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Chapter 4Completing the

Accounting Cycle

© 2016 Pearson Education, Inc.

Learning Objectives

1. Prepare the financial statements including the classified balance sheet

2. Use the worksheet to prepare financial statements

3. Explain the purpose of, journalize, and post closing entries

4. Prepare the post-closing trial balance

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Learning Objectives

5. Describe the accounting cycle

6. Use the current ratio to evaluate business performance

7. Explain the purpose of, journalize, and post reversing entries (Appendix 4A)

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Learning Objective 1

Prepare the financial statements including the classified balance sheet

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How Do We Prepare Financial Statements?

• The financial statements:– Income statement:

• Reports revenues and expenses and calculates net income or loss for the period

– Statement of retained earnings:• Shows how retained earnings changed during the

period

– Balance sheet:• Reports assets, liabilities, and stockholders’ equity as

of the last day of the period

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The financial statements are prepared from the adjusted trial balance.

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Relationships Among the Financial Statements

• The financial statements relate to each other. – Net income or net loss from the income

statement flows to the statement of retained earnings.

– Ending Retained Earnings from the statement of retained earnings flows to the balance sheet.

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Net income flows to the statement of

retained earnings.

Exhibit 4-2 Smart Touch Learning Financial Statements

The net income from the income

statement flows to the statement of

retained earnings.

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The ending Retained

Earnings flows to the balance

sheet.


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The ending value of Retained Earnings from the

statement of retained earnings

flows to the balance sheet.



Classified Balance Sheet

• A classified balance sheet places each asset and each liability into a specific category.– Assets are shown in order of liquidity. – Liabilities are classified as current (due within

one year) or long term (due after one year).

• Liquidity measures how quickly and easily an account can be converted to cash.

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Assets

The operating cycle is the time span during which cash is paid

for goods and services, which are then sold to customers, from

whom the business collects cash.

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Current assets• Converted to cash or used within 12 months

or within the operating cycle.

Long-term assets• Not converted to cash or used up within the

operating cycle or one year. • Long-term investments• Plant assets• Intangible assets


Liabilities

• Current liabilities must be paid either with cash or with goods and services within one year or within the entity’s operating cycle. – Examples:

• Accounts Payable• Salaries Payable• Unearned Revenue

• Long-term liabilities are all liabilities that do not need to be paid within one year or within the operating cycle.

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Stockholders’ Equity

• Stockholders’ equity represents the stockholders’ claims to the assets of the business. – Reflects the stockholders’ contributions

through common stock– Represents the amount of assets left over after

the corporation has paid its liabilities

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Use the worksheet to prepare financial statements

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How Could a Worksheet Help in Preparing Financial Statements?

• The first four sections of the worksheet (see Chapter 3) helped determine the adjusted trial balance, from which we prepare financial statements.– Section 5—Income Statement

• Includes only revenue and expense accounts

– Section 6—Balance Sheet• Includes asset, liability, and equity accounts except

revenues and expenses

– Section 7—Determine Net Income or Net Loss• The balancing amount for the income statement and

balance sheet sections (will be the same amount)

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Explain the purpose of, journalize, and post closing entries

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What Is the Closing Process, and How Do We Close the Accounts?

The closing process zeros out all revenue and expense accounts in order to measure each period’s net income separately from all other periods.

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Temporary Accounts

Revenues

Expenses

Dividends

Permanent Accounts

Assets

Liabilities

Equity



• Closing entries– Transfer revenues, expenses, and Dividends to

Retained Earnings

• Revenues and expenses may be transferred first to an account titled Income Summary. – The Income Summary account summarizes the

net income (or net loss) for the period.

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Closing Temporary Accounts—Net Income for the Period

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Closing Temporary Accounts—Net Loss for the Period

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Prepare the post-closing trial balance

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How Do We Prepare a Post-Closing Trial Balance?

• The accounting cycle ends with a post-closing trial balance:– A list of the accounts and their balances at the

end of the period, after journalizing and posting the closing entries

– Includes only permanent accounts

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Describe the accounting cycle

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What Is the Accounting Cycle?

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Use the current ratio to evaluate business performance

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How Do We Use the Current Ratio to Evaluate Business Performance?

• The current ratio measures a company’s ability to pay its current liabilities with its current assets.

• The formula is:

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Explain the purpose of, journalize, and post reversing entries (Appendix 4A)

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What Are Reversing Entries?

• Special journal entries that ease the burden of accounting for transactions in a later period

• The opposite of adjusting entries• Not required by GAAP• Used for convenience and to save time

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Accounting for Accrued Expenses

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To record accrued salaries of $1,200, Smart Touch Learning recorded the following adjusting entry:


Accounting Without a Reversing Entry

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To record the payment of total salaries of $2,400 on January 15 without a reversing entry, Smart Touch would:


Accounting with a Reversing Entry

A reversing entry is a special journal entry that eases the burden of accounting for transactions in the next period.

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Accounting with a Reversing Entry

The credit balance in the Salaries Expense account is eliminated on January 15, when Smart Touch Learning pays the payroll and debits Salaries Expense.

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