Acctg.

Ed 1 - Financial Accounting & Reporting

Unit 3

Completing Accounting Cycle

Module 9

Accounting Cycle – Service Business

Acctg. Ed 1 - Financial Accounting & Reporting

Unit 3 – Completing Accounting Cycle

Unit 3 discuss the what and how of the remaining steps in accounting cycle both in
service and merchandising businesses.

Module 9– Accounting Cycle – Service Business

This module covers topics on preparation of worksheet, closing entries, balance sheet
and income statement of a business service and reversing entries.

Objectives

At the end of the module, you should be able to:

1. Prepare a worksheet
2. Prepare closing entries
3. Prepare a balance sheet and income statement of a service business
4. Prepare reversing entries

Introduction
The remaining steps in the accounting cycle will be covered in the life of a service business. A
service business is one that offers services as its main product rather than physical goods.

Review of steps in the accounting cycle:

1. Identifying and analyzing
2. Journalizing
3. Posting
4. Unadjusted trial balance
5. Adjusting entries
6. Adjusted trial balance (and/or Worksheet)
7. Financial statements In this module
8. Closing entries
9. Post-closing trial balance
10. Reversing entries

THE WORKSHEET
A worksheet is an analytical device used to facilitate the gathering of data for adjustments, the
preparation of financial statements and closing entries.

Although optional and not part of the formal accounting records, worksheets are usually
prepared because they greatly facilitate the orderly preparation of the financial statements.
Acctg. Ed 1 - Financial Accounting & Reporting
The heading of the worksheet the
following:
(1) Name of the business;
(2) Title of the report; and
(3) Date covered by the report.

ABC Co.
Worksheet
For the period ended December 31, 20x1

Unadjusted Trial Adjusted Trial Income

Accounts Balance Adjustments Balance Statement Balance Sheet
Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.

The The ending The debits The adjusted The The

accounts balances of and credits balances adjusted adjusted
in the the of the (computed by amounts of amounts of
ledger accounts in adjusting combining income and assets,
are listed the general entries are amounts in the expense liabilities,
here ledger are placed unadjusted trial accounts and equity
listed here. here balance and ae accounts ae
adjusting entries) extended extended
are placed here here. here.

Illustration: Worksheet
Mr. Bruno Manly opened up a beauty salon, called “Brunah’s Salon,” on December 1, 20x1.
The following were the transactions during the month:

1. The owner provided P200,000 cash as initial investment to the business on December 1,
20x1.
2. Obtained a 12%, one-year, bank loan for P100,000 on December 1, 20x1. Principal and
interest are due at maturity date.
3. Paid six months’ rent in advance of P60,000 on December 1, 20x1. Rent per month is
P10,000.
4. Acquired equipment for P180,000 cash on December 1, 20x1. The equipment has a useful
life of 5 years.
5. Purchased supplies for P50,000 cash during the period.
6. Rendered services worth P220,000 for cash during the period.
7. The owner withdrew a total of P40,000 cash from the business during the period.

Requirement: Prepare the worksheet on December 3, 20x1.

Solutions:

Steps 1 & 2: Identifying and analyzing & Journalizing

Acctg. Ed 1 - Financial Accounting & Reporting

The transactions are recorded in the journal as follows:

(1) Cash 20,000
Owner's equity 20,000
to record the owner's investment
to the b usiness
(2) Cash 100,000
Notes payable 100,000
to record the b ank loan

• If Brunah uses the asset method, the prepayment of rent is recorded as follows:
(3A) Prepaid rent 60,000
Cash 60,000
to record the payment of rent

• If Brunah uses the expense method, the prepayment of rent is recorded as follows:
(3B) Rent expense 60,000
Cash 60,000
to record the payment of rent

Both the entries (3A) and (3B) above are acceptable. However, Brunah should only choose
one method as its accounting policy (either asset method or expense method) and apply that
policy consistently in the current and succeeding accounting periods (Consistency Concept).

We will assume that Brunah chose to use the expense method (journal entry ‘3B’).
(4) Equipment 180,000
Cash 180,000
to record the acquisition of
equipment for cash

• If Brunah uses the asset method, the purchase of supplies is recorded as follows:
(5A) Prepaid supplies 50,000
Cash 50,000
to record the purchase of supplies

• If Brunah uses the expense method, the purchase of supplies is recorded as follows:
(5B) Supplies expense 50,000
Cash 50,000
to record the purchase of supplies

Again, we will assume that Brunah chose to use the expense method (journal entry ‘5B’)
Acctg. Ed 1 - Financial Accounting & Reporting

(6) Cash 220,000

Service fees 220,000
to record service fees

(7) Owner's drawings 40,000

Cash 40,000
to record service fees

Steps 3: Posting

The journal entries are posted to the ledger as follows:

ASSETS
Cash Equipment
1 200,000 4 180,000
2 100,000 60,000 3B
180,000 4
6 220,000 50,000 5B
1 40,000 7
Bal. 190,000 Bal. 180,000

LIABILITIES
Notes payable
100,000 2
100,000 Bal.

EQUITY (CAPITAL)
Owner's equity Owner's drawings
200,000 1 7 40,000
200,000 Bal. 40,000

INCOME (REVENUE) EXPENSE

Service fees Rent expense
3B 60,000
220,000 6
220,000 Bal. 60,000

Supplies expense

5B 50,000
Bal. 50,000

Step 4: Unadjusted trial balance

The unadjusted trial balance on December 31, 20x1 is prepared as follows:
Acctg. Ed 1 - Financial Accounting & Reporting

Brunah's Salon
Unadjusted Trial Balance
December 31, 20x1
Debit Credit
Cash 190,000
Equipment 180,000
Notes payable 100,000
Owner's equity 200,000
Owner's drawings 40,000
Service fees 220,000
Rent expense 60,000
Supplies expense 50,000
520,000 520,000

Step 5: Adjusting entries

Additional information:
The following information was identified on December 31, 20x1:
a. The water and electricity bills in December amounting to P3,000 are not yet paid.
b. The cost of unused supplies is P20,000

Reminder:
Let us recall the common adjusting entries:
1. Accruals of income and expenses
2. Recognition of depreciation expense and bad debts expense
3. Deferrals of income and expenses (splitting of ‘mixed accounts’)

Guide Analysis
1. Accruals of income and • The cost of water and electricity already used but
expenses not yet paid must be accrued as expense.
• Brunah’s salon has notes payable. Therefore,
interest expense shall be recognized for the period.
2. Recognition of depreciation • Brunah’s salon has equipment. Depreciation
expense expense shall be recognized
3. Deferrals of income and • Brunah prepaid 6 month’s worth of rent. One month
expenses (splitting of ‘mixed of the total 6 months has already been used. This
accounts’) portion shall be recognized as expense; the
remainder as asset.
• Of the total supplies purchased during the period,
P20,000 remains unused. The unused portion shall
be recognized as asset; the remainder as expense.

From our analyses above, we have identified adjustments for the following:
1. Utilities expense for the cost of electricity and water used but not yet paid;
2. Interest expense on the note payable;
Acctg. Ed 1 - Financial Accounting & Reporting

3. Depreciation expense on the equipment;

4. Rent expense for the used portion, and prepaid rent (asset) for the unused portion, of the
rent paid in advance; and
5. Supplies expense for the used portion, and prepaid supplies (asset) for the unused
portion, of the total supplies purchased during the period.

AJE #1: Utilities expense

The unpaid water and electricity bills in December totaling P3,000 are accrued as follows:
Dec. 31, 20x1 Utilities expense 3,000
AJE 1 Utilities payable 3,000
to accrue utilities expese incurred
b ut not yet paid

AJE #2: Interest expense

i = Prt
P = 100,000
r = 12%
t = 1 month passed (Dec. 1 to Dec. 31, 20x1) over 12 months in a year or (1/12)

Interest expense = (100,000 x 12% x 1/12) = 1,000

The adjusting entry for interest expense is as follows:

Dec. 31, 20x1 Interest expense 1,000
AJE 2 Interest payable 1,000
to accrue interest incurred
b ut not yet paid

AJE #3: Depreciation expense

The annual depreciation expense is computed as follows:
Cost of equipment P180,000
Divide by: Useful life 5
Annual depreciation expense P36,000

However, because the equipment has only been used for 1 month in 20x1 (Dec. 20x1), only a
1-month depreciation expense shall be recognized. This is computed as follows:

Annual depreciation P36,000

Multiply by: 1/12
Depreciation expense – Dec. 20x1 P3,000

Shortcut: (180,000 x 1/5 x 1/12) = 3,000

The adjusting entry is as follows:

Dec. 31, 20x1 Depreciation expense 3,000
AJE 3 Accumulated depreciation 3,000
to record depreciation expense
for the period
Acctg. Ed 1 - Financial Accounting & Reporting

The carrying amount of the equipment as of December 31, 20x1 is determined as follows:

Equipment P180,000
Accumulated depreciation (3,000)
Equipment - net P177,000

AJE #4: Rent expense

Previous transaction:
3. Paid six months’ rent in advance of P60,000 on December 1, 20x1. Rent per month is
P10,000.

Initial recording: (Expense method assumed)

(3B) Rent expense 60,000
Cash 60,000
to record the prepayment
of rent

Year-end analysis:
Used portion (Rent expense)
1 mo. – Dec. 20x1
(10,000 rent per month x 1 mo.) = P10,000
P60,000
6 months’ rent
prepaid on Dec. 1, 20x1 Unused portion (Prepaid rent):
5 mos. – Jan. 20x2 to May 20x2
(10,000 rent per month x 5 mos.) = P5,000

Under the expense method, the adjusting entry is to take up the asset (unused or unexpired)
portion (i.e., the opposite). The adjusting entry therefore involves debiting “Prepaid rent” for
the unexpired portion of P50,000 and crediting rent expense for the same amount. The
adjusting entry is as follows:

Dec. 31, 20x1 Prepaid rent 50,000

AJE4 Rent expense 50,000
to record the unused portion of the
rent paid in advance as prepared asset

The adjusting entry above can also be analyzed as follows:

Unadjusted balances:
Prepaid rent Rent expense

0 3B 60,000

The unadjusted balance of prepaid rent is zero because we assumed that Brunah chose to
use the expense method.
Acctg. Ed 1 - Financial Accounting & Reporting

Adjusted balances:
Prepaid rent Rent expense

0 3B 60,000
50,000 Adj. Bal. 10,000

Adjusted balances (‘SQUEEZE’)

Prepaid rent Rent expense

0 3B 60,000
AJE 4 50,000 50,000 AJE 4
50,000 Bal. 10,000

Rechecking:
• Prepaid rent: 0 + 50,000 Dr. = 50,000 adjusted balance.
• Rent expense: 60,000 Dr. -50,000 Cr. = 10,000 adjusted balance.

AJE #5: Supplies expense

Previous transaction:
5. Purchased supplies for P50,000 cash during the period.

Initial recording: (Expense method assumed)

(5B) Supplies expense 50,000
Cash 50,000
to record the purcahse of
supplies

Additional information at year-end:

b. The cost of unused supplies is P20,000.

Year-end analysis:

Unused portion (Prepaid supplies):

P20,000 (given)
P50,000
Total supplies
Purchased during the period
Used portion (Supplies expense):
(50,000 total – 20,000unused) = P30,000
Acctg. Ed 1 - Financial Accounting & Reporting

Recall again that under the expense method, the adjusting entry is to take up the asset
(unused or unexpired) portion. The adjusting entry therefore involves debiting “Prepaid
supplies” for the unexpired portion of P20,000 and crediting supplies expense for the same
amount. The adjusting entry is as follows:

Dec. 31, 20x1 Prepaid Supplies 20,000

AJE5 Supplies expense 20,000
to record unused supplies as
prepaid asset

The adjusting entry above can also be analyzed as follows:

Unadjusted balances: (Refer to postings above)

Prepaid supplies Supplies expense

0 5B 50,000

*The unadjusted balance of prepaid supplies is zero because Brunah uses the expense
method. Thus, we used journal entry (5B) in our postings.

Adjusted balances: (See computations of adjusted balances above – ‘unused’ and ‘used’)

Prepaid supplies Supplies expense

0 (5B) 50,000
Adj. Bal. 20,000 Adj. Bal. 30,000

Adjustments: (‘squeeze’)

Prepaid supplies Supplies expense

0 (5B) 50,000
AJE 5 20,000 20,000 AJE5
Adj. Bal. 20,000 Adj. Bal. 30,000

Rechecking:
• Prepaid supplies: 0 + 20,000 Dr. = 20,000 adjusted balance.
• Supplies expense: 50,000 Dr. Dr. – 20,000 Cr. = 30,000 adjusted balance.

Step 6: Adjusted trial balance (Worksheet)

Acctg. Ed 1 - Financial Accounting & Reporting

ABC Co.
Brunah’s Salon
Worksheet
For the period ended December 31, 20x1

Unadjusted Trial AJE AJE Adjusted Trial

Accounts Balance #'S Adjustments #'S Balance
Dr. Cr. Dr. Cr. Dr. Cr.
Cash 190,000 190,000
Equipment 180,000 180,000
Notes payable 100,000 100,000
Owner's equity 200,000 200,000
Owner's drawings 40,000 40,000
Service fees 220,000 220,000
Rent expense 60,000 50,000 4 10,000
Supplies expense 50,000 20,000 5 30,000
Totals 520,000 520,000
Adjustments:
Utilities expense 1. 3,000 3,000
Utilities payable 3,000 1. 3,000
Interest Expense 2. 1,000 1,000
Interest payable 1,000 2. 1,000
Depreciation expense 3. 3,000 3,000
Accum. Depreciation 3,000 3. 3,000
Prepaid rent 4. 50,000 50,000
Prepaid supplies 5. 20,000 20,000
Totals 77,000 77,000 527,000 527,000

The adjusting entries are re-provided below to facilitate understanding of the partial worksheet
above:

AJE #1 Utilities expense 3,000

Utilities payable 3,000
AJE #2 Interest expense 1,000
Interest payable 1,000
AJE #3 Depreciation expense 3,000
Accumulated depreciation 3,000
AJE #4 Prepaid rent 50,000
Rent expense 50,000
AJE #5 Prepaid supplies 20,000
Supplies expense 20,000

Notes: Preparing the Worksheet

1. Account tiles used in the adjusting entries but were not previously included in the unadjusted
trial balance are placed at the bottom part of the “Accounts” column of the worksheet.
2. The debits and credits of the adjusting entries are then placed on the “Adjustments” column
of the worksheet.
Acctg. Ed 1 - Financial Accounting & Reporting

3. Amounts in the “Unadjusted trial balance” and “Adjustments” columns are combined to
come up with the adjusted balances of the accounts. The adjusted balances are placed on
the “Adjusted trial balance” columns.

To combine amounts, we observe the following rules of debits and credits:

a. Debit and debit means you add.
b. Credit and credit means you add.
c. Debit and credit, or vice versa, means you subtract.

Unadjusted Trial AJE AJE Adjusted Trial

Accounts Balance #'S Adjustments #'S Balance
Dr. Cr. Dr. Cr. Dr. Cr.
Rent expense 60,000 50,000 4 10,000

P60,000 (debit balance in the “Unadjusted trial

balance) minus P50,000 (credit adjustment)
equals P10,000 adjusted debit balance.

Unadjusted Trial AJE AJE Adjusted Trial

Accounts Balance #'S Adjustments #'S Balance
Dr. Cr. Dr. Cr. Dr. Cr.
Interest payable 1,000 2. 1,000

No balance (zero) in the “Unadjusted trial

balance’ plus P1,000 (credit adjustment) equals
P1,000 adjusted credit balance.

The procedure to compute for the adjusted balances of accounts in the adjusted trial balance
is called “cross-footing.” “Cross-footing” involves adding (or subtracting) amounts
horizontally.

Observe that the total debits and credits in the columns of the worksheet are equal.
ABC Co.
Brunah’s Salon
Worksheet
For the period ended December 31, 20x1

Unadjusted Trial AJE AJE Adjusted Trial

Accounts Balance #'S Adjustments #'S Balance
Dr. Cr. Dr. Cr. Dr. Cr.
Supplies expense 50,000 20,000 5 30,000
Totals 520,000 520,000
Prepaid supplies 5. 20,000 20,000
Totals 77,000 77,000 527,000 527,000

The procedure to compute for the “totals” of the columns is called “footing.” “Footing”
involves adding (or subtracting) amounts vertically.
Acctg. Ed 1 - Financial Accounting & Reporting

10 Footing Cross - footing

15
25 10 15 25

• The use of “double rule.”

Unadjusted Trial AJE AJE Adjusted Trial

Accounts Balance #'S Adjustments #'S Balance
Dr. Cr. Dr. Cr. Dr. Cr.
Supplies expense 50,000 20,000 5 30,000
Totals 520,000 520,000
Prepaid supplies 5. 20,000 20,000
Totals 77,000 77,000 527,000 527,000

These two lines underneath an amount are called

“double rule.” In accounting, “double rules” are used
to connote a total or the end of a computation. It is
like placing a period after a sentence or the phase
“The end” after a story.

FINANCIAL STATEMENTS
The financial statements are the end product of the accounting process. Information from the
journal and the ledger are meaningless to most users unless they are summarized and
communicated through the financial statements.
The major processes in accounting are summarized below:
1. Journalizing - Recording
2. Posting - Classifying
3. Financial statements - Summarizing and Communicating

1. Statement of financial position (or Balance sheet) – shows information on assets,

liabilities and capital (equity).
2. Statement of profit or loss (or Income statement) – shows information on income
and expenses, and consequently, the profit or loss for the period.

The preparation of the balance sheet and the income statement is greatly facilitated by the
worksheet. In the worksheet, all income and expenses accounts in the adjusted trial balance
are simply extended to the “income statement columns,” while all asset, liability and capital
(equity) accounts are extended to the “balance sheet columns.”

Illustration: Preparation of financial statements

Let us prepare the balance sheet and income statement columns of Brunah’s Salon:
Acctg. Ed 1 - Financial Accounting & Reporting

Brunah's Salon
Worksheet
For the period ended December 31, 20x1

Unadjusted Trial Adjusted Trial

Accounts Balance Adjustments Balance Income Statement Balance Sheet
Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
Cash 190,000 190,000 190,000
Equipment 180,000 180,000 180,000
Notes payable 100,000 100,000 100,000
Owner's equity 200,000 200,000 200,000
Owner's drawings 40,000 40,000 40,000
Service fees 220,000 220,000 220,000
Rent expense 60,000 50,000 10,000 10,000
Supplies expense 50,000 20,000 30,000 30,000
Totals 520,000 520,000
Adjustments:
Utilities expense 3,000 3,000 3,000
Utilities payable 3,000 3,000 3,000
Interest Expense 1,000 1,000 1,000
Interest payable 1,000 1,000 1,000
Depreciation expense 3,000 3,000 3,000
Accum. Depreciation 3,000 3,000 3,000
Prepaid rent 50,000 50,000 50,000
Prepaid supplies 20,000 20,000 20,000
Totals 77,000 77,000 527,000 527,000 47,000 220,000 480,000 307,000
173,000 173,000
220,000 220,000 480,000 480,000

The adjusted balances The adjusted balances of asset,

of income and liability, and equity and accounts
expense accounts are are extended to the balance
extended to the sheet columns.
income statement After amounts are extended to the income statement and balance sheet
columns. columns, the balancing figure is the profit (or loss).

Notes:
Concept: Income minus expenses equals profit or loss. If income exceeds expenses, there is profit. If income
is less than expenses, there is loss.

Thus, in the income statement columns of the worksheet:

• If total credits exceed total debits, there is profit. This is because total credits in the income
statement columns pertain to income, while total debits pertain to expenses.
Acctg. Ed 1 - Financial Accounting & Reporting

Therefore, if total credits exceed total debits in the income statement columns, the balancing
figure is on the debit side. This balancing figure is the profit. (See ‘P173,000’ in the
worksheet above)

• If total debits exceed total credits, there is loss. In this case, income is less than
expenses. The balancing figure is the loss and it is placed on the credit side of the income
statement columns.

Concept: Profit or loss is closed to the “Owner’s capital” account at the end of each period. Profit increases
equity, while loss decreases equity.

Thus, in the balance sheet columns of the worksheet:

• If total debits exceed total credits, there is profit. This is because the balancing figure on
the credit side will be added to equity when closing entries are made. (See ‘P173,000’ in
the worksheet above)

• If total debits are less than total credits, there is loss. The balancing figure on the debit
side will be deducted from equity when closing entries are made.

Summary:

Income Statement Columns Balance Sheet Columns

Total credits exceed total debits, there is Total debits exceed total credits, there is
profit. Balancing figure is on the debit side. profit. Balancing figure is on the credit
side.
Total credits less than total debits, there is Total debits less than total credits, there is
loss. Balancing figure is on the credit side. loss. Balancing figure is on the debit side.

*** Before we present the balance sheet and income statement in formal reports, let us
prepare first the closing entries and post-closing trial balance.

Review of steps in the accounting cycle:

1. Identifying and analyzing
2. Journalizing
3. Posting
4. Unadjusted trial balance
5. Adjusting entries
6. Adjusted trial balance (and/or Worksheet)
7. Financial statements In this section
8. Closing entries
9. Post-closing trial balance
10. Reversing entries
Acctg. Ed 1 - Financial Accounting & Reporting

CLOSING ENTRIES
Closing entries are entries prepared at the end of the accounting period to “zero out” all nominal
accounts in the ledger. This is done so that the transactions during the period will not commingle
with transactions in the next period.

The preparation of closing entries is also referred to as “closing the books.” This is an
application of the time period concept.

Closing entries are prepared as follows:

1. All income accounts are debited and all expense accounts are credited. The
resulting balance is recorded in a clearing account called the “Income summary.”
2. The balance of “Income summary” is closed to the “Owner’s capital” account.
3. Any balance in the “Owner’s drawings” account is closed to the “Owner’s capital”
account.

Illustration: Preparation of closing entries

Let us prepare the closing entries of Brunah’s Salon. The income statement and balance sheets
columns are re-provided below to aid us in determining the accounts to be closed:

Brunah's Salon
Worksheet
For the period ended December 31, 20x1

Accounts I ncome Sta tement Ba l a nce Sheet

Dr. Cr. Dr. Cr.
Ca s h 190,000
Equi pment 180,000
Notes pa ya bl e 100,000
Owner's equi ty 200,000
Owner's drawings 40,000
Service fees 220,000
Rent expense 10,000
Supplies expense 30,000
Tota l s
Adj us tments :
Utilities expense 3,000
Uti l i ti es pa ya bl e 3,000
Interest Expense 1,000
I nteres t pa ya bl e 1,000
Depreciation expense 3,000
Accum. Depreci a ti on 3,000
Prepa i d rent 50,000
Prepa i d s uppl i es 20,000
Tota l s 47,000 220,000 480,000 307,000
173,000 173,000
220,000 220,000 480,000 480,000

We will close all the nominal accounts – income and expenses, including owner’s
drawings (i.e., those that are highlighted above).
Acctg. Ed 1 - Financial Accounting & Reporting

Closing entry #1: Income summary

The income and expense accounts are closed to the “Income summary” account as follows:
Dec. 31, Service fees 220,000
20x1 Rent expense 10,000
Supplies expense 30,000
Utilities expense 3,000
Interest expense 1,000
Depreciation expense 3,000
Income summary 173,000
to close income and expense
accounts to income summary

The amount in the income summary account (i.e., P173,000) is the balancing figure in the
closing entry. This amount represents the profit (or loss) for the period. Notice that this is the
same amount of balancing figure in the worksheet.

Notes:

• If the “Income summary” account has a credit balance, there is profit (like in the closing entry above).
• If the “Income summary” account has a debit balance, there is loss.

Closing entry #2: Income summary closed to Equity

The income summary is closed to the “Owner’s capital” account as follows:

Dec. 31, Income summary 173,000

20x1 Owner's equity 173,000
to close income summary to
equity.

If the “Income summary” is debited when closing to equity, there is profit (like in the entry
above). If the “Income summary” is credited when closing to equity, there is loss. These are
because profit increases equity, while loss decreases equity.

Closing entry #3: Drawings account closed to Equity

The “Owner’s drawings” account is closed to the “Owner’s equity” account as follows:

Dec. 31, Owner's equity 40,000

20x1 Owner's drawings 40,000
to close the drawings account

Notice that the drawings account is closed directly to the “Owner’s equity” account rather than
through the income summary account. This is because the drawings account is neither an
Acctg. Ed 1 - Financial Accounting & Reporting

income nor an expense account but rather a contra equity account. As such, owner’s drawings
do not enter into the computation of profit or loss.

POST-CLOSING TRIAL BALANCE

The columns in the “worksheet” can be extended by adding columns for the following:

1. Closing entries – the debits and credits in the closing entries are placed here.
2. Post-closing trial balance – the amounts in the “Adjusted trial balance” (or the “Income
statement” and “Balance sheet” columns) are cross-footed with the amounts in the
“Closing entries” columns. The resulting amounts are then placed in the “Post-closing
trial balance.”

The amounts in the “Post-closing trial balance” will be the beginning balances of
accounts in the next accounting period.

Let us complete the worksheet of Brunah’s Salon. The closing entries are re-provided to
facilitate your understanding of the completed worksheet below:

Closing entries:
Dec. 31, Service fees 220,000
20x1 Rent expense 10,000
Supplies expense 30,000
Utilities expense 3,000
Interest expense 1,000
Depreciation expense 3,000
Income summary 173,000
to close income and expense
accounts to income summary
Dec. 31, Income summary 173,000
20x1 Owner's equity 173,000
to close income summary to
equity.
Dec. 31, Owner's equity 40,000
20x1 Owner's drawings 40,000
to close the drawings account

Notes:

After closing entries are posted, the nominal accounts (income, expense, and drawings
accounts) have zero balances. At this point, these accounts are referred to as closed
accounts.
• Closed account – an account that has no balance.
• Open account – an account that has a balance.
Acctg. Ed 1 - Financial Accounting & Reporting

The post-closing trial balance contains only real accounts (asset, liability, and equity accounts).
The post-closing trial balance is similar to the “balance sheet” columns in the worksheet except
that the balance of the “Owner’s capital” account in the post-closing trial balance is the updated
amount after closing profit or loss and drawings.

Columns in the Type of accounts Equality of debits and

worksheet contained in the credits
columns
Unadjusted trial Real, nominal & mixed Debits and credits are
balance accounts equal
Adjusted trial Real & nominal Debits and credits are
balance accounts equal
Income statement Nominal accounts only The difference between
debits and credits
represents profit or loss
Balance sheet Real accounts only The difference between
debits and credits
represents profit or loss
Post-closing trial Real accounts only Debits and credits are
balance equal

We can now present the balance sheet and income statement in formal reports.

Brunah's Salon
Income Statement
For the month ended December 31, 20x1

INCOME
Service Fees 220,000

EXPENSES
Rent expense - 10,000
Supplies expense - 30,000
Utilities expense - 3,000
Interest expense - 1,000
Depreciation expense - 3,000
TOTAL EXPENSES - 47,000

PROFIT FOR THE PERIOD 173,000

Acctg. Ed 1 - Financial Accounting & Reporting

Brunah's Salon
Balance Sheet
As of December 31, 20x1

ASSETS
Cash 190,000
Prepaid rent 50,000
Prepaid supplies 20,000
Equpment 180,000
Accumulated depreciation - 3,000
TOTAL ASSETS 437,000

LIABILITIES
Notes payable 100,000
Utilities payable 3,000
Interest payable 1,000
TOTAL LIABILITIES 104,000

EQUITY
Ouner's equity 333,000
TOTAL EQUITY 333,000

TOTAL LIABILITIES & EQUITY 437,000

REVERSING ENTRIES
Reversing entries are entries usually made on the first day of the next accounting period to
reverse certain adjusting entries in the immediately preceding period.

As mentioned earlier, reversing entries are optional, meaning they are not required in the
preparation of the financial statements. However, business often use reversing entries to
simplify the recording process in the next accounting period.

The following are the purposes of reversing entries:

1. To facilitate the recording of cash receipts and disbursements in the next accounting
period;
2. To promote convenience in recording the next period’s year-end adjustments for
accruals; and
3. To promote consistency of accounting procedure.

Adjusting entries that may be reversed

Not all adjusting entries may be reversed. Only the adjusting entries made for the following
may be reversed:
1. Accruals for income or expense
2. Prepayments initially recorded using the expense method
3. Advanced collections initially recorded using the income method
Acctg. Ed 1 - Financial Accounting & Reporting

Let’s continue the accounting cycle of Brunah’s Salon. The adjusting entries are provided
below:

AJE #1 Utilities expense 3,000

Utilities payable 3,000
AJE #2 Interest expense 1,000
Interest payable 1,000
AJE #3 Depreciation expense 3,000
Accumulated depreciation 3,000
AJE #4 Prepaid rent 50,000
Rent expense 50,000
AJE #5 Prepaid supplies 20,000
Supplies expense 20,000

Using the guide provided above, the adjusting entries that may be reversed are identified as
follows:

Guide AJE’s that may be reversed

I. Accruals for income or expense 1. AJE #1 (unpaid utilities)
2. AJE #2 (unpaid interest)
II. Prepayments (expense method) 3. AJE #4 (prepaid rent)
4. AJE #5 (prepaid supplies)
III. Advanced collections (income method) None in this illustration

Hints:
• AJE’s involving “receivables” and “payables” are normally reversible.
• AJE’s involving “depreciation” and “bad debts” are not reversible.

The reversing entries (RE) are prepared as follows:

RE #1 Utilities payable 3,000

Utilities expense 3,000
RE #2 Interest payable 1,000
Interest expense 1,000
RE #3 Rent expense 50,000
Prepaid rent 50,000
RE #4 Supplies expense 20,000
Prepaid supplies 20,000

*** Notice that the reversing entries are the exact opposites of the adjusting entries.
Acctg. Ed 1 - Financial Accounting & Reporting

SAQ # 1

Identify the following:

1. _____________________ is an analytical device used to facilitate the gathering of data

for adjustments, the preparation of financial statements, and closing entries.
2. ____________________________ are the end product of the accounting process.
3. The ____________________ are the means by which information periodically
communicated to the users.
4. The ___________________ shows the assets, liabilities and capital (equity) of a
business.
5. The ___________________ shows the revenue (income) and expenses, and
consequently, the profit or loss, of a business.
6. _____________________ are entries prepared at the end of the accounting period to
“zero out” all nominal accounts in the ledger.
7. The ______________________________ is prepared to check the equality of debits
and credits in the general ledger after closing entries are made.
8. ______________________ are entries usually made on the first day of the next
accounting period to reverse certain adjusting entries in the immediately preceding period.

ASAQ # 1

Identify the following:

1. ____WORKSHEET_____ is an analytical device used to facilitate the gathering of data

for adjustments, the preparation of financial statements, and closing entries.
2. __FINANCIAL STATEMENTS____ are the end product of the accounting process.
3. The __FINANCIAL STATEMENTS___ are the means by which information periodically
communicated to the users.
4. The _BALANCE SHEET___ shows the assets, liabilities and capital (equity) of a
business.
5. The __INCOME STATEMENT__ shows the revenue (income) and expenses, and
consequently, the profit or loss, of a business.
6. __CLOSING ENTRIES___ are entries prepared at the end of the accounting period to
“zero out” all nominal accounts in the ledger.
7. The _POST-CLOSING TRIAL BALANCE__ is prepared to check the equality of debits
and credits in the general ledger after closing entries are made.
8. ___REVERSING ENTRIES___ are entries usually made on the first day of the next
accounting period to reverse certain adjusting entries in the immediately preceding period.