Chapter 4 Financial Statements Preparation It All Starts with the Trial Balance 4-1

How Do We Prepare Financial Statements? The financial statements: – Income statement: Reports revenues and expenses and calculates net income or loss for the period. – Statement of owner’s equity: Shows how capital changed during the period. – Balance sheet: Reports assets, liabilities, and stockholders’ equity as of the last day of the period. It All Starts with the Trial Balance 4-2

The financial statements are prepared from the adjusted trial balance. It All Starts with the Trial Balance 4-3

Relationships Among the Financial Statements The financial statements relate to each other. – Net income or net loss from the income statement flows to the statement of owner’s equity. – Ending Capital from the statement of owner’s equity flows to the balance sheet. It All Starts with the Trial Balance 4-4

Net income flows to the statement of owner’s equity. Exhibit 4-2 Smart Touch Learning Financial Statements 4-5

The net income from the income statement flows to the statement of owner’s equity. The ending capital flows to the balance sheet. Exhibit 4-2 Smart Touch Learning Financial Statements It All Starts with the Trial Balance 4-6

The ending value of Capital from the statement of owner’s equity flows to the balance sheet. Exhibit 4-2 Smart Touch Learning Financial Statements It All Starts with the Trial Balance 4-7

Classified Balance Sheet A classified balance sheet places each asset and each liability into a specific category. – Assets are shown in order of liquidity. – Liabilities are classified as current (due within one year) or long term (due after one year). Liquidity measures how quickly and easily an account can be converted to cash. It All Starts with the Trial Balance 4-8

Assets The operating cycle is the time span during which cash is paid for goods and services, which are then sold to customers, from whom the business collects cash. Current assets Converted to cash or used within 12 months or within the operating cycle. Long-term assets Not converted to cash or used up within the operating cycle or one year. Long-term investments Plant assets Intangible assets It All Starts with the Trial Balance 4-9

Liabilities Current liabilities must be paid either with cash or with goods and services within one year or within the entity’s operating cycle. – Examples: Accounts Payable Salaries Payable Unearned Revenue Long-term liabilities are all liabilities that do not need to be paid within one year or within the operating cycle. It All Starts with the Trial Balance 4-10

Owner’s Equity Owner’s equity represents the owner’s claims to the assets of the business. – Reflects the owner’s contributions to the business, net income or net loss of the business, and owner’s withdrawals. – Represents the amount of assets left over after the corporation has paid its liabilities. It All Starts with the Trial Balance 4-11

It All Starts with the Trial Balance 4-12

How Could a Worksheet Help in Preparing Financial Statements? The first four sections of the worksheet (see Chapter 3) helped determine the adjusted trial balance, from which we prepare financial statements. – Section 5—Income Statement Includes only revenue and expense accounts – Section 6—Balance Sheet Includes asset, liability, and equity accounts except revenues and expenses – Section 7—Determine Net Income or Net Loss The balancing amount for the income statement and balance sheet sections (will be the same amount) It All Starts with the Trial Balance 4-13

It All Starts with the Trial Balance 4-14

What Is the Closing Process, and How Do We Close the Accounts? The closing process zeros out all revenue and expense accounts in order to measure each period’s net income separately from all other periods. Temporary Accounts RevenuesExpenses Owner’s Withdrawals Permanent Accounts AssetsLiabilities Owner’s Capital It All Starts with the Trial Balance 4-15

What Is the Closing Process, and How Do We Close the Accounts? Closing entries – Transfer revenues, expenses, and Owner, Withdrawals balances to the Owner, Capital account. Revenues and expenses may be transferred first to an account titled Income Summary. – The Income Summary account summarizes the net income (or net loss) for the period. It All Starts with the Trial Balance 4-16

What Is the Closing Process, and How Do We Close the Accounts? It All Starts with the Trial Balance 4-17

Closing Temporary Accounts—Net Income for the Period (Revenues) It All Starts with the Trial Balance 4-18

Closing Temporary Accounts—Net Income for the Period (Expenses) It All Starts with the Trial Balance 4-19

Closing Temporary Accounts—Net Income for the Period (Income Summary) It All Starts with the Trial Balance 4-20

Closing Temporary Accounts—Net Income for the Period (Withdrawals) It All Starts with the Trial Balance 4-21

Closing Temporary Accounts—Net Loss for the Period It All Starts with the Trial Balance 4-22

Closing Temporary Accounts—Net Income for the Period It All Starts with the Trial Balance 4-23

Closing Temporary Accounts—Net Income for the Period It All Starts with the Trial Balance 4-24

How Do We Prepare a Post-Closing Trial Balance? The accounting cycle ends with a post- closing trial balance: – A list of the accounts and their balances at the end of the period, after journalizing and posting the closing entries. – Includes only permanent accounts. It All Starts with the Trial Balance 4-25

It All Starts with the Trial Balance 4-26

What Is the Accounting Cycle? It All Starts with the Trial Balance 4-27

How Do We Use the Current Ratio to Evaluate Business Performance? The current ratio measures a company’s ability to pay its current liabilities with its current assets. The formula is: It All Starts with the Trial Balance 4-28

What Are Reversing Entries? Special journal entries that ease the burden of accounting for transactions in a later period. The opposite of certain adjusting entries. Not required by GAAP. Used for convenience and to save time. It All Starts with the Trial Balance 4-29

Accounting for Accrued Expenses To record accrued salaries of $1,200, Smart Touch Learning recorded the following adjusting entry: It All Starts with the Trial Balance 4-30

Accounting Without a Reversing Entry To record the payment of total salaries of $2,400 on January 15 without a reversing entry, Smart Touch would: It All Starts with the Trial Balance 4-31

Accounting with a Reversing Entry A reversing entry is a special journal entry that eases the burden of accounting for transactions in the next period. It All Starts with the Trial Balance 4-32

Accounting with a Reversing Entry The credit balance in the Salaries Expense account is eliminated on January 15, when Smart Touch Learning pays the payroll and debits Salaries Expense. It All Starts with the Trial Balance 4-33