Chapter 4Chapter 4

Completing the Accounting Cycle

Accounting 211

Instructor: Professor John Ahmad

1 Prepare a work sheet

2 Explain the process of closing the books

3 Describe the content and purpose of a post-closing trial balance

4 State the required steps in the accounting cycle

5 Explain the approaches to preparing correcting entries

6 Identify the sections of a classified balance sheet

In Chapter 4, we will:

multiple-column form used for the adjustment process and preparing financial statements

working tool for the accountant

not a permanent accounting record

Eases preparation of adjusting entries and financial statements

What is a Worksheet?

Example of a Work Sheet

A work sheet is not a permanent accounting record

When it is used: financial statements are prepared from

the work sheet adjustments are journalized and posted

from the work sheet after financial statements, so management can receive the financial statements more quickly

Remember:

To Prepare A Work Sheet:

1 Prepare the trial balance

2 Enter adjustments in the adjustments columns

3 Enter adjusted balances in adjusted trial balance columns

4 Extend adjusted trial balance amounts to the appropriate financial statement columns

5 Total the statement columns, compute net income (loss), and complete the work sheet

Now, let’s see how this works!

FastForwardWork Sheet

For Month Ended December 31, 2004

First, enter the

unadjusted trial balance amounts to

the worksheet!

First, enter the

unadjusted trial balance amounts to

the worksheet!

Here are our adjusting entries for December.

a) Insurance expense 100

Prepaid insurance 100

b) Supplies expense 1050

Supplies 1050

c) Depreciation expense 375

Accum. Depr. – Equip. 375

Here Are More Adjusting Entries for December.

d) Unearned revenue 250

Consulting Revenue 250

e) Salaries Expense 210

Salaries Payable 210

f) Accounts Receivable 1,800

Consulting Revenue 1,800

Next, enter the adjustments!

Next, enter the adjustments!

FastForwardWork Sheet

For Month Ended December 31, 2004

Prepare the adjusted trial

balance!

Prepare the adjusted trial

balance!

FastForwardWork Sheet

For Month Ended December 31, 2004

FastForwardWork Sheet

For Month Ended December 31, 2004

Then, extend the adjusted trial balance amounts to the financial statements!

Then, extend the adjusted trial balance amounts to the financial statements!

FastForwardWork Sheet

For Month Ended December 31, 2004

Total statement columns, compute income or loss, and balance columns.

Total statement columns, compute income or loss, and balance columns.

Prepare the IncomeStatement.

Prepare the Financial Statements

A work sheet does not

substitute for financial

statements.

A work sheet does not

substitute for financial

statements.

Prepare the Statement of Changes in Owner’s Equity.

FastForwardBalance Sheet

December 31, 2004

AssetsCash 3,950$ Accounts receivable 1,800 Supplies 8,670 Prepaid insurance 2,300 Equipment 26,000$ Less: accum. depr. (375) 25,625 Total assets 42,345$

LiabilitiesAccounts payable 6,200$ Salaries payable 210 Unearned consulting revenues 2,750 Total liabilities 9,160$

Owner's EquityC.Taylor, Capital 33,185 Total liabilities and equity 42,345$

FastForwardBalance Sheet

December 31, 2004

AssetsCash 3,950$ Accounts receivable 1,800 Supplies 8,670 Prepaid insurance 2,300 Equipment 26,000$ Less: accum. depr. (375) 25,625 Total assets 42,345$

LiabilitiesAccounts payable 6,200$ Salaries payable 210 Unearned consulting revenues 2,750 Total liabilities 9,160$

Owner's EquityC.Taylor, Capital 33,185 Total liabilities and equity 42,345$

Prepare the Balance Sheet.

Which of these characteristics are true about a work sheet?

a permanent accounting record an optional device used by accountants a part of the general ledger a part of the journal

Answer!

permanent accounting record optional device used by accountants part of the general ledger part of the journal

Although it’s optional, the work sheet is a very useful tool!

TEMPORARY VS. PERMANENT ACCOUNTS

TEMPORARY (NOMINAL) PERMANENT (REAL) These accounts are closed These accounts are not closed

All revenue accounts All asset accounts

All expense accounts All liability accounts

Owner’s drawing Owner’s capital account

Now, let’s talk about closing entries and income summary!

CLOSING ENTRIES

Closing entries Transfer net income (loss) and owner’s drawings

to owner’s capital Journalizing and posting is a required step in the

accounting cycle

Income Summary A temporary account Used in closing revenue and expense accounts Minimizes the details in the permanent owner’s

capital account

Resets revenue, expense and withdrawal account balances to zero at the end of the period.

Helps summarize a period’s revenues and expenses in the Income Summary account.

Identify accounts for closing.

Record and post closing entries.

Prepare post-closing trial balance.

Closing Process

Temporary Accounts

Revenues

Income Summary

Exp

ense

s

With

draw

als

Permanent Accounts

Assets

Lia

bili

ties

Ow

ner’s

Cap

ital

The closing process applies only to

temporary accounts.

The closing process applies only to

temporary accounts.

Temporary and Permanent Accounts

Let’s see how the closing process

works!

Recording Closing Entries

Close Revenue accounts to Income Summary.

Close Expense accounts to Income Summary.

Close Income Summary account to Owner’s Capital.

Close Withdrawals to Owner’s Capital.

Close Revenue accounts to Income Summary.

Close Expense accounts to Income Summary.

Close Income Summary account to Owner’s Capital.

Close Withdrawals to Owner’s Capital.

Balances before closing.

Income Summary

Owner's Capital30,000

30,000

Revenue Accounts25,000

25,000

Withdrawals Account5,000

5,000

Expense Accounts10,000

10,000

Closing Process

Income Summary25,000

25,000

Close Revenue accounts to Income

Summary.

Owner's Capital30,000

30,000

Revenue Accounts25,000 25,000

-

Withdrawals Account5,000

5,000

Expense Accounts10,000

10,000

Closing Process

Income Summary10,000 25,000

15,000 Owner's Capital30,000

30,000

Revenue Accounts25,000 25,000

-

Withdrawals Account5,000

5,000

Close Expense accounts to Income

Summary.

Expense Accounts10,000 10,000

-

Closing Process

The balance in Income Summary equals net

income.

The balance in Income Summary equals net

income.

Owner's Capital30,000 15,000

45,000

Owner's Capital30,000 15,000

45,000

Withdrawals Account5,000

5,000

Withdrawals Account5,000

5,000

Close Income Summary to

Owner’s Capital.

Revenue Accounts25,000 25,000

-

Expense Accounts10,000 10,000

-

Income Summary10,000 25,000 15,000

-

Closing Process

Owner's Capital30,000 15,000

45,000

Owner's Capital5,000 30,000

15,000

40,000

Withdrawals Account5,000

5,000

Withdrawals Account5,000 5,000

-

Revenue Accounts25,000 25,000

-

Expense Accounts10,000 10,000

-

Income Summary10,000 25,000 15,000

-

Closing Process

Close Withdrawals account to Owner’s

Capital.

Using the adjusted trial balance, let’s prepare the

closing entries for

FastForward.

Close Revenue accounts to

Income Summary.

Close Revenue Accounts to Income Summary

Dec. 31 Consulting revenue 7,850 Rental revenue 300

Income summary 8,150

Dec. 31 Consulting revenue 7,850 Rental revenue 300

Income summary 8,150

Now, let’s look at the ledger accounts after posting this closing entry.

Now, let’s look at the ledger accounts after posting this closing entry.

Close Expense Accounts to Income Summary

Dec. 31 Income summary 4,365Depreciation expense-Equipment 375Salaries expense 1,610Insurance expense 100Rent expense 1,000Supplies expense 1,050Utilities expense 230

Income Summary4,365 7,850

300 3,785

Utilities Expense230 230

-

Rent Expense1,000 1,000

-

Net Income

Close Expense Accounts to Income Summary

Close Expense Accounts to Income Summary Close Expense Accounts to Income Summary

Supplies Expense1,050 1,050

-

Depreciation Expense- Eq.

375 375 -

Salaries Expense1,610 1,610

-

Insurance Expense100 100

-

Close Income Summary to

Owner’s Capital.

Now, let’s look at the ledger accounts after posting this closing entry.

Close Income Summary to Owner’s Capital

Dec. 31 Income summary 3,785C. Taylor, Capital 3,785

C. Taylor, Capital30,000 3,785

33,785

Close Income Summary to Owner’s Capital

Close Income Summary to Owner’s Capital Close Income Summary to Owner’s Capital

Income Summary4,365 7,850 3,785 300

-

Close Withdrawals to

Owner’s Capital.

Now, let’s look at the ledger accounts after posting this closing entry.

Close Withdrawals to Owner’s Capital

Dec. 31 C. Taylor, Capital 600C. Taylor, Withdrawals 600

C. Taylor, Capital600 30,000

3,785

33,185

C. Taylor, Withdrawals

600 600

-

Close Withdrawals to Owner’s Capital

Close Withdrawals to Owner’s Capital

ABOUT CLOSING ENTRIES

Be Careful!

Avoid doubling revenue and expense balances – watch debits and credits

Remember: owner’s drawing does not move to the Income Summary account. Owner’s drawing is not an expense and it is not a factor in determining net income.

RESULTS OF POSTING CLOSING ENTRIES

Temporary accounts All temporary accounts will have zero balances

after posting the closing entries Temporary accounts (revenues and expenses)

are totaled, balanced and double ruledOwner’s capital Total equity of the owner at the end of the

accounting period No entries are journalized and posted to

owner’s capital during the yearPermanent accounts (assets, liabilities, and owner’s capital) are not closed

POST-CLOSING TRIAL BALANCE

After all closing entries have been journalized the post-closing trial balance is prepared from the ledger.

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.

Let’s look at FastForward’s

post-closing trial balance.

Post-Closing Trial Balance

List of permanent accounts and their balances after posting closing entries.

Total debits and credits must be equal.

List of permanent accounts and their balances after posting closing entries.

Total debits and credits must be equal.

Post-Closing Trial Balance

Post-closing Trial BalancePost-closing Trial Balance

1 Analyze business transactions

2 Journalize the transactions

3 Post to ledger accounts

4 Prepare a trial balance

5 Journalize and post adjusting entries

Summary of Steps in the Accounting Cycle

6 Prepare an adjusted trial balance7 Prepare financial statements:

Income Statement, Owner’s Equity Statement, Balance Sheet

8 Journalize and post closing entries

9 Prepare a post-closing trial balance

STEPS IN THE ACCOUNTING CYCLE

1. Correcting Entries

Correcting Entries errors should be corrected as soon as discovered

correcting entries are unnecessary if records are

free of errors

can be journalized and posted whenever an error is discovered

involve any combination of balance sheet and income statement accounts

Illustrative Example Of Correcting Entry

Cash 50 Service Revenue 50

Cash 50 Accounts Receivable 50

Service Revenue 50 Accounts Receivable 50

Another Illustrative Example Of Correcting Entry

Incorrect Entry May 18

(To record purchase of equipment on account)

Correct Entry 18

(To record purchase of equipment on account)

Correcting Entry June 3

(To correct entry of May 18)

Delivery Equipment 45 Accounts Payable 45

Office Equipment 450 Accounts Payable 450

Office Equipment 450 Delivery Equipment 45 Accounts Payable 405

Question: The closing entry process consists of closing:

all asset and liability accounts out the owner's capital account all permanent accounts all temporary accounts

Which answer is correct?

The closing entry process consists of closing

all asset and liability accounts out the owner's capital account all permanent accounts all temporary accounts

Standard Balance Sheet Classifications

Financial statements become more useful when the elements are classified into significant subgroups.

A classified balance sheet generally has the following standard classifications (see

next slide):

Categories of a Classified Balance SheetAssets Liabilities and Equity

Current Assets Current LiabilitiesNoncurrent Assets Noncurrent Liabilities

Long-Term Investments EquityPlant AssetsIntangible Assets

Current items are those expected to come due (both collected and owed) within the longer of one year or

the company’s normal operating cycle.

Classified Balance Sheet

Snowboarding ComponentsBalance Sheet

January 31, 2005

Current assets Cash 6,500$ Short-term investments 2,100 Accounts receivable 4,400 Merchandise inventory 27,500 Prepaid expenses 2,400 Total current assets 42,900$ Long-term investments Notes receivable 1,500 Investments in stocks and bonds 18,000 Land held for future expansion 48,000 Total investments 67,500 Plant assets Store equipment 33,200$ Less accumulated depreciation 8,000 25,200 Buildings 170,000 Less accumulated depreciation 45,000 125,000 Land 73,200 Total plant assets 223,400 Intangible assets 10,000 Total assets 343,800$

ASSETS

Current assets are expected to be sold, collected, or used within one year or the company’s operating

cycle.

Snowboarding ComponentsBalance Sheet

January 31, 2005

Current assets Cash 6,500$ Short-term investments 2,100 Accounts receivable 4,400 Merchandise inventory 27,500 Prepaid expenses 2,400 Total current assets 42,900$ Long-term investments Notes receivable 1,500 Investments in stocks and bonds 18,000 Land held for future expansion 48,000 Total investments 67,500 Plant assets Store equipment 33,200$ Less accumulated depreciation 8,000 25,200 Buildings 170,000 Less accumulated depreciation 45,000 125,000 Land 73,200 Total plant assets 223,400 Intangible assets 10,000 Total assets 343,800$

ASSETS

Long-term investments are expected to be held for the longer of one year or the operating cycle.

Snowboarding ComponentsBalance Sheet

January 31, 2005

Current assets Cash 6,500$ Short-term investments 2,100 Accounts receivable 4,400 Merchandise inventory 27,500 Prepaid expenses 2,400 Total current assets 42,900$ Long-term investments Notes receivable 1,500 Investments in stocks and bonds 18,000 Land held for future expansion 48,000 Total investments 67,500 Plant assets Store equipment 33,200$ Less accumulated depreciation 8,000 25,200 Buildings 170,000 Less accumulated depreciation 45,000 125,000 Land 73,200 Total plant assets 223,400 Intangible assets 10,000 Total assets 343,800$

ASSETS

Plant assets are tangible long-lived assets used to produce or sell

products and services.

Snowboarding ComponentsBalance Sheet

January 31, 2005

Current assets Cash 6,500$ Short-term investments 2,100 Accounts receivable 4,400 Merchandise inventory 27,500 Prepaid expenses 2,400 Total current assets 42,900$ Long-term investments Notes receivable 1,500 Investments in stocks and bonds 18,000 Land held for future expansion 48,000 Total investments 67,500 Plant assets Store equipment 33,200$ Less accumulated depreciation 8,000 25,200 Buildings 170,000 Less accumulated depreciation 45,000 125,000 Land 73,200 Total plant assets 223,400 Intangible assets 10,000 Total assets 343,800$

ASSETS

Intangible assets are long-term resources used to produce or sell

products and services and that lack physical form.

Current liabilities are obligations due within the longer of one year or the

company’s operating cycle.

Snowboarding ComponentsBalance Sheet

January 31, 2005

Current liabilities Accounts payable 15,300$ Wages payable 3,200 Notes payable 3,000 Current portion of long-term liabilities 7,500 Total current liabilities 29,000$ Long-term liabilities: Notes payable (net of current portion) 150,000 Total liabilities 179,000$

T. Hawk, Capital 164,800 Total liabilities and equity 343,800$

LIABILITIES

EQUITY

Long-term liabilities are obligations not due within the longer of one year

or the company’s operating cycle.

Snowboarding ComponentsBalance Sheet

January 31, 2005

Current liabilities Accounts payable 15,300$ Wages payable 3,200 Notes payable 3,000 Current portion of long-term liabilities 7,500 Total current liabilities 29,000$ Long-term liabilities: Notes payable (net of current portion) 150,000 Total liabilities 179,000$

T. Hawk, Capital 164,800 Total liabilities and equity 343,800$

LIABILITIES

EQUITY

Equity is the owner’s claim on the assets.

Snowboarding ComponentsBalance Sheet

January 31, 2005

Current liabilities Accounts payable 15,300$ Wages payable 3,200 Notes payable 3,000 Current portion of long-term liabilities 7,500 Total current liabilities 29,000$ Long-term liabilities: Notes payable (net of current portion) 150,000 Total liabilities 179,000$

T. Hawk, Capital 164,800 Total liabilities and equity 343,800$

LIABILITIES

EQUITY

Reversing entry Made at the beginning of the next

accounting period Purpose is to simplify the recording of a

subsequent transaction related to an adjusting entry

Most often used to reverse two types of adjusting entries: accrued revenues and accrued expenses

REVERSING ENTRIES

ILLUSTRATIVE EXAMPLE OF REVERSING ENTRY

Questions?

Homework for Chapter 4

Have a great weekend!