Chapter 13 Skyline College

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.

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.

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.

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)

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 28,000 Expenses Salaries Expense 5,000 Utilities Expense 600 Supplies Expense 500 Rent Expense 3,000 Depreciation Expense - Equipment 583 Total Expenses 9,683 Net Income for the Month 18,317 Here is a single step income statement. Total expenses are subtracted from total revenues to get net income of $18,317.00

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.

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

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

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.

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.

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

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

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.

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.

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.

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

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.

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.

Net income from operations Simpson Antiques is reporting $51,193.80 net income from operations.

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).

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.

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.

Net income for Simpson Antiques Simpson Antiques had $51,171.80 of net income.

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 $84,792.80.

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.).

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.

Current Assets Current assets for Simpson Antiques Total current assets for Simpson Antiques is $98,716.00. Current assets for Simpson Antiques

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

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

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.

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 $45,823.20.

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.

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 $130,616.00. The ending balance from the statement of owner’s equity is transferred to the Owner's Equity section of the balance sheet.

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.

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.

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).

GENERAL JOURNAL PAGE 25 DATE DESCRIPTION POST. DEBIT CREDIT REF. 2007 Dec. 31 Adjusting Entries (Adjustment a) Income Summary 52,000.00 Merchandise Inventory 52,000.00 To transfer beginning inventory to Income Summary (Adjustment b) 31 Merchandise Inventory 47,000.00 Here are the first two adjusting journal entries regarding merchandise inventory. Income Summary 47,000.00 To record ending inventory

GENERAL JOURNAL PAGE 25 DATE DESCRIPTION POST. DEBIT CREDIT REF. 2007 Dec. 31 Adjusting Entries (Adjustment c) Uncollectible Accounts Expense 800.00 Allowance for Doubtful Accounts 800.00 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. 2,400.00 Accum. Depreciation - Store Equip. 2,400.00 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. 700.00 Accum. Depreciation - Office Equip. 700.00 To record depreciation for 2007 as shown by schedule on file.

GENERAL JOURNAL PAGE 25 DATE DESCRIPTION POST. DEBIT CREDIT REF. 2007 Dec. 31 Adjusting Entries (Adjustment f) Salaries Expense - Sales 1,200.00 Salaries Payable 1,200.00 To record accrued salaries of part-time sales clerks for Dec. 28-31 (Adjustment g) 31 Payroll Taxes Expense 91.80 Social Security Tax Payable 74.40 Here are the payroll related adjusting journal entries. Medicare Tax Payable 17.40 To record accrued payroll tax on accrued salaries for Dec. 28-31

GENERAL JOURNAL PAGE 25 DATE DESCRIPTION POST. DEBIT CREDIT REF. 2007 Dec. 31 Adjusting Entries (Adjustment h) Payroll Taxes Expense 74.40 Fed. Unemployment Tax Payable 9.60 State Unemployment Tax Payable 64.80 To record accrued payroll tax on accrued salaries for Dec. 28-31 (Adjustment i) 31 Interest Expense 20.00 Interest Payable 20.00 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

GENERAL JOURNAL PAGE 26 DATE DESCRIPTION POST. DEBIT CREDIT REF. 2007 Dec. 31 Adjusting Entries (Adjustment j) Supplies Expense 4,975.00 Supplies 4,975.00 To record supplies used (Adjustment k) 31 Insurance Expense 2,450.00 Prepaid Insurance 2,450.00 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 150.00 Prepaid Interest 150.00 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

GENERAL JOURNAL PAGE 27 DATE DESCRIPTION POST. DEBIT CREDIT REF. 2007 Dec. 31 Adjusting Entries (Adjustment m) Interest Receivable 30.00 Interest Income 30.00 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 216.00 Miscellaneous Income 216.00 To record accrued commission earned on sales tax owed for fourth quarter of 2007: Sales Tax Payable $7,200 Commission rate x 0.03 Commission due $ 216

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.

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.

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.

Step 1: Closing the Revenue Accounts and the Cost of Goods Sold Accounts with credit balances. GENERAL JOURNAL PAGE 28 DATE DESCRIPTION POST. DEBIT CREDIT REF. 2007 Dec. 31 Closing Entries Income Summary 568,578.00 Sales 561,650.00 Interest Income 166.00 Miscellaneous Income 582.00 Purchases Returns and Allowances 3,050.00 Purchases Discounts 3,130.00 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.

Step 2: Closing the Expense Accounts and the Cost of Goods Sold Accounts with Debit Balances. GENERAL JOURNAL PAGE 28 DATE DESCRIPTION POST. DEBIT CREDIT REF. Dec. 31 Sales Returns and Allowances 13,000.00 Income Summary 512,406.20 Purchases 321,500.00 Salaries Expense – Sales 79,990.00 Advertising Expense 7,425.00 Cash Short or Over 125.00 Supplies Expense 4,975.00 Depreciation Expense - Store Equip 2,400.00 Rent Expense 27,600.00 Freight In 9,800.00 Salaries Expense - Office 26,500.00 Telephone Expense 1,875.00 Uncollectible Accounts Expense 800.00 Utilities Expense 5,925.00 Depreciation Expense - Office Equip. 700.00 Interest Expense 770.00 Payroll Taxes Expense 7,371.20 Insurance Expense 2,450.00 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.

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) 12/31 52,000.00 Closing Entries 12/31 512,406.20 564,406.20 12/31 47,000.00 12/31 568,578.00 615,578.00 Bal. 51,171.80 GENERAL JOURNAL PAGE 28 DATE DESCRIPTION POST. DEBIT CREDIT REF. Dec. 31 Income Summary 51,171.80 Patricia Simpson, Capital 51,171.80 Step 3: Closing the Income Summary Account. Close the balance into the owner’s capital account.

Step 4: Closing the Drawing account. This entry closes the drawing account and updates the capital account. GENERAL JOURNAL PAGE 28 DATE DESCRIPTION POST. DEBIT CREDIT REF. Dec. 31 Patricia Simpson, Capital 27,600.00 Patricia Simpson, Drawing 27,600.00 Step 4: Closing the Drawing account. Close the balance into the owner’s capital account.

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.

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.

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

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

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

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.

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 = = 0.3988 = 39.9%

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. = 2.15 to 1 Current assets $98,716.00 Current liabilities $45,823.20 =

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.

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 25 DATE DESCRIPTION POST. DEBIT CREDIT REF. 2007 Dec. 31 Salaries Expense—Sales 602 1,200.00 Salaries Payable 229 1,200.00 (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 29 DATE DESCRIPTION POST. DEBIT CREDIT REF. 2008 Jan. 1 Salaries Payable 1,200.00 Salaries Expense—Sales 1,200.00 Reversing Entries

On January 3 the payment of $1,700 of salaries is recorded in the normal manner. GENERAL JOURNAL PAGE 30 DATE DESCRIPTION POST. DEBIT CREDIT REF. 2008 Jan. 3 Salaries Expense 1,700.00 Cash 1,700.00 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.

Reversing Accrued Salaries Expense Salaries Payable 12/31 1,200 Closing 1,200 1/1 1,200 12/31 1,200 1/1 1,200 Bal. 0 Bal. 1,200 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.

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

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 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 6 Journalize and post adjusting entries Step 7 Journalize and post closing entries Step 8 Prepare a postclosing trial balance