Chapter Five Closing Entries and the Post-Closing Trial Balance

Accounting is Fun! Performance Objectives 1.List the steps in the accounting cycle 2.Journalize and post closing entries for a service enterprise 3.Prepare a post-closing trial balance 4.Define the following methods of accounting: accrual basis and modified cash basis 5.Prepare interim statements

Accounting is Fun! List The Steps In The Accounting Cycle 1.Analyze source documents & record business transactions in a journal 2.Post journal entries to the ledger accounts 3.Prepare a trial balance 4.Gather adjustment data and record adjustments in the work sheet 5.Complete the work sheet 6.Create financial reports from data in work sheet 7.Journalize and post the adjusting entries 8.Journalize and post the closing entries 9.Prepare the post-closing trial balance

Accounting is Fun! Closing Entries Entries made at the end of a fiscal period to close off the revenue, expense, and drawing accounts—that is, to make the balances of the temporary-equity accounts equal to zero Also called clearing the accounts

Accounting is Fun! Purpose of Closing Entries

Accounting is Fun! Purpose of Closing Entries To close out balances that relate to one fiscal period and start fresh in the next period To zero out the following ledger accounts: –Revenue –Expenses To update the owner’s Capital account

Accounting is Fun! Balances on the Financial Statements

Accounting is Fun! Revenue - Expenses = Net Income Net Income Statement of Owner’s Equity

Accounting is Fun! Withdrawals Statement of Owner’s Equity

Accounting is Fun! Ending Capital Balance Sheet

Accounting is Fun! Revenues, Expenses, & Withdrawals Ending Capital

Accounting is Fun! Start Fresh for Next Period, July 1 To July 31, 2005 All Revenues, Expenses, and Withdrawals from last period are reflected in the Capital account See all the zeros?

Accounting is Fun! Nominal or Temporary-Equity Accounts Accounts that apply to only one fiscal period and that are to be closed at the end of that fiscal period, such as revenue, expense, Income Summary, and Drawing accounts May also be described as all accounts except assets, liabilities, and the Capital account

Accounting is Fun! Real or Permanent Accounts The accounts that remain open (assets, liabilities, and the Capital account in owner’s equity) and that have balances that will be carried over to the next fiscal period

Accounting is Fun! Let’s Look at Closing with T Accounts = DRCRDRCRDRCR DRCRDRCR DRCRDRCR DrawingCapital AssetsLiabilitiesOwner's Equity ExpensesRevenues Real Accounts “Permanent Accounts” Nominal Accounts “Temporary Equity Accounts” Closed & Put Here

Accounting is Fun! After Closing = DRCRDRCRDRCR DRCR AssetsLiabilitiesOwner's Equity Capital Revenues, Expenses, Drawings Closed & Put Here

Accounting is Fun! Closing Using T-Accounts Closing Procedure 1.Close revenue account(s) into Income Summary 2.Close expense accounts into Income Summary 3.Close Income Summary into Capital 4.Close Drawing into Capital

Accounting is Fun!

Accounting is Fun! Income Summary An account brought into existence to have a debit and credit for each closing entry –It does not have plus or minus sign, just debits and credits Revenue and expense account balances are transferred to this account to allow calculation of net income and net loss Serves as the in-between account, or “holding tank,” before net income or net loss transferred to the Capital account

Accounting is Fun! Step 1: Close Revenue Accounts into Income Summary

Accounting is Fun! Step 2:Close Expense Accounts into Income Summary

Accounting is Fun! Step 3: Close Income Summary into Capital

Accounting is Fun! Step 4: Close Drawing into Capital Account

Accounting is Fun! Closing Entries Entries into the journal made at the end of a fiscal period to close off the revenue, expense, and Drawing accounts—that is, to make the balances of the temporary-equity accounts equal to zero Closing is also called clearing the accounts

Accounting is Fun! Journalize the Closing Entries Close the revenue accounts into Income Summary Close the expense accounts into Income Summary Close the Income Summary account into the Capital account (transferring net income or net loss to the Capital account) Close the Drawing account into Capital Be sure to label the entries “Closing Entries” before you begin to enter them into the journal

Accounting is Fun! Journalize Steps 1–2

Accounting is Fun! Journalize Steps 1–4

Accounting is Fun! Closing Hints When you want revenue and expense accounts to go to zero: –Create an offsetting debit or credit in Income Summary to “balance it off” When closing Income Summary into Capital: –Net income is a credit to Capital –Net loss is a debit to Capital When closing Drawing into Capital: –Drawing is a debit to Capital –Remember: withdrawals are not expenses

Accounting is Fun! Creating Journal Entries Directly from the Work Sheet Revenue and expenses come from the Income Statement columns Withdrawals come from the Balance Sheet debit column Automatic check: if your closing number from Income Summary to Capital is not the same as net income, you made a mistake

Accounting is Fun! Post the Closing Entries Revenue, expense, and Drawing accounts should end up with zero balances –Draw a line through both the debit and credit balance columns to indicate that they have been zeroed and closed Capital will more than likely have some net change for the period Be sure to write “Closing” in the Item column of the ledger account

Accounting is Fun! Posting Step 1 for Arch Copy Co.

Accounting is Fun! Posting Steps 1-3 for Arch Copy Co.

Accounting is Fun! Post-Closing Trial Balance The listing of the final balances of the real accounts at the end of the fiscal period The opening balances for the next period

Accounting is Fun! Post-Closing Trial Balance Accountant uses the post-closing trial balance to make sure that DR = CR –Have you done all the work correctly?

Accounting is Fun! Errors: Post-Closing Trial Balance If DR ≠ CR –Columns added correctly? –Correct amounts transferred from the ledger accounts? –Adjusting entries posted correctly? New balances correct? –Closing entries posted correctly? New balances correct? –All nominal accounts closed?

Accounting is Fun! Performance Objective 4 Define the following methods of accounting: accrual basis and modified cash basis

Accounting is Fun! Accrual Basis An accounting method under which revenue is recorded when it is earned, regardless of when the cash is received, and expenses are recorded when they are incurred, regardless of when they are paid

Accounting is Fun! Modified Cash Basis An accounting method under which revenue is recorded only when it is received as cash Most expenses are recorded only when they are paid in cash –However, exceptions are made for expenditures on items having a useful life of more than one year and for certain prepaid items

Accounting is Fun! Modified Cash Basis Exceptions Expenditure for insurance premiums can be prorated, or spread out, over the fiscal periods covered Expenditures for long-lived items are recorded as assets and later depreciated as expenses over their useful lives

Accounting is Fun! Interim Statements Financial statements prepared during the fiscal year, covering a period of time less than twelve months

Accounting is Fun! Prepare Interim Statements

Accounting is Fun! Prepare Interim Statements Accountant prepares financial statements from the work sheet Accountant does not journalize and post the adjusting or closing entries until the end of the fiscal year

Accounting is Fun! Demonstration Problem On the following page is the completed work sheet for: We are going to complete the following tasks: –Journalize the closing entries –Create the post-closing trial balance

Accounting is Fun!

Accounting is Fun! Closing: Step 1

Accounting is Fun!

Accounting is Fun! Closing: Step 2

Accounting is Fun! Closing: Step 3

Accounting is Fun! Check Number for Step 3 Closing Entry

Accounting is Fun! Closing: Step 4

Accounting is Fun! Post In Order To Get Information Into Ledger Accounts

Accounting is Fun! Post Reference!

Accounting is Fun! Create Post-Closing Trial Balance