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Chapter 5: The annual report and closing accounts

• The closure of the accounting cycle and accounting information disclosed to the public

• Six steps in the accounting cycle:1. Analyze transactions from the source documents2. Journalize transactions3. Post entries to the ledger and prepare a trial balance4. Make end-of-period adjustments and prepare an

adjusted trial balance5. Prepare financial statements6. Close the accounts and prepare a post-closing trial balance

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Example

A small company named ZiscoSys. The transactions are stated in chronological order:

(1) € 8.000 Owner‘s Investment to start up the business(2) Purchase of equipment for € 4.000 paid in cash(3) Purchase of supplies on credit for € 500(4) € 400 payment of a liability (accounts payable resulting from

delivery of supplies)(5) € 5.000 revenues earned on credit(6) € 3.000 collection of accounts receivable(7) Incurring expenses of € 500 for rent and € 200 for utility, resp., and

Prepaid Insurance of € 1.200(8) reception of a down payment of € 2.400 for services to be

performed (unearned revenue or deferred revenue), and(9) Owner‘s withdrawal of € 800.

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Trial Balance – ZiscoSys Magdeburg

Cash 6.500Accounts Receivable 2.000Equipment 4.000Supplies 500Prepaid Insurance 1.200Accounts Payable 300Unearned Revenue 2.400Owner´s Investment 8.000Owner´s Withdrawal 800Revenues 5.000Expenses 700

15.700 15.700

Trial Balance

ZiscoSys Magdeburg Trial Balance

September 30, 2013

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Step 1 – include all accounts with balances from ledger

Account titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.

Cash 6.500Accounts Receivable 2.000Equipment 4.000Supplies 500Prepaid Insurance 1.200Accounts Payable 300Unearned Revenue 2.400Owner´s Investment 8.000Owner´s Withdrawal 800Revenues 5.000Rent Expense 500Uility Expense 200

Totals 15.700 15.700

ZiscoSys Magdeburg Work Sheet

For the month ended September 30, 2013Trial                       

BalanceAdjustments

Adjusted                  Trial Balance

Income                   Statement

Balance                   Sheet

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Step 2 – add adjustment data

Account titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.

Cash 6.500Accounts Receivable 2.000Equipment 4.000Supplies 500 200Prepaid Insurance 1.200 100Accounts Payable 300Unearned Revenue 2.400 200Owner´s Investment 8.000Owner´s Withdrawal 800Revenues 5.000 200Rent Expense 500Uility Expense 200

Totals 15.700 15.700

Supplies Expense 200Insurance Expense 100Accumulated Depreciation 84 ‐ Office Equipment

Deprecitation Expense 84

Totals 584 584

ZiscoSys Magdeburg Work Sheet

For the month ended September 30, 2013Trial                       

BalanceAdjustments

Adjusted                  Trial Balance

Income                   Statement

Balance                   Sheet

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Step 3 – combine trial balance amounts with adjustment amounts

Account titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.

Cash 6.500 6.500Accounts Receivable 2.000 2.000Equipment 4.000 4.000Supplies 500 200 300Prepaid Insurance 1.200 100 1.100Accounts Payable 300 300Unearned Revenue 2.400 200 2.200Owner´s Investment 8.000 8.000Owner´s Withdrawal 800 800Revenues 5.000 200 5.200Rent Expense 500 500Uility Expense 200 200

Totals 15.700 15.700

Supplies Expense 200 200Insurance Expense 100 100Accumulated Depreciation 84 84 ‐ Office Equipment

Deprecitation Expense 84 84

Totals 584 584 15.784 15.784

ZiscoSys Magdeburg Work Sheet

For the month ended September 30, 2013Trial                        

BalanceAdjustments

Adjusted                          Trial Balance

Income                   Statement

Balance                   Sheet

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Account titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.

Cash 6.500 6.500 6.500Accounts Receivable 2.000 2.000 2.000Equipment 4.000 4.000 4.000Supplies 500 200 300 300Prepaid Insurance 1.200 100 1.100 1.100Accounts Payable 300 300 300Unearned Revenue 2.400 200 2.200 2.200Owner´s Investment 8.000 8.000 8.000Owner´s Withdrawal 800 800 800Revenues 5.000 200 5.200 5.200Rent Expense 500 500 500Uility Expense 200 200 200

Totals 15.700 15.700

Supplies Expense 200 200 200Insurance Expense 100 100 100Accumulated Depreciation 84 84 84 ‐ Office Equipment

Deprecitation Expense 84 84 84

Totals 584 584 15.784 15.784

ZiscoSys Magdeburg Work Sheet

For the month ended September 30, 2013Trial                        

BalanceAdjustments

Adjusted                          Trial Balance

Income                    Statement

Balance                    Sheet

Step 4 – transfer adjusted balances to appropriate statement accounts

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Step 5 – total statement accounts and compute net income/loss

Account titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.

Cash 6.500 6.500 6.500Accounts Receivable 2.000 2.000 2.000Equipment 4.000 4.000 4.000Supplies 500 200 300 300Prepaid Insurance 1.200 100 1.100 1.100Accounts Payable 300 300 300Unearned Revenue 2.400 200 2.200 2.200Owner´s Investment 8.000 8.000 8.000Owner´s Withdrawal 800 800 800Revenues 5.000 200 5.200 5.200Rent Expense 500 500 500Uility Expense 200 200 200

Totals 15.700 15.700

Supplies Expense 200 200 200Insurance Expense 100 100 100Accumulated Depreciation 84 84 84 ‐ Office Equipment

Deprecitation Expense 84 84 84

Totals 584 584 15.784 15.784 1.084 5.200 14.700 10.584

Net Income 4.116 4.116Totals 5.200 5.200 14.700 14.700

ZiscoSys Magdeburg Work Sheet

For the month ended September 30, 2013Trial                        

BalanceAdjustments

Adjusted                  Trial Balance

Income                    Statement

Balance                    Sheet

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Closing the books

• ... means making accounts ready for the next accounting period• ... is done at the end of each accounting period

Source: Weygandt/Kieso/Kimmel, p.141

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Purpose of closing entries

• „zero out“ all nominal accounts

• transfer net income (loss) and owner‘s withdrawal into owner‘s capital account

• journalizing and posting closing entries is a required step in the accounting process

• closing entries are journalized in the general journal and then posted

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The closing process

• Debit each revenue account for its balance, and credit Income Summary for total revenues.

• Credit each expense account for its balance, and debit Income Summary for total expenses.

• Closing the Income Summary account balance to the Capital account.

• Closing the Withdrawals account balance to the Capital account.

• Alternative: close revenue and expense accounts directly to the capital account

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One example before we go through the whole closing process...

• let‘s close the revenue account for ZiscoSys

Closing the account on

September 30, yields the following

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Expense Accounts Revenue

1.084 5.200

Withdrawals Capital8.000

800

ZiscoSys accounts before closing

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Closing process for ZiscoSys

Expense Accounts Revenue

1.084 5.200

Withdrawals Capital8.000

800

Income Summary

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Step 1: close revenue account

Expense Accounts Revenue

1.084 5.200

Withdrawals Capital8.000

800

Income Summary

5.200

5.200

=

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Step 2: close expense accounts

Expense Accounts Revenue

1.084 5.200

Withdrawals Capital8.000

800

Income Summary

5.200

5.200

=1.084

1.084

=

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Step 3: close income summary account

Expense Accounts Revenue

1.084 5.200

Withdrawals Capital8.000

800

Income Summary

5.200

5.200

=1.084

1.084

=

4.116

4.116

=

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Step 4: close withdrawal account

Expense Accounts Revenue

1.084 5.200

Withdrawals Capital8.000

800

Income Summary

5.200

5.200

=1.084

1.084

=

4.116

4.116

=

800800=

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Preparing a Post-Closing Trial Balance

• Why? ... to prove equality of permanent account balances

note that all temporary accounts have zero balances after closing –hence, they don‘t enter the post-closing trial balance

Cash 6.500Accounts Receivable 2.000Equipment 4.000Supplies 300Prepaid Insurance 1.100Accumulated Depreciation  ‐  Office Equipment 84Accounts Payable 300Unearned Revenue 2.200Owner´s Capital 11.316

13.900 13.900

Post‐Closing Trial Balance

ZiscoSys Magdeburg Post‐Closing Trial Balance

September 30, 2013

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Summary of the Accounting Cycle

1 - Analyze transactions from source documents

2 - Journalize transactions

5 - Make end-of-period adjusting entries

6 - Prepare adjustedtrial balance

7 – Preparefinancial statements

8 - Close accounts and prepare post-closing trial balance

4 - Prepare trial balance

3 - Post entriesto ledger

Start of a new accounting cycle

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Reversing entries – an example

• employer has a biweekly payroll of € 8.000, salaries are paid on the 10th and 24th each month

• September 24, initial salary entry : € 8.000 of salaries earned between September 10 and September 24 are paid.

• September 30, adjusting entry : salaries earned between September 24 and September 30 amount to € 4.000 and will be paid in the October 10 payroll.

• October 10, subsequent salary entry : salaries paid are € 8.000. Of this amount, € 4.000 accrued in September as salaries payable and € 4.000 was earned in October

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No Reversing Entry

Initial Salary EntrySept. 24 Salaries Expense 8.000

Cash 8.000

Adjusting EntrySept. 30 Salaries Expense 4.000

Salaries Payable 4.000

Closing EntrySept. 30 Income Summary 12.000

Salaries Expense 12.000

Reversing EntryOct. 1 no reversing entry

Subsequent Salary EntryOct. 10 Salaries Payable 4.000

Salaries Expense 4.000 Cash 8.000

Reversing Entry Used

Initial Salary EntrySept. 24 Salaries Expense 8.000

Cash 8.000

Adjusting EntrySept. 30 Salaries Expense 4.000

Salaries Payable 4.000

Closing EntrySept. 30 Income Summary 12.000

Salaries Expense 12.000

Reversing EntryOct. 1 Salaries Payable 4.000

Salaries Expense 4.000

Subsequent Salary EntryOct. 10 Salaries Expense 8.000

Cash 8.000

Illustration of reversing entries

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Correcting entries

• needed when errors are discovered• correcting entries are journalized and posted whenever an error is

detected

Balance in cash account is reduced to zero by posting the correcting entry.