Chapter 4 Completing the Accounting Cycle

1. Chapter 4Completing the Accounting Cycle

2. LEARNING OBJECTIVES 1. State all the steps in the accounting cycle. 2. Explain the purposes of closing entries. 3. Prepare the required closing entries. 4. Prepare the post-closing trial balance. 5. Prepare reversing entries as appropriate. 6. Prepare a work sheet. 7. Use a work sheet for three different purposes.

3. Overview of theAccounting Cycle OBJECTIVE 1 State all the steps in the accounting cycle.

4. DECISION BUSINESS MAKERS ACTIVITIES THE ACCOUNTING CYCLE PROCESSING COMMUNICATION MEASUREMENT 1. 6. 2. 3. 4. 5. Analyze Prepare Close the Record the Post the Adjust the business financial entries entries and accounts accounts transactions statements prepare a and prepare and prepare a post- trial balance an adjusted closing trial trial balance balance Overview of the Accounting Cycle

5. Short Exercise #1 1. Analyzebusiness transactions from source documents. 2. Record the entries in the journal. 3. Post the entries to the ledger and 4. Prepare the initial trial balance.

6. Short Exercise #1 (continued) 5. Adjust the accounts 6. Prepare an adjusted trial balance. 7. Close the accounts 8. Prepare financial statements. 9. Prepare a post-closing trial balance.

7. Closing Entries OBJECTIVE 2 Explain the purposes of closing entries.

8. Types of Accounts and Closing Entries • Balance sheet accountsare known as permanent accounts. • Revenue and expense accounts are temporaryaccounts. • The withdrawals account is also atemporary account. • Closing entriesare journal entries made at the end of an accounting period.

9. Purposes of Closing Entries 1. To clear the revenue, expense, and withdrawals accounts of their balances and prepare the accounts for the next accounting period. 2. To summarize a period’s revenues and expenses. • The balance of the Income Summary account equals the net income or loss for the period. • The net income or loss is transferred to the Owner’s Capital account.

10. Discussion Q. What is the purpose of the Income Summary account? A. The Income Summary account summarizes the revenue and expense accounts. The balance in the account before it is closed is either the net income or the net loss for the period.

11. Required Closing Entries OBJECTIVE 3 Prepare the required closing entries.

12. Expense Accounts Revenue Accounts xxx xxx To close To close Expense Revenue Accounts Accounts Income Summary xxx xxx xx To close Income Summary Owner’s Withdrawals Owner’s Capital xx xx xx To close Withdrawals Overview of the Closing Process

13. The Four Steps to Close the Accounts 1. Close the credit balances from income statement accounts to the Income Summary account. • Sets the balances of the revenue accounts to zero. • Transfers the total revenues to the credit side of the Income Summary account. 2. Close the debit balances from income statement accounts to the Income Summary account. • Reduces the expense account balances to zero. • Transfers the total expenses to the debit side of the Income Summary account.

14. 3. Close the Income Summaryaccount balance to the Owner’s Capital account. • Closes the Income Summary account. • Transfers the balance, income or loss, to the Owner’s Capital account.

15. 3. Close the Income Summaryaccount balance to the Owner’s Capital account. • Closes the Income Summary account. • Transfers the balance, income or loss, to the Owner’s Capital account. 4. Close the Withdrawal account balance to the Owner’s Capitalaccount. • Closes the Withdrawal account. • Transfers the balance to the Owner’s Capital account.

16. Preparing Closing EntriesShort Exercise #2 Entry 1: Dec 31 Patient Services 3,400 Lab Fees 1,800 Income Summary 5,200 To close the revenue accounts.

17. Preparing Closing EntriesShort Exercise #3 Entry 1: Dec 31 Income Summary 3,000 Rent Expense 1,400 Wages Expense 1,100 Other Expense 500 To close the expense accounts.

18. Preparing Closing EntriesShort Exercise #4 Entry 1: Dec 31 Income Summary 2,200 R. Richards, Capital 2,200 To close the income summary accounts.

19. Preparing Closing EntriesShort Exercise #5 Entry 1: Dec 31 R. Richards, Capital 800 R. Richards, Withdrawals 800 To close the withdrawals account.(Also known as Drawing)

20. The Accounts After Closing • Accounts are ready for the next period. • Revenue, expense, and withdrawals (temporary accounts) have zero balances. • Owner’s Capital has been increased to reflect the company’s net income and decreased for dividends. • The balance sheet accounts (permanent accounts) show the correct balances, which are carried forward to the next period.

21. 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.

22. How to remember what is closed Draw a Boot around the WER---Accounts that WER with a balance. CLR AWE

23. The Post-Closing Trial Balance OBECTIVE 4 Prepare the post-closing trial balance.

24. The Post-Closing Trial Balance • Errors can be made in posting the closing entries to the ledger accounts. • A post-closing trial balance is prepared to determine that: 1. All temporary accounts have a zero balance. 2. Debits equal credits. • Only balance sheet accounts should show a balance. (AL&C)

25. Discussion Q. What is the significance of the post-closing 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 and that only balance sheet accounts show balances.

26. Reversing Entries:The Optional First Step in theNext Accounting Period SUPPLEMENTAL OBJECTIVE 5 Prepare reversing entries as appropriate.

27. About Reversing Entries • A reversing entryis a general journal entry made on the first day of a new accounting period that is the exact reverse of an adjusting entry made at the end of the previous period. • Reversing entries are optional. • Reversing entries simplify the bookkeeping for accrued revenues and accrued expenses. • Deferrals cannot be reversed.

28. Example of an Accrual Without Reversing Entry Jan. 31 Wages Expense 180 Wages Payable 180 To accrue unrecorded wages Feb. 9 Wages Payable 180 Wages Expense 420 Cash 600 Payment of two weeks’ wages to secretary, $180 of which accrued in the previous period.

29. Example of an Accrual With Reversing Entry 1. Adjusting entry Jan. 31 Office Wages Expense 180 Wages Payable 180 2. Closing entry Jan. 31 Income Summary 1,380 Office Wages Expense 1,380 3. Reversing entry Feb. 1 Wages Payable 180 Office Wages Expense 180 4. Payment entry Feb. 9 Office Wages Expense 600 Cash 600

30. Discussion Q. What is the purpose of reversing entries? A. Reversing entries enable the bookkeeper to continue preparing routine journal entries in the new accounting period.

31. The Work Sheet:An Accountant’s Tool SUPPLEMENTAL OBJECTIVE 6 Prepare a work sheet.

32. Working Papers • In order to prepare financial reports, accountants must collect data in various forms to determine what should be included. • The data collected make up the accountant’s working papers. • Working papersare important for two reasons. 1. They help accountants organize their work and avoid omitting important data or steps. 2. They provide evidence of past work so that accountants or auditors can retrace their steps and support the information in the financial statements.

33. The Work Sheet • The work sheet, a special kind of working paper, is often used as a preliminary step in the preparation of financial statements. • A work sheet lessens the possibility of leaving out an adjustment. • A work sheet helps check the mathematical accuracy of the accounts. • A work sheet facilitates the preparation of financial statements. • A work sheet is not a published financial statement. • A work sheet is often prepared using a computer.

34. Preparing the Work Sheet 1. Enter and total the account balances in the Trial Balance columns. 2. Enter and total the adjustments in the Adjustments columns. 3. Enter and total the adjusted account balances in the Adjusted Trial Balance columns.

35. 4. Extend the account balances from the Adjusted Trial Balance columns to the Income Statement columns or the Balance Sheet columns.

36. 4. Extend the account balances from the Adjusted Trial Balance columns to the Income Statement columns or the Balance Sheet columns. 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 the column totals.

37. Discussion Q. Why are work sheets never published and rarely seen by management? A. Work sheets are never published and are rarely seen by management because they are a preliminary step in preparing financial statements. They are a tool for the accountant.

38. Using the Work Sheet SUPPLEMENTAL OBJECTIVE 7 Use a work sheet for three different purposes.

39. Using the Work Sheet The completed work sheet aids the accountant in three principal tasks: 1. Preparing the Financial Statements. Account balances have been sorted into Income Statement and Balance Sheet columns. 2. Recording the Adjusting Entries. Adjusting entries are copied to the general journal and then posted to the general ledger. 3. Recording the Closing Entries. Closing entries are entered in the journal and posted to the ledger. All accounts that need closing, except Dividends, may be found in the Income Statement columns of the work sheet.

40. 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.

41. OK, LET’S REVIEW . . . 1. State all the steps in the accounting cycle. 2. Explain the purposes of closing entries. 3. Prepare the required closing entries. 4. Prepare the post-closing trial balance.

42. I was better looking in • the last chapter--it’s not your imagination. 5. Prepare reversing entries as appropriate. 6. Prepare a work sheet. 7. Use a work sheet for three different purposes.