College Accounting, by Heintz and Parry Chapter 6: Financial Statements and the Closing Process

Eddie’s Winter Quarter looked rough, with too much macroeconomics and not enough macrame, so he decided to prepare the general ledger for 2000 before classes started. That meant he needed to make closing entries, entries that would set the revenue, expense, and drawing accounts back to zero. This would allow these accounts to accumulate the information necessary to prepare an income statement and statement of owner’s equity for 2000. Question: What accounts do not get closed?

How it relates to your audience Supporting information and examples Details about this topic Answer: The assets, liabilities, and capital accounts do not get closed (although Eddie certainly wishes that his liabilities automatically returned to zero at year end). There are 4 closing entries. Eddie remembered the purpose and order of the four entries because the 4 types of accounts being closed spelled the last name of his friend Robert REID. The 4 entries are to close: 1) Revenue accounts 2) Expense accounts 3) Income Summary, and the 4) Drawing account.

Entry One: Close the Revenue Account(s) Because revenue accounts have credit balances, we need to debit them (for the amount of their balance) to close them. The credit goes to a new account called Income Summary. Income Summary is used to summarize the income statement accounts, so it gets used only for closing entries. Date Description P. R. Debit Credit Closing Entries 1999 Dec. 31 Gig Revenue 525.00 Income Summary 525.00

Entry Two: Close the Expense Accounts Because expense accounts have debit balances, we need to credit them (for the amount of their balance) to close them. The debit (for the total amount of the expenses) goes to Income Summary. Date Description P. R. Debit Credit 1999 Dec. 31 Income Summary 335.00 Wage Expense 160.00 Equipment Rental Expense 30.00 Supply Expense 35.00 Insurance Expense 20.00 Depr’n. Exp.-Mus. Instruments 90.00

Entry Three: Close the Income Summary Account At this point, the income summary account has been credited for the total amount of revenues ($525) and debited for the total amount of expenses ($335). Thus, its balance should equal $190. Income Summary 335 525 Bal. 190 Questions: 1) This $190 balance should equal what amount found on the financial statements? 2) If we close Income Summary with a $190 debit, what account should we credit?

Answers: 1) The balance of $190 represents the company’s net income Answers: 1) The balance of $190 represents the company’s net income. 2) The credit goes to Eddie O’Hare, Capital, because the net income increases his ownership in the business. Date Description P. R. Debit Credit 1999 Dec. 31 Income Summary 190.00 Eddie O’Hare, Capital 190.00

Entry Four: Close the Drawing Account Because the drawing account has a debit balance, we need to credit it to close it. The debit goes to Eddie’s capital account because withdrawals reduce his ownership in the business. Date Description P. R. Debit Credit Closing Entries 1999 Dec. 31 Eddie O’Hare, Capital 12.00 Eddie O’Hare, Drawing 12.00

When the closing entries are posted, the accounts have no balance (signified by two straight lines in the balance column), and the new year’s transactions can be entered. account Eddie O’Hare, Drawing account no. 312 Balance Date Item P.R. Debit Credit Debit Credit 1999 Oct..17 J1 12.00 12.00 Dec.31 J3 12.00 ----------- ----------

At this point, Eddie prepared financial statements At this point, Eddie prepared financial statements. His income statement (REN, remember?) confirmed that net income was $190. Eddie and the Losers Income Statement For Year Ended Dec. 31, 1999 Revenues: Gig Revenue $525 Expenses: Wage Expense $160 Depn. Exp.-M.I. 90 Supply Expense 35 Equip. Rental Expense 30 Insurance Expense 20 Total Expenses 335 Net Income $190

Eddie did his Statement of Owner’s Equity next Eddie did his Statement of Owner’s Equity next. Although Eddie invested no additional money during the period, the two lines in red show how the statement would reflect it if he did. The sentence to help you remember the format would become Connie and Tom need less ice cream. Eddie and the Losers Statement of Owner’s Equity For Year Ended Dec. 31, 1999 E. O’Hare, Cap., Oct. 1 $2000 Additional Investment 0 Total 2000 Net Income $190 Less Withdrawals 12 Increase in Capital 178 E. O’Hare, Cap, Dec. 31 $2178

Eddie’s balance sheet had some new headings Eddie’s balance sheet had some new headings. He divided his assets into Current Assets (assets that will be used up or turned into cash within one year) and Plant, Property and Equipment (physical assets that will last for more than one year). Eddie and the Losers Balance Sheet Dec. 31, 1999 Assets Current Assets: Cash $383 Supplies 25 Prepaid Insurance 100 Total Current Assets $508 Plant, Prop., & Equip.: Musical Instruments $2200 Less Accum. Dep’n. 90 2110 Total Assets $2618

Eddie’s liabilities will also go into one of two headings: Current Liabilities (those that will be paid within one year) and Long-term Liabilities (which will not be paid in the next year). At this point, all of Eddie’s liabilities are current. Eddie and the Losers Balance Sheet Dec. 31, 1999 Liabilities Current Liabilities: Accounts Payable $360 Wages Payable 80 Total Current Liabilities $ 440 Owner’s Equity Eddie O’Hare, Capital 2178 Total Liabilities & Owner’s Equity $2618

Eddie’s last step, after financial statements and the posting of closing entries, is a post-closing trial balance. It is used to confirm that all posting was done correctly (only balance sheet accounts should have balances, and debits should equal credits). Eddie and the Losers Post-Closing Trial Balance Dec. 31, 1999 Debits Credits Cash 383 Supplies 25 Prepaid Insurance 100 Musical Instruments 2200 Acc. Depn.-M.I. 90 Accts. Payable 360 Wages Payable 80 Eddie O’Hare, Capital 2178 2708 2708 It balances!