25 Describe and Prepare Closing Entries for a Business

In this chapter, we finish the last steps (steps 8 and 9) of the accounting cycle, the closing process. You will alert that we execute not cover action 10, reversing entries. This is an optional action in the audit cycle that you will learn around in future courses. Steps 1 through 4 were covered in Assessing and Recording Transactions and Steps 5 via 7 were spanned in The Adjustment Process.

You are watching: Which of the following groups of accounts contains only those that normally have credit balances?

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Should You Compromise to Please Your Supervisor?
You are an accountant for a little event-planning service. The service has been operating for a number of years but does not have actually the resources for accountancy software. This means you are preparing all measures in the accounting cycle by hand.

It is the finish of the month, and you have completed the post-cshedding trial balance. You notice that there is still a organization revenue account balance detailed on this trial balance. Why is it taken into consideration an error to have a revenue account on the post-closing trial balance? How carry out you resolve this error?


Overview to the Closing Entries

Companies are compelled to cshed their books at the end of each fiscal year so that they deserve to prepare their annual financial statements and taxes returns. However before, a lot of service providers prepare monthly financial statements and close their publications each year, so they have a clear image of company performance throughout the year, and give users timely information to make decisions.

Closing entries prepare a company for the following accounting duration by clearing any kind of superior balances in specific accounts that need to not transfer over to the next period. Cshedding, or clearing the balances, means returning the account to a zero balance. Having a zero balance in these accounts is necessary so a agency can compare performance throughout durations, specifically via revenue. It also helps the firm keep thorough records of account balances affecting kept income. Revenue, cost, and also dividend accounts affect maintained income and also are closed so they have the right to accumulate brand-new balances in the following period, which is an application of the moment duration presumption.

To better clarify this concept, balances are closed to assure all earnings and prices are videotaped in the proper duration and also then start over the adhering to duration. The revenue and price accounts should begin at zero each period, bereason we are measuring just how a lot revenue is earned and expenses incurred during the duration. However, the cash balances, and the various other balance sheet accounts, are lugged over from the end of a present duration to the start of the next duration.

For instance, a store has an inventory account balance of $100,000. If the save closed at 11:59 p.m. on January 31, 2019, then the inventory balance when it reopened up at 12:01 a.m. on February 1, 2019, would certainly still be $100,000. The balance sheet accounts, such as inventory, would carry over into the next duration, in this situation February 2019.

The accounts that have to start with a clean or $0 balance going into the following bookkeeping period are revenue, earnings, and any kind of dividends from January 2019. To determine the earnings (profit or loss) from the month of January, the keep requirements to cshed the income statement indevelopment from January 2019. Zeroing January 2019 would certainly then permit the keep to calculate the earnings (profit or loss) for the next month (February 2019), rather of merging it into January’s revenue and also for this reason giving invalid indevelopment solely for the month of February.

However, if the firm likewise wanted to keep year-to-day indevelopment from month to month, a separate collection of documents can be kept as the firm progresses with the remaining months in the year. For our objectives, assume that we are cshedding the publications at the end of each month unless otherwise detailed.

Let’s look at one more instance to show the suggest. Assume you very own a little landscaping business. It is the finish of the year, December 31, 2018, and also you are reviewing your financials for the whole year. You view that you earned $120,000 this year in revenue and had actually prices for rent, electrical energy, cable, internet, gas, and also food that totaled $70,000.

You likewise testimonial the complying with information:

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The revenue summary account is an intermediary between profits and also expenses, and the Retained Wages account. It stores all of the cshedding information for earnings and prices, causing a “summary” of revenue or loss for the period. The balance in the Income Summary account amounts to the net earnings or loss for the period. This balance is then moved to the Retained Salaries account.

Income summary is a nonidentified account category. This implies that it is not an ascollection, liability, stockholders’ equity, revenue, or expense account. The account has a zero balance throughout the entire accounting period till the closing entries are prepared. Therefore, it will certainly not show up on any trial balances, including the adjusted trial balance, and also will certainly not appear on any of the financial statements.

You might be asking yourself, “is the Income Synopsis account even necessary?” Could we just cshed out earnings and also costs straight right into kept income and not have this added short-term account? We could perform this, but by having actually the Income Overview account, you obtain a balance for net earnings a 2nd time. This provides you the balance to compare to the revenue statement, and allows you to double examine that all earnings statement accounts are closed and also have correct quantities. If you put the earnings and also costs directly right into retained income, you will not view that inspect number. No issue which way you pick to cshed, the exact same final balance is in maintained income.


Following is a list of accounts. State whether each account is a long-term or short-term account.

rent expenseunearned revenueaccumulated depreciation, vehiclecommon stockfees revenuedividendsprephelp insuranceaccounts payable

Solution

A, E, and F are temporary; B, C, D, G, and also H are irreversible.


Journalizing and Posting Closing Entries

The eighth action in the accounting cycle is preparing cshedding entries, which has journalizing and posting the entries to the ledger.

Four entries happen throughout the closing procedure. The first enattempt closes revenue accounts to the Income Overview account. The second enattempt closes price accounts to the Income Summary account. The 3rd enattempt closes the Income Summary account to Retained Wages. The fourth entry closes the Dividends account to Retained Wages. The information required to prepare cshedding entries comes from the adjusted trial balance.

Let’s discover each entry in even more information using Printing Plus’s information from Analyzing and Recording Transactions and also The Adjustment Process as our instance. The Printing Plus changed trial balance for January 31, 2019, is presented in (Figure).


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The T-accounts after this closing entry would certainly look like the following.

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The T-accounts after this closing entry would look like the complying with.

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Why are these 2 numbers the same? The income statement summarizes your revenue, as does income summary. If both summarize your income in the very same duration, then they have to be equal. If they perform not match, then you have an error.

The 3rd enattempt requires Income Rundown to close to the Retained Salaries account. To acquire a zero balance in the Income Outline account, tright here are guidelines to take into consideration.

If the balance in Income Rundown prior to closing is a crmodify balance, you will delittle Income Rundown and also crmodify Retained Wages in the closing entry. This situation occurs once a company has a net earnings.If the balance in Income Summary before closing is a delittle bit balance, you will certainly credit Income Overview and also delittle bit Retained Salaries in the closing enattempt. This case occurs once a firm has actually a net loss.

Remember that net earnings will rise kept earnings, and also a net loss will certainly decrease retained income. The Retained Incomes account rises on the crmodify side and decreases on the debit side.

Printing Plus has actually a $4,665 credit balance in its Income Outline account before cshedding, so it will certainly delittle bit Income Rundown and credit Retained Earnings.

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Notice that the Income Overview account is currently zero and is ready for use in the following duration. The Retained Wages account balance is presently a credit of $4,665.

The fourth enattempt calls for Dividends to cshed to the Retained Earnings account. Remember from your previous studies that dividends are not prices, such as salaries phelp to your employees or staff. Instead, advertising and paying dividends is a method used by corporations to rerotate component of the revenues produced by the company to the owners of the company—in this situation, its shareholders.

If dividends were not asserted, closing entries would cease at this point. If dividends are claimed, to obtain a zero balance in the Dividends account, the enattempt will certainly present a crmodify to Dividends and a delittle to Retained Salaries. As you will certainly learn in Corporation Accounting, tbelow are 3 components to the declaration and also payment of dividends. The first component is the day of declaration, which creates the duty or licapability to pay the dividfinish. The second component is the day of record that determines that receives the dividends, and the 3rd component is the date of payment, which is the date that payments are made. Printing Plus has $100 of dividends with a delittle balance on the adjusted trial balance. The closing enattempt will credit Dividends and delittle Retained Incomes.

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Why was income summary not used in the dividends cshedding entry? Dividends are not an earnings statement account. Only earnings statement accounts assist us summarize earnings, so just earnings statement accounts have to go right into earnings summary.

Remember, dividends are a contra stockholders’ equity account. It is contra to kept income. If we pay out dividends, it means kept income decreases. Retained earnings decreases on the delittle side. The continuing to be balance in Retained Salaries is $4,565 ((Figure)). This is the same number found on the statement of kept earnings.


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The statement of kept income reflects the period-ending kept earnings after the closing entries have been posted. When you compare the retained revenue ledger (T-account) to the statement of maintained earnings, the figures should enhance. It is essential to understand kept income is not closed out, it is just updated. Retained Salaries is the only account that shows up in the cshedding entries that does not close. You should recall from your previous material that kept revenue are the revenue maintained by the company over time—not cash flow yet income. Now that we have actually closed the temporary accounts, let’s testimonial what the post-closing ledger (T-accounts) looks favor for Printing Plus.


T-Account Summary

The T-account summary for Printing Plus after cshedding entries are journalized is presented in (Figure).


Notice that earnings, expenses, dividends, and also income summary all have actually zero balances. Retained earnings maintains a $4,565 crmodify balance. The post-cshedding T-accounts will certainly be moved to the post-closing trial balance, which is action 9 in the audit cycle.

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A company has revenue of $48,000 and also full costs of $52,000. What would certainly the 3rd cshedding entry be? Why?


Key Concepts and Summary

Closing entries: Cshedding entries prepare a firm for the next period and zero out balance in momentary accounts.Purpose of closing entries: Closing entries are important because they help a firm evaluation revenue buildup in the time of a duration, and verify information figures found on the adjusted trial balance.Permanent accounts: Permanent accounts carry out not cshed and are accounts that move balances to the following duration. They encompass balance sheet accounts, such as assets, liabilities, and stockholder’s equityTemporary accounts: Temporary accounts are closed at the end of each accounting period and also encompass revenue statement, dividends, and revenue summary accounts.Income Summary: The Income Summary account is an intermediary between revenues and costs, and also the Retained Salaries account. It stores all the closing indevelopment for earnings and also costs, causing a “summary” of revenue or loss for the period.Recording cshedding entries: There are 4 closing entries; cshedding revenues to income summary, cshedding expenses to income summary, closing income summary to preserved revenue, and also close dividends to kept revenue.Posting cshedding entries: Once all cshedding entries are finish, the information is transferred to the general ledger T-accounts. Balances in momentary accounts will certainly display a zero balance.