ACCOUNTING PRINCIPLES SIXTH CANADIAN EDITION Chapter 4 Completion of the Accounting Cycle Prepared by: Debbie Musil Kwantlen Polytechnic University Completion of the Accounting Cycle • Closing the books – Preparing and posting closing entries – Preparing the post-closing trial balance • Summary of the accounting cycle – Worksheets, reversing and correcting entries • Classified balance sheet • Using information in the financial statements – Working capital and current and acid-test ratios Copyright John Wiley & Sons Canada, Ltd. 2 CHAPTER 4: Completion of the Accounting Cycle LEARNING OBJECTIVES: 1. Prepare closing entries and a post-closing trial balance. 2. Explain the steps in the accounting cycle including optional steps. 3. Prepare correcting entries. 4. Prepare a classified balance sheet. 5. Illustrate measures used to evaluate liquidity. 6. Prepare a work sheet (Appendix 4A). 7. Prepare reversing entries (Appendix 4B). Copyright John Wiley & Sons Canada, Ltd. 3 Closing the Books • Done at the end of the accounting period – Accounts are made ready for the next period • Temporary accounts: – Only collect data for a single period; closed at the end of the period – Revenue, expense and owner’s drawings accounts • Permanent accounts: – Not closed – Balances are carried forward into next period – All balance sheet accounts Copyright John Wiley & Sons Canada, Ltd. 4 Closing Entries • Transfer temporary account balances to the owner’s capital account – Updates the owner’s capital account balance – Reduces balances in all temporary accounts to zero, so they are ready for the next period • Journalizing and posting closing entries are a required step in the accounting cycle • Revenue and expense accounts are closed to Income Summary (a temporary account) Copyright John Wiley & Sons Canada, Ltd. 5 The Closing Process Copyright John Wiley & Sons Canada, Ltd. 6 The Closing Process 1. Close revenue accounts – – Debit each revenue account for its balance Credit Income Summary for total revenues 2. Close expense accounts – – Debit Income Summary for total expenses Credit each expense account for its balance 3. Close Income Summary – – Debit Income Summary for balance (credit if loss) Credit owner’s capital account (debit if loss) 4. Close drawings – – Debit owner’s capital account Credit owner’s drawings account for the balance Copyright John Wiley & Sons Canada, Ltd. 7 Post-Closing Trial Balance • Prepared after all closing entries have been journalized and posted • Provides a list of all permanent accounts and their balances – These balances are carried forward into the next period – Since all temporary accounts have zero balances, only permanent accounts remain Copyright John Wiley & Sons Canada, Ltd. 8 Post-Closing Trial Balance Copyright John Wiley & Sons Canada, Ltd. 9 CHAPTER 4: Completion of the Accounting Cycle LEARNING OBJECTIVES: 1. Prepare closing entries and a post-closing trial balance. 2. Explain the steps in the accounting cycle including optional steps. 3. Prepare correcting entries. 4. Prepare a classified balance sheet. 5. Illustrate measures used to evaluate liquidity. 6. Prepare a work sheet (Appendix 4A). 7. Prepare reversing entries (Appendix 4B). Copyright John Wiley & Sons Canada, Ltd. 10 Accounting Cycle Summarized Copyright John Wiley & Sons Canada, Ltd. 11 Work Sheets – An Optional Step • Multiple-column form to help prepare adjusting entries and financial statements • A working tool - not a permanent accounting record • Useful for the preparation of interim financial information or for internal use Copyright John Wiley & Sons Canada, Ltd. 12 Reversing Entries – An Optional Step • Reversing entries reverse certain adjusting entries made in the previous period – Made at the beginning of the next accounting period – To simplify recording of transactions in future accounting periods Copyright John Wiley & Sons Canada, Ltd. 13 CHAPTER 4: Completion of the Accounting Cycle LEARNING OBJECTIVES: 1. Prepare closing entries and a post-closing trial balance. 2. Explain the steps in the accounting cycle including optional steps. 3. Prepare correcting entries. 4. Prepare a classified balance sheet. 5. Illustrate measures used to evaluate liquidity. 6. Prepare a work sheet (Appendix 4A). 7. Prepare reversing entries (Appendix 4B). Copyright John Wiley & Sons Canada, Ltd. Correcting Entries – An Avoidable Step • Correcting entries correct errors that have occurred in the recording process – Unnecessary if the records are free of errors – Can be journalized and posted whenever an error is discovered – Must be done before closing entries are prepared and posted Copyright John Wiley & Sons Canada, Ltd. 15 CHAPTER 4: Completion of the Accounting Cycle LEARNING OBJECTIVES: 1. Prepare closing entries and a post-closing trial balance. 2. Explain the steps in the accounting cycle including optional steps. 3. Prepare correcting entries. 4. Prepare a classified balance sheet. 5. Illustrate measures used to evaluate liquidity. 6. Prepare a work sheet (Appendix 4A). 7. Prepare reversing entries (Appendix 4B). Copyright John Wiley & Sons Canada, Ltd. Classified Balance Sheet • Financial statements are more useful when similar assets and liabilities are grouped together • A classified balance sheet generally has the following standard classifications: Copyright John Wiley & Sons Canada, Ltd. 17 Current Assets • Cash and other resources that will be converted to cash, sold or used up in one year from the balance sheet date • Can be longer period if operating cycle is greater than one year • Listed in order of liquidity • Examples: – Cash, short-term investments, accounts receivable, inventory, prepaid expenses Copyright John Wiley & Sons Canada, Ltd. 18 Operating Cycle • The length of it takes from starting with cash to ending with cash in producing revenues • Usually less than one year, but for some companies it may be longer than one year Copyright John Wiley & Sons Canada, Ltd. 19 Long-Term Investments • Investments in debt or equity that are expected to be held for many years • Not readily marketable or expected to be converted into cash within one year • Examples: – Investments in shares or bonds of another company, investment in land held for resale Copyright John Wiley & Sons Canada, Ltd. 20 Property, Plant and Equipment • Long-lived tangible assets that are used in the business and not intended for sale • Examples: – Land, buildings, equipment Copyright John Wiley & Sons Canada, Ltd. 21 Intangible Assets • Long-lived assets that do not have physical substance • Examples: – Patents, copyrights, trademarks, trade names, licences • Goodwill is a type of intangible asset – Arises when a company is acquired at a price greater than the fair value of the assets Copyright John Wiley & Sons Canada, Ltd. 22 Current Liabilities • Obligations expected to be settled within one year from the balance sheet date or in the normal operating cycle • Listed first in the liabilities and equity section of the balance sheet • Listed in order of liquidity • Examples: – Accounts payable, interest payable, salaries payable, unearned revenue, current maturities of long-term debt Copyright John Wiley & Sons Canada, Ltd. 23 Non-current Liabilities • Obligations expected to be paid after one year or longer • Examples: – Long-term notes payable, bonds payable, mortgages payable, lease liabilities, deferred income taxes (or future income taxes) Copyright John Wiley & Sons Canada, Ltd. 24 Equity • Content of the equity section varies with the form of business organization: – Proprietorship: one capital account under the heading “Owner’s Equity” – Partnership: Capital account for each partner under the heading “Partners’ Equity” – Corporation: shareholders’ equity consists of two sections: “Share Capital” and “Retained Earnings” Copyright John Wiley & Sons Canada, Ltd. 25 IFRS Versus ASPE • Statement Name – IFRS: Statement of Financial Position – ASPE: Balance Sheet – But both allow either name • Order of Items – IFRS: May present assets, liabilities, equity in reverse order of liquidity – ASPE: typically uses order of liquidity IFRS Versus ASPE 2 • Classification of Assets – Long-term investments, property, plant and equipment, intangible assets – IFRS: May use sub-heading “NonCurrent Assets” – ASPE: does not use this sub-heading, uses the separate classifications CHAPTER 4: Completion of the Accounting Cycle LEARNING OBJECTIVES: 1. Prepare closing entries and a post-closing trial balance. 2. Explain the steps in the accounting cycle including optional steps. 3. Prepare correcting entries. 4. Prepare a classified balance sheet. 5. Illustrate measures used to evaluate liquidity. 6. Prepare a work sheet (Appendix 4A). 7. Prepare reversing entries (Appendix 4B). Copyright John Wiley & Sons Canada, Ltd. Using Information in the Financial Statements • Liquidity: the ability to pay obligations as they come due within the next year • Working capital: an important measure of liquidity = Current assets - Current liabilities Copyright John Wiley & Sons Canada, Ltd. 29 Using Information in the Financial Statements (Continued) • Current ratio: a measure of short-term debt-paying ability = Current assets ÷ Current liabilities • Acid-test ratio: measures immediate short-term liquidity ={Cash + Short-term investments + Receivables} ÷ Current liabilities Copyright John Wiley & Sons Canada, Ltd. 30 CHAPTER 4: Completion of the Accounting Cycle LEARNING OBJECTIVES: 1. Prepare closing entries and a post-closing trial balance. 2. Explain the steps in the accounting cycle including optional steps. 3. Prepare correcting entries. 4. Prepare a classified balance sheet. 5. Illustrate measures used to evaluate liquidity. 6. Prepare a work sheet (Appendix 4A). 7. Prepare reversing entries (Appendix 4B). Copyright John Wiley & Sons Canada, Ltd. Appendix 4A: Work Sheets • A multiple-column form used in preparing financial statements • Steps in preparing a work sheet: 1. Prepare a trial balance on the work sheet 2. Enter adjustments in the adjustment columns 3. Enter adjusted balances in the adjusted trial balance columns 4. Enter adjusted trial balance amounts in the correct financial statement columns 5. Total columns, calculate profit (loss) and complete the work sheet Copyright John Wiley & Sons Canada, Ltd. 32 CHAPTER 4: Completion of the Accounting Cycle LEARNING OBJECTIVES: 1. Prepare closing entries and a post-closing trial balance. 2. Explain the steps in the accounting cycle including optional steps. 3. Prepare correcting entries. 4. Prepare a classified balance sheet. 5. Illustrate measures used to evaluate liquidity. 6. Prepare a work sheet (Appendix 4A). 7. Prepare reversing entries (Appendix 4B). Copyright John Wiley & Sons Canada, Ltd. Appendix 4B: Reversing Entries • Entries that reverse the adjusting entries at the beginning of the next period – Used to reverse accrued revenues and expenses • Simplifies the recording of future transactions related to an adjusting entry – When transaction is recorded, no need to refer back to adjusting entries to determine how much relates to prior period Copyright John Wiley & Sons Canada, Ltd. 34 Copyright Copyright © 2013 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by Access Copyright (the Canadian copyright licensing agency) is unlawful. Requests for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his or her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages caused by the use of these files or programs or from the use of the information contained herein. Prepared by: A. Davis, MSc, BComm, CA, CFE Copyright John Wiley & Sons Canada, Ltd. 35