Sec Preparing for New Fiscal Years

 In order to meet the financial reporting demands of each new financial year, certain ledger accounts in any business need to be reset through a process called closing

Closing Procedures with Accounting Software  By seeing how accounting software handles these tasks, it will give a clearer picture of what is going to happen to account balances  This will make what happens with pen and paper more straightforward  Firstly, adjustments must be journalized and posted to ensure ledger account balances match those on the year-end financial statements

 Once adjusting journal entries have been posted, preparing accounts for a new fiscal period is simply a matter of changing the date to a new year (see fig. 8.10, p. 290)  Real accounts have balances that continue into the next fiscal period.  Typically capital account is the only real account to have its balance change when the transition to the new fiscal period is made

 Nominal accounts have balances that do not continue into the next fiscal period  With the exception of the drawings account, nominal accounts are related to the income statement, and the income statement measures business performance one year at a time  All nominal accounts begin each fiscal period with a zero balance  Closing an account means to cause it to have no balance (see Fig. 8.11, p. 291)

 After accounts in the new income statement have been closed, they are now ready to measure net income in the new year  The new Capital amount is as follows; Capital – Drawings + Current Earnings (or – Loss) = New Capital Amount

Preparing the Closing Journal Entries  When done manually, we can use a four-step approach to closing entries; Closing Entry No. 1 – Revenues  The first closing entry deals with revenue  Revenue must be reset to zero as it is a nominal account  Typically accountants would take an intermediate step by creating a temporary equity account called Income Summary, which is used to record debit and credit amounts during the closing process

 This account summarizes revenue and expense amounts in one ledger account and will then reveal the amount of net income or loss  This amount can then be transferred to the capital account

Closing Entry No. 2 – Expenses  The second closing entry clears the balance of each expense account in the ledger  Since expense accounts have debit balances, credit entries are needed to bring the expense account balances to zero  The total of all expense accounts will be debited to Income Summary

Closing Entry No. 3 – Income (or loss)  The amount for the third closing journal entry is also found on the worksheet  If in an account format, total expenses are subtracted from total revenue to produce the account balance  If the account balance is a credit amount, this is because revenues (credits) are greater than expenses (debits), therefore the balance represents the net income figure  If Income summary had a credit balance, it needs a debit entry to clear it

Closing Entry No. 4 – Drawings  The fourth and final closing entry transfers the balance of the drawings account to the capital account  This amount can be picked up from the worksheet  Since the drawings account always has a debit balance, a credit entry is needed to close it

 In Ch. 5 we learned; Beginning Capital + Net Income – Drawings = Ending Capital  Now, revenue, expense, and drawings accounts have come full circle.  The net effects of their balances are returned to the capital account at year-end

Post-Closing Trial Balance  The accuracy of the ledger must be checked after you have finished journalizing and posting the adjusting and closing entries  This is done by taking off the post-closing trial balance (see fig. 8.10, p. 290)

Complete Accounting Cycle  We can now see that accounting is cyclical in nature  In a manual system, the post-closing trial balance is the final step in the accounting cycle  See Fig (p. 296) to see the major steps in the accounting cycle that occur every fiscal year  Accounting software makes the whole process much simpler and automatic  A worksheet is unnecessary and closing journal entries are for the most part unnecessary