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Accounting Cycle IV. Lecture Outline Closing Entries Defined Closing Revenue Accounts Closing Expense Accounts Allocation of Profit/Loss (Partnership)

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Presentation on theme: "Accounting Cycle IV. Lecture Outline Closing Entries Defined Closing Revenue Accounts Closing Expense Accounts Allocation of Profit/Loss (Partnership)"— Presentation transcript:

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 DebitCredit Sales Revenue60,000 P&L Summary60,000

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 DebitCredit P&L Summary10,000 Wages Expense10,000

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 DebitCredit P&L Summary50,000 Profit Distribution50,000

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). DebitCredit Profit Distribution 50,000 Retained Profits - Justin30,000 Retained Profits - Matt20,000

15 Statement of Financial Position Equity Equity Capital - Justin200,000 Capital - Matt150,000 Retained Profits- Justin 30,000 Retained Profits - Matt 20,000 Total Equity400,000

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 DebitCredit Profit Distribution 50,000 Retained Profits - Justin28,571 Retained Profits - Matt21,429

18 Statement of Financial Position Equity Equity Capital – Justin200,000 Capital - Matt150,000 Retained Profits- Justin 28,571 Retained Profits - Matt 21,429 Total Equity400,000

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 $50,000 Justin $20,000 Matt 15,000

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 $50,000 Justin $20,000 $7,000 Matt $15,000 $3,000

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 profit Justin: 60% x 5,000 = 3,000 Matt: 40% x 5,000 = 2,000

25 $50,000 Justin $20,000 $7,000 $3,000 Total $30,000 Matt $15,000 $3,000 $2,000 Total $20,000

26 Distribution of Profit DebitCredit Profit Distribution 50,000 Retained Profits - Justin30,000 Retained Profits - Matt20,000

27 Statement of Financial Position Equity Equity Capital - Justin200,000 Capital - Matt150,000 Retained Profits- Justin 30,000 Retained Profits - Matt 20,000 Total Equity400,000

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 DebitCredit Retained Profits - Justin9,000 Retained Profits – Matt6,000 Drawings - Justin9,000 Drawings – Matt6,000

30 Statement of Financial Position Equity Equity Capital – Justin200,000 Capital - Matt150,000 Retained Profits- Justin 21,000 Retained Profits - Matt 14,000 Total Equity385,000


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