Financial Accounting, 3e
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
Using a Work Sheet
Closing the Books
Classified
Balance
Sheet
Summary of
Accounting Cycle

Steps in
preparation

Preparing closing
entries

Reversing entries an optional step


Preparing
financial
statements

Posting closing
entries

Correcting entriesan avoidable step


Preparing a postclosing trial
balance

Preparing
adjusting entries
Standard
classification
Balance sheet
illustration
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
Account
Titles
Trial Balance
Dr.
Cr.
Adjustments
Dr.
Cr.
Adjusted
Trial Balance
Dr.
Cr.
1.
Prepare a
trial balance
on the
work sheet
2.
Enter
adjustment
dates
3.
Enter
adjusted
balances
Income
Statement
Dr.
Cr.
Balance
Sheet
Dr.
Cr.
(Ledger
account
titles)
(Additional
account titles
for
adjustments)
4.
Extend adjusted balances to
appropriate statement columns
5.
Total the statement columns,
compute net income (or net
loss), and complete 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
PIONEER ADVERTISING AGENCY
Work Sheet
For the Month Ended October 31, 2001
Account Titles
Cash
Advertising Supplies
Prepaid Insurance
Office Equipment
Notes Payable
Accounts Payable
Unearned Revenue
Common Stock
Retained Earnings
Service Revenue
Salaries Expense
Rent Expense
Totals
Advertising Supplies Expense
Insurance Expense
Accum. Depr. — Office Equip.
Depreciation Expense
Interest Expense
Accounts Receivable
Interest Payable
Salaries Payable
Totals
Trial Balance
Dr.
Cr.
15,200
2,500
600
5,000
5,000
2,500
1,200
10,000
500
10,000
4,000
900
28,700
28,700
Adjustments
Dr.
Cr.
Adjusted
Trial Balance
Dr.
Cr.
PREPARING A WORKSHEET
2 ENTER THE ADJUSTMENTS
PIONEER ADVERTISING AGENCY
Work Sheet
For the Month Ended October 31, 2001
Cash
Advertising Supplies
Prepaid Insurance
Office Equipment
Notes Payable
Accounts Payable
Unearned Revenue
Common Stock
Retained Earnings
Service Revenue
Trial Balance
Dr.
Cr.
15,200
2,500
600
5,000
5,000
2,500
1,200
10,000
500
10,000
Salaries Expense
Rent Expense
Totals
4,000
900
28,700
Account Titles
Advertising Supplies Expense
Insurance Expense
Accum. Depr. — Office Equip.
Depreciation Expense
Interest Expense
Accounts Receivable
Interest Payable
Salaries Payable
Totals
Adjustments
Dr.
Cr.
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
28,700 g 1,200
3,440
3,440
Adjusted
Trial Balance
Dr.
Cr.
PREPARING A WORKSHEET
3 ENTER ADJUSTED BALANCES
PIONEER ADVERTISING AGENCY
Work Sheet
For the Month Ended October 31, 2000
Cash
Advertising Supplies
Prepaid Insurance
Office Equipment
Notes Payable
Accounts Payable
Unearned Fees
Common Stock
Retained Earnings
Fees Earned
Trial Balance
Dr.
Cr.
15,200
2,500
600
5,000
5,000
2,500
1,200
10,000
500
10,000
Salaries Expense
Rent Expense
Totals
4,000
900
28,700
Account Titles
Advertising Supplies Expense
Insurance Expense
Accum. Depr. — Office Equip.
Depreciation Expense
Interest Expense
Accounts Receivable
Interest Payable
Salaries Payable
Totals
Adjustments
Dr.
Cr.
a 1,500
b 50
d 400
d 400
e 200
g 1,200
28,700
a 1,500
b 50
c
40
c 40
f 50
e 200
3,440
f 50
g 1,200
3,440
Adjusted
Trial Balance
Dr.
Cr.
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
30,190
30,190
PREPARING A WORKSHEET
4 EXTEND ADJUSTED BALANCES
PIONEER ADVERTISING AGENCY
Work Sheet
For the Month Ended October 31, 2001
Account Titles
Cash
Advertising Supplies
Prepaid Insurance
Office Equipment
Notes Payable
Accounts Payable
Unearned Revenue
Common Stock
Retained Earnings
Service Revenue
Salaries Expense
Rent Expense
Advertising Supplies Expense
Insurance Expense
Accum. Depr. — Office Equip.
Depreciation Expense
Interest Expense
Accounts Receivable
Interest Payable
Salaries Payable
Totals
Net Income
Totals
Adjusted
Trial Balance
Dr.
Cr.
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
30,190
30,190
Income
Statement
Dr.
Cr.
Balance Sheet
Dr.
Cr.
10,600
5,200
900
1,500
50
40
50
7,740
2,860
10,600
10,600
10,600
22,450
19,590
22,450
2,860
22,450
PREPARING A WORKSHEET
4 EXTEND ADJUSTED BALANCES
PIONEER ADVERTISING AGENCY
Work Sheet
For the Month Ended October 31, 2001
Account Titles
Cash
Advertising Supplies
Prepaid Insurance
Office Equipment
Notes Payable
Accounts Payable
Unearned Revenue
C.R. Byrd, Capital
C.R. Byrd, Drawing
Service Revenue
Salaries Expense
Rent Expense
Advertising Supplies Expense
Insurance Expense
Accum. Depr. — Office Equip.
Depreciation Expense
Interest Expense
Accounts Receivable
Interest Payable
Salaries Payable
Totals
Net Income
Totals
Adjusted
Trial Balance
Dr.
Cr.
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
30,190
30,190
Income
Statement
Dr.
Cr.
10,600
5,200
900
1,500
50
Balance Sheet
Dr.
Cr.
15,200
1,000
550
5,000
5,000
2,500
800
10,000
500
40
200
50
1,200
40
50
7,740
2,860
10,600
10,600
10,600
22,450
19,590
22,450
2,860
22,450
ADJUSTING ENTRIES
JOURNALIZED
GENERAL JOURNAL
Date
Account Titles and Explanation
2001
a
Oct. 31 Advertising Supplies Expense
Advertising Supplies
Insurance
Expense
b
31 Prepaid Insurance
Depreciation Expense
c
Accumulated
Depreciation - Office Equipment
31 Unearned Revenue
Service Revenue
d
Accounts
Receivable
31 Service Revenue
Interest Expense
e Payable
Interest
31 Salaries Expense
Salaries Payable
f
31
g
31
Ref.
Debit
Credit
1,500
1,500
50
50
40
40
400
400
200
200
50
50
1,200
1,200
PREPARATION OF FINANCIAL STATEMENTS
INCOME STATEMENT
PIONEER ADVERTISING AGENCY
Income Statement
For the Month Ended October 31, 2001
Revenues
Service Revenue
Expenses
Salaries expense
Advertising supplies expense
Rent expense
Insurance expense
Interest expense
Depreciation expense
Total expenses
Net income
$ 10,600
The income statement is
prepared from the income
statement columns of the
work sheet.
$ 5,200
1,500
900
50
50
40
7,740
$ 2,860
PREPARATION OF FINANCIAL STATEMENTS
RETAINED EARNINGS STATEMENT
PIONEER ADVERTISING AGENCY
Retained Earnings Statement
For the Month Ended October 31, 2001
Retained earnings, October 1
Add: Net income
Less: Dividends
Retained earnings, October 31
The Retained Earnings
statement is prepared from
the balance sheet columns
of the work sheet.
$
-02,860
2,860
500
$ 2,360
PREPARATION OF FINANCIAL STATEMENTS
BALANCE SHEET
PIONEER ADVERTISING AGENCY
Balance Sheet
October 31,2001
Liabilities and Stockholders’ Equity
Assets
$ 15,200
Cash
Accounts receivable 200
Advertising supplies 1,000
Prepaid insurance 550
Office equipment $ 5,000
Less: Accumulated 1,200
depreciation 40
4,960
10,000
2,360
$ 21,910
Total assets
Liabilities
$ 5,000
Notes payable
2,500
Accounts payable
50
Interest payable
Unearned Revenue
Salaries payable
Total liabilities
9,550
Stockholders’ equity
Common Stock
Retained earnings
$ 21,910
Total liabilities and
stockholders’ equity
The balance sheet is prepared from the
balance sheet columns of the work sheet.
800
ILLUSTRATION 4-5
TEMPORARY VERSUS PERMANENT ACCOUNTS
TEMPORARY (NOMINAL)
These accounts are closed
PERMANENT (REAL)
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
(INDIVIDUAL)
EXPENSES
(INDIVIDUAL)
REVENUES
2
1
INCOME
SUMMARY
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
INCOME
SUMMARY
3
RETAINED
EARNINGS
3 Debit (credit) Income Summary and credit (debit)
Retained Earnings for the amount of net income (loss).
ILLUSTRATION 4-6
DIAGRAM OF CLOSING PROCESS
RETAINED
EARNINGS
4
DIVIDENDS
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
2001
(1)
Oct. 31 Service Revenue
10,600Summary
Income
(To close revenue account)
Ref.
Debit
Credit
50 10,600
49
10,600
10,600
INCOME SUMMARY
Date
2001
Oct. 31
31
31
Explanation
Debit
NO. 49
Credit Balance
10,600
FEES EARNED
Date
2001
Oct. 31
31
Explanation
Debit
NO. 50
Credit Balance
10,600
–0–
ILLUSTRATION 4-7
CLOSING ENTRIES JOURNALIZED
GENERAL JOURNAL
Date
2001
Oct. 31
Account Titles and Explanation
(2)
Income Summary
Salaries Expense
5,200
Advertising Supplies
1,500Expense
Rent Expense 900
Insurance Expense
50
Interest Expense50
Depreciation Expense
40
(To close expense
accounts)
7,740
Explanation
Debit
Debit
49
60
61
62
63
64
65
7,740
NO. 49
INCOME SUMMARY
Date
2001
Oct. 31
31
Ref.
Credit Balance
10,600
10,600
2,860
Credit
ILLUSTRATION 4-7
CLOSING ENTRIES JOURNALIZED
GENERAL JOURNAL
Date
2001
Oct. 1
Account Titles and Explanation
(3)
Income Summary
2,860
Retained Earnings
(To close net income to
2,860 Retained earnings)
Ref.
49
40
Debit
Credit
2,860
2,860
NO. 49
INCOME SUMMARY
Date
2001
Oct. 31
31
31
Explanation
Debit
Credit Balance
10,600
7,740
10,600
2,860
–0–
RETAINED EARNINGS
Date
2001
Oct. 31
31
Explanation
Debit
NO. 40
Credit Balance
–0–
2,860
ILLUSTRATION 4-7
CLOSING ENTRIES JOURNALIZED
GENERAL JOURNAL
Date
2001
Oct. 1
Account Titles and Explanation
Ref.
(3)
Income Summary
49
500 Retained Earnings
40
(To close net income to
Retained earnings)
500
500
DIVIDENDS
Date
2001
Oct. 31
31
Explanation
Debit
NO. 41
Credit Balance
500
–0–
Debit
Credit
500
RETAINED EARNINGS
Date
2001
Oct. 31
31
Explanation
Debit
NO. 40
Credit Balance
2,860
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 divdends through the Income
Summary account. Dividends is not an
expense, and it is 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, and retained
earnings) are not closed.
ILLUSTRATION 4-8
POSTING OF CLOSING ENTRIES
Salaries Expense
4,000
(2)
5,200
1,200
5,200
60
(1)
5,200
Advertising Supplies Expense
1,500
(2)
1,500
1
2
61
(2)
(3)
Rent Expense
900
(2)
Service Revenue
10,600
10,000
400
200
10,600
10,600
Income Summary
7,740
(1)
10,600
2,860
49
62
900
10,600
10,600
3
Insurance Expense
50
(2)
63
50
(4)
2
Interest Expense
50
(2)
Retained Earnings
500
–0–
(3)
2,860
64
40
2,360
50
4
Depreciation Expense
40
(2)
65
40
500
Dividends
(4)
41
500
50
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, 2001
Debit
Cash
The post-closing trial
Accounts Receivable balance is prepared from the
Advertising Supplies permanent accounts in the
ledger.
Prepaid Insurance
Office Equipment
Accumulated Depreciation — Office Equipment
Notes Payable
The post-closing trial balance
Accounts Payable
provides evidence that the
Interest Payable
journalizing and posting of
Unearned Revenue
closing entries has been
Salaries Payable
properly completed.
Common Stock
Retained Earnings
Credit
$ 15,200
200
1,000
550
5,000
$
40
5,000
2,500
50
800
1,200
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
REVERSING ENTRIES
 A reversing entry is made at the
beginning of the next accounting period.
 The purpose of reversing entries is to
simplify the recording of a subsequent
transaction related to an adjusting
entry.
 Reversing entries are most often used to
reverse two types of adjusting entries:
accrued revenues and accrued expenses.
ILLUSTRATIVE EXAMPLE
OF REVERSING ENTRY
2001
Oct. 26
31
31
Initial Salary Entry
Salaries Expense
Cash
(To
record Oct. 26 payroll)
Salaries
Expense
Adjusting
Entry
Salaries
Payable
Income Summary
Salaries Expense
(To
record accrued salaries)
Salaries
Payable
Closing Expense
Entry
Salaries
Salaries Expense
Cash
(To close salaries expense)
Reversing Entry
Nov. 1
(To reverse Oct. 31
adjusting entry)
Subsequent Salary Entry
9
(To record Nov. 9 payroll)
4,000
4,000
1,200
1,200
5,200
5,200
1,200
1,200
4,000
4,000
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 can be
journalized and posted whenever an error
is discovered.
They involve any combination of balance
sheet and income statement accounts
ILLUSTRATIVE EXAMPLE
OF CORRECTING ENTRY 1
May 10
Incorrect Entry
Cash
Service Revenue
(To record collection from
customer an account)
Cash
Correct
Entry
Accounts
Receivable
50
50
50
50
10
Service(To
Revenue
record collection from
Accounts
Receivable
customer
an account)
Correcting Entry
20
(To correct entry of May 10)
50
50
ILLUSTRATIVE EXAMPLE
OF CORRECTING ENTRY 2
May 18
Incorrect Entry
Delivery Equipment
Accounts Payable
(To record purchase of
equipment on account)
Office Equipment
Correct
Entry
Accounts
Payable
45
45
450
450
18
Office Equipment
(To record purchase of
Delivery
Equipment
equipment
on account)
Accounts Payable
Correcting Entry
June 3
(To correct entry of May 18)
450
45
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:
Assets
Liabilities and Owner’s Equity
Current Assets
Current Liabilities
Long-Term Invesments
Long-Term Liabilities
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 inventory, accounts
receivable and cash.
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 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 and
machinery.
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 used 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
PIONEER ADVERTISING AGENCY
Balance Sheet
October 31, 2001
Assets
Current assets
Cash
Accounts receivable
Advertising supplies
Prepaid insurance
Total current assets
Property, plant, and equipment
Office equipment
Less: Accumulated depreciation
Total assets
$ 15,200
200
1,000
550
16,950
$ 5,000
40
$ 21,910
4,960
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
Liabilities and Stockholders’ Equity
Current liabilities
Notes payable
Accounts payable
Interest payable
Unearned reveneue
Salaries payable
Total current liabilities
Long-term liabilities
Notes payable
Total liabilities
Stockholders’ equity
Common stock
Retained earnings
Total liabilities and stockholders’ equity
The balance sheet is most often presented in the report
form, with the assets shown above the liabilities and
stockholders’ equity.
$ 1,000
2,500
50
800
1,200
5,550
4,000
9,550
10,000
2,360
$ 21,910
COPYRIGHT
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CHAPTER 4
COMPLETION OF THE ACCOUNTING CYCLE