CHAPTER 4
COMPLETING THE ACCOUNTING CYCLE
Related Assignment Materials
Student Learning Objectives
Questions
Conceptual objectives:
C1. Explain why temporary
1, 2, 4, 5
accounts are closed each
period.
C2. Identify steps in the accounting 8
cycle.
C3. Explain and prepare a classified 9, 10, 11,
balance sheet.
14, 15
Analytical objectives:
A1. Compute the current ratio and
describe what it reveals about a
company’s financial condition.
Procedural objectives:
P1. Prepare a work sheet and
6, 7
explain its usefulness.
Quick
Studies*
Exercises*
Problems*
Beyond the
Numbers
4-1
4-3
4-2
RIA, CIP
4-2
4-5
4-2
EC, HTR
4-3, 4-4
4-4
4-1, 4-3,
4-4, 4-5
BW, ED
4-4
4-6, 4-7
4-1, 4-2, 4-3 CA, TTN,
4-4
BW, ED,
GD
4-5, 4-6,
4-7, 4-8
4-5
TIA
4-2, 4-3
4-4, 4-5
RIA, CIP,
TIA, ED
4-6
P2. Describe and prepare closing
entries.
2, 3, 4,5,6
4-1, 4-9
P3. Explain and prepare a postclosing trial balance.
P4. Prepare reversing entries and
explain their purpose.
(Appendix 4A)
4
4-3
4-8, 4-9,
4-10, 4-11,
4-12
4-1, 4-2,
4-3, 4-4,
4-11, 4-12
4-2, 4-3
12, 13
4-11
4-13, 4-14
4-2, 4-3
*See additional information on next page that pertains to these quick studies, exercises and problems.
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Additional information on Related Assignment Material
Corresponding problems in set B (in text) and set C (on book’s website), also relate to learning
objectives identified in grid on previous page. The Serial Problem for Success Systems continues in this
chapter. Problems 4-2A and 4-3A can be completed using Excel. Problem 4-3A, 4-4A and the Serial
Problem can be completed with Peachtree or Carol Yatch General Ledger Software.
Homework Manager (on book’s website) repeats all numerical Quick Studies all Exercises and
Problems 4-5A, 4-6A. Homework Manager provides new numbers each time the Quick Study, Exercise
or Problem is worked. It can be used in practice, homework, or exam mode.
Synopsis of Chapter Revision
Premier Snowskate NEW opener
Streamlined discussion of accounting work sheet
Revised Excel screen captures with acetates for work sheet
Shortened section on closing process
Reduced presentation on operating cycles
Active Learning Activities
Found in STUDENT LEARNING TOOLS
Activity
Topic(s)
Description
Class Activity # 11
SLT
pp.#
66-70
The Closing Process
Class Activity # 12
71
The Accounting
Cycle
Class Activity # 13
72-78
Balance sheet
classifications,
current ratio, and
working capital ratio.
Class Activity # 14
79-81
Classified Balance
Sheet
Writing
Assignment # 4
240
Loan Application
Analysis
Uses team observation and collaboration and
writing to learn techniques to engage students in
discovering the objectives of the closing process
and required entries.
Uses think-square-share and writing to learn to
reinforce the objectives and relationships of the
steps in a complete accounting cycle. Assumes
the use of a work sheet in the cycle.
Uses observation & comparison and team
collaboration to introduce the need for and
categories of balance sheet classifications
Requires deductive reasoning. Uses classified
information for analysis
Uses think-square-share and challenges students
to use critical thinking skills to discover errors in
statement presentation. Students generally find
this activity especially enjoyable.
Requires students to prepare a memo evaluating
two loan applications based on two classified
balance sheets provided.
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Chapter Outline
I.
II.
Notes
Work Sheet as a Tool
A. The work sheet is an internal document that serves as a useful tool
for organizing accounting information. It is not a required report.
B. Benefits include: aids the preparation of financial statements,
reduces possibility of errors, captures links accounts and
adjustments to their impacts in financial statements, assists in
planning and organizing an audit of financial statements, helps in
preparing interim (monthly and quarterly) financial statements,
and shows the effect of proposed or “what if” transactions.
C. Steps to prepare a work sheet:
1. Enter the unadjusted trial balance in the first two columns.
2. Enter the adjustments in the third and fourth columns. Total
columns to verify debit adjustments equal credit adjustments.
3. Prepare the Adjusted Trial Balance. This is done by
combining the unadjusted trial balance and adjustment
columns. Total Adjusted Trial Balance columns to verify
debits equal credits.
4. Sort the adjusted trial balance amounts to the appropriate
financial statement columns.
5. Total statement columns, compute net income or loss and
balance the columns by adding net income or loss.
D. Work Sheet Applications and Analysis—it does not substitute for
financial statements. The financial statement columns yield pro
forma financial statements because they show the statements as if
the proposed transactions occurred.
Closing Process—The closing process is an important step at end
of the accounting period after financial statements have been
completed.
A Steps in closing process:
1. Identify accounts for closing.
2. Record and post closing entries.
3. Preparing a post-closing trial balance.
B. Purpose of closing process:
1. To reset revenues, expenses, and withdrawals account to zero
at the end of every period to prepare these accounts to proper
measurement in the next period.
2. To summarize a period's revenues and expenses.
C. Temporary and Permanent Accounts
1. Temporary (or nominal) accounts accumulate data related to
one accounting period. (All income statement accounts,
withdrawals accounts, and the Income Summary.)
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Chapter Outline
Notes
2. Permanent (or real) accounts report on activities related to one
or more future accounting periods. They are all balance sheet
accounts that are not closed.
D. Recording Closing Entries—the purpose is to transfer the end-ofperiod balances in revenues, expense, and withdrawals accounts to
the permanent capital account.
1. Use a new temporary account called Income Summary. The
four closing entries are:
a. Close credit balances in revenue (and gain) accounts by
debiting the accounts and crediting Income Summary.
This transfers revenue balances to the credit side Income
Summary.
b. Close debit balances in expense (and loss) accounts by
crediting the accounts and debiting Income Summary.
This transfers the expense balances to the debit side of
Income Summary.
c. Close the Income Summary account to the owner’s capital
account.
Note: The Income Summary account, prior to closing, will
have a credit balance equal to net income or a debit balance
equal to net loss. Therefore this entry will credit capital for the
amount of net income (or debit capital for a net loss).
d. Close withdrawals account by crediting the account and
debiting the owner's capital account.
2. After all closing entries are posted, all temporary accounts
have a zero balance and capital is up to date.
C. Post-Closing Trial Balance—a list of permanent accounts and their
balances taken from the ledger.
1. Prepared after closing entries are journalized and posted.
2. Verifies that total debits equal total credits for permanent
accounts and all temporary accounts have zero balances.
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Fundamental Accounting Principles, 17/e
Chapter Outline
III.
Notes
D. The Accounting Cycle--steps can vary if a worksheet is used (see
Visual 7)
The ten steps repeated each accounting cycle are as follows:
1. Analyze transactions
2. Journalize
3. Post
4. Prepare unadjusted trial balance
5. Adjust
6. Prepare an adjusted trial balance
7. Prepare statements
8. Close
9. Prepare a post-closing trial balance.
10. Reverse (optional)
Classified Balance Sheet—organizes assets and liabilities into
important subgroups and provides more information for decision
makers.
A. Classification Structure
1. One of the more important classifications is the separation
between current and noncurrent assets and liabilities.
2. Current items are expected to come due (both collected and
owed) within the longer of one year or the company’s
operating cycle.
3. Operating cycle is the time span from when cash is used to
acquire goods and services until cash is received from the sale
of those goods and services.
B. Classification Categories
1. Current assets—cash or other resources that are expected to be
sold, collected, or used within one year or the operating cycle,
whichever is longer. Examples: cash, short-term investments,
accounts receivable, notes receivable, merchandise inventory,
and prepaid expenses.
2. Long-Term Investments—assets held for more than one year,
that are not used in business operations. Examples: stocks,
bonds, promissory notes, and land held for future expansion.
3. Plant Assets—tangible, long-lived assets that are used to
produce or sell goods and services. Examples: equipment,
buildings, land.
4. Intangible assets—long-term resources that benefit business
operation. They lack physical form. Their value comes from
the privileges or rights that are granted to or held by the
owner. Examples: goodwill, patents, trademarks, franchises,
copyrights.
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IV.
V.
5. Current liabilities—obligations due to be paid or settled within
the longer of one year or the operating cycle. Examples:
accounts payable, notes payable, wages payable, taxes
payable, interest payable, unearned revenues, current portions
of long-term liabilities.
6. Long-term liabilities—obligations that are not due to be paid
within one year or the operating cycle of the business.
Examples: notes payable, mortgage payable, bonds payable.
7. Equity—Owner’s claim on assets. For a proprietorship it is
reported in this section as the owner's capital account. In a
corporation , equity is divided into two main subsections:
capital stock and retained earnings.
Decision Analysis—Current Ratio
A. Assesses a company’s ability to pay its debts in the near future.
B. Calculated as total current assets divided by total current
liabilities.
Appendix 4A—Reversing Entries
A. Accounting with reversing Entries
1. An optional step.
2. Linked to asset and liability account balances that arose from
the accrual of revenues and expenses.
3. Purpose is to simplify recordkeeping.
4. They are prepared after closing entries and dated the first day
of the new period.
5. Procedure is to transfer accrued asset and liability account
balances to related revenue and expense accounts creating an
abnormal balance in these accounts
6. The full subsequent cash receipts (and payments) are recorded
as increases in revenue (and expense) accounts creating a net
balance equal to the amount earned or incurred in that period.
B. Accounting without reversing entries
1. To construct proper entries when the cash receipt/payment
occurs in the new accounting period, the related accrual or
deferral adjustment must be recalled and considered.
2. Accounting with or without reversing entries must yield the
same result.
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Fundamental Accounting Principles, 17/e
VISUAL #7
THE ACCOUNTING CYCLE
1.
2.
3.
4.
5.
6.
7.
This Cycle Assumes a Worksheet is Used
STEPS
PURPOSE
Journalizing
To record the daily transactions
Posting
To transfer the amounts from journal
entries to the individual accounts
affected by the recorded transaction
Work sheet
 To summarize the balances of
ledger accounts and test the
accuracy of journalizing and
posting and the computation of
account balances (unadjusted trial
balance columns)
 To plan the adjusting entries and
the income statement and balance
sheet numbers
 To prove the mathematical
accuracy of net income
 To provide information for closing
entries
Preparing the
To report financial information
statements
Journalizing and To bring the ledger accounts to
posting of
adjusted balances
adjusting entries
Journalizing and To bring all temporary accounts to
posting of
zero and the capital account up-toclosing entries
date
Post-closing
To prove the accuracy of the
trial balance
adjusting and closing procedures
Instructor’s Resource Manual, Chapter 4
TIMING
During the period
During the period
End of period
End of period
End of year
End of year
End of year
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Fundamental Accounting Principles, 17/e
VISUAL #8
MUSIC WORLD
BALANCE SHEET
DECEMBER 31, 20XX
Assets
Current Assets
Cash
Short-Term Investments
Notes Receivable
Accounts Receivable
Merchandise Inventory
Prepaid Insurance
Supplies
Total Current Assets
Investments
Land Held for Future Use
Property, Plant, and Equipment
Land
Building
Less Accumulated Depreciation
Office Equipment
Less Accumulated Depreciation
Total Property, Plant, and Equipment
Intangible Assets
Trademark
Total Assets
$30,360
2,000
8,000
35,300
60,400
6,600
1,696
$144,356
13,950
$ 4,500
$20,650
8,640
$ 8,600
5,000
12,010
3,600
20,110
500
$178,916
Liabilities
Current Liabilities
Notes Payable
Accounts Payable
Salaries Payable
Mortgage Payable
Total Current Liabilities
Long-Term Liabilities
Mortgage Payable
Total Liabilities
$15,000
25,683
2,000
10,200
$52,883
27,600
$ 80,483
Owner’s Equity
Joy Melody, Capital
Total Liabilities and Owner’s Equity
Instructor’s Resource Manual, Chapter 4
98,433
$178,916
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Fundamental Accounting Principles, 17/e
Alternate Demo Problem Four
The trial balance of Large Company, Inc. at the end of its annual
accounting period is as follows:
LARGE COMPANY, INC.
Trial Balance
December 31, 2004
Cash ..........................................................................
Prepaid Insurance ...................................................
Supplies ..................................................................
Equipment ...............................................................
Accumulated depreciation equipment ..................
C. Large, Capital .....................................................
C. Large, Withdrawals .............................................
Revenue ...................................................................
Salaries expense .....................................................
Rent expense ..........................................................
Totals ........................................................................
$ 4,000
1,600
2,100
20,000
$ 2,000
19,000
2,000
33,000
18,300
6,000
$54,000
______
$54,000
Additional information:
1.
Expired insurance, $600.
2.
Unused supplies, per inventory, $800.
3.
Estimated depreciation, $1,000.
4.
Earned but unpaid salaries, $700.
5.
Earned but unpaid salaries, $700.
Required
1.
Prepare adjusting entries.
2.
Prepare closing entries.
3.
Prepare a post-closing trial balance.
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Solution: Alternate Demo Problem Four
1.
Insurance Expense ...........................................
600
Prepaid Insurance ......................................
Supplies Expense .............................................
600
1,300
Supplies ......................................................
Depreciation Expense Equip. ..........................
1,300
1,000
Accumulated Depreciation Equip. ............
Salaries Expense ..............................................
1,000
700
Salaries Payable .........................................
2.
Revenue .............................................................
700
33,000
Income Summary .......................................
Income Summary ..............................................
33,000
27,900
Salaries Expense ........................................
19,000
Rent Expense..............................................
6,000
Insurance Expense.....................................
600
Supplies Expense.......................................
1,300
Depreciation Expense ................................
1,000
Income Summary ..............................................
5,100
C. Large, Capital .........................................
C. Large, Capital ...............................................
C. Large, Withdrawal ..................................
5,100
2,000
2,000
Solution continued next page
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Fundamental Accounting Principles, 17/e
3.
LARGE COMPANY, INC.
Post-Closing Trial Balance
December 31, 2004
Dr.
Cash ...................................................................
$4,000
Prepaid Insurance .............................................
1,000
Supplies .............................................................
800
Equipment .........................................................
20,000
Cr.
Accumulated depreciation, equipment ...........
$ 3,000
Salaries payable ................................................
700
C. Large, Capital ...............................................
______
22,100
Totals .................................................................
$25,800
$25,800
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