Closing the Books 4th Edition

Steven M. Bragg

Table of Contents Chapter 1 – The General Ledger and Other Ledgers ........................................................................... 1

Learning Objectives ............................................................................................................................. 1 Introduction .......................................................................................................................................... 1 The Ledger Concept ............................................................................................................................ 1 General Ledger Overview .................................................................................................................... 2 The Accounts Receivable Ledger ......................................................................................................... 3 The Purchase Ledger .......................................................................................................................... 4 Chapter Summary ................................................................................................................................ 5 Review Questions ................................................................................................................................ 6 Review Answers .................................................................................................................................. 7

Chapter 2 – The Trial Balance ............................................................................................................... 9

Learning Objectives ............................................................................................................................. 9 Introduction .......................................................................................................................................... 9 Overview of the Trial Balance .............................................................................................................. 9 The Trial Balance Format ..................................................................................................................... 9 The Extended Trial Balance ............................................................................................................... 10 Trial Balance Error Correction ............................................................................................................ 11 The Post-Closing Trial Balance .......................................................................................................... 12 Evaluation of the Trial Balance ........................................................................................................... 12 Chapter Summary .............................................................................................................................. 13 Review Questions .............................................................................................................................. 14 Review Answers ................................................................................................................................ 15

Chapter 3 – Journal Entries ................................................................................................................ 17

Learning Objectives ........................................................................................................................... 17 Introduction ........................................................................................................................................ 17 The Accruals Concept ........................................................................................................................ 17 Adjusting Entries ................................................................................................................................ 17 Reversing Entries .............................................................................................................................. 18 Common Adjusting Entries ................................................................................................................. 19

Depreciation .................................................................................................................................. 19 Allowance for Doubtful Accounts .................................................................................................... 20 Accrued Revenue .......................................................................................................................... 20 Accrued Expenses ......................................................................................................................... 20 Prepaid Assets .............................................................................................................................. 21

Closing Entries .................................................................................................................................. 21 Correcting Entries .............................................................................................................................. 22 Journal Entry Efficiencies ................................................................................................................... 23

Immaterial Journal Entries ............................................................................................................. 23 Reversing Entries .......................................................................................................................... 23 Journal Entry Templates ................................................................................................................ 23 Recurring Journal Entries ............................................................................................................... 24 Standard Journal Entry Checklist ................................................................................................... 24 Journal Entry Responsibility ........................................................................................................... 25 Avoid Journal Entries Entirely ........................................................................................................ 26

Standardize Accounts ........................................................................................................................ 26 Chapter Summary .............................................................................................................................. 26 Review Questions .............................................................................................................................. 27 Review Answers ................................................................................................................................ 28

Chapter 4 – The Closing Process ....................................................................................................... 29

Learning Objectives ........................................................................................................................... 29 Introduction ........................................................................................................................................ 29

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Prior Steps: Update Reserves ............................................................................................................ 29 Core Steps: Issue Customer Invoices ................................................................................................ 30 Core Steps: Value Inventory .............................................................................................................. 30 Core Steps: Calculate Depreciation.................................................................................................... 31 Core Steps: Accrue Expenses ........................................................................................................... 31 Core Steps: Consolidate Division Results........................................................................................... 31 Core Steps: Eliminate Intercompany Transactions ............................................................................. 31 Core Steps: Review Journal Entries ................................................................................................... 32 Core Steps: Reconcile Accounts ........................................................................................................ 32 Core Steps: Close Subsidiary Ledgers ............................................................................................... 34 Core Steps: Create Financial Statements ........................................................................................... 34 Core Steps: Review Financial Statements .......................................................................................... 34 Core Steps: Accrue Tax Liabilities ...................................................................................................... 35 Core Steps: Close the Month ............................................................................................................. 35 Core Steps: Calculate Earnings per Share ......................................................................................... 35 Core Steps: Add Disclosures ............................................................................................................. 35 Core Steps: Write Cover Letter .......................................................................................................... 36 Core Steps: Issue Financial Statements ............................................................................................. 37 Delayed Steps: Issue Customer Invoices ........................................................................................... 37 Delayed Steps: Closing Metrics.......................................................................................................... 37 Delayed Steps: Document Future Closing Changes ........................................................................... 38 Delayed Steps: Update Closing Procedures ....................................................................................... 38 Case Study ........................................................................................................................................ 39 Closing Checklist ............................................................................................................................... 45

Customer Billings ........................................................................................................................... 45 Accounts Payable .......................................................................................................................... 45 Fixed Assets .................................................................................................................................. 46 Inventory........................................................................................................................................ 46 Journal Entries ............................................................................................................................... 46 Balance Sheet Reconciliations ....................................................................................................... 46 Consolidate Results ....................................................................................................................... 47 Error Checking ............................................................................................................................... 47 Preparation of the Financial Statements – Private Company .......................................................... 47 Preparation of the Financial Statements – Public Company ............................................................ 48 Final Tasks – Month-End ............................................................................................................... 48 Final Tasks – Year-End.................................................................................................................. 48

Chapter Summary .............................................................................................................................. 49 Review Questions .............................................................................................................................. 50 Review Answers ................................................................................................................................ 51

Chapter 5 – Fine-Tune the Closing Process ....................................................................................... 53

Learning Objectives ........................................................................................................................... 53 Introduction ........................................................................................................................................ 53 Task Interdependency Analysis.......................................................................................................... 53 Correct Errors Early ........................................................................................................................... 54 Reconcile Accounts Early .................................................................................................................. 55 Adjust Reserves Early ........................................................................................................................ 55 Alter Overhead Allocations Early ........................................................................................................ 55 Review the Shipping Log Early........................................................................................................... 55 Review Billable Hours Early ............................................................................................................... 56 Accrue Early ...................................................................................................................................... 56 Accelerate Depreciation Calculations ................................................................................................. 57 Examine Commissions Early .............................................................................................................. 57 Standardize the Accounting System ................................................................................................... 57 Centralize the Accounting System ...................................................................................................... 58 Standardize Exception Handling ........................................................................................................ 59 Centralize Travel Bookings ................................................................................................................ 60

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Process Centering ............................................................................................................................. 60 Mitigate Information Dependencies .................................................................................................... 61 Standardize the Report Layout ........................................................................................................... 61 Reduce the Financial Statements ....................................................................................................... 61 Collect Report Information Early ......................................................................................................... 62 Electronic Delivery ............................................................................................................................. 63 Defer Activities ................................................................................................................................... 63 Automation Solutions ......................................................................................................................... 63

Intercompany Transactions ............................................................................................................ 63 Consolidation Software .................................................................................................................. 64 Enterprise Resources Planning Systems ........................................................................................ 64 Workflow Management Systems .................................................................................................... 64 Incremental Automation ................................................................................................................. 65 Automation Summary .................................................................................................................... 65

Ongoing Process Improvements ........................................................................................................ 65 Chapter Summary .............................................................................................................................. 66 Review Questions .............................................................................................................................. 68 Review Answers ................................................................................................................................ 69

Chapter 6 – Closing Cash ................................................................................................................... 71

Learning Objectives ........................................................................................................................... 71 Introduction ........................................................................................................................................ 71 Overview of the Bank Reconciliation .................................................................................................. 71 The Bank Reconciliation Procedure ................................................................................................... 71 Bank Reconciliation Problems ............................................................................................................ 72 The Bank Reconciliation Statement.................................................................................................... 73 The Timing of the Bank Reconciliation ............................................................................................... 73 Negative Cash on the Balance Sheet ................................................................................................. 74 Closing Petty Cash ............................................................................................................................ 74 Chapter Summary .............................................................................................................................. 75 Review Questions .............................................................................................................................. 76 Review Answers ................................................................................................................................ 77

Chapter 7 – Closing Accounts Receivable ......................................................................................... 79

Learning Objectives ........................................................................................................................... 79 Introduction ........................................................................................................................................ 79 The Shipping Log Interface ................................................................................................................ 79 Revenue Accruals .............................................................................................................................. 79 Revenue Recognition Rules ............................................................................................................... 80 Treatment of Deferred Revenue ......................................................................................................... 81 Issues with Subcontractors ................................................................................................................ 81 Recurring Invoices ............................................................................................................................. 82 Rebillable Expenses .......................................................................................................................... 82 Reconciling Accounts Receivable ...................................................................................................... 83 Non-Trade Receivables ..................................................................................................................... 84 The Allowance for Doubtful Accounts ................................................................................................. 84 Recording Contra Revenue ................................................................................................................ 85 Chapter Summary .............................................................................................................................. 85 Review Questions .............................................................................................................................. 86 Review Answers ................................................................................................................................ 87

Chapter 8 – Closing Inventory ............................................................................................................ 89

Learning Objectives ........................................................................................................................... 89 Introduction ........................................................................................................................................ 89 Valuation Step 1: The Quantity of Inventory on Hand ......................................................................... 89 The Periodic Inventory System........................................................................................................... 89 The Perpetual Inventory System ........................................................................................................ 90

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The Gross Profit Method .................................................................................................................... 91 Valuation Step 2: Inventory Costing (Typical Inventory) ...................................................................... 92 The First In, First Out Method ............................................................................................................ 92 The Last In, First Out Method ............................................................................................................. 93 The Weighted Average Method .......................................................................................................... 94 Standard Costing ............................................................................................................................... 95 The Retail Inventory Method .............................................................................................................. 96 Valuation Step 3: Overhead Allocation ............................................................................................... 97 Valuation Step 4: Inventory Valuation ................................................................................................. 99 The Lower of Cost or Market Rule ...................................................................................................... 99 Obsolete Inventory Accounting......................................................................................................... 101 Chapter Summary ............................................................................................................................ 102 Review Questions ............................................................................................................................ 103 Review Answers .............................................................................................................................. 104

Chapter 9 – Closing Fixed Assets..................................................................................................... 105

Learning Objectives ......................................................................................................................... 105 Introduction ...................................................................................................................................... 105 Initial Asset Recognition ................................................................................................................... 105 The Depreciation Entry .................................................................................................................... 106 Interest Capitalization ...................................................................................................................... 107 Asset Impairment ............................................................................................................................. 108 Reconciling Fixed Assets ................................................................................................................. 110 Chapter Summary ............................................................................................................................ 110 Review Questions ............................................................................................................................ 111 Review Answers .............................................................................................................................. 112

Chapter 10 – Closing Accounts Payable .......................................................................................... 113

Learning Objectives ......................................................................................................................... 113 Introduction ...................................................................................................................................... 113 Accounts Payable Accruals .............................................................................................................. 113 Invoice Approval Delays................................................................................................................... 114 Expense Reports ............................................................................................................................. 115 Issues with the Credit Card Close .................................................................................................... 116 Accounts Payable Suspense Items .................................................................................................. 116 Reconciling Accounts Payable ......................................................................................................... 117 Chapter Summary ............................................................................................................................ 118 Review Questions ............................................................................................................................ 119 Review Answers .............................................................................................................................. 120

Chapter 11 – Closing Payroll ............................................................................................................ 121

Learning Objectives ......................................................................................................................... 121 Introduction ...................................................................................................................................... 121 The Wage Accrual ........................................................................................................................... 121 The Commission Accrual ................................................................................................................. 123 The Bonus Accrual .......................................................................................................................... 124 The Payroll Tax Accrual ................................................................................................................... 124 The Benefits Accrual ........................................................................................................................ 125 The Vacation Accrual ....................................................................................................................... 125 Reconciling Compensation Accruals ................................................................................................ 126 Chapter Summary ............................................................................................................................ 126 Review Questions ............................................................................................................................ 127 Review Answers .............................................................................................................................. 128

Chapter 12 – The Income Statement ................................................................................................. 129

Learning Objectives ......................................................................................................................... 129 Introduction ...................................................................................................................................... 129

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Income Statement Overview ............................................................................................................ 129 The Single-Step Income Statement .................................................................................................. 131 The Multi-Step Income Statement .................................................................................................... 132 The Condensed Income Statement .................................................................................................. 132 The Contribution Margin Income Statement ..................................................................................... 133 The Multi-Period Income Statement ................................................................................................. 133 The Statement of Activities .............................................................................................................. 134 How to Construct the Income Statement .......................................................................................... 136 Other Income Statement Topics ....................................................................................................... 137

What is a Cash Basis Income Statement? .................................................................................... 137 What is a Partial Income Statement? ........................................................................................... 138 What are Headline Earnings? ...................................................................................................... 138

Chapter Summary ............................................................................................................................ 139 Review Questions ............................................................................................................................ 140 Review Answers .............................................................................................................................. 141

Chapter 13 – The Balance Sheet ....................................................................................................... 143

Learning Objectives ......................................................................................................................... 143 Introduction ...................................................................................................................................... 143 Overview of the Balance Sheet ........................................................................................................ 143 The Common Size Balance Sheet ................................................................................................... 145 The Comparative Balance Sheet ...................................................................................................... 146 The Nonprofit Balance Sheet ........................................................................................................... 147

Unrestricted Net Assets ............................................................................................................... 148 Temporarily Restricted Net Assets ............................................................................................... 148 Permanently Restricted Net Assets .............................................................................................. 148

How to Construct the Balance Sheet ................................................................................................ 149 Other Balance Sheet Topics ............................................................................................................ 150

Does an Expense Appear on the Balance Sheet? ........................................................................ 150 Where do Accruals Appear on the Balance Sheet? ...................................................................... 150 What is Order of Liquidity? ........................................................................................................... 150

Chapter Summary ............................................................................................................................ 151 Review Questions ............................................................................................................................ 152 Review Answers .............................................................................................................................. 153

Chapter 14 – The Statement of Cash Flows ..................................................................................... 155

Learning Objectives ......................................................................................................................... 155 Introduction ...................................................................................................................................... 155 Overview of the Statement of Cash Flows ........................................................................................ 155 The Direct Method ........................................................................................................................... 158 The Indirect Method ......................................................................................................................... 159 Information Sources ......................................................................................................................... 161 Chapter Summary ............................................................................................................................ 164 Review Questions ............................................................................................................................ 165 Review Answers .............................................................................................................................. 166

Chapter 15 – The Statement of Retained Earnings .......................................................................... 167

Learning Objectives ......................................................................................................................... 167 Introduction ...................................................................................................................................... 167 Overview of the Statement of Retained Earnings ............................................................................. 167 How to Prepare the Statement of Retained Earnings ........................................................................ 168 Chapter Summary ............................................................................................................................ 168 Review Questions ............................................................................................................................ 169 Review Answers .............................................................................................................................. 170

Chapter 16 – Financial Statement Disclosures ................................................................................ 171

Learning Objectives ......................................................................................................................... 171

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Introduction ...................................................................................................................................... 171 Accounting Disclosures .................................................................................................................... 171 Chapter Summary ............................................................................................................................ 177 Review Questions ............................................................................................................................ 178 Review Answers .............................................................................................................................. 179

Chapter 17 – Segment Reporting ...................................................................................................... 181

Learning Objectives ......................................................................................................................... 181 Introduction ...................................................................................................................................... 181 Overview of Segment Reporting ....................................................................................................... 181 Segment Disclosure ......................................................................................................................... 183

Segment Disclosure ..................................................................................................................... 183 Products, Services, and Customer Disclosure .............................................................................. 185 Geographic Area Disclosure ........................................................................................................ 185

Chapter Summary ............................................................................................................................ 186 Review Questions ............................................................................................................................ 187 Review Answers .............................................................................................................................. 188

Chapter 18 – Interim Reporting ......................................................................................................... 189

Learning Objectives ......................................................................................................................... 189 Introduction ...................................................................................................................................... 189 Overview of Interim Reporting .......................................................................................................... 189

General Interim Reporting Rule .................................................................................................... 189 Variations from the Interim Reporting Rule ................................................................................... 190 Changes in Accounting Principle in Interim Periods ...................................................................... 191 Changes in Accounting Estimate in Interim Periods ...................................................................... 191 Error Correction in Interim Periods ............................................................................................... 191 Adjustments to Prior Interim Periods ............................................................................................ 192

The Integral View ............................................................................................................................. 192 The Discrete View ............................................................................................................................ 193 Comparison of the Integral and Discrete Views ................................................................................ 193 Disclosures for Interim Reporting ..................................................................................................... 194 Chapter Summary ............................................................................................................................ 194 Review Questions ............................................................................................................................ 195 Review Answers .............................................................................................................................. 196

Chapter 19 – Earnings per Share ...................................................................................................... 197

Learning Objectives ......................................................................................................................... 197 Introduction ...................................................................................................................................... 197 Basic Earnings per Share ................................................................................................................ 197 Diluted Earnings per Share .............................................................................................................. 198 Presentation of Earnings per Share.................................................................................................. 201 Chapter Summary ............................................................................................................................ 202 Review Questions ............................................................................................................................ 203 Review Answers .............................................................................................................................. 204

Chapter 20 – The Public Company Close ......................................................................................... 205

Learning Objectives ......................................................................................................................... 205 Introduction ...................................................................................................................................... 205 The Public Company Closing Process.............................................................................................. 205 The Form 10-Q ................................................................................................................................ 207 The Form 10-K ................................................................................................................................ 208 Chapter Summary ............................................................................................................................ 209 Review Questions ............................................................................................................................ 210 Review Answers .............................................................................................................................. 211

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Chapter 21 – Controls for Closing the Books .................................................................................. 213 Learning Objectives ......................................................................................................................... 213 Introduction ...................................................................................................................................... 213 Preventive and Detective Controls ................................................................................................... 213 Basic Controls ................................................................................................................................. 213 Additional Controls for Public Companies ......................................................................................... 216 Balancing Controls against Speed ................................................................................................... 216 Chapter Summary ............................................................................................................................ 217 Review Questions ............................................................................................................................ 218 Review Answers .............................................................................................................................. 219

Chapter 22 – Record Keeping ........................................................................................................... 221

Learning Objectives ......................................................................................................................... 221 Introduction ...................................................................................................................................... 221 Month-End Record Keeping ............................................................................................................. 221 Year-End Record Keeping ............................................................................................................... 221 Public Company Record Keeping ..................................................................................................... 222 Chapter Summary ............................................................................................................................ 223 Review Questions ............................................................................................................................ 224 Review Answers .............................................................................................................................. 225

Chapter 23 – Soft Close and Virtual Close ....................................................................................... 227

Learning Objectives ......................................................................................................................... 227 Introduction ...................................................................................................................................... 227 The Soft Close ................................................................................................................................. 227 The Virtual Close ............................................................................................................................. 228 The Reporting Package ................................................................................................................... 229 Chapter Summary ............................................................................................................................ 230 Review Questions ............................................................................................................................ 231 Review Answers .............................................................................................................................. 232

Glossary ............................................................................................................................................. 233 Index .................................................................................................................................................. 239