Chapter 4

Closing entries

Closing entries transfer revenues, expenses, and Dividends to Retained Earnings. Revenues and expenses may be transferred first to an account titled Income Summary. Income Summary is a temporary account that summarizes the net income (or net loss) for the period. Closing entries are prepared after the financial statements are prepared. To close revenues accounts: Debit Revenue Credit Income Summary To close expense accounts: Debit Income Summary Credit Expense To close Income Summary account, the debit or credit depends on whether there is a net income or net loss Net Income: Debit Retained Earnings Credit Income Summary Net Loss: Debit Income Summary Credit Retained Earnings To close dividends: Debit Retained Earnings Credit Dividend

Current Assets VS. Long-term Assets

Current Assets will be converted to cash, sold, or used up during the next 12 months or within the business operating cycle if the cycle is longer than a year. Examples of current assets listed in order of liquidity: cash, accounts receivable, inventory, supplies, prepaid expenses Long-term assets are all the assets that will not converted to cash or used up within the business's operating cycle or one year, whichever is greater.

Current Liabilities VS. Long-term Liabilities

Current liabilities must be paid either with cash or with goods and services within one year or within the entity's operating cycle. Examples of current liabilities: Accounts Payable, Salaries Payable, Unearned Revenues. Long-term liabilities are liabilities that do not need to be paid within one year or within the operating cycle.

Classified Balance Sheet

A classified balance sheet places each asset and each liability into a specific category. Assets are shown in order of liquidity (liquidity measures how quickly and easily an account can be converted to cash) Liabilities are classified as current (due within one year) or long term (due after one year)

Relationship Among the Financial Statements

Net income or net loss from the income statement flows to the Statement of Retained Earnings. Ending balance of Retained Earnings (=Beginning Balance + Revenue - Expenses - Dividends) from the Statement of Retained Earnings flows to the Balance Sheet. Ending balance of all other accounts except for Retained Earnings are acquired from adjusted trial balance. Ending balance of cash is used to prepare statement of cash flows (total change of cash account=ending balance of cash in the current period - ending balance of cash in the prior period=change of cash from operating+change of cash from investing+change of cash from financing activities)

Stockholders' Equity

Stockholders' equity represents the stockholders' claims to the assets of the business. Reflects the stockholders' contributions through common stock Represents the amount of assets left over after the corporation has paid its liabilities

Post-closing trial balance

The accounting cycle ends with a post-closing trial balance: A list of the accounts and their balances at the end of the period, after journalizing and posting the closing entries Includes only permanent accounts Differences between Post-closing Trial Balance and Adjusted Trial Balance: All accounts before Retained Earnings (include Assets, Liabilities, and Common Stock) have the same balance; Retained Earnings is updated to ending balance in post-closing trial balance (adjusted trial balance has a beginning balance in Retained Earnings); All the temporary accounts (revenue, expenses, dividends) are removed or have zero balances in the post-closing trial balance

What is the accounting cycle?

The accounting cycle is the process by which companies produce their financial statements for a specific period. It is the steps that are followed throughout the time period. It starts with the beginning asset, liability, and stockholders' equity account balances left over from the preceding period.

What is the closing process, and how do we close the accounts?

The closing process zeroes out all revenue and expense accounts in order to measure each period's net income separately from all other periods. Temporary accounts relate to a particular accounting period and are closed at the end of that period Revenues, Expenses, Income Summary, and Dividends accounts are temporary accounts. Permanent accounts are not closed at the end of the period Asset, Liability, Common Stock, and Retained Earnings accounts are permanent accounts.

Operating Cycle

The period of time between the purchase of inventory and the collection of any receivable from the sale of the inventory. The cycle is a 3-step cycle: 1. cash is used to acquire goods and services 2. these goods and services are sold to customers 3. the business collects cash from customers

Examples of Long-term Assets

There are three types of long-term assets: 1. long-term investments: investments in bonds or stocks that the company intends to hold for longer than one year 2. Property, Plant, and Equipment (PPE): long-lived, tangible assets, used in the operation of a business 3. Intangible Assets: are assets with no physical form that are valuable because of special rights carried

Balance Sheet

reports assets, liabilities, and stockholders' equity as of the last day of the accounting period (balance sheet recorded at the point of time)

Income Statement

reports revenues and expenses and calculates net income or net loss for the period

Statement of Retained Earnings

shows how retained earnings changed during the period due to net income (or net loss) and dividends