COMPLETION OF THE ACCOUNTING CYCLE - Closing Entries - CHAPTER 10 COMPLETION OF THE ACCOUNTING CYCLE - Closing Entries -

Worksheet Over View 4. Extend adjusted balance to appropriate columns. 5. Calculate income/loss and complete the worksheet. 1. Prepare trial balance on the worksheet. 2. Enter adjustment data. 3. Enter adjusted balances

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.

Purpose of Closing Entries Updates the owner’s capital account in the ledger by transferring net income (loss) and owner’s drawings to owner’s capital. 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.

Real Accounts and Nominal 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, Trucks, and Accounts Payable.

Real Accounts and 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.

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).

Temporary Versus Permanent TEMPORARY (NOMINAL) PERMANENT (REAL) These accounts are closed 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 (INDIVIDUAL) EXPENSES Normal Dr. Balance Normal Cr. Balance Cr. to close Dr. to close 2 1 - 0 - - 0 - Expenses Revenues Opening Balance 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.

Diagram of the Closing Process Expenses Revenues Opening Balance Drawings Ending Balance 3 OWNER’S DRAWINGS Normal Dr. Balance Cr. to close - 0 - 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 four steps involved in closing the books: Close the revenue accounts into Income Summary. Close the expense accounts into Income Summary. Close Income Summary into Capital. Close Drawings into Capital. 1 2 3 4

Journalizing and Posting the Closing Entries Don’t forget to post to the General Ledger Closing Entry No. 1

Journalizing and Posting the Closing Entries Don’t forget to post to the General Ledger Closing Entry No. 2

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 Don’t forget to post to the General Ledger Closing Entry No. 4

Closing Entries STOP AND CHECK 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.

Post - Closing Trial Balance The post-closing trial balance is prepared from the permanent accounts in the ledger. The post-closing trial balance provides evidence that the journalizing and posting of closing entries has been properly completed.

Steps in the Accounting Cycle 1. Source Documents: Analyse Transactions 9. Prepare post-closing trial balance 2. Journalize the transactions 3. Post to ledger accounts 8. Journalize and post closing entries 4. Prepare a trial balance 7. Prepare financial statements 5. Journalize and post adjusting entries 6. Prepare adjusted trial balance