Chapter Five Closing Entries and the Post-Closing Trial Balance

Copyright © Houghton Mifflin Company. All rights reserved Performance Objectives 1.List the steps in the accounting cycle 2.Journalize and post closing entries for a service enterprise 3.Prepare a post-closing trial balance 4.Define the following methods of accounting: accrual basis and modified cash basis 5.Prepare interim statements

Copyright © Houghton Mifflin Company. All rights reserved Performance Objective 1 List the steps in the accounting cycle

Copyright © Houghton Mifflin Company. All rights reserved The Accounting Cycle Chapter 3 1.Analyze source documents and record business transactions in a journal 2.Post journal entries to the ledger accounts 3.Prepare a trial balance Chapter 4 4.Gather adjustment data and record adjustments in the work sheet 5.Complete the work sheet 6.Create financial reports from data in work sheet 7.Journalize and post the adjusting entries Chapter 5 8.Journalize and post the closing entries 9.Prepare the post-closing trial balance

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Copyright © Houghton Mifflin Company. All rights reserved Performance Objective 2 Journalize and post closing entries for a service enterprise

Copyright © Houghton Mifflin Company. All rights reserved Closing Entries Entries made at the end of a fiscal period to close off the revenue, expense, and drawing accounts—that is, to make the balances of the temporary-equity accounts equal to zero Also called clearing the accounts

Copyright © Houghton Mifflin Company. All rights reserved Purpose of Closing Entries

Copyright © Houghton Mifflin Company. All rights reserved Purpose of Closing Entries To close out balances that relate to one fiscal period and start fresh in the next period To zero out the following ledger accounts: –Revenue –Expenses To update the owner’s Capital account

Copyright © Houghton Mifflin Company. All rights reserved Balances on the Financial Statements

Copyright © Houghton Mifflin Company. All rights reserved Revenue - Expenses = Net Income Net Income Statement of Owner’s Equity

Copyright © Houghton Mifflin Company. All rights reserved Withdrawals Statement of Owner’s Equity

Copyright © Houghton Mifflin Company. All rights reserved Ending Capital Balance Sheet

Copyright © Houghton Mifflin Company. All rights reserved Revenues, Expenses, & Withdrawals Ending Capital

Copyright © Houghton Mifflin Company. All rights reserved Start Fresh for Next Period, July 1 To July 31, 2005 All Revenues, Expenses, and Withdrawals from last period are reflected in the Capital account See all the zeros?

Copyright © Houghton Mifflin Company. All rights reserved Nominal or Temporary-Equity Accounts Accounts that apply to only one fiscal period and that are to be closed at the end of that fiscal period, such as revenue, expense, Income Summary, and Drawing accounts May also be described as all accounts except assets, liabilities, and the Capital account

Copyright © Houghton Mifflin Company. All rights reserved Real or Permanent Accounts The accounts that remain open (assets, liabilities, and the Capital account in owner’s equity) and that have balances that will be carried over to the next fiscal period

Copyright © Houghton Mifflin Company. All rights reserved Let’s Look at Closing with T Accounts = DRCRDRCRDRCR DRCRDRCR DRCRDRCR DrawingCapital AssetsLiabilitiesOwner's Equity ExpensesRevenues Real Accounts “Permanent Accounts” Nominal Accounts “Temporary Equity Accounts” Closed & Put Here

Copyright © Houghton Mifflin Company. All rights reserved After Closing = DRCRDRCRDRCR DRCR AssetsLiabilitiesOwner's Equity Capital Revenues, Expenses, Drawings Closed & Put Here

Copyright © Houghton Mifflin Company. All rights reserved Closing Using T-Accounts Closing Procedure 1.Close revenue account(s) into Income Summary 2.Close expense accounts into Income Summary 3.Close Income Summary into Capital 4.Close Drawing into Capital

Copyright © Houghton Mifflin Company. All rights reserved Income Summary An account brought into existence to have a debit and credit for each closing entry –It does not have plus or minus sign, just debits and credits Revenue and expense account balances are transferred to this account to allow calculation of net income and net loss Serves as the in-between account, or “holding tank,” before net income or net loss transferred to the Capital account

Copyright © Houghton Mifflin Company. All rights reserved Step 1: Close Revenue Accounts into Income Summary

Copyright © Houghton Mifflin Company. All rights reserved Step 2:Close Expense Accounts into Income Summary

Copyright © Houghton Mifflin Company. All rights reserved Step 3: Close Income Summary into Capital

Copyright © Houghton Mifflin Company. All rights reserved Step 4: Close Drawing into Capital Account

Copyright © Houghton Mifflin Company. All rights reserved Closing Entries Entries into the journal made at the end of a fiscal period to close off the revenue, expense, and Drawing accounts—that is, to make the balances of the temporary-equity accounts equal to zero Closing is also called clearing the accounts

Copyright © Houghton Mifflin Company. All rights reserved Journalize the Closing Entries Close the revenue accounts into Income Summary Close the expense accounts into Income Summary Close the Income Summary account into the Capital account (transferring net income or net loss to the Capital account) Close the Drawing account into Capital Be sure to label the entries “Closing Entries” before you begin to enter them into the journal

Copyright © Houghton Mifflin Company. All rights reserved Journalize Steps 1–2

Copyright © Houghton Mifflin Company. All rights reserved Journalize Steps 1–4

Copyright © Houghton Mifflin Company. All rights reserved Closing Hints When you want revenue and expense accounts to go to zero: –Create an offsetting debit or credit in Income Summary to “balance it off” When closing Income Summary into Capital: –Net income is a credit to Capital –Net loss is a debit to Capital When closing Drawing into Capital: –Drawing is a debit to Capital –Remember: withdrawals are not expenses

Copyright © Houghton Mifflin Company. All rights reserved Creating Journal Entries Directly from the Work Sheet Revenue and expenses come from the Income Statement columns Withdrawals come from the Balance Sheet debit column Automatic check: if your closing number from Income Summary to Capital is not the same as net income, you made a mistake

Copyright © Houghton Mifflin Company. All rights reserved Post the Closing Entries Revenue, expense, and Drawing accounts should end up with zero balances –Draw a line through both the debit and credit balance columns to indicate that they have been zeroed and closed Capital will more than likely have some net change for the period Be sure to write “Closing” in the Item column of the ledger account

Copyright © Houghton Mifflin Company. All rights reserved Posting Step 1 for Arch Copy Co.

Copyright © Houghton Mifflin Company. All rights reserved Posting Steps 1-3 for Arch Copy Co.

Copyright © Houghton Mifflin Company. All rights reserved Performance Objective 3 Prepare a post-closing trial balance

Copyright © Houghton Mifflin Company. All rights reserved Post-Closing Trial Balance The listing of the final balances of the real accounts at the end of the fiscal period The opening balances for the next period

Copyright © Houghton Mifflin Company. All rights reserved Post-Closing Trial Balance Accountant uses the post-closing trial balance to make sure that DR = CR –Have you done all the work correctly?

Copyright © Houghton Mifflin Company. All rights reserved Errors: Post-Closing Trial Balance If DR ≠ CR –Columns added correctly? –Correct amounts transferred from the ledger accounts? –Adjusting entries posted correctly? New balances correct? –Closing entries posted correctly? New balances correct? –All nominal accounts closed?

Copyright © Houghton Mifflin Company. All rights reserved Performance Objective 4 Define the following methods of accounting: accrual basis and modified cash basis

Copyright © Houghton Mifflin Company. All rights reserved Accrual Basis An accounting method under which revenue is recorded when it is earned, regardless of when the cash is received, and expenses are recorded when they are incurred, regardless of when they are paid

Copyright © Houghton Mifflin Company. All rights reserved Modified Cash Basis An accounting method under which revenue is recorded only when it is received as cash Most expenses are recorded only when they are paid in cash However, exceptions are made for expenditures on items having a useful life of more than one year and for certain prepaid items

Copyright © Houghton Mifflin Company. All rights reserved Modified Cash Basis Exceptions Expenditure for insurance premiums can be prorated, or spread out, over the fiscal periods covered Expenditures for long-lived items are recorded as assets and later depreciated as expenses over their useful lives

Copyright © Houghton Mifflin Company. All rights reserved Performance Objective 5 Prepare interim statements

Copyright © Houghton Mifflin Company. All rights reserved Interim Statements Financial statements prepared during the fiscal year, covering a period of time less than twelve months

Copyright © Houghton Mifflin Company. All rights reserved Prepare Interim Statements

Copyright © Houghton Mifflin Company. All rights reserved Prepare Interim Statements Accountant prepares financial statements from the work sheet Accountant does not journalize and post the adjusting or closing entries until the end of the fiscal year

Copyright © Houghton Mifflin Company. All rights reserved Demonstration Problem The completed work sheet for Colfeld company for the year ended June 30, 2005, is shown on the following slide We are going to complete the following tasks: –Journalize the closing entries –Create the post-closing trial balance

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Copyright © Houghton Mifflin Company. All rights reserved Closing: Step 1 June 2005

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Copyright © Houghton Mifflin Company. All rights reserved Closing: Step 2 June 2005

Copyright © Houghton Mifflin Company. All rights reserved Check Number for Step 3 Closing Entry

Copyright © Houghton Mifflin Company. All rights reserved Closing: Step 3 June 2005

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Copyright © Houghton Mifflin Company. All rights reserved Closing: Step 4 June 2005

Copyright © Houghton Mifflin Company. All rights reserved Create Post-Closing Trial Balance