Recording Adjusting & Closing Entries for a Service Business

Recording Adjusting & Closing Entries for a Service Business Accounting Chapter 8

Adjusting Entries • Remember the Adjustment Column of the Work Sheet? • Adjustments must be journalized and posted • WHY? • Accounting Period Cycle • Adequate Disclosure • Matching Expenses with Revenue • Adjusting Entries are journal entries recorded to update general ledger accounts at the end of a fiscal period

Recording Adjusting Entries • Information for adjusting entries are found in the Adjustment columns of the Work Sheet • Which accounts are impacted? • Supplies, Prepaid Insurance, Supplies Exp., Insurance Expense • A new journal page is started for adjusting entries • The title: Adjusting Entries is written in the middle of the Account Title column of the General Journal – WHY?

An Adjusting Entry (page 203)

Posting Adjusting Entries • All journal entries must be posted • Posting to the General Ledger insures that all account balances are up to date and match the information on the company’s financial statements • Remember the steps for posting? • Don’t forget to record the account number on the general journal entry • WT 81-83.xls

Account Classifications • Permanent Accounts collect information from one fiscal period to the next • AKA Real Accounts • Ending account balances for permanent accounts become the beginning account balances for the next fiscal period • Balance Sheet items are permanent accounts • WHY?

Account Classifications • Temporary Accounts accumulate information that is transferred to the owner’s capital account at the end of the fiscal period • AKA Nominal Accounts • Income Statement items are temporary accounts • WHY? • Temporary accounts begin a new fiscal period with a zero balance

Closing Entries • Temporary Accounts balances must be reduced to zero at the end of each fiscal period • Closing entries prepare temporary accounts for a new fiscal period • To close a temporary account, an amount equal to its balance is recorded in the amount on the opposite to its balance: • If Advertising Expense has a $100 debit balance, then a $100 credit to Advertising Expense will reduce the balance to zero

But Debits Must Equal Credits!!!!! • The Income Summary account is a temporary account that summarizes the closing entries associated with Revenues and Expenses • All expenses (debit normal balances) are debits to Income Summary • All revenues (credit normal balances) are credits to Income Summary • Income Summary is eventually closed to Capital • What is relationship between the Income Summary account and Net Income(Loss)?

Four Closing Entries • The balance of the Income Summary account is determined by whether the business earns net income or suffers a net loss • There are four closing entries for a service business (sole proprietorship): • An entry to close income statement accounts with credit balances • An entry to close income statement accounts with debit balances • An entry to record net income or loss and close Income Summary • An entry to close the owner’s drawing account

Closing Entry for Income Statement Accounts with Credit Balances • Which accounts are these?

Closing Entry for Income Statement Accounts with Debit Balances • Only one closing entry is required to close all expense accounts

Closing Entry to Record Net Income or Loss and Close the Income Summary Account • Income Summary is a temporary account that is closed to the Capital account – WHY? • If there is net income: • If there is net loss

Closing Entry for the Owner's Drawing Account • Drawing is not a revenue or expense account and cannot be closed through the Income Summary account • WT 81-83.xls

Posting Closing Entries • Closing entries must be posted to prepare the company’s books for the next fiscal period • Accounts that are closed have a zero balance at the end of the fiscal period • Lines are drawn in both the Balance Debit and Balance Credit columns of closed temporary accounts to verify that the account has been closed

Preparing a Post Closing Trial Balance • A Post Closing Trial Balance is a trial balance prepared after the closing entries are posted • Verifies that debits equal credits in the general ledger • Only general ledger accounts with balances are included on a post-closing trial balance • Only balance sheet items – WHY? • A Post-Closing Trial Balance is included on page 216 • It follows a similar format to the Trial Balance prepared on the Work Sheet

CONCEPT: Accounting Cycle • The series of accounting activities included in recording financial information for a fiscal period • Since it is a cycle, step 1 begins again after step 8

Steps in the Accounting Cycle • Source documents are analyzed • Transactions are recorded in the General Journal • Journal Entries are posted to the General Ledger • A Work Sheet is prepared from the General Ledger • Financial statements are prepared from the Work Sheet • Adjusting and closing entries are journalized from the Work Sheet • Adjusting an closing entries are posted to the General Ledger • A Post-Closing Trial Balance of the General Ledger is preparedWT 81-83.xls

Recording Adjusting & Closing Entries for a Service Business