Procedure Preliminary to Adjusting and Closing.—Before tracing the detail of the adjusting and closing entries through the books, explanation will be given of the usual method of insuring the accuracy of this periodic work preliminary to the formal closing of the books. This preliminary work comprises the technical procedure employed in drawing up the balance sheet and profit and loss statement before the books are closed. It thus brings about a summarization of the period’s results made outside the books instead of in them. Therefore, a proof of the accuracy and correctness of the work of adjusting and closing can be secured before the summarization entries are made in the books. After proof of accuracy has thus been secured, the statements are used as a guide in making the formal adjusting and closing entries.

The information for the balance sheet and profit and loss statements comes mostly from the regular monthly trial balance taken at the end of the period just before the adjusting entries are made. This trial balance must of course be modified in order to include the effect of the adjustments. For the purpose of incorporating the adjustments in the trial balance and then separating the accounts into the two groups, namely, those which are to be summarized in the profit and loss statement and those which are to be used for the balance sheet, a regular form is used known as the accountant’s “work sheet.” This form and the method of its use will now be explained.

The Work Sheet.—For the work sheet “analysis” paper is used, which is ruled in its simple form as shown in the illustration on pages 226 and 227, space being provided for:

• 1. Account titles
• 2. Trial balance items
• 3. Adjustment items
• 4. Profit and loss items
• 5. Balance sheet items

For the purpose of illustration, a trial balance and a list of adjustments are given below, followed by the work sheet and the necessary explanatory detail.

The student must understand that the work sheet is no part of the formal accounting record, nor is the procedure employed by it a part of the formal work of closing the books. It is only a means by which a rough summarization of the period’s results may be made outside the regular accounting records and all the data needed for the formal statements be brought together. Its purpose is to secure and prove the accuracy of results before the formal adjusting and closing work is entered on the books. Where many or complicated adjustments are to be made, with a resulting probability of error and difficulty in an orderly arrangement of the adjusting entries, the method of the work sheet is almost indispensable. The formal adjusting entries are then made up from the adjustment columns of the work sheet.

Illustration

Trial Balance, December 31, 19—

Adjustment Data, December 31, 19—

The initial step in the use of the work sheet is to enter the trial balance in the first two columns, as shown on pages 226, 227. The accounts in the trial balance should be arranged in classified form before being entered on the work sheet, as this aids greatly in drawing up the statements. The various adjustment entries, debit and credit, which are almost the same as in the ledger, are then entered in the adjustment columns. The work sheet may be looked upon somewhat as a ledger, entries in whose accounts are to be made horizontally instead of vertically. The analogy to the ledger cannot be carried too far, however. It should be noted that when it is necessary to adjust any account in the trial balance by increasing its debit, this is accomplished by entering the item in the debit adjustment column on the same line with the account to be adjusted. On the other hand, if a subtraction is to be made from a debit amount shown in the trial balance, the amount to be deducted is entered in the credit adjustment column. A complete debit and credit entry must be made in the adjustment columns for each adjustment.

There is given below a debit and credit list of these entries as they are to appear on the work sheet. The manner of making and cross-indexing these adjustment entries is indicated by the cross-reference letters used. It will be noted that, while in most instances these entries are exactly the same as the formal adjusting journal entries, there is a difference in the case of the merchandise inventories.

The student should understand that the list of adjustment entries given below does not appear anywhere in the formal accounting records. It is shown here in journal form only to indicate the debits and credits of the entries to the work sheet. Entries of the adjustment transactions are always made direct to the work sheet, never being set up in journal form. Each of these entries should be traced into the adjustment columns of the work sheet. The figures in parentheses just preceding the debit and credit amounts are, of course, not ledger folios but refer to the similarly numbered items on the work sheet so that the student will have no difficulty in tracing them.

In order to set up some of these adjusting entries, it becomes necessary to add some new accounts on the work sheet. The student will note these appended at the end of the regular trial balance shown on the work sheet. They are, first, Bad Debts and Depreciation, under the latter of which the detail of the fixed assets subject to depreciation is given, and then follow in order the balance sheet classifications of Accrued Income, Deferred Charges to Operation, Accrued Expenses, and Deferred Income, provision being made to show under each of these titles the detail of the accounts involved.

It will be noted that some of the adjusting entries are not set up in the adjustment columns in exact accord with the way in which the same items are entered on the ledger, but rather in accord with the use to be made of the particular items in drawing up the periodic statements. The purpose of the columns is not to make the adjustments and summarization in a formal manner as is done in the books, but to gather together all the adjusting data so that a correct separation of the balance sheet and profit and loss items can be made for use in the formal summary entries and in the statements. Thus, instead of transferring the initial inventory to the Purchases account, it is allowed to remain under its own title, because it will be needed as a separate item in drawing up the cost-of-goods-sold section of the profit and loss statement. Similarly, the final inventory is not shown deducted from Purchases, but is set up, debit and credit, in the adjustment columns, opposite the title “Merchandise Inventory—Final,” which is inserted immediately following the account “Merchandise Inventory—Initial.” At the time of summarizing, the debit item goes into the balance sheet, while the credit item goes into profit and loss. This method of handling provides in the profit and loss columns the detailed information needed for the cost-of-goods-sold section of the statement, comprising Initial Inventory, Purchases, In-Freight, Purchases Returns and Allowances, and Final Inventory.

The bad debts adjustment is entered in the adjustment columns as a debit to Bad Debts and a credit to Reserve for Doubtful Accounts. Similarly, the depreciation entry is shown as a debit to Depreciation in detail, the credits going to the various depreciation reserve accounts.

The adjustments covering deferred charges are shown as debits to the “Deferred Charges to Operation” classification in detail, the offsetting credits being to the various expense accounts as shown in the trial balance. These credits in the adjustment column will, when combined with the corresponding debit in the trial balance column, indicate the net amount of the charge to profit and loss. The other classes of adjustment entries follow the same procedure.

After all adjustments have been made, a complete distribution of the items in the trial balance and adjustment columns is made either to the profit and loss or the balance sheet columns. The difference between the profit and loss columns will thus show the net profit or loss for the period and must be transferred to the balance sheet as a vested proprietorship item. Instead of being shown as a definite addition to the proprietor’s capital, the transfer is indicated as the final item on the work sheet, being a debit in the profit and loss columns to balance them, and a credit in the balance sheet columns. This difference, $14,747.12 in our illustration, constitutes the net profit for the period, and when added to the credit side of the balance sheet columns should give a total equal to the total of the debit balance sheet column. This transfer of net profit effects a proof of the accuracy of the work.

When this proof has been secured, the formal profit and loss statement should be drawn up, all of the material for which will be found in the profit and loss columns of the work sheet, where it is arranged in almost the exact order needed for the formal statement. The information for the balance sheet is found similarly in the balance sheet columns, all of the detail being properly grouped but a rearrangement of the order of some items being necessary. Thus, while the detail of the deferred charges to operation has been gathered together in one place in the work sheet, in the formal balance sheet this group of items must appear immediately after the current asset section. See page 234 for the profit and loss statement and page 232 for the balance sheet.

It is thus seen that the work sheet provides a convenient method of passing through the trial balance the adjustments necessary to a summarization of the results of the period and of effecting a rough summarization of these results. The work sheet becomes the source of information for the formal statements and a preliminary stage to the adjustment and closing of the books.

The purpose of the formal adjusting entries and the manner of framing them are fully explained in Chapter XXVIII. After the information on which they are based is brought together and entered on the work sheet and after the work of summarization has been proven, the adjustment columns of the work sheet are made the source for these entries. The formal adjusting entries as they appear in the journal are given on page 245. They should be compared with the debit and credit list for the work sheet as given above and the differences noted.

Need for the Summary Statements.—Before setting up the formal journal entries necessary to adjust and close the books, the balance sheet and statement of profit and loss will be shown. These two periodic statements do not form an integral part of the books of account. They are drawn up periodically and submitted to the proprietor, because the latter does not always have ready access to the books of account and often lacks sufficient knowledge of accounting to interpret correctly the information shown by the journal and ledger. The periodic statements are intended to show the results of the year in a concise, non-technical form, so that a proprietor, even though not versed in the science of accounts, can readily understand them.

The Two Forms of Balance Sheet.—The balance sheet may be arranged in either of two forms. The first form (illustrated on page 232) follows the principles already laid down in Chapter III. This is called the “report form” and is based on the proprietorship equation when written

Assets - Liabilities = Proprietorship

Being non-technical, it is perhaps more favored by executives not versed in technical account-keeping.

The second form (illustrated on page 233) follows the proprietorship equation when written

Assets = Liabilities + Proprietorship

This form shows financial condition by means of the account form, the subtraction of the liabilities from the assets being indicated by their respective debit and credit positions in the account. It will be noticed, however, that this method of showing the subtractions is not strictly adhered to, some deductions being actually performed, as for instance in the case of the valuation reserves which are subtracted from the respective assets to which they apply. This is done in order to render the statement more intelligible. The same principles govern the arrangement of the items and groups of items as in the first form, viz., degree of liquidity for the assets and a similar arrangement for the liabilities. The account form is used almost always when the statement is submitted for publication.

Two Forms for the Profit and Loss Statement.—The statement of profit and loss is also made up in either of two forms, called the report form and the account form, based on the same principles as the two forms of balance sheet just discussed. Explanation of the report form has already been given in Chapters V and VI. The account form (illustrated on page 235) is very nearly a transcript of the ledger Profit and Loss account. It differs chiefly in that the information concerning “sales” which is summarized in the Sales account on the ledger is here set up in an inner column and shown summarized on the face of the statement. The information as to cost of goods sold is similarly summarized.

Interim Statements.—In many businesses, where the fiscal period is six months or a year, it is often desirable and important that at least approximate results be secured at interim periods. This can be accomplished by means of the work sheet without entailing the burdensome work involved in a formal closing of the books. At the time of the taking of any trial balance, the work sheet can be used as a means of making the necessary adjustments before securing results as to financial and operating condition. Accurate results would of course require as careful work as at the end of the regular fiscal period. The purpose of interim summaries is to indicate trends rather than to show accurate and definite results. At such times, therefore, the inventory is usually estimated, oftentimes the same amount being used as at the beginning of the period. Accruals and deferred items are not so carefully estimated nor in so great detail. Bad debts and depreciation must be taken into account. In this way approximate results for any period—frequently every month—may be secured without interfering with those for the regular fiscal period.