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Chapter 04 - Completing the Accounting Cycle
CHAPTER 4
COMPLETING THE ACCOUNTING CYCLE
Related Assignment Materials
Student Learning Objectives Questions
Quick
Studies* Exercises* Problems*
Beyond the
Numbers
Conceptual objectives:
C1. Explain why temporary
accounts are closed each period.
2, 3, 4, 5 4-5 4-5 4-1 4-1, 4-4
C2. Identify steps in the accounting
cycle.
8 4-8 4-11 4-1 4-3, 4-8
C3. Explain and prepare a classified
balance sheet.
9, 10, 11, 14,
15
4-9 4-12 4-2, 4-3,
4-4, 4-5
4-7
Analytical objectives:
A1. Compute the current ratio and
describe what it reveals about a
company’s financial condition.
4-11 4-14, 4-15 4-4 4-2, 4-5,
4-7, 4-9
Procedural objectives:
P1. Prepare a work sheet and
explain its usefulness.
6, 7 4-1, 4-2,
4-3, 4-4,
4-7, 4-8
4-1, 4-2, 4-3,
4-4, 4-6, 4-7
4-2 4-6
P2. Describe and prepare closing
entries.
1, 3, 4, 5, 6,
16, 17
4-6, 4-10 4-6, 4-7, 4-8,
4-9, 4-10,
4-13
4-1, 4-2,
4-4, 4-5
4-1, 4-4,
4-6, 4-7
P3. Explain and prepare a
post-closing trial balance.
4 4-7 4-9, 4-10 4-1, 4-5 4-6
P4A. Prepare reversing entries and
explain their purpose.
12, 13 4-11 4-16, 4-17 4-6
*See additional information on next page that pertains to these quick studies, exercises and problems.
4-1
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
Chapter 04 - Completing the Accounting Cycle
Additional Information on Related Assignment Material
The Serial Problem for Success Systems continues in this chapter. Problems 4-2A and 4-4A can be
completed using Excel. Problem 4-4A, 4-5A and the Serial Problem can be completed with Sage 50
Software and QuickBooks.
Connect (Available on the instructor’s course-specific website) repeats all numerical Quick Studies, all
Exercises and Problems Set A. Connect provides new numbers each time the Quick Study, Exercise or
Problem is worked. It allows instructors to monitor, promote, and assess student learning. It can be used
in practice, homework, or exam mode.
Synopsis of Chapter Revision
The Naked Hippie: NEW opener with new entrepreneurial assignment
New multi-color-coded 5-step layout for work sheet preparation and use
Updated current ratio section using Limited Brands
4-2
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
Chapter 04 - Completing the Accounting Cycle
Chapter Outline Notes
I. Work Sheet as a Tool
A. The work sheet is an internal document that serves as a useful tool
for organizing accounting information. It is not a required report.
B. Benefits include: aids the preparation of financial statements,
reduces possibility of errors, links accounts and adjustments to
their impacts in financial statements, assists in planning and
organizing an audit of financial statements, helps in preparing
interim (monthly and quarterly) financial statements, and shows
the effect of proposed or “what if” transactions.
C. Steps to prepare a work sheet:
1. Enter the unadjusted trial balance in the first two columns.
2. Enter the adjustments in the third and fourth columns. Total
columns to verify debit adjustments equal credit adjustments.
3. Prepare the Adjusted Trial Balance. This is done by
combining the unadjusted trial balance and adjustment
columns. Total Adjusted Trial Balance columns to verify
debits equal credits.
4. Sort the adjusted trial balance amounts to the appropriate
financial statement columns.
5. Total statement columns, compute net income or loss and
balance the columns by adding net income or loss.
D. Work Sheet Applications and Analysis—it does not substitute for
financial statements. The financial statement columns yield pro
forma financial statements because they show the statements as if
the proposed transactions occurred.
II. Closing Process—The closing process is an important step at end of
the accounting period after financial statements have been completed.
Prepares accounts for recording transactions and events for the next
period.
A Steps in closing process:
1. Identify accounts for closing.
2. Record and post closing entries.
3. Prepare a post-closing trial balance.
B. Purpose of closing process:
1. To reset revenues, expenses, and withdrawals account
balances to zero at the end of every period to prepare these
accounts for proper measurement in the next period.
2. To update the capital account with the effect of the period’s
net income (revenue minus expenses) and owner withdrawals.
C. Temporary and Permanent Accounts
1. Temporary (or nominal) accounts accumulate data related to
one accounting period. (They are the income statement
accounts, withdrawals accounts, and Income Summary.)
4-3
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Education.
Chapter 04 - Completing the Accounting Cycle
Chapter Outline Notes
2. Permanent (or real) accounts report on activities related to
one or more future accounting periods. They are all balance
sheet accounts that are not closed.
D. Recording Closing Entries—the purpose is to transfer the
end-of-period balances in revenue, expense, and withdrawals
accounts to the permanent capital account.
1. Use a new temporary account called Income Summary. The
four closing entries are:
a. Close credit balances in revenue (and gain) accounts by
debiting the accounts and crediting Income Summary.
This transfers revenue balances to the credit side Income
Summary.
b. Close debit balances in expense (and loss) accounts by
crediting the accounts and debiting Income Summary.
This transfers the expense balances to the debit side of
Income Summary.
c. Close the Income Summary account to the owner’s capital
account.
Note: The Income Summary account, prior to closing, will
have a credit balance equal to net income or a debit balance
equal to net loss. Therefore this entry will credit capital for the
amount of net income (or debit capital for a net loss).
d. Close withdrawals account by crediting the account and
debiting the owner's capital account.
2. After all closing entries are posted, all temporary accounts
have a zero balance and capital is up to date.
E. Post-Closing Trial Balance—a list of permanent accounts and their
balances taken from the ledger.
1. Prepared after closing entries are journalized and posted.
2. Verifies that total debits equal total credits for permanent
accounts and all temporary accounts have zero ending
balances.
4-4
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Education.
Chapter 04 - Completing the Accounting Cycle
Chapter Outline Notes
F. The Accounting Cycle--steps can vary if a worksheet is used (see
Visual #4-1)
The ten steps repeated each accounting cycle are as follows:
1. Analyze transactions
2. Journalize
3. Post
4. Prepare unadjusted trial balance
5. Adjust
6. Prepare an adjusted trial balance
7. Prepare statements
8. Close
9. Prepare a post-closing trial balance.
10. Reverse (optional)
III. Classified Balance Sheet—organizes assets and liabilities into
important subgroups and provides more information for decision
makers.
A. Classification Structure
1. One of the more important classifications is the separation
between current and noncurrent assets and liabilities.
2. Current items are expected to come due (both collected and
owed) within the longer of one year or the company’s
operating cycle.
3. An operating cycle is the time span from when cash is used to
acquire goods and services until cash is received from the sale
of those goods and services.
B. Classification Categories
1. Current assets—cash or other resources that are expected to be
sold, collected, or used within one year or the operating cycle,
whichever is longer. Examples: cash, short-term investments,
accounts receivable, short-term notes receivable, merchandise
inventory, and prepaid expenses.
2. Long-term investments—assets held for more than one year,
that are not used in business operations. Examples: stocks,
bonds, promissory notes, and land held for future expansion.
3. Plant assets—tangible, long-lived assets that are used to
produce or sell goods and services. Examples: equipment,
buildings, land.
4. Intangible assets—long-term resources that benefit business
operation. They lack physical form. Their value comes from
the privileges or rights that are granted to or held by the
owner. Examples: goodwill, patents, trademarks, franchises,
copyrights.
4-5
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Education.
Chapter 04 - Completing the Accounting Cycle
5. Current liabilities—obligations due to be paid or settled within
the longer of one year or the operating cycle. Examples:
accounts payable, notes payable, wages payable, taxes
payable, interest payable, unearned revenues, current portions
of long-term liabilities.
6. Long-term liabilities—obligations that are not due to be paid
within one year or the operating cycle of the business.
Examples: notes payable, mortgage payable, bonds payable.
7. Equity—owner’s claim on assets. For a proprietorship it is
reported in this section as the owner's capital account. In a
corporation, equity is divided into two main subsections:
capital stock and retained earnings.
IV. Global View—Compares U.S.GAAP to IFRS
A. Both systems have similar definitions of assets that involve the
same three basic criteria.
B. Both systems define initial asset value as historical cost for nearly
all assets.
C. After acquisition both systems value at historical cost or fair value
but GAAP and IFRS differ slightly in how they define fair value.
D. Both systems have similar definitions of liabilities that involve the
same three basic criteria and similar valuation at acquisition.
Later chapter discuss specific difference in valuation after
acquisition.
V. Decision Analysis—Current Ratio
A. Assesses a company’s ability to pay its debts in the near future.
B. Calculation: total current assets divided by total current liabilities.
VI. Appendix 4A—Reversing Entries
A. Accounting with reversing entries (an optional step)
1. Linked to asset and liability account balances that arose from
the accrual of revenues and expenses.
2. Purpose is to simplify recordkeeping.
3. They are prepared after closing entries and dated the first day
of the new period.
4. Procedure is to transfer accrued asset and liability account
balances to related revenue and expense accounts creating an
abnormal balance in these accounts.
5. The full subsequent cash receipts (and payments) are recorded
as increases in revenue (and expense) accounts creating a net
balance equal to the amount earned or incurred in that period.
B. Accounting without reversing entries
1. To construct proper entries when the cash receipt/payment
occurs in the new accounting period, the related accrual or
deferral adjustment must be recalled and considered.
2. With or without reversing entries use, it will yield the same
result.
4-6
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Education.
Chapter 04 - Completing the Accounting Cycle
VISUAL #4-1
THE ACCOUNTING CYCLE
STEPS PURPOSE TIMING
1. Analyze
transactions
To determine accounts to be debited
and credited
During the period
2. Journalize To record the daily transactions During the period
3. Post To transfer the amounts from journal
entries to the individual accounts
affected by the recorded transaction
During the period
4. Prepare
unadjusted trial
balance
To summarize unadjusted ledger
accounts and amount.
End of period
5. Journalizing and
posting of
adjusting entries
To bring the ledger accounts to
adjusted balances
End of year
6. Prepare adjusted
trial balance
To summarize adjusted ledger
accounts and amounts
End of year
7. Preparing the
statements
To report financial information End of period*
8. Journalizing and
posting of
closing entries
To bring all temporary accounts to
zero and the capital account
up-to-date
End of year
9. Post-closing
trial balance
To prove the accuracy of the
adjusting and closing procedures
End of year
10. Reversing
entries
(optional)
To provide for recording in new fiscal
period without consideration of
accruals from previous periods
adjustments.
Beginning of new
year
*If statements are to be prepared for interim period (less than a year), a worksheet
is generally used to project adjusted numbers for statements.
Steps 4 and 6 can be done on a worksheet.
4-7
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Education.
Chapter 04 - Completing the Accounting Cycle
VISUAL #4-2
MUSIC WORLD
BALANCE SHEET
DECEMBER 31, 20XX
Assets
Current Assets
Cash $30,360
Short-Term Investments 2,000
Notes Receivable 8,000
Accounts Receivable 35,300
Merchandise Inventory 60,400
Prepaid Insurance 6,600
Supplies 1,696
Total Current Assets $144,356
Investments
Land Held for Future Use 13,950
Property, Plant, and Equipment
Land $ 4,500
Building $20,650
Less Accumulated Depreciation 8,640 12,010
Office Equipment $ 8,600
Less Accumulated Depreciation 5,000 3,600
Total Property, Plant, and Equipment 20,110
Intangible Assets
Trademark 500
Total Assets $178,916
Liabilities
Current Liabilities
Notes Payable $15,000
Accounts Payable 25,683
Salaries Payable 2,000
Mortgage Payable 10,200
Total Current Liabilities $52,883
Long-Term Liabilities
Mortgage Payable 27,600
Total Liabilities $ 80,483
Owner’s Equity
Joy Melody, Capital 98,433
Total Liabilities and Owner’s Equity $178,916
4-8
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Education.
Chapter 04 - Completing the Accounting Cycle
Alternate Demo Problem Four
The trial balance of Large Company, Inc. at the end of its annual accounting
period is as follows:
LARGE COMPANY, INC.
Trial Balance
December 31, 2013
Cash........................................................................ $ 4,000
Prepaid Insurance.................................................. 1,600
Supplies ................................................................. 2,100
Equipment ............................................................. 20,000
Accumulated Depreciation—Equipment.............. $ 2,000
C. Large, Capital .................................................... 19,000
C. Large, Withdrawals............................................ 2,000
Revenue.................................................................. 33,000
Salaries Expense................................................... 18,300
Rent Expense ........................................................ 6,000 ______
Totals...................................................................... $54,000 $54,000
Additional information:
1. Expired insurance, $600.
2. Unused supplies, per inventory, $800.
3. Estimated depreciation, $1,000.
4. Earned but unpaid salaries, $700
Required
1. Prepare adjusting entries.
2. Prepare closing entries.
3. Prepare a post-closing trial balance.
4-9
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Education.
Chapter 04 - Completing the Accounting Cycle
Solution: Alternate Demo Problem Four
1. Insurance Expense........................................... 600
Prepaid Insurance...................................... 600
Supplies Expense............................................ 1,300
Supplies...................................................... 1,300
Depreciation Expense Equip........................... 1,000
Accumulated Depreciation Equip............. 1,000
Salaries Expense.............................................. 700
Salaries Payable........................................ 700
2. Revenue............................................................ 33,000
Income Summary....................................... 33,000
Income Summary............................................. 27,900
Salaries Expense....................................... 19,000
Rent Expense............................................. 6,000
Insurance Expense.................................... 600
Supplies Expense...................................... 1,300
Depreciation Expense............................... 1,000
Income Summary............................................. 5,100
C. Large, Capital........................................ 5,100
C. Large, Capital............................................... 2,000
C. Large, Withdrawal................................. 2,000
Solution continued next page
4-10
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Education.
Chapter 04 - Completing the Accounting Cycle
3. LARGE COMPANY, INC.
Post-Closing Trial Balance
December 31, 2013
Dr. Cr.
Cash.................................................................. $4,000
Prepaid Insurance............................................ 1,000
Supplies............................................................ 800
Equipment........................................................ 20,000
Accumulated Depreciation, Equipment.......... $ 3,000
Salaries Payable............................................... 700
C. Large, Capital............................................... ______ 22,100
Totals................................................................. $25,800 $25,800
4-11
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