Chapter Four Accounting Cycle (III): Closing Entries and Post-closing Trial
Balance
I.
Learning objectives
After completing this session, students should be able to
1. Explain the purposes of closing entries;
2. Understand the closing procedures;
3. Journalize and post the closing entries;
4. Prepare an after-closing trial balance.
II. Lecture notes
1. Purposes of closing entries
Closing entries serve three basic purposes:
(1) To return the balances of the temporary owner’s equity accounts (revenue,
expense and drawing accounts) to zero so that these accounts may be used to
measure the activities of the next reporting period.
(2) To update the balance of Capital account.
At the end of a fiscal year, the management of a business needs financial
statements to evaluate and adjust their decisions and strategies. Therefore,
they need up-to-date information about the results and status of operation
during a certain period.
(3) For income tax purpose, no company wants to pay income tax more than once
on the same income.
Net income/loss = Revenue – Expenses
The balances of revenue and expense accounts apply to only one fiscal period
and the difference between revenue and expenses (net income/loss) applies to
this period only. When this fiscal period is over, we should start from scratch
for the next period.
2. The closing entries
(1) The closing process gets the temporary/nominal accounts ready for the next
accounting period.
(2) Permanent/real accounts vs. temporary/nominal accounts
Permanent accounts or real accounts
--- Accounts that remain open all the time until the business is liquidated.
Temporary accounts or nominal accounts
--- Accounts that apply to only one accounting period and that are closed
at the end of that accounting period.
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Assets
=
+ Owner’s equity +
Liabilities
Revenue –
Permanent accounts
Open
Expenses
–
Drawing
Temporary accounts
Closed
(3) Closing entries
--- journal entries made at the end of a fiscal year to reduce the balances of
the temporary accounts to zero.
Example:
Account title
Dr
Bal. 100
0
Cr
Closing 100
Account title
Dr
Closing 100
Cr
Bal. 100
0
3. Closing procedures
(1) Close the revenue accounts into the income summary account
 Creation of the income summary account
According to the principle of the double-entry bookkeeping, every entry must
have at least a debit and a credit.
Example:
Income from services
Dr
Cr
Closing 1,000 Bal.1,000
Income Summary
Dr
Cr
1,000
0
 Journalizing the entry
Income from services
Income summary
1,000
1,000
(2) Close the expense accounts into the income summary account
Gas expense
Income Summary
Dr
Cr
Dr
Cr
Bal. 50 Closing 50
200
1,000
0
Depreciation Expense
Dr
Cr
Bal. 150 Closing 150
0
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 Journalize the closing entry
Income summary
Gas expense
Depreciation expense
200
50
150
 A summary
Income Summary
Expenses bal.
Revenue Bal.
Net loss
Net income
(if R< E)
(if R > E)
(3) Close the income summary account into the Capital account
 We create the Income Summary account so that we can have a debit and a
credit with each closing entry. After we have closed the revenue and expense
accounts, we shall close this temporary account.
Example:
Income Summary
Dr
Cr
200
1,000
Closing 800 bal. 800 (NI)
Dr
Capital
Cr
Beginning bal. 10,000
800 (NI)
 Journalize the closing entry
Income summary
Capital
800
800
 If the company suffers a loss:
Income Summary
Dr
Cr
1,200
1,000
Bal. 200(NL) Closing 200
Capital
Dr
Cr
Beginning bal. 10,000
200 (NL)
 Journalize the closing entry
Capital
200
Income summary
200
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(4) Close the Drawing account into the Capital account
 Drawing is a deduction from the Capital account, so it is closed direct into the
Capital account.
 Example:
Drawing
Capital
Dr
Cr
Dr
Cr
Bal. 100
Closing 100
Beginning bal. 10,000
100
Net income 800
Bal. 10,700
 This shows the changes in the Capital account
Ending capital = Beginning capital + Net income (-Net loss) – Drawing
 Journalize the closing entry
Capital
100
Drawing
100
(5) A summary of the closing procedures
Expenses
+
Bal.
Closing
②
③
Revenue
Closing
+
Bal.
①
Income Summary
Expenses
Revenue
Closing
Net income
Net loss
Closing
③
Drawing
Capital
+
④
+
Bal.
Closing
Drawing Beginning Bal.
Net loss
Net income
4. Post the closing entries
Refer to the examples on Pages 91-94.
5. Prepare a post-closing trial balance
Refer to the example on Page 95 (remind the students of the differences between
the pre-closing trial balance and the post-closing trial balance)
6. A summary of the accounting cycle (refer to Page 96)
7. Assignment for this chapter
Page 99: Problem 3 (handouts: one work sheet, two sheets for the preparation of
financial statements, and one general journal sheet for closing entries)
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