Closing Entries Examples And Solutions Pdf
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- Closing entries
- How to Prepare Your Closing Entries
- Why the Post-Closing Trial Balance Is so Important for Your Business
Closing journal entries are made at the end of an accounting period to prepare temporary accounts for the next period.
In this chapter, we complete the final steps steps 8 and 9 of the accounting cycle, the closing process. You will notice that we do not cover step 10, reversing entries. This is an optional step in the accounting cycle that you will learn about in future courses. Our discussion here begins with journalizing and posting the closing entries Figure 5. These posted entries will then translate into a post-closing trial balance , which is a trial balance that is prepared after all of the closing entries have been recorded.
You are an accountant for a small event-planning business. The business has been operating for several years but does not have the resources for accounting software. This means you are preparing all steps in the accounting cycle by hand. It is the end of the month, and you have completed the post-closing trial balance. You notice that there is still a service revenue account balance listed on this trial balance. Why is it considered an error to have a revenue account on the post-closing trial balance?
How do you fix this error? Companies are required to close their books at the end of each fiscal year so that they can prepare their annual financial statements and tax returns. However, most companies prepare monthly financial statements and close their books annually, so they have a clear picture of company performance during the year, and give users timely information to make decisions. Closing entries prepare a company for the next accounting period by clearing any outstanding balances in certain accounts that should not transfer over to the next period.
Closing , or clearing the balances, means returning the account to a zero balance. Having a zero balance in these accounts is important so a company can compare performance across periods, particularly with income. It also helps the company keep thorough records of account balances affecting retained earnings. Revenue, expense, and dividend accounts affect retained earnings and are closed so they can accumulate new balances in the next period, which is an application of the time period assumption.
To further clarify this concept, balances are closed to assure all revenues and expenses are recorded in the proper period and then start over the following period. The revenue and expense accounts should start at zero each period, because we are measuring how much revenue is earned and expenses incurred during the period.
However, the cash balances, as well as the other balance sheet accounts, are carried over from the end of a current period to the beginning of the next period. If the store closed at p. The balance sheet accounts, such as inventory, would carry over into the next period, in this case February To determine the income profit or loss from the month of January, the store needs to close the income statement information from January However, if the company also wanted to keep year-to-date information from month to month, a separate set of records could be kept as the company progresses through the remaining months in the year.
For our purposes, assume that we are closing the books at the end of each month unless otherwise noted. Assume you own a small landscaping business. It is the end of the year, December 31, , and you are reviewing your financials for the entire year.
The next day, January 1, , you get ready for work, but before you go to the office, you decide to review your financials for What are your year-to-date earnings? So far, you have not worked at all in the current year. What are your total expenses for rent, electricity, cable and internet, gas, and food for the current year? You have also not incurred any expenses yet for rent, electricity, cable, internet, gas or food.
This means that the current balance of these accounts is zero, because they were closed on December 31, , to complete the annual accounting period. Next, you review your assets and liabilities. What is your current bank account balance? What is the current book value of your electronics, car, and furniture?
What about your credit card balances and bank loans? Are the value of your assets and liabilities now zero because of the start of a new year?
Your car, electronics, and furniture did not suddenly lose all their value, and unfortunately, you still have outstanding debt. Therefore, these accounts still have a balance in the new year, because they are not closed, and the balances are carried forward from December 31 to January 1 to start the new annual accounting period. This is no different from what will happen to a company at the end of an accounting period.
A company will see its revenue and expense accounts set back to zero, but its assets and liabilities will maintain a balance. In summary, the accountant resets the temporary accounts to zero by transferring the balances to permanent accounts.
Understanding the accounting cycle and preparing trial balances is a practice valued internationally. The Philippines Center for Entrepreneurship and the government of the Philippines hold regular seminars going over this cycle with small business owners.
They are also transparent with their internal trial balances in several key government offices. Check out this article talking about the seminars on the accounting cycle and this public pre-closing trial balance presented by the Philippines Department of Health. All accounts can be classified as either permanent real or temporary nominal Figure 5. These accounts will not be set back to zero at the beginning of the next period; they will keep their balances. Permanent accounts are not part of the closing process.
Temporary nominal accounts are accounts that are closed at the end of each accounting period, and include income statement, dividends, and income summary accounts. The new account, Income Summary, will be discussed shortly. These accounts are temporary because they keep their balances during the current accounting period and are set back to zero when the period ends. Revenue and expense accounts are closed to Income Summary, and Income Summary and Dividends are closed to the permanent account, Retained Earnings.
The income summary account is an intermediary between revenues and expenses, and the Retained Earnings account. The balance in the Income Summary account equals the net income or loss for the period. This balance is then transferred to the Retained Earnings account. Income summary is a nondefined account category. The account has a zero balance throughout the entire accounting period until the closing entries are prepared. Therefore, it will not appear on any trial balances, including the adjusted trial balance, and will not appear on any of the financial statements.
We could do this, but by having the Income Summary account, you get a balance for net income a second time. This gives you the balance to compare to the income statement, and allows you to double check that all income statement accounts are closed and have correct amounts. If you put the revenues and expenses directly into retained earnings, you will not see that check figure.
No matter which way you choose to close, the same final balance is in retained earnings. Following is a list of accounts. State whether each account is a permanent or temporary account. The eighth step in the accounting cycle is preparing closing entries, which includes journalizing and posting the entries to the ledger. Four entries occur during the closing process. The first entry closes revenue accounts to the Income Summary account. The second entry closes expense accounts to the Income Summary account.
The third entry closes the Income Summary account to Retained Earnings. The fourth entry closes the Dividends account to Retained Earnings. The information needed to prepare closing entries comes from the adjusted trial balance. The Printing Plus adjusted trial balance for January 31, , is presented in Figure 5.
The first entry requires revenue accounts close to the Income Summary account. To get a zero balance in a revenue account, the entry will show a debit to revenues and a credit to Income Summary. The closing entry will debit both interest revenue and service revenue, and credit Income Summary. Notice that the balances in interest revenue and service revenue are now zero and are ready to accumulate revenues in the next period. The second entry requires expense accounts close to the Income Summary account.
To get a zero balance in an expense account, the entry will show a credit to expenses and a debit to Income Summary. Notice that the balances in the expense accounts are now zero and are ready to accumulate expenses in the next period. Why are these two figures the same? The income statement summarizes your income, as does income summary. If both summarize your income in the same period, then they must be equal.
If they do not match, then you have an error. The third entry requires Income Summary to close to the Retained Earnings account. To get a zero balance in the Income Summary account, there are guidelines to consider.
Remember that net income will increase retained earnings, and a net loss will decrease retained earnings. The Retained Earnings account increases on the credit side and decreases on the debit side. Notice that the Income Summary account is now zero and is ready for use in the next period. The fourth entry requires Dividends to close to the Retained Earnings account. Remember from your past studies that dividends are not expenses, such as salaries paid to your employees or staff.
Instead, declaring and paying dividends is a method utilized by corporations to return part of the profits generated by the company to the owners of the company—in this case, its shareholders. If dividends were not declared, closing entries would cease at this point. If dividends are declared, to get a zero balance in the Dividends account, the entry will show a credit to Dividends and a debit to Retained Earnings.
As you will learn in Corporation Accounting , there are three components to the declaration and payment of dividends. The first part is the date of declaration, which creates the obligation or liability to pay the dividend.
How to Prepare Your Closing Entries
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Why the Post-Closing Trial Balance Is so Important for Your Business
Closing entries are those journal entries made in a manual accounting system at the end of an accounting period to shift the balances in temporary accounts to permanent accounts. Examples of temporary accounts are the revenue, expense, and dividends paid accounts. Any account listed in the balance sheet except for dividends paid is a permanent account.
The accounts which collected information about revenue and expenses for the accounting period are temporary. Learn the four closing entries and how to prepare a post closing trial balance. Recording transactions into journal entries 3. Be substantive and clear, and use examples to reinforce your ideas. Simple 5B Analyse errors and prepare corrections. This is the fourth step in the accounting cycle. LO 4: Prepare an adjusted trial balance and closing entries.
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