hhofma3e_ch04_inst

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Chapter 4 1 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

2 Prepare an accounting worksheet Use the worksheet to prepare financial statements Close the revenue, expense, and dividend accounts Prepare the post-closing trial balance Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

3 Classify assets and liabilities as current or long-term Describe the effect of various transactions on the current ratio and the debt ratio Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Prepare the post-closing trial balance.

Start with the beginning account balances.

During the period

Analyze and journalize transactions as they occur.

Journalize and post the closing entries.

Post to the accounts.

IPO

At the end of the period

Prepare the financial anyone?

5 statements.

Compute the unadjusted balance in each account.

Enter the trial balance and complete the worksheet. Journalize and post adjusting entries Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

6 1 Prepare an accounting worksheet Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

A tool used to summarize information It is not a: journal ledger financial statement Computerized spreadsheets & sensitivity analysis Contains heading similar to statements 7 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Enter account titles unadjusted balances Total the amounts 8 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Enter the adjusting entries Total the amounts Remember, these still need to be journalized and posted 9 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

$2,200 (Dr) + $400 (Dr) = $2,600 Compute each account’s adjusted balance Enter the adjusted balance in the adjusted trial balance column 10 $600 (Cr) - $200 (Dr) = $400 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Draw an imaginary line above the first revenue account Every account above the line are Balance Sheet accounts Every account below the line are Income Statement accounts Copy the totals to the appropriate column 11

Assets Liabilities Equity Revenue Expenses

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Using the income statement columns, compute net income Revenues minus expenses Enter net income as the balancing amount Revenues total = $7,600 Expenses total = $3,900 Net income = $3,700 12 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Also enter net income as a balancing amount on the balance sheet Net income from previous columns 13 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Complete Worksheet

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Draper Consulting, Inc.

Just complete the instruction for completing the worksheet, not the rest of them.

Draw a line between BS and IS accounts Move Income statement accounts Sub total each column Plug in net income to balance & finalize totals Move Balance sheet accounts Sub total each column Plug in net income to balance & finalize totals 18 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

2 Use the worksheet to prepare financial statements 19 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

The worksheet contains the financial statement data.

Income statement column equals the income statement The Net income total is for our retained earnings statement Connects the Net income to the balance sheet Balance sheet column equals the balance sheet Worksheet is an

internal

document Financial statements are for

external

users 20 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Worksheet

21 Compare the balances here with the Income Statement appearing next.

Income Statement

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Beginning Retained earnings is found in the balance sheet columns, along with Dividends Net income is found in the income statement columns Ending Retained earnings is computed here Carry the ending Retained earnings balance to the balance sheet 22 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

23

Worksheet Balance Sheet

Compare the balances on the worksheet with the Balance Sheet appearing next.

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Liquidity measures quickness of cash How quickly an item can be converted into cash Classified Balance Sheet Lists assets in order of their liquidity Current Assets Converted to cash, sold, or used Most commonly within one year 24 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Examples: Cash Accounts receivable Supplies Prepaid expenses Inventory 25 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Not converted to cash within the current year Categories Plant assets Land Building Furniture Equipment Long-term investments Other assets 26 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Must be paid either with cash or goods and services within one year Examples: Accounts payable Notes payable due within one year Salary payable Interest payable Unearned revenue 27 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Are not due within the current year Examples: Notes payable with due dates over one year Mortgages 28 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Report form should be read top to bottom 30 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Draper Consulting, Inc.

Just complete instruction for preparing financial statements, not the rest.

Prepare Income statement first Prepare Statement of retained earnings second Prepare

Classified

Balance sheet third Remember to update retained earnings balance!

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Draper Consulting, Inc. Balance Sheet December 31, 2012 ASSETS Current assets: Cash Accounts receivable LIABILITIES Current liabilities: $ 16,350 1,750 Accounts payable Salary payable $ 4,650 685 Supplies Total current assets Plant assets: Equipment Acc. depr. 200 18,300 Unearned service revenue 700 1,800 (30) 1,770 Total current liabilities 6,035 STOCKHOLDERS’ EQUITY Common stock $ 18,000 Furniture Acc. depr. Total assets 4,200 Retained earnings (70) 4,130 Total stockholders’ equity Total liabilities and $ 24,200 stockholders’ equity 165 18,165 $ 24,200

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3 Close the revenue, expense, and dividend accounts 35 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Occurs at the end of the period Gets accounts ready for next period Zeroes out revenue and expense accounts Updates Retained earnings to the ending balance Four step process Close temporary accounts Closing entries do not capture new transactions like adjusting entries did. All closing entries do is transfer balances to their permanent destinations.

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Temporary

Closed at the end of the period Revenues Expenses Dividends Start next period with a zero balance

Permanent

Not closed at the end of the period Assets Liabilities Common stock Retained earnings Ending balance carries forward to next period 37 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Step 1 – Close Revenues to Income summary account Step 2 – Close individual Expense accounts to Income summary account Step 3 – Close Income summary account to Retained earnings account Step 4 - Close Dividends account to retained earnings account 38 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

The closing process 39 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

The adjusted trial balance from the January worksheet of Silver Sign Company is shown:

Requirement:

1. Journalize Silver’s closing entries at January 31.

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1. Journalize Silver’s closing entries at January 31.

Jan. 31 Service revenue Income summary $16,800 $16,800 31 Income summary Salary expense Rent expense Depreciation expense Supplies expense Utilities expense 6,200 3,600 1,400 400 200 600 41 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

31 Income summary Retained earnings 10,600 10,600 31 Retained earnings Dividends 800 800 2. How much net income or net loss did Silver earn for January? How can you tell?

Silver had

net income of $10,600

. We know this because

service revenue exceeded total expenses.

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Draper Consulting, Inc.

Just complete the instruction for closing entries and posting them Link to Draper Consulting, Inc. Adjusted trial balance 43 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

44 4 Prepare post-closing trial balance Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

List of permanent accounts and their balances after posting closing entries Total debits and credits must be equal Same accounts as on the balance sheet 45 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

After closing its accounts at July 31, 2012, Goodrow Electric Company had the following account balances: 1. Prepare Goodrow’s post-closing trial balance at July 31, 2012.

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Goodrow Electric Company Post-Closing Trial Balance Cash Accounts receivable Supplies Equipment Accumulated depreciation Land Accounts payable Unearned service revenue Long-term liabilities Common stock Retained earnings Total 47 July 31, 2012 $ 100 1,600 200 4,500 $ 1,300 1,200 $ 7,600 1,100 1,400 800 1,000 2,000 $ 7,600 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

58 6 Use the debt ratio, current ratio and the interest coverage ratio to evaluate a company Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

To measure the business’s financial position Decision makers use financial ratios Widely used debt analysis ratios: Debt ratio Current ratio Extra: Interest coverage ratio 59 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

A ratio is a mathematical expression of the relationship between two items.

Miles per hour Miles per gallon Defects per thousands Risk to Reward ratio Fun to trouble ratio Odds of winning Hundreds more uses

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We can compare business ratios with company history, competitors, or another industry to learn several things about businesses.

Debt exposure Strategy Profitability Value Impending doom Efficiency Managerial effectiveness Hundreds more uses

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Is the company borrowing responsibly?

Find a tool to measure responsible borrowing Debt exposure aka leverage Debt Ratio: debt ÷ assets The #’s: 810 ÷900 = 90% The story 50% is optimal, they have way too much debt and way too little equity.

This is too much borrowing compared to the industry norm of equal liability and equity financing. They may be in danger of failing to make the associated interest payments and in paying back principle. If they can’t pay, the equity holders lose their entire investment. This is very risky.

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Total liabilities Total assets

Indicates the proportion of a business’s assets that are financed with debt Measures business’s ability to pay its debts Rule of thumb: Above 60% is considered unsafe 50% is widely regarded as optimal Lower may suffer from unnecessarily high cost of capital 63 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Current assets Current liabilities

Measures a company’s ability to pay its current liabilities Rule of thumb Strong current ratio is 1.5

Ample cash on hand, with little wasteful excess 1.0 is either dangerously low, or well managed How to tell?

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Interest Coverage Ratio Earnings before interest & taxes Interest expense

Compares earnings to borrowing costs.

If too much earnings are going to lenders, then the company isn’t handling their debt well.

Rule of thumb Norm is between 2.0 and 3.0

Twice as much earnings as interest charges Lower than 2.0 means high interest is consuming over half of the company’s earnings Leaves little margin of performance safety 65 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

www.yahoo.com/finance Debt ratio Current ratio Interest coverage ratio Liabilities ÷ Assets Current Assets ÷ Current liabilities EBIT ÷ Interest expense Compare each number against benchmark Judge each number and interpret 66 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Groups of up to 6 One laptop per team User name: default Password: mpcmpcmpc Follow the Yahoo Finance debt analysis procedure Report on the debt analysis reporting form 20 minutes of work, not enough to finish everyone Submit individual sheet for points next class 67 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Practice Set Page 250 Complete the worksheet.

Prepare financials Prepare closing entries Prepare post-closing trial balance 68 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Complete Worksheet

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Be

on time

or you will miss out on the action Be prepared to execute the entire accounting cycle at warp speed If you put maximum effort into it, you will master the accounting cycle and get the point of the financial statements This is a huge help toward your test preparation, but only if you are prepared Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Heart of Texas Telecom has these account balances at December 31, 2012: Note payable, long-term $ 7,800 Accounts payable $ 3,700 Prepaid rent 2,300 Accounts receivable 5,700 Salary payable 3,000 Cash 3,500 Service revenue 29,400 Depreciation expense 6,000 Supplies 500 Equipment 15,000 1. Compute Heart of Texas Telecom’s current ratio and debt ratio

.

Current ratio = Total current assets Total current liabilities = $12,000 6,700 = 1.79

Debt ratio = Total liabilities Total assets = $14,500 $27,000 = 0.54

2. How much in current assets does Heart of Texas Telecom have for every dollar of current liabilities that it owes?

Heart of Texas Telecom has

$1.79

of current assets for every dollar of current liabilities that it owes.

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The worksheet is a tool that puts the whole accounting process in one place. Remember that debits = credits in the first three columns. Columns 4 and 5 (Income Statement and Balance Sheet) debits do not equal credits until you post the net income or net loss for the period. The formal financial statements yield the same net income or loss that is shown on the worksheet.

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Closing the accounts is just like starting a new baseball game. The score is 0-0. All temporary account balances are zero after closing.

The post-closing trial balance contains the same accounts that the balance sheet contains— assets, liabilities, Common stock, and Retained earnings.

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Classification means dividing assets and liabilities between those that will last less than a year (current) and those that will last longer than a year (long-term). The classified balance sheet still represents the accounting equation and must balance (Assets = Liabilities + Equity).

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The current ratio measures liquidity within one year by comparing current assets to current liabilities. The debt ratio measures the ability to pay liabilities in the long term by comparing all liabilities to all assets. The different ratios give different views of a company’s financial health.

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Copyright

77 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America.

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