Accounting Cycle, Financial Statements, and Closing Procedures

Benefits of a worksheet

Reduces risk of error; helps prepare financial statements; links accounts and adjustments to financial statements; shows effects of proposed transactions.

Steps of preparing a worksheet

1. Enter the unadjusted trial balance 2. Enter adjustments 3. Prepare adjusted trial balance 4. Sort adjusted trial balance amounts to financial statements 5. Total statement column, compute income or loss, and balance columns

Purpose of the closing process

To reset revenue, expense, and withdrawal account balances to zero at the end of the period, and update the owner's capital account.

Temporary accounts

Revenues, Expenses, Income Summary, Withdrawals

Permanent accounts

Assets, Owner's Capital, Liabilities

Closing process applies to

Only temporary accounts

Steps in recording closing entries

1. Close credit balances in revenue accounts to Income Summary 2. Close debit balances in expense accounts to Income Summary 3. Close Income Summary to Owner's Capital 4. Close Withdrawals to Owner's Capital

Post-closing trial balance

A list of permanent accounts and their balances after posting closing entries; total debits and credits must be equal; all temporary accounts have zero balance.

Steps of the accounting cycle

1. Analyze transactions 2. Journalize 3. Post to ledger 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

Purpose of the classified balance sheet

To separate current and long-term assets and liabilities based on when they are expected to be used or due.

Current items

Items expected to be collected or owed within one year or the company's normal operating cycle (whichever is longer).

Current assets

Assets expected to be sold, collected, or used within one year or the operating cycle. Examples: cash, short-term investments, accounts receivable, inventory, prepaid expenses.

Long-term investments

Investments expected to be held for more than one year or the operating cycle. Examples: notes receivable, stocks and bonds held long-term.

Plant assets (PP&E)

Tangible, long-lived assets used to produce or sell products and services. Examples: equipment, buildings, land, machinery.

Intangible assets

Long-term assets that benefit operations but lack physical form. Examples: patents, trademarks, copyrights.

Current liabilities

Liabilities due within one year or the operating cycle. Examples: accounts payable, wages payable, taxes payable, interest payable, unearned revenue.

Long-term liabilities

Liabilities not due within one year or the operating cycle. Examples: notes payable, bonds payable, mortgage payable, lease obligations.

Equity

The owner's claim on the assets; for a proprietorship, reported in the owner's capital account.

Current ratio formula

Current Ratio = Current Assets ÷ Current Liabilities

Reversing entries

Optional entries that reverse adjusting entries involving accrued revenues and expenses to simplify recordkeeping.

Difference between post-closing trial balance and adjusted trial balance

Adjusted trial balance: Includes all accounts (temporary and permanent) after adjustments. Post-closing trial balance: Includes only permanent accounts (temporary = 0).