25 Describe and also Prepare closing Entries for a Business

In this chapter, we finish the final steps (steps 8 and also 9) of the accounting cycle, the closing process. Girlfriend will an alert that we execute not cover action 10, reversing entries. This is one optional action in the audit cycle the you will learn about in future courses. Measures 1 through 4 were extended in analyzing and recording Transactions and also Steps 5 with 7 were covered in The mediate Process.

You are watching: There is really no benefit in preparing financial statements in any particular order.

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Should You compromise to Please her Supervisor?
You room an accountant because that a small event-planning business. The business has been operation for number of years but does not have actually the resources for accountancy software. This means you are preparing all procedures in the bookkeeping cycle by hand.

It is the end of the month, and you have actually completed the post-closing psychological balance. You notice that over there is tho a business revenue account balance noted on this attempt balance. Why is it taken into consideration an error to have a revenue account top top the post-closing psychological balance? how do you deal with this error?


Introduction come the close up door Entries

Companies are forced to near their publications at the end of every fiscal year so the they have the right to prepare their yearly financial statements and also tax returns. However, many companies prepare monthly financial statements and close their publications annually, therefore they have actually a clear photo of company performance during the year, and also give users timely details to do decisions.

Closing entries prepare a firm for the following accounting period by clearing any type of outstanding balances in specific accounts that should not deliver over come the next period. Closing, or clearing the balances, way returning the account come a zero balance. Having actually a zero balance in these accounts is vital so a agency can compare performance throughout periods, specifically with income. It additionally helps the company keep thorough documents of account balances affecting retained earnings. Revenue, expense, and dividend accounts influence retained earnings and also are closed for this reason they can accumulate new balances in the next period, i m sorry is an application of the time duration assumption.

To further clarify this concept, balances are closed to guarantee all revenues and expenses are recorded in the proper duration and then begin over the complying with period. The revenue and also expense accounts should start at zero each period, because we space measuring how much revenue is earned and expenses incurred during the period. However, the cash balances, and the other balance paper accounts, are carried over indigenous the finish of a current period to the beginning of the following period.

For example, a store has an inventory account balance that $100,000. If the keep closed in ~ 11:59 p.m. ~ above January 31, 2019, then the list balance when it reopened in ~ 12:01 a.m. ~ above February 1, 2019, would still it is in $100,000. The balance paper accounts, such as inventory, would carry over into the next period, in this case February 2019.

The accounts that have to start v a clean or $0 balance going right into the next accounting duration are revenue, income, and any dividends from January 2019. To recognize the revenue (profit or loss) indigenous the month of January, the store requirements to near the income statement info from January 2019. Zeroing January 2019 would certainly then permit the store to calculation the revenue (profit or loss) for the following month (February 2019), instead of merger it right into January’s income and also thus offering invalid information exclusively for the month the February.

However, if the firm also wanted to save year-to-date info from month to month, a separate set of records could be maintained as the firm progresses through the remaining months in the year. For our purposes, assume that we room closing the publications at the finish of each month unless otherwise noted.

Let’s watch at one more example to illustrate the point. Assume you own a tiny landscaping business. That is the end of the year, December 31, 2018, and you room reviewing her financials because that the entire year. You watch that you earned $120,000 this year in revenue and had costs for rent, electricity, cable, internet, gas, and food the totaled $70,000.

You additionally review the following information:

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The income summary account is an intermediary in between revenues and also expenses, and also the Retained revenue account. It stores every one of the closing information for revenues and also expenses, causing a “summary” of earnings or loss for the period. The balance in the Income summary account equals the net earnings or loss for the period. This balance is then moved to the Retained income account.

Income review is a nondefined account category. This method that it is no an asset, liability, stockholders’ equity, revenue, or expense account. The account has a zero balance transparent the whole accounting period until the closeup of the door entries room prepared. Therefore, it will certainly not show up on any type of trial balances, including the adjusted trial balance, and also will not appear on any type of of the jae won statements.

You might be asking yourself, “is the Income an introduction account also necessary?” can we just close out revenues and expenses straight into maintained earnings and not have this extra momentary account? We might do this, but by having the Income an introduction account, you gain a balance because that net revenue a second time. This provides you the balance to to compare to the earnings statement, and permits you to double check that all revenue statement accounts room closed and have correct amounts. If you put the revenues and also expenses straight into maintained earnings, you will certainly not see that inspect figure. No issue which way you choose to close, the same last balance is in retained earnings.


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

rent expenseunearned revenueaccumulated depreciation, vehiclecommon stockfees revenuedividendsprepaid insuranceaccounts payable

Solution

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


Journalizing and Posting closeup of the door Entries

The eighth action in the audit cycle is prepare closing entries, which has journalizing and posting the entries come the ledger.

Four entries occur throughout the close up door process. The first entry close the door revenue accounts to the Income review account. The 2nd entry closes cost accounts come the Income summary account. The 3rd entry closes the Income review account to preserved Earnings. The 4th entry close the door the dividends account to maintained Earnings. The info needed to prepare close up door entries comes from the readjusted trial balance.

Let’s check out each entry in much more detail making use of Printing Plus’s details from analyzing and recording Transactions and also The Adjustment procedure as our example. The to press Plus adjusted trial balance for January 31, 2019, is presented in (Figure).


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

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

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Why room these two figures the same? The income statement summarizes her income, as does income summary. If both summarize your income in the very same period, climate they must be equal. If they perform not match, then you have an error.

The third entry calls for Income review to close come the Retained income account. To acquire a zero balance in the Income an overview account, there space guidelines to consider.

If the balance in Income review before closeup of the door is a credit transaction balance, you will debit Income review and credit Retained earnings in the close up door entry. This case occurs once a company has a net income.If the balance in Income summary before close up door is a debit balance, you will credit Income an overview and debit Retained income in the close up door entry. This situation occurs when a company has a net loss.

Remember the net earnings will increase retained earnings, and a net loss will certainly decrease retained earnings. The Retained earnings account boosts on the credit transaction side and also decreases top top the debit side.

Printing Plus has a $4,665 credit balance in its Income summary account before closing, so it will debit Income an introduction and credit preserved Earnings.

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Notice the the Income review account is now zero and also is prepared for usage in the next period. The Retained revenue account balance is currently a credit of $4,665.

The fourth entry calls for Dividends to close to the Retained earnings account. Remember indigenous your previous studies that dividends space not expenses, together as salaries paid to your employees or staff. Instead, declaring and also paying dividends is a method utilized through corporations come return component of the profits generated by the firm to the owners of the company—in this case, its shareholders.

If dividends were no declared, closing entries would certainly cease at this point. If dividends are declared, to obtain a zero balance in the dividends account, the entrance will present a credit to Dividends and also a debit to maintained Earnings. Together you will learn in corporation Accounting, there room three materials to the declaration and payment that dividends. The an initial part is the date of declaration, which creates the responsibility or liability to salary the dividend. The second part is the day of document that determines who receives the dividends, and the third part is the day of payment, i beg your pardon is the date that payments are made. Printing Plus has actually $100 that dividends v a debit balance ~ above the adjusted trial balance. The close up door entry will credit Dividends and also debit preserved Earnings.

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Why was income summary not provided in the dividend closing entry? Dividends space not an revenue statement account. Only revenue statement accounts assist us summarize income, therefore only revenue statement accounts should enter income summary.

Remember, dividends room a contra stockholders’ equity account. It is contra to maintained earnings. If us pay out dividends, it way retained earnings decreases. Retained earnings decreases on the debit side. The continuing to be balance in Retained revenue is $4,565 ((Figure)). This is the exact same figure uncovered on the declare of kept earnings.


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The declare of retained revenue shows the period-ending retained earnings after the closing entries have actually been posted. Once you to compare the retained income ledger (T-account) to the declare of kept earnings, the numbers must match. That is crucial to know retained revenue is not closeup of the door out, that is only updated. Retained income is the just account that shows up in the close up door entries the does not close. You must recall from your previous material that retained revenue are the earnings retained by the firm over time—not cash flow but earnings. Now that we have actually closed the short-term accounts, let’s testimonial what the post-closing ledger (T-accounts) looks favor for print Plus.


T-Account Summary

The T-account review for Printing to add after closing entries room journalized is presented in (Figure).


Notice the revenues, expenses, dividends, and income review all have zero balances. Retained income maintains a $4,565 credit transaction balance. The post-closing T-accounts will certainly be transferred to the post-closing attempt balance, which is action 9 in the bookkeeping cycle.

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


Key Concepts and Summary

Closing entries: close up door entries prepare a firm for the next period and zero out balance in short-term accounts.Purpose of closing entries: closeup of the door entries space necessary due to the fact that they aid a firm review income buildup during a period, and also verify data figures found on the adjusted trial balance.Permanent accounts: long-term accounts execute not close and are accounts that transport balances come the next period. They encompass balance paper accounts, such as assets, liabilities, and also stockholder’s equityTemporary accounts: short-lived accounts space closed in ~ the end of every accounting duration and include income statement, dividends, and also income an overview accounts.Income Summary: The Income review account is one intermediary between revenues and expenses, and also the Retained revenue account. It stores every the closing details for revenues and also expenses, resulting in a “summary” of earnings or loss for the period.Recording close up door entries: there are 4 closing entries; closing revenues to revenue summary, closing prices to income summary, close up door income an introduction to retained earnings, and close dividends to preserved earnings.Posting closeup of the door entries: as soon as all closeup of the door entries room complete, the information is transferred to the general ledger T-accounts. Balances in temporary accounts will present a zero balance.