Journalize the four entries required to close the accounts

142

Chapter 4 Completing the Accounting Cycle

Scan Study Objectives ■

Read Feature Story ■

Read Preview ■

Read text and answer Before You Go On p. 150 ■ p. 160 ■ p. 168 ■

Work Demonstration Problem ■

Review Summary of Study Objectives ■

Answer Self-Study Questions ■

Complete Assignments ■

After studying this chapter, you should be able to: 1 Prepare a worksheet. 2

books. 3 Describe the content and purpose of a

post-closing trial balance. 4 State the required steps in the

accounting cycle. 5 Explain the approaches to preparing

correcting entries. 6

balance sheet.

The NavigatorS T U D Y O B J E C T I V E S ✓

Feature Story EVERYONE LIKES TO WIN

When Ted Castle was a hockey coach at the University of Vermont, his play- ers were self-motivated by their desire to win. Hockey was a game you either won or lost. But at Rhino Foods, Inc., a bakery-foods company he founded in Burlington, Vermont, he discovered that manufacturing-line work- ers were not so self-motivated. Ted thought, what if he turned the food- making business into a game, with rules, strategies, and trophies?

Ted knew that in a game knowing the score is all-important. He felt that only if the employees know the score—know exactly how the business is doing daily, weekly, monthly—could he turn food-making into a game. But Rhino is a closely held, family-owned business, and its financial statements

The Navigator✓

Explain the process of closing the

Identify the sections of a classified

143

and profits were confidential. Ted wondered, should he open Rhino’s books to the employees?

A consultant put Ted’s concerns in per- spective when he said, “Imagine you’re playing touch football. You play for an hour or two, and the whole time I’m sit- ting there with a book, keeping score. All of a sudden I blow the whistle, and I say, ‘OK, that’s it. Everybody go home.’ I close my book and walk away. How would you feel?” Ted opened his books and revealed the financial statements to his employees.

The next step was to teach employees the rules and strategies of how to “win” at making food. The first lesson: “Your opponent at Rhino is expenses. You must cut and control expenses.” Ted and his staff distilled those lessons into daily scorecards—production reports and income statements—that keep Rhino’s employees up-to-date on the game. At noon each day, Ted posts the previous day’s results at the entrance to the production room. Everyone checks whether they made or lost money on what they produced the day before. And it’s not just an academic exercise: There’s a bonus check for each employee at the end of every four-week “game” that meets profitability guidelines.

Rhino has flourished since the first game. Employment has increased from 20 to 130 people, while both revenues and profits have grown dramatically.

The Navigator✓

Inside Chapter 4 • Cisco Performs the Virtual Close (p. 155)

• Yale Express Loses Some Transportation Bills (p. 160)

• Big Changes Are Coming to Chinese Balance Sheets (p. 165)

• All About You: Your Personal Balance Sheet (p. 167)

Preview of Chapter 4 At Rhino Foods, Inc., financial statements help employees understand what is happening in the business. In Chapter 3, we prepared financial statements directly from the adjusted trial balance. However, with so many details involved in the end-of-period accounting procedures, it is easy to make errors. One way to minimize errors in the records and to simplify the end-of-period procedures is to use a worksheet.

In this chapter we will explain the role of the worksheet in accounting. We also will study the remaining steps in the accounting cycle, especially the closing process, again using Pioneer Advertising Agency Inc. as an example. Then we will consider correcting entries and classified balance sheets. The content and organiza- tion of Chapter 4 are as follows.

Closing the Books

• Preparing closing entries • Posting closing entries • Preparing a post-closing

trial balance

Using a Worksheet

• Steps in preparation • Preparing financial

statements • Preparing adjusting

entries

Summary of Accounting Cycle

• Reversing entries—An optional step

• Correcting entries—An avoidable step

Classified Balance Sheet

• Current assets • Long-term investments • Property, plant, and

equipment • Intangible assets • Current liabilities • Long-term liabilities • Stockholders’ equity

The Navigator✓

USING A WORKSHEET

Completing the Accounting Cycle

A worksheet is a multiple-column form that companies use in the adjust- ment process and in preparing financial statements. As its name suggests, the worksheet is a working tool. It is not a permanent accounting record;

it is neither a journal nor a part of the general ledger. The worksheet is merely a device used in preparing adjusting entries and the financial statements. Companies generally computerize worksheets using an electronic spreadsheet program such as Excel.

Illustration 4-1 shows the basic form of a worksheet and the five steps for preparing it. Each step is performed in sequence. The use of a worksheet is optional. When a company chooses to use one, it prepares financial statements from the worksheet. It enters the adjustments in the worksheet columns and then journalizes and posts the adjustments after it has prepared the financial state- ments. Thus, worksheets make it possible to provide the financial statements to management and other interested parties at an earlier date.

Steps in Preparing a Worksheet We will use the October 31 trial balance and adjustment data of Pioneer Advertising Inc., from Chapter 3, to illustrate how to prepare a worksheet. We

144

Prepare a worksheet.

S T U D Y O B J E C T I V E 1

describe each step of the process and demonstrate these steps in Illustration 4-2 and transparencies 4-3A, B, C, and D.

STEP 1. PREPARE A TRIAL BALANCE ON THE WORKSHEET Enter all ledger accounts with balances in the account titles space. Enter debit and credit amounts from the ledger in the trial balance columns. Illustration 4-2 shows the worksheet trial balance for Pioneer Advertising Agency Inc.

STEP 2. ENTER THE ADJUSTMENTS IN THE ADJUSTMENTS COLUMNS Turn over the first transparency, Illustration 4-3A. When using a worksheet, enter all adjustments in the adjustments columns. In entering the adjustments, use appli- cable trial balance accounts. If additional accounts are needed, insert them on the lines immediately below the trial balance totals. A different letter identifies the debit and credit for each adjusting entry. The term used to describe this process is keying. Companies do not journalize the adjustments until after they complete the worksheet and prepare the financial statements.

Using a Worksheet 145

Worksheet.xls

File Edit View Insert Format Tools Data Window Help

B C D E F G H I J K

Trial Balance Adjustments Adjusted

Trial Balance Income

Statement Balance Sheet

Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.Account Titles

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25

A

Trial Balance Adjustments Adjusted

Trial Balance Income

Statement Balance Sheet

Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.Account Titles

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22

Worksheet

Extend adjusted balances to appropriate

statement columns

Total the statement columns, compute net income

(or net loss), and complete worksheet

Enter adjustment

data

2 4

5

Prepare a trial balance

on the worksheet

1 Enter

adjusted balances

3

Illustration 4-1 Form and procedure for a worksheet

(Note: Text continues on page 147, following acetate overlays.)

Pioneer Advertising.xls

B C D E F G H I J K

Trial Balance Adjustments Adjusted

Trial Balance Income

Statement Balance

Sheet Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.Account Titles

1 2 3 4 5 6 7 8 9

10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36

A

Cash Advertising Supplies Prepaid Insurance Office Equipment Notes Payable Accounts Payable Unearned Revenue Common Stock Dividends Service Revenue

Salaries Expense Rent Expense Totals

15,200 2,500

600 5,000

500

4,000 900

28,700

5,000 2,500 1,200

10,000

10,000

28,700

Include all accounts with balances from ledger.

Trial balance amounts come directly from ledger accounts.

PIONEER ADVERTISING AGENCY INC. Worksheet

For the Month Ended October 31, 2008

File Edit View Insert Format Tools Data Window Help

Illustration 4-2 Preparing a trial balance

Illustration 4-3A Entering the adjustments in the adjustments columns

Advertising Supplies Expense Insurance Expense Accum. Depreciation—Office Equipment Depreciation Expense

Interest Expense Accounts Receivable

Interest Payable Salaries Payable Totals

400

1,200

1,500 50

40 200 50

3,440

1,500 50

400 200

40

50 1,200 3,440

Add additional accounts as needed to complete the adjustments:

(a) Supplies Used. (b) Insurance Expired. (c) Depreciation Expensed. (d) Service Revenue Earned. (e) Service Revenue Accrued. (f) Interest Accrued. (g) Salaries Accrued.

Enter adjustment amounts in appropriate columns, and use letters to cross- reference the debit and credit adjustments.

Total adjustments columns and check for equality.

(d)

(g)

(a) (b)

(c) ( e ) (f)

(a) (b)

(d) (e)

(c)

( f ) (g)

Illustration 4-3B Entering adjusted balances in the adjusted trial balance columns

15,200 1,000

550 5,000

500

5,200 900

1,500 50

40 200 50

30,190

5,000 2,500

800 10,000

10,600

40

50 1,200

30,190

Combine trial balance amounts with adjustment amounts to obtain the adjusted trial balance.

Total adjusted trial balance columns and check for equality.

Illustration 4-3C Extending the adjusted trial balance amounts to appropriate financial statement columns

5,200 900

1,500 50

40

50

10,600

15,200 1,000

550 5,000

500

200

5,000 2,500

800 10,000

40

50 1,200

Extend all revenue and expense account balances to the income statement columns.

Extend all asset and liability account balances, as well as common stock and dividends account balances, to the balance sheet columns.

Illustration 4-3D Computing net income or net loss and completing the worksheet

7,740

2,860 10,600

10,600

10,600

22,450

22,450

19,590

2,860 22,450

The difference between the totals of the two income statement columns determines net income or net loss.

Net income is extended to the credit column of the balance sheet columns. (Net loss would be extended to the debit column.)

Net Income Totals

Using a Worksheet 147

The adjustments for Pioneer Advertising Agency Inc. are the same as the adjust- ments illustrated on page 110. They are keyed in the adjustments columns of the worksheet as follows.

(a) Pioneer debits an additional account, Advertising Supplies Expense, $1,500 for the cost of supplies used, and credits Advertising Supplies $1,500.

(b) Pioneer debits an additional account, Insurance Expense, $50 for the insurance that has expired, and credits Prepaid Insurance $50.

(c) The company needs two additional depreciation accounts. It debits Depreciation Expense $40 for the month’s depreciation, and credits Accumulated Depreciation—Office Equipment $40.

(d) Pioneer debits Unearned Revenue $400 for services provided, and credits Service Revenue $400.

(e) Pioneer debits an additional account, Accounts Receivable, $200 for services provided but not billed, and credits Service Revenue $200.

(f) The company needs two additional accounts relating to interest. It debits Interest Expense $50 for accrued interest, and credits Interest Payable $50.

(g) Pioneer debits Salaries Expense $1,200 for accrued salaries, and credits an ad- ditional account, Salaries Payable, $1,200.

After Pioneer has entered all the adjustments, the adjustments columns are totaled to prove their equality.

STEP 3. ENTER ADJUSTED BALANCES IN THE ADJUSTED TRIAL BALANCE COLUMNS Turn over the second transparency, Illustration 4-3B. Pioneer determines the ad- justed balance of an account by combining the amounts entered in the first four columns of the worksheet for each account. For example, the Prepaid Insurance account in the trial balance columns has a $600 debit balance and a $50 credit in the adjustments columns. The result is a $550 debit balance recorded in the adjusted trial balance columns. For each account, the amount in the adjusted trial balance columns is the balance that will appear in the ledger after journalizing and posting the adjusting entries. The balances in these columns are the same as those in the adjusted trial balance in Illustration 3-24 (page 112).

After Pioneer has entered all account balances in the adjusted trial balance columns, the columns are totaled to prove their equality. If the column totals do not agree, the financial statement columns will not balance and the financial state- ments will be incorrect.

STEP 4. EXTEND ADJUSTED TRIAL BALANCE AMOUNTS TO APPROPRIATE FINANCIAL STATEMENT COLUMNS Turn over the third transparency, Illustration 4-3C. The fourth step is to extend ad- justed trial balance amounts to the income statement and balance sheet columns of the worksheet. Pioneer enters balance sheet accounts in the appropriate balance sheet debit and credit columns. For instance, it enters Cash in the balance sheet debit column, and Notes Payable in the credit column. Pioneer extends Accumulated Depreciation to the balance sheet credit column; the reason is that accumulated depreciation is a contra-asset account with a credit balance.

Because the worksheet does not have columns for the retained earnings state- ment, Pioneer extends the balances in Common Stock and Retained Earnings, if any, to the balance sheet credit column. In addition, it extends the balance in Dividends to the balance sheet debit column because it is a stockholders’ equity ac- count with a debit balance.

The company enters the expense and revenue accounts such as Salaries Expense and Service Revenue in the appropriate income statement columns. Illustration 4-3C shows all of these extensions.

H E L P F U L H I N T Every adjusted trial balance amount must be extended to one of the four statement columns.

STEP 5. TOTAL THE STATEMENT COLUMNS, COMPUTE THE NET INCOME (OR NET LOSS), AND COMPLETE THE WORKSHEET Turn over the fourth transparency, Illustration 4-3D. The company now must total each of the financial statement columns. The net income or loss for the period is the difference between the totals of the two income statement columns. If total credits exceed total debits, the result is net income. In such a case, as shown in Illustration 4-3D, the company inserts the words “Net Income” in the account titles space. It then enters the amount in the income statement debit column and the balance sheet credit column. The debit amount balances the income statement columns; the credit amount balances the balance sheet columns. In addition, the credit in the balance sheet column indicates the increase in stockholders’ equity resulting from net income.

What if total debits in the income statement columns exceed total credits? In that case, the company has a net loss. It enters the amount of the net loss in the in- come statement credit column and the balance sheet debit column.

After entering the net income or net loss, the company determines new col- umn totals. The totals shown in the debit and credit income statement columns will match. So will the totals shown in the debit and credit balance sheet columns. If either the income statement columns or the balance sheet columns are not equal after the net income or net loss has been entered, there is an error in the worksheet. Illustration 4-3D shows the completed work sheet for Pioneer Advertising Agency Inc.

Preparing Financial Statements from a Worksheet After a company has completed a worksheet, it has at hand all the data required for preparation of financial statements. The income statement is prepared from the income statement columns. The balance sheet and retained earnings statement are prepared from the balance sheet columns. Illustration 4-4 shows the financial state- ments prepared from Pioneer’s worksheet. At this point, the company has not journalized or posted adjusting entries. Therefore, ledger balances for some accounts are not the same as the financial statement amounts.

The amount shown for common stock on the worksheet does not change from the beginning to the end of the period unless the company issues additional stock during the period. Because there was no balance in Pioneer’s retained earnings, the account is not listed on the worksheet. Only after dividends and net income (or loss) are posted to retained earnings does this account have a balance at the end of the first year of the business.

Using a worksheet, companies can prepare financial statements before they journalize and post adjusting entries. However, the completed worksheet is not a substitute for formal financial statements. The format of the data in the financial statement columns of the worksheet is not the same as the format of the financial statements. A worksheet is essentially a working tool of the accountant; companies do not distribute it to management and other parties.

Preparing Adjusting Entries from a Worksheet A worksheet is not a journal, and it cannot be used as a basis for posting to ledger accounts. To adjust the accounts, the company must journalize the adjustments and post them to the ledger. The adjusting entries are prepared from the adjustments columns of the worksheet. The reference letters in the adjustments columns and the explanations of the adjustments at the bottom of the worksheet help identify

148 Chapter 4 Completing the Accounting Cycle

Accounting Cycle Tutorial— Preparing Financial Statements and Closing the Books

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H E L P F U L H I N T Note that writing the explanation to the ad- justment at the bottom of the worksheet is not required.

Using a Worksheet 149

Illustration 4-4 Financial statements from a worksheet

PIONEER ADVERTISING AGENCY INC. Income Statement

For the Month Ended October 31, 2008

Revenues Service revenue $10,600

Expenses Salaries expense $5,200 Advertising supplies expense 1,500 Rent expense 900 Insurance expense 50 Interest expense 50 Depreciation expense 40

Total expenses 7,740

Net income $ 2,860

PIONEER ADVERTISING AGENCY INC. Retained Earnings Statement

For the Month Ended October 31, 2008

Retained earnings, October 1 $ –0– Add: Net income 2,860

2,860 Less: Dividends 500

Retained earnings, October 31 $2,360

PIONEER ADVERTISING AGENCY INC. Balance Sheet

October 31, 2008

Assets Cash $15,200 Accounts receivable 200 Advertising supplies 1,000 Prepaid insurance 550 Office equipment $5,000 Less: Accumulated depreciation 40 4,960

Total assets $21,910

Liabilities and Stockholders’ Equity Liabilities

Notes payable $ 5,000 Accounts payable 2,500 Interest payable 50 Unearned revenue 800 Salaries payable 1,200

Total liabilities 9,550 Stockholders’ equity

Common stock 10,000 Retained earnings 2,360

Total liabilities and stockholders’ equity $21,910

CLOSING THE BOOKS

150 Chapter 4 Completing the Accounting Cycle

At the end of the accounting period, the company makes the accounts ready for the next period. This is called closing the books. In closing the books, the company distinguishes between temporary and permanent accounts.

Temporary accounts relate only to a given accounting period. They include all income statement accounts and the dividends account. The company closes all temporary accounts at the end of the period.

In contrast, permanent accounts relate to one or more future accounting peri- ods. They consist of all balance sheet accounts, including the stockholders’ equity accounts. Permanent accounts are not closed from period to period. Instead, the

REVIEW IT 1. What are the five steps in preparing a worksheet? 2. How is net income or net loss shown in a worksheet? 3. How does a worksheet relate to preparing financial statements and adjusting

entries?

DO IT Susan Elbe is preparing a worksheet. Explain to Susan how she should extend the following adjusted trial balance accounts to the financial statement columns of the worksheet:

Cash Dividends Accumulated Depreciation Service Revenue Accounts Payable Salaries Expense

Action Plan ■ Extend asset balances to the balance sheet debit column. Extend liability bal-

ances to the balance sheet credit column. Extend accumulated depreciation to the balance sheet credit column.

■ Extend the Dividends account to the balance sheet debit column. ■ Extend expenses to the income statement debit column. ■ Extend revenue accounts to the income statement credit column.

Solution Balance sheet debit column—Cash; Dividends Balance sheet credit column—Accumulated Depreciation; Accounts Payable Income statement debit column—Salaries Expense Income statement credit column—Service Revenue

Related exercise material: BE4-1, BE4-2, BE4-3, E4-1, E4-2, E4-5, and E4-6.

Before You Go On...

The Navigator✓

Explain the process of closing the books.

S T U D Y O B J E C T I V E 2

the adjusting entries. The journalizing and posting of adjusting entries follows the preparation of financial statements when a worksheet is used. The adjusting entries on October 31 for Pioneer Advertising Agency Inc. are the same as those shown in Illustration 3-22 (page 110).

A L T E R N A T I V E T E R M I N O L O G Y

Temporary accounts are sometimes called nominal accounts, and permanent accounts are sometimes called real accounts.

Preparing Closing Entries At the end of the accounting period, the company transfers temporary account bal- ances to the permanent stockholders’ equity account, Retained Earnings, by means of closing entries.

Closing entries formally recognize in the ledger the transfer of net income (or net loss) and Dividends to Retained Earnings. The retained earnings statement shows the results of these entries. Closing entries also produce a zero balance in each temporary account. The temporary accounts are then ready to accumulate data in the next accounting period separate from the data of prior periods. Permanent accounts are not closed.

Journalizing and posting closing entries is a required step in the accounting cycle. (See Illustration 4-12 on page 158.) The company performs this step after it has prepared financial statements. In contrast to the steps in the cycle that you have already studied, companies generally journalize and post closing entries only at the end of the annual accounting period. Thus, all temporary accounts will contain data for the entire year.

In preparing closing entries, companies could close each income statement account directly to Retained Earnings. However, to do so would result in exces- sive detail in the Retained Earnings account. Instead, companies close the rev- enue and expense accounts to another temporary account, Income Summary, and they transfer the resulting net income or net loss from this account to Retained Earnings.

Companies record closing entries in the general journal. A center caption, Closing Entries, inserted in the journal between the last adjusting entry and the first closing entry, identifies these entries. Then the company posts the closing en- tries to the ledger accounts.

Companies generally prepare closing entries directly from the adjusted balances in the ledger. They could prepare separate closing entries for each nominal account, but the following four entries accomplish the desired result more efficiently:

1. Debit each revenue account for its balance, and credit Income Summary for to- tal revenues.

Closing the Books 151

PERMANENT These accounts are not closed

TEMPORARY These accounts are closed

Dividends

All expense accounts

All revenue accounts

Stockholders’ equity

All liability accounts

All asset accounts

Illustration 4-5 Temporary versus permanent accounts

H E L P F U L H I N T A contra-asset account, such as accumulated depreciation, is a perma- nent account also.

company carries forward the balances of permanent accounts into the next accounting period. Illustration 4-5 identifies the accounts in each category.

2. Debit Income Summary for total expenses, and credit each expense account for its balance.

3. Debit Income Summary and credit Retained Earnings for the amount of net income.

4. Debit Retained Earnings for the balance in the Dividends account, and credit Dividends for the same amount.

Illustration 4-6 presents a diagram of the closing process. In it, the boxed numbers refer to the four entries required in the closing process.

152 Chapter 4 Completing the Accounting Cycle

Retained Earnings is a permanent account; all other accounts are temporary accounts.

(Individual) Revenues

Income Summary

2 1

(Individual) Expenses

Retained Earnings

3

Dividends

4

Key: Close Revenues to Income Summary. Close Expenses to Income Summary. Close Income Summary to Retained Earnings. Close Dividends to Retained Earnings.

2

4

1

3

Illustration 4-6 Diagram of closing process

H E L P F U L H I N T Dividends is closed directly to Retained Earnings and not to In- come Summary because Dividends is not an expense.

If there were a net loss (because expenses exceeded revenues), entry 3 in Illustration 4-6 would be reversed: there would be a credit to Income Summary and a debit to Retained Earnings.

CLOSING ENTRIES ILLUSTRATED In practice, companies generally prepare closing entries only at the end of the an- nual accounting period. However, to illustrate the journalizing and posting of clos- ing entries, we will assume that Pioneer Advertising Agency Inc. closes its books monthly. Illustration 4-7 shows the closing entries at October 31. (The numbers in parentheses before each entry correspond to the four entries diagrammed in Illustration 4-6.)

Closing the Books 153

GENERAL JOURNAL J3

Date Account Titles and Explanation Ref. Debit Credit

Closing Entries 2008 (1) Oct. 31 Service Revenue 400 10,600

Income Summary 350 10,600 (To close revenue account)

(2)

31 Income Summary 350 7,740 Advertising Supplies Expense 631 1,500 Depreciation Expense 711 40 Insurance Expense 722 50 Salaries Expense 726 5,200 Rent Expense 729 900 Interest Expense 905 50

(To close expense accounts)

(3)

31 Income Summary 350 2,860 Retained Earnings 320 2,860

(To close net income to retained earnings)

(4)

31 Retained Earnings 320 500 Dividends 332 500

(To close dividends to capital)

Illustration 4-7 Closing entries journalized

Note that the amounts for Income Summary in entries (1) and (2) are the totals of the income statement credit and debit columns, respectively, in the worksheet.

A couple of cautions in preparing closing entries: (1) Avoid unintentionally doubling the revenue and expense balances rather than zeroing them. (2) Do not close Dividends through the Income Summary account. Dividends are not an expense, and they are not a factor in determining net income.

Posting Closing Entries Illustration 4-8 shows the posting of the closing entries and the ruling of the ac- counts. Note that all temporary accounts have zero balances after posting the clos- ing entries. In addition, you should realize that the balance in Retained Earnings represents the accumulated undistributed earnings of the corporation at the end of the accounting period. This balance is shown on the balance sheet and is the ending amount reported on the retained earnings statement, as shown in Illustration 4-4.

4,000 1,200

Salaries Expense

5,200

5,200

5,200

(2)

726

900

Rent Expense

900(2)

729

50

Insurance Expense

50(2)

722

40

Depreciation Expense

40(2)

711

50

Interest Expense

50(2)

905

1,500

Advertising Supplies Expense

1,500(2)

631

500

Retained Earnings

2,860

Bal. 2,360

(3)

320

(4)

10,600

Service Revenue

10,600

10,000 400 200

10,600

400

(1)

500

Dividends

500(4)

332

7,740 2,860

Income Summary

10,600

10,600

10,600

(1)

350

(2) (3)

2

2

3

4

1

Illustration 4-8 Posting of closing entries

The Income Summary account is used only in closing. Companies do not journal- ize and post entries to this account during the year.

As part of the closing process, companies total, balance, and double-rule the temporary accounts—revenues, expenses, and Dividends—in T-account form, as shown in Illustration 4-8. The permanent accounts—assets, liabilities, and stock- holders’ equity (Common Stock and Retained Earnings)—are not closed. A single rule is drawn beneath the current-period entries, and the account balance carried forward to the next period is entered below the single rule. (For example, see Retained Earnings.)

154 Chapter 4 Completing the Accounting Cycle

H E L P F U L H I N T The balance in Income Summary before it is closed must equal the net income or net loss for the period.

Closing the Books 155

PIONEER ADVERTISING AGENCY INC. Post-Closing Trial Balance

October 31, 2008

Debit Credit Cash $15,200 Accounts Receivable 200 Advertising Supplies 1,000 Prepaid Insurance 550 Office Equipment 5,000 Accumulated Depreciation—Office Equipment $ 40 Notes Payable 5,000 Accounts Payable 2,500 Unearned Revenue 800 Salaries Payable 1,200 Interest Payable 50 Common Stock 10,000 Retained Earnings 2,360

$21,950 $21,950

Illustration 4-9 Post-closing trial balance

Preparing a Post-Closing Trial Balance After Pioneer has journalized and posted all closing entries, it prepares another trial balance, called a post-closing trial balance, from the ledger. The post-closing trial balance lists permanent accounts and their balances after journalizing and posting of closing entries. The purpose of the post- closing trial balance is to prove the equality of the permanent account bal- ances carried forward into the next accounting period. Since all temporary accounts will have zero balances, the post-closing trial balance will contain only permanent—balance sheet—accounts.

Illustration 4-9 shows the post-closing trial balance for Pioneer Advertising Agency Inc.

Describe the content and purpose of a post-closing trial balance.

S T U D Y O B J E C T I V E 3

ACCOUNTING ACROSS THE ORGANIZATION Cisco Performs the Virtual Close

Technology has dramatically shortened the closing process. Recent surveys have reported that the average company now takes only six to seven days to close,

rather than 20 days. But a few companies do much better. Cisco Systems can perform a “virtual close”—closing within 24 hours on any day in the quarter. The same is true at Lockheed Martin Corp., which improved its closing time by 85% in just the last few years. Not very long ago it took 14 to 16 days. Managers at these companies emphasize that this in- creased speed has not reduced the accuracy and completeness of the data.

This is not just showing off. Knowing exactly where you are financially all of the time allows the company to respond faster than competitors. It also means that the hundreds of people who used to spend 10 to 20 days a quarter tracking transactions can now be more usefully employed on things such as mining data for business intelligence to find new business opportunities.

Source: “Reporting Practices: Few Do It All,” Financial Executive, November 2003, p. 11.

Who else benefits from a shorter closing process?

Pioneer prepares the post-closing trial balance from the permanent accounts in the ledger. Illustration 4-10 shows the permanent accounts in Pioneer’s general ledger.

A post-closing trial balance provides evidence that the company has properly journalized and posted the closing entries. It also shows that the accounting equa- tion is in balance at the end of the accounting period. However, like the trial bal- ance, it does not prove that Pioneer has recorded all transactions or that the ledger is correct. For example, the post-closing trial balance will balance if a transaction is not journalized and posted or if a transaction is journalized and posted twice.

156 Chapter 4 Completing the Accounting Cycle

Illustration 4-10 General ledger, permanent accounts (Permanent Accounts Only)

GENERAL LEDGER

Cash No. 101 Date Explanation Ref. Debit Credit Balance

2008 Oct. 1 J1 10,000 10,000

2 J1 1,200 11,200 3 J1 900 10,300 4 J1 600 9,700

20 J1 500 9,200 26 J1 4,000 5,200 31 J1 10,000 15,200

Accounts Receivable No. 112 Date Explanation Ref. Debit Credit Balance

2008 Oct. 31 Adj. entry J2 200 200

Advertising Supplies No. 126 Date Explanation Ref. Debit Credit Balance

2008 Oct. 5 J1 2,500 2,500

31 Adj. entry J2 1,500 1,000

Prepaid Insurance No. 130 Date Explanation Ref. Debit Credit Balance

2008 Oct. 4 J1 600 600

31 Adj. entry J2 50 550

Office Equipment No. 157 Date Explanation Ref. Debit Credit Balance

2008 Oct. 1 J1 5,000 5,000

Accumulated Depreciation—Office Equipment No. 158 Date Explanation Ref. Debit Credit Balance

2008 Oct. 31 Adj. entry J2 40 40

Notes Payable No. 200 Date Explanation Ref. Debit Credit Balance

2008 Oct. 1 J1 5,000 5,000

Accounts Payable No. 201 Date Explanation Ref. Debit Credit Balance

2008 Oct. 5 J1 2,500 2,500

Unearned Revenue No. 209 Date Explanation Ref. Debit Credit Balance

2008 Oct. 2 J1 1,200 1,200

31 Adj. entry J2 400 800

Salaries Payable No. 212 Date Explanation Ref. Debit Credit Balance

2008 Oct. 31 Adj. entry J2 1,200 1,200

Interest Payable No. 230 Date Explanation Ref. Debit Credit Balance

2008 Oct. 31 Adj. entry J2 50 50

Common Stock No. 311 Date Explanation Ref. Debit Credit Balance

2008 Oct. 1 J1 10,000 10,000

Retained Earnings No. 320 Date Explanation Ref. Debit Credit Balance

2008 Oct. 1 –0–

31 Closing entry J3 2,860 2,860 31 Closing entry J3 500 2,360

Note: The permanent accounts for Pioneer Advertising Agency Inc. are shown here; the temporary accounts are shown in Illus- tration 4-11. Both permanent and temporary accounts are part of the general ledger; we segregate them here to aid in learning.

The remaining accounts in the general ledger are temporary accounts, shown in Illustration 4-11. After Pioneer correctly posts the closing entries, each temporary account has a zero balance. These accounts are double-ruled to finalize the closing process.

Summary of the Accounting Cycle 157

Illustration 4-11 General ledger, temporary accounts

SUMMARY OF THE ACCOUNTING CYCLE Illustration 4-12 (page 158) summarizes the steps in the accounting cycle. You can see that the cycle begins with the analysis of business transactions and ends with the preparation of a post-closing trial balance. Companies perform the steps in the cycle in sequence and repeat these steps in each accounting period.

Steps 1–3 may occur daily during the accounting period, as explained in Chapter 2. Companies perform Steps 4–7 on a periodic basis, such as monthly, quarterly, or annually. Steps 8 and 9—closing entries, and a post-closing trial balance—usually take place only at the end of a company’s annual accounting period.

State the required steps in the accounting cycle.

S T U D Y O B J E C T I V E 4

(Temporary Accounts Only)

GENERAL LEDGER

Dividends No. 332 Date Explanation Ref. Debit Credit Balance

2008 Oct. 20 J1 500 500

31 Closing entry J3 500 –0–

Income Summary No. 350 Date Explanation Ref. Debit Credit Balance

2008 Oct. 31 Closing entry J3 10,600 10,600

31 Closing entry J3 7,740 2,860 31 Closing entry J3 2,860 –0–

Service Revenue No. 400 Date Explanation Ref. Debit Credit Balance

2008 Oct. 31 J1 10,000 10,000

31 Adj. entry J2 400 10,400 31 Adj. entry J2 200 10,600 31 Closing entry J3 10,600 –0–

Advertising Supplies Expense No. 631 Date Explanation Ref. Debit Credit Balance

2008 Oct. 31 Adj. entry J2 1,500 1,500

31 Closing entry J3 1,500 –0–

Depreciation Expense No. 711 Date Explanation Ref. Debit Credit Balance

2008 Oct. 31 Adj. entry J2 40 40

31 Closing entry J3 40 –0–

Insurance Expense No. 722 Date Explanation Ref. Debit Credit Balance

2008 Oct. 31 Adj. entry J2 50 50

31 Closing entry J3 50 –0–

Salaries Expense No. 726 Date Explanation Ref. Debit Credit Balance

2008 Oct. 26 J1 4,000 4,000

31 Adj. entry J2 1,200 5,200 31 Closing entry J3 5,200 –0–

Rent Expense No. 729 Date Explanation Ref. Debit Credit Balance

2008 Oct. 3 J1 900 900

31 Closing entry J3 900 –0–

Interest Expense No. 905 Date Explanation Ref. Debit Credit Balance

2008 Oct. 31 Adj. entry J2 50 50

31 Closing entry J3 50 –0–

Note: The temporary accounts for Pioneer Advertising Agency Inc. are shown here; Illustration 4-10 shows the permanent accounts. Both permanent and temporary accounts are part of the general ledger; we segregate them here to aid in learning.

There are also two optional steps in the accounting cycle. As you have seen, companies may use a worksheet in preparing adjusting entries and financial state- ments. In addition, they may use reversing entries, as explained below.

Reversing Entries—An Optional Step Some accountants prefer to reverse certain adjusting entries by making a reversing entry at the beginning of the next accounting period. A reversing entry is the exact opposite of the adjusting entry made in the previous period. Use of reversing entries is an optional bookkeeping procedure; it is not a required step in the accounting cycle. Accordingly, we have chosen to cover this topic in an appendix at the end of the chapter.

Correcting Entries—An Avoidable Step Unfortunately, errors may occur in the recording process. Companies should correct errors, as soon as they discover them, by journalizing and posting correcting entries. If the accounting records are free of errors, no correcting entries are needed.

158 Chapter 4 Completing the Accounting Cycle

7

Prepare financial statements:

Income statement Retained earnings statement

Balance sheet

5

Journalize and post adjusting entries:

Prepayments/Accruals 6

Prepare an adjusted trial balance

Optional steps: If a worksheet is prepared, steps 4, 5, and 6 are incorporated in the worksheet. If reversing entries are prepared, they occur between steps 9 and 1 as discussed below.

4

Prepare a trial balance

3

Post to ledger accounts

2

Journalize the transactions

1

Analyze business transactions

9

Prepare a post-closing trial balance

8

Journalize and post closing entries

Illustration 4-12 Steps in the accounting cycle

Explain the approaches to preparing correcting entries.

S T U D Y O B J E C T I V E 5

You should recognize several differences between correcting entries and adjusting entries. First, adjusting entries are an integral part of the ac- counting cycle. Correcting entries, on the other hand, are unnecessary if the records are error-free. Second, companies journalize and post adjust- ments only at the end of an accounting period. In contrast, companies make correcting entries whenever they discover an error. Finally, adjusting entries always affect at least one balance sheet account and one income statement account. In contrast, correcting entries may involve any combi- nation of accounts in need of correction. Correcting entries must be posted before closing entries.

To determine the correcting entry, it is useful to compare the incorrect entry with the correct entry. Doing so helps identify the accounts and amounts that should—and should not—be corrected. After comparison, the accountant makes an entry to correct the accounts. The following two cases for Mercato Co. illustrate this approach.

CASE 1 On May 10, Mercato Co. journalized and posted a $50 cash collection on account from a customer as a debit to Cash $50 and a credit to Service Revenue $50. The company discovered the error on May 20, when the customer paid the remaining balance in full.

Summary of the Accounting Cycle 159

E T H I C S N O T E

When companies find errors in previously released in-

come statements, they restate those numbers. Perhaps because of the increased scrutiny caused by Sarbanes-Oxley, in 2005 companies filed a record 1,195 restatements.

Illustration 4-13 Comparison of entries

Illustration 4-14 Correcting entry

Illustration 4-15 Comparison of entries

CASE 2 On May 18, Mercato purchased on account office equipment costing $450. The transaction was journalized and posted as a debit to Delivery Equipment $45 and a credit to Accounts Payable $45. The error was discovered on June 3, when Mercato received the monthly statement for May from the creditor.

Comparison of the incorrect entry with the correct entry reveals that the debit to Cash $50 is correct. However, the $50 credit to Service Revenue should have been credited to Accounts Receivable. As a result, both Service Revenue and Accounts Receivable are overstated in the ledger. Mercato makes the following correcting entry.

A � L � SE �50 Rev

�50

Cash Flows no effect

Incorrect Entry (May 10) Correct Entry (May 10)

Cash 50 Cash 50 Service Revenue 50 Accounts Receivable 50

Correcting Entry

May 20 Service Revenue 50 Accounts Receivable 50

(To correct entry of May 10)

Incorrect Entry (May 18) Correct Entry (May 18)

Delivery Equipment 45 Office Equipment 450 Accounts Payable 45 Accounts Payable 450

Instead of preparing a correcting entry, it is possible to reverse the incorrect en- try and then prepare the correct entry. This approach will result in more entries and postings than a correcting entry, but it will accomplish the desired result.

160 Chapter 4 Completing the Accounting Cycle

Illustration 4-16 Correcting entry

Cash Flows no effect

A � L � SE �450 �45

�405

Comparison of the two entries shows that three accounts are incorrect. Delivery Equipment is overstated $45; Office Equipment is understated $450; and Accounts Payable is understated $405. Mercato makes the following correcting entry.

ACCOUNTING ACROSS THE ORGANIZATION Yale Express Loses Some Transportation Bills

Yale Express, a short-haul trucking firm, turned over much of its cargo to local truckers to complete deliveries. Yale collected the entire delivery charge;

when billed by the local trucker, Yale sent payment for the final phase to the local trucker. Yale used a cutoff period of 20 days into the next accounting period in making its adjust- ing entries for accrued liabilities. That is, it waited 20 days to receive the local truckers’ bills to determine the amount of the unpaid but incurred delivery charges as of the balance sheet date.

On the other hand, Republic Carloading, a nationwide, long-distance freight forwarder, frequently did not receive transportation bills from truckers to whom it passed on cargo until months after the year-end. In making its year-end adjusting entries, Republic waited for months in order to include all of these outstanding transportation bills.

When Yale Express merged with Republic Carloading, Yale’s vice president employed the 20-day cutoff procedure for both firms. As a result, millions of dollars of Republic’s accrued transportation bills went unrecorded. When the company detected the error and made cor- recting entries, these and other errors changed a reported profit of $1.14 million into a loss of $1.88 million!

What might Yale Express’s vice president have done to produce more accurate financial statements without waiting months for Republic’s outstanding transportation bills?

REVIEW IT 1. How do permanent accounts differ from temporary accounts? 2. What four different types of entries do companies make in closing the books? 3. What are the content and purpose of a post-closing trial balance? 4. What are the required and optional steps in the accounting cycle?

Before You Go On...

Correcting Entry

June 3 Office Equipment 450 Delivery Equipment 45 Accounts Payable 405

(To correct entry of May 18)

The balance sheet presents a snapshot of a company’s financial position at a point in time. To improve users’ understanding of a company’s financial position, companies often group similar assets and similar liabilities to- gether. This is useful because it tells you that items within a group have similar economic characteristics. A classified balance sheet generally contains the standard classifications listed in Illustration 4-17.

The Classified Balance Sheet 161

DO IT The worksheet for Hancock Company shows the following in the financial state- ment columns:

Dividends $15,000 Common Stock $42,000 Net income $18,000

Prepare the closing entries at December 31 that affect owner’s capital.

Action Plan ■ Remember to make closing entries in the correct sequence. ■ Make the first two entries to close revenues and expenses. ■ Make the third entry to close net income to retained earnings. ■ Make the final entry to close dividends to retained earnings.

Solution Dec. 31 Income Summary 18,000

Retained Earnings 18,000 (To close net income to retained earnings)

31 Retained Earnings 15,000 Dividends 15,000

(To close dividends to retained earnings)

Related exercise material: BE4-4, BE4-5, BE4-6, BE4-7, BE4-8, E4-4, E4-7, E4-8, E4-10, and E4-11.

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THE CLASSIFIED BALANCE SHEET

Identify the sections of a classified balance sheet.

S T U D Y O B J E C T I V E 6

Illustration 4-17 Standard balance sheet classifications

Assets Liabilities and Owner’s Equity Current assets Current liabilities Long-term investments Long-term liabilities Property, plant, and equipment Stockholders’ equity Intangible assets

These groupings help readers determine such things as (1) whether the com- pany has enough assets to pay its debts as they come due, and (2) the claims of short- and long-term creditors on the company’s total assets. Many of these group- ings can be seen in the balance sheet of Franklin Corporation shown in Illustration 4-18 (page 162). In the sections that follow, we explain each of these groupings.

Current Assets Current assets are assets that a company expects to convert to cash or use up within one year. In Illustration 4-18, Franklin Corporation had current assets of $22,100. For most businesses the cutoff for classification as current assets is one year from the balance sheet date. For example, accounts receivable are current assets because the company will collect them and convert them to cash within one year. Supplies is a current asset because the company expects to use it up in oper- ations within one year.

162 Chapter 4 Completing the Accounting Cycle

FRANKLIN CORPORATION Balance Sheet

October 31, 2008

Assets Current assets

Cash $ 6,600 Short-term investments 2,000 Accounts receivable 7,000 Notes receivable 1,000 Inventories 3,000 Supplies 2,100 Prepaid insurance 400

Total current assets $22,100

Long-term investments Investment in stock of Walters Corp. 5,200 Investment in real estate 2,000 7,200

Property, plant, and equipment Land 10,000 Office equipment $24,000 Less: Accumulated depreciation 5,000 19,000 29,000

Intangible assets Patents 3,100

Total assets $61,400

Liabilities and Stockholders’ Equity

Current liabilities Notes payable $11,000 Accounts payable 2,100 Salaries payable 1,600 Unearned revenue 900 Interest payable 450

Total current liabilities $16,050

Long-term liabilities Mortgage note payable 10,000 Notes payable 1,300

Total long-term liabilities 11,300

Total liabilities 27,350

Stockholders’ equity Common stock 20,000 Retained earnings 14,050

Total stockholders’ equity 34,050

Total liabilities and stockholders’ equity $61,400

Illustration 4-18 Classified balance sheet

H E L P F U L H I N T

Recall that the accounting equation is Assets � Lia- bilities � Stockholders’ Equity.

Some companies use a period longer than one year to classify assets and liabil- ities as current because they have an operating cycle longer than one year. The operating cycle of a company is the average time that it takes to purchase inven- tory, sell it on account, and then collect cash from customers. For most businesses this cycle takes less than a year, so they use a one-year cutoff. But, for some busi- nesses, such as vineyards or airplane manufacturers, this period may be longer than a year. Except where noted, we will assume that companies use one year to deter- mine whether an asset or liability is current or long-term.

Common types of current assets are (1) cash, (2) short-term investments (such as short-term U.S. government securities), (3) receivables (notes receivable, ac- counts receivable, and interest receivable), (4) inventories, and (5) prepaid ex- penses (insurance and supplies). On the balance sheet, companies usually list these items in the order in which they expect to convert them into cash.

Illustration 4-19 presents the current assets of The Coca-Cola Company.

The Classified Balance Sheet 163

THE COCA-COLA COMPANY Balance Sheet (partial)

(in millions)

Current assets Cash and cash equivalents $ 6,707 Short-term investments 61 Trade accounts receivable 2,171 Inventories 1,420 Prepaid expenses and other assets 1,735

Total current assets $12,094

As explained later in the chapter, a company’s current assets are important in assessing its short-term debt-paying ability.

Long-Term Investments Long-term investments are generally investments in stocks and bonds of other companies that are normally held for many years. This category also includes investments in long-term assets such as land or buildings that a company is not currently using in its operating activities. In Illustration 4-18 Franklin Corporation reported total long-term investments of $7,200 on its balance sheet.

Yahoo! Inc. reported long-term investments in its balance sheet as shown in Illustration 4-20.

A L T E R N A T I V E T E R M I N O L O G Y

Long-term investments are often referred to simply as investments.

Illustration 4-19 Current assets section

YAHOO! INC. Balance Sheet (partial)

(in thousands)

Long-term investments Long-term marketable debt securities $1,042,575

Illustration 4-20 Long-term investments section

Property, Plant, and Equipment Property, plant, and equipment are assets with relatively long useful lives that a company is currently using in operating the business. This category includes land, buildings, machinery and equipment, delivery equipment, and furniture. In Illustration 4-18 Franklin Corporation reported property, plant, and equipment of $29,000.

Depreciation is the practice of allocating the cost of assets to a number of years. Companies do this by systematically assigning a portion of an asset’s cost as an expense each year (rather than expensing the full purchase price in the year of purchase). The assets that the company depreciates are reported on the balance sheet at cost less accumulated depreciation. The accumulated depreciation account shows the total amount of depreciation that the company has expensed thus far in the asset’s life. In Illustration 4-18 Franklin Corporation reported accumulated de- preciation of $5,000.

Illustration 4-21 presents the property, plant, and equipment of ski and sport- ing goods manufacturer K2, Inc.

164 Chapter 4 Completing the Accounting Cycle

K2, INC. Balance Sheet (partial)

(in thousands)

Property, plant, and equipment Land and land improvements $ 6,794 Buildings and leasehold improvements 55,900 Machinery and equipment 204,651 Construction in process 5,614 $272,959

Less: Accumulated depreciation 131,995

$140,964

Illustration 4-21 Property, plant, and equipment section

TIME WARNER, INC. Balance Sheet (partial)

(in millions)

Intangible assets Film library $ 3,361 Customer lists 868 Cable television franchises 29,751 Sports franchises 262 Brands, trademarks, and other intangible assets 9,643

$43,885

Illustration 4-22 Intangible assets section

Intangible Assets Many companies have assets that do not have physical substance yet often are very valuable. We call these assets intangible assets. One common intangible asset is goodwill. Other intangibles include patents, copyrights, and trademarks or trade names that give the company exclusive right of use for a specified period of time. Franklin Corporation reported intangible assets of $3,100.

Illustration 4-22 shows how media giant Time Warner, Inc. reported its intangi- ble assets.

A L T E R N A T I V E T E R M I N O L O G Y

Property, plant, and equip- ment is sometimes called fixed assets.

H E L P F U L H I N T

Sometimes intangible assets are reported un- der a broader heading called “Other assets.”

Current Liabilities In the liabilities and stockholders’ equity section of the balance sheet, the first grouping is current liabilities. Current liabilities are obligations that the company is to pay within the coming year. Common examples are accounts payable, wages payable, bank loans payable, interest payable, and taxes payable. Also included as current liabilities are current maturities of long-term obligations—payments to be made within the next year on long-term obligations. In Illustration 4-18 Franklin Corporation reported five different types of current liabilities, for a total of $16,050.

Within the current liabilities section, companies usually list notes payable first, followed by accounts payable. Other items then follow in the order of their magni- tude. In your homework, you should present notes payable first, followed by ac- counts payable, and then other liabilities in order of magnitude.

Illustration 4-23 shows the current liabilities section adapted from the balance sheet of Marcus Corporation.

The Classified Balance Sheet 165

Big Changes Are Coming to Chinese Balance Sheets

Beginning in 2007 many Chinese companies will be following International Financial Reporting Standards to prepare financial statements. Many people say that the largest change will occur on Chinese balance sheets. The new standards will require the companies to report a market value for many assets, including things like plant and equip- ment. (This, of course, is not in accordance with the cost principle, which U.S. GAAP follows.)

Chinese authorities hope that adopting international standards will give investors more confidence in the validity of Chinese financial reports.

Source: James T. Areddy, “Adding Up Chinese Data”, Wall Street Journal, February 27, 2006, p. C10.

I N T E R N A T I O N A L I N S I G H T

What are the potential benefits and challenges presented by reporting assets like plant and equipment at their market value rather than historical cost?

MARCUS CORPORATION Balance Sheet (partial)

(in thousands)

Current liabilities Notes payable $ 2,066 Accounts payable 17,516 Current maturities of long-term debt 26,321 Taxes payable 14,889 Other current liabilities 14,809 Accrued compensation payable 8,614

Total current liabilities $84,215

Illustration 4-23 Current liabilities section

Users of financial statements look closely at the relationship between current as- sets and current liabilities. This relationship is important in evaluating a company’s

liquidity—its ability to pay obligations expected to be due within the next year. When current assets exceed current liabilities at the balance sheet date, the likeli- hood for paying the liabilities is favorable. When the reverse is true, short-term cred- itors may not be paid, and the company may ultimately be forced into bankruptcy.

Long-Term Liabilities Long-term liabilities are obligations that a company expects to pay after one year. Liabilities in this category include bonds payable, mortgages payable, long-term notes payable, lease liabilities, and pension liabilities. Many companies report long- term debt maturing after one year as a single amount in the balance sheet and show the details of the debt in notes that accompany the financial statements. Others list the various types of long-term liabilities. In Illustration 4-18 Franklin Corporation reported long-term liabilities of $11,300. In your homework, list long-term liabilities in the order of their magnitude.

Illustration 4-24 shows the long-term liabilities that Northwest Airlines Corporation reported in its balance sheet.

166 Chapter 4 Completing the Accounting Cycle

S.S. Ongoing

Liquidity

S.S. Bankruptcy

Illiquidity

NORTHWEST AIRLINES CORPORATION Balance Sheet (partial)

(in millions)

Long-term liabilities Long-term debt $ 7,715 Other liabilities 4,346 Long-term obligations under capital leases 308

Total long-term liabilities $12,369

Illustration 4-24 Long-term liabilities section

NORDSTROM, INC. Balance Sheet (partial)

($ in thousands)

Stockholders’ equity Common stock, 271,331 shares $ 685,934 Retained earnings 1,406,747

Total stockholders’ equity $2,092,681

Illustration 4-25 Stockholders’ equity section

Stockholders’ (Owners’) Equity The content of the owners’ equity section varies with the form of business organi- zation. In a proprietorship, there is one capital account. In a partnership, there is a capital account for each partner. Corporations divide owners’ equity into two accounts—Common Stock and Retained Earnings. Corporations record stock- holders’ investments in the company by debiting an asset account and crediting the Common Stock account. They record in the Retained Earnings account income re- tained for use in the business. Corporations combine the Common Stock and Retained Earnings accounts and report them on the balance sheet as stockholders’ equity. (We’ll learn more about these corporation accounts in later chapters.) Nordstrom, Inc. recently reported its stockholders’ equity section as follows.

Be sure to read ALL ABOUT YOU: Your Personal Balance Sheet on the next page for information on how topics in this chapter apply to you.*

all about Y U*all about Y U* Your Personal Balance Sheet

*

Some Facts*

About the Numbers*

* 48% of Americans think they know how much wealth they have.

* 2005 was the first year since the Depression when Americans spent more money than they made.

* The total net worth of U.S. households hit a record of $51.09 trillion during 2005.

* Economists note that a rise in house prices actually results in a fall in individual savings. It has been documented that a $1,000 rise in the value of a home results in a $50 fall in savings per year, presumably because homeowners feel more wealthy and therefore spend more (save less).

* When asked about very important wealth-building strategies for all Americans, 16% said “win the lottery.”

Your ability to make good financial decisions is often influenced by your attitudes toward saving versus spending. The authors of a recent study conclude that “people commonly fall prey to psychologically driven impulses that affect their financial de- cisions.” For example, when individuals were asked whether could they save 20% of their household income, nearly half said they couldn’t. But, when asked if they could spend less, well more than half (71%) said they could live comfortably on 80% of their income. This clearly is inconsistent thinking: If you can live on 80% of your current income, you can save 20% of your current income.

The authors’ comments on this situation appear on page 193.

BBy now you should be pretty comfortable with how toprepare a company’s balance sheet. Maybe it is time for us to look at your personal financial position.

What are your personal assets? These are the items of value that you own. Some of your assets are liquid —cash or items that are easily converted to cash. Others, like cars, real estate, and some types of investments, are less liquid. Some assets, like houses and investments, tend to rise in value over time, which increases your net worth. Other assets, such as cars, tend to fall in value over time, decreasing your net worth.

What are your personal liabilities—the amounts that you owe to others? Student loans, car loans, credit card bills, and amounts owed to relatives are all personal liabilities. These liabilities are either current (to be repaid within 12 months) or long-term.

The difference between your assets and liabilities is, to use the terminology of the accounting equation, your “owner’s equity.” In personal finance terminology, this is your net worth. Having a high net worth does not guarantee happiness—but most believe that it is better than being broke. By monitoring your personal balance sheet, you can begin to take control of your financial future. Source: Northwestern Mutual Life, www.nmfn.com/contentassets/pdfs/fin_misbehav.pdf, p. 6.

What Do You Think?* Should you prepare a personal balance sheet?

YES: In order to attain your desired financial objectives, you need to set goals early. The personal balance sheet provides a benchmark by which you can measure progress toward your financial goals. You need to do it now so that you begin to develop good financial habits. It provides a mechanism so that you don’t allow your finances to get too “out-of-whack” while you are in school. That is, you don’t want to dig too deep a hole.

NO: Your financial situation right now bears very little resemblance to what it will look like after you graduate. At that point, you will have a better job, and you won’t have to pay tuition. Right now, you’re just “bleeding cash.”

Sources: Andrew Blackman, “How to Calculate Your Savings Rate; For Americans in 2005, Earnings Didn’t Keep Pace with Boom in Spending,” Wall Street Journal, January 3, 2006, p. D2; “Financial Planners Share Views on Saving,” Consumer Federation of America and Financial Planning Association, January 2006.

“How much could you save?”

Nearly half could not comfortably save 20% of household's annual income at

this point in life.

71% said they could comfortably live on 80% of household's annual income at

this point in life.

BUT

Could not save 20%

Could save 20%

Could live on 80%

Could not live on 80%

167

168 Chapter 4 Completing the Accounting Cycle

REVIEW IT 1. What are the major sections in a classified balance sheet? 2. Using the PepsiCo annual report, determine its current liabilities at

December 31, 2005, and December 25, 2004. Were current liabilities higher or lower than current assets in these two years? The answer to this question appears on page 193.

Before You Go On...

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Demonstration Problem

At the end of its first month of operations, Watson Answering Service Inc. has the following unadjusted trial balance.

WATSON ANSWERING SERVICE INC. August 31, 2008

Trial Balance

Debit Credit

Cash $ 5,400 Accounts Receivable 2,800 Prepaid Insurance 2,400 Supplies 1,300 Equipment 60,000 Notes Payable $40,000 Accounts Payable 2,400 Common Stock 30,000 Dividends 1,000 Service Revenue 4,900 Salaries Expense 3,200 Utilities Expense 800 Advertising Expense 400

$77,300 $77,300

Other data:

1. Insurance expires at the rate of $200 per month. 2. $1,000 of supplies are on hand at August 31. 3. Monthly depreciation on the equipment is $900. 4. Interest of $500 on the notes payable has accrued during August.

Instructions (a) Prepare a worksheet. (b) Prepare a classified balance sheet assuming $35,000 of the notes payable are

long-term. (c) Journalize the closing entries.

action plan ✔ In completing the worksheet, be sure to (a) key the adjustments; (b) start at the top of the adjusted trial balance columns and extend adjusted balances to the correct statement columns; and (c) enter net income (or net loss) in the proper columns.

✔ In preparing a classified balance sheet, know the contents of each of the sections.

✔ In journalizing closing entries, remember that there are only four entries and that Dividends are closed to Retained Earnings.

Demonstration Problem 169

Solution

(a) WATSON ANSWERING SERVICE INC. Worksheet

For the Month Ended August 31, 2008

Adjusted Trial Income Trial Balance Adjustments Balance Statement Balance Sheet

Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.

Cash 5,400 5,400 5,400 Accounts Receivable 2,800 2,800 2,800 Supplies 1,300 (b) 300 1,000 1,000 Prepaid Insurance 2,400 (a) 200 2,200 2,200 Equipment 60,000 60,000 60,000 Notes Payable 40,000 40,000 40,000 Accounts Payable 2,400 2,400 2,400 Common Stock 30,000 30,000 30,000 Dividends 1,000 1,000 1,000 Service Revenue 4,900 4,900 4,900 Salaries Expense 3,200 3,200 3,200 Utilities Expense 800 800 800 Advertising Expense 400 400 400

Totals 77,300 77,300

Insurance Expense (a) 200 200 200 Supplies Expense (b) 300 300 300 Depreciation Expense (c) 900 900 900 Accumulated Depreciation—

Equipment (c) 900 900 900 Interest Expense (d) 500 500 500 Interest Payable (d) 500 500 500

Totals 1,900 1,900 78,700 78,700 6,300 4,900 72,400 73,800

Net Loss 1,400 1,400

Totals 6,300 6,300 73,800 73,800

(b) WATSON ANSWERING SERVICE INC. Balance Sheet

August 31, 2008

Assets

Current assets Cash $ 5,400 Accounts receivable 2,800 Supplies 1,000 Prepaid insurance 2,200

Total current assets $11,400 Property, plant, and equipment

Equipment 60,000 Less: Accumulated depreciation—equipment 900 59,100

Total assets $70,500

Explanation: (a) Insurance expired, (b) Supplies used, (c) Depreciation expensed, (d) Interest accrued.

170 Chapter 4 Completing the Accounting Cycle

Liabilities and Stockholders’ Equity

Current liabilities Notes payable $ 5,000 Accounts payable 2,400 Interest payable 500

Total current liabilities $7,900 Long-term liabilities

Notes payable 35,000

Total liabilities 42,900 Stockholders’ equity

Common stock 30,000 Retained earnings (2,400)*

Total stockholders’ equity 27,600

Total liabilities and stockholders’ equity $70,500

*Net loss of $1,400 plus dividends of $1,000.

Aug. 31 Service Revenue 4,900 Income Summary 4,900

(To close revenue account)

31 Income Summary 6,300 Salaries Expense 3,200 Depreciation Expense 900 Utilities Expense 800 Interest Expense 500 Advertising Expense 400 Supplies Expense 300 Insurance Expense 200

(To close expense accounts)

31 Retained Earnings 1,400 Income Summary 1,400

(To close net loss to retained earnings)

31 Retained Earnings 1,000 Dividends 1,000

(To close dividends to retained earnings)

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SUMMARY OF STUDY OBJECTIVES 1 Prepare a worksheet. The steps in preparing a worksheet

are: (a) Prepare a trial balance on the worksheet. (b) Enter the adjustments in the adjustments columns. (c) Enter adjusted balances in the adjusted trial balance columns. (d) Extend adjusted trial balance amounts to appropriate financial statement columns. (e) Total the statement columns, compute net income (or net loss), and complete the work- sheet.

2 Explain the process of closing the books. Closing the books occurs at the end of an accounting period. The process is to journalize and post closing entries and then rule and balance all accounts. In closing the books, companies make separate entries to close revenues and expenses to Income Summary, Income Summary to Retained Earnings, and Dividends to Retained Earnings. Only temporary accounts are closed.

3 Describe the content and purpose of a post-closing trial balance. A post-closing trial balance contains the balances in permanent accounts that are carried forward to the next accounting period. The purpose of this trial bal- ance is to prove the equality of these balances.

4 State the required steps in the accounting cycle. The required steps in the accounting cycle are: (1) analyze busi- ness transactions, (2) journalize the transactions, (3) post to ledger accounts, (4) prepare a trial balance, (5) journalize and post adjusting entries, (6) prepare an adjusted trial balance, (7) prepare financial statements, (8) journalize and post closing entries, and (9) prepare a post-closing trial balance.

5 Explain the approaches to preparing correcting entries. One way to determine the correcting entry is to compare the incorrect entry with the correct entry. After comparison, the

(c)

Appendix Reversing Entries 171

company makes a correcting entry to correct the accounts. An alternative to a correcting entry is to reverse the incor- rect entry and then prepare the correct entry.

6 Identify the sections of a classified balance sheet. A classified balance sheet categorizes assets as current assets;

long-term investments; property, plant, and equipment; and intangibles. Liabilities are classified as either current or long-term. There is also a stockholders’ (owners’) equity section, which varies with the form of business organization.

GLOSSARY

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Classified balance sheet A balance sheet that contains a number of standard classifications or sections. (p. 161).

Closing entries Entries made at the end of an accounting period to transfer the balances of temporary accounts to a permanent stockholders’ equity account, Retained Earnings. (p. 151).

Correcting entries Entries to correct errors made in recording transactions. (p. 158).

Current assets Assets that a company expects to convert to cash or use up within one year. (p. 162).

Current liabilities Obligations that a company expects to pay from existing current assets within the coming year. (p. 165).

Income Summary A temporary account used in closing rev- enue and expense accounts. (p. 151).

Intangible assets Noncurrent assets that do not have phys- ical substance. (p. 164).

Liquidity The ability of a company to pay obligations expected to be due within the next year. (p. 166).

Long-term investments Generally, investments in stocks and bonds of other companies that companies normally hold for many years. Also includes long-term assets, such as land and buildings, not currently being used in operations. (p. 163).

Long-term liabilities Obligations that a company expects to pay after one year. (p. 166).

Operating cycle The average time that it takes to go from cash to cash in producing revenues. (p. 163).

Permanent (real) accounts Accounts that relate to one or more accounting periods. Consist of all balance sheet accounts. Balances are carried forward to next accounting period. (p. 150).

Post-closing trial balance A list of permanent accounts and their balances after a company has journalized and posted closing entries. (p. 155).

Property, plant, and equipment Assets with relatively long useful lives, currently being used in operations. (p. 164).

Reversing entry An entry, made at the beginning of the next accounting period, that is the exact opposite of the adjusting entry made in the previous period. (p. 158).

Stockholders’ equity The ownership claim of shareholders on total assets. It is to a corporation what owner’s equity is to a proprietorship. (p. 166).

Temporary (nominal) accounts Accounts that relate only to a given accounting period. Consist of all income state- ment accounts and the Dividends account. All temporary accounts are closed at end of accounting period. (p. 150).

Worksheet A multiple-column form that may be used in making adjusting entries and in preparing financial state- ments. (p. 144).

APPENDIX Reversing Entries After preparing the financial statements and closing the books, it is often helpful to reverse some of the adjusting entries before recording the regular transactions of the next period. Such entries are reversing entries. Companies make a reversing entry at the beginning of the next accounting period. Each reversing entry is the exact opposite of the adjusting entry made in the previ- ous period. The recording of reversing entries is an optional step in the accounting cycle.

The purpose of reversing entries is to simplify the recording of a subsequent transaction related to an adjusting entry. For example, in Chapter 3 (page 109), the payment of salaries after an adjusting entry resulted in two debits: one to Salaries Payable and the other to Salaries Expense. With reversing entries, the company can debit the entire subsequent payment to Salaries Expense. The use of reversing entries does not change the amounts reported in the financial statements. What it does is simplify the recording of subsequent transactions.

Prepare reversing entries.

S T U D Y O B J E C T I V E 7

Reversing Entries Example Companies most often use reversing entries to reverse two types of adjusting entries: accrued revenues and accrued expenses. To illustrate the optional use of reversing entries for accrued expenses, we will use the salaries expense transac- tions for Pioneer Advertising Agency Inc. The transaction and adjustment data are as follows.

1. October 26 (initial salary entry): Pioneer pays $4,000 of salaries earned be- tween October 15 and October 26.

2. October 31 (adjusting entry): Salaries earned between October 29 and October 31 are $1,200. The company will pay these in the November 9 payroll.

3. November 9 (subsequent salary entry): Salaries paid are $4,000. Of this amount, $1,200 applied to accrued wages payable and $2,800 was earned be- tween November 1 and November 9.

Illustration 4A-1 shows the entries with and without reversing entries.

172 Chapter 4 Completing the Accounting Cycle

Without Reversing Entries (per chapter)

Initial Salary Entry

Oct. 26 Salaries Expense 4,000 Cash 4,000

Adjusting Entry

Oct. 31 Salaries Expense 1,200 Salaries Payable 1,200

Closing Entry

Oct. 31 Income Summary 5,200 Salaries Expense 5,200

Reversing Entry

Nov. 1 No reversing entry is made.

Subsequent Salary Entry

Nov. 9 Salaries Payable 1,200 Salaries Expense 2,800

Cash 4,000

With Reversing Entries (per appendix)

Initial Salary Entry

Oct. 26 (Same entry)

Adjusting Entry

Oct. 31 (Same entry)

Closing Entry

Oct. 31 (Same entry)

Reversing Entry

Nov. 1 Salaries Payable 1,200 Salaries Expense 1,200

Subsequent Salary Entry

Nov. 9 Salaries Expense 4,000 Cash 4,000

The first three entries are the same whether or not Pioneer uses reversing entries. The last two entries are different. The November 1 reversing entry elimi- nates the $1,200 balance in Salaries Payable created by the October 31 adjusting entry. The reversing entry also creates a $1,200 credit balance in the Salaries Expense account. As you know, it is unusual for an expense account to have a credit balance. The balance is correct in this instance, though, because it anticipates that the entire amount of the first salary payment in the new accounting period will be debited to Salaries Expense. This debit will eliminate the credit balance. The resulting debit balance in the expense account will equal the salaries expense incurred in the new accounting period ($2,800 in this example).

Illustration 4A-1 Comparative entries—not reversing vs. reversing

If Pioneer makes reversing entries, it can debit all cash payments of expenses to the expense account. This means that on November 9 (and every payday) Pioneer can debit Salaries Expense for the amount paid, without regard to any ac- crued salaries payable. Being able to make the same entry each time simplifies the recording process: The company can record subsequent transactions as if the re- lated adjusting entry had never been made.

Illustration 4A-2 shows the posting of the entries with reversing entries.

Self-Study Questions 173

Illustration 4A-2 Postings with reversing entries

A company can also use reversing entries for accrued revenue adjusting en- tries. For Pioneer Advertising, the adjusting entry was: Accounts Receivable (Dr.) $200 and Service Revenue (Cr.) $200. Thus, the reversing entry on November 1 is:

Nov. 1 Service Revenue 200 Accounts Receivable 200

(To reverse October 31 adjusting entry)

When Pioneer collects the accrued service revenue, it debits Cash and credits Service Revenue.

Salaries Expense

10/26 Paid 4,000 10/31 Closing 5,200 31 Adjusting 1,200

5,200 5,200

11/9 Paid 4,000 11/1 Reversing 1,200

Salaries Payable

11/1 Reversing 1,200 10/31 Adjusting 1,200

SUMMARY OF STUDY OBJECTIVE FOR APPENDIX

*Note: All asterisked Questions, Exercises, and Problems relate to material in the appendix to the chapter.

Cash Flows no effect

A � L � SE �200 Rev

�200

7 Prepare reversing entries. Reversing entries are the opposite of the adjusting entries made in the preceding period. Some companies choose to make reversing entries at the beginning of a new accounting period to simplify the

recording of later transactions related to the adjusting entries. In most cases, only accrued adjusting entries are reversed.

SELF-STUDY QUESTIONS Answers are at the end of the chapter.

1. Which of the following statements is incorrect concern- ing the worksheet? a. The worksheet is essentially a working tool of the

accountant. b. The worksheet is distributed to management and

other interested parties. c. The worksheet cannot be used as a basis for posting to

ledger accounts. d. Financial statements can be prepared directly from

the worksheet before journalizing and posting the adjusting entries.

2. In a worksheet, net income is entered in the following columns: a. income statement (Dr) and balance sheet (Dr). b. income statement (Cr) and balance sheet (Dr). c. income statement (Dr) and balance sheet (Cr). d. income statement (Cr) and balance sheet (Cr).

3. An account that will have a zero balance after closing entries have been journalized and posted is: a. Service Revenue. b. Advertising Supplies. c. Prepaid Insurance. d. Accumulated Depreciation.

(SO 1)

(SO 1)

(SO 2)

174 Chapter 4 Completing the Accounting Cycle

4. When a net loss has occurred, Income Summary is: a. debited and Retained Earnings is credited. b. credited and Retained Earnings is debited. c. debited and Common Stock is credited. d. credited and Common Stock is debited.

5. The closing process involves separate entries to close (1) expenses, (2) dividends, (3) revenues, and (4) income summary. The correct sequencing of the entries is: a. (4), (3), (2), (1) b. (1), (2), (3), (4) c. (3), (1), (4), (2) d. (3), (2), (1), (4)

6. Which types of accounts will appear in the post-closing trial balance? a. Permanent (real) accounts. b. Temporary (nominal) accounts. c. Accounts shown in the income statement columns of

a work sheet. d. None of the above.

7. All of the following are required steps in the accounting cycle except: a. journalizing and posting closing entries. b. preparing financial statements. c. journalizing the transactions. d. preparing a work sheet.

8. Cash of $100 received at the time the service was pro- vided was journalized and posted as a debit to Cash $100 and a credit to Accounts Receivable $100. Assuming the incorrect entry is not reversed, the correcting entry is: a. debit Service Revenue $100 and credit Accounts

Receivable $100. b. debit Accounts Receivable $100 and credit Service

Revenue $100.

c. debit Cash $100 and credit Service Revenue $100. d. debit Accounts Receivable $100 and credit Cash $100.

9. In a classified balance sheet, assets are usually classified using the following categories: a. current assets; long-term assets; property, plant, and

equipment; and intangible assets. b. current assets; long-term investments; property, plant,

and equipment; and other assets. c. current assets; long-term investments; tangible assets;

and intangible assets. d. current assets; long-term investments; property, plant,

and equipment; and intangible assets. 10. Current assets are listed:

a. by liquidity. b. by importance. c. by longevity. d. alphabetically.

*11. On December 31, Frank Voris Company correctly made an adjusting entry to recognize $2,000 of accrued salaries payable. On January 8 of the next year, total salaries of $3,400 were paid. Assuming the correct reversing entry was made on January 1, the entry on January 8 will result in a credit to Cash $3,400 and the following debit(s): a. Salaries Payable $1,400, and Salaries Expense $2,000. b. Salaries Payable $2,000 and Salaries Expense $1,400. c. Salaries Expense $3,400. d. Salaries Payable $3,400.

Go to the book’s website, www.wiley.com/college/weygandt, for Additional Self-Study questions.

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QUESTIONS 1. “A worksheet is a permanent accounting record and its

use is required in the accounting cycle.” Do you agree? Explain.

2. Explain the purpose of the worksheet.

3. What is the relationship, if any, between the amount shown in the adjusted trial balance column for an ac- count and that account’s ledger balance?

4. If a company’s revenues are $125,000 and its expenses are $113,000, in which financial statement columns of the worksheet will the net income of $12,000 appear? When expenses exceed revenues, in which columns will the dif- ference appear?

5. Why is it necessary to prepare formal financial state- ments if all of the data are in the statement columns of the worksheet?

6. Identify the account(s) debited and credited in each of the four closing entries, assuming the company has net income for the year.

7. Describe the nature of the Income Summary account and identify the types of summary data that may be posted to this account.

8. What are the content and purpose of a post-closing trial balance?

9. Which of the following accounts would not appear in the post-closing trial balance? Interest Payable; Equipment; Depreciation Expense; Dividends; Unearned Revenue; Accumulated Depreciation—Equipment; and Service Revenue.

10. Distinguish between a reversing entry and an adjusting entry. Are reversing entries required?

11. Indicate, in the sequence in which they are made, the three required steps in the accounting cycle that involve journalizing.

12. Identify, in the sequence in which they are prepared, the three trial balances that are often used to report financial information about a company.

13. How do correcting entries differ from adjusting entries? 14. What standard classifications are used in preparing a

classified balance sheet? 15. What is meant by the term “operating cycle?” 16. Define current assets. What basis is used for arranging

individual items within the current assets section?

(SO 2)

(SO 2)

(SO 3)

(SO 4)

(SO 5)

(SO 6)

(SO 6)

(SO 7)

BE4-1 The steps in using a worksheet are presented in random order below. List the steps in the proper order by placing numbers 1–5 in the blank spaces.

(a) _____ Prepare a trial balance on the worksheet. (b) _____ Enter adjusted balances. (c) _____ Extend adjusted balances to appropriate statement columns. (d) _____ Total the statement columns, compute net income (loss), and complete the worksheet. (e) _____ Enter adjustment data.

BE4-2 The ledger of Ley Company includes the following unadjusted balances: Prepaid Insurance $3,000, Service Revenue $58,000, and Salaries Expense $25,000. Adjusting entries are required for (a) expired insurance $1,200; (b) services provided $1,100, but unbilled and uncol- lected; and (c) accrued salaries payable $800. Enter the unadjusted balances and adjustments into a worksheet and complete the worksheet for all accounts. Note: You will need to add the fol- lowing accounts: Accounts Receivable, Salaries Payable, and Insurance Expense.

BE4-3 The following selected accounts appear in the adjusted trial balance columns of the worksheet for Batan Company: Accumulated Depreciation; Depreciation Expense; Common Stock; Dividends; Service Revenue; Supplies; and Accounts Payable. Indicate the financial state- ment column (income statement Dr., balance sheet Cr., etc.) to which each balance should be extended.

BE4-4 The ledger of Swann Company contains the following balances: Retained Earnings $30,000; Dividends $2,000; Service Revenue $50,000; Salaries Expense $27,000; and Supplies Expense $4,000. Prepare the closing entries at December 31.

BE4-5 Using the data in BE4-4, enter the balances in T accounts, post the closing entries, and rule and balance the accounts.

BE4-6 The income statement for Crestwood Golf Club for the month ending July 31 shows Green Fee Revenue $13,600, Salaries Expense $8,200, Maintenance Expense $2,500, and Net Income $2,900. Prepare the entries to close the revenue and expense accounts. Post the entries to the revenue and expense accounts, and complete the closing process for these accounts using the three-column form of account.

BE4-7 Using the data in BE4-3, identify the accounts that would be included in a post-closing trial balance.

BE4-8 The steps in the accounting cycle are listed in random order below. List the steps in proper sequence, assuming no worksheet is prepared, by placing numbers 1–9 in the blank spaces.

(a) _____ Prepare a trial balance. (b) _____ Journalize the transactions. (c) _____ Journalize and post closing entries. (d) _____ Prepare financial statements. (e) _____ Journalize and post adjusting entries. (f) _____ Post to ledger accounts. (g) _____ Prepare a post-closing trial balance. (h) _____ Prepare an adjusted trial balance. (i) _____ Analyze business transactions.

Brief Exercises 175

17. Distinguish between long-term investments and prop- erty, plant, and equipment.

18. (a) What is the term used to describe the owner’s equity section of a corporation? (b) Identify the two owners’ equity accounts in a corporation and indicate the pur- pose of each.

*19. Sanchez Company prepares reversing entries. If the ad- justing entry for interest payable is reversed, what type of

an account balance, if any, will there be in Interest Payable and Interest Expense after the reversing entry is posted?

*20. At December 31, accrued salaries payable totaled $3,500. On January 10, total salaries of $8,000 are paid. (a) Assume that reversing entries are made at January 1. Give the January 10 entry, and indicate the Salaries Expense ac- count balance after the entry is posted. (b) Repeat part (a) assuming reversing entries are not made.

BRIEF EXERCISES List the steps in preparing a worksheet.

(SO 1)

Prepare partial worksheet.

(SO 1)

Identify worksheet columns for selected accounts.

(SO 1)

Prepare closing entries from ledger balances.

(SO 2)

Post closing entries; rule and balance T accounts.

(SO 2)

Journalize and post closing entries using the three-column form of account.

(SO 2)

Identify post-closing trial balance accounts.

(SO 3)

List the required steps in the accounting cycle in sequence.

(SO 4)

BE4-9 At Batavia Company, the following errors were discovered after the transactions had been journalized and posted. Prepare the correcting entries.

1. A collection on account from a customer for $780 was recorded as a debit to Cash $780 and a credit to Service Revenue $780.

2. The purchase of store supplies on account for $1,570 was recorded as a debit to Store Supplies $1,750 and a credit to Accounts Payable $1,750.

BE4-10 The balance sheet debit column of the worksheet for Diaz Company includes the fol- lowing accounts: Accounts Receivable $12,500; Prepaid Insurance $3,600; Cash $15,400; Supplies $5,200, and Short-term Investments $6,700. Prepare the current assets section of the balance sheet, listing the accounts in proper sequence.

BE4-11 The following are the major balance sheet classifications:

Current assets (CA) Current liabilities (CL) Long-term investments (LTI) Long-term liabilities (LTL) Property, plant, and equipment (PPE) Stockholders’ equity (SE) Intangible assets (IA)

Match each of the following accounts to its proper balance sheet classification.

_____ Accounts payable _____ Income tax payable _____ Accounts receivable _____ Investment in long-term bonds _____ Accumulated depreciation _____ Land _____ Building _____ Merchandise inventory _____ Cash _____ Patent _____ Copyrights _____ Supplies

*BE4-12 At October 31, Nathan Company made an accrued expense adjusting entry of $1,400 for salaries. Prepare the reversing entry on November 1, and indicate the balances in Salaries Payable and Salaries Expense after posting the reversing entry.

176 Chapter 4 Completing the Accounting Cycle

Prepare correcting entries.

(SO 5)

Prepare the current assets section of a balance sheet.

(SO 6)

Classify accounts on balance sheet.

(SO 6)

Prepare reversing entries.

(SO 7)

Complete the worksheet.

(SO 1)

EXERCISES E4-1 The trial balance columns of the worksheet for Briscoe Company at June 30, 2008, are as follows.

BRISCOE COMPANY Worksheet

For the Month Ended June 30, 2008

Trial Balance Account Titles Dr. Cr.

Cash $2,320 Accounts Receivable 2,440 Supplies 1,880 Accounts Payable $1,120 Unearned Revenue 240 Common Stock 3,600 Service Revenue 2,400 Salaries Expense 560 Miscellaneous Expense 160