### hhofma3e_ch04_inst

```Chapter 4
1
Prepare an accounting worksheet
Use the worksheet to prepare financial
statements
Close the revenue, expense, and dividend
accounts
Prepare the post-closing trial balance
2
Classify assets and liabilities as current or
long-term
Describe the effect of various transactions
on the current ratio and the debt ratio
3
account balances.
Prepare the post-closing
trial balance.
During the period
Journalize and post
the closing entries.
Analyze and journalize
transactions as they
occur.
Post to the accounts.
At the end of the period
balance in each
account.
Prepare the financial
statements.
Enter the trial balance
and complete the
worksheet. Journalize
entries
IPO
anyone?
5
1
Prepare an accounting worksheet
6
A tool used to summarize information
It is not a:
journal
ledger
financial statement
analysis
7
Enter
account titles
Total the amounts
8
Enter the
Total the
amounts
Remember,
these still need
to be journalized
and posted
9
\$2,200 (Dr) + \$400 (Dr) = \$2,600
Compute each
balance
trial balance column
10
\$600 (Cr) - \$200 (Dr) = \$400
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
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
Also enter net income
as a balancing amount
on the balance sheet
Net income from
previous columns
13
Complete Worksheet
14
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
2
Use the worksheet to prepare financial statements
19
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
Worksheet
Compare the balances here
with the Income Statement
appearing next.
Income Statement
21
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
Worksheet
Balance Sheet
Compare the
balances on the
worksheet with the
Balance Sheet
appearing next.
23
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
Examples:
Cash
Accounts receivable
Supplies
Prepaid expenses
Inventory
25
Not converted to cash within the current year
Categories
Plant assets
Land
Building
Furniture
Equipment
Long-term investments
Other assets
26
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
Are not due within the current year
Examples:
Notes payable with due dates over one year
Mortgages
28
Report form should
bottom
30
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!
32
Draper Consulting, Inc.
Balance Sheet
December 31, 2012
ASSETS
LIABILITIES
Current assets:
Current liabilities:
Cash
\$ 16,350
Accounts payable
\$ 4,650
Accounts receivable
1,750
Salary payable
685
Supplies
200
Unearned service
Total current
18,300
revenue
700
assets
Plant assets:
Total current liabilities
6,035
Equipment
1,800
Acc. depr.
(30)
1,770
STOCKHOLDERS’ EQUITY
Common stock
\$ 18,000
Furniture
4,200
Retained earnings
165
Acc. depr.
(70)
4,130 Total stockholders’ equity
18,165
Total liabilities and
Total assets
\$ 24,200 stockholders’ equity
\$ 24,200
33
3
Close the revenue, expense, and dividend accounts
35
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.
36
Temporary
Closed at the end of the
period
Revenues
Expenses
Dividends
Start next period with a
zero balance
37
Permanent
Not closed at the end of
the period
Assets
Liabilities
Common stock
Retained earnings
Ending balance carries
forward to next period
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
The closing process
39
balance from the
January worksheet of
Silver Sign Company
is shown:
Requirement:
1. Journalize Silver’s
closing entries at
January 31.
40
1. Journalize Silver’s closing entries at January 31.
Jan. 31 Service revenue
Income summary
31 Income summary
Salary expense
Rent expense
Depreciation expense
Supplies expense
Utilities expense
41
\$16,800
\$16,800
6,200
3,600
1,400
400
200
600
31 Income summary
Retained earnings
31 Retained earnings
Dividends
10,600
10,600
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.
42
Draper Consulting, Inc.
Just complete the instruction for closing entries
and posting them
43
4
Prepare post-closing trial balance
44
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
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.
46
Goodrow Electric Company
Post-Closing Trial Balance
July 31, 2012
Cash
\$
Accounts receivable
Supplies
Equipment
Accumulated depreciation
Land
Accounts payable
Unearned service revenue
Long-term liabilities
Common stock
Retained earnings
Total
\$
47
100
1,600
200
4,500
\$
1,300
7,600 \$
1,100
1,400
800
1,000
2,000
7,600
1,200
6
Use the debt ratio, current ratio and the
interest coverage ratio
to evaluate a company
58
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
A ratio is a mathematical expression of the relationship
between two items.
Miles per
hour
Miles per
gallon
Risk to
Reward
ratio
Defects per
thousands
Fun to
trouble
ratio
Odds of
winning
Hundreds
more uses
We can compare business ratios with company history,
competitors, or another industry to learn several things about
Debt
exposure
Profitability
Managerial
effectiveness
Value
Strategy
Efficiency
Impending
doom
Hundreds
more uses
Is the company borrowing
responsibly?
Debt exposure aka
leverage
Find a tool to measure responsible
borrowing
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.
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
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?
64
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
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
Groups of up to 6
One laptop per team
User name: default
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
Practice Set Page 250
Complete the worksheet.
Prepare financials
Prepare closing entries
Prepare post-closing trial balance
68
Complete Worksheet
69
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
Heart of Texas Telecom has these account balances at December 31,
2012:
Note payable, long-term
Prepaid rent
Salary payable
Service revenue
Supplies
\$ 7,800
2,300
3,000
29,400
500
Accounts payable
Accounts receivable
Cash
Depreciation expense
Equipment
\$ 3,700
5,700
3,500
6,000
15,000
1. Compute Heart of Texas Telecom’s current ratio and debt ratio.
Total current assets
=
Total current liabilities
Total liabilities
\$14,500
=
=
Total assets
\$27,000
Current ratio =
Debt ratio
\$12,000
6,700
=
= 1.79
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.
71
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.
72
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.
73
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).
74
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.
75