BMSH2203

COMPLETION OF THE ACCOUNTING CYCLE FOR A SERVICE BUSINESS

Flow of Accounting Information
The general ledger for accounts receives information from the chart of accounts. After that, the bookkeeping
system combines the activity for a predetermined amount of time for each account to create a trial balance.
The trial balance can be used to create financial statements. The accountant of a business must match each
line item in the financial statement (such as revenue, cost of goods sold, selling expenses, and general and
administrative expenses) to the trial balance account.

Figure 1: Flow of Information in Accounting Records

Source: https://www.universalcpareview.com/ask-joey/what-is-the-flow-of-information-in-accounting-
records/

Accounting Worksheet
According to Srivastav, the Accounting Worksheet records all accounting data and prepares the company's
financial statements at the end of each accounting cycle to guarantee accuracy. These accounting
spreadsheets are designed primarily for internal use; however, the company's external users, such as
investors, creditors, and so on, rarely have the opportunity to view the company's accounting worksheet.

Because of this, the person who makes the accounting worksheet can change its format to meet their
internal and workflow needs. Therefore, this spreadsheet aids in tracking each stage of the company's
accounting cycle.

Steps in Preparing a Worksheet

1. Enter the unadjusted trial balance
2. Enter adjustments
3. Prepare the adjusted trial balance
4. Sort adjusted trial balance amounts to financial statements
5. Total statement columns, compute income or loss, and balance columns

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Figure 2: Sample of a Modern Accounting Worksheet

Source: https://www.wallstreetmojo.com/accounting-worksheet/

Preparation of Financial Statement

One of the final steps in the accounting cycle is the preparation of your financial statements, which use
information from previous statements to create the current financial statement. We can also file quarterly
and year-end statements and analyze your financial statements, depending on your requirements (De
Guzman, 2018).

Financial Statement Preparations:

1. Prepare Income Statement. Sales revenue, expenses, and general ledger records are used to
calculate the net profit or loss on the income statement.
2. Prepare the Statement of Owner’s Equity (Retained Earnings). The distribution of profit between
dividends and retained earnings is shown on the statement of retained earnings.
3. Prepare the Balance Sheet. The balance sheet is a snapshot of the company's financial situation
from the final day of the accounting cycle.
4. Prepare the Statement of Cash Flow. From a cash basis, the statement of cash flow is a compilation
and comparison of information from the three (3) primary financial reports: income, balance sheet,
and retained earnings
5. Financial Statements Analysis. Although business owners may not require all the specifics, they
must comprehend the big picture of their current financial and cash positions. These insights are
crucial when making decisions about running a business.
Preparing general-purpose financial statements can be simple or complex, depending on the company's size.
Some statements need footnote disclosures, while others can be presented without any. Details generally
depend on the purpose of the financial statements.

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Income Statement
An income statement is prepared monthly, quarterly, or even annually in the business world. The report will
include Revenue and Expenses account balances from the Adjusted Trial balance. If the total revenue is
lower than the total expenses, the result is considered a “Net Loss”; however, if the total revenue is higher
than the total expenses, the result is considered a “Net Gain.”

Figure 3: Sample of Income Statement

Source: Fundamental Accounting Principles. McGraw-Hill Education. Wild, J., & Shaw, K. (2018).

Importance of Income Statement

The following are some excellent reasons why preparing an income statement is so crucial for any business
size (Tripathi, 2018):
• By reading the income statement, business owners can learn about the company's current financial
situation. The company owners can make quick and informed decisions regarding the business's
expenditures based on the precise data displayed on the income statement.
• An income statement gives stakeholders, shareholders, and the business owner insight into the
business's financial state.
• If a company operates in a country, it must pay various business taxes following that country's tax
laws. By law, businesses must pay taxes. The income statement and other financial statements
(balance sheet and cash flow statement) will provide you with the financial data required to
calculate your tax liability.

Statement of Owner’s Equity (Retained earnings)

The accumulated portion of a company's profits that are not distributed as dividends to shareholders but are
instead reserved for reinvestment back into the business is known as retained earnings (RE). Typically, these
funds are allocated for debt repayment or the acquisition of working capital and fixed assets (CFI, 2022).

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Figure 4: Sample of Statement of Owner’s Equity

Source: Fundamental Accounting Principles. McGraw-Hill Education. Wild, J., & Shaw, K. (2018).

Importance of Statement of Owner’s Equity

Because retained earnings are recorded under shareholders' equity, which links the income statement and
balance sheet, retained earnings provide a helpful link.
• These profits can be kept for a variety of reasons, including spending on new machinery and
equipment, investing in research and development, or engaging in other activities that have the
potential to propel the business forward.
• This reinvestment in the business aims to increase earnings even further in the future.

Preparation of the Balance Sheet (Statement of Financial Position)

Based on the definition provided by Riccio (n.d), the balance sheet is essential to accounting and financial
modeling. The total company assets and their financing methods —equity or debt— are shown on the
balance sheet. It is also known as a statement of financial position or net worth.

As a result, the assets and liabilities are further broken down and divided into the categories "current" and
"non-current." Current refers to a period of less than one (1) year, while non-current refers to a period of
more than one (1) year. We can see how quickly they need to be paid back (liabilities) or turned into cash
(assets) in this way.

Stocks, accounts receivable (also known as debtors), and other items that can be converted into cash within
a year are all current assets. Following current assets are non-current assets, including business vehicles,
furniture, and equipment, that will not be monetized for more than a year.

Figure 5: Sample of Balance Sheet (Statement of Financial Position)

Source: Fundamental Accounting Principles. McGraw-Hill Education. Wild, J., & Shaw, K. (2018).

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Importance of Balance Sheet (Statement of Financial Position)

The balance sheet can show a company's financial health at a specific time —typically at the end of a fiscal
year or the end of a month.
• Shows how much money the business owes and how much assets are worth.
• It helps monitor the company's performance, spot trends, and implement financial support
strategies using balance sheet data.
• It can help you assess the ability to pay bills on time and how well to use credit to finance the
business.
• Data from the previous year will typically also be included on most balance sheets to make it
easier to compare and see how the business is doing over time.
• The balance sheet can provide warning signs that can assist in resolving potential issues before
they harm the business, so it is a good idea to become familiar with financial ratios.
• The data on the balance sheet can also be used to determine an investment's profitability in
conjunction with other financial reports like the profit and loss statement. Pricing policies and
investments in inventory or equipment can be evaluated by small businesses using a "return on
investment" (ROI) indicator.

Statement of Cash Flow

According to Stobierski (2020), the objective of a Statement of Cash Flow is to provide a comprehensive
picture of a company's cash flow over a specific period or accounting period. Based on the amount of money
entering and leaving the company demonstrates an organization's capacity to function both now and in the
future.

The cash flow statement is typically broken into three (3) sections:
1. Operating activities detail cash flow generated once the company delivers its regular goods or
services, including revenue and expenses.
2. Investing activities include cash flow from purchasing or selling assets—physical properties, such
as real estate or vehicles, and non-physical properties, like patents—using free cash, not debt.
3. Financing activities detail cash flow from both debt and equity financing.

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Figure 6: Sample of Statement of Cash Flow

Source: https://i0.wp.com/content.edupristine.com/images/blogs/cash-flow-statement

Importance of Statement of Cash Flow

Whenever a business reviews any financial statement, it should consider it from a business perspective.
Financial documents provide insight into an organization's financial health and status.
• Cash flow statements can reveal what phase a business is in: a rapidly growing startup or a
mature and profitable company. It can also reveal whether a company is going through a
transition or in a state of decline.
• Using the statement of cash flow, an investor might decide that a company with uneven cash
flow is too risky to invest in, or they might decide that a company with positive cash flow is
primed for growth.
• Cash flow might also impact internal decisions, such as budgeting or hiring (or firing) employees.
• Cash flow is typically depicted as being positive (the business is taking in more cash than its
expending) or negative (the business is spending more cash than it’s receiving).

Closing Entries
According to Pineda (2022), closing journal entries are made at the end of the accounting period to prepare
temporary accounts for the next period. Temporary or nominal accounts are measured periodically. The
amounts in one accounting period should be closed or brought to zero, so they would not mix with those of
the next period.

Temporary accounts consist of all revenue and expense accounts and also withdrawal accounts of owners in
the case of sole proprietorships and partnerships. Take note that closing entries are prepared only for
temporary accounts. Permanent accounts are never closed.

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Four (4) steps in preparing closing entries:

1. Close all income accounts to Income Summary.
2. Close all expense accounts to Income Summary.
3. Close all income summaries to the appropriate capital account.
4. Close withdrawals to the capital accounts (This step is for sole proprietorship and partnership
only).

Income Summary
The income summary is a temporary account used to make closing entries (CFI, 2022).

At the end of the accounting period, all temporary accounts must be reset to zero. Their balances are
emptied into the income summary account to accomplish this. The income summary account then transfers
the net balances of all temporary accounts to retained earnings, a permanent account on the balance sheet.

Example of a Closing Entries

1. Close Revenue Accounts. Clear the revenue account balance by debiting the revenue and
crediting the income summary.
Date Accounts Debit Credit
Dec. 31, 2022 Fees Earned P16,840
Rent Revenue 120
Income Summary P16,960

2. Close Expense Accounts. Clear the balance of the expense accounts by debiting the income
summary and crediting the related expenses.
Date Accounts Debit Credit
Dec. 31, 2022 Income Summary P92,000
Cost of Goods Sold P55,000
Depreciation Expense 5,000
Rent Expense 15,000
Wages Expense 15,000
Interest Expense 2,000

3. Close Income Summary. Close the income summary account by debiting the income summary
and crediting retained earnings.
Date Accounts Debit Credit
Dec. 31, 2022 Income Summary P8,000
Retained Earnings P8,000

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4. Close Withdrawals. Close the withdrawals account by debiting the owner’s capital and crediting
withdrawals.
Date Accounts Debit Credit
Dec. 31, 2022 Owner, Capital P4,000
Owner, Drawing P4,000

Post-Closing Trial Balance

The final trial balance prepared before the beginning of the new accounting period is called a post-closing
trial balance. The post-closing trial balance is used to verify that beginning balances are correct and that
debits and credits remain in balance after completing closing entries (De Guzman, 2018).

Three (3) main types of reports can be run on the trial balance, and each can be run at a specific point in the
accounting cycle.
1. The unadjusted trial balance should be completed after all accounting period entries have been
completed. It shows the first look at credit and debit balances.
2. The adjusted trial balance. Before the end of the accounting period, every business must make
adjusting entries. Depreciation expenses, prepaid expenses, insurance costs, and accumulated
depreciation are all included in these adjusting entries.
3. Post-closing trial balance. After completing the adjusted trial balance, the business can begin
recording the month's post-closing entries. The closing of all temporary accounts and the
adjustment of real account balances, such as owner's capital, are the goals of closing entries. The
debits and credits on the post-closing balance must match, just like they did on all trial balances.

Figure 7: Sample of Post-Closing Trial Balance

Source: Fundamental Accounting Principles. McGraw-Hill Education. Wild, J., & Shaw, K. (2018).

Reversing Entries
A reversing entry is a journal entry made during an accounting period that reverses some entries from the
period before it. The reversing entry is typically made at the beginning of an accounting period. It is
frequently used when the accountant does not want the accruals to remain in the accounting system for
another period, and either revenue or expenses were accrued in the preceding period (Pineda, 2022).

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Example of Reversing Entries: The company's fiscal year ends each year at the end of December. In the
middle of December, the company hired employees with a salary of P4,200. At the end of December 2022,
this amount was accrued but not paid.

Thus, the following adjusting entry will be made when the books of accounts are closed at the end of
December 2022:
Date Accounts Debit Credit
Dec. 31, 2022 Salary Expense P4,200
Accrued Salary P4,200
Being the salary is accrued for the month of
December

The preceding entry will be reversed in the following year (at the beginning of the 2023 fiscal year), and the
following entry will be:
Date Accounts Debit Credit
Jan. 1, 2023 Accrued Salary P4,200
Salary Expense P4,200
Reversing the previous year's accrued salary of
December

Using this example of a reversal entry at the beginning of the new fiscal year, the effect of the previous entry
will be canceled because the reverse entry causes the salary expense account to have a negative balance.

References
CFI Team (2022) Retained Earnings https://corporatefinanceinstitute.com/resources/accounting/retained-
earnings-guide/

De Guzman, A. (2018) Fundamentals of Accountancy, Business, and Managment: A Textbook in Basic

Accounting 1 . Manila: Lori Mar Publishing

Pineda, A. (2022) Fundamentals of Accountancy, Business, and Managment: A Textbook in Basic Accounting
1 . Manila: Mindshapers Co., Inc

Riccio, S. (n.d) Why the Balance Sheet is Important to your Business https://mgiadelaide.com.au/financial-
performance/why-the-balance-sheet-is-important-to-your-business

Srivastav, A. (n.d) What is an Accounting Worksheet? https://www.wallstreetmojo.com/accounting-

worksheet/

Stobierski, T. (2020) How to read and understand cash flow https://online.hbs.edu/blog/post/how-to-read-

a-cash-flow-statement

Tripathi, P. (2018) What Is an Income Statement and Why Is It Important?

https://www.deskera.com/blog/income-statement/

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