acct 100 chapter 4 completing the accounting cycle
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ACCT 100
Chapter 4
Completing the Accounting Cycle
Accrual Accounting and the Financial Statements 2
Objectives of the Chapter Discuss the steps in the accounting cycle. Introduce the worksheet paper to facilitate the
preparation of financial statements. Explain the process of closing the books. Discuss the content of a post-closing trial
balance. Explain the correcting entries. Discuss the sections of a classified balance
sheet. Accounting ratios for decision making.
Accounting Cycle 3
The Accounting Process1. Identification and measurement of business
transactions;
2. Journalization (record business transactions using the double-entry system);
3. Post (post journal entries to ledger accounts);
4. Prepare worksheet (including unadjusted trial balance, adjustments; adjusted trial balance, etc.)
5. Prepare financial statements based on the adjusted trial balance;
Accounting Cycle 4
Accounting Process (contd.)
6. Prepare and post adjusting entries;
7. Prepare and post closing entries;
8. Prepare post-closing trial balance (optional).
Note: Steps 1,2 ,3 and the unadjusted trial balance are discussed in chapter 2. The adjustments (i.e., adjusting entries) are discussed in chapter 3.
A multiple-column form used in preparing financial statements.
Not a permanent accounting record.
Use of worksheet is optional.
Using A Worksheet Using A Worksheet (Source: KWW PowerPoint Presentations)
Using A Worksheet Using A Worksheet (Source: KWW PowerPoint Presentations)
SO 1 Prepare a worksheet.SO 1 Prepare a worksheet.
Steps in Preparing a Worksheet Steps in Preparing a Worksheet (Source: KWW (Source: KWW PowerPoint Presentations) PowerPoint Presentations) Steps in Preparing a Worksheet Steps in Preparing a Worksheet (Source: KWW (Source: KWW PowerPoint Presentations) PowerPoint Presentations)
SO 1 Prepare a worksheet.SO 1 Prepare a worksheet.
Illustration 4-1
Accrual Accounting and the Financial Statements 7
A Worksheet Paper with Unadjusted Trial Balance (Source: Financial Accounting by Harrison and Horngren)
Trial Balance Account Title Debit Credit Cash 24,800 Accounts receivable 2,250 Supplies 700 Prepaid rent 3,000 Furniture 16,500 Accumulated depreciation Accounts payable 13,100 Salary Payable Unearned service revenue 450 Income tax payable Common stock 20,000 Retained earnings 11,250 Dividends 3,200 Service revenue 7,000 Rent expense Salary expense 950 Supplies expense Depreciation expense Utilities expense 400 Income tax expense
AIR & SEA TRAVEL, INC.Unadjusted Trial Balance
April 30, 19X1
7
Accrual Accounting and the Financial Statements 8
Information for Adjustments at 4/30/ 19x1 (from Financial Accounting by Harrison and Horngren and used in chapter 3 notes):
(a) Prepaid rent expired, $1,000.
(b) Supplies on hand, $400 (balance before adjustment equals $700).
(c) Depreciation on furniture, $275.
(d) Accrued salary expense, $950.
(e) Accrued service revenue, $250.
(f) Amount of unearned service revenue that has been earned, $150.
(g) Accrued income tax expense, $540.8
Accrual Accounting and the Financial Statements 9
Worksheet Paper with Adjusted Trial Balance
Trial Balance Adjustments Adjusted Trial BalanceAccount Title Debit Credit Debit Credit Debit CreditCash 24,800 24,800Accounts receivable 2,250 (e) 250 2,500Supplies 700 (b) 300 400Prepaid rent 3,000 (a) 1,000 2,000Furniture 16,500 16,500Accumulated depreciation (c) 275 275Accounts payable 13,100 13,100Salary Payable (d) 950 950Unearned service revenue 450 (f) 150 300Income tax payable (g) 540 540Common stock 20,000 20,000Retained earnings 11,250 11,250Dividends 3,200 3,200Service revenue 7,000 (e) 250 7,400
(f) 150Rent expense (a) 1,000 1,000Salary expense 950 (d) 950 1,900Supplies expense (b) 300 300Depreciation expense (c) 275 275Utilities expense 400 400Income tax expense (g) 540 540
AIR & SEA TRAVEL, INC.Preparation of Adjusted Trial BalanceApril 30, 19X1 (from Harrison and Horngren)
9
Accrual Accounting and the Financial Statements 10
Preparing the Financial Statements of Air & Sea Travel, Inc., from the Adjusted Trial Balance (from Harrison and Horngren
Adjusted Trial BalanceAccount Title Debit CreditCash 24,800Accounts receivable 2,500Supplies 400Prepaid rent 2,000Furniture 16,500Accumulated depreciation 275Accounts payable 13,100Salary Payable 950Unearned service revenue 300Income tax payable 540Common stock 20,000Retained earnings 11,250Dividends 3,200Service revenue 7,400Rent expense 1,000Salary expense 1,900Supplies expense 300Depreciation expense 275Utilities expense 400Income tax expense 540
53,815 53,815
Balance Sheet(Exhibit 4-3)
Income Statement(Exhibit 4-1)
Statement of Retained Earnings(Exhibit 4-2)
10
Accrual Accounting and the Financial Statements 11
Exhibit 4-1 Income Statement (from Harrison and Horngren)
Revenue:Service revenue…………...
$7,400Expenses:
Salary expense…………… $1,900Rent expense……………… 1,000Utilities expense………….. 400Supplies expense…………. 300Depreciation expense…….. 275 3,875
Income before tax………….. 3,525Income tax expense………… 540Net income…………………. $2,985
AIR & SEA TRAVEL, INC.Income Statement
For the Month Ended April 30, 19X1
11
Accrual Accounting and the Financial Statements 12
Exhibit 4-2 Statement of Earnings (from Harrison and Horngren)
Retained earnings, April 1, 19X1…… $11,250Add: Net income……………………… $2,985
14,235Less: Dividends……………………… 3,200Retained earnings, April 30, 19X1….. $11,035
AIR & SEA TRAVEL, INC.Statement of Retained Earnings
For the Month Ended April 30, 19X1
12
Accrual Accounting and the Financial Statements 13
Exhibit 4-3 Balance Sheet (from Harrison and Horngren
AssetsCash……………….….. $24,800Account receivable...…. 25,00Supplies………………. 400Prepaid rent…………... 2,000Furniture…….. $16,500
Less Accumulateddepreciation….. 275 16,225
.
Total assets………….. $45,925
LiabilitiesAccounts payable…………. $13,100Salary payable…………….. 950Unearned service revenue.... 300Income tax payable….……. 540Total liabilities……………. 14,890
Stockholders’ EquityCommon stock……………. 20,000Retained earnings…………. 11,035 Total stockholders’ equity… 31,035Total liabilities and .
stockholders’ equity……. $45,925
AIR & SEA TRAVEL, INC.Balance SheetApril 30, 19X1
13
Accrual Accounting and the Financial Statements 14
Preparing the Adjusting Entries (a) Rent Expense 1,000
Prepaid Rent 1,000To record rent expense.
(b) Supplies Expense 300Supplies 300
To record supplies used.
(c) Depreciation Exp. - Furniture 275Accumulated Depr. - Furniture 275
To record depreciation on furniture.
(d) Salary Expense 950Salary Payable 950
To accrue salary expense.
14
Accrual Accounting and the Financial Statements 15
Adjusting Entries(contd.)
(e) Accounts Receivable 250Service Revenue 250
To accrue service revenue.
(f) Unearned Service Revenue 150Service Revenue 150
To record unearned revenue that has been earned.
(g) Income Tax Expense 540Income Tax Payable 540
To accrue income tax expense.
15
Accrual Accounting and the Financial Statements 16
Ledger Accounts with Adjusted Entries Posted
ASSETS LIABILITIES STOCKHOLDERS’ EQUITYCash
Bal.24,800
Salary Payable(d) 950
Bal. 950
Comm Stock Bal. 20,000
EXPENSESRent Exp.
(a) 1,000Bal.1,000
A/R2,250
(e) 250Bal. 2,500
Supplies700 (b) 300
Bal. 400
Prepaid Rent3,000 (a) 1,000
Bal. 2,000
Retained Earnings
Bal.11,250
REVENUEService Rev.
7,000(e) 250(f) 150
Bal. 7,400
Salary Exp.950
(d) 950Bal.1,900
Supplies Exp.(b) 300Bal. 300
FurnitureBal.16,500
AccumulatedDepr.--Furniture
(c) 275Bal. 275
A/PBal.13,100
UnearnedService Rev.
(f) 150 450Bal. 300
I/T Payable(g) 540
Bal. 540
DividendsBal.3,200
Depr. Exp.-Furniture
(c) 275Bal. 275
Utilities Exp.Bal. 400
I/T Exp.(g) 540Bal. 540
16
Accrual Accounting and the Financial Statements 17
Closing Entries
All temporary accounts (i.e., revenues, expenses, gains and losses accounts) are closed to an income summary account.
The income summary account is closed to the retained earnings account.
Purpose: all temporary accounts would have a zero beginning balance in a subsequent period after being closed at the end of a previous period.
At the end of the accounting period, the company makes the accounts ready for the next period.
Closing the Books Closing the Books (source: KWW (source: KWW PowerPoint presentations)PowerPoint presentations)Closing the Books Closing the Books (source: KWW (source: KWW PowerPoint presentations)PowerPoint presentations)
SO 2 Explain the process of closing the books.SO 2 Explain the process of closing the books.
Illustration 4-5
Accrual Accounting and the Financial Statements 19
Closing Entries for Air and Sea Travel, Inc. on 4/30
4/30 Service Revenue 7,400Income Summary 7,400
4/30 Income Summary 4,415Rent Exp. 1,000Salary Exp. 1,900Supplies Exp 300Depre. Exp. 275Utilities Exp. 400Income Tax Exp. 540
4/30 Income Summary ($7,400-$4,415) 2,985Retained Earnings 2,985
4/30 Retained Earnings 3,200Dividends 3,200
19
Accrual Accounting and the Financial Statements 20
Posting Closing Entries to the Ledger Accounts
Adj. 1,000 7,000Bal. 1,000 Clo. 1,000 Adj. 250
Adj. 150Col. 7,400 Bal. 7,400
950Adj. 950Bal. 1,900 Clo. 1,900
Adj. 300 Clo. 4,415 Clo. 7,400Bal. 300 Clo. 300 Clo. 2,985 Bal. 2,985
Adj. 275 Bal. 3,200 Clo. 3,200Bal. 275 Clo. 275
Adj. 400 Clo. 3,200 11,250Bal. 400 Clo. 400 Clo. 2,985
Bal. 11,035
Adj. 540Bal. 540 Clo. 540
Rent Expense
Salary Expense
Supplies Expense
Income Tax Expense
Utilities Expense
Depreciation Expense
Service Revenue
Income Summary
Dividends
Retained Earnings
20
Accrual Accounting and the Financial Statements 21
Post-Closing Trial Balance (from Harrison and Horngren
Cash………………………………. $24,800Accounts receivable…………….. 2,500Supplies…………………………… 400Prepaid rent……………………….. 2,000Furniture…………………………... 16,500Accumulated depreciation………. $ 275Accounts payable…………………. 13,100Salary payable…………………….. 950Unearned service revenue………. 300Income tax payable……………….. 540Common stock…………………….. 20,000Retained earnings………………… 11,035Total……………………………….. $46,200 $46,200
AIR & SEA TRAVEL, INC.Post-closing Trial Balance
April 30, 19X1
21
Accrual Accounting and the Financial Statements 22
Correcting Accounting Errors
When an error is detected after posting, the accountant makes a correcting entry.
Example: $5,000 cash was paid for furniture but was erroneously debited supplies as follows:
Supplies 5,000Cash 5,000
Correcting EntryFurniture 5,000
Supplies 5,000
Accrual Accounting and the Financial Statements 23
Classified Balance Sheet Statement
Accounts with similar characteristics are grouped together on the balance sheet.
Categories of accounts:
1. Assets
2. Liabilities
3. Stockholders’ equity
The Classified Balance Sheet The Classified Balance Sheet (Source: KWW PowerPoint (Source: KWW PowerPoint Presentations)Presentations)The Classified Balance Sheet The Classified Balance Sheet (Source: KWW PowerPoint (Source: KWW PowerPoint Presentations)Presentations)
SO 6 Identify the sections of a classified balance sheet.SO 6 Identify the sections of a classified balance sheet.
Presents a snapshot at a point in time.
To improve understanding, companies group similar assets and similar liabilities together.
Assets Liabilities and Owner’s Equity
Current assets Current liabilitiesLong-term investments Long-term liabilitiesProperty, plant, and equipment Stockholders’ equityIntangible assets
Illustration 4-17Standard Classifications
Accrual Accounting and the Financial Statements 25
Assets
Assets: Resources with future economic benefit to a business entity as a result of a past transaction
a. Current assets: Cash and other assets that are reasonably expected to be realized in cash or sold, or consumed during the normal operating cycle or one year, whichever is longer.
The Classified Balance Sheet The Classified Balance Sheet (Source: KWW (Source: KWW PowerPoint Presentations)PowerPoint Presentations)The Classified Balance Sheet The Classified Balance Sheet (Source: KWW (Source: KWW PowerPoint Presentations)PowerPoint Presentations)
SO 6 Identify the sections of a classified balance sheet.SO 6 Identify the sections of a classified balance sheet.
Companies usually list current asset accounts in the order they expect to convert them into cash.
Illustration 4-19
Current Assets
The Classified Balance Sheet The Classified Balance Sheet (Source: KWW (Source: KWW PowerPoint Presentations)PowerPoint Presentations)The Classified Balance Sheet The Classified Balance Sheet (Source: KWW (Source: KWW PowerPoint Presentations)PowerPoint Presentations)
SO 6 Identify the sections of a classified balance sheet.SO 6 Identify the sections of a classified balance sheet.
b.Investments in buildings or land not used in current operations; investments in bonds or stocks of other companies .
Long-Term Investments
Illustration 4-20
Accrual Accounting and the Financial Statements 28
Assets (contd.)
c. Property, plant, and equipment: assets used in firms' operations and meet the following criteria:
Economic life > 1 year. Acquired for use in operation. Not for resale to customers. $ is material.Depreciation is applied.
The Classified Balance Sheet The Classified Balance Sheet (Source: KWW (Source: KWW PowerPoint Presentations)PowerPoint Presentations)The Classified Balance Sheet The Classified Balance Sheet (Source: KWW (Source: KWW PowerPoint Presentations)PowerPoint Presentations)
SO 6 Identify the sections of a classified balance sheet.SO 6 Identify the sections of a classified balance sheet.
Illustration 4-21
Property, Plant, and Equipment
Accrual Accounting and the Financial Statements 30
Assets (contd.)
d. Intangible assets: Assets with no physical substance but have value based on rights or privileges that belong to the owner (i.e., patents, franchises, trademarks,…)
e. Other assets: Deferred charges (long-term prepayments)
The Classified Balance Sheet The Classified Balance Sheet (Source: KWW (Source: KWW PowerPoint Presentations)PowerPoint Presentations)The Classified Balance Sheet The Classified Balance Sheet (Source: KWW (Source: KWW PowerPoint Presentations)PowerPoint Presentations)
SO 6 Identify the sections of a classified balance sheet.SO 6 Identify the sections of a classified balance sheet.
Assets that do not have physical substance.
Intangible Assets
Illustration 4-22
Accrual Accounting and the Financial Statements 32
Liabilities
Legal obligations required future payments of assets or services as a result of a business entity’s past transactions or events.
a. Current liabilities:
Obligations must be fulfilled in one year or one operating cycle, whichever is longer. Will require the use of current assets or the creation of current liability.
The Classified Balance Sheet The Classified Balance Sheet (Source: KWW (Source: KWW PowerPoint Presentations)PowerPoint Presentations)The Classified Balance Sheet The Classified Balance Sheet (Source: KWW (Source: KWW PowerPoint Presentations)PowerPoint Presentations)
SO 6 Identify the sections of a classified balance sheet.SO 6 Identify the sections of a classified balance sheet.
Illustration 4-23
Current Liabilities
Accrual Accounting and the Financial Statements 34
Liabilities (contd.)
b. Long-term liabilities:
Obligations are not due in next year or next operating cycle, whichever is longer.
c. Other liabilities:
Long-term advances from customers, deferred income taxes.
The Classified Balance Sheet The Classified Balance Sheet (Source: KWW (Source: KWW PowerPoint PresentationsPowerPoint Presentations))The Classified Balance Sheet The Classified Balance Sheet (Source: KWW (Source: KWW PowerPoint PresentationsPowerPoint Presentations))
SO 6 Identify the sections of a classified balance sheet.SO 6 Identify the sections of a classified balance sheet.
Obligations a company expects to pay after one year.
Long-Term Liabilities
Illustration 4-24
Accrual Accounting and the Financial Statements 36
Stockholders’ Equity Residual claims (Assets-Liabilities) to the
business entity from stockholders.
a. Contributed capital (Legal capital): includes Par value of common stock, par value of prefer stock and paid-in capital in excess of par value of common stock or preferred stock.
b. Retained Earnings (or deficit): income not distributed to stockholders
The Classified Balance Sheet The Classified Balance Sheet (Source: KWW (Source: KWW PowerPoint Presentations)PowerPoint Presentations)The Classified Balance Sheet The Classified Balance Sheet (Source: KWW (Source: KWW PowerPoint Presentations)PowerPoint Presentations)
SO 6 Identify the sections of a classified balance sheet.SO 6 Identify the sections of a classified balance sheet.
Proprietorship - one capital account.
Partnership - capital account for each partner.
Corporation - Capital Stock and Retained Earnings.
Stockholders’ (Owner’s) Equity
Illustration 4-25
Accrual Accounting and the Financial Statements 38
Classified Balance Sheet of Hawaiian Airlines, Inc. (Source: Harrison and Horngren)
ASSETSCurrent Assets:
1.Cash and cash equivalents…………….. $ 5,389 $ 3,501 2.Accounts receivable………………….... 18,178 16,275 3. Inventories…………………………….. 7,648 6,234 4.Assets held for sale……………………. 1,344 1,594 5.Prepaid expenses………………………. 5,804 6,079 6. Total current assets………………... 38,363 33,683
PROPERTY AND EQUIPMENT 7.Flight equipment……………………….. 40,659 34,702 8.Ground equipment, buildings, and
leasehold improvements…………….. 5,775 3,976 9.Accumulated depr. and amortization…... (5,043)
(922)10. Property and equipment, net…………. 41,391 37,75611. Other Assets…………………………… 81,886 91,86212. Total Assets…………………………. $ 161,640 $163,301
HAWAIIAN AIRLINES, INC.Classified Balance Sheet (Adapted)
December 31, 1995 and 1994 (In thousands)1995 1994
38
Accrual Accounting and the Financial Statements 39
Exhibit 3-17 (Continued)
LIABILITIES AND SHAREHOLDERS’ EQUITYCurrent Liabilities:
13.Current portion of long-term debt………………….. $ 6,027 $ 6,39414.Current portion of capital lease obligations………... 2,662 2,90715.Accounts payable…………………………………... 35,182 17,52916.Air traffic liability…………………………………... 30,461 40,38217.Other accrued liabilities…………………………….. 15,730 12,29818. Total current liabilities…………………………. 90,062 79,51019.Long-Term Debt…………………………………... 5,523 14,15220.Capital Lease Obligations………………………… 10,102 12,76421.Other Liabilities…………………………………… 26,775 23,026
Shareholders’ Equity22.Common stock……………………………………… 41,287 40,00023.Other………………………………………………... (452) ----24.Accumulated deficit………………………………… (11,657) (6,151)25. Shareholders’ equity……………………………. 29,178 33,84926. Total Liabilities and Shareholders’ Equity...$161,640 $163,301
(In thousands)1995 1994
39
Accrual Accounting and the Financial Statements 40
6. Different Formats for the Balance Sheet
B/S B/S
Assets Liabilities Assets
Equity
Liabilities and Equity
Accrual Accounting and the Financial Statements 41
Using Accounting Information in Decision making: Accounting Ratios
A. Current Ratio
B. Debt Ratio
Accrual Accounting and the Financial Statements 42
A. Current Ratio
Current Ratio = Current Assets Current Liabilities
1. This ratio measures the company’s ability to pay current liabilities with current assets.
2. Users of this ratios: creditor, stockholders, and managers (who must maintain enough cash to pay the company’s current liabilities).
1.
Accrual Accounting and the Financial Statements 43
A. Current Ratio (contd.)
3. What is a good value of this ratio: depends on the industry and the cash flows of a company. A company with a strong cash flow can operate at a lower current ratio than a company with weak cash flow.
4. What happens when the ratio is low?
5. Can the current ratio be too high?
Accrual Accounting and the Financial Statements 44
B. Debt Ratio
Debt Ratio = Total Liabilities Total Assets
1. This ratio measures the ability of a company to pay its total liabilities.
2. Users of this ratio: creditors, stockholders and manager.
Accrual Accounting and the Financial Statements 45
B. Debt Ratio (contd.)
3. What is a good value of this ratio: depends on the industry and the cash flows of a company. A company with a strong cash flow can operate with a high debt ratio at than otherwise.
4. What happens when the debt ratio is high?
5. Can the ratio be too low?