Acct 151A Week 7, Chap 6. Instructor: Michael Booth Cabrillo College

Acct 151A Week 7, Chap 6 Instructor: Michael Booth Cabrillo College

The Closing Process

The Accounting Cycle Step 1 Analyze transactions Step 2 Journalize the data about transactions Step 3 Post the data about transactions Step 4 Prepare a worksheet Step 5 Prepare financial statements Step 9 Interpret the financial information Step 8 Prepare a postclosing trial balance Step 7 Journalize and post closing entries Step 6 Journalize and post adjusting entries The seventh step in the accounting cycle is to journalize and post closing entries.

QUESTION: ANSWER: What are closing entries? Closing entries are journal entries that transfer the results of operations (net income or net loss) to owner s equity and reduce the revenue, expense, and drawing account balances to zero.

The Income Summary Account

QUESTION: What is the Income Summary account? ANSWER: The Income Summary account is a special owner s equity account that is used only in the closing process to summarize the results of operations.

Income Summary Account Classified as a temporary owner s equity account Does not have a normal balance Has a zero balance after the closing process and remains with a zero balance until after the closing procedure for the next period

Journalize and post closing entries. Steps in the Closing Process

There are four steps in the closing process: 1. Transfer the balance of the revenue account to the Income Summary account. 2. Transfer the expense account balances to the Income Summary account. 3. Transfer the balance of the Income Summary account to the owner s capital account. 4. Transfer the balance of the drawing account to the owner s capital account.

Step 1: Transfer Revenue Account Balances

ACCOUNT NAME TRIAL BALANCE ADJUSTMENTS ADJ. TRIAL BAL. DEBIT CREDIT DEBIT CREDIT DEBIT CREDIT Cash 111,350 Accounts Receivable 5,000 Supplies 1,500 (a) 500 Prepaid Rent 8,000 Equipment 11,000 Accum. Depr. Equip. Accounts Payable 3,500 Carolyn Wells, Cap. 100,000 Carolyn Wells, Draw. 5,000 Fees Income 47,000 Salaries Expense 8,000 Utilities Expense 650 Supplies Expense (a) 500 Rent Expense (b) 4,000 Depr. Exp. Equip. (c) 183 Totals 150,500 150,500 4,683 4,683 Net Income 111,350 5,000 1,000 (b) 4,000 4,000 (c) 183 11,000 183 3,500 100,000 5,000 47,000 8,000 650 500 4,000 183 150,683 150,683 It has a credit balance of $47,000. INCOME STMT. DEBIT CREDIT DEBIT 111,350 5,000 1,000 BALANCE SHEET 4,000 11,000 5,000 CREDIT 183 3,500 100,000 47,000 8,000 650 500 4,000 183 13,333 47,000 137,350 103,683 33,667 33,667 47,000 47,000 137,350 137,350

Step 1: Close Revenue The Fees Income account is closed to the Income Summary account.

Step 1: Close Revenue The revenue account, Fees Income, is decreased by $47,000 to zero. The $47,000 is transferred to the temporary owner s equity account, Income Summary.

Step 1: Close Revenue Revenue Account Income Summary Record decreases No normal balance

Step 1: Close Revenue Which account is debited? Which account is credited? For what amount? For what amount?

Step 1: Close Revenue Fees Income Income Summary Closing 47,000 Balance 47,000 Closing 47,000

Step 1: Close Revenue GENERAL JOURNAL PAGE 4 DATE DESCRIPTION POST. DEBIT CREDIT REF. 2010 Closing Entries Dec. 31 Fees Income 47,000 Income Summary 47,000 The words Closing Entries are written in the Description column of the general journal.

Step 2: Transfer Expense Account Balances

Step 2: Close Expenses The Income Statement section of the worksheet for lists five expense accounts. Since expense accounts have debit balances, enter a credit in each account to reduce its balance to zero. This closing entry transfers total expenses to the Income Summary account.

Step 2: Close Expenses The five expense account balances are reduced to zero. The total, $13,333 of expenses are transferred to the temporary owner s equity account, Income Summary.

Step 2: Close Expenses Income Summary Expense Accounts No normal balance Record decreases

Step 2: Close Expenses Which accounts are debited? Which accounts are credited? For what amounts? For what amounts?

Step 2: Close Expenses Closing 13,333 Income Summary BAL 47,000 Balance 8,000 Salaries Expense Closing 8,000 Utilities Expense Supplies Expense Balance 650 Balance 500 Closing 650 Closing 500 Rent Expense Depr. Expense Equip. Balance 4,000 Balance 183 Closing 4,000 Closing 183

Step 2: Close Expenses GENERAL JOURNAL PAGE 4 DATE DESCRIPTION POST. DEBIT CREDIT REF. 2010 Closing Entries Dec. 31 Income Summary 13,333.00 Salaries Expense 8,000.00 Utilities Expense 650.00 Supplies Expense 500.00 Rent Expense 4,000.00 Depreciation Exp.-Equip. 183.00

The Income Summary account reflects all entries in the Income Statement section of the worksheet. Income Summary Dr. Closing 13,333 Cr. Closing 47,000 Balance 33.667 Net Income

Step 3: Transfer Net Income or Net Loss to Owner s Equity

Step 3: Close Net Income to Capital The journal entry to transfer net income to owner s equity is a debit to Income Summary, and a credit to Owner s, Capital. The balance of Income Summary is reduced to zero; the owner s capital account is increased by the amount of net income.

Step 3: Close Net Income to Capital The Income Summary account is reduced to zero. The net income amount, $33,667, is transferred to the owner s capital account. Owner s, Capital is increased by $33,667.

Step 3: Close Net Income to Capital Which account is debited? Which account is credited? For what amount? For what amount?

Step 3: Close Net Income to Capital Closing 33,667 Income Summary Balance 33,667 Carolyn Well s, Capital Balance 100,000 Closing 33,667

Step 3: Close Net Income to Capital GENERAL JOURNAL PAGE 4 DATE DESCRIPTION POST. DEBIT CREDIT REF. Closing Entries Dec. 31 Income Summary 33,667.00 Carolyn Well s, Capital 33,667.00

Step 4: Transfer the Drawing Account Balance to Capital

Step 4: Close Drawing to Capital Withdrawals appear in the statement of owner s equity as a deduction from capital. The drawing account is closed directly to the capital account.

Step 4: Close Drawing to Capital The drawing account balance is reduced to zero. The balance of the drawing account, $5,000, is transferred to the owner s capital account.

Step 4: Close Drawing to Capital Which account is debited? Which accounts is credited? For what amount? For what amount?

Step 4: Close Drawing to Capital Carolyn Well s, Capital Carolyn Well s, Drawing Closing 5,000 Balance 133,667 Balance 5,000 Closing 5,000

Step 4: Close Drawing to Capital GENERAL JOURNAL PAGE 4 DATE DESCRIPTION POST. DEBIT CREDIT REF. Closing Entries Dec. 31 Carolyn Well s, Capital 5,000.00 Carolyn Well s, Drawing 5,000.00

The new balance of the Carolyn Well s, Capital account agrees with the amount listed on Owner s Equity Statement and the balance sheet. Carolyn Wells, Drawing Carolyn Wells, Capital Dr. Cr. Dr. Cr. Balance 5,000 Closing 5,000 Balance 100,000 Balance 0 Drawing 5,000 Net Inc. 33,667 Balance 128,667 Owner s, Capital

Summary of Closing Entries GENERAL JOURNAL PAGE 4 STEPS 1. CLOSE REVENUE 2. CLOSE EXPENSE ACCTS 3. CLOSE INCOME SUMMARY 4. CLOSE DRAWING ACCOUNT POST. DATE DESCRIPTION REF. DEBIT CREDIT 2010 Closing Entries Dec. 31 Fees Income 401 47,000.00 Income Summary 309 47,000.00 31 Income Summary 309 13,333.00 Salaries Expense 511 8,000.00 Utilities Expense 514 650.00 Supplies Expense 517 500.00 Rent Expense 520 4,500.00 Depr. Expense-Equip. 523 183.00 31 Income Summary 309 33,667.00 Carolyn Wells, Capital 301 33,667.00 31 Carolyn Wells, Capital 301 5,000.00 Carolyn Wells, Draw. 302 5,000.00

All journal entries are posted to the general ledger accounts.

Posting the Closing Entries Closing is entered in the Description column of the ledger accounts. The ending balances of the drawing, revenue, and expense accounts are zero.

Summary of Closing Entries STEPS GENERAL JOURNAL PAGE 4 POST. DATE DESCRIPTION REF. DEBIT CREDIT 2010 Closing Entries Dec. 31 Fees Income 401 47,000.00 Income Summary 309 47,000.00 1. CLOSE REVENUE ACCOUNT 2. CLOSE EXPENSE Fees Income ACCOUNT NO. 401 ACCOUNTS DATE DESCRIPTION REF. DEBIT CREDIT DEBIT CREDIT 31 Income Summary 309 13,333.00 Salaries POST. Expense 511 BALANCE 8,000.00 Utilities Expense 514 650.00 Supplies Expense 517 500.00 Rent Expense 520 4,500.00 Depr. Expense-Equip. 523 183.00 31 Income Summary 309 33,667.00 Carolyn Wells, Capital 301 33,667.00 2010 Dec. 31 J2 36,000.00 36,000.00 Dec. 31 J2 11,000.00 47,000.00 Dec. 3. CLOSE 31 Closing Entry J4 47,000.00-0- INCOME SUMMARY 4. CLOSE DRAWING ACCOUNT 31 Carolyn Wells, Capital 301 5,000.00 Carolyn Wells, Draw. 302 5,000.00

Summary of Closing Entries STEPS 1. CLOSE REVENUE GENERAL JOURNAL PAGE 4 POST. DATE DESCRIPTION REF. DEBIT CREDIT 2010 Closing Entries Dec. 31 Fees Income 401 47,000.00 Income Summary 309 47,000.00 31 Income Summary 309 13,333.00 Salaries Expense 511 8,000.00 Utilities Expense 514 650.00 Supplies POST. Expense 517 BALANCE 500.00 Rent Expense 520 4,500.00 Depr. Expense-Equip. 523 183.00 31 Income Summary 309 33,667.00 Carolyn Wells, Capital 301 33,667.00 2. CLOSE EXPENSE ACCOUNT ACCOUNTS Income Summary ACCOUNT NO. 309 DATE DESCRIPTION REF. DEBIT CREDIT DEBIT CREDIT 2010 Dec. 3. CLOSE 31 Closing INCOME J4 47,000.00 47,000.00 SUMMARY 4. CLOSE DRAWING ACCOUNT 31 Carolyn Wells, Capital 301 5,000.00 Carolyn Wells, Draw. 302 5,000.00

McGraw-Hill Using Accounting Information Objectives: 1. Prepare a postclosing trial balance. 2. Interpret financial statements. 3. Review the steps in the accounting cycle.

Preparing the Postclosing Trial Balance

The Accounting Cycle The last two steps of the accounting cycle. Post Closing Trial Balance Interpret Financial Information

Prepare a postclosing trial balance.

QUESTION: What is a postclosing trial balance? ANSWER: A postclosing trial balance is a statement that is prepared to prove the equality of total debits and credits after the closing process is completed.

The Postclosing Trial Balance Proves that total debits equal total credits Verifies that revenue, expense, and drawing accounts have zero balances

Only permanent accounts appear on the postclosing trial balance. Assets Liabilities Owner s equity

Postclosing Trial Balance Well s Consulting Services Postclosing Trial Balance December 31, 2010 ACCOUNT NAME DEBIT CREDIT Cash 111,350.00 Accounts Receivable 5,000.00 Supplies 1,000.00 Prepaid Rent 4,000.00 Equipment 11,000.00 Accumulated Depreciation Equipment 183.00 Accounts Payable 3,500.00 Carolyn Well s, Capital 128,667.00 Totals 132,350.00 132,350.00

Finding and Correcting Errors

If the postclosing trial balance does not balance, the accounting records contain errors. Use the audit trail to trace data through the accounting records.

McGraw-Hill 2007 The McGraw-Hill Companies, Inc. All rights reserved. Using Accounting Information Objectives 1. Prepare a postclosing trial balance. 2. Interpret financial statements. 3. Review the steps in the accounting cycle.

Interpreting the Financial Statements

Interpret financial statements.

QUESTION: What is meant by interpreting financial statements? ANSWER: To interpret means to understand and explain the meaning and importance of something.

Financial statements provide answers. What is the cash balance? How much do customers owe the business? How much does the business owe suppliers? What is the profit or loss?

Lets Analyze the financial statements for Carloyn Well s Consulting Services at the end of the accounting period.

What is the cash balance?

Wells Consulting Services Partial Balance Sheet December 31, 2010 Assets Cash $111,350.00 Accounts Receivable 5,000.00 Supplies 1,000.00 Prepaid Rent 4,000.00 Equipment $ 11,000.00 Less Accumulated Depreciation 183.00 10,817.00 Total Assets $ 132,167.00 What is the cash balance? How much do the customers owe the business?

How much does the business owe suppliers?

Wells Consulting Services Balance Sheet December 31, 2010 Assets Cash $111,350.00 Accounts Receivable 5,000.00 Supplies 1,000.00 Prepaid Rent 4,000.00 Equipment $ 11,000.00 Less Accumulated Depreciation 183.00 10,817.00 Total Assets $ 132,167.00 Liabilities and Owner s Equity Liabilities Accounts Payable $3,500.00 Owner s Equity Carolyn Wells, Capital 128,667.00 Total Liabilities and Owner s Equity $132,167.00 How much does the business owe its suppliers?

What is the profit or loss?

Prepare financial statements from the worksheet Revenue Wells Consulting Services Income Statement Month Ended December 31, 2010 Fees Income $47,000 Expenses Salaries Expense $8,000 Utilities 650 Supplies Expense 500 Rent Expense 4,000 Depreciation Expense - Equipment 183 Total Expenses $13,333 Net Income for the Month $33,667

McGraw-Hill 2007 The McGraw-Hill Companies, Inc. All rights reserved. Using Accounting Information Section Objectives 1. Prepare a postclosing trial balance. 2. Interpret financial statements. 3. Review the steps in the accounting cycle.

The Accounting Cycle

The Accounting Cycle Step 1 Analyze transactions Analyze the source documents. Sales slips Purchase invoices Credit memorandums Check stubs

The Accounting Cycle Step 1 Analyze transactions Step 2 Journalize the data about transactions Record the effects of the transactions in a journal.

The Accounting Cycle Step 1 Analyze transactions Step 2 Journalize the data about transactions Step 3 Post the data about transactions Transfer data from the journal to the general ledger accounts.

The Accounting Cycle Step 1 Analyze transactions Step 2 Journalize the data about transactions Step 3 Post the data about transactions Step 4 Prepare a worksheet Prepare a worksheet with five sections. Trial Balance Adjustments Adjusted Trial Balance Income Statement Balance Sheet

The Accounting Cycle Step 1 Analyze transactions Step 2 Journalize the data about transactions Step 3 Post the data about transactions Prepare financial statements. Income Statement Statement of Owner s Equity Balance Sheet Step 4 Prepare a worksheet Step 5 Prepare financial statements

The Accounting Cycle Step 1 Analyze transactions Step 2 Journalize the data about transactions Step 3 Post the data about transactions Step 4 Prepare a worksheet The adjusting entries are a permanent record of the changes in account balances shown on the worksheet. Step 5 Prepare financial statements Step 6 Journalize and post adjusting entries

The Accounting Cycle Step 1 Analyze transactions Step 2 Journalize the data about transactions Step 3 Post the data about transactions Step 4 Prepare a worksheet Transfer net income or net loss to owner s equity. Reduce the balances of the temporary accounts to zero. Step 7 Journalize and post closing entries Step 5 Prepare financial statements Step 6 Journalize and post adjusting entries

The Accounting Cycle Step 1 Analyze transactions Step 2 Journalize the data about transactions Step 3 Post the data about transactions Step 4 Prepare a worksheet Confirm that the general ledger is in balance. Confirm that the revenue, expense, and drawing accounts have zero balances. Step 5 Prepare financial statements Step 8 Prepare a postclosing trial balance Step 7 Journalize and post closing entries Step 6 Journalize and post adjusting entries

The Accounting Cycle Step 1 Analyze transactions Step 2 Journalize the data about transactions Step 3 Post the data about transactions Step 4 Prepare a worksheet Use financial statements to understand and communicate the financial information and to make decisions. Step 5 Prepare financial statements Step 9 Interpret the financial information Step 8 Prepare a postclosing trial balance Step 7 Journalize and post closing entries Step 6 Journalize and post adjusting entries

Flow of Data Through a Simple Accounting System Source Documents documents General journal General ledger Worksheet Financial statements Source documents are analyzed.

Flow of Data Through a Simple Accounting System Source documents General journal General ledger Worksheet Financial statements Transactions are recorded in the general journal.

Flow of Data Through a Simple Accounting System Source documents General journal General ledger Worksheet Financial statements Transactions are posted from the general journal to the general ledger.

Flow of Data Through a Simple Accounting System Source documents General journal General ledger Worksheet Financial statements Financial information is proved, adjusted, and summarized on the worksheet.

Flow of Data Through a Simple Accounting System Source documents General journal General ledger Worksheet Financial statements Financial information is reported on financial statements.

SECTION R E V I E W Complete the following sentences: A postclosing trial balance is a statement to prove the equalityof total debits and credits. Only the permanent accounts appear on the postclosing trial balance. Preparing a postclosing trial balance is the eighth step of the accounting cycle.

SECTION R E V I E W Complete the following sentences: The ninth step of the accounting cycle is interpreting the financial statements. The flow of data through an accounting system begins with a(n). source document The financial statement that reports the same items as the postclosing trial balance is the. balance sheet

SECTION R E V I E W Complete the following sentences: Closing entries transfer the results of operations to owner s equity and reduce the revenue, expense, and drawing account balances to zero. The Income Summary account is classified as a(n) temporary owner s equity account. The first step in the closing process is to transfer revenue account balances.

SECTION R E V I E W Complete the following sentences: The ledger is called the record of final entrybecause it is the last place where accounting transactions are recorded. Posting is the process of transferring data from a journal to a ledger. The general ledger is the master reference file for the accounting system.

SECTION R E V I E W Complete the following sentences: The first three steps of the accounting cycle are to, analyze, journalize and post transactions. Posting references are an important part of the audit trail. A correcting entry is a journal entry made to correct an erroneous entry.

SECTION R E V I E W Complete the following sentences: A journal is a diary of business activities. The journal is sometimes called the record of original entry because it is where transactions are first entered in the accounting records. The general journal is a financial record for entering all types of business transactions.

SECTION R E V I E W Complete the following sentences: Journalizing is the process of recording transactions in the general journal. The audit trail is a chain of references that makes it possible to trace information, locate errors, and prevent fraud. A journal entry that contains more than one debit or credit is called compound a. entry

SECTION R E V I E W Complete the following sentences: The journal entry to close the drawing account is debit Capitaland credit. Drawing After the closing entries are posted, the Income Summary account has a(n) zero balance. After the closing entries are posted, all temporary accounts have zero balances.

Assignments: See web: http//www.cabrillo.edu/~mbooth This will be updated weekly as required Note: Use McGrawHill HOMEWORK manager to submit assignments