ACCT1101
Financial Accounting
LECTURE NOTES
LECTURE 6
Chapter 5
CHAPTER 5
Completing the
accounting cycle
LEARNING OBJECTIVES
1.
2.
3.
4.
Describe all the steps in the complete accounting cycle
Explain why temporary ledger accounts need to be closed
Explain how to record adjusting entries from the worksheet
Describe the closing process, enter closing entries in accounting
records and prepare a post-closing trial balance
5. Account for accrual items in subsequent periods using reversing
entries
6. Prepare the equity accounts for a partnership and for a company
COMPLETE ACCOUNTING CYCLE
1. Recognise and record
transactions
Source documents
2. Journalise transaction
General journal
3. Post to ledger accounts
General ledger
4. Prepare unadjusted trial
balance of general ledger
Continued Next Slide
Trial balance
(unadjusted)
COMPLETE ACCOUNTING CYCLE
5. Determine adjusting entries
and journalise
General journal
6. Post adjusting entries to
general ledger
General ledger
(accounts adjusted)
Trial balance
(adjusted)
7. Prepare adjusted trial
balance
8. Journalise closing entries
General journal
Continued Next Slide
COMPLETE ACCOUNTING CYCLE
9. Post closing entries to
general ledger
General ledger
(temp a/c’s closed)
10. Prepare post closing trial
balance
11. Prepare financial
statements
Trial balance
(post closing)
Work
sheet
Financial statements
12. Journalise reversing entries
General journal
13. Post reversing entries to
general ledger
General ledger
CLOSING TEMPORARY ACCOUNTS
• Income and expense accounts must be reduced
to zero at the end of each period in order to
determine the profit or loss for the period
• These are called closing entries
• Income and expense accounts then begin the
next accounting period with a zero balance
• The Profit or Loss Summary account is used to
summarise balances and calculate profit
• Note: Balance sheet accounts are NOT closed
USING THE WORKSHEET TO RECORD
ADJUSTING ENTRIES
• Gathers information together in one place
– “One stop shop”
• Enables fast preparation of interim statements
• Adjusting entries easily reflected
• Facilitates closing journal preparation
RECORDING ADJUSTING ENTRIES
• From worksheet formal adjusting entries may
be entered in general journal
• Entries are dated the last day of the
accounting period
• Data for determining the entity’s closing
entries for the period are found in income
statement columns of worksheet which
contain temporary income and expense
accounts
THE CLOSING PROCESS
1. Income accounts closed to P or L summary
– Debit income
– Credit P or L Summary
2. Expense accounts closed to P or L summary
– Debit P or L summary
– Credit expense
THE CLOSING PROCESS
3. Profit or Loss Summary balances to
determine profit/loss then closed to
capital
– Debit P or L summary (assuming a profit)
– Credit capital account
4. Drawings closed to capital
– Debit capital account
– Credit drawings account
THE CLOSING PROCESS
Expenses
Total
Income
14 940 Closing Ent. 14 940
Closing Ent. 20 500 Total
2
20 500
1
Profit or Loss Summary
Expense
14 940 Income
Closing Ent. 5 560
20 500
Drawings
Balance
1 200 Closing Ent.
20 500
20 500
3
Capital
1 200
Closing Ent. 1 200 Balance 240 000
4 Bal. c/d 244 560 Close Ent. 5 560
(Profit)
245 560
245 560
12 360
Bal. b/d 244
ACCOUNT BALANCES AFTER THE
CLOSING PROCESS
•
•
•
•
All income accounts have nil balances
All expense accounts have nil balances
The drawings account has a nil balance
The capital account has either been
– increased by the profit, or
– decreased by the loss
• and decreased by the drawings
• The Capital balance is now updated
THE POST-CLOSING
TRIAL BALANCE
• Prepared to verify the equality of debits and
credits
– i.e. ledger is “in balance”
• Confirms that only permanent accounts have
balances
• Starting point for next accounting period
ACCRUAL ENTRIES IN SUBSEQUENT
PERIODS
• Adjusting entries are made at the end of the
accounting period to record accruals
• Cash received or paid in subsequent periods
for accruals must be analysed to correctly
apportion amount between the two periods
– e.g. payment for salaries
ACCRUAL ENTRIES IN SUBSEQUENT
PERIODS
• Original adjusting Entry
General Journal
Jun 30 Salaries Expense
3 980
Salaries Payable
3 980
(Adjusting entry for salaries payable)
• Subsequent Entry
Balance is cleared by payment
Jul 6 Salaries Payable
3 980
Salaries Expense
3 420
Cash at Bank
(Payment of salaries earned 23 June to 6
July)
7 400
REVERSING ENTRIES
• Alternative to previous treatment
• Dated the first day of the subsequent
accounting period
• Exactly reverse certain adjusting entries
• An accounting technique used to simplify the
recording of regular transactions in the next
period
• They are optional in an accounting system
(however very useful)
REVERSING ENTRIES
• Adjusting Entry
General Journal
Jun 30 Salaries Expense
3 980
Salaries Payable
3 980
(Adjusting entry for salaries payable)
• Reversing Entry
Jul 1 Salaries Payable
Salaries Expense
(Reversing entry for salaries payable)
3 980
3 980
• Subsequent Entry
Jul 6 Salaries Expense
7 400
Cash at Bank
7 400
(Payment of salaries earned 23 June to 6
July)
Salaries Expense
Adjusting Entry
Subsequent Entry
3 980
0
Closing Entry
7 400
3 420
Reversing Entry
3 980
3 980
Correct expense recorded
in prior period, and closed
Correct expense recorded
in current period, without
needing to know what had
been accrued previously
REVERSING ENTRIES
• Not required for all adjusting entries
• Used to simplify recording of transactions in
future periods
• Only used where adjustment is temporary
– Accrued expenses
– Accrued income
– Prepayments originally recorded as expenses
– Unearned income originally recorded as income
ACCOUNTING FOR A PARTNERSHIP
• Similar in most respects to accounting for a
sole trader
• Separate capital and drawings accounts for
each partner
• Profit/loss at the end of the period is allocated
to each partner in accordance with the
partnership agreement
• Each drawings account is closed off to the
partner’s capital account
ACCOUNTING FOR A
COMPANY
• Some key conceptual/terminology differences
• Company is a separate legal entity (unlike sole
trader and partnership)
• Owners are referred to as shareholders
• Owners’ interests are called share capital
• Not all profits/losses are distributed to
shareholders, may be retained/accumulated
• Share capital represents retained profits (or
accumulated losses) + share of assets
ACCOUNTING FOR A
COMPANY
• Note profits are distributed as dividends
INTELLECT MANAGEMENT SERVICES LTD
Statement of Changes in Equity
For the year ended 31 December 2013
Share Capital, 1 January 2013
$240 000
Share Capital, 31 December 2013
$240 000
Retained Earnings, 1 January 2013
Add: Profit for the year
50 000
50 000
Less: Cash dividends for the year
Retained Earnings, 31 December 2013
24 000
$ 26 000
ACCOUNTING FOR A
COMPANY
• Equity section of balance sheet
INTELLECT MANAGEMENT SERVICES LTD
Balance Sheet (extract)
as at 31 December 2013
EQUITY
Share Capital, (240 000 shares issued for $1)
Retained Earnings
Total equity
$240 000
26 000
$226 000