Chapter

5
The Accounting Cycle
Reporting Financial Results

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2008

Learning Objective

To prepare an income
statement, a statement
of retained earnings,
and a balance sheet.

LO1
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This is the
Adjusted Trial
Balance for JJs.

JJ's Lawn Care Service

Adjusted Trial Balance
May 31, 2007
Cash

Accounts receivable

3,925
75

Tools & equipm ent

Accum ulated depreciation: tools &
equipm ent

2,650
$

Truck

15,000

Accum um lated 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 & equipm ent

50

Depreciation expense: truck

Total

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50

250
$

22,200

22,200

Now, lets
prepare the
financial
statements for
JJs Lawn Care
Service for May.
The McGraw-Hill Companies, Inc., 2008

JJ's Lawn Care Service

Income Statement
For the month ending May 31, 2007
Sales revenue

750

Operating expenses:
Gasoline expense
Depreciation: tools & equipment
Depreciation: truck
Net income

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50
50
250

350
$

Net income also appears on the

Statement of Retained Earnings.

400

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Statement of Retained Earnings

This statement summarizes the increases
and decreases in Retained Earnings during
the period.
Business
Earnings

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Dividends
Business
Losses

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JJ's Lawn Care Service

Statement of Retained Earnings
For the Month Ended May 31, 2007
Retained earnings, May 1
Add: Net income
Subtotal
Less: Dividends
Retained earnings, May 31

400
$ 400
200
$ 200

Now, lets prepare the Balance Sheet.

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JJ's Lawn Care Service

Balance Sheet
May 31, 2007
Assets
Cash
Accounts receivable
Tools & equipment
$ 2,650
Less: Accumulated depreciation
50
Truck
$ 15,000
Less: Accumulated depreciation
250
Total assets
Liabilities & Stockholders' Equity
Liabilities:
Notes payable
Accounts payable
Total liabilities
Stockholders' equity:
Capital stock
$ 8,000
Retained earnings
200
Total stockholders' equity
Total liabilities & stockholders' equity

McGraw-Hill/Irwin

3,925
75
2,600

14,750
$ 21,350

$ 13,000
150
$ 13,150

8,200
$ 21,350

The McGraw-Hill Companies, Inc., 2008

Learning Objective
To explain how the
income statement and
the statement of
retained earnings relate
to the balance sheet.

LO2
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The McGraw-Hill Companies, Inc., 2008

Preparing Financial Statements

JJ's Lawn Care Service
Income Statement
For the month ending May 31, 2007

JJ's Lawn Care Service

Balance Sheet
May 31, 2007
Assets
Cash
Accounts receivable
Tools & equipment
$ 2,650
Less: Accumulated depreciation
50
Truck
$ 15,000
Less: Accumulated depreciation
250
Total assets
Liabilities & Stockholders' Equity
Liabilities:
Notes payable
Accounts payable
Total liabilities
Stockholders' equity:
Capital stock
$ 8,000
Retained earnings
200
Total stockholders' equity
Total liabilities & stockholders' equity

McGraw-Hill/Irwin

3,925
75
2,600

14,750
$ 21,350

$ 13,000
150
$ 13,150

Sales revenue
Operating expenses:
Gasoline expense
Depreciation: tools & equipment
Depreciation: truck
Net income

$ 750
$

50
50
250

350
$ 400

JJ's Lawn Care Service

Statement of Retained Earnings
For the Month Ended May 31, 2007
Retained earnings, May 1
Add: Net income
Subtotal
Less: Dividends
Retained earnings, May 31

400
$ 400
200
$ 200

8,200
$ 21,350
The McGraw-Hill Companies, Inc., 2008

Learning Objective

To explain the concept

of adequate disclosure.

LO3
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Drafting Notes to the Financial

Statements
Examples of Items Disclosed
Notes to the
Financial Statements

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

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Learning Objective

To explain the purposes

of closing entries;
prepare these entries.

LO4
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Closing the Temporary Accounts

Close Revenue accounts
to Income Summary.

Close Expense accounts

to Income Summary.

The closing process

gets the temporary
accounts ready for the
next accounting
period.

Close Income Summary

account to Retained
Earnings.

Close Dividends to
Retained Earnings.

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Closing the Temporary Accounts

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
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Lets prepare the

closing entries
for JJs Lawn
Care Service.

The McGraw-Hill Companies, Inc., 2008

Closing Entries for Revenue Accounts

Since Sales Revenue has a credit balance, the
closing entry requires a debit to the Sales Revenue
account.
GENERAL JOURNAL
Date

Account Titles and Explanation

May 31 Sales Reveune

Income Summary

Debit

Credit

750
750

To close the revenue account.

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Closing Entries for Revenue Accounts

Income Summary
750

Sales Revenue
750
750

750

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Closing Entries for Expense Accounts

Since expense accounts have a debit balance, the
closing entry requires a credit to the expense
accounts.
GENERAL JOURNAL
Date

Account Titles and Explanation

Debit

May 31 Income Summary

350

Gasoline Expense

50

Depreciation Exp.: Tools & Equipment

50

Depreciation Exp.: Truck

To close the expense accounts.

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Credit

250
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Closing Entries for Expense Accounts

Gasoline Exp.
50
50
Depr. Exp.: Tools &
Equipment
50
50
-

Depr. Exp.: Truck

250
250
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Income Summary
350
750

400
Net Income
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Closing the Income Summary Account

Since Income Summary has a $400 credit balance,
the closing entry requires a debit to Income
Summary.
GENERAL JOURNAL
Date

Account Titles and Explanation

May 31 Income Summary

Retained Earnings

Debit Credit
400
400

To close Income Summary.

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Closing the Income Summary Account

Retained Earnings
400

Income Summary
350
750
400

400

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The balance in Income

Summary is now zero.
The McGraw-Hill Companies, Inc., 2008

Closing 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

May 31 Retained Earnings

Dividends

Debit Credit
200
200

To close the Dividends account.

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Closing the Dividends Account

Dividends
200
200

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Retained Earnings
200
400

200

The McGraw-Hill Companies, Inc., 2008

Learning Objective

To prepare an afterclosing trial balance.

LO5
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The McGraw-Hill Companies, Inc., 2008

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

McGraw-Hill/Irwin

After all
closing
entries are
made, JJs
After-Closing
Trial Balance
looks like
this.

The McGraw-Hill Companies, Inc., 2008

Learning Objective

To use financial
statement information to
evaluate profitability and
liquidity.

LO6
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Evaluating the Business

Evaluating
Profitability

Evaluating
Liquidity

Did the business earn a

profit or loss in the
current period?

Does the business have

assets available to pay
debts as they become
due?

What is the businesss

future potential for a
profit?
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The McGraw-Hill Companies, Inc., 2008

Evaluating the Business

Evaluating
Profitability

Evaluating
Liquidity

Net Income
Net Income
=
Percentage
Total Revenue

Working
Current Assets
=
Capital
Current Liabilities

Return on
Equity

Current
Current Assets
=
Ratio
Current Liabilities

McGraw-Hill/Irwin

Net Income
Avg. Stockholders
Equity

The McGraw-Hill Companies, Inc., 2008

Learning Objective
To explain how interim
financial statements are
prepared in a business
that closes its accounts
only at year-end.

LO7
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The McGraw-Hill Companies, Inc., 2008

Preparing Financial Statements

Covering Different Periods of Time
Many companies prepare financial statements at
various points throughout the year.
Annually
Interim
Financial
Statements

Quarterly
Monthly

Jan. 1
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Dec. 31
The McGraw-Hill Companies, Inc., 2008

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 companys
earnings.
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2008

Learning Objective

To prepare a worksheet
and explain its uses.

LO8
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The McGraw-Hill Companies, Inc., 2008

The Worksheet
OVERNIGHT AUTO SERVICES
Worksheet
For the Year Ended December 31, 2007

Balance Sheet Accounts

Cash
Accounts Receivable
Shop Supplies

Trial Balance
Dr
Cr
18,592
6,500
1,800

Adjustments
Dr
Cr
(h)

750
(a)

600

Adjusted Trial
Balance
Dr
Cr
18,592
7,250
1,200

Income Statement
Dr
Cr

Balance Sheet
Dr
Cr
18,592
7,250
1,200

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Notes Payable
Accounts Payable

4,000
2,690

4,000
2,690

4,000
2,690

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Income Statement Accounts
Repair Service Revenue
Advertising Expense
Wages Expense

171,250
3,900
56,800

(h)

750

172,000
3,900

(f)

1,950

58,750

172,000
3,900

58,750

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
272,000
Net Income
Totals

McGraw-Hill/Irwin

272,000

12,200

12,200

279,100

279,100

135,058
39,942
175,000

175,000

144,042

175,000

144,042

104,100
39,942
144,042

The McGraw-Hill Companies, Inc., 2008

End of Chapter 5

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2008