Chapter 7 –Closing Entries

Bellringer:

•Solve the following formulas:1.10,000 – X = 02.40,000 – X = 0

What is the opposite of $10,000?What is the opposite of $40,000?

What is the opposite of Debit?What is the opposite of Credit?

Objectives – SWBAT:

•Explain the purposes of the closing process.

•Record closing entries.

STEP # 5 – Adjusted Trial Balance•A trial balance completed after the

adjusting entries have been made and posted to the appropriate accounts.

How does the periodicity concept affect the accounting cycle?•Accounting periods MUST be kept separate

For example, if we have a fiscal Calendar year as our accounting cycle…

January 1, 2010 – December 31, 2010 We would track and keep this separate

from…. January 1, 2011 – December 31, 2011

•We must prepare financial statements and closing entries.

How does the periodicity concept affect the accounting cycle?• What is a closing entry? This is step # 7 in Accounting

Cycle.▫ An entry prepared to close (zero-out) income statement accounts.

▫ Recall: Net income belongs to the owners.

▫ Closing entries transfers the balance in an income statement account to an account classified as owner’s equity.

• Corporation – Net income closes to Retained Earnings (Net income or “earnings” that have not been distributed to owners/shareholders)

• Sole Proprietorship or Partnership – Account balances are transferred to the Owner’s Capital accounts.

How does the periodicity concept affect the accounting cycle?•What is the formula for Net Income?

▫Revenue – Expenses = Net Income or Net Loss

•Revenues with a credit and Owner’s Equity

•Owner’s Equity is on the right side of the accounting equation: right side▫Assets = Liabilities + Owner’s Equity

•Therefore, Revenues have CREDIT BALANCES

How does the periodicity concept affect the accounting cycle?• We MUST ZERO-OUT these accounts and transfer

the balances to retained earnings or capital.• How do we do this?• If, Revenues have CREDIT BALANCES …

• AND we have a $175,000 “Sales” Credit balance…

• THEN what is the opposite of $175,000 Sales Credit?

• $175,000 Sales Debit

How does the periodicity concept affect the accounting cycle?

Date Description Debit Credit

1/31/10 Sales 175,000

Retained Earnings 175,000

To close out Sales account

Date Description Debit Credit Balance

1/17/10 175,000 175,000

1/31/10 175,000 0.00

Sales Account:

General Journal:

Date Description Debit Credit Balance

1/31/10 5,000 <5,000>

1/31/10 175,000 170,000

Retained Earnings

How does the periodicity concept affect the accounting cycle?•What is the formula for Net Income?

▫Revenue – Expenses = Net Income or Net Loss

•Expense with a debit and Owner’s Equity

•Owner’s Equity is on the right side of the accounting equation: right side▫Assets = Liabilities + Owner’s Equity

•Therefore, Expenses have DEBIT BALANCES

How does the periodicity concept affect the accounting cycle?• We MUST ZERO-OUT these accounts and

transfer the balances to retained earnings or capital.

• How do we do this?• If, Expenses have DEBIT BALANCES …

• AND we have a $100,000 Debit balance in Cost of Goods Sold …

• THEN what is the opposite of $100,000 Debit - Cost of Goods Sold?

• $100,000 Credit in Cost of Goods Sold

How does the periodicity concept affect the accounting cycle?Date Description Debit Credit

1/31/10 Retained Earnings 100,000

Cost of Goods Sold 100,000

To close out Cost of Goods Sold

Cost of Goods Sold Account:

Date Description Debit Credit Balance

1/17/10 100,000 100,000

1/31/10 100,000 0.00

How does the periodicity concept affect the accounting cycle?

•Now look at Page 199.•Look at the Expenses and total them up,

how much do you have?• 112,375•These expense accounts all have Debit

Balances, therefore we need to Credit each balance for all of these accounts and …….Debit $112,375 to ?????

How does the periodicity concept affect the accounting cycle?Date Description Debit Credit

1/31/10 Retained Earnings 112,375

Cost of Goods Sold 100,000

Salary Expense 5,000

Utilities Expense 1,500

Depreciation Expense 4,000

Interest Expense 1,875

Date Description Debit Credit Balance

1/17/10 100,000 100,000

1/31/10 100,000 0.00

Cost of Goods Sold:

General Journal:

Date Description Debit Credit Balance

1/15/10 5,000 5,000

1/31/10 5,000 0.00

Salary Expense:

Date Description Debit Credit

1/31/10 Retained Earnings 112,375.00

Cost of Goods Sold 100,000

Salary Expense 5,000.00

Utilities Expense 1,500.00

Utilities Expense:

Date Description Debit Credit Balance

1/16/10 1,500 1,500

1/31/10 1,500 0.00

General Journal:

Date Description Debit Credit Balance

1/31/10 4,000 4,000

1/31/10 4,000 0.00

Depreciation Expense:

Date Description Debit Credit

1/31/10 Retained Earnings 112,375

Cost of Goods Sold 100,000

Salary Expense 5,000

Utilities Expense 1,500

Depreciation Expense 4,000

Interest Expense 1,875

Interest Expense:

Date Description Debit Credit Balance

1/31/10 1,875 1,875

1/31/10 1,875 0.00

How does the periodicity concept affect the accounting cycle?• What is the Net income? Revenue – Expenses• $175,000 - $112,375 = $62,625.

• The difference between the in Retained Earnings of $175,000 due to closing the Revenue account and the in Retained Earnings of $112,375 due to closing the expense accounts is the ……

• $62,625 NET INCOME that belongs to the owners.

• Note: Revenues – Expenses = Net Income or LOSS!

How does the periodicity concept affect the accounting cycle?

Date Description Debit Credit Balance

1/31/10 Beginning Balance

<5,000>

1/31/10 175,000 170,000

1/31/10 112,375 62,625

Retained Earnings Account:

General Journal:

Date Description Debit Credit

1/31/10 Sales 175,000

Retained Earnings 175,000

To close out Sales account

How does the periodicity concept affect the accounting cycle?

Date Description Debit Credit

1/31/10 Retained Earnings 112,375

Cost of Goods Sold 100,000

Salary Expense 5,000

Utilities Expense 1,500

Depreciation Expense

4,000

Interest Expense 1,875

General Journal:

Retained Earnings Account:Date Description Debit Credit Balance

1/31/10 Beginning Balance

<5,000>

1/31/10 175,000 170,000

1/31/10 112,375

62,625

How does the periodicity concept affect the accounting cycle?

•IF you have a Withdrawal or Drawing account, you will need to ZERO-OUT this account too.

•Withdrawals with a debit and Owner’s Equity

•Owner’s Equity is on the right side of the accounting equation: right side▫Assets = Liabilities + Owner’s Equity

•Therefore, Withdrawals have DEBIT BALANCES

How does the periodicity concept affect the accounting cycle?Date Description Debit Credit

1/31/10 Retained Earnings 300

Drawing Account 300

To close out Cost of Goods Sold

Drawing Account:

Date Description Debit Credit Balance

1/31/10 300 300

1/31/10 300 0.00

WHAT HAPPENS AFTER CLOSING ENTRIES?•A POST – CLOSING TRIAL BALANCE IS

PREPARED

•WHY?

•TO ensure DEBITS = CREDITS to begin the new accounting period…

•This is STEP # 8