUESTION: What is the gross profit percentage? Page 484

Gross Profit Percentage The gross profit percentage is calculated by dividing gross profit by net sales. For Modern Casuals, for every dollar of net sales, gross profit was almost 40 cents. Page 484 Gross profit $218,030 Net sales $546,650 = = = 39.9%

The current ratio is a relationship between current assets and current liabilities. It provides a measure of a firm's ability to pay its current debts. ANSWER: QUESTION: What is the current ratio? Page 484

Current Ratio Modern Casuals has $2.26 in current assets for every dollar of current liabilities. The current ratio is calculated in the following manner: Page 484 = 2.26 to 1 Current assets $104, Current liabilities $ 46, =

Inventory turnover is the number of times inventory is purchased and sold during the accounting period. ANSWER: QUESTION: What is inventory turnover? Page 485

Page 485 Beginning inventory + Ending inventory 2 Average inventory = $51,500 + $46,000 2 Average inventory == $48,750 Inventory Turnover Compute the average inventory: For Modern Casuals the average inventory for the year was $48,750.

Inventory Turnover Compute inventory turnover : Page 485 Cost of goods sold Average inventory Inventory turnover = $328,620 $ 48,750 Inventory turnover == 6.74 times The inventory turnover was 6.74; that is, inventory was replaced about seven times during the year.

Page 485 Journalizing and Posting Reversing Entries

Objective 7 Journalize and post reversing entries. Page 485

Reversing entries are journal entries made to reverse the effect of certain adjusting entries involving accrued income or accrued expenses. ANSWER: QUESTION: What are reversing entries? Page 485

Recall that on December 31 Modern Casuals owed $1,500 of salaries to its part-time sales clerks. The salaries will be paid in January. To recognize the salaries expense in December, adjustment (f) was made. GENERAL JOURNAL PAGE 25 DATE DESCRIPTION POST. DEBIT CREDIT REF Dec. 31 Salaries Expense–Sales 602 1, Salaries Payable 229 1, (Adjustment f) Adjusting Entries Page 485

Salaries Expense - Sales Salaries Payable Page /31 1,500 Accrued Salaries Expense

GENERAL JOURNAL PAGE 25 DATE DESCRIPTION POST. DEBIT CREDIT REF Dec. 31 Salaries Expense—Sales 602 1, Salaries Payable 229 1, (Adjustment f) Adjusting Entries GENERAL JOURNAL PAGE 29 DATE DESCRIPTION POST. DEBIT CREDIT REF Jan. 1 Salaries Payable 1, Salaries Expense—Sales 1, Reversing Entries Page 486/487 Reversing Entry At the beginning of the year, a reversing entry is made. This will simplify recordkeeping when the paychecks are issued.

Page 486/487 The credit balance in Salaries Expense—Sales is unusual because the normal balance of an expense account is a debit. Salaries Expense - Sales Salaries Payable 12/31 1,500 Closing 1,500 Bal. 1,500 Bal. 0 Reversing Accrued Salaries Expense 1/1 1,500

GENERAL JOURNAL PAGE 30 DATE DESCRIPTION POST. DEBIT CREDIT REF Jan. 3 Salaries Expense—Sales 2, Cash 2, Page 487 On January 3 the payment of $2,000 of salaries is recorded in the normal manner.

Page 487 Salaries Expense - Sales Salaries Payable 12/31 1,500 1/1 1,500 Closing 1,500 1/1 1,500 Cash 21,136 1/3 2,000 After this entry is posted, the expense is properly divided between two periods. December=$1,500 January=$ 500 Total=$2,000 1/3 2,000 Bal. 500

Identifying Items for Reversal Page 488

Identifying Items for Reversal Not all adjustments need to be reversed. Normally, reversing entries are made for accrued items that involve future payments or receipts of cash. Page 488

Page 490 Review of the Accounting Cycle

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 6 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 Page 490 Step 9 Interpret the financial information Step 8 Prepare a postclosing trial balance Step 5 Prepare financial statements Step 4 Prepare a worksheet Step 3 Post the data about transactions Step 2 Journalize the data about transactions Step 1 Analyze transactions Step 6 Journalize and post adjusting entries Step 7 Journalize and post closing entries

REVIEWREVIEW At the end of the accounting period, the _________ accounts are closed. Only the accounts that have ________ appear on the postclosing trial balance. The current ratio is computed by dividing _____________ by _______________. balances temporary Complete the following sentences: current liabilities current assets

REVIEWREVIEW _____________________ is the amount of gross profit from each dollar of sales. Inventory turnover is computed by dividing ________________ by ________________. _______________ are journal entries made to reverse the effect of certain adjusting entries involving accrued income or accrued expenses. Reversing entries cost of goods sold Gross profit percentage Complete the following sentences: average inventory

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