Chapter 10: Completing the Accounting Cycle for a Sole Proprietor Accounting I Ms. Alltucker.

Chapter 10: Completing the Accounting Cycle for a Sole Proprietor

Accounting I

Ms. Alltucker

Chapter Objectives

Explain why it is necessary to update accounts through closing entries.

Explain the purpose of the Income Summary account.

Explain the relationship between the Income Summary account and the capital account.

Analyze and journalize closing entries.

Post the closing entries to the general ledger.

Prepare a post-closing trial balance.

Define the accounting terms introduced in this chapter.

Section 1: Preparing Closing Entries

What you will learn: Why temporary capital accounts are closed at the end of the

fiscal year.

The purpose of the Income Summary account.

The relationship between the Income Summary account and the capital account.

How to analyze and journalize closing entries.

Why it’s important: Closing entries are made to prepare the financial records for

the next fiscal year.

Completing the Accounting Cycle

At the end of an accounting period, an accountant transfers the balances of the temporary accounts to the owner’s capital account to bring it up to date and to prepare the accounting records for the next period.

Temporary accounts: Revenue

Expenses

Withdrawals

8th Step: Journalizing the Closing Entries Closing Entries: journal entries made to close, or reduce

to zero, the balances in the temporary capital accounts and to transfer the net income or net loss for the period to the capital account

Purpose of Closing Process

In your worksheet you found net income or net loss

Net income or net loss is seen on the Income Statement

Changes in Owner’s Equity reflects the net income or net loss.

General ledger capital account balance does not equal the amount on the balance sheet. Look on page 234 for a visual aid

Income Summary account

Look on page 73 at the chart of accounts. What type of account is Income Summary?

The Income Summary Account

Which general ledger account have you seen that has not been used yet?

Income summary: used to accumulate and summarize the revenue and expenses for the period. Serves as a simple income statement in the ledger

Expenses: debit balances are transferred as debits to the income summary account as a debit

Revenue: credit balances are transferred as credits to Income Summary

Balance of Income Summary equals the net income or the net loss for the fiscal period.

The balance of Income Summary is transferred to the capital account at the end of the closing process.

Income Summary Used only at the end of the fiscal year to summarize the

balances from the revenue and expense accounts

Balance before and after the closing process is zero

Does not appear on any financial statement

Does not have a normal balance Does not have an increase or a decrease side

Income Summary

Debit Credit

Expenses Revenue

If Revenue > Expenses Balance is net income

If Revenue < Expenses Balance is net loss

Preparing Closing Entries

Four journal entries are prepared to close the temporary capital accounts

1. the balance of the revenue account is transferred to the credit side of the income summary account

2. The expense account balances are transferred to the debit side of the Income Summary account.

3. The balance of the Income Summary account is transferred to the capital account Net income to credit side

Net loss to debit side

4. The balance of the withdrawals account is transferred to the debit side of the capital account.

Closing the Balance of the Revenue Account to Income Summary

Balance of the revenue account is found in the Income Statement of the work sheet

1. Enter “Closing Entries” in the center of the description column.

2. Enter the date (last day of the fiscal period)

3. Enter the names of the accounts to be debited and the amounts to be debited.

4. Enter the name of the account, Income Summary, to be credit and the amount credited

Closing the Revenue account to Income Summary

JOURNAL ENTRY

First Closing Entry—Close Revenue to Income Summary

Closing the Expense accounts to Income Summary

Balances of the expense accounts are found in the income statement section of the worksheet

JOURNAL ENTRY

Second Closing Entry—Close Expenses to Income Summary

Closing the Income Summary Account to Capital

Income Summary

2650

1500

1150 New Balance

Closing entry for revenue

Closing entry for expenses

If Income Summary has a credit balance net profit

If Income Summary has a debit balance net loss

Closing the Income Summary Account to Capital

JOURNAL ENTRY 7.

Fourth Closing Entry—Close Withdrawals to Capital

Closing Withdrawals to Capital Withdrawals decrease owner’s equity

Balance of the withdrawals account is found in the Balance Sheet section of the work sheet

JOURNAL ENTRY 7.

Fourth Closing Entry—Close Withdrawals to Capital

Thinking Critically

Why are closing entries for revenue and expense accounts recorded?

What is the order in which you journalize closing entries?

What is the purpose of the Income Summary account?

Section 2:Posting Closing Entries and Preparing a Post-Closing Trial Balance

What you will learn: How to record closing entries in the general ledger.

The purpose of a post-closing trial balance.

How to prepare a post-closing trial balance.

Why it’s important: A post-closing trial balance verifies that the closing entries

are properly recorded in the general ledger and that you are ready to start the next accounting period.

Completing the Accounting Cycle

Post the closing entries to the general ledger accounts

Procedure is exactly the same as other general ledger postings, with ONE exception.

“Closing Entries” are written in the Description column of the general ledger account

Review: Posting to General Ledger Steps

1. Enter the date of the journal entry in the Date column

2. Description is usually left blank in general posting When doing closing entries write “Closing Entries”

3. Identify where the journal entry is recorded in post reference column—Example: G1

4. Enter the debit amount in the debit column

5. Compute and record the new account balance in the appropriate balance column

6. Return to journal and enter the ledger account number of the account you just posted

7. Repeat the same steps for the credit entry

Review: Posting to General Ledger Steps

Posting Closing Entries

Maria Sanchez, Capital 301

20Oct 1 25000 25000

2G1G1G3G3

3131

Closing EntryClosing Entry

400 25400265501150

500 26050

Income Summary Balance (credit): $1150Withdrawal balance: $500

You have to do this for every line in the general journal.

DO NOT FORGET TO PUT THE POST REFERENCE IN THE JOURNAL AFTERYOU HAVE POSTED.

The Ninth Step in the Accounting Cycle

Preparing a Post-Closing Trial Balance Prepared to make sure total debits equal total credits after

the closing entries are posted.

Only accounts with balances are listed on the post-closing trial balance

Only permanent accounts have balances

Temporary accounts have zero balances—no need to list them

Post-Closing Trial Balance

After the journal entries are posted to the accounts in the general ledger, the total of all the debit balances should equal the total of all the credit balances Proving the ledger

Debits = Credits

Prepared on a two-column accounting stationery

Post Closing Trial Balance

Thinking Critically

After the closing process, what types of accounts have balances other than zero, and what types of accounts have zero balances?

What is the purpose of the eighth and ninth steps in the accounting cycle?

What happens when your debits don’t equal credits in the post closing trial balance?