Financial Accounting, 4e

Weygandt, Kieso, & Kimmel

Prepared by
Gregory K. Lowry
Mercer University
Marianne Bradford
The University of Tennessee

John Wiley & Sons, Inc.

 CHAPTER 4
COMPLETION OF THE ACCOUNTING CYCLE

After studying this chapter, you should be able to:

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.
 PREVIEW OF CHAPTER 4
COMPLETION OF THE
ACCOUNTING CYCLE

Classified
Summary of
Using a Work Sheet Closing the Books Balance
Accounting Cycle
Sheet

 Steps in 
Preparing closing 
Reversing entries - 
Standard
preparation entries an optional step classification

Posting closing 
Correcting entries-  Balance sheet
 Preparing financial
statements entries an avoidable step illustration

Preparing 
Preparing a post-
 adjusting entries closing trial
balance
 WORK SHEET

 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.
 ILLUSTRATION 4-1
FORM AND PROCEDURE FOR A WORK SHEET
 WORK SHEET

 The use of a work sheet is optional.

 When a work sheet is used, financial statements
are prepared from the worksheet.
 Adjustments are journalized and posted from
the work sheet after financial statements are
prepared.
 STEPS IN PREPARING
A WORKSHEET
1 Prepare a trial balance on the worksheet
2 Enter the adjustments in the adjustments
columns
3 Enter adjusted balances in the adjusted
trial balance columns
4 Extend adjusted trial balance amounts
to appropriate financial statement
columns
5 Total the statement columns, compute net
income (loss), and complete the worksheet
PREPARING A WORKSHEET
1 PREPARING A TRIAL BALANCE

15,200

2,500

600

5,000

5,000

2,500

1,200

10,000

4,000 500

10,000

900

28,700
28,700
PREPARING A WORKSHEET
2 ENTER THE ADJUSTMENTS

a 1,500

b 50

d 400

d 400

e 200

g 1,200

a 1,500

b 50

c 40

c 40

f 50

e 200

f 50

g 1,200
PREPARING A WORKSHEET
3 ENTER ADJUSTED BALANCES

15,200

1,000

550

5,000

5,000

2,500

800

10,000

500

10,600

5,200

900

1,500

50

40

40

50

200

50

1,200
PREPARING A WORKSHEET
4 EXTEND ADJUSTED BALANCES

10,600

5,200

900

1,500

50

40

50
PREPARING A WORKSHEET
4 EXTEND ADJUSTED BALANCES

15,200

1,000

550

5,000

5,000

2,500

800

10,000

500

40

200

50

1,200
 ADJUSTING ENTRIES
JOURNALIZED
GENERAL JOURNAL
Date Account Titles and Explanation Ref. Debit Credit
2002
Oct. 31 a Advertising Supplies Expense 1,500
Advertising Supplies 1,500

31 b Insurance Expense 50
Prepaid Insurance 50

c Depreciation Expense 40
Accumulated Depreciation - Office Equipment 40
31
d Unearned Revenue 400
31 Service Revenue 400

31 e
Accounts Receivable 200
Service Revenue 200

31 f Interest Expense 50
Interest Payable 50
31 g Salaries Expense
1,200 Salaries Payable
1,200
PREPARATION OF FINANCIAL STATEMENTS
INCOME STATEMENT
PIONEER ADVERTISING AGENCY
Income Statement
For the Month Ended October 31, 2002

Revenues $ 10,600

Service Revenue

Expenses
Salaries expense
Advertising supplies expense
The income statement is
Rent expense prepared from the income $ 5,200
Insurance expense statement columns of the
Interest expense work sheet. 1,500

Depreciation expense 900

Total expenses 50

Net income
50

40

7,740
PREPARATION OF FINANCIAL STATEMENTS
RETAINED EARNINGS STATEMENT

$ -0-

The Retained Earnings 2,860

statement is prepared from 2,860

the balance sheet columns 500

of the work sheet. $ 2,360

PREPARATION OF FINANCIAL STATEMENTS
BALANCE SHEET
PIONEER ADVERTISING AGENCY
Balance Sheet
October 31, 2002

Assets Liabilities and Stockholders’ Equity

Cash $ 15,200 Liabilities

Accounts receivable Notes payable 200
$ 5,000
Advertising supplies 1,000 Accounts 2,500
payable
Prepaid insurance Interest payable
550
50 $ 5,000
Office equipment Unearned
800 Revenue
Less: Accumulated Salaries payable 1,200
40 4,960
depreciation 9,550 Total liabilities
Stockholders’ equity
10,000 Common Stock
2,360
Retained earnings
Total liabilities and
$ 21,910 $ 21,910
Total assets stockholders’ equity

The balance sheet is prepared from the

balance sheet columns of the work sheet.
 ILLUSTRATION 4-5
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

Dividends Stockholders’ equity

 CLOSING ENTRIES

 Closing entries formally recognize in the

ledger the transfer of net income (loss) and
dividends to retained earnings.
 Journalizing and posting closing entries is a
required step in the accounting cycle.
 A temporary account, Income Summary, is
used in closing revenue and expense
accounts to minimize the amount of detail in
the permanent retained earnings account.
 ILLUSTRATION 4-6
DIAGRAM OF CLOSING PROCESS

2 1

1 Debit each revenue account for its balance, and credit

Income Summary for total revenues.
2 Debit Income Summary for total expenses, and credit each
expense account for its balance.
 ILLUSTRATION 4-6
DIAGRAM OF CLOSING PROCESS

3 Debit (credit) Income Summary and credit (debit)

Retained Earnings for the amount of net income (loss).
 ILLUSTRATION 4-6
DIAGRAM OF CLOSING PROCESS

4 Debit Retained Earnings for the balance in the Dividends

account and credit Dividends for the same amount.
 ILLUSTRATION 4-7
CLOSING ENTRIES JOURNALIZED

GENERAL JOURNAL
Date Account Titles and Explanation Ref. Debit Credit
2002 (1) 10,600

Oct. 31 Service Revenue 400

Income Summary 350 10,600

(To close revenue account)

INCOME SUMMARY NO.350 Service Revenue NO. 400

Date Explanation Debit Credit Balance Date Explanation Debit Credit Balance
2002 2002
Oct. 31 10,600 10,600 Oct. 31 10,600
31 31 10,600 –0–
31
 ILLUSTRATION 4-7
CLOSING ENTRIES JOURNALIZED

GENERAL JOURNAL
Date Account Titles and Explanation Ref. Debit Credit
2002 (2)
7,740
Oct. 31 Income Summary 350
5,200
Salaries Expense 726 1,500

Advertising Supplies Expense 611

900

50
Rent Expense 729 50

Insurance Expense 72240

Interest Expense 905
Depreciation Expense 711
(To close expense
accounts)
INCOME SUMMARY NO. 350
Date Explanation Debit Credit Balance
2002
Oct. 31 10,600 10,600
31 7,740 2,860
 ILLUSTRATION 4-7
CLOSING ENTRIES JOURNALIZED

2,860

2,860

2,860
2,860
 ILLUSTRATION 4-7
CLOSING ENTRIES JOURNALIZED

500

500

RETAINED EARNINGS NO. 320

Date Explanation Debit Credit Balance
2002
500 Oct. 31 2,860
31 500 2,360
 CAUTIONS RELATING TO
CLOSING ENTRIES

A couple of cautions relating to closing entries:

1 Avoid unintentionally doubling the revenue
and expense balances rather than zeroing
them.
2 Do not close dividends through the Income
Summary account. Dividends are not
expenses, and they are not a factor in
determining net income.
 POSTING CLOSING ENTRIES

 All temporary accounts have zero balances after posting the

closing entries.
 The balance in Retained Earnings represents the accumulated
undistributed earnings of the corporation at the end of the
accounting period.
 The Income Summary account is used only in closing. No
entries are journalized and posted to this account during the
year.
 As part of the closing process, the temporary accounts
(revenues, expenses and dividends) are totaled, balanced, and
double ruled.
 The permanent accounts (assets, liabilities, stockholders’
equity) are not closed.
 ILLUSTRATION 4-8
POSTING OF CLOSING ENTRIES

Salaries Expense 726 Service Revenue 400

4,000 (2) 5,200 (1) 10,600 10,000
1,200 400
200
5,200 5,200 2
1 10,600 10,600

Advertising Supplies Expense 611

1,500 (2) 1,500
Income Summary 350
(2) 7,740 (1) 10,600
(3) 2,860
Rent Expense 729
900 (2) 900 10,600 10,600

3
Insurance Expense 722
50 (2) 50 Retained Earnings 320
(4) 500 –0–
2 (3) 2,860

Interest Expense 905

2,360
50 (2) 50

Depreciation Expense 711 Dividends 332

40 (2) 40 500 (4) 500
 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
account balances that are carried
forward into the next accounting
period.
 ILLUSTRATION 4-9
POST-CLOSING TRIAL BALANCE
PIONEER ADVERTISING AGENCY
Post-Closing Trial Balance
October 31, 2002
Debit Credit
Cash The post-closing trial 15,200

Accounts Receivable balance is prepared from the

200

Advertising Supplies permanent accounts in the 1,000

Prepaid Insurance ledger. 550

Office Equipment 5,000

Accumulated Depreciation — Office Equipment 40

Notes Payable
The post-closing trial balance 5,000

Accounts Payable 2,500

provides evidence that the
Interest Payable
journalizing and posting of 50

Unearned Revenue
closing entries has been 800

Salaries Payable properly completed. 1,200

Common Stock
Retained Earnings 10,000

2,360
$ 21,950 $ 21,950
 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, Retained
Earnings Statement, Balance Sheet
8 Journalize and post closing entries
9 Prepare a post-closing trial balance
 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 involve any combination of balance
sheet and income statement accounts
ILLUSTRATIVE EXAMPLE
OF CORRECTING ENTRY 1

Cash 50
Service Revenue 50

Cash 50
Accounts Receivable 50

Service Revenue 50
Accounts Receivable 50
ILLUSTRATIVE EXAMPLE
OF CORRECTING ENTRY 2

Delivery Equipment 45
Accounts Payable 45

Office Equipment 450

Accounts Payable 450

Office Equipment 450

Delivery Equipment 45
Accounts Payable 405
 ILLUSTRATION 4-17
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:

Current Assets Current Liabilities

AssetsInvestments
Long-Term Liabilities and Owner’s
Long-Term Liabilities Equity
Property, Plant and Owner’s (Stockholders’) Equity

Equipment
Intangible Assets
 CURRENT ASSETS

 Current assets are cash and other resources that are

reasonably expected to be realized in cash or sold
or consumed in the business within one year of the
balance sheet date or the company’s operating cycle,
whichever is longer.
 Current assets are listed in the order of their
liquidity.
 The operating cycle of a company is the average
time that is required to go from cash to cash in producing
revenues.
 Examples of current assets are cash, short-term
investments, receivables and prepaid expenses.
 LONG-TERM
INVESTMENTS
 Long-term investments are resources that can
be realized in cash, but the conversion into
cash in not expected within one year or the
operating cycle, whichever is longer.
 Examples include investments in stocks and
bonds of another company or investment in
land held for resale.
10 shares

XYZ stock
 PROPERTY, PLANT,
AND EQUIPMENT
 Tangible resources of a relatively permanent
nature that are used in the business and not
intended for sale are classified as property,
plant, and equipment.
 Examples include land, buildings, machinery,
equipment, and furniture and fixtures.
 INTANGIBLE ASSETS

 Intangible assets are noncurrent resources

that do not have physical substance.
 Examples include patents, copyrights,
trademarks, or trade names that give the
holder exclusive right of use for
a specified period of time.
 CURRENT LIABILITIES

 Current liabilities are obligations that

are reasonably expected to be paid from
existing current assets or through the
creation of other current liabilities
within one year or the operating cycle,
whichever is longer.
 Examples include accounts payable,
wages payable, interest payable, and
current maturities of long-term debt.
 LONG-TERM
LIABILITIES
Obligations expected to be paid
after one year are classified as
long-term liabilities.
Examples include long-term
notes payable, bonds payable,
mortgages payable, and lease
liabilities.
 STOCKHOLDERS’
(OWNERS’) EQUITY
 The content of the owner’s equity section
varies with the form of business organization.
 In a proprietorship, there is one capital
account.
 In a partnership, there are separate capital
accounts for each partner.
 For a corporation, owners’ (stockholders’)
equity is divided into two accounts:
1 Common Stock and
2 Retained Earnings.
 ILLUSTRATION 4-25
CLASSIFIED BALANCE SHEET IN REPORT FORM

$ 15,200

200

1,000

550

16,950

$ 5,000

40
4,960

$ 21,910
A classified balance sheet helps the financial statement user determine 1
the availability of assets to meet debts as they come due and 2 the
claims of short- and long-term creditors on total assets.
 ILLUSTRATION 4-25
CLASSIFIED BALANCE SHEET IN REPORT FORM

$1,000

2,500

50

800

1,200

5,550

4,000

9,550

10,000

2,360

$21,910

The balance sheet is most often presented in the report

form, with the assets shown above the liabilities and
stockholders’ equity.
 APPENDIX:
REVERSING ENTRIES
 A reversing entry is made at the
beginning of the next accounting period.
 Reversing entries are most often used to
reverse two types of adjusting entries:
accrued revenues and accrued expenses.
 Preparation of reversing entries is
optional.
ILLUSTRATIVE EXAMPLE
OF REVERSING ENTRY
2002 Initial Salary Entry4,000
Salaries Expense
Oct. 26 Cash 4,000

(To record Oct. 26 payroll)

Adjusting Entry 1,200
Salaries Expense
31 Salaries Payable 1,200

(To record accrued salaries)

Closing Entry
Income Summary 5,200
31 Salaries Expense 5,200

(To close salaries expense)

Reversing Entry
Salaries Payable 1,200
Nov. 1 Salaries Expense 1,200

(To reverse Oct. 31

adjusting entry)
Subsequent Salary
Salaries Expense
Cash
Entry
4,000
4,000
9

(To record Nov. 9 payroll)

 COPYRIGHT

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programs or from the use of the information contained herein.
 CHAPTER 4
COMPLETION OF THE ACCOUNTING CYCLE