copyright © 2012 pearson education, inc. publishing as prentice hall. chapter 4 1

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Completing the Accounting Cycle

Chapter 4

1


Learning Objectives

2

Prepare an accounting worksheet

Use the worksheet to prepare financialstatements

Close the revenue, expense, and dividendaccounts

Prepare the post-closing trial balance


Learning Objectives

3

Classify assets and liabilities as current orlong-term

Describe the effect of various transactions on the current ratio and the debt ratio


Steps in the Accounting CycleStart with the beginning

account balances.

Analyze and journalize transactions as they

occur.

Post to the accounts.

Compute the unadjusted

balance in each account.

Enter the trial balanceand complete the

worksheet. Journalizeand post adjusting

entries

Prepare the financial

statements.

Journalize and postthe closing entries.

Prepare the post-closing

trial balance.

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During the period

At the end of the period

IPO anyone?

http://www.mpcfaculty.net/jon_mikkelsen/Busi1A/Lectures/Forms/AllItems.aspx


Prepare an accounting worksheet

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1


WorksheetA tool used to summarize informationIt is not a:

journalledgerfinancial statement

Computerized spreadsheets & sensitivity analysisContains heading similar to statements

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Worksheet Step 1

Enter account titlesunadjusted balances

Total the amounts

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Worksheet Step 2

Enter the adjusting entriesTotal the amountsRemember, these still need to be journalized and posted

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Worksheet Step 3

Compute each account’s adjusted balanceEnter the adjusted balance in the adjusted trial balance column

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$2,200 (Dr) + $400 (Dr) = $2,600

$600 (Cr) - $200 (Dr) = $400


Worksheet Step 4Draw an imaginary line above the firstrevenue accountEvery account above the line are Balance Sheet accountsEvery account below the line are Income Statement accountsCopy the totals to the appropriate column

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Assets

Liabilities

Equity

Expenses

Revenue


Worksheet Step 5

Using the income statement columns, compute net income

Revenues minus expenses

Enter net income as the balancing amount

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Expenses total = $3,900Revenues total = $7,600

Net income = $3,700


Worksheet Step 5

Also enter net income as a balancing amount on the balance sheet

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Net income from previous columns

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.14

Complete Worksheet


Work opportunityDraper Consulting, Inc.

Just complete the instruction for completing the worksheet, not the rest of them.

Draw a line between BS and IS accountsMove Income statement accounts

Sub total each columnPlug in net income to balance & finalize totals

Move Balance sheet accountsSub total each columnPlug in net income to balance & finalize totals

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Use the worksheet to prepare financial statements

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2


Preparing Financial Statements from a Worksheet

The worksheet contains the financial statement data.

Income statement column equals the income statementThe Net income total is for our retained earnings statement

Connects the Net income to the balance sheet

Balance sheet column equals the balance sheet

Worksheet is an internal documentFinancial statements are for external users

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Compare the balances here with the Income Statement appearing next.

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Worksheet

Income Statement


Preparing Financial StatementsBeginning Retained earnings is found in the balance sheet columns, along with DividendsNet income is found in the income statement columnsEnding Retained earnings is computed here Carry the ending Retained earnings balance to the balance sheet


Compare the balances on the worksheet with the Balance Sheet appearing next.

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Worksheet

Balance Sheet


Classified balance sheetLiquidity measures quickness of cash

How quickly an item can be converted into cash

Classified Balance Sheet Lists assets in order of their liquidity

Current AssetsConverted to cash, sold, or usedMost commonly within one year

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Current Assets

Examples:CashAccounts receivableSuppliesPrepaid expensesInventory

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Long-Term Assets

Not converted to cash within the current year Categories

Plant assetsLandBuildingFurnitureEquipment

Long-term investmentsOther assets

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Current Liabilities

Must be paid either with cash or goods and services within one year Examples:

Accounts payableNotes payable due within one yearSalary payableInterest payableUnearned revenue

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Long-Term Liabilities

Are not due within the current year Examples:

Notes payable with due dates over one yearMortgages

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Classified BalanceSheet: Report Form

Report form should be read top to bottom

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Work opportunityDraper Consulting, Inc.

Just complete instruction for preparing financial statements, not the rest.

Prepare Income statement firstPrepare Statement of retained earnings secondPrepare Classified Balance sheet third

Remember to update retained earnings balance!

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Draper’s Classified Balance Sheet

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Draper Consulting, Inc. Balance Sheet

December 31, 2012 ASSETS LIABILITIES

Current assets: Current liabilities: Cash $ 16,350 Accounts payable $ 4,650 Accounts receivable 1,750 Salary payable 685 Supplies 200 Unearned service Total current assets

18,300 revenue 700

Plant assets: Total current liabilities 6,035 Equipment 1,800 Acc. depr. (30) 1,770 STOCKHOLDERS’ EQUITY Common stock $ 18,000 Furniture 4,200 Retained earnings 165 Acc. depr. (70) 4,130 Total stockholders’ equity 18,165 Total liabilities and Total assets $ 24,200 stockholders’ equity $ 24,200


Close the revenue, expense, and dividend accounts

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3


Closing the AccountsOccurs at the end of the period

Gets accounts ready for next period

Zeroes out revenue and expense accountsUpdates Retained earnings to the ending balanceFour step processClose temporary accounts

Closing entries do not capture new transactions like adjusting entries did. All closing entries do is transfer balances to their permanent destinations.

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Temporary and Permanent Accounts

TemporaryClosed at the end of the period

RevenuesExpenses Dividends

Start next period with a zero balance

PermanentNot closed at the end of the period

AssetsLiabilitiesCommon stockRetained earnings

Ending balance carries forward to next period

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Closing the Accounts

Step 1 – Close Revenues to Income summary account

Step 2 – Close individual Expense accounts to Income summary account

Step 3 – Close Income summary account to Retained earnings account

Step 4 - Close Dividends account to retained earnings account

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Four Step Closing ProcessThe closing process

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E4-18: PREPARING CLOSING ENTRIES FROM A PARTIAL WORKSHEET

The adjusted trial balance from the January worksheet of Silver Sign Company is shown:

Requirement:1. Journalize Silver’s closing entries at January 31.

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1. Journalize Silver’s closing entries at January 31.

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Jan. 31 Service revenue $16,800Income summary $16,800

31 Income summary 6,200Salary expense 3,600Rent expense 1,400Depreciation expense 400Supplies expense 200Utilities expense 600



2. How much net income or net loss did Silver earn for January? How can you tell?

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31 Income summary 10,600Retained earnings 10,600

31 Retained earnings 800Dividends 800

Silver had net income of $10,600. We know this because service revenue exceeded total expenses.


Work opportunity

Draper Consulting, Inc.

Just complete the instruction for closing entries and posting them

Link to Draper Consulting, Inc. Adjusted trial balance

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Prepare post-closing trial balance

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4


Post-Closing Trial Balance

List of permanent accounts and their balances after posting closing entriesTotal debits and credits must be equalSame accounts as on the balance sheet

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S4-8: PREPARING A POST-CLOSING TRIAL BALANCE

After closing its accounts at July 31, 2012, Goodrow Electric Company had the following account balances:

1. Prepare Goodrow’s post-closing trial balance at July 31, 2012.

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S4-8: PREPARING A POST-CLOSING TRIAL BALANCE

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Cash $ 100Accounts receivable 1,600Supplies 200Equipment 4,500Accumulated depreciation $ 1,300Land 1,200Accounts payable 1,100Unearned service revenue 1,400Long-term liabilities 800Common stock 1,000Retained earnings 2,000 Total $ 7,600 $ 7,600

Goodrow Electric CompanyPost-Closing Trial Balance

July 31, 2012


Use the debt ratio, current ratio and the interest coverage ratio

to evaluate a company

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6


Accounting Ratios

To measure the business’s financial positionDecision makers use financial ratiosWidely used debt analysis ratios:

Debt ratioCurrent ratioExtra: Interest coverage ratio

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Ratios

Fun to trouble

ratio

A ratio is a mathematical expression of the relationship between two items.

Miles per hour

Defects per thousands

Hundreds more uses

Miles per gallon

Odds of winning

Risk to Reward

ratio


Ratios

Debt exposure

We can compare business ratios with company history, competitors, or another industry to learn several things about

businesses.

Profitability

Value

Efficiency

Hundreds more uses

StrategyImpending

doom

Managerial effectiveness


Ratios are evidence to a story. The story is what really matters.

Debt exposure aka leverage

Is the company borrowing responsibly?

Debt Ratio:debt ÷ assets

Find a tool to measure responsible borrowing

50% is optimal, they have way too much debt and way too little equity.

The #’s: 810 ÷900 = 90%

The story

This is too much borrowing compared to the industry norm of equal liability and equity financing. They may be in

danger of failing to make the associated interest payments and in paying back principle. If they can’t pay, the equity

holders lose their entire investment. This is very risky.


Debt Ratio

Indicates the proportion of a business’s assets that are financed with debtMeasures business’s ability to pay its debtsRule of thumb:

Above 60% is considered unsafe50% is widely regarded as optimalLower may suffer from unnecessarily high cost of capital

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Total liabilities Total assets


Current Ratio

Measures a company’s ability to pay its current liabilitiesRule of thumb

Strong current ratio is 1.5Ample cash on hand, with little wasteful excess

1.0 is either dangerously low, or well managedHow to tell?

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Current assets Current liabilities


Interest Coverage Ratio

Compares earnings to borrowing costs.If too much earnings are going to lenders, then the company isn’t handling their debt well.Rule of thumb

Norm is between 2.0 and 3.0Twice as much earnings as interest charges

Lower than 2.0 means high interest is consuming over half of the company’s earnings

Leaves little margin of performance safety65

Earnings before interest & taxesInterest expense


Yahoo debt analysis

www.yahoo.com/finance

Debt ratio Liabilities ÷ Assets

Current ratio Current Assets ÷ Current liabilities

Interest coverage ratio EBIT ÷ Interest expense

Compare each number against benchmarkJudge each number and interpret

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http://www.yahoo.com/finance


Your turnGroups of up to 6One laptop per team

User name: defaultPassword: mpcmpcmpc

Follow the Yahoo Finance debt analysis procedureReport on the debt analysis reporting form20 minutes of work, not enough to finish everyoneSubmit individual sheet for points next class

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Work opportunity

Practice Set Page 250

Complete the worksheet.Prepare financialsPrepare closing entriesPrepare post-closing trial balance

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Complete Worksheet


Next Time

Be on time or you will miss out on the actionBe prepared to execute the entire accounting cycle at warp speedIf you put maximum effort into it, you will master the accounting cycle and get the point of the financial statementsThis is a huge help toward your test preparation, but only if you are prepared


S4-11: COMPUTING THE CURRENT AND DEBT RATIOS

Heart of Texas Telecom has these account balances at December 31, 2012:

1. Compute Heart of Texas Telecom’s current ratio and debt ratio.

2. How much in current assets does Heart of Texas Telecom have for every dollar of current liabilities that it owes?

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Note payable, long-term $ 7,800 Accounts payable $ 3,700Prepaid rent 2,300 Accounts receivable 5,700Salary payable 3,000 Cash 3,500Service revenue 29,400 Depreciation expense 6,000Supplies 500 Equipment 15,000

Current ratio =Total current assets

Total current liabilities=

$12,0006,700

= 1.79

Debt ratio =Total liabilities

Total assets=

$14,500$27,000

= 0.54

Heart of Texas Telecom has $1.79 of current assets for every dollar of current liabilities that it owes.


Chapter 4 SummaryThe worksheet is a tool that puts the whole accounting process in one place. Remember that debits = credits in the first three columns. Columns 4 and 5 (Income Statement and Balance Sheet) debits do not equal credits until you post the net income or net loss for the period. The formal financial statements yield the same net income or loss that is shown on the worksheet.

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Chapter 4 Summary

Closing the accounts is just like starting a new baseball game. The score is 0-0. All temporary account balances are zero after closing.The post-closing trial balance contains the same accounts that the balance sheet contains—assets, liabilities, Common stock, and Retained earnings.

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Chapter 4 Summary

Classification means dividing assets and liabilities between those that will last less than a year (current) and those that will last longer than a year (long-term). The classified balance sheet still represents the accounting equation and must balance (Assets = Liabilities + Equity).

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The current ratio measures liquidity within one year by comparing current assets to current liabilities. The debt ratio measures the ability to pay liabilities in the long term by comparing all liabilities to all assets. The different ratios give different views of a company’s financial health.

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Chapter 4 Summary


Copyright

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America.

copyright © 2012 pearson education, inc. publishing as prentice hall. chapter 4 1

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