Chapter 10: Completing the Accounting Cycle for a Sole Proprietor

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

2. 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.

3. 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.

4. 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

5. 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

6. 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

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

8. 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.

9. 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

10. 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.

11. 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

12. Closing the Revenue account to Income Summary First Closing Entry—Close Revenue to Income Summary JOURNAL ENTRY

13. Closing the Expense accounts to Income Summary • Balances of the expense accounts are found in the income statement section of the worksheet Second Closing Entry—Close Expenses to Income Summary JOURNAL ENTRY

14. Closing the Income Summary Account to Capital Income Summary Closing entry for revenue 2650 Closing entry for expenses 1500 1150 New Balance If Income Summary has a credit balance net profit If Income Summary has a debit balance  net loss

15. Closing the Income Summary Account to Capital Fourth Closing Entry—Close Withdrawals to Capital JOURNAL ENTRY7.

16. 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 Fourth Closing Entry—Close Withdrawals to Capital JOURNAL ENTRY7.

17. 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?

18. 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.

19. 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

20. 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

21. Review: Posting to General Ledger Steps

22. Posting Closing Entries Income Summary Balance (credit): $1150 Withdrawal balance: $500 Maria Sanchez, Capital 301 20 G1 25000 Oct 1 25000 G1 400 2 25400 31 G3 Closing Entry 1150 26550 31 Closing Entry G3 26050 500 You have to do this for every line in the general journal. DO NOT FORGET TO PUT THE POST REFERENCE IN THE JOURNAL AFTER YOU HAVE POSTED.

23. 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

24. 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

25. Post Closing Trial Balance

26. 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?