Chapter 4

Accounting Principles Second Canadian Edition Weygandt Kieso Kimmel Trenholm Prepared by: Carole Bowman, Sheridan College Edited by: Carolyn Doering, HHSS 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 owners capital account in the ledger by transferring net income (loss) and owners drawings to owners capital. 2. Prepares the temporary accounts (revenue, expense, drawings) for the next periods 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 These accounts are All asset accounts All expense accounts All liability accounts Owners drawings Owners capital account (Income Statement / Drawings Accounts) (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 OWNERS 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 owners owners capital

capital account account for for total total revenues. revenues. 22 Debit Debit the the owners owners 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 OWNERS CAPITAL Expenses Drawings Opening Balance Revenues Ending Balance 3 OWNERS DRAWINGS Normal Dr. Balance Cr. to close

-0- 3 Debit owners capital for the balance in the owners drawings account and credit owners drawings for the same amount. CLOSING ENTRIES STOP AND CHECK 1. Does the balance in your Owners Capital account equal the ending capital balance reported in the Balance Sheet and Statement of Owners 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 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 Owners/ 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 companys 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 owners equity account called (Owners 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 owners 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 companys 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 = COPYRIGHT Copyright 2002 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by CANCOPY (Canadian Reprography Collective) is unlawful. Request for further information should be addressed to the Permissions Department, John

Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his / her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.

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