14 completing the accounting cycle

8/11/2019 14 Completing the Accounting Cycle

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Completing the Accounting Cycle


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Adjusting Entries

Transactions generally are recorded in a journal in chronological order andthen posted to the ledger accounts. These are based on the best informationavailable at the time of recording enteries.

Although the majority of accounts are up to date at the end of an accountingperiod and their balances can be included in the financial statements, some

accounts require adjustment to reflect current circumstances. In general, these accounts are not updated throughout the period because it is

impractical or inconvenient to make such entries on a daily or weekly basis. Atthe end of each accounting period, necessary adjustments are needed prior topreparing the financial statements.

The entries that reflect these adjustments are called adjusting entries.

Adjusting entries are not made based on transactions; rather, adjusting entriesare recorded based on the circumstances at the close of each accountingperiod.

Each adjusting entry involves at least one income statement account and onebalance sheet account.


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Financial Statements Preparation

After preparing adjusting entries, the entries are posted in respective

ledger accounts. The adjusted balance of ledgers is calculated and is used

to prepare an Adjusted Trial Balance.

Adjusted Trial Balance is used to prepare the Financial Statements.

Financial Statements are prepared by Management and are audited byExternal Auditorswho express opinion on the correctness of the Financial

Statements. External users of Accounts rely on the opinion of the Auditors.

But the story of Financial Accounting does not end on Financial

Statements because the business is a going concern, transactions continue

to occur and the cycle of entries, adjustments, trial balance and financialstatements continue period after period in the organization.

To make the loop / cycle restart, a closing and opening process has to be

carried out in the accounting system.


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Closing Entries

Closing entries are journal entries made at the end of an accounting

period.

They have two purposes:

1. They set the stage for the next accounting period by clearing revenue

and expense accounts and the Drawing account of their balances.2. They summarize a periods revenues and expenses by transferring the

balances of revenue and expense accounts to the Profit and Loss /

Retained earnings / Income Summary account. This account is a

temporary account that summarizes all revenues and expenses for

the period. It is used only in the closing processnever in thefinancial statements. Its balance equals the net income or loss

reported on the income statement. The net income or loss is then

transferred to the owners Capital account.


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Closing Entries

The steps involved in making closing entries are as follows:

Step 1. Close the credit balances on the income statement accounts to the

Retained earnings account.

Step 2. Close the debit balances on the income statement accounts to the

Retained earnings account.

Step 3. Close the Drawing account balance to the owners Capital account.


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Closing Entries


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Closing Entries


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Post-closing Trial BalanceAfter posting closing entry, we can prepare a Post-closing Trial Balance.

There are only Asset, Liability and Equity Accounts in a post-closing trial balance. Why?


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Work Sheet

Preparing the Work Sheet

STEPS:1. Enter and Total the Account Balances in the Trial Balance Columns

2. Enter and Total the Adjustments in the Adjustments Columns

3. Enter and Total the Adjusted Account Balances in the Adjusted Trial Balance

Columns

4. Extend the Account Balances from the Adjusted Trial Balance Columns to the

Income Statement or Balance Sheet Columns5. Total the Income Statement Columns and the Balance Sheet Columns. Enter the Net

Income or Net Loss in Both Pairs of Columns as a Balancing Figure, and Recompute

the Column Totals


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14 completing the accounting cycle

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