Completing the Accounting Cycle for a
Service Business: Closing Entries and the
Post-Closing Trial Balance
Chapter 5
© Paradigm Publishing, Inc.
1
Learning Objectives
1. Explain the purpose of the closing
process.
2. Journalize and post closing entries.
3. Prepare a post-closing trial balance.
© Paradigm Publishing, Inc.
2
Learning Objective 1
Explain the purpose of the closing process
© Paradigm Publishing, Inc.
3
Temporary Accounts
 Revenue and expense accounts and the owner’s
drawing account
 Used to show changes in owner’s equity during a
single accounting period
Closing Process: The process of transferring the
balances of the temporary accounts to the owner’s
capital account
Closing Entries: Entries necessary to accomplish the
closing process
© Paradigm Publishing, Inc.
4
1. To reduce the balance of temporary owner’s equity
accounts to zero and thus make the accounts ready
for entries in the next accounting period.
2. To update the balance of the owner’s capital
account.
© Paradigm Publishing, Inc.
5
Learning Objective 2
Journalize and post closing entries
© Paradigm Publishing, Inc.
6
1. Close the balance of each revenue account to the
Income Summary account.
2. Close the balance of each expense account to
Income Summary.
3. Close the balance of Income Summary to the
owner’s capital account.
4. Close the balance of the owner’s drawing account
directly to the owner’s capital account.
© Paradigm Publishing, Inc.
7
A clearing account used to summarize the balances of
revenue and expense accounts
 Used only at the end of an accounting period
 Opened and closed during the closing process
Does not have a normal balance as do other accounts
Will never appear on the financial statements
© Paradigm Publishing, Inc.
8
Quick Check
The balance in the Income Summary account
a. appears on the income statement.
b. appears on the balance sheet.
c. appears on the income statement and the statement
of owner’s equity.
d. does not appear on any financial statement.
e. appears on the balance sheet and the statement of
owner’s equity.
© Paradigm Publishing, Inc.
9
We’ll use the numbers on the work sheet to demonstrate
the closing entries.
© Paradigm Publishing, Inc.
10
© Paradigm Publishing, Inc.
11
To close an account, we must make an entry that will
reduce the balance of the account the zero.
Thus, a revenue account must be debited for the
amount of its credit balance.
The credit will be to the Income Summary account.
© Paradigm Publishing, Inc.
12
Quick Check
When closing a revenue account, the
a. revenue account is credited for its balance.
b. owner’s capital account is credited for the balance of
the revenue account.
c. owner’s drawing account is credited for the balance
of the revenue account.
d. Income Summary account is credited for the balance
of the revenue account.
e. Income Summary account is debited for the balance
of the revenue account.
© Paradigm Publishing, Inc.
13
An expense account
must be credited for the
amount of its debit
balance.
The debit will be to the
Income Summary
account.
© Paradigm Publishing, Inc.
14
Quick Check
When closing an expense account the
a. expense account is credited for its balance.
b. owner’s capital account is credited for the balance
of the expense account.
c. owner’s drawing account is credited for the balance
of the expense account.
d. Income Summary account is credited for the
balance of the expense account.
e. owner’s capital account is debited for the balance
of the expense account.
© Paradigm Publishing, Inc.
15
Compute the balance in the Income Summary account.
The balance in the Income Summary account will
always reflect the amount of net income or net loss.
Assuming a net income, it is transferred to the credit
side of the owner’s capital account.
© Paradigm Publishing, Inc.
16
The Income Summary account is debited for its balance
to close it.
© Paradigm Publishing, Inc.
17
Quick Check
When closing the Income Summary account, assuming
a net income the
a. Income Summary account is credited for its balance.
b. owner’s capital account is credited for the amount of
the net income.
c. owner’s capital account is debited for the amount of
the net income.
d. owner’s drawing account is credited for the amount of
the net income.
e. owner’s drawing account is debited for the amount of
the net income.
© Paradigm Publishing, Inc.
18
The balance of the owner’s drawing account does not
enter into the determination of net income or net loss.
Therefore, the drawing account is not closed to the
Income Summary account.
Instead, it is closing directly into the owner’s capital
account.
The drawing account has a debit balance and is
credited to close it.
© Paradigm Publishing, Inc.
19
The owner’s capital account is debited since drawing
decreases the owner’s capital.
© Paradigm Publishing, Inc.
20
Quick Check
When closing the owner’s drawing account, the
a. owner’s capital account is debited for the amount of
net income.
b. owner’s capital account is credited for the balance
of the owner’s drawing account.
c. owner’s drawing account is credited for its balance.
d. Income Summary account is credited for the
balance of the owner’s drawing account.
e. Income Summary account is debited for the balance
of the owner’s drawing account.
© Paradigm Publishing, Inc.
21
The balance in the owner’s capital account after all
closing entries have been prepared will be the updated
balance appearing on the balance sheet and the postclosing balance.
© Paradigm Publishing, Inc.
22
Quick Check
The owner’s capital account is
a. increased by the balance in the owner’s drawing
account.
b. increased by the amount of net loss.
c. decreased by the balance in the owner’s drawing
account.
d. closed at the end of each accounting period.
e. decreased by the amount of net income.
© Paradigm Publishing, Inc.
23
Temporary Accounts
 All revenue accounts
 All expense accounts
 All drawing accounts
 Close at the end of the accounting period
© Paradigm Publishing, Inc.
24
Permanent Accounts
 All balance sheet accounts
 Do not close at the end of the accounting period
© Paradigm Publishing, Inc.
25
© Paradigm Publishing, Inc.
26
Quick Check
Select the correct statement:
a. Revenues, assets, and expenses are permanent
accounts.
b. Liabilities and the owner’s capital account are
temporary accounts.
c. Revenues, expenses, and the owner’s drawing
account are temporary accounts.
d. Assets, liabilities, and the owner’s drawing account
are temporary accounts.
e. Expenses and liabilities are permanent accounts.
© Paradigm Publishing, Inc.
27
© Paradigm Publishing, Inc.
28
Example
Assume the Service Revenue account has an ending
balance of $3,000.
Prepare the closing entry.
General Journal
Date
20X1
Dec.
Account Title
31 Service Revenue
Income Summary
© Paradigm Publishing, Inc.
P.R.
Debit
Credit
3,000
3,000
29
Example
Assume Salaries Expense has an ending balance of
$1,200.
Prepare the closing entry.
General Journal
Date
20X1
Dec.
Account Title
31 Income Summary
Salaries Expense
© Paradigm Publishing, Inc.
P.R.
Debit
Credit
1,200
1,200
30
Example
Assume net income for the current period is $1,800
for June Delugas Interiors.
Prepare the closing entry.
General Journal
Date
20X1
Dec.
Account Title
31 Income Summary
June Delugas, Capital
© Paradigm Publishing, Inc.
P.R.
Debit
Credit
1,800
1,800
31
Example
Assume June Delugas, Drawing, has an ending
balance of $500.
Prepare the closing entry.
General Journal
Date
20X1
Dec.
Account Title
31 June Delugas, Capital
June Delugas, Drawing
© Paradigm Publishing, Inc.
P.R.
Debit
Credit
500
500
32
1. Close the balance of revenue accounts to Income
Summary.
2. Close the balance of expense accounts to Income
Summary.
3. Close the balance of Income Summary to the
owner’s capital account.
4. Close the balance of the owner’s drawing account
to the owner’s capital account.
© Paradigm Publishing, Inc.
33
© Paradigm Publishing, Inc.
34
Review Quiz 5-1
Close the temporary accounts.
© Paradigm Publishing, Inc.
35
Review Quiz 5-1
© Paradigm Publishing, Inc.
36
Review Quiz 5-1
The closing entries are journalized.
© Paradigm Publishing, Inc.
37
Review Quiz 5-1
© Paradigm Publishing, Inc.
38
After closing entries have been journalized, the next
step in the accounting cycle is to post these entries
from the general ledger to the general journal
After posting has occurred
 The permanent accounts will have up-to-date
balances
 The temporary accounts will have zero balances
© Paradigm Publishing, Inc.
39
Review Quiz 5-2
T-Account Balances
© Paradigm Publishing, Inc.
40
Review Quiz 5-2
The temporary accounts are journalized.
© Paradigm Publishing, Inc.
41
Learning Objective 3
Prepare a post-closing trial balance
© Paradigm Publishing, Inc.
42
The final step in the accounting cycle
Ensures the ledger will be in balance at the start of
the next account period
Only permanent accounts appear on the post-closing
trial balance, since the balances of all temporary
accounts have been reduced to zero
© Paradigm Publishing, Inc.
43
© Paradigm Publishing, Inc.
44
Quick Check
Select the correct statement:
a. The post-closing trial balance will list revenues and
assets.
b. The post-closing trial balance will list assets and the
owner’s capital account.
c. The post-closing trial balance will list expenses and
assets.
d. The post-closing trial balance will list the owner’s
drawing account and the owner’s capital account.
e. The post-closing trial balance will list expenses,
revenues, and liabilities.
© Paradigm Publishing, Inc.
45
1. Analyze transactions from source
documents
During the
accounting
period
2. Record transactions in a journal
3. Post from the journal to the ledger
4. Prepare a trial balance of the ledger
© Paradigm Publishing, Inc.
46
5. Determine needed adjustments
6. Prepare a work sheet
At the end
of the
accounting
period
7. Prepare financial statements from a
completed work sheet
8. Journalize and post adjusting entries
9. Journalize and post closing entries
10.Prepare a post-closing trial balance
© Paradigm Publishing, Inc.
47
Any period of time covering the complete
accounting cycle, from the analysis of transactions
to the post-closing trial balance.
A fiscal period consisting of 12 consecutive months
is a fiscal year.
A fiscal year does not necessarily coincide with the
calendar year.
A fiscal year ending at a business’s lowest point of
activity is referred to as a natural business year.
© Paradigm Publishing, Inc.
48
Accrual Basis of Accounting
The basis of accounting that requires that revenue is
recorded when earned, no matter when cash is
received, and that expenses are recorded when
incurred, no matter when cash is paid.
Cash Basis of Accounting
The basis of accounting where revenue is recorded
only when cash is received, and expenses are recorded
only when cash is paid.
The cash basis of accounting is not in accordance with
GAAP.
© Paradigm Publishing, Inc.
49
© Paradigm Publishing, Inc.
50
Focus on Ethics
Refer to the Focus on Ethics box on pages 191-192
in your text.
What pressures might lead executives to try to
illegally manipulate a company’s earnings?
© Paradigm Publishing, Inc.
51
Joining the Pieces
Steps in the
Accounting Cycle
for a Service
Business
© Paradigm Publishing, Inc.
52