Chapter 4

CHAPTER
4 Completing the
Accounting Cycle
human/iStock/360/Getty Images
Warren
Reeve
Duchac
Learning Objectives
• LO1: Describe the flow of accounting information from the

unadjusted trial balance into the adjusted trial balance and
financial statements.
• LO2: Prepare financial statements from adjusted account
balances.
• LO3: Prepare closing entries.
• LO4: Describe the accounting cycle.
• LO5: Illustrate the accounting cycle for one period.
• LO6: Explain what is meant by the fiscal year and the natural
business year.
• LO7: Describe and illustrate the use of working capital and the
current ratio in evaluating a company’s financial condition.
©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Fiscal Year
• The annual accounting period adopted by a business

is known as its fiscal year.
• Fiscal years begin with the first day of the month
selected and end on the last day of the following
twelfth month.
• When a corporation adopts a fiscal year that ends
when business activities have reached the lowest
point in its annual operating cycle, such a fiscal year
is called the natural business year.
Financial History of a Business
Overview of Accounting Process
End-of-Period Spreadsheet and
Flow of Accounting Data—NetSolutions
Flow of Accounting Information
(slide 1 of 5)
End-of-Period Spreadsheet (Work Sheet)
Unadjusted Adjusted
Trial Balance Adjustments Trial Balance
Accounts Dr Cr Dr Cr Dr Cr
• Account balances are listed in the Unadjusted Trial

Balance columns using the ending balances found in
the general ledger.
(slide 2 of 5)
Unadjusted Adjusted
• Adjustments are entered here. Two possibilities:

o Deferrals – Existing balances are changed.
o Accruals – New information is entered
(slide 3 of 5)
Unadjusted Adjusted
• Adjustments are added to or subtracted from the

amounts in the Unadjusted Trial Balance columns.
Account balances are now adjusted.
(slide 4 of 5)
Adjusted Income Balance Sheet

Trial Balance Statement
• Amounts for revenues and expenses in the Adjusted

Trial Balance columns are extended to the Income
Statement columns.
(slide 5 of 5)
Adjusted Trial Income Balance Sheet

Balance Statement
• The amounts for assets, liabilities, common stock,

and dividends in the Adjusted Trial Balance columns
are extended to the Balance Sheet columns.
Closing Entries - Permanent Accounts
• Accounts that are relatively permanent from year to

year are called permanent accounts or real
accounts.
• The balances of these accounts are carried forward
from year to year.
• This includes accounts reported on the balance sheet.
Closing Entries - Temporary Accounts
• Accounts that report amounts for only one period are

called temporary accounts or nominal accounts.
• Temporary accounts are not carried forward from
year to year because they relate to only one period.
• This includes all accounts reported on the income
statement as well as the dividends account, which is
reported on the retained earnings statement.
Comparison
Permanent account Temporary account
Balance Carried forward to the next period Not carried forward

Þ Transferring Þ Closing balance
Þ Closing of previous period = Þ Opening account = 0
Opening of current period
Financial Balance Sheet Income statement
Statement (Cash, Car, Account Receivable, (Fee earned, expenses,
Account Payable, so on) devidends)
Closing Process
Closing Process – Net Solutions
Financial statement in proprietorship companies
The accounting reports providing information for users are called financial
statements.
A proprietorship has four primary financial statements

 Income statement (Statement of performance)
The income statement reports the revenues and expenses for a period
of time, based on the matching concept.
Revenue - Expenses = Net Income/Net profit/ Earnings
• Expenses > Revenue Negative earnings Net

loss
Financial statements in proprietorship companies
 Statement of owner’s equity (The U.S’ system)
The statement of owner’s equity reports the changes in owner’s equity

for a period of time.
• It is prepared after the income statement because the net income or net
loss for the period must be reported in this statement.
• It is prepared before the balance sheet, since the amount of owner’s
equity at the end of the period must be reported on the balance sheet.
 Balance sheet (Statement of financial position)
The balance sheet reports the amount of assets, liabilities, and

owner’s equity for a period of time.
Assets = Liabilities + Owner’s equity

• The asset and liability amounts are taken from the last line of income statement
• The equity is taken from the last line of the statement of owner’s equity
• Form of balance sheet: account form => Basic format of the accounting equation
ASSETS LIABILITIES
OWNER’S EQUITY
 Statement of cash flows
The statement of cash flow reports the changes of cash in operating

activities, investing activities, and financing activities.
Cash flow from operating activities: summary of cash receipts and

cash payments from operations.
Cash flow from investing activities: reports the cash transactions for the
acquisition and sale of relatively permanent assets.
Cash flow from financing activities: reports the cash transactions related
to to cash investments by the owner, borrowings, and withdrawals by
the owner.
 Statement of cash flows
Example: A summary of cash flows for Chickadee Travel Service for the
year ended April 30, 2016, follows:
Interrelationships Among Financial Statements
Financial Statements—NetSolutions:
Income Statement
To Statement of Owner’s
Equity
PRACTICE – Prepare an Income Statement
Statement of Owner’s Equity
From Income Statement
To Balance Sheet
PRACTICE – Prepare a Statement of Owner’s Equity
Balance Sheet
From Statement of Owner’s
Equity
Current Assets
(slide 1 of 2)
• Cash and other assets that are expected to be

converted into cash or sold or used up usually within
one year or less, through the normal operations of the
business, are called current assets.
• Current assets include:
o Cash
o Accounts receivable
o Notes receivable
o Supplies
o Other prepaid expenses
Current Assets
(slide 2 of 2)
• Notes receivable are written promises by the

customer to pay the amount of the note and interest.
Like accounts receivable, notes receivable are
amounts that customers owe, but they are more
formal than accounts receivable.
• Notes receivable and accounts receivable are current
assets because they are usually converted to cash
within one year or less.
Property, Plant, and Equipment or Non-current
Assets
• Property, plant, and equipment (also called fixed

assets or plant assets) include land and assets that
depreciate over a period of time.
o Assets that depreciate over time include:
 Equipment
 Machinery
 Buildings
Current Liabilities
• Amounts the business owes to creditors that will be

due within a short time (usually one year or less) and
that are to be paid out of current assets are called
current liabilities.
• Current liabilities include:
o Accounts payable
o Notes payable
o Wages payable
o Interest payable
o Unearned revenue
Non-current Liabilities
• Amounts the business owes to creditors that will not

be due for a long time (usually more than one year)
are called long-term liabilities.
Owners’ Equity
• Owners’ equity is the owners’ right to the assets of

the business.
• It is presented on the balance sheet below the
liabilities section.
• Owners’ equity is added to the total liabilities, and
this total must be equal to the total assets.
Example Exercise Classified Balance Sheet
The following accounts appear in an adjusted trial balance of Hindsight

Consulting. Indicate whether each account would be reported in the (a)
Current asset; (b) Non-current assets; (c) Current liability; (d) Non-current
liability; or (e) Owners’ equity section of the December 31, 2015, balance
sheet of Hindsight Consulting.
1. Common Stock
2. Notes Receivable (due in six months)
3. Notes Payable (due in 10 years)
4. Land
5. Cash
6. Unearned Rent (three months)
7. Accumulated Depreciation—
Equipment
8. Accounts Payable
©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in
part.
Example Exercise Classified Balance Sheet
The following accounts appear in an adjusted trial balance of Hindsight

Consulting. Indicate whether each account would be reported in the (a)
Current asset; (b) Non-current assets; (c) Current liability; (d) Non-current
liability; or (e) Owners’ equity section of the December 31, 2015, balance
sheet of Hindsight Consulting.
1. Common Stock 1. Owners’ equity

2. Notes Receivable (due in six months) 2. Current asset
3. Notes Payable (due in 10 years) 3. Long-term liability
4. Land 4. Non-current assets
5. Cash 5. Current asset
6. Unearned Rent (three months) 6. Current liability
7. Accumulated Depreciation— 7. Non-current assets
Equipment 8. Current liability
8. Accounts Payable
part.
PRACTICE – Prepare a Balance Sheet
Financial Analysis and Interpretation:
Working Capital and Current Ratio
• The ability to convert assets into cash is called

liquidity.
• The ability of a business to pay its debts is called
solvency.
• Two financial measures for evaluating a business’s
short-term liquidity and solvency are working
capital and the current ratio.
Working Capital
(slide 1 of 2)
• Working capital is the excess of the current assets of

a business over its current liabilities.
• Working capital is computed as follows:
Working Capital = Current Assets – Current Liabilities
• A positive working capital implies that the business is
able to pay its current liabilities and is solvent.
Working Capital
(slide 2 of 2)
• NetSolutions’ working capital at the end of 2015 is

computed as follows:
Current Ratio
(slide 1 of 2)
• The current ratio is another means of expressing the

relationship between current assets and current
liabilities.
• The current ratio is computed by dividing current
assets by current liabilities, as follows:
Current Assets
Current Ratio
Current Liabilities
=
Current Ratio
(slide 2 of 2)
• The current ratio for NetSolutions at the end of 2015

is computed as follows:
Example Exercise Working Capital and Current Ratio
Current assets and current liabilities for Fortson

Company follow:
a. Determine the working capital and current ratio for

2016 and 2015.
b. Does the change in the current ratio from 2015 to
2016 indicate a favorable or an unfavorable trend?
part.
PRACTICE – Big Problem
Andrew Joel is a market trader. On the September 1, 20XX, he opened

a hotel named Queen Hotel. The company’s trial balance as at October
1, 20XX, appears below:
PRACTICE – Big Problem (cont)
During the month of October, the company completed the following

transactions:
1. Received cash from credit customers, $10,000.
2. Purchased a car by cash, $1,000.
3. Made a payment to suppliers by cash, $500.
4. Paid wages and salaries for the period by cash, $700.
Adjustment data consists of:
5. Insurance expired at the rate of $450 per month.
6. A count of supplies on October 31 showed $3,000 on hand.
7. Rental of $1,600 was due from tenants at October 31.
Requirement:
a. Journalize October transactions.
b. Prepare an adjusted Trial Balance.
c. Prepare Income Statement.
d. Prepare Balance Sheet.
HOMEWORK
HOMEWORK
Requirements:
1. Journalize September transactions
2. Prepare an adjusted Trial Balance
3. Prepare Income Statement
4. Prepare Balance Sheet

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Chapter 4

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CHAPTER

• LO1: Describe the flow of accounting information from the

• The annual accounting period adopted by a business

End-of-Period Spreadsheet (Work Sheet)

• Account balances are listed in the Unadjusted Trial

End-of-Period Spreadsheet (Work Sheet)

• Adjustments are entered here. Two possibilities:

End-of-Period Spreadsheet (Work Sheet)

• Adjustments are added to or subtracted from the

End-of-Period Spreadsheet (Work Sheet)

Adjusted Income Balance Sheet

• Amounts for revenues and expenses in the Adjusted

End-of-Period Spreadsheet (Work Sheet)

Adjusted Trial Income Balance Sheet

• The amounts for assets, liabilities, common stock,

• Accounts that are relatively permanent from year to

• Accounts that report amounts for only one period are

Permanent account Temporary account

Balance Carried forward to the next period Not carried forward

A proprietorship has four primary financial statements

Revenue - Expenses = Net Income/Net profit/ Earnings

• Expenses > Revenue Negative earnings Net

The statement of owner’s equity reports the changes in owner’s equity

The balance sheet reports the amount of assets, liabilities, and

Assets = Liabilities + Owner’s equity

The statement of cash flow reports the changes of cash in operating

Cash flow from operating activities: summary of cash receipts and

• Cash and other assets that are expected to be

• Notes receivable are written promises by the

• Property, plant, and equipment (also called fixed

• Amounts the business owes to creditors that will be

• Amounts the business owes to creditors that will not

• Owners’ equity is the owners’ right to the assets of

The following accounts appear in an adjusted trial balance of Hindsight

The following accounts appear in an adjusted trial balance of Hindsight

1. Common Stock 1. Owners’ equity

• The ability to convert assets into cash is called

• Working capital is the excess of the current assets of

• NetSolutions’ working capital at the end of 2015 is

• The current ratio is another means of expressing the

• The current ratio for NetSolutions at the end of 2015

Current assets and current liabilities for Fortson

a. Determine the working capital and current ratio for

Andrew Joel is a market trader. On the September 1, 20XX, he opened

During the month of October, the company completed the following

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