1. Accounting Cycle IV

2. Lecture Outline Closing Entries
Defined
Closing Revenue Accounts
Closing Expense Accounts
Allocation of Profit/Loss (Partnership)
Fixed Capital Balance Method
Closing Drawings Account

3. Closing Entries
At the end of each new accounting period the balances within the revenue and expense accounts at the end of the old accounting period must be “closed off”.
“Closing Off the accounts”
Simply means that accounts are returned to a zero balance.

4. Closing Entries
Revenue and expense accounts are closed off to ensure that only revenues earnt and expenses incurred within a period are included within the Statement of Financial Performance.

5. Closing Revenue Accounts
Revenue accounts are closed by debiting the revenue account by the amount of the closing balance and then crediting the P&L Summary account by the same amount.
Example
“Novel Sports” sells $60,000 worth of goods in the period. The sales revenue account would be debited by $60,000 and the P&L Summary account would be credited by $60,000.

6. Closing Revenue Accounts General Journal Entry
Debit Credit
Sales Revenue 60,000
P&L Summary 60,000

7. Closing Expense Accounts
Expense accounts are closed by crediting the expense account by the amount of the closing balance and then debiting the P&L Summary account by the same amount.
Example
The wages expense for “Novel Sports” is $10,000. The wages account needs to be credited by $10,000 and the P&L Summary account debited by $10,000.

8. Closing Expense Accounts General Journal Entry
Debit Credit
P&L Summary 10,000
Wages Expense 10,000

9. Closing the P&L Summary
The P&L Summary is a temporary account. It is closed off to the Profit Distribution account at the end of the accounting period.

10. Closing the P&L Summary
Example
“Novel Sports” has made a $50,000 profit (ie $60,000 – 10,000) then the P&L Summary will have a $50,000 credit balance. This needs to be closed off to the profit distribution account

11. Closing the P&L Summary
Debit Credit
P&L Summary 50,000
Profit Distribution 50,000

12. Allocation of Profit/Loss
Three methods for allocating profit are as follows:
Fixed ratio
Ratio based on capital balances
Fixed ratio after deducting interest on partners capital and salaries paid to partners.
The manner in which profits are to be allocated should be outlined in the partnership agreement.

13. Example Matt and Justin are partners in “Novel Sports”.
Capital Investments are as follows:
Justin $200,000
Matt $150,000
Profit for the year is $50,000.

14. 1. Fixed Ratio
The partnership agreement specifies that net profit is to be allocated on the following basis (60% Justin, 40% Matt).
Debit Credit
Profit Distribution ,000
Retained Profits - Justin 30,000
Retained Profits - Matt 20,000

15. Statement of Financial Position Equity
Capital - Justin ,000
Capital - Matt ,000
Retained Profits- Justin 30,000
Retained Profits - Matt 20,000
Total Equity ,000

16. 2. Ratio Based on Capital Balances
Justin and Matt agree to share profit based on opening capital balances.
In this way, the partner that has invested more money into the business receives a greater proportion of any profit or loss.

17. 2. Ratio Based on Capital Balances
Justin: 200/350 x 50,000 = 28,571
Matt: 150/350 x 50,000 = 21,429
Debit Credit
Profit Distribution 50,000
Retained Profits - Justin 28,571
Retained Profits - Matt 21,429

18. Statement of Financial Position Equity
Capital – Justin ,000
Capital - Matt ,000
Retained Profits- Justin 28,571
Retained Profits - Matt 21,429
Total Equity ,000

19. 3. Fixed Ratio after Interest on Capital and Salaries
Partners may specify within the partnership agreement that each partner is to receive the following:
Interest on Opening Capital
Salary
Interest and Salaries to partners are paid out of the profit (ie they are not expenses of the business).

20. 3. Fixed Ratio after Interest on Capital and Salaries
Matt and Justin agree that 10% interest on opening capital should be paid each year.
Interest allocated to each partner from profit
Justin: 10% x 200,000 = 20,000
Matt: 10% x 150,000 = 15,000

21. Profit Distribution

22. 3. Fixed Ratio after Interest on Capital and Salaries
The partners agree that Justin should receive a salary of $7,000 and Matt a salary of $3,000.

23. Profit Distribution

24. 3. Fixed Ratio after Interest on Capital and Salaries
The remaining profit ($5,000) is then allocated according to fixed ratio (ie 4:6)
Profit allocated to each partner from profit
Justin: 60% x 5,000 = 3,000
Matt: 40% x 5,000 = 2,000

26. Distribution of Profit
Debit Credit
Profit Distribution ,000
Retained Profits - Justin 30,000
Retained Profits - Matt 20,000

27. Statement of Financial Position Equity
Capital - Justin ,000
Capital - Matt ,000
Retained Profits- Justin 30,000
Retained Profits - Matt 20,000
Total Equity ,000

28. Closing Drawings
At the end of the period any drawings by partners are closed off to the respective partners retained profit account.
Drawings by each partner during the period
Justin: 9,000
Matt: 6,000

29. Closing Drawings Retained Profits - Justin 9,000
Debit Credit
Retained Profits - Justin 9,000
Retained Profits – Matt 6,000
Drawings - Justin 9,000
Drawings – Matt 6,000

30. Statement of Financial Position Equity
Capital – Justin ,000
Capital - Matt ,000
Retained Profits- Justin 21,000
Retained Profits - Matt 14,000
Total Equity ,000