Accounting Principles

Chapter 4

Completing the Accounting Cycle

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The Worksheet
• Multiple-column form used in preparing financial
statements
• Not a permanent accounting record
• May be a computerized worksheet
• Prepared using a five step process
• Use of worksheet is optional

LO 1
Form and Procedure for a Worksheet

Illustration 4.1
LO 1
Step 1—Trial Balance

Illustration 4.2
LO 1
Step 2—Adjustments
The adjustments are the same as in Illustration 3.27.
a. Pioneer debits an additional account, Supplies Expense, $1,500 for the cost of
supplies used, and credits Supplies $1,500.
b. Pioneer debits an additional account, Insurance Expense, $50 for the insurance
that has expired, and credits Prepaid Insurance $50.
c. The company needs two additional depreciation accounts. It debits Depreciation
Expense $40 for the month’s depreciation, and credits Accumulated
Depreciation—Equipment $40.
d. Pioneer debits Unearned Service Revenue $400 for services performed, and
credits Service Revenue $400.
e. Pioneer debits an additional account, Accounts Receivable, $200 for services
performed but not billed, and credits Service Revenue $200.
f. The company needs two additional accounts relating to interest. It debits Interest
Expense $50 for accrued interest, and credits Interest Payable $50.
g. Pioneer debits Salaries and Wages Expense $1,200 for accrued salaries, and
credits an additional account, Salaries and Wages Payable, $1,200.

LO 1
Step 2—Enter the Adjustments

Illustration 4.2

LO 1
Step 3—Enter Adjusted Balances in
the Adjusted Trial Balance Columns

Illustration 4.2

LO 1
Step 4—Extend Adj. Trial Bal.
Amounts to Appropriate Financial
Statement Columns

Illustration 4.2

LO 1
Step 5—Total the Statement Columns,
Compute the Net Income (or Net Loss),
and Complete the Worksheet

Illustration 4.2

LO 1
Preparing Financial Statements from
a Worksheet
• Income statement is prepared from the income
statement columns
• Balance sheet and owner’s equity statement are
prepared from the balance sheet columns
• Companies can prepare financial statements before
they journalize and post adjusting entries by using a
worksheet

LO 1
Income Statement

Illustration 4.3

LO 1
Owner’s Equity Statement

Illustration 4.3

LO 1
Balance Sheet

Illustration 4.3

LO 1
Preparing Adjusting Entries from a
Worksheet
• Adjusting entries are prepared from the
adjustments columns of the worksheet
• Journalizing and posting of adjusting entries follows
the preparation of financial statements when a
worksheet is used

LO 1
Closing the Books
At the end of the accounting period, the company makes
the accounts ready for the next period.

LO 2
Temporary Versus Permanent
Accounts

Illustration 4.4

LO 2
Preparing Closing Entries
Closing entries formally recognize in the ledger the
transfer of:
• Net income (or net loss) to owner’s capital
• Owner’s drawings to owner’s capital
Produce a zero balance in each temporary account.
Companies generally journalize and post closing
entries only at end of the annual accounting period.
Permanent accounts are not closed.

LO 2
Diagram of Closing Process—
Proprietorship

Illustration 4.5

LO 2
Closing Entries Journalized

Illustration 4.6
LO 2
Posting Closing Entries

Illustration 4.7
LO 2
Post-Closing Trial Balance

Illustration 4.8
LO 2
General Ledger Permanent Accounts

Illustration 4.9
LO 2
General Ledger Temporary Accounts

Illustration 4.10
LO 2
The Accounting Cycle and Correcting
Entries

Illustration 4.11

LO 3
1. Analyze Business Transactions

Illustration 4.11

LO 3
2. Journalize the Transactions

Illustration 4.11

LO 3
3. Post to the Ledger Accounts

Illustration 4.11

LO 3
4. Prepare a Trial Balance

Illustration 4.11

LO 3
5. Journalize and Post Adjusting
Entries: Deferrals/Accruals

Illustration 4.11

LO 3
6. Prepare an Adjusted Trial Balance

Illustration 4.11

LO 3
7. Prepare Financial Statements

Illustration 4.11
LO 3
8. Journalize and Post Closing Entries

Illustration 4.11

LO 3
9. Prepare a Post-Closing Trial Balance

Illustration 4.11

LO 3
Correcting Entries—An Avoidable
Step
• Unnecessary if accounting records are free of errors
• Made whenever an error is discovered
• Must be posted before closing entries
Instead of preparing a correcting entry, it is possible to
reverse the incorrect entry and then prepare the
correct entry.

LO 3
Correcting Entries—Case 1
On May 10, Mercato Co. journalized and posted a $50 cash
collection on account from a customer as a debit to Cash $50
and a credit to Service Revenue $50. The company discovered
the error on May 20, when the customer paid the remaining
balance in full.
Incorrect Cash 50
entry Service Revenue 50

Correct Cash 50
entry Accounts Receivable 50

Correcting Service Revenue 50

LO 3
Correcting Entries—Case 2
On May 18, Mercato purchased on account equipment costing
$450. The transaction was journalized and posted as a debit to
Equipment $45 and a credit to Accounts Payable $45. The error
was discovered on June 3, when Mercato received the monthly
statement for May from the creditor.
Incorrect Equipment 45
entry Accounts Payable 45

Correct Equipment 450

Correcting Equipment 405

LO 3
Classified Balance Sheet
• Presents a snapshot at a point in time
• To improve understanding, companies group similar
assets and similar liabilities together
Assets Liabilities and Owner’s Equity
Current assets Current liabilities
Long-term investments Long-term liabilities
Property, plant, and equipment Owner’s equity
Intangible assets

Illustration 4.16

LO 4
Classified Balance Sheet
Assets

Illustration 4.17

LO 4
Classified Balance Sheet
Liabilities and Owner’s Equity

Illustration 4.17

LO 4
Current Assets
• Assets that a company expects to convert to cash or
use up within one year or the operating cycle,
whichever is longer
• Operating cycle is the average time that it takes to
o purchase inventory,
o sell it on account, and
o collect cash from customers

LO 4
Current Assets Section

Illustration 4.18

Accounts are usually listed in order of liquidity.

LO 4
Long-Term Investments Section
• Investments in stocks and bonds of other companies
• Investments in long-term assets such as land or
buildings that are not currently being used in
operating activities
• Long-term notes receivable

Illustration 4.19

LO 4
Property, Plant, and Equipment
• Long useful lives
• Currently used in operations
• Depreciation - allocating the cost of assets to a
number of years
• Accumulated depreciation - total amount of
depreciation expensed thus far in the asset’s life
• Sometimes called fixed assets or plant assets

LO 4
Property, Plant, and Equipment
Section

Illustration 4.20

LO 4
Intangible Assets Section
• Long-lived assets that do not have physical substance

Illustration 4.21

LO 4
Current Liabilities
• Obligations company is to pay within coming year or
its operating cycle, whichever is longer
• Usually list notes payable first, followed by accounts
payable, other items follow in order of magnitude
• Common examples are accounts payable, salaries
and wages payable, notes payable, interest payable,
income taxes payable current maturities of long-
term obligations
• Liquidity - ability to pay obligations expected to be
due within the next year
LO 4
Current Liabilities Section

Illustration 4.22

LO 4
Long-Term Liabilities Section
• Obligations a company expects to pay after one year.

Illustration 4.23

LO 4
Owner’s Equity Section
• Proprietorship - one capital account
• Partnership - capital account for each partner
• Corporation - Common Stock and Retained Earnings

Illustration 4.24

LO 4
Reversing Entries
• It is often helpful to reverse some adjusting entries
before recording regular transactions of the next
period
• Companies make a reversing entry at beginning of
next accounting period
• Each reversing entry is exact opposite of adjusting
entry made in previous period
• Use of reversing entries does not change amounts
reported in the financial statements

LO 5
Reversing Entries Example
We use the salaries expense transactions for Pioneer Advertising
as illustrated in Chapters 2, 3, and 4.
1. October 26 (initial salary entry): Pioneer pays $4,000 of
salaries and wages earned between October 15 and October
26.
2. 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.
3. 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 was earned between
November 1 and November 9.
LO 5
Comparative Entries
Without and With Reversing Entries

Illustration 4A.1
LO 5
Posting With Reversing Entries

Illustration 4A.2

LO 5