chapter

4
Completing the Accounting Cycle
______________________________________________
OPENING COMMENTS
Chapter 4 opens with a review of the flow of accounting information. The text introduces the end-ofperiod spreadsheet (work sheet) as a tool for the completion of the accounting process. The text discusses the spreadsheet (work sheet) as optional, and it will be up to the individual instructor to determine if the spreadsheet will be covered in the class. The end-of-period spreadsheet (work sheet) is discussed in detail in the appendix to the chapter. The spreadsheet (work sheet) becomes the source of information used to prepare formal financial statements. The classified balance sheet is introduced. The closing process, including post-closing trial balance, is explained. The chapter continues by listing and then illustrating in detail the ten steps in the accounting cycle. This presentation provides a solid foundation for financial accounting. Chapter 4 reminds students that it is not sufficient to record adjusting entries only on the end-of-period spreadsheet. These entries must be journalized and posted to make them a part of a companys accounting records. The chapter also discusses the fiscal year and the natural business year. It ends with an explanation of how working capital demonstrates a companys solvency and how current ratio is useful when making company comparisons. After studying the chapter, your students should be able to: 1. Describe the flow of accounting information from the unadjusted trial balance into the adjusted trial balance and financial statements. 2. Prepare financial statements from adjusted account balances. 3. Prepare closing entries. 4. Describe the accounting cycle.

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5. Illustrate the accounting cycle for one period. 6. Explain what is meant by the fiscal year and the natural business year. 7. Describe and illustrate the use of working capital and the current ratio in evaluating a companys financial condition.

STUDENT FAQS
Does anyone make manual entries anymore or even keep a manual set of books? Is there a need for manual work sheets since computerized accounting packages bypass them and allow the financial reports all to be printed out after adjusting and closing entries are recorded and posted? Why do the steps in the accounting cycle have to be done in order? Can I skip or combine any of the steps in the accounting cycle? Why is Dividends not in the income statement? If you use an end-of-period spreadsheet (work sheet), why do you still have to prepare the financial statements? Isnt all the information the user needs on the spreadsheet? Why is it important to classify assets and liabilities? The total assets and liabilities do not change on a classified balance sheet versus a regular balance sheet. Isnt it more confusing to the user? Why dont we close all the accounts at year end? Why do we use the income summary account each month to clear out the revenue and expense accounts? What is the normal account balance of Income Summary? Why doesnt Income Summary appear on any financial statement? Why do we close the dividends account to the Retained Earnings account instead of to Income Summary? Wouldnt it be easier to close all the temporary accounts to Income Summary and then close Income Summary to Retained Earnings since the ending balance in the Retained Earnings account will be the same either way? Why do we list each expense and revenue during the closing process? Wouldnt it be easier to debit a generic revenue account for all revenues and credit a generic expense account for all expenses? Who or what kind of organizations are most interested in a companys current ratio?

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4 Completing the Accounting Cycle

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IN-CLASS AND HOMEWORK ASSIGNMENT CHART

Number DQ4-1 DQ4-2 DQ4-3 DQ4-4 DQ4-5 DQ4-6 DQ4-7 DQ4-8 DQ4-9 DQ4-10 PE4-1A PE4-1B PE4-2A PE4-2B PE4-3A PE4-3B PE4-4A PE4-4B PE4-5A PE4-5B PE4-6A Objective 4-1 4-2 4-2 4-3 4-3 4-3 4-4 4-4 4-6 4-6 4-1 4-1 4-2 4-2 4-2 4-2 4-3 4-3 4-4 4-4 4-7 Description Difficulty Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Time 5 min 5 min 5 min 5 min 5 min 5 min 5 min 5 min 5 min 5 min 5 min 5 min 5 min 5 min 5 min 5 min 5 min 5 min 5 min 5 min 5 min AACSB Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic AICPA FN-Measurement FN-Measurement FN-Measurement FN-Measurement FN-Measurement FN-Measurement FN-Measurement FN-Measurement BB-Industry BB-Industry FN-Measurement FN-Measurement FN-Measurement FN-Measurement FN-Measurement FN-Measurement FN-Measurement FN-Measurement FN-Measurement FN-Measurement FN-Measurement SS GL

Flow of accounts into financial statements Flow of accounts into financial statements Retained Earnings Statement Retained Earnings Statement Classified balance sheet Classified balance sheet Closing entries Closing entries Accounting cycle Accounting cycle Working capital and current ratio

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Number PE4-6B Ex4-1 Ex4-2 Ex4-3

Objective 4-7 4-1, 4-2 4-1, 4-2 4-1, 4-2

Description Working capital and current ratio Flow of accounts into financial statements Classifying accounts Financial statements from the end-of-period spreadsheet

Difficulty Easy Easy Easy Moderate

Time 5 min 5 min 5 min 15 min

AACSB Analytic Analytic Analytic Analytic

AICPA FN-Measurement FN-Measurement FN-Measurement FN-Measurement

SS

GL

Ex4-4

4-1, 4-2

Ex4-5 Ex4-6 Ex4-7 Ex4-8 Ex4-9 Ex4-10 Ex4-11 Ex4-12 Ex4-13 Ex4-14 Ex4-15 Ex4-16 Ex4-17 Ex4-18 Ex4-19 Ex4-20 Ex4-21 Ex4-22 Ex4-23

4-2 4-2 4-2 4-2 4-2 4-2 4-2 4-2 4-2 4-3 4-3 4-3 4-3 4-3 4-3 4-4 4-7 4-7 Appendix

Financial statements from the end-of-period spreadsheet Income statement Income statement; net loss Income statement Retained Earnings Statement Retained Earnings Statement Classifying assets Balance sheet classification Balance sheet Balance sheet Identifying accounts to be closed Closing entries Closing entries with net income Closing entries with net loss Identifying permanent accounts Post-closing trial balance Steps in the accounting cycle Working capital and current ratio Working capital and current ratio Completing an end-ofperiod spreadsheet (work sheet) Adjustment data on an end-of-period spreadsheet (work sheet) Completing an end-ofperiod spreadsheet (work sheet) Financial statements from an end-of-period spreadsheet (work sheet) Adjusting entries from an end-of-period spreadsheet (work sheet)

Moderate

15 min

Analytic

FN-Measurement

Easy Easy Easy Moderate Moderate Easy Easy Moderate Moderate Easy Easy Moderate Easy Easy Moderate Moderate Moderate Moderate Moderate

10 min 10 min 10 min 10 min 10 min 5 min 5 min 10 min 15 min 5 min 5 min 10 min 10 min 5 min 10 min 10 min 10 min 10 min 10 min

Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic

FN-Measurement FN-Measurement FN-Measurement FN-Measurement FN-Measurement FN-Measurement FN-Measurement FN-Measurement FN-Measurement FN-Measurement FN-Measurement FN-Measurement FN-Measurement FN-Measurement FN-Measurement FN-Measurement FN-Measurement FN-Measurement FN-Measurement

Ex4-24

Appendix

Moderate

15 min

Analytic

FN-Measurement

Exl

Ex4-25

Appendix

Moderate

15 min

Analytic

FN-Measurement

Exl

Ex4-26

Appendix

Moderate

15 min

Analytic

FN-Measurement

Exl

Ex4-27

Appendix

Easy

10 min

Analytic

FN-Measurement

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Number Ex4-28

Objective Appendix

Pr4-1A Pr4-2A Pr4-3A

4-1, 4-2, 4-3 4-2, 4-3 4-2, 4-3

Pr4-4A

4-2, 4-3

Pr4-5A

4-2, 4-3

Pr4-6A Pr4-1B Pr4-2B Pr4-3B

4-4, 4-5 4-1, 4-2, 4-3 4-2, 4-3 4-2, 4-3

Description Appendix: Closing entries from an end-of-period spreadsheet (work sheet) Financial statements and closing entries Financial statements and closing entries T accounts, adjusting entries, financial statements, and closing entries; optional end-ofperiod spreadsheet (work sheet) Ledger accounts, adjusting entries, financial statements, and closing entries; optional end-of-period spreadsheet (work sheet) Ledger accounts, adjusting entries, financial statements, and closing entries; optional spreadsheet (work sheet) Complete accounting cycle Financial statements and closing entries Financial statements and closing entries T accounts, adjusting entries, financial statements, and closing entries; optional end-ofperiod spreadsheet (work sheet) Ledger accounts, adjusting entries, financial statements, and closing entries; optional end-of-period spreadsheet (work sheet) Ledger accounts, adjusting entries, financial statements, and closing entries; optional end-of-period spreadsheet (work sheet) Complete accounting cycle Continuing Problem Transactions adjustments, financial statements, closing entries, postclosing trial balance Ethics and professional conduct in business Financial statements

Difficulty Moderate

Time 10 min

AACSB Analytic

AICPA FN-Measurement

SS

GL

Moderate Moderate Moderate

1 hr 1 hr 2 1/4 hr

Analytic Analytic Analytic

FN-Measurement FN-Measurement FN-Measurement

Exl Exl

GL

GL

Difficult

2 1/2 hr

Analytic

FN-Measurement

Exl

Difficult

2 1/2 hr

Analytic

FN-Measurement

GL

Difficult Moderate Moderate Moderate

3 hr 1 hr 1 hr 2 1/4 hr

Analytic Analytic Analytic Analytic

FN-Measurement FN-Measurement FN-Measurement FN-Measurement

Exl Exl GL

GL

Pr4-4B

4-2

Difficult

2 1/2 hr

Analytic

FN-Measurement

Exl

Pr4-5B

4-2, 4-3

Difficult

2 1/2 hr

Analytic

FN-Measurement

GL

Pr4-6B MD-4 Comp Problem 1

4-4, 4-5

Difficult

3 hr

Analytic

FN-Measurement

Exl GL GL

4-1, 4-2, 4-3, 4-4

Difficult

3 hr.

Analytic

FN-Measurement

CP4-1 CP4-2

4-2 4-4

Easy Moderate

5 min 10 min

Ethics Technology

BB-Industry BB-Leveraging

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Number CP4-3 CP4-4

Objective 4-1, 4-4 4-2

Description Financial statements Compare balance sheets

Difficulty Moderate Moderate

Time 15 min 30 min

AACSB Reflective Thinking Reflective Thinking

AICPA Technology BB-Critical Thinking BB-Critical Thinking

SS

GL

OBJECTIVE 1
Describe the flow of accounting information from the unadjusted trial balance into the adjusted trial balance and financial statements.

SUGGESTED APPROACH
This objective reviews the flow of accounting information. It provides an opportunity to review the material discussed in Chapters 13 and explain that many of the ten steps of the accounting cycle, discussed later in Chapter 4, have already been discussed in those first three chapters. Exhibit 1 shows the relationship between the end-of-period spreadsheet (work sheet) and financial statements. The text discusses the end-of-period spreadsheet (work sheet) as an optional tool to assist the accountant in the completion of accounting cycle. Some instructors may choose to skip the end-of-period spreadsheet due to the automation of the process through computerized accounting software packages that automatically complete this process. The end-of-period spreadsheet, regardless of its usefulness in the real world, provides the student with an insight to the process that is required to complete the accounting cycle. The spreadsheet also provides a valuable visual overview of the process from unadjusted trial balance, through the adjusting process, to adjusted trial balance and to the preparation of financial statements. This knowledge of what actually goes into completing the accounting cycle is invaluable to the students understanding of the entire accounting cycle. Should you choose to include the end-of-period spreadsheet (work sheet) as part of the learning process, you may want to move to the appendix and cover the detailed material included there for the completion of the spreadsheet.

WRITING EXERCISEBenefits of the End-of-Period Spreadsheet (Work Sheet)

Ask your students to read and answer the following case (also shown on Transparency Master [TM] 410). Keith Martin is the controller for Daniels Printing Service. Keith has been putting in a lot of overtime; therefore, Mr. Daniels has allowed Keith to hire an assist ant. Keiths assistant is a bright, high-school graduate, but he has never taken an accounting class. Keith is trying to decide which accounting activities could be delegated to his assistant. Keith is willing to give the assistant a few simple instructions on how to complete each task, but he doesnt have the time to teach the assistant to be an accountant. For each task listed, state whether Keith should continue to do the work or delegate the task to his assistant. Explain each answer.

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1. List the account balances from the general ledger in the Trial Balance columns of the end-ofperiod spreadsheet. 2. Add the Debit and Credit columns of the trial balance. 3. Make the adjusting entries on the spreadsheet. 4. Complete the spreadsheet. 5. Type the formal financial statements using the data from the Income Statement and Balance Sheet columns of the spreadsheet. 6. Journalize and post the adjusting entries. Possible response: Tasks 1 and 2 are tasks that could possibly be delegated to the assistant. With little instruction, the assistant could copy the accounts and the balances in a trial balance format. Adding the debit and credit columns are also tasks suited for the assistant. After the assistant is comfortable with these tasks, completing the work sheet (not adjusting entries, but from the adjusted trial balance to the income statement and balance sheet columns) could be trusted to an assistant with some training and supervision. Since final accuracy and completion of all tasks resides with the controller, close supervision is recommended.

OBJECTIVE 2
Prepare financial statements from adjusted account balances.

KEY TERMS
Current Assets Current Liabilities Fixed (Plant) Assets Long-Term Liabilities Notes Receivable

SUGGESTED APPROACH
If the instructor has elected to use the end-of-period spreadsheet (work sheet), the group learning activity used to explain the appendix will yield a completed spreadsheet. Use that spreadsheet to prepare financial statements. If the end-of-period spreadsheet (work sheet) discussion is not planned, the financial statements can be prepared from the information found on the adjusted trial balance. Before preparing financial statements, however, you will need to explain account classifications. Optional discussion: International Financial Reporting Standards (IFRSs). You may want to mention that while financial statements prepared for companies from different countries may appear different from those prepared for U.S. companies, the basic principles underlying the accounting equation are the same.

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GROUP LEARNING ACTIVITYPreparing Financial Statements

To complete this activity, you can either break the class into small groups or ask each student to work individually. Ask the students to list all the asset and liability accounts they can think of. Give the students two to three minutes to complete their lists. Ask the students to call out the accounts on their lists as you write them on the board. Next, explain the following account classifications: Current Assets Property, Plant, and Equipment Current Liabilities Long-Term Liabilities Instruct your students to go back to the accounts on their lists and indicate where each account would be classified on a balance sheet: current assets; property, plant, and equipment; current liabilities; or longterm liabilities. After giving the students a minute or two to work, list the proper classification for each account on the board. Next, using the end-of-period spreadsheet (work sheet) from the appendix or an adjusted trial balance, ask the students to prepare formal financial statements. You may want to show your students TM 4-7 to guide them through the process of preparing financial statements. The completed financial statements are displayed on TMs 4-8 and 4-9. If time allows, compare these financial statements to the real-world financial statements found in Appendix C of the text. Students need to be reminded that writing adjusting entries on the end-of-period spreadsheet does not make the entries a part of the companys accounting records. The only way to get adjustments on the books is to journalize and post these entries.

GROUP LEARNING ACTIVITYJournalizing Adjusting Entries

At this point, the students will have a completed end-of-period spreadsheet (work sheet). Ask the students to break into groups and record the adjusting entries in journal format. If the end-of-period spreadsheet approach is not included, the students must still understand that adjusting entries need to be journalized and posted prior to the completion of financial statements.

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OBJECTIVE 3
Prepare closing entries.

KEY TERMS
Clearing Account Closing Entries Closing Process Closing the Books Income Summary Real (Permanent) Accounts Temporary (Nominal) Accounts

SUGGESTED APPROACH
Understanding closing entries tends to be a real struggle for students. All too frequently, students resort to memorizing the mechanics of closing entries without understanding the purpose of this step in the accounting cycle. As a result, the instructor may want to introduce this topic with a few attention-getting exercises that attempt to explain why closing entries are prepared. As a next step, try a group learning activity that allows students to discover the mechanics of preparing closing entries. End the class with a short writing exercise to summarize why and how closing entries are prepared.

LECTURE AIDPurpose of Closing Entries

Bring a stopwatch to class. Ask for a student volunteer who knows how to run a stopwatch. Instruct your volunteer to time a few students completing a simple activity. For example, you may want to time how long it takes the first row in your classroom to pass out Handout 4-2, which will be used in the next group learning activity, to all the students in that row. Then time the next row in your class. Ask the student volunteer to write the time for each row on the board. Next, ask the student volunteer to explain how he or she timed each row. As part of that students explanation, he or she should mention that after timing each row, the stopwatch had to be reset to zero. Discuss the problems that would have resulted if the student had neglected to reset the stopwatch to zero. Because the information we wanted from the exercise was how long it took each row to distribute the papers, it was important to time each row separately and reset the stopwatch after each row performed the task. In business, we want to know how much income a business earns during the course of one year. Therefore, we record revenues and expenses for the year and prepare an income statement. Before we begin recording revenues and expenses for the second year, however, we must reset each of the revenue and expense accounts to a zero balance, just as the stopwatch was reset. The dividend account is also reset to a zero balance. The process of getting these accounts to a zero balance is accomplished through closing entries.

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GROUP LEARNING ACTIVITYClosing Entries

Before beginning this exercise, review the purpose of closing entries. One primary concern in closing entries is to reset the revenue, expense, and dividend accounts (the temporary or nominal accounts) to a zero balance. The second purpose of closing entries is to move the balance of all revenue, expense, and dividend accounts to the retained earnings account. Remind students that in Chapter 1, all revenue, expense, and dividend transactions affected the stockholders equity. In Chapter 2, students began recording these transactions in separate accounts to make it easier to prepare financial statements. Now it is time to move those transactions back to the stockholders equity through the retained earnings account . Be sure your students can identify nominal (or temporary) and real (or permanent) accounts. Ask them to turn to the completed end-of-period spreadsheet (work sheet) (Exhibit 1) in the textbook. From that exhibit, quiz students on which accounts will be closed at the end of the accounting period and which will be left open. Ask your students to break into groups of three or four and, using Handout 4-2, Part A, prepare entries that will zero-out the revenue, expense, and dividend accounts and move their balances to the Retained Earnings account. Remind students that they must keep debits and credits equal in all entries. If some groups finish early, ask them to practice preparing financial statements by constructing an income statement and a Retained Earnings Statement for this company. Review the exercise with the class, using TM 4-11. Next, compute the balance of the Retained Earnings account. Show your students that the account balance equals the ending Retained Earnings balance shown on a Retained Earnings statement (TM 4-12). At this time, explain the purpose of Income Summary. When preparing closing entries, accountants first move the balances of all revenue and expense accounts to Income Summary. If all revenue and expense accounts are correctly transferred to Income Summary, the accounts balance should equal net income. After verifying that the account balance does equal net income, Income Summary is closed to the retained earnings account. Therefore, the income summary account is used simply to check the accuracy of the closing entries, similar to a trial balance being used to check the equality of debits and credits after preparing journal entries and posting. Emphasize that the income summary account does not appear on financial statements. Instruct the class to use Part B of Handout 4-2 to prepare the closing entries in the actual format used by accountants. The following instructions will guide them in the proper order to prepare the entries: a) Close the revenue account to Income Summary. b) Close the expense accounts to Income Summary. c) Make sure that the balance in Income Summary equals net income. If it doesnt, correct entries from a or b. d) Close Income Summary to Retained Earnings.

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e) Close the dividends account to Retained Earnings. Review these entries using TM 4-13. Stress that the dividend account is not closed to Income Summary, since it is not included when calculating net income. Instead, the dividend account is closed directly to Retained Earnings. After completing T account entries, you may want to ask your students to prepare these same entries in journal entry format. Review with students that like adjusting entries, closing entries are journalized and posted to the general ledger to assure the account balances are correct prior to starting a new financial period.

LECTURE AIDClosing Entries

You can also illustrate closing entries with a visual example using five cups and paper clips. Label each of the five cups with one of the following titles: Revenues, Expenses, Income Summary, Dividend, and Retained Earnings. Styrofoam cups work well because you can write on them with an ink pen. Next, place a few paper clips in each cup. Illustrate closing entries by pouring the paper clips from the Revenue cup into the Income Summary cup. Emphasize that the Revenue cup is now closed (empty) because its contents were transferred to the Income Summary cup. Repeat the same process for the Expenses cup. Now, explain to your students that the analogy is not perfect because the revenue paper clips are positive clips and the expense paper clips are negative. But, in effect, the Income Summary cup now holds the net income. Pour the contents of the Income Summary cup into the Retained Earnings cup, illustrating the transfer of net income to the Retained Earnings account. Finally, pour the paper clips from the Dividend cup into the Retained Earnings cup. Emphasize that all the cups except Retained Earnings are now empty (closed). You can also reinforce that the Retained Earnings account is not closedthe contents of all the other cups were transferred there. Reinforce the fact that the revenue, expense, dividends, as well as the income summary accounts are temporary accounts that get zeroed out in the closing process, while the Retained Earnings account is a permanent account that resides on the balance sheet and the balance is updated as part of the closing process. Net income and the dividend amount for the year are transferred to the Retained Earnings account and reflect the Retained Earnings statement. Retained Earnings per the Retained Earnings statement and the balance of the Retained Earnings account after the closing process is complete should match if the closing process is completed correctly.

WRITING EXERCISEClosing Entries

After discussing closing entries, ask your students to write answers to the following questions (also shown on TM 4-14). 1. Why are closing entries prepared?

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2. Why do we use Income Summary when preparing closing entries? 3. Why are closing entries prepared after financial statements? 4. What are some examples of temporary accounts that would be closed for a physician?

Possible answers: 1. Closing entries are prepared to reset the temporary account balances to zero. This reset will assure that the upcoming financial period will accurately reflect the activity of the period and not erroneously report revenue or expenses that actually occur in previous accounting periods. It facilitates adherence to the matching principle. 2. The income summary account is used as a clearing account and provides a balance check prior to transferring net income to the Retained Earnings account. Closing revenue and expense accounts to income summary will result in a balance equal to net income (or net loss) for the period. If the balance after step two is not equal to net income (or net loss), then a mistake has been made in closing either the revenue or expense accounts. Closing revenue and expenses directly to the Retained Earnings account would not provide this check in the process. 3. If the income statement accounts (temporary or nominal accounts) are closed prior to financial statements, then no revenue or expense accounts would have a balance and therefore no net income would be reported. 4. Temporary revenue accounts could include office exam fees, hospital visit fees, or surgery fees. Temporary expense accounts could include medical staff wages expense, administrative staff wages expense, rent expense, utilities expense, and others. Dont forget the Dividend account.

LECTURE AIDPost-Closing Trial Balance

Remind your students that a post-closing trial balance is a trial balance prepared after closing entries. The post-closing trial balance is prepared to make sure that the ledger is in balance to start the next accounting period. You may want to refer your students to an example of a post-closing trial balance by turning to Exhibit 7 in the text. Pose the following questions to stimulate class discussion: 1. What three classes of accounts will not appear on a post-closing trial balance? Answer: revenues, expenses, and dividend. 2. What accounts will appear on a post-closing trial balance? Answer: assets, liabilities, and capital stock/retained earnings. 3. If a temporary account was overlooked in the closing process, would the post-closing trial balance still balance? Answer: Yes, but the balance of the retained earnings account would not agree with the amount shown on the balance sheet.

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OBJECTIVE 4
Describe the accounting cycle.

KEY TERMS
Accounting Cycle

SUGGESTED APPROACH
Rather than simply memorizing the ten steps in their proper order, it is helpful if students understand the relationships between the steps in the accounting cycle. Students will not make the mistake of listing Financial statements prepared before completing the end-of-period spreadsheet (work sheet) if they understand that the spreadsheet provides the data necessary to prepare financial statements. Therefore, you may want to use the activities described below after covering the end-of-period spreadsheet and closing entries (learning objectives 1 through 3). Emphasize that the accounting cycle is the same for all businesses, no matter how complex or how simple. The accounting cycle is repeated each period in which financial statements are prepared.

GROUP LEARNING ACTIVITYAccounting Cycle

Show your class TM 4-1, which lists the steps in the accounting cycle in random order. Ask students to put the steps in the proper order. You can ask them to work individually or in small groups. TM 4-15 lists the steps in the accounting cycle in the correct order.

WRITING EXERCISEAccounting Cycle

Write the ten steps of the accounting cycle on the board or display TM 4-15. Ask your students to record what information is needed as an input to each step in the accounting cycle. For example, source documents are needed in order to analyze transactions and record them in journals (step 1). Completed journal entries are needed to post transactions to the ledger (step 2). After giving the students a few minutes to write, review the inputs needed for each step. Show students that knowing what information is needed to complete each step in the accounting cycle will make it easy to put the steps in the proper order. Possible answers: 1. and 2. Provided above. 3. The unadjusted trial balance requires that steps 1 and 2 are completed and the account names and balances are obtained from the general ledger. 4. Although adjustment data for the student is provided, the accountant would need to examine the various accounts to determine which ones require adjustments and the amount to be adjusted. Once the adjustment accounts have been identified, these tend to repeat in subsequent financial periods.

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5. The optional spreadsheet requires data from the unadjusted trial balance and the adjustment data in order to start and complete the spreadsheet. 6. Step 6 requires the input from step 4 to complete. If the end-of-period spreadsheet is completed, the adjusting data can be taken from the spreadsheet in order to journalize the adjustments. The posting of the adjustments is a required step. 7. The adjusted trial balance requires that step 6 be completed. The data is then obtained from the general ledger once the adjusting data has been posted to update the account balances. If the optional end-ofperiod spreadsheet is completed, this step maybe skipped since the spreadsheet contains an adjusted trial balance as part of the completion process. 8. Financial statements are prepared using the data from the adjusted trial balance or the optional spreadsheet. 9. Closing data are obtained from the general ledger, trial balance, or spreadsheet. Temporary accounts are closed in the process described earlier. 10. Post-closing trial balance is completed once the closing process is finalized. The accounts and their balances can be found in the general ledger once all closing entries are posted. All temporary accounts should have zero balances. Only permanent (balance sheet) accounts will have a positive balance; therefore, the post-closing trial balance will include only asset, liability and the capital stock/retained earnings accounts. Each step in the process depends on the previous step in order to obtain the necessary information to complete the subsequent step. The optional spreadsheet can consolidate and simplify the process; however, it does not eliminate the requirements of recording and updating the general ledger using the journalizing and posting process.

OBJECTIVE 5
Illustrate the accounting cycle for one period.

SUGGESTED APPROACH
After defining and working with the accounting cycle in Objective 3, you may wish to select PR 4-6A or PR 4-6B and work it through using the Excel templates provided in the instructor resources. This will allow the student to see the entire accounting cycle demonstrated at one time. A word of caution: This problem is rather lengthy and could take an entire class period to complete. Nevertheless, it is a valuable review to demonstrate to the students all the foundation materials that have been covered in Chapters 1-4.

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OBJECTIVE 6
Explain what is meant by the fiscal year and the natural business year.

KEY TERMS
Fiscal Year Natural Business Year

SUGGESTED APPROACH
Objective 6 asks students to understand the definitions of fiscal year and natural business year, not just to memorize these definitions. Therefore, the instructor must get the student to internalize these concepts.

LECTURE AIDFiscal Year

To begin this exercise, explain the definitions of fiscal year and natural business year. Then ask students who work either full- or part-time to raise their hands. Call on one of these students and ask where he or she works. Next, ask the student at what time of the year the company is at the end of its natural business year (e.g., when stocks are lowest; prices are normal; the company is not buying heavily). Ask the student whether he or she knows when the company closes its fiscal year. If the student doesnt know, ask when the company takes a physical inventory count. That may provide a clue. Repeat the same exercise with several other students. Use the following examples to help students understand why the fiscal business year may vary from the calendar year. First, ask students if they would like to be taking inventory and working through the accounting cycle financial statements closing process the week of Christmas. For retail stores, this is typically a high volume sales time with after-Christmas sales, returns, and exchanges. Explain that a retail store will typically choose the slowest time of the year, when inventory levels are low and sales are slow, to complete this process. A second example for demonstration purposes is a ski resort. Ski resorts busy season is in the winter, when there is snow. A secondary busy season might be summer for hiking and fishing. Ski resorts slow time is typically in the spring, when snow is melting and the slopes are a muddy mess. This is the time a ski resort would choose to complete the accounting cycle.

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OBJECTIVE 7
Describe and illustrate the use of working capital and the current ratio in evaluating a companys financial condition.

KEY TERMS
Current Ratio Liquidity Solvency Working Capital

SUGGESTED APPROACH
To help students understand these terms, make it personal. For example, for liquidity, ask them to imagine being offered the deal of a lifetime but the opportunity is available only for the next hour. What is the first item they possess that comes to mind that would be easiest to use to pay for the deal? For those who have cash in the bank, a quick trip to the ATM would seal the deal or selling something very popular among their peers could work. Which items would take more time to sell and thus convert to cash? Probably more expensive items. Tie solvency to working capital by asking students that if they had to pay their current obligations in a timely manner, could they do it? They should think about their current sources of cash (job, allowance from parents, etc.) and their current bills (rent, utilities, school supplies, etc.). Ask students to consider why current ratio is more indicative of how a companys ability to meet its current obligations compares to its industry average than only knowing the value of its current assets and liabilities.

APPENDIXEnd-of-Period Spreadsheet (Work Sheet)

If you elect to include the end-of-period spreadsheet (work sheet) in the curriculum, you may want to include this discussion early in the chapter material.

GROUP LEARNING ACTIVITYPreparing an End-of-Period Spreadsheet (Work Sheet)

TM 4-2 presents information that can be used in explaining the purpose of the end-of-period spreadsheet (work sheet). After reviewing this material, use TM 4-3 to explain how to complete the columns of the spreadsheet. You may want to instruct your students to turn to the end-of-period spreadsheet illustrated in the text while you review this information. Point out that it is not necessary to prepare a separate trial

Chapter 4

Completing the Accounting Cycle

71

balance if an end-of-period spreadsheet is used. You may also want to emphasize that the adjusted trial balance columns are a check on the mathematical accuracy of the spreadsheet. It is helpful to allow your students to practice completing an end-of-period spreadsheet. The following group learning activity will assist in accomplishing this goal. Handout 4-1 is an end-of-period spreadsheet (work sheet) for Dixie Machinery. The Trial Balance columns have been completed using account balances from the companys ledger. Make copies of this handout for each of your students. Divide the class into small groups and instruct them to enter the adjusting entries from TM 4-4 on the spreadsheet. Also ask them to complete the Adjusted Trial Balance columns. At this point, display TM 4-5, which shows the first three columns of the completed spreadsheet. After your students have checked their work, instruct them to complete the income statement and balance sheet columns by sorting the account balances to the proper financial statement. TM 4-6 shows the adjusted trial balance, income statement, and balance sheet columns. The net income is not illustrated on this TM. This gives you the opportunity to complete that step for your students on the TM. Fill in these columns as follows: Income Statement Debit Credit 11,290 15,140 3,850 15,140 15,140 Balance Sheet Debit Credit 7,400 3,550 3,850 7,400 7,400

Total of Accounts Net Income

Check your students understanding of using the end-of-period spreadsheet to compute net income by asking the following questions: 1. If the totals of the Income Statement columns of a spreadsheet are Debit, $2,800 and Credit, $2,500, what is the net income or net loss? Answer: Net loss, $300. 2. If the totals of the Balance Sheet columns of a spreadsheet are Debit, $1,250 and Credit, $1,110, what is the net income or net loss? Answer: Net income, $140. Once the spreadsheet is completed, it may be beneficial to have students complete financial statements from the data on the spreadsheet. This will help them understand that the purpose of the spreadsheet is to provide a tool that will assist the preparer in getting from an unadjusted trial balance to producing financial statements in a very efficient manner. Remind them that using the spreadsheet does not excuse the requirement to journalize and post adjusting entries in order to make sure the general ledger account balances are accurate.

Handout 4-1 A 1 2 3 4 5 6 Account Title 7 Cash 8 Accounts Receivable 9 Prepaid Insurance 10 Office Equipment 11 Acc. Depr.Office Equip. 12 Accounts Payable 13 Salaries Payable 14 Capital Stock 15 Dividends 16 Repair Revenue 17 Salaries Expense 18 Rent Expense 19 Utilities Expense 20 Insurance Expense 21 Depr. Exp.Office Equip. 22 23 24 25 26 27 28 29 30 E F G Dixie Machinery End-of-Period Spreadsheet (Work Sheet) For the Year Ended December 31, 20-Unadjusted Adjusted Trial Balance Adjustments Trial Balance Dr. Cr. Dr. Cr. Dr. Cr. 825 300 500 5,050 180 250 2,370 1,100 15,140 8,025 1,500 640 B C D H I J K

Income Statement Dr. Cr.

Balance Sheet Dr. Cr.

17,940

17,940

Handout 4-2

CLOSING ENTRIES
Part AMake entries that will bring the revenue, expense, and dividend accounts to a zero balance. Do this by moving the balance of each account to the Retained Earnings account. After you have completed your entries, compute the balance of the Retained Earnings account.

Service Revenue 3,500

Salaries Expense 1,400

Rent Expense 600

Dividends 1,200

Retained Earnings

Capital Stock 10,000

Part BPrepare closing entries in the format used by accountants. To do this, close the revenue, expense, and dividend accounts in the following order: (a) (b) (c) (d) (e) Close the revenue account to Income Summary. Close the expense accounts to Income Summary. Make sure that the balance in Income Summary equals net income. If it doesnt, correct entries from (a) or (b). Close Income Summary to Retained Earnings. Close the dividend account to Retained Earnings.

After you have completed all the entries, compute the balance in the Retained Earnings account.

Service Revenue 3,500

Salaries Expense 1,400

Rent Expense 600

Dividends 1,200

Income Summary

Retained Earnings