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Solutions manual to accompany

Financial accounting 10th edition by Hoggett, Medlin, Chalmers, Hellmann, Beattie and Maxfield Prepared by John Medlin

© John Wiley & Sons Australia, Ltd 2018

Solutions manual to accompany Financial accounting 10e by Hoggett et al.

Chapter 5: Completing the accounting cycle – closing and reversing entries Questions and solutions which have a GST version:       

Exercise 5.5 Exercise 5.14 Problem 5.17 Problem 5.19 Problem 5.21 Problem 5.28 Problem 5.29

© John Wiley & Sons Australia, Ltd 2018

Chapter 5: Completing the accounting cycle — closing and reversing entries

Discussion questions Please note: suggested topics for discussions are provided for each question. Discussions need not be confined to the topics indicated. 1. In figure 5.1, the accounting cycle is illustrated. Explain the purpose and importance of each step in the cycle. Step 1 of the accounting cycle is to capture the data from every transaction involving the entity in the form of source documents, which may take many different formats. For example, source documents can consist of sales or service invoices, cash dockets, credit card slips, purchase invoices, delivery notes, credit notes, computerised cash register tapes, EFTPOS records. Step 1 is important in that it is the chief means of collecting data about the economic activities of the entity, which then must be recorded in the accounting system. The step provides a vital first stage in developing an audit trail for auditors to assess the effectiveness of control procedures in the accounting information system. Step 2 records (enters), in journals, all of the transactions about the entity from source documents developed in Step 1. This is usually done as a double entry process. The journals are important in that they provide a chronological record of the economic transactions and events that affect the entity. Step 3 posts all of the information from the journals into the entity’s ledger accounts. In so doing, financial information is reclassified into items of a like nature, i.e. into different types of assets, liabilities and equity accounts. Step 4 is performed periodically e.g. at the end of each month, whereby the ledger accounts developed in Step 3 are totalled and a trial balance is prepared. This step is important in that it provides a preliminary check on the accuracy of the double entry process. If interim financial statements are to be prepared, a worksheet may be developed outside of the accounting records to generate and summarise the necessary information. Steps 5, 6 and 7 are the preparation of adjusting journal entries, the posting of these entries to the accounts, and the completion of an adjusted trial balance. These steps are important under an accrual system of accounting to record all accruals and deferrals of income and expenses that affect an entity at the end of the accounting period. Preparation of the adjusted trial balance after posting to the accounts provides a check on the accuracy of the adjustment process. Steps 8 and 9 are the preparation of closing entries at the end of the accounting period in order to close off all temporary equity accounts (income, expenses and drawings accounts). The step is useful in that it calculates the performance of the entity, and closes off the temporary accounts, leaving them with zero balances at the beginning of the next accounting period. As a result of this step, an entity’s financial performance, or profit, is determined. Step 10 is the process of footing the balances in all permanent accounts at the end of the period, and the preparation of a post-closing trial balance. The step is important in determining the financial position of the entity, as shown in the entity’s statement of financial position or balance sheet. The post-closing trial balance provides a further check on the accuracy of posting all closing entries.

© John Wiley & Sons Australia, Ltd 2018

Solutions manual to accompany Financial accounting 10e by Hoggett et al.

Step 11 is the preparation of financial statements after completion of the recording process. The entity’s statement of financial position can be prepared directly from the post-closing trial balance, and the income statement can be prepared from temporary account balances listed in the adjusted trial balance. Alternatively, the statements can be prepared from a worksheet. These financial statements are important sources of information about an entity for the use of interested parties. Steps 12 and 13 are the preparation and posting of reversing entries, which is performed on the first day of the new accounting period. This step is not necessary, but it is helpful in simplifying the recording of cash transactions in the new period in relation to economic events requiring adjusting entries at the end of the current period. Reversing entries are particularly helpful in the case of accrual adjusting entries at the end of the period.

2.

Compare and contrast the purposes of adjusting entries, closing entries and reversing entries.

Adjusting entries are made on the last day of each financial/reporting period in order to account for any accruals and deferrals arising from acceptance of the period assumption and the accrual basis of accounting. These entries are necessary to measure correctly the entity’s profits/performance and financial position, as opposed to the entity’s cash performance and cash position. Closing entries are made on the last day of the financial period in order to close off all temporary equity accounts, so that these accounts are given zero balances for the beginning of the new financial period. Temporary equity accounts consist of income (revenue), expenses, and drawings. These temporary accounts are used to determine the total value of such items for the current period. At the end of that period, they are closed into permanent equity accounts (capital or retained earnings) in preparation for the next period. Reversing entries, which are made on the first day of the new accounting period, are not necessary in the accounting cycle; however, they are handy for reversing certain types of adjusting entries where cash is to be received or paid in relation to that adjustment in the next accounting period. The main types of adjustments which benefit from reversing entries are accruals, as, by making reversing entries in relation to accruals, the entries for cash receipts and cash payments in the new period are simplified. Reversing entries are also useful for deferral adjustments where the initial cash transactions are recorded in temporary accounts rather than in permanent accounts. See the discussion in this chapter of the text, under reversing entries, in relation to the handling of an insurance payment as an example where reversing entries can be used for deferrals.

© John Wiley & Sons Australia, Ltd 2018

Chapter 5: Completing the accounting cycle — closing and reversing entries

3. For a sole trader, which accounts generally are involved in closing entries? Why are these accounts closed? The accounts involved in the closing process are:  all revenue accounts  all expense accounts  the profit or loss summary account  the owner’s Drawings account  the owner’s Capital account, a permanent equity account. All revenue and expense accounts, which are temporary accounts set up each period in order to calculate the entity’s profit, are closed through closing entries to the profit or loss summary account. The balance of the profit or loss summary account then represents the profit or loss for the accounting period. This profit or loss is transferred, though closing entries, to the owner’s capital account, which is a permanent equity account reported on the balance sheet/statement of financial position. The owner’s Drawings account is also a temporary account established to record how much assets the owner has withdrawn from the entity during the period. This account is also closed off to the capital account at the end of the period.

4. So far, we have heard of the existence of three trial balances – the unadjusted trial balance, the adjusted trial balance and the post-closing trial balance. Explain the purpose of each, and indicate the types of account balances that are contained in each. The unadjusted trial balance is prepared periodically to provide a preliminary check on the accuracy of the posting process (debits and credits) from the journals to the ledger accounts. This trial balance contains the balances of all general ledger accounts as at the date on which the trial balance is prepared. The adjusted trial balance is prepared only at the end of the accounting period and includes the balances of all general ledger accounts after the adjusting entries have been posted to the accounts. It provides a preliminary check of the accuracy of posting all adjusting entries. The post-closing trial balance is prepared at the end of the accounting period after all closing entries have been posted to the accounts and the account balances determined. Since all temporary accounts are closed as a result of closing entries, the post-closing trial balance contains the balances of all permanent accounts only. Hence, the only types of accounts appearing in this trial balance are the assets, the liabilities, and permanent equity accounts such as the capital accounts, or, in the case of a company, the share capital, reserve, and retained earnings accounts.

© John Wiley & Sons Australia, Ltd 2018

Solutions manual to accompany Financial accounting 10e by Hoggett et al.

5. You have been approached by a neighbour who is studying first-year accounting at university. He is very worried about reversing entries and can see no purpose for them. He also finds it very difficult to decide when a reversing entry would be helpful and when it would not. Discuss the major points to be included in a suitable tutorial to overcome his concerns. Reversing entries, which are made on the first day of the new accounting period, are not necessary in the accounting cycle; however, they are very handy to reverse the effects of certain adjusting entries where cash is to be received or to be paid in relation to that adjusting entry in the next accounting period. The main types of adjustments which benefit from reversing entries are accruals. By making reversing entries for accruals, the entries for cash receipts and cash payments in the new period are simplified. To illustrate, consider an accrual for interest payable at the end of the accounting period for $1 000. The adjusting entry is to debit Interest Expense, and to credit Interest Payable. In the new period, when an interest payment of, say, $1 400 is paid, the entry to record the payment, if a reversing entry is not made, requires a reference back to the existence of the Interest Payable account at the end of the previous period. Interest Expense Interest Payable Cash at Bank To record payment of interest to creditor

400 1 000 1 400

However, if a reversing entry is made to reverse the adjusting entry on the first day of the new period, the entry for payment of interest is then simplified, as no reference needs to be made back to the existence of the Interest Payable account at the beginning of the year. The reversing entry and subsequent cash entry for this example are: Interest Payable Interest Expense To reverse adjusting entry in previous period

1 000

Interest Expense Cash at Bank To record payment of interest to creditor

1 400

1 000

1 400

Reversing entries are also useful for adjustments involving deferrals where the initial cash transactions are recorded in temporary accounts rather than in permanent accounts. For example, if supplies, when purchased, are recorded in the Supplies Used expense account, an adjusting entry must be made at the end of the period for any supplies remaining on hand. This entry can then be reversed to put the supplies on hand back into the Supplies Used account for the new period, in which the consumption of such supplies is likely to occur. As a further example where reversing entries can be used for deferrals, see the discussion in Chapter 5 of the text, under reversing entries, in relation to the handling of an insurance payment recorded as an expense rather than as a prepaid asset.

© John Wiley & Sons Australia, Ltd 2018

Chapter 5: Completing the accounting cycle — closing and reversing entries

6.

At the end of the preceding period, a company recorded accrued salaries payable of $3 500. On 2 July, the second day of the new period, the company debited Salaries Expense and credited Cash at Bank for $4 000. (a) If a reversing entry had not been made on 1 July, would the financial statements be in error for the month of July? Explain. (b) What entry should have been made on 2 July given that a reversing entry was not made? (c) If the company made reversing entries, what reversing entry should have been made on 1 July and what entry would then be made on 2 July?

(a) Yes; Salaries Expense for July will be overstated by $3 500, Salaries Payable will be overstated by $3 500, and equity will be understated by $3 500. (b) Salaries Payable Salaries Expense Cash at Bank

Dr Dr Cr

3 500 500

Salaries Payable Salaries Expense (Reversing entry)

Dr Cr

3 500

Salaries Expense Cash at Bank (Cash paid for salaries)

Dr Cr

4 000

4 000

(c)

7.

3 500

4 000

The accountant in Bede Cameron’s business has never worried about preparing reversing entries. However, a newly employed trainee accountant has strongly suggested to Bede that reversing entries are quite useful. Show, by way of a numerical example involving interest payable, how reversing entries can be used in the business accounts and discuss the benefits that reversing entries can provide.

See the answer to discussion question 5 above. See also the answer to Exercise 5.8 below.

© John Wiley & Sons Australia, Ltd 2018

Solutions manual to accompany Financial accounting 10e by Hoggett et al.

8. Different equity accounts are used depending on the type of organisational structure of the business. Illustrate and explain. It is traditional for different equity accounts to be used for different types of entities. For example, in a sole trader business, the owner’s capital contributions and all profits retained in the business are closed off to one account, Capital – J. Bloggs. Assets withdrawn from such a business are shown in the Drawings account. However, in a company, the capital contributed by owners (shareholders) is recorded separately in the Share Capital account, and profits retained in the company any distributions of those profits to owners (dividends) are recorded in a separate Retained Earnings account. Such a separation of contributed capital and retained earnings is possible even for a sole trader, or for a partnership, if so desired. Other types of organisations use different names for the equity accounts. As a further example, a not-for-profit club or society records the initial entrance fees of members on a Members Fees or Accumulated Surplus account, which is equivalent to the capital contributed by members to the club.

9. Explain the difference between the payment of cash dividends by a company and the withdrawal of cash by a sole trader. What is the effect of each on assets? On equity? On profit? Cash dividends is a term used to designate the distribution of cash to the shareholders of a company, usually based on profits. Both cash dividends and cash withdrawals by a sole trader reduce cash, total assets and the equity in the business entity. Cash dividends must be declared by the board of directors, a step not necessary for a sole trader. Profit is not reduced because such cash distributions to owners are not an expense incurred to produce revenue.

10. ‘When preparing interim financial statements, certain steps in the accounting cycle may be omitted.’ Discuss. Step 1: Transactions occur and source documents are prepared. Step 2: Transactions are recorded in the journal. Step 3: Entries are posted to ledgers. Step 4: A worksheet is prepared. Step 5: Financial statements are prepared. Adjusting entries will be made on the worksheet but not in the general journal when interim financial statements are prepared and closing entries are omitted completely.

© John Wiley & Sons Australia, Ltd 2018

Chapter 5: Completing the accounting cycle — closing and reversing entries

Exercises Exercise 5.1 Closing entries Craig’s Car Detailing Service had the following accounts and account balances in the adjusted trial balance columns of its worksheet for the year ended 30 June 2020.

Required (a) Record the required closing entries for Craig’s Car Detailing Service. (LO4)

© John Wiley & Sons Australia, Ltd 2018

Solutions manual to accompany Financial accounting 10e by Hoggett et al.

(a)

Date 2020 June 30

General journal Particulars Service Fees Revenue Interest Revenue Profit or Loss Summary Close income accounts to Profit or Loss Summary Profit or Loss Summary Salaries Expense Rent Expense Advertising Expense

Debit

Credit

$124 600 5 750 $130 350

120 560 68 560 17 980 12 100

Depreciation Expense Sundry Expenses

15 680 6 240

Close expense accounts to Profit or Loss Summary Profit or Loss Summary Craig Fraser, Capital

9 790 9 790

Close Profit or Loss Summary to Capital Account Craig Fraser, Capital Craig Fraser, Drawings Close Drawings to Capital Account

© John Wiley & Sons Australia, Ltd 2018

25 000 25 000

Chapter 5: Completing the accounting cycle — closing and reversing entries

Exercise 5.2 Closing entries and equity The accounts below are taken from the ledger of Bartel Music Consulting on 30 June 2019, the end of the current financial year.

Required (a) Record the closing entries which affected the accounts. (b) Prepare a statement of changes in equity as at 30 June. (LO4)

© John Wiley & Sons Australia, Ltd 2018

Solutions manual to accompany Financial accounting 10e by Hoggett et al.

30/6

G. Bartel, Capital 21 910 1/7

12 070

30/6

16 380

30/6

G. Bartel, Drawings 15/8 6 480 29/10

4 220

18/11

3 920

14/1

7 290

Profit or loss summary 39 470 30/6

30/6

30/6

21 910

55 850

16 380

(a) General journal Date 2019 June 30

Particulars Income accounts

Debit

Credit

$55 850

Profit or Loss Summary Close income accounts to Profit or Loss Summary

$55 850

Profit or Loss Summary Expense accounts Close expense accounts to Profit or Loss Summary

39 470

Profit or Loss Summary

16 380

39 470

G. Bartel, Capital Close Profit or Loss Summary to Capital G. Bartel, Capital G. Bartel, Drawings Close Drawings to Capital

© John Wiley & Sons Australia, Ltd 2018

16 380

21 910 21 910

Chapter 5: Completing the accounting cycle — closing and reversing entries

(b) BARTEL MUSIC CONSULTING Statement of Changes in Equity For the year ended 30 June 2019 G. Bartel, Capital – 1 July 2018

$12 070

Add: Profit for the year

$16 380

Less: Drawings during the year

(...