Accounting principles chapter 04

Accounting
Principles

Second Canadian Edition
Weygandt · Kieso · Kimmel ·
Trenholm

Prepared by:
Carole Bowman, Sheridan College


CHAPTER

4
COMPLETION OF THE
ACCOUNTING CYCLE


WORK SHEET






A work sheet is a multiple-column form that
may be used in the adjustment process and in
preparing financial statements.
It is a working tool or a supplementary device
for the accountant and not a permanent
accounting record.

Use of a work sheet should make
the preparation of adjusting entries
and financial statements easier.


ILLUSTRATION 4-1

WORK SHEET
Account Titles

Trial Balance
Debit
Credit

1. Prepare
trial balance
on the
worksheet.

Adjustments
Debit
Credit

2. Enter
adjustment
data.

Adjusted Trial Balance
Debit
Credit

3. Enter
adjusted
balances

Income Statement
Debit
Credit

Balance Sheet
Debit
Credit

4. Extend adjusted
balance to appropriate
columns.
5. Calculate income/loss
and complete the
worksheet.


PURPOSE OF CLOSING ENTRIES
1. Updates the owner’s capital account
in the ledger by transferring net
income (loss) and owner’s drawings
to owner’s capital.
2. Prepares the temporary accounts
(revenue, expense, drawings) for the
next period’s postings by reducing
their balances to zero.

ILLUSTRATION 4-2

TEMPORARY VERSUS
PERMANENT ACCOUNTS
TEMPORARY (NOMINAL)
closed

PERMANENT (REAL)

These accounts are not closed

All revenue accounts

All asset accounts

All expense accounts

All liability accounts

Owner’s drawings

Owner’s capital account

(Income Statement /
Drawings Accounts)

These accounts are

(Balance Sheet Accounts)


ILLUSTRATION 4-3

DIAGRAM OF CLOSING PROCESS
(INDIVIDUAL)
REVENUES

(INDIVIDUAL)
EXPENSES

Normal Dr.
Balance
-0-

Cr. to close

Dr. to close

2

Normal Cr.
Balance
-0-

1
OWNER’S
CAPITAL

Expenses

Opening Balance
Revenues

11 Debit
Debit each
each revenue
revenue account
account for
for its
its balance,
balance, and
and credit
credit the
the
owner’s
owner’s capital
capital account
account for
for total
total revenues.
revenues.
22 Debit
Debit the
the owner’s
owner’s capital
capital account
account for
for total

total expenses,
expenses, and
and credit
credit
each
each expense
expense account
account for
for its
its balance.
balance.


ILLUSTRATION 4-3

DIAGRAM OF CLOSING PROCESS
OWNER’S
CAPITAL

Expenses
Drawings

Opening Balance
Revenues
Ending Balance

3
OWNER’S
DRAWINGS

Normal Dr.
Balance

Cr. to close

-0-

3 Debit owner’s capital for the balance in the owner’s drawings
account and credit owner’s drawings for the same amount.


CLOSING ENTRIES
STOP AND CHECK
1. Does the balance in your
Owner’s Capital account
equal the ending capital
balance reported in the
Balance Sheet and
Statement of Owner’s
Equity?
2. Are all of your temporary
account balances zero?


POST-CLOSING TRIAL BALANCE




After all closing entries have been

journalized and posted, a post-closing trial
balance is prepared.
The purpose of this trial balance is to prove
the equality of the permanent (balance
sheet) account balances that are carried
forward into the next accounting period.


ILLUSTRATION 4-8

POST-CLOSING TRIAL BALANCE
Pioneer Advertising Agency
Post-Closing Trial Balance
October 31, 2002
After Adjustment
Debit
Credit
Cash
$ 15,200
The
post-closing
trial
Accounts Receivable
200
balance is prepared
Advertising Supplies
1,000
from the permanent
Prepaid Insurance
550

Office Equipment
5,000
accounts in the ledger.
Accumulated Amortization
$
83
Notes Payable
5,000
The post-closing trial
Accounts Payable
2,500
balance provides evidence
Unearned Revenue
800
that the journalizing and
Salaries Payable
1,200
posting of closing entries
Interest Payable
25
C.R. Byrd, Capital
12,342
has been properly
$ 21,950
$ 21,950
completed.


STEPS IN THE ACCOUNTING CYCLE
9. Prepare

post-closing
trial balance

1. Analyse
transactions

3. Post to ledger
accounts

8. Journalize
and post
closing entries
7. Prepare
financial
statements

2. Journalize the
transactions

4. Prepare a
trial balance

6. Prepare
adjusted trial
balance

5. Journalize
and post
adjusting
entries

REVERSING ENTRIES
(OPTIONAL STEP)





A reversing entry is made at the beginning
of the next accounting period.
A reversing entry reverses certain adjusting
entries made in the previous period.
Opening balances can then be ignored
when preparing year-end adjusting entries.
This topic is illustrated in Appendix 4A.


CORRECTING ENTRIES






Errors that occur in recording transactions
should be corrected as soon as they are
discovered by preparing correcting entries.
Correcting entries are unnecessary if the
records are free of errors; they can be

journalized and posted whenever an error
is discovered.
They involve any combination of balance
sheet and income statement accounts.


ILLUSTRATION 4-10

STANDARD BALANCE SHEET
CLASSIFICATIONS
 Financial

statements become more useful when the
elements are classified into significant subgroups.
 A classified balance sheet generally has the following
standard classifications:
Assets

Liabilities and Equity
Current

Assets
Current Liabilities
Long-Term Investments
Long-Term Liabilities
Capital Assets
Owner’s/ Partners’/ Shareholders’ Equity


CURRENT ASSETS






Current assets are cash and other resources
that are reasonably expected to be realized in
cash or sold or consumed in the business
within one year of the balance sheet date or
the company’s operating cycle, whichever is
longer.
Listed in the order of liquidity.
Examples of current assets are cash,
temporary investments, accounts receivable,
inventory, and prepaids.


LONG-TERM
INVESTMENTS




Long-term investments are resources that can
be realized in cash, but the conversion into
cash is not expected within one year or the
operating cycle, whichever is longer.
Examples include investments in shares or
bonds of another company or investment in
land held for resale.

100

XYZ shares


CAPITAL ASSETS


Tangible resources of a relatively permanent nature
that are used in the business and not intended for sale
are classified as (1) property, plant, and equipment and
(2) natural resources.
(1) Examples of property, plant, and equipment include land,
buildings, and machinery.
(2) Examples of natural resources include tracts of timber, oil
and gas reserves, and mineral deposits.


CAPITAL ASSETS



Intangible assets are noncurrent resources that
do not have physical substance.
Examples include patents, copyrights,
trademarks, or trade names that give the
holder exclusive right of use for
a
specified period of time.

CURRENT LIABILITIES




Current liabilities are obligations that are
reasonably expected to be paid from
existing current assets or through the
creation of other current liabilities within
one year or the operating cycle, whichever
is longer.
Examples include accounts payable,
unearned revenue, interest payable, and
current maturities of long-term debt.


LONG-TERM LIABILITIES



Obligations expected to be paid after one
year are classified as long-term liabilities.
Examples include long-term notes payable,
bonds payable, mortgages payable, and
lease liabilities.


EQUITY






The content of the equity section varies with the
form of business organization.
In a proprietorship, there is a single owner’s
equity account called (Owner’s Name), Capital.
In a partnership, there are separate capital
accounts for each partner.
For a corporation, owners’ equity is called
shareholders’ equity, and it consists of two
accounts: Share Capital and Retained Earnings.


ILLUSTRATION 4-17
CLASSIFIED BALANCE SHEET IN REPORT FORM
Pioneer Advertising Agency
Balance Sheet
October 31, 2002
Assets
Current Assets
Cash
Accounts Receivable
Advertising Supplies
Prepaid Insurance
Total Current Assets
Capital Assets
Office Equipment

Less: Accumulated Amortization
Total Assets

$

$

5,000
83
$

15,200
200
1,000
550
16,950

4,917
21,867

Liabilities and Owner's Equity
Current Liabilities
Notes Payable
Accounts Payable
Unearned Revenue
Salaries Payable
Interest Payable
Total Current Liabilities
Long-term Liabilties
Notes Payable

Total Liabilities
Owner's Equity
C.R. Byrd, Capital
Total Liabilities and Owner's Equity

$

1,000
2,500
800
1,200
25
5,525
4,000
9,525

$

12,342
21,867

A classified balance
sheet helps the
financial statement
user determine:
• The availability of
assets to meet debts as
they come due, and
•The claims of shortand long-term
creditors on total

assets.
The balance sheet is
most often presented in
the report form, with
the assets shown above
the liabilities and
owner’s equity.


LIQUIDITY



Liquidity measures ability to pay shortterm obligations when they come due.
Working capital is one important measure
of liquidity.

WORKING CAPITAL = CURRENT ASSETS - CURRENT LIABILITIES


CURRENT RATIO
The current ratio (working capital ratio) is a
widely used measure for evaluating a company’s
liquidity and short-term debt-paying ability. It is
calculated by dividing current assets by current
liabilities and is a more dependable indicator of
liquidity than working capital.

CURRENT ASSETS
CURRENT RATIO =

———————————