Financial Accounting Chapter 4

What are closing entries?

Entries made at the end of an accounting period to transfer the balances of temporary accounts to a permanent stockholders' equity account, Retained Earnings

What are correction entries?

Entries to correct errors made in recording transactions

What are standard balance sheet classifications for liabilities and stockholders' equity?

current liabilities; long-term liabilities; stockholders' equity

Where does net income and net loss appear on a worksheet?

net income is extended to the credit column of the balance sheet columns; net loss would be extended to the debit column

What is the accumulated depreciation account?

shows the total amount of depreciation that the company has expensed thus far in the asset's life

What are long-term investments generally?

(1) investments in stocks and bonds of other companies that are normally held for many years, (2) long-term assets such as land or buildings that a company is not currently using in its operating activities, and (3) long-term notes receivable

What is a classified balance sheet?

A balance sheet that contains standard classifications or sections; This is useful because items within a group have similar economic characteristics

What is a post-closing trial balance?

A list of permanent accounts and their balances after a company has journalized and posted closing entries; the purpose of the post-closing trial balance is to prove the equality of the permanent account balances carried forward into the next accounting period; Since all temporary accounts will have zero balances, the post-closing trial balance will contain only permanent—balance sheet—accounts

What is an income summary?

A temporary account used in closing revenue and expense accounts

What are temporary accounts?

Accounts that relate only to a given accounting period; Consist of all income statement accounts and the Dividends account; All temporary accounts are closed at the end of the accounting period

What are permanent accounts?

Accounts that relate to one or more future accounting periods; Consist of all balance sheet accounts; Balances are carried forward to the next accounting period.

What is a reversing entry?

An entry, made at the beginning of the next accounting period, that is the exact opposite of the adjusting entry made in the previous period; Use of reversing entries is an optional bookkeeping procedure, it is not a required step in the accounting cycle

Where do companies transfer temporary account balances to at the end of the accounting period?

At the end of the accounting period, the company transfers temporary account balances to the permanent stockholders' equity account, Retained Earnings, by means of closing entries

What are some cautions in preparing closing entries?

Avoid unintentionally doubling the revenue and expense balances rather than zeroing them; Do not close Dividends through the Income Summary account; Dividends are not an expense, and they are not a factor in determining net income

Describe closing entries

Closing entries also produce a zero balance in each temporary account; The temporary accounts are then ready to accumulate data in the next accounting period separate from the data of prior periods; Permanent accounts are not closed.

What is stockholders' equity?

Corporations combine the Common Stock and Retained Earnings accounts and report them on the balance sheet as stockholders' equity

Companies generally prepare closing entries directly from the adjusted balances in the ledger. They could prepare separate closing entries for each nominal account, but which four entries accomplish the desired result more efficiently?

Debit each revenue account for its balance, and credit Income Summary for total revenues; Debit Income Summary for total expenses, and credit each expense account for its balance; Debit Income Summary and credit Retained Earnings for the amount of net income; Debit Retained Earnings for the balance in the Dividends account, and credit Dividends for the same amount; (If there were a net loss (because expenses exceeded revenues), there would be a credit to Income Summary and a debit to Retained Earnings.)

What does the amount in the adjusted trial balance columns indicate for each amount?

For each account, the amount in the adjusted trial balance columns is the balance that will appear in the ledger after journalizing and posting the adjusting entries

What is keying?

If additional accounts are needed, insert them on the lines immediately below the trial balance totals; A different letter identifies the debit and credit for each adjusting entry; Companies do not journalize the adjustments until after they complete the worksheet and prepare the financial statements

What if total debits exceed total credits in the income statement columns?

In that case, the company has a net loss; It enters the amount of the net loss in the income statement credit column and the balance sheet debit column

Describe the journaling and posting closing entries step in the accounting cycle

The company performs this step after it has prepared financial statements; companies generally journalize and post closing entries only at the end of the annual accounting period; Thus, all temporary accounts will contain data for the entire year

What do the debit amounts and credit amounts do?

The debit amount balances the income statement columns; the credit amount balances the balance sheet columns; the credit in the balance sheet column indicates the increase in stockholders' equity resulting from net income.

What is a worksheet?

a multiple-column form that may be used in making adjusting entries and in preparing financial statements; It is not a permanent accounting record; The worksheet is merely a device used in preparing adjusting entries and the financial statements; The use of a worksheet is optional

What is liquidity?

ability to pay obligations expected to be due within the next year; When current assets exceed current liabilities, the likelihood for paying the liabilities is favorable; When the reverse is true, short-term creditors may not be paid, and the company may ultimately be forced into bankruptcy

Summarize the steps in the accounting cycle

analyze business transactions; journalize transactions; post to ledger accounts; prepare a trial balance; journalize and post journal entries: deferrals/accruals; prepare an adjusted trial balance; prepare financial statements: income statement, retained earnings statement, balance sheet; journalize and post closing entries; prepare a post-trial balance

What are current assets?

assets that a company expects to convert to cash or use up within one year or its operating cycle, whichever is longer; Some companies use a period longer than one year to classify assets and liabilities as current because they have an operating cycle longer than one year

What is property, plant, and equipment?

assets with relatively long useful lives that a company is currently using in operating the business; This category includes land, buildings, machinery and equipment, delivery equipment, and furniture

What are common types of current assets?

cash; investments (such as short-term U.S. government securities); receivables (notes receivable, accounts receivable, and interest receivable); inventories; prepaid expenses (supplies and insurance); On the balance sheet, companies usually list these items in the order in which they expect to convert them into cash

What are standard balance sheet classifications for assets?

current assets; long-term investments; property, plant, equipment, intangible assets

What are intangible assets?

long-lived assets that do not have physical substance yet often are very valuable; include goodwill, patents, copyrights, and trademarks or trade names that give the company exclusive right of use for a specified period of time

What are long-term liabilities?

obligations that a company expects to pay after one year; Liabilities in this category include bonds payable, mortgages payable, long-term notes payable, lease liabilities, and pension liabilities

What are current liabilities?

obligations that the company is to pay within the coming year or its operating cycle, whichever is longer; Common examples are accounts payable, salaries and wages payable, notes payable, interest payable, and income taxes payable; Also included as current liabilities are current maturities of long-term obligations—payments to be made within the next year on long-term obligations.

When do companies journalize and post adjustment entries?

only at the end of an accounting period

What are the steps in creating a worksheet?

prepare a trial balance on the worksheet; enter adjustment data; enter adjusted balances; extend adjusted balances to appropriate statement columns; total the statement columns, compute net income (or net loss), and compute the worksheet

What is an operating cycle?

the average time that it takes to purchase inventory, sell it on account, and then collect cash from customers; For most businesses, this cycle takes less than a year, so they use a one-year cutoff; Except where noted, we will assume that companies use one year to determine whether an asset or liability is current or long-term

What happens in "closing the books?"

the company distinguishes between temporary and permanent accounts

What is depreciation?

the practice of allocating the cost of assets to a number of years; The assets that the company depreciates are reported on the balance sheet at cost less accumulated depreciation

When do companies make correcting entries?

whenever they discover an error; must be posted before closing entries

What do classifications on a financial statement determine?

whether the company has enough assets to pay its debts as they come due; the claims of short- and long-term creditors on the company's total assets