Corporate finance accounting 14e by warren reeve duchac chapter 4

Chapter

4

Completing the
Accounting Cycle

Corporate
Financial
Accounting
14e
Warren
Reeve
Duchac
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Income Statement

•

The income statement is prepared directly from
the Adjusted Trial Balance columns of the endof-period spreadsheet, beginning with fees
earned.

•

The expenses in the income statement are listed
in order of size, beginning with the larger items.
o

Miscellaneous Expense is the last item, regardless of
its amount.

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Retained Earnings Statement

•

The first item normally presented on the retained
earnings statement is the balance of the retained
earnings account at the beginning of the period.

•

The amount of dividends is deducted from the
net income to determine the ending retained
earnings account balance.

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Balance Sheet
(slide 1 of 2)

•

The balance sheet is prepared directly from the
Adjusted Trial Balance columns of the end-ofperiod spreadsheet, beginning with Cash.

•

The asset and liability amounts are taken from
the spreadsheet.

•

The retained earnings amount is taken from the
retained earnings statement.

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Balance Sheet
(slide 2 of 2)

•

A balance sheet that shows subsections for
assets and liabilities is a classified balance
sheet.
o

Assets are commonly divided into two sections on the
balance sheet: (1) current assets and (2) property,
plant, and equipment.

o

Liabilities are commonly divided into two sections on
the balance sheet: (1) current liabilities and (2) longterm liabilities.

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Current Assets
(slide 1 of 2)

•

Cash and other assets that are expected to be converted
to cash or sold or used up usually within one year or
less, through the normal operations of the business, are
called current assets.

•

Current assets include:
o

Cash

o

Notes receivable

o

Accounts receivable

o

Supplies

o

Other prepaid expenses

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Current Assets
(slide 2 of 2)

•

Notes receivable are written promises by the
customer to pay the amount of the note and
interest. Like accounts receivable, notes
receivable are amounts that customers owe, but
they are more formal than accounts receivable.

•

Notes receivable and accounts receivable are
current assets because they are usually
converted to cash within one year or less.

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Property, Plant, and Equipment

•

Property, plant, and equipment (also called
fixed assets or plant assets) include land and
assets that depreciate over a period of time.
o

Assets that depreciate over time include:
 Equipment
 Machinery
 Buildings

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Current Liabilities

•

Amounts the business owes to creditors that will be due
within a short time (usually one year or less) and that are
to be paid out of current assets are called current
liabilities.

•

Current liabilities include:
o

Notes payable

o

Accounts payable

o

Wages payable

o

Interest payable

o

Taxes payable

o

Unearned fees
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Long-Term Liabilities

•

Amounts the business owes to creditors that will
not be due for a long time (usually more than
one year) are called long-term liabilities.

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Stockholders’ Equity

•

Stockholders’ equity is the stockholders’ right to
the assets of the business.

•

It is presented on the balance sheet below the
liabilities section.

•

Stockholders’ equity is added to the total
liabilities, and this total must be equal to the total
assets.

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Permanent Accounts

•

Accounts that are relatively permanent from year
to year are called permanent accounts or real
accounts.

•

The balances of these accounts are carried
forward from year to year.

•

This includes accounts reported on the balance
sheet.

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Temporary Accounts

•

Accounts that report amounts for only one period
are called temporary accounts or nominal
accounts.

•

Temporary accounts are not carried forward from
year to year because they relate to only one
period.

•

This includes all accounts reported on the
income statement as well as the dividends
account, which is reported on the retained
earnings statement.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Closing Entries
(slide 1 of 4)

•

At the beginning of the next period, temporary accounts
should have zero balances.

•

To achieve this, temporary account balances are
transferred to permanent accounts at the end of the
accounting period through journal entries.

•

The entries that transfer these balances are called

closing entries. The transfer process is called the
closing process and is sometimes referred to as
closing the books.

•

After the closing entries are posted, all of the temporary
accounts have zero balances.

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Closing Entries
(slide 2 of 4)

•

The closing entries involves the following four steps:
o

Step 1. Revenue account balances are transferred to
an account called Income Summary.

o

Step 2. Expense account balances are transferred to
an account called Income Summary.

o

Step 3. The balance of Income Summary (net income
or net loss) is transferred to the retained earnings
account.

o

Step 4. The balance of the dividends account is
transferred to the retained earnings account.

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Closing Entries
(slide 3 of 4)

•

Income Summary is a temporary account that is only
used during the closing process.

•

At the beginning of the closing process, Income
Summary has no balance.

•

During the closing process, revenue and expense
accounts are cleared by debiting or crediting Income
Summary for their amounts.

o

Because it has the effect of clearing the revenue and expense
accounts of their balances, Income Summary is sometimes
called a clearing account.

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Closing Entries
(slide 4 of 4)

•

The four closing entries required in the closing process
are as follows:
1.

Debit each revenue account for its balance and credit Income
Summary for the total revenue.

2.

Credit each expense account for its balance and debit Income
Summary for the total expenses.

3.

Debit Income Summary for its balance (net income) and credit
the retained earnings account. (In the case of a net loss, credit

Income Summary for the amount of its balance and debit the
retained earnings account for the amount of the net loss.)

4.

Debit the retained earnings account for the balance of the
dividends account and credit the dividends account.

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Post-Closing Trial Balance

•

A post-closing trial balance is prepared after the
closing entries have been posted.

•

The purpose of the post-closing (after closing)
trial balance is to verify that the ledger is in
balance at the beginning of the next period.

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Accounting Cycle
(slide 1 of 2)

•

The accounting process that begins with
analyzing and journalizing transactions and ends
with the post-closing trial balance is called the
accounting cycle.

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Accounting Cycle
(slide 2 of 2)

•

The steps in the accounting cycle are as follows:
o

Step 1. Transactions are analyzed and recorded in the journal.

o

Step 2. Transactions are posted to the ledger.

o

Step 3. An unadjusted trial balance is prepared.

o

Step 4. Adjustment data are assembled and analyzed.

o

Step 5. An optional end-of-period spreadsheet is prepared.

o

Step 6. Adjusting entries are journalized and posted to the ledger.

o

Step 7. An adjusted trial balance is prepared.

o

Step 8. Financial statements are prepared.

o

Step 9. Closing entries are journalized and posted to the ledger.

o

Step 10. A post-closing trial balance is prepared.

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Fiscal 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 day of the following
twelfth month.

•

When a corporation adopts a fiscal year that
ends when business activities have reached the
lowest point in its annual operating cycle, such a
fiscal year is called the natural business year.

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Analysis for Decision Making:
Working Capital and Current Ratio

•

The ability to convert assets into cash is called
liquidity.

•

The ability of a business to pay its debts is called
solvency.

•

Two financial measures for evaluating a
business’s short-term liquidity and solvency are
working capital and the current ratio.

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Analysis for Decision Making:
Working Capital

•

Working capital is the excess of the current
assets of a business over its current liabilities.

•

Working capital is computed as follows:
Working Capital = Current Assets – Current Liabilities

•

A positive working capital implies that the

business is able to pay its current liabilities and
is solvent.

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Analysis for Decision Making:
Current Ratio

•

The current ratio is another means of
expressing the relationship between current
assets and current liabilities.

•

The current ratio is computed by dividing current
assets by current liabilities, as follows:
Current Assets
Current Ratio =

Current Liabilities

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Appendix 1: End-of-Period Spreadsheet

•

Spreadsheets are usually prepared by using a
computer program such as Microsoft’s Excel®.

•

Some accountants prefer to expand the end-ofperiod spreadsheet to include financial
statement columns.

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.