Chapter 4: Completing the Accounting System

Describe flow of accounting information from unadjusted trial balance into adjusted trial balance and financial statement

The spreadsheet begins with unadjusted trial balance

• the unadjusted trial balance verifies that total of debits = credits

Flow of account from adjusted trial balance into financial statements?

1. Revenues and expenses flow into income

2. Common stock and dividends flow into stockholders equity

3. Asset and liabilities flow into balance sheet. Common stock and retained earnings also flow into balance sheet

What would be the primary objective of the accounting system?

It will allow managers and accountants to see the effect of adjustments on the finanical statements

Income Statement

It’s prepared directly from the adjusted trial balance columns spreadsheet, beginning with fees earned

• The expenses in the income statement are listed in order of size, beginning with the large items and ending with Miscellaneous expense

Stockholders equity

Enter beginning balance for common stock and retained earnings

• Ending balance = Stock + earnings - Dividends

Balance sheet

• Assets → CA, Property, equipment, Plant, and Notes payable

• Liabilities → CL (All payables except Notes), Long-termLiabilities (loans and bonds payable)

• Stockholders equity → common stock and retained earnings

Statement of Cash Flow

Is prepared by analyzing cash amount → operating, investing, and financial activity

• While the income statement, statement of stockholders' equity, and balance sheet can be prepared from the Adjusted Trial Balance columns, the statement of cash flows is prepared by analyzing the cash account.

• In doing so, each cash transaction is classified as an operating, investing, or financing activity.

• In practice, however, the statement of cash flows is normally prepared using a different, more complex method called the indirect method.

Permanent Account

reported on balance sheet and are carried forward from year to year

• ae those who will always be there

• also known as Real Account

• ex. cash, accounts receivable, equipment, Accumulated depreciation, common stock, and retained earnings

Temporary accounts

reported on Income statement are not carried foward from year to year

• Those that will not be repeated after the period will = 0

• ex. revenues, expenses, fees earned

Closing entries

Journal entries that transfer balances

• At the beginning of the next period, temporary accounts should have zero balances.

  • To achieve this, temporary account balances are transferred to permanent accounts at the end of the accounting period.

• transfer process is called the closing process

• If closing exceeds debit, then there was a loss, and we would need to debit retained earnings

What are the two steps involving closing entries?

1. Revenues and expenses account balances are transferred to retained earnings account

2. Balance of dividends account is transferred to retained earnings account

Post closing trial balance

Its purpose is to verify that the ledger is in balance at the beginning of next period

• its prepared after closing entries

• accounts and amounts should agree exactly with accounts and amounts of balance sheet at the end period

What is the accounting system?

is the process that begins with analyzing and journalizing transactions and ends with post-closing trial balance

What is step one in accounting system?

Transactions are analyzed and recorded in ledger

• analyze and record using double-entry system

What is step two in accounting system?

Transactions are posted to the ledger

• Credits and debits are posted to the account in the order they occur in the journal

What is step three in accounting system?

unadjusted trial balance is prepared

• Unadjusted is prepared to determine if error has happened

What is step four in accounting system?

Adjusted data are assembled and analyzed.

• Accounts need to be updated: accrued revenue and expenses, unearned revenue, prepaid expenses, and depreciation for land

What is step five in accounting system?

optimal end-of-period spreadsheet is prepared

• End-of-period spreadsheet is not required, but useful in showing the flow of accounting info from the unadjusted trial balance to the adjusted trial balance

What is step six in accounting system?

Adjusting entries are journalized and posted to the ledgers

• Each adjusting entry affects at least one income statement and one balance sheet

What is step seven in accounting system?

An adjusted trial balance is prepared

• After adjustments, an adjusted trial balance is prepared

What is step eight in accounting system?

Financial statements are made.

• MOST important outcome is Financial statement: is equity → balance sheet

What is step nine in accounting system?

Closing entries are journalized and posted to the ledger

• Prepare the TWO closing entries

What is step ten in accounting system?

The post-closing balance is prepared

• Prepare post-closing trial balance

Why is Accrual Basis of Accounting required by GAAP

• The primary alternative to the accrual basis per GAAP is the cash basis of accounting, which records transactions only when cash is received or paid.

• The accrual basis of accounting uses the revenue and expense recognition principles to record revenues and expenses.

  • Under the revenue recognition principle, revenues are recorded when earned, which is when the services have been performed or products have been delivered to customers.

  • Under the expense recognition principle, the expenses incurred in generating revenue are recorded in the same period as the related revenue.

What is liability and its two measures of short-term?

Is the ability to convert assets into cash

• Working Capital

• Current Ratio

Working Capital

Is the excess of current assets of a business over current liabilities

• FORMULA: Current Assets — Current Liabilities

Current Ratio

measures a company’s ability to cover its current liabilities against its current assets

• FORMULA → Current Assets / Current Liabilities