Lesson 4: Completion of the Accounting Cycle

Chapter 4 completes the Accounting Cycle. The objective is to generate the financial statements, perform the closing entries, and prepare the General Ledger for the following accounting period. The accounting period may be a year, a quarter (three months) or one month. Usually, your text assumes that the Accounting Cycle is completed each month.

Illustration 4-12, page 149, shows the entire accounting cycle and is an outline of what is covered in chapters 1-4. Note that some of the steps are ongoing, repetitive activities -- such as analyzing transactions, journalizing and posting. Repeatedly, trial balances will be prepared to assure that the ledger is in balance. Steps 5 through 9 however, are performed only at the end of the accounting period.

The worksheet provides an overview of the end-of-period activities. A worksheet allows the accountant to begin at the trial balance stage of the accounting cycle, and, armed with the adjustment information, model the resulting financial statements, and journalize/post the closing entries. Why should you learn about worksheets? Here are several reasons:

  1. The financial statements may have to be published before the journalizing/posting of the adjustments and closing entries can be completed;

  2. You may be delegating some accounting tasks, and the worksheet provides check figures that should reconcile with those of your subordinates;

  3. A worksheet is a fundamental tool for an accountant, and is useful for modeling any financial problem or project. Additionally, the development of "electronic spreadsheet" programs such as Microsoft Excel enhances the usefulness of worksheets for financial or managerial accounting purposes.

The Worksheet

Begin your study of Chapter 4 by examining Illustration 4-1 on page 136 of your text. What are the column headers for a typical worksheet? You will find columns for the Trial Balance, the Adjustments, the Adjusted Trial Balance, the Income Statement and the Balance Sheet.

The procedure for completing a worksheet is as follows. You might study the example worksheet for Chapter 4, Illustrations 4-2 through 4-3D, beginning on page 138. This example utilizes the "plastic pages" and allows you to overlay each set of columns as you read.

Start with the Trial Balance columns. The Trial Balance comes from the ending ledger balances for the period. Enter these figures onto the worksheet. Special Note: After you enter the trial balance into the worksheet, take your calculator and add up both sides. If the trial balance columns do not balance, nothing else will! If you are copying the trial balance from your text, do not just copy the debit total and credit total -- add them up for yourself to verify that they do indeed balance.

  1. Enter your Adjustments in the columns provided. They too must balance.

  2. If your Trial Balance figures balance, and the Adjustments also balance, calculate each Adjusted Trial Balance figure and enter it in the appropriate columns. Go slowly. If you are adding two debits, you'll get a debit balance; two credits result in a credit balance; a debit and a credit requires subtraction, with the result a debit or credit. Your Adjusted Trial Balance figures should balance.

  3. After you have balanced the Adjusted Trial Balance, you will need to transfer each figure from those columns to either: a cell in the Income Statement columns or a cell in the Balance Sheet columns. If you have trouble with this part, refer to the sample chart of accounts in Lesson 2, or your text. Revenues and Expenses go to the Income Statement; Assets, Liabilities, Capital and Drawing balances go to the Balance Sheet columns.

  4. When you get to the Income Statement columns, they probably won't balance. In fact, the best thing that could happen would be if Revenues are greater than Expenses, indicating that a Net Income was earned. See the text example regarding the entry of Net Income at the bottom of the Income Statement columns. Notice that Net Income is also transferred to the Balance Sheet, credit side. (If a Net Loss occurs, the Loss goes to the debit side of the Balance Sheet columns).

  5. Finish off the totals of the columns and place an appropriate heading on the worksheet.

Hints Just in Case Your Worksheet Does Not Balance

  1. Figure out how far you are out of balance. Suppose it's $216. Are there any $216 items that you may have inadvertently left out...or entered twice? Since $216 is evenly divisible by 9, you might suspect that a slide or transposition has occurred (see items 2 and 3 below).>

  2. Check for slides. A slide happens when you copy or enter a number like 2560 as 256 or 25.60. The digits are correct, but the decimal point is in the wrong place. Such errors will cause you to be out of balance by a number that will be evenly divisible by 9.

  3. Check for transpositions. A transposition will happen when you copy or enter a number like 5280.00 as 5820.00. As with a slide, you will be out of balance by a number evenly divisible by 9.

  4. When you are out of balance, try to step back from the situation -- either mentally or physically. Were there any assumptions you made in your work that might not be true? As a last resort, ask a friend or fellow student (or even your instructor) to look at the situation and render assistance.

Closing Entries

What does it mean to close an account? The term "close" means to bring an account to a zero balance.

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Here is an unknown account, Account X, with a $2000 credit balance. What would it take to close it? (Answer: a debit of $2000). What would it take to close Acct Y below?

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(Answer: a credit of $3000.)

Not all accounts get closed at the end of the accounting period. Which ones do get closed? Answer: the ones that get closed are the temporary Owner's Equity Accounts. In other words, Revenue accounts, Expense accounts, and the Drawing Account.

There is one new account that is added to the ledger -- the Income Summary account. The account title is appropriate -- Income Summary does indeed summarize the net income. The total revenues will end up on the right side of Income Summary; the total expenses will end up on the left side, and the balance of Income Summary will equal the net income. The Income Summary account gets closed to the Capital account.

Which accounts do not get closed at the end of the accounting period? Answer-- Assets, Liabilities, and the Owner's Capital Account.

Here is a summary of the closing process.

  1. Close all Revenue accounts to Income Summary.

  2. Close all Expense accounts to Income Summary.

  3. Close Income Summary to the Capital Account.

  4. Close Drawings to the Capital Account.

Example: Suppose, at the end of January, the balances in the General Ledger appear as follows. (Assets and Liabilities are not detailed here; only the Owner's Equity accounts).

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Here is how the closing entries would be journalized (numbers refer to steps outlined above):
1.  Close Revenue account(s) to Income Summary account:

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2.  Close Expense accounts to the Income Summary account:

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After you have penciled in the first two closing entries, pause and reflect. Note that the Income Summary account does indeed summarize the income for the period, with the revenue total on the credit side and the expense total on the debit side. And, of course, the difference between the two sides is the net income for the period. Now the final two entries.

3.  Close the net income into the Capital account:

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4.  Close the Drawing account into the Capital account:

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Note that every closing entry must be journalized, then posted, in order to have the desired effect on the ledger. If you looked through the journal for one month's time (January, let's say), what would you find? You would find the regular journal entries from January 1 through 31; immediately after those entries, you'd find the adjusting entries, all with a date of January 31; and finally, the four closing entries, all dated January 31.

As you will note after penciling in the closing entries:

  1. Revenues and Expenses are now at 0 balance;

  2. Drawings are at 0 balance;

  3. The net income has been transferred to the Owner's Capital account;

  4. The only open account in Owner's Equity is the Owner's Capital account.

To finish the Accounting Cycle, you would take a Post-Closing Trial Balance, consisting of the Asset and Liability balances, as well as the Owner's Capital account. As you would expect, the post closing trial balance will have no revenue account balances, no expense account balances, and no Drawing account balance.

In most Accounting textbooks, the authors try to encourage you to memorize the steps in the Accounting Cycle. This task is made more difficult, however, because it takes several chapters to adequately explore each step.  Refer to page 149 in your text for a diagram of all nine steps in the Accounting Cycle.

A final topic in Chapter 4 is the Classified Balance Sheet. A classified balance sheet is one in which the Assets and Liabilities are further subclassified. The typical categories for assets consist of:

Current Assets -- those that will be used up or converted to cash within one year.
Investments -- in stocks or bonds, with the intent of holding those investments indefinitely.
Property, Plant and Equipment -- Land, Buildings, Equipment. Accumulated Depreciation must be subtracted from buildings and equipment accounts.
Intangibles -- Certain rights like patents and copyrights that may produce revenue.

For liabilities, there are two main categories:
Current Liabilities -- Accounts Payable and short term Notes Payable, payroll liabilities and other debts expected to be paid from current assets, and with maturities of less than one year.
Long Term Liabilities -- debts that have maturities that stretch past one year. These would include mortgages, leases and bonds payable.

An example of a Classified Balance Sheet appears in Illustration 4-26 on page 157.

Homework Assignment, Lesson 4

Review the Demonstration Problem on pages 158-159 and answer the following Questions, Exercises and Problems on pages 164-180. You do not need to read the Appendix section on reversing entries.


Hints and Check Figures for Chapter 4

Q5 A worksheet is not in the proper financial statement format. As one example, note that in the Balance Sheet columns, the Owner's Capital is at its beginning amount; the worksheet shows the net income added to the credit side, and there may be drawings on the debit side. But nowhere is the final Owner's Capital for the period calculated. A formal Balance Sheet needs to be constructed.

Q11 Journalize the regular transactions; journalize the adjustments; journalize the closing entries.
E4-1 Net Income = $1,262; Balance Sheet debit column total= $51,572.
E4-3 c. Debit column = $47,922.
E4-10 Remember to update the Capital account--Net income is $3,440.  Total Assets = $228,120. Can Rego meet its short-term obligations? Yes. Its liquidity is good.
P4-1A Total of Adjustments column = $1680; Net Income = $760.

Web Assignment

For this assignment, I would like for you to examine at least three academic programs in Business Administration.  These could be Bachelor's Degree (BBA)or Master's Degree (MBA) programs.  A good source of information on this topic can be found at Yahoo! (www.yahoo.com).  Look under the Business and Economy heading, and there'll be a subheading called Business Schools.  For BBA and MBA programs, most schools provide a mixture of courses in the "functional areas" of business, including Managment, Marketing, and Finance.  Additionally, there are relatively new areas of study such as Information Systems, International Business, and Total Quality Managment.

If you are interested in further Accounting courses beyond Accounting 210/220/230, these can be found at many colleges and universities.  Although an "Accounting major" must complete the academic requirements in the functional areas listed above for the BBA, a "concentration" in the Accounting discipline can also be accomplished by completing courses such as:

Intermediate Accounting (may be two quarters)
Advanced Accounting
Governmental Accounting
Cost Accounting
Income Tax
Computer Information Systems

You might look at programs for an Accounting concentration if Accounting is an area of interest for you.  By the way, the courses listed above would provide the basic knowledge base for preparing for the CPA Examination.  I suggest, however, that you also consider a CPA Review course.  Such courses are offered by private training firms and focus on content, strategy, and study techniques for passing the CPA Examination.  There are probably some Web sites for those as well!

Self Quiz

Chapter 4 Quiz

Preview of Examination 1

Examination 1 covers Chapters 1 through 4.  I suggest you print out the Exam and try it on your own; then check yourself using the Answers provided.

Examination 1 Preview
Examination 1: Suggested Answers

If you have questions regarding this lesson, please email me at the following address:

Revised: December 2004