Chapter 10 Closing Entries Closing the period out Chapter 10 Closing Entries

Main Idea Closing entries transfer the temporary account balances to the owner’s capital account. After the closing entries are posted, a post-closing trial balance is prepared to verify that debits equal credits.

Objectives Explain why it is necessary to update accounts through closing entries. Explain the purpose of the Income Summary account. Explain the relationship between the Income Summary Account and the capital account. Analyze and journalize the closing entries. Post the closing entries to the general ledger. Prepare a post-closing trial balance

Vocabulary Temporary Accounts Permanent Accounts Accounts used to collect information that will be transferred to a permanent capital (permanent) account. Permanent Accounts Accounts that are continuous from one accounting period to the next; balances are carried forward to the next period.

The permanent account to which balances are transferred depend upon the type of business. In case of a company, retained earnings account, and in case of a firm or a sole proprietorship, owner's capital account receives the balances of temporary accounts. Income summary account is a temporary account which facilitates the closing process.

Vocabulary Closing entries Journal entries made to close, or reduce to zero, the balances in the temporary accounts and to transfer the net income or net loss for the period to the capital account.

Vocabulary The Income Summary Account Income Summary account Used to accumulate revenue and expenses for the period Equals the net income or loss for the period Income Summary account The general ledger account used to summarize the revenue and expenses for the period. The Income Summary account is a temporary account has a zero balance before and after the closing. does not appear on any financial statement.

vocabulary Closing entries Are journal entries made at the end of an accounting period which transfer the balances of temporary accounts to permanent accounts. Closing entries are based on the account balances in an adjusted trial balance. Temporary accounts include: Revenue, Income and Gain Accounts Expense and Loss Accounts Dividend, Drawings or Withdrawals Accounts Income Summary Account

Closing entries Closing Entry First Closing Entry—Close Revenue to Income Summary

Closing entries Closing Entry Second Closing Entry—Close Expenses to Income Summary

Closing entries Closing Entry Second Closing Entry—Close Expenses to Income Summary

Closing entries Closing Entry Third Closing Entry—Close Income Summary to Capital

Reasons for the work Why are all of the temporary accounts reset to zero at the end of the fiscal year? All revenues increase owner’s equity, and all expenses reduce owner’s equity. These transactions are separated from capital so the business can analyze how a profit or loss was made during the year. At the end of the year, the accumulation of these revenues and expenses are transferred into the capital account. The temporary accounts are reset to zero, which allows the business to compare the revenue and expense data from one period to the next.

Example The following example shows the closing entries based on the adjusted trial balance of Company A. Note Date Account Debit Credit 1 Jan 31 Service Revenue 85,600 Income Summary 2 77,364 Wages Expense 38,200 Supplies Expense 18,480 Rent Expense 12,000 Miscellaneous Expense 3,470 Electricity Expense 2,470 Telephone Expense 1,494 Depreciation Expense 1,100 Interest Expense 150 3 8,236 Retained Earnings 4 5,000 Dividend