Unit 13 Chapter 6
Adjusting Entries
They need to be included in the worksheet (and this will carry over to the balance sheet or income statement). As well,
they need to be recorded in the journal and then the ledger.
Closing Entries
Revenue and expense accounts need to be at a zero balance at the beginning of a new accounting period (ex. Every
month or year – depending on how often the company produces financial statements). Therefore at the end of the
accounting period we need to bring all revenue and expense accounts to a zero balance – this is a process called closing
the books.
Why do we close the books? Meaning why do we bring the revenue and expense accounts back to zero after we
complete the financial statements? We do this to prepare these accounts for the next period and to update owner’s
equity account.
Purpose of Closing the Books
1. To prepare revenue and expense accounts for the next accounting period by reducing them to zero. This is
important since the matching principle stats that revenue for each accounting period must be matched with the
expenses for that same accounting period to determine net income or net loss.
2. To update the owner’s equity account.
Revenue and expense accounts are known as temporary accounts because they are closed out each period. Asset,
Liabilities and Owner’s Equity accounts are known as permanent accounts because we never close these accounts out –
their balances are carried forward from one accounting period to another.
Income Summary Account
Revenue and expense accounts are closed by transferring their balances to an account called the income summary
account. The amount of revenue will go on the credit side since your journal entry will be a debit to revenue and credit
to income summary in the amount of the revenue for the accounting period. An amount equal to that of each of that
period’s expense will go on the debit side of the income summary account since your journal entry will be a debit to
income summary and credit to expense in the amount of the expense for the accounting period.
In Summary there are four steps involved in closing the books:
1. Close the revenue accounts into the Income Summary
To close Sales means to reduce its balance to zero by transferring the balance to Income Summary. This is done by the
following journal entry:
Dec.31
Sales
Debit
Xxx
Income Summary
To close the sales account
Credit
xxx
2. Close the expense accounts into the Income Summary
To close expense account means to reduce its balance to zero by transferring the balance to Income Summary. If there
are more than one expense, you can enter them all into one journal entry. This is done by the following journal entry:
Dec.31
Income Summary
Advertising Expense
To close the income summary account
Debit
Xxx
Credit
xxx
3. Close the Income Summary into the Capital account
After the entries to close the revenue and expense accounts have been posted, Income Summary contains the revenue
for the period on the credit side and the expenses on the debit side. Thinking of T-accounts, you will find the balance of
the Income Summary Account and close it using the following entry:
The entry would look like this if the revenue for the period was larger than the expenses:
Dec.31
Income Summary
Capital
To close the capital account
Debit
Xxx
Credit
xxx
The entry would look like this if the revenue for the period was smaller than the expenses:
Dec.31
Capital
Income Summary
To close the capital account
Debit
Xxx
Credit
xxx
4. Close the Drawings account into the Capital account
The withdrawals the owner takes out of the business are recorded in the drawings account. This account needs to be
closed to the capital account since the money the owner takes out of the business brings the capital amount down.
Dec.31
Capital
Drawings
To close the drawings account
Debit
Xxx
Credit
xxx
Here is an example of how the close entries can look as a journal entry:
Dec. 31 Sales
Income Summary
To close the sales account
31 Income Summary
Advertising Expense
Salaries Expense
Telephone Expense
To close the expense accounts
Debit Credit
20000
20000
15000
5000
9000
1000
31 Income Summary
J. Joudrey, Capital
To close Income summary and
transfer the net income to capital
5000
31 J. Joudrey, Capital
J. Joudrey, Drawings
To Close the drawings account
1000
5000
1000
Once the journal is completed you will have to post these to the general ledger accounts. In the particulars column you
will put “adjusting entry” for all adjustments you do at the end of the year (unit 12) “net income for year” and
“drawings” will be included in the capital account and all revenue and expense accounts will have “closing entry”.
Income summary will have “to close revenue account”, “to close expense account”, “to close income summary” (See
pages 246-248).
Complete exercise 12 on page 252 together!
Students complete: exercise 10, 11, 13 for tomorrow.