Accounting Cycle IV
Lecture Outline
 Closing Entries



Defined
Closing Revenue Accounts
Closing Expense Accounts
 Allocation of Profit/Loss (Partnership)

Fixed Capital Balance Method
 Closing Drawings Account
Closing Entries
 At the end of each new accounting period the
balances within the revenue and expense
accounts at the end of the old accounting
period must be “closed off”.
“Closing Off the accounts”
 Simply means that accounts are returned to a
zero balance.
Closing Entries
 Revenue and expense accounts are closed
off to ensure that only revenues earnt and
expenses incurred within a period are
included within the Statement of Financial
Performance.
Closing Revenue Accounts
 Revenue accounts are closed by debiting the
revenue account by the amount of the closing
balance and then crediting the P&L Summary
account by the same amount.
Example
 “Novel Sports” sells $60,000 worth of goods in the
period. The sales revenue account would be debited
by $60,000 and the P&L Summary account would be
credited by $60,000.
Closing Revenue Accounts
General Journal Entry
Debit
Sales Revenue
P&L Summary
Credit
60,000
60,000
Closing Expense Accounts
 Expense accounts are closed by crediting the
expense account by the amount of the
closing balance and then debiting the P&L
Summary account by the same amount.
Example
 The wages expense for “Novel Sports” is $10,000.
The wages account needs to be credited by $10,000
and the P&L Summary account debited by $10,000.
Closing Expense Accounts
General Journal Entry
Debit
P&L Summary
Wages Expense
Credit
10,000
10,000
Closing the P&L Summary
 The P&L Summary is a temporary
account. It is closed off to the Profit
Distribution account at the end of the
accounting period.
Closing the P&L Summary
Example
 “Novel Sports” has made a $50,000 profit (ie
$60,000 – 10,000) then the P&L Summary
will have a $50,000 credit balance. This
needs to be closed off to the profit distribution
account
Closing the P&L Summary
Debit
P&L Summary
50,000
Profit Distribution
Credit
50,000
Allocation of Profit/Loss
 Three methods for allocating profit are as
follows:



Fixed ratio
Ratio based on capital balances
Fixed ratio after deducting interest on partners
capital and salaries paid to partners.
 The manner in which profits are to be
allocated should be outlined in the
partnership agreement.
Example
 Matt and Justin are partners in “Novel
Sports”.
 Capital Investments are as follows:


Justin
Matt
$200,000
$150,000
 Profit for the year is $50,000.
1. Fixed Ratio
 The partnership agreement specifies that net profit is
to be allocated on the following basis (60% Justin,
40% Matt).
Debit
Profit Distribution
Retained Profits - Justin
Retained Profits - Matt
Credit
50,000
30,000
20,000
Statement of Financial Position
Equity
Equity
Capital - Justin
Capital - Matt
Retained Profits- Justin
Retained Profits - Matt
Total Equity
200,000
150,000
30,000
20,000
400,000
2. Ratio Based on Capital
Balances
 Justin and Matt agree to share profit based
on opening capital balances.
 In this way, the partner that has invested
more money into the business receives a
greater proportion of any profit or loss.
2. Ratio Based on Capital
Balances
Justin:
Matt:
200/350 x 50,000 = 28,571
150/350 x 50,000 = 21,429
Debit
Profit Distribution
50,000
Retained Profits - Justin
Retained Profits - Matt
Credit
28,571
21,429
Statement of Financial Position
Equity
Equity
Capital – Justin
Capital - Matt
Retained Profits- Justin
Retained Profits - Matt
Total Equity
200,000
150,000
28,571
21,429
400,000
3. Fixed Ratio after Interest on
Capital and Salaries
 Partners may specify within the partnership
agreement that each partner is to receive the
following:


Interest on Opening Capital
Salary
 Interest and Salaries to partners are paid out
of the profit (ie they are not expenses of the
business).
3. Fixed Ratio after Interest on
Capital and Salaries
 Matt and Justin agree that 10% interest on
opening capital should be paid each year.
 Interest allocated to each partner from profit
Justin:
Matt:
10% x 200,000 = 20,000
10% x 150,000 = 15,000
Profit Distribution
$50,000
Justin
$20,000
Matt
15,000
3. Fixed Ratio after Interest on
Capital and Salaries
 The partners agree that Justin should receive
a salary of $7,000 and Matt a salary of
$3,000.
Profit Distribution
$50,000
Justin
$20,000
Matt
$15,000
$7,000
$3,000
3. Fixed Ratio after Interest on
Capital and Salaries
 The remaining profit ($5,000) is then
allocated according to fixed ratio (ie 4:6)
 Profit allocated to each partner from profit
Justin:
Matt:
60% x 5,000 = 3,000
40% x 5,000 = 2,000
$50,000
Matt
$15,000
Justin
$20,000
$3,000
$7,000
$3,000
$2,000
Total
$30,000
Total
$20,000
Distribution of Profit
Debit
Profit Distribution
Retained Profits - Justin
Retained Profits - Matt
Credit
50,000
30,000
20,000
Statement of Financial Position
Equity
Equity
Capital - Justin
Capital - Matt
Retained Profits- Justin
Retained Profits - Matt
Total Equity
200,000
150,000
30,000
20,000
400,000
Closing Drawings
 At the end of the period any drawings by
partners are closed off to the respective
partners retained profit account.
 Drawings by each partner during the period
Justin:
Matt:
9,000
6,000
Closing Drawings
Debit
Retained Profits - Justin
Retained Profits – Matt
Drawings - Justin
Drawings – Matt
Credit
9,000
6,000
9,000
6,000
Statement of Financial Position
Equity
Equity
Capital – Justin
Capital - Matt
Retained Profits- Justin
Retained Profits - Matt
Total Equity
200,000
150,000
21,000
14,000
385,000