Instructor’s Manual for Larson/Dieckmann/Harris Fundamental Accounting Principles 17ce

CHAPTER 4: COMPLETING THE ACCOUNTING CYCLE AND CLASSIFYING

ACCOUNTS

Learning Objectives

Closing Process (LO1)

The Closing Process is an important step at end of accounting period to prepare for the next
period.

In the closing process we must:

 Identify accounts for closing.

 Record and post closing entries.
 Prepare a post-closing trial balance.

After closing, effects on accounts are as follows:

1. Revenue, expense and withdrawals accounts will be reflected in equity and will begin
the new period with a zero balance.
2. Owner’s equity account will reflect increases from profit and decreases from loss and
withdrawals.

Temporary and Permanent Accounts

3. Temporary (or nominal) accounts accumulate data related to one accounting period. (All
income statement accounts, withdrawals accounts, and the Income Summary.)
4. Permanent (or real) accounts report on activities related to one or more future
accounting periods. (All balance sheet accounts.)

The closing process applies only to temporary accounts.

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Recording and Posting Closing Entries (LO2)

(Refer to Exhibit 4.2)

Use a new temporary account called Income Summary. The four closing entries are:

1. Close credit balances in revenue accounts. (By debiting the accounts and crediting Income
Summary)
2. Close debit balances in expense accounts. (By crediting the accounts and debiting Income
Summary)
3. Close the Income Summary account to owner's capital account.
4. Note: Income Summary, prior to closing, will have a credit balance equal to profit or a debit
balance equal to loss. Therefore, this entry will credit capital for the profit or debit capital for a
loss.
5. Close withdrawals account to owner’s capital. (By crediting the account and debiting the
owner’s capital account)

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After all closing entries are posted, all temporary accounts have a zero balance, and the capital account
reflects the company’s period to date balance.

Preparing a Post-Closing Trial Balance (LO3)

Prepared after closing entries are journalized and posted.

Verifies that total debits equal total credits for permanent accounts, and all temporary accounts have
zero balances.

Students should note that post-closing trial balance is usually very short.

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Completing the Accounting Cycle (LO4)

The sequence of accounting procedures followed each accounting period:

1. Analyze Transactions
2. Journalize
3. Post
4. Unadjusted trial balance
5. Adjust
6. Adjusted trial balance
7. Prepare statements
8. Close
9. Post closing trial balance

Classified Balance Sheet (LO5)

The Classified Balance Sheet is commonly used classifications and contains:

A. Current assets—cash or other assets that are reasonably expected to be sold, collected, or
consumed within one year or within the normal operating cycle of the business, whichever is
longer. Examples are cash, short term investments, accounts receivable, notes receivable,
merchandise inventory, prepaid expenses- reported in order of liquidity. Prepaid expenses are
sometimes combined on a balance sheet.
B. Non-current Investments—long term assets such as stocks, bonds, promissory notes, and land
held for future expansion.
C. Property, Plant and Equipment- tangible assets that are used for more than one accounting
period to produce or sell goods and services. Examples include equipment, buildings, land.
D. Intangible assets—long term resources used to produce or sell products and services; they do
not have a physical form; their benefits are uncertain. Value comes from the privileges or rights
that are granted to or held by the owner. Examples include patents, trademarks, franchises and
copyrights.

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E. Current liabilities—obligations due to be paid or liquidated within one year or the operating
cycle, whichever is longer. Examples include accounts payable, wages payable, taxes payable,
interest payable, unearned revenues, current portions of long term liabilities.
F. Non-current liabilities—obligations that are due to be paid beyond the longer of one year or the
operating cycle of the business. Examples include notes payable, bonds payable, mortgages
payable.
G. Equity—presentation of the owner’s claim on the business. Equity section for sole
proprietorship shows one owner’s capital account. Partnerships and corporations are discussed
in detail in later chapters.

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Financial Statement Analysis (LO6)

Focus should be on the calculations and how these ratios are used within a company and for
measurement against industry.

Current Ratio:

The current ratio is one important measure used to evaluate a company’s ability to pay its short-term
obligations. The ability to pay day-to-day obligations (current liabilities) with existing liquid assets is
commonly referred to as liquidity.

Quick Ratio:

The quick ratio is a simple modification from the current ratio, and is a more robust measure of liquidity.

Debt to Equity Ratio:

The debt-to-equity ratio (Exhibit 4.19) is another calculation that is important for understanding
financial statements as it indicates the risk position of a company.

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Work Sheet as a Tool (LO7)

Useful to organize accounting information. (Not a financial statement)

A. Some benefits include reduces errors, captures linked accounting information, helps organize an
audit, and plans interim financial statements and useful for “what if” analysis and planning
purposes.
B. Steps to prepare a work sheet: (Refer to Exhibit 4A.1 for the format and steps)
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. Total Adjusted Trial Balance columns to verify debits
equal credits.
4. Extend the adjusted trial balance amounts to the financial statement columns.
5. Enter profit (or loss) and balance the financial statement columns. Prepare financial
statements from worksheet information.

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It is helpful to know what to are look for in completing the final 4 columns. You should only be “filling
in” the 2 inside columns for a loss and the 2 outside columns for a profit.

Reversing Entries (LO8)

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Reversing entries are optional entries used to simplify recordkeeping. They are prepared on the first day
of the new accounting period. Reversing entries are prepared for those adjusting entries that created
accrued assets and liabilities (such as interest receivable and salaries payable).

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Summary of
THE ACCOUNTING CYCLE

Assuming a worksheet is used

STEPS PURPOSE TIMING

1. Journalizing To record the daily transactions During the period

2. Posting To transfer the amounts from journal entries During the period
to the individual accounts affected by the
recorded transaction

3. Work sheet To summarize the balances of ledger accounts End of period

and test the accuracy of journalizing and
posting and the computation of account
balances (unadjusted trial balance columns)

To plan the adjusting entries and the income

statement and balance sheet numbers

To prove the mathematical accuracy of profit

To provide information for closing entries

4. Preparing the To report financial information End of period

statements

5. Journalizing and To bring the ledger accounts to adjusted End of period

posting of adjusting balances
entries

6. Journalizing and To bring all temporary accounts to zero and End of period
posting of closing entries the capital account up-to-date

7. Post-closing trial To prove the accuracy of the End of period

balance
adjusting and closing procedures

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Additional Example of Classified Balance Sheet

(Very comprehensive, uses all classifications)

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MUSIC WORLD

BALANCE SHEET

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DECEMBER 31, 2022

Assets

Current Assets

Cash $30,360

Short-Term Investments 2,000

Accounts Receivable 43,000

Merchandise Inventory 60,700

Prepaid Insurance 6,600

Supplies 1,696

Total Current Assets $144,356

Non-current 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 Plant and Equipment 20,110

Intangible Assets

Trademark 500

Total Assets $178,916

Liabilities

Current Liabilities

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Accounts Payable 25,683

Salaries Payable 17,000

Current portion of long-term liabilities 10,200

Total Current Liabilities $52,883

Non-current Liabilities

Mortgage Payable (less current portion) 27,600

Total Liabilities $ 80,483

Equity

Joy Melody, Capital 98,433

Total Liabilities and Equity $178,916

Chapter 4 Alternate Demo Problem

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, 2021

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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.

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Chapter 4 Solution: Alternate Demo Problem

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

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C. Large, Withdrawal........................................ 2,000

Solution continued next page

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3. LARGE COMPANY, INC.

Post-Closing Trial Balance
December 31, 2021
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

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