Page 175 - Accounting Principles (A Business Perspective)

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As you can see from these comparisons, the current ratios vary a great deal. An old rule of thumb is that the
current ratio should be at least 2:1. However, what constitutes an adequate current ratio depends on available lines
of credit, the cash-generating ability of the company, and the nature of the industry in which the company operates.

For instance, companies in the airline industry are able to generate huge amounts of cash on a daily basis and may
be able to pay their current liabilities even if their current ratio is less than 1:1. Comparing a company's current
ratio with other companies in the same industry makes sense because all of these companies face about the same
economic conditions. A company with the lowest current ratio in its industry may be unable to pay its short-term
obligations on a timely basis, unless it can borrow funds from a bank on a line of credit. A company with the highest
current ratio in its industry may have on hand too many current assets, such as cash and marketable securities,
which could be invested in more productive assets.

The next chapter describes the assumptions, concepts, and principles that constitute the accounting theory
underlying financial accounting. Thus, accounting theory dictates the standards and procedures applied to the
reporting of financial information in the financial statements.
Understanding the learning objectives
• Analyze transactions by examining source documents.
• Journalize transactions in the journal.

• Post journal entries to the accounts in the ledger.
• Prepare a trial balance of the accounts and complete the work sheet.
• Prepare financial statements.
• Journalize and post adjusting entries.
• Journalize and post closing entries.
• Prepare a post-closing trial balance.

• The work sheet is a columnar sheet of paper on which accountants summarize information needed to make
the adjusting and closing entries and to prepare the financial statements.
• Work sheets may vary in format. The work sheet illustrated in the chapter has 12 columns—two each for
trial balance, adjustments, adjusted trial balance, income statement, statement of retained earnings, and
balance sheet.
• The information needed to prepare the income statement is in the Income Statement columns of the work
sheet. Net income for the period is the amount needed to balance the two Income Statement columns in the
work sheet.
• The information needed to prepare the statement of retained earnings is in the Statement of Retained

Earnings columns of the work sheet. The ending Retained Earnings balance is carried forward to the
balance sheet.
• The information needed to prepare the balance sheet is in the Balance Sheet columns of the work sheet.
• As explained in Chapter 3, adjusting entries are necessary to bring the accounts to their proper balances
before preparing the financial statements. Closing entries are necessary to reduce the balances of revenue,
expense, and Dividends accounts to zero so they are ready to receive data for the next accounting period.

• Revenue accounts are closed by debiting them and crediting the Income Summary account.
• Expense accounts are closed by crediting them and debiting the Income Summary account.

Accounting Principles: A Business Perspective 176 A Global Text