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Completing the Accounting Cycle

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  1. 4 Completing the Accounting Cycle

  2. After studying this chapter, you should be able to: 4 Describe the accounting cycle. Describe the flow of accounting information from the unadjusted trial balance into the adjusted trial balance and financial statements. 1 Prepare financial statements from adjusted account balances. 2 3 Prepare closing entries. Completing the Accounting Cycle After studying this chapter, you should be able to: 4-2

  3. Illustrate the accounting cycle for one period. Explain what is meant by the fiscal year and the natural business year. 5 6 Completing the Accounting Cycle (continued) 4-3

  4. 1 Describe the flow of accounting information from the unadjusted trial balance into the adjusted trial balance and financial statements. 4-4

  5. 1 Exhibit 1 End-of-Period Spreadsheet (Work Sheet)

  6. 1 Flow of Accounting Information Spreadsheet (Work Sheet) Trial Balance Adjustments Adjusted TB Accounts Dr Cr Dr Cr Dr Cr Accounts are listed in the Trial Balance column using the ending balance found in the general ledger.

  7. 1 Flow of Accounting Information Spreadsheet (Work Sheet) Trial Balance Adjustments Adjusted TB Accounts Dr Cr Dr Cr Dr Cr Adjustments are entered here. Two possibilities: 1. Deferrals – Existing balances are changed. 2. Accruals – New information is entered.

  8. 1 Flow of Accounting Information Spreadsheet (Work Sheet) Trial Balance Adjustments Adjusted TB Accounts Dr Cr Dr Cr Dr Cr Adjustments are combined with the trial balance. Account balances are now adjusted.

  9. 1 Flow of Accounting Information Spreadsheet (Work Sheet) Adjusted TB Income State. Balance Sheet Accounts Dr Cr Dr Cr Dr Cr Revenue and expense balances in the Adjusted Trial Balance column are extended to the Income Statement column.

  10. 1 Flow of Accounting Information Spreadsheet (Work Sheet) Adjusted TB Income State. Balance Sheet Accounts Dr Cr Dr Cr Dr Cr Asset, liability, owner’s equity, and drawing balances in the Adjusted Trial Balance column are extended to the Balance Sheet column.

  11. 1 Example Exercise 4-1 Flow of Accounts into Financial Statements The balances for the accounts listed below appear in the Adjusted Trial Balance columns of the end-of-period spreadsheet (work sheet). Indicate whether each balance should be extended to (a) an Income Statement column or (b) a Balance Sheet column. • Fees Earned • Accounts Payable • Rent Revenue • Supplies • Amber Bablock, Drawing • Utilities Expense • Accumulated Depreciation—Equipment • Unearned Rent 4-11

  12. For Practice: PE 4-1A, PE 4-1B Follow My Example 4-1 1 Example Exercise 4-1 (continued) • Balance Sheet column • Income Statement column • Balance Sheet column • Balance Sheet column • Income Statement column • Balance Sheet column • Income Statement column • Balance Sheet column 4-12

  13. 2 Prepare financial statements from adjusted account balances. 4-13

  14. 2 The income statement is prepared directly from the Income Statement or Adjusted Trial Balance columns of the spreadsheet (work sheet).

  15. Exhibit 2 2 Financial Statements Prepared from Work Sheet to statement of owner’s equity

  16. 2 Example Exercise 4-2 Determining the Net Income from End-of-Period Spreadsheet In the Balance Sheet columns of the end-of-period spreadsheet (work sheet) for Dimple Consulting Co. for the current year, the Debit column total is $678,450, and the Credit column total is $599,750 before the amount of net income or net loss has been included. In preparing the income statement from the end-of-period spreadsheet (work sheet), what is the amount of net income or net loss? 4-16

  17. For Practice: PE 4-2A, PE 4-2B Follow My Example 4-2 2 Example Exercise 4-2 (continued) A net income of $78,700 ($678,450 – $599,750) would be reported. When the Debit column of the Balance Sheet columns is more than the Credit column, net income is reported. If the Credit column exceeds the Debit column, a net loss is reported. 4-17

  18. 2 The first item presented on the statement of owner’s equity is the balance of the owner’s capital account at the beginning of the period.

  19. Exhibit 2 2 Financial Statements Prepared from Work Sheet (continued) from the income statement to the balance sheet

  20. 2 Example Exercise 4-3 Statement of Owner’s Equity Zack Gaddis owns and operates Gaddis Employment Services. On January 1, 2009, Zack Gaddis, Capital had a balance of $186,000. During the year, Zack invested an additional $40,000 and withdrew $25,000. For the year ended December 31, 2007, Gaddis Employment Services reported a net income of $18,750. Prepare a statement of owner’s equity for the year ended December 31, 2009. 4-20

  21. GADDIS EMPLOYMENT SERVICES STATEMENT OF OWNER’S EQUITY For the Year Ended December 31, 2009 Follow My Example 4-3 For Practice: PE 4-3A, PE 4-3B 2 Example Exercise 4-3 (continued) Zack Gaddis, capital, January 1, 2009 $186,000 Additional investment during 2009 40,000 Total $226,000 Withdrawals $ 25,000 Less net income 18,750 Decrease in owner’s equity 6,250 Zack Gaddis, capital, December 31, 2009 $219,750 4-21

  22. 2 The balance sheet is prepared directly from the Balance Sheet or Adjusted Trial Balance columns of the spreadsheet (or worksheet).

  23. 2 A classified balance sheet is a balance sheet that was expanded by adding subsections for current assets; property, plant, and equipment; and current liabilities.

  24. 2 Cash and other assets that are expected to be converted into cash, sold or used up usually within a year or less, through the normal operations of the business, are called current assets. • Cash • Accounts Receivable • Supplies

  25. 2 Notes receivable are written promises by the customer to pay the amount of the note and possibly interest at an agreed rate.

  26. 2 Property, plant, and equipment (also called fixed assets) include assets that depreciate over a period of time. Land is an exception as it is not subject to depreciation. • Equipment • Machinery • Buildings • Land

  27. 2 Liabilities that will be due within a short time (usually one year or less) and that are to be paid out of current assets are called current liabilities. • Accounts payable • Wages payable • Interest payable • Unearned fees

  28. 2 Liabilities not due for a long time (usually more than one year) are long-term liabilities. • Notes payable • Mortgage payable • Bond payable

  29. 2 Owner’s equity is the owner’s right to the assets of the business. Owner’s equity is added to the total liabilities, and the total must be equal to the total assets.

  30. Exhibit 2 2 Financial Statements Prepared from Work Sheet (continued) from the statement of owner’s equity

  31. 2 Example Exercise 4-4 Classified Balance Sheet The following accounts appear in the adjusted trial balance of Hindsight Consulting. Indicate whether each account would be reported in the (a) current asset; (b) property, plant, and equipment; (c) current liability, (d) long-term liability; or (e) owner’s equity section of the December 31, 2009 balance sheet of Hindsight Consulting. • Jason Corbin, Capital 5. Cash • Notes Receivable (due 6. Unearned Rent • in 6 months) 7. Accumulated Depr.— • 3. Notes Payable (due in Equipment • 2011) 8. Accounts Payable • 4. Land 4-31

  32. For Practice: PE 4-4A, PE 4-4B Follow My Example 4-4 2 Example Exercise 4-4 (continued) Follow My Example 4-4 • Stockholders’ equity • Current asset 2. Current asset • Current liability 3. Long-term liability 7. Property, plant, and equipment 4. Property, plant, and equipment 8. Current liability 4-32

  33. 3 Prepare closing entries. 4-33 4-33

  34. 3 Closing Entries Accounts that are relatively permanent from year to year are called real accounts. Accounts that report amounts for only one period are called temporary accounts or nominal accounts.

  35. 3 Closing Entries To report amounts for only one period, temporary accounts should have zero balances at the beginning of the period. At the end of the period the revenue and expense account balances are transferred to Income Summary.

  36. 3 Closing Entries The balanceof Income Summary is then transferred to the owner’s capital account. The balance of the owner’s drawing account is also transferred to the owner’s capital account. The entries that transfer these balances are called closing entries.

  37. 3 Exhibit 3 The Closing Process

  38. Fees Earned Bal. 16,840 3 Exhibit 4 Flowchart of Closing Entries for NetSolutions Debit each revenue account for the amount of its balance, and credit Income Summary for the total revenue. Step 1: 16,840 Income Summary Step 1 16,960 Rent Revenue Bal. 120 120

  39. Bal. 4,525 4,525 Bal. 1,600 1,600 Bal. 50 50 Bal. 985 985 Bal. 2,040 2,040 Insurance Expense 200 Bal. 200 Miscellaneous Expense 455 Bal. 455 3 Flowchart of Closing Entries for NetSolutions (continued) Exhibit 4 Wages Expense Income Summary Rent Expense 9,855 16,960 Depreciation Expense Utilities Expense Step 2 Debit Income Summary for the total expenses and credit each expense account for its balance. Supplies Expense

  40. Step 3 Debit Income Summaryfor the amount of its balance (in this case, the net income) and credit the capital account. Chris Clark, Capital Bal. 25,000 Chris Clark, Drawing Bal. 4,000 3 Flowchart of Closing Entries for NetSolutions (continued) Exhibit 4 Income Summary 9,855 16,960 7,105 7,105

  41. Step 4 Debit the capital account for the balance of the drawing account, and credit drawing for the same amount. Chris Clark, Capital Bal. 25,000 7,105 Chris Clark, Drawing Bal. 4,000 3 Flowchart of Closing Entries for NetSolutions (continued) Exhibit 4 4,000 4,000

  42. 3 Flowchart of Closing Entries for NetSolutions (summary) Exhibit 4

  43. 3 Exhibit 5 Closing Entries for NetSolutions Step 1 Step 2 Step 3 Step 4

  44. 3 After the closing entries are posted, all of the temporary accounts have zero balances.

  45. 3 Exhibit 6 Ledger for NetSolutions

  46. Exhibit 6 3 Ledger for NetSolutions (continued)

  47. Exhibit 6 3 Ledger for NetSolutions (continued)

  48. Exhibit 6 3 Ledger for NetSolutions (continued)

  49. 3 Example Exercise 4-5 Closing Entries After the accounts have been adjusted at July 31, the end of the fiscal year, the following balances are taken from the ledger of Cabriolet Services Co. Terry Lambert, Capital $615,850 Terry Lambert, Drawing 25,000 Fees Earned 380,450 Wages Expense 250,000 Rent Expense 65,000 Supplies Expense 18,250 Miscellaneous Expense 6,200 Journalize the four entries required to close the accounts. 4-49

  50. Follow My Example 4-5 For Practice: PE 4-5A, PE 4-5B 3 Example Exercise 4-5 (continued) July 31 Fees Earned…………………………….. 380,450 Income Summary…………………. 380,450 31 Income Summary……………………… 339,450 Wages Expense…………………… 250,000 Rent Expense……………………… 65,000 Supplies Expense………………… 18,250 Miscellaneous Expense…………. 6,200 31 Income Summary………………………. 41,000 Terry Lambert, Capital…………… 41,000 31 Terry Lambert, Capital………………… 25,000 Terry Lambert, Drawing………….. 25,000 4-50