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Chapter 4: Completing the Accounting Cycle

by: Stacy OK

Chapter 4: Completing the Accounting Cycle 51499

Marketplace > Leeward Community College > Accounting > 51499 > Chapter 4 Completing the Accounting Cycle
Stacy OK

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Outline of Chapter 4: Completing the Accounting Cycle of Wiley's Financial and Managerial Accounting Second Edition Textbook.
Introduction to Financial Accounting
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This 13 page Class Notes was uploaded by Stacy OK on Wednesday September 14, 2016. The Class Notes belongs to 51499 at Leeward Community College taught by Kamida in Fall 2016. Since its upload, it has received 4 views. For similar materials see Introduction to Financial Accounting in Accounting at Leeward Community College.

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Date Created: 09/14/16
Sunday, September 25, 2016 Chapter 4: Completing the Accounting Cycle Accounting 201 I. Chapter 4: Completing the Accounting Cycle 
 LO1. Prepare a worksheet.
 Worksheet- multiple-column form used in the adjustment process and in preparing financial statements, a working tool
 *not a permanent accounting record
 *the use of a worksheet is optional
 -makes it possible to provide the financial statements to management and other interested parties at an earlier date. A. Steps in Preparing a Worksheet 1. Step 1. Prepare a Trial Balance on the Worksheet
 -Enter all ledger accounts with balances in the account titles column.
 -Enter debit and credit amount from the ledger in the trial balance columns. 2. Enter the Adjustments in the Adjustments Column
 -Enter all adjustments in the adjustments columns using applicable trial balance accounts.
 -If additional accounts are needed, insert them on the lines immediately below the trial balance totals.
 Keying - Using a different letter to identify the debit and credit for each adjusting entry
 *Companies do not journalize the adjustments until after they complete the worksheet and prepare the financial statements.
 Examples of credit/debit adjustment accounts:
 -debit Supplies Expense/credit Supplies
 -debit Insurance Expense/credit Prepaid Insurance
 -debit Depreciation Expense/credit Accumulated Deprecation— Equipment
 -debit Unearned Service Revenue/credit Service Revenue
 -debit Accounts Receivable/credit Service Revenue
 -debit Interest Expense/credit Interest Payable
 -debit Salaries and Wages Expense/ credit Salaries and Wages Payable
 -After all adjustments have been entered, the adjustments columns are 1 Sunday, September 25, 2016 totaled to prove their equality.
 3. Step 3. Enter the Adjusted Balances in the Adjusted Trial Balance Columns
 -Determine the adjusted balance of an account by combining the amounts entered in the first four columns of the worksheet for each account.
 *For each account the amount in the adjusted trial balance columns is the balance that will appear in the ledger after journalizing and posting the adjusting entries.
 -After all account balances have been entered in the adjusted trial balance columns, the columns are totaled to prove their equality. If the column totals dod not agree, the financial statement columns will not balance and the financial statements will be incorrect. 4. Step 4. Extend Adjusted Trial Balance Amount to Appropriate Financial Statement Columns
 -Extend adjusted trial balance amounts to the income statement and balance sheet columns of the worksheet.
 -Enter balance sheet accounts n the appropriate balance sheet debit and credit columns.
 -The balance sheet has contra asset accounts (w/credit balance), Common Stock, Retained Earnings to credit. Dividends to the debit column.
 -The income statement is EXPENSES and REVENUES ONLY to appropriate columns. 5. Step 5. Total the Statement Columns, Compute the Net Income (Or Net Loss), and Complete the Worksheet
 Total Statement Columns:
 -Total each of the financial statement columns. 
 Net Income:
 -Net income/loss for the period is the difference between the totals of the two income statement columns.
 -Total credits exceed total debits in income statement columns = Net Income
 -Insert “Net Income” in the account titles space, enter the amount in the income statement debit column and the balance sheet credit column.
 *The debit amount balances the income statement columns; the credit amount balances the balance sheet columns.
 -Credit in the balance sheet column indicates the increase in stockholders’ 2 Sunday, September 25, 2016 equity resulting from net income.
 Net Loss:
 -Total debits exceed total credits in income statement column = Net Loss
 -Enter amount of net loss in the income statement credit column and the balance sheet debit column.
 Net Income/Loss:
 -After entering the net income/loss the company determines new column totals. Totals should show that debit and credit income statement columns and balance sheet columns match. If it is not equal, there is an error in the worksheet. B. Preparing Financial Statements from a Worksheet
 -After worksheet is completed, all data required for preparation of financial statements is available except for journalized or posted adjusting entries. Ledger balances for some accounts are not the same as the financial statement amounts.
 *Completed worksheets are not a substitute for focal financial statements.
 *Worksheet is essentially a working tool of the accountant Preparing Adjusting Entries from a Worksheet
 C. *A worksheet is not a journal, and it cannot be used as a basis for posting to ledger accounts.
 -To adjust the accounts, the company must journalize the adjustments and post them to the ledger. 
 *Adjusting entries are prepared form the adjustments columns of the worksheet.
 -Use reference letters in the adjustments columns and the explanations of the adjustments at the bottom of the worksheet to help identify the adjusting entries
 -Journalizing and posting of adjusting entries follow the preparation of financial statements when a worksheet is used. 
 LO2. Prepare closing entires and a post-closing trial balance
 Closing the Books - at the end of the accounting period, when the company makes accounts ready for the next period. Company distinguishes between temporary and permanent accounts.
 Temporary Accounts - relate only to a given accounting period, such as all income statement accounts and the Dividends account
 3 Sunday, September 25, 2016 *The company closes all temporary accounts at the end of the period.
 Permanent Accounts - relate to one or more future accounting periods, such as all balance sheet accounts and stockholders’ equity.
 *Permanent accounts are not closed from period to period, carries over the balances into next accounting period.
 Alternative Terminology: 
 Temporary Accounts - nominal accounts
 Permanent account - real accounts D. Preparing Closing Entries
 Closing Entries - formally recognize in the ledger the transfer of net income (or net loss) and Dividends to Retained Earnings. The retained earnings statement shows the results of these entries.
 *Closing entries also produce a zero balance in each temporary account to separate and be ready to accumulate data for next accounting period.
 *Journalizing an posting closing entries is a required step in the accounting cycle after preparing financial statements.
 *Journalizing and posting closing entries generally happen only at the end of the annual accounting period. (All temp accounts will contain data for the entire year)
 Income Summary - temporary account for closing revenue and expense 4 Sunday, September 25, 2016 accounts used to transfer the resulting net income or net loss to Retained Earnings.
 *Companies record closing entries in the general journal
 -A center caption, Closing Entries, inserted in the journal between the last adjusting entry and the first closing entry, identifies these entries. Then the company posts the closing entries to the ledger accounts.
 The four following entries are most efficient in preparing closing entries after adjusting balances in the ledger:
 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.
 3) Debit Income Summary and credit Retained Earnings for the amount of net income.
 4) Debit Retained Earnings for the balance in the Dividends account, and credit Dividends for the same amount.
 5 Sunday, September 25, 2016 *If there was a net loss, entry 3 would be reversed: there would be a credit to Income Summary and a debit to Retained Earnings.
 Helpful Hint: Dividends account is closed directly to Retained Earnings, NOT to Income Summary because dividends are not an expense. 1. Closing Entries Illustrated
 -Amounts for Income Summary are the totals of the income statement credit and debit columns, respectively, in the worksheet.
 -Avoid unintentionally doubling the revenue and expense balances rather than zeroing them
 -Do not close Dividends through the Income Summary account. *Dividends are not an expense, and they are not a factor in determining net income. E. 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. This balance is shown on the balance sheet and is the ending amount reported on the retained earnings statement.
 -As part of the closing process, total balance and double-underline all temporary accounts — revenues, expenses and Dividends in the T-account form. 
 -Do not close permeant accounts — assets, liabilities and stockholders’ equity (Common Stock and Retained Earnings). Draw a single underline beneath the current-period entries for the permanent accounts. The account balance should be entered below the single underline and carried forward to the next period.
 Helpful Hint: The balance in Income Summary before it is closed must equal the net income or net loss for the period. F. Preparing a Post-Closing Trial Balance
 Post-Closing Trial Balance - A list of permanent accounts and their balances after a company has journalized and posted all closing entries from the ledger.
 -The purpose of the post-closing trial balance is to prove the equality of the permanent account balance carried forward into the next accounting period.
 *Post-closing trial balance will contain only permanent —balance sheet— accounts.
 6 Sunday, September 25, 2016 Post-closing trial balance:
 -provides evidence that the company has properly journalized and posted the closing entries
 -accounting equation is in balance at end of accounting period
 -DOES NOT prove that all transactions have been recorded or that ledger is correct.
 LO3. Explain the steps in the accounting cycle and how to prepare correcting entries. G. Summary of the Accounting Cycle
 7 Sunday, September 25, 2016 
 Steps 1-3 may occur daily during accounting period
 Steps 4-7 are performed by companies on a periodic basis, such as monthly, quarterly, or annually.
 Steps 8-9 usually take place only at the end of the company’s annual accounting period.
 There are also two optional steps in the accounting cycle— reversing entries.
 H. Reversing Entries— An Optional Step
 Reversing Entry - An entry made at the beginning of the next accounting period that is the exact opposite of the adjusting entry made in the previous period. 
 *Use of reversing entries is an optional bookkeeping procedure; it is not a required step in the accounting cycle. I. Correcting Entries— An Avoidable Step
 -Companies should correct errors as soon as they discover them by journalizing and posting correcting entries.
 Correcting Entries - Entries made to correct errors made in recording transactions.
 Adjusting Entries VS Correcting Entries Integral part of accounting cycle Unnecessary records are error-free Journalize and post adjustments only at the end Posted whenever they discover an error of an accounting period Affects at least one balance sheet account and May involve any combination of accounts in need one income statement account of correction. Correcting entries must be posted before closing entries. 
 To determine correcting entry:
 -Compare the incorrect entry with the correct entry to identify accounts and amounts that should/should not be corrected.
 -Make an entry to correct accounts. 1. Case 1
 -Journalized and posted $50 cash collect on account as debit to Cash and credit to Service Revenue.
 8 Sunday, September 25, 2016 -To correct this entry, compare accounts and adjust: debit to Service Revenue and credit to Accounts receivable. 2. Case 2
 -Purchased on account equipment costing $450. Transaction was journalized and posted as a debit to Equipment $45 and credit to Accounts Payable $45.
 -To correct this entry, compare accounts and adjust: 450 - 45 = 405, so debit 405 to Equipment and credit 405 to Accounts Payable.
 *Instead of preparing a correcting entry, it is possible to reverse the incorrect entry and then prepare the correct entry. This approach will result in more entries and posting than a correcting entry but produce the same result.
 LO4. Identify the sections of a classified balance sheet.
 Classified Balance Sheet - A balance sheet that groups together similar assets and similar liabilities, using a number of standard classifications and sections. J. Current Assets
 Current Assets - Assets that a company expects to convert to cash or use up within one year or its operating cycle, whichever is longer.
 Operating Cycle - average time for a company to purchase inventory, sell it on accounts, and then collect cash from customers. 
 *Except where noted, we will assume that companies use one year to determine whether an asset or liability is current or long-term.
 Common types of current assets are:
 1) Cash
 9 Sunday, September 25, 2016 2) Investments
 3) Receivable (notes receivable, accounts receivable and interest receivable)
 4) Inventories
 5) Prepaid Expenses (Supplies and insurance)
 *On the balance sheet, companies usually list these items in the order in which they expect to convert them into cash. K. Long-Term Investments
 Long-Term Investments - Generally, (1) investments in stocks and bonds of other companies that are normally held for many years, (2) long-term assets such as land or buildings that a company is not currently using in its operating activities, and (3) long-term notes receivable. 
 Alternative Terminology: Long-term investments are often referred to simply as investments. Property, Plant, and Equipment
 L. Property, Plant and Equipment - Assets with relatively long useful lives that a company is currently using in operating the business such as land, buildings, machinery and equipment, delivery equipment, and furniture. 
 Deprecation - the practice of allocating the cost of assets to a number of years by systematically assigning a portion of an asset’s cost as an expense each year (Rather than expensing the full purchase price in the year of purchase). 
 Accumulated Depreciation - shows the total amount of depreciation that the company has expensed thus far in the asset’s life.
 Alternative Terminology: Sometimes called fixed assets or plant assets. M. Intangible Assets
 Intangible Assets - long-lived assets that do not have physical substance yet often are very valuable such as goodwill, patents, copyrights, and trademarks or trade names that give the company exclusive right of use for a specified period of time.
 Helpful Hint: Sometimes reported under a broader heading called “Other Assets” N. Current Liabilities
 Current Liabilities - obligations that the company is to pay within the coming year or its operating cycle, whichever is longer.
 -Found in the liabilities and stockholders’ equity section of the balance sheet, the 10 Sunday, September 25, 2016 first grouping
 -Examples: accounts payable, salaries and wages payable, notes payable, interest payable, and income taxes payable and current maturities of long-term obligations
 -Liquidity - the ability to pay obligations expected to be due within the next year, the relationship between current assets and current liabilities.
 -When current assets exceed current liabilities, the likelihood for paying the liabilities is favorable. 
 -When the reverse is true, short-term creditors may not be paid, and the company may ultimately be forced into bankruptcy. O. Long-Term Liabilities
 Long-Term Liabilities - obligations that a company expects to pay after one year.
 -Examples: bonds payable, mortgages payable, long-term notes payable, lease liabilities, and pension liabilities. 
 -Many companies report long-term debt maturing after one year as as single amount in the balance sheet and show the details of the debt in notes that accompany the financial statements. Others list the various types. P. Stockholders’ (Owners’) Equity
 Content of owners’ equity section varies with form of business organization:
 Proprietorship— one capital account
 Partnership — capital account for each partner
 Corporation — divide owners’ equity into two account: Common Stock (or Capital Stock) and Retained Earnings.
 -record stockholders’ investments in the company by debiting an asset account and crediting the Common Stock account.
 -record in the Retained Earnings account income retained for use in business
 -Combine the Common Stock and Retained Earnings accounts and report them on the balance sheet as stockholders’ equity. LO5. APPENDIX 4A: Prepare Reversing Entries.
 Reversing Entries - after preparing the financial statements and closing the books, the reversal of some adjusting entries before recording the regular transactions of the next period.
 11 Sunday, September 25, 2016 *Companies make a reversing entry at the beginning of the next accounting period
 *Each reversing entry is the exact opposite of the adjusting entry made in the previous period
 *Recording of reversing entries is an optional step in the accounting cycle.
 *The use of reversing entries does not change the amount reported in the financial statements. Q. Reversing Entries Example
 -Two most common types of reversed adjusting entries: Accrued revenues and accrued expenses.
 Reversing vs. Not Reversing
 -October 26 (initial salary entry): Pioneer pays $4,000 of salaries and wages earned between October 15 and October 26.
 -October 31 (adjusting entry): Salaries and wages earned between October 29 and October 31 are $1,200. The company will pay these in the November 9 payroll.
 -November 9 (subsequent salary entry): Salaries and wages paid are $4,000. Of this amount, $1,200 applied to accrued salaries and wages payable and $2,800 12 Sunday, September 25, 2016 was earned between November 1 and November 9.
 -First three entries are the same. 
 -Last two entries are different:
 Nov 1 reversing entry eliminates the $1200 balance in Salaries and Wages Payable and credits $1200 to Salaries and Wages Expense. This way, the company can make the same entry each time/debit Salaries and Wages Expense for a consistent amount month-to-month without worrying about the accrued balance when pay periods overlap into a new accounting period. 13


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