2 Lecture Outline Closing Entries DefinedClosing Revenue AccountsClosing Expense AccountsAllocation of Profit/Loss (Partnership)Fixed Capital Balance MethodClosing Drawings Account
3 Closing EntriesAt 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 EntriesRevenue 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.
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.ExampleThe 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.
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 CreditP&L Summary 50,000Profit Distribution 50,000
12 Allocation of Profit/Loss Three methods for allocating profit are as follows:Fixed ratioRatio based on capital balancesFixed 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 $200,000Matt $150,000Profit for the year is $50,000.
14 1. Fixed RatioThe partnership agreement specifies that net profit is to be allocated on the following basis (60% Justin, 40% Matt).Debit CreditProfit Distribution ,000Retained Profits - Justin 30,000Retained Profits - Matt 20,000
15 Statement of Financial Position Equity Capital - Justin ,000Capital - Matt ,000Retained Profits- Justin 30,000Retained Profits - Matt 20,000Total 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 = 28,571Matt: 150/350 x 50,000 = 21,429Debit CreditProfit Distribution 50,000Retained Profits - Justin 28,571Retained Profits - Matt 21,429
18 Statement of Financial Position Equity Capital – Justin ,000Capital - Matt ,000Retained Profits- Justin 28,571Retained Profits - Matt 21,429Total 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 CapitalSalaryInterest 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 profitJustin: 10% x 200,000 = 20,000Matt: 10% x 150,000 = 15,000
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 profitJustin: 60% x 5,000 = 3,000Matt: 40% x 5,000 = 2,000
26 Distribution of Profit Debit CreditProfit Distribution ,000Retained Profits - Justin 30,000Retained Profits - Matt 20,000
27 Statement of Financial Position Equity Capital - Justin ,000Capital - Matt ,000Retained Profits- Justin 30,000Retained Profits - Matt 20,000Total Equity ,000
28 Closing DrawingsAt 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 periodJustin: 9,000Matt: 6,000