ACCT 201 WEEK 4 Completing the Accounting Cycle Chapter 4

Prepare an accounting work sheet

The Accounting Work Sheet Used to help move data from the trial balance to the financial statements An internal document – not financial statement

Accounting Cycle: Process by which accountants prepare financial statements for an entity for a specific period of time

The Accounting Cycle For a new business, begin by setting up ledger accounts. For an established business, begin with account balances carried over from the previous period.

The Accounting Cycle Accounts Receivable Accounts Receivable 1,700 1,350 Accounts Receivable 1,700 Service Revenue 1,700 Accounts Receivable 1,350 1,700 3,050 Accounts Receivable 1,350 1,700

The Accounting Cycle Work Sheet Cash Accounts receivable 12,100 3,050 Balance Sheet Income Statement

Postclosing Trial Balance The Accounting Cycle Adjusting entries Closing entries Cash Accounts Receivable 12,100 3,050 Postclosing Trial Balance Cash Accounts receivable 12,100 3,050

Use the work sheet to complete the accounting cycle.

Recording the Adjusting Entries The work sheet helps identify the accounts that need adjustments. Actual adjustment of the accounts requires journalizing and posting the entries.

Recording the Adjusting Entries The adjusting entries may be recorded in the journal when they are entered on the work sheet. Many accountants journalize and post the adjusting entries just before they make the closing entries.

The Accounting Work Sheet What is the work sheet? A work sheet is a multi-columned document used by accountants to help move data from the trial balance to the financial statements. It is an internal document.

The Accounting Work Sheet Adjusted Trial Balance Adjustments Trial Balance Account Title Dr. Cr. Dr. Cr. Dr. Cr. Cash Accounts receivable Supplies Equipment Accum. depreciation Accounts payable Salary payable Unearned revenue Capital Withdrawals Revenue Salary expense Supplies expense Depreciation expense Totals 12,100 1,350 250 15,500 1,000 12,000 42,200 7,500 1,200 1,100 1,500 7,200 23,700 42,200 ©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 4 - 9

The Accounting Work Sheet The company has earned revenue of $1,700 which will be collected next month. Inventory of supplies at month end totaled $150. Depreciation for the period was calculated as $200.

The Accounting Work Sheet Adjusted Trial Balance Adjustments Trial Balance Account Title Dr. Cr. Dr. Cr. Dr. Cr. Cash Accounts receivable Supplies Equipment Accum. depreciation Accounts payable Salary payable Unearned revenue Capital Withdrawals Revenue Salary expense Supplies expense Depreciation expense Totals 12,100 1,350 250 15,500 1,000 12,000 42,200 12,100 3,050 150 15,500 1,000 12,000 100 200 44,100 a) 1,700 b) 100 c) 200 2,000 b) 100 c) 200 a) 1,700 2,000 7,500 1,200 1,100 1,500 7,200 23,700 42,200 7,700 1,200 1,100 1,500 7,200 25,400 44,100 ©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 4 - 11

Close the revenue, expense, and withdrawal accounts.

Closing the Accounts Closing the accounts is the end of period process that prepares the accounts for recording transactions during the next period.

Expenses and Withdrawals Closing the Accounts Closing Entries Expenses and Withdrawals decrease Owner’s Equity. Revenues increase Owner’s Equity.

Closing the Accounts Revenues and Expense accounts are closed to Income Summary. Income Summary is closed to Capital. Withdrawals are closed to Capital. In a corporation, Dividends are closed to Retained Earnings.

Closing the Accounts Income Summary A debit balance represents net loss. A credit balance represents net income.

(Close Revenue Account) Closing the Accounts (Close Revenue Account) Income Summary Revenue 28,500 12,000 7,500 9,000 (Close Expense Accounts) 4,450 28,500 24,050 Salary Exp (Close Income Summary) 1,500 1,800 3,300 Capital Account Rent Exp 2,500 24,050 800 800 (Close Withdrawals Account) Withdrawals Supplies Exp 2,500 2,500 350 350 ©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 4 - 23

Postclosing Trial Balance The accounting cycle ends with the postclosing trial balance. The postclosing trial balance is dated as of the end of the period for which the statements have been prepared.

Permanent Accounts What accounts never close? Assets Liabilities Owner’s equity Balances of permanent accounts carry over to the next period.

Classify assets and liabilities as current or long-term.

Liquidity This is a measure of how quickly an item can be converted into cash. On the balance sheet, assets and liabilities are classified as either current or long-term to indicate their relative liquidity.

Current Assets Current assets are cash, or will be converted to cash, in one year or within the normal business operating cycle. What are some other examples? short-term receivables inventory prepaid expenses

Current Liabilities Current liabilities are debts or obligations due within one year or within the operating cycle. What are some examples? accounts and salary payables short-term notes payable unearned revenue

Long-term Assets and Liabilities Long-term assets include all other assets. property, equipment, and intangibles Long-term liabilities are all other debts due in longer than one year or the entity’s operating cycle.

The Classified Balance Sheet Debit side Current assets Long-term assets Credit side Current liabilities Long-term liabilities Listed in the order of decreasing liquidity Listed in the order of how soon they must be paid

The Classified Balance Sheet XYZ Services January 31, 20XX Assets Liabilities Current assets: Current liabilities: Cash 12,100 Accounts payable 1,200 Accounts receivable 3,050 Salary payable 1,100 Supplies 150 Unearned revenue 1,500 Total current assets 15,300 Total liabilities 3,800 Plant assets Owner’s equity Equipment 15,500 Capital 19,300 Less Accum. deprec. 7,700 7,800 Total liabilities and Total assets 23,100 owner’s equity 23,100

Different Formats of Balance Sheet Report Format Account Format Assets Liabilities Owner’s Equity Assets = Liabilities + Owner’s Equity

Use the current ratio and the debt ratio to evaluate a company.

Comparative Financial Statements They enhance the user’s ability to analyze a company’s past performance. What are two common ratios used to measure liquidity? Current ratio Debt ratio

Current Ratio This measures the ability of a business to pay its current liabilities with its current assets. Current ratio = Current assets ÷ Current liabilities

Total liabilities ÷ Total assets Debt Ratio It indicates the proportion of a business’s assets that are financed with debt. It measures their ability to pay both current and long-term debt. Total liabilities ÷ Total assets

Trend Analysis Decision makers compare various ratios over a period of time.

Closing the Accounts Permanent Accounts Temporary Accounts Prepares accounts for recording transactions during next period Updates retained earnings account Permanent Accounts Temporary Accounts

Four Closing Entries Close all income statement accounts to Income Summary Entry 1: Close revenue accounts to Income Summary Entry 2: Close expense accounts to Income Summary

Four Closing Entries Revenue Expense Income Summary 500 500 200 200 Bal 0 Bal 0 Income Summary 200 500 Bal 300 Revenues – Expenses = Net Income

Four Closing Entries Entry 3: Close Income Summary to Retained Earnings Entry 4: Close Dividends to Retained Earnings

Four Closing Entries Income Summary Dividends Retained Earnings 200 500 100 100 300 Bal 300 Bal 0 Bal 0 Retained Earnings 1,000 Beginning balance 100 300 1,200 Ending balance

Income Summary Account Debit balance = Net Loss Credit balance = Net Income

Post-Closing Trial Balance List of permanent accounts and their balances after posting closing entries Total debits and credits must be equal

Current Assets Cash Receivables Prepaid expenses Long-term Assets Equipment Buildings Accumulated depreciation Current Liabilities Accounts payable Accrued liabilities Long-term liabilities None

Current Ratio: Current assets/ Current liabilities = EXAMPLE Current Assets: Cash $3,000 Accounts receivable 6,000 Prepaid rent 2,000 Supplies 1,000 Total $12,000 Current Liabilities: Accounts payable $4,000 Salary payable 2,000 Total $6,000 Current Ratio: Current assets/ Current liabilities = $12,000 / $6,000 = 2

Debt Ratio: Total liabilities/Total assets = EXAMPLE Total Assets: Cash $3,000 Accounts receivable 6,000 Prepaid rent 2,000 Supplies 1,000 Equipment 12,000 Total $24,000 Total Liabilities: Accounts payable $4,000 Salary payable 2,000 Note payable 9,000 Total $15,000 Debt Ratio: Total liabilities/Total assets = $15,000 / $24,000 = 0.63

REVISION QUESTIONS

The worksheet helps accountants with all of the following except: Post to the accounts Prepare financial statements Close the accounts Make adjusting entries

Answer: 1 The worksheet is a tool that helps accountants organize the end-of-year activities – preparing adjusting and closing entries and the financial statements.

On the work sheet, in the balance sheet columns, if the total credits are $600 and total debits are $200, then An error has been made Net loss is $400 Total assets are $400 Net income is $400

Answer: 2 The difference between the debit and credit columns is the amount of net income or loss, which is used to balance the columns. In this case, $400 is needed in the debit column to balance them. A debit indicates that capital is decreasing.

Granite Company had revenues of $600 and expenses of $200 during the year. The owner’s beginning capital balance was $1,000, and the owner made no additional investments during the year. What is the balance in the capital account on Granite Company’s worksheet?

Answer: $1,000 The capital balance on the worksheet is the amount in the account before closing entries. If the beginning balance was $1,000 and there were no additional investments, $1,000 would appear in the worksheet.

The purpose of closing entries is to Get the accounts ready for the next period Verify that the balances in the accounts are correct Ensure that debits equal credits Bring the accounts up to date so that financial statements can be prepared

Answer: 1 Closing entries zero out the temporary accounts and transfers their balances to the owner’s capital account. The temporary accounts are now ready to begin measuring activity for the next accounting period.

Which of the following accounts would not be closed? Utilities Expense Accumulated Depreciation Service Revenue Withdrawals

Answer: 2 Accumulated depreciation is a permanent account and is reported on the balance sheet. Permanent account balances carry forward into the next period.

Which of the following is a permanent account? Fees earned Unearned revenue Depreciation expense Income summary

Answer: 2 Unearned revenue is a liability. It’s balance carries forward into the next accounting period.

Revenues for an accounting period are $900 and expenses are $500 Revenues for an accounting period are $900 and expenses are $500. The balance in the income summary account before closing it to capital would be $500 debit $900 credit $400 credit $400 debit

Answer: 3 Revenues are closed by debiting revenues and crediting income summary. Expenses are closed by debiting income summary and crediting expenses. Income Summary 900 500 400 Bal

Which account would not appear in the postclosing trial balance? Cash Prepaid Insurance Fees earned E. Morgan, Capital

Answer: 3 Fees earned is a temporary account and would have been closed before the postclosing trial balance was prepared.

In what order are assets listed on a classified balance sheet? In the order of their liquidity Alphabetically In ascending dollar amounts In descending dollars amounts

Answer: 1

Mica Company has the following assets:. Land. $600. Building. 800 Mica Company has the following assets: Land $600 Building 800 Inventory 300 Accumulated depreciation, Building 200 Prepaid rent 400 Cash 100 How much are total current assets?

Answer: $800 Current assets: Cash $100 Prepaid rent 400 Inventory 300 $800

Mica Company has the following assets:. Land……………………………. $600 Mica Company has the following assets: Land……………………………. $600 Building………………………… 800 Inventory……………………….. 300 Accumulated depreciation, building…………………………. 200 Prepaid rent……………………. 400 Cash……………………………. 100 How much are total plant assets?

Answer: $1,200 Current assets: Land $600 Building 800 Less Accumulated depreciation (200) 600 $1,200

At the end of the accounting period, Quartz Company has a note payable of $82,000. Quartz Company pays $1,000 per month on the principal amount of the note. The company also has $3,000 in accounts payable. How much are total current liabilities?

Answer: $15,000 Current liabilities: Accounts payable $3,000 Currently maturing portion of long-term note 12,000 $15,000

A 2:1 current ratio indicates that Current assets are two times greater than current liabilities Total assets are two times greater than total liabilities Current liabilities are two times greater than current assets Total liabilities are two times greater than total assets

Answer: 1 The current ratio is current assets ÷ current liabilities.

A high debt ratio is Safer than a low debt ratio Riskier than a low debt ratio Indicates high profitability Indicates that total assets are considerably higher than total liabilities

Answer: 2 The debt ratio is computed by dividing total liabilities by total assets. The debt ratio indicates the proportion of a company’s assets that are financed with debt. A low debt ratio is safer than a high debt ratio.