Explain the purpose of a trial balance.
A trial balance is a list of all accounts with their debit or credit balances indicated in the appropriate column to provide a check on the equality of the debits and credits. The trial balance may be
Unadjusted-before adjustments are made.
Adjusted-after adjustments are made.
Post-closing-after revenues and expenses are closed to Retained Earnings.
Analyze the adjustments necessary at the end of the period to update balance sheet and income statements accounts.
Adjusting entries are necessary at the end of the accounting period to measure income properly, correct errors, and provide for adequate valuation of balance sheet accounts. The analysis involves
Identifying deferred accounts (created in the past when cash was received or paid before being earned or incurred) and accrued accounts (revenues earned and expenses incurred before cash is received or paid; cash will be received or paid in the future).
Drawing a timeline and setting up T-accounts with any computations.
Recording the adjusting entry needed to obtain the appropriate ending balances in the accounts.
Recording adjusting entries has no effect on the Cash account.
Present an income statement with earnings per share, statement of stockholders' equity, balance sheet, and supplemental cash flow information.
Adjusted account balances are used in preparing the following financial statements:
Income Statement: Revenues - Expenses = Net Income (including earnings per share computed as net income available to the common stockholders divided by the weighted average number of shares of common stock outstanding during the period).
Statement of Stockholders' Equity: (Beginning Contributed Capital + Stock Issuances - Stock Repurchases) + (Beginning Retained Earnings + Net Income - Dividends) = Ending Total Stockholders' Equity.
Supplemental cash flow information: Interest paid, income taxes paid, and significant noncash transactions.
Compute and interpret the net profit margin.
Net profit margin (Net Income / Net Sales) measures how much of every dollar of sales generated during the period is profit. A rising net profit margin signals more efficient management of sales and expenses.
Explain the closing process.
Temporary accounts (revenues, expenses, gains, and losses) are closed to a zero balance at the end of the accounting period to allow for the accumulation of income items in the following period. To close these accounts, debit each revenue and gain account, credit each expense and loss account, and record the difference (equal to net income) to Retained Earnings.
This chapter discussed the important steps in the accounting process that take place at year-end. These include the adjustment process, the preparation of the basic financial statements, and the closing process that prepares the records for the next accounting period. This end to the internal portions of the accounting process, however, is just the beginning of the process of communicating accounting information to external users.
In the next chapter we take a closer look at more sophisticated financial statements and related disclosures. We also examine the process by which financial information is disseminated to professional analysts, investors, the Securities and Exchange Commission, and the public, and the role each plays in analyzing and interpreting the information. These discussions will help you consolidate much of what you have learned about the financial reporting process from previous chapters. It will also preview many of the important issues we address later in the book.
