Chapter 4

Completing the
Accounting Cycle

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Learning Objectives

1. Prepare the financial

statements including the
classified balance sheet
2. Use the worksheet to
prepare financial statements
3. Explain the purpose of,
journalize, and post closing
entries
4. Prepare the post-closing trial
balance
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Learning Objectives

5. Describe the accounting

cycle
6. Use the current ratio to
evaluate business
performance
7. Explain the purpose of,
journalize, and post
reversing entries (Appendix
4A)

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Learning Objective 1

Prepare the financial

statements including the
classified balance sheet

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 How Do We Prepare Financial
Statements?
• The financial statements:
– Income statement:
• Reports revenues and expenses and calculates net
income or loss for the period
– Statement of retained earnings:
• Shows how retained earnings changed during the
period
– Balance sheet:
• Reports assets, liabilities, and stockholders’ equity as
of the last day of the period

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 The financial
statements are
prepared from
the adjusted trial
balance.

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Relationships Among the Financial
Statements
• The financial statements relate to each
other.
– Net income or net loss from the income
statement flows to the statement of retained
earnings.
– Ending Retained Earnings from the statement
of retained earnings flows to the balance
sheet.

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Exhibit 4-2 Smart Touch Learning
Financial Statements

Net income flows to

the statement of
retained earnings.

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 Exhibit 4-2 Smart Touch Learning
Financial Statements

The net income

from the income
statement flows to
the statement of The ending
retained earnings. Retained
Earnings flows
to the balance
sheet.

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Exhibit 4-2 Smart Touch Learning
Financial Statements

The ending
value of
Retained
Earnings
from the
statement
of retained
earnings
flows to the
balance
sheet.

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 Classified Balance Sheet
• A classified balance sheet places each
asset and each liability into a specific
category.
– Assets are shown in order of liquidity.
– Liabilities are classified as current (due within
one year) or long term (due after one year).
• Liquidity measures how quickly and easily
an account can be converted to cash.

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 Assets
Current assets
• Converted to cash or used within 12
months or within the operating cycle.

Long-term assets
• Not converted to cash or used up within
the operating cycle or one year.
• Long-term investments The operating cycle is the time
• Plant assets span during which cash is paid
• Intangible assets for goods and services, which
are then sold to customers,
from whom the business
collects cash.
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 Liabilities
• Current liabilities must be paid either with
cash or with goods and services within one
year or within the entity’s operating cycle.
– Examples:
• Accounts Payable
• Salaries Payable
• Unearned Revenue
• Long-term liabilities are all liabilities that
do not need to be paid within one year or
within the operating cycle.

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 Stockholders’ Equity
• Stockholders’ equity represents the
stockholders’ claims to the assets of the
business.
– Reflects the stockholders’ contributions
through common stock
– Represents the amount of assets left over after
the corporation has paid its liabilities

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© 2016 Pearson Education, Ltd. 4-15
Learning Objective 2

Use the worksheet to

prepare financial
statements

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 How Could a Worksheet Help in
Preparing Financial Statements?
• The first four sections of the worksheet (see
Chapter 3) helped determine the adjusted
trial balance, from which we prepare financial
statements.
– Section 5—Income Statement
• Includes only revenue and expense accounts
– Section 6—Balance Sheet
• Includes asset, liability, and equity accounts except
revenues and expenses
– Section 7—Determine Net Income or Net Loss
• The balancing amount for the income statement and
balance sheet sections (will be the same amount)

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© 2016 Pearson Education, Ltd. 4-18
Learning Objective 3

Explain the purpose of,

journalize, and post closing
entries

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What Is the Closing Process, and
How Do We Close the Accounts?
Temporar
Permanen The closing process
y
t Accounts zeros out all
Accounts
revenue and
Revenue expense accounts
Assets
s in order to measure
each period’s net
Expense Liabilitie income separately
s s from all other
periods.
Dividend
Equity
s

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 What Is the Closing Process, and
How Do We Close the Accounts?
• Closing entries
– Transfer revenues, expenses, and Dividends to
Retained Earnings
• Revenues and expenses may be
transferred first to an account titled
Income Summary.
– The Income Summary account summarizes the
net income (or net loss) for the period.

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What Is the Closing Process, and
How Do We Close the Accounts?

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Closing Temporary Accounts—Net
Income for the Period

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Closing Temporary Accounts—Net
Income for the Period

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Closing Temporary Accounts—Net
Income for the Period

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Closing Temporary Accounts—Net
Income for the Period

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Closing Temporary Accounts—Net
Income for the Period

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Closing Temporary Accounts—Net
Loss for the Period

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Learning Objective 4

Prepare the post-closing trial

balance

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How Do We Prepare a Post-Closing
Trial Balance?
• The accounting cycle ends with a
post-closing trial balance:
– A list of the accounts and their balances at the
end of the period, after journalizing and
posting the closing entries
– Includes only permanent accounts

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© 2016 Pearson Education, Ltd. 4-31
Learning Objective 5

Describe the accounting

cycle

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What Is the Accounting Cycle?

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Learning Objective 6

Use the current ratio to

evaluate business
performance

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How Do We Use the Current Ratio
to Evaluate Business
Performance?
• The current ratio measures a company’s
ability to pay its current liabilities with its
current assets.
• The formula is:

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Learning Objective 7

Explain the purpose of,

journalize, and post reversing
entries (Appendix 4A)

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 What Are Reversing Entries?
• Special journal entries that ease the
burden of accounting for transactions in
a later period
• The opposite of adjusting entries
• Not required by GAAP
• Used for convenience and to save time

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Accounting for Accrued Expenses

To record accrued salaries of $1,200, Smart Touch

Learning recorded the following adjusting entry:

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 Accounting Without a Reversing
Entry
To record the payment of total salaries of $2,400 on
January 15 without a reversing entry, Smart Touch
would:

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Accounting with a Reversing Entry
A reversing entry is a special journal entry that
eases the burden of accounting for transactions in
the next period.

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Accounting with a Reversing Entry

The credit balance in the Salaries Expense

account is eliminated on January 15, when
Smart Touch Learning pays the payroll and
debits Salaries Expense.

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