CHAPTER
4
Completing the Accounting
Cycle
Principles of
Accounting
12e
Needles
Powers
Crosson
© human/iStockphoto
Concepts Underlying Closing Entries
 Closing entries are journal entries at the end of
the accounting period. They have two purposes:
– Setting the stage for the next accounting period
 Closing entries clear revenue, expense, and withdrawals
accounts of their balances so that they can start over with a
zero balance in the next accounting period.
– Summarizing a period’s revenues and expenses
 The Income Summary account is a temporary account that
summarizes all revenues and expenses for the period. It is
used only in the closing process, and its balance equals the net
income or loss.
 The net income or loss is transferred from the Income Summary
account to the owner’s Capital account.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Concepts Underlying Closing Entries
 Closing entries help achieve periodicity by dividing the life
of the business into equal time periods.
 To accomplish the closing process, it is important to
understand the concepts of permanent and temporary
accounts.
– Balance sheet accounts are considered permanent accounts (or
real accounts) because they carry their end-of-period balances into
the next accounting period.
– Revenue and expense accounts are considered temporary
accounts (or nominal accounts) because they are cleared by means
of the closing entries.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Preparing Closing Entries
 The steps involved in making closing entries are:
– 1. Close the credit balances on the income statement accounts to
the Income Summary account.
– 2. Close the debit balances on the income statement accounts to
the Income Summary account.
– 3. Close the Income Summary account balance to the owner’s
Capital account.
– 4. Close the Withdrawals account balance to the owner’s Capital
account.
 The adjusted trial balance provides all the data needed to
record the closing entries.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
The Accounts After Closing
 After all closing entries have been posted, everything is ready for the next accounting period.
– The revenue, expense, and withdrawals accounts
(temporary accounts) have zero balances.
– The owner’s Capital account has been increased or
decreased to reflect net income or net loss and has
been decreased for withdrawals.
– The balance sheet accounts (permanent accounts) show
the correct balances, which are carried forward to the
next period, as shown in the post-closing trial balance.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Reversing Entries: An Optional First Step
 A reversing entry is an optional journal entry made on the
first day of an accounting period.
– It has the opposite effect of an adjusting entry made at the end of
the previous period: It debits the credits and credits the debits of
an earlier adjusting entry.
– The sole purpose of reversing entries is to simplify routine
bookkeeping procedures, and they apply only to certain adjusting
entries, such as accruals.
– As illustrated on the next slide, reversing entries solve the problem
of applying expenses and revenues to the correct accounting
period.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Reversing Entry for Accrued Revenue
 Reversing entries apply to any accrued expenses
or revenues.
 An adjusting entry for Blue Design Studio’s
accrued revenue would require the reversing entry
below.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
The Work Sheet: An Accountant’s Tool
 To organize data and important information,
accountants use working papers.
– They provide evidence of past work.
– They enable accountants to retrace their steps when
they need to verify information on the financial
statements.
 A work sheet is a special kind of working paper.
– It serves as a preliminary step in preparing financial
statements and lessens the possibility of errors.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Preparing the Work Sheet
(slide 1 of 2)
 Step 1: Enter and total the account balances in the Trial
Balance columns.
 Step 2: Enter and total the adjustments in the Adjustments
columns.
 Step 3: Enter and total the adjusted account balances in
the Adjusted Trial Balance columns.
– The work sheet uses crossfooting, or adding or
subtracting a group of numbers horizontally.
– The Adjusted Trial Balance columns are then footed
(totaled) to check the accuracy of the crossfooting.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Preparing the Work Sheet
(slide 2 of 2)
 Step 4: Extend the account balances from the
Adjusted Trial Balance columns to the Income
Statement or Balance Sheet columns.
 Step 5: Total the Income Statement columns and
the Balance Sheet columns. Enter the net income or
loss in both pairs of columns as a balancing figure,
and recompute the column totals.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Closing Entries and the Financial Statements
 Closing entries set the accounts on the income
statement to zero and transfer the resulting
balance of net income or loss to the owner’s
Capital account on the balance sheet.
 Closing entries do not affect cash flows.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
The Importance of the Work Sheet and
Closing Entries for Managers
 Accountants use the completed work sheet in performing
three principal tasks:
– Recording the adjusting entries in the general journal.
 The information needed to record the adjusting entries can be
copied from the work sheet.
– Recording the closing entries in the general journal.
 The Income Statement columns of the work sheet show all the
accounts that need to be closed, except for the Withdrawals
account.
– Preparing the financial statements.
 Once the work sheet has been completed, preparing the
financial statements is easy because the account balances have
been sorted into Income Statement and Balance Sheet columns.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
The Importance of the Work Sheet and
Closing Entries for Managers
 Closing entries are important to managing a
business for the following reasons:
– The owners of the business expect periodic reports of
the progress of the business.
– In planning a business’s future operations, management
needs to prepare budgets for future time periods.
– For management to evaluate a company’s progress in
achieving its profitability goals, it is necessary to divide
the life of the business into relatively short time periods.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.