Needles 9e CL Ready Notes Ch04

Chapter 4
Completing the
Accounting
Cycle
Multimedia Slides by: Gail A. Mestas, MAcc, New Mexico State University
Learning Objectives
1. State all the steps in the accounting
cycle.
2. Explain and prepare closing entries.
3. Prepare the post-closing trial balance.
4. Prepare reversing entries as
appropriate.
5. Prepare and use a work sheet.
Copyright Houghton Mifflin Company.
42
Overview of the Accounting Cycle

Objective 1
State all the steps in the accounting cycle
43
The Accounting Cycle

A series of steps in the accounting
system
Purpose
Measure business activities in the form of
transactions
Transform these transactions into financial
statements
Communicate useful information to decision
makers
44
Steps in the Accounting Cycle

1. Analyze
2. Record
3. Post
business transactions from source documents

the entries in the journal
the entries to the ledger and prepare a trial balance
4. Adjust
5. Close
the accounts and prepare an adjusted trial balance

the accounts and prepare a post-closing trial balance
6. Prepare
financial statements
The order of these steps can vary depending on the

system in place
Step 6 may be completed before Step 5
45
Overview of the Accounting Cycle

Input
Output
Accounting System
46
Discussion
Q. Is it necessary to complete all six
steps in the accounting cycle?
A. Yes. All six steps must be accomplished
to complete the accounting cycle.
However, the order of these steps can
vary somewhat depending on the system
in place
47
Closing Entries
Objective 2
Explain and prepare closing entries
48
Two Account Types

Permanent accounts
Balance sheet accounts
Also called real accounts
Carry end-of-period balances into the next
accounting period
Temporary accounts
Income statement accounts (revenues and
expenses)
Also called nominal accounts
Begin each accounting period with a zero balance
49
Closing Entries
Journal entries made at the end of an

accounting period
Two purposes
1. Clear revenue, expense, and Withdrawal
accounts (temporary accounts) of their balances
2. Summarize a period's revenues and expenses
Revenue and expense accounts must begin each
new period with zero balances for the income
statement to present the activity of a single period
410
Income Summary Account

Summarizes revenues and expenses
for a period
Temporary account
Used only in the closing process
Never appears in the financial
statements
Appears in chart of accounts after
Withdrawals and before revenue
accounts
411
Income Summary Account (contd)

All revenue and expense account balances
are transferred to Income Summary during
the closing process
The balance in Income Summary equals net
income or loss reported on the income
statement
This balance is then transferred to the Capital
account (an owner's equity account)
Revenue and expense accounts represent
increases and decreases to owner's equity
412
Required Closing Entries

1. Close credit balances from income statement
accounts to Income Summary
2. Close debit balances from income statement
accounts to Income Summary
3. Close the Income Summary account balance
to the Capital account
4. Close the Withdrawals account balance to the
Capital account
413
The Closing Process

Step 1
Revenue accounts carry normal credit

balances
To close: Credit revenue accounts
Debit Income Summary
Step 2
Expense accounts carry normal debit

balances
To close: Debit expense accounts
Credit Income Summary
Step 3
A credit balance in Income Summary

represents net income for the period
To close: Debit Income Summary
Credit Capital
Withdrawals
Revenue Accounts
XXX Bal. XXX
Bal.
-0Expense Accounts
Bal.
XXX
XXX
Bal.
-0Income Summary
XXX
XX Bal.
Bal.
XXX
XX
-0-
Capital
XX
414
The Closing Process (cont.)

Step 3
(cont.)
Step 4
If a net loss occurred for the period, Income

Summary would carry a debit balance
To close: Credit Income Summary
Debit Capital
The Withdrawals account carries a normal
debit balance
To close: Credit Withdrawals
Debit Income Summary
Notice that all the temporary accounts
now carry zero balances. Capital is a
permanent account and will carry its
balance into the next accounting period
Withdrawals
Bal.
Bal.
XX
-0-
Revenue Accounts
XXX Bal. XXX
Bal. -0Expense Accounts
Bal. XXX
XXX
Bal.
-0Income Summary
Bal.
XXX
XX
Bal.
-0-
XXX
XX
Capital
XX
XX
XX
415
Closing Revenue Accounts

Joan Miller has two revenue accounts with balances
Advertising Fees Earned
6,400
July 31 6,400
Bal.
-0-
A compound entry can be used to

close the two revenue accounts to
Income Summary
Copyright Houghton Mifflin Company. All rights reserved.
Art Fees Earned

400
July 31
400
Bal.
-0Income Summary
July 31 6,800
416
Closing Expense Accounts

Joan Miller has nine revenue accounts with balances
The same closing procedure is used as with the revenue accounts
except expense accounts carry credit balances and must be
debited to be closed
A compound entry closes the nine
revenue accounts to Income
Summary
Income Summary
July 31 4,800 July 31 6,800
417
Closing the Income Summary Account

Revenues and expenses are now summarized in the Income
Summary account
The balance in the Income Summary
account represents net income or loss
for the period
The Income Summary account must
now be closed to the Capital account
Income Summary
July 31 4,800 July 31 6,800
2,000 Bal.
Bal.
2,000
-0-
Joan Miller, Capital

2,000
A credit balance in the Income

If the Income Summary account had a
Summary account represents net
debit balance, it would represent a net
income for the period
loss for the period
Revenues > Expenses = Net Income
Revenues < Expenses = Net Loss
418
Closing the Withdrawals Account

Joan Miller made withdrawals of $1,400 from the
business during the period
Withdrawals represent reductions in
owner's equity so the account carries
a normal debit balance
The Withdrawals account must be
closed to the Capital account
Joan Miller, Withdrawals

1,400
1,400
Bal.
-0-
Joan Miller, Capital

1,400
1,600
Bal.
200
The Capital account now reflects net income

and withdrawals for the period
Copyright Houghton Mifflin Company. All rights reserved.
419
The Accounts After Closing

Revenue, expense, and Withdrawals
accounts have zero balances
The Capital account reflects
Net income or loss
Withdrawals
Balance sheet accounts reflect correct

balances to be carried forward into the
next accounting period
420
Discussion
Q. Could the Income Summary account
have a debit balance when the income
statement accounts are closed to it?
A. Yes, if a net loss has been incurred
421
The Post-Closing Trial Balance

Objective 3
Prepare the post-closing trial balance
422
The Post-Closing Trial Balance

The final trial balance
Used to verify that total debits equal total
credits
Only balance sheet accounts show balances
because income statement accounts and
Withdrawals have been closed
The Capital account now reflects previous
revenue, expense, and Withdrawals balances
423
The Post-Closing Trial Balance (contd)

Only balance
sheet accounts
appear on the
post-closing trial
balance
Income
statement and
Withdrawals
accounts have
been closed and
are reflected in
the Capital
account balance
Only accounts
with balances are
listed on a trial
balance
424
Discussion
Q. What is the significance of the postclosing trial balance?
A. The post-closing trial balance checks that
The total debits and total credits in the ledger

are equal after the closing entries have been
posted
Only balance sheet accounts show balances
425
Reversing Entries: The Optional First

Step in the Next Accounting Period
Objective 4
Prepare reversing entries as appropriate
426
Reversing Entries
Are made to reverse adjusting entries
recorded at the end of the previous accounting
period
Simplify the bookkeeping process
Are optional
Are made on the first day of the new
accounting period
Only adjustments for accruals are reversed
Reversing deferrals would not simplify the
bookkeeping process
427
Effects of Reversing Entries
Adjusting and closing entries are the same whether

reversing entries are used or not
Reversing entries are made on the first day of the new
accounting period
428
Effects of Reversing Entries
Payment of wages
If no reversing entry was made, the amount of wages expense
must be determined for the current period ($1,200 - $360)
If a reversing entry was made, the entire amount of wages paid
is entered as an expense
429
Effects on the Wages Expense Account

(1) Adjusting
Entry:
Records accrued
unrecorded wages (1)Jul 31
expense for the
Aug 1
current period
Wages Expense
360 (2)Jul 31
-0- (3)Aug 1
(4)Aug 9 1,200
(4) Entry to
record payment
of wages:
Full amount of
payment is
recorded as an
expense
Bal.
(2) Closing Entry:

Brings account
balance to zero.
360 Expense will be
reported on income
360 statement for July
840
The balance in the Wages Expense

account correctly reflects the amount of
expense that applies to August
It was not necessary to look in previous
records to determine this amount
(3) Reversing
Entry:
Reduces Wages
Expense account
by the amount of
accrued expense
that was recorded
for July
430
Recording Wages Expense Using a

Reversing Entry
July 31: Joan Miller Advertising Agency made an adjusting entry to
accrue unrecorded wages
Wages Expense
July 31 360 Jul 31
360
Aug 1
Wages Payable
July 31 360
-0-
July 31: The Wages Expense account is closed to Income Summary
The Wages Expense account

will now carry a zero balance
into the next accounting period
The Wages Payable account

will carry a $360 balance into
the next accounting period
Recording Wages Expense Using a

Reversing Entry (contd)
Aug 1: The adjusting entry for accrued wages is reversed
Wages Expense
July 31 360 Jul 31
360
Aug 1
-0- Aug 1
360
Aug 9 1,200
Bal.
840
Wages Payable
Aug 1
360 July 31 360
Bal.
-0-
Aug 9: Secretarys wages are paid, $1,200
The Wages Expense account

will now reflect $840 of wages
expense for August
The liability for the secretarys

wages for July was removed
with the reversing entry
432
Recording Revenue Using a Reversing

Entry
July 31: Joan Miller Advertising Agency made an adjusting entry to
accrue unrecorded revenue
Accounts Receivable
July 31 200

Jul 31
200 July 31 200
Aug 1
-0-
July 31: The Advertising Fees Earned account is closed to Income

Summary
The Advertising Fees Earned

account will now carry a zero balance
into the next accounting period
The Accounts Receivable account

will carry a $200 balance into the
Recording Revenue Using a Reversing

Entry (contd)
Aug 1: The adjusting entry for accrued revenue is reversed
Accounts Receivable
July 31 200 Aug 1
200

Jul 31
200 July 31 200
-0Aug 1
200 Aug 1
The Advertising Fees Earned account now reflects an abnormal

balance of $200
When payment is received, advertising fees earned for that period
will automatically be reduced by the amount that applied to July
434
Discussion
Q. What is the purpose of reversing
entries?
A. To simplify the bookkeeping process
They enable the bookkeeper to continue

preparing routine journal entries in the new
accounting period
435
The Work Sheet:

An Accountants Tool
Objective 5
Prepare and use a work sheet
436
Working Papers
Relevant data collected by accountants
Calculations to determine the amount of
Prepaid insurance that has expired
Depreciation
Inventory of supplies on hand
Accrued wages
Analyses
Preliminary drafts of financial statements
437
Working Papers (contd)
Important for two reasons

1. Organization
Avoid omitting important data or tasks that

affect financial statements
2. Provide evidence of past work
Other accountants or auditors can retrace

steps used to prepare financial statements
438
The Work Sheet

A working paper; a tool for the
accountant
Lessens the possibility of leaving out an
adjustment
Essential for larger companies
Helps in checking the accuracy of
accounts
439
The Work Sheet (contd)

Facilitates the preparation of the
financial statements
Is never published
Preparation may be aided using a
microcomputer
Spreadsheet program
General ledger system
440
Common Form of Work Sheet

A title that consists of
The name of the company
The title, Work Sheet
The period of time covered
One column for account names

Ten working columns
Preparing the Work Sheet

Step 1
Enter and total account balances in the

Trial Balance column
When using the work sheet, a separate trial
balance does not need to be prepared
Includes only those accounts with balances
442

Step 2
Enter and total the adjustments in the

Adjustments column
If an adjustment calls for an account not used
in the trial balance, it is added below the
accounts already listed
443

Step 3
Enter and total the adjusted account balances

in the Adjusted Trial Balance column
The adjusted account balances are obtained by

crossfooting
Combining the amount of each account in the Trial
Balance columns with the corresponding amounts in
the Adjustments columns
444
Crossfooting
Adding or subtracting a group of numbers horizontally
Pay attention to debits and credits
The $500 credit adjustment to Art Supplies decreases the
$1,800 debit balance to an adjusted $1,300 debit balance
The $360 debit adjustment to Wages Expense increases the
$2,400 debit balance to an adjusted $2,760 debit balance
445

Step 4
Extend the account balances from the Adjusted Trial
Balance columns to the appropriate Income Statement
or Balance Sheet columns
Revenue and expense accounts are extended to the

Income Statement columns
Assets, liabilities, and owner's equity accounts are
extended to the Balance Sheet columns
446

Step 5
Total the Income Statement columns and the
Balance Sheet columns
Enter the net income or net loss in both pairs of
columns as a balancing figure and recompute
This step determines net income or loss for the period and
proves the arithmetical accuracy of the work sheet
5,200
1,600
6,800
6,800 26,320 24,720

1,600
6,800 26,320 26,320
447
Example of Preparing the Work Sheet

Wages Expense
Step 1
Enter Wages Expense account balance
in the Trial Balance column
448

Wages Expense
Step 2
Enter the adjustments in the
Adjustments column
The Wages Payable account must

now be added to the list of accounts
449

Wages Expense
Step 3
Enter the adjusted account balances in
the Adjusted Trial Balance column
450

Wages Expense
Step 4
Extend the account balances from the
Adjusted Trial Balance columns to the
appropriate Income Statement or
Balance Sheet columns
Income
Statement
Account
Balance
Sheet
Account
451
Using the Work Sheet
The work sheet assists the accountant

in three principal tasks
1. Recording the adjusting entries
2. Recording the closing entries in the
general journal
Prepares the records for the beginning of the

3. Preparing the financial statements

452
Recording the Adjusting Entries

Adjustments are determined while preparing the
work sheet
Adjusting entries can be recorded
When determined
Later when closing entries are recorded
Information can be copied from the work sheet

and recorded in the general journal
Include appropriate explanations
Post to the general ledger

453
Recording the Closing Entries

All accounts that need to be closed,
except for Withdrawals, may be found in
the Income Statement columns of the
work sheet
Closing entries are entered in the
general journal and posted to the ledger
454
Preparing the Financial Statements

Account balances have been sorted into
Income Statement and Balance Sheet
columns on the work sheet
The income statement is prepared from
accounts in the Income Statement
columns
The statement of owners equity and
balance sheet are prepared from
accounts in the Balance Sheet columns
455
The Balance Sheet

Total assets and total liabilities and owner's equity on the balance sheet
are not the same as
the totals of the Balance Sheet columns in the work sheet
The Balance Sheet

This is because the Accumulated Depreciation accounts
have normal balances that appear in different columns from their
associated accounts on the balance sheet
The Balance Sheet

Also, the owners Capital account on the balance sheet is the amount
determined on the statement of owners equity
Discussion
Q. Do the Income Statement columns and the
Balance Sheet columns of the work sheet
balance after the amounts from the
Adjusted Trial Balance columns are
extended?
A. No, they do not balance by the amount of net
income or loss for the period
459
Time for Review

1. State all the steps in the accounting
cycle.
2. Explain and prepare closing entries.
3. Prepare the post-closing trial balance.
4. Prepare reversing entries as
appropriate.
5. Prepare and use a work sheet.
460

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Chapter 4

Overview of the Accounting Cycle

Copyright Houghton Mifflin Company.

The Accounting Cycle

Steps in the Accounting Cycle

business transactions from source documents

the entries to the ledger and prepare a trial balance

the accounts and prepare an adjusted trial balance

The order of these steps can vary depending on the

Overview of the Accounting Cycle

Copyright Houghton Mifflin Company.

Copyright Houghton Mifflin Company.

Copyright Houghton Mifflin Company.

Two Account Types

Journal entries made at the end of an

Copyright Houghton Mifflin Company.

Income Summary Account

Income Summary Account (contd)

Required Closing Entries

The Closing Process

Revenue accounts carry normal credit

Expense accounts carry normal debit

A credit balance in Income Summary

Copyright Houghton Mifflin Company.

The Closing Process (cont.)

If a net loss occurred for the period, Income

Copyright Houghton Mifflin Company.

Closing Revenue Accounts

A compound entry can be used to

Copyright Houghton Mifflin Company. All rights reserved.

Art Fees Earned

Closing Expense Accounts

Copyright Houghton Mifflin Company.

Closing the Income Summary Account

Joan Miller, Capital

A credit balance in the Income

Closing the Withdrawals Account

Joan Miller, Withdrawals

Joan Miller, Capital

The Capital account now reflects net income

The Accounts After Closing

Balance sheet accounts reflect correct

Copyright Houghton Mifflin Company.

The Post-Closing Trial Balance

Copyright Houghton Mifflin Company.

The Post-Closing Trial Balance

The Post-Closing Trial Balance (contd)

Copyright Houghton Mifflin Company.

The total debits and total credits in the ledger

Only balance sheet accounts show balances

Copyright Houghton Mifflin Company.

Reversing Entries: The Optional First

Copyright Houghton Mifflin Company.

Effects of Reversing Entries

Adjusting and closing entries are the same whether

Effects of Reversing Entries

Effects on the Wages Expense Account

(2) Closing Entry:

The balance in the Wages Expense

Copyright Houghton Mifflin Company.

Recording Wages Expense Using a

July 31: The Wages Expense account is closed to Income Summary

The Wages Expense account