Completing the

Chapter 4 Accounting Cycle

1. Closing the books

2. Multi-step Income Statement

3. Classified Statement of Financial Position

4. In-Depth Look at the Statement of Cash Flows

4-1
 Closing the Books

At the end of the accounting period, the company makes the

accounts ready for the next period.

Clear balances of temporary accounts to ZERO.

4-2
 Closing the Books

Preparing Closing Entries

Closing entries formally recognize, in the general ledger, the
transfer of
net income (or net loss) and
dividends
to retained earnings.

Closing entries are only made at the end of the annual

accounting period.

4-3
 Closing the Books

Note:
Dividends are closed directly Illustration 4-6

to retained earnings and not

to Income Summary because
Retained earnings is a
dividends are not an permanent account; all
other accounts are
expense. temporary accounts.

4-4
 Closing the Books -- Example

Use the following information to prepare closing entries:

Revenues $10,000
Beg. Retained Earnings $30,000
Rent expense 2,000
Dividends 1,000
Salary expense 5,000

4-5
 Closing the Books -- Example

1. Close all Revenue and Expense accounts to Income

Summary.

Revenues 10,000
Income Summary 10,000

Income Summary 7,000

Rent Expense 2,000
Salary Expense 5,000

Income Summary Revenues

10,000 10,000

7,000 10,000

4-6 3,000 0 (balance)

 Closing the Books -- Example

2. Close Income Summary to Retained Earnings.

Income Summary 3,000

Retained Earnings 3,000

Income Summary
10,000
7,000
3,000
0 (balance)

4-7
 Closing the Books -- Example

3. Close Dividends to Retained Earnings.

Retained Earnings 1,000

Dividends 1,000

Retained Earnings
30,000 (beginning Balance)
3,000 (income summary)
(Dividends)1,000
32,000 (ending balance)

Beginning balance of next year

4-8
 Summary of the Accounting Cycle
Illustration 4-12

1. Analyze business transactions

9. Prepare a post-closing 2. Journalize the

trial balance transactions

8. Journalize and post

3. Post to ledger accounts
closing entries

7. Prepare financial
4. Prepare a trial balance
statements

6. Prepare an adjusted trial 5. Journalize and post

balance adjusting entries

4-9
 Summary of the Accounting Cycle

Correcting EntriesAn Avoidable Step

Unnecessary if the records are error-free.

Made whenever an error is discovered.

Must be posted before closing entries.

Instead of preparing a correcting entry, it is possible to reverse

the incorrect entry and then prepare the correct entry.

4-10
 Correcting EntriesAn Avoidable Step

Illustration: On May 10, Mercato Co. journalized and posted a $50

cash collection on account from a customer as a debit to Cash $50 and
a credit to Service Revenue $50. The company discovered the error on
May 20, when the customer paid the remaining balance in full.

Incorrect Cash 50
entry
Service revenue 50
Correct Cash 50
entry
Accounts receivable 50

Correcting Service revenue 50

entry Accounts receivable 50

4-11
 Correcting EntriesAn Avoidable Step
Incorrect Cash 50
entry
Service revenue 50
Correct Cash 50
entry
Accounts receivable 50

Alternatively, we correct this error by:

Reverse Service revenue 50

Wrong entry Cash 50

Make Cash 50

Correct entry Accounts receivable 50

4-12
 Multi-step Income Statement (Ch.5)

Identifying characteristics: Gross Profit, Income from

Operations.

Highlights components of income based on operating vs.

non-operating activities

4-13
 Multi-step Income Statement (Ch.5)

Net Sales
Sales Revenues
- Sales Returns and Allowances / Discounts
- Cost of Goods Sold (COGS)
= Gross Profit
- Operating Expenses
Selling Expense
General & Administrative Expense
Etc.
= Income from Operations
Other Income and Expenses
= Income before Income Taxes
- Income Tax Expense

4-14
= Net Income
 Multi-step Income Statement (Ch.5)

Revenues:
amounts of assets received or liabilities settled during
the period from delivering goods or providing services
to customers.

Other Revenues (non-operating):

revenues from other sources than sales, such as
interest revenue, rent revenue, etc.

Gains:
increases in assets due to peripheral or incidental
transactions, such as selling equipment.

4-15
 Multi-step Income Statement (Ch.5)

COGS:
(Direct) cost of products or services provided to customers

Operating Expense:
Costs of operating a business, other than COGS, such as
R&D Expense
Selling, General and Administrative Expense (SG&A)
Depreciation Expense

Other Expenses:
Non-operating expenses, such as Interest Expense

Loss:
Non-operating decreases in net assets that arise from peripheral
or incidental transactions, such as casualty loss from fires

4-16
 Multi-step Income Statement (Ch.5)

Net Sales
Whirlpool sold 10 washers at the price of $500 each on account at
March 1st, 2013. Whirlpool provides 30 day free return warranty. 3
washers were returned by customers on March 7th, 2013.

At sales on March 1st, 2013

Accounts Receivable 5,000
Sales Revenue 5,000

At returns on March 7th, 2013

Sales Returns and Allowances 1,500

Accounts Receivable 1,500

4-17
 Multi-step Income Statement (Ch.5)

Net Sales
Whirlpool provides an incentive to investors from prompt cash
payment, 2/10, n/30. Cash payment for 2 washers were made on
March 9th, 2013.

At payment on March 9th, 2013

Cash 980
Sales Discounts 20
Accounts Receivable 1,000

Net Sales = Sales Revenue

Sales Returns and Allowance Contra Revenue
Sales Discounts Account
4-18
 Multi-step Income Statement (Ch.5)

Gross Profit Ratio:

Gross Profit Net Sales

Example: Sales $175,000

(COGS) (125,000)
Gross Profit 50,000

Gross Profit 50,000

GP Ratio = = = 0.29 or 29%
Sales 175,000

For every $1 of sales, 29 cents is available to cover other expenses

(other than COGS) and to earn a profit.

4-19
 The Classified Statement of Financial Position

Presents a snapshot at a point in time.

To improve understanding, companies group similar

assets and similar liabilities together.

Standard Classifications under IFRS

4-20
 The Classified Statement of Financial Position

Illustration
4-18

4-21
 The Classified Statement of Financial Position

Illustration
4-18

4-22
 The Classified Statement of Financial Position

Intangible Assets
Assets that do not have physical substance.

Trademarks, copyrights, parents, goodwill

4-23
 The Classified Statement of Financial Position

Property, Plant, and Equipment

Long useful lives.

Currently used in operations.

Depreciation - allocating the cost of assets to a number

of years. (Land does not depreciate)

Accumulated depreciation - total amount of

depreciation expensed thus far in the assets life.

4-24
 The Classified Statement of Financial Position

Property, Plant, and Equipment

Illustration 4-20

4-25
 The Classified Statement of Financial Position

Long-Term Investments
Investments in ordinary shares and bonds of other
companies.
Investments in non-current assets such as land or buildings
that a company is not using in its operating activities.
Illustration 4-21

4-26
 The Classified Statement of Financial Position

Current Assets
Assets that a company expects to convert to cash or
use up within one year or the operating cycle, whichever
is longer.

Operating cycle is the average time it takes from the

purchase of inventory to the collection of cash from
customers.

4-27
 The Classified Statement of Financial Position

Current Assets
Illustration 4-22

Usually listed in the reverse order that they are expected to convert into
cash.
4-28
 The Classified Statement of Financial Position

Equity
Proprietorship - one capital account.

Partnership - capital account for each partner.

Corporation Share Capital and Retained Earnings.

Illustration 4-23

4-29
 The Classified Statement of Financial Position

Non-Current Liabilities
Obligations a company expects to pay after one year.
Illustration 4-24

4-30
 The Classified Statement of Financial Position

Current Liabilities
Obligations company is to pay within the coming year or
its operating cycle, whichever is longer.

Usually list notes payable first, followed by accounts

payable. Other items follow in order of magnitude.

Liquidity - ability to pay obligations expected to be due

within the next year.

4-31
 The Classified Statement of Financial Position

Current Liabilities
Illustration 4-25

4-32
 The Classified Statement of Financial Position

Under U.S. GAAP, list in the order that they are expected to
convert into cash

Assets Liabilities and Equity

Current assets Current liabilities
Cash
Short-term investments
A/R
Inventories
Long-term investments Non-current liabilities
Property, plant, and equipment Equity
Intangible assets

4-33
 Uses of Statement of Financial Position

Liquidity Measures
Measure a companys ability to pay its debts as they
come due

Working Capital = Current Assets Current Liabilities

Current Ratio = Current Assets Current Liabilities

4-34
 In-Depth Look at Statement of Cash Flows

Operating inflow or outflow of cash resulting from the

purchase or sale of a product or service

Investing inflow or outflow of cash resulting from the

sale or purchase of long-term assets (i.e. PP&E and
intangible assets)

Financing inflow or outflow of cash resulting from

issuance or retirement of long-term debt and capital stock
and payment of cash dividends

Total of three sections equals the change in cash from

beginning of period to end of period

4-35
 In-Depth Look at Statement of Cash Flows

Example:
From the following list, identify each item as operating (O),
investing (I), financing (F), or not on the statement of cash
flows (N):

1. Paid for supplies O

2. Collected cash from customers O
3. Purchased land (for construction of new building) I
4. Paid dividend F
5. Issued stock F
6. Purchased computers (for use in the business) I
7. Sold old equipment I

4-36
 Practice Question

These financial statement items are for Batra Corporation at year-end,

December 31, 2013:
Salaries expense $20,000 Utilities expense $14,900
Equipment 15,900 Accounts Payable 6,220
Sales Revenue 89,600 Accounts receivable 10,785
Unearned rent revenue 1,800 Dividends 14,000
Share capital -- ordinary 20,000 Depreciation expense 4,000
Cost of Goods Sold (COGS) 38,700 Retained earnings (Jan. 1, 2013) 25,200
Cash 20,440 Prepaid Expenses 3,500
Interest revenue 200 Loss on sale of equipment 850
Accumulated depreciation 5,400 Sales Discounts 2,800
Required:
a. Prepare a multi-step income statement, assuming income tax rate is
30%.
4-37b. Prepare a classified balance sheet at December 31, 2013.