25 Describe and Prepare Closing Entries for a Business

In this chapter, we finish the last measures (procedures 8 and also 9) of the bookkeeping cycle, the cshedding procedure. You will alert that we execute not cover action 10, reversing entries. This is an optional step in the audit cycle that you will certainly learn around in future courses. Steps 1 through 4 were covered in Assessing and also Recording Transactions and Steps 5 with 7 were spanned in The Adjustment Process.

You are watching: Which of the following accounts are permanent (real) accounts?

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Should You Compromise to Please Your Supervisor?
You are an accountant for a small event-planning service. The organization has actually been operating for several years however does not have the resources for bookkeeping software. This means you are preparing all procedures in the accounting cycle by hand also.

It is the end of the month, and also you have actually completed the post-cshedding trial balance. You notice that tright here is still a business revenue account balance listed on this trial balance. Why is it taken into consideration an error to have a revenue account on the post-cshedding trial balance? How do you fix this error?


Summary to the Closing Entries

Companies are compelled to close their publications at the finish of each fiscal year so that they deserve to prepare their annual financial statements and also tax returns. However before, a lot of companies prepare monthly financial statements and also close their publications every year, so they have a clear picture of company performance during the year, and give individuals timely information to make decisions.

Closing entries prepare a firm for the following accounting duration by clearing any type of exceptional balances in certain accounts that should not carry over to the following duration. Closing, or clearing the balances, means returning the account to a zero balance. Having a zero balance in these accounts is vital so a agency deserve to compare performance throughout periods, particularly through earnings. It also helps the agency store thoturbulent documents of account balances affecting maintained earnings. Revenue, cost, and dividend accounts influence maintained income and are closed so they can accumulate new balances in the following period, which is an application of the time period presumption.

To better clarify this idea, balances are closed to ascertain all earnings and also costs are videotaped in the appropriate period and then start over the following duration. The revenue and also price accounts need to begin at zero each period, because we are measuring exactly how much revenue is earned and prices incurred throughout the period. However, the cash balances, and the various other balance sheet accounts, are lugged over from the end of a existing duration to the start of the following period.

For example, a save has actually an inventory account balance of $100,000. If the keep 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 lug over right into the next period, in this case February 2019.

The accounts that have to begin through a clean or $0 balance going right into the next audit period are revenue, revenue, and any type of dividends from January 2019. To identify the earnings (profit or loss) from the month of January, the store needs to close the income statement indevelopment from January 2019. Zeroing January 2019 would certainly then enable the save to calculate the revenue (profit or loss) for the next month (February 2019), instead of merging it right into January’s revenue and for this reason providing invalid indevelopment exclusively for the month of February.

However, if the agency likewise wanted to store year-to-day information from month to month, a separate collection of records could be maintained as the firm progresses with the remaining months in the year. For our objectives, assume that we are closing the publications at the end of each month unmuch less otherwise detailed.

Let’s look at another example to highlight the suggest. Assume you own a tiny landscaping company. It is the end of the year, December 31, 2018, and also you are reviewing your financials for the whole year. You see that you earned $120,000 this year in revenue and had actually prices for rent, electrical power, cable, internet, gas, and food that totaled $70,000.

You likewise review the following information:

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The income summary account is an intermediary in between profits and also expenses, and the Retained Incomes account. It stores all of the closing indevelopment for profits and costs, bring about a “summary” of revenue or loss for the duration. The balance in the Income Summary account equals the net earnings or loss for the duration. This balance is then moved to the Retained Earnings account.

Income summary is a noncharacterized account category. This suggests that it is not an ascollection, licapacity, stockholders’ equity, revenue, or expense account. The account has a zero balance throughout the entire audit duration until the cshedding entries are prepared. Therefore, it will certainly not appear on any kind of trial balances, including the readjusted trial balance, and will not show up on any kind of of the financial statements.

You could be asking yourself, “is the Income Synopsis account even necessary?” Could we just close out revenues and prices straight right into preserved revenue and also not have actually this extra temporary account? We can perform this, however by having the Income Synopsis account, you gain a balance for net revenue a 2nd time. This provides you the balance to compare to the income statement, and permits you to double inspect that all income statement accounts are closed and have correct amounts. If you put the profits and also expenses straight right into maintained revenue, you will certainly not check out that examine figure. No matter which method you select to cshed, the same final balance is in kept revenue.


Following is a list of accounts. State whether each account is a irreversible or short-lived account.

rent expenseunearned revenuebuilt up depreciation, vehiclecommon stockfees revenuedividendsprepaid insuranceaccounts payable

Solution

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


Journalizing and Posting Cshedding Entries

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

Four entries occur in the time of the cshedding process. The first entry closes revenue accounts to the Income Rundown account. The second enattempt closes price accounts to the Income Summary account. The third enattempt closes the Income Overview account to Retained Incomes. The fourth entry closes the Dividends account to Retained Incomes. The indevelopment required to prepare cshedding entries comes from the readjusted trial balance.

Let’s check out each enattempt in even more information utilizing Printing Plus’s information from Assessing and Recording Transactions and also The Adjustment Process as our instance. The Printing Plus adjusted trial balance for January 31, 2019, is presented in (Figure).


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

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The T-accounts after this closing enattempt would certainly look prefer the complying with.

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Why are these 2 numbers the same? The income statement summarizes your income, as does earnings summary. If both summarize your earnings in the exact same duration, then they must be equal. If they carry out not complement, then you have actually an error.

The 3rd enattempt requires Income Outline to close to the Retained Earnings account. To gain a zero balance in the Income Overview account, there are guidelines to consider.

If the balance in Income Synopsis prior to closing is a credit balance, you will delittle Income Overview and crmodify Retained Earnings in the closing enattempt. This instance occurs as soon as a company has actually a net earnings.If the balance in Income Synopsis before cshedding is a delittle balance, you will credit Income Overview and also delittle Retained Incomes in the closing entry. This instance occurs as soon as a agency has actually a net loss.

Remember that net revenue will rise retained income, and also a net loss will decrease retained revenue. The Retained Salaries account boosts on the credit side and also decreases on the debit side.

Printing Plus has a $4,665 crmodify balance in its Income Overview account prior to closing, so it will delittle bit Income Summary and credit Retained Wages.

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Notice that the Income Synopsis account is currently zero and is ready for usage in the following period. The Retained Earnings account balance is presently a credit of $4,665.

The fourth enattempt requires Dividends to cshed to the Retained Wages account. Remember from your previous researches that dividends are not expenses, such as salaries passist to your employees or staff. Instead, declaring and also paying dividends is a method made use of by corporations to rerevolve component of the revenues created by the company to the owners of the company—in this case, its shareholders.

If dividends were not declared, cshedding entries would cease at this suggest. If dividends are declared, to obtain a zero balance in the Dividends account, the enattempt will certainly show a credit to Dividends and also a delittle to Retained Salaries. As you will certainly learn in Corporation Accounting, tright here are 3 components to the declaration and also payment of dividends. The initially part is the date of declaration, which creates the duty or liability to pay the dividend. The second component is the day of document that determines that receives the dividends, and also the third part is the day of payment, which is the date that payments are made. Printing Plus has $100 of dividends through a debit balance on the changed trial balance. The cshedding enattempt will certainly credit Dividends and delittle bit Retained Earnings.

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Why was income summary not offered in the dividends closing entry? Dividends are not an income statement account. Only earnings statement accounts aid us summarize income, so only earnings statement accounts should go into earnings summary.

Remember, dividends are a contra stockholders’ equity account. It is contra to retained income. If we pay out dividends, it indicates retained income decreases. Retained revenue decreases on the delittle bit side. The remaining balance in Retained Earnings is $4,565 ((Figure)). This is the very same figure discovered on the statement of maintained revenue.


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The statement of retained earnings shows the period-ending retained revenue after the closing entries have actually been posted. When you compare the maintained earnings ledger (T-account) to the statement of kept earnings, the numbers need to match. It is crucial to understand kept revenue is not closed out, it is only updated. Retained Salaries is the only account that appears in the cshedding entries that does not cshed. You have to recall from your previous material that kept income are the earnings kept by the agency over time—not cash circulation however revenue. Now that we have closed the momentary accounts, let’s testimonial what the post-cshedding ledger (T-accounts) looks prefer for Printing Plus.


T-Account Summary

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


Notice that earnings, costs, dividends, and revenue summary all have actually zero balances. Retained income maintains a $4,565 credit balance. The post-cshedding T-accounts will certainly be transferred to the post-closing trial balance, which is step 9 in the accounting cycle.

See more: What Is The Difference Between Oxidation And Reduction Is That


A firm has actually revenue of $48,000 and total prices of $52,000. What would certainly the third cshedding entry be? Why?


Key Concepts and also Summary

Closing entries: Cshedding entries prepare a agency for the following duration and zero out balance in temporary accounts.Purpose of closing entries: Cshedding entries are vital bereason they help a firm review earnings buildup throughout a period, and also verify data figures found on the readjusted trial balance.Permanent accounts: Permanent accounts carry out not cshed and are accounts that deliver balances to the following period. They encompass balance sheet accounts, such as assets, liabilities, and stockholder’s equityTemporary accounts: Temporary accounts are closed at the end of each bookkeeping duration and also include revenue statement, dividends, and also earnings summary accounts.Income Summary: The Income Summary account is an intermediary between profits and prices, and also the Retained Incomes account. It stores all the cshedding indevelopment for profits and prices, resulting in a “summary” of earnings or loss for the period.Recording closing entries: Tbelow are 4 cshedding entries; closing revenues to income summary, cshedding expenses to earnings summary, closing revenue summary to preserved revenue, and cshed dividends to retained revenue.Posting cshedding entries: Once all closing entries are complete, the indevelopment is moved to the basic ledger T-accounts. Balances in short-lived accounts will certainly show a zero balance.