Chapter 4: Completing the Accounting Cycle

Question 1

Accounting Cycle

Answer 1

The process to produce financial statements for a period.
1) Analyze business transactions
2) Journalize transactions
3) Post to ledger accounts
4) Prepare Trial Balance
4.5) Prepare Worksheet (optional)
5) Journalize and post adjusting entries
6) Prepare an adjusted Trial Balance
7) Prepare Financial Statements
8) Journalize and post closing entries
9) Prepare post closing Trial Banace
then back to one!
(1-3 happen during the period, 4-9 at the end of the period)

Question 2

Closing Process

Answer 2

At the end of a period, jounalizing and posting the closing entries to set the balance of temporary accounts (revenues, expenses, income summary and dividends) to zero.

Question 3

Liquidity

Answer 3

Ability to pay obligations expected due in the next year

Question 4

Operating Cycle

Answer 4

Average time from purchase of inventory to collection of cash from customers

Question 5

Current Assets

Answer 5

Assets that the company expects to convert to cash or use up within one year (or one operating cycle - whichever is longer).

Generally listed on balance sheet in the order assets are expected to be converted to cash.

Cash
Short Term Investments
Accounts Receivable
Inventory
Prepaid Expenses

Question 6

Long Term Assets

Answer 6

Long term investments (over 1 year holding) such as:

• stocks and bonds
• Property, plant and Equiptment
• land or buildings NOT being used in operating activities
• Intangible assets

Question 7

Current Liabilities

Answer 7

Obligation to pay in one year/ one operating cycle (whichever is less)

usually:

1) Notes Payable
2) Accounts Payable
3) Other current liabilities in order of magnitude most to least. Including long term liabilities/ portions of long term liabilities that are coming due within the operating cycle.

Question 8

Long Term Liabilities

Answer 8

Obligations the company expects to pay after a year

Liabilities or portions of long term liabilities that are due within the year are moved to current.

Question 9

Temporary vs Permanent Accounts

Answer 9

Temporary (aka “nominal”): accounts that are closed at the end of the fiscal year - these account relate to a specific accounting period.

• Revenue and Expense accounts
• Owner’s Drawing Accounts

Permanent (aka “real”): accounts that are not closed at the end of the fiscal year.

• Asset and Liability Accounts
• Owner’s Capital/ Stock accounts

Question 10

Correcting Entries

Answer 10

Must be posted BEFORE the closing entries

Alternate option to reverse the incorrect entry and then post the correct entry

Question 11

Closing Entries

Answer 11

Fiscal year-end adjusting journal entries that formally recognize net income (or loss) and drawings to owner’s capital or retained earnings.

Question 12

Closing the Books (Revenue and Expenses)

Answer 12

Debit Revenue account to $0
Credit Income Summary

Debit Income Summary
Credit Expense Accounts to $0.00

If net gain (normal balance Credit side)
Debit Income Summary to $0.00
Credit Owner’s Capital

if net loss (balance Debit Side)
Debit Owner’s Capital
Credit Income Summary to $0.00

(Computer’s simplify this process)

Question 13

Closing the Books (Owner’s Drawing)

Answer 13

Debit Owner’s Capital (or retained earnings)
Credit Owner’s Drawing to $0.00

(Computer’s simplify this process)

Question 14

Income Summary

Answer 14

Account used to close out expenses and revenue at the end of the accounting period

Debit Decrease | Credit Increase
Credit Normal Balance

Question 15

Reversing Entry

Answer 15

Switches the debit and credit of a previous entry to make the next period’s accounting easier
(review this further)

Question 16

Balance Sheet Accounts

Answer 16

All assets, liabilities and stockholders equity
- Assets and Contra-assets 
   (inc prepaid expenses)
- Liabilities (payables0
   (inc unearned revenue)
- Equity/ common stock

All Permanent Accounts

Question 17

Classified balance sheet

Answer 17

Snapshot of a single point in time
Similar assets/ similar liabilities grouped (but still in A= L+OE form)

Asset types:

• Current assets
• Long term investments
• Property, Plant, and Equipment
• Intangible assets

Liability Types:

• Current Liabilities
• Long term Liabilities

Question 18

Post-Closing Trial Balance

Answer 18

Proves the Debit vs. Credit equality of the permanent account balances after temporary accounts are closed

Question 19

Liquidity Ratios

Answer 19

Measure the ability of the company to pay current liabilities with current assets

• Current Ratio
• Working Capital

Question 20

Current Ratio

Answer 20

Shows $qty of current assets available for every $1.00 of current liabilities. $2 and up preferred. (1.5 strong, 1 and lower is risky.)

Current Assets / Current Liabilities= Current Ratio

Question 21

Working Capital

Answer 21

Shows the current assets left after paying all current liabilties

Current Assets - Current Liabilities= Working Capital