BASIC FINANCIAL ACCOUNTING & REPORTING

Completing the Accounting Cycle

Learning Objectives:

After studying this chapter, you should be able to:

1. Explain why temporary accounts are closed each period.

2. Recognize the need for a post-closing trial balance and reversing entries in particular instances.
3. Prepare a post adjusting entries, closing entries and reversing entries.
4. Prepare a post-closing trial balance

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 ADJUSTMENTS ARE JOURNALIZED AND POSTED (Step 7)

The adjustment process is a key element of accrual basis accounting. The worksheet helps in the
identification of the accounts that need adjustments. The entries are directly entered in the worksheet.
Most accountants prepare the financial statements immediately after completing the worksheet. The
adjustments are journalized and posted as the closing entries are made. This step in the accounting cycle
brings the ledger into agreement with the data reported in the financial statements.

Illustration. The adjustments pertinent to the Weddings “R” Us illustration follow:

Journal
page
1

Date Account Titles and Explanation P. R. Debit Credit

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2019

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May 31 Rent Expense 530 4,000

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Prepaid Rent 140 4,000

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31 Insurance Expense 540 1,200

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Prepaid Rent 150 1,200

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31 Supplies Expense 520 3,000
Supplies 130 3,000

31 Depreciation Expense- Service Vehicle 560 4,000

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Accumulated Depreciation- Serv. Vehicle 165 4,000

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31 Depreciation Expense- Office Equipment 570 1,000

Accumulated Depreciation- Off. Equipt 175 1,000

31 Unearned Referral Revenues 260 4,000

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Referral Revenues 420 4,000

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31 Salaries Expense 510 1,800

Salaries Payable 230 1,800

31 Interest Expense 590 3,500

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Interest Payable 250 3,500

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31 Accounts Receivable 120 5,300

Consulting Revenues 410 5,300
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CLOSING ENTRIES ARE JOURNALIZED AND POSTED (Step 8)

Income, expense and withdrawal accounts are temporary accounts that accumulate information related
to a specific accounting period. These temporary accounts facilitate income statement preparation. At
the end of each year, the balance of the owner’s capital account represents the cumulative net result of
income, expense, and withdrawal transactions. This phase of the cycle is called the closing procedure.

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 A temporary account is said to be closed when an entry is made such that its balance becomes zero. The
balances of the temporary accounts are transferred to the capital account. A summary account – Income
Summary is used to close the income and expense accounts. .the steps in closing the accounts of an
entity will be illustrated using the Weddings “R” Us case.

1. Close the income accounts

Income accounts have credit balances before the closing entries are posted. For this reason, an
entry debiting each revenue account in the amount of its balance is needed to close the account.
The credit is made to the income summary account. The entry to close the income accounts for
the Weddings “R” Us is as follows:

2019
May 41 67,70

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31 Consulting Revenues 0 0

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42

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Referral Revenues 0 4,000

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33 71,70
Income Summary 0 0

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The dual effect of the entry is to make the balances of the income accounts equal to zero, and to
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transfer the balances in total to credit side of the income summary account. Note that the data
for closing the income accounts can be found in the credit side of the income statement columns
of the worksheet in Exhibit 5-4.
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2. Close the expense accounts

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Expense accounts have debit balances before the closing entries are posted. For this reason, a
compound entry is needed crediting each expense account for its balance and debiting the
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income summary for the total. These data can be found in the debit side of the income
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statement columns of the worksheet.

2019
May 33 36,70
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31 Income Summary 0 0
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Salaries Expense 0 15,600

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Supplies Expense 0 3,000
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Rent Expense 0 4,000

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Insurance Expense 0 1,200
55
Utilities Expense 0 4,400
56
Depreciation Expense- Serv. Vehicle 0 4,000
Depreciation Expense- Off. Equipt. 57 1,000

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 0
59
Interest Expense 0 3,500

The effect of posting the closing entry is to reduce the expense account balances to zero and to
transfer the total of the account balances to the debit side of the income summary account.

3. Close the income summary account

After posting the closing entries involving the income and expense accounts, the balance of the
income summary account will be equal to the profit or loss for the period. A profit is indicated by
a credit balance and a loss by a debit balance. The income summary account, regardless of the
nature of its balance, must be closed to the capital account. For the Weddings “R” Us, the entry
is as follows:

2019

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May 33 35,00
31 Income Summary 0 0

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31 35,00

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Perez-Manalo, Capital 0 0

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The effect of posting this closing entry is to close the income summary account balance and to
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transfer the balance to Perez Manalo’s capital account for the profit.

4. Close the withdrawal account

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The withdrawal account shows the amount by which capital is reduced during the period by
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withdrawals of cash or other assets of the business by the owner for personal use. For this
reason, the debit balance of the withdrawal account must be closed to the capital account as
follows:
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2019
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May 31 14,00
31 Perez-Manalo, Capital 0 0
32 14,00
Perez-Manalo, Withdrawals 0 0
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The effect of posting this closing entry is to close the withdrawal account and to transfer the
balance to the capital account.
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PREPARATION OF A POST-CLOSING TRIAL BALANCE (Step 9)

It is possible to commit an error in posting the adjustments and closing entries to the ledger accounts;
thus, it is necessary to test the equality of the accounts by preparing a new trial balance. This final trial
balance is called a post-closing trial balance.

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  The post-closing trial balance verifies that all the debits equal the credits in the trial balance.
 The trial balance contains only balance sheet items such as assets, liabilities, and ending capital
because all income and expense accounts, as well as the withdrawal account, have zero
balances.

Notice that only the balance sheet accounts have balances because at this point, all the income
statement accounts have been closed.

Weddings "R" Us
Post-Closing Trial Balance
May 31, 2019

Cash 12,200

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Accounts Receivable 17,300

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Supplies 15,000

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Prepaid rent 4,000

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Prepaid Insurance 13,200

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Service vehicle 420,000
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Accumulated Depreciation-Service Vehicle 4,000
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Office Equipment 60,000
Accumulated Depreciation-Office Equipt 1,000
Notes Payable 210,000
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Account Payable 53,000

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Salaries Payable 1,800

Utilities Payable 1,400
Interest Payable 3,500
Unearned Referral Revenues 6,000
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Perez-Manalo, Capital 271,000

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541,700 551,700
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REVERSING ENTRIES (Step 10)

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Preparing the post-closing trial balance may not be the last step in the accounting cycle. Some
entities elect to reverse certain end-of-period adjustments on the first day of the new period. A
reversing entry is a journal entry which is the exact opposite of a related adjusting entry made at
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the end of the period. It is basically a bookkeeping technique made to simplify the recording of
regular transactions in the next accounting period.

It should be emphasized that reversing entries are optional. Also, the act of reversing a previously
recorded adjusting entry should not lead us to the conclusion that the entries reversed are
unnecessary or inaccurate.

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 Even when an entity follows the policy of making reversing entries, not all adjusting entries should
be reversed. Generally, a reversing entry should be made for any adjusting entry that increased an
asset or a liability account. Therefore, all accruals are reversed but only deferrals initially recorded in
income statement – income or expense – accounts are reversed.

After analyzing the rest of the adjusting entries , the adjustments that can be reversed are as follows:
prepaid expenses (expense method), unearned revenues (income method), accrued expenses and
accrued revenues.

Illustration. To show how reversing entries can be helpful, consider the adjusting entry made in the
records of Weddings “R” Us to accrue salaries expense:

2019
May 1,80
31 Salaries Expense 0
1,80

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Salaries Payable 0

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When the employees are paid on the next regular payday, the entry would be:

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2019
May rs e 1,80
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31 Salaries Payable 0
5,40
Salaries Expense 0
7,20
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Cash 0
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Note that when the payment is made, without a prior reversing entry, the accountant must look into
the records to find out how much of the P4,200 applies to the current accounting period and how
much was accrued at the beginning of the period.
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This step may appear easy in this simple case, but think of the problems that may arise if the
company has many employees, especially if some of them are paid on different time schedules such
as weekly or monthly. A reversing entry is an accounting procedure that helps to solve this difficult
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problem. As noted above, a reversing entry is exactly what its name implies. It is a reversal of the
adjusting entry made. For example, observe the following sequence of transactions and their effects
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on the ledger account – salaries expense:

1
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. Adjusting Entry

2019
May 31 Salaries Expense 1,800
Salaries Payable 1,800

2
. Closing Enty

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 2019
15,60
May 31 Income Summary 0
15,60
Salaries Expense 0

3
. Reversing Entry

2019
May 31 Salaries Payable 1,800
Salaries Expense 1,800

4
. Payment Entry

2019

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May 31 Salaries Expense 7,200

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Cash 7,200

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These transactions had the following effects on salaries expense:

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a. Adjusted salaries expense to accrue P1,800 in the proper accounting period.
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b. Closed the P15,600 in total salaries expense for May to income summary.
c. Established a credit balance of P1,800 on June 1 in salaries expense equal to the expense
recognized through the adjusting entry on May 31. The liability account salaries payable was
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reduced to a zero balance.

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d. Recorded the P7,200 payment of two weeks’ salaries in the usual manner. The reversing entry
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has the effect of leaving a balance of P5,400(P7,200-P1,800) in the salaries expense account.
This P5,400 balance represented the salaries expense for the nine workdays in June.
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Making the payment entry was simplified by the reversing entry. Reversing entries apply to all
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accrued expenses or revenues.

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