Accounting
Chapter 26
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Financial statements are used to report a business’s financial progress and
condition as well as changes in the owner’s equity
Prepare three financial statements: income statement, statement of
stockholder’s equity, and balance sheet
Owners; Equity ins reported in two categories
• Capital contributed by the owners
• Capital earned by the corporation
Section 1
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An income statement reports the financial progress of a business during a
fiscal period
Have to do 4 extra steps on the income statement for a corporation
• From Sales subtract Sales Discount and Sales Returns and
Allowances – leftover is Net Sales
• From Purchases subtract Purchases Discount and Purchases
Returns and Allowances – leftover amount is Net Purchases
• Income from operations is the income earned from he normal
business activities, Other revenue and expenses (interest income,
interest expense, and gains/losses on plant assets) are not normal
business activities and are not included in operations income
• Net Income before federal income tax and net income after federal
income tax are reported separately
For a business to determine whether it is progressing okay, results of
operations are compared with industry standards and/or previous fiscal
periods
To figure component percentage: component ¸ net sales = component %
If the component % of any cost or expense item for a fiscal period
exceeds the acceptable % that cost or expense is reviewed further to
determine the cost.
Section 2
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Statement of Stockholder’s Equity (SSE): a financial statement that shows
changes in a corporations’ ownership for a fiscal period.
Similar to owners’ equity statement for a partnership
SSE has two main parts: capital stock and retained earnings.
The amount of capital stock issued as of the beginning of the year is the
beginning balance of the capital stock account
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Any additional stock transactions would be added together to calculate the
amount of stock issued during the fiscal period
Par Value: a value assigned to a share of stock and printed on the stock
certificate
Preparing the capital stock section of a SSE – see page 668
Net income increases ac corporation’s total capital
Some net income is retained to use in business expansion
Some net income may be distributed as dividends
Amounts used to prepare the SSE are found on the work sheet in the
income statement and balance sheet columns
Preparing the retained earnings section of a SSE – see page 669
Section 3
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A corporation’s balance sheet reports assets, liabilities, and stockholders’
equity on a specific date.
An asset’s book value is reported on a balance sheet by listing three
amounts: balance of the asset account, the balance of the contra account,
and book value
Liabilities owed for more than 1 year are long-term liabilities
Liabilities due within a short time, usually within one year, are current
liabilities
Stockholders’ equity contains the total amounts of capital stock and
retained earnings
Steps to completing a balance sheet look on pages 671, 672, 673
The balance sheet is the primary source of data to determine the financial
strength of a business
Creditors and investors use financial strength analysis to determine if the
company is a good credit and investment risk
Working capital: the amount of total current assets less total current
liabilities
Working capital is a measure of financial resources available for the daily
operations of a business
Working capital does NOT mean cash
A ratio that shows the numeric relationship of current assets to current
liabilities is the current ratio
The current ratio is a measure of a company’s ability to pay its current
liabilities
Total current assets ¸ Total current liabilities = Current ratio
Section 4
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After financial statements are prepared, adjusting and closing entries are
journalize and posted.
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A post-closing trial balance is prepared to prove the equality of debits and
credits in the general ledger after adjusting and closing entries have been
posted.
Then reversing entries are journalized and posted.
A corporation’s adjusting entries are made from the Adjustments columns
of a work sheet.
To make sure that they all get journalized, record the entries in the order
of the letters assigned to the adjustment.
Closing entries are made from info in a work sheet
Corporation’s Four Closing Entries
Closing entry for income statement accounts with credit balances
o Revenue: Sales, Gain on Plant Assets, Interest Income
o Contra cost accounts: Purchases Discount, Purchases Returns and
Allowances
o Cash Short and Over IF it has a credit balance
o Debit the above accounts and credit Income Summary for the total
amount
Closing entry for income statement accounts with debit balance
o Contra Revenue: Sales Discount and Sales Returns and Allowances
o Cost: Purchases
o Expenses: all the expense accounts
o Debit Income Summary for the total amount and Credit all of the
above accounts
Need to post all of these before proceed to the next closings
Closing entry to record net income or net loss in the retained earnings
account and close the income summary account
o After closing entries for the income statement accounts are posted,
Income Summary has a credit balance – this should equal the net
income on the work sheet
o Need to Debit Income Summary and credit Retained Earnings
o If have a net loss, Income Summary has a debit balance. Then
need to credit Income Summary and debit Retained Earnings
Closing entry for the dividends account
o Dividends decrease the Retained Earnings account
o Debit Retained Earnings and Credit Dividends for the amount in
that account
Reversing Entries
o If an adjusting entry creates a balance in an asset or liability
account, the adjusting entry should be reversed
o Reverse the adjusting entries that created balances in Interest
Receivable, Interest Payable, and Federal Income Tax Payable