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Chapter 6
Completion of the Accounting Cycle
The Accounts Finalisation Process
Completion of the accounting cycle in one accounting period culminates in the preparation of
financial statements
...
Different users of accounting information and their
varied interests were covered in Chapter One
...
Chapter Eighteen will deal with the Cash Flow
Statement in more depth
...
Errors are easily made in such an undertaking
...
The use of the
worksheet starts immediately a trial balance has been prepared, before any adjusting entries have
been made
...
1
...
1: Format of a Worksheet
Trial Balance
Title of Account
Dr
...
Adjustments
Dr
...
Adjusted Trial
Balance
Dr
...
Income
Statement
Dr
...
Balance Sheet
Dr
...
Titles of all general ledger accounts and their respective general ledger balances are recorded on
the rows on the first three columns
...
A worksheet is not part of the ledger or any formal
accounting records
...
It is a helpful device for bringing together everything in one place
...
100 Introductory Financial Accounting
recording of the trial balance figures before adjustments
recording of adjusting entries
preparation of an adjusted trial balance
preparation of the Income Statement and Balance Sheet
preparation of closing entries
The worksheet has become so successful that it ushered the development of computer application
packages commonly known as spreadsheets
...
Spreadsheet packages have made easier the arithmetic
component of the worksheet
...
Following are the steps taken in preparing a worksheet:
a)
Copy all general ledger accounts on the rows of the first column, which will usually be
the Title of Account column
...
These will usually be the first pair of columns after the Title of
Account column
...
c)
Enter the adjusting entries in the next pair of columns
...
New accounts initiated by adjusting entries, which were not listed in the
original trial balance should be inserted where the original list ended
...
d)
Fill up the next pair of columns under Adjusted Trial Balance by incorporating the
effects of adjusting entries on the original trial balance figures
...
Since the original trial balance and
the adjustment pairs of columns agreed, the pairs under adjusted trial balance must also
come to an agreement when summed
...
Expenses and revenue accounts are extended to the
debit and credit columns of the Income Statement respectively
...
Liabilities, contra-assets and owner's
capital are extended to the credit column of the Balance Sheet
...
The difference
between the debit and credit totals of the Income Statement columns represents a net
profit (if the credit total is larger) or a net loss (if the debit total is larger)
...
A net profit is extended to the credit column of the
Balance Sheet whereas a net loss is extended to the debit column
...
Example
Using the trial balance and adjusting entries prepared for B
...
Asha, Capital
B
...
Balance
Dr
Cr
1,236,000
2,570,000
Depreciation - furniture
Accumulated depreciation
Doubtful debts
Provision for doubtful debts
Prepaid rent
Electricity expense
Accrued electricity
Shop supplies expense
Stock, 31st July
Adjustments
Dr
Cr
37,500
500
9,600
9,600
20,000
1,400
-
1,400
6,000
-
-
-
2,581,500
2,581,500
1,400
6,000
800,000
800,000
1,046,500
1,176,000
2,335,000
2,205,500
129,500
1,176,000
1,176,000
2,335,000
129,500
2,335,000
102 Introductory Financial Accounting
End-of-period entries for Stocks of Merchandise and Supplies
Ordinarily at the end of the accounting period a physical stock taking is carried out to determine
the actual amount and value of unsold merchandise still on hand
...
Supplies consumed are charged to expense while the unused
supplies are carried over to the subsequent accounting period as assets
...
Asha Grocers conducted a stock taking exercise at the end of July, and the following items
were in stock:
i)
ii)
Unused shop supplies of shs
...
Merchandise stocks of shs
...
Consumable Supplies
The entry required to record the existence of shop supplies stock at the end of an accounting
period is in principle similar to that of an adjusting entry for prepaid expenses
...
Folio
Debit
Credit
6,000
6,000
This general journal entry reduces the figure of shop supplies in the trial balance from shs
...
12,000
...
Merchandise stocks
B
...
These are Stocks 1st July shs
...
800,000 as derived from the stock taking
exercise
...
500,000 is known as Opening Stock while Stocks, 31st July, shs
...
The relationship in these two figures is that closing stock in a
current reporting period will be the opening stock for the subsequent accounting period
...
The
value of shs
...
The following general journal entry effects this:
Completion of the Accounting Cycle 103
Date
Description
Folio
20X1
Jul 31 Trading, Profit and Loss
Debit
Credit
500,000
500,000
Stocks, 1st July
To release to the Trading, Profit and
Loss Account the value of opening
stock
...
Closing Stock
The value of shs
...
This figure is included in the figure of total purchases as at the end of
July
...
In this regard the figure of purchases cannot be taken
to be the total cost of goods sold
...
Because of existence of unsold stocks, the following two events must be recorded in the
accounting records:
the existence of stocks as an asset, and
the reduction of the cost of goods available for sale by the value of closing stock in order
for the cost of goods sold to be determined
...
The effect of the two entries made to record opening and closing stocks would appear in the
ledger accounts as follows:
Stocks, 1st July
Date
Details
Account no
...
Debit
20X1
Jul1 Capital, B
...
Credit
20X1
GJ1
500,000
500,000
Jul31 Trading, Profit and Loss GJ0
500,000
500,000
104 Introductory Financial Accounting
Stocks, 31st July
Date
Details
Account no
...
Debit
20X1
Date
Details
Fol
...
500,000 ceased to exist, while Stocks, 31st July, shs
...
800,000, an item to be listed on the balance sheet as
a current asset
...
There is no need to distinguish between opening and closing stock of the same
category of stocks because the closing stock of the current period is the opening stock for the
subsequent period
...
00
Fol
...
Credit
20X1
GJ1
500,000
Jul31 Trading, Profit and Loss GJ0
500,000
Jul31 Trading, Profit and Loss GJ0
800,000
Jul31 Balance
800,000
Jul1 Capital, B
...
The Closing Stock is extended to the credit column under Income Statement and to the debit
column under Balance Sheet
...
Preparation of financial statements
Once the worksheet has been completed, the outlines of financial statements can be seen clearly
...
Completion of the Accounting Cycle 105
The Income Statement or Trading and Profit and Loss Account
This statement shows the results of operations for the business during an accounting period
...
TFASs do not
prescribe a format
...
This is the format students of accounting should follow
...
For a trading firm it is important that the
first subsection of the income statement shows clearly, how the trading results or gross profit is
arrived at
...
Asha Grocers the Income Statement or Trading and
Profit and Loss Account is prepared as follows:
Account format
B
...
Asha Grocers
Income Statement
for the Month ended 31 July, 20X1
shs
...
shs
...
Completion of the Accounting Cycle 107
Balance Sheet
This statement shows the financial position of the business at a given date usually the last day of
the accounting period
...
It is important to show clearly in the balance sheet the various classification of accounts
and as much information as possible concerning the financial condition of the business
...
Asha Grocers
Balance Sheet as at July 31, 20X1
shs
...
depreciation
65,000
500
less: Prov
...
Liabilities and Capital:
Owner's equity
B
...
profits 1st July
64,500 Net profit for the year
Net book value
Current assets
Stocks
Debtors
shs
...
2,000,000
0
129,500
129,500
800,000 less: Drawings
192,000
9,600
10,000
119,500
Accum
...
Asha, Grocers
Balance Sheet as at 31 July, 20X1
shs
...
shs
...
Asha, Capital
Accumulated profits 1st July
Net profit for the year
2,000,000
0
129,500
129,500
10,000
Less: Drawings
Accumulated profits
31st
July
119,500
Total Owner's equity
2,119,500
Total Capital employed
2,119,500
Completion of the Accounting Cycle 109
Closing entries
Revenue and expense accounts
Revenue and expense accounts are temporary accounts
...
The net result which is profit or
loss is carried on to the Balance Sheet
...
The entries to record the closing entries for B
...
Folio
Debit
Credit
370,000
6,000
376,000
The compound journal entry is a standard feature of closing entries
...
They are reproduced here as they had been made
...
Date
Description
20X1
Jul 31 Stocks
Trading, Profit and Loss
To record closing stock of
merchandise at the end of July
...
The traditional approach was to close the net profit or loss in the Trading,
Profit and Loss Account to the Capital Account as follows:
Completion of the Accounting Cycle 111
Date
Description
Folio
Debit
20X1
Jul 31 Trading, Profit and Loss
Credit
129,500
129,500
B
...
On the Balance Sheet the capital section would look as follows:
Balance Sheet (extract only)
shs
B
...
Asha, Capital, 31st July
shs
2,000,000
129,500
10,000
2,119,500
The above presentation will in subsequent periods obscure the figure of initial and incremental
equity brought in by the owners
...
These kind of adjusting entries do not need reversing
...
00
Fol
...
Credit
20X1
20X1
Jan1 Cash
60,000
Dec31 Accrued Electricity
Dec31 Profit and Loss
128,000
68,000
Expense
128,000
128,000
Accrued Electricity Expense
Date
Details
Fol
...
00
Debit
20X1
Dec31
Date
Details
Fol
...
80,000 covering the
period from July, 20X1 to January, 20X2
...
Asha Grocers paid the bills immediately, not all
of the shs
...
Of that amount only shs
...
68,000 is towards settling an outstanding liability of bills unpaid in
20X1
...
80,000 would be recorded in a general journal as follows:
114 Introductory Financial Accounting
Date
Description
Folio
Debit
20X2
Jan 31 Electricity expenses
Credit
12,000
68,000
Accrued Electricity expenses
Cash
To record payment of electricity bills
from July, 20X1 to January, 20X2
...
68,000 in the
Accrued Electricity Expenses account and will also record the correct expense of shs
...
The work of the bookkeeper can however, be made easier by simply reversing the adjusting entry
on the first day of the new accounting period
...
The
reversing entry for the adjustment associated with the above example would be as follows:
Date
Description
Folio
Debit
20X2
Jan 1 Accrued Electricity expenses
Credit
68,000
68,000
Electricity Expenses
To record the reversing of the
adjusting entry of accrued electricity
...
00
Fol
...
Credit
20X1
20X1
Jan1 Cash
60,000
Dec31 Accrued Electricity
Dec31 Profit and Loss
128,000
68,000
Expense
128,000
20X2
Jan31 Cash
128,000
20X2
GJ0
80,000
Jan1 Accrued Electricity
Expenses
GJ0
68,000
Completion of the Accounting Cycle 115
Accrued Electricity Expense
Date
Details
Fol
...
00
Debit
20X1
Dec31
Date
Details
Fol
...
68,000 on January 1st
20X2, just after the reversing entry is made
...
80,000 is posted only a shs
...
Notice that a similar effect would have
been achieved if a mixed account were used, in which case no reversing entries would have been
necessary
...
Reversing entries can also be made for accrued revenues, prepaid expenses and unearned
revenues
...
The Income Statement as we know it today used to be the “Trading, Profit and Loss Account”
...
Account
Fol
...
500,000 is on the debit side together with purchases
...
800,000 is on the opposite side
...
116 Introductory Financial Accounting
If a report format was used to present the same information, it would look as follows:
Income Statement
Shs
...
370,000
500,000
500,000
5,000
1,005,000
800,000
205,000
165,000
Contrasting contents of the two formats it is now possible to observe why opening stock is
debited to the Trading, Profit and Loss Account while the closing stock figure is recorded as a
credit to that account
...
What is the purpose of an adjusted trial balance?
2
...
Why are adjusting entries recorded in the general journal and posted to the ledger
even though they are entered on the worksheet?
4
...
Why are revenue and expense accounts closed but assets, contra-assets, liability and
capital accounts are not?
6
...
216,000 greater than the debit column total
...
7
...
(a) Debtors (b) Creditors (c) Cash (d) Depreciation expense (e) Capital (f) Drawings
(g) Equipment (h) Prepaid insurance (i) Retained profit (j) Wages payable (k) Salary
expense (l) Sales
...
What is a post-closing trial balance? Is it a necessary part of the accounts finalization
process? Explain
...
What are reversing entries? When are reversing entries useful?
10
...
118 Introductory Financial Accounting
Exercises
1
...
The
year end is 31st December, 20X2
...
Dr
Cash
Debtors
Furniture
Accumulated Depreciation
Other Assets
Creditors
Bank Loan
Capital
Retained Profits
Revenues
Expenses
Total
Cr
24 000
14 000
30 000
9 000
64 000
11 000
21 000
40 000
14 000
90 000
53 000
185 000
185 000
You are to record depreciation of shs
...
Required:
Complete a worksheet for Coffee Tree Inn
...
Wabonike Company prepared the unadjusted trial balance given below at the end of
the accounting year, 31st December 20X1
...
20,000
...
c) Wages payable shs
...
Required:
Completion of the Accounting Cycle 119
i) Give the adjusting entries and closing entries for 20X1
...
3
...
Reversing entries are under consideration for 1st January 20X2 for
two different adjusting entries
...
Prepaid Insurance
Account
20X1
20X1
Jan1
Balance b/f
600,000 Dec31
Insurance Expense
Account
20X1
Dec31
400,000
Prepaid Insurance
20X1
Prepaid Insurance
400,000 Dec31
400,000
Profit and loss
Accrued Wages
Account
20X1
Dec31
Wages Expen