Financial Accounting Cycle II - Adjustments

Classified Balance Sheet

Overview of Balance Sheet in Practice

  • Purpose: The classified balance sheet facilitates the evaluation of the performance of the business based on financial ratios.
  • Asset Listing: Assets are listed in order of liquidity.
  • Liabilities Listing: Liabilities are listed in the order in which they must be paid.

Financial Ratios Widely Used by Lenders

  1. Current Ratio (CR)

    • Definition: Measures the ability of the business to meet current obligations; specifically, it assesses the ability of the business to pay current liabilities (CLs) with current assets (CAs).
    • Formula:
      ext{Current Ratio (CR)} = rac{ ext{Current Assets (CA)}}{ ext{Current Liabilities (CL)}}
    • Interpretation:
      • A CR of 2 means the business has $2 of current assets for every $1 of current liabilities.
      • A CR of 1.5 is considered good.
      • A CR of 1 is considered low and risky.

  2. Debt Ratio (DR)

    • Definition: Also known as the leverage or gearing ratio, it measures the overall ability of the business to pay its debts (both current and long-term).
    • Funding Sources: Businesses are financed by either debt (borrowed funds) or equity (funds provided by the owner(s)).
    • Interpretation: The DR indicates the portion of the assets of the business that is financed by debt.
    • Formula:
      ext{Debt Ratio (DR)} = rac{ ext{Total Liabilities (TL)}}{ ext{Total Assets (TA)}}
    • Safety Thresholds:
      • A DR of less than or equal to 0.6 (60%) is considered safe.
      • A DR greater than 0.8 (80%) is considered risky.

Income Summary

Account Types Involved

  1. Revenue Account
  2. Expense Account
  3. Drawings Account
  4. Capital Account

Transfer Process from Revenue, Expenses, & Drawings to Capital

Closing Entries Steps

  1. Close Revenue Account to Income Summary
    • Debit: Revenue (Tuition Fees Earned) $248,200
    • Credit: Income Summary $248,200
  2. Close Expense Accounts to Income Summary
    • Debit: Income Summary $166,200
    • Credits:
      • Salaries Expense $55,000
      • Rent Expense $36,000
      • Utilities Expense $39,000
      • Depreciation Expense: Computer Equipment $30,000
      • Depreciation Expense: Office Equipment $12,000
      • Insurance Expense $10,000
      • Teaching Supplies Expense $7,000
      • Utilities Expense $6,400
      • Advertising Expense $5,000
  3. Close Income Summary to Owner, Capital Account
    • Debit: Income Summary $82,000
    • Credit: June Wells, Capital $82,000
  4. Close Owner, Withdrawals to Owner, Capital
    • Debit: June Wells, Capital $42,000
    • Credit: June Wells, Withdrawals $42,000

Post-Closing Trial Balance

Overview

The accounting cycle ends with the post-closing trial balance, which is:

  • Dated as of the end of the period for which the statements have been prepared.
  • Reflects only permanent accounts, i.e., real and personal accounts.

Sample Post-Closing Trial Balance Details for Wells Technical Institute at June 30, 2012

  • Name of Account
    • Dr. $
    • Cr. $
    • Cash 77,700
    • Tuition Fees Receivable 25,600
    • Teaching Supplies 8,000
    • Prepaid Insurance 14,000
    • Office Equipment 54,000
    • Accumulated Depreciation - Office Equipment 12,000
    • Accounts Payable 26,000
    • Salaries Payable 4,000
    • Interest Payable 4,800
    • June Wells, Capital 196,000
  • Total Dr. $340,300
  • Total Cr. $340,300
  • Other Accounts:
    • Notes Payable Due 14,000
    • Computer Equipment 160,000
    • Accumulated Depreciation - Computer Equipment 50,000
    • Long-Term Notes Payable 26,000
    • Unearned Client Fees 7,500
    • Prepaid Rent 6,000

--End of Notes--