Chapter TitlePowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA
Copyright © 2012 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin
The Accounting Cycle Reporting Financial Results
Chapter 5
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Preparing Financial Statements
Publicly owned companies – those with shares listed on a stock exchange – have obligations to release annual and
quarterly information to their stockholders and to the public.
The annual report includes comparative financial statements and other information relating to the company’s financial position,
business operations, and future prospects.
The financial statements contained in the annual report must be audited by a firm of certified public accountants (CPAs).
Presenter
Presentation Notes
Publicly owned companies – those with shares listed on a stock exchange – have obligations to release annual and quarterly information to their stockholders and to the public. These companies don’t simply prepare financial statements – they publish annual reports. An annual report includes comparative financial statements for several years and a wealth of other information about the company’s financial position, business operations, and future prospects. Before the annual report is issued, the financial statements must be audited by a firm of certified public accounts (CPAs). Publicly owned companies must file their audited financial statements and detailed supporting schedules with the Securities and Exchange Commission.
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JJ's Lawn Care Service Adjusted Trial Balance
May 31, 2011 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$
Now, let’s prepare the financial statements for JJ’s Lawn Care Service for May.
Presenter
Presentation Notes
Here is the Adjusted Trial Balance for JJ’s Lawn Care at May 31, 2011, that was completed at the end of Chapter 4. We will use the adjusted trial balance to prepare the financial statements. The first financial statement to prepare is the income statement. We prepare the income statement first because it determines the amount of net income to be reported in the statement of retained earnings.
Sheet1
JJ's Lawn Care Service Income Statement
For the month ending May 31, 2011 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.
The Income Statement
Presentation Notes
Here is JJ’s Income Statement for the month ended May 31, 2011. JJ’s has produced net income of $400. Revenues total $750. Expenses include gasoline expense and depreciation on the company’s equipment and truck.When preparing financial statements, we always begin with the income because net income is an integral part of the statement of retained earnings. Once the income statement is completed, the statement of retained earnings can be prepared.
Sheet1
Sales revenue
Business Losses
Summarizes the increases and decreases in Retained Earnings during the period.
The Statement of Retained Earnings
Presenter
Presentation Notes
Remember that net income increases retained earnings. Dividends and net losses decrease retained earnings for the period.
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For the Month Ended May 31, 2011
Retained earnings, May 1 -$ Add: Net income 400 Subtotal 400$ Less: Dividends 200 Retained earnings, May 31 200$
Now, let’s prepare the Balance Sheet.
The Statement of Retained Earnings
Presenter
Presentation Notes
Retained earnings is that portion of stockholders’ equity created by earning net income and retaining the related resources in the business. The statement of retained earnings summarizes the increases and decreases in retained earnings from business operations during the period. JJ’s Lawn Care was started in May, so the beginning balance in retained earnings was zero. We add net income of $400 to the beginning balance of zero and subtract the dividends paid of $200 to arrive at the ending retained earnings balance of $200.Retained earnings at May 31st will appear on the balance sheet of JJ’s Lawn Care.
Sheet1
Retained earnings, May 1
Assets Cash 3,925$ 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 Balance Sheet
Presentation Notes
The balance sheet lists the amounts of the company’s assets, liabilities, and owners’ equity at the end of the accounting period. The balances of the asset and liability accounts are taken directly from the adjusted trial balance. The amount of retained earnings at the end of the period is taken from the statement of retained earnings we just prepared. Note that the contra accounts, Accumulated Depreciation –Tools and Equipment and Accumulated Depreciation—Truck, reduce the balance in the related asset accounts.
Sheet1
JJ's Lawn Care Service Income Statement
For the month ending May 31, 2011
Sales revenue 750$ Operating expenses: Gasoline expense 50$ Depreciation: tools & equipment 50 Depreciation: truck 250 350 Net income 400$
JJ's Lawn Care Service Statement of Retained Earnings
For the Month Ended May 31, 2011
Retained earnings, May 1 -$ Add: Net income 400 Subtotal 400$ Less: Dividends 200 Retained earnings, May 31 200$
JJ's Lawn Care Service Balance Sheet May 31, 2011
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$
Presenter
Presentation Notes
This is the income statement for JJ’s Lawn Care at the end of May. Net income impacts the retained earnings of the company.The ending balance of retained earnings appears on the balance sheet. Now, it’s clear to see how all the financial statements articulate with each other.
Sheet1
Sales revenue
Retained earnings, May 1
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 the Notes that Accompany Financial Statements
Presenter
Presentation Notes
In addition to the basic financial statements, accountants must prepare notes to the financial statements. The purpose of the notes is to explain certain items or transactions to the reader. There is no comprehensive list of all information that should be disclosed in financial statements. The adequacy of disclosure is based on a combination of official rules, tradition, and accountants’ professional judgment. Two items always disclosed in the notes to financial statements are the accounting methods in use and the due dates of major liabilities. So, for example, JJ’s Lawn Care would disclose that straight-line depreciation was used to determine depreciation expense.The notes also explain any unusual or infrequent items that may be of interest to the reader. Almost all major corporations have a note disclosure about pending litigation.
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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.
Presenter
Presentation Notes
Once the financial statements have been prepared, the books are closed and it’s time to get ready for the next accounting period. Net income is earned over a period of time. At the start of a new period we want all revenue and expense accounts to have a zero balance so we can start recording income in this period.The closing of a company’s books is a four step process.Step one is to close all revenue accounts to a temporary account called Income Summary.Step two is to close all expense accounts to the Income Summary account. At this point, net income is isolated in the Income Summary.Step three is to then close Income Summary to Retained Earnings. Net income transfers from Income Summary to Retained Earnings and zeros out Income Summary. The Income Summary account never appears in the financial statements.The forth and final step is to close Dividends to Retained earnings. Net income is added to Retained Earnings and Dividends is subtracted from Retained Earnings. This updates Retained Earnings.
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JJ's Lawn Care Service Adjusted Trial Balance
May 31, 2011 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$
Closing the Temporary Accounts
Presentation Notes
All of the accounts that must be closed for JJ’s Lawn Care Service are highlighted on the adjusted trial balance shown here—dividends, sales revenue, and the three expense accounts. When the closing process is complete, the Retained Earnings account will have the proper balance. Notice that there is no Retained Earnings account because the company was started in May.Let’s get started by closing Sales Revenue.
Sheet1
GENERAL JOURNAL
Date Account Titles and Explanation Debit 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.
Presenter
Presentation Notes
Sales Revenue has a credit balance, so to close the account it must be debited for its current balance and credited to Income Summary.The closing entry for revenues is to debit the revenue account, Sales Revenue, for its balance of $750, and credit Income Summary for the same amount. Let’s look at the ledger accounts to see what we have accomplished with this entry.
Sheet: )Sheet1
GENERAL JOURNAL
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Presenter
Presentation Notes
Notice that the balance in the Sales Revenue account is zero. We can now start accumulating revenue for the next accounting period, the month of June.Income Summary has a credit balance of $750. The total revenues have been transferred to the credit side of Income Summary. Now, let’s close the three expenses.
Sheet: Sheet1
Expense Accounts
Revenue Accounts
Income Summary
GENERAL JOURNAL
Date Account Titles and Explanation Debit 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.
Presenter
Presentation Notes
Expense accounts have a debit balance. The account is closed by a credit to the expense account and a debit to Income Summary.A credit is made to each of the three expense accounts for their balances with a debit to Income Summary for the total of $350. Let’s look at the ledger accounts after making the second closing entry.
Sheet: )Sheet1
GENERAL JOURNAL
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Income Summary 350 750
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Presentation Notes
After we credit the expense accounts, each expense account has a zero balance. Now the expense accounts are ready to begin recording expenses incurred during the month of June.Income Summary is debited for $350 and now has a credit balance of $400. This $400 represents the net income for the month of May.Next, net income must be transferred from Income Summary to Retained Earnings.
Sheet1
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Since Income Summary has a $400 credit balance, the closing entry requires a debit to
Income Summary.
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit May 31 Income Summary 400
Retained Earnings 400 To close Income Summary.
Closing the Income Summary Account
Presenter
Presentation Notes
Income Summary has a credit balance of $400. To close this account, Income Summary must be debited for $400 and a credit must be made to Retained Earnings for that amount.Let’s look at the ledger account balances.
)Sheet1
-
Closing the Income Summary Account
Presenter
Presentation Notes
Income Summary now has a zero balance and net income appears on the credit side of Retained Earnings. Remember, credits to Retained Earnings increase the account balance.The final closing entry deals with Dividends.
Sheet1
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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 Debit Credit May 31 Retained Earnings 200
Dividends 200 To close the Dividends account.
Closing the Dividends Account
Presentation Notes
The Dividends account has a debit balance. To close this account a credit is made to the Dividends account and debit to Retained earnings.Our final closing entry transfers the amount of dividends to the Retained Earnings account. Let’s look at the ledger account balances.
)Sheet1
&A
Presentation Notes
After we post the closing entry, the Dividends account has a zero balance. Retained Earnings now has a credit balance of $200. This is the ending balance of retained earnings and is the amount that appears on the balance sheet for JJ’s Lawn Care.
Sheet1
JJ's Lawn Care Service After-Closing Trial Balance
May 31, 2011 Cash 3,925$ 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-Closing Trial Balance
Presentation Notes
After preparing all the closing entries, an after-closing trial balance is prepared. Here is the after-closing trial balance for JJ’s Lawn Care Service. The after-closing trial balance shows we have no revenues, expenses, or dividends. The proper balance of Retained Earnings appears on the after-closing trial balance.If there are any revenues, expenses, or dividends on the after-closing trial balance, an error has been made and the closing entries must be reviewed.
Sheet1
Presentation Notes
Measures of profitability help users of financial information assess current profitability of a company and future potential for increased profits. Profitability measures help answer questions like “Did the business earn a profit or loss in the current period?” and “What is the business’s future potential for a profit?” Two common measures of profitability include the company’s net income percent, and its return on equity. When a ratio is calculated that has an income measure in the numerator and balance sheet measures in the denominator, an average must be used for the denominator. For the return on equity, add together the beginning balance in stockholders’ equity and the ending balance, then divide by two.Measures of liquidity help users assess the ability of the company to pay its debts when they fall due. Liquidity measures help answer a question like “Does the business have assets available to pay debts as they become due?” Almost all companies calculate working capital and current ratio. Working capital is current assets less current liabilities. The current ratio is current assets divided by current liabilities.
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Monthly
Quarterly
the year.
Interim Financial
Presenter
Presentation Notes
Almost all companies prepare annual and interim financial statements. An annual financial statement covers one year of operations. The year does not have to be a calendar year.Interim financial statements are usually prepared monthly and quarterly. Most large corporations publish quarterly reports for their shareholders.
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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.
Presenter
Presentation Notes
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.
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Supplemental Topic: The Worksheet
Balance Sheet Accounts Dr Cr Dr Cr Dr Cr Cash 18,592 18,592 Accounts Receivable 6,500 (h) 750 7,250 Shop Supplies 1,800 (a) 600 1,200
Notes Payable 4,000 4,000 Accounts Payable 2,690 2,690
Income Statement Accounts Repair Service Revenue 171,250 (h) 750 172,000 Advertising Expense 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 Net Income Totals
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Trial Balance Adjustments Adjusted Trial Balance
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Presentation Notes
Supplemental Topic: The Worksheet A worksheet illustrates in one place the relationships among the unadjusted trial balance, proposed adjusting entries, and financial statements. A worksheet is prepared at the end of the period, but before the adjusting entries are formally recorded in the accounting records. On this slide we illustrated an abbreviated version of a worksheet. The dotted lines indicate that some accounts are not listed for illustrative purposes. To complete a worksheet follow these 5 steps. Enter the ledger account balances in the Trial Balance columns. Enter the adjustments in the Adjustments columns. Prepare an adjusted trial balance. Extend the adjusted trial balance amounts into the appropriate financial statement columns. Total the financial statement columns and determine and record net income or net loss.
Sheet1
Trial Balance
Preparing Financial Statements
Slide Number 3
The Income Statement
The Balance Sheet
Drafting the Notes that Accompany Financial Statements
Closing the Temporary Accounts
Closing the Temporary Accounts
Closing the Dividends Account
Closing the Dividends Account
Ethics, Fraud, andCorporate Governance
Supplemental Topic: The Worksheet
End of Chapter 5