3The Accounting CycleStep 2 Journalize the data about transactionsStep 3 Post the data about transactionsStep 1 Analyze transactionsStep 4 Prepare a worksheetStep 5 Prepare financial statementsStep 9 Interpret the financial informationStep Journalize and post adjusting entriesJournalizing and posting closing entries is the seventh step in the accounting cycle. Closing entries are journal entries which are done at the end of an accounting cycle so that the business can start fresh in the next accounting period. Closing entries are journal entries that transfer the results of operations (net income or net loss) to owner’s equity and reduce the revenue, expense, and drawing account balances to zero.Step 7 Journalize and post closing entriesStep 7 Journalize and post closing entriesStep 8 Prepare a postclosing trial balanceThe seventh step in the accounting cycle is to journalize and post closing entries
4What is the Income Summary account? QUESTION:What is the Income Summary account?The Income Summary account is a special owner’s equity account that is used only in the closing process to summarize the results of operations.ANSWER:The income Summary account is only used during the closing process.
5Income Summary Account Classified as a temporary owner’s equity account.Does not have a normal balance.Has a zero balance after the closing process and remains with a zero balance until after the closing procedure for the next period.The Income Summary account is classified as a temporary owner’s equity account which will have a zero balance at the end of the accounting period.
6Journalize and post closing entries Objective 1Journalize and post closing entriesThere are four steps in the closing process:1. Transfer the balance of the revenue account tothe Income Summary account.2. Transfer the expense account balances to theIncome Summary account.3. Transfer the balance of the Income Summaryaccount to the owner’s capital account.Let’s further discuss the closing process. Objective one is to journalize and post closing entries. There are four steps in the closing process: close the revenue accounts, close the expense accounts, close the income summary account, and close the drawing account.4. Transfer the balance of the drawing account to the owner’s capital account.
7Wells’ Consulting Services WorksheetMonth Ended December 31, 2010TRIAL BALANCEADJUSTMENTSADJ. TRIAL BAL.INCOME STMT.BALANCE SHEETACCOUNT NAMEDEBITCREDITDEBITCREDITDEBITCREDITDEBITCREDITDEBITCREDITCash111,350111,350111,350Accounts Receivable5,0005,0005,000Supplies1,500(a) 5001,0001,000Prepaid Rent8,000(b) 4,0004,0004,000Equipment11,00011,00011,000Accum. Depr.—Equip.(c)183183Accounts Payable3,5003,5003,500Carolyn Wells, Cap.100,000100,000100,000Carolyn Wells, Draw.5,0005,0005,000Fees Income47,00047,00047,000Salaries Expense8,0008,0008,000Utilities ExpenseThe closing process begins by closing out all revenue accounts to zero. By reviewing the worksheet from the previous chapter, we will note that we only have one revenue account, Fees Income. So, we need to close the one revenue account to zero. Currently Fees Income has a $47,000 credit balance on the worksheet. Fees Income is closed to the Income Summary account.650650650Supplies Expense(a) 500500500Rent Expense(b) 4,0004,0004,000Depr. Exp.—Equip.150,500150,500(c)183183103,683Totals4,6834,683150,683150,68313,33347,000137,350Net IncomeFees Income has a creditbalance of $47,00033,66733,66747,00047,000137,350137,350
8Step 1: Close Revenue Fees Income Income Summary Balance 47,000 Closing 47,000Closing 47,000To record a decrease in a revenue account, debit it and then make a corresponding entry into the Income Summary account. The revenue account, Fees Income, is decreased by $47,000 to zero. The $47,000 is transferred to the temporary owner’s equity account, Income Summary.Fees Income would be debited for $47,000 and Income Summary would be credited for $47,000.Here is our first closing entry represented in T accounts. After this closing entry, Fees Income has a zero balance. That was the goal of our closing entry to get the account ready for next year with a starting zero balance.
9Step 1: Close Revenue GENERAL JOURNAL PAGE 4 DATE DESCRIPTION POST DEBIT CREDITREF.Closing EntriesDec Fees Income ,000Income Summary ,000Here is the first closing general journal entry. Notice that the notation “closing entry” was written above the first closing journal entry.The words “Closing Entries” are written in the Description column of the general journal
10Step 2: Close ExpensesThe Income Statement section of the worksheet for Wells’ Consulting Services lists five expense accounts.Since expense accounts have debit balances, enter a credit in each account to reduce its balance to zero.This closing entry transfers total expenses to the Income Summary account.Step 2 is to close all of the expense accounts. Since expense accounts have a debit balance, we need to credit them to close their balances to zero.
11Step 2: Close ExpensesThe five expense account balances are reduced to zero.The total, $13,333 of expenses are transferred to the temporary owner’s equity account, Income Summary.When closing the expensing accounts, we will transfer their balances to the Income Summary account.
12Income Summary Salaries Expense Bal 47,000 Balance 8,000 Closing ,333Closing 8,000Utilities ExpenseSupplies ExpenseBalanceBalanceClosing 650Closing 500Since the expense accounts have a debit balance, we need to credit them to close them to zero. A corresponding debit will be made to the Income Summary account. The Income Summary account will be debited for the total of all the credits made to the expense accounts. Each expense account will be credited to bring their balance down to zero.Here is what the T accounts look like. Each expense account was closed to zero and a corresponding debit was made to the Income Summary account for $13,333.Rent ExpenseDepr. Expense – Equip.Balance 4,000BalanceClosing 4,000Closing 183
13Step 2: Close Expenses GENERAL JOURNAL PAGE 4 DATE DESCRIPTION POST DEBIT CREDITREF.Closing EntriesDec Income Summary ,333.00Salaries Expense ,000.00Utilities ExpenseSupplies ExpenseRent Expense ,000.00Depreciation Exp.-EquipHere is the second closing journal entry. Notice that Income Summary is listed first because it is the only debited account.
14The Income Summary account reflects all entries in the Income Statement section of the worksheet. Cr.Balance 33,667Closing 47,000Dr.Closing 13,333After making the first two closing entries, Income Summary has a balance of $33,667. This is the difference between the revenues and the expenses, or net income. This amount will eventually be transferred to the capital account of the owner.Net Income
15Step 3: Close Net Income to Capital The journal entry to transfer net income to owner’s equity is a debit to Income Summary, and a credit to Carolyn Wells, Capital.The balance of Income Summary is reduced to zero; the owner’s capital account is increased by the amount of net income.Our third closing entry transfers net income to Carolyn Wells, Capital.The Income Summary account is reduced to zero.The net income amount, $33,667, is transferred to the owner’s capital account. Carolyn Wells, Capital is increased by $33,667.
16Step 3: Close Net Income to Capital Income SummaryCarolyn Wells, CapitalBalance 33,667Balance 100,000Closing 33,667Closing 33,667Income Summary has a credit balance of $33,667 at this point, so to close it we would debit it for this amount and make a corresponding credit to the Owner’s capital account for the same amount. Here is an illustration of what the third closing entry would look like in the T accounts.
17Step 3: Close Net Income to Capital GENERAL JOURNAL PAGE 4DATE DESCRIPTION POST DEBIT CREDITREF.Closing EntriesDec. 31 Income Summary ,667.00Carolyn Wells, Capital ,667.00Here is the third closing journal entry.
18Step 4: Close Drawing to Capital Withdrawals appear in the statement of owner’s equity as a deduction from capital.The drawing account is closed directly to the capital account.The drawing account balance is reduced to zero.The balance of the drawing account, $5,000, is transferred to the owner’s capital account.Our final step is to close the owner’s drawing account.Step 4—The owner’s drawing account has a debit balance and is closed directly to the owner’s capital account. In this step, we are reducing the drawing account balance of $5,000 to zero.
19Step 4: Close Drawing to Capital Carolyn Wells, CapitalCarolyn Wells, DrawingBalance 133,667Balance 5,000Closing 5,000Closing 5,000We need to debit Carolyn Wells, Capital for $5,000 and credit Carolyn Wells, Drawing for $5,000 to close it to zero.After making the credit to the Drawing account, its balance is zero and the capital account has been reduced by the withdrawals made during the period. This was another goal of the closing process; to update the owner’s capital account.
20Step 4: Close Drawing to Capital GENERAL JOURNAL PAGEDATE DESCRIPTION POST DEBIT CREDITREF.Closing EntriesDec. 31 Carolyn Wells, Capital ,000.00Carolyn Wells, Drawing ,000.00The last closing journal entry is shown here.
21The new balance of the Carolyn Wells, Capital account agrees with the amount listed on the balance sheet.Carolyn Wells, DrawingCarolyn Wells, CapitalDr.Balance 5,000BalanceCr.Balance 100,000Net Inc ,667Balance 128,667Closing 5,000Cr.Dr.Drawing 5,000Carolyn Wells, Capital will show a balance of $128,667 on the Balance Sheet.Carolyn Wells, Capital
22Summary of Closing Entries STEPSGENERAL JOURNAL PAGEPOST.DATE DESCRIPTION REF DEBIT CREDITClosing Entries1. Close Revenue AccountDec Fees Income ,000.00Income Summary ,000.00Income Summary ,333.00Salaries Expense ,000.00Utilities ExpenseSupplies ExpenseRent Expense ,000.00Depr. Expense-Equip2. Close Expense AccountsHere are all four of the closing journal entries:Step 1—close the revenue accountsStep 2—close the expense accountsStep 3—close the Income Summary accountStep 4—close the Drawing account3. CloseIncome SummaryIncome Summary ,667.00Carolyn Wells, Capital ,667.004. CloseDrawing AccountCarolyn Wells, Capital ,000.00Carolyn Wells, Draw ,000.00
23Posting the Closing Entries All journal entries are posted to the general ledger accounts.“Closing” is entered in the Description column of the ledger accounts.The ending balances of the drawing, revenue, and expense accounts are zero.Now all of the closing journal entries need to be posted to the general ledger.When posting the closing entries, make sure you write “closing” in the description column of the general ledger.
24GENERAL JOURNAL PAGE 4 POST. DATE DESCRIPTION REF. DEBIT CREDIT STEPS Closing EntriesDec Fees Income ,000.00Income Summary ,000.00STEPS1. CLOSEREVENUEACCOUNT Fees Income ACCOUNT NOPOST BALANCEDATE DESCRIPTION REF DEBIT CREDIT DEBIT CREDIT2010Dec J , ,000.00Dec J , ,000.00Dec Closing J , – 0 –Here is the Fees Income account in the general ledger. Notice that after posting the closing journal entry of a $47,000 debit, it now has an end of period balance of zero.
25GENERAL JOURNAL PAGE 4 POST. DATE DESCRIPTION REF. DEBIT CREDIT STEPS Closing Entries1. CLOSEREVENUEDec Fees Income ,000.00Income Summary ,000.00ACCOUNT Income Summary ACCOUNT NOPOST BALANCEDATE DESCRIPTION REF DEBIT CREDIT DEBIT CREDIT2010Dec Closing J , ,000.00After posting to the Fees Income account in the general ledger, we post to the Income Summary.
27The Accounting Cycle Step 2 Journalize the data about transactions Step 3 Post the data about transactionsStep 1 Analyze transactionsStep 4 Prepare a worksheetStep 5 Prepare financial statementsWe need to prepare another trial balance called the post-closing trial balance.Step 8 is to prepare a postclosing trial balance and Step 9 is to interpret the financial information.Step 9 Interpret the financial informationStep 9 Interpret the financial informationStep Journalize and post adjusting entriesStep 7 Journalize and post closing entriesStep 8 Prepare a postclosing trial balanceStep 8 Prepare a postclosing trial balance
28What is the postclosing trial balance QUESTION:What is the postclosing trial balanceA postclosing trial balance is a statement that is prepared to prove the equality of total debits and credits after the closing process is completed. It verifies that revenue, expense, and drawing accounts have zero balances.ANSWER:The post closing trial balance is prepared after the closing process. It contains only the permanent accounts which were not closed at the end of the period. It proves that debits still equal credits and that all temporary accounts were closed to zero. It verifies that revenue, expense, and drawing accounts have zero balances
29ACCOUNT NAME DEBIT CREDIT Wells’ Consulting ServicesPostclosing Trial BalanceDecember 31, 2010ACCOUNT NAME DEBIT CREDITCash ,350.00Accounts Receivable ,000.00Supplies ,000.00Prepaid Rent ,000.00Equipment ,000.00Accumulated Depreciation–EquipmentAccounts Payable ,500.00Carolyn Wells, Capital ,667.00Totals , ,350.00Only permanent accounts appear on the postclosing trial balance. This would include all asset and liability accounts, as well as capital. Notice that debits equal credits on the post closing trial balance.
30Finding and Correcting Errors If the postclosing trial balance does not balance, the accounting records contain errors.Use the audit trail to trace data through the accounting records.We can use the audit trail to help us locate errors.
31Interpret financial statements Objective 3 What do users do with the finished financial statements?In objective three we learned how users value the information provided in financial statements. To interpret means to understand and explain the meaning and importance of something. Financial statements help users make all kinds of decisions. Financial statements provide important answers to questions such as:What is the cash balance?How much do customers owe the business?How much does the business owe suppliers?What is the profit or loss?
32Wells’ Consulting Services Partial Balance Sheet December 31, 2010 AssetsCash $ 111,350.00Accounts Receivable ,000.00Supplies ,000.00Prepaid Rent ,000.00Equipment $ 11,000.00Less Accumulated Depreciation ,817.00Total Assets $ 132,167.00From looking at a balance sheet you can see that the Cash account has a balance of $111,350. Let’s look at Accounts Receivable on the balance sheet. You can see that our customers owe us $5,000.What is the cash balance?How much do the customers owe the business?
33Wells’ Consulting Services Balance Sheet December 31, 2010 AssetsCash $ 111,350.00Accounts Receivable ,000.00Supplies ,000.00Prepaid Rent ,000.00Equipment $ 11,000.00Less Accumulated Depreciation ,817.00Total Assets $ 132,167.00Liabilities and Owner’s EquityLiabilitiesAccounts Payable $ 3,500.00Owner’s EquityCarolyn Wells, Capital ,667.00Total Liabilities and Owner’s Equity $132,167.00You can also see what the company owes to other vendors. The business owes $3,500 to creditors.How much does the business owe its suppliers?
34Wells’ Consulting Services Income Statement Month Ended December 31, 2010RevenueFees Income ,000.00ExpensesSalaries Expense ,000.00Utilities ExpenseSupplies ExpenseRent Expense ,000.00Depr. Expense--EquipmentTotal Expenses ,333.00Net Income for the Month ,667.00Did the company generate a profit or loss? You can tell by reviewing the income statement that the business had net income of $33,667 or generated a profit.What is the profit?
35The Accounting Cycle Review the steps in the accounting cycle Objective 4Review the steps in the accounting cycleThe Accounting CycleStep 2 Journalize the data about transactionsStep 3 Post the data about transactionsStep 1 Analyze transactionsStep 4 Prepare a worksheetPrepare financial statementsIncome StatementStatement of Owner’s EquityBalance SheetStep 5 Prepare financial statementsStep 5 Prepare financial statementsObjective 4 is the last objective in this chapter.In step 5, we use the worksheet to prepare our financial statements.
36The Accounting CycleStep 2 Journalize the data about transactionsStep 3 Post the data about transactionsStep 1 Analyze transactionsStep 4 Prepare a worksheetTransfer net income or net loss to owner’s equity.Reduce the balances of thetemporary accounts to zero.Step 5 Prepare financial statementsIn step 6, we journalize and post adjusting entries. In step 7, we journalize and post our end of period closing entries.Step Journalize and post adjusting entriesStep 7 Journalize and post closing entriesStep 7 Journalize and post closing entries
37The Accounting Cycle Step 1 Analyze transactions Step 2 Journalize the data about transactionsStep 3 Post the data about transactionsStep 4 Prepare a worksheetStep 5 Prepare financial statementsStep Journalize and post adjusting entriesStep 7 Journalize and post closing entriesStep 8 Prepare a postclosing trial balanceStep 9 Interpret the financial informationStep 2 Journalize the data about transactionsStep 3 Post the data about transactionsStep 1 Analyze transactionsStep 4 Prepare a worksheetStep 5 Prepare financial statementsIn Step 8, we prepare a postclosing trial balance. In step 9, we interpret the financial information. These nine steps comprise an entire accounting cycle. Take a look at each one and see if you can remember what was involved in each step of the cycle.Step 9 Interpret the financial informationStep Journalize and post adjusting entriesStep 7 Journalize and post closing entriesStep 8 Prepare a postclosing trial balance
38Flow of Data Through a Simple Accounting System SourceDocumentsSourceDocumentsGeneraljournalGeneralledgerWorksheetFinancialstatementsSource documents are analyzedAfter studying the accounting cycle of Wells’ Consulting Services, you should have an understanding of how data flows through a simple accounting system for a small business. Review the flow and make certain that you are comfortable with the documents and reports.