1. Completing the Accounting Cycle
LO 3 – Preparing Closing Entries

2. LO 3
Closing Entries
Accounts that are relatively permanent from year to year are called permanent accounts or real accounts. These accounts are carried forward from year to year.
Balance sheet accounts are referred to as permanent or real accounts because their balances normally accumulate from period to period. Revenue and expense accounts are used to capture the effects of operating activities during a fiscal period. Revenue and expense accounts are considered temporary or nominal accounts because these accounts are reduced to a zero dollar balance or closed at the end of an accounting period, and the results are transferred to owner’s equity via retained earnings.

3. LO 3
Closing Entries
Accounts that report amounts for only one period are called temporary accounts or nominal accounts. Temporary accounts are not carried forward because they relate to only one period.
To report amounts for only one period, temporary accounts should have zero balances at the beginning of the period. To accomplish this, closing entries are made at the end of each accounting period.

4. LO 3
Closing Entries
To report amounts for only one period, temporary accounts should have zero balances at the beginning of the next period.
To achieve this, the revenue and expense account balances are transferred to Income Summary at the end of the period.
Each accounting cycle starts with a clean slate. We set the accounts back to zero, so we can isolate each accounting period’s results easily.
A four-step approach to closing the temporary accounts will be used. A temporary account, Income Summary, is used to assist in the process.

5. LO 3
Closing Entries
The balance of Income Summary (net income or net loss) is then transferred to the owner’s capital account.
The balance of the owner’s drawing account is also transferred to the owner’s capital account.
The entries that transfer these balances are called closing entries.
Closing entries are recorded in the journal and are dated as of the last day of the accounting period.

6. LO 3
Closing Entries
This diagram shows how the account Income Summary is used in closing the accounts. First, transfer revenues to Income Summary. Second, transfer expenses to Income Summary. Third, transfer either the net income or the net loss to capital, closing income summary. If the company has a net income, then Income Summary will have a credit balance. If the company has a net loss, then Income Summary will have a debit balance. Fourth, transfer the drawing account balance to Owner’s Capital. The following slides will illustrate the closing process for NetSolutions.

7. Journalizing and Posting Closing Entries
Debit Fees Earned for $16,840 and Rent Revenue for $120. Credit Income Summary for $16,960, the total of these two debits. This represents the total revenues earned for the period.

8. Journalizing and Posting Closing Entries
Step 2 requires that each of the expense accounts be credited for its balance. Closing entry 2 causes each account to equal zero. Total Expenses has been transferred to Income Summary. Credit Wage Expense for $4,525, Rent Expense for $1,600, Depreciation Expense for $50, Utilities Expense for $985, Supplies Expense for $2,040, Insurance Expense for $200, and Miscellaneous Expense for $455. Debit Income Summary for the total of these credits, $9,855.

9. Journalizing and Posting Closing Entries
Step 3 closes Income Summary by transferring its balance to Capital. Since the revenue earned of $16,960 exceeds the expenses incurred of $9,855, NetSolutions has a net income of $7,105. Transfer the net income to Capital by debiting Income Summary for $7,105 and crediting Capital for $7,105. Debiting Income Summary for $7,105 makes both the debits and credits of Income Summary equal. After step 3, the balance of Income Summary equals zero.

10. Journalizing and Posting Closing Entries
Close the Drawing account and transfer its balance to Capital by debiting Capital and crediting Drawing for $4,000. Do not transfer Drawing to Income Summary because it was closed in step 3. After posting this entry, the Capital account is updated to the end-of-period balance.

11. Closing Entries LO 3 Step 1 Step 2
This slide illustrates the closing entries being recorded in the journal. First, write the heading Closing Entries. The first-step entry closes the two revenue accounts to Income Summary. The second-step entry closes each of the expense accounts to Income Summary. The third-step entry closes Income Summary to Capital. The fourth-step entry closes Drawing to Capital.
Step 3
Step 4

12. Temporary Account Balances
LO 3
Temporary Account Balances
After the closing entries are posted, all of the temporary accounts have zero balances.
Revenue and expense accounts are temporary accounts, and the balances in these accounts after the closing entries should be zero.

13. Post-Closing Trial Balance
A post-closing trial balance is prepared after the closing entries have been posted. The purpose of the post-closing (after closing) trial balance is to verify that the ledger is in balance at the beginning of the next period.
After the closing entries have been journalized and posted to the ledger, another trial balance is prepared, called a post-closing trial balance. This statement should contain only real or permanent accounts. All temporary accounts should have zero balances.

14. Post-Closing Trial Balance
As illustrated on this slide, the post-closing trial balance contains only real or permanent accounts. All of the temporary accounts are zero because their balances have been transferred to Capital. They are not included in the post-closing trial balance. This trial balance proves the equality of debits and credits in the ledger after closing entries have been prepared. Another purpose of the post-closing trial balance is to verify that the ledger is in balance at the beginning of the next period.