1. Adjusting Accounts & Preparing Financial Statements
Chapter 3
Adjusting Accounts & Preparing Financial Statements

2. The Accounting Period Annually Semiannually Quarterly Monthly 1 2 1 23 4
Quarterly
The most common account period is one month. Companies also prepare quarterly reports and semi-annual reports. At the end of each year, most companies prepare an annual report of operations and financial position.
When we divide business activities into arbitrary fixed periods of time, it is often necessary to have special accounting for transactions that cross from one time period to the next.
Most of our time will be spent looking at the special adjusting process for some of these transactions. 1 2 3 4 5 6 7 8 9 10 11 12
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Monthly
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3. Accrual Basis vs. Cash Basis
Revenues are recognized when earned and expenses are recognized when incurred.
Cash Basis
Revenues are recognized when cash is received and expenses recorded when cash is paid.
Not GAAP
Part I
The accrual basis dictates that revenues be recognized when earned and expenses be recognized when incurred. The accrual basis of accounting is considered to be in compliance with generally accepted accounting principles, or GAAP.
The cash basis of accounting dictates that revenues be recognized when the cash is actually received and that expenses are recorded when the cash is paid.
Part II
The cash basis is not considered to be compliant with GAAP. While you may be on the cash basis for your transactions, almost all companies follow the accrual basis of accounting. We believe that the cash basis waits too long to recognize revenue and expenses and, therefore, misstates income.
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4. Accrual Basis of Accounting
Revenue reported when earned;
Expense reported when incurred;
Properly matches revenues and expenses in determining net income;
Requires adjusting entries at end of period.

5. Seven Basic Steps of the Accounting Cycle
1. Transactions are analyzed and recorded in the journal.
2. Transactions are posted to the ledger.
3. A trial balance is prepared, adjustment data are assembled, and an optional work sheet is completed.
Adjusting entries are journalized and posted.
Financial statements are prepared.
6. Closing entries are journalized and posted.
7. A post-closing trial balance is prepared.

6. Accounting Adjustments
Because running a business often requires you to purchase goods before they are actually used, accounting adjustments are often used to reclassify items from assets to expenses.
Personal examples would include personal auto insurance or magazines. You must prepay it before it is actually used or received.

7. Adjusting Accounts
C2, P1
An adjusting entry is recorded to bring an asset or liability account balance to its proper amount.
Adjustments
Paid (or received) cash before expense (or revenue) recognized
Paid (or received) cash after expense (or revenue) recognized
Prepaid (Deferred) expenses*
Unearned (Deferred) revenues
Accrued expenses
Accrued revenues
Here is a framework for adjusting the books of the company.
There are two broad categories of adjustments. The first is when we pay or receive cash before the expense or revenue is recognized. This category includes prepaid or deferred expenses (including depreciation), and unearned or deferred revenues.
The second major category of adjustments is when cash is paid or received after the expense or revenue is recognized. These are some very common adjustments. The category includes accrued expenses and accrued revenues.
*including depreciation
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8. Prepaid/ Deferred Expenses
Items paid for in ADVANCE of receiving the benefit
(i.e. prepaid insurance, supplies, depreciation)

9. NetSolutions
Trial Balance
December 31, 2015
Cash
Accounts Receivable
Supplies
Prepaid Insurance
Land
Office Equipment
Accounts Payable
Unearned Rent
Chris Clark, Capital
Chris Clark, Drawing
Fees Earned
Wages Expense
Rent Expense
Utilities Expense
Supplies Expense
Miscellaneous Expense
Some of these supplies have been used. On December 31, a count reveals that $760 of supplies are on hand.

10. Supplies (balance on trial balance) $2,000
Supplies on hand, December 31 – 760
Supplies used $1,240 1 2 3 4
Dec. 31
2015
Supplies Expense 55
Supplies 14
Supplies
Supplies Expense 14 55
Bal. 2,000
Dec. 31 1,240
Bal. 800
760
Dec. 31 1,240
2,040

11. Asset Cost - Salvage ValueP1
Depreciation
Depreciation is the process of allocating the cost of plant and equipment over their expected useful lives.
Straight-Line
Depreciation
Expense =
Asset Cost - Salvage Value
Useful Life
Plant assets, with the exception of land, are depreciated over their useful lives. Depreciation is the process of allocating the cost of a plant asset over its useful life in a systematic and rational manner. At this point in the accounting process, we want to introduce you to a depreciation method known as straight-line depreciation. Straight line depreciation is the most popular method used by companies. They determine the amount of annual depreciation by taking the cost of the plant assets, subtracting the estimated salvage value and dividing that amount by the useful life of the asset. The salvage value is the amount we expect to receive for the asset when we dispose of it at the end of its useful life. In a later chapter, we will discuss other acceptable methods of depreciation. For now, let’s look at the adjusting entry to record depreciation expense.
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12. Depreciation Useful Life: 5 years
On Jan 1, 2015, Barton, Inc. purchased equipment for $62,000 cash.
Useful Life: 5 years
Salvage Value*: $2,000 (est. sales price at end of five years)
Let’s record depreciation expense for the year ended Dec 31, 2015.
Part I
On January 1, 2009, Barton purchased equipment for sixty-two thousand dollars cash. The equipment has an estimated useful life of five years and an estimated salvage value of two thousand dollars. Can you determine the annual depreciation expense for 2009?
Part II
How did you do? The numerator of the equation is sixty thousand dollars, cost less salvage value, and the denominator is 5, so our annual depreciation expense is twelve thousand dollars. Now, let’s record the adjusting journal entry.
2015
Depreciation
Expense =
$62, $2,000 5
$12,000
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13. Accumulated depreciation is
a contra asset account.
Part I
On December 31, 2009, we will debit, or increase, depreciation expense for twelve thousand dollars and credit a new account called accumulated depreciation – (dash) -- equipment.
Part II
Accumulated depreciation is a contra asset account. A contra- account means that the amount in the account reduces the related asset account. In our case, accumulated depreciation will reduce the asset account, equipment. Because this is a new type of account, let’s look at the treatment of the contra and related asset account.
We have posted the adjusting entry to record depreciation expense. We have also shown you the balance in the equipment account. The depreciation expense account will appear on our income statement for the year ended December 31, Let’s see how we will deal with the other two accounts.
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14. P1
Depreciation
Equipment is shown net of accumulated depreciation. This amount is referred to as the asset’s net book value. $
The contra-account, accumulated depreciation, will be shown as a reduction in the cost of the asset, equipment.
Cost of a plant asset less accumulated depreciation is known as book value. So the asset, equipment, will be shown on the balance sheet at its net amount, or book value, of fifty thousand dollars.
Because the contra account appears on the balance sheet it will not be closed at the end of the period. It will be carried forward to 2010 and used to accumulate the depreciation related to the equipment.
Now let’s move on to the second category of adjusting entries, deferred revenues.
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15. Go over Ex 3-1d & e

16. Deferred Revenues
Cash received in ADVANCE of providing products or services.
(i.e. subscriptions for recipient, event tickets, gift cards)

17. NetSolutions
Trial Balance
December 31, 2015
Cash
Accounts Receivable
Supplies
Prepaid Insurance
Land
Office Equipment
Accounts Payable
Unearned Rent
Chris Clark, Capital
Chris Clark, Drawing
Fees Earned
Wages Expense
Rent Expense
Utilities Expense
Supplies Expense
Miscellaneous Expense
Three months’ rent, $360, was received on December 1. As of December 31, only $120 has been earned.

18. Unearned Rent Rent Revenue Dec. 31 120 Bal. 360 Dec. 31 120 240 7 8 910 31
Unearned Rent 23
Rent Revenue 42
Unearned Rent
Rent Revenue 23 42
Dec
Bal. 360
Dec
240

19. Unearned (Deferred) RevenuesP1
Unearned (Deferred) Revenues
Buy your season tickets for
all home basketball games NOW!
“Go Big Blue”
Cash received in advance of providing products or services.
Liability
Unadjusted
Balance
Revenue
Part I
When accounting for deferred revenues, we are faced with a transaction where cash is received in advance of providing a product or service. In other words, we have received the cash, but have done nothing to earn it. In our example, we will examine accounting for the sale of season tickets to a University’s home basketball games.
Part II
When dealing with adjustments for deferred revenues we always debit, or reduce, a liability account and credit, or increase, a revenue account. Let’s move on to our season ticket example.
Debit
Adjustment
Credit
Adjustment
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20. Unearned (Deferred) RevenuesP1
Unearned (Deferred) Revenues
On October 1, 2015, Ox University sold 1,000 season tickets to its 20 home basketball games for $100 each. Ox University makes the following entry:
Part I
On October 1, 2009, Ox University sold one thousand season tickets to its 20 home basketball games for one hundred dollars each. On the date of sale, the university made a debit, or increase, to the cash account and a credit, or increase, to a liability account called unearned revenue. We know the use of the word revenue may be a little confusing for now, but remember that the key word is unearned. The university has done nothing to earn the revenue from the sale of the tickets. Let’s post the entry to the ledger account, unearned revenue.
Part II
Remember, the unearned revenue account is a liability account and will remain a liability until the University provides basketball games for the season ticket holders. Now, let’s look at the adjusting entry the University will make on December 31, 2009, the end of the accounting period.
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21. Unearned (Deferred) RevenuesP1
Unearned (Deferred) Revenues
On December 31, Ox University has played 10 of its regular home games, winning 2 and losing 8.
Part I
As of December 31, 2009, the University had played ten home games and compiled a record of two wins and eight losses. Let’s make the adjusting entry.
Part II
The adjusting entry is to debit, or decrease, the liability account, unearned revenue and credit, or increase, the revenue account basketball revenue for fifty thousand dollars. The team has played one-half of its home games so one-half of the unearned revenue has now been earned. Let’s post the adjusting entry so we can look at the balances in the ledger account.
Part III
The unearned revenue account has a credit balance of fifty thousand dollars. This money will be recognized as more home games are played. The basketball revenue account has a credit balance of fifty thousand dollars. The revenue account will appear on the income statement and be closed at the end of the accounting period. The liability account, unearned revenue, will appear on the balance sheet on December 31, 2009.
Now let’s change the subject and look at adjustments for accrued expenses.
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22. Go over Ex 3-1a

23. Accrued Expenses Costs incurred that are UNPAID & UNRECORDED.
(i.e. Salaries/Wages, Interest, Rent and Taxes)

24. want to be paid for our work!
Accrued Expenses
We’re about one-half
done with this job and
want to be paid for our work!
Costs incurred in a period that are
both unpaid and unrecorded.
Expense
Liability
Credit
Adjustment
Debit
Part I
An accrued expense is defined as a cost incurred in the current period that is both unpaid and unrecorded. When you use your credit card, often you do not record the transaction until you pay your monthly invoice; even though you have incurred the cost.
Part II
For all accrued expense adjusting entries, we debit, or increase an expense account, and credit, or increase, a liability account. Let’s look at a specific example of an accrued expense.
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25. P1
Accrued Expenses
Barton, Inc. pays its employees every Friday. Year-end, 12/31/15, falls on a Wednesday. As of 12/31/15, the employees have earned salaries of $47,250 for Monday through Wednesday.
12/1/15
12/31/15
Year end
Last pay
date
12/26/15
Next pay
Record adjusting
journal entry.
Part I
Barton, Inc. pays its employees every Friday. The current year end, December 31, 2009, falls on a Wednesday. As of December 31, 2009, the employees have earned salaries of forty-seven thousand, two hundred fifty dollars that will not be paid until the following Friday, January 2, 2010.
Part II
Here is a schematic of the dates. We need to record an adjusting entry on December 31, 2009, to recognize the salaries earned by employees but not paid. Let’s look at the adjusting entry.
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26. P1
Accrued Expenses
Barton, Inc. pays its employees every Friday. Year-end, 12/31/15, falls on a Wednesday. As of 12/31/15, the employees have earned salaries of $47,250 for Monday through Wednesday.
Part I
In our adjusting journal entry we will debit, or increase, salaries expense and credit, or increase, salaries payable. After the adjustment, salaries expense for 2009 is stated properly. Let’s look at the posting to the ledger accounts.
Part II
Salaries expense recorded during the year amounted to six-hundred, fifty-seven thousand, five hundred dollars. After posting our adjusting entry, the new balance at the end of the year is seven hundred, four thousand, seven hundred fifty dollars. The salaries payable account will be eliminated when the employees are paid on January 2, Now let’s move on and look at accrued revenue.
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27. Go over Ex 3-1b, c & g

28. Revenues earned that are UNPAID & UNRECORDED. (i.e. Unbilled Fees)
Accrued Revenues
Revenues earned that are UNPAID & UNRECORDED.
(i.e. Unbilled Fees)

29. P1
Accrued Revenues
Smith & Jones, CPAs, had $31,200 of work completed but not yet billed to clients. Let’s make the adjusting entry necessary on December 31, 2015, the end of the company’s fiscal year.
The term accrued revenues refers to revenues earned in a period that are both unrecorded and not yet received.
Part I
This adjusting entry is needed because many firms have delivered a product or provided a service but have not recorded the revenue in the current period. You can see our example of an accountant who prepared a tax return for a client but has yet to send that client a bill for the service. The accountant has earned the revenue, but has not recorded it at year-end.
Part II
In adjusting entries, to record accrued revenue, we will always debit, or increase, an asset account and credit, or increase, a revenue account. Let’s look at a specific example.
In our example, Smith and Jones, CPAs, have completed work amounting to thirty one thousand, two hundred dollars at the end of the year but have not billed this amount to specific clients. Let’s look at the necessary adjusting entry.
The company will debit, or increase, the asset, accounts receivable, and credit, or increase, the revenue account, service revenue for the thirty one thousand, two hundred dollars. Let’s look at the adjusted account balances.
Part III
Notice that the accounts receivable and service revenue accounts have been updated to include the earned but unbilled amount of services provided. On the next slide we have prepared a summary of the adjusting process.
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30. Links to Financial Statements
This summary will prove very useful when completing your homework or studying for the next exam. Here is how we read the table. Before we record a prepaid expense, the assets of the company are overstated and the expenses are understated in the current period. The proper adjusting entry is to debit, or increase, an expense account and credit, or decrease, an asset account.
Take a few minutes to go over the remaining three types of adjusting entries before going to the next slide where we will use a spreadsheet to prepare the adjusting entries and financial statements.
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31. Go over Ex 3-1f

32. FastForward - Trial Balance - December 31, 2015P2
FastForward - Trial Balance - December 31, 2015 $
First, the initial unadjusted amounts are added to the work sheet.
We prepared this work sheet using Excel but you could use any electronic spreadsheet. We begin with the unadjusted trial balance, that is, the trial balance before we make our adjusting entries. On the next slide, we will post our adjusting entries for FastForward.
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33. Next, FastForward’s adjustments are added.P2
FastForward - Recording Adjustments
Trial Balance - December 31, 2015
Next, FastForward’s adjustments are added.
Look at adjusting journal entry c. This is the entry to record depreciation expense for the period ended December 31, We debit, or increase, depreciation expense and credit, or increase, accumulated depreciation – equipment. Do you recall this type of adjusting entry from our previous discussion? The total debits and credits are equal on the unadjusted trial balance and on the adjustments set of columns. Let’s move on to the adjusted trial balance.
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34. Finally, the amts are totaled across.P2
FastForward – Computing the Adjusted Trial Balance - December 31, 2015
The adjusted trial balance combines the unadjusted trial balance account balances with the adjustments we make. Be careful when doing the arithmetic. For example, look at entry b. It is the entry to adjust the supplies account for the physical inventory taken at year end. The supplies account on the unadjusted trial balance is nine thousand, seven hundred twenty dollars. Our adjustment reduced the supplies on hand, so the adjusted trial balance account is eight thousand, six hundred seventy dollars.
Once we have completed the work sheet, we can move on to the preparation of the company’s financial statements. We always begin with the income statement.
Finally, the amts are totaled across.
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35. Prepare the Income Statement
You can see how we took the information directly from the work sheet and prepared the income statement for the month ended December 31, The income statement includes only the revenue and expense accounts. Net income reported by FastForward for the month is three thousand, seven hundred eighty-five dollars. We will see this amount again on the statement of retained earnings.
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36. Prepare Statement of Retained Earnings
The statement of retained earnings adds net income to the beginning balance in the account and subtracts dividends paid of six hundred dollars. This item is needed to carry over to the balance sheet. That’s why the statement of retained earnings is prepared second. Now let’s prepare the balance sheet for FastForward.
Note: Net Income from the Income Statement carries to the Statement of Retained Earnings.
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37. Prepare Balance Sheet P3
Our third financial statement that we prepare is the balance sheet. We find all the asset and liability accounts on the worksheet and put them into proper form for the balance sheet. In addition, we bring forward the retained earnings balance that we calculated previously on the statement of retained earnings. The books are in balance because total assets are equal to total liabilities plus owner’s equity. Now, we have completed the adjusting process leading to the preparation of the financial statements of FastForward.
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38. The Closing Process: Temporary and Permanent Accounts
Temporary (nominal) accounts accumulate data related to one accounting period. They include all income statement accounts, the dividends account, and the Income Summary account. These accounts are “closed” at the end of the period to get ready for the next accounting period.
Once the formal financial statements have been prepared, we may begin the process of closing the books and getting ready for the next accounting period.
Income is earned over a period of time. At the end of the time period, we start over and calculate income for the next period. The closing process’ goal is to reset all revenue, expense and dividends accounts to a zero balance at the end of the period. By doing this, we can start the next accounting period fresh.
We will use a temporary account called income summary to facilitate the closing process. The account will never appear on any financial statement and will have a zero balance when the closing process is complete. All accounts that will be closed are known as temporary accounts. Temporary accounts include revenues, expenses, dividends, and the income summary. These accounts should all have a zero balance at the end of the period.
Permanent accounts include assets, liabilities and owner’s equity. These accounts are permanent in nature because they are carried forward from one accounting period to the next.
Permanent (real) accounts report activities related to one or more future accounting periods. They carry ending balances to the next accounting period and are not “closed.”
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39. The Closing Process
Closing entries clear revenue, expense & dividend accounts to a zero balance. They allow to you to close out a fiscal year and start the new year with no balances in those accounts.
Personal example: If someone asked you how much you made in 2014, what would your response be? What if that same person asked you how much you’ve made in 2015, would your answer be the same?

40. The Closing Process
Closing entries are made to revenue and expense accounts. They are also used to update an owner’s capital account.
Closing entries are NOT made to asset, liability and capital accounts.
Personal example: If someone asked you how much you had in your bank account on Dec 31st, would you answer be any different if that same person asked you on January 1st?

41. 2 1 3 4 The Closing Process Income Summary
Expenses are transferred to Income Summary 1
Revenues are transferred to Income Summary 3
Net Income or Net Loss is transferred to Owner’s Capital
OWNER’S CAPITAL 4
Drawings are transferred to Owner’s Capital

42. Adjusting and Closing Entries
Income Summary 2
Expenses are transferred to Income Summary 1
Revenues are transferred to Income Summary
The Income Summary account does not appear on the financial statements. 3
Net Income or Net Loss is transferred to Owner’s Capital
OWNER’S CAPITAL 4
Drawings are transferred to Owner’s Capital

43. Closing Steps
Close the Revenue accounts into the Income Summary.
Close the Expense accounts in the Income Summary.
Close the Income Summary accounts to the Capital Account as either a net income or net loss.
Close the Dividends account into the Capital account.
R E I D

44. Recording Closing EntriesP4
Recording Closing Entries
Salaries Expenses
Consulting Revenues
$ 18,100
Examine the accounts presented.
$ 25,000
Income Summary
Retained Earnings
To illustrate the closing process we will assume that the company has only one expense account and only one revenue account. The beginning credit balance in retained earnings is seven thousand dollars, and dividends of two thousand dollars have been paid.
The first step in the closing process is to transfer all revenues to the income summary account. Let’s do this now.
$ 7,000
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45. Recording Closing EntriesP4
Recording Closing Entries
Salaries Expenses
Consulting Revenues
$ 18,100
$ 25,000
$ 25,000
Income Summary
Close revenues with a debit to the revenue account and a credit to Income Summary.
You can see that the closing entry requires a debit to the revenue account. The revenue account now has a zero balance. The credit portion of the entry is made to income summary. Revenues have been transferred from the revenue account to the income summary.
The next step is to close all expense accounts.
Let’s get started with that entry.
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46. Recording Closing EntriesP4
Recording Closing Entries
Salaries Expenses
Consulting Revenues
$ 18,100
$ 18,100
$ 25,000
$ 25,000
Close expense accounts with a credit to expenses and a debit to Income Summary.
Income Summary
We close the expense account with a credit to that account and a debit to the income summary. The expense account now has a zero balance and the expenses appear on the debit side of the income summary. We know the company had net income because revenues are greater than expenses.
Notice that all revenue and expense accounts now have a zero balance so we accomplished part of our goal.
$ 25,000
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47. Recording Closing EntriesP4
Recording Closing Entries
Salaries Expenses
Consulting Revenues
$ 18,100
$ 18,100
$ 25,000
$ 25,000
Income Summary
Determine the balance in the Income Summary account.
Net income for the period is sixty-nine hundred dollars. This balance must be transferred to the retained earnings account.
$ 18,100
$ 25,000
$ 6,900
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48. Recording Closing EntriesP4
Recording Closing Entries
Salaries Expenses
Close the Income Summary to Retained Earnings.
$ 18,100
$ 18,100
Income Summary
Retained Earnings
We debit the income summary for sixty-nine hundred dollars and credit retained earnings for the same amount. The balance in the income summary account is now zero.
Our last closing entry involves dividends.
$ 18,100
$ 25,000
$ 7,000
$ 6,900
$ 6,900
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49. Recording Closing EntriesP4
Recording Closing Entries
The dividends account is closed to Retained Earnings.
Retained Earnings
Dividends
$ 2,000
$ 2,000
$ 7,000
6,900
We close the dividends account with a credit and debit the retained earnings for two thousand dollars. The balance in the dividends account is zero. Let’s determine the balance in retained earnings after all closing entries have been made.
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50. Recording Closing EntriesP4
Recording Closing Entries
The dividends account is closed to Retained Earnings.
Dividends
Retained Earnings
$ 2,000
$ 2,000
$ 2,000
$ 7,000
6,900
Retained earnings has a balance of eleven thousand, nine hundred dollars. We arrive at this amount by adding together the beginning balance in the account and net income for the period, and subtracting dividends paid. We have now finished the closing process and we are ready to start the next accounting period.
$ 11,900
Determine the ending balance in Retained Earnings.
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51. Go over Ex 3-6

52. Post Closing Trial Balance
Trial Balance prepared after the closing entries have been posted.
The purpose is to insure that all nominal or temporary accounts have been closed.
The only accounts on this trial balance should be assets, liabilities, and equity accounts.
After the closing entries have been posted, then the next step is to prepare the post closing, or “after-closing,” trial balance. The purpose of this trial balance is to insure that all the nominal accounts have been closed out. The only accounts that should appear on this trial balance should be the permanent, or real accounts. These would include asset, liability, and equity accounts. Of course, the purpose of any trial balance is to insure that debits equal credits. This is one more feature that insures that the closing process has been successfully completed.
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53. Classified Balance Sheet
Current items are those expected to come due (either collected or owed) within one year or the company’s operating cycle, whichever is longer.
A classified balance sheet is the most popular format used by business. On the asset side of the balance sheet, we group assets as current or noncurrent. A current asset is one that is expected to be converted into cash in one year or the company’s normal operating cycle, whichever is longer.
The operating cycle of a service company is the time it takes to acquire resources devoted to providing a service, plus the time it takes to provide that service, and finally, the time it takes to collect the cash from that service provider. For many companies the operating cycle is less than one year. These companies would classify an asset as current as long as that asset is expected to be converted into cash within one year.
Current assets normally include cash, short-term investments, accounts receivable, merchandise inventory, office supplies, and prepaid expenses.
Short-term investments are expected to be sold within one year or the normal operating cycle, whichever is longer.
Merchandise inventory contains inventory items we expect to sell to customers in the normal course of business. For a service business, like an attorney, we would not expect to find a merchandise inventory account.
The next major section of the classified balance sheet includes long-term investments, meaning those we expect to hold for more than one year. Some common long-term investments includes notes receivable, investments in the stock or bonds of another company, and land that a company is holding for a future plant site. Companies often purchase stock of another company in order to control or own the other company.
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54. Classified Balance Sheet
Plant Assets
Plant assets are tangible assets that are both long lived and used to produce or sell products or services. Examples include equipment, machinery, buildings, and land that are used to produce or sell products and services.
Intangible Assets
The third section of the classified balance sheet shows our property, plant and equipment. This section includes productive assets of the company along with any land containing structures such as buildings.
Productive assets include machinery, equipment, furniture and fixtures, and buildings. Productive assets are normally depreciated over their useful life.
The cost of the asset less any accumulated depreciation is called book value.
We do not depreciate land.
The final category of assets on the classified balance sheet include intangible assets. Intangibles include long-term resources that lack physical form -- accounts like patents, copyrights, trademarks, and goodwill. In general, it is very difficult to properly value intangible assets.
In summary, we have current assets, and noncurrent assets that are divided among long-term investments, plant assets, and intangible assets.
Long-term resources that benefit business operations. They usually lack physical form and have uncertain benefits. Examples include patents, trademarks, copyrights, franchises, and goodwill.
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55. Current Liabilities Long Term Liabilities
Obligations due to be paid or settled within one year or the operating cycle, whichever is longer.
Long Term Liabilities
Obligations not due within one year or the operating cycle, whichever is longer.
Current liabilities normally include accounts payable, wages payable, short-term notes payable, and the current portion of long-term liabilities. Other examples of current liabilities are interest payable and unearned revenues.
Long-term liabilities include long-term notes payable (net of current amounts due), mortgages payable, and bonds payable.
We will look at the accounting for long-term liabilities later in the text.
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56. Classified Balance Sheet
Let’s take a look at how these accounts would appear on a balance sheet. A classified Balance Sheet separates the assets into current and long term assets. It also separates the liabilities into current and long-term liabilities. When the data is presented in a classified format, it makes the calculation of key ratios easier.
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57. Go over Prob 3-5

58. A2
Profit Margin
The profit margin ratio measures the company’s net income to net sales.
Profit
Margin
Net Income
Net Sales =
Profit margin is an important measure in business. It tells us about the relationship between sales and profits or net income. We calculate the ratio by dividing net income for the period by sales revenue. A high profit margin is an indicator of future growth.
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59. A3
Current Ratio
This ratio is an important measure of a company’s ability to pay its short-term obligations; it helps a lender decide on the interest rate, due date and collateral requirements for a potential borrower. The higher the number the better.
Current
ratio
Current assets
Current liabilities =
The current ratio of a company gives us a good indication of the company’s ability to pay its debts when they fall due. The current ratio is calculated by dividing current assets by current liabilities.
Let’s look at a quick example.
Suppose we have a company that has two hundred thousand dollars in current assets and one hundred thousand dollars in current liabilities. The current ratio is two to one, that is, two hundred thousand divided by one hundred thousand. A two to one current ratio means that for each dollar of current liabilities falling due in the next year, we expect to have two dollars of current assets to pay the liabilities.
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