Completing the Accounting Cycle
Background Accounting cycle is the financial process starting with recording business transactions and leading up to the preparation of financial statements. This process demonstrates the purpose of financial accounting–to create useful financial information in the form of general-purpose financial statements. In other words, the sole purpose of recording transactions and keeping track of expenses and revenues is turn this data into meaning financial information by presenting it in the form of a balance sheet, income statement, statement of owner′s equity, and statement of cash flows. The accounting cycle is a set of steps that are repeated in the same order every period. The culmination of these steps is the preparation of financial statements. Some companies prepare financial statements on a quarterly basis whereas other companies prepare them annually. This means that quarterly companies complete one entire accounting cycle every three months while annual companies only complete one accounting cycle per year. Adjusting entries are recorded in the journal at the end of the accounting period. If a work sheet has been prepared, the data for these entries are in the Adjustments columns. Using a Work Sheet A work sheet is a multiple-column form that may be used in the adjustment process and in preparing financial statements. As its name suggests, the work sheet is a working tool. A work sheet is not a permanent accounting record; it is neither a journal nor a part of the general ledger. The work sheet is merely a device used to make it easier to prepare adjusting entries and the financial statements. In small companies with relatively few accounts and adjustments, a work sheet may not be needed. In large companies with numerous accounts and many adjustments, it is almost indispensable. [unique_solution]Closing Entries Definition Closing entries are journal entries used to empty temporary accounts at the end of a reporting period and transfer their balances into permanent accounts. The use of closing entries resets the temporary accounts to begin accumulating new transactions in the next period. Otherwise, the balances in these accounts would be incorrectly included in the totals for the following reporting period. The basic sequence of closing entries is: ü Debit all revenue accounts and credit the income summary account, thereby clearing out the balances in the revenue accounts. ü Credit all expense accounts and debit the income summary account, thereby clearing out the balances in all expense accounts. Close the income summary account to the retained earnings account. If there was a profit in the period, then this entry is a debit to the income summary account and a credit to the retained earnings account. If there was a loss in the period, then this entry is a credit to the income summary account and a debit to the retained earnings account. The net result of these activities is to move the net profit or loss for the period into the retained earnings account, which appears in the stockholders′ equity section of the balance sheet. Since the income summary account is only a transitional account, it is also acceptable to close directly to the retained earnings account and bypass the income summary account entirely. With some accounting software the closing entries are prepared and posted by selecting ″closing entries.″ With other accounting software, formal closing entries are not used. Instead, the user specifies the beginning and ending dates of the information needed. Post Closing Trial Balance Desсrіption After the closing entries are posted, all of the temporary accounts have zero balances. The post closing trial balance is a list of all accounts and their balances after the closing entries have been journalized and posted to the ledger. In other words, the post closing trial balance is a list of accounts or permanent accounts that still have balances after the closing entries have been made. This accounts list is identical to the accounts presented on the balance sheet. This makes sense because all of the income statement accounts have been closed and no longer have a current balance. The purpose of preparing the post closing trial balance is verify that all temporary accounts have been closed properly and the total debits and credits in the accounting system equal after the closing entries have been made. Merchandise Business Definition A merchandising business, sometimes called merchandisers, is one of the most common types of businesses we interact with daily. It is a business that purchases finished products and resells them to consumers. Think of the last time you went shopping for food, household items, or personal supplies. You were likely in a merchandising business. That store had purchased the items wholesale from a distributor or a manufacturer and made it available to you. While the store may have been required to purchase in large quantities, they offer the product to you in a small, personal-use size. For instance, a wholesaler may offer deodorant to a merchandising business at a large discount, but they will likely require the store to purchase hundreds, even thousands, of units to qualify for a discount. The store then offers the deodorant to you at the retail price and allows you to purchase one container. The difference in the amount you paid the store and the store paid the wholesaler is the store′s profit. The profit allows the store to stay in business and offer you products in the future. Companies who provide services are not considered merchandising businesses, unless they offer merchandise as part of their service. For instance, if you go to a tanning salon, the tanning session is considered a service. However, if the salon offers tanning lotions, creams, and tanning enhancers, it could be considered a merchandising business. A special journal is used to group similar types of transactions, such as all sales of merchandise on account, or all cash receipts. The types of special journals an enterprise uses depend largely on the types of transactions that occur frequently in its business. Most merchandising enterprises use the following journals to record transactions daily: ü Sales journal– all sales of merchandise on account. ü Cash receipts journal– all cash received (including cash sales). ü Purchases journal– all purchases of merchandise on account. ü Cash payments journal– all cash paid (including cash purchases). If the transaction cannot be recorded in a special journal, it is recorded in the general journal. For example, if you had special journals for only the four types of transactions listed, purchase returns and allowances or sales returns and allowances would be recorded in the general journal. Similarly, correcting, adjusting, and closing entries are recorded in the general journal. Other types of special journals may be used in some situations. For example, where purchase returns and allowances or sales returns and allowances are frequent, special journals may be employed to record these transactions. The journalization and posting process is illustrated using the sales journal and the cash receipts journal. The same procedures apply to all special journals with only the column and account names being different. Sales Journal The sales journal is used to record sales of merchandise on account. Cash sales of merchandise are entered in the cash receipts journal. Similarly, credit sales of assets other than merchandise are entered in the general journal. Cash Receipts Journal All receipts of cash are recorded in the cash receipts journal. The most common types of cash receipts are cash sales of merchandise and collections of accounts receivable. Many other possibilities exist, however, such as receipt of money from bank loans and cash proceeds from disposals of equipment, buildings, or land. As a result, a one-column cash receipts journal is not sufficient to accommodate all possible cash receipts transactions; therefore, a multiple-column cash receipts journal is used. Generally, a cash receipts journal includes debit columns for cash and sales discounts and credit columns for accounts receivable, sales, and ″other″ accounts. The other accounts category is used when the cash receipt does not involve a cash sale or a collection of accounts receivable. Purchase Journal A purchases journal is a special journal used to record only purchases of merchandise on account. A purchase is recorded in the purchases journal by entering the following information: 1. Date 2. Invoice number 3. Supplier (from whom purchased) 4. Dollar amount After the posting of the accounts payable ledger and general ledger is completed, the total of the accounts payable ledger balances should equal the Accounts Payable balance in the general ledger. Cash Payment Journal A cash payments journal is a special journal used to record only cash payments