Chapter 5: The annual report and closing accounts The closure of the accounting cycle and accounting information disclosed to the public Six steps in the accounting cycle: 1. Analyze transactions from the source documents 2. Journalize transactions 3. Post entries to the ledger and prepare a trial balance 4. Make end-of-period adjustments and prepare an adjusted trial balance 5. Prepare financial statements 6. Close the accounts and prepare a post-closing trial balance 1
Example A small company named ZiscoSys. The transactions are stated in chronological order: (1) 8.000 Owner s Investment to start up the business (2) Purchase of equipment for 4.000 paid in cash (3) Purchase of supplies on credit for 500 (4) 400 payment of a liability (accounts payable resulting from delivery of supplies) (5) 5.000 revenues earned on credit (6) 3.000 collection of accounts receivable (7) Incurring expenses of 500 for rent and 200 for utility, resp., and Prepaid Insurance of 1.200 (8) reception of a down payment of 2.400 for services to be performed (unearned revenue or deferred revenue), and (9) Owner s withdrawal of 800. 2
Trial ZiscoSys Magdeburg Trial ZiscoSys Magdeburg Trial September 30, 2013 Cash 6.500 Accounts Receivable 2.000 Equipment 4.000 Supplies 500 Prepaid Insurance 1.200 Accounts Payable 300 Unearned Revenue 2.400 Owner s Investment 8.000 Owner s Withdrawal 800 Revenues 5.000 Expenses 700 15.700 15.700 3
Step 1 include all accounts with balances from ledger Trial ZiscoSys Magdeburg Work Sheet For the month ended September 30, 2013 Adjusted Adjustments Trial Income Statement Sheet Account titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Cash 6.500 Accounts Receivable 2.000 Equipment 4.000 Supplies 500 Prepaid Insurance 1.200 Accounts Payable 300 Unearned Revenue 2.400 Owner s Investment 8.000 Owner s Withdrawal 800 Revenues 5.000 Rent Expense 500 Uility Expense 200 Totals 15.700 15.700 4
Step 2 add adjustment data Trial Account titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Cash 6.500 Accounts Receivable 2.000 Equipment 4.000 Supplies 500 200 Prepaid Insurance 1.200 100 Accounts Payable 300 Unearned Revenue 2.400 200 Owner s Investment 8.000 Owner s Withdrawal 800 Revenues 5.000 200 Rent Expense 500 Uility Expense 200 Totals 15.700 15.700 ZiscoSys Magdeburg Work Sheet For the month ended September 30, 2013 Adjusted Adjustments Trial Supplies Expense 200 Insurance Expense 100 Accumulated Depreciation 84 Office Equipment Deprecitation Expense 84 Income Statement Sheet Totals 584 584 5 5
Step 3 combine trial balance amounts with adjustment amounts Trial ZiscoSys Magdeburg Work Sheet For the month ended September 30, 2013 Adjusted Trial Adjustments Income Statement Account titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Sheet Cash 6.500 6.500 Accounts Receivable 2.000 2.000 Equipment 4.000 4.000 Supplies 500 200 300 Prepaid Insurance 1.200 100 1.100 Accounts Payable 300 300 Unearned Revenue 2.400 200 2.200 Owner s Investment 8.000 8.000 Owner s Withdrawal 800 800 Revenues 5.000 200 5.200 Rent Expense 500 500 Uility Expense 200 200 Totals 15.700 15.700 Supplies Expense 200 200 Insurance Expense 100 100 Accumulated Depreciation 84 84 Office Equipment Deprecitation Expense 84 84 Totals 584 584 15.784 15.784 6
Step 4 transfer adjusted balances to appropriate statement accounts Trial ZiscoSys Magdeburg Work Sheet For the month ended September 30, 2013 Adjusted Trial Adjustments Income Statement Account titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Sheet Cash 6.500 6.500 6.500 Accounts Receivable 2.000 2.000 2.000 Equipment 4.000 4.000 4.000 Supplies 500 200 300 300 Prepaid Insurance 1.200 100 1.100 1.100 Accounts Payable 300 300 300 Unearned Revenue 2.400 200 2.200 2.200 Owner s Investment 8.000 8.000 8.000 Owner s Withdrawal 800 800 800 Revenues 5.000 200 5.200 5.200 Rent Expense 500 500 500 Uility Expense 200 200 200 Totals 15.700 15.700 Supplies Expense 200 200 200 Insurance Expense 100 100 100 Accumulated Depreciation 84 84 84 Office Equipment Deprecitation Expense 84 84 84 Totals 584 584 15.784 15.784 7
Step 5 total statement accounts and compute net income/loss Trial Account titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Cash 6.500 6.500 6.500 Accounts Receivable 2.000 2.000 2.000 Equipment 4.000 4.000 4.000 Supplies 500 200 300 300 Prepaid Insurance 1.200 100 1.100 1.100 Accounts Payable 300 300 300 Unearned Revenue 2.400 200 2.200 2.200 Owner s Investment 8.000 8.000 8.000 Owner s Withdrawal 800 800 800 Revenues 5.000 200 5.200 5.200 Rent Expense 500 500 500 Uility Expense 200 200 200 Totals 15.700 15.700 ZiscoSys Magdeburg Work Sheet For the month ended September 30, 2013 Adjusted Adjustments Trial Income Statement Supplies Expense 200 200 200 Insurance Expense 100 100 100 Accumulated Depreciation 84 84 84 Office Equipment Deprecitation Expense 84 84 84 Totals 584 584 15.784 15.784 1.084 5.200 14.700 10.584 Net Income 4.116 4.116 Totals 5.200 5.200 14.700 14.700 Sheet 8
Closing the books... means making accounts ready for the next accounting period... is done at the end of each accounting period Source: Weygandt/Kieso/Kimmel, p.141 9
Purpose of closing entries zero out all nominal accounts transfer net income (loss) and owner s withdrawal into owner s capital account journalizing and posting closing entries is a required step in the accounting process closing entries are journalized in the general journal and then posted 10
The closing process Debit each revenue account for its balance, and credit Income Summary for total revenues. Credit each expense account for its balance, and debit Income Summary for total expenses. Closing the Income Summary account balance to the Capital account. Closing the Withdrawals account balance to the Capital account. Alternative: close revenue and expense accounts directly to the capital account 11
One example before we go through the whole closing process... let s close the revenue account for ZiscoSys Closing the account on September 30, yields the following 12
ZiscoSys accounts before closing Expense Accounts Revenue 1.084 5.200 800 Withdrawals Capital 8.000 13
Closing process for ZiscoSys Expense Accounts Revenue 1.084 5.200 800 Withdrawals Capital 8.000 Income Summary 14
Step 1: close revenue account Expense Accounts Revenue 1.084 5.200 = 5.200 800 Withdrawals Capital 8.000 Income Summary 5.200 15
Step 2: close expense accounts Expense Accounts Revenue 1.084= 1.084 5.200 = 5.200 800 Withdrawals Capital 8.000 Income Summary 1.084 5.200 16
Step 3: close income summary account Expense Accounts Revenue 1.084 = 1.084 5.200 = 5.200 800 Withdrawals Capital 8.000 4.116 Income Summary 1.084 4.116 5.200 = 17
Step 4: close withdrawal account Expense Accounts Revenue 1.084 = 1.084 5.200 = 5.200 Withdrawals Capital 800 800 = 800 8.000 4.116 Income Summary 1.084 4.116 5.200 = 18
Preparing a Post-Closing Trial Why?... to prove equality of permanent account balances Post Closing Trial ZiscoSys Magdeburg Post Closing Trial September 30, 2013 Cash 6.500 Accounts Receivable 2.000 Equipment 4.000 Supplies 300 Prepaid Insurance 1.100 Accumulated Depreciation Office Equipment 84 Accounts Payable 300 Unearned Revenue 2.200 Owner s Capital 11.316 13.900 13.900 note that all temporary accounts have zero balances after closing hence, they don t enter the post-closing trial balance 19
Summary of the Accounting Cycle 1 - Analyze transactions from source documents 2 - Journalize transactions 3 - Post entries to ledger Start of a new accounting cycle 4 - Prepare trial balance 5 - Make end-of-period adjusting entries 8 - Close accounts and prepare post-closing trial balance 7 Prepare financial statements 6 - Prepare adjusted trial balance 20
Reversing entries an example employer has a biweekly payroll of 8.000, salaries are paid on the 10th and 24th each month September 24, initial salary entry : 8.000 of salaries earned between September 10 and September 24 are paid. September 30, adjusting entry : salaries earned between September 24 and September 30 amount to 4.000 and will be paid in the October 10 payroll. October 10, subsequent salary entry : salaries paid are 8.000. Of this amount, 4.000 accrued in September as salaries payable and 4.000 was earned in October 21
Illustration of reversing entries No Reversing Entry Initial Salary Entry Sept. 24 Salaries Expense 8.000 Cash 8.000 Adjusting Entry Sept. 30 Salaries Expense 4.000 Salaries Payable 4.000 Closing Entry Sept. 30 Income Summary 12.000 Salaries Expense 12.000 Reversing Entry Used Initial Salary Entry Sept. 24 Salaries Expense 8.000 Cash 8.000 Adjusting Entry Sept. 30 Salaries Expense 4.000 Salaries Payable 4.000 Closing Entry Sept. 30 Income Summary 12.000 Salaries Expense 12.000 Oct. 1 Reversing Entry no reversing entry Reversing Entry Oct. 1 Salaries Payable 4.000 Salaries Expense 4.000 Subsequent Salary Entry Oct. 10 Salaries Payable 4.000 Salaries Expense 4.000 Cash 8.000 Subsequent Salary Entry Oct. 10 Salaries Expense 8.000 Cash 8.000 22
Correcting entries needed when errors are discovered correcting entries are journalized and posted whenever an error is detected in cash account is reduced to zero by posting the correcting entry. 23