College
Accounting,
by Heintz and Parry
Chapter 6:
Financial
Statements and
the Closing
Process
Eddie’s Winter Quarter looked rough, with
too much macroeconomics and not enough macrame, so he
decided to prepare the general ledger for 2000 before
classes started. That meant he needed to make closing
entries, entries that would set the revenue, expense, and
drawing accounts back to zero. This would allow these
accounts to accumulate the information necessary to
prepare an income statement and statement of owner’s
equity for 2000.
Question: What accounts do not get closed?
Answer:
The assets, liabilities, and capital accounts do
not get closed (although Eddie certainly wishes that his
liabilities automatically returned to zero at year end).
There are 4 closing entries. Eddie remembered the purpose
and order of the four entries because the 4 types of accounts
being closed spelled the last name of his friend Robert REID.
The 4 entries are to close:
1) Revenue accounts
2) Expense accounts
3) Income Summary, and the
4) Drawing account.
Entry One:
Close the Revenue Account(s)
Because revenue accounts have credit balances, we need to
debit them (for the amount of their balance) to close them.
The credit goes to a new account called Income Summary.
Income Summary is used to summarize the income statement
accounts, so it gets used only for closing entries.
Date
Description
Closing Entries
1999
Dec. 31 Gig Revenue
Income Summary
P. R.
Debit
Credit
525.00
525.00
Entry Two:
Close the Expense Accounts
Because expense accounts have debit balances, we need to
credit them (for the amount of their balance) to close them.
The debit (for the total amount of the expenses) goes to
Income Summary.
Date
Description
P. R.
1999
Dec. 31 Income Summary
Wage Expense
Equipment Rental Expense
Supply Expense
Insurance Expense
Depr’n. Exp.-Mus. Instruments
Debit
335.00
Credit
160.00
30.00
35.00
20.00
90.00
Entry Three:
Close the Income Summary Account
At this point, the income summary account has been credited
for the total amount of revenues ($525) and debited for the total
amount of expenses ($335). Thus, its balance should equal
$190.
Income Summary
335
525
Bal. 190
Questions: 1) This $190 balance should equal what
amount found on the financial statements?
2) If we close Income Summary with a $190 debit, what
account should we credit?
Answers:
1) The balance of $190 represents the company’s net income.
2) The credit goes to Eddie O’Hare, Capital, because the net
income increases his ownership in the business.
Date
Description
1999
Dec. 31 Income Summary
Eddie O’Hare, Capital
P. R.
Debit
190.00
Credit
190.00
Entry Four:
Close the Drawing Account
Because the drawing account has a debit balance, we need to
credit it to close it. The debit goes to Eddie’s capital account
because withdrawals reduce his ownership in the business.
Date
Description
Closing Entries
1999
Dec. 31 Eddie O’Hare, Capital
Eddie O’Hare, Drawing
P. R.
Debit
Credit
12.00
12.00
When the closing entries are posted,
the accounts have no balance (signified by two straight lines in
the balance column), and the new year’s transactions can be
entered.
account
Date
Eddie O’Hare, Drawing
Item
P.R.
1999
Oct..17
J1
Dec.31
J3
Debit
account no.
Credit
12.00
312
Balance
Debit
Credit
12.00
12.00
-----------
----------
At this point, Eddie
prepared financial
statements. His income statement (REN, remember?)
confirmed that net income was $190.
Eddie and the Losers
Income Statement
For Year Ended Dec. 31, 1999
Revenues:
Gig Revenue
$525
Expenses:
Wage Expense
$160
Depn. Exp.-M.I.
90
Supply Expense
35
Equip. Rental Expense 30
Insurance Expense
20
Total Expenses
335
Net Income
$190
Eddie did his Statement of Owner’s Equity next.
Although Eddie invested no additional money during the
period, the two lines in red show how the statement
would reflect it if he did. The sentence to help you
remember the format would become Connie and Tom
need less ice cream.
Eddie and the Losers
Statement of Owner’s Equity
For Year Ended Dec. 31, 1999
E. O’Hare, Cap., Oct. 1
$2000
Additional Investment
0
Total
2000
Net Income
$190
Less Withdrawals
12
Increase in Capital
178
E. O’Hare, Cap, Dec. 31
$2178
Eddie’s balance sheet had some new headings. He
divided his assets into Current Assets (assets that will
be used up or turned into cash within one year) and
Plant, Property and Equipment (physical assets that will
last for more than one year).
Eddie and the Losers
Balance Sheet
Dec. 31, 1999
Assets
Current Assets:
Cash
$383
Supplies
25
Prepaid Insurance
100
Total Current Assets
$508
Plant, Prop., & Equip.:
Musical Instruments $2200
Less Accum. Dep’n.
90
2110
Total Assets
$2618
Eddie’s liabilities will also go into one of two
headings: Current Liabilities (those that will be paid
within one year) and Long-term Liabilities (which will
not be paid in the next year). At this point, all of Eddie’s
liabilities are current.
Eddie and the Losers
Balance Sheet
Dec. 31, 1999
Liabilities
Current Liabilities:
Accounts Payable
Wages Payable
Total Current Liabilities
Owner’s Equity
Eddie O’Hare, Capital
Total Liabilities & Owner’s Equity
$360
80
$ 440
2178
$2618
Eddie’s last step, after financial statements and the
posting of closing entries, is a post-closing trial
balance. It is used to confirm that all posting was done
correctly (only balance sheet accounts should have
balances, and debits should equal credits).
Eddie and the Losers
Post-Closing Trial Balance
Dec. 31, 1999
Debits Credits
Cash
383
Supplies
25
Prepaid Insurance
100
Musical Instruments 2200
Acc. Depn.-M.I.
90
Accts. Payable
360
Wages Payable
80
Eddie O’Hare, Capital
2178
2708
2708 It balances!