Ch7 acctg cycle service business

INTRODUCTORY ACCOUNTING

CHAPTER 7

COMPLETING THE ACCOUNTING CYCLE FOR SERVICE BUSINESS

Accrual Accounting and the Financial 2

Objectives of the Chapter

1. Introduce the worksheet paper to facilitate the preparation of financial statements.

2. Explain the process of closing the books (i.e., preparing the closing entries).

3. Discuss the content of a post-closing trial balance.

4. Explain the correcting entries.

5. Discuss a classified balance sheet.

6. Formats of the balance sheet.

7. Accounting ratios for decision making.

© 2007 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 10e by Slater

Steps in Accounting Cycle

Transaction Journalize Post

WorksheetFinancial

StatementsJournalize &

Post Adjusting

Entries

Journalize & Post

Closing Entries

Post-Closing Trial

Balance

Reversing entry

• multiple-column form used for the adjustment

process and preparing financial statements

• working tool for the accountant

• not a permanent accounting record

• Eases preparation of adjusting entries and

financial statements

What is a Worksheet?

Example of a Work Sheet

Remember:

• A work sheet is not a permanent accounting record

• When it is used:o financial statements are prepared from

the work sheet

o adjustments are journalized and posted from the work sheet after financial statements, so management can receive the financial statements more quickly

To Prepare A Work Sheet:

1 Prepare the trial balance

2 Enter adjustments in the adjustments columns

3 Enter adjusted balances in adjusted trial balance

columns

4 Extend adjusted trial balance amounts to the

appropriate financial statement columns

5 Total the statement columns, compute net income

(loss), and complete the work sheet

Now, let’s see how this works!

Dr. Cr. Dr. Cr. Dr. Cr.

Cash 3,950

Accounts receivable -

Supplies 9,720

Prepaid insurance 2,400

Equipment 26,000

Accum. depr. - Equip. -

Accounts payable 6,200

Salaries payable -

Unearned revenue 3,000

C. Taylor, Capital 30,000

C. Taylor, Withdrawals 600

Consulting revenue 5,800

Rental revenue 300

Depr. expense -

Salaries expense 1,400

Insurance expense -

Rent expense 1,000

Supplies expense -

Utilities expense 230

Totals 45,300 45,300

Adjusted

Trial BalanceAdjustments

Unadjusted

Trial Balance

FastForwardWork Sheet

For Month Ended December 31, 2004

First, enter

the

unadjusted

trial balance

amounts to

the

worksheet!

Here are our adjusting entries for December.

a) Insurance expense 100

Prepaid insurance 100

b) Supplies expense 1050

Supplies 1050

c) Depreciation expense 375

Accum. Depr. – Equip. 375

Here Are More Adjusting Entries for December.

d) Unearned revenue 250

Consulting Revenue 250

e) Salaries Expense 210Salaries Payable 210

f) Accounts Receivable 1,800Consulting Revenue 1,800


Cash 3,950

Accounts receivable - f 1,800

Supplies 9,720 b 1,050

Prepaid insurance 2,400 a 100

Equipment 26,000

Accum. depr. - Equip. - c 375


Salaries payable - e 210

Unearned revenue 3,000 d 250



Consulting revenue 5,800 d 250

f 1,800

Rental revenue 300

Depr. expense - c 375

Salaries expense 1,400 e 210

Insurance expense - a 100

Rent expense 1,000

Supplies expense - b 1,050


Totals 45,300 45,300 3,785 3,785

Adjusted


Unadjusted

Trial Balance

Next, enter the

adjustments!




Cash 3,950 3,950

Accounts receivable - f 1,800 1,800

Supplies 9,720 b 1,050 8,670

Prepaid insurance 2,400 a 100 2,300

Equipment 26,000 26,000

Accum. depr. - Equip. - c 375 375

Accounts payable 6,200 6,200

Salaries payable - e 210 210

Unearned revenue 3,000 d 250 2,750

C. Taylor, Capital 30,000 - 30,000

C. Taylor, Withdrawals 600 600

Consulting revenue 5,800 d 250 7,850

f 1,800

Rental revenue 300 300

Depr. expense - c 375 375

Salaries expense 1,400 e 210 1,610

Insurance expense - a 100 100

Rent expense 1,000 1,000

Supplies expense - b 1,050 1,050

Utilities expense 230 230

Totals 45,300 45,300 3,785 3,785 47,685 47,685

Adjusted


Unadjusted

Trial Balance

Prepare the

adjusted trial

balance!





Then, extend the adjusted trial balance

amounts to the financial statements!


Cash 3,950 3,950

Accounts receivable 1,800 1,800

Supplies 8,670 8,670

Prepaid insurance 2,300 2,300

Equipment 26,000 26,000

Accum. depr. - Equip. 375 375


Salaries payable 210 210

Unearned revenue 2,750 2,750

C. Taylor, Capital 30,000 30,000


Consulting revenue 7,850 7,850


Depr. expense 375 375

Salaries expense 1,610 1,610

Insurance expense 100 100


Supplies expense 1,050 1,050


Totals 47,685 47,685 4,365 8,150 43,320 39,535

Balance Sheet &

Statement of EquityStatement

Adjusted

Trial Balance

Income


Cash 3,950 3,950

Accounts receivable 1,800 1,800

Supplies 8,670 8,670

Prepaid insurance 2,300 2,300

Equipment 26,000 26,000

Accum. depr. - Equip. 375 375


Salaries payable 210 210

Unearned revenue 2,750 2,750

C. Taylor, Capital 30,000 30,000


Consulting revenue 7,850 7,850


Depr. expense 375 375

Salaries expense 1,610 1,610

Insurance expense 100 100


Supplies expense 1,050 1,050


Totals 47,685 47,685 4,365 8,150 43,320 39,535

Net income 3,785 3,785

8,150 8,150 43,320 43,320

Balance Sheet &

Statement of EquityStatement

Adjusted

Trial Balance

Income



Total statement columns, compute income or loss, and

balance columns.

FastForward

Income Statement

For the Month Ended December 31, 2004

Revenues:

Consulting revenue 7,850$

Rental revenue 300

Total revenues 8,150

Operating expenses:

Depr. expense - Equip. 375$


Insurance expense 100

Rent expense 1,000

Supplies expense 1,050


Total expenses 4,365

Net income 3,785$

Prepare the Income

Statement.

Prepare the Financial Statements

A work sheet

does not

substitute for

financial

statements.

Prepare the Statement of

Changes in Owner’s Equity.

FastForward

Income Statement


Revenues:

Consulting revenue 7,850$

Rental revenue 300

Total revenues 8,150

Operating expenses:

Depr. expense - Equip. 375$



Rent expense 1,000



Total expenses 4,365

Net income 3,785$ FastForward

Statement of Changes in Owner's Equity


C. Taylor, Capital 12/1/04 $ -0-

Add: Net income 3,785$

Investment by owner 30,000 33,785

Total 33,785

Less: Withdrawal by owner 600

C. Taylor, Capital 12/31/04 33,185$

FastForward

Balance Sheet

December 31, 2004

AssetsCash 3,950$

Accounts receivable 1,800

Supplies 8,670


Equipment 26,000$

Less: accum. depr. (375) 25,625

Total assets 42,345$

LiabilitiesAccounts payable 6,200$

Salaries payable 210

Unearned consulting revenues 2,750

Total liabilities 9,160$

Owner's EquityC.Taylor, Capital 33,185

Total liabilities and equity 42,345$

Prepare the

Balance Sheet.

FastForward

Statement of Changes in Owner's Equity


C. Taylor, Capital 12/1/04 $ -0-

Add: Net income 3,785$

Investment by owner 30,000 33,785

Total 33,785

Less: Withdrawal by owner 600

C. Taylor, Capital 12/31/04 33,185$

Which of these characteristics are

true about a work sheet?

o a permanent accounting record

o an optional device used by accountants

o a part of the general ledger

o a part of the journal

Answer!

o permanent accounting record

o optional device used by

accountants

o part of the general ledger

o part of the journal

Although it’s optional, the work sheet is a very useful tool!

Chapter 7

Completing the

Accounting Cycle

Accounting 1

TEMPORARY VS.

PERMANENT ACCOUNTS

TEMPORARY (NOMINAL) PERMANENT (REAL) These accounts are closed These accounts are not

closed

All revenue accounts All asset accounts

All expense accounts All liability accounts

Owner’s drawing Owner’s capital account

Now, let’s talk about closing entries and income summary!

CLOSING ENTRIES

• Closing entries

o Transfer net income (loss) and owner’s drawings

to owner’s capital

o Journalizing and posting is a required step in the

accounting cycle

• Income Summary

o A temporary account

o Used in closing revenue and expense accounts

o Minimizes the details in the permanent owner’s

capital account

Closing Process• Resets revenue,

expense and

withdrawal account

balances to zero at

the end of the period.

• Helps summarize a

period’s revenues and

expenses in the

Income Summary

account.

Identify accounts for

closing.

Record and post closing

entries.

Prepare post-closing trial

balance.

Temporary

Accounts

Revenues

Income Summary

Exp

en

ses

With

dra

wals

Permanent

Accounts

Assets

Lia

bilit

ies O

wn

er’s

C

ap

ital

The closing process

applies only to

temporary accounts.

Temporary and Permanent Accounts

Let’s see how the

closing process

works!

Recording Closing Entries

Close Revenue accounts to Income Summary.

Close Expense accounts to Income Summary.

Close Income Summary account to Owner’s Capital.

Close Withdrawals to Owner’s Capital.

Balances before closing.

Income Summary

Owner's Capital

30,000

30,000

Revenue Accounts

25,000

25,000

Withdrawals Account

5,000

5,000

Expense Accounts

10,000

10,000

Closing Process

Income Summary

25,000

25,000

Close Revenue

accounts to Income

Summary.

Owner's Capital

30,000

30,000

Revenue Accounts

25,000 25,000

-

Withdrawals Account

5,000

5,000

Expense Accounts

10,000

10,000

Closing Process

Income Summary

10,000 25,000

15,000 Owner's Capital

30,000

30,000

Revenue Accounts

25,000 25,000

-

Withdrawals Account

5,000

5,000

Close Expense

accounts to Income

Summary.

Expense Accounts

10,000 10,000

-

Closing Process

The balance in Income

Summary equals net

income.

Owner's Capital

30,000

15,000

45,000

Owner's Capital

30,000

15,000

45,000

Withdrawals Account

5,000

5,000

Withdrawals Account

5,000

5,000

Close Income

Summary to

Owner’s Capital.

Revenue Accounts

25,000 25,000

-

Expense Accounts

10,000 10,000

-

Income Summary

10,000 25,000

15,000

-

Closing Process

Owner's Capital

30,000

15,000

45,000

Owner's Capital

5,000 30,000

15,000

40,000

Withdrawals Account

5,000

5,000

Withdrawals Account

5,000 5,000

-

Revenue Accounts

25,000 25,000

-

Expense Accounts

10,000 10,000

-

Income Summary

10,000 25,000

15,000

-

Closing Process

Close Withdrawals

account to Owner’s

Capital.

FastForward

Adjusted Trial Balance

December 31, 2004

Cash 3,950$


Supplies 8,670


Equipment 26,000

Accumulated depreciation-Equip. 375$



Unearned consulting revenue 2,750




Rental revenue 300

Depreciation expense-Equipment 375



Rent expense 1,000



Totals 47,685$ 47,685$

Using the

adjusted trial

balance, let’s

prepare the

closing

entries for

FastForward.

Close Revenue

accounts to

Income Summary.

FastForward


December 31, 2004

Cash 3,950$


Supplies 8,670


Equipment 26,000








Rental revenue 300




Rent expense 1,000



Totals 47,685$ 47,685$

Close Revenue Accounts to Income

Summary

Dec. 31 Consulting revenue 7,850

Rental revenue 300

Income summary 8,150

Now, let’s look at the ledger accounts after

posting this closing entry.



Close Expense Accounts to Income

Summary

Dec. 31 Income summary 4,365




Rent expense 1,000



Income Summary

4,365 7,850

300

3,785

Utilities Expense

230 230

-

Rent Expense

1,000 1,000

-

Net Income

Close Expense Accounts to Income

Summary Close Expense Accounts to Income Summary

Supplies Expense

1,050 1,050

-

Depreciation

Expense- Eq.

375 375

-

Salaries Expense

1,610 1,610

-

Insurance Expense

100 100

-

Close Income

Summary to

Owner’s Capital.

FastForward


December 31, 2004

Cash 3,950$


Supplies 8,670


Equipment 26,000








Rental revenue 300




Rent expense 1,000



Totals 47,685$ 47,685$



Close Income Summary to Owner’s Capital

Dec. 31 Income summary 3,785


C. Taylor, Capital

30,000

3,785

33,785



Income Summary

4,365 7,850

3,785 300

-

Close

Withdrawals to

Owner’s Capital.

FastForward


December 31, 2004

Cash 3,950$


Supplies 8,670


Equipment 26,000








Rental revenue 300




Rent expense 1,000



Totals 47,685$ 47,685$



Close Withdrawals to Owner’s Capital

Dec. 31 C. Taylor, Capital 600


C. Taylor, Capital

600 30,000

3,785

33,185

C. Taylor,

Withdrawals

600 600

-

Close Withdrawals to Owner’s Capital

ABOUT CLOSING ENTRIES

Be Careful!

•Avoid doubling revenue and expense balances – watch debits and credits

•Remember: owner’s drawing does not move to the Income Summary account. Owner’s drawing is not an expense and it is not a factor in determining net income.

RESULTS OF POSTING

CLOSING ENTRIES

• Temporary accounts

o All temporary accounts will have zero balances after posting the closing entries

o Temporary accounts (revenues and expenses) are totaled, balanced and double ruled

• Owner’s capital

o Total equity of the owner at the end of the accounting period

o No entries are journalized and posted to owner’s capital during the year

• Permanent accounts (assets, liabilities, and owner’s capital) are not closed

POST-CLOSING TRIAL BALANCE

After all closing entries have been

journalized the post-closing trial

balance is prepared from the ledger.

The purpose of this trial balance is to

prove the equality of the permanent

account balances that are carried

forward into the next accounting period.

Let’s look at

FastForward’s

post-closing trial

balance.

Post-Closing Trial Balance

• List of permanent

accounts and their

balances after posting

closing entries.

• Total debits and credits

must be equal.

FastForward


December 31, 2004

Cash 3,950$


Supplies 8,670


Equipment 26,000

Accumulated depreciation-Equipment 375$




C.Taylor, Capital 33,185

Totals 42,720$ 42,720$


Post-closing Trial Balance

Summary of Steps in the

Accounting Cycle

1 Analyze business transactions

2 Journalize the transactions

3 Post to ledger accounts

4 Prepare a trial balance

5 Journalize and post adjusting

entries

STEPS IN THE ACCOUNTING

CYCLE6 Prepare an adjusted trial balance

7 Prepare financial statements: Income Statement, Owner’s Equity Statement, Balance Sheet

8 Journalize and post closing entries

9 Prepare a post-closing trial balance

1. Correcting Entries

• Correcting Entrieso errors should be corrected as soon as discovered

o correcting entries are unnecessary if records are

free of errors

o can be journalized and posted whenever an error

is discovered

o involve any combination of balance sheet and

income statement accounts

Illustrative Example Of

Correcting Entry

Incorrect Entry

May 10

(To record collection from

customer an account)

Correct Entry

10

(To record collection from

customer an account)

Correcting Entry

20

(To correct entry of May 10)

Cash 50

Service Revenue 50

Cash 50

Accounts Receivable 50

Service Revenue 50

Accounts Receivable 50

Another Illustrative Example Of

Correcting Entry

Incorrect Entry

May 18

(To record purchase of

equipment on account)

Correct Entry

18

(To record purchase of

equipment on account)

Correcting Entry

June 3

(To correct entry of May 18)

Delivery Equipment 45

Accounts Payable 45

Office Equipment 450

Accounts Payable 450

Office Equipment 450

Delivery Equipment 45

Accounts Payable 405

Question: The closing entry process consists of closing:o all asset and liability accounts

o out the owner's capital

account

o all permanent accounts

o all temporary accounts

Which answer is correct?

The closing entry process consists of closing

o all asset and liability accounts

o out the owner's capital

account

o all permanent accounts

o all temporary accounts

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 (see

next slide):

Categories of a Classified Balance Sheet

Assets Liabilities and Equity

Current Assets Current Liabilities

Noncurrent Assets Noncurrent Liabilities

Long-Term Investments Equity

Plant Assets

Intangible Assets

Current items are those expected to come due (both

collected and owed) within the longer of one year or

the company’s normal operating cycle.

Classified Balance Sheet

Snowboarding Components

Balance Sheet

January 31, 2005

Current assets

Cash 6,500$

Short-term investments 2,100


Merchandise inventory 27,500

Prepaid expenses 2,400

Total current assets 42,900$

Long-term investments

Notes receivable 1,500

Investments in stocks and bonds 18,000

Land held for future expansion 48,000

Total investments 67,500

Plant assets

Store equipment 33,200$

Less accumulated depreciation 8,000 25,200

Buildings 170,000


Land 73,200

Total plant assets 223,400

Intangible assets 10,000


ASSETS

Current assets are expected to be

sold, collected, or used within one

year or the company’s operating

cycle.


Balance Sheet

January 31, 2005

Current assets

Cash 6,500$











Plant assets



Buildings 170,000


Land 73,200




ASSETS

Long-term investments are

expected to be held for the longer

of one year or the operating cycle.


Balance Sheet

January 31, 2005

Current assets

Cash 6,500$











Plant assets



Buildings 170,000


Land 73,200




ASSETS

Plant assets are tangible long-lived

assets used to produce or sell

products and services.


Balance Sheet

January 31, 2005

Current assets

Cash 6,500$











Plant assets



Buildings 170,000


Land 73,200




ASSETS

Intangible assets are long-term

resources used to produce or sell

products and services and that

lack physical form.

Current liabilities are obligations due

within the longer of one year or the

company’s operating cycle.


Balance Sheet

January 31, 2005

Current liabilities

Accounts payable 15,300$

Wages payable 3,200

Notes payable 3,000

Current portion of long-term liabilities 7,500

Total current liabilities 29,000$

Long-term liabilities:

Notes payable (net of current portion) 150,000


T. Hawk, Capital 164,800


LIABILITIES

EQUITY

Long-term liabilities are obligations

not due within the longer of one year

or the company’s operating cycle.


Balance Sheet

January 31, 2005

Current liabilities


Wages payable 3,200

Notes payable 3,000








LIABILITIES

EQUITY

Equity is the owner’s claim on the

assets.


Balance Sheet

January 31, 2005

Current liabilities


Wages payable 3,200

Notes payable 3,000








LIABILITIES

EQUITY

• Reversing entry o Made at the beginning of the next accounting period

o Purpose is to simplify the recording of a subsequent transaction related to an adjusting entry

o Most often used to reverse two types of adjusting entries: accrued revenues and accrued expenses

REVERSING

ENTRIES

ILLUSTRATIVE EXAMPLE OF

REVERSING ENTRY

The end of Chapter 7