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Chapter 4

Chapter 4. Completing the Accounting Cycle. Financial and Managerial Accounting 8th Edition Warren Reeve Fess. Objectives. 1. Review the seven basic steps of the accounting cycle. 2. Prepare a work sheet. 3. Prepare financial statements from a work sheet.

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Chapter 4

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  1. Chapter 4 Completing the Accounting Cycle Financial and Managerial Accounting 8th Edition Warren Reeve Fess

  2. Objectives 1.Review the seven basic steps of the accounting cycle. 2.Prepare a work sheet. 3.Prepare financial statements from a work sheet. 4.Prepare adjusting and closing entries from a work sheet. 5.Explain what is meant by the fiscal year and the natural business year. 6.Analyze and interpret the financial solvency of a business by computing working capital and the current ratio.

  3. 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. 4. Financial statements are prepared. 5. Adjusting entries are journalized and posted. 6. Closing entries are journalized and posted. 7. A post-closing trial balance is prepared.

  4. Assets are commonly divided into classes and that two of these classes are current assets and property, plant, and equipment. That’s correct. Cash and other assets that are expected to be converted into cash, sold, or used up usually in less than a year are current assets.

  5. Well… besides cash, there’s notes receivable, accounts receivable, supplies, and other prepaid items. For example?

  6. There are some exceptions, but that’s basically correct. Assets such as office equipment, machinery, buildings, and land would appear under that heading. So, assets that have a life over a year are listed under property, plant, and equipment.

  7. Liabilities not due for more than a year usually are long-term liabilities. Liabilities due usually within one year or less and that are to be paid out of current assets are called current liabilities. • Mortgage note payable • Mortgage payable • Bond payable • Accounts payable • Wages payable • Interest payable • Unearned fees

  8. The work sheet is a useful device for understanding the flow of accounting data from the unadjusted trial balance to the financial statements. The Work Sheet Trial Balance Adjustments Adjusted TB Accounts Dr Cr Dr Cr Dr Cr Prepared from the general ledger. Accounts are listed in the following order: assets, liabilities, stockholders’ equity, revenues, and expenses.

  9. The 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.

  10. The 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.

  11. NetSolutions Work Sheet For the Two Months Ended December 31, 2005 Adjusted Trial Balance Adjustments Trial Balance Account Title Debit Credit Debit Credit Debit Credit 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 Cash 2,065 Accounts Receivable 2,220 Supplies 2,000 Prepaid Insurance 2,400 Land 20,000 Office Equipment 1,800 Accounts Payable 900 Unearned Rent 360 Capital Stock 25,000 Dividends 4,000 Fees Earned 16,340 Wages Expense 4,275 Rent Expense 1,600 Utilities Expense 985 Supplies Expense 800 Miscellaneous Expense 455 42,600 42,600 The Unadjusted Trial Balance

  12. (a) The Supplies account has a debit of $2,000. A count of supplies at the end of the period reveals that $760 is on hand. Therefore, $1,240 in supplies was used during the two-month period.

  13. NetSolutions Work Sheet For the Two Months Ended December 31, 2005 Adjusted Trial Balance Adjustments Trial Balance Account Title Debit Credit Debit Credit Debit Credit 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 Cash 2,065 Accounts Receivable 2,220 Supplies 2,000 Prepaid Insurance 2,400 Land 20,000 Office Equipment 1,800 Accounts Payable 900 Unearned Rent 360 Capital Stock 25,000 Dividends 4,000 Fees Earned 16,340 Wages Expense 4,275 Rent Expense 1,600 Utilities Expense 985 Supplies Expense 800 Miscellaneous Expense 455 42,600 42,600 (a) 1,240 (a) 1,240

  14. (b) The Prepaid Insurance account has a debit balance of $2,400, which represents prepayment of insurance for 24 months beginning December 1. Thus, the insurance expense for this month is $100 ($2,400 ÷ 24).

  15. NetSolutions Work Sheet For the Two Months Ended December 31, 2005 Accounts are added as needed. Adjusted Trial Balance Adjustments Trial Balance Account Title Debit Credit Debit Credit Debit Credit 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 Cash 2,065 Accounts Receivable 2,220 Supplies 2,000 (a) 1,240 Prepaid Insurance 2,400 Land 20,000 Office Equipment 1,800 Accounts Payable 900 Unearned Rent 360 Capital Stock 25,000 Dividends 4,000 Fees Earned 16,340 Wages Expense 4,275 Rent Expense 1,600 Utilities Expense 985 Supplies Expense 800 (a) 1,240 Miscellaneous Expense 455 42,600 42,600 (b) 100 Insurance Expense (b) 100

  16. FOR RENT (c) The Unearned Rent account has a credit balance of $360, which represents the receipt of three-months’ rent beginning with December 1. Thus, the rent revenue for December is $120.

  17. NetSolutions Work Sheet For the Two Months Ended December 31, 2005 Adjusted Trial Balance Adjustments Trial Balance Account Title Debit Credit Debit Credit Debit Credit 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 Cash 2,065 Accounts Receivable 2,220 Supplies 2,000 (a) 1,240 Prepaid Insurance 2,400 (b) 100 Land 20,000 Office Equipment 1,800 Accounts Payable 900 Unearned Rent 360 Capital Stock 25,000 Dividends 4,000 Fees Earned 16,340 Wages Expense 4,275 Rent Expense 1,600 Utilities Expense 985 Supplies Expense 800 (a) 1,240 Miscellaneous Expense 455 42,600 42,600 (c) 120 Insurance Expense (b) 100 Rent Revenue (c) 120

  18. Net Solutions - Work Sheet For the Two Months Ended December 31, 2005 (d) Wages accrued but not paid at the end of December total $250. Adjusted Trial Balance Adjustments Trial Balance Account Title Debit Credit Debit Credit Debit Credit 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 Cash 2,065 Accounts Receivable 2,220 Supplies 2,000 (a) 1,240 Prepaid Insurance 2,400 (b) 100 Land 20,000 Office Equipment 1,800 Accounts Payable 900 Unearned Rent 360 (c) 120 Capital Stock 25,000 Dividends 4,000 Fees Earned 16,340 Wages Expense 4,275 Rent Expense 1,600 Utilities Expense 985 Supplies Expense 800 (a) 1,240 Miscellaneous Expense 455 42,600 42,600 (d) 250 Insurance Expense (b) 100 Rent Revenue (c) 120 Wages Payable (d) 250

  19. Net Solutions - Work Sheet For the Two Months Ended December 31, 2005 (e) Fees accrued at the end of December, but not recorded, total $500. Adjusted Trial Balance Adjustments Trial Balance Account Title Debit Credit Debit Credit Debit Credit 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 Cash 2,065 Accounts Receivable 2,220 Supplies 2,000 (a) 1,240 Prepaid Insurance 2,400 (b) 100 Land 20,000 Office Equipment 1,800 Accounts Payable 900 Unearned Rent 360 (c) 120 Capital Stock 25,000 Dividends 4,000 Fees Earned 16,340 Wages Expense 4,275 (d) 250 Rent Expense 1,600 Utilities Expense 985 Supplies Expense 800 (a) 1,240 Miscellaneous Expense 455 42,600 42,600 (e) 500 (e) 500 Insurance Expense (b) 100 Rent Revenue (c) 120 Wages Payable (d) 250

  20. Net Solutions - Work Sheet For the Two Months Ended December 31, 2005 (f) Depreciation of the office equipment is $50 for December. Adjusted Trial Balance Adjustments Trial Balance Account Title Debit Credit Debit Credit Debit Credit 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 Cash 2,065 Accounts Receivable 2,220 (e) 500 Supplies 2,000 (a) 1,240 Prepaid Insurance 2,400 (b) 100 Land 20,000 Office Equipment 1,800 Accounts Payable 900 Unearned Rent 360 (c) 120 Capital Stock 25,000 Dividends 4,000 Fees Earned 16,340 (e) 500 Wages Expense 4,275 (d) 250 Rent Expense 1,600 Utilities Expense 985 Supplies Expense 800 (a) 1,240 Miscellaneous Expense 455 42,600 42,600 Insurance Expense (b) 100 Rent Revenue (c) 120 Wages Payable (d) 250 Depreciation Expense (f) 50 Accum. Depreciation (f) 50

  21. Adjusted Trial Balance Adjustments Trial Balance Account Title Debit Credit Debit Credit Debit Credit 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Cash 2,065 Accounts Receivable 2,220 (e) 500 Supplies 2,000 (a) 1,240 Prepaid Insurance 2,400 (b) 100 Land 20,000 Office Equipment 1,800 Accounts Payable 900 Unearned Rent 360 (c) 120 Capital Stock 25,000 Dividends 4,000 Fees Earned 16,340 (e) 500 Wages Expense 4,275 (d) 250 Rent Expense 1,600 Utilities Expense 985 Supplies Expense 800 (a) 1,240 Miscellaneous Expense 455 42,600 42,600 Insurance Expense (b) 100 Rent Revenue (c) 120 Wages Payable (d) 250 Depreciation Expense (f) 50 Accum. Depreciation (f) 50 2,260 2,260 Summed and ruled

  22. Adjusted Trial Balance Adjustments Trial Balance Account Title Debit Credit Debit Credit Debit Credit 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Cash 2,065 2,065 Accounts Receivable 2,220 (e) 500 2,720 Supplies 2,000 (a) 1,240 760 Prepaid Insurance 2,400 (b) 100 2,300 Land 20,000 20,000 Office Equipment 1,800 1,800 Accounts Payable 900 900 Unearned Rent 360 (c) 120 240 Capital Stock 25,000 25,000 Dividends 4,000 4,000 Fees Earned 16,340 (e) 500 16,840 Wages Expense 4,275 (d) 250 4,525 Rent Expense 1,600 1,600 Utilities Expense 985 985 Supplies Expense 800 (a) 1,240 2,040 Miscellaneous Expense 455 455 42,600 42,600 Insurance Expense (b) 100 100 Rent Revenue (c) 120 120 Wages Payable (d) 250 250 Depreciation Expense (f) 50 50 Accum. Depreciation (f) 50 50 2,260 2,260 43,400 43,400

  23. The 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.

  24. The Work Sheet Adjusted TB Income State. Balance Sheet Accounts Dr Cr Dr Cr Dr Cr Asset, liability, and stockholders’ equity balances in the Adjusted Trial Balance column are extended to the Balance Sheet column.

  25. Adjusted Trial Balance Income Statement Balance Sheet Account Title Debit Credit Debit Credit Debit Credit 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Cash 2,065 Accounts Receivable 2,720 Supplies 760 Prepaid Insurance 2,300 Land 20,000 Office Equipment 1,800 Accounts Payable 900 Unearned Rent 240 Capital Stock 25,000 Dividends 4,000 Fees Earned 16,840 Wages Expense 4,525 Rent Expense 1,600 Utilities Expense 985 Supplies Expense 2,040 Miscellaneous Expense 455 Insurance Expense 100 Rent Revenue 120 Wages Payable 250 Depreciation Expense 50 Accum. Depreciation 50 43,400 43,400

  26. Adjusted Trial Balance Income Statement Balance Sheet Account Title Debit Credit Debit Credit Debit Credit 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Cash 2,065 2,065 Accounts Receivable 2,720 2,720 Supplies 760 760 Prepaid Insurance 2,300 2,300 Land 20,000 20,000 Office Equipment 1,800 1,800 Accounts Payable 900 900 Unearned Rent 240 240 Capital Stock 25,000 25,000 Dividends 4,000 4,000 Fees Earned 16,840 16,840 Wages Expense 4,525 4,525 Rent Expense 1,600 1,600 Utilities Expense 985 985 Supplies Expense 2,040 2,040 Miscellaneous Expense 455 455 Insurance Expense 100 100 Rent Revenue 120 120 Wages Payable 250 250 Depreciation Expense 50 50 Accum. Depreciation 50 50 43,400 43,400

  27. Adjusted Trial Balance Income Statement Balance Sheet Account Title Debit Credit Debit Credit Debit Credit 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Cash 2,065 2,065 Accounts Receivable 2,720 2,720 Supplies 760 760 Prepaid Insurance 2,300 2,300 Land 20,000 20,000 Office Equipment 1,800 1,800 Accounts Payable 900 900 Unearned Rent 240 240 Capital Stock 25,000 25,000 Dividends 4,000 4,000 Fees Earned 16,840 16,840 Wages Expense 4,525 4,525 Rent Expense 1,600 1,600 Utilities Expense 985 985 Supplies Expense 2,040 2,040 Miscellaneous Expense 455 455 Insurance Expense 100 100 Rent Revenue 120 120 Wages Payable 250 250 Depreciation Expense 50 50 Accum. Depreciation 50 50 43,400 43,400 9,755 16,960 33,645 26,440

  28. The difference between the Income Statement column totals is the net income (or net loss) for the period. Net Income Net Income The difference between the Balance Sheet column totals is also the income (or net loss) for the period. Income Statement Balance Sheet 9,755 16,960 33,645 26,440 7,205 7,205 16,960 16,960 33,645 33,645

  29. NetSolutionsIncome StatementFor Two Months Ended December 31, 2005 Fees earned $16,840 Rent revenue 120 Total revenues $16,960 Expenses: Wages expense $ 4,525 Supplies expense 2,040 Rent expense 1,600 Utilities expense 985 Insurance expense 100 Depreciation expense 50 Miscellaneous expense 455 Total expenses 9,755 Net income $ 7,205 Every amount on this income statement was taken from the Income Statement column of the work sheet.

  30. NetSolutionsRetained Earnings StatementFor the Two Months Ended December 31, 2005 Net income for November and December 7,205 Less dividends 4,000 Retained earnings, December 31, 2005 $3,205 From the Balance Sheet debit column of the work sheet. Either from the income statement or from the balance sheet on the work sheet.

  31. NetSolutionsBalance SheetDecember 31, 2005 Assets Liabilities Current assets: Current liabilities: Cash $ 2,065 Accounts payable $900 Accounts receivable 2,720 Wages payable 250 Supplies 760 Unearned rent 240 Prepaid insurance 2,300 Total liabilities $ 1,390 Total current assets $ 7,845 Property, plant, and equipment: Land $20,000 Office equip. $1,800 Less accum. depreciation 50 1,750 Capital stock $25,000 Total property, plant Retained earnings 3,205 28,205 and equipment 21,750 Total liabilities and Total assets $29,595 stockholders’ equity $29,595 From the Retained Earnings Statement Stockholders’ Equity

  32. Adjusting and Closing Entries Adjusting entries are recorded in the journal at the end of the accounting period. If a work sheet has been prepared, the data for these entries are in the Adjustments columns.

  33. Expenses are transferred to Income Summary Revenues are transferred to Income Summary 2 1 3 Net Income or Net Loss is transferred to Retained Earnings 4 Dividends are transferred to Retained Earnings The Closing Process Income Summary RETAINED EARNINGS

  34. Expenses are transferred to Income Summary Revenues are transferred to Income Summary 2 1 3 Net Income or Net Loss is transferred to Retained Earnings 4 Dividends are transferred to Retained Earnings The Closing Process Income Summary The Income Summary account does not appear on the financial statements. RETAINED EARNINGS

  35. Fees Earned Wages Expense Bal. 16,840 Bal. 4,525 Rent Expense Bal. 1,600 Depreciation Expense Bal. 50 Utilities Expense Retained Earnings Bal. 985 Supplies Expense Bal. 2,040 Insurance Expense Bal. 100 Dividends Miscellaneous Expense Bal. 4,000 Bal. 455 The Closing Process Income Summary Rent Revenue Bal. 120 Note: The balances shown are adjusted balances before closing. The following sequence demonstrates the closing process.

  36. Fees Earned Wages Expense Bal. 16,840 Bal. 4,525 Rent Expense Bal. 1,600 Depreciation Expense Bal. 50 Utilities Expense Retained Earnings Bal. 985 Supplies Expense Bal. 2,040 Insurance Expense Bal. 100 Dividends Miscellaneous Expense Bal. 4,000 Bal. 455 The Closing Process 16,840 Income Summary 16,960 Rent Revenue Bal. 120 120 Step 1 Debit each revenue account for the amount of its balance, and credit Income Summary for the total revenue.

  37. Fees Earned Wages Expense Bal. 16,840 16,840 4,525 Bal. 4,525 Rent Expense Rent Revenue 1,600 Bal. 1,600 Bal. 120 120 Depreciation Expense 50 Bal. 50 Utilities Expense Retained Earnings Bal. 985 985 Supplies Expense 2,040 Bal. 2,040 Insurance Expense Bal. 100 100 Dividends Miscellaneous Expense Bal. 4,000 455 Bal. 455 The Closing Process Income Summary 9,755 16,960 Step 2 Debit Income Summary for the total expenses and credit each expense account for its balance.

  38. Fees Earned Wages Expense Bal. 16,840 16,840 4,525 Bal. 4,525 Rent Expense Rent Revenue 1,600 Bal. 1,600 Bal. 120 120 Depreciation Expense 50 Bal. 50 Utilities Expense Retained Earnings Bal. 985 985 Supplies Expense 2,040 Bal. 2,040 Insurance Expense Bal. 100 100 Dividends Miscellaneous Expense Bal. 4,000 455 Bal. 455 The Closing Process Income Summary 9,755 16,960 7,205 Step 3 Debit Income Summaryfor the amount of its balance (in this case, the net income) and credit Retained Earnings. 7,205

  39. Fees Earned Wages Expense Bal. 16,840 16,840 4,525 Bal. 4,525 Rent Expense Rent Revenue 1,600 Bal. 1,600 Bal. 120 120 Depreciation Expense 50 Bal. 50 Utilities Expense Retained Earnings Bal. 985 985 Supplies Expense 2,040 Bal. 2,040 Insurance Expense Bal. 100 100 Dividends Miscellaneous Expense Bal. 4,000 455 Bal. 455 The Closing Process Income Summary 9,755 16,960 7,205 Step 4 Debit Retained Earnings for the balance of Dividends and credit Dividend for the same amount. 7,205 4,000 4,000

  40. Review of the Closing Process Fees Earned Wages Expense Bal. 16,840 16,480 16,840 4,525 4,525 Bal. 4,525 Rent Expense 16,960 Rent Revenue 1,600 Bal. 1,600 1,600 Bal. 120 120 120 Depreciation Expense 50 Bal. 50 50 Utilities Expense Retained Earnings Bal. 985 985 985 Supplies Expense 2,040 Bal. 2,040 2,040 Insurance Expense Bal. 100 100 100 Dividends Miscellaneous Expense Bal. 4,000 445 455 Bal. 455 Income Summary 9,775 16,960 9,755 7,205 7,205 Close Revenues 7,205 4,000 4,000 7,205 Close Expenses Close Income Summary Close Dividends 4,000 4,000 After the closing entries are posted, all of the temporary accounts have zero balances.

  41. Post-closing Trial Balance NetSolutions Post-Closing Trial Balance December 31, 2005 Cash 2 065 00 Accounts Receivable 2 720 00 Supplies 760 00 Prepaid Insurance 2 300 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 Capital Stock 25 000 00 Retained Earnings 3 205 00 29 645 00 29 645 00

  42. Working Capital Current Assets Current Liabilities – = Working Capital Working Capital = = – $1,390 $7,845 $6,455 Financial Analysis for NetSolutions

  43. Current Ratio Current Ratio Current Ratio Current Assets Current Liabilities ÷ = = = ÷ $7,845 5.6 $1,390 Financial Analysis for NetSolutions

  44. Financial Analysis for NetSolutions This ratio implies that NetSolutions is able to pay its current liabilities. NetSolutions can use the current ratio to make comparisons across companies and with industry averages.

  45. Chapter 4 The End

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