Chapter 4

process of preparing financial statements

1. prepare a trial balance (analyze for potential adjustments; develop a list of necessary adjusting entries) 2. record adjusting entries in the journal 3. post entries to the ledger 4. prepare the adjusted trial balance from the ledger 5. prepare financial statements from the adjusted trial balance

steps to accounting cycle

1. transactions are recorded in the journal 2. journal entries are posted to appropriate ledger accounts 3. trial balance is constructed 4. adjusting entries are prepared and posted 5. an adjusted trial balance is prepared 6. formal financial statements are produced (worksheet may be used)

worksheet approach

a way to prepare financial statements that takes into account necessary adjustments without actually updating journals and ledgers; used to prepare financial statements at any point in time

nominal accounts

accounts that will be reset to a zero balance with each new accounting period; revenue, expense, and dividend accounts

temporary accounts

accounts that will be reset to a zero balance with each new accounting period; revenue, expense, and dividend accounts (aka nominal accounts)

full disclosure principle

all relevant facts that would influence investors' and creditors' judgments about the company are disclosed in the financial statements or related notes

capital stock

amounts received from investors for the stock of the company; investors become the owners

real account

asset, liability, and equity accounts; balances are carried forward from the end of the period into the beginning of the next period

accounting cycle

captures transaction and event data through an orderly process that produces financial statements

classified assets

cash and those assets that will be converted into cash or consumed within one year of the operating cycle, whichever is longer

current ratio equation

current ratio = current assets / current liabilities

sole proprietorship

equity consists of a single owner's capital account

partnership

equity divided into separate accounts for each partner

current ratio

expresses the relative amount of working capital

full disclosure

financial statements result in a fair presentation, and all relevant facts that would influence investors' and creditors' judgements about the company are dislcosed in the financial statement or related notes

intangible assets

lack physical existence; purchased patents and copyrights, goodwill, etc.

long-term investments

land purchased for speculation, funds set aside for plant expansion, investments in other entities, etc.

property, plant, and equipment

land, buildings, equipment, etc.

quick ratio

more stringent test of liquidity; uses quick assets, which do not include inventory and prepaid expenses

if credits exceed debits in income statements, the company has....

net income (more revenues than expenses)

if debits exceeds credits, the company has....

net loss

income summary

non-financial statement account to facilitate the closing process

current liabilities

obligations that will be liquidated within one year or the operating cycle, whichever is longer

operating cycle

period of time it takes to convert cash back into cash

quick ratio equation

quick ratio = (cash + short term investments + accounts receivable) / (current liabilities)

"zero out" temporary/nominal accounts

resets the accounts for the next period

post-closing trial balance

reveals the balance of accounts after the closing process and consists of balance sheet accounts only; all of the revenue, expense, and dividend accounts were zeroes away via closing and do not appear

liquidity

the ability of a firm to meet its near-term obligations as they come due; inadequate liquidity can spell doom

working capital

the difference between current assets and current liabilities; a negative amount may be a sign of financial stress, but not always

retained earnings

the excess of a corporation's income over its dividends; profit that has been retianed and will be reinvested into the business

closing process

updates the retained earnings account in the ledger to equal the end-of-period balance; revenues, expenses, and dividends do not automatically produce an updating debit/credit to retained earnings