Completing the Accounting Cycle

This chapter will explain the steps required to complete the accounting cycle. This includes understanding the full accounting information cycle, and what is used to create the financial statements that will be provided to required and interested stakeholders. The accounting cycle happens every month for most companies, and requires distinct steps and cutoffs in order to create useful, consistent financial reports that managers can use to make decisions that improve the performance of the company. On a quartery and annual basis, financial statements are created for outside stakeholders as well.

Understanding the learning objectives

  • Analyze transactions by examining source documents.
  • Journalize transactions in the journal.
  • Post journal entries to the accounts in the ledger.
  • Prepare a trial balance of the accounts and complete the work sheet.
  • Prepare financial statements.
  • Journalize and post adjusting entries.
  • Journalize and post closing entries.
  • Prepare a post-closing trial balance.
  • The work sheet is a columnar sheet of paper on which accountants summarize information needed to make the adjusting and closing entries and to prepare the financial statements.
  • Work sheets may vary in format. The work sheet illustrated in the chapter has 12 columns two each for trial balance, adjustments, adjusted trial balance, income statement, statement of retained earnings, and balance sheet.
  • The information needed to prepare the income statement is in the Income Statement columns of the work sheet. Net income for the period is the amount needed to balance the two Income Statement columns in the work sheet.
  • The information needed to prepare the statement of retained earnings is in the Statement of Retained Earnings columns of the work sheet. The ending Retained Earnings balance is carried forward to the balance sheet.
  • The information needed to prepare the balance sheet is in the Balance Sheet columns of the work sheet.
  • As explained in Chapter 3, adjusting entries are necessary to bring the accounts to their proper balances before preparing the financial statements. Closing entries are necessary to reduce the balances of revenue, expense, and Dividends accounts to zero so they are ready to receive data for the next accounting period.
  • Revenue accounts are closed by debiting them and crediting the Income Summary account.
  • Expense accounts are closed by crediting them and debiting the Income Summary account.
  • The balance in the Income Summary account represents the net income or net loss for the period.
  • To close the Income Summary account, the balance is transferred to the Retained Earnings account.
  • To close the Dividends account, the balance is transferred to the Retained Earnings account.
  • Only the balance sheet accounts have balances and appear on the post-closing trial balance.
  • All revenue, expense, and Dividends accounts have zero balances and are not included in the post-closing trial balance.
  • Manual systems and computerized systems perform the same accounting functions.
  • The ease of accounting with a PC has encouraged even small companies to convert to computerized systems.
  • A classified balance sheet subdivides the major categories on the balance sheet. For instance, a classified balance sheet subdivides assets into current assets; long-term investments; property, plant, and equipment; and intangible assets. It subdivides liabilities into current liabilities and long-term liabilities. Later chapters show more accounts in the stockholders' equity section, but the subdivisions remain basically the same.
  • The current ratio gives some indication of the short-term debt-paying ability of a company.
  • To find the current ratio, divide current assets by current liabilities.