completing the accounting cycle€¦ · objectives 4 completing the accounting cycle after studying...

o b j e c t i v e s

4COMPLETING THE ACCOUNTING CYCLE

After studying this chapter, youshould be able to:

1 Review the seven basic steps of theaccounting cycle.

2 Prepare a work sheet.

3 Prepare financial statements from awork sheet.

4 Prepare the adjusting and closingentries from a work sheet.

5 Explain what is meant by the fiscalyear and the natural business year.

6 Analyze and interpret the financialsolvency of a business by computingworking capital and the current ratio.

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MMost of us have had to file a personal tax return. At the beginning of the year,you estimate your upcoming income and decide whether you need to increase yourpayroll tax withholdings or perhaps pay estimated taxes. During the year, you earnincome, make investments, and enter into other tax-related transactions, such as mak-ing charitable contributions. At the end of the year, your employer sends you a taxwithholding information form (W-2 form), and you collect the tax records needed forcompleting your yearly tax forms. If any tax is owed, you pay it; if you overpaid yourtaxes, you file for a refund. As the next year begins, you start the cycle all over again.

Businesses also go through a cycle of activities. At the beginning of the cycle, man-agement plans where it wants the business to go and begins the necessary actionsto achieve its operating goals. Throughout the cycle, which is normally one year, theaccountant records the operating activities (transactions) of the business. At the endof the cycle, the accountant prepares financial statements that summarize the oper-ating activities for the year. The accountant then prepares the accounts for recordingthe operating activities in the next cycle.

As we saw in Chapter 1, the initial cycle for NetSolutions began with Chris Clark’sinvestment in the business on November 1, 2005. The cycle continued with record-ing NetSolutions’ transactions for November and December, as we discussed in Chap-ters 1 and 2. In Chapter 3, the cycle continued and we recorded the adjusting entriesfor the two months ending December 31, 2005. Now, in this chapter, we discuss theflow of the adjustment data into the accounts and into the financial statements.

The accounting process that begins with analyzing and journalizing transactions andends with summarizing and reporting these transactions is called the accountingcycle. The most important output of this cycle is the financial statements.

The basic steps of the accounting cycle are shown, by number, in the flowchartin Exhibit 1.

In earlier chapters, we described and illustrated the analysis and record-ing of transactions, posting to the ledger, preparing a trial balance, ana-lyzing adjustment data, preparing adjusting entries, and preparing financialstatements. In this chapter, we complete our discussion of the accountingcycle by describing how work sheets may be used as an aid in preparingthe financial statements. We also describe and illustrate how closing entriesand a post-closing trial balance are used in preparing the accounting recordsfor the next period.

o b j e c t i v e 1Review the seven basic stepsof the accounting cycle.

In a computerized accounting sys-tem, the software automaticallyrecords and posts transactions.The ledger and supporting recordsare maintained in computerizedmaster files. In addition, a worksheet is normally not prepared.

AAccounting Cycle

Accountants often use working papers for collecting and summarizing data theyneed for preparing various analyses and reports. Such working papers are usefultools, but they are not considered a part of the formal accounting records. This isin contrast to the chart of accounts, the journal, and the ledger, which are essentialparts of the accounting system. Working papers are usually prepared by using aspreadsheet program on a computer.

The work sheet is a working paper that accountants can use to summarize ad-justing entries and the account balances for the financial statements. In small com-panies with few accounts and adjustments, a work sheet may not be necessary. Forexample, the financial statements for NetSolutions can be prepared directly from theadjusted trial balance illustrated in Chapter 3. In a computerized accounting system,

o b j e c t i v e 2Prepare a work sheet.

Common spread-sheet programs usedin business includeMicrosoft Excel® andLotus 1-2-3®.

WWork Sheet

Chapter 4 • Completing the Accounting Cycle 141

a work sheet may not be necessary be-cause the software program automaticallyposts entries to the accounts and preparesfinancial statements.

The work sheet (Exhibits 2 through 5on pages 142–146) is a useful device forunderstanding the flow of the accountingdata from the unadjusted trial balance tothe financial statements (Exhibit 6). Thisflow of data is the same in either a man-ual or a computerized accounting system.

Unadjusted Trial Balance ColumnsTo begin the work sheet, list at the top the name of the business, the type ofworking paper (work sheet), and the period of time, as shown in Exhibit 2. Next,enter the unadjusted trial balance directly on the work sheet. The work sheet inExhibit 2 shows the unadjusted trial balance for NetSolutions at December 31,2005.

②

⑤

⑥

①

③

④

⑥

⑦

Source Documents JournalLedger

Financial Statements

Post-ClosingTrial Balance

Work Sheet(optional)

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 to the ledger.

⑥ Closing entries are journalized and posted to the ledger.

⑦ A post-closing trial balance is prepared.

XYZ Co.Post-Closing Trial Balance

December 31, 20––

⑤

Balance Sheet

Statement ofRetained Earnings

Income Statement

Accts. Rec. 112

Cash 111

XYZ Co.Work Sheet

For the Period Ended December 31, 20––

TrialBalance Adjustments

AdjustedTrial

BalanceIncome

StatementBalanceSheet

•Exhibit 1•Exhibit 1 Accounting Cycle

The work sheet is a usefuldevice for understandingthe flow of the accountingdata from the unadjustedtrial balance to the financialstatements.

Chapter 4 • Completing the Accounting Cycle142

Adjustments ColumnsThe adjustments that we explained and illustrated for NetSolutions in Chapter 3 areentered in the Adjustments columns, as shown in Exhibit 3. Cross-referencing (byletters) the debit and credit of each adjustment is useful in reviewing the work sheet.It is also helpful for identifying the adjusting entries that need to be recorded in thejournal.

The order in which the adjustments are entered on the work sheet is not im-portant. Most accountants enter the adjustments in the order in which the data areassembled. If the titles of some of the accounts to be adjusted do not appear in thetrial balance, they should be inserted in the Account Title column, below the trialbalance totals, as needed.

To review, the entries in the Adjustments columns of the work sheet are:

(a) Supplies. The supplies account has a debit balance of $2,000. The cost of thesupplies on hand at the end of the period is $760. Therefore, the suppliesexpense for December is the difference between the two amounts, or $1,240.Enter the adjustment by writing (1) $1,240 in the Adjustments Debit column onthe same line as Supplies Expense and (2) $1,240 in the Adjustments Creditcolumn on the same line as Supplies.

(b) Prepaid Insurance. The prepaid insurance account has a debit balance of$2,400, which represents the prepayment of insurance for 24 months beginningDecember 1. Thus, the insurance expense for December is $100 ($2,400/24).Enter the adjustment by writing (1) $100 in the Adjustments Debit column on

•Exhibit 2•Exhibit 2 Work Sheet with Unadjusted Trial Balance Entered

NetSolutions Work Sheet

For the Two Months Ended December 31, 2005

Cash

Accounts Receivable

Supplies

Prepaid Insurance

Land

Office Equipment

Accounts Payable

Unearned Rent

Capital Stock

Dividends

Fees Earned

Wages Expense

Rent Expense

Utilities Expense

Supplies Expense

Miscellaneous Expense

2,065

2,220

2,000

2,400

20,000

1,800

4,000

4,275

1,600

985

800

455

42,600

900

360

25,000

16,340

42,600

Account Title

Trial Balance

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

Dr. Cr.

AdjustedTrial BalanceAdjustments

Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.

Balance SheetIncome

Statement

The work sheet is used for sum-

marizing the effects of adjusting

entries. It also aids in preparing

financial statements.


the same line as Insurance Expense and (2) $100 in the Adjustments Creditcolumn on the same line as Prepaid Insurance.

(c) Unearned Rent. The unearned rent account has a credit balance of $360, whichrepresents the receipt of three months’ rent, beginning with December. Thus,the rent revenue for December is $120. Enter the adjustment by writing (1) $120in the Adjustments Debit column on the same line as Unearned Rent and (2)$120 in the Adjustments Credit column on the same line as Rent Revenue.

(d) Wages. Wages accrued but not paid at the end of December total $250. Thisamount is an increase in expenses and an increase in liabilities. Enter the ad-justment by writing (1) $250 in the Adjustments Debit column on the same lineas Wages Expense and (2) $250 in the Adjustments Credit column on the sameline as Wages Payable.

(e) Accrued Fees. Fees accrued at the end of December but not recorded total$500. This amount is an increase in an asset and an increase in revenue. Enterthe adjustment by writing (1) $500 in the Adjustments Debit column on the sameline as Accounts Receivable and (2) $500 in the Adjustments Credit column onthe same line as Fees Earned.

(f) Depreciation. Depreciation of the office equipment is $50 for December. Enterthe adjustment by writing (1) $50 in the Adjustments Debit column on the sameline as Depreciation Expense and (2) $50 in the Adjustments Credit column onthe same line as Accumulated Depreciation.

Total the Adjustments columns to verify the mathematical accuracy of the adjust-ment data. The total of the Debit column must equal the total of the Credit column.

Adjusted Trial Balance ColumnsThe adjustment data are added to or subtracted from the amounts in the unadjustedTrial Balance columns. The adjusted amounts are then extended to (placed in) theAdjusted Trial Balance columns, as shown in Exhibit 3. For example, the cashamount of $2,065 is extended to the Adjusted Trial Balance Debit column, sinceno adjustments affected Cash. Accounts Receivable has an initial balance of $2,220and a debit adjustment (increase) of $500. The amount to write in the AdjustedTrial Balance Debit column is the debit balance of $2,720. The same procedurecontinues until all account balances are extended to the Adjusted Trial Balancecolumns. Total the columns of the Adjusted Trial Balance to verify the equality ofdebits and credits.

Income Statement and Balance SheetColumnsThe work sheet is completed by extending the adjusted trial balance amounts to theIncome Statement and Balance Sheet columns. The amounts for revenues and ex-penses are extended to the Income Statement columns. The amounts for assets, li-abilities, owner’s capital, and drawing are extended to the Balance Sheet columns.1

In the NetSolutions work sheet, the first account listed is Cash, and the balanceappearing in the Adjusted Trial Balance Debit column is $2,065. Cash is an asset,is listed on the balance sheet, and has a debit balance. Therefore, $2,065 is ex-tended to the Balance Sheet Debit column. The Fees Earned balance of $16,840 isextended to the Income Statement Credit column. The same procedure continuesuntil all account balances have been extended to the proper columns, as shown inExhibit 4 (page 145).

After all of the balances have been extended to the four statement columns, to-tal each of these columns, as shown in Exhibit 5. The difference between the two

1The balances of the retained earnings and dividends accounts are also extended to the Balance Sheet columns becausethis work sheet does not provide for separate Retained Earnings Statement columns.


•Exhibit 3•Exhibit 3 Work Sheet with Unadjusted Trial Balance, Adjustments, and Adjusted Trial Balance Entered



Cash

Accounts Receivable

Supplies

Prepaid Insurance

Land

Office Equipment

Accounts Payable

Unearned Rent

Capital Stock

Dividends

Fees Earned

Wages Expense

Rent Expense

Utilities Expense

Supplies Expense


Insurance Expense

Rent Revenue

Wages Payable

Depreciation Expense

Accumulated Depreciation

2,065

2,220

2,000

2,400

20,000

1,800

4,000

4,275

1,600

985

800

455

42,600

900

360

25,000

16,340

42,600

Account Title

Trial Balance

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

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

(e) 500

(c) 120

(d) 250

(a)1,240

(b) 100

(f) 50

2,260

2,065

2,720

760

2,300

20,000

1,800

4,000

4,525

1,600

985

2,040

455

100

50

43,400

(a)1,240

(b) 100

(e) 500

(c) 120

(d) 250

(f) 50

2,260

900

240

25,000

16,840

120

250

50

43,400

Dr. Cr.



Balance SheetIncome

Statement

Accounts are added, as

needed, to complete the

adjustments.

The adjustments on the

work sheet are used in

preparing the adjusting

journal entries.

The adjusted trial balance

amounts are determined by

adding the adjustments to or

subtracting the adjustments from

the trial balance amounts. For

example, the Wages Expense

debit of $4,525 is the trial bal-

ance amount of $4,275 plus the

$250 adjustment debit.

Income Statement column totals is the amount of the net income or the net loss forthe period. Likewise, the difference between the two Balance Sheet column totalsis also the amount of the net income or net loss for the period.

If the Income Statement Credit column total (representing total revenue) is greaterthan the Income Statement Debit column total (representing total expenses), the dif-ference is the net income. If the Income Statement Debit column total is greaterthan the Income Statement Credit column total, the difference is a net loss. For Net-Solutions, the computation of net income is as follows:

Total of Credit column (revenues) $16,960Total of Debit column (expenses) 9,755Net income (excess of revenues over expenses) $ 7,205

As shown in Exhibit 5 (page 146), write the amount of the net income, $7,205,in the Income Statement Debit column and the Balance Sheet Credit column. Write


the term Net income in the Account Title column. If there was a net loss instead ofnet income, you would write the amount in the Income Statement Credit columnand the Balance Sheet Debit column and the term Net loss in the Account Title col-umn. Inserting the net income or net loss in the statement columns on the worksheet shows the effect of transferring the net balance of the revenue and expenseaccounts to the retained earnings account. Later in this chapter, we explain how tojournalize this transfer.

After the net income or net loss has been entered on the work sheet, again totaleach of the four statement columns. The totals of the two Income Statement columnsmust now be equal. The totals of the two Balance Sheet columns must also be equal.

•Exhibit 4•Exhibit 4 Work Sheet with Amounts Extended to Income Statement and Balance Sheet Columns



Cash

Accounts Receivable

Supplies

Prepaid Insurance

Land

Office Equipment

Accounts Payable

Unearned Rent

Capital Stock

Dividends

Fees Earned

Wages Expense

Rent Expense

Utilities Expense

Supplies Expense


Insurance Expense

Rent Revenue

Wages Payable



2,065

2,220

2,000

2,400

20,000

1,800

4,000

4,275

1,600

985

800

455

42,600

900

360

25,000

16,340

42,600

Account Title

Trial Balance

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

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

(e) 500

(c) 120

(d) 250

(a)1,240

(b) 100

(f) 50

2,260

2,065

2,720

760

2,300

20,000

1,800

4,000

4,525

1,600

985

2,040

455

100

50

43,400

(a)1,240

(b) 100

(e) 500

(c) 120

(d) 250

(f) 50

2,260

900

240

25,000

16,840

120

250

50

43,400

4,525

1,600

985

2,040

455

100

50

16,840

120

2,065

2,720

760

2,300

20,000

1,800

4,000

900

240

25,000

250

50

Dr. Cr.



Balance SheetIncome

Statement

The revenue and

expense amounts

are extended

to (placed in) the

Income Statement

columns.

The asset, liability,

capital stock, and

dividends amounts

are extended to

(placed in) the Ba-

lance Sheet columns.

If the total of the Balance SheetDebit column of the work sheetis $350,000 and the total of theBalance Sheet Credit column is$400,000, what is the net incomeor net loss?

$50,000 net loss ($350,000 �$400,000)


The work sheet is an aid in preparing the income statement, the re-tained earnings statement, and the balance sheet, which are presentedin Exhibit 6. In the following paragraphs, we discuss these financialstatements for NetSolutions, prepared from the completed work sheetin Exhibit 5. The statements are similar in form to those presented inChapter 1.

o b j e c t i v e 3Prepare financial statementsfrom a work sheet.

FFinancial Statements

•Exhibit 5•Exhibit 5 Completed Work Sheet with Net Income Shown



Cash

Accounts Receivable

Supplies

Prepaid Insurance

Land

Office Equipment

Accounts Payable

Unearned Rent

Capital Stock

Dividends

Fees Earned

Wages Expense

Rent Expense

Utilities Expense

Supplies Expense


Insurance Expense

Rent Revenue

Wages Payable



Net income

2,065

2,220

2,000

2,400

20,000

1,800

4,000

4,275

1,600

985

800

455

42,600

900

360

25,000

16,340

42,600

Account Title

Trial Balance

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

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

(e) 500

(c) 120

(d) 250

(a)1,240

(b) 100

(f) 50

2,260

2,065

2,720

760

2,300

20,000

1,800

4,000

4,525

1,600

985

2,040

455

100

50

43,400

(a)1,240

(b) 100

(e) 500

(c) 120

(d) 250

(f) 50

2,260

900

240

25,000

16,840

120

250

50

43,400

4,525

1,600

985

2,040

455

100

50

9,755

7,205

16,960

16,840

120

16,960

16,960

2,065

2,720

760

2,300

20,000

1,800

4,000

33,645

33,645

900

240

25,000

250

50

26,440

7,205

33,645

Dr. Cr.



Balance SheetIncome

Statement

The difference between the Income State-

ment column totals is the net income (or net

loss) for the period. The difference between

the Balance Sheet column totals is also the

net income (or net loss) for the period.


NetSolutionsIncome Statement

For the Two Months Ended December 31, 2005$16 8 4 0 00

1 2 0 00

$ 4 5 2 5 00

2 0 4 0 00

1 6 0 0 00

9 8 5 00

1 0 0 00

5 0 00

4 5 5 00

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 9 6 0 00

9 7 5 5 00

$ 7 2 0 5 00

NetSolutionsRetained Earnings Statement

For the Two Months Ended December 31, 2005Net income for November and December

Less dividends

Retained earnings, December 31, 2005

$ 7 2 0 5 00

4 0 0 0 00

$ 3 2 0 5 00

NetSolutionsBalance Sheet

December 31, 2005

Current assets:

Cash

Accounts receivable

Supplies

Prepaid insurance

Total current assets

Property, plant, and equipment:

Land

Office equipment $1,800

Less accum. depr. 50

Total property, plant,

and equipment

Total assets

$ 7 8 4 5 00

21 7 5 0 00

$29 5 9 5 00

$ 2 0 6 5 00

2 7 2 0 00

7 6 0 00

2 3 0 0 00

$20 0 0 0 00

1 7 5 0 00

Current liabilities:

Accounts payable

Wages payable

Unearned rent

Total liabilities

$ 9 0 0 00

2 5 0 00

2 4 0 00

Capital stock

Retained earnings

Total liabilities and

stockholders’ equity

Liabilities

Stockholders’ Equity

Assets

$ 1 3 9 0 00

$25 0 0 0 00

3 2 0 5 00

$29 5 9 5 00

•Exhibit 6•Exhibit 6 Financial Statements Prepared from Work Sheet

Income StatementThe income statement is normally prepared directly from the work sheet. However,the order of the expenses may be changed. As we did in Chapter 1, we list the ex-penses in the income statement in Exhibit 6 in order of size, beginning with thelarger items. Miscellaneous expense is the last item, regardless of its amount.


THE ROUND TRIP

product to C and is paid with the money just loaned toC! This looks like a sale in the accounting records, but inreality, S is shipping free product. The fraud is exposedwhen it is determined that there was no intent to repaythe original loan.

I N T E G R I T Y I N B U S I N E S SI N T E G R I T Y I N B U S I N E S S

Retained Earnings StatementThe first item normally presented on the retained earnings statement is the balanceof the retained earnings account at the beginning of the period. Since NetSolutionsbegan operations on November 1, this balance is zero in Exhibit 5. Then, the re-tained earnings statement shows the net income for the two months ended Decem-ber 31, 2005. The amount of dividends is deducted from the net income to arrive atthe retained earnings as of December 31, 2005.

For the following period, the beginning balance of retained earnings for NetSolu-tions is the ending balance that was reported for the previous period. For example,assume that during 2006, NetSolutions earned net income of $59,595 and paid div-idends of $24,000. The retained earnings statement for the year ending December31, 2006, for NetSolutions is as follows:

AA common type of fraud involves artificially inflating rev-enue. One fraudulent method of inflating revenue is called“round tripping.” Under this scheme, a selling company (S)“lends” money to a customer company (C). The money isthen used by C to purchase a product from S. Thus, S sells

NetSolutionsRetained Earnings Statement

For the Year Ended December 31, 2006

$659 5 9 5 00

24 0 0 0 00

Retained earnings, January 1, 2005

Net income for the year

Less dividends

Increase in retained earnings

Retained earnings, December 31, 2006

$ 3 2 0 5 00

35 5 9 5 00

$38 8 0 0 00

I’m one of theworld’s largest hoteloperating companies,with names such as

these under my roof: Sheraton,Westin, St. Regis, W, Ciga, LuxuryCollection and Four Points. Someof my better known units includethe St. Regis in New York; thePhoenician in Scottsdale, Ariz.;the Hotel Danieli in Venice; andthe Palace Hotel in Madrid. MyWestin division recently boughtnine legendary luxury hotels inEurope. I own, lease, manage orfranchise more than 700 hotelswith more than 217,000 roomsin some 80 countries. I aim toincrease earnings per share by15 percent annually. Who am I?(Go to page 169 for answer.)

For NetSolutions, the amount of dividends was less than the net income. If thedividends had exceeded the net income, the order of the net income and the divi-dends could have been reversed. The difference between the two items would thenbe deducted from the beginning Retained Earnings balance. Other factors, such asa net loss, may also require some change in the form of the retained earnings state-ment, as shown in the following example:

Retained earnings, January 1, 20— . . . . . . . . . . . $45,000Net loss for the year . . . . . . . . . . . . . . . . . . . . . $5,600Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9,500Decrease in retained earnings . . . . . . . . . . . . . . 15,100Retained earnings, December 31, 20— . . . . . . . . $29,900

Some accountants prefer to debit dividends directly to Retained Earnings. Whenyou are preparing a retained earnings statement and there is no dividends accountin the ledger, you will need to refer to the retained earnings account to determinethe beginning balance of Retained Earnings and the amount of the dividends paidduring the period.


Balance SheetThe balance sheet in Exhibit 6 was expanded by adding subsections for current as-sets; property, plant, and equipment; and current liabilities. Such a balance sheet isa classified balance sheet. In the following paragraphs, we describe some of thesections and subsections that may be used in a balance sheet. We will introduceadditional sections in later chapters.

AssetsAssets are commonly divided into classes for presentation on the balance sheet. Twoof these classes are (1) current assets and (2) property, plant, and equipment.

Current Assets Cash and other assets that are expected to be con-verted to cash or sold or used up usually within one year or less,through the normal operations of the business, are called current as-sets. In addition to cash, the current assets usually owned by a ser-vice business are notes receivable, accounts receivable, supplies, andother prepaid expenses.

Notes receivable are amounts customers owe. They are writtenpromises to pay the amount of the note and possibly interest at an

agreed-upon rate. Accounts receivable are also amounts customersowe, but they are less formal than notes and do not provide for interest. Accountsreceivable normally result from providing services or selling merchandise on ac-count. Notes receivable and accounts receivable are current assets because they willusually be converted to cash within one year or less.

Property, Plant, and Equipment The property, plant, and equipment sectionmay also be described as fixed assets or plant assets. These assets include equip-ment, machinery, buildings, and land. With the exception of land, as we discussedin Chapter 3, fixed assets depreciate over a period of time. The cost, accumulateddepreciation, and book value of each major type of fixed asset is normally reportedon the balance sheet or in accompanying notes.

LiabilitiesLiabilities are the amounts the business owes to creditors. The twomost common classes of liabilities are (1) current liabilities and (2)long-term liabilities.

Current Liabilities Liabilities that will be due within a short time(usually one year or less) and that are to be paid out of current as-

sets are called current liabilities. The most common liabilities in thisgroup are notes payable and accounts payable. Other current liability accountscommonly found in the ledger are Wages Payable, Interest Payable, Taxes Payable,and Unearned Fees.

Long-Term Liabilities Liabilities that will not be due for a long time (usually morethan one year) are called long-term liabilities. If NetSolutions had long-term lia-bilities, they would be reported below the current liabilities. As long-term liabil-ities come due and are to be paid within one year, they are classified as currentliabilities. If they are to be renewed rather than paid, they would continue to beclassified as long-term. When an asset is pledged as security for a liability, the oblig-ation may be called a mortgage note payable or a mortgage payable.

Stockholders’ EquityThe stockholders’ right to the assets of the business is presented on the balancesheet below the liabilities section. The stockholders’ equity is added to the total li-abilities, and this total must be equal to the total assets.

Two common classes ofassets are current assets andproperty, plant, andequipment.

Two common classes ofliabilities are current liabilitiesand long-term liabilities.


As we discussed in Chapter 3, the adjusting entries are recorded in the journal atthe end of the accounting period. If a work sheet has been prepared, the data forthese entries are in the Adjustments columns. For NetSolutions, the adjusting entriesprepared from the work sheet are shown in Exhibit 7.

After the adjusting entries have been posted to NetSolutions’ ledger,shown in Exhibit 11 (on pages 153–157), the ledger is in agreement withthe data reported on the financial statements. The balances of the ac-counts reported on the balance sheet are carried forward from year toyear. Because they are relatively permanent, these accounts are calledreal accounts. The balances of the accounts reported on the income statement arenot carried forward from year to year. Likewise, the balance of the dividends ac-count, which is reported on the retained earnings statement, is not carried forward.Because these accounts report amounts for only one period, they are called tem-porary accounts or nominal accounts.

o b j e c t i v e 4Prepare the adjusting andclosing entries from a worksheet.

1 2 4 0 00

1 0 0 00

1 2 0 00

2 5 0 00

5 0 0 00

5 0 00

1 2 4 0 00

1 0 0 00

1 2 0 00

2 5 0 00

5 0 0 00

5 0 00

Supplies Expense

Supplies

Insurance Expense

Prepaid Insurance

Unearned Rent

Rent Revenue

Wages Expense

Wages Payable

Accounts Receivable

Fees Earned


Accumulated Depreciation––

Office Equipment

JOURNAL Page 5

Date DescriptionPost.Ref. Debit Credit

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

Dec.2005 31

31

31

31

31

31

55

14

56

15

23

42

51

22

12

41

53

19

Adjusting Entries

To report amounts for only one period, temporary accounts should havezero balances at the beginning of a period. How are these balances convertedto zero? The revenue and expense account balances are transferred to an ac-count called Income Summary. The balance of Income Summary is thentransferred to the retained earnings account. The balance of the dividends ac-count is also transferred to the retained earnings account. The entries thattransfer these balances are called closing entries. The transfer process iscalled the closing process. Exhibit 8 is a diagram of this process.

Closing entries transfer thebalances of temporaryaccounts to the retainedearnings account.

AAdjusting and Closing Entries

•Exhibit 7•Exhibit 7Adjusting Entries forNetSolutions


INCOME SUMMARY

T H E C LO S I N G P R O C E S S

11REVENUES

are transferred to Income Summary

22EXPENSES

are transferred to Income Summary

33NET INCOME or NET LOSS

is transferred to Retained Earnings

44DIVIDENDS

are transferred toRetained Earnings

Retained Earnings

You should note that Income Summary is used only at the end ofthe period. At the beginning of the closing process, Income Summaryhas no balance. During the closing process, Income Summary will bedebited and credited for various amounts. At the end of the closingprocess, Income Summary will again have no balance. Because In-come Summary has the effect of clearing the revenue and expenseaccounts of their balances, it is sometimes called a clearing account.

Other titles used for this account include Revenue and Expense Sum-mary, Profit and Loss Summary, and Income and Expense Summary.

It is possible to close the temporary revenue and expense accounts without us-ing a clearing account such as Income Summary. In this case, the balances of therevenue and expense accounts are closed directly to the retained earnings account.This process is automatic in a computerized accounting system. In a manual sys-tem, the use of an income summary account aids in detecting and correcting errors.

Journalizing and Posting Closing EntriesFour closing entries are required at the end of an accounting period, as outlined inExhibit 8. The account titles and balances needed in preparing these entries may beobtained from the work sheet, the income statement and the retained earningsstatement, or the ledger. If a work sheet is used, the data for the first two entriesappear in the Income Statement columns. The amount for the third entry is the netincome or net loss appearing at the bottom of the work sheet. The amount for thefourth entry is the dividends account balance that appears in the Balance Sheet Debitcolumn of the work sheet.

A flowchart of the closing entries for NetSolutions is shown in Exhibit 9. The bal-ances in the accounts are those shown in the Adjusted Trial Balance columns of thework sheet in Exhibit 3.

The closing entries for NetSolutions are shown in Exhibit 10. After the closingentries have been posted to the ledger, as shown in Exhibit 11 (on pages 153–157),the balance in the retained earnings account will agree with the amount reportedon the retained earnings statement and the balance sheet. In addition, the revenue,expense, and dividend accounts will have zero balances.

After the entry to close an account has been posted, a line should be inserted inboth balance columns opposite the final entry. The next period’s transactions forthe revenue, expense, and dividends accounts will be posted directly below the clos-ing entry.

The income summary accountdoes not appear on thefinancial statements.

If total revenues are $600,000,total expenses are $525,000, anddividends are $50,000, what is thebalance of the income summaryaccount that is closed to retainedearnings?

$75,000 ($600,000 � $525,000).The dividends account balance isclosed directly to retained earnings,rather than to Income Summary.

•Exhibit 8•Exhibit 8



Wages Expense

Bal. 4,525 4,525

Rent Expense

Bal. 1,600 1,600


Bal. 50 50

Utilities Expense

Bal. 985 985

Supplies Expense

Bal. 2,040 2,040

Insurance Expense

Bal. 100 100


Bal. 455 455

Retained Earnings

Bal.4,000 07,205

Dividends

Bal. 4,000 4,000

Income Summary

9,7557,205

16,960

Fees Earned

Bal.16,840 16,840

Rent Revenue

Bal.120 120

1. Debit each revenue account for the amount of its balance, and credit Income Summary for the total revenue.2. Debit Income Summary for the total expenses, and credit each expense account for the amount of its balance.3. Debit Income Summary for the amount of its balance (net income), and credit the retained earnings account for the same amount. (The accounts debited and credited are reversed if there is a net loss.)4. Debit the retained earnings account for the balance of the dividends account, and credit the dividends account for the same amount.

①②

③

④

16 9 6 0 00

4 5 2 5 00

1 6 0 0 00

5 0 00

9 8 5 00

2 0 4 0 00

1 0 0 00

4 5 5 00

7 2 0 5 00

4 0 0 0 00

16 8 4 0 00

1 2 0 00

9 7 5 5 00

7 2 0 5 00

4 0 0 0 00

Fees Earned

Rent Revenue

Income Summary

Income Summary

Wages Expense

Rent Expense


Utilities Expense

Supplies Expense

Insurance Expense


Income Summary

Retained Earnings

Retained Earnings

Dividends

JOURNAL Page 6


1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

Dec.2005 31

31

31

31

41

42

34

34

51

52

53

54

55

56

59

34

32

32

33

Closing Entries

•Exhibit 9•Exhibit 9 Flowchart of Closing Entries for NetSolutions

•Exhibit 10•Exhibit 10 Closing Entries for NetSolutions


1

1

1

1

1

2

2

2

2

2

2

3

3

3

3

3

3

3

4

4

4

LEDGER

ACCOUNT NO. 11

Date ItemPost.Ref. Debit Credit

Nov. 1

5

18

30

30

30

1

1

1

6

11

13

16

20

21

23

27

31

31

31

31

2005 25 0 0 0 00

5 0 0 0 00

12 5 0 0 00

8 8 5 0 00

7 9 0 0 00

5 9 0 0 00

3 5 0 0 00

2 7 0 0 00

3 0 6 0 00

2 8 8 0 00

2 4 8 0 00

1 5 3 0 00

4 6 3 0 00

3 7 3 0 00

4 3 8 0 00

2 9 3 0 00

1 7 3 0 00

1 4 2 0 00

1 1 9 5 00

4 0 6 5 00

2 0 6 5 00

ACCOUNT Cash

Debit Credit

20 0 0 0 00

3 6 5 0 00

9 5 0 00

2 0 0 0 00

2 4 0 0 00

8 0 0 00

1 8 0 00

4 0 0 00

9 5 0 00

9 0 0 00

1 4 5 0 00

1 2 0 0 00

3 1 0 00

2 2 5 00

2 0 0 0 00

25 0 0 0 00

7 5 0 0 00

3 6 0 00

3 1 0 0 00

6 5 0 00

2 8 7 0 00

Balance

Dec.

3

3

4

5

ACCOUNT NO. 12


Dec. 16

21

31

31

20051 7 5 0 00

1 1 0 0 00

2 2 2 0 00

2 7 2 0 00

ACCOUNT Accounts Receivable

Debit Credit

6 5 0 00

1 7 5 0 00

1 1 2 0 00

5 0 0 00

Balance

Adjusting

1

1

3

5

ACCOUNT NO. 14


Nov. 10

30

23

31

20051 3 5 0 00

5 5 0 00

2 0 0 0 00

7 6 0 00

ACCOUNT Supplies

Debit Credit

8 0 0 00

1 2 4 0 00

1 3 5 0 00

1 4 5 0 00

Balance

AdjustingDec.

•Exhibit 11•Exhibit 11 Ledger for NetSolutions


2

5

ACCOUNT NO. 15


Dec. 1

31

20052 4 0 0 00

2 3 0 0 00

ACCOUNT Prepaid Insurance

Debit Credit

1 0 0 00

2 4 0 0 00

Balance

Adjusting

1

ACCOUNT NO. 17


Nov. 52005

ACCOUNT Land

Debit Credit

20 0 0 0 00 20 0 0 0 00

Balance

— —

2

ACCOUNT NO. 18


Dec. 42005

ACCOUNT Office Equipment

Debit Credit

1 8 0 0 00 1 8 0 0 00

Balance

— —

5

ACCOUNT NO. 19


Dec. 312005

ACCOUNT Accumulated Depreciation

Debit Credit

5 0 00 5 0 00

Balance

— —

Adjusting

1

1

2

2

3

ACCOUNT NO. 21


Nov. 10

30

4

11

20

20051 3 5 0 00

4 0 0 00

2 2 0 0 00

1 8 0 0 00

9 0 0 00

ACCOUNT Accounts Payable

Debit Credit

1 3 5 0 00

1 8 0 0 00

9 5 0 00

4 0 0 00

9 0 0 00

Balance

Dec.

5

ACCOUNT NO. 22


Dec. 312005

ACCOUNT Wages Payable

Debit Credit

2 5 0 00 2 5 0 00

Balance

— —

Adjusting

•Exhibit 11•Exhibit 11(continued)


2

5

ACCOUNT NO. 23


Dec. 1

31

20053 6 0 00

2 4 0 00

ACCOUNT Unearned Rent

Debit Credit

3 6 0 00

1 2 0 00

Balance

Adjusting

1

ACCOUNT NO. 31


Nov. 12005

25 0 0 0 00

ACCOUNT Capital Stock

Debit Credit

25 0 0 0 00

Balance

6

6

ACCOUNT NO. 32


Dec. 31

31

20057 2 0 5 00

3 2 0 5 00

ACCOUNT Retained Earnings

Debit Credit

7 2 0 5 00

4 0 0 0 00

Balance

Closing

Closing

2

4

6

ACCOUNT NO. 33


Nov. 30

31

31

20052 0 0 0 00

4 0 0 0 00

ACCOUNT Dividends

Debit Credit

4 0 0 0 00

2 0 0 0 00

2 0 0 0 00

Balance

Dec.

Closing — —

6

6

6

ACCOUNT NO. 34


Dec. 31

31

31

200516 9 6 0 00

7 2 0 5 00

ACCOUNT Income Summary

Debit Credit

16 9 6 0 00

9 7 5 5 00

7 2 0 5 00

Balance

Closing

Closing

Closing — —



1

3

3

4

4

5

6

ACCOUNT NO. 41


Nov. 18

16

16

31

31

31

31

20057 5 0 0 00

10 6 0 0 00

12 3 5 0 00

15 2 2 0 00

16 3 4 0 00

16 8 4 0 00

ACCOUNT Fees Earned

Debit Credit

7 5 0 0 00

3 1 0 0 00

1 7 5 0 00

2 8 7 0 00

1 1 2 0 00

5 0 0 00

16 8 4 0 00

Balance

Dec.

Adjusting

Closing ——

5

6

ACCOUNT NO. 42


Dec. 31

31

20051 2 0 00

ACCOUNT Rent Revenue

Debit Credit

1 2 0 00

1 2 0 00

Balance

Adjusting

Closing — —

1

3

3

5

6

ACCOUNT NO. 51


Nov. 30

13

27

31

31

20052 1 2 5 00

3 0 7 5 00

4 2 7 5 00

4 5 2 5 00

ACCOUNT Wages Expense

Debit Credit

4 5 2 5 00

2 1 2 5 00

9 5 0 00

1 2 0 0 00

2 5 0 00

Balance

Dec.

Adjusting

Closing — —

1

2

6

ACCOUNT NO. 52


Nov. 30

1

31

20058 0 0 00

1 6 0 0 00

ACCOUNT Rent Expense

Debit Credit

1 6 0 0 00

8 0 0 00

8 0 0 00

Balance

Closing — —Dec.



5

6

ACCOUNT NO. 53


Dec. 31

31

2005

ACCOUNT Depreciation Expense

Debit Credit

5 0 00

5 0 00 5 0 00

Balance

Adjusting

Closing — —

1

3

4

6

ACCOUNT NO. 54


Nov. 30

31

31

31

20054 5 0 00

7 6 0 00

9 8 5 00

ACCOUNT Utilities Expense

Debit Credit

9 8 5 00

4 5 0 00

3 1 0 00

2 2 5 00

Balance

Closing

Dec.

— ––

1

5

6

ACCOUNT NO. 55


Nov. 30

31

31

20058 0 0 00

2 0 4 0 00

ACCOUNT Supplies Expense

Debit Credit

2 0 4 0 00

8 0 0 00

1 2 4 0 00

Balance

Adjusting

Closing — —Dec.

5

6

ACCOUNT NO. 56


Dec. 31

31

2005

ACCOUNT Insurance Expense

Debit Credit

1 0 0 00

1 0 0 00 1 0 0 00

Balance

Adjusting

Closing — —

1

2

6

ACCOUNT NO. 59


Nov. 30

6

31

20052 7 5 00

4 5 5 00

ACCOUNT Miscellaneous Expense

Debit Credit

4 5 5 00

2 7 5 00

1 8 0 00

Balance

Closing — —Dec.

•Exhibit 11•Exhibit 11(concluded)


NetSolutionsPost-Closing Trial Balance

December 31, 2005

5 0 00

9 0 0 00

2 5 0 00

2 4 0 00

25 0 0 0 00

3 2 0 5 00

29 6 4 5 00

2 0 6 5 00

2 7 2 0 00

7 6 0 00

2 3 0 0 00

20 0 0 0 00

1 8 0 0 00

29 6 4 5 00

Cash

Accounts Receivable

Supplies

Prepaid Insurance

Land

Office Equipment


Accounts Payable

Wages Payable

Unearned Rent

Capital Stock

Retained Earnings

INTERNATIONAL DIFFERENCES

of balance sheet is organized to emphasize creditor inter-pretation and analysis. For example, current assets and cur-rent liabilities are presented first, so that working capital(current assets � current liabilities) and the current ratio(current assets � current liabilities) can be easily com-puted. Likewise, to emphasize their importance, liabilitiesare reported before owner’s equity.

Regardless of these differences, the basic principles un-derlying the accounting equation and the double-entry ac-counting system are the same in Germany and the UnitedStates. Even though differences in recording and report-ing exist, the accounting equation holds true: the total as-sets still equal the total liabilities and owner’s equity.

F I N A N C I A L R E P O R T I N G A N D D I S C L O S U R EF I N A N C I A L R E P O R T I N G A N D D I S C L O S U R E

Post-Closing Trial BalanceThe last accounting procedure for a period is to prepare a trial balance after theclosing entries have been posted. The purpose of the post-closing (after closing)trial balance is to make sure that the ledger is in balance at the beginning of thenext period. The accounts and amounts should agree exactly with the accounts andamounts listed on the balance sheet at the end of the period. The post-closing trialbalance for NetSolutions is shown in Exhibit 12.

Instead of preparing a formal post-closing trial balance, it is possible to list the ac-counts directly from the ledger, using a computer. The computer printout, in effect,becomes the post-closing trial balance. Without such a printout, there is no efficientmeans of determining the cause of unequal trial balance totals.

•Exhibit 12•Exhibit 12Post-Closing TrialBalance

FF inancial statements prepared under accounting prac-tices in other countries often differ from those preparedunder generally accepted accounting principles found inthe United States. This is to be expected, since culturesand market structures differ from country to country.

To illustrate, BMW Group prepares its financial state-ments under German law and German accounting princi-ples. In doing so, BMW’s balance sheet reports fixed assetsfirst, followed by current assets. It also reports owner’sequity before the liabilities. In contrast, balance sheets pre-pared under U.S. accounting principles report current as-sets followed by fixed assets and current liabilities followedby long-term liabilities and owner’s equity. The U.S. form


Balance sheetDec. 31, 2004

DEC.31

2 0 0 4

F I N A N C I A L H I STO RY O F A B U S I N E S S

Income statementfor the year ended

Dec. 31, 2004


DEC.31

2 0 0 5Income statementfor the year ended

Dec. 31, 2005


DEC.31

2 0 0 6Income statementfor the year ended

Dec. 31, 2006

You may think of the income statements, balance sheets, andfinancial history of a business as similar to the record of a collegefootball team. The final score of each football game is similar tothe net income reported on the income statement of a business.The team’s season record after each game is similar to the balancesheet. At the end of the season, the final record of the team mea-sures its success or failure. Likewise, at the end of a life of a busi-ness, its final balance sheet is a measure of its financial successor failure.

In the NetSolutions illustration, operations began on November 1 andthe accounting period was for two months, November and December.Since Chris Clark, the sole stockholder, decided to adopt a calendar-yearaccounting period, NetSolutions’ accounts were closed on December 31,2005. In future years, the financial statements for NetSolutions will beprepared for twelve months ending on December 31 each year.

The annual accounting period adopted by a business is known as its fiscal year.Fiscal years begin with the first day of the month selected and end on the last dayof the following twelfth month. The period most commonly used is the calendaryear. Other periods are not unusual, especially for businesses organized as corpo-rations. For example, a corporation may adopt a fiscal year that ends when busi-ness activities have reached the lowest point in its annual operating cycle. Such afiscal year is called the natural business year. At the low point in its operatingcycle, a business has more time to analyze the results of operations and to preparefinancial statements.

Because companies with fiscal years often have highly seasonal operations, in-vestors and others should be careful in interpreting partial-year reports for such com-panies. That is, you should expect the results of operations for these companies tovary significantly throughout the fiscal year.

The financial history of a business may be shown by a series of balance sheetsand income statements for several fiscal years. If the life of a business is expressedby a line moving from left to right, the series of balance sheets and income state-ments may be graphed as follows:

o b j e c t i v e 5Explain what is meant by thefiscal year and the naturalbusiness year.

Percentage of Companies with Fiscal Years Ending in:

January 5% July 1%February 2 August 3March 3 September 6April 1 October 3May 3 November 3June 8 December 62

Source: Accounting Trends & Techniques, 56th edition, 2002(New York: American Institute of Certified Public Accountants).

FFiscal Year


WHAT’S NEXT FOR AMAZON?

tive of their prices and have refused to make Amazon.coman authorized dealer. As Lauren Levitan, a noted financialanalyst, recently said, “It’s hard to be the low-cost retailer.You have to execute flawlessly on a very consistent basis.Most people who try a low-price strategy fail.” This risk offailing at the low-cost strategy was validated by Kmart’sfiling for bankruptcy protection in 2002 because of its in-ability to compete with Wal-Mart’s low prices.

Source: Saul Hansell, “A Profitable Amazon Looks to Do an Encore,”The New York Times, January 26, 2002.

S P O T L I G H T O N S T R A T E G YS P O T L I G H T O N S T R A T E G Y

The ability of a business to pays its debts is called solvency. Two financial mea-sures for evaluating a business’s short-term solvency are working capital and thecurrent ratio. Working capital is the excess of the current assets of a business overits current liabilities, as shown below.

Working capital � Current assets � Current liabilities

An excess of the current assets over the current liabilities implies that the businessis able to pay its current liabilities. If the current liabilities are greater than the cur-rent assets, the business may not be able to pay its debts and continue in business.

To illustrate, NetSolutions’ working capital at the end of 2005 is $6,455, as com-puted below. This amount of working capital implies that NetSolutions can pay itscurrent liabilities.

Working capital � Current assets � Current liabilitiesWorking capital � $7,845 � $1,390Working capital � $6,455

The current ratio is another means of expressing the relationship between cur-rent assets and current liabilities. The current ratio is computed by dividing currentassets by current liabilities, as shown below.

Current ratio � Current assets/Current liabilities

To illustrate, the current ratio for NetSolutions at the end of 2005 is 5.6, com-puted as follows:

Current ratio � Current assets/Current liabilitiesCurrent ratio � $7,845/$1,390 � 5.6

The current ratio is useful in making comparisons across companies and with in-dustry averages. To illustrate, assume that as of December 31, 2005, the workingcapital of a company that competes with NetSolutions is much greater than $6,455,but its current ratio is only 1.3. Considering these facts alone, NetSolutions is in amore favorable position to obtain short-term credit, even though the competing com-pany has a greater amount of working capital.

o b j e c t i v e 6Analyze and interpret the fi-nancial solvency of a businessby computing working capitaland the current ratio.

FFinancial Analysis and Interpretation

AAmazon.com built its online business strategy on of-fering books at significant discounts that traditional chainscouldn’t match. Over the years, Amazon has expanded itsonline offerings to include DVDs, toys, electronics, andeven kitchen appliances. But can its low-cost, discountstrategy continue to work across a variety of products?Some have their doubts. The electronics business has lowermargins and more competition than books. For example,Dell Computers is already an established low-costprovider of personal computers and software. In addition,some electronic manufacturers such as Sony are protec-


December

S M T W T F S

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 26 27 28

29 30 31

January

1 2 3 4

5 6 7 8 9 10 11Wages expense(paid), $1,275

Wages expense(accrued), $250

Wages expense(paid), $1,200

Wages expense(paid), $950

1.

2.

3.

Wages are paid on the second and fourth Fridays for the two-week periods ending onthose Fridays.

The wages accrued for Monday and Tuesday, December 30 and 31, are $250.

Wages paid on Friday, January 10, total $1,275.

AAppendix Reversing Entries

Some of the adjusting entries recorded at the end of an accounting period have animportant effect on otherwise routine transactions that occur in the following period.A typical example is accrued wages owed to employees at the end of a period. Ifthere has been an adjusting entry for accrued wages expense, the first payment ofwages in the following period will include the accrual. In the absence of somespecial provision, Wages Payable must be debited for the amount owed for the ear-lier period, and Wages Expense must be debited for the portion of the payroll thatrepresents expense for the later period. However, an optional entry—the reversingentry—may be used to simplify the analysis and recording of this first payroll entryin a period. As the term implies, a reversing entry is the exact opposite of theadjusting entry to which it relates. The amounts and accounts are the same as theadjusting entry; the debits and credits are reversed.

We will illustrate the use of reversing entries by using the data for NetSolutions’accrued wages, which were presented in Chapter 3. These data are summarized inExhibit 13.

•Exhibit 13•Exhibit 13 Accrued Wages


The adjusting entry for the accrued wages of December 30 and 31 is as follows:

2 5 0 0031 51

22

Wages Expense

Wages Payable 2 5 0 00

Dec.

After the adjusting entry has been posted, Wages Expense will have a debit bal-ance of $4,525 ($4,275 � $250), and Wages Payable will have a credit balance of$250. After the closing process is completed, Wages Expense will have a zero bal-ance and will be ready for entries in the next period. Wages Payable, on the otherhand, has a balance of $250. Without a reversing entry, it is necessary to record the$1,275 payroll on January 10 as follows:

The employee who records the January 10th entry must refer to the prior pe-riod’s adjusting entry to determine the amount of the debits to Wages Payable andWages Expense. Because the January 10th payroll is not recorded in the usual man-ner, there is a greater chance that an error may occur. This chance of error is re-duced by recording a reversing entry as of the first day of the fiscal period. Forexample, the reversing entry for the accrued wages expense is as follows:

2 5 0 00

1 0 2 5 00

10 22

51

11

Wages Payable

Wages Expense

Cash 1 2 7 5 00

Jan.2006

The reversing entry transfers the $250 liability from Wages Payable to the creditside of Wages Expense. The nature of the $250 is unchanged—it is still a liability.When the payroll is paid on January 10, the following entry is recorded:

2 5 0 001 22

51

Wages Payable

Wages Expense 2 5 0 00Jan.2006

After this entry is posted, Wages Expense has a debit balance of $1,025. Thisamount is the wages expense for the period January 1–10. The sequence of entries,including adjusting, closing, and reversing entries, is illustrated in the followingaccounts:

1 2 7 5 0010 51

11

Wages Expense

Cash 1 2 7 5 00

Jan.

ACCOUNT NO. 22


2005

ACCOUNT Wages Payable

Debit Credit

Balance

Dec.

Jan.

5

7

31

1 2 5 0 00

2 5 0 002 5 0 00

——

Adjusting

Reversing2006


1

3

3

5

6

7

7

ACCOUNT NO. 51


Nov. 30

13

27

31

31

1

10

2005

ACCOUNT Wages Expense

Debit Credit

4 5 2 5 00

2 5 0 00

2 1 2 5 00

9 5 0 00

1 2 0 0 00

2 5 0 00

1 2 7 5 00

Balance

Dec.

Adjusting

Closing

Reversing

——

2 5 0 00

2 1 2 5 00

3 0 7 5 00

4 2 7 5 00

4 5 2 5 00

1 0 2 5 00Jan.2006

Reversing entries may also be journalized for prepaid expenses that are initiallyrecorded as expenses and unearned revenues that are initially recorded as revenues.These situations are described and illustrated in Appendix C.

As we mentioned, the use of reversing entries is optional. However, with the in-creased use of computerized accounting systems, data entry personnel may be in-putting routine accounting entries. In such an environment, reversing entries maybe useful, since these individuals may not recognize the impact of adjusting entrieson the related transactions in the following period.

In addition to accrued expenses (accrued liabilities), reversing entries may bejournalized for accrued revenues (accrued assets). For example, the following re-versing entry could be recorded for NetSolutions’ accrued fees earned:

5 0 0 001 41

12

Fees Earned

Accounts Receivable 5 0 0 00

Jan.

KKey Points

dends to the Balance Sheet columns.The Adjusted Trial Balance amountsof revenues and expenses are ex-tended to the Income Statementcolumns. The net income (or netloss) for the period is entered on thework sheet in the Income StatementDebit (or Credit) column and theBalance Sheet Credit (or Debit) col-umn. Each of the four statementcolumns is then totaled.

3 Prepare financial statementsfrom a work sheet.

The income statement is normallyprepared directly from the worksheet. On the income statement, the

7. A post-closing trial balance is pre-pared.

2 Prepare a work sheet.

The work sheet is prepared by firstentering a trial balance in the TrialBalance columns. The adjustmentsare then entered in the AdjustmentsDebit and Credit columns. The TrialBalance amounts plus or minus theadjustments are extended to theAdjusted Trial Balance columns. Thework sheet is completed by ex-tending the Adjusted Trial Balanceamounts of assets, liabilities, capitalstock, retained earnings, and divi-

1 Review the seven basic stepsof the accounting cycle.

The basic steps of the accountingcycle are:

1. Transactions are analyzed andrecorded in a journal.

2. Transactions are posted to theledger.

3. A trial balance is prepared, adjust-ment data are assembled, and anoptional work sheet is completed.

4. Financial statements are prepared.5. Adjusting entries are journalized

and posted to the ledger.6. Closing entries are journalized

and posted to the ledger.


expenses are normally presented inthe order of size, from largest tosmallest.

The basic form of the retainedearnings statement is prepared bylisting the beginning balance of re-tained earnings, adding net incomeduring the period, and deductingdividends.

Various sections and subsectionsare often used in preparing a bal-ance sheet. Two common classes ofassets are current assets and fixedassets. Cash and other assets that arenormally expected to be convertedto cash or sold or used up within oneyear or less are called current assets.Property, plant, and equipment mayalso be called fixed assets or plantassets. The cost, accumulated de-preciation, and book value of eachmajor type of fixed asset are nor-mally reported on the balance sheet.

Two common classes of liabilitiesare current liabilities and long-termliabilities. Liabilities that will be duewithin a short time (usually one yearor less) and that are to be paid outof current assets are called currentliabilities. Liabilities that will not bedue for a long time (usually morethan one year) are called long-termliabilities.

The stockholders’ claim againstthe assets is presented below theliabilities section and added to the

total liabilities. The total liabilitiesand total stockholders’ equity mustequal the total assets.

4 Prepare the adjusting andclosing entries from a worksheet.

The data for journalizing the adjust-ing entries are in the Adjustmentscolumns of the work sheet. The fourentries required in closing the tem-porary accounts are:

1. Debit each revenue account forthe amount of its balance, andcredit Income Summary for thetotal revenue.

2. Debit Income Summary for thetotal expenses, and credit eachexpense account for the amountof its balance.

3. Debit Income Summary for theamount of its balance (net in-come), and credit the retainedearnings account for the sameamount. (Debit and credit are re-versed if there is a net loss.)

4. Debit the retained earnings ac-count for the balance of the div-idends account, and credit thedividends account for the sameamount.

After the closing entries have beenposted to the ledger, the balance inthe retained earnings account willagree with the amount reported onthe retained earnings statement and

balance sheet. In addition, the rev-enue, expense, and dividends ac-counts will have zero balances.

The last step of the accountingcycle is to prepare a post-closingtrial balance. The purpose of thepost-closing trial balance is to makesure that the ledger is in balance atthe beginning of the next period.

5 Explain what is meant by thefiscal year and the naturalbusiness year.

The annual accounting periodadopted by a business is known asits fiscal year. A corporation mayadopt a fiscal year that ends whenbusiness activities have reached thelowest point in its annual operatingcycle. Such a fiscal year is called thenatural business year.

6 Analyze and interpret the fi-nancial solvency of a businessby computing working capitaland the current ratio.

The ability of a business to pay itsdebts is called solvency. Two fi-nancial measures for evaluating abusiness’s short-term solvency areworking capital and the current ra-tio. Working capital is the excessof the current assets of a businessover its current liabilities. The cur-rent ratio is computed by dividingcurrent assets by current liabilities.

accounting cycle (140)clearing account (151)closing entries (150)closing process (150)current assets (149)current liabilities (149)current ratio (160)fiscal year (159)

fixed (plant) assets (149)Income Summary (150)long-term liabilities (149)natural business year (159)notes receivable (149)post-closing trial balance (158)property, plant, and equipment

(149)

real accounts (150)reversing entry (161)solvency (160)temporary (nominal) accounts

(150)work sheet (140)working capital (160)

KKey Terms


Three years ago, T. Roderick organized Harbor Realty Inc. At July 31, 2006, the endof the current fiscal year, the trial balance of Harbor Realty is as follows:

The data needed to determine year-end adjustments are as follows:

a. Supplies on hand at July 31, 2006, are $380.b. Insurance premiums expired during the year are $315.c. Depreciation of equipment during the year is $4,950.d. Wages accrued but not paid at July 31, 2006, are $440.e. Accrued fees earned but not recorded at July 31, 2006, are $1,000.f. Unearned fees on July 31, 2006, are $750.

Instructions1. Enter the trial balance on a ten-column work sheet and complete the work sheet.2. Prepare an income statement, a retained earnings statement, and a balance sheet.3. On the basis of the data in the work sheet, journalize the closing entries.

Harbor Realty Inc.Trial BalanceJuly 31, 2006

9 7 0 0 00

9 2 5 00

1 2 5 0 00

5 0 0 0 00

24 0 0 0 00

59 1 2 5 00

100 0 0 0 00

3 4 2 5 00

7 0 0 0 00

1 2 7 0 00

6 2 0 00

51 6 5 0 00

5 2 0 0 00

22 4 1 5 00

4 2 0 0 00

2 7 1 5 00

1 5 0 5 00

100 0 0 0 00

Cash

Accounts Receivable

Supplies

Prepaid Insurance

Office Equipment


Accounts Payable

Unearned Fees

Capital Stock

Retained Earnings

Dividends

Fees Earned

Wages Expense

Rent Expense

Utilities Expense


IIllustrative Problem


Harbor Realty Inc.Work Sheet

For the Year Ended July 31, 2006

Cash

Accounts Receivable

Supplies

Prepaid Insurance

Office Equipment

Accum. Depreciation

Accounts Payable

Unearned Fees

Capital Stock

Dividends

Retained Earnings

Fees Earned

Wages Expense

Rent Expense

Utilities Expense


Supplies Expense

Insurance Expense


Wages Payable

Net Income

3 4 2 5

7 0 0 0

1 2 7 0

6 2 0

51 6 5 0

5 2 0 0

22 4 1 5

4 2 0 0

2 7 1 5

1 5 0 5

100 0 0 0

9 7 0 0

9 2 5

1 2 5 0

5 0 0 0

24 0 0 0

59 1 2 5

100 0 0 0

Account Title

Trial Balance

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

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

(e)1 0 0 0

(f) 5 0 0

(d) 4 4 0

(a) 8 9 0

(b) 3 1 5

(c)4 9 5 0

8 0 9 5

3 4 2 5

8 0 0 0

3 8 0

3 0 5

51 6 5 0

5 2 0 0

22 8 5 5

4 2 0 0

2 7 1 5

1 5 0 5

8 9 0

3 1 5

4 9 5 0

106 3 9 0

(a) 8 9 0

(b) 3 1 5

(c)4 9 5 0

(e)1 0 0 0

(f) 5 0 0

(d) 4 4 0

8 0 9 5

14 6 5 0

9 2 5

7 5 0

5 0 0 0

24 0 0 0

60 6 2 5

4 4 0

106 3 9 0

22 8 5 5

4 2 0 0

2 7 1 5

1 5 0 5

8 9 0

3 1 5

4 9 5 0

37 4 3 0

23 1 9 5

60 6 2 5

60 6 2 5

60 6 2 5

60 6 2 5

3 4 2 5

8 0 0 0

3 8 0

3 0 5

51 6 5 0

5 2 0 0

68 9 6 0

68 9 6 0

14 6 5 0

9 2 5

7 5 0

5 0 0 0

24 0 0 0

4 4 0

45 7 6 5

23 1 9 5

68 9 6 0

Dr. Cr.



Balance SheetIncome

Statement

Harbor Realty Inc.Income Statement


$60 6 2 5 00

37 4 3 0 00

$23 1 9 5 00

$22 8 5 5 00

4 9 5 0 00

4 2 0 0 00

2 7 1 5 00

8 9 0 00

3 1 5 00

1 5 0 5 00

Fees earned

Operating expenses:

Wages expense

Depreciation expense

Rent expense

Utilities expense

Supplies expense

Insurance expense

Miscellaneous expense

Total operating expenses

Net income

2.

Solution1.


Harbor Realty Inc.Retained Earnings Statement


$24 0 0 0 00

17 9 9 5 00

$41 9 9 5 00

$23 1 9 5 00

5 2 0 0 00

Retained earnings, August 1, 2005

Net income for the year

Less dividends

Increase in retained earnings

Retained earnings, July 31, 2006

Harbor Realty Inc.Balance SheetJuly 31, 2006

Current assets:

Cash

Accounts receivable

Supplies

Prepaid insurance

Total current assets

Property, plant, and equipment:

Office equipment

Less accumulated depr.

Total assets

$12 1 1 0 00

37 0 0 0 00

$49 1 1 0 00

$ 3 4 2 5 00

8 0 0 0 00

3 8 0 00

3 0 5 00

$51 6 5 0 00

14 6 5 0 00

Current liabilities:

Accounts payable

Unearned fees

Wages payable

Total liabilities

$ 9 2 5 00

7 5 0 00

4 4 0 00

$ 5 0 0 0 00

41 9 9 5 00

Capital stock

Retained earnings

Total liabilities and

stockholders’ equity

Liabilities


Assets

$ 2 1 1 5 00

46 9 9 5 00

$49 1 1 0 00

60 6 2 5 00

22 8 5 5 00

4 2 0 0 00

2 7 1 5 00

1 5 0 5 00

8 9 0 00

3 1 5 00

4 9 5 0 00

23 1 9 5 00

5 2 0 0 00

60 6 2 5 00

37 4 3 0 00

23 1 9 5 00

5 2 0 0 00

Fees Earned

Income Summary

Income Summary

Wages Expense

Rent Expense

Utilities Expense


Supplies Expense

Insurance Expense


Income Summary

Retained Earnings

Retained Earnings

Dividends

JOURNAL Page


1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

July2006 31

31

31

31

Closing Entries

3.


C. Debit the income summary account, credit thedividends account.

D. Debit the dividends account, credit the retainedearnings account.

4. Which of the following accounts would not beclosed to the income summary account at the endof a period?A. Fees EarnedB. Wages ExpenseC. Rent ExpenseD. Accumulated Depreciation

5. Which of the following accounts would not be in-cluded in a post-closing trial balance?A. CashB. Fees EarnedC. Accumulated DepreciationD. Capital Stock

1. Which of the following accounts in the AdjustedTrial Balance columns of the work sheet would beextended to the Balance Sheet columns?A. Utilities Expense C. DividendsB. Rent Revenue D. Miscellaneous Expense

2. Which of the following accounts would be classi-fied as a current asset on the balance sheet?A. Office EquipmentB. LandC. Accumulated DepreciationD. Accounts Receivable

3. Which of the following entries closes the dividendsaccount at the end of the period?A. Debit the dividends account, credit the income

summary account.B. Debit the retained earnings account, credit the

dividends account.

1. (a) What is the most important output of the accounting cycle? (b) Do all com-panies have an accounting cycle? Explain.

2. Is the work sheet a substitute for the financial statements? Discuss.3. In the Income Statement columns of the work sheet, the Debit column total is

greater than the Credit column total before the amount for the net income ornet loss has been included. Would the income statement report a net incomeor a net loss? Explain.

4. In the Balance Sheet columns of the work sheet for Teton Co. for the currentyear, the Debit column total is $68,500 greater than the Credit column total be-fore the amount for net income or net loss has been included. Would the in-come statement report a net income or a net loss? Explain.

5. Describe the nature of the assets that compose the following sections of a bal-ance sheet: (a) current assets, (b) property, plant, and equipment.

6. What is the difference between a current liability and a long-term liability?7. What types of accounts are referred to as temporary accounts?8. Why are closing entries required at the end of an accounting period?9. What is the difference between adjusting entries and closing entries?

10. Describe the four entries that close the temporary accounts.11. What is the purpose of the post-closing trial balance?12. What is the natural business year?13. Why might a department store select a fiscal year ending January 31, rather than

a fiscal year ending December 31?14. The fiscal years for several well-known companies were as follows:

Company Fiscal Year Ending Company Fiscal Year Ending

Kmart January 30 Toys “R” Us, Inc. February 3J.C.Penney January 26 Federated Department Stores February 3Zayre Corp. January 26 The Limited, Inc. February 2

S

C

Self-Examination Questions (Answers at End of Chapter)

C lass Discussion Questions


What general characteristic shared by these companies explains why they donot have fiscal years ending December 31?

15. If a company has positive working capital, will its current ratio always be greaterthan 1? Explain.

Remember! If you need additional help, visit South-Western’s Website. See page 28 for a description of the online and printed materialsthat are available. http://warren.swlearning.com

Answer: Starwood Hotels & Resorts Worldwide, Inc.

Rearrange the following steps in the accounting cycle in proper sequence:

a. Closing entries are journalized and posted to the ledger.b. Adjusting entries are journalized and posted to the ledger.c. Transactions are posted to the ledger.d. A post-closing trial balance is prepared.e. Transactions are analyzed and recorded in the journal.f. Financial statements are prepared.g. A trial balance is prepared, adjustment data are assembled, and an optional work

sheet is completed.

The balances for the accounts listed below appear in the Adjusted Trial Balancecolumns of the work sheet. Indicate whether each balance should be extended to(a) an Income Statement column or (b) a Balance Sheet column.

1. Accounts Payable 6. Supplies2. Accounts Receivable 7. Unearned Fees3. Dividends 8. Utilities Expense4. Fees Earned 9. Wages Expense5. Retained Earnings 10. Wages Payable

Balances for each of the following accounts appear in an adjusted trial balance.Identify each as (a) asset, (b) liability, (c) revenue, or (d) expense.

1. Accounts Receivable 7. Rent Revenue2. Fees Earned 8. Salary Expense3. Insurance Expense 9. Salary Payable4. Land 10. Supplies5. Prepaid Advertising 11. Supplies Expense6. Prepaid Insurance 12. Unearned Rent

The steps performed in completing a work sheet are listed below in random order.

a. Extend the adjusted trial balance amounts to the Income Statement columns andthe Balance Sheet columns.

EXERCISE 4-1Steps in the accountingcycle

Objective 1

EXERCISE 4-2Place account balances in awork sheet

Objective 2

EXERCISE 4-3Classify accounts

Objective 2

EXERCISE 4-4Steps in completing a worksheet

Objective 2 (continued)

EExercises

b. Enter the adjusting entries into the work sheet, based upon the adjustment data.c. Add the Debit and Credit columns of the unadjusted Trial Balance columns of

the work sheet to verify that the totals are equal.d. Enter the amount of net income or net loss for the period in the proper Income

Statement column and Balance Sheet column.e. Add the Debit and Credit columns of the Balance Sheet and Income Statement

columns of the work sheet to verify that the totals are equal.f. Enter the unadjusted account balances from the general ledger into the unad-

justed Trial Balance columns of the work sheet.g. Add or deduct adjusting entry data to trial balance amounts and extend amounts

to the Adjusted Trial Balance columns.h. Add the Debit and Credit columns of the Adjustments columns of the work sheet

to verify that the totals are equal.i. Add the Debit and Credit columns of the Balance Sheet and Income Statement

columns of the work sheet to determine the amount of net income or net lossfor the period.

j. Add the Debit and Credit columns of the Adjusted Trial Balance columns of thework sheet to verify that the totals are equal.

Indicate the order in which the preceding steps would be performed in preparingand completing a work sheet.

Ithaca Services Co. offers cleaning services to business clients. The trial balance forIthaca Services Co. has been prepared on the work sheet for the year ended Janu-ary 31, 2006, shown below.

Ithaca Services Co.Work Sheet

For the Year Ended January 31, 2006

AdjustedTrial Balance Adjustments Trial Balance

Account Title Dr. Cr. Dr. Cr. Dr. Cr.

Cash 8Accounts Receivable 50Supplies 8Prepaid Insurance 12Land 50Equipment 32Accumulated Depr.—Equip. 2Accounts Payable 26Wages Payable 0Capital Stock 20Retained Earnings 92Dividends 8Fees Earned 60Wages Expense 16Rent Expense 8Insurance Expense 0Utilities Expense 6Depreciation Expense 0Supplies Expense 0Miscellaneous Expense 2Totals 200 200

The data for year-end adjustments are as follows:

a. Fees earned, but not yet billed, $7.b. Supplies on hand, $3.c. Insurance premiums expired, $6.d. Depreciation expense, $5.e. Wages accrued, but not paid, $1.


EXERCISE 4-5Adjustment data on worksheet

Objective 2

!Total debits ofAdjustments column: $24


EXERCISE 4-8Adjusting entries

Objective 4

EXERCISE 4-6Complete a work sheet

Objective 2

!Net income: $18

Enter the adjustment data, and place the balances in the Adjusted Trial Balancecolumns.

Ithaca Services Co. offers cleaning services to business clients. Complete the fol-lowing work sheet for Ithaca Services Co.

Ithaca Services Co.Work Sheet

For the Year Ended January 31, 2006

Adjusted IncomeTrial Balance Statement Balance Sheet

Account Title Dr. Cr. Dr. Cr. Dr. Cr.

Cash 8Accounts Receivable 57Supplies 3Prepaid Insurance 6Land 50Equipment 32Accumulated Depr.—Equip. 7Accounts Payable 26Wages Payable 1Capital Stock 20Retained Earnings 92Dividends 8Fees Earned 67Wages Expense 17Rent Expense 8Insurance Expense 6Utilities Expense 6Depreciation Expense 5Supplies Expense 5Miscellaneous Expense 2Totals 213 213

Net income (loss)

Based upon the data in Exercise 4-6, prepare an income statement, retained earningsstatement, and balance sheet for Ithaca Services Co.

Based upon the data in Exercise 4-5, prepare the adjusting entries for Ithaca Ser-vices Co.

Based upon the data in Exercise 4-6, prepare the closing entries for Ithaca Ser-vices Co.

The following account balances were taken from the Adjusted Trial Balance columnsof the work sheet for Larynx Messenger Service, a delivery service firm, for the cur-rent fiscal year ended June 30, 2006:

EXERCISE 4-7Financial statements

Objective 3

!Retained earnings, Jan.31, 2006: $102

EXERCISE 4-9Closing entries

Objective 4

EXERCISE 4-10Income statement

Objective 3


Fees Earned $273,700 Supplies Expense $2,750Salaries Expense 77,100 Miscellaneous Expense 1,350Rent Expense 22,500 Insurance Expense 1,500Utilities Expense 6,500 Depreciation Expense 5,200

Prepare an income statement.

The following revenue and expense account balances were taken from the ledgerof Sirocco Services Co. after the accounts had been adjusted on March 31, 2006, theend of the current fiscal year:

Depreciation Expense $ 8,000 Service Revenue $103,850Insurance Expense 4,100 Supplies Expense 3,100Miscellaneous Expense 2,250 Utilities Expense 11,500Rent Expense 21,270 Wages Expense 56,800

Prepare an income statement.

FedEx Corporation had the following revenue and expense account balances (inmillions) at its fiscal year-end of May 31, 2002:

Rentals and Landing Fees $1,524 Depreciation and Amortization $ 806Maintenance and Repairs 980 Interest Expense 56Purchased Transportation 562 Revenues 15,327Fuel 1,009 Provision for Income Taxes 260Salaries and Employee Benefits 6,467 Other Expenses 52Other Operating Expenses 3,168

a. Prepare an income statement.b. Compare your income statement with the 2002 income statement that is

available at the FedEx Corporation Web site, which is linked to the text’s Web siteat http://warren.swlearning.com. What similarities and differences do you see?

Synthesis Systems Co. offers its services to residents in the Dillon City area. Selectedaccounts from the ledger of Synthesis Systems Co. for the current fiscal year endedOctober 31, 2006, are as follows:

EXERCISE 4-11Income statement; net loss

Objective 3

EXERCISE 4-12Income statement

Objective 3

!a. Net income: $443

EXERCISE 4-13Retained earningsstatement

Objective 3

EXERCISE 4-14Retained earningsstatement; net loss

Objective 3

!Retained earnings, Oct.31, 2006: $206,000

Retained Earnings

Oct. 31 12,000 Nov. 1 (2005) 173,750Oct. 31 44,250

Dividends

Jan. 31 3,000 Oct. 31 12,000Apr. 30 3,000July 31 3,000Oct. 31 3,000

Income Summary

Oct. 31 277,150 Oct. 31 321,40031 44,250

Prepare a retained earnings statement for the year.

Selected accounts from the ledger of Bobcat Sports for the current fiscal year endedAugust 31, 2006, are as follows:

Retained Earnings

Aug. 31 16,000 Sep. 1 (2005) 210,30031 49,650

Dividends

Nov. 30 4,000 Aug. 31 16,000Feb. 28 4,000May 31 4,000Aug. 31 4,000


!Retained earnings, Aug.31, 2006: $144,650

Income Summary

Aug. 31 224,900 Aug. 31 175,25031 49,650

Prepare a retained earnings statement for the year.

Identify each of the following as (a) a current asset or (b) property, plant, and equip-ment:

1. Cash2. Equipment3. Accounts receivable4. Building5. Prepaid insurance6. Supplies

At the balance sheet date, a business owes a mortgage note payable of $500,000,the terms of which provide for monthly payments of $13,750.

Explain how the liability should be classified on the balance sheet.

Tudor Co. offers personal weight reduction consulting services to individuals. Afterall the accounts have been closed on April 30, 2006, the end of the current fiscalyear, the balances of selected accounts from the ledger of Tudor Co. are as follows:

Accounts Payable $ 9,500 Prepaid Insurance $ 7,200Accounts Receivable 21,850 Prepaid Rent 4,800Accumulated Depreciation— Retained Earnings 74,200

Equipment 21,100 Salaries Payable 1,750Capital Stock 40,000 Supplies 1,800Cash ? Unearned Fees 1,200Equipment 80,600

Prepare a classified balance sheet that includes the correct balance for Cash.

List the errors you find in the following balance sheet. Prepare a corrected balancesheet.

Warburg Services Co.Balance Sheet

For the Year Ended May 31, 2006

Assets LiabilitiesCurrent assets: Current liabilities:

Cash $ 4,170 Accounts receivable $ 12,500Accounts payable 7,250 Accum. depr.—building 23,000Supplies 1,650 Accum. depr.—equipment 16,000Prepaid insurance 2,400 Net loss 10,000Land 75,000 Total liabilities $ 61,500

Total current assets $ 90,470Property, plant, Stockholders’ Equity

and equipment: Wages payable $ 1,500Building $ 55,500 Capital stock 35,000Equipment 28,280 Retained earnings 96,750

Total property, plant, Total stockholders’ equity $133,250and equipment $104,280 Total liabilities and

Total assets $194,750 stockholders’ equity $194,750

Green Earth Co. is a consulting firm specializing in pollution control. The entries inthe Adjustments columns of the work sheet for Green Earth Co. are as follows.

EXERCISE 4-15Classify assets

Objective 3

EXERCISE 4-16Balance sheet classification

Objective 3

EXERCISE 4-17Balance sheet

Objective 3

!Total assets: $126,650

EXERCISE 4-18Balance sheet

Objective 3

!Corrected balance sheet,total assets: $140,500

EXERCISE 4-19Adjusting entries fromwork sheet

Objective 4


Adjustments

Dr. Cr.

Accounts Receivable 4,100Supplies 1,300Prepaid Insurance 2,000Accumulated Depreciation—Equipment 2,800Wages Payable 1,000Unearned Rent 2,500Fees Earned 4,100Wages Expense 1,000Supplies Expense 1,300Rent Revenue 2,500Insurance Expense 2,000Depreciation Expense 2,800

Prepare the adjusting journal entries.

From the following list, identify the accounts that should be closed to Income Sum-mary at the end of the fiscal year:

a. Accounts Payable g. Fees Earnedb. Accumulated Depreciation— h. Land

Equipment i. Salaries Expensec. Capital Stock j. Salaries Payabled. Depreciation Expense—Equipment k. Suppliese. Dividends l. Supplies Expensef. Equipment

Prior to its closing, Income Summary had total debits of $450,750 and total creditsof $712,500.

Briefly explain the purpose served by the income summary account and thenature of the entries that resulted in the $450,750 and the $712,500.

After all revenue and expense accounts have been closed at the end of the fiscal year,Income Summary has a debit of $312,600 and a credit of $480,150. At the same date,Retained Earnings has a credit balance of $142,350, and Dividends has a balance of$25,000. (a) Journalize the entries required to complete the closing of the accounts.(b) Determine the amount of Retained Earnings at the end of the period.

Edessa Services Co. offers its services to individuals desiring to improve their per-sonal images. After the accounts have been adjusted at March 31, the end of the fis-cal year, the following balances were taken from the ledger of Edessa Services Co.

Retained Earnings $225,750Dividends 50,000Fees Earned 180,700Wages Expense 180,000Rent Expense 75,000Supplies Expense 24,000Miscellaneous Expense 6,200

Journalize the four entries required to close the accounts.

Which of the following accounts will usually appear in the post-closing trial balance?

a. Accounts Receivable g. Equipmentb. Accumulated Depreciation h. Fees Earnedc. Capital Stock i. Retained Earningsd. Cash j. Suppliese. Depreciation Expense k. Wages Expensef. Dividends l. Wages Payable

EXERCISE 4-20Identify accounts to beclosed

Objective 4

EXERCISE 4-21Closing entries

Objective 4

EXERCISE 4-22Closing entries with netincome

Objective 4!b. $284,900

EXERCISE 4-23Closing entries with net loss

Objective 4

EXERCISE 4-24Identify permanentaccounts

Objective 4


An accountant prepared the following post-closing trial balance:

Rhombic Repairs Co.Post-Closing Trial Balance

March 31, 2006

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9,225Accounts Receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33,300Supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,980Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63,000Accumulated Depreciation—Equipment . . . . . . . . . . . . . . . . . . . . . . . . . 19,980Accounts Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11,250Salaries Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,700Unearned Rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,400Capital Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18,000Retained Earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50,175

147,330 67,680

Prepare a corrected post-closing trial balance. Assume that all accounts have nor-mal balances and that the amounts shown are correct.

The financial statements for The Home Depot are presented in Appendix F at theend of the text.

a. Determine the working capital (in millions) and the current ratio for Home Depotas of February 2, 2003 and February 3, 2002.

b. What conclusions concerning the company’s ability to meets its financialobligations can you draw from these data?

The following data (in thousands) were taken from recent financial statements of7 Eleven, Inc., a convenience store chain:

December 31

2002 2001

Current assets $624,176 $632,247Current liabilities 767,210 791,700

a. Compute the working capital and the current ratio as of December 31, 2002 and2001. Round to two decimal places.

b. What conclusions concerning the company’s ability to meet its financial obliga-tions can you draw from (a)?

On the basis of the following data, (a) journalize the adjusting entries at December31, the end of the current fiscal year, and (b) journalize the reversing entries on Jan-uary 1, the first day of the following year.

1. Sales salaries are uniformly $16,200 for a five-day workweek, ending on Friday.The last payday of the year was Friday, December 27.

2. Accrued fees earned but not recorded at December 31, $10,250.

Portions of the wages expense account of a business are shown at the top of thefollowing page.

a. Indicate the nature of the entry (payment, adjusting, closing, reversing) from whicheach numbered posting was made.

b. Journalize the complete entry from which each numbered posting was made.

EXERCISE 4-25Post-closing trial balance

Objective 4

!Correct column totals,$107,505

EXERCISE 4-26Working capital andcurrent ratio

Objective 6

EXERCISE 4-27Working capital andcurrent ratio

Objective 6

APPENDIXEXERCISE 4-28Adjusting and reversingentries

APPENDIXEXERCISE 4-29Entries posted to the wagesexpense account


The trial balance of Dynamite Laundry at July 31, 2006, the end of the current fis-cal year, and the data needed to determine year-end adjustments are as follows:

Dynamite LaundryTrial BalanceJuly 31, 2006

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,900Laundry Supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,500Prepaid Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,800Laundry Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 109,050Accumulated Depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41,100Accounts Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,100Capital Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,000Retained Earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27,800Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,000Laundry Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 165,000Wages Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71,400Rent Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36,000Utilities Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13,650Miscellaneous Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,700

250,000 250,000

a. Wages accrued but not paid at July 31 are $1,200.b. Depreciation of equipment during the year is $6,800.c. Laundry supplies on hand at July 31 are $1,750.d. Insurance premiums expired during the year are $2,400.

Instructions1. Enter the trial balance on a ten-column work sheet and complete the work sheet.

Add accounts as needed.2. Prepare an income statement, a retained earnings statement, and a balance sheet.3. On the basis of the adjustment data in the work sheet, journalize the adjusting

entries.4. On the basis of the data in the work sheet, journalize the closing entries.

The Xavier Company is a financial planning services firm owned and operated byKim Bosworth. As of August 31, 2006, the end of the current fiscal year, the accoun-tant for The Xavier Company prepared a work sheet, part of which is shown on thefollowing page.

PROBLEM 4-1AWork sheet and relateditems

Objectives 2, 3, 4

!2. Net income: $25,100

PROBLEM 4-2AAdjusting and closingentries; retained earningsstatement

Objectives 3, 4

ACCOUNT Wages Expense ACCOUNT NO. 53

Post. Balance

Date Item Ref. Dr. Cr. Dr. Cr.

2006Dec. 26 (1) 91 45,000 1,102,800

31 (2) 92 18,000 1,120,80031 (3) 93 1,120,800 — —

2007Jan. 1 (4) 94 18,000 18,000

2 (5) 95 43,000 25,000

PProblems Series A


The Xavier CompanyWork Sheet (Partial)

August 31, 2006

Income Statement Balance Sheet

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,650Accounts Receivable . . . . . . . . . . . . . . . . . . 13,960Supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,800Prepaid Insurance . . . . . . . . . . . . . . . . . . . . 2,500Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60,000Buildings . . . . . . . . . . . . . . . . . . . . . . . . . . 120,000Accumulated Depreciation—Buildings . . . . . 72,400Equipment . . . . . . . . . . . . . . . . . . . . . . . . . 86,090Accumulated Depreciation—Equipment . . . . 40,900Accounts Payable . . . . . . . . . . . . . . . . . . . . 7,100Salaries Payable . . . . . . . . . . . . . . . . . . . . . 1,100Taxes Payable . . . . . . . . . . . . . . . . . . . . . . . 4,000Unearned Rent . . . . . . . . . . . . . . . . . . . . . . 500Capital Stock . . . . . . . . . . . . . . . . . . . . . . . 15,000Retained Earnings . . . . . . . . . . . . . . . . . . . . 98,500Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . 10,000Service Fees Earned . . . . . . . . . . . . . . . . . . . 175,000Rent Revenue . . . . . . . . . . . . . . . . . . . . . . . 1,500Salary Expense . . . . . . . . . . . . . . . . . . . . . . 73,000Depreciation Expense—Equipment . . . . . . . 9,500Rent Expense . . . . . . . . . . . . . . . . . . . . . . . 8,500Supplies Expense . . . . . . . . . . . . . . . . . . . . . 7,650Utilities Expense . . . . . . . . . . . . . . . . . . . . . 5,300Depreciation Expense—Buildings . . . . . . . . . 5,200Taxes Expense . . . . . . . . . . . . . . . . . . . . . . . 4,150Insurance Expense . . . . . . . . . . . . . . . . . . . . 1,000Miscellaneous Expense . . . . . . . . . . . . . . . . 1,700

116,000 176,500 300,000 239,500Net income . . . . . . . . . . . . . . . . . . . . . . . . . 60,500 60,500

176,500 176,500 300,000 300,000

Instructions1. Journalize the entries that were required to close the accounts at August 31.2. Prepare a retained earnings statement for the fiscal year ended August 31.3. If the balance of Retained Earnings decreased $15,000 after the closing entries

were posted, and the dividends remained the same, what was the amount of netincome or net loss?

If the working papers correlating with this textbook are not used, omit Problem 4-3A.

The ledger and trial balance of Lithium Services Co. as of March 31, 2006, the endof the first month of its current fiscal year, are presented in the working papers.

Instructions1. Complete the ten-column work sheet. Data needed to determine the necessary

adjusting entries are as follows:a. Service revenue accrued at March 31 is $1,500.b. Supplies on hand at March 31 are $300.c. Insurance premiums expired during March are $150.d. Depreciation of the building during March is $625.e. Depreciation of equipment during March is $200.f. Unearned rent at March 31 is $2,100.g. Wages accrued but not paid at March 31 are $501.

2. Prepare an income statement, a retained earnings statement, and a balance sheet.3. Journalize and post the adjusting entries, inserting balances in the accounts affected.

!2. Retained earnings,Aug. 31: $149,000

(continued)

PROBLEM 4-3ALedger accounts and worksheet, and related items

Objectives 2, 3, 4!2. Net income: $18,017


4. Journalize and post the closing entries. Indicate closed accounts by inserting aline in both Balance columns opposite the closing entry.

5. Prepare a post-closing trial balance.

Heritage Company offers legal consulting advice to death-row inmates. HeritageCompany prepared the following trial balance at April 30, 2006, the end of the cur-rent fiscal year:

Heritage CompanyTrial Balance

April 30, 2006

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,200Accounts Receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,500Prepaid Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,800Supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,350Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50,000Building . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 136,500Accumulated Depreciation—Building . . . . . . . . . . . . . . . . . . . . . . . . . . 50,700Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 92,700Accumulated Depreciation—Equipment . . . . . . . . . . . . . . . . . . . . . . . . 36,300Accounts Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,500Unearned Rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,000Capital Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50,000Retained Earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 162,500Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,000Fees Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 191,000Salaries and Wages Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96,200Advertising Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63,200Utilities Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18,000Repairs Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,500Miscellaneous Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,050

500,000 500,000


a. Accrued fees revenue at April 30 are $2,800.b. Insurance expired during the year is $450.c. Supplies on hand at April 30 are $650.d. Depreciation of building for the year is $1,620.e. Depreciation of equipment for the year is $3,500.f. Accrued salaries and wages at April 30 are $1,800.g. Unearned rent at April 30 is $1,500.

Instructions1. Optional: Enter the trial balance on a ten-column work sheet and complete the

work sheet. Add accounts as needed.2. Journalize the adjusting entires, adding accounts as needed.3. Prepare an adjusted trial balance of April 30, 2006.4. Prepare an income statement for the year ended April 30.5. Prepare a retained earnings statement for the year ended April 30.6. Prepare a balance sheet as of April 30.7. Compute the percent of total revenue to total assets for the year.

The trial balance of Pablo Repairs at December 31, 2006, the end of the currentyear, is shown at the top of the following page.

PROBLEM 4-4AOptional work sheet andfinancial statements

Objectives 2, 3, 4

!4. Net loss: $6,720

PROBLEM 4-5ALedger accounts, optionalwork sheet, and relateditems

Objectives 2, 3, 4


Pablo RepairsTrial Balance

December 31, 2006

11 Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,82513 Supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,82014 Prepaid Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,50016 Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44,20017 Accumulated Depreciation—Equipment . . . . . . . . . . . . . . . . . . . . 12,05018 Trucks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45,00019 Accumulated Depreciation—Trucks . . . . . . . . . . . . . . . . . . . . . . . . 27,10021 Accounts Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,01531 Capital Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,00032 Retained Earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20,88533 Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,00041 Service Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75,95051 Wages Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28,01053 Rent Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,10055 Truck Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,35059 Miscellaneous Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,195

150,000 150,000


a. Supplies on hand at December 31 are $1,250.b. Insurance premiums expired during year are $1,000.c. Depreciation of equipment during year is $5,080.d. Depreciation of trucks during year is $3,500.e. Wages accrued but not paid at December 31 are $900.

Instructions1. For each account listed in the trial balance, enter the balance in the appropriate

Balance column of a four-column account and place a check mark (!) in thePosting Reference column.

2. Optional: Enter the trial balance on a ten-column work sheet and complete thework sheet. Add accounts as needed.

3. Journalize and post the adjusting entries, inserting balances in the accounts affected.The following additional accounts from Pablo’s chart of accounts should be used:Wages Payable, 22; Supplies Expense, 52; Depreciation Expense—Equipment, 54;Depreciation Expense—Trucks, 56; Insurance Expense, 57.

4. Prepare an adjusted trial balance.5. Prepare an income statement, a retained earnings statement, and a balance sheet.6. Journalize and post the closing entries. (Income Summary is account #34 in the

chart of accounts.) Indicate closed accounts by inserting a line in both Balancecolumns opposite the closing entry.


!2. Net income: $16,245

The trial balance of The Utopia Laundromat at October 31, 2006, the end of the cur-rent fiscal year, is shown at the top of the next page.


a. Laundry supplies on hand at October 31 are $1,250.b. Insurance premiums expired during the year are $1,800.c. Depreciation of equipment during the year is $5,500.d. Wages accrued but not paid at October 31 are $2,160.

PROBLEM 4-1BWork sheet and relateditems

Objectives 2, 3, 4

PProblems Series B


!2. Net income: $10,240

PROBLEM 4-2BAdjusting and closingentries; retained earningsstatement

Objectives 3, 4

!2. Retained earnings,June 30: $56,910

The Utopia LaundromatTrial Balance

October 31, 2006

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,600Laundry Supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,850Prepaid Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,600Laundry Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 120,000Accumulated Depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62,700Accounts Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,100Capital Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18,000Retained Earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28,450Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,500Laundry Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96,750Wages Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43,400Rent Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16,400Utilities Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,500Miscellaneous Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,150

210,000 210,000

Instructions1. Enter the trial balance on a ten-column work sheet and complete the work sheet.

Add accounts as needed.2. Prepare an income statement, a retained earnings statement, and a balance sheet.3. On the basis of the adjustment data in the work sheet, journalize the adjusting

entries.4. On the basis of the data in the work sheet, journalize the closing entries.

The Alligator Company is an investigative services firm that is owned and operated byBruce Driskell. On June 30, 2006, the end of the current fiscal year, the accountant forThe Alligator Company prepared a work sheet, a part of which is shown here.

The Alligator CompanyWork Sheet (Partial)

June 30, 2006

Income Statement Balance Sheet

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,500Accounts Receivable . . . . . . . . . . . . . . . . . . 18,600Supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,750Prepaid Insurance . . . . . . . . . . . . . . . . . . . . 2,400Equipment . . . . . . . . . . . . . . . . . . . . . . . . . 84,750Accumulated Depreciation—Equipment . . . . 26,100Accounts Payable . . . . . . . . . . . . . . . . . . . . 5,230Salaries Payable . . . . . . . . . . . . . . . . . . . . . 1,260Taxes Payable . . . . . . . . . . . . . . . . . . . . . . . 1,500Unearned Rent . . . . . . . . . . . . . . . . . . . . . . 1,000Capital Stock . . . . . . . . . . . . . . . . . . . . . . . 20,000Retained Earnings . . . . . . . . . . . . . . . . . . . . 51,410Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . 8,000Service Fees Earned . . . . . . . . . . . . . . . . . . . 180,000Rent Revenue . . . . . . . . . . . . . . . . . . . . . . . 3,000Salary Expense . . . . . . . . . . . . . . . . . . . . . . 133,500Rent Expense . . . . . . . . . . . . . . . . . . . . . . . 18,000Supplies Expense . . . . . . . . . . . . . . . . . . . . . 4,000Depreciation Expense—Equipment . . . . . . . 3,500Utilities Expense . . . . . . . . . . . . . . . . . . . . . 3,200Taxes Expense . . . . . . . . . . . . . . . . . . . . . . . 3,100Insurance Expense . . . . . . . . . . . . . . . . . . . . 2,400Miscellaneous Expense . . . . . . . . . . . . . . . . 1,800

169,500 183,000 120,000 106,500Net income . . . . . . . . . . . . . . . . . . . . . . . . . 13,500 13,500

183,000 183,000 120,000 120,000


Instructions1. Journalize the entries that were required to close the accounts at June 30.2. Prepare a retained earnings statement for the fiscal year ended June 30, 2006.3. If Retained Earnings decreased $30,000 after the closing entries were posted, and

the dividends remained the same, what was the amount of net income or netloss?

If the working papers correlating with this textbook are not used, omit Problem 4-3B.

The ledger and trial balance of Lithium Services Co. as of March 31, 2006, the endof the first month of its current fiscal year, are presented in the working papers.

Instructions1. Complete the ten-column work sheet. Data needed to determine the necessary

adjusting entries are as follows:a. Service revenue accrued at March 31 is $1,250.b. Supplies on hand at March 31 are $400.c. Insurance premiums expired during March are $150.d. Depreciation of the building during March is $500.e. Depreciation of equipment during March is $150.f. Unearned rent at March 31 is $2,000.g. Wages accrued at March 31 are $601.

2. Prepare an income statement, a retained earnings statement, and a balance sheet.3. Journalize and post the adjusting entries, inserting balances in the accounts af-

fected.4. Journalize and post the closing entries. Indicate closed accounts by inserting a

line in both Balance columns opposite the closing entry.5. Prepare a post-closing trial balance.

Flamingo Company maintains and repairs warning lights, such as those found onradio towers and lighthouses. Flamingo Company prepared the following trial bal-ance at July 31, 2006, the end of the current fiscal year:

Flamingo CompanyTrial BalanceJuly 31, 2006

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,500Accounts Receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13,500Prepaid Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,000Supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,950Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70,000Building . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100,500Accumulated Depreciation—Building . . . . . . . . . . . . . . . . . . . . . . . . . . 71,700Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71,400Accumulated Depreciation—Equipment . . . . . . . . . . . . . . . . . . . . . . . . 60,800Accounts Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,100Unearned Rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,500Capital Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,000Retained Earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50,700Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,000Fees Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 181,200Salaries and Wages Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73,200Advertising Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15,500Utilities Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,100Repairs Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,300Miscellaneous Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,050

375,000 375,000

PROBLEM 4-3BLedger accounts, worksheet, and related items

Objectives 2, 3, 4!2. Net income: $18,042

PROBLEM 4-4BOptional worksheet andfinancial statements

Objectives 2, 3, 4

!4. Net income: $69,470



a. Fees revenue accrued at July 31 is $3,500.b. Insurance expired during the year is $2,000.c. Supplies on hand at July 31 are $350.d. Depreciation of building for the year is $1,520.e. Depreciation of equipment for the year is $2,160.f. Accrued salaries and wages at July 31 are $2,800.g. Unearned rent at July 31 is $500.

Instructions1. Optional: Enter the trial balance on a ten-column work sheet and complete the

work sheet. Add accounts as needed.2. Journalize the adjusting entries, adding accounts as needed.3. Prepare an adjusted trial balance as of July 31, 2006.4. Prepare an income statement for the year ended July 31.5. Prepare a retained earnings statement for the year ended July 31.6. Prepare a balance sheet as of July 31.7. Compute the percent of net income to total revenue for the year.

The trial balance of Gesundheit Repairs at October 31, 2006, the end of the currentyear, is shown below.

Gesundheit RepairsTrial Balance

October 31, 2006

11 Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,95013 Supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,29514 Prepaid Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,73516 Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50,65017 Accumulated Depreciation—Equipment . . . . . . . . . . . . . . . . . . . . 11,20918 Trucks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36,30019 Accumulated Depreciation—Trucks . . . . . . . . . . . . . . . . . . . . . . . . 7,40021 Accounts Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,01531 Capital Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9,00032 Retained Earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28,42633 Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,00041 Service Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89,95051 Wages Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26,92553 Rent Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9,60055 Truck Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,35059 Miscellaneous Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,195

150,000 150,000


a. Supplies on hand at October 31 are $1,150.b. Insurance premiums expired during year are $1,800.c. Depreciation of equipment during year is $3,380.d. Depreciation of trucks during year is $4,400.e. Wages accrued but not paid at October 31 are $1,075.

Instructions1. For each account listed in the trial balance, enter the balance in the appropriate

Balance column of a four-column account and place a check mark (!) in thePosting Reference column.

2. Optional: Enter the trial balance on a ten-column work sheet and complete thework sheet. Add accounts as needed.

3. Journalize and post the adjusting entries, inserting balances in the accounts af-fected. The following additional accounts from Gesundheit’s chart of accountsshould be used: Wages Payable, 22; Supplies Expense, 52; Depreciation Expense—Equipment, 54; Depreciation Expense—Trucks, 56; Insurance Expense, 57.

PROBLEM 4-5BLedger accounts, optionalwork sheet, and relateditems

Objectives 2, 3, 4

!5. Net income: $30,080


4. Prepare an adjusted trial balance.5. Prepare an income statement, a retained earnings statement, and a balance sheet.6. Journalize and post the closing entries. (Income Summary is account #34 in the



!2. Net income: $2,550

!4. Net income: $17,930

CContinuing ProblemThe unadjusted trial balance of Dancin Music as of May 31, 2006, along with theadjustment data for the two months ended May 31, 2006, are shown in Chapter 3.

Instructions1. Prepare a ten-column work sheet.2. Prepare an income statement, a retained earnings statement, and a balance sheet.3. Journalize and post the closing entries. The income summary account is #34 in

the ledger of Dancin Music. Indicate closed accounts by inserting a line in bothBalance columns opposite the closing entry.


CComprehensive Problem 1For the past several years, Kelly Pitney has operated a part-time consulting businessfrom her home. As of April 1, 2006, Kelly decided to move to rented quarters andto operate the business, which was to be known as Hippocrates Consulting, on afull-time basis. Hippocrates Consulting entered into the following transactions dur-ing April:

April 1. The following assets were received from Kelly Pitney in exchange forcapital stock: cash, $13,100; accounts receivable, $3,000; supplies, $1,400;and office equipment, $12,500. There were no liabilities received.

1. Paid three months’ rent on a lease rental contract, $4,800.2. Paid the premiums on property and casualty insurance policies, $1,800.4. Received cash from clients as an advance payment for services to be pro-

vided and recorded it as unearned fees, $5,000.5. Purchased additional office equipment on account from Office Station Co.,

$2,000.6. Received cash from clients on account, $1,800.

10. Paid cash for a newspaper advertisement, $120.12. Paid Office Station Co. for part of the debt incurred on April 5, $1,200.12. Recorded services provided on account for the period April 1–12, $4,200.14. Paid part-time receptionist for two weeks’ salary, $750.17. Recorded cash from cash clients for fees earned during the period April

1–16, $6,250.18. Paid cash for supplies, $800.20. Recorded services provided on account for the period April 13–20, $2,100.24. Recorded cash from cash clients for fees earned for the period April

17–24, $3,850.26. Received cash from clients on account, $5,600.27. Paid part-time receptionist for two weeks’ salary, $750.29. Paid telephone bill for April, $130.30. Paid electricity bill for April, $200.


April 30. Recorded cash from cash clients for fees earned for the period April25–30, $3,050.

30. Recorded services provided on account for the remainder of April, $1,500.30. Paid dividends, $6,000.

Instructions1. Journalize each transaction in a two-column journal, referring to the following

chart of accounts in selecting the accounts to be debited and credited. (Do notinsert the account numbers in the journal at this time.)

11 Cash 31 Capital Stock12 Accounts Receivable 32 Retained Earnings14 Supplies 33 Dividends15 Prepaid Rent 41 Fees Earned16 Prepaid Insurance 51 Salary Expense18 Office Equipment 52 Rent Expense19 Accumulated Depreciation 53 Supplies Expense21 Accounts Payable 54 Depreciation Expense22 Salaries Payable 55 Insurance Expense23 Unearned Fees 59 Miscellaneous Expense

2. Post the journal to a ledger of four-column accounts.3. Prepare a trial balance as of April 30, 2006, on a ten-column work sheet, listing

all the accounts in the order given in the ledger. Complete the work sheet, us-ing the following adjustment data:a. Insurance expired during April is $300.b. Supplies on hand on April 30 are $1,350.c. Depreciation of office equipment for April is $700.d. Accrued receptionist salary on April 30 is $120.e. Rent expired during April is $1,600.f. Unearned fees on April 30 are $2,500.

4. Prepare an income statement, a retained earnings statement, and a balance sheet.5. Journalize and post the adjusting entries.6. Journalize and post the closing entries. (Income Summary is account #34 in the



Alternative Instructions for P.A.S.SComplete the above instructions in the following order: 1, 2, 5 (using the adjustmentdata in 3), and 4.

Lighthouse Co. is a graphics arts design consulting firm. Robin Dover, its treasurerand vice president of finance, has prepared a classified balance sheet as of July 31,2006, the end of its fiscal year. This balance sheet will be submitted with Light-house’s loan application to Central Trust & Savings Bank.

In the Current Assets section of the balance sheet, Robin reported an $80,000 re-ceivable from Ron Knoll, the president of Lighthouse, as a trade account receivable.Ron borrowed the money from Lighthouse in February 2005 for a down paymenton a new home. He has orally assured Robin that he will pay off the account re-ceivable within the next year. Robin reported the $80,000 in the same manner onthe preceding year’s balance sheet.

Evaluate whether it is acceptable for Robin Dover to prepare the July 31,2006 balance sheet in the manner indicated above.

ACTIVITY 4-1Ethics and professionalconduct in business

SSpecial Activities


ACTIVITY 4-2Financial statements

ACTIVITY 4-3Financial statements

The following is an excerpt from a telephone conversation between Pedro Mendoza,president of Goliath Supplies Co., and Natalie Welch, owner of Flint Employment Co.

Pedro: Natalie, you’re going to have to do a better job of finding me a new com-puter programmer. That last guy was great at programming, but he didn’t haveany common sense.

Natalie: What do you mean? The guy had a master’s degree with straight A’s.Pedro: Yes, well, last month he developed a new financial reporting system. He

said we could do away with manually preparing a work sheet and financialstatements. The computer would automatically generate our financial statementswith “a push of a button.”

Natalie: So what’s the big deal? Sounds to me like it would save you time andeffort.

Pedro: Right! The balance sheet showed a minus for supplies!Natalie: Minus supplies? How can that be?Pedro: That’s what I asked.Natalie: So, what did he say?Pedro: Well, after he checked the program, he said that it must be right. The

minuses were greater than the pluses . . .Natalie: Didn’t he know that supplies can’t have a credit balance—it must have a

debit balance?Pedro: He asked me what a debit and credit were.Natalie: I see your point.

1. Comment on (a) the desirability of computerizing Goliath Supplies Co.’sfinancial reporting system, (b) the elimination of the work sheet in a computer-ized accounting system, and (c) the computer programmer’s lack of accountingknowledge.

2. Explain to the programmer why supplies could not have a credit balance.

Assume that you recently accepted a position with the Bozeman National Bank as anassistant loan officer. As one of your first duties, you have been assigned the responsi-bility of evaluating a loan request for $150,000 from Sasquatch.com, a small proprietor-ship. In support of the loan application, Samantha Joyner, owner, submitted a “Statementof Accounts” (trial balance) for the first year of operations ended December 31, 2006.

1. Explain to Samantha Joyner why a set of financial statements (incomestatement, retained earnings statement, and balance sheet) would be useful toyou in evaluating the loan request.

2. In discussing the “Statement of Accounts” with Samantha Joyner, you discoveredthat the accounts had not been adjusted at December 31. Analyze the “Statementof Accounts” (shown below) and indicate possible adjusting entries that might benecessary before an accurate set of financial statements could be prepared.

Sasquatch.comStatement of Accounts

December 31, 2006

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,100Billings Due from Others . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30,150Supplies (chemicals, etc.) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14,950Trucks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52,750Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16,150Amounts Owed to Others . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,700Investment in Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47,000Service Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 147,300Wages Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60,100Utilities Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14,660Rent Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,800Insurance Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,400Other Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 940

200,000 200,000

(continued)


3. Assuming that an accurate set of financial statements will be submittedby Samantha Joyner in a few days, what other considerations or information wouldyou require before making a decision on the loan request?

In groups of three or four, compare the balance sheets of two different companies,and present to the class a summary of the similarities and differences of the twocompanies. You may obtain the balance sheets you need from one of the follow-ing sources:

1. Your school or local library.2. The investor relations department of each company.3. The company’s Web site on the Internet.4. EDGAR (Electronic Data Gathering, Analysis, and Retrieval), the electronic archives

of financial statements filed with the Securities and Exchange Commission.

SEC documents can be retrieved using the EdgarScan™ service from Pricewater-houseCoopers at http://edgarscan.pwcglobal.com. To obtain annual report in-formation, key in a company name in the appropriate space. EdgarScan will list thereports available to you for the company you’ve selected. Select the most recent an-nual report filing, identified as a 10-K or 10-K405. EdgarScan provides an outline ofthe report, including the separate financial statements, which can also be selectedin an Excel® spreadsheet.

Mohawk Industries is a leading distributor of carpets and rugs in the United States.The company sells its carpets and rugs to locally-owned, independent carpet retail-ers, home centers such as Home Depot and Lowe’s, and department stores such asSears. Mohawk’s carpets are marked under the brand names that include “Aladdin,Mohawk Home, Bigelow, Custom Weave, Durkan, Karastan, and Townhouse.”

1. List some factors that increase the demand for carpet.2. From a strategic viewpoint, do you think Mohawk should view itself as

a carpet or floorcovering manufacturer? Discuss the advantages and disadvantagesof Mohawk viewing itself as a floorcovering manufacturer rather than just a carpetmanufacturer.

3. Read Mohawk’s latest 10-K filing with the Securities and ExchangeCommission by using EdgarScan (http://edgarscan.pwcglobal.com). DoesMohawk view itself as a carpet manufacturer or as a floorcovering manufacturer?Explain.

ACTIVITY 4-4Compare balance sheets

ACTIVITY 4-5Business strategy

1. C The dividends account (answer C), would beextended to the Balance Sheet columns of the worksheet. Utilities Expense (answer A), Rent Revenue(answer B), and Miscellaneous Expense (answer D)would all be extended to the Income Statementcolumns of the work sheet.

2. D Cash or other assets that are expected to beconverted to cash or sold or used up within oneyear or less, through the normal operations of thebusiness, are classified as current assets on the bal-ance sheet. Accounts Receivable (answer D) is acurrent asset, since it will normally be converted tocash within one year. Office Equipment (answer A),

Land (answer B), and Accumulated Depreciation(answer C) are all reported in the property, plant,and equipment section of the balance sheet.

3. B The entry to close the dividends account is todebit the retained earnings account and credit thedividends account (answer B).

4. D Since all revenue and expense accounts areclosed at the end of the period, Fees Earned (an-swer A), Wages Expense (answer B), and Rent Ex-pense (answer C) would all be closed to IncomeSummary. Accumulated Depreciation (answer D) isa contra asset account that is not closed.

AAnswers to Self-Examination Questions


and Capital Stock (answer D) would appear on thepost-closing trial balance. Fees Earned (answer B)is a temporary account that is closed prior to prepar-ing the post-closing trial balance.

5. B Since the post-closing trial balance includesonly balance sheet accounts (all of the revenue,expense, and dividends accounts are closed), Cash(answer A), Accumulated Depreciation (answer C),