Chapter 12

Financial Statements,
Closing Entries, and
Reversing Entries

1
College Accounting
10th Edition
McQuaig Bille Nobles

McQuaig PowerPoint presented by Douglas Cloud

Professor Emeritus of Accounting, Pepperdine
Bille © 2011 Cengage Learning
University 12–1
 The
The Income
Income Statement
Statement
 Each of the amounts that appear in the Income
Statement columns of the work sheet will be
used in the income statement.
 The basic format of an incomes statement—

Net
Net Sales
Sales
–– Cost
Cost of
of Goods
Goods Sold
Sold
== Gross
Gross Profit
Profit
–– Operating
Operating Expenses
Expenses
== Income
Income from
from Operations
Operations

12–2
 Gross
Gross Profit
Profit Contrasted
Contrasted
with
with Net
Net Profit
Profit
Several years ago, Della Reyes bought an antique
table at a second-hand store for $800. She sold
the table for $1,850. She advertised in the daily
newspaper at a cost of $73. How much did she
clear as profit?
Sale of Table $1,850
Less Cost of Table – 800
Gross Profit $1,050
Less Advertising Expense – 73
Net Income or Net Profit $ 977

12–3
 Gross
Gross Profit
Profit Contrasted
Contrasted
with
with Net
Net Profit
Profit
 Gross Profit is the profit on the sale of the
table before any expenses have been
deducted.
 Net Income, or Net Profit, is the final or
clear profit after all expenses have been
deducted.
 Most accountants prefer Net Income.

12–4
 Revenue
Revenue from
from Sales
Sales

 Sales Returns and Allowances and Sales

Discounts are deducted from Sales to give us
Net Sales.
 Note that we record these items in the same
order in which they appear in the ledger.

12–5
Gross
Gross Profit
Profit Percentage
Percentage

Net Sales
is the 100
percent
row

12–6
Gross
Gross Profit
Profit Percentage
Percentage
In 2010, for
every $100 in
net sales, cost
of goods
available for
sale amounted
to $59.

$294,000
$500,000

12–7
Gross
Gross Profit
Profit Percentage
Percentage
In 2011, for
every $100 in
net sales,
advertising
expense
amounted to $4.

$21,400
$528,000

12–8
Gross
Gross Profit
Profit Percentage
Percentage
In 2010, for
every $100 in
net sales, net
income
amounted to
$26.

$132,000
$500,000

12–9
 Cost
Cost of
of Goods
Goods Sold
Sold
The section of the income statement that requires
the greatest amount of concentration is the Cost
of Goods Sold section.

12–10
 Delivered
Delivered Cost
Cost of
of Purchases
Purchases
First, let’s look closely at the Purchases section.

To arrive at Net Purchases, we deduct the sum

of Purchases Returns and Allowances and
Purchases Discounts from Purchases. Then
we add Freight In to get Delivered Cost of
Purchases.
12–11
 Cost
Cost of
of Goods
Goods Sold
Sold
You might think of Cost of Goods Sold like this:
Amount we started with (beginning inventory) $ 67,000
+ Net amount we purchased, including freight charges 87,920
Total amount that could have been sold (available) $154,920
‒ Amount left over (ending inventory) 64,800
Cost of the goods that were actually sold $ 90,120
Here’s the same Cost of Goods Sold expressed in proper wording:
Merchandise Inventory, January 1, 20‒‒ $ 67,000
+ Delivered Cost of Purchases 87,920
Cost of Goods Available for Sale $154,920
‒ Merchandise Inventory, December 31, 20‒‒ 64,800
Cost of Goods Sold $ 90,120

12–12
 Operating
Operating Expenses
Expenses
Selling Expenses are any expenses directly
connected with the selling activity:
 Sales Salary Expense
 Sales Commissions Expense
 Advertising Expense
 Store Supplies Expense
 Delivery Expense
 Depreciation Expense, Store Equipment

12–13
 Operating
Operating Expenses
Expenses
General Expenses are any expenses related to
the office or administration, or any expense that
cannot be directly connected with a selling
activity:
 Office Salary Expense
 Property Tax Expense
 Depreciation Expense, Office Equipment
 Rent Expense
 Insurance Expense
 Office Supplies Expense
12–14
Income
Income from
from Operations
Operations
Net Sales
– Cost of Goods Sold
Gross Profit
– Operating Expenses
Income from Operations

12–15
 Other
Other Income
Income and
and Other
Other Expenses
Expenses
The Other Income classification includes any revenue
account other than Sales. Typical accounts are as
follows:
 Rent Income
 Interest Income
 Gain on Disposal of Equipment
 Miscellaneous Income
The Other Expense classification includes various
nonoperating expenses:
 Interest Expense
 Loss on Disposal of Equipment
12–16
 The
The Statement
Statement of
of Owner’s
Owner’s
Equity
Equity and
and the
the Balance
Balance Sheet
Sheet

 Every figure in the Balance Sheet columns of the

work sheet is used in either the statement of
owner’s equity or the balance sheet.
 The income statement is prepared first, the
statement of owner’s equity second, and the
balance sheet last.

12–17
Balance
Sheet for
Whitewater
Raft Supply

12–18
 Current
Current Assets
Assets
 Current Assets consist of cash and any other assets or
resources that are expected to be realized in cash or to
be sold or consumed during the normal operating cycle of
the business (or one year, if the normal operating cycle is
less than twelve months).
 Examples of accounts that are current assets include
Cash, Notes Receivable, Accounts Receivable, and
Merchandise Inventory.
 Notes Receivable (current) are short-term (one year or
less) promissory notes (promise-to-pay notes) held by the
firm.
 Prepaid Insurance and Supplies are considered prepaid
items that will be used or will expire with the following
operating cycle or one year. 12–19
 Property
Property and
and Equipment
Equipment
 Property and Equipment are relatively long-lived
assets that are held for use in the production or sale of
other assets or services.
 Some accountants refer to them as fixed assets.
 Three accounts that usually appear in this category are
Land, Building, and Equipment.
 Building and Equipment are followed by their
respective Accumulated Depreciation accounts.

12–20
 Current
Current Liabilities
Liabilities
 Current Liabilities are debts that will become due
within the normal operating cycle of the business,
usually within one year.
 They normally will be paid, when due, from current
assets.
 Three accounts that usually appear in this category are
Notes Payable, Wages Payable, and Interest
Payable.

12–21
 Long-Term
Long-Term Liabilities
Liabilities

 Long-Term Liabilities are debts that are payable over

a comparatively long period, usually longer than one
year.
 The current portion of notes, contracts, and loans is
shown as a current liability.
 An account that usually appears in this category is
Mortgage Payable.

12–22
 Working
Working Capital
Capital and
and
Current
Current Ratio
Ratio
Working capital is the amount of capital a firm has
available to use or to work with during a normal
operating cycle
Current Assets – Current Liabilities = Working Capital
The Current ratio is useful in revealing a firm’s
ability to pay its bills. It is calculated as follows:
Current Assets (amount coming in within one year)
Current Liabilities (amount going out within one year)

12–23
 Working
Working Capital
Capital and
and
Current
Current Ratio
Ratio
Two portions of Whitewater Raft Supply follow:

12–24
Working
Working Capital
Capital
Current Assets – Current Liabilities = Working Capital
$123,355 ‒ $43,330 = $80,025

Current
Current Ratio
Ratio
Current Assets
= Current Ratio
Current Liabilities
Whitewater Raft
$123,355
= 2.85 Supply has current
$43,330
assets available to pay
every dollar currently
due on December 31.
12–25
 Chart
Chart of
of Accounts
Accounts
The second digit in the chart of accounts stands
for the subclassification.
Assets: 1-- Revenue 4--
Current Assets 11- Revenue from Sales 41-
Property and Equip- Other Income 42-
ment 12- Cost of Goods Sold 5--
Liabilities 2-- Purchases 51-
Current Liabilities 21- Expenses 6--
Long-Term Liabilities 22- Selling Expenses 61-
Owner’s Equity 3-- General Expenses 62-
Capital 31- Other Expenses 63-

12–26
 Closing
Closing Entries
Entries
 At the end of the fiscal period, you close the
revenue and expense accounts so that you
can start the next fiscal period with zero
balances.
 You close the Drawing account because it,
too, applies to one fiscal period.
 Recall that these accounts are called
temporary-equity accounts, or nominal
accounts.

12–27
Four
Four Steps
Steps in
in the
the Closing
Closing Procedure
Procedure
STEP 1: Close the revenue accounts and the other
accounts that appear on the income
statement that have credit balances into
Income Summary.

12–28
 Four
Four Steps
Steps in
in the
the Closing
Closing Procedure
Procedure
STEP 2: Close the expense and other accounts appearing on
the income statement that have debit balances into
Income Summary. Note that you close Sales
Discounts and Sales Returns and Allowances along
with the expense accounts.
Four
Four Steps
Steps in
in the
the Closing
Closing Procedure
Procedure
STEP 3: Close the Income Summary account into
the Capital account, transferring net income
or loss to the Capital account.

12–30
Four
Four Steps
Steps in
in the
the Closing
Closing Procedure
Procedure

12–31
Four
Four Steps
Steps in
in the
the Closing
Closing Procedure
Procedure
STEP 4: Close the Drawing account into the Capital
account.

12–32
Four
Four Steps
Steps in
in the
the Closing
Closing Procedure
Procedure

12–33
 Reversing
Reversing Entries
Entries
 Reversing entries are general journal entries
that are the exact reverse of certain adjusting
entries.
 A reversing entry enables the accountant to
record routine transactions in the usual
manner, even though an adjusting entry
affecting one of the accounts involved in the
transaction has intervened.

12–34
 Reversing
Reversing Entries
Entries Example
Example
All the employees of Mason Company earn, altogether, $400 per
day for a five-day week and their payday occurs every Friday.
Their current paychecks include wages for that Friday and for the
preceding four days. The last day of the fiscal year falls on
Wednesday, December 31.

Wages Expense is debited and Cash Wages Expense is debited and

is credited (ignoring taxes and Cash is credited (ignoring taxes
deductions) $2,000. and deductions) $2,000. 12–35
 Reversing
Reversing Entries
Entries
The following reversing entry is made on the first day
of the following fiscal period (which is an exact reverse
of the adjusting entry):

12–36
 Reversing
Reversing Entries
Entries
Now, let’s follow the T accounts to see what happens.
We begin with the adjusting entry at December 31.

12–37
 Reversing
Reversing Entries
Entries
Next, we close Wages Expense (but not Wages
Payable).

Then we reverse the adjusting entry.

12–38
 Reversing
Reversing Entries
Entries

Note that this gives Wages Expense a credit balance,

and closes Wages Payable.

12–39
 Reversing
Reversing Entries
Entries
On the first payday of
the new fiscal period,
the accountant can
debit Wages Expense
and credit Cash for
$2,000 (just as if it was
the middle of the fiscal
year). After the payroll
entry, there will now be
a debit balance of $800
in Wages Expense,
which is the correct
amount.

12–40
Reversing
Reversing Entries
Entries

12–41
 Reversing
Reversing Entries
Entries Rules
Rules
If an adjusting entry is to be reversed, it must
meet both of the following qualifications:
1. The adjusting entry increases an asset or
liability account.
2. The asset or liability account did not have a
previous balance.

12–42