Chapter 4 - Book notes

In the closing process we:

(1) identify accounts for closing, (2) record and post the closing entries, and (3) prepare a post-closing trial balance.

A post-closing trial balance verifies that?

(1) total debits equal total credits for permanent accounts and (2) all temporary accounts have zero balances.

A work sheet:

- Helps in preparing financial statements. - Reduces the risk of errors when working with many accounts and adjustments. - Links accounts and adjustments to financial statements. - Shows the effects of proposed or "what-if" transactions.

Closing entries are necessary at the end of each period after financial statements are prepared because ?

- Revenue, expense, and withdrawals accounts must begin each period with zero balances. - Owner's capital must reflect prior periods' revenues, expenses, and withdrawals.

The 10 step in the Accounting cycle are:

1. Analyze transactions 2. Journalize 3. Post 4. Prepare unadjusted trial balance. 5. Adjust and post accounts 6. Prepare adjusted trial balance 7. Prepare financial statements 8. Close accounts 9. Prepare post-closing trial balance 10. Optional: Reverse and post. Steps 1 through 3 occur regularly as a company enters into transactions. Steps 4 through 9 are done at the end of a period. Reversing entries in step 10 are optional.

What are the four Step of Closing ?

1. Close income statement credit balances by debiting the Consulting Revenue and Rental Revenue accounts and crediting the Income Summary account. 2. Close income statement debit balances by crediting expense accounts for depreciation, salaries, insurance, rent, supplies, and utilities, and debiting those amounts to the Income Summary account. 3. Close Income Summary account by debiting its credit balance and crediting that amount to C. Taylor, Capital, account. 4. Close withdrawals account by crediting its debit balance and debiting that amount to C. Taylor, Capital, account.

Preparing Closing Entries General Journal entries:

1. Debit Consulting Revenue and Rental Revenue and credit the Income Summary account. Description line reads: Close revenue accounts. 2. Debit Income Summary for totals of expense accounts and credit depreciation, salaries, insurance, rent, supplies, and utilities expense accounts. Description line reads: Close expense accounts. 3. Debit Income Summary and credit that amount to C. Taylor, Capital. Description line reads: Close Income Summary account. 4. Debit C. Taylor, Capital, and credit withdrawals account. Description line reads: Close withdrawals account.

Income Summary is a ?

A temporary account only used for the closing process that contains a credit for total revenues (and gains) and a debit for total expenses (and losses).

Definition od Temporary account:

Accounts that reflect activities related to one or more future periods; balance sheet accounts whose balances are not closed.

Current liabilities

Are liabilities due to be paid or settled within one year or the operating cycle, whichever is longer. They usually are settled by paying out cash. Current liabilities include accounts payable, wages payable, taxes payable, interest payable, and unearned revenues. Also, any portion of a long-term liability due to be paid within one year or the operating cycle, whichever is longer, is a current liability. So are obligations due to be paid or settled within one year or the company's operating cycle, whichever is longer.

Long-term liabilities

Are liabilities not due within one year or the operating cycle, whichever is longer. Notes payable, mortgages payable, bonds payable, and lease obligations are common long-term liabilities. So are obligations not due to be paid within one year or the operating cycle, whichever is longer.

An income statement reports revenues and expenses for an ___________________________. Owner withdrawals are also reported for an accounting period. Because, __________________________________, they must start each period with zero balances.

Blank 1: accounting period. Blank 2: revenue, expense, and withdrawals accounts record information separately for each period

A balance sheet lists _____________________ before noncurrent assets and ________________________before noncurrent liabilities. Current assets and current liabilities are listed in order of how quickly they will be converted to, or paid in, cash.

Blank 1: current assets Blank 2: current liabilities

Preparing a work sheet Step 3. Prepare Adjusted Trial Balance.

Blue section. The adjusted trial balance is prepared by combining the adjustments with the unadjusted balances for each account. As an example, the Prepaid Insurance account has a $2,400 debit balance in the Unadjusted Trial Balance columns. This $2,400 debit is combined with the $100 credit in the Adjustments columns to give Prepaid Insurance a $2,300 debit in the Adjusted Trial Balance columns. The totals of the Adjusted Trial Balance columns confirm debits and credits are equal.

Unclassified balance sheet

Broadly groups accounts into assets, liabilities, and equity.

Which of the statements below describe(s) a permanent account? (Check all that apply.) A permanent account is closed at the end of an accounting period. A permanent account has a balance for only one period. A permanent account is reported on the balance sheet. A permanent account's balance is carried forward to the next accounting period

Correct Answer A permanent account is reported on the balance sheet. A permanent account's balance is carried forward to the next accounting period.

Definition of Closing entries

Entries recorded at the end of each accounting period to transfer end-of-period balances in revenue, gain, expense, loss, and withdrawals (dividends for a corporation) accounts to the capital account (or retained earnings for a corporation).

The closing process has two purposes.

First, it resets revenue, expense, and withdrawals account balances to zero at the end of each period. This is done so that these accounts can properly measure income and withdrawals for the next period. Second, it updates the balance in the owner's capital account to match the amount reported on the statement of owner's equity and the balance sheet.

Long-term (or noncurrent) investments

Include notes receivable and investments in stocks and bonds when they are expected to be held for more than the longer of one year or the operating cycle. So in other words are Long-term assets not used in operating activities such as notes receivable and investments in stocks and bonds.

Accounting cycle

Is the steps in preparing financial statements. It is called a cycle because the steps are repeated each reporting period. Recurring steps performed each accounting period, starting with analyzing transactions and continuing through the post-closing trial balance (or optional reversing entries).

Preparing a work sheet Step 4. Sort Adjusted Trial Balance Amounts to Financial Statements..

Orange section. This step involves sorting account balances from the adjusted trial balance to their proper financial statement columns. - Expenses go to the Income Statement Debit column, and revenues to the Income Statement Credit column. - Assets and withdrawals go to the Balance Sheet & Statement of Owner's Equity Debit column. - Liabilities and owner's capital go to the Balance Sheet & Statement of Owner's Equity Credit column.

Permanent Accounts

Permanent accounts report on activities related to one or more future accounting periods. (not closed at period-end). They include asset, liability, and owner capital accounts (all balance sheet accounts). Permanent accounts are not closed each period and carry their ending balance into future periods

Preparing a work sheet Step 5. Total Statement Columns, Compute Income or Loss, and Balance Columns.

Purple section. Each financial statement column (from step 4) is totaled. The difference between the Debit and Credit column totals of the Income Statement columns is net income or net loss. This occurs because revenues are entered in the Credit column and expenses in the Debit column. If the Credit total exceeds the Debit total, there is net income. If the Debit total exceeds the Credit total, there is a net loss. For FastForward, the Credit total exceeds the Debit total, giving a $3,785 net income. The net income from the Income Statement columns is then entered in the Balance Sheet & Statement of Owner's Equity Credit column. Adding net income to the last Credit column means that it is to be added to owner's capital. If a loss occurs, it is added to the Debit column. This means that it is to be subtracted from owner's capital. The ending balance of owner's capital does not appear in the last two columns as a single amount, but it is computed in the statement of owner's equity using these account balances. When net income or net loss is added to the Balance Sheet & Statement of Owner's Equity column, the totals of the last two columns must balance. If they do not, one or more errors have occurred.

Preparing a work sheet Step 1. Enter Unadjusted Trial Balance

Refer to green section of the image. The first step in preparing a work sheet is to list the title of each account and its account number. This includes all accounts in the ledger plus any expected ones from adjusting entries. The unadjusted balance for each account is then entered in the correct Debit or Credit column of the unadjusted trial balance columns. The totals of these two columns must be equal.

Preparing the work sheet has five steps:

Step 1. Enter Unadjusted Trial Balance. Step 2. Enter Adjustments. Step 3. Prepare Adjusted Trial Balance. Step 4. Sort Adjusted Trial Balance Amounts to Financial Statements.. Step 5. Total Statement Columns, Compute Income or Loss, and Balance Columns.

The four closing journal entries to apply the closing process are:

Step 1: Close Credit Balances in Revenue Accounts to Income Summary First, we close revenues to Income Summary. We bring accounts with credit balances to zero by debiting them. Step 2: Close Debit Balances in Expense Accounts to Income Summary Second, we close expenses to Income Summary. We bring expense accounts' debit balances to zero by crediting them. With a balance of zero, these accounts are ready to record expenses for next period. Step 3: Close Income Summary to Owner's Capital. The third closing entry transfers the balance of the Income Summary account to the capital account. This entry closes the Income Summary account. Step 4: Close Withdrawals Account to Owner's Capital. The fourth closing entry transfers any debit balance in the withdrawals account to the owner's capital account. This entry gives the withdrawals account a zero balance, and the account is now ready to record next period's withdrawals.

Income Summary

Temporary account used only in the closing process to which the balances of revenue and expense accounts (including any gains or losses) are transferred; its balance is transferred to the capital account (or retained earnings for a corporation).

Temporary Accounts

Temporary accounts relate to one accounting period. (closed at period-end). They include all income statement accounts, the owner withdrawals account, and the Income Summary account. it also include Revenues; Expenses. They are temporary because such accounts are used for a period and then closed at period-end. The closing process applies only to temporary accounts.

How is it called when a identifying letter links the debit and credit of each adjustment?

This is called keying the adjustments.

The Income Summary balance, which equals net income or net loss, is transferred to the?

Transferred to the capital account.

Preparing a work sheet Step 2. Enter Adjustments.

Yellow section. The second step is to enter adjustments in the Adjustments columns. An identifying letter links the debit and credit of each adjustment. This is called keying the adjustments. After preparing a work sheet, adjustments must still be entered in a journal and posted to the ledger. The Adjustments columns provide the information for adjusting entries in the journal.

A post-closing trial balance is

a list of permanent accounts (assets, liabilities, equity) and their balances after all closing entries. Only balance sheet (permanent) accounts are on a post-closing trial balance.

Current Assets

are cash and other resources that are expected to be sold, collected, or used within one year or the company's operating cycle, whichever is longer. Examples are cash, short-term investments, accounts receivable, short-term notes receivable, merchandise inventory (goods for sale), and prepaid expenses.

Intangible assets

are long-term assets that benefit business operations but lack physical form. Examples are patents, trademarks, copyrights, franchises, and goodwill. Their value comes from the privileges or rights granted to or held by the owner. i simple words are Long-term assets (resources) used to produce or sell products or services; usually lack physical form and have uncertain benefits.

Reversing entries

are optional. They are dated the first day of the next accounting period, and they reverse the debits and credits of adjusting entries using the same accounts and amounts. Reversing entries are used for adjusting entries involving accrued revenues and accrued expenses

Plant Assets

are tangible assets that are both long-lived and used to produce or sell products and services. Examples are equipment, machinery, buildings, and land that are used to produce or sell products and services. Plant assets are also called property, plant and equipment (PP&E) or fixed assets.

When a work sheet is used to prepare financial statements, it is constructed at the ?

constructed at the end of a period before the adjusting process.

An important classification is the separation between _____________________and__________________________for both assets and liabilities. Current items are expected to come due (either collected or owed) within one year or the company's operating cycle, whichever is longer..

current (short-term) and noncurrent (long-term)

A current ratio of over 1.0 means that ?

current obligations can be covered with current assets.

A worksheet does not substitute for ____________________________. And It is a tool we use to help prepare financial statements.

financial statements

An important use of financial statements is to

help assess a company's ability to pay its debts in the near future. Such analysis affects decisions by suppliers when allowing a company to buy on credit. It also affects decisions by creditors when lending money to a company, including loan terms such as interest rate and due date.

The complete worksheet includes a?

includes a list of the accounts, their balances and adjustments, and their sorting into financial statement columns.

A Work sheet is a ?

is a document that is used internally by companies to help with adjusting and closing accounts and with preparing financial statements. It is an internal accounting aid and is not a substitute for journals, ledgers, or financial statements.

Equity

is the owner's claim on assets. For a proprietorship, this claim is reported in the equity section with an owner's capital account. Equity is not separated into current and noncurrent categories.

The operating cycle

is the time span from when cash is used to acquire goods and services until cash is received from the sale of goods and services. In other words normal time between paying cash for merchandise or employee services and receiving cash from customers. Most operating cycles are less than one year, which means most companies use a one-year period to classify current and noncurrent items.

The difference between the Debit and Credit column totals of the Income Statement columns is? And this occurs because?

net income or net loss. This occurs because revenues are entered in the Credit column and expenses in the Debit column.

The closing process at the? First, it resets revenue, expense, and withdrawals account balances to zero at the end of each period. This is done so that these accounts can properly measure income and withdrawals for the next period. Second, it updates the balance in the owner's capital account to match the amount reported on the statement of owner's equity and the balance sheet.

occurs at the end of an accounting period after financial statements are completed.Resets revenue, expense, and withdrawals balances to zero.

The current ratio is

one measure of a company's ability to pay its short-term obligations. It is defined in current ratio= current assets _______________________________ Current liabilities

Classified balance sheet

organizes assets and liabilities into subgroups. Including current and noncurrent classifications.

The withdrawals account balance is transferred to the capital account. After closing entries are posted, the revenue, expense, withdrawals, and Income Summary accounts have zero balances and are said to be ?

said to be closed or cleared.

The purpose of reversing entries is to?

simplify recordkeeping.

Post-closing trial balance is often the?

the last step in the accounting process.

Closing entries

transfer the end-of-period balances in revenue, expense, and withdrawals accounts to the permanent capital account.

To close revenue and expense accounts, we?

transfer their balances to Income Summary.

Definition of Temporary accounts

used to record revenues, expenses, and withdrawals (dividends for a corporation); they are closed at the end of each period.