10

Closing Entry Concepts

The final stage of the accounting cycle is to prepare the accounts for the next fiscal period.

To do this, you must understand which accounts have balances that continue from one period to the next and which do not.

Purpose of Closing Entries
1.
Updates the owner’s capital account in the ledger by transferring net income (loss) and owner’s drawings to owner’s capital.
2.
Prepares the temporary accounts (revenue, expense, drawings) for the next period’s postings by reducing their balances to zero .


The revenue and expense accounts are reduced to zero by a process called closing the books.

Closing the books is the process by which revenue and expense accounts are reduced to zero of the end of each accounting period.

Closing the accounts is sometimes called clearing the accounts.

Real Accounts and Nominal Accounts
Real Accounts

All asset and liability accounts, as well as the owner's capital account, are considered to be real accounts.

Real accounts have balances that continue into the next fiscal period.

Examples of real accounts are Bank, Trucks, and Accounts
Payable.

Real Accounts and Nominal Accounts
Nominal Accounts

Nominal accounts (Revenue, Expense, and Drawings) have balances that do not continue into the next fiscal period.

Nominal accounts, with the exception of the Drawings account , are related to the income statement, and the income statement deals only with a single fiscal period.

All nominal accounts begin each fiscal period with a nil balance.

Real Accounts and Nominal Accounts
Income Summary
 A special nominal account, called the Income Summary account, is used only during the closing entry process.

The Income Summary account summarizes the revenues and expenses of the period.

The temporary balance in this account represents either the amount of net income or the amount of net loss .

Real Accounts and Nominal
Accounts

Other names for REAL and NOMINAL accounts are
Permanent and TEMPORARY accounts.

These alternative terms help you remember which accounts will continue to have balances ( PERMANENT ) and which will be closed out ( TEMPORARY ).

TEMPORARY (NOMINAL)
These accounts are closed
PERMANENT (REAL)
These accounts are not closed
All revenue accounts All asset accounts
All expense accounts All liability accounts
Owner’s drawings Owner’s capital account
(Income Statement /
Drawings Accounts)
(Balance Sheet Accounts)

Journalizing and Posting the Closing
Entries
Don’t forget to post to the General Ledger
Closing Entry No. 1

Journalizing and Posting the
Closing Entries
Closing Entry No. 2

Journalizing and Posting the
Closing Entries
Don’t forget to post to the General Ledger
Closing Entry No. 3

Journalizing and Posting the
Closing Entries
Don’t forget to post to the General Ledger
Closing Entry No. 4

Closing Entries
STOP AND CHECK
1. Does the balance in your
Owner’s Capital account equal the ending capital balance reported in the
Balance Sheet and Statement of Owner’s Equity?
2. Are all of your temporary account balances zero?

Post - Closing Trial Balance
 After all closing entries have been journalized and posted, a post-closing trial balance is prepared.
 The purpose of this trial balance is to prove the equality of the permanent (balance sheet) account balances that are carried forward into the next accounting period.

Post - Closing Trial Balance
Notes Payable
Accounts Payable
Unearned Revenue
Salaries Payable
Interest Payable
C.R. Byrd, Capital
Pioneer Advertising Agency
Post-Closing Trial Balance
October 31, 2002
After Adjustment
Debit Credit
Cash
Accounts Receivable
Advertising Supplies
Prepaid Insurance
The post-closing trial
$ 15,200 balance is prepared
200
1,000 from the permanent
550
Office Equipment accounts in the ledger.
5,000
Accumulated Amortization
The post-closing trial balance provides evidence that the journalizing and posting of closing entries has been properly
$ 83
5,000
2,500
800
1,200
25
12,342 completed.
$ 21,950 $ 21,950

9. Prepare post-closing trial balance
8. Journalize and post closing entries
1. Source
Documents:
Analyse
Transactions
2. Journalize the transactions
3. Post to ledger accounts
4. Prepare a trial balance
7. Prepare financial statements
6. Prepare adjusted trial balance
5. Journalize and post adjusting entries