Chapter 4

COMPLETING THE ACCOUNTING CYCLE

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CHAPTER LEARNING OBJECTIVES

After studying this chapter, you should be able to:

  1. Prepare a worksheet.

  2. Explain the process of closing the books.

  3. Describe the content and purpose of a post-closing trial balance.

  4. State the required steps in the accounting cycle.

  5. Explain the approaches to preparing correcting entries.

  6. Identify the sections of a classified balance sheet.

*7. Prepare reversing entries.

*8. Compare the procedures for the closing process under GAAP and IFRS.

*Note: All asterisked (*) items relate to material contained in the Appendix to the chapter.

PREVIEW OF CHAPTER 4

In this chapter we will explain the role of the worksheet in accounting as well as the remaining steps in the accounting cycle, most especially, the closing process. Then we will consider (1) correcting entries and (2) classified balance sheets. The organization and content of the chapter are as follows:

CHAPTER REVIEW

Preparing a Worksheet

1. (L.O. 1) The steps in preparing a worksheet are:
   1. Prepare a trial balance on the worksheet.
   2. Enter the adjustments in the adjustments columns.
   3. Enter adjusted balances in the adjusted trial balance columns.
   4. Extend adjusted trial balance amounts to appropriate financial statement columns.
   5. Total the statement columns, compute the net income (or loss), and complete the worksheet.
2. A worksheet is a multiple-column form that may be used in the adjustment process and in preparing financial statements. The basic form of a worksheet consists of the following columns:

   

3. For each account in the worksheet, the amount in the adjusted trial balance columns is equal to the account balance that will appear in the ledger after the adjusting entries have been journalized and posted.
4. After the worksheet has been completed the statement columns contain all data that are required for the preparation of financial statements. The income statement is prepared from the income statement columns, and the owner's equity statement and balance sheet are prepared from the balance sheet columns.
5. Using a worksheet accountants can prepare financial statements before adjusting entries are journalized and posted.
6. A worksheet is not a journal and it cannot be used as a basis for posting to ledger accounts.

Closing Entries

7. (L.O. 2) Closing entries formally recognize in the ledger the transfer of net income (or loss) and owner's drawings to owner's capital as shown in the owner's equity statement.

8. Journalizing and posting closing entries is a required step in the accounting cycle.

9. The drawing, revenue, and expense accounts are temporary (nominal) accounts. Asset accounts, liability accounts, and the owner's capital account are permanent (real) accounts.

10. A temporary account, Income Summary, is used in closing revenue and expense accounts to minimize the amount of detail in the permanent owner's capital account.

11. In closing the books of a proprietorship:

a. Debit each revenue account for its balance, and credit Income Summary for total revenues.

b. Debit Income Summary for total expenses, and credit each expense account for its balance.

c. Debit Income Summary, and credit Owner's Capital for the amount of net income; conversely, credit Income Summary and debit Owner's Capital if a net loss exists.

d. Debit Owner's Capital for the balance in the Owner's Drawing account and credit Owner's Drawing for the same amount.

Post-Closing Trial Balance

12. (L.O. 3) After all closing entries have been journalized and posted, a post-closing trial balance is prepared. The purpose of this trial balance is to prove the equality of the permanent account balances that are carried forward into the next accounting period.

Steps in the Accounting Cycle

13. (L.O. 4) The required steps in the accounting cycle are:

a. Analyze business transactions.

b. Journalize the transactions.

c. Post to ledger accounts.

d. Prepare a trial balance.

e. Journalize and post adjusting entries: Prepayments/Accruals.

f. Prepare an adjusted trial balance.

g. Prepare financial statements: Income statement, Owner's equity statement, Balance sheet.

h. Journalize and post closing entries.

i. Prepare a post-closing trial balance.

14. A reversing entry is the exact opposite of an adjusting entry. The preparation of reversing entries is an optional bookkeeping procedure that is not a required step in the accounting cycle.

Correcting Entries

15. (L.O. 5) Errors that occur in recording transactions should be corrected as soon as they are discovered by preparing correcting entries. Correcting entries:

a. are unnecessary if the records are free of errors.

b. are journalized and posted whenever an error is discovered.

c. may involve any combination of balance sheet and income statement accounts.

16. To determine the correcting entry, it is useful to compare the incorrect entry with the correct entry, and then make a correcting entry. Another approach is to reverse the incorrect entry and then prepare the correct entry.

Classified Balance Sheet

17. (L.O. 6) Financial statements become more useful when the elements are classified into significant subgroups. A classified balance sheet generally has the following standard classifications:

Assets

18. Current assets are assets that a company expects to convert to cash or use up within one year. Current assets are listed in the order of their liquidity.

19. The operating cycle of a company is the average time that it takes to purchase inventory, sell it on account, and then collect cash from customers.

20. Long-term investments are generally investments in stocks and bonds of other companies that are normally held for many years.

21. Property, plant, and equipment are assets with relatively long useful lives that a company is currently using in operating the business.

22. Intangible assets do not have physical substance yet often are very valuable.

Liabilities

23. Current liabilities are obligations that the company is to pay within the coming year.

24. Long-term liabilities are obligations that a company expects to pay after one year.

Owner's Equity

25. The content of the owner's equity section varies with the form of business organization. In a proprietorship, there is one capital account. In a partnership, there are separate capital accounts for each partner. For a corporation, owners' equity is called stockholders' equity and it consists of two accounts: Capital Stock and Retained Earnings.

Form of Balance Sheet

26. A balance sheet is most often presented in report form with the assets shown above the liabilities and owner's equity. It may also be presented in account form with the assets section placed on the left and the liabilities and owner's equity section on the right.

Reversing Entries

*27. (L.O. 7) A reversing entry is made at the beginning of the next accounting period. The purpose of reversing entries is to simplify the recording of a subsequent transaction related to an adjusting entry.

*28. Reversing entries are most often used to reverse two types of adjusting entries: accrued revenues and accrued expenses.

A Look at IFRS

*29. (L.O. 8) The procedures of the closing process are applicable to all companies, whether they are using IFRS or GAAP.

*30. IFRS recommends but does not require the use of the title “statement of financial position” rather than balance sheet.

*31. Most companies that follow IFRS present statement of financial position information in this order.

• Noncurrent assets

• Current assets

• Equity

• Noncurrent liabilities

• Current liabilities

*32. Under IFRS, current assets are usually listed in the reverse order of liquidity. Under IFRS cash is listed last.

*33. Some companies report the subtotal net assets, which equals total assets minus total liabilities.

*34. Both GAAP and IFRS are increasing the use of fair value to report assets. However, at this point IFRS has adopted it more broadly (e.g. fair value can be applied to property, plant and equipment; natural resources; and in some cases intangible assets).

(b)

REVIEW QUESTIONS AND EXERCISES

TRUE—FALSE

Indicate whether each of the following is true (T) or false (F) in the space provided.

_____ 1.	(L.O. 1) A worksheet is not a permanent accounting record.
_____ 2.	(L.O. 1) If total debits exceed total credits in the income statement columns on a worksheet, net income has resulted.
_____ 3.	(L.O. 1) After a worksheet has been completed, the statement columns contain all data that are required for the preparation of financial statements.
_____ 4.	(L.O. 1) A worksheet is not a journal, but it can be used as a basis for posting to ledger accounts.
_____ 5.	(L.O. 2) All balance sheet accounts are considered to be permanent or real accounts.
_____ 6.	(L.O. 2) After the closing entries are posted, all nominal accounts will have zero balances.
_____ 7.	(L.O. 2) The journalizing and posting of closing entries is a required step in the accounting cycle.
_____ 8.	(L.O. 2) To close net income to owner's capital, Income Summary is debited and Owner's Capital is credited.
_____ 9.	(L.O. 2) Revenue accounts are closed by debiting the individual revenue accounts and crediting Income Summary for total revenues.
_____ 10.	(L.O. 2) In one closing entry, Owner's Drawing is credited and Income Summary is debited.
_____ 11.	(L.O. 2) Income Summary is used in preparing both adjusting and closing entries.
_____ 12.	(L.O. 3) The post-closing trial balance will contain only owner's equity statement accounts and balance sheet accounts.
_____ 13.	(L.O. 3) The preparation of reversing entries is an optional step in the accounting cycle.
_____ 14.	(L.O. 5) Correcting entries are only made at the end of an accounting period.
_____ 15.	(L.O. 6) The operating cycle of a company is the average time required to collect the receivables resulting from producing revenues.
_____ 16.	(L.O. 6) Current assets are listed in the order of liquidity.
_____ 17.	(L.O. 6) Long-term investments are generally investments in stocks and bonds of other companies that are normally held for many years.
_____ 18.	(L.O. 6) Property, plant, and equipment are tangible assets that are reported at market value in the balance sheet.
_____ 19.	(L.O. 6) Current liabilities are obligations that the company is to pay within the coming year.
_____ 20.	(L.O. 6) The relationship of current assets and current liabilities is important in evaluating a company's liquidity.

MULTIPLE CHOICE

Circle the letter that best answers each of the following statements.

1. (L.O. 1) The following is not a column heading in a worksheet:
   1. Trial Balance.
   2. Income Statement.
   3. Post-Closing Trial Balance.
   4. Adjusted Trial Balance.
2. (L.O. 1) The steps in the preparation of a worksheet do not include:
   1. analyzing documentary evidence.
   2. preparing a trial balance on the worksheet.
   3. entering the adjustments in the adjustment columns.
   4. entering adjusted balances in the adjusted trial balance columns.
3. (L.O. 1) Which of the following account balances is extended to the income statement columns on a worksheet?
   1. Prepaid Insurance.
   2. Unearned Revenue.
   3. Depreciation Expense.
   4. Accumulated Depreciation.
4. (L.O. 1) The worksheet is:
   1. used as a basis for posting to the ledger accounts.
   2. never computerized.
   3. part of the ledger.
   4. essentially a working tool of the accountant.
5. (L.O. 2) Balance sheet accounts are considered to be:
   1. temporary owner's equity accounts.
   2. permanent accounts.
   3. retained earnings accounts.
   4. nominal accounts.
6. (L.O. 2) The owner's drawing account is a(n):
   1. expense account.
   2. revenue account.
   3. permanent account.
   4. temporary account.
7. (L.O. 2) Income Summary has a credit balance of $12,000 in J. Spencer, Co. after closing revenues and expenses. The entry to close Income Summary is:
   1. credit Income Summary $12,000, debit Owner's, Capital $12,000.
   2. credit Income Summary $12,000, debit Owner's, Drawing $12,000.
   3. debit Income Summary $12,000, credit Owner's, Drawing $12,000.
   4. debit Income Summary $12,000, credit Owner's, Capital $12,000.
8. (L.O. 3) The account that will appear on the post-closing trial balance is:
   1. Fees Earned.
   2. Accumulated Depreciation.
   3. Depreciation Expense.
   4. Drawing.
9. (L.O. 3) The number of accounts appearing in the trial balance will normally be:
   1. less than the number of accounts in the post-closing trial balance.
   2. equal to the number of accounts in the adjusted trial balance.
   3. more than the number of accounts in the post-closing trial balance.
   4. more than the number of accounts in the adjusted trial balance.
10. (L.O. 3) The post-closing trial balance contains only:
    1. income statement accounts.
    2. balance sheet accounts.
    3. balance sheet and income statement accounts.
    4. income statement, balance sheet, and owner's equity statement accounts.
11. (L.O. 4) One of the following statements concerning the accounting cycle is incorrect. The incorrect statement is:
    1. The accounting cycle includes journalizing transactions and posting to ledger accounts.
    2. The accounting cycle includes only one optional step.
    3. The steps in the accounting cycle are performed in sequence.
    4. The steps in the accounting cycle are repeated in each accounting period.
12. (L.O. 5) On September 23, the Polar Company received a $350 check from Mike Moluf for services to be performed in the future. The bookkeeper for Polar Company incorrectly debited Cash for $350 and credited Accounts Receivable for $350. The amounts have been posted to the ledger. To correct this entry, the bookkeeper should:
    1. debit Cash $350 and credit Unearned Fees $350.
    2. debit Accounts Receivable $350 and credit Unearned Fees $350.
    3. debit Accounts Receivable $350 and credit Cash $350.
    4. debit Accounts Receivable $350 and credit Fees Earned $350.
13. (L.O. 5) On June 19, the Pinkowski Company bought office supplies on account from the Ewell Company for $550. Pinkowski Company incorrectly debited Office Equipment for $500 and credited Accounts Payable for $500. The entries have been posted to the ledger. The correcting entry should be:

    

14. (L.O. 6) Which of the following accounts is not classified under the current asset section of the balance sheet?
    1. Prepaid Expenses.
    2. Supplies.
    3. Equipment.
    4. Cash.
15. (L.O. 6) One of the following statements about current assets is correct. The correct statement is:
    1. The time period for current assets is within one year after the balance sheet date or the company's operating cycle, whichever is longer.
    2. The time period for current assets is within one year after the balance sheet date or the company's operating cycle, whichever is shorter.
    3. The operating cycle is the average time to collect accounts receivable in the process of earning revenue.
    4. Current assets are listed in the balance sheet in the order of magnitude.
16. (L.O. 6) Long-term investments are:
    1. reported in the balance sheet after property, plant, and equipment.
    2. resources that are not expected to be realized in cash within one year or operating cycle, whichever is longer.
    3. resources that are intended for use or consumption.
    4. resources that may include rights and privileges granted by governmental authority.
17. (L.O. 6) Which of the following statements is incorrect? Property, plant and equipment:
    1. are assets with relatively long useful lives that a company is currently using in business.
    2. is reported in the balance sheet at cost less accumulated depreciation.
    3. includes long-lived, non-physical resources such as patents and copyrights.
    4. includes land, buildings, equipment, and machinery.
18. (L.O. 6) Current liabilities:
    1. must reasonably be expected to be paid from existing current assets or through the creation of other current liabilities.
    2. are listed in the balance sheet in order of their expected maturity.
    3. must reasonably be expected to be paid within one year or the operating cycle, whichever is shorter.
    4. should not include long-term debt that is expected to be paid within the next year.

*19. (L.O. 7) Malikowski Company had accrued salaries between September 15 and September 30 of $6,000 that will be paid on October 5. The appropriate adjusting entry was made at the year end, September 30. If a reversing entry is made on October 1, the entry would be:

a. debit Salaries and Wages Payable $6,000 and credit Salaries and Wages Expense $6,000.

b. credit Salaries and Wages Payable $6,000 and debit Salaries and Wages Expense $6,000.

c. debit Salaries and Wages Payable $6,000 and credit Income Summary $6,000.

d. credit Salaries and Wages Payable $6,000 and debit Income Summary $6,000.

*20. (L.O. 7) On November 1, 2014, Nilsson Company issued a $12,000, 10% three-month note payable to Barshinger Bank. At the year end, Nilsson made the appropriate adjusting and reversing entries. On February 1, 2015, Nilsson paid Barshinger Bank the amount of the note payable plus the appropriate interest. The entry on February 1, 2015 is:

MATCHING

Match each term with its definition by writing the appropriate letter in the space provided.

EXERCISES

EX. 4-1 (L.O. 1, 2, and 3) King Oliver began Jazz Company on January 1, 2014. At December 31, 2014, the company had the following adjustment data.

1. Inventory clerk, Count Basie, determined that $4,000 of supplies were on hand.
2. The insurance was obtained through the Dizzy Gillespie Insurance Agency; during the year $3,000 of the insurance had expired.
3. The equipment was purchased from Miles Davis on January 1, 2014 and it is depreciated at a rate of $1,000 per year.
4. Unearned fees of $450 were earned as a result of the Duke Ellington concert on December 4.
5. Fees earned from the Ella Fitzgerald performance on December 31 totaling $2,250 have not been billed.
6. The note payable was a loan from Louis Armstrong; interest of $300 has accrued at December 31.
7. A salary of $850 earned by Jimmy Dorsey in December has not been recorded or paid.

Instructions

(a) Enter the adjustments in the adjustment columns of the worksheet that follows and complete the worksheet (use 10-column paper).

(b) Prepare the closing entries at December 31.

(c) Prepare a post-closing trial balance at December 31.

(a)

(b)

(c)

SOLUTIONS TO REVIEW QUESTIONS AND EXERCISES

TRUE-FALSE

1. (T)
2. (F)	If total debits exceed total credits, a net loss has occurred.
3. (T)
4. (F)	Since a worksheet is not a journal, it cannot be used as a basis for posting to ledger accounts.
5. (T)
6. (T)
7. (T)
8. (T)
9. (T)
10. (F)	Owner's Drawing is credited and Owner's Capital is debited.
11. (F)	Income Summary is only used in preparing closing entries.
12. (F)	The post-closing trial balance will contain only balance sheet accounts.
13. (T)
14. (F)	Correcting entries are made whenever an error is discovered.
15. (F)	The operating cycle is the average time that it takes to purchase inventory, sell it on account, and then collect cash from customers.
16. (T)
17. (T)
18. (F)	Property, plant, and equipment are reported at cost less accumulated depreciation.
19. (T)
20. (T)

MULTIPLE CHOICE

1. (c)	The trial balance (a), income statement (b), and adjusted trial balance (d), are all columns on the worksheet. A post-closing trial balance is not presented on the worksheet.
2. (a)	The preparation of a worksheet involves the following steps: Prepare a trial balance on the worksheet. Enter the adjustments in the adjustment columns. Enter adjusted balances in the adjusted trial balance columns. Extend adjusted trial balance amounts to appropriate financial statement columns. Total the statement columns, compute the net income (or loss), and complete the worksheet.
3. (c)	Prepaid Insurance (a), Unearned Revenue (b), and Accumulated Depreciation (d) are all account balances that are extended to the balance sheet columns. Depreciation Expense is transferred to the income statement columns.
4. (d)	The worksheet is not used as a basis for posting to the ledger. The worksheet is frequently computerized using a spreadsheet software program (like Lotus 1-2-3). The worksheet is not part of the ledger.
5. (b)	The drawing, revenue, and expense accounts are considered to be temporary owner's equity accounts (a) or nominal accounts (d). At the end of an accounting period, these accounts are transferred to the capital account. Not all balance sheet accounts are capital accounts (c), but all are permanent accounts.
6. (d)	The drawing account is not an expense account (a) or a revenue account (b). It is also not a permanent account (c) because it is transferred to the capital account.
7. (d)	A credit balance in Income Summary indicates the company has earned net income. The closing entry results in a debit to Income Summary and a credit to the owner's capital account.
8. (b)	Fees Earned, Depreciation Expense, and Drawing are temporary accounts that are closed annually.
9. (c)	The post-closing trial balance would have the least number of accounts because it would only have the real accounts. The trial balance would have both the real and nominal accounts. The adjusted trial balance would probably have more accounts than the trial balance, because it would have the same real and nominal accounts plus any new accounts resulting from any adjustments.
10. (b)	The post-closing trial balance contains only balance sheet accounts because income statement accounts are nominal accounts and are closed out.
11. (b)	The accounting cycle contains two optional steps: (1) use of a worksheet and (2) preparing reversing entries. Each of the other statements about the accounting cycle is true.
12. (b)	The correct entry in this case was Cash (Dr) $350 and Unearned Fees (Cr) $350. A comparison with the incorrect entry shows that both Accounts Receivable and Unearned Fees are understated by $350. The correcting entry, therefore, is (b).
13. (d)	The error has caused three accounts to be incorrect. Office Equipment is overstated by $500. Office Supplies is understated by $550, and Accounts Payable is understated by $50. The correcting entry is therefore (d).
14. (c)	Prepaid Expenses, Supplies, and Cash are current assets. Equipment would be classified as Property, Plant, and Equipment.
15. (a)	The time period for current assets is within one year or the operating cycle, whichever is longer, not shorter as in (b). Choice (c) is incorrect because the operating cycle is the average time to go from cash to cash in producing revenues. Choice (d) is incorrect because current assets are listed in order of liquidity.
16. (b)	Long-term investments are not expected to be realized in cash within the next year or operating cycle, whichever is longer. Choice (a) is incorrect because long-term investments are reported between current assets and property, plant, and equipment. Choice (c) is incorrect because long-term investments are not expected to be used or consumed. Choice (d) is a correct statement for intangible assets.
17. (c)	Long-lived, non-physical resources are intangible assets. Each of the other statements is true.
18. (a)	This answer choice correctly states the expected source of payment. Choice (b) is incorrect because current liabilities are not listed in order of maturity. Choice (c) is incorrect because the time period is one year or the operating cycle, whichever is longer. Choice (d) is incorrect because current maturities of long-term debt should be reported under current liabilities.
*19. (a)	First, the adjusting entry should be determined. For this transaction the following adjusting entry would be made:
*20. (b)	On December, 31, 2014 an adjusting entry was made to accrue $200 ($12,000 X 10% X 2/12) of interest by debiting Interest Expense for $200 and crediting Interest Payable for $200. By reversing the entry after the closing entries are made, the balance in the Interest Payable account will be zero, and Interest Expense will have a credit balance of $200. Therefore, by making the entry in (b), which includes a debit to Interest Expense of $300, the correct amount of interest, $100 ($300 - $200) for January will be shown in Interest Expense.

MATCHING

1. h
2. i
3. l
4. j
5. o
6. n
7. d
8. k
9. m
10. b
11. c
12. f
13. g
14. a
15. e

EXERCISES

EX. 4-1

(a)

(b)

(c)