Chapter 4—Completion of the Accounting Cycle
Study Objectives:
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
I. USING A WORK SHEET
A. WORK SHEET FORM AND PROCEDURE: the 10-column Work Sheet
(an informal working paper used by the accountant to organize data for the
financial statements and lessen the possibility of overlooking an adjustment)
has 5 steps to prepare it where each step must be performed in the prescribed
sequence. The first two columns show the Trial Balance. When a Work Sheet is
used, it is not necessary to prepare a separate trial balance to test the equality
of the debits and the credits of the ledger account balances because this is
done on the first two columns of the work sheet. Once the accounts are all
presented in the work sheet format, it makes it easier to determine what
accounts need to be adjusted. Note the columns shown on the work sheet as
follows:
Name of the Company
Work Sheet
For the Period Ended Month, Day, Year
Account
Titles
Trial Balance
Debit
Credit
Adjustments
Debit
Credit
Adj. Trial Balance
Debit
Credit
Income Statement
Debit
Credit
Balance Sheet
Debit
Credit
B. Note the characteristics and purposes of a work sheet:
1. A work sheet is a multiple-column form that may be used in the
adjustment process, in preparing financial statements, and in the closing
of the books process.
2. It is a working tool for the accountant and not a permanent accounting
record. The work sheet is not a formal statement, but is a working paper (a
tool) for the accountant (no one other than the accountant usually sees it).
Therefore it is OK to abbreviate words as long as the full names for accounts
are used and capitalization does not matter.
3. Use of a work sheet should make the preparation of adjusting entries and
financial statements easier. The work sheet is a useful tool for organizing
data and collecting one’s thoughts as to what accounts need to be adjusted (to
lessen the possibility of overlooking an adjustment). Since the accounts are
all presented on the work sheet it makes it easier to go down through the list
of accounts to determine which ones need adjusted or brought up-to-date.
4. The use of a work sheet is optional. Preparation of the work sheet is not
mandatory. It is simply something done to make end-of-period work easier
and provide an arithmetical check on the accuracy of work. It makes it
1
easier to see the adjustments needed and the balance of the accounts after
the adjustment as a check once the entries have been journalized and then
posted to the accounts.
5. When one is used, financial statements are prepared from the worksheet.
After the work sheet is completed, it summarizes all the information
necessary to prepare the financial statements and complete the accounting
cycle.
6. Adjustments are journalized and posted from the work sheet after
financial statements are prepared. The work sheet is a useful tool as well
to journalize the closing entries.
C. Steps in Preparing a Work Sheet.
1. Some textbooks use overlays to show the preparation process. First note the
heading of the work sheet:
a) First line answers the question Who: Name of the Company.
b) Second line answers the question What: Name of the report (Work
Sheet).
c) Third line gives the When: Period of time which the Work Sheet
covers. There is a misconception that since the first columns of the
Work Sheet are showing a Trial “Balance” and an Adjusted Trial
“Balance” that the “when” would be a single date in time. But that is
not correct as the bottom line of the Work Sheet is going to disclose
the amount of net income or not loss that the company has generated
over the accounting period. Remember that a net income or a net loss
is shown on the income statement stating a period of time for which it
covers. Think of this that is someone asked, “How much did you
make?” The question is not complete until you add the time period:
last month, last week, last year, etc. Since the bottom line is intended
to disclose the net income or the net loss, then a period of time must be
shown.
2. Step 1: Prepare a Trial Balance on the Work Sheet. There are
actually 2 formats for preparing a work sheet. The textbook shows the first
format but the format that works the best for spreadsheet applications is the
second format below as works better when using formulas on work sheets.
a) Format #1: All ledger accounts with balances are entered in the
account titles space.
1) Trial balance amounts are taken directly from ledger accounts.
2) If additional accounts are needed for the adjusting entries, they
are inserted on the lines immediately below the trial balance totals.
b) Format #2: Refer to Pioneer Advertising Agency below to show the
second format:
1) All accounts should be listed in the trial balance, even those with a
zero balance. Notice on the work sheet below that there are accounts
with zero balances listed on the trial balance. These are the accounts
that will be used in the adjusting process and they are listed by
2
their classification which makes it easier to determine how the
adjustment will affect the account.
2) Since the first two columns of a work sheet contain a trial balance
which will prove the equality of the debit and credit entries in the
ledger accounts’ a separate trial balance will not be necessary. So
these columns are added at this point and if they do not balance, the
same procedures outlined in Chapter 2 need to be used to
determine the error and correct it before going any further.
3) The amount in the account with a zero balance can show a zero or
have a line drawn straight through the account that shows it does not
have a balance. The first step in the preparation of a work sheet is
accomplished under Format #2:
Pioneer Advertising Agency
Work Sheet
For the Month Ended October 31, 20-Account
Titles
Cash
AcctsRec.
AdvertSup
Prepd Ins.
Off.Equip
A/D OffEq
Notes Pay.
Accts.Pay.
Interest Pay
UnearnRev
Sal. Pay.
CRB, Cap..
CRB, Draw
Ser.Rev.
Sal. Exp.
Rent.Exp.
Adv,SupExp.
Ins.Exp.
DepEx. OE
Interest Exp
Totals
Trial Balance
Debit
Credit
15,200
0
2,500
600
5,000
0
5,000
2,500
0
1,200
0
10,000
500
10,000
4,000
900
0
0
0
0
28,700
28,700
Adjustments
Debit
Credit
Adj. Trial Balance
Debit
Credit
Income Statement
Debit
Credit
Balance Sheet
Debit
Credit
4) Note the bold line that was drawn (NOT done on an actual work
sheet) that shows the separation of the balance sheet accounts (as
well as owner’s equity) from the income statement accounts. This is
an advantage of Format #2 as the accounts needed for the various
financial statements appear together which helps not to forget any
when preparing them.
3. Step 2: Enter the Adjustments in the Adjustments Columns.
a) Enter adjustment amounts in appropriate columns, and use letters to cross
reference the debit and credit adjustments. . Letters are used to show
which account is debited and which account is credited for each
adjustment. Notice how the adjustments for the (a) supplies used; (b)
insurance expired, (c) depreciation of office equipment (d) unearned
revenue that now has been earned are handled; and for the (e) service
3
revenue accrued, (f) interest accrued, and (g) salaries accrued but not
received or paid as yet are handled in the adjustments columns.
b) Total adjustments columns and check for equality. After the adjustments
are entered, the adjustments columns need to be added to determine at
this point if there is an equal amount of debits and credits:
Pioneer Advertising Agency
Work Sheet
For the Month Ended October 31, 20-Account Titles
Debit
15,200
0
2,500
600
5,000
Cash
AcctsRec.
AdvertSup
Prepd Ins.
Off.Equip
A/D OffEq
Notes Pay.
Accts.Pay.
Interest Pay
UnearnRev
Sal. Pay.
CRB, Cap..
CRB, Draw
Service.Revenue.
Sal. Exp.
Rent.Exp.
Adv,SupExp.
Ins.Exp.
DepEx. OE
Interest Exp
Totals
Trial Balance
Credit
Adjustments
Debit
Adj. Trial
Balance
Debit
Credit
Credit
Income
Statement
Debit
Credit
Balance Sheet
Debit
Credit
(e) 200
(a)1500
(b) 50
0
5,000
2,500
0
1,200
0
10,000
(c ) 40
(f) 50
(d) 400
(g)1200
500
10,000
4,000
900
0
0
0
0
28,700
(d)(e)
600
(g)1200
28,700
(a)1500
(b) 50
(c ) 40
(f) 50
3,440
3,440
4. Step 3: Enter the Adjusted Balances in the Adjusted Trial
Balance.
a) Combine trial balance amounts with adjustment amounts to obtain the
adjusted trial balance. To complete the adjusted trial balance, the original
trial balance total needs to reflect the debit or credit that was made with
the adjusting entry if there is one. The assets which have a debit balance
would add any entries in the debit column of the adjustments column and
subtract any credits to the adjustments column. The contra asset accounts
(those with credit balances) would add the amounts in the credit column
under the adjustments as those would increase those accounts; the liability
accounts would add any credit entries in the credit column of the
adjustment and subtract any debit entries there; the capital and drawing
accounts should not be adjusted so the amounts would carry over to the
adjusted trial balance; the revenue accounts would add any credit and
deduct any debits under the adjustments columns and the expenses would
add any entries in the debit adjustments columns and subtract any credits
in the adjustments column
4
b) Total adjusted trial balance columns and check for equality. Again the
equality of the debits and credits are proven by adding up the column
totals:
Pioneer Advertising Agency
Work Sheet
For the Month Ended October 31, 20-Account
Titles
Cash
AcctsRec.
AdvertSup
Prepd Ins.
Off.Equip
A/D OffEq
Notes Pay.
Accts.Pay.
Interest Pay
UnearnRev
Sal. Pay.
CRB, Cap..
CRB, Draw
Ser.Rev.
Sal. Exp.
Rent.Exp.
Adv,SupExp.
Ins.Exp.
DepEx. OE
Interest Exp
Totals
Trial Balance
Debit
15,200
0
2,500
600
5,000
500
4,000
900
0
0
0
0
28,700
Adjustments
Credit
→
→
→
→
→
0
5,000
2,500
0
1,200
0
10,000
→
10,000
Debit
→
(e) 200
→
→
→
→
→
→
→
(d) 400
→
→
→
→
→
→
→
→
→
→
28,700
(g)1200
→
(a)1500
(b) 50
(c ) 40
(f) 50
3,440
Credit
→
→
(a)1500
(b) 50
→
(c ) 40
→
→
(f) 50
→
(g)1200
→
→
(d)(e)
600
→
→
→
→
→
→
3,440
Adj. Trial
Balance
Debit
Credit
15,200
200
1,000
550
5,000
→
40
→
5,000
→
2,500
→
50
→
800
→
1,200
→
10,000
500
→
10,600
5,200
900
1,500
50
40
50
30,190
Income Statement
Debit
Credit
Balance Sheet
Debit
Credit
30,190
5. Step 4: Extend the Adjusted Trial Balance Amounts to the
Appropriate Financial Statements.
a) Extend all revenue and expense account balances to the income
statement columns. Follow the arrows to see how the accounts moves
across the page to either end up on the balance sheet OR the income
statement The income statement has only revenue and expense
accounts.
b) Extend all asset and liability account balances, as well as owner’s
capital and drawing account balances, to the balance sheet columns.
Follow the arrows to see how the accounts moves across the page to
either end up on the balance sheet OR the income statement. The OR is
emphasized as from the adjusted trial balance, a number will end up on
the BALANCE SHEET OR on the INCOME STATEMENT. There
should NOT be any numbers on both the balance sheet and the income
statement. The heavy line after the owner’s drawing account is show
the dividing line between the numbers that end on the Balance Sheet
and those that end up on the income statement. The balance sheet has
the assets, the liabilities, and the owner’s equity including owner’s
capital, and owner’s drawing accounts.
5
c) The columns are totaled but NOTE at this point they do NOT
BALANCE. Total the income statement columns and the balance
sheet columns. Both the income statement columns and the balance sheet
columns should be out of balance by the same amount. See example
above that the difference between the income statement columns is $2,860
and the difference between he balance sheet totals is $2,860.
Pioneer Advertising Agency
Work Sheet
For the Month Ended October 31, 20-Account
Titles
Cash
AcctsRec.
AdvertSup
Prepd Ins.
Off.Equip
A/D OffEq
Notes Pay.
Accts.Pay.
Interest Pay
UnearnRev
Sal. Pay.
CRB, Cap..
CRB, Draw
Ser.Rev.
Sal. Exp.
Rent.Exp.
Adv,SupExp.
Ins.Exp.
DepEx. OE
Interest Exp
Totals
Trial Balance
Debit
15,200
0
2,500
600
5,000
500
4,000
900
0
0
0
0
28,700
Adjustments
Credit
→
→
→
→
→
0
5,000
2,500
0
1,200
0
10,000
→
10,000
Debit
→
(e) 200
→
→
→
→
→
→
→
(d) 400
→
→
→
→
→
→
→
→
→
→
28,700
(g)1200
→
(a)1500
(b) 50
(c ) 40
(f) 50
3,440
Credit
→
→
(a)1500
(b) 50
→
(c ) 40
→
→
(f) 50
→
(g)1200
→
→
(d)(e)
600
→
→
→
→
→
→
3,440
Adj. Trial
Balance
Debit
Credit
15,200
→
200
→
1,000
→
550
→
5,000
→
→
40
→
5,000
→
2,500
→
50
→
800
→
1,200
→
10,000
500
→
→
10,600
5,200
900
1,500
50
40
50
30,190
→
→
→
→
→
→
30,190
Income Statement
Balance Sheet
Debit
→
→
→
→
→
→
→
→
→
→
→
→
→
→
Credit
→
→
→
→
→
→
→
→
→
→
→
→
→
10,600
Debit
15,200
200
1,000
550
5,000
→
→
→
→
→
→
→
500
Credit
5,200
900
1,500
50
40
50
7,740
10,600
22,450
19,590
40
5,000
2,500
50
800
1,200
10,000
6. Step 5: Total the Statement Columns, Compute the Net Income
(or Net Loss), and Complete the Work Sheet:
a) The difference between the totals of the two income statement
columns determines net income or net loss. Determine the difference
between both sets of totals. Actually find the difference in the income
statement and determine if that balance will complete the balance sheet so
that it will balance. You subtract the smaller total from the larger total
and the difference goes on the shortest side of the income statement.
b) Net income is extended to the credit column of the balance sheet
columns. (Net loss would be extended to the debit column): You
subtract the smaller total from the larger total and the difference goes
on the shortest side of the income statement and then take it to the
balance sheet shortest side to see if it will balance the balance sheet.
This is a check figure when it balances that the numbers have been
carried across to the right areas with the right amounts.
6
c) Record the net income or loss figure, Add the columns down, and rule
them. As you can see, a net income figure appears on the debit column of
the income statement and the credit column of the balance sheet. The
reason it shows on the credit column of the balance sheet is that a net
income increases owner’s capital and owner’s capital increases on the
credit side. Note that owner’s capital is bolded to emphasize why the net
income appears on the credit side of the balance sheet columns. A net
income example below:
Pioneer Advertising Agency
Work Sheet
For the Month Ended October 31, 20-Account
Titles
Cash
AcctsRec.
AdvertSup
Prepd Ins.
Off.Equip
A/D OffEq
Notes Pay.
Accts.Pay.
Interest Pay
UnearnRev
Sal. Pay.
CRB, Cap..
CRB, Draw
Ser.Rev.
Sal. Exp.
Rent.Exp.
Adv,SupExp.
Ins.Exp.
DepEx. OE
Interest Exp
Totals
Net Income
Trial Balance
Debit
15,200
0
2,500
600
5,000
500
4,000
900
0
0
0
0
28,700
→
Adjustments
Credit
→
→
→
→
→
0
5,000
2,500
0
1,200
0
10,000
→
10,000
Debit
→
(e) 200
→
→
→
→
→
→
→
(d) 400
→
→
→
→
→
→
→
→
→
→
28,700
→
(g)1200
→
(a)1500
(b) 50
(c ) 40
(f) 50
3,440
→
Credit
→
→
(a)1500
(b) 50
→
(c ) 40
→
→
(f) 50
→
(g)1200
→
→
(d)(e)
600
→
→
→
→
→
→
3,440
→
Adj. Trial
Balance
Debit
Credit
15,200
→
200
→
1,000
→
550
→
5,000
→
→
40
→
5,000
→
2,500
→
50
→
800
→
1,200
→
10,000
500
→
→
10,600
5,200
900
1,500
50
40
50
30,190
→
→
→
→
→
→
→
30,190
→
Income Statement
Debit
→
→
→
→
→
→
→
→
→
→
→
→
→
→
5,200
900
1,500
50
40
50
7,740
2,860
10,600
Balance Sheet
Credit
→
→
→
→
→
→
→
→
→
→
→
→
→
10,600
Debit
15,200
200
1,000
550
5,000
→
→
→
→
→
→
→
500
Credit
10,600
22,450
10,600
22,450
19,590
2,860
22,450
40
5,000
2,500
50
800
1,200
10,000
For a work sheet showing a net loss example, you would add the columns down, and
rule them. A net loss figure appears on the credit column of the income statement and
the debit column of the balance sheet. The reason it shows on the debit column of the
balance sheet is that a net loss decreases owner’s capital and owner’s capital decreases
on the debit side.
The work sheet can be computerized using an electronic spreadsheet program (Excel,
for example) where formulas can be entered that will speed up the process of preparing a
work sheet to just a few minutes. A tremendous advantage of an electronic work sheet is
the ability to change data easily. When preparing an electronic work sheet using
formulas, the formulas are entered in the template and then the template can be copied
over and over for later use for each period’s preparation of a new work sheet.
7
D. Preparing Financial Statements from a Work Sheet. All figures for
the financial statements are on the work sheet. Using a work sheet, financial
statements can be prepared before adjusting entries are journalized and posted.
However, the completed work sheet is not a substitute for formal financial
statements. Data in the financial statement columns of the work sheet are not
properly arranged for statement purposes. A work sheet is essentially a working
tool of the accountant; it is not distributed to management or other parties.
1. Income Statement--use the figures from the income statement columns
of the work sheet:
a) Heading: shows Who (name of the company; What (name of the
statement); and When (period of time) which is stated: “For the Period
(Month, Quarter, Year, etc.) Ended Month, Day, Year.”
b) Only capitalize the first word on a line. Note that there is an error on
the handout example as the word, “revenue,” after the word, “Service,”
should NOT be capitalized as shown in the text example.
c) Individual revenue and expense items are indented (use the increase
indent button and click once) after the word “Revenue:” and “Expenses:”
with a colon is entered to indicate to look what follows.
d) Remember that revenues (if more than one) and expenses are listed in
the order of magnitude (largest to smallest).
e) Note that there are no abbreviations on the statement.
f) Words must be spelled correctly (use Excel’s spell checker feature) for
full points on the statement.
2. Owner’s Equity or Statement of Retained Earnings:
a) Heading: shows Who (name of the company; What (name of the
statement); and When (period of time). .
b) Only the first word on a line is capitalized unless it is a proper noun
and note that no abbreviations are used.
c) The beginning capital or retained earnings shows the date at the
beginning of the period (month, day, year). The amount shown for
owner’s capital or retained earnings on the work sheet is the account
balance before considering drawings (dividends) and net income (or
loss).
d) The net income or net loss figure is brought it from the Income
Statement to be added (net income) or subtracted (net loss) from the
beginning capital or retained earnings.
e) “Less: Drawings “or “Less: Dividends” shows the amount from the
owner’s drawing account or the dividends account.
f) The ending capital is indicated by listing the owner’s name as given or
retained earnings and the date at the end of the period (month, day,
year).
3. Balance sheet:
a) Assets and liabilities are listed in the appropriate column.
b) The first column is used to show the long-term assets.
8
c) Accumulated depreciation is shown as a deduction from the related asset
and is under the asset.
d) The book value (original cost minus accumulated depreciation) of the
long-term asset is listed with the other assets in the appropriate
column.
e) “Total assets” is shown in the appropriate column.
f) The new capital figure is taken from the owner’s equity statement (or
retained earnings from the Statement of Retained Earnings) is listed
in the appropriate column.
g) Total liabilities and owner’s (stockholders’) equity appears in the
appropriate column.
h) Only the first word on a line is capitalized and there are no
abbreviations on the balance sheet.
E. Preparing Adjusting Entries from a Work Sheet. The entries have
already been worked out while preparing the work sheet. So it is just a matter of
transferring the numbers from the adjustment columns of the work sheet to a
general journal. A work sheet is not a journal, and it cannot be used as a basis
for posting to ledger accounts. The adjusting entries are prepared from the
adjustments columns of the work sheet. The numbers are taken in order so that
none are left out beginning with the (a) and continuing until all the adjustments
have been entered into the journal.
II. CLOSING THE BOOKS—the process of transferring the balances of
temporary accounts to the owner’s capital account or retained earnings, a
permanent account.
A.
1. Define temporary accounts. Revenue, expense, and drawing accounts are
temporary accounts used to show changes in owner’s equity during a
single fiscal period. When that period is over, the balances of all
temporary accounts are summarized, and the information is transferred
to the owner’s capital account. Temporary accounts are also called
nominal accounts.
2. The permanent or real accounts are assets, liabilities, and owner’s capital
because their balances will be carried into the next accounting period.
3. Below are the T-accounts for Pioneer Advertising Agency with the
balances in the accounts with after adjusting entries have been posted to
helping understanding the closing process. Below the temporary accounts
have been highlighted that need to be closed at the end of the accounting
period:
Assets
+
=
-
Cash
15,200
Liabilities
+
Notes Payable
3,000
+ Owner’s Equity
+
C. R. Byrd, Capital
10,000
9
+ Revenues
+
ServiceRev
10,600
-
Expenses
+
Adv. Sup. Exp.
1,500
Accts.Rec.
200
Accts. Payable
210
Int. Payable
C.R. Byrd Drawing
500
Prepd Ins.
40
Insur. Exp.
Adver. Sup.
1,000
Depr. Exp.
Unearn. Rev.
50
Salar. Payable
Salaries Exp.
550
5,200
Off. Equip.
Rent Exp.
900
5,000
A/D-Off. Eq.
40
Interest Exp.
50
B. Describe the objectives of the closing process.
1. To reduce the balances of the temporary owner’s equity accounts to zero
and thus make the accounts ready for entries in the next accounting
period. The normal accounting period is one year because tax returns
need to be prepared ever year. Therefore, the amounts are there for the
tax return for the current year and then these temporary accounts are
reduced to zero so are ready to accumulate amounts for the next year for
the next year’s tax return. Also the accounts are zero to follow the
matching principle of accounting so that revenues and expenses are
reported in the same accounting period so do not want to mix accounting
period together.
2. To update the balance of the owner’s capital or retained earnings
account. The owner’s capital and the retained earnings are permanent
accounts that show the owner’s right or claims to the assets and will be
carried forward to the new year.
C. Describe the Income Summary account—a clearing account used to
summarize the balances of revenue and expense accounts (Hence, the name
Income summary). A clearing account is an account used to summarize (clear
out) the balances of other accounts. The Income Summary account is used
only at the end of the period and is opened and closed during the process. Note
that the Income Summary below in located in the Owner’s (Stockholders’)
Equity section of the accounting equation to emphasize that this account will
be closed to the owner’s capital or retained earnings account which are
permanent owner’s equity accounts Some points that should be noted about
the Income Summary account are:
1. It does not have a “normal” balance as other accounts do. It is just a
clearing account used to close the balances of revenue and expense
accounts.
10
2. The use of the Income Summary account avoids the unnecessary detail of
closing revenue and expense accounts directly into the owner’s capital
account.
3. Income Summary will never appear on the financial statements.
D. Identify the four steps in the closing process, and describe the entries needed
to accomplish them. The acronym REID (pronounced read) will be used to
help remember the 4-step closing process. To close an account so that it will
end up with a zero balance, you do the exact opposite of what is in the
account. To close an account with a credit balance, you make an equal debit;
to close an account with a debit balance, you make an equal credit.
1. Close the balance of each Revenue account to the Income Summary
account. Debit each revenue account; credit the Income Summary account
for the total of all the revenue accounts. Note that since Pioneer Advertising
Agency has only one revenue account, there is only one debit amount for
service revenue and the credit to Income Summary. But if there were more
than one revenue account, then a compound entry would be made with a
debit to each revenue account and one credit to income summary for the
total of the revenue accounts. Below the entry is shown in the T-accounts
with the numbers in bold and highlighted which reduces the revenue account
to zero where a line in both the debit and credit balance columns indicates
that there is now not a debit or a credit balance:
Assets
+
=
-
Cash
Liabilities
+
Notes Payable
15,200
+ Owner’s Equity
+
C. R. Byrd, Capital
3,000
Accts.Rec.
200
Accts. Payable
210
Int. Payable
Adver. Sup.
1,000
10,000
Revenues
+
ServiceRev
10,600
10,600
--
--
- Expenses
+
Adv. Sup.
Exp.
1,500
C.R. Byrd Drawing
500
Depr. Exp.
Income Summary
Insur. Exp.
Unearn. Rev.
Prepd Ins.
+
10,600
40
50
Salaries Exp.
Salar. Payable
550
5,200
Off. Equip.
Rent Exp.
900
5,000
A/D-Off. Eq.
40
Interest Exp.
50
2. Close the balance of each Expense account to the Income Summary
account. Debit the Income Summary account for the total of all the
11
Assets
+
Cash
expense account balances; credit each expense account. Below the entry
is shown in the T-accounts with the numbers in bold and highlighted
which reduces the expense accounts to zero where a line in both the
debit and credit balance columns indicates that there is now not a debit
or a credit balance: Note how the Income Summary account is debited
for the total 7,740 (1,500 + 40 + 50 + 5,200 + 900 + 50) of all the expense
accounts.
=
Liabilities
+ Owner’s Equity + Revenues
- Expenses
+
+
+
+
Notes Payable
3,000
15,200
Accts.Rec.
200
Accts. Payable
210
Int. Payable
Adver. Sup.
1,000
Service Rev
10,600
1,500
1,500
--
--
--
--
Depr. Exp.
C.R. Byrd Drawing
500
7,740
Adv. Sup. Exp.
10,600
40
--
40
--
Insur. Exp.
Income Summary
Unearn. Rev.
Prepd Ins.
C. R. Byrd, Capital
10,000
10,600
50
--
50
--
Salaries Exp.
Salar. Payable
550
Off. Equip.
5,200
5,200
--
--
Rent Exp.
5,000
900
--
A/D-Off. Eq.
40
900
--
Interest Exp.
50
--
50
--
3. Close the balance of the Income Summary account to the owner’s
capital or retained earnings account. The balance of the Income
Summary account is the net income or loss. Debit the Income Summary
account and credit the capital account or retained earnings; reverse if a
net loss. First, you must determine the balance in the income
summary account. Since Pioneer Advertising Agency have a net
income, income summary has a credit balance of 2860. To CONFIRM
that all the revenue and expense accounts were properly closed,
compare the balance of the income summary account to the net
income or net loss amount on the Income Statement that was prepared
for the company. Below the entry is shown in the T-accounts with the
numbers in bold and highlighted which reduces the income summary
account to zero where a line in both the debit and credit balance
columns indicates that there is now not a debit or a credit balance.
Assets
=
Liabilities
+ Owner’s Equity + Revenues
- Expenses
+
+
+
+
+
Cash
Notes Payable
C. R. Byrd, Capital
12
Service Rev
Adv. Sup. Exp.
15,200
3,000
10,000
2,860
Accts.Rec.
200
Accts. Payable
210
Int. Payable
Adver. Sup.
1,000
10,600
1,500
1,500
--
--
--
--
Depr. Exp.
C.R. Byrd Drawing
500
40
--
Clo.
Salar. Payable
7,740
2,860
--
10,600
2,860
--
40
--
Insur. Exp.
Income Summary
Unearn. Rev.
Prepd Ins.
10,600
50
--
Bal.
50
--
Salaries Exp.
550
Off. Equip.
5,200
5,200
--
--
Rent Exp.
5,000
900
--
A/D-Off. Eq.
40
900
--
Interest Exp.
50
--
50
--
4. Close the balance of the owner’s Drawing or Dividends account to the
owner’s capital or retained earnings account. Debit the capital or
retained earnings account; credit the drawing or dividend account. The
balance of the capital or retained earnings account now agrees with the
final figure on the statement of owner’s equity or the statement of
retained earnings. Below the entry is shown in the T-accounts with the
numbers in bold and highlighted which reduces the drawing account to
zero where a line in both the debit and credit balance columns indicates
that there is now not a debit or a credit balance. After the last closing
entry, the balance of the capital account is calculated. NOTE that the
capital or retained earnings account is not zero as these accounts are
permanent accounts and will carry this balance forward into the new
year. Also NOTE that none of the assets or liabilities were closed
during the closing process as these accounts are permanent accounts
that will carry their balances forward into the new year.
Assets
=
Liabilities
+ Owner’s Equity + Revenues
- Expenses
+
+
+
+
+
Cash
15,200
Notes Payable
3,000
C. R. Byrd, Capital
10,000
500
2,860
12,360
Accts.Rec.
200
Accts. Payable
210
Int. Payable
Adver. Sup.
1,000
Unearn. Rev.
C.R. Byrd Drawing
500
500
Service Rev
Adv. Sup. Exp.
10,600
10,600
1,500
1,500
--
--
--
--
Depr. Exp.
40
--
40
--
Income Summary
Insur. Exp.
7,740
2,860
50
--
13
10,600
2,860
50
--
Prepd Ins.
Salar. Payable
--
Salaries Exp.
--
550
5,200
5,200
--
--
Off. Equip.
Rent Exp.
5,000
900
--
A/D-Off. Eq.
40
900
Interest Exp.
50
--
50
--
E. Keep in mind that closing the income summary account depends on whether
the business has a net income or a net loss. If the company has a net income,
income summary will be debited and the owner’s capital or retained earnings
will be credited. But if the company has a net loss, the income summary will
be credited and owner’s capital or retained earnings will be debited.
F. Closing Entries Illustrated
1. Journalizing the closing entries from a work sheet.
a) The Work Sheet is very useful when preparing closing entries, because
up-to-date balances of all temporary accounts are clearly shown together
in one place. Refer to page 144 with the last overlay (Illustration 4-3D)
of the textbook and the last 4 columns of the work sheet shown below.
Only the last 4 columns are referred to as those are the columns that
contain the numbers needed for the closing entries. Again use the
acronym REID to remember the 4-steps in the closing process:
b) Step 1—Close the balance of each Revenue account to the Income
Summary account. To locate all the revenue accounts, you look at all
the numbers in the credit column of the Income Statement columns on
the work sheet. Below is the partial work sheet with the journal entry
below showing how entered into there:
PIONEER ADVERTISING AGENCY
Work Sheet
For the Month Ended October 31, 20-Account Name
Cash
Accts. Receivable.
Advert. Supplies
Prepaid Insurance.
Office Equip.
Income Statement
Debit
Credit
Balance Sheet
Debit
Credit
15,200
200
1,000
550
5,000
Accum. Depr. Off. Eq
Notes Payable
Accts. Payable
Interest Payable
Unearned Revenue
Salaries Payable
C.R. Byrd, Capital
40
5,000
2,500
50
800
1,200
10,000
14
C.R. Byrd, Drawing
Service Revenue
Salaries Expense
Rent Expense
Advert. Sup. Expense
Insurance Expense
Depr. Exp. Off. Eq.
Interest Expense
Totals
Net Income
500
10,600
5,200
900
1,500
50
40
50
7,740
10,600
22,450
19,590
2,860
10,600
10,600
22,450
2,860
22,450
Note: the words, “Closing Entries,” head the closing entries where explanations
are not needed but optional when you distinguish these type of entries:
General Journal
Page 3
Date
Account Title
P.R.
Debit
Credit
20-Closing Entries
Oct.
31 Service Revenue
10,600
Income Summary
10,600
c) Step 2—Close the balance of each Expense account to the
Income Summary account. To locate all the expense accounts,
you look at all the numbers in the debit column of the Income
Statement columns on the work sheet. . Below is the partial
work sheet with the journal entry below showing how entered
into there and note that the expenses are entered in the journal
in the order that they are appear on the work sheet to prevent
omitting any accounts:
PIONEER ADVERTISING AGENCY
Work Sheet
For the Month Ended October 31, 20-Account Name
Cash
Accts. Receivable.
Advert. Supplies
Prepaid Insurance.
Office Equip.
Accum. Depr. Off. Eq
Notes Payable
Accts. Payable
Interest Payable
Unearned Revenue
Salaries Payable
C.R. Byrd, Capital
C.R. Byrd, Drawing
Service Revenue
Salaries Expense
Rent Expense
Advert. Sup. Expense
Income Statement
Debit
Credit
Balance Sheet
Debit
Credit
15,200
200
1,000
550
5,000
40
5,000
2,500
50
800
1,200
10,000
500
10,600
5,200
900
1,500
15
Insurance Expense
Depr. Exp. Off. Eq.
Interest Expense
Totals
Net Income
50
40
50
7,740
2,860
10,600
10,600
10,600
22,450
19,590
22,450
2,860
22,450
General Journal
Date
Account Title
20-Closing Entries
Oct.
31 Service Revenue
Income Summary
P.R.
31 Income Summary
Salaries Expense
Rent Expense
Advert. Supplies Expense
Insurance Expense
Depr. Expense—Office Equip.
Interest Expense
Debit
Page 3
Credit
10,600
10,600
7,740
5,200
900
1,500
50
40
50
d) Step 3—Close the balance of the Income Summary account to
the owner’s capital account. To locate the balance in the
Income Summary account, you look at the net income (2,860 for
Pioneer Advertising Agency) or net loss amount that is at the
bottom of the income statement columns of the work sheet
before the final totals. Actually the T-account for the income
summary account is actually shown on the income statement
columns because the total debit column (7,740) is the debit
entry into the income summary account and the total credit
column (10,600) is the credit entry into the income summary
account. Therefore, the balance at this point in the Income
Summary account is the difference between the credit of
$10,600 and the debit of $7,749 which is the net income figure
of $2,860 as a credit balance in the Income Summary account.
To close, then, the Income Summary account requires a debit
of $2,860. Below is the partial work sheet with the journal
entry below showing how entered into there:
PIONEER ADVERTISING AGENCY
Work Sheet
For the Month Ended October 31, 20-Account Name
Cash
Accts. Receivable.
Advert. Supplies
Prepaid Insurance.
Income Statement
Debit
Credit
Balance Sheet
Debit
Credit
15,200
200
1,000
550
16
Office Equip.
Accum. Depr. Off. Eq
Notes Payable
Accts. Payable
Interest Payable
Unearned Revenue
Salaries Payable
C.R. Byrd, Capital
C.R. Byrd, Drawing
Service Revenue
Salaries Expense
Rent Expense
Advert. Sup. Expense
Insurance Expense
Depr. Exp. Off. Eq.
Interest Expense
Totals
Net Income
5,000
40
5,000
2,500
50
800
1,200
10,000
500
10,600
5,200
900
1,500
50
40
50
7,740
10,600
22,450
19,590
2,860
10,600
10,600
22,450
2,860
22,450
General Journal
Date
Account Title
20-Closing Entries
Oct.
31 Service Revenue
Income Summary
P.R.
Debit
Page 3
Credit
10,600
10,600
31 Income Summary
Salaries Expense
Rent Expense
Advert. Supplies Expense
Insurance Expense
Depr. Expense—Office Equip.
Interest Expense
7,740
31 Income Summary
C.R. Byrd, Capital
2,860
5,200
900
1,500
50
40
50
2,860
e) Step 4—Close the balance of the owner’s Drawing
account to the owner’s capital account. To locate the
balance in the drawing account, you look for the amount
on the debit column of the Balance Sheet columns of the
work sheet. Below is the partial work sheet with the
journal entry below showing how entered into there:
PIONEER ADVERTISING AGENCY
Work Sheet
For the Month Ended October 31, 20-Account Name
Cash
Income Statement
Debit
Credit
Balance Sheet
Debit
Credit
15,200
17
Accts. Receivable.
Advert. Supplies
Prepaid Insurance.
Office Equip.
Accum. Depr. Off. Eq
Notes Payable
Accts. Payable
Interest Payable
Unearned Revenue
Salaries Payable
C.R. Byrd, Capital
C.R. Byrd, Drawing
Service Revenue
Salaries Expense
Rent Expense
Advert. Sup. Expense
Insurance Expense
Depr. Exp. Off. Eq.
Interest Expense
Totals
Net Income
200
1,000
550
5,000
40
5,000
2,500
50
800
1,200
10,000
500
10,600
5,200
900
1,500
50
40
50
7,740
10,600
22,450
19,590
2,860
10,600
10,600
22,450
2,860
22,450
General Journal
Date
Account Title
20-Closing Entries
Oct.
31 Service Revenue
Income Summary
P.R.
Debit
Page 3
Credit
10,600
10,600
31 Income Summary
Salaries Expense
Rent Expense
Advert. Supplies Expense
Insurance Expense
Depr. Expense—Office Equip.
Interest Expense
7,740
31 Income Summary
C.R. Byrd, Capital
2,860
5,200
900
1,500
50
40
50
2,860
31 C.R. Byrd, Capital
C.R. Byrd, Drawing
500
500
Below is an example of a company with a net loss (Taylor and Associates) which
would be journalized below the partial work sheet illustrating that the difference is Step
3 of the closing process because Income Summary will have a debit balance of $555
prior to closing and therefore it will require that that the Income Summary account
is credited to close and the capital account will be debited as a net loss decreases
owner’s equity illustrated as follows:
18
Taylor and Associates
Work Sheet
For the Month Ended December 31, 20-Account Name
Cash
Accts. Receivable.
Office Supplies
Prepaid Insurance.
Office Equip.
Accum. Depr. Off. Eq
Off ice Furniture
Acc.Depr. Office Furn.
Accts. Payable
Salaries Payable
W. Taylor, Capital
W. Taylor, Drawing
Service Revenue
Rent Expense
Repairs Expense
Salaries Expense
Office Sup Expense
Insur. .Expense
Depr. Exp. Off. Eq.
Depr. .Exp. Off. Furn.
Totals
Income Statement
Debit
Credit
Balance Sheet
Debit
Credit
5,485
300
230
220
3,000
50
2,000
30
3,000
210
10,000
1,500
1,700
800
50
1,260
45
20
50
30
2,255
Net Loss
2,255
1,700
555
12,735
2,255
13,290
13,290
555
General Journal
Date
Account Title
20-Closing Entries
Dec.
31 Service Revenue
Income Summary
31 Income Summary
Rent Expense
Repairs Expense
Salaries Expense
Office Supplies Expense
Insurance Expense
Depr. Expense—Office Equip.
Depr. Expense—Office Furn.
31 William Taylor, Capital
Income Summary
13,290
P.R.
Debit
Page 3
Credit
1,700
1,700
2,255
800
50
1,260
45
20
50
30
555
555
31 William Taylor, Capital
William Taylor, Drawing
1,500
1,500
19
Below shows Pioneer Advertising Agency Adjusting Entries (Chapter 3) journalized
from the adjustments columns of the work sheet by letter entered with the Closing
Entries (Chapter 4) journalized from the income statement and balance sheet columns of
the work sheet illustrating that these entries can all be entered on the same journal page
with the respective titles for each section.
General Journal
Page 3
Date
Account Title
P.R.
Debit
Credit
20-Adjusting Entries
Oct.
31 Advert. Supplies Expense
1,500
Advert. Supplies
1,500
31 Insurance Expense
Prepaid Insurance
50
31 Depr. Expense—Office Equip.
Accum. Depr.—Office Equip.
40
50
40
31 Unearned Revenue
Service Revenue
400
31 Accounts Receivable
Service Revenue
200
31 Interest Expense
Interest Payable
50
400
200
50
31 Salaries Expense
Salaries Payable
Closing Entries
31 Service Revenue
Income Summary
1,200
1,200
10,600
10,600
31 Income Summary
Salaries Expense
Rent Expense
Advert. Supplies Expense
Insurance Expense
Depr. Expense—Office Equip.
Interest Expense
7,740
31 Income Summary
C.R. Byrd, Capital
2,860
5,200
900
1,500
50
40
50
2,860
31 C.R. Byrd, Capital
C.R. Byrd, Drawing
500
500
20
NOTE: The 4 steps (REID) in the closing process produce only 4 journal entries. A
typical student misconception is that every separate revenue and every separate
expense require a separate journal entry to close rather than making one compound
journal entry for all revenues and one compound journal entry for all expenses.
Doing separate entries defeats the purpose of having an income summary account.
Another typical error when closing more than one revenue and closing the expense
accounts is to just enter the word, “Revenues,” as a debit to close the total revenues
into the journal for the first entry and enter the word, “Expenses,” as the credit to
close all the expenses for the second entry. Remember all the accounts need to be
posted to the general ledger to form an audit trail so all accounts must be listed in
the general journal and posted to the general ledger as shown in the post reference
column of the journal and the ledger.
G. Posting Closing Entries
1. Refer to example in the textbook showing the T-accounts used in the closing
process:
a) Note that all temporary accounts (revenues, expenses, and owner’s
drawing or dividends) have zero balances after posting the closing
entries.
b) All permanent accounts (assets, liabilities, and owner’s capital or retained
earnings) are not closed.
c) Also, the balance is the owner’s capital account or retained earnings
represents the amount shown as the ending capital on the owner’s equity
statement and the owner’s capital shown on the balance sheet or the
ending retained earnings on the statement of retained earnings and the
retained earnings on the balance sheet.
d) The Income Summary account is used only in closing to clear out the
revenue and expenses and then net income (or net loss) for the period.
2. Only the permanent accounts after closing will have balances in the general
ledger:
a) Note that the only words that you see in the Explanation column (NOT
for an “explanation” but only to identify special types of postings) of
the General Ledger are the words, “Balance, “or “Adjusting,”or
“Closing”(“Adjusting” or “Closing” are needed to identify these special
type of postings in the General Ledger) Below is the example of one
account with an adjusting entry, closing entry, and showing how the line
across the “balance” columns showing that the account is closed or the
account can show a 0.
General Ledger (partial)
Advertising Supplies Expense
No.631
Date
Explanation
P.R. Debit (+)
Credit (-)
Balance
20-Dec.
J2
1,500
31 Adjusting
1,500
J3
31 Closing
1,500
--b) The ledger account for the owner’s, capital or retained earnings has
the word, “Closing” entered for entries posted into the account. Those
21
words are entered there to alert the reader that these entries are
closing entries, but the capital or retained earnings account was NOT
CLOSED.
H. Preparing a Post-Closing Trial Balance. Only the permanent accounts
appear on the post-closing trial balance because it is prepared after the closing
entries have been posted. Its purpose:
1. to prove the equality of the permanent (or balance sheet) account balances
that are carried forward into the next accounting period to make sure that
the ledger will be in balance at the start of the next accounting period.
2. to provide evidence that the journalizing and posting of the closing entries
have been properly completed as only permanent accounts should appear on
the post-closing trial balance and if any temporary accounts are shown then
all closing entries were NOT properly completed.
3. to show that the accounting equation is in balance at the end of the
accounting period but does NOT prove that ALL transactions have been
recorded or that the ledger is correct (as would be the case with any type of
trial balance).
III. SUMMARY OF ACCOUNTING CYCLE:
A. The following are steps in the accounting cycle are performed in sequence
and are repeated in each accounting period:
1. Analyze transactions form source documents;
2. Record (journalize) the transactions in a journal;
3. Post to ledger accounts;
4. Prepare a trial balance;
5. Determine the needed adjustments;
6. Prepare a work sheet (optional step) journalizing and posting adjusting
entries (prepayments or deferrals and accruals) and preparing an
adjusted trial balance
7. Prepare financial statements;
8. Journalize and post closing entries;
9. Prepare a post-closing trial balance; and
10. Prepare reversing entries (optional step)—see discussion below.
B. Journalizing and posting the closing entries and preparing the post-closing
trial balance are usually prepared ONLY AT THE END OF A COMPANY’S
ANNUAL ACCOUNTING PERIOD.
C. Correcting Entries—an avoidable step:
1. They need to be prepared when errors have been made as soon as the
errors are discovered by journalizing and posting correcting entries.
2. Differences between adjusting and correcting entries:
a) Adjusting entries are an integral (necessary) part of the accounting
cycle; correcting entries only need to be made if errors have been
made.
22
b) Adjusting entries are journalized and posted only at the end of the
accounting period; correcting entries are made whenever an error is
discovered.
c) Adjusting entries ALWAYS affect one balance sheet and one income
statement account; correcting entries may involve any combination of
accounts in need to correction. Correcting entries MUST BE
POSTED BEFORE CLOSING ENTRIES.
3. To determine the correcting entry, it is useful to compare the incorrect
entry with the correct entry so that only the accounts that should be
corrected are involved in the correcting entry:
a) The most efficient correcting entry is NOT REVERSING the
incorrect entry and then making a correct entry but
1) Comparing the incorrect entry with the correct entry and then;
2) Determining which accounts and amounts need to be corrected;
and
3) Recording only one correcting entry to correct the amounts in just
the accounts that are incorrect.
IV.
CLASSIFIED BALANCE SHEET—a balance sheet that divides the assets
and liabilities sections into standard classifications or sections as shown on
handout, STANDARD CLASSIFICATIONS and will be used from now
on as this format gives the user (management, creditors, potential
investors, etc.) more useful information about the company and allows
ratios to be computed to properly analyze the company.
A. The two formats of the classified balance sheet:
1. Account form—where the assets section is placed on the left and
the liabilities and owner’s equity on the right side as with the
accounting equation which is why it is called the “account”
form.
2. Report form —where the assets are listed above the liabilities and
owner’s equity sections which is the form, most often presented as
it is like reading a report from top to bottom.
B. ONLY THE FIRST WORD ON THE LINE IS CAPITALIZED
UNLESS IT FOLLOWS A COLON and the rule for abbreviations is
this: only abbreviate when it is necessary as the description column is
shorter when there is a 3-column format so on some lines, you may
have to abbreviate but if there is room on a line as is usually the case
with an Excel template where columns can be increased, DO NOT
ABBREVIATE).
C. The "classifications" occur in the ASSETS and LIABILITY sections
as follows:
1. ASSETS are classified into the following sections.
a) Current assets are resources at are cash, expected to be realized
in cash (like receivables), sold (like inventory), or consumed or
used (like supplies, prepaid insurance, etc.) in within one year of
23
the balance sheet date or the company’s operating cycle,
whichever is longer. An operating cycle of a company is the
average time that is required to go from cash to cash in
producing revenues—to make and sell the product or service
which can turn into a receivable and finally into cash.
1) The common types of current assets that are customary in a
service enterprise.
2) These items are listed in order of liquidity—how fast can
turn into cash or use (if not intended to turn into cash as with
prepaid expenses). The prepaid expenses (prepaid insurance,
supplies, etc.) are listed last and one prepaid expense is NO
MORE LIQUID than another so they are usually listed how
they appear in the general ledger accounts.
b) Long-Term Investments (not shown in the textbook)are resources
not expected to be realized in cash within the next year or
operating cycle and are not intended for use or consumption
within the business but held for investment such as stock and
bonds in other corporations.
c) Property, Plant, and Equipment (Plant Assets)are tangible
resources of a relatively permanent nature (long-term), that are
used in the business and not intended for sale (such as
inventory).
1) These assets are subject to depreciation except for land.
2) These assets should be reported at cost less accumulated
depreciation (book value).
d) Intangible assets (not shown in the textbook) are noncurrent
resources that do not have physical substance.
1) These assets give the holder exclusive right of use for a
specified period of time. Their value to a company is generally
derived from the rights or privileges granted by governmental
authority.
2. LIABILITIES are classified into the following sections:
a) Current liabilities are obligations (debts) that are reasonably
expected to be paid from existing current assets or through the
creation of other current liabilities within the next year or
operating cycle, whichever is longer.
1) The arrangement of items within the current liabilities
section is usually done through custom rather than a
prescribed rule. Notes payable and Accounts Payable
usually are listed first in that order and the others in any
order.
2) Users of the financial statements look closely at the
relationship between current assets and current liabilities
through the use of ratios. This relationship is important in
evaluating a company’s liquidity—its ability to pay
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obligations that are expected to become due within the next
year or operating cycle.
1. When current assets are greater that current liabilities
by a certain amount (usually 2:1), this is considered
favorable in ability to pay.
2. When there is not a safe cushion of current assets
exceeding current liabilities or when the reverse is true,
there is less of a chance that the current liabilities will
be paid and the company may even be forced into
bankruptcy.
b) Long-term liabilities are obligations (debts) that will be paid
beyond one year. (NOTE: a debt that is paid on the monthly
installment basis will be classified into both the Current
liabilities section (the portion that will be paid within the
following year) and the Long-term liabilities section (the
portion that will be paid beyond one year)).
3. OWNER’S (STOCKHOLDERS’) EQUITY section.. The content of
the owner’s equity section varies with the form of organization:
a) In a proprietorship, there is one capital account. The up-to-date
capital balance has been taken from the owner’s equity
statement. is shown by the owner’s equity section with the
owner’s name and the word, “capital.”.
b) In a partnership, there is a capital account for each partner.
c) For a corporation, owner’s (stockholders’) equity is divided
into two sections—Capital or Common stock (for the sale of
the corporations stock) and retained earnings (income retained
for the use in the business).
V. REVERSING ENTRIES are optional entries made at the first day of the new
fiscal year and are the exact opposite of the adjusting entries made in the
previous period so that certain adjusting entry amounts will not be forgotten to
take care of in the new accounting period. The adjusting entries that are often
forgotten are the accrued entries such as accrued salaries or also called accrued
wages expenses in some companies.
A. A reversing entry on the first day of the new accounting period reverses an
adjusting entry that was made at the end of the prior accounting period. To
explain the example, the accounting equation with T-accounts will be used
with the example. Throughout the accounting period the salaries are debited
to Salaries Expense and credited to Cash. With the example for Pioneer
Advertising Agency, only the first month of operation is used as an example
and they have only had one payment for Salaries Expense of $4,000. Then on
October 31, there is an adjustment made to accrue $1,200 of salaries owed to
properly match the revenues and expenses in the same accounting period
leaving a balance in the account of $5,200. During the closing process the
Salaries Expense account is reduced to zero to begin the new accounting
period. But there is still the $1,200 credit balance in the Salaries Payable
account to carry to the new period.
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=
Assets
Cash
+
Liabilities
Owner's
+ Revs. Equity
Salaries Payable
4,000
Expenses
Salaries Expense
1,200 Adj. Oct. 31
Oct.26
4,000
Oct.31 Adj. 1,200
Bal. 5,200 5,200 Close
Oct.26
-----
-----
B. The Salaries Payable account needs to be debited for $1,200 the first
payday of the new period, but since that is not the normal entry each
time salaries are paid, it is often forgotten to do. I have asked clients
when auditing their books at the end of the year what the credit
number in a salaries or wages payable account represents and a
typical response that I would get is, "I don't know. It's been there all
year." That means the adjusting entry from the prior period into the
liability account, Salaries Payable, was never shown to be paid as the
normal entry to record the salaries in this example is to debit Salaries
Expense and credit Cash. The correct entry for the first payroll of the
new period should be to debit Salaries Payable for $1,200, debit
Salaries Expense for $2,800 and credit cash for $4,000.
C. To alleviate the problem of forgetting about the amount in the
Salaries Payable account, some companies do reversing entries the
first day of the new accounting period. The reversing entry is the
exact opposite of the adjusting entry where on November 1 as the
example shows in the second column of Illustration 4A-1 page 170,
there would be a debit to Salaries Payable of $1,200 and a credit to
Salaries Expense of $1,200, under “Reversing Entry,” which as can be
seen below leaves an unnatural (not normal) balance in the Salaries
Expense account on November 1 of a credit balance of $1,200, but it
does reduce the Salaries Payable account to zero. But what happens
when the salaries are paid on Nov.9 of the new period, the normal
entry is made to debit Salaries Expense and to credit Cash, the correct
balance is now in the Salaries Expense account of $2,800 which is the
portion that is an expense in the new accounting period shown in the
T-accounts as follows:
Assets
Cash
4,000
Nov. 9
=
Liabilities
+
Owner's
+ Revenues Equity
Salaries Payable
Rev. 1,200
1,200
Adj. Oct.31
Salaries Expense
1200 Nov1
Nov.1
-----
Expenses
Reversing
-----
4,000
Bal.Nov 92800
Nov. 9
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