Chapter 4: Closing the books Flashcards
Closing Process Purpose
Purpose: The closing process is the final step in the accounting cycle.
Objective: It marks the end of the current period and the beginning of the next period.
Permanent (Real) Accounts
Definition: Accounts like assets, liabilities, and shareholders’ equity.
Characteristics: Their ending balances become the beginning balances for the next period.
Note: Permanent accounts are not reduced to zero except when the item they represent is no longer owned or owed.
Temporary (Nominal) Accounts
Definition: Accounts like revenue, expense, gain, loss, and dividends declared.
Purpose: They accumulate transaction effects for the current accounting period only.
Characteristic: Their balances start at zero at the beginning of the year and change throughout the year.
Closing Entries
Purpose: To transfer balances in temporary accounts to retained earnings.
Objective: To establish a zero balance in temporary accounts for the next accounting period.
Process: Closing entries are recorded and effects are posted to appropriate accounts.
Closing Process Entries
Entries Required: Three journal entries are needed for the closing process.
First Entry: Close revenue and gain accounts by debiting each account and crediting the total to Income Summary.
Second Entry: Close expense and loss accounts by crediting each account and debiting the total to Income Summary.
Third Entry: Close dividends declared account.
Income Summary: Temporary account used for closing temporary accounts.
Closing Revenue and Gain Accounts
Accounts Closed: Revenue and gain accounts (credit balances).
Closing Entry: Debit each account for its balance; credit the total amount to Income Summary.
Closing Expense and Loss Accounts
Accounts Closed: Expense and loss accounts (debit balances).
Closing Entry: Credit each account for its balance; debit the total amount to Income Summary.
Closing Income Summary Account
Purpose: Reflects net earnings (loss) and is closed to the retained earnings account.
Process: Balance of Income Summary is transferred to retained earnings after closing revenue, gain, expense, and loss accounts.
Closing Entries Procedure
Date: Closing entries are dated the last day of the accounting period.
Recording: Entered in the usual journal format and immediately posted to the ledger or T-accounts.
Practical Note: Most companies use computerized accounting applications for closing entries and financial statements.
Computerized Accounting Applications
Common Usage: Most companies use computerized accounting applications, from desktop to cloud-based packages.
Example: QuickBooks is a popular software package for small- and medium-sized businesses.
Functionality: Helps record journal entries, produce trial balances, financial statements, and close the books efficiently.
Post-Closing Trial Balance
Purpose: Prepared after the closing process is complete.
Status of Statement of Earnings Accounts: All statement of earnings accounts have a zero balance after closing.
Function: Accounts are ready for new period transactions, including revenues and expenses.
Retained Earnings: Ending balance matches the statement of financial position, becomes the beginning balance for the next period.
Purpose of Post-Closing Trial Balance
Verification: Ensures debits equal credits.
Confirmation: Confirms that all temporary accounts have been closed.
End of Accounting Cycle: Prepared as the last step in the accounting cycle.
Accounting Standards for Private Enterprises
Application: The concepts and procedures related to adjusting and closing accounts apply to private enterprises.
Uniformity: Standard practices are equally applicable to private businesses in the closing and post-closing processes.
