Closing the Books

An Accountant’s Guide

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 .................................................................................................................... 3 The Accounts Receivable Ledger......................................................................................................... 4 The Purchase Ledger .......................................................................................................................... 4 Summary ............................................................................................................................................. 5 Review Questions ................................................................................................................................ 6 Review Answers .................................................................................................................................. 7

Chapter 2 – The Trial Balance ............................................................................................................... 8

Learning Objectives ............................................................................................................................. 8 Introduction.......................................................................................................................................... 8 Overview of the Trial Balance .............................................................................................................. 8 The Trial Balance Format..................................................................................................................... 8 The Extended Trial Balance ............................................................................................................... 10 Trial Balance Error Correction ............................................................................................................ 10 The Post-Closing Trial Balance .......................................................................................................... 11 Evaluation of the Trial Balance ........................................................................................................... 12 Summary ........................................................................................................................................... 12 Review Questions .............................................................................................................................. 13 Review Answers ................................................................................................................................ 14

Chapter 3 – Journal Entries ................................................................................................................ 15

Learning Objectives ........................................................................................................................... 15 Introduction........................................................................................................................................ 15 The Accruals Concept........................................................................................................................ 15 Adjusting Entries ................................................................................................................................ 15 Reversing Entries .............................................................................................................................. 16 Common Adjusting Entries ................................................................................................................. 17

Depreciation .................................................................................................................................. 17 Allowance for Doubtful Accounts .................................................................................................... 18 Accrued Revenue .......................................................................................................................... 19 Accrued Expenses ......................................................................................................................... 19 Prepaid Assets............................................................................................................................... 19

Closing Entries .................................................................................................................................. 20 Journal Entry Efficiencies ................................................................................................................... 21

Immaterial Journal Entries.............................................................................................................. 21 Reversing Entries .......................................................................................................................... 22 Journal Entry Templates ................................................................................................................ 22 Recurring Journal Entries ............................................................................................................... 22 Standard Journal Entry Checklist ................................................................................................... 23 Journal Entry Responsibility ........................................................................................................... 24 Avoid Journal Entries Entirely......................................................................................................... 24

Standardize Accounts ........................................................................................................................ 24 Summary ........................................................................................................................................... 25 Review Questions .............................................................................................................................. 26 Review Answers ................................................................................................................................ 27

Chapter 4 – The Closing Process ....................................................................................................... 28

Learning Objectives ........................................................................................................................... 28 Introduction........................................................................................................................................ 28

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Prior Steps: Update Reserves ............................................................................................................ 28 Core Steps: Issue Customer Invoices ................................................................................................ 29 Core Steps: Value Inventory .............................................................................................................. 29 Core Steps: Calculate Depreciation ................................................................................................... 30 Core Steps: Accrue Expenses ........................................................................................................... 30 Core Steps: Consolidate Division Results .......................................................................................... 30 Core Steps: Eliminate Intercompany Transactions ............................................................................. 30 Core Steps: Review Journal Entries ................................................................................................... 31 Core Steps: Reconcile Accounts ........................................................................................................ 31 Core Steps: Close Subsidiary Ledgers ............................................................................................... 33 Core Steps: Create Financial Statements ........................................................................................... 33 Core Steps: Review Financial Statements .......................................................................................... 33 Core Steps: Accrue Tax Liabilities ...................................................................................................... 34 Core Steps: Close the Month ............................................................................................................. 34 Core Steps: Calculate Earnings per Share ......................................................................................... 34 Core Steps: Add Disclosures ............................................................................................................. 35 Core Steps: Write Cover Letter .......................................................................................................... 35 Core Steps: Issue Financial Statements ............................................................................................. 36 Delayed Steps: Issue Customer Invoices ........................................................................................... 36 Delayed Steps: Closing Metrics ......................................................................................................... 37 Delayed Steps: Document Future Closing Changes ........................................................................... 37 Delayed Steps: Update Closing Procedures ....................................................................................... 37 Summary ........................................................................................................................................... 38 Review Questions .............................................................................................................................. 39 Review Answers ................................................................................................................................ 40

Chapter 5 – Fine-Tune the Closing Process ....................................................................................... 41

Learning Objectives ........................................................................................................................... 41 Introduction........................................................................................................................................ 41 Task Interdependency Analysis ......................................................................................................... 41 Correct Errors Early ........................................................................................................................... 42 Reconcile Accounts Early .................................................................................................................. 43 Adjust Reserves Early........................................................................................................................ 43 Alter Overhead Allocations Early ........................................................................................................ 43 Review the Shipping Log Early .......................................................................................................... 44 Review Billable Hours Early ............................................................................................................... 44 Accrue Early ...................................................................................................................................... 44 Accelerate Depreciation Calculations ................................................................................................. 45 Examine Commissions Early.............................................................................................................. 45 Standardize the Accounting System ................................................................................................... 46 Centralize the Accounting System ...................................................................................................... 46 Centralize Travel Bookings ................................................................................................................ 48 Process Centering ............................................................................................................................. 48 Mitigate Information Dependencies .................................................................................................... 49 Standardize the Report Layout ........................................................................................................... 49 Reduce the Financial Statements....................................................................................................... 49 Collect Report Information Early......................................................................................................... 50 Electronic Delivery ............................................................................................................................. 51 Defer Activities................................................................................................................................... 51 Automation Solutions ......................................................................................................................... 51

Intercompany Transactions ............................................................................................................ 52 Consolidation Software .................................................................................................................. 52 Enterprise Resources Planning Systems ........................................................................................ 52 Workflow Management Systems .................................................................................................... 52 Incremental Automation ................................................................................................................. 53 Automation Summary .................................................................................................................... 53

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Ongoing Process Improvements ........................................................................................................ 53 Summary ........................................................................................................................................... 54 Review Questions .............................................................................................................................. 56 Review Answers ................................................................................................................................ 57

Chapter 6 – Closing Cash ................................................................................................................... 58

Learning Objectives ........................................................................................................................... 58 Introduction........................................................................................................................................ 58 Overview of the Bank Reconciliation .................................................................................................. 58 The Bank Reconciliation Procedure ................................................................................................... 59 Bank Reconciliation Problems ............................................................................................................ 60 The Bank Reconciliation Statement ................................................................................................... 61 The Timing of the Bank Reconciliation ............................................................................................... 61 Negative Cash on the Balance Sheet ................................................................................................. 61 Closing Petty Cash ............................................................................................................................ 62 Summary ........................................................................................................................................... 63 Review Questions .............................................................................................................................. 64 Review Answers ................................................................................................................................ 65

Chapter 7 – Closing Accounts Receivable ......................................................................................... 66

Learning Objectives ........................................................................................................................... 66 Introduction........................................................................................................................................ 66 The Shipping Log Interface ................................................................................................................ 66 Revenue Accruals.............................................................................................................................. 66 Revenue Recognition Rules ............................................................................................................... 67 Treatment of Deferred Revenue ......................................................................................................... 68 Issues with Subcontractors ................................................................................................................ 68 Recurring Invoices ............................................................................................................................. 69 Rebillable Expenses .......................................................................................................................... 69 Reconciling Accounts Receivable ...................................................................................................... 71 Non-Trade Receivables ..................................................................................................................... 71 The Allowance for Doubtful Accounts ................................................................................................. 71 Recording Contra Revenue ................................................................................................................ 72 Summary ........................................................................................................................................... 73 Review Questions .............................................................................................................................. 74 Review Answers ................................................................................................................................ 75

Chapter 8 – Closing Inventory ............................................................................................................ 76

Learning Objectives ........................................................................................................................... 76 Introduction........................................................................................................................................ 76 Valuation Step 1: The Quantity of Inventory on Hand ......................................................................... 76 The Periodic Inventory System .......................................................................................................... 76 The Perpetual Inventory System ........................................................................................................ 77 The Gross Profit Method .................................................................................................................... 78 Valuation Step 2: Inventory Costing ................................................................................................... 79 The First In, First Out Method ............................................................................................................ 79 The Last In, First Out Method............................................................................................................. 80 The Weighted Average Method .......................................................................................................... 82 Standard Costing ............................................................................................................................... 83 The Retail Inventory Method .............................................................................................................. 84 Valuation Step 3: Overhead Allocation ............................................................................................... 84 The Lower of Cost or Market Rule ...................................................................................................... 87 The Lower of Cost or Market Rule ...................................................................................................... 87 Obsolete Inventory Accounting .......................................................................................................... 88 Summary ........................................................................................................................................... 89 Review Questions .............................................................................................................................. 91

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Review Answers ................................................................................................................................ 92 Chapter 9 – Closing Fixed Assets....................................................................................................... 93

Learning Objectives ........................................................................................................................... 93 Introduction........................................................................................................................................ 93 Initial Asset Recognition ..................................................................................................................... 93 The Depreciation Entry ...................................................................................................................... 94 Interest Capitalization ........................................................................................................................ 95 Asset Impairment ............................................................................................................................... 97 Reconciling Fixed Assets ................................................................................................................... 98 Summary ........................................................................................................................................... 98 Review Questions .............................................................................................................................. 99 Review Answers .............................................................................................................................. 100

Chapter 10 – Closing Accounts Payable .......................................................................................... 101

Learning Objectives ......................................................................................................................... 101 Introduction...................................................................................................................................... 101 Accounts Payable Accruals .............................................................................................................. 101 Invoice Approval Delays .................................................................................................................. 102 Expense Reports ............................................................................................................................. 103 Issues with the Credit Card Close .................................................................................................... 104 Accounts Payable Suspense Items .................................................................................................. 105 Issues with Subcontractors .............................................................................................................. 106 Reconciling Accounts Payable ......................................................................................................... 106 Summary ......................................................................................................................................... 107 Review Questions ............................................................................................................................ 108 Review Answers .............................................................................................................................. 109

Chapter 11 – Closing Payroll ............................................................................................................ 110

Learning Objectives ......................................................................................................................... 110 Introduction...................................................................................................................................... 110 The Wage Accrual ........................................................................................................................... 110 The Commission Accrual ................................................................................................................. 112 The Bonus Accrual .......................................................................................................................... 113 The Payroll Tax Accrual ................................................................................................................... 113 The Benefits Accrual ........................................................................................................................ 114 The Vacation Accrual ....................................................................................................................... 114 Reconciling Compensation Accruals ................................................................................................ 116 Summary ......................................................................................................................................... 116 Review Questions ............................................................................................................................ 117 Review Answers .............................................................................................................................. 118

Chapter 12 – The Income Statement ................................................................................................. 119

Learning Objectives ......................................................................................................................... 119 Introduction...................................................................................................................................... 119 Income Statement Overview ............................................................................................................ 119 The Single-Step Income Statement .................................................................................................. 121 The Multi-Step Income Statement .................................................................................................... 122 The Condensed Income Statement .................................................................................................. 123 The Contribution Margin Income Statement ..................................................................................... 123 The Multi-Period Income Statement ................................................................................................. 124 How to Construct the Income Statement .......................................................................................... 125 Summary ......................................................................................................................................... 126 Review Questions ............................................................................................................................ 127 Review Answers .............................................................................................................................. 128

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Chapter 13 – The Balance Sheet ....................................................................................................... 129 Learning Objectives ......................................................................................................................... 129 Introduction...................................................................................................................................... 129 Overview of the Balance Sheet ........................................................................................................ 129 The Common Size Balance Sheet ................................................................................................... 131 The Comparative Balance Sheet...................................................................................................... 132 How to Construct the Balance Sheet ................................................................................................ 133 Summary ......................................................................................................................................... 135 Review Questions ............................................................................................................................ 136 Review Answers .............................................................................................................................. 137

Chapter 14 – The Statement of Cash Flows ..................................................................................... 138

Learning Objectives ......................................................................................................................... 138 Introduction...................................................................................................................................... 138 Overview of the Statement of Cash Flows ........................................................................................ 138 The Direct Method ........................................................................................................................... 139 The Indirect Method ......................................................................................................................... 140 How to Prepare the Statement of Cash Flows .................................................................................. 141 Summary ......................................................................................................................................... 142 Review Questions ............................................................................................................................ 143 Review Answers .............................................................................................................................. 144

Chapter 15 – The Statement of Retained Earnings .......................................................................... 145

Learning Objectives ......................................................................................................................... 145 Introduction...................................................................................................................................... 145 Overview of the Statement of Retained Earnings ............................................................................. 145 How to Prepare the Statement of Retained Earnings ........................................................................ 146 Summary ......................................................................................................................................... 146 Review Questions ............................................................................................................................ 147 Review Answers .............................................................................................................................. 148

Chapter 16 – Financial Statement Disclosures ................................................................................ 149

Learning Objectives ......................................................................................................................... 149 Introduction...................................................................................................................................... 149 Accounting Disclosures .................................................................................................................... 149 Summary ......................................................................................................................................... 155 Review Questions ............................................................................................................................ 157 Review Answers .............................................................................................................................. 158

Chapter 17 – Segment Reporting ...................................................................................................... 159

Learning Objectives ......................................................................................................................... 159 Introduction...................................................................................................................................... 159 Primary Segment Reporting Issues .................................................................................................. 159 The Segment Report ....................................................................................................................... 161 Summary ......................................................................................................................................... 161 Review Questions ............................................................................................................................ 162 Review Answers .............................................................................................................................. 163

Chapter 18 – Interim Reporting ......................................................................................................... 164

Learning Objectives ......................................................................................................................... 164 Introduction...................................................................................................................................... 164 The Integral View ............................................................................................................................. 164 The Discrete View............................................................................................................................ 165 Comparison of the Integral and Discrete Views ................................................................................ 165 Changes in Accounting Principle ...................................................................................................... 166 Changes in Accounting Estimate...................................................................................................... 166

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Interim Reporting Issues .................................................................................................................. 166 Summary ......................................................................................................................................... 167 Review Questions ............................................................................................................................ 168 Review Answers .............................................................................................................................. 169

Chapter 19 – Earnings per Share ...................................................................................................... 170

Learning Objectives ......................................................................................................................... 170 Introduction...................................................................................................................................... 170 Basic Earnings per Share ................................................................................................................ 170 Diluted Earnings per Share .............................................................................................................. 171 Presentation of Earnings per Share ................................................................................................. 174 Summary ......................................................................................................................................... 175 Review Questions ............................................................................................................................ 176 Review Answers .............................................................................................................................. 177

Chapter 20 – The Public Company Close ......................................................................................... 178

Learning Objectives ......................................................................................................................... 178 Introduction...................................................................................................................................... 178 The Public Company Closing Process ............................................................................................. 178 The Form 10-Q ................................................................................................................................ 180 The Form 10-K ................................................................................................................................ 181 Summary ......................................................................................................................................... 183 Review Questions ............................................................................................................................ 184 Review Answers .............................................................................................................................. 185

Chapter 21 – Controls for Closing the Books .................................................................................. 186

Learning Objectives ......................................................................................................................... 186 Introduction...................................................................................................................................... 186 Basic Controls ................................................................................................................................. 186 Basic Controls ................................................................................................................................. 186 Additional Controls for Public Companies ......................................................................................... 188 Balancing Controls against Speed ................................................................................................... 189 Summary ......................................................................................................................................... 189 Review Questions ............................................................................................................................ 190 Review Answers .............................................................................................................................. 191

Chapter 22 – Record Keeping ........................................................................................................... 192

Learning Objectives ......................................................................................................................... 192 Introduction...................................................................................................................................... 192 Month-End Record Keeping ............................................................................................................. 192 Year-End Record Keeping ............................................................................................................... 192 Public Company Record Keeping..................................................................................................... 193 Summary ......................................................................................................................................... 194 Review Questions ............................................................................................................................ 195 Review Answers .............................................................................................................................. 196

Appendix A – Selected Topics .......................................................................................................... 197 Appendix B – The Closing Checklist ................................................................................................ 202 Appendix C – Case Study ................................................................................................................. 206 Glossary ............................................................................................................................................. 213 Index .................................................................................................................................................. 219