Completing the Accounting Cycle Chapter 4 HORNGREN HARRISON

Completing the Accounting Cycle Chapter 4 HORNGREN ♦ HARRISON ♦ BAMBER ♦ BEST ♦ FRASER ♦ WILLETT

Objectives 1. Prepare an accounting work sheet. 2. Use the work sheet to complete the accounting cycle. 3. Close the revenue, expense and drawings accounts. 4. Classify assets and liabilities as current or non-current. 5. Use the current and debt ratios to evaluate a business’s ability to pay its debts Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 4 -2

Objective 1 Prepare an accounting work sheet. Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 4 -3

The Accounting Cycle l The accounting cycle is the process by which accountants prepare financial statements for an entity for a specific period of time. Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 4 -4

The Accounting Cycle For a new business, begin by setting up ledger accounts. . l For an established business, begin with account balances carried over from the previous period. l Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 4 -5

The Accounting Cycle Accounts Receivable 1, 350 Accounts Receivable 1, 700 Service Revenue 1, 700 Accounts Receivable 1, 350 1, 700 3, 050 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 4 -6

The Accounting Cycle Work Sheet 12, 100 Cash Accounts receivable 3, 050 Statement of Financial Position Statement of Financial Performance Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 4 -7

The Accounting Cycle Adjusting entries Cash 12, 100 Closing entries Accounts Receivable 3, 050 Postclosing Trial Balance Cash 12, 100 Accounts receivable 3, 050 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 4 -8

The Accounting Work Sheet What is the work sheet? l A work sheet is a multi-columned document used by accountants to help move data from the trial balance to the financial statements. l It is an internal document. l Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 4 -9

The Accounting Work Sheet Trial Balance Dr. Cr. 12, 100 1, 350 250 15, 500 7, 500 1, 200 1, 100 1, 500 7, 200 1, 000 23, 700 12, 000 Account Title Cash Accounts receivable Supplies Equipment Accum. depreciation Accounts payable Salary payable Unearned revenue Capital Drawings Revenue Salary expense Supplies expense Depreciation expense Totals 42, 200 Adjustments Dr. Cr. Adjusted Trial Balance Dr. Cr. Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 4 - 10

The Accounting Work Sheet a The company has earned revenue of $1, 700 which will be collected next month. b Inventory of supplies at month end totaled $150. c Depreciation for the period was calculated as $200. Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 4 - 11

The Accounting Work Sheet Trial Balance Adjustments Account Title Dr. Cr. Cash 12, 100 Accounts receivable a) 1, 700 1, 350 Supplies b) 100 250 Equipment 15, 500 Accum. depreciation 7, 500 c) 200 Accounts payable 1, 200 Salary payable 1, 100 Unearned revenue 1, 500 Capital 7, 200 Drawings 1, 000 Revenue 23, 700 a) 1, 700 Salary expense 12, 000 Supplies expense b) 100 Depreciation expense c) 200 Totals 2, 000 42, 200 Adjusted Trial Balance Dr. Cr. 12, 100 3, 050 15, 500 7, 700 1, 200 1, 100 1, 500 7, 200 1, 000 25, 400 12, 000 100 200 44, 100 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 4 - 12

The Accounting Work Sheet Adjusted Trial Balance Account Title Dr. Cash 12, 100 Accounts receivable 3, 050 Supplies 150 Equipment 15, 500 Accum. depreciation 7, 700 Accounts payable 1, 200 Salary payable 1, 100 Unearned revenue 1, 500 Capital 7, 200 Drawings 1, 000 Revenue 25, 400 Salary expense 12, 000 Supplies expense 100 Depreciation expense 200 Totals 44, 100 Income Statement Dr. Cr. Balance Sheet Dr. Cr. 12, 100 3, 050 15, 500 7, 700 1, 200 1, 100 1, 500 7, 200 1, 000 31, 800 18, 700 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 4 - 13

The Accounting Work Sheet Adjusted Trial Balance Account Title Dr. Cash 12, 100 Accounts receivable 3, 050 Supplies 150 Equipment 15, 500 Accum. depreciation 7, 700 Accounts payable 1, 200 Salary payable 1, 100 Unearned revenue 1, 500 Capital 7, 200 Drawings 1, 000 Revenue 25, 400 Salary expense 12, 000 Supplies expense 100 Depreciation expense 200 Totals 44, 100 Income Statement Dr. Cr. 12, 000 100 200 12, 300 25, 400 Balance Sheet Dr. Cr. 12, 100 3, 050 15, 500 7, 700 1, 200 1, 100 1, 500 7, 200 1, 000 31, 800 18, 700 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 4 - 14

The Accounting Work Sheet Adjusted Trial Balance Account Title Dr. Cash 12, 100 Accounts receivable 3, 050 Supplies 150 Equipment 15, 500 Accum. depreciation 7, 700 Accounts payable 1, 200 Salary payable 1, 100 Unearned revenue 1, 500 Capital 7, 200 Drawings 1, 000 Revenue 25, 400 Salary expense 12, 000 Supplies expense 100 Depreciation expense 200 Totals 44, 100 Net profit Income Statement Dr. Cr. 12, 000 100 200 12, 300 13, 100 25, 400 Balance Sheet Dr. Cr. 12, 100 3, 050 15, 500 7, 700 1, 200 1, 100 1, 500 7, 200 1, 000 31, 800 18, 700 13, 100 31, 800 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 4 - 15

Objective 2 Use the work sheet to complete the accounting cycle. Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 4 - 16

Recording the Adjusting Entries The work sheet helps identify the accounts that need adjustments. Actual adjustment of the accounts requires journalising and posting the entries. Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 4 - 17

Recording the Adjusting Entries The adjusting entries may be recorded in the journal when they are entered on the work sheet. l Many accountants journalise and post the adjusting entries just before they make the closing entries. l Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 4 - 18

Objective 3 Close the revenue, expense, and drawings accounts. Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 4 - 19

Closing the Accounts l Closing the accounts is the end of period process that prepares the accounts for recording transactions during the next period. Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 4 - 20

Closing the Accounts Closing Entries Revenues increase Owner’s Equity. Expenses and Drawings decrease Owner’s Equity. Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 4 - 21

Closing the Accounts Revenues and Expense accounts are closed to Profit and Loss Summary. l Profit and Loss Summary is closed to Capital. l Drawings are closed to Capital. l In a company, Dividends are closed to Retained Profits. l Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 4 - 22

Closing the Accounts Profit and Loss Summary A debit balance represents net loss. A credit balance represents net profit. Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 4 - 23

Closing the Accounts Revenue 28, 500 12, 000 7, 500 9, 000 Salary Exp 1, 500 3, 300 1, 800 Rent Exp 800 Supplies Exp 350 (Close Revenue Account) (Close Expense Accounts) (Close Drawings Account) P&L Summary 4, 450 28, 500 24, 050 (Close P & L Summary) Capital Account 2, 500 24, 050 Drawings 2, 500 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 4 - 24

Post-closing Trial Balance The accounting cycle ends with the postclosing trial balance. l The postclosing trial balance is dated as of the end of the period for which the statements have been prepared. l Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 4 - 25

Permanent Accounts What accounts never close? – Assets – Liabilities – Owner’s equity l Balances of permanent accounts carry over to the next period. l Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 4 - 26

Objective 4 Classify assets and liabilities as current or non-current. Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 4 - 27

Liquidity This is a measure of how quickly an item can be converted into cash. l On the statement of financial position, assets and liabilities are classified as either current or non-current to indicate their relative liquidity. l Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 4 - 28

Current Assets Current assets are cash, or will be converted to cash, in one year (or within the normal business operating cycle). l What are some other examples? – short-term receivables – inventory – prepaid expenses l Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 4 - 29

Current Liabilities Current liabilities are debts or obligations due within one year or within the operating cycle. l What are some examples? – accounts and salary payables – short-term bills payable – unearned revenue l Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 4 - 30

Non-current Assets and Liabilities Non-current assets include all other assets. – property, equipment, and intangibles l Non-current liabilities are all other debts due in longer than one year (or the entity’s operating cycle). l Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 4 - 31

The Classified Statement of Financial Position Debit side Current assets Non-current assets Credit side Current liabilities Non-current liabilities Listed in the order of decreasing liquidity Listed in the order of how soon they must be paid Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 4 - 32

The Classified Statement of Financial Position XYZ Services June 30, 2005 Assets Current assets: Cash 12, 100 Accounts receivable 3, 050 Supplies 150 Total current assets 15, 300 Non-current assets Equipment 15, 500 Less Accum. deprec. 7, 700 7, 800 Total assets 23, 100 Liabilities Current liabilities: Accounts payable Salary payable Unearned revenue Total liabilities Owner’s equity Capital 19, 300 Total liabilities and owner’s equity 23, 100 1, 200 1, 100 1, 500 3, 800 See exhibit 4 -12 (MYOB) page 151 of the textbook Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 4 - 33

Different Formats of Statements of Financial Position Report Format Assets = Liabilities + Owner’s Equity Account Format Assets = Liabilities + Owner’s Equity Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 4 - 34

Objective 5 Use the current and debt ratios to evaluate a business’s ability to pay its debts. Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 4 - 35

Comparative Financial Statements They enhance the user’s ability to analyse a company’s past performance. l What are two common ratios used to measure liquidity? 1 Current ratio 2 Debt ratio l Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 4 - 36

Current Ratio l This measures the ability of a business to pay its current liabilities with its current assets. Current ratio = Current assets ÷ Current liabilities Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 4 - 37

Debt Ratio It indicates the proportion of a business’s assets that are financed with debt. l It measures their ability to pay both current and long-term debt. l Total liabilities ÷ Total assets Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 4 - 38

Trend Analysis l Decision makers compare various ratios over a period of time. Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 4 - 39

End of Chapter 4 Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4 e Copyright © 2004 Pearson Education Australia 4 - 40