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Chapter 4 Completing the Accounting Cycle Accounting, 21st Edition Warren Reeve Fess PowerPoint Presentation by Douglas Cloud Professor Emeritus of Accounting Pepperdine University © Copyright 2004 South-Western, a division of Thomson Learning. All rights reserved. Task Force Image Gallery clip art included in this electronic presentation is used with the permission of NVTech Inc. Some of the action has been automated, so click the mouse when you see this lightning bolt in the lower right-hand corner of the screen. You can point and click anywhere on the screen. Objectives 1. Review the seven basic steps of the accounting cycle. After studying this 2. Prepare a work sheet.you should chapter, 3. Prepare financial be statements able to: 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. 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. 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. For example? Well… besides cash, there’s notes receivable, accounts receivable, supplies, and other prepaid items. There are some exceptions, but that’s basically correct. Assets such So, assets that have a life as office equipment, machinery, over a year are listed under buildings, and land would appear property, plant, and under that heading. equipment. Liabilities due usually within 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 Liabilities not due for more than a year usually are long-term liabilities. Mortgage note payable Mortgage payable Bond payable 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 Accounts Dr Cr Adjustments Adjusted TB Dr Dr Cr Cr Prepared from the general ledger. Accounts are listed in the following order: assets, liabilities, owner’s equity, revenues, and expenses. The Work Sheet Trial Balance Accounts Dr Cr Adjustments Adjusted TB Dr Dr Cr Cr Adjustments are entered here. Two possibilities: 1. Deferrals – Existing balances are changed. 2. Accruals – New information is entered. The Work Sheet Trial Balance Accounts Dr Cr Adjustments Adjusted TB Dr Dr Cr Cr Adjustments are combined with the trial balance. Account balances are now adjusted. NetSolutions Work Sheet For the Two Months Ended December 31, 2005 Trial Balance Account Title 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Chris Clark, Capital Chris Clark, Drawing Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense Debit Credit Adjustments Debit Credit Adjusted Trial Balance Debit 2,065 2,220 2,000 2,400 20,000 1,800 900 360 25,000 4,000 16,340 4,275 1,600 985 800 455 42,600 42,600 The Unadjusted Trial Balance Credit (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. NetSolutions Work Sheet For the Two Months Ended December 31, 2005 Trial Balance Account Title 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Chris Clark, Capital Chris Clark, Drawing Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense Debit Credit Adjustments Debit 2,065 2,220 2,000 2,400 20,000 1,800 (a) 1,240 900 360 25,000 4,000 16,340 4,275 1,600 985 800 455 42,600 Credit (a) 1,240 42,600 Adjusted Trial Balance Debit Credit (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). NetSolutions Work Sheet For the Two Months Ended December 31, 2005 Trial Balance Account Title 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Chris Clark, Capital Chris Clark, Drawing Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense Insurance Expense Debit Adjustments Credit Debit 2,065 2,220 2,000 2,400 20,000 1,800 (a) 1,240 (b) 100 900 360 25,000 4,000 16,340 4,275 1,600 985 800 455 42,600 Credit (a) 1,240 42,600 (b) 100 Accounts are added as needed. Adjusted Trial Balance Debit Credit (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. FOR RENT NetSolutions Work Sheet For the Two Months Ended December 31, 2005 Trial Balance Account Title 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Chris Clark, Capital Chris Clark, Drawing Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense Insurance Expense Rent Revenue Debit Credit Adjustments Debit 2,065 2,220 2,000 2,400 20,000 1,800 Credit (a) 1,240 (b) 100 900 360 25,000 (c) 120 4,000 16,340 4,275 1,600 985 800 455 42,600 (a) 1,240 42,600 (b) 100 (c) 120 Adjusted Trial Balance Debit Credit (d) Wages accrued but not paid at the end of December total $250. NetSolutions Work Sheet For the Two Months Ended December 31, 2005 Trial Balance Account Title 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Chris Clark, Capital Chris Clark, Drawing Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense Insurance Expense Rent Revenue Wages Payable Debit Credit Adjustments Debit 2,065 2,220 2,000 2,400 20,000 1,800 Credit (a) 1,240 (b) 100 900 360 25,000 (c) 120 4,000 16,340 4,275 1,600 985 800 455 42,600 (d) 250 (a) 1,240 42,600 (b) 100 (c) 120 (d) 250 Adjusted Trial Balance Debit Credit (e) Fees accrued at the end of December, but not recorded, total $500. NetSolutions Work Sheet For the Two Months Ended December 31, 2005 Trial Balance Account Title 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Chris Clark, Capital Chris Clark, Drawing Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense Insurance Expense Rent Revenue Wages Payable Debit Adjustments Credit 2,065 2,220 2,000 2,400 20,000 1,800 Adjusted Trial Balance Debit (e) Credit 500 (a) 1,240 (b) 100 900 360 25,000 (c) 120 4,000 16,340 4,275 1,600 985 800 455 42,600 (e) 500 (d) 250 (a) 1,240 42,600 (b) 100 (c) 120 (d) 250 Debit Credit (f) Depreciation of the office equipment is $50 for December. NetSolutions Work Sheet For the Two Months Ended December 31, 2005 Trial Balance Account Title 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Chris Clark, Capital Chris Clark, Drawing Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense Insurance Expense Rent Revenue Wages Payable Depreciation Expense Accum. Depreciation Debit Credit 2,065 2,220 2,000 2,400 20,000 1,800 Adjusted Trial Balance Adjustments Debit Credit (e) 500 (a) 1,240 (b) 100 900 360 25,000 (c) 120 4,000 16,340 4,275 1,600 985 800 455 42,600 (e) 500 (d) 250 (a) 1,240 42,600 (b) 100 (c) 120 (d) 250 (f) 50 (f) 50 Debit Credit NetSolutions Work Sheet For the Two Months Ended December 31, 2005 Adjustments To make more space, Debit Credit Debit Credit 2,065 let’s remove the 2,220 (e) 500 heading.(a) 1,240 2,000 Trial Balance Account Title 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Chris Clark, Capital Chris Clark, Drawing Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense Insurance Expense Rent Revenue Wages Payable Depreciation Expense Accum. Depreciation 2,400 20,000 1,800 (b) 100 900 360 25,000 (c) 120 4,000 16,340 4,275 1,600 985 800 455 42,600 (e) 500 (d) 250 (a) 1,240 42,600 (b) 100 (c) 120 (d) 250 (f) 50 (f) 50 Adjusted Trial Balance Debit Credit Trial Balance Account Title 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 Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Chris Clark, Capital Chris Clark, Drawing Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense Insurance Expense Rent Revenue Wages Payable Depreciation Expense Accum. Depreciation Debit Credit 2,065 2,220 2,000 2,400 20,000 1,800 Adjustments Debit Credit (e) 500 (a) 1,240 (b) 100 900 360 25,000 (c) 120 4,000 16,340 4,275 1,600 985 800 455 42,600 (e) 500 (d) 250 (a) 1,240 42,600 (b) 100 (c) 120 (d) 250 Summed and ruled (f) 50 (f) 2,260 50 2,260 Adjusted Trial Balance Debit 31 Credit Next, the unadjusted Trial Balance columns and the Adjustments columns are combined to determine the amounts displayed in the Adjusted Trial Balance. Trial Balance Account Title 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 Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Chris Clark, Capital Chris Clark, Drawing Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense Insurance Expense Rent Revenue Wages Payable Depreciation Expense Accum. Depreciation Debit Credit 2,065 2,220 2,000 2,400 20,000 1,800 Adjustments Debit Credit (e) 500 (a) 1,240 (b) 100 900 360 25,000 (c) 120 4,000 16,340 4,275 1,600 985 800 455 42,600 (e) 500 (d) 250 (a) 1,240 42,600 (b) 100 (c) 120 (d) 250 (f) 50 (f) 2,260 50 2,260 Adjusted Trial Balance Debit 33 Credit Trial Balance Account Title 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 Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Chris Clark, Capital Chris Clark, Drawing Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense Insurance Expense Rent Revenue Wages Payable Depreciation Expense Accum. Depreciation Debit Credit 2,065 2,220 2,000 2,400 20,000 1,800 Adjustments Debit Credit (e) 500 (a) 1,240 (b) 100 900 360 25,000 Debit 34 Credit 2,065 2,720 760 2,300 20,000 1,800 900 240 25,000 (c) 120 4,000 4,000 16,340 4,275 1,600 985 800 455 42,600 Adjusted Trial Balance (e) 500 (d) 250 16,840 4,525 1,600 985 2,040 455 (a) 1,240 42,600 (b) 100 100 (c) 120 (d) 250 (f) 50 50 (f) 2,260 120 250 50 2,260 43,400 50 43,400 The Work Sheet Adjusted TB Accounts Dr Cr Income State. Dr Cr Balance Sheet Dr Cr Revenue and expense balances in the Adjusted Trial Balance column are extended to the Income Statement column. The Work Sheet Adjusted TB Accounts Dr Cr Income State. Dr Cr Balance Sheet Dr Cr Asset, liability, owner’s equity, and drawing balances in the Adjusted Trial Balance column are extended to the Balance Sheet column. To make room on the slides for the Income statement and Balance Sheet columns, the Trial Balance and Adjustments columns have been removed. Adjusted Trial Balance Account Title 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 Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Chris Clark, Capital Chris Clark, Drawing Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense Insurance Expense Rent Revenue Wages Payable Depreciation Expense Accum. Depreciation Debit Income Statement Credit 2,065 2,720 760 2,300 20,000 1,800 900 240 25,000 4,000 16,840 4,525 1,600 985 2,040 455 100 120 250 50 43,400 50 43,400 Debit Credit Balance Sheet Debit 38 Credit Now, let’s extend the balances from the Adjusted Trial Balance column. Adjusted Trial Balance Account Title 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 Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Chris Clark, Capital Chris Clark, Drawing Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense Insurance Expense Rent Revenue Wages Payable Depreciation Expense Accum. Depreciation Debit 40 Income Statement Credit Debit Credit 2,065 2,720 760 2,300 20,000 1,800 Balance Sheet Debit 2,065 2,720 760 2,300 20,000 1,800 900 240 25,000 900 240 25,000 4,000 4,000 16,840 16,840 4,525 1,600 985 2,040 455 4,525 1,600 985 2,040 455 100 100 120 250 50 43,400 Credit 120 250 50 50 43,400 50 These four columns are summed. Adjusted Trial Balance Account Title 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 Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Chris Clark, Capital Chris Clark, Drawing Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense Insurance Expense Rent Revenue Wages Payable Depreciation Expense Accum. Depreciation Debit 42 Income Statement Credit Debit Credit 2,065 2,720 760 2,300 20,000 1,800 Balance Sheet Debit 2,065 2,720 760 2,300 20,000 1,800 900 240 25,000 900 240 25,000 4,000 4,000 16,840 16,840 4,525 1,600 985 2,040 455 4,525 1,600 985 2,040 455 100 100 120 250 50 43,400 Credit 120 250 50 50 43,400 9,755 16,960 33,645 50 26,440 The difference between the Income Statement column totals is the net income (or net loss) for the period. 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 7,205 16,960 16,960 33,645 Net Income 26,440 7,205 33,645 Net Income NetSolutions Income Statement For Two Months Ended December 31, 2005 Fees earned Rent revenue Total revenues Expenses: Wages expense Supplies expense Rent expense Utilities expense Insurance expense Depreciation expense Miscellaneous expense Total expenses Net income $16,840 120 $16,960 $ 4,525 2,040 1,600 985 100 50 455 9,755 $ 7,205 Every amount on this income statement was taken from the Income Statement column of the work sheet. NetSolutions Statement of Owner’s Equity For the Two Months Ended December 31, 2005 Chris Clark, Capital, November 1, 2005 Investment on November 1, 2005 Net income for November and December $ $25,000 7,205 $32,205 4,000 0 Less withdrawals Increase in owner’s equity 28,205 Fromfrom the$28,205 the Chris Clark, Capital, December 31, 2005Either Balance Sheet income debit column of statement or the thework worksheet. sheet. NetSolutions Balance Sheet December 31, 2005 Assets Liabilities Current assets: Current liabilities: Cash $ 2,065 Accounts payable Accounts receivable 2,720 Wages payable Supplies 760 Unearned rent Prepaid insurance 2,300 Total liabilities Total current assets $ 7,845 Property, plant, and equipment: Land $20,000 Office equip. $1,800 Less accum. depreciation 50 1,750 Owner’s Equity Total property, plant Chris Clark, Capital and equipment 21,750 Total liabilities and Total assets $29,595 owner’s equity $900 From the 250 240 Statement $ 1,390 of Owner’s Equity 28,205 $29,595 Adjusting and Closing Entries Adjusting entries are recorded in the journal at the end of the accounting period. Adjusting and Closing Entries If a work sheet has been prepared, the data for these entries are in the Adjustments columns. The Closing Process Income Summary 2 Expenses are transferred to Income Summary 3 1 Revenues are transferred to Income Summary Net Income or Net Loss is transferred to Owner’s Capital OWNER’S CAPITAL 4 Drawings are transferred to Owner’s Capital Adjusting and Closing Entries Income Summary 2 Expenses are transferred to Income Summary 1 Revenues are transferred to Income Summary The Summary Net Income Income or Net Loss is transferred to Owner’s account does not appearCapital on the financial statements. 3 OWNER’S CAPITAL 4 Drawings are transferred to Owner’s Capital The Closing Process Fees Earned Wages Expense Bal. Income Summary 4,525 Rent Expense Bal. Bal. 16,840 Rent Revenue 1,600 Bal. 120 Depreciation Expense Bal. 50 Utilities Expense Bal. 985 Chris Clark, Capital Bal. 25,000 Supplies Expense Bal. 2,040 Insurance Expense Bal. 100 Chris Clark, Drawing Miscellaneous Expense Bal. 455 Bal. 4,000 Note: The balances shown are adjusted balances before closing. The following sequence demonstrates the closing process. The Closing Process Fees Earned Wages Expense Bal. Income Summary 4,525 16,960 Rent Expense Bal. 1,600 16,840 Bal. 16,840 Rent Revenue 120 Bal. 120 Depreciation Expense Bal. 50 Utilities Expense Bal. 985 Chris Clark, Capital Bal. 25,000 Supplies Expense Bal. 2,040 Insurance Expense Bal. 100 Chris Clark, Drawing Miscellaneous Expense Bal. 455 Bal. 4,000 Debit each revenue account for the amount of its balance, and credit Income Summary for the total revenue. The Closing Process Fees Earned Wages Expense Bal. 4,525 Income Summary 4,525 9,775 Rent Expense Bal. 1,600 16,960 1,600 16,840 Bal. 16,840 Rent Revenue 120 Bal. 120 Depreciation Expense Bal. 50 50 Utilities Expense Bal. 985 985 Chris Clark, Capital Bal. 25,000 Supplies Expense Bal. 2,040 2,040 Insurance Expense Bal. 100 100 Miscellaneous Expense Bal. 455 455 Chris Clark, Drawing Bal. 4,000 Debit Income Summary for the total expenses and credit each expense account for its balance. The Closing Process Fees Earned Wages Expense Bal. 4,525 Income Summary 4,525 9,775 7,205 Rent Expense Bal. 1,600 1,600 16,960 16,840 Bal. 16,840 Rent Revenue 120 Bal. 120 Depreciation Expense Bal. 50 50 Utilities Expense Bal. 985 985 Chris Clark, Capital Bal. 25,000 7,205 Supplies Expense Bal. 2,040 2,040 Insurance Expense Bal. 100 100 Miscellaneous Expense Bal. 455 455 Chris Clark, Drawing Bal. 4,000 Debit Income Summary for the amount of its balance (in this case, the net income) and credit the capital account. The Closing Process Fees Earned Wages Expense Bal. 4,525 Income Summary 4,525 9,775 Rent Expense Bal. 1,600 16,960 7,205 1,600 16,840 Bal. 16,840 Rent Revenue 120 Bal. 120 Depreciation Expense Bal. 50 50 Utilities Expense Bal. 985 985 Chris Clark, Capital 4,000 Bal. 25,000 7,205 Supplies Expense Bal. 2,040 2,040 Insurance Expense Bal. 100 100 Miscellaneous Expense Bal. 455 455 Chris Clark, Drawing Bal. 4,000 4,000 Debit the capital account for the balance of the drawing account, and credit drawing for the same amount. Review of the Closing Process Fees Earned Wages Expense Bal. 4,525 Income Summary 4,525 4,525 9,775 7,205 Rent Expense Bal. 1,600 1,600 1,600 16,960 16,960 16,480 Bal. 16,840 16,840 Rent Revenue 120 Bal. 120 120 Depreciation Expense Bal. 50 50 50 Utilities Expense Bal. 985 985 985 Chris Clark, Capital 4,000 Bal. 25,000 4,000 7,205 7,205 Supplies Expense Bal. 2,040 2,040 2,040 Close Revenues Close Expenses Close Income Summary Insurance Expense Bal. 100 100 100 Miscellaneous Expense Bal. 455 455 445 Close Drawing Chris Clark, Drawing Bal. 4,000 4,000 After the closing entries are posted, all of the temporary accounts have zero balances. 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 Chris Clark, Capital 28 205 00 29 645 00 29 645 00 Financial Analysis for NetSolutions Working Current Current – = Capital Assets Liabilities Working $7,845 – $1,390 = Capital Working $6,455 = Capital Financial Analysis for NetSolutions Current Ratio Current Ratio Current Ratio Current Current = Assets ÷ Liabilities = $7,845 ÷ = 5.6 $1,390 Financial Analysis for NetSolutions This ratio implies that NetSolutions is able to pay its current liabilities. Financial Analysis for NetSolutions Current ratio Current Current = Assets ÷ Liabilities Current $7,845 ÷ $1,390 = ratio Current 5.6 = ratio Financial Analysis for NetSolutions NetSolutions can use the current ratio to make comparisons across companies and with industry averages. Chapter 4 The End