Chapter 4—Completion of the Accounting Cycle



Chapter 4—Completion of the Accounting Cycle

Study Objectives:

1. Prepare a work sheet.

2. Explain the process of closing the books.

3. Describe the content and purpose of a post-closing trial balance.

4. State the required steps in the accounting cycle.

5. Explain the approaches to preparing correcting entries.

6. Identify the sections of a classified balance sheet

I. USING A WORK SHEET

A. WORK SHEET FORM AND PROCEDURE: the 10-column Work Sheet (an informal working paper used by the accountant to organize data for the financial statements and lessen the possibility of overlooking an adjustment) has 5 steps to prepare it where each step must be performed in the prescribed sequence. The first two columns show the Trial Balance. When a Work Sheet is used, it is not necessary to prepare a separate trial balance to test the equality of the debits and the credits of the ledger account balances because this is done on the first two columns of the work sheet. Once the accounts are all presented in the work sheet format, it makes it easier to determine what accounts need to be adjusted. Note the columns shown on the work sheet as follows:

|Name of the Company |

|Work Sheet |

|For the Period Ended Month, Day, Year |

|Account |Trial Balance |Adjustments |Adj. Trial Balance |Income Statement |Balance Sheet |

|Titles | | | | | |

| |

|Work Sheet |

|For the Month Ended October 31, 20-- |

|Account Titles |Trial Balance |Adjustments |Adj. Trial Balance |Income Statement |Balance Sheet |

| |

|Work Sheet |

|For the Month Ended October 31, 20-- |

|Account Titles |Trial Balance |Adjustments |Adj. Trial Balance |Income Statement |Balance Sheet |

| |

|Work Sheet |

|For the Month Ended October 31, 20-- |

|Account Titles |Trial Balance |Adjustments |Adj. Trial Balance |Income Statement |Balance Sheet |

| |

|Work Sheet |

|For the Month Ended October 31, 20-- |

|Account Titles |Trial Balance |Adjustments |Adj. Trial Balance |Income Statement |Balance Sheet |

| |

|Work Sheet |

|For the Month Ended October 31, 20-- |

|Account Titles |Trial Balance |Adjustments |Adj. Trial Balance |Income Statement |Balance Sheet |

| |

|Work Sheet |

|For the Month Ended October 31, 20-- |

| | |Income Statement |Balance Sheet |

|Account Name | |Debit |Credit |Debit |Credit |

|Cash | | | |15,200 | |

|Accts. Receivable. | | | |200 | |

|Advert. Supplies | | | |1,000 | |

|Prepaid Insurance. | | | |550 | |

|Office Equip. | | | |5,000 | |

|Accum. Depr. Off. Eq | | | | |40 |

|Notes Payable | | | | |5,000 |

|Accts. Payable | | | | |2,500 |

|Interest Payable | | | | |50 |

|Unearned Revenue | | | | |800 |

|Salaries Payable | | | | |1,200 |

|C.R. Byrd, Capital | | | | |10,000 |

|C.R. Byrd, Drawing | | | |500 | |

|Service Revenue | | |10,600 | | |

|Salaries Expense | |5,200 | | | |

|Rent Expense | |900 | | | |

|Advert. Sup. Expense | |1,500 | | | |

|Insurance Expense | |50 | | | |

|Depr. Exp. Off. Eq. | |40 | | | |

|Interest Expense | |50 | | | |

|Totals | |7,740 |10,600 |22,450 |19,590 |

|Net Income | |2,860 | | |2,860 |

| | |10,600 |10,600 |22,450 |22,450 |

|Note: the words, “Closing Entries,” head the closing entries where explanations are not needed but optional when you |

|distinguish these type of entries: |

|General Journal |Page 3 |

|Date |Account Title |P.R. |Debit |Credit |

|20-- |Closing Entries | | | |

|Oct. |31 |Service Revenue | |10,600 | |

| | | Income Summary | | |10,600 |

| | | | | | |

a) Step 2—Close the balance of each Expense account to the Income Summary account. To locate all the expense accounts, you look at all the numbers in the debit column of the Income Statement columns on the work sheet. . Below is the partial work sheet with the journal entry below showing how entered into there and note that the expenses are entered in the journal in the order that they are appear on the work sheet to prevent omitting any accounts:

|PIONEER ADVERTISING AGENCY |

|Work Sheet |

|For the Month Ended October 31, 20-- |

| | |Income Statement |Balance Sheet |

|Account Name | |Debit |Credit |Debit |Credit |

|Cash | | | |15,200 | |

|Accts. Receivable. | | | |200 | |

|Advert. Supplies | | | |1,000 | |

|Prepaid Insurance. | | | |550 | |

|Office Equip. | | | |5,000 | |

|Accum. Depr. Off. Eq | | | | |40 |

|Notes Payable | | | | |5,000 |

|Accts. Payable | | | | |2,500 |

|Interest Payable | | | | |50 |

|Unearned Revenue | | | | |800 |

|Salaries Payable | | | | |1,200 |

|C.R. Byrd, Capital | | | | |10,000 |

|C.R. Byrd, Drawing | | | |500 | |

|Service Revenue | | |10,600 | | |

|Salaries Expense | |5,200 | | | |

|Rent Expense | |900 | | | |

|Advert. Sup. Expense | |1,500 | | | |

|Insurance Expense | |50 | | | |

|Depr. Exp. Off. Eq. | |40 | | | |

|Interest Expense | |50 | | | |

|Totals | |7,740 |10,600 |22,450 |19,590 |

|Net Income | |2,860 | | |2,860 |

| | |10,600 |10,600 |22,450 |22,450 |

|General Journal |Page 3 |

|Date |Account Title |P.R. |Debit |Credit |

|20-- |Closing Entries | | | |

|Oct. |31 |Service Revenue | |10,600 | |

| | | Income Summary | | |10,600 |

| | | | | | |

| |31 |Income Summary | |7,740 | |

| | | Salaries Expense | | |5,200 |

| | | Rent Expense | | |900 |

| | |Advert. Supplies Expense | | |1,500 |

| | | Insurance Expense | | |50 |

| | | Depr. Expense—Office Equip. | | |40 |

| | | Interest Expense | | |50 |

| | | | | | |

b) Step 3—Close the balance of the Income Summary account to the owner’s capital account. To locate the balance in the Income Summary account, you look at the net income (2,860 for Pioneer Advertising Agency) or net loss amount that is at the bottom of the income statement columns of the work sheet before the final totals. Actually the T-account for the income summary account is actually shown on the income statement columns because the total debit column (7,740) is the debit entry into the income summary account and the total credit column (10,600) is the credit entry into the income summary account. Therefore, the balance at this point in the Income Summary account is the difference between the credit of $10,600 and the debit of $7,749 which is the net income figure of $2,860 as a credit balance in the Income Summary account. To close, then, the Income Summary account requires a debit of $2,860. Below is the partial work sheet with the journal entry below showing how entered into there:

|PIONEER ADVERTISING AGENCY |

|Work Sheet |

|For the Month Ended October 31, 20-- |

| | |Income Statement |Balance Sheet |

|Account Name | |Debit |Credit |Debit |Credit |

|Cash | | | |15,200 | |

|Accts. Receivable. | | | |200 | |

|Advert. Supplies | | | |1,000 | |

|Prepaid Insurance. | | | |550 | |

|Office Equip. | | | |5,000 | |

|Accum. Depr. Off. Eq | | | | |40 |

|Notes Payable | | | | |5,000 |

|Accts. Payable | | | | |2,500 |

|Interest Payable | | | | |50 |

|Unearned Revenue | | | | |800 |

|Salaries Payable | | | | |1,200 |

|C.R. Byrd, Capital | | | | |10,000 |

|C.R. Byrd, Drawing | | | |500 | |

|Service Revenue | | |10,600 | | |

|Salaries Expense | |5,200 | | | |

|Rent Expense | |900 | | | |

|Advert. Sup. Expense | |1,500 | | | |

|Insurance Expense | |50 | | | |

|Depr. Exp. Off. Eq. | |40 | | | |

|Interest Expense | |50 | | | |

|Totals | |7,740 |10,600 |22,450 |19,590 |

|Net Income | |2,860 | | |2,860 |

| | |10,600 |10,600 |22,450 |22,450 |

|General Journal |Page 3 |

|Date |Account Title |P.R. |Debit |Credit |

|20-- |Closing Entries | | | |

|Oct. |31 |Service Revenue | |10,600 | |

| | | Income Summary | | |10,600 |

| | | | | | |

| |31 |Income Summary | |7,740 | |

| | | Salaries Expense | | |5,200 |

| | | Rent Expense | | |900 |

| | |Advert. Supplies Expense | | |1,500 |

| | | Insurance Expense | | |50 |

| | | Depr. Expense—Office Equip. | | |40 |

| | | Interest Expense | | |50 |

| | | | | | |

| |31 |Income Summary | |2,860 | |

| | | C.R. Byrd, Capital | | |2,860 |

| | | | | | |

c) Step 4—Close the balance of the owner’s Drawing account to the owner’s capital account. To locate the balance in the drawing account, you look for the amount on the debit column of the Balance Sheet columns of the work sheet. Below is the partial work sheet with the journal entry below showing how entered into there:

|PIONEER ADVERTISING AGENCY |

|Work Sheet |

|For the Month Ended October 31, 20-- |

| | |Income Statement |Balance Sheet |

|Account Name | |Debit |Credit |Debit |Credit |

|Cash | | | |15,200 | |

|Accts. Receivable. | | | |200 | |

|Advert. Supplies | | | |1,000 | |

|Prepaid Insurance. | | | |550 | |

|Office Equip. | | | |5,000 | |

|Accum. Depr. Off. Eq | | | | |40 |

|Notes Payable | | | | |5,000 |

|Accts. Payable | | | | |2,500 |

|Interest Payable | | | | |50 |

|Unearned Revenue | | | | |800 |

|Salaries Payable | | | | |1,200 |

|C.R. Byrd, Capital | | | | |10,000 |

|C.R. Byrd, Drawing | | | |500 | |

|Service Revenue | | |10,600 | | |

|Salaries Expense | |5,200 | | | |

|Rent Expense | |900 | | | |

|Advert. Sup. Expense | |1,500 | | | |

|Insurance Expense | |50 | | | |

|Depr. Exp. Off. Eq. | |40 | | | |

|Interest Expense | |50 | | | |

|Totals | |7,740 |10,600 |22,450 |19,590 |

|Net Income | |2,860 | | |2,860 |

| | |10,600 |10,600 |22,450 |22,450 |

| | |

|General Journal |Page 3 |

|Date |Account Title |P.R. |Debit |Credit |

|20-- |Closing Entries | | | |

|Oct. |31 |Service Revenue | |10,600 | |

| | | Income Summary | | |10,600 |

| | | | | | |

| |31 |Income Summary | |7,740 | |

| | | Salaries Expense | | |5,200 |

| | | Rent Expense | | |900 |

| | |Advert. Supplies Expense | | |1,500 |

| | | Insurance Expense | | |50 |

| | | Depr. Expense—Office Equip. | | |40 |

| | | Interest Expense | | |50 |

| | | | | | |

| |31 |Income Summary | |2,860 | |

| | | C.R. Byrd, Capital | | |2,860 |

| | | | | | |

| |31 |C.R. Byrd, Capital | |500 | |

| | |C.R. Byrd, Drawing | | |500 |

Below is an example of a company with a net loss (Taylor and Associates) which would be journalized below the partial work sheet illustrating that the difference is Step 3 of the closing process because Income Summary will have a debit balance of $555 prior to closing and therefore it will require that that the Income Summary account is credited to close and the capital account will be debited as a net loss decreases owner’s equity illustrated as follows:

|Taylor and Associates |

|Work Sheet |

|For the Month Ended December 31, 20-- |

| | |Income Statement |Balance Sheet |

|Account Name | |Debit |Credit |Debit |Credit |

|Cash | | | |5,485 | |

|Accts. Receivable. | | | |300 | |

|Office Supplies | | | |230 | |

|Prepaid Insurance. | | | |220 | |

|Office Equip. | | | |3,000 | |

|Accum. Depr. Off. Eq | | | | |50 |

|Off ice Furniture | | | |2,000 | |

|Acc.Depr. Office Furn. | | | | |30 |

|Accts. Payable | | | | |3,000 |

|Salaries Payable | | | | |210 |

|W. Taylor, Capital | | | | |10,000 |

|W. Taylor, Drawing | | | |1,500 | |

|Service Revenue | | |1,700 | | |

|Rent Expense | |800 | | | |

|Repairs Expense | |50 | | | |

|Salaries Expense | |1,260 | | | |

|Office Sup Expense | |45 | | | |

|Insur. .Expense | |20 | | | |

|Depr. Exp. Off. Eq. | |50 | | | |

|Depr. .Exp. Off. Furn. | |30 | | | |

|Totals | |2,255 |1,700 |12,735 |13,290 |

|Net Loss | | |555 |555 | |

| | |2,255 |2,255 |13,290 |13,290 |

|General Journal |Page 3 |

|Date |Account Title |P.R. |Debit |Credit |

|20-- |Closing Entries | | | |

|Dec. |31 |Service Revenue | |1,700 | |

| | | Income Summary | | |1,700 |

| | | | | | |

| |31 |Income Summary | |2,255 | |

| | | Rent Expense | | |800 |

| | | Repairs Expense | | |50 |

| | | Salaries Expense | | |1,260 |

| | | Office Supplies Expense | | |45 |

| | | Insurance Expense | | |20 |

| | | Depr. Expense—Office Equip. | | |50 |

| | | Depr. Expense—Office Furn. | | |30 |

| | | | | | |

| |31 |William Taylor, Capital | |555 | |

| | | Income Summary | | |555 |

| | | | | | |

| |31 |William Taylor, Capital | |1,500 | |

| | | William Taylor, Drawing | | |1,500 |

| | | | | | |

Below shows Pioneer Advertising Agency Adjusting Entries (Chapter 3) journalized from the adjustments columns of the work sheet by letter entered with the Closing Entries (Chapter 4) journalized from the income statement and balance sheet columns of the work sheet illustrating that these entries can all be entered on the same journal page with the respective titles for each section.

|General Journal |Page 3 |

|Date |Account Title |P.R. |Debit |Credit |

|20-- |Adjusting Entries | | | |

|Oct. |31 |Advert. Supplies Expense | |1,500 | |

| | | Advert. Supplies | | |1,500 |

| | | | | | |

| |31 |Insurance Expense | |50 | |

| | | Prepaid Insurance | | |50 |

| | | | | | |

| |31 |Depr. Expense—Office Equip. | |40 | |

| | | Accum. Depr.—Office Equip. | | |40 |

| | | | | | |

| |31 |Unearned Revenue | |400 | |

| | | Service Revenue | | |400 |

| | | | | | |

| |31 |Accounts Receivable | |200 | |

| | | Service Revenue | | |200 |

| | | | | | |

| |31 |Interest Expense | |50 | |

| | | Interest Payable | | |50 |

| | | | | | |

| |31 |Salaries Expense | |1,200 | |

| | | Salaries Payable | | |1,200 |

| | |Closing Entries | | | |

| |31 |Service Revenue | |10,600 | |

| | | Income Summary | | |10,600 |

| | | | | | |

| |31 |Income Summary | |7,740 | |

| | | Salaries Expense | | |5,200 |

| | | Rent Expense | | |900 |

| | |Advert. Supplies Expense | | |1,500 |

| | | Insurance Expense | | |50 |

| | | Depr. Expense—Office Equip. | | |40 |

| | | Interest Expense | | |50 |

| | | | | | |

| |31 |Income Summary | |2,860 | |

| | | C.R. Byrd, Capital | | |2,860 |

| | | | | | |

| |31 |C.R. Byrd, Capital | |500 | |

| | | C.R. Byrd, Drawing | | |500 |

NOTE: The 4 steps (REID) in the closing process produce only 4 journal entries. A typical student misconception is that every separate revenue and every separate expense require a separate journal entry to close rather than making one compound journal entry for all revenues and one compound journal entry for all expenses. Doing separate entries defeats the purpose of having an income summary account. Another typical error when closing more than one revenue and closing the expense accounts is to just enter the word, “Revenues,” as a debit to close the total revenues into the journal for the first entry and enter the word, “Expenses,” as the credit to close all the expenses for the second entry. Remember all the accounts need to be posted to the general ledger to form an audit trail so all accounts must be listed in the general journal and posted to the general ledger as shown in the post reference column of the journal and the ledger.

A. Posting Closing Entries

1. Refer to example in the textbook showing the T-accounts used in the closing process:

a) Note that all temporary accounts (revenues, expenses, and owner’s drawing or dividends) have zero balances after posting the closing entries.

b) All permanent accounts (assets, liabilities, and owner’s capital or retained earnings) are not closed.

c) Also, the balance is the owner’s capital account or retained earnings represents the amount shown as the ending capital on the owner’s equity statement and the owner’s capital shown on the balance sheet or the ending retained earnings on the statement of retained earnings and the retained earnings on the balance sheet.

d) The Income Summary account is used only in closing to clear out the revenue and expenses and then net income (or net loss) for the period.

2. Only the permanent accounts after closing will have balances in the general ledger:

a) Note that the only words that you see in the Explanation column (NOT for an “explanation” but only to identify special types of postings) of the General Ledger are the words, “Balance, “or “Adjusting,”or “Closing”(“Adjusting” or “Closing” are needed to identify these special type of postings in the General Ledger) Below is the example of one account with an adjusting entry, closing entry, and showing how the line across the “balance” columns showing that the account is closed or the account can show a 0.

|General Ledger (partial) |

|Advertising Supplies Expense |No.631 |

|Date |Explanation |P.R. |Debit (+) |Credit (-) |Balance |

|20-- | | | | | |

|Dec. |31 |Adjusting |J2 |1,500 | |1,500 |

| |31 |Closing |J3 | |1,500 |--- |

b) The ledger account for the owner’s, capital or retained earnings has the word, “Closing” entered for entries posted into the account. Those words are entered there to alert the reader that these entries are closing entries, but the capital or retained earnings account was NOT CLOSED.

B. Preparing a Post-Closing Trial Balance. Only the permanent accounts appear on the post-closing trial balance because it is prepared after the closing entries have been posted. Its purpose:

1. to prove the equality of the permanent (or balance sheet) account balances that are carried forward into the next accounting period to make sure that the ledger will be in balance at the start of the next accounting period.

2. to provide evidence that the journalizing and posting of the closing entries have been properly completed as only permanent accounts should appear on the post-closing trial balance and if any temporary accounts are shown then all closing entries were NOT properly completed.

3. to show that the accounting equation is in balance at the end of the accounting period but does NOT prove that ALL transactions have been recorded or that the ledger is correct (as would be the case with any type of trial balance).

II. SUMMARY OF ACCOUNTING CYCLE:

A. The following are steps in the accounting cycle are performed in sequence and are repeated in each accounting period:

1. Analyze transactions form source documents;

2. Record (journalize) the transactions in a journal;

3. Post to ledger accounts;

4. Prepare a trial balance;

5. Determine the needed adjustments;

6. Prepare a work sheet (optional step) journalizing and posting adjusting entries (prepayments or deferrals and accruals) and preparing an adjusted trial balance

7. Prepare financial statements;

8. Journalize and post closing entries;

9. Prepare a post-closing trial balance; and

10. Prepare reversing entries (optional step)—see discussion below.

B. Journalizing and posting the closing entries and preparing the post-closing trial balance are usually prepared ONLY AT THE END OF A COMPANY’S ANNUAL ACCOUNTING PERIOD.

C. Correcting Entries—an avoidable step:

1. They need to be prepared when errors have been made as soon as the errors are discovered by journalizing and posting correcting entries.

2. Differences between adjusting and correcting entries:

a) Adjusting entries are an integral (necessary) part of the accounting cycle; correcting entries only need to be made if errors have been made.

b) Adjusting entries are journalized and posted only at the end of the accounting period; correcting entries are made whenever an error is discovered.

c) Adjusting entries ALWAYS affect one balance sheet and one income statement account; correcting entries may involve any combination of accounts in need to correction. Correcting entries MUST BE POSTED BEFORE CLOSING ENTRIES.

3. To determine the correcting entry, it is useful to compare the incorrect entry with the correct entry so that only the accounts that should be corrected are involved in the correcting entry:

a) The most efficient correcting entry is NOT REVERSING the incorrect entry and then making a correct entry but

1) Comparing the incorrect entry with the correct entry and then;

2) Determining which accounts and amounts need to be corrected; and

3) Recording only one correcting entry to correct the amounts in just the accounts that are incorrect.

III. CLASSIFIED BALANCE SHEET—a balance sheet that divides the assets and liabilities sections into standard classifications or sections as shown on handout, STANDARD CLASSIFICATIONS and will be used from now on as this format gives the user (management, creditors, potential investors, etc.) more useful information about the company and allows ratios to be computed to properly analyze the company.

A. The two formats of the classified balance sheet:

1. Account form—where the assets section is placed on the left and the liabilities and owner’s equity on the right side as with the accounting equation which is why it is called the “account” form.

2. Report form—where the assets are listed above the liabilities and owner’s equity sections which is the form, most often presented as it is like reading a report from top to bottom.

B. ONLY THE FIRST WORD ON THE LINE IS CAPITALIZED UNLESS IT FOLLOWS A COLON and the rule for abbreviations is this: only abbreviate when it is necessary as the description column is shorter when there is a 3-column format so on some lines, you may have to abbreviate but if there is room on a line as is usually the case with an Excel template where columns can be increased, DO NOT ABBREVIATE).

C. The "classifications" occur in the ASSETS and LIABILITY sections as follows:

1. ASSETS are classified into the following sections.

a) Current assets  are resources at are cash, expected to be realized in cash (like receivables), sold (like inventory), or consumed or used (like supplies, prepaid insurance, etc.) in within one year of the balance sheet date or the company’s operating cycle, whichever is longer. An operating cycle of a company is the average time that is required to go from cash to cash in producing revenues—to make and sell the product or service which can turn into a receivable and finally into cash.

1) The common types of current assets that are customary in a service enterprise.

2) These items are listed in order of liquidity—how fast can turn into cash or use (if not intended to turn into cash as with prepaid expenses). The prepaid expenses (prepaid insurance, supplies, etc.) are listed last and one prepaid expense is NO MORE LIQUID than another so they are usually listed how they appear in the general ledger accounts.

b) Long-Term Investments (not shown in the textbook)are resources not expected to be realized in cash within the next year or operating cycle and are not intended for use or consumption within the business but held for investment such as stock and bonds in other corporations.

c) Property, Plant, and Equipment (Plant Assets)are tangible resources of a relatively permanent nature (long-term), that are used in the business and not intended for sale (such as inventory).

1) These assets are subject to depreciation except for land.

2) These assets should be reported at cost less accumulated depreciation (book value).

d) Intangible assets (not shown in the textbook) are noncurrent resources that do not have physical substance.

1) These assets give the holder exclusive right of use for a specified period of time. Their value to a company is generally derived from the rights or privileges granted by governmental authority.

2. LIABILITIES are classified into the following sections:

a) Current liabilities are obligations (debts) that are reasonably expected to be paid from existing current assets or through the creation of other current liabilities within the next year or operating cycle, whichever is longer.

1) The arrangement of items within the current liabilities section is usually done through custom rather than a prescribed rule. Notes payable and Accounts Payable usually are listed first in that order and the others in any order.

2) Users of the financial statements look closely at the relationship between current assets and current liabilities through the use of ratios. This relationship is important in evaluating a company’s liquidity—its ability to pay obligations that are expected to become due within the next year or operating cycle.

1. When current assets are greater that current liabilities by a certain amount (usually 2:1), this is considered favorable in ability to pay.

2. When there is not a safe cushion of current assets exceeding current liabilities or when the reverse is true, there is less of a chance that the current liabilities will be paid and the company may even be forced into bankruptcy.

b) Long-term liabilities are obligations (debts) that will be paid beyond one year. (NOTE: a debt that is paid on the monthly installment basis will be classified into both the Current liabilities section (the portion that will be paid within the following year) and the Long-term liabilities section (the portion that will be paid beyond one year)).

3. OWNER’S (STOCKHOLDERS’) EQUITY section.. The content of the owner’s equity section varies with the form of organization:

a) In a proprietorship, there is one capital account. The up-to-date capital balance has been taken from the owner’s equity statement. is shown by the owner’s equity section with the owner’s name and the word, “capital.”.

b) In a partnership, there is a capital account for each partner.

c) For a corporation, owner’s (stockholders’) equity is divided into two sections—Capital or Common stock (for the sale of the corporations stock) and retained earnings (income retained for the use in the business).

V. REVERSING ENTRIES are optional entries made at the first day of the new fiscal year and are the exact opposite of the adjusting entries made in the previous period so that certain adjusting entry amounts will not be forgotten to take care of in the new accounting period. The adjusting entries that are often forgotten are the accrued entries such as accrued salaries or also called accrued wages expenses in some companies.

A. A reversing entry on the first day of the new accounting period reverses an adjusting entry that was made at the end of the prior accounting period.  To explain the example, the accounting equation with T-accounts will be used with the example. Throughout the accounting period the salaries are debited to Salaries Expense and credited to Cash. With the example for Pioneer Advertising Agency, only the first month of operation is used as an example and they have only had one payment for Salaries Expense of $4,000.  Then on October 31, there is an adjustment made to accrue $1,200 of salaries owed to properly match the revenues and expenses in the same accounting period leaving a balance in the account of $5,200.  During the closing process the Salaries Expense account is reduced to zero to begin the new accounting period. But there is still the $1,200 credit balance in the Salaries Payable account to carry to the new period.

Assets |= |Liabilities |+ |Owner's Equity |+ |Revs. |- |Expenses | |Cash |  |Salaries Payable |  |  |  |  |  |Salaries Expense | |  |4,000 |  |  |1,200 Adj. | Oct. 31 |  | Oct.26  |4,000 |  | |  | Oct.26 |  |  |  |  |  |  | Oct.31 |Adj.  1,200 |  | |  |  |  |  |  |  |  |  |  |  |Bal.  5,200 |5,200  Close | |  |  |  |  |  |  |  |  |  |  |----- |----- | |The Salaries Payable account needs to be debited for $1,200 the first payday of the new period, but since that is not the normal entry each time salaries are paid, it is often forgotten to do.  I have asked clients when auditing their books at the end of the year what the credit number in a salaries or wages payable account represents and a typical response that I would get is, "I don't know. It's been there all year." That means the adjusting entry from the prior period into the liability account, Salaries Payable, was never shown to be paid as the normal entry to record the salaries in this example is to debit Salaries Expense and credit Cash.  The correct entry for the first payroll of the new period should be to debit Salaries Payable for $1,200, debit Salaries Expense for $2,800 and credit cash for $4,000.

B. To alleviate the problem of forgetting about the amount in the Salaries Payable account, some companies do reversing entries the first day of the new accounting period. The reversing entry is the exact opposite of the adjusting entry where on November 1 as the example shows in the second column of Illustration 4A-1 page 170, there would be a debit to Salaries Payable of $1,200 and a credit to Salaries Expense of $1,200, under “Reversing Entry,” which as can be seen below leaves an unnatural (not normal) balance in the Salaries Expense account on November 1 of a credit balance of $1,200, but it does reduce the Salaries Payable account to zero.  But what happens when the salaries are paid on Nov.9 of the new period, the normal entry is made to debit Salaries Expense and to credit Cash, the correct balance is now in the Salaries Expense account of $2,800 which is the portion that is an expense in the new accounting period shown in the T-accounts as follows:

Assets |= |Liabilities |+ |Owner's Equity |+ |Revenues |- |Expenses | |Cash |  |Salaries Payable |  |  |  |  |  |Salaries Expense | |  |4,000 Nov. 9 |  |Nov.1 Rev. 1,200 |1,200   Adj. | 

 Oct.31 |  |  |  |  |1200 Nov1 Reversing | |  |  |  |----- |----- |  |  |  |  |  |Nov. 9   4,000 |  | | | | | | | | | | | |Bal.Nov 92800 | | |

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