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AccountingCycle|Steps|FlowChart|Example

AccountingCycle
Accountingcycleisthefinancialprocessstartingwithrecordingbusinesstransactionsandleadinguptothe
preparationoffinancialstatements.Thisprocessdemonstratesthepurposeoffinancialaccountingtocreate
usefulfinancialinformationintheformofgeneralpurposefinancialstatements.Inotherwords,thesole
purposeofrecordingtransactionsandkeepingtrackofexpensesandrevenuesisturnthisdatainto
meaningfinancialinformationbypresentingitintheformofabalancesheet,incomestatement,statementof
owner'sequity,andstatementofcashflows.
Theaccountingcycleisasetofstepsthatarerepeatedinthesameordereveryperiod.Theculminationof
thesestepsisthepreparationoffinancialstatements.Somecompaniespreparefinancialstatementsona
quarterlybasiswhereasothercompaniespreparethemannually.Thismeansthatquarterlycompanies
completeoneentireaccountingcycleeverythreemonthswhileannualcompaniesonlycompleteone
accountingcycleperyear.

AccountingCycleSteps
Thiscyclestartswithabusinessevent.Bookkeepersanalyzethetransactionandrecorditinthegeneral
journalwithajournalentry.Thedebitsandcreditsfromthejournalarethenpostedtothegeneralledger
whereanunadjustedtrialbalancecanbeprepared.
Afteraccountantsandmanagementanalyzethebalancesontheunadjustedtrialbalance,theycanthen
makeendofperiodadjustmentslikedepreciationexpenseandexpenseaccruals.Theseadjustedjournal
entriesarepostedtothetrialbalanceturningitintoanadjustedtrialbalance.
Nowthatalltheendoftheyearadjustmentsaremadeandtheadjustedtrialbalancematchesthesubsidiary
accounts,financialstatementscanbeprepared.Afterfinancialstatementsarepublishedandreleasedtothe
public,thecompanycancloseitsbooksfortheperiod.Closingentriesaremadeandpostedtothepost
closingtrialbalance.
Atthestartofthenextaccountingperiod,occasionallyreversingjournalentriesaremadetocanceloutthe
accrualentriesmadeinthepreviousperiod.Afterthereversingentriesareposted,theaccountingcycle
startsalloveragainwiththeoccurrenceofanewbusinesstransaction.
Hereisasimplifiedsummaryofthestepsinatraditionalaccountingcycle.Sometextbookslistmoresteps
thanthis,butIliketosimplifythemandcombineasmanystepsaspossible.
Identifybusinessevents,analyzethesetransactions,andrecordthemasjournalentries
PostjournalentriestoapplicableTaccountsorledgeraccounts
Prepareanunadjustedtrialbalancefromthegeneralledger
Analyzethetrialbalanceandmakeendofperiodadjustingentries
Postadjustingjournalentriesandpreparetheadjustedtrialbalance
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AccountingCycle|Steps|FlowChart|Example

Usetheadjustedtrialbalancetopreparefinancialstatements
Closealltemporaryincomestatementaccountswithclosingentries
Preparethepostclosingtrialbalanceforthenextaccountingperiod
Preparereversingentriestocanceltemporaryadjustingentriesifapplicable

FlowChart
Afterthiscycleiscomplete,itstartsoveratthebeginning.Hereisanaccountingcycleflowchart.

Asyoucansee,thecyclekeepsrevolvingeveryperiod.Notethatsomestepsarerepeatedmorethanonce
duringaperiod.Obviously,businesstransactionsoccurandnumerousjournalentriesarerecordingduring
oneperiod.Onlyonesetoffinancialstatementsispreparedhowever.
Throughoutthissection,we'llbelookingatthebusinesseventsandtransactionsthathappentoPaul's
GuitarShop,Inc.overthecourseofitsfirstyearinbusiness.Let'stakealookathowPaulstartshis
accountingcyclebelow.

JournalEntries
TAccounts
UnadjustedTrialBalance
AdjustingEntries
AdjustedTrialBalance
FinancialStatements
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AccountingCycle|Steps|FlowChart|Example

AccountingWorksheet
ClosingEntries
IncomeSummaryAccount
PostClosingTrialBalance
ReversingEntries

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JournalEntries|Format|Example|MyAccountingCourse

JournalEntries
Journalentriesarethefirststepintheaccountingcycleand
areusedtorecordallbusinesstransactionsandeventsin
theaccountingsystem.Asbusinesseventsoccur
throughouttheaccountingperiod,journalentriesare
recordedinthegeneraljournaltoshowhowtheevent
changedintheaccountingequation.Forexample,when
thecompanyspendscashtopurchaseanewvehicle,the
cashaccountisdecreasedorcreditedandthevehicle
accountisincreasedordebited.

IdentifyTransactions
Therearegenerallythreestepstomakingajournalentry.First,thebusinesstransactionhastobeidentified.
Obviously,ifyoudon'tknowatransactionoccurred,youcan'trecordone.Usingourvehicleexampleabove,
youmustidentifywhattransactiontookplace.Inthiscase,thecompanypurchasedavehicle.Thismeansa
newassetmustbeaddedtotheaccountingequation.

AnalyzeTransactions
Afteraneventisidentifiedtohaveaneconomicimpactontheaccountingequation,thebusinesseventmust
beanalyzedtoseehowthetransactionchangedtheaccountingequation.Whenthecompanypurchasedthe
vehicle,itspentcashandreceivedavehicle.Bothoftheseaccountsareassetaccounts,sotheoverall
accountingequationdidn'tchange.Totalassetsincreasedanddecreasedbythesameamount,butan
economictransactionstilltookplacebecausethecashwasessentiallytransferredintoavehicle.

JournalizingTransactions
Afterthebusinesseventisidentifiedandanalyzed,itcanberecorded.Journalentriesusedebitsandcredits
torecordthechangesoftheaccountingequationinthegeneraljournal.Traditionaljournalentryformat
dictatesthatdebitedaccountsarelistedbeforecreditedaccounts.Eachjournalentryisalsoaccompaniedby
thetransactiondate,title,anddescriptionoftheevent.Hereisanexampleofhowthevehiclepurchasewould
berecorded.
Sincetherearesomanydifferenttypesofbusinesstransactions,accountantsusuallycategorizethemand
recordtheminseparatejournaltohelpkeeptrackofbusinessevents.Forinstance,cashwasusedto
purchasethisvehicle,sothistransactionwouldmostlikelyberecordedinthecashdisbursementsjournal.
Therearenumerousotherjournalslikethesalesjournal,purchasesjournal,andaccountsreceivablejournal.

Example
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JournalEntries|Format|Example|MyAccountingCourse

WearefollowingPaularoundforthefirstyearashestartshisguitarstorecalledPaul'sGuitarShop,Inc.
Herearetheeventsthattakeplace.
JournalEntry1Paulformsthecorporationbypurchasing10,000sharesof$1parstock.

JournalEntry2Paulfindsaniceretailstorefrontinthelocalmallandsignsaleasefor$500amonth.

JournalEntry3PGStakesoutabankloantorenovatethenewstorelocationfor$100,000andagreesto
pay$1,000amonth.Hespendsallofthemoneyonimprovingandupdatingthestore'sfixturesandlooks.

JournalEntry4PGSpurchases$50,000worthofinventorytoselltocustomersonaccountwithits
vendors.Heagreestopay$1,000amonth.

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JournalEntries|Format|Example|MyAccountingCourse

JournalEntry5PGS'sfirstrentpaymentisdue.

JournalEntry6PGShasagrandopeningandmakesitfirstsale.Itsellsaguitarfor$500thatcost$100.

JournalEntry7PGSsellsanotherguitartoacustomeronaccountfor$300.Thecostofthisguitarwas
$100.

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JournalEntries|Format|Example|MyAccountingCourse

JournalEntry8PGSpayselectricbillfor$200.

JournalEntry9PGSpurchasessuppliestousearoundthestore.

JournalEntry10Paulisgettingsobusythathedecidestohireanemployeefor$500aweek.Paymakes
hisfirstpayrollpayment.

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JournalEntries|Format|Example|MyAccountingCourse

JournalEntry11PGS'sfirstvendorinventorypaymentisdueof$1,000.

JournalEntry12Paulstartsgivingguitarlessonsandreceives$2,000inlessonincome.

JournalEntry13PGS'sfirstbankloanpaymentisdue.

JournalEntry14PGShasmorecashsalesof$25,000withcostofgoodsof$10,000.

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JournalEntries|Format|Example|MyAccountingCourse

JournalEntry15Inlieuofpayinghimself,Pauldecidestodeclarea$1,000dividendfortheyear.

Nowthatthesetransactionsarerecordedintheirjournals,theymustbepostedtotheTaccountsorledger
accountsinthenextstepoftheaccountingcycle.
Hereisanadditionallistofthemostcommonbusinesstransactionsandthejournalentryexamplestogowith
them.
SaleEntry
DepreciationExpenseEntry
AccumulatedDepreciationEntry
AccruedExpenseEntry

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SalesJournalEntry|MyAccountingCourse

SalesJournalEntry
Asalesjournalentryisajournalentryinthesales
journaltorecordacreditsaleofinventory.Allofthecash
salesofinventoryarerecordedinthecashreceiptsjournal
andallnoninventorysalesarerecordedinthegeneral
journal.
Sinceasalesjournalentryconsistsofsellinginventoryon
credit,fourmainaccountsareaffectedbythebusiness
transaction:theaccountsreceivableandrevenue
accountsaswellastheinventoryandcostofgoodssold
accounts.
Whenapieceofmerchandiseorinventoryissoldon
credit,twobusinesstransactionsneedtoberecord.First,theaccountsreceivableaccountmustincreaseby
theamountofthesaleandtherevenueaccountmustincreasebythesameamount.Thisentryrecordsthe
amountofmoneythecustomerowesthecompanyaswellastherevenuefromthesale.
Second,theinventoryhastoberemovedfromtheinventoryaccountandthecostoftheinventoryneedsto
berecorded.Soatypicalsalesjournalentrydebitstheaccountsreceivableaccountforthesalepriceand
creditsrevenueaccountforthesalesprice.Costofgoodssoldisdebitedforthepricethecompanypaidfor
theinventoryandtheinventoryaccountiscreditedforthesameprice.

SalesJournalEntryExample
LittleElectrodes,Inc.isaretailerthatsellselectronicsandcomputerparts.OnJanuary1,LittleElectrode,
Inc.sellsacomputermonitortoacustomerfor$1,000.LittleElectrode,Inc.purchasedthismonitorfromthe
manufacturerfor$750threemonthsago.Here'showLittleElectrode,Inc.wouldrecordthissalesjournal
entry.

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DepreciationJournalEntry|MyAccountingCourse

DepreciationJournalEntry
Adepreciationjournalentryisusedattheendofeach
periodtorecordthefixedassetorplantassetdepreciation
intheaccountingsystem.
Unlikejournalentriesfornormalbusinesstransactions,the
deprecationjournalentrydoesnotactuallyrecorda
businessevent.Instead,itrecordsthepassageoftimeand
theuseofanasset.
Accordingtothematchingprinciple,longtermassetsor
capitalassetscan'tbeexpensedimmediatelywhenthey
arepurchasedbecausetheirusefullifeislongerthanone
year.Thismakessensebecausethecompanywillhavea
benefitfromtheseassetsinfutureyears,sotheyshouldalsorealizeexpensesinfuturesthatmatchthe
benefits.Thatiswhycapitalassetsmustbecapitalizedanddepreciatedonasystematicandconsistent
basis.
It'sacommonmisconceptionthatdepreciationisaformofexpensingacapitalassetovermanyyears.
Depreciationisreallytheprocessofdevaluingthecapitalassetoveraperiodoftimeduetoageanduse.
Depreciationandaccumulateddepreciationshowsthecurrentvalueorbookvalueoftheusedasset.
Thedepreciationjournalentryrecordsdepreciationexpenseaswellasaccumulateddepreciation.
Depreciationexpenseisdebitedforthecurrentdepreciationamountandaccumulateddepreciationis
credited.Thedepreciationexpenseisthenpresentedontheincomestatementasanoperatingexpenseand
theaccumulateddepreciationispresentedonthebalancesheetasacontracapitalassetaccount.
Therearemanydifferentdepreciationmethodsandrates,butwewillusethestraightlinedeprecationmethod
forthisexample.Thestraightlinedepreciationmethodcomputesdepreciationexpenselikethis:depreciation
expense=(assetpurchasepricesalvagevalue)/usefullife.

DepreciationJournalEntryExample
BigJohn'sPizza,LLCboughtanewpizzaovenatthebeginningofthisyearfor$10,000.BigJohn,the
owner,estimatesthatthisovenwilllastabout10yearsandprobablywon'tbeworthanythingafter10years.
Attheendoftheyear,BigJohnwouldrecordthisdepreciationjournalentry.

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DepreciationJournalEntry|MyAccountingCourse

Depreciationfortheyearwascalculatedonthestraightlinemethod.Sincetheovenhadnosalvagevalue,
thedepreciationexpensefortheyearissimply$10,000dividedby10yearsor$1,000peryear.

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AccumulatedDepreciationJournalEntry|MyAccountingCourse

AccumulatedDepreciationJournal
Entry
Anaccumulateddepreciationjournalentryisanendofthe
yearjournalentryusedtoaddthecurrentyeardepreciation
expensetotheexistingaccumulateddepreciationaccount.
Theaccumulateddepreciationaccountrepresentsthetotal
amountofdepreciationthatthecompanyhasexpensed
overtime.Eachyearwhentheaccumulateddepreciation
journalentryisrecorded,theaccumulateddepreciation
accountisincreased.
Accumulateddepreciationisacontraassetaccount(an
assetaccountwithacreditbalance)thatadjuststhebook
valueofthecapitalassets.Soifafixedassetthatwas
purchasedfor$100,000has$90,000ofaccumulateddepreciation,thebookvalueofthisassetwouldonlybe
$10,000.
Eachyearastheaccumulateddepreciationincreases,thebookvalueofthefixedassetdecreasesuntilthe
bookvalueiszero.Inotherwords,theaccumulateddeprecationaccountcanneverbemorethantheasset
account.Intheexampleabove,accumulateddeprecationcouldneverbemorethan$100,000.Whenthe
accumulateddepreciationequalstheassetpurchaseprice,thebookvalueiszeroandtheassetcanno
longerbedepreciated.
Theaccumulateddepreciationjournalentryisrecordedbydebitingthedepreciationexpenseaccountand
creditingtheaccumulateddepreciationaccount.

AccumulatedDepreciationJournalEntryExample
ConstructionBob's,Inc.recentlypurchasedanewcarthatcost$5,000formakingdeliveriesandpickingup
newsupplies.Thiscar'susefullifeis5yearsandBobexpectsthesalvagevaluetobezero.Thecaris
depreciatedatarateof$1,000ayear.Attheendofthisyear,Bobwillrecordthisaccumulateddepreciation
journalentry.

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AccumulatedDepreciationJournalEntry|MyAccountingCourse

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AccruedExpenseJournalEntry|MyAccountingCourse

AccruedExpenseJournalEntry
Anaccruedexpensejournalentryisayearendadjustment
torecordexpensesthatwereincurredinthecurrentyear
butweren'tactuallypaiduntilthenextyear.
Thematchingprincipledictatesthatallrevenueand
expensesneedtobematchedaccordingtotheyearthey
wereearnedandincurred.Inotherwords,expenses
usuallybenefitthebusinessbyprovidingresourcesto
producerevenue.Ifanexpensewasincurredduringthe
year,itmustbematchedtotherevenuethatwascreated
fromtheexpenseduringtheyear.
Eveniftheexpensewasn'tactuallypaidduringtheyear,
theexpenseshouldberecordedwithanaccruedexpensejournalentryandmatchedwiththecorresponding
income.Expensesthatareincurredbutnotpaidarecalledaccruedexpenses.Someofthemostcommonly
accruedexpensesarerent,utilities,andpayroll.
Payrollisprobablythemostcommonaccruedexpense.Manytimestheendoftheyearfallsinbetweenpay
periods.ForexampleapayperiodmightstartonDecember24thandendonJanuary7th.Soemployees
workoneweekinDecember,buttheyaren'tpaiduntilthefollowingyear.TheamountofpayrollinDecember
shouldberecordedinDecemberwithanaccruedexpensejournalentryandaccountedforonthatyear's
incomestatement.
Theaccruedexpensejournalentrydebitstheexpenseaccountthatisbeingaccruedandcreditstheaccrued
liabilityaccount.Aliabilityisrecordedbecausethecompanystillowestheexpense.Ithasn'tpaidforityet.
Thecompanyonlyincurredtheexpense.

AccruedExpenseJournalEntryExample
Jen'sFashionBoutiqueisaretailerwiththreeemployees.Jen'sFashionBoutiquerentsasmallstorefrontin
thelocalmallfor$1,000amonthandusuallyincurs$200amonthinutilityexpenses.Jen'selectricbillisdue
onthe15thofeverymonth.AttheendofDecember,Jenhasincurred15daysworthofelectricalexpenses
butwon'tactuallypaythemuntilJanuary15th.These15daysworthofutilityexpensemustbeaccruedatthe
endoftheyear.Jen'sFashionBoutiquewouldaccrueitsutilitiesinthisaccruedexpensejournalentry.

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AccruedExpenseJournalEntry|MyAccountingCourse

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TAccounts|LedgerAccounts|Example|MyAccountingCourse

PostJournalEntriestoTAccountsor
LedgerAccounts
Oncejournalentriesaremadeinthegeneraljournalor
subsidiaryjournals,theymustbepostedandtransferredto
theTaccountsorledgeraccounts.Thisisthesecondstep
intheaccountingcycle.
Thepurposeofjournalizingistorecordthechangein
theaccountingequationcausedbyabusinessevent.
Ledgeraccountscategorizethesechangesordebitsand
creditsintospecificaccounts,somanagementcanhave
usefulinformationforbudgetingandperformance
purposes.
Sincemanagementusestheseledgeraccounts,journal
entriesarepostedtotheledgeraccountsregularly.Mostcompanieshavecomputerizedaccountingsystems
thatupdateledgeraccountsassoonasthejournalentriesareinputintotheaccountingsoftware.Manual
accountingsystemsareusuallypostedweeklyormonthly.Justlikejournalizing,postingentriesisdone
throughouteachaccountingperiod.

TAccount
LedgeraccountsusetheTaccountformattodisplaythebalancesineachaccount.Eachjournalentryis
transferredfromthegeneraljournaltothecorrespondingTaccount.Thedebitsarealwaystransferredtothe
leftsideandthecreditsarealwaystransferredtotherightsideofTaccounts.
Sincemostaccountswillbeaffectedbymultipletransactions,thereareusuallyseveralnumbersinboththe
debitandcreditcolumns.AccountbalancesarealwayscalculatedatthebottomofeachTaccount.Notice
thattheseareaccountbalancesnotcolumnbalances.Thetotaldifferencebetweenthedebitandcredit
columnswillbedisplayedonthebottomofthecorrespondingside.Inotherwords,anaccountwithacredit
balancewillhaveatotalonthebottomoftherightsideoftheaccount.
Asarefresheroftheaccountingequation,allassetaccountshavedebitbalancesandliabilityandequity
accountshavecreditbalances.Allcontraaccountshaveoppositebalances.
Sincesomanytransactionsarepostedatonce,itcanbedifficultpostthemall.Inordertokeeptrackof
transactions,IliketonumbereachjournalentryasitsdebitandcreditisaddedtotheTaccounts.Thisway
youcantraceeachbalancebacktothejournalentryinthegeneraljournalifyouhaveanyquestionslaterin
theaccountingcycle.

Example
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TAccounts|LedgerAccounts|Example|MyAccountingCourse

Let'spostthejournalentriesthatPaul'sGuitarShop,Inc.madeduringthefirstyearinbusinesstotheledger
accounts.

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TAccounts|LedgerAccounts|Example|MyAccountingCourse

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TAccounts|LedgerAccounts|Example|MyAccountingCourse

Asyoucansee,allofthejournalentriesarepostedtotheirrespectiveTaccountsandtheaccountbalances
arecalculatedonthebottomofeachledgeraccount.
Nowtheseledgerscanbeusedtocreateanunadjustedtrialbalanceinthenextstepoftheaccountingcycle.

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UnadjustedTrialBalance|Format|Preparation|Example

UnadjustedTrialBalance
Anunadjustedtrialbalanceisalistingofallthebusiness
accountsthataregoingtoappearonthefinancial
statementsbeforeyearendadjustingjournalentriesare
made.Thatiswhythistrialbalanceiscalledunadjusted.
Thisisthethirdstepintheaccountingcycle.Aftertheall
thejournalentriesarepostedtotheledgeraccounts,the
unadjustedtrialbalancecanbeprepared.

Format
Anunadjustedtrialbalanceisdisplayedinthreecolumns:a
columnforaccountnames,debits,andcredits.Accountswithdebitbalancesarelistedintheleftcolumnand
accountswithcreditbalancesarelistedontheright.
Accountsareusuallylistedinorderoftheiraccountnumber.Mostchartsofaccountsarenumbered
inbalancesheetorder,sotheunadjustedtrialbalancealsodisplaystheaccountnumbersinbalancesheet
orderstartingwiththeassets,liabilities,andequityaccountsandendingwithincomeandexpenseaccounts.
Boththedebitandcreditcolumnsarecalculatedatthebottomofatrialbalance.Aswiththeaccounting
equation,thesedebitandcredittotalsmustalwaysbeequal.Iftheyaren'tequal,thetrialbalancewas
preparedincorrectlyorthejournalentriesweren'ttransferredtotheledgeraccountsaccurately.
Aswithallfinancialreports,trialbalancesarealwayspreparedwithaheading.Typically,theheadingconsists
ofthreelinescontainingthecompanyname,nameofthetrialbalance,anddateofthereportingperiod.

Preparation
Postingaccountstotheunadjustedtrialbalanceisquitesimple.Basically,eachoneoftheaccountbalances
istransferredfromtheledgeraccountstothetrialbalance.Allaccountswithdebitbalancesarelistedonthe
leftcolumnandallaccountswithcreditbalancesarelistedontherightcolumn.That'sallthereistoit.

Example
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UnadjustedTrialBalance|Format|Preparation|Example

AfterPaul'sGuitarShop,Inc.recordsitsjournalentriesandpoststhemtoledgeraccounts,itpreparesthis
unadjustedtrialbalance.

Asyoucansee,alltheaccountsarelistedwiththeiraccountnumberswithcorrespondingbalances.In
accordancewithdoubleentryaccounting,bothofthedebitandcreditcolumnsareequaltoeachother.
Managersandaccountantscanusethistrialbalancetoeasilyassessaccountsthatmustbeadjustedor
changedbeforethefinancialstatementsareprepared.
Aftertheaccountsareanalyzed,thetrialbalancecanbepostedtotheaccountingworksheetandadjusting
journalentriescanbeprepared.

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AdjustingEntries|Types|Example|MyAccountingCourse

AdjustingEntries
Adjustingentries,alsocalledadjustingjournalentries,
arejournalentriesmadeattheendofaperiodtocorrect
accountsbeforethefinancialstatementsareprepared.This
isthefourthstepintheaccountingcycle.Adjustingentries
aremostcommonlyusedinaccordancewiththematching
principletomatchrevenueandexpensesintheperiodin
whichtheyoccur.

AdjustingEntryTypes
Therearethreedifferenttypesofadjustingjournalentries.
Eachoneadjustsincomeorexpensestomatchthecurrent
period.Thisconceptisbasedonthetimeperiodprinciplewhichstatesthataccountingrecordsandactivities
canbedividedintoseparatetimeperiods.Inotherwords,wearedividingincomeandexpensesintothe
amountsthatwereusedinthecurrentperiodanddeferringtheamountsthataregoingtobeusedinfuture
periods.

AJEsareusedtorecord:
PrepaidexpensesorunearnedrevenuesPrepaidexpensesaregoodsorservicesthathavebeenpaid
forbyacompanybuthavenotbeenconsumedyet.Insuranceisagoodexampleofaprepaidexpense.
Insuranceisusuallyprepaidatleastsixmonths.Thismeansthecompanypaysfortheinsurancebutdoesn't
actuallygetthefullbenefitoftheinsurancecontractuntiltheendofthesixmonthperiod.Thistransactionis
recordedasaprepaymentuntiltheexpensesareincurred.Thesameistrueattheendofanaccounting
period.Onlyexpensesthatareincurredarerecorded,therestarebookedasprepaidexpenses.
Unearnedrevenuesarealsorecordedbecausetheseconsistofincomereceivedfromcustomers,butno
goodsorserviceshavebeenprovidedtothem.Inthissense,thecompanyowesthecustomersagoodor
serviceandmustrecordtheliabilityinthecurrentperioduntilthegoodsorservicesareprovided.
AccruedexpensesandaccruedrevenuesManytimescompanieswillincurexpensesbutwon'thaveto
payforthemuntilthenextmonth.Utilitybillsareagoodexample.December'selectricbillisalwaysduein
January.SincetheexpensewasincurredinDecember,itmustberecordedinDecemberregardlessof
whetheritwaspaidornot.Inthissense,theexpenseisaccruedorshownasaliabilityinDecemberuntilitis
paid.
NoncashexpensesAdjustingjournalentriesarealsousedtorecordpaperexpenseslikedepreciation,
amortization,anddepletion.Theseexpensesareoftenrecordedattheendofperiodbecausetheyareusually
calculatedonaperiodbasis.Forexample,depreciationisusuallycalculatedonanannualbasis.Thus,itis
recordedattheendoftheyear.Thisalsorelatestothematchingprinciplewheretheassetsareusedduring
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AdjustingEntries|Types|Example|MyAccountingCourse

theyearandwrittenoffaftertheyareused.

RecordingAJEs
Recordingadjustingjournalentriesisquitesimple.Theprocessincludesthreemainsteps:
Determinecurrentaccountbalance
Determinewhatcurrentbalanceshouldbe
Recordadjustingentry

Theseadjustmentsarethenmadeinjournalsandcarriedovertotheaccountledgersandaccounting
worksheetinthenextaccountingcyclestep.

Example
FollowingouryearendexampleofPaul'sGuitarShop,Inc.,wecanseethathisunadjustedtrial
balanceneedstobeadjustedforthefollowingevents.
Paulpayshis$1,000JanuaryrentinDecember.

Paul'sDecemberelectricbillwas$200andisdueJanuary15th.

Paul'sleaseholdimprovementdepreciationis$2,000fortheyear.

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AdjustingEntries|Types|Example|MyAccountingCourse

OnDecember31,acustomerprepaysPaulforguitarlessonsforthenext6months.

Paul'semployeeworkshalfapayperiod,soPaulaccrues$500ofwages.

NowthatallofPaul'sAJEsaremadeinhisaccountingsystem,hecanrecordthemontheaccounting
worksheetandprepareanadjustedtrialbalance.

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AdjustedTrialBalance|Format|Preparation|Example

AdjustedTrialBalance
Anadjustedtrialbalanceisalistingofallcompany
accountsthatwillappearonthefinancialstatementsafter
yearendadjustingjournalentrieshavebeenmade.
Preparinganadjustedtrialbalanceisthefifthstepin
theaccountingcycleandisthelaststepbeforefinancial
statementscanbeproduced.

Format
Anadjustedtrialbalanceisformattedexactlylikean
unadjustedtrialbalance.Threecolumnsareusedto
displaytheaccountnames,debits,andcreditswiththedebitbalanceslistedintheleftcolumnandthecredit
balancesarelistedontheright.
Liketheunadjustedtrialbalance,theadjustedtrialbalanceaccountsareusuallylistedinorderoftheir
accountnumberorinbalancesheetorderstartingwiththeassets,liabilities,andequityaccountsandending
withincomeandexpenseaccounts.
Boththedebitandcreditcolumnsarecalculatedatthebottomofatrialbalance.Aswiththeaccounting
equation,thesedebitandcredittotalsmustalwaysbeequal.Iftheyaren'tequal,thetrialbalancewas
preparedincorrectlyorthejournalentriesweren'ttransferredtotheledgeraccountsaccurately.
Aswithallfinancialreports,trialbalancesarealwayspreparedwithaheading.Typically,theheadingconsists
ofthreelinescontainingthecompanyname,nameofthetrialbalance,anddateofthereportingperiod.

Preparation
Therearetwomainwaystoprepareanadjustedtrialbalance.Bothwaysareusefuldependingonthesiteof
thecompanyandchartofaccountsbeingused.
Youcouldpostaccountstotheadjustedtrialbalanceusingthesamemethodusedincreatingtheunadjusted
trialbalance.TheaccountbalancesaretakenfromtheTaccountsorledgeraccountsandlistedonthetrial
balance.Essentially,youarejustrepeatingthisprocessagainexceptnowtheledgeraccountsincludethe
yearendadjustingentries.
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AdjustedTrialBalance|Format|Preparation|Example

Youcouldalsotaketheunadjustedtrialbalanceandsimplyaddtheadjustmentstotheaccountsthathave
beenchanged.Inmanywaysthisisfasterforsmallercompaniesbecauseveryfewaccountswillneedtobe
altered.
Notethatonlyactiveaccountsthatwillappearonthefinancialstatementsmusttobelistedonthetrial
balance.Ifanaccounthasazerobalance,thereisnoneedtolistitonthetrialbalance.

Example
UsingPaul'sunadjustedtrialbalanceandhisadjustedjournalentries,wecanpreparetheadjustedtrial
balance.

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AdjustedTrialBalance|Format|Preparation|Example

Oncealltheaccountsareposted,youhavetochecktoseewhetheritisinbalance.Rememberthatalltrial
balances'debitandcreditsmustequal.
Nowthatthetrialbalanceismade,itcanbepostedtotheaccountingworksheetandthefinancial
statementscanbeprepared.

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FinancialStatementPreparation|Steps|Example

FinancialStatementPreparation
Preparinggeneralpurposefinancialstatementsincluding
thebalancesheet,incomestatement,statementofretained
earnings,andstatementofcashflowsisthemost
importantstepintheaccountingcyclebecauseit
representsthepurposeoffinancialaccounting.Inother
words,theconceptfinancialreportingandtheprocessof
theaccountingcyclearefocusedonprovidingexternal
userswithusefulinformationintheformoffinancial
statements.Thesestatementsaretheendproductofthe
accountingsysteminanycompany.Basically,preparing
thesestatementsiswhatfinancialaccountingisallabout.

Preparation
Preparinggeneralpurposefinancialstatementscanbesimpleorcomplexdependingonthesizeofthe
company.Somestatementsneedfootnotedisclosureswhileothercanbepresentedwithoutany.Detailslike
thisgenerallydependonthepurposeofthefinancialstatements.
Forinstance,banksoftenwantbasicfinancialstoverifytheacompanycanpayitsdebts,whiletheSEC
requiredauditedfinancialstatementsfromallpubliccompanies.
Financialstatementsarepreparedbytransferringtheaccountbalancesontheadjustedtrialbalancetoaset
offinancialstatementtemplates.Wewilldiscussthefinancialstatementforminthenextsectionofthe
course.

Example
HereisanexampleofPaul'sGuitarShop,Inc.'sfinancialstatementsbasedonhisadjustedtrialbalancein
ourpreviousexample.
Asyoucanseeallfourgeneralpurposefinancialstatementsarepreparedandpresentedhere.Paulcanuse
thesestatementsinternallytogaugetheperformanceofhisstorefortheyearorhecanissuethemtolenders
orinvestorstohelpraisefundstoexpandthestore.
Oncethestatementshavebeenprepared,Paulcanaddthefinancialstatementstotheaccounting
worksheetandclosehisbooksfortheyearbyrecordingclosingentriesinthenextaccountingcyclestep.
Thereismoretechnicalinformationabouthowtopreparefinancialstatementsinthenextsectionofmy
accountingcourse.

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AccountingWorksheet|Format|Example

AccountingWorksheet
Anaccountingworksheetisatoolusedtohelp
bookkeepersandaccountantscompletetheaccounting
cycleandprepareyearendreportslikeunadjustedtrial
balances,adjustingjournalentries,adjustedtrialbalances,
andfinancialstatements.

Format
Theaccountingworksheetisessentiallyaspreadsheet
thattrackseachstepoftheaccountingcycle.The
spreadsheettypicallyhasfivesetsofcolumnsthatstart
withtheunadjustedtrialbalanceaccountsandendwiththe
financialstatements.Inotherwords,anaccountingworksheetisbasicallyaspreadsheetthatshowsallofthe
majorstepsintheaccountingcyclesidebyside.
Eachsteplistsitsdebitsandcreditswithtotalscalculatedatthebottom.Justlikethetrialbalances,thework
sheetalsohasaheadingthatconsistsofthecompanyname,titleofthereport,andtimeperiodthereport
documents.

Example
HereiswhatPaul'sGuitarShop'syearendwouldlooklikeinaccountingworksheetformatfortheaccounting
cycleexamplesinthissection.

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AccountingWorksheet|Format|Example

Asyoucansee,theworksheetlistsallthetrialbalancesandadjustmentssidebyside.Duringtheaccounting
cycleprocess,anaccountingworksheetcanbehelpfultokeeptrackofthedifferentstepsandreduceerrors.
Itcanalsobeusedforaanalyticalandsummarytooltoshowhowaccountswereoriginallypostedtothe
ledgerandwhatadjustmentsweremadebeforetheywerepresentedonthefinancialstatements.
Isuggestusingtheaccountingworksheetforallyouryearendaccountingproblems.Itsavestimeand
maintainsaccuracyintheprocess.Hereisadownloadableexcelversionofthisaccountingworksheet
template,soyoucanuseitwithyouraccountinghomework.

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ClosingEntries|Types|Example|MyAccountingCourse

ClosingEntries
Closingentries,alsocalledclosingjournalentries,are
entriesmadeattheendofanaccountingperiodtozeroout
alltemporaryaccountsandtransfertheirbalancesto
permanentaccounts.Inotherwords,thetemporary
accountsareclosedorresetattheendoftheyear.Thisis
commonlyreferredtoasclosingthebooks.
Temporaryaccountsareincomestatementaccountsthat
areusedtotrackaccountingactivityduringanaccounting
period.Forexample,therevenuesaccountrecordsthe
amountofrevenuesearnedduringanaccountingperiod
notduringthelifeofthecompany.Wedon'twantthe2015
revenueaccounttoshow2014revenuenumbers.
Permanentaccountsarebalancesheetaccountsthattracktheactivitiesthatlastlongerthananaccounting
period.Forexample,avehicleaccountisafixedassetaccountthatisrecordedonthebalance.Thevehicle
willprovidebenefitsforthecompanyinfutureyears,soitisconsideredapermanentaccount.
Attheendoftheyear,allthetemporaryaccountsmustbeclosedorreset,sothebeginningofthefollowing
yearwillhaveacleanbalancetostartwith.Inotherwords,revenue,expense,andwithdrawalaccounts
alwayshaveazerobalanceatthestartoftheyearbecausetheyarealwaysclosedattheendofthe
previousyear.Thisconceptisconsistentwiththematchingprinciple.

ClosingEntryTypes
Temporaryaccountscaneitherbecloseddirectlytotheretainedearningsaccountortoanintermediate
accountcalledtheincomesummaryaccount.Theincomesummaryaccountisthenclosedtotheretained
earningsaccount.Bothwayshavetheiradvantages.
Closingalltemporaryaccountstotheincomesummaryaccountleavesanaudittrailforaccountantstofollow.
Thetotaloftheincomesummaryaccountafterthealltemporaryaccountshavebeencloseshouldbeequal
tothenetincomefortheperiod.
Closingalltemporaryaccountstotheretainedearningsaccountisfasterthanusingtheincomesummary
accountmethodbecauseitsavesastep.Thereisnoneedtoclosetemporaryaccountstoanothertemporary
account(incomesummaryaccount)inordertothenclosethatagain.
Bothclosingentriesareacceptableandbothresultinthesameoutcome.Alltemporaryaccountseventually
getclosedtoretainedearningsandarepresentedonthebalancesheet.

Example
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ClosingEntries|Types|Example|MyAccountingCourse

InthisexamplewewillclosePaul'sGuitarShop,Inc.'stemporaryaccountsusingtheincomesummary
accountmethodfromhisfinancialstatementsinthepreviousexample.
Therearethreegeneralclosingentriesthatmustbemade.

Closeallrevenueandgainaccounts
AllofPaul'srevenueorincomeaccountsaredebitedandcreditedtotheincomesummaryaccount.This
resetstheincomeaccountstozeroandpreparesthemforthenextyear.

Rememberthatallrevenue,sales,income,andgainaccountsareclosedinthisentry.Paul'sbusinessorhas
afewaccountstoclose.

Closeallexpenseandlossaccounts
Allexpenseaccountsarethenclosedtotheincomesummaryaccountbycreditingtheexpenseaccounts
anddebitingincomesummary.

Closealldividendorwithdrawalaccounts
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ClosingEntries|Types|Example|MyAccountingCourse

Sincedividendandwithdrawalaccountsarenotincomestatementaccounts,theydonottypicallyusethe
incomesummaryaccount.Theseaccountsarecloseddirectlytoretainedearningsbyrecordingacreditto
thedividendaccountandadebittoretainedearnings.
Nowthatallthetemporaryaccountsareclosed,theincomesummaryaccountshouldhaveabalanceequal
tothenetincomeshownonPaul'sincomestatement.NowPaulmustclosetheincomesummaryaccountto
retainedearningsinthenextstepoftheclosingentries

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IncomeSummaryAccount|Example|Closing

IncomeSummaryAccount
Theincomesummaryaccountisatemporaryaccount
usedtostoreincomestatementaccountbalances,
revenueandexpenseaccounts,duringtheclosingentry
stepoftheaccountingcycle.Inotherwords,theincome
summaryaccountissimplyaplaceholderforaccount
balancesattheendoftheaccountingperiodwhileclosing
entriesarebeingmade.
Attheendofeachaccountingperiod,allofthetemporary
accountsareclosed.Youmighthaveheardpeoplecallthis
"closingthebooks."Temporaryaccountslikeincomeand
expensesaccountskeeptrackoftransactionsfora
specificperiodandgetclosedorresetattheendofthe
period.Thiswayeachaccountingperiodstartswithazerobalanceinallthetemporaryaccounts,so
revenuesandexpensesareonlyrecordedforcurrentyears.v
Therearetwowaystoclosetemporaryaccounts.Youcaneitherclosetheseaccountsdirectlytotheretained
earningsaccountorclosethemtotheincomesummaryaccount.
Closingtemporaryaccountstotheincomesummaryaccountdoestakeanextrastep,butitalsoprovides
andanaudittrailshowingtherevenues,expenses,andnetincomefortheyear.
Oncethetemporaryaccountsareclosedtotheincomesummaryaccount,thebalancesareheldthereuntil
finalclosingentriesaremade.Thisprovidesausefulcheckforerrors.Onceallthetemporaryaccountsare
closed,thebalanceintheincomesummaryaccountshouldbeequaltothenetincomeofthecompanyforthe
year.
Thentheincomesummaryaccountiszeroedoutandtransfersitsbalancetotheretainedearnings(for
corporations)orcapitalaccounts(forpartnerships).Thistransferstheincomeorlossfromanincome
statementaccounttoabalancesheetaccount.Thisistheonlytimethattheincomesummaryaccountis
used.Fortherestoftheyear,theincomesummaryaccountmaintainsazerobalance.

Example
AfterPaul'sGuitarShoppreparesitsclosingentries,theincomesummaryaccounthasabalanceequaltoits
netincomefortheyear.Thisbalanceisthentransferredtotheretainedearningsaccountinajournalentry
likethis.

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IncomeSummaryAccount|Example|Closing

Afterthisentryismade,alltemporaryaccounts,includingtheincomesummaryaccount,shouldhaveazero
balance.
NowthatPaul'sbooksarecompletelyclosedfortheyear,hecanpreparethepostclosingtrialbalanceand
reopenhisbookswithreversingentriesinthenextstepsoftheaccountingcycle.

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PostClosingTrialBalance|Format|Example|MyAccountingCourse

PostClosingTrialBalance
Thepostclosingtrialbalanceisalistofallaccountsand
theirbalancesaftertheclosingentrieshavebeen
journalizedandpostedtotheledger.Inotherwords,the
postclosingtrialbalanceisalistofaccountsorpermanent
accountsthatstillhavebalancesaftertheclosingentries
havebeenmade.
Thisaccountslistisidenticaltotheaccountspresentedon
thebalancesheet.Thismakessensebecauseallofthe
incomestatementaccountshavebeenclosedandno
longerhaveacurrentbalance.Thepurposeofpreparing
thepostclosingtrialbalanceisverifythatalltemporary
accountshavebeenclosedproperlyandthetotaldebits
andcreditsintheaccountingsystemequalaftertheclosingentrieshavebeenmade.

Format
Anpostclosingtrialbalanceisformattedthesameastheothertrialbalancesintheaccounting
cycledisplayinginthreecolumns:acolumnforaccountnames,debits,andcredits.
Sinceonlybalancesheetaccountsarelistedonthistrialbalance,theyarepresentedinbalancesheetorder
startingwithassets,liabilities,andendingwithequity.
Aswiththeunadjustedandadjustedtrialbalances,boththedebitandcreditcolumnsarecalculatedatthe
bottomofatrialbalance.Ifthesecolumnsaren'tequal,thetrialbalancewaspreparedincorrectlyorthe
closingentriesweren'ttransferredtotheledgeraccountsaccurately.
Aswithallfinancialreports,trialbalancesarealwayspreparedwithaheading.Typically,theheadingconsists
ofthreelinescontainingthecompanyname,nameofthetrialbalance,anddateofthereportingperiod.

Preparation
Postingaccountstothepostclosingtrialbalancefollowstheexactsameproceduresaspreparingtheother
trialbalances.Eachaccountbalanceistransferredfromtheledgeraccountstothetrialbalance.Allaccounts
withdebitbalancesarelistedontheleftcolumnandallaccountswithcreditbalancesarelistedontheright
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PostClosingTrialBalance|Format|Example|MyAccountingCourse

column.
Theprocessisthesameastheprevioustrialbalances.Nowtheledgeraccountsjusthavepostclosingentry
totals.

Example
AfterPaul'sGuitarShopposteditsclosingjournalentriesinthepreviousexample,itcanpreparethispost
closingtrialbalance.

NoticethatthistrialbalancelooksalmostexactlylikethePaul'sbalancesheetexceptintrialbalanceformat.
Thisisbecauseonlybalancesheetaccountsarehavebalancesafterclosingentrieshavebeenmade.
Nowthatthepostclosingtrialbalanceispreparedandcheckedforerrors,Paulcanstartrecordingany
necessaryreversingentriesbeforethestartofthenextaccountingperiod.

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ReversingEntries|Accounting|Example|MyAccountingCourse

ReversingEntries
Reversingentries,orreversingjournalentries,arejournal
entriesmadeatthebeginningofanaccountingperiodto
reverseorcanceloutadjustingjournalentriesmadeatthe
endofthepreviousaccountingperiod.Thisisthelaststep
intheaccountingcycle.Reversingentriesaremade
becausepreviousyearaccrualsandprepaymentswillbe
paidofforusedduringthenewyearandnolongerneedto
berecordedasliabilitiesandassets.Theseentriesare
optionaldependingonwhetherornotthereareadjusting
journalentriesthatneedtobereversed.
Reversingentriesareusuallymadetosimplify
bookkeepinginthenewyear.Forexample,ifanaccrued
expensewasrecordedinthepreviousyear,thebookkeeperoraccountantcanreversethisentryand
accountfortheexpenseinthenewyearwhenitispaid.Thereversingentryerasestheprioryear'saccrual
andthebookkeeperdoesn'thavetoworryaboutit.
Ifthebookkeeperdoesn'treversethisaccrualenter,hemustremembertheamountofexpensethatwas
previouslyrecordedintheprioryear'sadjustingentryandonlyaccountforthenewportionoftheexpenses
incurred.Hecan'trecordtheentireexpensewhenitispaidbecausesomeofitwasalreadyrecorded.He
wouldbedoublecountingtheexpense.

Example
Itmightbehelpfultolookattheaccountingforbothsituationstoseehowdifficultbookkeepingcanbewithout
recordingthereversingentries.Let'slookatlet'sgobacktoyouraccountingcycleexampleofPaul'sGuitar
Shop.
InDecember,Paulaccrued$250ofwagespayableforthehalfofhisemployee'spayperiodthatwasin
Decemberbutwasn'tpaiduntilJanuary.Thisendoftheyearadjustingjournalentrylookedlikethis:

Accountingwiththereversingentry:
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ReversingEntries|Accounting|Example|MyAccountingCourse

Paulcanreversethiswagesaccrualentrybydebitingthewagespayableaccountandcreditingthewages
expenseaccount.Thiseffectivelycancelsoutthepreviousentry.

Butwait,didn'twezerooutthewagesexpenseaccountinlastyear'sclosingentries?Yes,wedid.This
reversingentryactuallyputsanegativebalanceintheexpense.You'llseewhyinasecond.
OnJanuary7th,Paulpayshisemployee$500forthetwoweekpayperiod.Paulcanthenrecordthe
paymentbydebitingthewagesexpenseaccountfor$500andcreditingthecashaccountforthesame
amount.
Sincetheexpenseaccounthadanegativebalanceof$250initfromourreversingentry,the$500payment
entrywillbringthebalanceuptopositive$250inotherwords,thehalfofthewagesthatwereincurredin
January.

Seehoweasythatis?Oncethereversingentryismade,youcansimplyrecordthepaymententryjustlike
anyotherpaymententry.

Accountingwithoutthereversingentry:
IfPauldoesnotreverselastyear'saccrual,hemustkeeptrackoftheadjustingjournalentrywhenitcomes
timetomakehispayments.SincehalfofthewageswereexpensedinDecember,Paulshouldonlyexpense
halfoftheminJanuary.
OnJanuary7th,Paulpayshisemployee$500forthetwoweekpayperiod.Hewoulddebitwagesexpense
for$250,debitwagespayablefor$250,andcreditcashfor$500.

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ReversingEntries|Accounting|Example|MyAccountingCourse

Theneteffectofbothjournalentrieshavethesameoveralleffect.Cashisdecreasedby$250.Wages
payableiszeroedoutandwagesexpenseisincreasedby$250.Makingthereversingentryatthebeginning
oftheperiodjustallowstheaccountanttoforgetabouttheadjustingjournalentriesmadeintheprioryearand
goonaccountingforthecurrentyearlikenormal.

AsyoucanseefromtheTAccountsabove,bothaccountingmethodresultinthesamebalances.Theleftset
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ReversingEntries|Accounting|Example|MyAccountingCourse

ofTAccountsaretheaccountingentriesmadewiththereversingentryandtherightTAccountsarethe
entriesmadewithoutthereversingentry.
Recordingreversingentriesisthefinalstepintheaccountingcycle.Aftertheseentriesaremade,the
accountantcanstartthecycleoveragainwithrecordingjournalentries.Thiscyclerepeatsintheexactsame
formatthroughoutthecurrentyear.

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