Accounting Principles, 9th Edition

Weygandt.Kieso.Kimmel

Chapter 4

Completing the Accounting Cycle

Aims of Lecture

Prepare a work sheet. Explain the process of closing the books. Describe the content and purpose of a post-closing trial balance. State the required steps in the accounting cycle. Explain the approaches to preparing correcting entries. Identify the sections of a classified balance sheet.

Using a Worksheet

A worksheet is a multiple-column form used for the adjustment process and preparing financial statements. It is a working tool, not a permanent accounting record. Use of a worksheet is optional. Worksheet make it possible to provide the financial statements to the interested parties at an earlier date.

Form and Procedure for a Worksheet

Steps in Preparing A Worksheet

Prepare a trial balance on the worksheet Enter the adjustments in the adjustments columns Enter adjusted balances in adjusted trial balance columns Extend adjusted trial balance amounts to appropriate financial statement columns Total the statement columns, compute net income (loss), and complete the work sheet

Preparing Financial Statements from a Worksheet

After completing a worksheet a company will have all the required data at hand to prepare financial statements.
Using a worksheet, companies can prepare financial statements before they journalize or post adjusting entries. A completed worksheet is not a substitute for formal financial statements.

Preparing Adjusting Entries from a Worksheet

A worksheet is not a journal. It cannot be used as a basis for posting to ledger accounts. The adjusting entries are prepared from the adjustment columns of the worksheet. The journalizing and posting of adjusting entries follows the preparations of financial statements.

Closing the Books

Closing the books means making the accounts

ready for the next period. Distinguishes between permanent and temporary accounts. Temporary accounts relate only to given accounting period. For example: revenues or expenses accounts and owners drawing account. Permanent accounts relate to one or more future accounting periods. For example: Balance sheet accounts.

Temporary vs. Permanent Accounts

TEMPORARY (Nominal)
These accounts are closed

PERMANENT (Real)
These accounts are not closed

All revenue accounts

All asset accounts

All expense accounts Owners drawing account

All liability accounts Owners capital account

Preparing Closing Entries

Companies transfers temporary account balances to the permanent owners equity account, Owners capital, by means of closing entries.

Closing entries formally transfers net income (loss) and owners drawings to owners capital.
It produce a zero balance in each temporary account.

Journalizing and posting is a required step in the accounting cycle.

Companies record closing entries in the general journal.

Preparing Closing Entries

Income Summary

It is a temporary account used in closing revenue and expense accounts. It minimizes the details in the permanent owners capital account.

Debit/Credit Rules for closing entries:

Debit each revenue account for its balance, and credit Income Summary for total revenues. Debit income summary for total expenses, and credit each expense account for its balance. Debit income summary and credit Owners capital for the amount of net income. Debit owners capital for the balance in the owners drawing account and credit owners drawing for the same amount.

Diagram of Closing ProcessProprietorship

(INDIVIDUAL) EXPENSES (INDIVIDUAL) REVENUES

INCOME SUMMARY

Diagram of Closing ProcessProprietorship

INCOME SUMMARY

3
OWNERS CAPITAL

Diagram of Closing ProcessProprietorship

OWNERS CAPITAL

4
OWNERS DRAWING

Cautions in Preparing closing entries

Avoid doubling revenue and expense balances.

Do not close Owners Drawing through the Income Summary account.

Posting Closing Entries

All temporary accounts will have zero balances after posting the closing entries. Owners capital represents total equity of the owner at the end of the accounting period. No entries are journalized and posted to Income Summary account during the year. We cannot close permanent accounts (assets, liabilities, and owners capital).

Post Closing Trial Balance

Post-closing trial balance has been prepared from the ledger after all closing entries have been journalized and posted.

The purpose of this trial balance is to prove the equality of the permanent account balances that are carried forward into the next accounting period.

Post-Closing Trial Balance

Steps in the Accounting Cycle

Analyze business transactions

Journalize the transactions Post to ledger accounts

Prepare a trial balance

Journalize and post adjusting entries (Deferrals/Accruals)

Steps in the Accounting Cycle

Prepare an adjusted trial balance

Prepare financial statements: Income Statement, Owners Equity Statement, Balance Sheet Journalize and post closing entries Prepare a post-closing trial balance

Reversing Entries-An Optional Step

Made at the beginning of the next accounting period. Exact opposite of adjusting entry.

Its an optional bookkeeping procedure.

Correcting Entries-An Avoidable Step

Errors should be corrected as soon as discovered There are differences between correcting entries and adjusting entries. No correcting entries are needed, if records are free of errors. Correcting entries can be journalized and posted whenever an error is discovered. Involve any combination of balance sheet and income statement accounts. Correcting entries must be posted before closing entries.

Comparisons of Entries & Correcting Entry

Cash Service Revenue 50 50

Cash Accounts Receivable

50 50

Service Revenue Accounts Receivable

50 50

Comparisons of Entries & Correcting Entry

Incorrect Entry May 18

Delivery Equipment Accounts Payable

(To record purchase of equipment on account) Correct Entry

45 45

18

Office Equipment Accounts Payable

(To record purchase of equipment on account) Correcting Entry

450 450

June 3

Office Equipment Delivery Equipment Accounts Payable

(To correct entry of May 18)

450 45 405

It is possible to reverse the incorrect entry and then prepare the correct entry.

The Classified Balance Sheet

Balance sheet presents a snapshot of a companys financial position at a point in time. Financial statements become more useful when the elements are classified into significant subgroups.

The Classified Balance Sheet

A classified balance sheet generally has the following standard classifications: Assets Current Assets Long-Term Investments Property, Plant and Equipment Intangible Assets
Liabilities & Owners Equity

Current Liabilities Long-Term Liabilities Owners Equity

Current Assets

Current assets are assets that a company expects to convert to cash or use up within one year. Some companies use a period longer than one year. Operating cycle of a company is the average time required to go from cash to cash in producing revenues. Example: Inventory, accounts receivable and cash. Current assets are listed in the order of their liquidity.

Long-Term Investments

Long-term investments are generally,

Investments in stocks and bonds of another companies that are held for many years & Long-term assets (buildings or equipments) that a company is not currently using in its operating activities.

Property, Plant, and Equipment

Tangible resources, relatively permanent nature, used in the business, and not intended for sale.

Examples: Land, buildings, and machinery.

Depreciation is the process of allocating the cost of assets to a number of years. The accumulated depreciation account shows the total amount of depreciation that the company has expensed .

Intangible Assets
Non-current resources that do not have physical
substance.

Examples includes patents, copyrights, trademarks, or trade names, gives the holder exclusive right of use for a specified period of time.

Current Liabilities

Obligations that the company is to pay within the coming year.

Examples: Accounts payable, wages payable, interest payable, tax payable, bank loans payable and current maturities of long-term debt. the relationship between current assets and current liabilities is important in evaluating a companys liquidity.
Liquidity is the ability of a company to pay obligations that are expected to become due within the next year or operating cycle.

Long-Term Liabilities

Long-term liabilities are obligations that a company expects to pay after one year. Examples: Long-term notes payable, bonds payable, mortgages payable, and lease liabilities

Owners Equity

The content of the owners equity section varies with the form of business organization. In Proprietorship, there is one capital account. In a Partnership there is a separate capital accounts for each partner. Corporations divide owners equity into two accounts-Capital Stock and Retained Earnings. Corporation combine the capital stock and retained earnings accounts and report them on the balance sheet as stockholders equity.