Project 3

Project 3: Closing Entries

 

What Do I Need to Know?

 

Closing an account means transferring any balance in that account and leaving the account with a zero balance. 

 

Temporary capital accounts are closed at the end of each fiscal period and reopened again at the beginning of the next fiscal period. The permanent capital is also updated to include changes made because of net income, net loss, and drawing for the fiscal period.

 

Permanent and Temporary Capital Accounts

 

As mentioned in Project 2, Training Room 1, temporary capital accounts are accounts that are opened at the beginning of the fiscal period and closed at the end (i.e., revenue and expense accounts that appear on the income statement). The permanent accounts are accounts that have balances that continue on from one fiscal period to the next. The permanent accounts are the balance sheet accounts; the temporary accounts are the income statement accounts.

 

 

 

Drawing is one exception to the rule. Although drawing is considered a balance sheet account, it is also called a contra-asset account, which means that it takes away from assets. Drawing is a temporary capital account because it is closed at the end of each fiscal period.

 

The following is a list of accounts. Go to Permanent and Temporary Capital Accounts. Identify the temporary accounts by dragging them into the bucket.

 

Income Summary Account

 

During the closing process, it is necessary to collect all the revenue amounts and all the expense amounts in one account. This account is called the income summary account. This is a temporary account that appears in the owner’s equity section of the company’s chart of accounts.

 

 

The income summary account is used only for closing the accounts of the company. The resulting balance will be either a net income, which will increase capital, or net loss, which will decrease capital. This amount will be transferred to the permanent capital account and the income summary account will be closed.

 

Why Is This Important?

 

By closing the temporary capital accounts of revenue, expenses, and drawing to zero, a business can easily compare revenue made, expenses incurred, or how much the owner withdrew from one period of time to the next. 

Also, by transferring total revenue and total expenses into the income summary accounts, a summary of income incurred is created in one location and is easy to find. After the accounts are closed and posted, the permanent capital account will include any changes made from a net income, a net loss, or any withdrawals by the owner.

 

What Do I Need to Do?

 

As you learned in FIN1020, all entries must appear in the general journal before they are posted to the ledger. This is also true for the closing entries. Posting will be covered in the next training room.

 

To journalize the closing entries, you need to complete the following steps using the information from the worksheet. We will use the following worksheet prepared for Gurpreet’s Lawn Care and Snow Removal.

 

 

1. Closing Revenue

 

The revenue account ends the fiscal period with a credit balance. Debit entries are needed to close them out or make them equal zero. The total revenue is transferred as a credit into the income summary account, so that this fiscal period’s revenue will be clearly visible and not mixed in with the capital account.

 

Using Gurpreet’s information from his worksheet, it is useful to create T-accounts to analyze this transaction. Go to T-accounts. Remember that T-accounts are rough ledger accounts used to help decide whether to debit or credit an account.

 

Notice that the total amount placed on the debit or left side of the revenue account is equal to the amount placed on the credit or right side of the income summary account. The revenue account now has a balance of zero, and the income summary account is holding the total revenue as a credit.

 

Remember that the first book to record financial information is the journal. Since this is the first closing entry, the title Closing Entries is centred in the general journal and is used as the heading of the section, which replaces the explanation or source document information. 

 

These accounts will appear as follows in the general journal. Notice that total debits equal total credits.

 

 

 

2. Closing Expenses

 

The expense accounts end the fiscal period with debit balances. Credit entries are needed to close them out or make them equal zero. The total expenses are transferred as a debit into the income summary account, so that this fiscal period’s expenses will be clearly visible and not mixed in with the capital account.

 

To see how using information from Gurpreet’s worksheet and the T-accounts needed to close the expense accounts would look, go to T-account Example 1.

The balances of all the expense accounts are now zero and the income summary account is holding the total expenses as a debit.

 

The expense accounts will appear as follows in the general journal. Notice that total debits equal total credits.

 

 

3. Closing Income Summary and Recording Net Income or Net Loss

 

The income summary account is a summary of the company’s income; therefore, it contains the total revenue and the total expenses for this fiscal period. The balance of the income summary account is either the net income or the net loss for the period—the difference between total revenue and total expenses.

 

If the company had a net income, capital would be increased, resulting in a credit to capital. If the company had a net loss, capital would be decreased, resulting in a debit to capital. Remember that capital’s balance side is on the credit or right side; therefore, the credit side is the increase side and the debit side is the decrease side.

 

 

To review increase and decrease sides of accounts, refer to Analyzing Transactions. This tool is also available for your reference in the Toolkit.

 

 

To see how rough T-accounts for closing the income summary and transferring the net income to capital for Gurpreet’s Lawn Care and Snow Removal would look, go to T-account Example 2.

 

The income summary account for Gurpreet has a credit balance before it is closed because there is a net income. This credit balance is transferred to the capital account, which increases capital. The income summary account is debited. Debiting the income summary results in a zero balance in this account. The amount debited equals the amount credited and the accounts remain balanced.

 

Debit entries are always recorded first. The journal entry for the net income section will appear as follows.

 

 

If there is a net loss, the capital account would be debited, or decreased, and income summary would be credited.

 

4. Closing Drawing

 

Drawing represents decreases in capital due to the owner withdrawing assets (usually cash) from the business for personal use during the fiscal period. You could debit the capital account directly for these amounts; however, debiting the drawings account keeps all the drawings in one account for easy reference. Finding out how much the owner withdrew from the business in the fiscal period is easily done by looking at the debit balance in the drawing account.

 

The last closing entry, the drawing section, is a debit to capital that will decrease the capital account and a credit to drawing that will close the drawing account.

 

The rough T-accounts would be as follows:

 

The journal entry to close the drawing account would appear in the general journal the way that it’s shown in Gurpreet’s Closing Entries.

 

That completes the four journal entries necessary in the closing entries section of the journal. View Four Closing Entries.

 

You may refer at any time to the above diagram by opening Four Closing Entries in the Toolkit.

 

 

You may also want to refer to the Closing Entries Rubric, which includes a checklist of what belongs in the closing entries, to help you complete your practice and assignments.

 

 

There is also a Closing Entry Exemplar for your reference. These items are also available in the Toolkit.

 

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