Completing the Accounting CycleAccounting, 21st EditionWarren Reeve Fess

PowerPoint Presentation by Douglas CloudProfessor Emeritus of Accounting Pepperdine University

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Objectives1. Review the seven basic steps of the accounting cycle. After studying this 2. Prepare a work sheet.you should chapter, 3. Prepare financial be able to: from a work sheet. statements 4. Prepare adjusting and closing entries from a work sheet. 5. Explain what is meant by the fiscal year and the natural business year. 6. Analyze and interpret the financial solvency of a business by computing working capital and the current ratio.

Seven Basic Steps of the Accounting Cycle1. Transactions are analyzed and recorded in the journal. 2. Transactions are posted to the ledger. 3. A trial balance is prepared, adjustment data are assembled, and an optional work sheet is completed. 4. Financial statements are prepared. 5. Adjusting entries are journalized and posted. 6. Closing entries are journalized and posted. 7. A post-closing trial balance is prepared.

Assets are commonly divided into classes and that two of these classes are current assets and property, plant, and equipment.

Thats correct. Cash and other assets that are expected to be converted into cash, sold, or used up usually in less than a year are current assets.

For example?

Well besides cash, theres notes receivable, accounts receivable, supplies, and other prepaid items.

There are some exceptions, but thats basically correct. Assets such So, assets that have a life as office equipment, machinery, over a appear listed under year are buildings, and land would property, plant, and under that heading. equipment.

Liabilities due usually within one year or less and that are to be paid out of current assets are called current liabilities. Accounts payable Wages payable Interest payable Unearned fees

Liabilities not due for more than a year usually are long-term liabilities. Mortgage note payable Mortgage payable Bond payable

The work sheet is a useful device for understanding the flow of accounting data from the unadjusted trial balance to the financial statements.

The Work SheetTrial Balance Adjustments Adjusted TB

Accounts

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Prepared from the general ledger. Accounts are listed in the following order: assets, liabilities, owners equity, revenues, and expenses.

The Work SheetTrial Balance Adjustments Adjusted TB

Accounts

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Adjustments are entered here. Two possibilities: 1. Deferrals Existing balances are changed. 2. Accruals New information is entered.

The Work SheetTrial Balance Adjustments Adjusted TB

Accounts

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Adjustments are combined with the trial balance. Account balances are now adjusted.

NetSolutions Work Sheet For the Two Months Ended December 31, 2005Trial Balance Account Title1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22

Adjustments Debit Credit

Adjusted Trial Balance Debit Credit

Debit

Credit

Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Chris Clark, Capital Chris Clark, Drawing Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense

2,065 2,220 2,000 2,400 20,000 1,800 900 360 25,000 4,000 16,340 4,275 1,600 985 800 455 42,600

The Unadjusted Trial Balance

42,600

(a) The Supplies account has a debit of $2,000. A count of supplies at the end of the period reveals that $760 is on hand. Therefore, $1,240 in supplies was used during the two-month period. two-

NetSolutions Work Sheet For the Two Months Ended December 31, 2005Trial Balance Account Title1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22

Adjustments Debit Credit

Adjusted Trial Balance Debit Credit

Debit

Credit

Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Chris Clark, Capital Chris Clark, Drawing Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense

2,065 2,220 2,000 2,400 20,000 1,800 900 360 25,000 4,000 16,340 4,275 1,600 985 800 455 42,600

(a) 1,240

(a) 1,240 42,600

(b)The (b) The Prepaid Insurance account has a debit balance of $2,400, which represents prepayment of insurance for 24 months beginning December 1. Thus, the insurance expense for this month is $100 ($2,400 24).

NetSolutions Work Sheet For the Two Months Ended December 31, 2005Trial Balance Account Title1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22

Adjustments Debit Credit

Adjusted Trial Balance Debit Credit

Debit

Credit

Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Chris Clark, Capital Chris Clark, Drawing Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense Insurance Expense

2,065 2,220 2,000 2,400 20,000 1,800 900 360 25,000 4,000 16,340 4,275 1,600 985 800 455 42,600

(a) 1,240 (b) 100

(a) 1,240 42,600 (b) 100

Accounts are added as needed.

(c) The Unearned Rent account has a credit balance of $360, which represents the receipt of three-months rent beginning threewith December 1. Thus, the rent revenue for December is $120.

FOR RENT

NetSolutions Work Sheet For the Two Months Ended December 31, 2005Trial Balance Account Title1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22

Adjustments Debit Credit

Adjusted Trial Balance Debit Credit

Debit

Credit

Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Chris Clark, Capital Chris Clark, Drawing Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense Insurance Expense Rent Revenue

2,065 2,220 2,000 2,400 20,000 1,800 900 360 25,000 4,000 16,340 4,275 1,600 985 800 455 42,600 (c) 120

(a) 1,240 (b) 100

(a) 1,240 42,600 (b) 100 (c) 120

(d) Wages accrued but not paid at the end of December total $250.

NetSolutions Work Sheet For the Two Months Ended December 31, 2005Trial Balance Account Title1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22

Adjustments Debit Credit

Adjusted Trial Balance Debit Credit

Debit

Credit

Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Chris Clark, Capital Chris Clark, Drawing Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense Insurance Expense Rent Revenue Wages Payable

2,065 2,220 2,000 2,400 20,000 1,800 900 360 25,000 4,000 16,340 4,275 1,600 985 800 455 42,600 (d) 250 (c) 120

(a) 1,240 (b) 100

(a) 1,240 42,600 (b) 100 (c) 120 (d) 250

(e) Fees accrued at the end of December, but not recorded, total $500.

NetSolutions Work Sheet For the Two Months Ended December 31, 2005Trial Balance Account Title1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22

Adjustments Debit Credit

Adjusted Trial Balance Debit Credit

Debit

Credit

Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Chris Clark, Capital Chris Clark, Drawing Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense Insurance Expense Rent Revenue Wages Payable

2,065 2,220 2,000 2,400 20,000 1,800 900 360 25,000 4,000 16,340 4,275 1,600 985 800 455 42,600

(e)

500 (a) 1,240 (b) 100

(c)

120 (e) 500

(d)

250

(a) 1,240 42,600 (b) 100 (c) 120 (d) 250

(f) Depreciation of the office equipment is $50 for December.

NetSolutions Work Sheet For the Two Months Ended December 31, 2005Trial Balance Account Title1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22

Adjustments Debit Credit

Adjusted Trial Balance Debit Credit

Debit

Credit

Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Chris Clark, Capital Chris Clark, Drawing Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense Insurance Expense Rent Revenue Wages Payable Depreciation Expense Accum. Depreciation

2,065 2,220 2,000 2,400 20,000 1,800 900 360 25,000 4,000 16,340 4,275 1,600 985 800 455 42,600

(e)

500 (a) 1,240 (b) 100

(c)

120 (e) 500

(d)

250

(a) 1,240 42,600 (b) 100 (c) 120 (d) 250 (f) 50 (f) 50

NetSolutions Work Sheet For the Two Months Ended December 31, 2005Adjustments To make more space, Debit Credit Debit Credit lets remove the 2,065 2,220 (e) 500 heading.(a) 1,240 2,000 Trial Balance Adjusted Trial Balance Debit Credit

Account Title1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22

Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Chris Clark, Capital Chris Clark, Drawing Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense Insurance Expense Rent Revenue Wages Payable Depreciation Expense Accum. Depreciation

2,400 20,000 1,800 900 360 25,000 4,000 16,340 4,275 1,600 985 800 455 42,600 (d) 250 (c) 120

(b)

100

(e) 500

(a) 1,240 42,600 (b) 100 (c) 120 (d) 250 (f) 50 (f) 50

Trial Balance Account Title1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25

Adjustments Debit Credit

Adjusted Trial Balance Debit

31

Debit

Credit

Credit

Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Chris Clark, Capital Chris Clark, Drawing Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense Insurance Expense Rent Revenue Wages Payable Depreciation Expense Accum. Depreciation

2,065 2,220 2,000 2,400 20,000 1,800 900 360 25,000 4,000 16,340 4,275 1,600 985 800 455 42,600

(e)

500 (a) 1,240 (b) 100

(c)

120 (e) 500

(d)

250

(a) 1,240 42,600 (b) 100 (c) 120 (d) 250 (f) 50 (f) 2,260 50 2,260

Summed and ruled

Next, the unadjusted Trial Balance columns and the Adjustments columns are combined to determine the amounts displayed in the Adjusted Trial Balance.

Trial Balance Account Title1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25

Adjustments Debit Credit

Adjusted Trial Balance Debit

33

Debit

Credit

Credit

Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Chris Clark, Capital Chris Clark, Drawing Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense Insurance Expense Rent Revenue Wages Payable Depreciation Expense Accum. Depreciation

2,065 2,220 2,000 2,400 20,000 1,800 900 360 25,000 4,000 16,340 4,275 1,600 985 800 455 42,600

(e)

500 (a) 1,240 (b) 100

(c)

120 (e) 500

(d)

250

(a) 1,240 42,600 (b) 100 (c) (d) (f) 50 (f) 2,260 50 2,260 120 250

Trial Balance Account Title1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25

Adjustments Debit Credit

Adjusted Trial Balance Debit

34

Debit

Credit

Credit

Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Chris Clark, Capital Chris Clark, Drawing Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense Insurance Expense Rent Revenue Wages Payable Depreciation Expense Accum. Depreciation

2,065 2,220 2,000 2,400 20,000 1,800 900 360 25,000 4,000 16,340 4,275 1,600 985 800 455 42,600

(e)

500 (a) 1,240 (b) 100

2,065 2,720 760 2,300 20,000 1,800 900 240 25,000 4,000

(c)

120 (e) 500

16,840 4,525 1,600 985 2,040 455 100

(d)

250

(a) 1,240 42,600 (b) 100 (c) (d) (f) 50 (f) 2,260 50 2,260 120 250

120 250 50 43,400 50 43,400

The Work SheetAdjusted TB Income State. Balance Sheet

Accounts

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Revenue and expense balances in the Adjusted Trial Balance column are extended to the Income Statement column.

The Work SheetAdjusted TB Income State. Balance Sheet

Accounts

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Asset, liability, owners equity, and drawing balances in the Adjusted Trial Balance column are extended to the Balance Sheet column.

To make room on the slides for the Income statement and Balance Sheet columns, the Trial Balance and Adjustments columns have been removed.

Adjusted Trial Balance Account Title1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25

Income Statement Debit Credit

Balance Sheet Debit

38

Debit

Credit

Credit

Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Chris Clark, Capital Chris Clark, Drawing Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense Insurance Expense Rent Revenue Wages Payable Depreciation Expense Accum. Depreciation

2,065 2,720 760 2,300 20,000 1,800 900 240 25,000 4,000 16,840 4,525 1,600 985 2,040 455 100 120 250 50 43,400 50 43,400

Now, lets extend the balances from the Adjusted Trial Balance column.

Adjusted Trial Balance Account Title1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25

40Income Statement Debit Credit Balance Sheet Debit Credit

Debit

Credit

Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Chris Clark, Capital Chris Clark, Drawing Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense Insurance Expense Rent Revenue Wages Payable Depreciation Expense Accum. Depreciation

2,065 2,720 760 2,300 20,000 1,800 900 240 25,000 4,000 16,840 4,525 1,600 985 2,040 455 100 120 250 50 43,400 50 43,400 50 4,525 1,600 985 2,040 455 100 120 16,840

2,065 2,720 760 2,300 20,000 1,800 900 240 25,000 4,000

250 50

These four columns are summed.

Adjusted Trial Balance Account Title1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25

42Income Statement Debit Credit Balance Sheet Debit Credit

Debit

Credit

Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accounts Payable Unearned Rent Chris Clark, Capital Chris Clark, Drawing Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Miscellaneous Expense Insurance Expense Rent Revenue Wages Payable Depreciation Expense Accum. Depreciation

2,065 2,720 760 2,300 20,000 1,800 900 240 25,000 4,000 16,840 4,525 1,600 985 2,040 455 100 120 250 50 43,400 50 43,400 50 9,755 16,960 4,525 1,600 985 2,040 455 100 120 16,840

2,065 2,720 760 2,300 20,000 1,800 900 240 25,000 4,000

250 33,645 50 26,440

The difference between the Income Statement column totals is the net income (or net loss) for the period.

The difference between the Balance Sheet column totals is also the income (or net loss) for the period.

Income Statement

Balance Sheet

9,755 16,960 33,645 7,205 16,960 16,960 33,645

26,440 7,205 33,645

Net Income

Net Income

NetSolutions Income Statement For Two Months Ended December 31, 2005 Fees earned Rent revenue Total revenues Expenses: Wages expense Supplies expense Rent expense Utilities expense Insurance expense Depreciation expense Miscellaneous expense Total expenses Net income $16,840 120 $16,960 $ 4,525 2,040 1,600 985 100 50 455 9,755 $ 7,205

Every amount on this income statement was taken from the Income Statement column of the work sheet.

NetSolutions Statement of Owners Equity For the Two Months Ended December 31, 2005 Chris Clark, Capital, November 1, 2005 Investment on November 1, 2005 Net income for November and December $ $25,000 7,205 $32,205 4,000 0

Less withdrawals Increase in owners equity 28,205 From the Chris Clark, Capital, December 31, 2005Either from the $28,205

Balance Sheet income debit column the statement or of the work sheet. work sheet.

NetSolutions Balance Sheet December 31, 2005 Assets Liabilities Current assets: Current liabilities: Cash $ 2,065 Accounts payable Accounts receivable 2,720 Wages payable Supplies 760 Unearned rent Prepaid insurance 2,300 Total liabilities Total current assets $ 7,845 Property, plant, and equipment: Land $20,000 Office equip. $1,800 Less accum. depreciation 50 1,750 Owners Equity Total property, plant Chris Clark, Capital and equipment 21,750 Total liabilities and Total assets $29,595 owners equity

$900 From the 250 240 Statement $ 1,390

of Owners Equity

28,205 $29,595

Adjusting and Closing EntriesAdjusting entries are recorded in the journal at the end of the accounting period.

Adjusting and Closing EntriesIf a work sheet has been prepared, the data for these entries are in the Adjustments columns.

The Closing ProcessIncome SummaryExpenses are transferred to Income Summary Revenues are transferred to Income Summary

2

1

3 4

Net Income or Net Loss is transferred to Owners Capital OWNERS CAPITAL Drawings are transferred to Owners Capital

Adjusting and Closing EntriesIncome SummaryExpenses are transferred to Income Summary Revenues are transferred to Income Summary

2

1

The Incomeor Net Loss is Net Income Summary transferred to appear on account does notOwners Capital the financial statements.

3

OWNERS CAPITAL

4

Drawings are transferred to Owners Capital

The Closing ProcessWages Expense Bal. 4,525 Rent Expense Bal. 1,600 Income Summary Fees Earned Bal. 16,840 Rent Revenue Bal. 120

Depreciation Expense Bal. Bal. 50 Utilities Expense 985 Supplies Expense Bal. Bal. 2,040 Insurance Expense 100 Chris Clark, Drawing Miscellaneous Expense Bal. 455 Bal. 4,000 Chris Clark, Capital Bal. 25,000

Note: The balances shown are adjusted balances before closing. The following sequence demonstrates the closing process.

The Closing ProcessWages Expense Bal. 4,525 Rent Expense Bal. 1,600 Income Summary 16,960 Fees Earned 16,840 Bal. 16,840 Rent Revenue 120 Bal. 120

Depreciation Expense Bal. Bal. 50 Utilities Expense 985 Supplies Expense Bal. Bal. 2,040 Insurance Expense 100 Chris Clark, Drawing Miscellaneous Expense Bal. 455 Bal. 4,000 Chris Clark, Capital Bal. 25,000

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

The Closing ProcessWages Expense Bal. 4,525 4,525 1,600 Income Summary 9,775 16,960 Fees Earned 16,840 Bal. 16,840 Rent Revenue 120 Bal. 120 Rent Expense Bal. 1,600

Depreciation Expense Bal. Bal. 50 Utilities Expense 985 985 2,040 Chris Clark, Capital Bal. 25,000 50

Supplies Expense Bal. Bal. 2,040 100 Insurance Expense 100 455

Chris Clark, Drawing Bal. 4,000

Miscellaneous Expense Bal. 455

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

The Closing ProcessWages Expense Bal. 4,525 4,525 1,600 Income Summary 9,775 7,205 16,960 Fees Earned 16,840 Bal. 16,840 Rent Revenue 120 Bal. 120 Rent Expense Bal. 1,600

Depreciation Expense Bal. Bal. 50 Utilities Expense 985 985 Chris Clark, Capital Bal. 25,000 7,205 50

Supplies Expense 2,040 Bal. 2,040 Insurance Expense Bal. 100 100 455

Chris Clark, Drawing Bal. 4,000

Miscellaneous Expense Bal. 455

Debit Income Summary for the amount of its balance (in this case, the net income) and credit the capital account.

The Closing ProcessWages Expense Bal. 4,525 4,525 1,600 Income Summary 9,775 7,205 16,960 Fees Earned 16,840 Bal. 16,840 Rent Revenue 120 Bal. 120 Rent Expense Bal. 1,600

Depreciation Expense Bal. Bal. 50 Utilities Expense 985 985 Chris Clark, Capital 4,000 Bal. 25,000 7,205 50

Supplies Expense 2,040 Bal. 2,040 Insurance Expense Bal. 100 100 455

Chris Clark, Drawing Bal. 4,000 4,000

Miscellaneous Expense Bal. 455

Debit the capital account for the balance of the drawing account, and credit drawing for the same amount.

Review of the Closing ProcessWages Expense Bal. 4,525 4,525 4,525 1,600 1,600 50 50 985 985 Chris Clark, Capital 4,000 4,000 Bal. 25,000 7,205 7,205 Close Revenues Close Expenses Close Income Summary Close Drawing Chris Clark, Drawing Bal. 4,000 4,000 Income Summary 9,775 7,205 16,960 16,960 Fees Earned 16,480 16,840 Bal. 16,840 Rent Revenue 120 120 Bal. 120 Rent Expense Bal. 1,600

Depreciation Expense Bal. Bal. 50 Utilities Expense 985

Supplies Expense 2,040 Bal. 2,040 2,040 Insurance Expense Bal. 100 100 100 445 455

Miscellaneous Expense Bal. 455

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

PostPost-closing Trial BalanceNetSolutions Post-Closing Trial Balance December 31, 2005 Cash 2 065 00 Accounts Receivable 2 720 00 Supplies 760 00 Prepaid Insurance 2 300 00 Land 20 000 00 Office Equipment 1 800 00 Accumulated Depreciation 50 00 Accounts Payable 900 00 Wages Payable 250 00 Unearned Rent 240 00 Chris Clark, Capital 28 205 00 29 645 00 29 645 00

Financial Analysis for NetSolutionsCurrent Working Current = Assets Liabilities Capital Working = $7,845 $1,390 Capital Working = $6,455 Capital

Financial Analysis for NetSolutionsCurrent Ratio Current Ratio Current Ratio Current Current = Assets Liabilities = $7,845 = 5.6 $1,390

Financial Analysis for NetSolutionsThis ratio implies that NetSolutions is able to pay its current liabilities.

Financial Analysis for NetSolutionsCurrent ratio Current Current = Assets Liabilities

Current = $7,845 $1,390 ratio Current = 5.6 ratio

Financial Analysis for NetSolutionsNetSolutions can use the current ratio to make comparisons across companies and with industry averages.

The End