THE ACCOUNTING CYCLE: Closing Entries 1

Previous Lecture 2 Unadjusted Trial Balance Adjustments Adjusted Trial Balance Income statement Balance Sheet All above together in one sheet is called work sheet Statement of Retained Earnings

Adjusting and Closing Entries If a work sheet has been prepared, the data for these entries are in the Adjustments columns. 3

4 Closing the Books Closing entries – Transfer the temporary account balances to update the retained earnings account – Reduce the balances in the temporary accounts to zero to prepare for the next period’s postings

5 TemporaryPermanent Temporary Permanent All revenue accountsAll asset accounts All expense accountsAll liability accounts Dividends account Shareholders’ equity accounts

6 Retained Earnings is a permanent account; the others shown here are temporary Individual Expenses Retained Earnings Income Summary Individual Revenues Dividends

7 Post-Closing Trial Balance Proves the equality of total debit balances and total credit balances after the closing entries have been made Should contain only permanent accounts

RETAINED EARNINGS The Closing Process Income Summary 1 Revenues are transferred to Income Summary2 Expenses are transferred to Income Summary 3 Net Income or Net Loss is transferred to Retained Earnings 4 Dividends are transferred to Retained Earnings 8

RETAINED EARNINGS The Closing Process Income Summary 1 Revenues are transferred to Income Summary2 Expenses are transferred to Income Summary 3 Net Income or Net Loss is transferred to Retained Earnings 4 Dividends are transferred to Retained Earnings The Income Summary account does not appear on the financial statements. 9

Wages Expense Bal.4,525 Rent Expense Bal.1,600 Depreciation Expense Bal.50 Utilities Expense Bal.985 Supplies Expense Bal.2,040 Insurance Expense Bal.100 Miscellaneous Expense Bal.455 Fees Earned Bal.16,840 Rent Revenue Bal.120 Retained Earnings Bal.25,000 Dividends Bal.4,000 Income Summary Note: The balances shown are adjusted balances before closing. The following sequence demonstrates the closing process. The Closing Process 10

Wages Expense Bal.4,525 Rent Expense Bal.1,600 Depreciation Expense Bal.50 Utilities Expense Bal.985 Supplies Expense Bal.2,040 Insurance Expense Bal.100 Miscellaneous Expense Bal.455 Fees Earned Bal.16,840 Rent Revenue Bal.120 Retained Earnings Dividends Bal.4,000 Income Summary Debit each revenue account for the amount of its balance, and credit Income Summary for the total revenue. 16, ,960 The Closing Process 11

Wages Expense Bal.4,525 Rent Expense Bal.1,600 Depreciation Expense Bal.50 Utilities Expense Bal.985 Supplies Expense Bal.2,040 Insurance Expense Bal.100 Miscellaneous Expense Bal.455 Retained Earnings Dividends Bal.4,000 Income Summary Debit Income Summary for the total expenses and credit each expense account for its balance. Fees Earned Bal.16,840 Rent Revenue Bal , ,9609, , ,600 4,525 The Closing Process 12

Wages Expense Bal.4,525 Rent Expense Bal.1,600 Depreciation Expense Bal.50 Utilities Expense Bal.985 Supplies Expense Bal.2,040 Insurance Expense Bal.100 Miscellaneous Expense Bal.455 Retained Earnings Dividends Bal.4,000 Income Summary Debit Income Summary for the amount of its balance (in this case, the net income) and credit Retained Earnings. Fees Earned Bal.16,840 Rent Revenue Bal , ,9609, , ,600 4,525 7,205 The Closing Process 13

Wages Expense Bal.4,525 Rent Expense Bal.1,600 Depreciation Expense Bal.50 Utilities Expense Bal.985 Supplies Expense Bal.2,040 Insurance Expense Bal.100 Miscellaneous Expense Bal.455 Retained Earnings Dividends Bal.4,000 Income Summary Debit Retained Earnings for the balance of Dividends and credit Dividend for the same amount. Fees Earned Bal.16,840 Rent Revenue Bal , ,9609, , ,600 4,525 7,205 4,000 The Closing Process 7,205 14

Wages Expense Bal.4,525 Rent Expense Bal.1,600 Depreciation Expense Bal.50 Utilities Expense Bal.985 Supplies Expense Bal.2,040 Insurance Expense Bal.100 Miscellaneous Expense Bal.455 Retained Earnings Dividends Bal.4,000 Income Summary Fees Earned Bal.16,840 Rent Revenue Bal , ,9609, , ,600 4,525 7,205 4,000 Close Revenues Close Revenues Close Expenses Close Expenses Close Income Summary Close Income Summary Close Dividends Close Dividends 16,840 16, ,960 16,960 4,525 4,525 1,600 1, ,040 2, ,775 9,775 7,205 7,205 4,000 4,000 Review of the Closing Process 15

After the closing entries are posted, all of the temporary accounts have zero balances. 16

Post-closing Trial Balance NetSolutions Post-Closing Trial Balance December 31, 2005 Cash Accounts Receivable Supplies Prepaid Insurance Land Office Equipment Accumulated Depreciation50 00 Accounts Payable Wages Payable Unearned Rent Capital Stock Retained Earnings

Closing the Temporary Equity Accounts  Close Revenue accounts to Income Summary.  Close Expense accounts to Income Summary.  Close Income Summary account to Retained Earnings.  Close Dividends to Retained Earnings. The closing process gets the temporary accounts ready for the next accounting period. 18

19 JJ’s Lawn Care Service would make the these closing entries.

Since Sales Revenue has a credit balance, the closing entry requires a debit to the Sales Revenue account. Closing Entries for Revenue Accounts 20

Closing Entries for Revenue Accounts 21

Since expense accounts have a debit balance, the closing entry requires a credit to the expense accounts. Closing Entries for Expense Accounts 22

Closing Entries for Expense Accounts Net Income 23

Since Income Summary has a $400 credit balance, the closing entry requires a debit to Income Summary. Closing the Income Summary Account 24

The balance in Income Summary is now zero. Closing the Income Summary Account 25

Since the Dividends account has a debit balance, the closing entry requires a credit to the Dividends account. Closing the Dividends Account 26

Closing the Dividends Account 27

After all closing entries are made, JJ’s After-Closing Trial Balance looks like this. 28

Did the business earn a profit or loss in the current period? What is the business’s future potential for a profit? Evaluating Profitability Does the business have assets available to pay debts as they are due? Evaluating Solvency Evaluating the Business 29

Are product lines profitable? Are resources being used efficiently? Are production processes efficient? Focusing Management’s Attention Evaluating the Business 30

Monthly Quarterly Jan. 1Dec. 31 Annually Many companies prepare financial statements at various points throughout the year. Interim Financial Statements Preparing Financial Statements Covering Different Periods of Time 31

32 Required Steps in the Accounting Cycle 1.Analyze business transactions 2.Journalize the transactions 3.Post to general ledger accounts 4.Prepare a trial balance 5.Journalize and post adjusting entries (prepayments and accruals)

33 Required Steps in the Accounting Cycle 6.Prepare an adjusted trial balance 7.Prepare financial statements 8.Journalize and post closing entries 9.Prepare a post-closing trial balance

Journalize transactions. Post entries to the ledger accounts. Prepare trial balance. Make end-of- year adjustments. Prepare adjusted trial balance. Prepare financial statements. Prepare after closing trial balance. Journalize and post closing entries. The Accounting Cycle 34

What we did in this lecturer Closing the Books Temporary Accounts – All Revenue Accounts – All Expenses Accounts – All Dividend Accounts Permanent Accounts – All Assets Accounts – All Liabilities Accounts – Shareholder Equity Accounts 35

End of Chapter 5 36