Needles 9e CL Ready Notes Ch04

Chapter 4
Completing the
Accounting
Cycle
Multimedia Slides by: Gail A. Mestas, MAcc, New Mexico State University
Learning Objectives
1. State all the steps in the accounting

cycle.
2. Explain and prepare closing entries.
3. Prepare the post-closing trial balance.
4. Prepare reversing entries as
appropriate.
5. Prepare and use a work sheet.
Copyright Houghton Mifflin Company. 42

Overview of the Accounting Cycle
Objective 1
State all the steps in the accounting cycle

The Accounting Cycle
A series of steps in the accounting

system
Purpose
Measure business activities in the form of
transactions
Transform these transactions into financial
statements
Communicate useful information to decision
makers

Steps in the Accounting Cycle
business transactions from source documents
1. Analyze
the entries in the journal
2. Record
the entries to the ledger and prepare a trial balance
3. Post
the accounts and prepare an adjusted trial balance
4. Adjust
the accounts and prepare a post-closing trial balance
5. Close
financial statements
6. Prepare
The order of these steps can vary depending on the
system in place
Step 6 may be completed before Step 5
Overview of the Accounting Cycle
Input Output
Accounting System

Discussion
Q. Is it necessary to complete all six

steps in the accounting cycle?
A. Yes. All six steps must be accomplished
to complete the accounting cycle.
However, the order of these steps can
vary somewhat depending on the system
in place

Closing Entries
Objective 2
Explain and prepare closing entries

Two Account Types
Permanent accounts
Balance sheet accounts
Also called real accounts
Carry end-of-period balances into the next
accounting period
Temporary accounts
Income statement accounts (revenues and
expenses)
Also called nominal accounts
Begin each accounting period with a zero balance

Closing Entries
Journal entries made at the end of an

accounting period
Two purposes
1. Clear revenue, expense, and Withdrawal
accounts (temporary accounts) of their balances
2. Summarize a period's revenues and expenses
Revenue and expense accounts must begin each

new period with zero balances for the income
statement to present the activity of a single period

Income Summary Account
Summarizes revenues and expenses

for a period
Temporary account
Used only in the closing process
Never appears in the financial
statements
Appears in chart of accounts after
Withdrawals and before revenue
accounts
Income Summary Account (contd)
All revenue and expense account balances

are transferred to Income Summary during
the closing process
The balance in Income Summary equals net
income or loss reported on the income
statement
This balance is then transferred to the Capital
account (an owner's equity account)
Revenue and expense accounts represent
increases and decreases to owner's equity

Required Closing Entries
1. Close credit balances from income statement

accounts to Income Summary
2. Close debit balances from income statement
accounts to Income Summary
3. Close the Income Summary account balance
to the Capital account
4. Close the Withdrawals account balance to the
Capital account

The Closing Process
Step 1 Revenue accounts carry normal credit Revenue Accounts
balances XXX Bal. XXX
To close: Credit revenue accounts Bal. -0-
Debit Income Summary
Step 2 Expense accounts carry normal debit Expense Accounts
balances Bal. XXX XXX
To close: Debit expense accounts Bal. -0-
Credit Income Summary
Step 3 Income Summary
A credit balance in Income Summary
represents net income for the period XXX XXX
To close: Debit Income Summary XX Bal. XX
Credit Capital Bal. -0-
Withdrawals Capital
XX

The Closing Process (cont.)
Step 3 If a net loss occurred for the period, Income Revenue Accounts
(cont.) Summary would carry a debit balance XXX Bal. XXX
To close: Credit Income Summary Bal. -0-
Debit Capital
Step 4 The Withdrawals account carries a normal Expense Accounts
debit balance Bal. XXX XXX
To close: Credit Withdrawals Bal. -0-
Debit Income Summary
Income Summary
Notice that all the temporary accounts
XXX XXX
now carry zero balances. Capital is a
permanent account and will carry its Bal. XX XX
balance into the next accounting period Bal. -0-
Withdrawals Capital
Bal. XX XX XX
Bal. -0- XX

Closing Revenue Accounts
Joan Miller has two revenue accounts with balances

Advertising Fees Earned Art Fees Earned
July 31 6,400 6,400 July 31 400 400
Bal. -0- Bal. -0-
Income Summary
A compound entry can be used to
July 31 6,800
close the two revenue accounts to
Income Summary
Copyright Houghton Mifflin Company. All rights reserved. 416

Closing Expense Accounts
Joan Miller has nine revenue accounts with balances
The same closing procedure is used as with the revenue accounts
except expense accounts carry credit balances and must be
debited to be closed
A compound entry closes the nine Income Summary
revenue accounts to Income July 31 4,800 July 31 6,800
Summary

Closing the Income Summary Account
Revenues and expenses are now summarized in the Income
Summary account
Income Summary
The balance in the Income Summary July 31 4,800 July 31 6,800
account represents net income or loss 2,000 Bal. 2,000
for the period
Bal. -0-
The Income Summary account must Joan Miller, Capital
now be closed to the Capital account 2,000
A credit balance in the Income If the Income Summary account had a

Summary account represents net debit balance, it would represent a net
income for the period loss for the period
Revenues > Expenses = Net Income Revenues < Expenses = Net Loss
Closing the Withdrawals Account
Joan Miller made withdrawals of $1,400 from the
business during the period
Joan Miller, Withdrawals
Withdrawals represent reductions in
1,400 1,400
owner's equity so the account carries
a normal debit balance Bal. -0-
The Withdrawals account must be Joan Miller, Capital

closed to the Capital account 1,400 1,600
Bal. 200
The Capital account now reflects net income

and withdrawals for the period
Copyright Houghton Mifflin Company. All rights reserved. 419

The Accounts After Closing
Revenue, expense, and Withdrawals

accounts have zero balances
The Capital account reflects
Net income or loss
Withdrawals
Balance sheet accounts reflect correct
balances to be carried forward into the
next accounting period

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

The Post-Closing Trial Balance
Objective 3
Prepare the post-closing trial balance

The Post-Closing Trial Balance
The final trial balance

Used to verify that total debits equal total
credits
Only balance sheet accounts show balances
because income statement accounts and
Withdrawals have been closed
The Capital account now reflects previous
revenue, expense, and Withdrawals balances

The Post-Closing Trial Balance (contd)
Only balance
sheet accounts
appear on the
post-closing trial
balance
Income
statement and
Withdrawals
accounts have
been closed and
are reflected in
the Capital
account balance
Only accounts
with balances are
listed on a trial
balance
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
Only balance sheet accounts show balances

Reversing Entries: The Optional First
Step in the Next Accounting Period
Objective 4
Prepare reversing entries as appropriate

Reversing Entries
Are made to reverse adjusting entries

recorded at the end of the previous accounting
period
Simplify the bookkeeping process
Are optional
Are made on the first day of the new
accounting period
Only adjustments for accruals are reversed

Reversing deferrals would not simplify the
bookkeeping process

Effects of Reversing Entries
Adjusting and closing entries are the same whether

reversing entries are used or not
Reversing entries are made on the first day of the new

accounting period

Effects of Reversing Entries
Payment of wages
If no reversing entry was made, the amount of wages expense
must be determined for the current period ($1,200 - $360)
If a reversing entry was made, the entire amount of wages paid
is entered as an expense

Effects on the Wages Expense Account
(1) Adjusting (2) Closing Entry:

Entry: Wages Expense Brings account
Records accrued balance to zero.
unrecorded wages (1)Jul 31 360 (2)Jul 31 360 Expense will be
expense for the reported on income
current period Aug 1 -0- (3)Aug 1 360 statement for July
(4)Aug 9 1,200
(4) Entry to Bal. 840 (3) Reversing
record payment Entry:
of wages: The balance in the Wages Expense Reduces Wages
Full amount of account correctly reflects the amount of Expense account
payment is expense that applies to August by the amount of
recorded as an accrued expense
expense It was not necessary to look in previous that was recorded
records to determine this amount for July

Recording Wages Expense Using a
Reversing Entry
July 31: Joan Miller Advertising Agency made an adjusting entry to
accrue unrecorded wages
Wages Expense Wages Payable

July 31 360 Jul 31 360 July 31 360
Aug 1 -0-
July 31: The Wages Expense account is closed to Income Summary
The Wages Expense account The Wages Payable account

will now carry a zero balance will carry a $360 balance into
into the next accounting period the next accounting period
Recording Wages Expense Using a
Reversing Entry (contd)
Aug 1: The adjusting entry for accrued wages is reversed
Wages Expense Wages Payable

July 31 360 Jul 31 360 Aug 1 360 July 31 360
Aug 1 -0- Aug 1 360 Bal. -0-
Aug 9 1,200
Bal. 840
Aug 9: Secretarys wages are paid, $1,200
The Wages Expense account The liability for the secretarys

will now reflect $840 of wages wages for July was removed
expense for August with the reversing entry
Recording Revenue Using a Reversing
Entry
July 31: Joan Miller Advertising Agency made an adjusting entry to
accrue unrecorded revenue
Accounts Receivable Advertising Fees Earned

July 31 200 Jul 31 200 July 31 200
Aug 1 -0-
July 31: The Advertising Fees Earned account is closed to Income

Summary
The Advertising Fees Earned The Accounts Receivable account

account will now carry a zero balance will carry a $200 balance into the
into the next accounting period next accounting period
Recording Revenue Using a Reversing
Entry (contd)
Aug 1: The adjusting entry for accrued revenue is reversed
Accounts Receivable Advertising Fees Earned

July 31 200 Aug 1 200 Jul 31 200 July 31 200
Aug 1 200 Aug 1 -0-
The Advertising Fees Earned account now reflects an abnormal

balance of $200
When payment is received, advertising fees earned for that period
will automatically be reduced by the amount that applied to July

Discussion
Q. What is the purpose of reversing

entries?
A. To simplify the bookkeeping process
They enable the bookkeeper to continue
preparing routine journal entries in the new
accounting period

The Work Sheet:
An Accountants Tool
Objective 5
Prepare and use a work sheet

Working Papers
Relevant data collected by accountants

Calculations to determine the amount of
Prepaid insurance that has expired
Depreciation
Inventory of supplies on hand
Accrued wages
Analyses
Preliminary drafts of financial statements

Working Papers (contd)
Important for two reasons

1. Organization
Avoid omitting important data or tasks that
affect financial statements
2. Provide evidence of past work
Other accountants or auditors can retrace
steps used to prepare financial statements

The Work Sheet
A working paper; a tool for the

accountant
Lessens the possibility of leaving out an
adjustment
Essential for larger companies
Helps in checking the accuracy of
accounts

The Work Sheet (contd)
Facilitates the preparation of the

financial statements
Is never published
Preparation may be aided using a
microcomputer
Spreadsheet program
General ledger system

Common Form of Work Sheet
A title that consists of

The name of the company
The title, Work Sheet
The period of time covered
One column for account names

Ten working columns
Preparing the Work Sheet
Step 1
Enter and total account balances in the

Trial Balance column
When using the work sheet, a separate trial
balance does not need to be prepared
Includes only those accounts with balances

Step 2
Enter and total the adjustments in the

Adjustments column
If an adjustment calls for an account not used
in the trial balance, it is added below the
accounts already listed

Step 3
Enter and total the adjusted account balances

in the Adjusted Trial Balance column
The adjusted account balances are obtained by
crossfooting
Combining the amount of each account in the Trial
Balance columns with the corresponding amounts in
the Adjustments columns

Crossfooting
Adding or subtracting a group of numbers horizontally

Pay attention to debits and credits
The $500 credit adjustment to Art Supplies decreases the
$1,800 debit balance to an adjusted $1,300 debit balance
The $360 debit adjustment to Wages Expense increases the
$2,400 debit balance to an adjusted $2,760 debit balance

Step 4
Extend the account balances from the Adjusted Trial

Balance columns to the appropriate Income Statement
or Balance Sheet columns
Revenue and expense accounts are extended to the
Income Statement columns
Assets, liabilities, and owner's equity accounts are
extended to the Balance Sheet columns

Step 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
This step determines net income or loss for the period and
proves the arithmetical accuracy of the work sheet
5,200 6,800 26,320 24,720

1,600 1,600
6,800 6,800 26,320 26,320

Example of Preparing the Work Sheet
Wages Expense
Step 1
Enter Wages Expense account balance
in the Trial Balance column

Wages Expense
Step 2
Enter the adjustments in the
Adjustments column
The Wages Payable account must

now be added to the list of accounts

Wages Expense
Step 3
Enter the adjusted account balances in
the Adjusted Trial Balance column

Wages Expense
Step 4
Extend the account balances from the
Adjusted Trial Balance columns to the
appropriate Income Statement or
Balance Sheet columns
Income
Statement
Account
Balance
Sheet
Account

Using the Work Sheet
The work sheet assists the accountant

in three principal tasks
1. Recording the adjusting entries
2. Recording the closing entries in the
general journal
Prepares the records for the beginning of the
next accounting period
3. Preparing the financial statements

Recording the Adjusting Entries
Adjustments are determined while preparing the

work sheet
Adjusting entries can be recorded
When determined
Later when closing entries are recorded
Information can be copied from the work sheet

and recorded in the general journal
Include appropriate explanations
Post to the general ledger

Recording the Closing Entries
All accounts that need to be closed,

except for Withdrawals, may be found in
the Income Statement columns of the
work sheet
Closing entries are entered in the
general journal and posted to the ledger

Preparing the Financial Statements
Account balances have been sorted into

Income Statement and Balance Sheet
columns on the work sheet
The income statement is prepared from
accounts in the Income Statement
columns
The statement of owners equity and
balance sheet are prepared from
accounts in the Balance Sheet columns
The Balance Sheet
Total assets and total liabilities and owner's equity on the balance sheet
are not the same as
the totals of the Balance Sheet columns in the work sheet
The Balance Sheet
This is because the Accumulated Depreciation accounts
have normal balances that appear in different columns from their
associated accounts on the balance sheet
The Balance Sheet
Also, the owners Capital account on the balance sheet is the amount
determined on the statement of owners equity
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

Time for Review
1. State all the steps in the accounting

cycle.
2. Explain and prepare closing entries.
3. Prepare the post-closing trial balance.
4. Prepare reversing entries as
appropriate.
5. Prepare and use a work sheet.

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Chapter 4

1. State all the steps in the accounting

Copyright Houghton Mifflin Company. 42

Copyright Houghton Mifflin Company. 43

A series of steps in the accounting

Copyright Houghton Mifflin Company. 44

Copyright Houghton Mifflin Company. 46

Q. Is it necessary to complete all six

Copyright Houghton Mifflin Company. 47

Copyright Houghton Mifflin Company. 48

Copyright Houghton Mifflin Company. 49

Journal entries made at the end of an

Revenue and expense accounts must begin each

Copyright Houghton Mifflin Company. 410

Summarizes revenues and expenses

All revenue and expense account balances

Copyright Houghton Mifflin Company. 412

1. Close credit balances from income statement

Copyright Houghton Mifflin Company. 413

Copyright Houghton Mifflin Company. 414

Copyright Houghton Mifflin Company. 415

Joan Miller has two revenue accounts with balances

Copyright Houghton Mifflin Company. All rights reserved. 416

Copyright Houghton Mifflin Company. 417

A credit balance in the Income If the Income Summary account had a

The Withdrawals account must be Joan Miller, Capital

The Capital account now reflects net income

Copyright Houghton Mifflin Company. All rights reserved. 419

Revenue, expense, and Withdrawals

Copyright Houghton Mifflin Company. 420

Q. Could the Income Summary account

A. Yes, if a net loss has been incurred

Copyright Houghton Mifflin Company. 421

Copyright Houghton Mifflin Company. 422

The final trial balance

Copyright Houghton Mifflin Company. 423

Q. What is the significance of the post-

Copyright Houghton Mifflin Company. 425

Copyright Houghton Mifflin Company. 426

Are made to reverse adjusting entries

Only adjustments for accruals are reversed

Copyright Houghton Mifflin Company. 427

Adjusting and closing entries are the same whether

Reversing entries are made on the first day of the new

Copyright Houghton Mifflin Company. 428

Copyright Houghton Mifflin Company. 429

(1) Adjusting (2) Closing Entry:

Copyright Houghton Mifflin Company. 430

Wages Expense Wages Payable

July 31: The Wages Expense account is closed to Income Summary

The Wages Expense account The Wages Payable account

Wages Expense Wages Payable

The Wages Expense account The liability for the secretarys

Accounts Receivable Advertising Fees Earned

July 31: The Advertising Fees Earned account is closed to Income

The Advertising Fees Earned The Accounts Receivable account

Accounts Receivable Advertising Fees Earned

The Advertising Fees Earned account now reflects an abnormal

Copyright Houghton Mifflin Company. 434

Q. What is the purpose of reversing

Copyright Houghton Mifflin Company. 435

Copyright Houghton Mifflin Company. 436

Relevant data collected by accountants