Chapter 4 Completing the Accounting Cycle Learning Objectives

Chapter 4 Completing the Accounting Cycle

Learning Objectives 1. Prepare the financial statements including the classified balance sheet 2. Use the worksheet to prepare financial statements 3. Explain the purpose of, journalize, and post closing entries 4. Prepare the post-closing trial balance © 2016 Pearson Education, Inc. 4 -2

Learning Objectives 5. Describe the accounting cycle 6. Use the current ratio to evaluate business performance 7. Explain the purpose of, journalize, and post reversing entries (Appendix 4 A) © 2016 Pearson Education, Inc. 4 -3

Learning Objective 1 Prepare the financial statements including the classified balance sheet © 2016

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 retained earnings: • Shows how retained earnings changed during the period – Balance sheet: • Reports assets, liabilities, and stockholders’ equity as of the last day of the period © 2016 Pearson Education, Inc. 4 -5

The financial statements are prepared from the adjusted trial balance. © 2016 Pearson Education,

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 retained earnings. – Ending Retained Earnings from the statement of retained earnings flows to the balance sheet. © 2016 Pearson Education, Inc. 4 -7

Exhibit 4 -2 Smart Touch Learning Financial Statements Net income flows to the statement of retained earnings. 4 -8

Exhibit 4 -2 Smart Touch Learning Financial Statements The net income from the income statement flows to the statement of retained earnings. The ending Retained Earnings flows to the balance sheet. 4 -9

Exhibit 4 -2 Smart Touch Learning Financial Statements The ending value of Retained Earnings from the statement of retained earnings flows to the balance sheet. 4 -10

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. © 2016 Pearson Education, Inc. 4 -11

Assets 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 The operating cycle is the time • Plant assets span during which cash is paid for goods and services, which • Intangible assets are then sold to customers, from whom the business collects cash. © 2016 Pearson Education, Inc. 4 -12

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. © 2016 Pearson Education, Inc. 4 -13

Stockholders’ Equity • Stockholders’ equity represents the stockholders’ claims to the assets of the business. – Reflects the stockholders’ contributions through common stock – Represents the amount of assets left over after the corporation has paid its liabilities © 2016 Pearson Education, Inc. 4 -14

Learning Objective 2 Use the worksheet to prepare financial statements © 2016 Pearson Education,

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) © 2016 Pearson Education, Inc. 4 -17

Learning Objective 3 Explain the purpose of, journalize, and post closing entries © 2016

What Is the Closing Process, and How Do We Close the Accounts? Temporary Accounts Permanent Accounts Revenues Assets Expenses Liabilities Dividends Equity © 2016 Pearson Education, Inc. The closing process zeros out all revenue and expense accounts in order to measure each period’s net income separately from all other periods. 4 -20

What Is the Closing Process, and How Do We Close the Accounts? • Closing entries – Transfer revenues, expenses, and Dividends to Retained Earnings • 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. © 2016 Pearson Education, Inc. 4 -21

What Is the Closing Process, and How Do We Close the Accounts? © 2016

Closing Temporary Accounts—Net Income for the Period © 2016 Pearson Education, Inc. 4 -23

Closing Temporary Accounts—Net Income for the Period © 2016 Pearson Education, Inc. 4 -24

Closing Temporary Accounts—Net Income for the Period © 2016 Pearson Education, Inc. 4 -25

Closing Temporary Accounts—Net Income for the Period © 2016 Pearson Education, Inc. 4 -26

Closing Temporary Accounts—Net Income for the Period © 2016 Pearson Education, Inc. 4 -27

Closing Temporary Accounts—Net Loss for the Period © 2016 Pearson Education, Inc. 4 -28

Learning Objective 4 Prepare the post-closing trial balance © 2016 Pearson Education, Inc. 4

How Do We Prepare a Post-Closing Trial Balance? • The accounting cycle ends with a postclosing 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 © 2016 Pearson Education, Inc. 4 -30

Learning Objective 5 Describe the accounting cycle © 2016 Pearson Education, Inc. 4 -32

What Is the Accounting Cycle? © 2016 Pearson Education, Inc. 4 -33

Learning Objective 6 Use the current ratio to evaluate business performance © 2016 Pearson

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: © 2016 Pearson Education, Inc. 4 -35

Learning Objective 7 Explain the purpose of, journalize, and post reversing entries (Appendix 4

What Are Reversing Entries? • Special journal entries that ease the burden of accounting for transactions in a later period • The opposite of adjusting entries • Not required by GAAP • Used for convenience and to save time © 2016 Pearson Education, Inc. 4 -37

Accounting for Accrued Expenses To record accrued salaries of $1, 200, Smart Touch Learning

Accounting Without a Reversing Entry To record the payment of total salaries of $2,

Accounting with a Reversing Entry A reversing entry is a special journal entry that

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. © 2016 Pearson Education, Inc. 4 -41