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Published byGriselda Golden Modified over 8 years ago
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Sec. 8.3 - Preparing for New Fiscal Years
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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
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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
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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
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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)
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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
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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
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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
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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
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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
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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
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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
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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)
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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. 8.20 (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
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