PURPOSE OF CLOSING ENTRIESPURPOSE OF CLOSING ENTRIESPURPOSE OF CLOSING ENTRIESPURPOSE 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.

ILLUSTRATION ILLUSTRATION 4-24-2 TEMPORARY VERSUS TEMPORARY VERSUS

PERMANENT ACCOUNTSPERMANENT ACCOUNTS

ILLUSTRATION ILLUSTRATION 4-24-2 TEMPORARY VERSUS TEMPORARY VERSUS

PERMANENT ACCOUNTSPERMANENT ACCOUNTSTEMPORARY (NOMINAL) PERMANENT (REAL) These accounts are closed These accounts are not closed

All revenue accounts All asset accounts

All expense accounts All liability accounts

Owner’s drawings Owner’s capital account

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

ILLUSTRATION 4-3 DIAGRAM OF CLOSING PROCESS

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.

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. Balance

Cr. to close Dr. to close

- 0 - - 0 -

OWNER’SCAPITAL

Expenses Revenues

Opening Balance

2

ILLUSTRATION 4-3 DIAGRAM OF CLOSING PROCESS

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.

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

Expenses

Revenues

Opening BalanceDrawings

Ending Balance

CLOSING ENTRIESCLOSING ENTRIESCLOSING ENTRIESCLOSING 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 BALANCEPOST-CLOSING TRIAL BALANCEPOST-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

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 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.

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

has been properly completed.

A reversing entry is made at the beginning of the next accounting period.

A reversing entry reverses certain adjusting entries made in the previous period. Opening balances can then be ignored when preparing year-end adjusting entries.

This topic is illustrated in Appendix 4A.

REVERSING ENTRIES REVERSING ENTRIES (OPTIONAL STEP)(OPTIONAL STEP)

REVERSING ENTRIES REVERSING ENTRIES (OPTIONAL STEP)(OPTIONAL STEP)

CORRECTING ENTRIESCORRECTING ENTRIESCORRECTING ENTRIESCORRECTING ENTRIES

Errors that occur in recording transactions should be corrected as soon as they are discovered by preparing correcting entries.

Correcting entries are unnecessary if the records are free of errors; they can be journalized and posted whenever an error is discovered.

They involve any combination of balance sheet and income statement accounts.

ILLUSTRATION ILLUSTRATION 4-104-10 STANDARD BALANCE SHEET STANDARD BALANCE SHEET

CLASSIFICATIONSCLASSIFICATIONS

ILLUSTRATION ILLUSTRATION 4-104-10 STANDARD BALANCE SHEET STANDARD BALANCE SHEET

CLASSIFICATIONSCLASSIFICATIONS

Assets Liabilities and Equity

Financial statements become more useful when the elements are classified into significant subgroups.

A classified balance sheet generally has the following standard classifications:

Current Assets Current Liabilities

Long-Term Investments Long-Term Liabilities

Capital Assets Owner’s/ Partners’/ Shareholders’ Equity

Current assets are cash and other resources that are reasonably expected to be realized in cash or sold or consumed in the business within one year of the balance sheet date or the company’s operating cycle, whichever is longer.

Listed in the order of liquidity. Examples of current assets are cash,

temporary investments, accounts receivable, inventory, and prepaids.

CURRENT ASSETSCURRENT ASSETSCURRENT ASSETSCURRENT ASSETS

100XYZ shares

LONG-TERM LONG-TERM INVESTMENTSINVESTMENTSLONG-TERM LONG-TERM

INVESTMENTSINVESTMENTS

Long-term investments are resources that can be realized in cash, but the conversion into cash is not expected within one year or the operating cycle, whichever is longer.

Examples include investments in shares or bonds of another company or investment in land held for resale.

CAPITAL ASSETSCAPITAL ASSETSCAPITAL ASSETSCAPITAL ASSETS

Tangible resources of a relatively permanent nature that are used in the business and not intended for sale are classified as (1) property, plant, and equipment and (2) natural resources.(1) Examples of property, plant, and equipment include land,

buildings, and machinery.(2) Examples of natural resources include tracts of timber, oil

and gas reserves, and mineral deposits.

Intangible assets are noncurrent resources that do not have physical substance.

Examples include patents, copyrights, trademarks, or trade names that give the holder exclusive right of use for a specified period of time.

CAPITAL ASSETSCAPITAL ASSETSCAPITAL ASSETSCAPITAL ASSETS

Current liabilities are obligations that are reasonably expected to be paid from existing current assets or through the creation of other current liabilities within one year or the operating cycle, whichever is longer.

Examples include accounts payable, unearned revenue, interest payable, and current maturities of long-term debt.

CURRENT LIABILITIESCURRENT LIABILITIESCURRENT LIABILITIESCURRENT LIABILITIES

Obligations expected to be paid after one year are classified as long-term liabilities.

Examples include long-term notes payable, bonds payable, mortgages payable, and lease liabilities.

LONG-TERM LIABILITIESLONG-TERM LIABILITIESLONG-TERM LIABILITIESLONG-TERM LIABILITIES

The content of the equity section varies with the form of business organization.

In a proprietorship, there is a single owner’s equity account called (Owner’s Name), Capital.

In a partnership, there are separate capital accounts for each partner.

For a corporation, owners’ equity is called shareholders’ equity, and it consists of two accounts: Share Capital and Retained Earnings.

EQUITYEQUITYEQUITYEQUITY

Current Assets Cash 15,200$ Accounts Receivable 200 Advertising Supplies 1,000 Prepaid Insurance 550

Total Current Assets 16,950 Capital Assets

Office Equipment 5,000$ Less: Accumulated Amortization 83 4,917

Total Assets 21,867$

Current Liabilities Notes Payable 1,000$ Accounts Payable 2,500 Unearned Revenue 800 Salaries Payable 1,200 Interest Payable 25

Total Current Liabilities 5,525 Long-term Liabilties

Notes Payable 4,000 Total Liabilities 9,525

Owner's Equity C.R. Byrd, Capital 12,342

Total Liabilities and Owner's Equity 21,867$

Pioneer Advertising AgencyBalance Sheet

Liabilities and Owner's Equity

October 31, 2002Assets

ILLUSTRATION ILLUSTRATION 4-174-17 CLASSIFIED BALANCE SHEET IN REPORT FORMCLASSIFIED BALANCE SHEET IN REPORT FORM

ILLUSTRATION ILLUSTRATION 4-174-17 CLASSIFIED BALANCE SHEET IN REPORT FORMCLASSIFIED BALANCE SHEET IN REPORT FORM

A classified balance sheet helps the financial statement user determine:• The availability of assets to meet debts as they come due, and •The claims of short- and long-term creditors on total assets.

A classified balance sheet helps the financial statement user determine:• The availability of assets to meet debts as they come due, and •The claims of short- and long-term creditors on total assets.

The balance sheet is most often presented in the report form, with the assets shown above the liabilities and owner’s equity.

The balance sheet is most often presented in the report form, with the assets shown above the liabilities and owner’s equity.

LIQUIDITYLIQUIDITY

Liquidity measures ability to pay short-term obligations when they come due.

Working capital is one important measure of liquidity.

WORKING CAPITAL = CURRENT ASSETS - CURRENT LIABILITIES

CURRENT RATIOCURRENT RATIO

The current ratio (working capital ratio) is a widely used measure for evaluating a company’s liquidity and short-term debt-paying ability. It is calculated by dividing current assets by current liabilities and is a more dependable indicator of liquidity than working capital.

CURRENT ASSETS CURRENT RATIO = ———————————

CURRENT LIABILITIES