Principles of financial accounting 12e by needles crosson chapter 04

C HAP TE R

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,
every-thing 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.

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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.