Task Team of FUNDAMENTAL ACCOUNTING
School of Business, Sun Yat-sen University
Lesson Notes
Lesson 5 Completing the Accounting Cycle
Learning objectives
1. Describe and prepare a worksheet and describe its usefulness.
2. Describe the closing process and explain why temporary accounts are closed
each period.
3. Prepare closing entries.
Teaching hours
Students major in accounting: 5 hours
Others:
2 hours
Teaching contents:
Before we start this lesson, let recall what we have studied:
– Analyzing transactions
– Journalizing the transactions
– Posting
– Unadjusted trial balance
– Adjusting
– Adjusted trial balance
What is worksheet ?
A worksheet is a working paper used by an accountant to organize accounting
information for preparing the financial statements and adjusting entries.
What the worksheet is used for?
The worksheet is used to gather information on adjustments and account balances
from the financial statements. This helps reduce the chance of error, omission,
duplication, and assures mathematical accuracy prior to the actual preparation of
the formal financial statements. The worksheet is useful in preparing interim
financial statements. The adjustments are reflected on the worksheet only, and not
yet recorded in the journal or ledger accounts. Interim statements can provide
useful monthly or quarterly data without disrupting the routine record keeping. The
worksheet facilitates the recording of adjusting and closing entries.
What does the worksheet include?
Normally, a worksheet has 5 sets of double columns:
1. Unadjusted trial balance column: the accounts and their balances are taken from
the ledger and entered in these columns;
2. Adjustments: adjusting entries are recorded in these columns. The worksheet is
not a journal but a worksheet. It is used only for gathering the adjustment data.
The adjusted trial balance is prepared by combining the adjustments with the
Task Team of FUNDAMENTAL ACCOUNTING
School of Business, Sun Yat-sen University
unadjusted balances.
3. Adjusted trial balance: the results of combining the unadjusted trial balance and
adjustments columns are entered here.
4. Income statement: those accounts that belong on the income statement are
extended from the adjusted trial balance columns to the income statement
columns.
5. Balance sheet and statement of owner’s equity : those accounts that belong on
these financial statements are extended from the adjusted trial balance into the
last two columns of the worksheet.
How to prepare the worksheet?
The procedure for preparing worksheets is as follows.
1. enter the unadjusted trial balance and ascertain the equality of debits and credits.
If the trial balance is in balance, it suggests accuracy in the accounts, although
this not a guarantee.
2. Enter the necessary adjustments into the two adjustments columns. Be sure that
debits equal credits for each adjustment. It is common practice to use an
identifying letter to relate the debit to the credit of each adjustment. Remember
that the purpose of adjusting entries is to bring the accounts to their proper
balances and to ensure that expenses are recorded in the period that they are
incurred and revenues are recorded when they are earned.
3. Enter the correct amounts in the adjusted trial balance columns by summing the
amounts in the unadjusted trial balance columns with the amounts in the
adjustment columns. The amounts in the adjusted trial balance are the same as
those in the accounts of the financial statements as a check, you should foot the
two adjusted trial balance columns and ensure that total debits still equal total
credits.
4. Extent the adjusted accounts to the income statement or balance sheet columns.
For each item, decide if it is a balance sheet account or an income statement
account. Then copy debit balances to the appropriate debit column and credit
balances to the appropriate credit column.
5. Footing of the income statement and balance sheet columns.
There are three different situations:
The income statement columns are equal, means that revenues equal
expenses and there is no net income or net loss. In this case there is no
change in owner’s equity.
The income statement credit column exceeds the debit column. the
difference represents net income for the period.
The income statement debit column exceeds the credit column ,the
difference represents a net loss.
Task Team of FUNDAMENTAL ACCOUNTING
School of Business, Sun Yat-sen University
The difference between revenues and expenses is added directly to the
statement of owner’s equity. Net income is added to the retained earnings.
How to use the worksheet for preparing financial statements?
The financial statement can be prepared by rearranging the items on the worksheet.
The income statement is typically prepared first and then the balance sheet.
Notice: the worksheet does not eliminate the need to journalize and post the
adjusting journal entries. This must still be done in order for the information to
enter the accounting system .Journalizing and posting the adjusting journal entries
will bring the ledger into agreement with the adjusted trial balance amounts shown
on the worksheet.
What are Temporary and Permanent Accounts?
Temporary accounts are also called nominal accounts. They are opened at the
beginning of a period, used to record events for that period and closed at the end of
the period. They accumulate data related to one accounting period only.
Permanent accounts are those accounts that their balances are carried forward from
one accounting period to the next.
What are closing entries?
Closing entries are entries that transfer the balances in the temporary accounts to a
balance sheet equity account.
The purpose of closing entries.
An the end of an accounting period, an income statement is prepared. The revenue
and expense accounts have served their purpose in determining the period’s net
income. New revenue and expense accounts will be needed for the next accounting
period. Closing entries can give the temporary accounts a zero balance.
How to prepare the closing entries?
First of all, we need to set a closing account called “Income Summary”.
Then the revenues and expenses are transferred to owner’s equity account through
the Income Summary account. The balance in the Income Summary account after
closing the revenues and expenses must equal the net income or net loss, it is used
to confirm that revenues and expenses have been closed properly.
Once the net income or loss has been proved, the balance in the Income Summary
is transferred to the owner’s equity account.
Four typical closing entries are:
1. Close revenue to income summary which will debit all revenue accounts and
Task Team of FUNDAMENTAL ACCOUNTING
School of Business, Sun Yat-sen University
credit income summary accounts;
2. Close expenses to income summary which will debit income summary accounts
and credit all expenses accounts;
3. Close income summary to the owner’s equity account which will debit income
summary (if there is a net income) and credit the owner’s equity account. Or
debit owner’s equity account (if there is a net loss) and credit the income
summary account.
Why post-closing trial balance is needed?
Post-closing trial balance is needed to ensure that the journalizing and posting of
closing entries have been done properly. That is to ensure that total debits still equal
total credits in the remaining permanent accounts. The income statement accounts
should have zero balances because they have been closed. Only balance sheet
accounts will appear in the post-closing trial balance.
Key points
1. The understanding and preparation of worksheet.
2. The Closing process.
Reading material
1. Philip E. Fess and Carl S. Warren, Accounting Principles, South-Western Publishing Co.,
1987.