COMPLETION OF THE ACCOUNTING CYCLE UNIT 4

A work sheet is a multiple-column form that may be used in the adjustment process and in preparing financial statements. It is a working tool or a supplementary device for the accountant and not a permanent accounting record. Use of a work sheet should make the preparation of adjusting entries and financial statements easier. WORK SHEET

ILLUSTRATION 4-1 WORK SHEET 1. Prepare trial balance on the worksheet. 2. Enter adjustment data. 3. Enter adjusted balances 4. Extend adjusted balance to appropriate columns. 5. Calculate income/loss and complete the worksheet.

PURPOSE OF CLOSING ENTRIES 1. Updates the owner’s capital account in the ledger by transferring net income (loss) and owner’s drawings to owner’s capital. 2. Prepares the temporary accounts (revenue, expense, drawings) for the next period’s postings by reducing their balances to zero.

ILLUSTRATION 4-2 TEMPORARY VERSUS 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 drawings Owner’s capital account (Balance Sheet Accounts) (Income Statement / Drawings Accounts)

ILLUSTRATION 4-3 DIAGRAM OF CLOSING PROCESS 1 1 Debit each revenue account for its balance, and credit the owner’s capital account for total revenues. 2 Debit the owner’s capital account for total expenses, and credit each expense account for its balance. 1 Debit each revenue account for its balance, and credit the owner’s capital account for total revenues. 2 Debit the owner’s capital account for total expenses, and credit each expense account for its balance. (INDIVIDUAL) EXPENSES Normal Dr. Balance Normal Cr. Balance Cr. to close Dr. to close Expenses Revenues Opening Balance 2

ILLUSTRATION 4-3 DIAGRAM OF CLOSING PROCESS 3 3 Debit owner’s capital for the balance in the owner’s drawings account and credit owner’s drawings for the same amount. OWNER’S DRAWINGS Normal Dr. Balance Cr. to close Expenses Revenues Opening Balance Drawings Ending Balance

CLOSING ENTRIES STOP AND CHECK 1.Does the balance in your Owner’s Capital account equal the ending capital balance reported in the Balance Sheet and Statement of Owner’s Equity? 2. Are all of your temporary account balances zero?

POST-CLOSING TRIAL BALANCE After all closing entries have been journalized and posted, a post-closing trial balance is prepared. The purpose of this trial balance is to prove the equality of the permanent (balance sheet) account balances that are carried forward into the next accounting period.

ILLUSTRATION 4-8 POST-CLOSING TRIAL BALANCE The post-closing trial balance is prepared from the permanent accounts in the ledger. The post-closing trial balance provides evidence that the journalizing and posting of closing entries has been properly completed.

1. Analyse transactions 2. Journalize the transactions 3. Post to ledger accounts 4. Prepare a trial balance 5. Journalize and post adjusting entries 6. Prepare adjusted trial balance 7. Prepare financial statements 8. Journalize and post closing entries 9. Prepare post-closing trial balance STEPS IN THE ACCOUNTING CYCLE

A reversing entry is made at the beginning of the next accounting period. A reversing entry reverses certain adjusting entries made in the previous period. Opening balances can then be ignored when preparing year-end adjusting entries. This topic is illustrated in Appendix 4A. REVERSING ENTRIES (OPTIONAL STEP)

CORRECTING ENTRIES Errors that occur in recording transactions should be corrected as soon as they are discovered by preparing correcting entries. Correcting entries are unnecessary if the records are free of errors; they can be journalized and posted whenever an error is discovered. They involve any combination of balance sheet and income statement accounts.