Accounting Principles, 9th EditionWeygandt.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.

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.

Using a Worksheet

Form and Procedure for 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

Steps in Preparing A Worksheet

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 owner’s drawing account.

Permanent accounts relate to one or more future accounting periods. For example: Balance sheet accounts.

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 account Owner’s capital account

Preparing Closing Entries Companies transfers temporary account balances to the

permanent owner’s equity account, Owner’s capital, by means of closing entries.

Closing entries formally transfers net income (loss) and owner’s drawings to owner’s 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 owner’s 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 Owner’s capital for the amount of net income.

Debit owner’s capital for the balance in the owner’s drawing account and credit owner’s drawing for the same amount.

Diagram of Closing Process- Proprietorship

INCOME SUMMARY

(INDIVIDUAL)REVENUES

12

(INDIVIDUAL)EXPENSES

3

INCOME SUMMARY

OWNER’SCAPITAL

Diagram of Closing Process- Proprietorship

4

OWNER’S DRAWING

Diagram of Closing Process- Proprietorship

OWNER’SCAPITAL

Cautions in Preparing closing entries

Avoid doubling revenue and expense balances.

Do not close Owner’s Drawing through the Income Summary account.

Posting Closing Entries

All temporary accounts will have zero balances after posting the closing entries.

Owner’s 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 owner’s 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

Post-Closing Trial Balance

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, Owner’s Equity Statement, Balance Sheet

Journalize and post closing entries

Prepare a post-closing trial balance

Steps in the Accounting Cycle

Made at the beginning of the next accounting period.

Exact opposite of adjusting entry.

Its an optional bookkeeping procedure.

Reversing Entries-An Optional 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.

Correcting Entries-An Avoidable Step

Comparisons of Entries& Correcting Entry

Cash 50 Service Revenue 50

Cash 50 Accounts Receivable 50

Service Revenue 50 Accounts Receivable 50

Comparisons of Entries& 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

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

Balance sheet presents a snapshot of a company’s financial position at a point in time.

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

The Classified Balance Sheet

The Classified Balance Sheet

A classified balance sheet generally has the

following standard classifications:

Current Assets Current Liabilities

Long-Term Investments Long-Term Liabilities

Property, Plant and Owner’s Equity Equipment

Intangible Assets

Assets Liabilities & Owner’s Equity

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.

Current Assets

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.

Long-Term Investments

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 .

Property, Plant, and Equipment

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.

Intangible Assets

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 company’s liquidity.

Liquidity is the ability of a company to pay obligations that are expected to become due within the next year or operating cycle.

Current 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

Long-Term Liabilities

The content of the owner’s 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 owner’s 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 stockholder’s equity.

Owner’s Equity