CHAPTER STUDY OBJECTIVES
After studying this chapter, you should be able to:
1. Prepare a work sheet.
2. Explain the process of closing the 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. Identify the sections of a classified balance sheet.
*7. Prepare reversing entries.
*Note: All asterisked (*) items relate to material contained in the Appendix to the chapter.
PREVIEW OF CHAPTER 4
In this chapter we will explain the role of the work sheet in accounting as well as the remaining steps in the accounting cycle, most especially, the closing process. Then we will consider (1) correcting entries and (2) classified balance sheets. The organization and content of the chapter are as follows:
CHAPTER REVIEW
Preparing a Worksheet
1. (S.O. 1) The steps in preparing a work sheet are:
a. Prepare a trial balance on the work sheet.
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 the net income (or loss), and complete the work sheet.
2. A work sheet is a multiple-column form that may be used in the adjustment process and in preparing financial statements. The basic form of a work sheet consists of the following columns:
3. For each account in the work sheet, the amount in the adjusted trial balance columns is equal to the account balance that will appear in the ledger after the adjusting entries have been journalized and posted.
4. After the work sheet has been completed the statement columns contain all data that are required for the preparation of financial statements. The income statement is prepared from the income statement columns, and the retained earnings statement and balance sheet are prepared from the balance sheet columns.
5. Using a work sheet accountants can prepare financial statements before adjusting entries are journalized and posted.
6. A work sheet is not a journal and it should not be used as a basis for posting to ledger accounts.
Closing Entries
7. (S.O. 2) Closing entries formally recognize in the ledger the transfer of net income (or loss) and dividends to retained earnings as shown in the retained earnings statement.
8. Journalizing and posting closing entries is a required step in the accounting cycle.
9. The dividends, revenue, and expense accounts are temporary (nominal) accounts. Asset accounts, liability accounts, common stock, and the retained earnings account are permanent (real) accounts.
10. A temporary account, Income Summary, is used in closing revenue and expense accounts to minimize the amount of detail in the permanent retained earnings account.
11. In closing the books of a corporation:
a. Debit each revenue account for its balance, and credit Income Summary for total revenues.
b. Debit Income Summary for total expenses, and credit each expense account for its balance.
c. Debit Income Summary, and credit Retained Earnings for the amount of net income; conversely, credit Income Summary and debit Retained Earnings if a net loss exists.
d. Debit Retained Earnings for the balance in the Dividends account and credit Dividends for the same amount.
Post-Closing Trial Balance
12. (S.O. 3) After all closing entries have been journalized and posted, a post-closing trial balance is prepared. The purpose of this trial balance is to prove the equality of the permanent account balances that are carried forward into the next accounting period.
Steps in the Accounting Cycle
13. (S.O. 4) The required steps in the accounting cycle are:
a. Analyze business transactions.
b. Journalize the transactions.
c. Post to ledger accounts.
d. Prepare a trial balance.
e. Journalize and post adjusting entries: Prepayments/Accruals.
f. Prepare an adjusted trial balance.
g. Prepare financial statements: Income statement, Retained earnings statement, Balance sheet.
h. Journalize and post closing entries.
i. Prepare a post-closing trial balance.
14. A reversing entry is the exact opposite of an adjusting entry. The preparation of reversing entries is an optional bookkeeping procedure that is not a required step in the accounting cycle.
Correcting Entries
15. (S.O. 5) Errors that occur in recording transactions should be corrected as soon as they are discovered by preparing correcting entries. Correcting entries:
a. are unnecessary if the records are free of errors.
b. are journalized and posted whenever an error is discovered.
c. may involve any combination of balance sheet and income statement accounts.
16. To determine the correcting entry, it is useful to compare the incorrect entry with the correct entry, and then make a correcting entry. Another approach is to reverse the incorrect entry and then prepare the correct entry.
Classified Balance Sheet
17. (S.O. 6) Financial statements become more useful when the elements are classified into significant subgroups. A classified balance sheet generally has the following standard classifications:
Liabilities and
Assets Stockholders' Equity
Current assets Current liabilities
Long-term investments Long-term liabilities
Property, plant, and Stockholders' equity
equipment
Intangible assets
Assets
18. Current assets are cash and other resources that are reasonably expected to be realized in cash or sold or consumed in the business within one year of the balance sheet date or the company's operating cycle, whichever is longer. Current assets are listed in the order of their liquidity.
19. The operating cycle of a company is the average time that is required to go from cash to cash in producing revenues.
20. Long-term investments are resources that can be realized in cash but the conversion into cash is not expected within one year or the operating cycle, whichever is longer.
21. Tangible resources of a relatively permanent nature that are used in the business and not intended for sale are classified as property, plant, and equipment.
22. Intangible assets are noncurrent resources that do not have physical substance, such as patents and copyrights.
Liabilities
23. Current liabilities are obligations that are reasonably expected to be paid from existing current assets or through the creation of other current liabilities within one year or the operating cycle, whichever is longer.
24. Obligations expected to be paid after one year are classified as long-term liabilities (or long-term debt).
Stockholders' Equity
25. The content of the stockholders' (owners') section varies with the form of business organization. In a proprietorship, there is a single owner's equity account, called (Owner's Name), Capital. In a partnership, there are separate capital accounts for each partner. For a corporation, owners' equity is called stockholders' equity and it consists of two accounts: Capital Stock and Retained Earnings.
Form of Balance Sheet
26. A balance sheet is most often presented in report form with the assets shown above the liabilities and stockholders' equity. It may also be presented in account form with the assets section placed on the left and the liabilities and owner's equity section on the right.
Reversing Entries
*27. (S.O. 7) A reversing entry is made at the beginning of the next accounting period. The purpose of reversing entries is to simplify the recording of a subsequent transaction related to an adjusting entry.
*28. Reversing entries are most often used to reverse two types of adjusting entries: accrued revenues and accrued expenses.
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