handout 5

• The general ledger for accounts receives information from the chart of accounts
• The bookkeeping system combines the activity for a predetermined amount of time for each account to create a trial balance
• The trial balance can be used to create financial statements
• The accountant of a business must match each line item in the financial statement to the trial balance account
• The Accounting Worksheet records all accounting data and prepares the company's financial statements at the end of each accounting cycle to guarantee accuracy
• Accounting spreadsheets are designed primarily for internal use
• External users, such as investors and creditors, rarely have the opportunity to view the company's accounting worksheet
• Steps in Preparing a Worksheet:

  • Enter the unadjusted trial balance
  • Enter adjustments
  • Prepare the adjusted trial balance
  • Sort adjusted trial balance amounts to financial statements
  • Total statement columns, compute income or loss, and balance columns
• One of the final steps in the accounting cycle is the preparation of financial statements
• Financial Statement Preparations:

  • Prepare Income Statement
  • Prepare the Statement of Owner’s Equity (Retained Earnings)
  • Prepare the Balance Sheet
  • Prepare the Statement of Cash Flow
  • Financial Statements Analysis
• An income statement is prepared monthly, quarterly, or annually in the business world
• If total revenue is lower than total expenses, the result is considered a “Net Loss”; if total revenue is higher than total expenses, the result is considered a “Net Gain”
• Importance of Income Statement:

  • Helps business owners learn about the company's current financial situation
  • Provides insight into the business's financial state for stakeholders, shareholders, and the business owner
  • Helps in calculating tax liability
• Retained earnings are profits not distributed as dividends but reserved for reinvestment back into the business
• Importance of Statement of Owner’s Equity:

  • Provides a link between the income statement and balance sheet
  • Reinvestment in the business aims to increase earnings in the future
• The balance sheet is essential to accounting and financial modeling
• Assets and liabilities are shown on the balance sheet, further broken down into categories "current" and "non-current"
• Importance of Balance Sheet:

  • Shows a company's financial health at a specific time
  • Helps monitor performance, spot trends, and implement financial support strategies
  • Assists in assessing the ability to pay bills on time and use credit to finance the business
  • Provides warning signs to resolve potential issues before they harm the business
  • Can be used to determine an investment's profitability
• The objective of a Statement of Cash Flow is to provide information about a company's cash inflows and outflows
• Statement of Cash Flow:

  • Objective: provide a comprehensive picture of a company's cash flow over a specific period
  • Shows the amount of money entering and leaving the company, demonstrating its capacity to function now and in the future
  • Typically broken into three sections:

  1. Operating activities: detail cash flow generated from regular goods or services, including revenue and expenses

  2. Investing activities: include cash flow from purchasing or selling assets (physical and non-physical) using free cash, not debt
• 3. Financing activities: detail cash flow from both debt and equity financing
• Importance of Statement of Cash Flow:

  • Reveals the phase a business is in: startup, mature, transitioning, or declining
  • Helps investors assess risk and growth potential
  • Impacts internal decisions like budgeting and hiring/firing
  • Cash flow can be positive (taking in more cash than spending) or negative (spending more than receiving)
• Closing Entries:

  • Made at the end of the accounting period to prepare temporary accounts for the next period
  • Temporary accounts (revenue, expenses, and withdrawals) should be closed or brought to zero
  • Four steps in preparing closing entries:

  1. Close all income accounts to Income Summary

  2. Close all expense accounts to Income Summary

  3. Close all income summaries to the appropriate capital account

  4. Close withdrawals to the capital accounts (for sole proprietorship and partnership)
• Income Summary:

  • Temporary account used to make closing entries
  • Balances of temporary accounts are emptied into the income summary account
  • Net balances of all temporary accounts are transferred to retained earnings, a permanent account on the balance sheet
• Post-Closing Trial Balance:

  • Final trial balance prepared before the beginning of the new accounting period
  • Used to verify beginning balances and ensure debits and credits remain in balance after closing entries
  • Three main types of reports can be run on the trial balance at specific points in the accounting cycle:

  1. Unadjusted trial balance

  2. Adjusted trial balance

  3. Post-closing trial balance
• Reversing Entries:

  • Journal entry made during an accounting period that reverses some entries from the previous period
  • Typically made at the beginning of an accounting period
  • Used when the accountant does not want accruals to remain in the system for another period
  • Example provided for reversing entries at the beginning of a fiscal year