Completing the Accounting Cycle | Financial Accounting | CPA Exam FAR

These lectures covers the worksheet, closing accounting entries, permanent account, temporary accounts, classified balance sheet, and reversing accounting entries.

Prepare a Worksheet Financial Accounting

Closing Entries Financial Accounting

Example: Closing Entries

Correcting Journal entries | Financial accounting |

Example: Correcting Journal Entries

Classified Balance Sheet

Example: Classified Balance Sheet

Reversing Accounting Entries

worksheet is a multiple-column form used in the adjustment process and in preparing financial statements. As its name suggests, the worksheet is a working tool. It is not a permanent accounting record. It is neither a journal nor a part of the general ledger. The worksheet is merely a device used in preparing adjusting entries and the financial statements. Companies generally computerize worksheets using an electronic spreadsheet program such as Microsoft Excel.

A worksheet is not a journal, and it cannot be used as a basis for posting to ledger accounts. To adjust the accounts, the company must journalize the adjustments and post them to the ledger. The adjusting entries are prepared from the adjustments columns of the worksheet. The reference letters in the adjustments columns and the explanations of the adjustments at the bottom of the worksheet help identify the adjusting entries. The journalizing and posting of adjusting entries follow the preparation of financial statements when a worksheet is used.

At the end of the accounting period, the company makes the accounts ready for the next period. This is called closing the books. In closing the books, the company distinguishes between temporary and permanent accounts.
Temporary accounts relate only to a given accounting period. They include all income statement accounts and the Dividends account. The company closes all temporary accounts at the end of the period.
In contrast, permanent accounts relate to one or more future accounting periods. They consist of all balance sheet accounts, including stockholders’ equity accounts. Permanent accounts are not closed from period to period.

Preparing Closing Entries

At the end of the accounting period, the company transfers temporary account balances to the permanent stockholders’ equity account, Retained Earnings, by means of closing entries.
Closing entries formally recognize in the ledger the transfer of net income (or net loss) and Dividends to Retained Earnings. The retained earnings statement shows the results of these entries. Closing entries also produce a zero balance in each temporary account. The temporary accounts are then ready to accumulate data in the next accounting period separate from the data of prior periods. Permanent accounts are not closed.
Journalizing and posting closing entries is a required step in the accounting cycle (see Illustration 4-11). The company performs this step after it has prepared financial statements. In contrast to the steps in the cycle that you have already studied, companies generally journalize and post closing entries only at the end of the annual accounting period. Thus, all temporary accounts will contain data for the entire accounting period.
In preparing closing entries, companies could close each income statement account directly to Retained Earnings. However, to do so would result in excessive detail in the permanent Retained Earnings account. Instead, companies close the revenue and expense accounts to another temporary account, Income Summary, and then transfer the resulting net income or net loss from this account to Retained Earnings.
Companies record closing entries in the general journal. A center caption, Closing Entries, inserted in the journal between the last adjusting entry and the first closing entry, identifies these entries. Then the company posts the closing entries to the ledger accounts.

Companies generally prepare closing entries directly from the adjusted balances in the ledger. They could prepare separate closing entries for each nominal account, but the following four entries accomplish the desired result more efficiently:

  • 1.Debit each revenue account for its balance, and credit Income Summary for total revenues.
  • 2.Debit Income Summary for total expenses, and credit each expense account for its balance.
  • 3.Debit Income Summary and credit Retained Earnings for the amount of net income.
  • 4.Debit Retained Earnings for the balance in the Dividends account, and credit Dividends for the same amount.

The balance sheet presents a snapshot of a company’s financial position at a point in time. To improve users’ understanding of a company’s financial position, companies often use a classified balance sheet. A classified balance sheet groups together similar assets and similar liabilities, using a number of standard classifications and sections. This is useful because items within a group have similar economic characteristics.

After preparing the financial statements and closing the books, it is often helpful to reverse some of the adjusting entries before recording the regular transactions of the next period. Such entries are reversing entries. Companies make a reversing entry at the beginning of the next accounting period. Each reversing entry is the exact opposite of the adjusting entry made in the previous period. The recording of reversing entries is an optional step in the accounting cycle.
The purpose of reversing entries is to simplify the recording of a subsequent transaction related to an adjusting entry.