Principles of Financial Accounting 2002e Belverd E. Needles, Jr. Marian Powers Susan Crosson - - - - - - - - - - - Multimedia Slides by: Harry Hooper Santa Fe Community College Copyright © by Houghton Mifflin Company. All rights reserved.

Chapter 4 Completing the Accounting Cycle Copyright © by Houghton Mifflin Company. All rights reserved.

Copyright © by Houghton Mifflin Company. All rights reserved. LEARNING OBJECTIVES 1. State all the steps in the accounting cycle. 2. Explain the purposes of closing entries. 3. Prepare the required closing entries. 4. Prepare the post-closing trial balance. Copyright © by Houghton Mifflin Company. All rights reserved.

Copyright © by Houghton Mifflin Company. All rights reserved. LEARNING OBJECTIVES 5. Prepare reversing entries as appropriate. 6. Prepare a work sheet. 7. Use a work sheet for three different purposes. Copyright © by Houghton Mifflin Company. All rights reserved.

Overview of the Accounting Cycle OBJECTIVE 1 State all the steps in the accounting cycle. Copyright © by Houghton Mifflin Company. All rights reserved.

Overview of the Accounting Cycle Copyright © by Houghton Mifflin Company. All rights reserved.

Steps in the Accounting Cycle 1. Analyze business transactions from source documents. 2. Record the entries in the journal. 3. Post the entries to the ledger and prepare a trial balance. Copyright © by Houghton Mifflin Company. All rights reserved.

Steps in the Accounting Cycle (continued…) 4. Adjust the accounts and prepare an adjusted trial balance. 5. Close the accounts and prepare a post-closing trial balance. 6. Prepare financial statements. Copyright © by Houghton Mifflin Company. All rights reserved.

Copyright © by Houghton Mifflin Company. All rights reserved. Discussion Q. Resequence the following activities to indicate the correct order of the accounting cycle. a. Prepare journal entries b. Prepare the financial statements c. The transactions are analyzed from the source documents d. Prepare adjusting entries e. The closing entries are prepared f. Post to the ledger A. c, a, f, d, e, b Copyright © by Houghton Mifflin Company. All rights reserved.

OBJECTIVE 2 Explain the purposes of closing entries. Copyright © by Houghton Mifflin Company. All rights reserved.

Overview of the Closing Process Copyright © by Houghton Mifflin Company. All rights reserved.

Types of Accounts and Closing Entries Balance sheet accounts are known as permanent or real accounts. Revenue and expense accounts are temporary or nominal accounts. Closing entries are journal entries made at the end of an accounting period. Copyright © by Houghton Mifflin Company. All rights reserved.

Purposes of Closing Entries 1. To clear the revenue, expense, and Withdrawals accounts of their balances and prepare the accounts for the next accounting period. Copyright © by Houghton Mifflin Company. All rights reserved.

Purposes of Closing Entries 2. To summarize a period’s revenues and expenses. The balance of the Income Summary account equals the net income or loss for the period. The net income or loss is transferred to the owner’s Capital account. Copyright © by Houghton Mifflin Company. All rights reserved.

Copyright © by Houghton Mifflin Company. All rights reserved. Discussion Q. What is the purpose of the Income Summary account? A. The Income Summary account summarizes the revenue and expense accounts. The balance in the account before it is closed is either the net income or the net loss for the period. Copyright © by Houghton Mifflin Company. All rights reserved.

Required Closing Entries OBJECTIVE 3 Prepare the required closing entries. Copyright © by Houghton Mifflin Company. All rights reserved.

The Four Steps to Close the Accounts 1. Close the credit balances from the Income Statement accounts to the Income Summary account. Sets the balances of the revenue accounts to zero. Transfers the total revenues to the credit side of the Income Summary account. Copyright © by Houghton Mifflin Company. All rights reserved.

The Four Steps to Close the Accounts (continued…) 2. Close the debit balances from the Income Statement accounts to the Income Summary account. Reduces the expense account balances to zero. Transfers the total expenses to the debit side of the Income Summary account. Copyright © by Houghton Mifflin Company. All rights reserved.

The Four Steps to Close the Accounts (continued…) 3. Close the Income Summary account balance to the Capital account. Closes the Income Summary account. Transfers the balance, net income or net loss, to the Capital account. A credit balance in the Income Summary account (before closing) indicates net income (profit); a debit balance indicates a net loss. Copyright © by Houghton Mifflin Company. All rights reserved.

The Four Steps to Close the Accounts (continued…) 4. Close the Withdrawals account balance to the Capital account. Closes the Withdrawals account. Transfers the balance to the Capital account. Copyright © by Houghton Mifflin Company. All rights reserved.

The Accounts After Closing Accounts are ready for next period. Revenue, expense, and Withdrawals accounts (temporary accounts) have zero balances. Copyright © by Houghton Mifflin Company. All rights reserved.

The Accounts After Closing The Capital account has been increased to reflect the company’s net income and decreased for withdrawals. The balance sheet accounts (permanent accounts) show the correct balances, which are carried forward to the next period. Copyright © by Houghton Mifflin Company. All rights reserved.

Copyright © by Houghton Mifflin Company. All rights reserved. Discussion Q. Could the Income Summary account have a debit balance when the income statement accounts are closed to it? A. Yes, if a net loss has been incurred. Copyright © by Houghton Mifflin Company. All rights reserved.

The Post-Closing Trial Balance OBJECTIVE 4 Prepare the post-closing trial balance. Copyright © by Houghton Mifflin Company. All rights reserved.

The Post-Closing Trial Balance A post-closing trial balance is prepared to determine that: 1. All temporary accounts have a zero balance. 2. Debits equal credits. Only balance sheet accounts should show a balance. Copyright © by Houghton Mifflin Company. All rights reserved.

Copyright © by Houghton Mifflin Company. All rights reserved. Discussion Q. What is the significance of the post-closing trial balance? A. The post-closing trial balance checks that the total debits and total credits in the ledger are equal after the closing entries have been posted and that only balance sheet accounts show balances. Copyright © by Houghton Mifflin Company. All rights reserved.

OBJECTIVE 5 Prepare reversing entries as appropriate. Reversing Entries: The Optional First Step in the Next Accounting Period OBJECTIVE 5 Prepare reversing entries as appropriate. Copyright © by Houghton Mifflin Company. All rights reserved.

Copyright © by Houghton Mifflin Company. All rights reserved. Reversing Entries Reversing entries are optional and simplify the bookkeeping for accrued revenues and accrued expenses. Deferrals cannot be reversed. Copyright © by Houghton Mifflin Company. All rights reserved.

Example of an Accrual Without Reversing Entry 1. Adjusting Entry Jan. 31 Wages Expense 180 Wages Payable 180 Accrued unrecorded wages 2. Payment Entry Feb. 9 Wages Payable 180 Wages Expense 420 Cash 600 Payment of two weeks’ wages to secretary, $180 of which accrued in the previous period Copyright © by Houghton Mifflin Company. All rights reserved.

Example of an Accrual With Reversing Entry 1. Adjusting entry Jan. 31 Wages Expense 180 Wages Payable 180 2. Closing entry Jan. 31 Income Summary 1,380 Wages Expense 1,380 3. Reversing entry Feb. 1 Wages Payable 180 Wages Expense 180 4. Payment entry Feb. 9 Wages Expense 600 Cash 600 Copyright © by Houghton Mifflin Company. All rights reserved.

Copyright © by Houghton Mifflin Company. All rights reserved. Discussion Q. What is the purpose of reversing entries? A. Reversing entries enable the bookkeeper to continue preparing routine journal entries in the new accounting period. Copyright © by Houghton Mifflin Company. All rights reserved.

The Work Sheet: An Accountant’s Tool OBJECTIVE 6 Prepare a work sheet. Copyright © by Houghton Mifflin Company. All rights reserved.

Copyright © by Houghton Mifflin Company. All rights reserved. Working Papers In order to prepare financial reports, accountants must collect relevant data in various forms to determine what should be included. The data collected make up the accountants’ working papers. Copyright © by Houghton Mifflin Company. All rights reserved.

Copyright © by Houghton Mifflin Company. All rights reserved. Working Papers Working papers are important for two reasons. 1. They help accountants organize their work and avoid omitting important data or steps. 2. They provide evidence of past work so that accountants or auditors can retrace their steps and support the information in the financial statements. Copyright © by Houghton Mifflin Company. All rights reserved.

Copyright © by Houghton Mifflin Company. All rights reserved. The Work Sheet The work sheet, a special kind of working paper, is often used as a preliminary step in recording, adjusting and closing entries and the preparation of financial statements. A work sheet lessens the possibility of leaving out an adjustment. A work sheet helps check the arithmetical accuracy of the accounts. Copyright © by Houghton Mifflin Company. All rights reserved.

The Work Sheet (continued…) A work sheet facilitates the preparation of financial statements. A work sheet is not a published financial statement. A work sheet is often prepared using a computer. Copyright © by Houghton Mifflin Company. All rights reserved.

Preparing the Work Sheet 1. Enter and total the account balances in the Trial Balance columns. 2. Enter and total the adjustments in the Adjustments columns. 3. Enter and total the adjusted account balances in the Adjusted Trial Balance columns. Copyright © by Houghton Mifflin Company. All rights reserved.

Preparing the Work Sheet (continued…) 4. Extend the account balances from the Adjusted Trial Balance columns to the Income Statement columns or the Balance Sheet columns. 5. Total the Income Statement columns and the Balance Sheet columns. Enter the net income or net loss in both pairs of columns as a balancing figure, and recompute the column totals. Copyright © by Houghton Mifflin Company. All rights reserved.

Copyright © by Houghton Mifflin Company. All rights reserved. Discussion Q. Why are work sheets never published and rarely seen by management? A. Work sheets are never published and are rarely seen by management because they are a preliminary step in preparing financial statements. They are a tool for the accountant. Copyright © by Houghton Mifflin Company. All rights reserved.

OBJECTIVE 7 Use a work sheet for three different purposes. Using the Work Sheet OBJECTIVE 7 Use a work sheet for three different purposes. Copyright © by Houghton Mifflin Company. All rights reserved.

Copyright © by Houghton Mifflin Company. All rights reserved. Using the Work Sheet The completed work sheet aids the accountant in three principal tasks: 1. Recording the adjusting entries. Adjusting entries are copied to the general journal and then posted to the general ledger. 2. Recording the closing entries. Closing entries are entered in the journal and posted to the ledger. Copyright © by Houghton Mifflin Company. All rights reserved.

Copyright © by Houghton Mifflin Company. All rights reserved. Tasks of the Work Sheet 3. Preparing the financial statements. Account balances have been sorted into Income Statement and Balance Sheet columns. Copyright © by Houghton Mifflin Company. All rights reserved.

Copyright © by Houghton Mifflin Company. All rights reserved. Discussion Q. Do the Income Statement columns and the Balance Sheet columns of the work sheet balance after the amounts from the Adjusted Trial Balance columns are extended? A. No, they do not balance by the amount of net income or loss for the period. Copyright © by Houghton Mifflin Company. All rights reserved.

Copyright © by Houghton Mifflin Company. All rights reserved. OK, LET’S REVIEW…. State all the steps in the accounting cycle. Explain the purposes of closing entries. Prepare the required closing entries. Prepare the post-closing trial balance. Copyright © by Houghton Mifflin Company. All rights reserved.

Copyright © by Houghton Mifflin Company. All rights reserved. AND FINALLY… Prepare reversing entries as appropriate. Prepare a work sheet. Use a work sheet for three different purposes. Copyright © by Houghton Mifflin Company. All rights reserved.