W7: Closing journal entries Flashcards
What’s the purpose of closing entry?
- To facilitate the preparetion of the financial statements
- To prepare the accounting records to begin the next period
How does closing entry facilitate and prepare for the next accouting period?
- Closing entries reset the income and expense account balances to 0 to begin recording these items for the next accouting period
- Clsoing entries only occur at the end of an accouting period
- Closing entries are recorded in the general journal and then posted to the genera ledger
Temporary accounts
- Relates only to a given accounting period
- Include: revenues, expenses, drawings/dividends
- Must be closed to set the account balance to 0 at the end of each accounting period (e.g. 1 year)
Permanent accounts
- Permanent accounts are carried forward to future accounting period
- Include: assets, liabilites, equity (capital, retained earnings)
What are closing entries?
- Closing entries are journal entries that effectively ‘close all’ temporary accounts to the permanent equity account (capital) at the end of the accouting period
Profit and Loss account
- A special temporary account
- Created to facilitate the closing process
- Income and Expense accounts then begin the next accounting period with a 0 balance
How to record closing entries?
- Close all Income Accounts ( 0 balance) to the P&L Summary account:
- Clsoe all Expense Accounts to the P&L Summary account:
- Sole trader - close P&L summary account to the Capital account; Company - close P&L summary account to the retained earnings account
- Sole trader - Close drawings account to the Capital account; Company (close Dividends account to the retained earnings account
Closing entries - Step 1
Close all Income Accounts to the P&L summary account:
* Since Income accoutns have a normal Cr balance –> Debit Income accounts when closing them
* Must close each individual income accounts
DR ( each individual) Income accounts
CR P&L Summary
Closing entries - Step 2
Close all Expense accounts to the P&L summary account:
* Since Expense accounts have a normal Debit balance –> Credit Expense accounts when closing
DR - P&L Summary
CR (each individual) - Expense accounts
Closing entries - Step 3 (Sole trader)
Close P&L Summary to the Owner’s Capital accounts
1. If the P&L Summary account has a CR balance (i.e. business made profit)
* DR - P&L Summary
* CR - Capital
2.If the P&L Summary account has a DR balance (i.e. business made loss)
* DR - Capital
* CR - P&L Summary
- Increase capital account is profit is madde
- Decrease capital account is a loss occurs
P&L Summary must be 0 after this step
Closing Entries - Step 3 (Company)
Close P&L Summary account to the Retained Earnings account:
1. If the P&L Summary account has a CR balance (i.e. company makes profit)
* DR - P&L Summary
* CR - Retained earnings
2. If the P&L Summary account has a DR balance (i.e. company makes loss)
* DR - retained earning
* CR = P&L Summary
- Increase retained earnings account if profit is made
- Decrease retained earnings account if loss occurs
P&L Summary account must be 0 after this step
Closing entries - Step 4 (Sole trader)
Close Drawings account to the Owner’s Capital account
* DR - Capital
* CR - Drawings
- Drawings is a temporary account
- Balance of drawings account mst be 0 after this step
Closing entries - Step 4 (Company)
Close Dividends account to the Retained earnings account
* DR - Retained earnings
* CR - Dividends
- Dividend is a temporary account
- Balance of dividend account must equal 0 after this step
How does closing entries affect the general ledgers?
- All income accounts have 0 balances
- All expense accounts have 0 balances
- The temporary P&L summary account has a 0 balance
- The drawings (dividends for a company) account has a 0 balance
What’s the purpose of post-closing trial balance
- To verify equality of Dr and Cr
- Confirms that only permanenet accounts have balances
