25 Describe and Prepare closing Entries for a Business

In this chapter, we complete the final steps (steps 8 and 9) of the audit cycle, the closeup of the door process. You will notification that we carry out not cover step 10, reversing entries. This is an optional step in the accountancy cycle the you will learn about in future courses. Steps 1 v 4 were extended in analyzing and record Transactions and also Steps 5 through 7 were covered in The mediate Process.

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Should You compromise to Please her Supervisor?
You room an accountant for a tiny event-planning business. The organization has been operation for numerous years however does not have the sources for accountancy software. This means you space preparing all steps in the accountancy cycle by hand.

It is the end of the month, and also you have actually completed the post-closing psychological balance. You notification that there is quiet a business revenue account balance provided on this attempt balance. Why is it taken into consideration an error to have actually a revenue account top top the post-closing attempt balance? exactly how do you fix this error?


Introduction come the closeup of the door Entries

Companies are required to nearby their books at the end of every fiscal year so the they have the right to prepare their yearly financial statements and also tax returns. However, most companies prepare monthly financial statements and close their books annually, so they have a clear snapshot of company performance throughout the year, and give customers timely information to do decisions.

Closing entries prepare a firm for the following accounting period by clearing any kind of outstanding balances in certain accounts that need to not carry over to the following period. Closing, or clearing the balances, way returning the account to a zero balance. Having a zero balance in these accounts is essential so a company can to compare performance throughout periods, particularly with income. It also helps the firm keep thorough documents of account balances affecting maintained earnings. Revenue, expense, and also dividend accounts affect retained earnings and are closed therefore they can accumulate new balances in the following period, i m sorry is an applications of the time duration assumption.

To further clarify this concept, balances space closed to assure all revenues and also expenses are recorded in the proper duration and then begin over the complying with period. The revenue and expense accounts have to start at zero every period, because we are measuring just how much revenue is earned and also expenses incurred during the period. However, the cash balances, and also the various other balance paper accounts, are lugged over native the finish of a current period to the beginning of the next period.

For example, a store has an list account balance of $100,000. If the save closed at 11:59 p.m. ~ above January 31, 2019, climate the list balance as soon as it reopened at 12:01 a.m. ~ above February 1, 2019, would still be $100,000. The balance sheet accounts, such together inventory, would lug over into the next period, in this situation February 2019.

The account that need to start v a clean or $0 balance going right into the next accounting duration are revenue, income, and also any dividend from January 2019. To determine the earnings (profit or loss) from the month that January, the store requirements to nearby the revenue statement info from January 2019. Zeroing January 2019 would certainly then enable the store to calculate the revenue (profit or loss) because that the next month (February 2019), instead of merger it into January’s income and thus providing invalid information exclusively for the month that February.

However, if the firm also wanted to keep year-to-date details from month to month, a separate set of records might be kept as the firm progresses with the remaining months in the year. Because that our purposes, assume that we space closing the publications at the end of every month uneven otherwise noted.

Let’s look at at another example to show the point. I think you very own a tiny landscaping business. That is the end of the year, December 31, 2018, and you room reviewing your financials for the entire year. You check out that girlfriend earned $120,000 this year in revenue and had prices for rent, electricity, cable, internet, gas, and food the totaled $70,000.

You also review the complying with information:

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The income summary account is an intermediary in between revenues and also expenses, and also the Retained income account. That stores all of the closing info for revenues and expenses, causing a “summary” of income or loss for the period. The balance in the Income review account amounts to the net earnings or loss for the period. This balance is then moved to the Retained income account.

Income an overview is a nondefined account category. This way that it is no an asset, liability, stockholders’ equity, revenue, or price account. The account has a zero balance transparent the entire accounting duration until the closeup of the door entries space prepared. Therefore, it will certainly not appear on any type of trial balances, consisting of the adjusted trial balance, and will not appear on any type of of the jae won statements.

You can be asking yourself, “is the Income summary account even necessary?” can we just close the end revenues and also expenses straight into kept earnings and not have actually this extra temporary account? We can do this, however by having the Income summary account, you acquire a balance for net revenue a 2nd time. This gives you the balance to compare to the revenue statement, and permits you to dual check that all revenue statement accounts space closed and have correct amounts. If you placed the revenues and also expenses directly into kept earnings, you will not check out that examine figure. No matter which way you choose to close, the same last balance is in kept earnings.


Following is a list of accounts. State whether each account is a long-term or short-lived account.

rent expenseunearned revenueaccumulated depreciation, vehiclecommon stockfees revenuedividendsprepaid insuranceaccounts payable

Solution

A, E, and F room temporary; B, C, D, G, and also H space permanent.


Journalizing and Posting closing Entries

The eighth action in the accountancy cycle is preparing closing entries, which has journalizing and posting the entries to the ledger.

Four entries occur throughout the close up door process. The very first entry closes revenue accounts to the Income an introduction account. The 2nd entry closes cost accounts come the Income an overview account. The third entry closes the Income an overview account to preserved Earnings. The fourth entry closes the dividends account to kept Earnings. The details needed come prepare closing entries originates from the adjusted trial balance.

Let’s check out each entry in more detail using Printing Plus’s information from examining and record Transactions and also The Adjustment process as our example. The print Plus changed trial balance because that January 31, 2019, is gift in (Figure).


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The T-accounts after this closing entry would certainly look prefer the following.

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The T-accounts after this close up door entry would look prefer the following.

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Why space these two numbers the same? The earnings statement summarizes your income, together does earnings summary. If both summary your income in the same period, climate they must be equal. If they do not match, then you have actually an error.

The 3rd entry needs Income an overview to close come the Retained earnings account. To gain a zero balance in the Income review account, there are guidelines come consider.

If the balance in Income review before close up door is a credit balance, you will debit Income an introduction and credit transaction Retained income in the closeup of the door entry. This situation occurs when a agency has a net income.If the balance in Income summary before closeup of the door is a debit balance, you will certainly credit Income review and debit Retained revenue in the close up door entry. This instance occurs when a firm has a net loss.

Remember that net income will boost retained earnings, and a net loss will decrease preserved earnings. The Retained revenue account increases on the credit transaction side and decreases ~ above the debit side.

Printing Plus has a $4,665 credit transaction balance in the Income an overview account prior to closing, therefore it will debit Income an overview and credit maintained Earnings.

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Notice that the Income review account is now zero and is all set for use in the next period. The Retained earnings account balance is right now a credit of $4,665.

The 4th entry needs Dividends to close to the Retained earnings account. Remember indigenous your past studies that dividends space not expenses, such as earnings paid to your employees or staff. Instead, declaring and paying dividend is a an approach utilized by corporations to return component of the profits created by the company to the owner of the company—in this case, that is shareholders.

If dividend were not declared, closing entries would certainly cease in ~ this point. If dividends are declared, to gain a zero balance in the dividend account, the entry will display a credit transaction to Dividends and also a debit to kept Earnings. Together you will find out in copy, group Accounting, there are three contents to the declaration and payment that dividends. The an initial part is the day of declaration, which create the obligation or legal responsibility to salary the dividend. The second part is the day of document that determines that receives the dividends, and also the third component is the day of payment, i m sorry is the day that payments room made. Printing Plus has $100 of dividends through a debit balance top top the readjusted trial balance. The closing entry will certainly credit Dividends and debit maintained Earnings.

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Why to be income summary not used in the dividend closing entry? Dividends space not an income statement account. Only revenue statement accounts aid us summary income, for this reason only income statement account should get in income summary.

Remember, dividends room a contra stockholders’ same account. That is contra to kept earnings. If us pay the end dividends, it means retained income decreases. Retained earnings decreases ~ above the debit side. The continuing to be balance in Retained income is $4,565 ((Figure)). This is the exact same figure discovered on the declare of maintained earnings.


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The declare of retained income shows the period-ending retained earnings after the closeup of the door entries have actually been posted. When you to compare the retained earnings ledger (T-account) come the explain of kept earnings, the figures must match. That is essential to know retained revenue is not closeup of the door out, the is just updated. Retained income is the just account that shows up in the closeup of the door entries that does no close. You should recall from her previous material that retained revenue are the revenue retained by the firm over time—not cash flow yet earnings. Now that we have actually closed the short-term accounts, let’s review what the post-closing ledger (T-accounts) looks favor for print Plus.


T-Account Summary

The T-account an introduction for Printing to add after closeup of the door entries room journalized is gift in (Figure).


Notice the revenues, expenses, dividends, and income an introduction all have actually zero balances. Retained revenue maintains a $4,565 credit transaction balance. The post-closing T-accounts will be transferred to the post-closing attempt balance, i m sorry is action 9 in the audit cycle.

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A company has revenue the $48,000 and also total prices of $52,000. What would certainly the third closing entry be? Why?


Key Concepts and Summary

Closing entries: closing entries prepare a company for the next period and zero the end balance in short-term accounts.Purpose of closeup of the door entries: close up door entries space necessary because they assist a agency review income accumulation during a period, and also verify data figures found on the readjusted trial balance.Permanent accounts: long-term accounts perform not close and also are account that move balances come the next period. They encompass balance paper accounts, such together assets, liabilities, and stockholder’s equityTemporary accounts: short-term accounts room closed in ~ the finish of every accounting period and incorporate income statement, dividends, and also income review accounts.Income Summary: The Income summary account is an intermediary between revenues and also expenses, and also the Retained earnings account. It stores all the closing information for revenues and expenses, bring about a “summary” of revenue or loss because that the period.Recording closing entries: over there are 4 closing entries; closing earnings to earnings summary, closing prices to revenue summary, closing income an introduction to retained earnings, and also close dividend to maintained earnings.Posting close up door entries: once all close up door entries space complete, the info is moved to the general ledger T-accounts. Balances in momentary accounts will show a zero balance.