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Completing the Accounting Cycle for a Service Business: Closing Entries and the Post-Closing Trial Balance
Chapter 5
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2. © Paradigm Publishing, Inc.
Learning Objectives
Explain the purpose of the closing process.
Journalize and post closing entries.
Prepare a post-closing trial balance.
Learning objectives appear in the text margins at the start of the section where the corresponding content is taught. Also, the chapter summary is organized by learning objective to aid student mastery of these objectives.
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3. Explain the purpose of the closing process
Learning Objective 1
Explain the purpose of the closing process
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4. Purpose of Closing Entries
Temporary Accounts
Revenue and expense accounts and the owner’s drawing account
Used to show changes in owner’s equity during a single accounting period
Closing Process: The process of transferring the balances of the temporary accounts to the owner’s capital account
Closing Entries: Entries necessary to accomplish the closing process
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5. Objectives of the Closing Process
To reduce the balance of temporary owner’s equity accounts to zero and thus make the accounts ready for entries in the next accounting period.
To update the balance of the owner’s capital account.
RE objective 1: Otherwise, amounts for the next account period would be added to amounts from previous accounting periods, which would violate the matching principle.
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6. Journalize and post closing entries
Learning Objective 2
Journalize and post closing entries
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7. Steps in the Closing Process
Close the balance of each revenue account to the Income Summary account.
Close the balance of each expense account to Income Summary.
Close the balance of Income Summary to the owner’s capital account.
Close the balance of the owner’s drawing account directly to the owner’s capital account.
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8. The Income Summary Account
A clearing account used to summarize the balances of revenue and expense accounts
Used only at the end of an accounting period
Opened and closed during the closing process
Does not have a normal balance as do other accounts
Will never appear on the financial statements
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Quick Check
The balance in the Income Summary account
appears on the income statement.
appears on the balance sheet.
appears on the income statement and the statement of owner’s equity.
does not appear on any financial statement.
appears on the balance sheet and the statement of owner’s equity.
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10. Financial Statement Columns of the Work Sheet
We’ll use the numbers on the work sheet to demonstrate the closing entries.
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11. Financial Statement Columns of the Work Sheet
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12. Closing the Balance of Revenue Accounts
To close an account, we must make an entry that will reduce the balance of the account the zero.
Thus, a revenue account must be debited for the amount of its credit balance.
The credit will be to the Income Summary account.
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Quick Check
When closing a revenue account, the
revenue account is credited for its balance.
owner’s capital account is credited for the balance of the revenue account.
owner’s drawing account is credited for the balance of the revenue account.
Income Summary account is credited for the balance of the revenue account.
Income Summary account is debited for the balance of the revenue account.
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14. Closing the Balance of Expense Account
An expense account must be credited for the amount of its debit balance.
The debit will be to the Income Summary account.
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Quick Check
When closing an expense account the
expense account is credited for its balance.
owner’s capital account is credited for the balance of the expense account.
owner’s drawing account is credited for the balance of the expense account.
Income Summary account is credited for the balance of the expense account.
owner’s capital account is debited for the balance of the expense account.
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16. Closing the Balance of Income Summary to the Owner’s Capital Account
Compute the balance in the Income Summary account.
The balance in the Income Summary account will always reflect the amount of net income or net loss.
Assuming a net income, it is transferred to the credit side of the owner’s capital account.
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17. Closing the Balance of Income Summary to the Owner’s Capital Account
The Income Summary account is debited for its balance to close it.
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Quick Check
When closing the Income Summary account, assuming a net income the
Income Summary account is credited for its balance.
owner’s capital account is credited for the amount of the net income.
owner’s capital account is debited for the amount of the net income.
owner’s drawing account is credited for the amount of the net income.
owner’s drawing account is debited for the amount of the net income.
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19. Closing the Owner’s Drawing Account
The balance of the owner’s drawing account does not enter into the determination of net income or net loss.
Therefore, the drawing account is not closed to the Income Summary account.
Instead, it is closing directly into the owner’s capital account.
The drawing account has a debit balance and is credited to close it.
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20. Closing the Owner’s Drawing Account
The owner’s capital account is debited since drawing decreases the owner’s capital.
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Quick Check
When closing the owner’s drawing account, the
owner’s capital account is debited for the amount of net income.
owner’s capital account is credited for the balance of the owner’s drawing account.
owner’s drawing account is credited for its balance.
Income Summary account is credited for the balance of the owner’s drawing account.
Income Summary account is debited for the balance of the owner’s drawing account.
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22. Balancing the Owner’s Capital Account
The balance in the owner’s capital account after all closing entries have been prepared will be the updated balance appearing on the balance sheet and the post- closing balance.
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Quick Check
The owner’s capital account is
increased by the balance in the owner’s drawing account.
increased by the amount of net loss.
decreased by the balance in the owner’s drawing account.
closed at the end of each accounting period.
decreased by the amount of net income.
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24. Temporary Accounts versus Permanent Accounts
All revenue accounts
All expense accounts
All drawing accounts
Close at the end of the accounting period
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25. Temporary Accounts versus Permanent Accounts
All balance sheet accounts
Do not close at the end of the accounting period
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26. Temporary Accounts versus Permanent Accounts
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Quick Check
Select the correct statement:
Revenues, assets, and expenses are permanent
accounts.
Liabilities and the owner’s capital account are temporary accounts.
Revenues, expenses, and the owner’s drawing account are temporary accounts.
Assets, liabilities, and the owner’s drawing account are temporary accounts.
Expenses and liabilities are permanent accounts.
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28. Journalizing Closing Entries
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Example
Example of Closing a Revenue Account
Assume the Service Revenue account has an ending balance of $3,000.
Prepare the closing entry.
General Journal
Date
Account Title
P.R.
Debit
Credit
20X1 31
Service Revenue
3,000
Dec.
Income Summary
3,000
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Example
Example of Closing an Expense Account
Assume Salaries Expense has an ending balance of $1,200.
Prepare the closing entry.
General Journal
Date
Account Title
P.R.
Debit
Credit
20X1 31
Income Summary
1,200
Dec.
Salaries Expense
1,200
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Example
Example of Closing an Net Income to Owner’s Capital
Assume net income for the current period is $1,800 for June Delugas Interiors.
Prepare the closing entry.
General Journal
Date
Account Title
P.R.
Debit
Credit
20X1 31
Income Summary
1,800
Dec.
June Delugas, Capital
1,800
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32. © Paradigm Publishing, Inc.
Example
Example of Closing the Owner’s Drawing Account
Assume June Delugas, Drawing, has an ending balance of $500.
Prepare the closing entry.
General Journal
Date
Account Title
P.R.
Debit
Credit
20X1 31
June Delugas, Capital
500
Dec.
June Delugas, Drawing
500
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33. Diagram of the Closing Process
Close the balance of revenue accounts to Income Summary.
Close the balance of expense accounts to Income Summary.
Close the balance of Income Summary to the owner’s capital account.
Close the balance of the owner’s drawing account to the owner’s capital account.
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34. Diagram of the Closing Process
Close the balance of revenue accounts to Income Summary.
Close the balance of expense accounts to Income Summary.
Close the balance of Income Summary to the owner’s capital account.
Close the balance of the owner’s drawing account to the owner’s capital account.
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Review Quiz 5-1
Close the temporary accounts. 
Review Quiz 5-1 appears on page 184.
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36. © Paradigm Publishing, Inc.
Review Quiz 5-1
Review Quiz 5-1 appears on page 184.
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Review Quiz 5-1
The closing entries are journalized.
Review Quiz 5-1 appears on page 184.
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38. © Paradigm Publishing, Inc.
Review Quiz 5-1
Review Quiz 5-1 appears on page 184.
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39. Posting Closing Entries
After closing entries have been journalized, the next step in the accounting cycle is to post these entries from the general ledger to the general journal
After posting has occurred
The permanent accounts will have up-to-date balances
The temporary accounts will have zero balances
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Review Quiz 5-2
T-Account Balances
Review Quiz 5-2 appears on page 188.
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Review Quiz 5-2
The temporary accounts are journalized.
Review Quiz 5-2 appears on page 188.
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42. Prepare a post-closing trial balance
Learning Objective 3
Prepare a post-closing trial balance
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43. Prepare a Post-Closing Trial Balance
The final step in the accounting cycle
Ensures the ledger will be in balance at the start of the next account period
Only permanent accounts appear on the post-closing trial balance, since the balances of all temporary accounts have been reduced to zero
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44. Post-Closing Trial Balance
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Quick Check
Select the correct statement:
The post-closing trial balance will list revenues and assets.
The post-closing trial balance will list assets and the owner’s capital account.
The post-closing trial balance will list expenses and assets.
The post-closing trial balance will list the owner’s drawing account and the owner’s capital account.
The post-closing trial balance will list expenses, revenues, and liabilities.
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46. Summary of the Steps in the Accounting Cycle
Analyze transactions from source documents
Record transactions in a journal
Post from the journal to the ledger
Prepare a trial balance of the ledger
During the accounting period
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47. Summary of the Steps in the Accounting Cycle
Determine needed adjustments
Prepare a work sheet
Prepare financial statements from a completed work sheet
Journalize and post adjusting entries
Journalize and post closing entries
Prepare a post-closing trial balance
At the end of the accounting period
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Fiscal Period
Any period of time covering the complete accounting cycle, from the analysis of transactions to the post-closing trial balance.
A fiscal period consisting of 12 consecutive months is a fiscal year.
A fiscal year does not necessarily coincide with the calendar year.
A fiscal year ending at a business’s lowest point of activity is referred to as a natural business year.
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49. The Basis of Accounting
Accrual Basis of Accounting
The basis of accounting that requires that revenue is recorded when earned, no matter when cash is received, and that expenses are recorded when incurred, no matter when cash is paid.
Cash Basis of Accounting
The basis of accounting where revenue is recorded only when cash is received, and expenses are recorded only when cash is paid.
The cash basis of accounting is not in accordance with GAAP.
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50. Accrual Basis of Accounting versus Cash Basis of Accounting
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Focus on Ethics
Refer to the Focus on Ethics box on pages in your text.
What pressures might lead executives to try to illegally manipulate a company’s earnings?
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52. © Paradigm Publishing, Inc.
Joining the Pieces
Steps in the Accounting Cycle for a Service Business
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