Completing the Accounting Cycle

1. 4 Completing the Accounting Cycle

2. 0 After studying this chapter, you should be able to: • Describe the flow of accounting information from the unadjusted trial balance into the adjusted trial balance and financial statements. • Prepare financial statements from adjusted account balances. • Prepare closing entries.

3. 0 After studying this chapter, you should be able to: • Describe the accounting cycle. • Illustrate the accounting cycle for one period. • Explain what is meant by the fiscal year and the natural business year. 3

4. 0 4-1 Objective 1 Describe the flow of accounting information from the unadjusted trial balance into the adjusted trial balance and financial statements.

5. 0 4-1 5

6. 0 4-1 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. 6

7. 0 4-1 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. 7

8. 0 4-1 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. 8

9. 0 4-1 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. 9

10. 0 4-1 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. 10

11. Example Exercise 4-1 0 4-1 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 11

12. Follow My Example 4-1 0 4-1 • Balance Sheet column • Income Statement column • Balance Sheet column • Balance Sheet column • Income Statement column • Balance Sheet column • Income Statement column • Balance Sheet column For Practice: PE 4-1A, PE 4-1B 12

13. 0 4-2 Objective 2 Prepare financial statements from adjusted account balances.

14. 0 4-2 To balance sheet 14

15. 0 4-2 (Concluded) From statement of owner’ equity 15

16. Example Exercise 4-2 0 4-2 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? 16

17. 0 4-2 Follow My Example 4-2 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. For Practice: PE 4-2A, PE 4-2B 17

18. Example Exercise 4-3 0 4-2 Zack Gaddis owns and operates Gaddis Employment Services. On January 1, 2007, 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, 2007. 18

19. 0 4-2 Follow My Example 4-3 Gaddis Employment Services Statement of Owner’s Equity For the Year Ended December 31, 2007 Zack Gaddis, capital, January 1, 2007 $186,000 Additional investment during 2007 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, 2007 $219,750 For Practice: PE 4-3A, PE 4-3B 19

20. 0 4-2 A classified balance sheet is a balance sheet that was expanded by adding subsections for current assets; property, plant, and equipment; and current liabilities.

21. 0 4-2 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

22. 0 4-2 Notes receivable are written promises by the customer to pay the amount of the note and possibly interest at an agreed rate.

23. 0 4-2 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

24. 0 4-2 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

25. 0 4-2 Liabilities not due for a long time (usually more than one year) are long-term liabilities. • Notes payable • Mortgage payable • Bond payable

26. 0 4-2 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.

27. Example Exercise 4-4 0 4-2 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, 2007 balance sheet of Hindsight Consulting. • Jason Corbin, Capital 5. Cash • Notes Receivable (due 6. Unearned Rent • in 6 months) months) • Notes Payable (due in 7. Accumulated Depr.— • 2009) Equipment • 4. Land 8. Accounts Payable 27

28. 0 4-2 Follow My Example 4-4 • Owner’s equity 5. Current asset • Current asset 6. Current liability • Long-term liability 7. Property, plant, and equipment • Property, plant, and equip. 8. Current liability For Practice: PE 4-4A, PE 4-4B 28

29. 0 4-3 Objective 3 Prepare closing entries.

30. 0 4-3 Accounts that are relatively permanent from year to year are called realaccounts. Accounts that report amounts for only one period are called temporary accounts or nominal accounts.

31. 0 4-3 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.

32. 0 4-3 The balance of 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.

33. 0 4-3 33

34. Fees Earned Bal. 16,840 0 4-3 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 34

35. Bal. 4,525 4,525 1,600 Bal. 1,600 Bal. 50 50 Bal. 985 985 Bal. 2,040 2,040 Insurance Expense 200 Bal. 200 Miscellaneous Expense 455 Bal. 455 4-3 Wages Expense Income Summary 9,855 16,960 Rent Expense Depreciation Expense Utilities Expense Step 2 Debit Income Summary for the total expenses and credit each expense account for its balance. Supplies Expense 35

36. 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 4-3 Income Summary 9,855 16,960 7,105 7,105 36

37. 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 4-3 4,000 4,000 37

38. 0 4-3 Step 1 Step 2 Step 3 Step 4 38

39. 0 4-3 After the closing entries are posted, all of the temporary accounts have zero balances.

40. Example Exercise 4-4 Example Exercise 4-5 0 4-3 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, 2007, balance sheet of Hindsight Consulting. 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. 40

41. Follow My Example 4-5 0 4-3 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 41 For Practice: PE 4-5A, PE 4-5B

42. NetSolutions Post-Closing Trial Balance December 31, 2007 Cash 2 065 00 Accounts Receivable 2 720 00 Supplies 760 00 Prepaid Insurance 2 200 00 Land 20 000 00 Office Equipment 1 800 00 Accumulated Depreciation 50 00 Accounts Payable 900 00 Wages Payable 250 00 Unearned Rent 240 00 Chris Clark, Capital 28 105 00 29 545 00 29 545 00 0 4-3 Exhibit 7 Post-Closing Trial Balance 42

43. 0 4-4 Objective 4 Describe the accounting cycle.

44. 0 4-4 The accounting process that begins with analyzing and journalizing transactions and ends with preparing the accounting records for the next period’s transactions is called the accounting cycle. There are ten steps in the accounting cycle.

45. 0 4-4 The Accounting Cycle • Transactions are analyzed and recorded in the journal. • Transactions are posted to the ledger. • An unadjusted trial balance is prepared. • Adjustment data are assembled and analyzed. • An optional end-of-period spreadsheet (work sheet) is prepared. Continued

46. 0 4-4 • Adjusting entries are journalized and posted to the ledger. • An adjusted trial balance is prepared. • Financial statements are prepared. • Closing entries are journalized and posted to the ledger. • A post-closing trial balance is prepared.

47. Example Exercise 4-4 Example Exercise 4-6 0 4-4 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, 2007, balance sheet of Hindsight Consulting. From the following list of steps in the accounting cycle, identify what two steps are missing. • Transactions are analyzed and recorded in the journal. • Transactions are posted to the ledger. • Adjustment data are assembled and analyzed. • An optional end-of-period spreadsheet (work sheet) is prepared. • Adjusting entries are journalized and posted to the ledger. • Financial statements are prepared. • Closing entries are journalized and posted to the ledger. • A post-closing trial balance is prepared. 21 47

48. Follow My Example 4-6 0 4-4 The following two steps are missing: (1) the preparation of an unadjusted trial balance and (2) the preparation of the adjusted trial balance. The unadjusted trial balance should be prepared after step (b). The adjusted trial balance should be prepared after step (e). 48 For Practice: PE 4-6A, PE 4-6B

49. 0 4-5 Objective 5 Illustrate the accounting cycle for one period. Refer to the textbook for this extended illustration.

50. 0 4-6 Objective 6 Explain what is meant by the fiscal year and the natural business year.