PURPOSE OF CLOSING ENTRIESPURPOSE OF CLOSING ENTRIES

start over move the company’s net income for a time period to the OE section of the balance sheet

Start over measure expenses for a time period

Intuitively… if a company has $245 million net income, the equity of the company goes up by $245 million

CLOSING ACCOUNTS1. 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.

3. Accounts are closed every time period (quarterly, annually)

4. Accounting software does this for you!!!

ILLUSTRATION ILLUSTRATION 4-24-2 TEMPORARY VERSUS TEMPORARY VERSUS

PERMANENT ACCOUNTSPERMANENT ACCOUNTSTEMPORARY (NOMINAL) These accounts are closed

All revenue accounts

All expense accounts

Owner’s drawings (&dividends)

PERMANENT (REAL)These accounts are not closed

All asset accounts

All liability accounts

Owner’s capital account

(Balance Sheet Accounts)(Income Statement / Drawings Accounts)

ILLUSTRATION 4-3 DIAGRAM OF CLOSING PROCESS

(INDIVIDUAL) REVENUES

1

1 Debit each revenue account for its balance, and credit the owner’s capital account for total revenues.

2 Debit the owner’s capital account for total expenses, and credit each expense account for its balance.

(INDIVIDUAL)EXPENSES

Normal Dr. Balance

Normal Cr. BalanceCr. to close Dr. to close

- 0 - - 0 -

OWNER’SCAPITAL

Expenses RevenuesOpening Balance

2

ILLUSTRATION 4-3 DIAGRAM OF CLOSING PROCESS

3

3 Debit owner’s capital for the balance in the owner’s drawings account and credit owner’s drawings for the same amount.

OWNER’SDRAWINGS

Normal Dr. Balance

Cr. to close

- 0 -

OWNER’SCAPITAL

ExpensesRevenuesOpening Balance

Drawings

Ending Balance

Example: Journalize the closing entries if Bert’s Pigeon Service had Revenue of $5000, salary expenses of $2000 and supply expenses of $1500; Bert had drawings of $1000Journalize the closing entries for Bert’s Pigeon ServiceWhat was the Net income? What was the overall increase in OE?

Revenue 5000Capital Bert 5000

Capital, Bert 3500Salary 2000Supply exp. 1500

Capital, Bert 1000drawings 1000

Net Income: 5000 – 3500 = 1500Increase in OE: 5000 – 3500 – 1000 = $500

POST-CLOSING TRIAL BALANCEPOST-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.

Debit CreditCash 15,200$ Accounts Receivable 200 Advertising Supplies 1,000 Prepaid Insurance 550 Office Equipment 5,000 Accumulated Amortization 83$ Notes Payable 5,000 Accounts Payable 2,500 Unearned Revenue 800 Salaries Payable 1,200 Interest Payable 25 C.R. Byrd, Capital 12,342

21,950$ 21,950$

After Adjustment

Pioneer Advertising AgencyPost-Closing Trial Balance

October 31, 2002

ILLUSTRATION ILLUSTRATION 4-84-8 POST-CLOSING TRIAL BALANCEPOST-CLOSING TRIAL BALANCE

The post-closing trial balance is prepared from the permanent

accounts in the ledger.

The post-closing trial balance provides evidence that the journalizing and posting of closing entries

has been properly completed.

1. Analyse transactions 2. Journalize the

transactions

3. Post to ledger accounts

4. Prepare a trial balance

5. Journalize and post adjusting entries

6. Prepare adjusted trial

balance

7. Prepare financial

statements

8. Journalize and post

closing entries

9. Prepare post-closing trial balance

STEPS IN THE ACCOUNTING CYCLESTEPS IN THE ACCOUNTING CYCLE