Completing the Accounting Cycle Instructor: Professor John Ahmad Chapter 4 Completing the Accounting Cycle Accounting 211 Instructor: Professor John Ahmad

In Chapter 4, we will: 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

What is a Worksheet? 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

Example of a Work Sheet

Remember: 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

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!

First, enter the unadjusted trial balance amounts to the worksheet! FastForward Work Sheet For Month Ended December 31, 2004 First, enter the unadjusted trial balance amounts to the worksheet! 43

Here are our adjusting entries for December. Insurance expense 100 Prepaid insurance 100 Supplies expense 1050 Supplies 1050 Depreciation expense 375 Accum. Depr. – Equip. 375

Here Are More Adjusting Entries for December. Unearned revenue 250 Consulting Revenue 250 Salaries Expense 210 Salaries Payable 210 Accounts Receivable 1,800 Consulting Revenue 1,800

Next, enter the adjustments! FastForward Work Sheet For Month Ended December 31, 2004 Next, enter the adjustments! 44

Prepare the adjusted trial balance! FastForward Work Sheet For Month Ended December 31, 2004 45

FastForward Work Sheet For Month Ended December 31, 2004 Then, extend the adjusted trial balance amounts to the financial statements! FastForward Work Sheet For Month Ended December 31, 2004 45

Total statement columns, compute income or loss, and balance columns. FastForward Work Sheet For Month Ended December 31, 2004 45

Prepare the Financial Statements Prepare the Income Statement. A work sheet does not substitute for financial statements.

Prepare the Statement of Changes in Owner’s Equity.

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

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

Closing Process Identify accounts for closing. 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. Record and post closing entries. Prepare post-closing trial balance.

Temporary and Permanent Accounts Temporary Accounts Revenues Income Summary Expenses Withdrawals Permanent Accounts Assets Liabilities Owner’s Capital The closing process applies only to temporary accounts.

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. Let’s see how the closing process works!

Balances before closing. Closing Process Balances before closing.

Close Revenue accounts to Income Summary. Closing Process Close Revenue accounts to Income Summary.

Closing Process Close Expense accounts to Income Summary. The balance in Income Summary equals net income.

Close Income Summary to Owner’s Capital. Closing Process Close Income Summary to Owner’s Capital.

Close Withdrawals account to Owner’s Capital. 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 Now, let’s look at the ledger accounts after posting this closing entry.

Close Expense Accounts to Income Summary Now, let’s look at the ledger accounts after posting this closing entry.

Close Expense Accounts to Income Summary Net Income

Close Income Summary to Owner’s Capital.

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

Close Withdrawals to Owner’s Capital.

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

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 ruled Owner’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 year Permanent 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.

Post-Closing Trial Balance Let’s look at FastForward’s post-closing trial balance. 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 Balance

Summary of Steps in the Accounting Cycle 1 Analyze business transactions 2 Journalize the transactions 3 Post to ledger accounts 4 Prepare a trial balance 5 Journalize and post adjusting entries

STEPS IN THE ACCOUNTING CYCLE 6 Prepare an adjusted trial balance 7 Prepare financial statements: Income Statement, Owner’s Equity Statement, Balance Sheet 8 Journalize and post closing entries 9 Prepare a post-closing trial balance

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 Accounts Receivable 50 Service Revenue 50

Another Illustrative Example Of Correcting Entry Delivery Equipment 45 Accounts Payable 45 Office Equipment 450 Accounts Payable 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):

Classified Balance Sheet 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.

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

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

Plant assets are tangible long-lived assets used to produce or sell products and services.

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.

Long-term liabilities are obligations not due within the longer of one year or the company’s operating cycle.

Equity is the owner’s claim on the assets.

REVERSING ENTRIES 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 Cant Get Bullets to appear one at a time.

ILLUSTRATIVE EXAMPLE OF REVERSING ENTRY

Questions? Homework for Chapter 4 Have a great weekend!