Accounting

Principles

Second Canadian Edition

Weygandt Kieso Kimmel Trenholm

Prepared by:

Carole Bowman, Sheridan College

CHAPTER

4
COMPLETION OF THE
ACCOUNTING CYCLE

WORK SHEET
A work sheet is a multiple-column form

that may be used in the adjustment

process and in preparing financial
statements.
It is a working tool or a supplementary
device for the accountant and not a
permanent accounting record.
Use of a work sheet should make
the preparation of adjusting entries
and financial statements easier.

ILLUSTRATION 4-1

WORK SHEET
Account Titles

Trial Balance
Debit
Credit

1. Prepare
trial balance
on the
worksheet.

Adjustments
Debit
Credit

2. Enter
adjustment
data.

Adjusted Trial Balance

Debit
Credit

3. Enter
adjusted
balances

Income Statement
Debit
Credit

Balance Sheet
Debit
Credit

4. Extend adjusted
balance to appropriate
columns.
5. Calculate income/loss
and complete the
worksheet.

PURPOSE OF CLOSING ENTRIES

1. Updates the owners capital account in
the ledger by transferring net income
(loss) and owners drawings to owners
capital.
2. Prepares the temporary accounts
(revenue, expense, drawings) for the next
periods postings by reducing their
balances to zero.

ILLUSTRATION 4-2

TEMPORARY VS. PERMANENT

ACCOUNTS
TEMPORARY (NOMINAL)
These accounts are closed

PERMANENT (REAL)

These accounts are not closed

All revenue accounts

All asset accounts

All expense accounts

All liability accounts

Owners drawings

(Income Statement /
Drawings Accounts)

Owners capital account

(Balance Sheet Accounts)

ILLUSTRATION 4-3

DIAGRAM OF CLOSING PROCESS

(INDIVIDUAL)
REVENUES

(INDIVIDUAL)
EXPENSES

Normal Dr.
Balance
-0-

Cr. to close

Dr. to close

Normal Cr.
Balance
-0-

1
OWNERS
CAPITAL

Expenses

Opening Balance
Revenues

1 Debit each revenue account for its balance, and credit the owners
capital account for total revenues.
2 Debit the owners capital account for total expenses, and credit
each expense account for its balance.

ILLUSTRATION 4-3

DIAGRAM OF CLOSING PROCESS

OWNERS
CAPITAL

Expenses
Drawings

Opening Balance
Revenues
Ending Balance

3
OWNERS
DRAWINGS

Normal Dr.
Balance

Cr. to close

-0-

3 Debit owners capital for the balance in the owners drawings

account and credit owners drawings for the same amount.

CLOSING ENTRIES
STOP AND CHECK
1. Does the balance in your Owners
Capital account equal the ending
capital balance reported in the
Balance Sheet and Statement of
Owners Equity?
2. Are all of your temporary account
balances zero?

POST-CLOSING TRIAL BALANCE

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 (balance

sheet) account balances that are carried
forward into the next accounting period.

ILLUSTRATION 4-8

POST-CLOSING TRIAL BALANCE

Pioneer Advertising Agency
Post-Closing Trial Balance
October 31, 2002
After Adjustment
Debit
Credit
Cash
The post-closing trial $ 15,200
Accounts Receivable
200
balance is prepared
Advertising Supplies
1,000
from the permanent
Prepaid Insurance
550
accounts in the ledger.
Office Equipment
5,000
Accumulated Amortization
$
83
Notes Payable
5,000
The post-closing trial
Accounts Payable
2,500
balance provides evidence
Unearned Revenue
800
that the journalizing and
Salaries Payable
1,200
posting of closing entries has
Interest Payable
25
been properly completed.
C.R. Byrd, Capital
12,342
$ 21,950
$ 21,950

STEPS IN THE ACCOUNTING CYCLE

9. Prepare
post-closing
trial balance

1. Analyse
transactions

3. Post to ledger
accounts

8. Journalize
and post
closing entries
7. Prepare
financial
statements

2. Journalize the
transactions

4. Prepare a
trial balance

6. Prepare
adjusted trial
balance

5. Journalize
and post
adjusting
entries

REVERSING ENTRIES
(OPTIONAL STEP)
A reversing entry is made at the beginning

of the next accounting period.

A reversing entry reverses certain adjusting
entries made in the previous period.
Opening balances can then be ignored when
preparing year-end adjusting entries.
This topic is illustrated in Appendix 4A.

CORRECTING ENTRIES
Errors that occur in recording transactions

should be corrected as soon as they are

discovered by preparing correcting entries.
Correcting entries are unnecessary if the
records are free of errors; they can be
journalized and posted whenever an error is
discovered.
They involve any combination of balance
sheet and income statement accounts.

ILLUSTRATION 4-10

STANDARD BALANCE SHEET

CLASSIFICATIONS
Financial statements become more useful when the

elements are classified into significant subgroups.

A classified balance sheet generally has the following
standard classifications:
Assets
Current Assets
Long-Term Investments
Capital Assets

Liabilities and Equity

Current Liabilities
Long-Term Liabilities
Owners/ Partners/ Shareholders Equity

CURRENT ASSETS
Current assets are cash and other resources

that are reasonably expected to be realized

in cash or sold or consumed in the business
within one year of the balance sheet date
or the companys operating cycle,
whichever is longer.
Listed in the order of liquidity.
Examples of current assets are cash,
temporary investments, accounts
receivable, inventory, and prepaids.

LONG-TERM INVESTMENTS
Long-term investments are resources that

can be realized in cash, but the conversion

into cash is not expected within one year or
the operating cycle, whichever is longer.
Examples include investments in shares or
bonds of another company or investment in
land held for resale.
100
XYZ shares

CAPITAL ASSETS
Tangible resources of a relatively permanent

nature that are used in the business and not

intended for sale are classified as (1) property,
plant, and equipment and (2) natural resources.
(1) Examples of property, plant, and equipment include land,
buildings, and machinery.
(2) Examples of natural resources include tracts of timber, oil
and gas reserves, and mineral deposits.

CAPITAL ASSETS
Intangible assets are noncurrent resources

that do not have physical substance.

Examples include patents, copyrights,
trademarks, or trade names that give the
holder exclusive right of use for
a specified period of time.

CURRENT LIABILITIES
Current liabilities are obligations that are

reasonably expected to be paid from existing

current assets or through the creation of
other current liabilities within one year or the
operating cycle, whichever is longer.
Examples include accounts payable, unearned
revenue, interest payable, and current
maturities of long-term debt.

LONG-TERM LIABILITIES
Obligations expected to be paid after one

year are classified as long-term liabilities.

Examples include long-term notes payable,
bonds payable, mortgages payable, and lease
liabilities.

EQUITY
The content of the equity section varies with the

form of business organization.

In a proprietorship, there is a single owners
equity account called (Owners Name), Capital.
In a partnership, there are separate capital
accounts for each partner.
For a corporation, owners equity is called
shareholders equity, and it consists of two
accounts: Share Capital and Retained Earnings.

ILLUSTRATION 4-17
CLASSIFIED BALANCE SHEET IN REPORT FORM
Pioneer Advertising Agency
Balance Sheet
October 31, 2002
Assets
Current Assets
Cash
Accounts Receivable
Advertising Supplies
Prepaid Insurance
Total Current Assets
Capital Assets
Office Equipment
Less: Accumulated Amortization
Total Assets

5,000
83
$

15,200
200
1,000
550
16,950

4,917
21,867

Liabilities and Owner's Equity

Current Liabilities
Notes Payable
Accounts Payable
Unearned Revenue
Salaries Payable
Interest Payable
Total Current Liabilities
Long-term Liabilties
Notes Payable
Total Liabilities
Owner's Equity
C.R. Byrd, Capital
Total Liabilities and Owner's Equity

1,000
2,500
800
1,200
25
5,525
4,000
9,525

12,342
21,867

A classified balance
sheet helps the
financial statement
user determine:
The availability of
assets to meet debts as
they come due, and
The claims of shortand long-term
creditors on total
assets.
The balance sheet is
most often presented in
the report form, with
the assets shown above
the liabilities and
owners equity.

LIQUIDITY
Liquidity measures ability to pay short-term

obligations when they come due.

Working capital is one important measure
of liquidity.

WORKING CAPITAL = CURRENT ASSETS - CURRENT LIABILITIES

CURRENT RATIO
The current ratio (working capital ratio) is a
widely used measure for evaluating a
companys liquidity and short-term debtpaying ability. It is calculated by dividing
current assets by current liabilities and is a
more dependable indicator of liquidity than
working capital.

CURRENT ASSETS
CURRENT RATIO =
CURRENT LIABILITIES