ACCT 210 Lecture, Fall 2005

© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 5-1 The Accounting Cycle Reporting Financial Results Chapter 5 © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 5-2 Learning Objective Learning Objective LO1 To prepare an income statement, a statement of retained earnings, and a balance sheet. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 5-3 JJ's Lawn Care Service Adjusted Trial Balance May 31, 2007 Cash 3,925 $ Accounts receivable 75 Tools & equipment 2,650 Accumulated depreciation: tools & equipment 50 $ Truck 15,000 Accumumlated depreciation: truck 250 Notes payable 13,000 Accounts payable 150 Capital stock 8,000 Dividends 200 Sales revenue 750 Gasoline expense 50 Depreciation expense: tools & equipment 50 Depreciation expense: truck 250 Total 22,200 $ 22,200 $ This is the Adjusted Trial Balance for JJ’s. This is the Adjusted Trial Balance for JJ’s. Now, let’s prepare the financial statements for JJ’s Lawn Care Service for May. Now, let’s prepare the financial statements for JJ’s Lawn Care Service for May. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 5-4 JJ's Lawn Care Service Income Statement For the month ending May 31, 2007 Sales revenue 750 $ Operating expenses: Gasoline expense 50 $ Depreciation: tools & equipment 50 Depreciation: truck 250 350 Net income 400 $ Net income also appears on the Statement of Retained Earnings. Net income also appears on the Statement of Retained Earnings. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 5-5 •Business Earnings •Dividends •Business Losses This statement summarizes the increases and decreases in Retained Earnings during the period. Statement of Retained Earnings Statement of Retained Earnings © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 5-6 Now, let’s prepare the Balance Sheet. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 5-7 JJ's Lawn Care Service Balance Sheet May 31, 2007 Assets Cash 3,925 $ Accounts receivable 75 Tools & equipment 2,650 $ Less: Accumulated depreciation 50 2,600 Truck 15,000 $ Less: Accumulated depreciation 250 14,750 Total assets 21,350 $ Liabilities & Stockholders' Equity Liabilities: Notes payable 13,000 $ Accounts payable 150 Total liabilities 13,150 $ Stockholders' equity: Capital stock 8,000 $ Retained earnings 200 Total stockholders' equity 8,200 Total liabilities & stockholders' equity $ 21,350 © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 5-8 Learning Objective Learning Objective LO2 To explain how the income statement and the statement of retained earnings relate to the balance sheet. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 5-9 Preparing Financial Statements Preparing Financial Statements JJ's Lawn Care Service Income Statement For the month ending May 31, 2007 Sales revenue 750 $ Operating expenses: Gasoline expense 50 $ Depreciation: tools & equipment 50 Depreciation: truck 250 350 Net income $ 400 JJ's Lawn Care Service Balance Sheet May 31, 2007 Assets Cash 3,925 $ Accounts receivable 75 Tools & equipment 2,650 $ Less: Accumulated depreciation 50 2,600 Truck 15,000 $ Less: Accumulated depreciation 250 14,750 Total assets 21,350 $ Liabilities & Stockholders' Equity Liabilities: Notes payable 13,000 $ Accounts payable 150 Total liabilities 13,150 $ Stockholders' equity: Capital stock 8,000 $ Retained earnings 200 Total stockholders' equity 8,200 Total liabilities & stockholders' equity $ 21,350 © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 5-10 Learning Objective Learning Objective LO3 To explain the concept of adequate disclosure. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 5-11 Notes to the Financial Statements Examples of Items Disclosed Lawsuits pending Scheduled plant closings Governmental investigations Significant events occurring after the balance sheet date Specific customers that account for a large portion of revenue Unusual transactions and related party transactions Examples of Items Disclosed Lawsuits pending Scheduled plant closings Governmental investigations Significant events occurring after the balance sheet date Specific customers that account for a large portion of revenue Unusual transactions and related party transactions Drafting Notes to the Financial Statements Drafting Notes to the Financial Statements © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 5-12 Learning Objective Learning Objective LO4 To explain the purposes of closing entries; prepare these entries. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 5-13 Closing the Temporary Accounts Closing the Temporary Accounts Close Revenue accounts to Income Summary. Close Expense accounts to Income Summary.  Close Income Summary account to Retained Earnings. Close Dividends to Retained Earnings. The closing process gets the temporary accounts ready for the next accounting period. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 5-14 JJ's Lawn Care Service Adjusted Trial Balance May 31, 2007 Cash 3,925 $ Accounts receivable 75 Tools & equipment 2,650 Accum. depreciation: tools & eq. 50 $ Truck 15,000 Accum. depreciation: truck 250 Notes payable 13,000 Accounts payable 150 Capital stock 8,000 Dividends 200 Sales revenue 750 Gasoline expense 50 Depreciation exp.: tools & eq. 50 Depreciation exp.: truck 250 Total 22,200 $ 22,200 $ Let’s prepare the closing entries for JJ’s Lawn Care Service. Let’s prepare the closing entries for JJ’s Lawn Care Service. Closing the Temporary Accounts Closing the Temporary Accounts © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 5-15 GENERAL JOURNAL Date Account Titles and Explanation P RDebit Credit May 31 Sales Reveune 750 Income Summary 750 To close the revenue account. Since Sales Revenue has a credit balance, the closing entry requires a debit to the Sales Revenue account. Since Sales Revenue has a credit balance, the closing entry requires a debit to the Sales Revenue account. Closing Entries for Revenue Accounts Closing Entries for Revenue Accounts © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 5-16 Income Summary 750 750 Sales Revenue 750 750 - Closing Entries for Revenue Accounts Closing Entries for Revenue Accounts © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 5-17 GENERAL JOURNAL Date Account Titles and Explanation P RDebit Credit May 31 Income Summary 350 Gasoline Expense 50 Depreciation Exp.: Tools & Equipment 50 Depreciation Exp.: Truck 250 To close the expense accounts. Since expense accounts have a debit balance, the closing entry requires a credit to the expense accounts. Since expense accounts have a debit balance, the closing entry requires a credit to the expense accounts. Closing Entries for Expense Accounts Closing Entries for Expense Accounts © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 5-18 Closing Entries for Expense Accounts Closing Entries for Expense Accounts Income Summary 350 750 400 Net Income Gasoline Exp. 50 50 - Depr. Exp.: Truck 250 250 - Depr. Exp.: Tools & Equipment 50 50 - © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 5-19 Since Income Summary has a $400 credit balance, the closing entry requires a debit to Income Summary. Since Income Summary has a $400 credit balance, the closing entry requires a debit to Income Summary. GENERAL JOURNAL Date Account Titles and Explanation P RDebit Credit May 31 Income Summary 400 Retained Earnings 400 To close Income Summary. Closing the Income Summary Account Closing the Income Summary Account © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 5-20 Retained Earnings 400 400 Income Summary 350 750 400 - The balance in Income Summary is now zero. Closing the Income Summary Account Closing the Income Summary Account © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 5-21 Since the Dividends account has a debit balance, the closing entry requires a credit to the Dividends account. Since the Dividends account has a debit balance, the closing entry requires a credit to the Dividends account. GENERAL JOURNAL Date Account Titles and Explanation P RDebit Credit May 31 Retained Earnings 200 Dividends 200 To close the Dividends account. Closing the Dividends Account Closing the Dividends Account © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 5-22 Closing the Dividends Account Closing the Dividends Account Retained Earnings 200 400 200 Dividends 200 200 - © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 5-23 Learning Objective Learning Objective LO5 To prepare an after- closing trial balance. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 5-24 JJ's Lawn Care Service After-Closing Trial Balance May 31, 2007 Cash 3,925 $ Accounts receivable 75 Tools & equipment 2,650 Accum. depreciation: tools & eq. 50 $ Truck 15,000 Accum. depreciation: truck 250 Notes payable 13,000 Accounts payable 150 Capital stock 8,000 Retained earnings 200 Total $ 21,650 21,650 $ After all closing entries are made, JJ’s After-Closing Trial Balance looks like this. After all closing entries are made, JJ’s After-Closing Trial Balance looks like this. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 5-25 Learning Objective Learning Objective LO6 To use financial statement information to evaluate profitability and liquidity. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 5-26 Did the business earn a profit or loss in the current period? What is the business’s future potential for a profit? Evaluating Profitability Evaluating Profitability Evaluating the Business Evaluating the Business Does the business have assets available to pay debts as they become due? Evaluating Liquidity Evaluating Liquidity © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 5-27 Evaluating Profitability Evaluating Profitability Evaluating Liquidity Evaluating Liquidity Evaluating the Business Evaluating the Business Net Income Percentage Net Income Total Revenue = Return on Equity Net Income Avg. Stockholders’ Equity = Current Ratio Current Assets Current Liabilities = Working Capital Current Assets – = Current Liabilities © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 5-28 Learning Objective Learning Objective LO7 To explain how interim financial statements are prepared in a business that closes its accounts only at year-end. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 5-29 Monthly Quarterly Jan. 1 Dec. 31 Annually Many companies prepare financial statements at various points throughout the year. Many companies prepare financial statements at various points throughout the year. Interim Financial Statements Preparing Financial Statements Covering Different Periods of Time Preparing Financial Statements Covering Different Periods of Time © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 5-30 Ethics, Fraud, and Corporate Governance Ethics, Fraud, and Corporate Governance A company should disclose any facts that an intelligent person would consider necessary for the statements to be interpreted properly. Public companies are required to file annual reports with the Securities and Exchange Commission (SEC). The SEC requires that companies include a section labeled “Management Discussion and Analysis” (MD&A) because the financial statements and related notes may be inadequate for assessing the quantity and sustainability of a company’s earnings. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 5-31 Learning Objective Learning Objective LO8 To prepare a worksheet and explain its uses. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 5-32 The Worksheet The Worksheet Balance Sheet Accounts Dr Cr Dr Cr Dr Cr Dr Cr Dr Cr Cash 18,592 18,592 18,592 Accounts Receivable 6,500 (h) 750 7,250 7,250 Shop Supplies 1,800 (a) 600 1,200 1,200 Notes Payable 4,000 4,000 4,000 Accounts Payable 2,690 2,690 2,690 Income Statement Accounts Repair Service Revenue 171,250 (h) 750 172,000 172,000 Advertising Expense 3,900 3,900 3,900 Wages Expense 56,800 (f) 1,950 58,750 58,750 272,000 272,000 12,200 12,200 279,100 279,100 135,058 175,000 144,042 104,100 Net Income 39,942 39,942 Totals 175,000 175,000 144,042 144,042 Balance Sheet . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . OVERNIGHT AUTO SERVICES Worksheet For the Year Ended December 31, 2007 Trial Balance Adjustments Adjusted Trial Balance Income Statement © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 5-33 End of Chapter 5 End of Chapter 5