accounting cycle and clasifying accounts

1. 1-1
Completing the Accounting
Cycle and Classifying Accounts
Chapter 4
Electronic Presentations in Microsoft® PowerPoint® to accompany
Fundamental Accounting Principles, 17ce
Prepared by
Regula Lewis
© 2022 McGraw Hill Ltd.

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Learning Objectives 1
1. Describe the closing process and explain why temporary accounts are
closed each period. (LO1)
2. Prepare closing entries. (LO2)
3. Explain and prepare a post-closing trial balance. (LO3)
4. Complete the steps in the accounting cycle. (LO4)

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Learning Objectives 2
5. Explain and prepare a classified balance sheet. (LO5)
6. Calculate the current ratio and debt to equity ratios and describe
what it reveals about a company’s financial condition. (LO6)
7. Describe and prepare a work sheet and explain its usefulness.
(Appendix 4A) (LO7)
8. Prepare reversing entries and explain their purpose. (Appendix 4B)
(LO8) NOT RESPONSIBLE FOR

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The Accounting Cycle
Step 1: Analyze Transactions
Step 2: Journalize
Step 3: Post
Step 4: Prepare unadjusted trial balance
Step 5: Adjust
Step 6: Prepare adjusted trial balance
Step 7: Prepare statements
Step 8: Close
Step 9: Prepare post-closing trial balance
EXHIBIT 4.1

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Completing The Accounting Cycle
Closing Process
• Temporary and permanent accounts
• Closing entries
• Post-closing trial balance
Accounting Cycle
• Definition of accounting cycle
• Review of accounting cycle
Classified Balance Sheet
• Classification structure
• Classification categories

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LO1: Closing Process
• Purpose is to prepare accounts for recording transactions in the next
accounting period.
• Closing entries are a necessary step because we want the revenue,
expense, and withdrawals accounts to begin with zero balances to
measure the results from the period just ending.
• Owner’s capital account to reflect:
a. Increases from profit (or decreases from losses), and
b. Decreases from withdrawals from the period just ending.
• In the closing process, we must:
1. Identify accounts for closing,
2. Record and post the closing entries, and
3. Prepare the post-closing trial balance.

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Identify Accounts For Closing –
Temporary and Permanent Accounts 1
Temporary accounts accumulate data related to one accounting period.
They include all income statement accounts, withdrawals accounts, and
the Income Summary account.
They are temporary because the accounts are opened at the beginning of
a period, used to record transactions for that period, and then closed at
the end of the period by transferring their balances to the owner’s capital
account.
They are temporary because the accounts describe transactions or
changes that have occurred rather than the financial position that exists at
the end of the period.

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Identify Accounts For Closing –
Temporary and Permanent Accounts 2
Permanent accounts report on transactions related to one or more future
accounting periods. T
hey carry their ending balances into the next period and include all
balance sheet accounts.
Asset, liability, and owner’s capital accounts are not closed as long as a
company continues to own the assets, owe the liabilities, and have equity.
They are permanent because they reflect the existing financial position.

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Identify Accounts For Closing –
Temporary and Permanent Accounts 3
Temporary Accounts Permanent Accounts
Revenues Assets
Expenses Liabilities
Withdrawals Owner’s Capital
Income Summary

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IMPORTANT TIP
Only temporary accounts are closed, resulting in a reset to zero for the
next accounting period.
Permanent account balances carry into the next accounting period.

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IMPORTANT TIP
If companies such as Apple, Inc. did not make closing entries, prior-year
revenue from iPhone sales would be included with current-year revenue.
Recording closing entries helps to reset revenue and expense accounts to
zero on the income statement and the owner’s withdrawal account to
capital.

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LO3: Preparing A Post-Closing Trial Balance 1
• A list of permanent accounts and their balances from the ledger after
all closing entries are journalized and posted.
• A list of balances for accounts not closed.
• The post-closing trial balance in Exhibit 4.7 was created by listing the
account balances found in Exhibit 4.6. Like the trial balance, the post-
closing trial balance does not prove that all transactions are recorded
or that the ledger is correct.

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Preparing A Post-Closing Trial Balance 2
Organico, Post-Closing Trial Balance, March 31, 2023
Debit Credit
Cash $8,070
Accounts receivable 1,800
Supplies 2,550
Prepaid Insurance 2,300
Equipment 6,000
Accumulated depreciation, equipment $200
Accounts payable 200
Interest payable 35
Salaries payable 140
Unearned food services revenue 2,750
Notes payable 6,000
Hailey Walker, capital 11,395
Totals $20,720 $20,720
EXHIBIT 4.7

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Completing the Accounting Cycle 2
7. Prepare statements. Use adjusted trial balance to prepare: income
statement, statement of changes in equity, balance sheet, and
statement of cash flows (details of preparing the statement of cash
flows are in Chapter 16).
8. Close. Journalize and post entries to close temporary accounts
(revenue, expense, and withdrawals) and update the owner’s capital
account.
9. Post-closing trial balance**. Test clerical accuracy of adjusting and
closing steps.
*Steps 4, 5, and 6 can be done on a work sheet.
**Reversing entries are optional and, if prepared, are done between Steps 9 and 1.

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LO5: Classified Balance Sheet
• Items are broadly grouped into assets, liabilities, and equity.
• Information to differentiate liabilities that are due in the near future
from those not due within the next fiscal year.
• Information helps financial statement users assess a company’s ability
to meet liabilities when they come due.

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Classification Scheme
Assets Liabilities and Equity
Current Assets Current Liabilities
Non-Current Investments* Non-Current Liabilities
Property, Plant and Equipment* Equity
Intangible Assets*
*Non-current assets
EXHIBIT 4.9

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Operating Cycles for a Service Company
and a Merchandising Company
EXHIBIT 4.10

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A Classified Balance Sheet Example VERY
IMPORTANT
The balance sheet for Elite Boardshop in Exhibit 4.11 shows the most
commonly used groupings.
Assets are classified into: (1) current assets, (2) equity investments,
(3) property, plant, and equipment, and (4) intangible assets.
Its liabilities are classified as either current or non-current.
Not all companies use the same categories of assets and liabilities on
their balance sheets.

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Current Assets 1
• Include all assets such as cash and other resources that are
expected to be sold, collected, or used within the longer of one
year of the company’s balance sheet date or the company’s
operating cycle.
• Examples are cash, short-term investments, accounts receivable,
notes receivable, goods for sale to customers (called merchandise
inventory or inventory), and prepaid expenses.
• Notes receivable expected to be collected after a year or operating
cycle would be classified under non-current assets.

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Current Assets 2
Example: Current Assets – Apple Inc. as at September 26, 2020
Apple Inc.
Consolidated Balance Sheets
Current assets (in millions of US dollars)
Cash and equivalents $38,016
Short-term marketable securities 52,927
Accounts receivable, net 16,120
Inventories 4,061
Vendor non-trade receivables 21,325
Other current assets 11,264
Total current assets $143,713
EXHIBIT 4.12

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Non-Current Investments
• Include all investments management intends to hold to maturity.
• The distinction between current and non-current classification is
determined largely by management’s strategic intent to keep the
instrument to maturity.
• Examples of non-current investments in debt instruments include
bonds, loans outstanding, and non-current notes receivable.
• Non-current equity investments generally relate to significant
equity ownership in another company usually held for strategic
purposes.
• Non-current investments also can include land that is not being
used in operations.

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Property, Plant and Equipment (PPE)
• Are tangible assets of which the company has legal ownership as a
result of a past business transaction and can use for more than
one accounting period to produce or sell products and services.
• Examples include machinery, vehicles, computer hardware,
buildings, and land.
• All PPE items are expected to be used in the business to carry out
its operations and are not intended to be sold.

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Intangible Assets
• Resources that lack physical form and have benefits that flow to
the company for more than one accounting period, result from a
past transaction for which the company has the legal right, and are
expected to provide future benefits.
• These intangibles add value to the company and are used to
produce or sell products and services.
• Examples include patents, trademarks, copyrights, and franchise
rights.
• Their value comes from the privileges or rights granted to or held
by the owner.

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Current Liabilities
• Obligations due to be paid or settled within the longer of one year
of the company’s balance sheet date or its normal operating cycle.
• They are usually settled by paying out current assets.
• Include accounts payable, notes payable, wages payable, taxes
payable, interest payable, and unearned revenues.
• Any portion of a non-current liability due to be paid within the
longer of one year or the operating cycle is classified as a current
liability.

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Non-Current Liabilities
• Obligations due beyond the longer of one year or the company’s
normal operating cycle.
• Include notes payable, mortgages payable, bonds payable, and
lease obligations.
• If a portion of a non-current liability is due to be paid within the
year immediately following the balance sheet date, it must be
separated and shown as a current liability on the balance sheet.

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CHECKPOINT
5. Identify which of the following assets are classified as (1) current
assets, (2) property, plant and equipment, or (3) intangible assets:
a) Land used in operations
b) Office supplies
c) Receivables from customers due in ten months
d) Insurance protection for the next nine months
e) Trucks used to provide services to customers
f) Trademarks used in advertising the company’s services
6. Name two examples of assets classified as non-current
investments on the balance sheet.
7. Explain an operating cycle for a service company and identify its
importance to the classified balance sheet.

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LO6: FINANCIAL STATEMENT ANALYSIS
Current Ratio 1
• Used to evaluate a company’s ability to pay its short-term
obligations.
• The ability to pay day-to-day obligations (current liabilities) with
existing liquid assets is commonly referred to as liquidity.
• Liquid assets are those that can easily be converted to cash or
used to pay for services or obligations.
• Cash is the most liquid asset.
• Useful for decision making and a widely used tool in making
decisions like whether or not to lend money to a company or allow
a customer to buy on credit.
Current Ratio =
𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐀𝐬𝐬𝐞𝐭𝐬
𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐋𝐢𝐚𝐛𝐢𝐥𝐢𝐭𝐢𝐞𝐬
EXHIBIT 4.13

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Current Ratio 2
For the most recent three years, Costco’s current ratio has been
slightly above or slightly below 1.0. This means Costco could face
challenges in covering current liabilities. Although Costco has a better
ratio than Walmart in each of the last three years, management must
continue to monitor current assets and liabilities.
Company $ millions Current Year 1 Year Ago 2 Years Ago
Costco Current assets $23,485 $20,289 $17,317
Current liabilities $23,237 $19,926 $17,495
Current ratio 1.01 1.02 0.99
Walmart Current ratio 0.80 1.02 0.86
EXHIBIT 4.14

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Quick Ratio
• A simple modification from the current ratio, and a more robust
measure of liquidity.
• Includes under-the-numerator-only assets that are easily
converted into cash, including cash and marketable securities,
short-term investments, and receivables.
• Measures the dollar value of liquid assets available to settle
current liabilities.
• Excludes items such as inventory and prepaid assets.
• A quick ratio of greater than one is important.
Quick Ratio =
𝐂𝐚𝐬𝐡+𝐄𝐪𝐮𝐢𝐯𝐚𝐥𝐞𝐧𝐭𝐬+𝐌𝐚𝐫𝐤𝐞𝐭𝐚𝐛𝐥𝐞 𝐒𝐞𝐜𝐮𝐫𝐢𝐭𝐢𝐞𝐬+𝐀𝐜𝐜𝐨𝐮𝐧𝐭𝐬 𝐑𝐞𝐜𝐞𝐢𝐯𝐚𝐛𝐥𝐞
𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐋𝐢𝐚𝐛𝐢𝐥𝐢𝐭𝐢𝐞𝐬
EXHIBIT 4.15

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Debt to Equity Ratio 1
• Another calculation that is important for understanding financial
statements as it indicates the risk position of a company.
• It is important to determine what is normal for the industry.
• A lower number is more favourable; the higher the number, the
higher the risk associated with the potential for bankruptcy.
Debt to Equity Ratio=
𝐓𝐨𝐭𝐚𝐥 𝐃𝐞𝐛𝐭
𝐓𝐨𝐭𝐚𝐥 𝐄𝐪𝐮𝐢𝐭𝐲
EXHIBIT 4.16

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Debt to Equity Ratio2
We investigate the financial statements of Recipe Unlimited
Corporation to calculate and compare its debt to equity ratios at
December 29, 2019, and December 30, 2018 (rounded to two decimal
places):
2019 2018
=
𝟏,𝟗𝟏𝟗,𝟎𝟖𝟎
𝟐,𝟐𝟔𝟒,𝟎𝟔𝟔
= 0.85 =
𝟏,𝟏𝟎𝟓,𝟐𝟕𝟏
𝟏,𝟓𝟗𝟏,𝟎𝟖𝟑
= 0.69

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Appendix 4A
Benefits Of A Work Sheet (Spreadsheet)
1. It is useful in preparing interim (monthly or quarterly) financial
statements when journalizing and posting adjusting entries are
postponed until the year-end.
2. It captures the entire accounting process, linking economic
transactions to their effects in financial statements.
3. Auditors of financial statements often use a work sheet for planning
and organizing the audit. It can also be used to reflect any additional
adjustments necessary as a result of the audit.
4. It helps preparers to avoid errors when working with a lot of
information in accounting systems involving many accounts and
adjustments.

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Appendix 4A
Step 1: Enter Unadjusted Trial Balance
The steps for
completing a
work sheet are
colour coded and
correspond to
the described
steps.
EXHIBIT 4A.2