COMPLETION OF THE ACCOUNTING CYCLE - Closing Entries -

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1 COMPLETION OF THE ACCOUNTING CYCLE - Closing Entries - Worksheet Overview Trial Balance Adjustments Adjusted Trial Balance Income Statement Balance Sheet Account Titles Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit 1. Prepare trial balance on the worksheet. 2. Enter adjustment data. 3. Enter adjusted balances 4. Extend adjusted balance to appropriate columns. 5. Calculate income/loss and complete the worksheet. 1

2 Steps in the Accounting Cycle 9. Prepare post-closing trial balance 8. Journalize and post closing entries 1. Source Documents: Analyse Transactions 2. Journalize the transactions 3. Post to ledger accounts 4. Prepare a trial balance 7. Prepare financial statements 6. Prepare adjusted trial balance 5. Journalize and post adjusting entries Closing the Books What is closing the books for? How would you do it? 2

3 Closing Entry Concepts The final stage of the accounting cycle is to prepare the accounts for the next fiscal period. To do this, you must understand which accounts have balances that continue from one period to the next and which do not. Closing Entry Concepts Continued When a new accounting period begins, the revenue and expense accounts should show zero balances so that they contain only data that refer to the new period. This allows the calculation of net income according to the matching principle, which states: Revenue for each accounting period is matched with expenses for that accounting period to determine the net income or net loss. 3

4 Purpose of Closing Entries 1. Updates the owner s capital account in the ledger by transferring net income (loss) and owner s drawings to owner s capital. 2. Prepares the temporary accounts (revenue, expense, drawings) for the next period s postings by reducing their balances to zero. Closing Entries The revenue and expense accounts are reduced to zero by a process called closing the books. Closing the books is the process by which revenue and expense accounts are reduced to zero of the end of each accounting period. Closing the accounts is sometimes called clearing the accounts. 4

5 Real Accounts and Nominal Accounts Real Accounts All asset and liability accounts, as well as the owner's capital account, are considered to be real accounts. Real accounts have balances that continue into the next fiscal period. Examples of real accounts are Bank, Vehicles, and Accounts Payable. Real Accounts and Nominal Accounts Nominal Accounts Nominal accounts (Revenue, Expense, and Drawings) have balances that do not continue into the next fiscal period. Nominal accounts, with the exception of the Drawings account, are related to the income statement, and the income statement deals only with a single fiscal period. All nominal accounts begin each fiscal period with a nil balance. 5

6 Real Accounts and Nominal Accounts Income Summary A special nominal account, called the Income Summary account, is used only during the closing entry process. The Income Summary account summarizes the revenues and expenses of the period. The temporary balance in this account represents either the amount of net income or the amount of net loss. Real Accounts and Nominal Accounts Other names for REAL and NOMINAL accounts are PERMANENT and TEMPORARY accounts. These alternative terms help you remember which accounts will continue to have balances (PERMANENT) and which will be closed out (TEMPORARY). 6

7 Temporary Versus Permanent TEMPORARY (NOMINAL) These accounts are closed PERMANENT (REAL) These accounts are not closed All revenue accounts All asset accounts All expense accounts All liability accounts Owner s drawings ** Owner s capital account (Income Statement / Drawings Accounts) (Balance Sheet Accounts) Diagram of the Closing Process Normal Dr. Balance (INDIVIDUAL) EXPENSES Cr. to close Dr. to close (INDIVIDUAL) REVENUES Normal Cr. Balance OWNER S CAPITAL 1 Expenses Opening Balance Revenues 1 Debit each revenue account for its balance, and credit the owner s capital account for total revenues. 2 Debit the owner s capital account for total expenses, and credit each expense account for its balance. 7

8 Diagram of the Closing Process Expenses Drawings OWNER S CAPITAL Opening Balance Revenues Ending Balance 3 Normal Dr. Balance OWNER S DRAWINGS Cr. to close 3 Debit owner s capital for the balance in the owner s drawings account and credit owner s drawings for the same amount Summary In summary, there are 4 steps involved in closing the books: 1. Close the revenue accounts into Income Summary. 2. Close the expense accounts into Income Summary. 3. Close Income Summary into Capital. 4. Close Drawings into Capital. 8

9 Journalizing and Posting the Closing Entries Closing Entry No. 1 Don t forget to post to the General Ledger Journalizing and Posting the Closing Entries Closing Entry No. 2 9

10 Journalizing and Posting the Closing Entries Don t forget to post to the General Ledger Closing Entry No. 3 Journalizing and Posting the Closing Entries Closing Entry No. 4 Don t forget to post to the General Ledger 10

11 Closing Entries STOP AND CHECK 1. Does the balance in your Owner s Capital account equal the ending capital balance reported in the Balance Sheet and Statement of Owner s Equity? 2. Are all of your temporary account balances zero? Post - Closing Trial Balance After all closing entries have been journalized and posted, a post-closing trial balance is prepared. The purpose of this trial balance is to prove the equality of the permanent (balance sheet) account balances that are carried forward into the next accounting period. 11

12 Post - Closing Trial Balance Pioneer Advertising Agency Post-Closing Trial Balance October 31, 2012 After Adjustment Debit Credit Cash $ 15,200 The post-closing trial Accounts Receivable 200 Advertising Supplies balance is prepared 1,000 Prepaid Insurance from the permanent 550 Office Equipment accounts in the ledger. 5,000 Accumulated Amortization $ 83 Notes Payable The post-closing trial 5,000 Accounts Payable 2,500 balance provides evidence Unearned Revenue 800 Salaries Payable that the journalizing and 1,200 Interest Payable posting of closing entries 25 C.R. Byrd, Capital has been properly 12,342 $ 21,950 $ 21,950 completed. Steps in the Accounting Cycle 9. Prepare post-closing trial balance 8. Journalize and post closing entries 7. Prepare financial statements 1. Source Documents: Analyse Transactions 6. Prepare adjusted trial balance 2. Journalize the transactions 3. Post to ledger accounts 4. Prepare a trial balance 5. Journalize and post adjusting entries 12