Chapter 6 – Closing Process and Financial Statements

 

This chapter looks at the final steps of the accounting cycle.  It will introduce closing entries and procedures for preparing the ledger accounts for the next accounting period.  This chapter will also provide a review of all of the steps of the accounting cycle.  You will NOT be responsible for preparing work sheets for quiz or exam purposes.  After reading and studying this chapter, you should be able to:

            1.         Describe the purpose of closing entries.

            2.         Journalize and post closing entries.

            3.         Prepare a post-closing trial balance.

 

Key Points to Remember:

 

1.                   Purpose of closing entries

·         To close (transfer) the balances out of the revenue and expense accounts so they will be available to accumulate information in the following accounting period

·         To summarize the period's revenues and expenses and transfer that information to owner’s capital.   (To facilitate this process, an account called Income Summary is used to close all revenue and expense accounts.)

·         To transfer the owner’s withdrawals to the owner’s capital.

 

2.         Steps to follow when preparing closing entries:

1.         Transfer the balances in all revenue accounts to Income Summary

 

XX Revenue

XX Revenue

$$

$$

 

 

Income Summary

 

$$

                                                                                   

            2.         Transfer the balances in all expense accounts to Income Summary

 

Income Summary

$$

 

 

XX Expense

XX Expense

 

$$

$$

                       

     3.         Compute the balance in Income Summary and transfer that balance to the Owner’s Capital account.  If this is a credit balance -- the company was in a net income position and the entry will be:

 

Income Summary

$$

 

 

Owner’s Capital

 

$$

                                               

If this is a debit balance -- the company was in a net loss position and the entry will be:

 

Owner’s Capital

$$

 

 

Income Summary

 

$$

 

4.                   Transfer the balance in owner’s withdrawals account to the owner’s capital account

 

Owner’s Capital

$$

 

 

Owner’s Withdrawals

 

$$

                                                                       


3.         Post-closing Trial Balance – trial balance prepared after closing entries have been journalized and posted.  It should contain only Balance Sheet accounts.

 

 

4.         Steps of the Accounting Cycle: (assumes a worksheet is NOT used)

1.                   Analyze source documents

2.                   Record journal entries

3.                   Post entries to the ledger

4.                   Prepare trial balance

5.                   Prepare adjusting entries (journalize and post adjusting journal entries)

6.                   Prepare an adjusted trial balance

7.                   Prepare financial statements

8.                   Prepare the closing entries (journalize and post)

9.                   Prepare a post-closing trail balance.

 

 

 

CHAPTER 6 REVIEW

 

I.          VOCABULARY  (Complete each of the following statement by filling in the appropriate word or words)

 

1.         The ____________________ account is used only during closing entries. 

 

2.         Entries made at the end of a reporting period to adjust the temporary accounts to zero are called ______________________ entries.

 

3.         The __________________ is the sequence of events from transaction analysis to closing entries.

 

 

II.        MULTIPLE CHOICE  (Circle the letter that best completes each of the following statements)

 

1.         A special temporary account used to close all of the revenue and expense accounts is

a.          Closeout Summary.

b.         Owner’s Capital.

c.         Income Summary.

d.         Temporary Summary.

 

2.         Which of the following accounts would not be debited or credited in closing entries?

a.          Prepaid Insurance

b.         Owner’s Capital

c.         Utility Expense

d.         Owner’s Withdrawals

 

3.         Which of the following is not an objective of closing entries?

a.          To transfer net income or net loss into Owner’s capital.

b.         To produce zero balances in all nominal (or income statement) accounts

c.         To produce a zero balance in all permanent (or balance sheet) accounts

d.         To prepare the revenue and expense accounts for the measurement of net income in the following period


4.         When a net loss has occurred,

a.          all expense accounts are closed with debits.

b.         the Income Summary account is closed with a credit.

c.         the Owner’s Withdrawals account is closed with a debit.

d.         all revenue accounts are closed with credits.

 

5.         The post-closing trial balance contains

a.          only balance sheet accounts.

b.         only income statement  accounts.

c.         both income statement and balance sheet accounts, with the balance sheet accounts at zero balances.

d.         both income statement and balance sheet accounts, none with a zero balance.

 

6.         Which of the following accounts will appear in the post-closing trial balance?

a.          Service Fees Earned

b.         Income Summary

c.         Owner’s Capital

d.         Owner’s Withdrawals

 

III.       QUESTIONS/PROBLEMS

 

1.         Describe the difference between an adjusted trial balance and post-closing trial balance.

 

2.         The following is the adjusted trial balance for Sample Company at the end of the current accounting period.

Sample Company

Adjusted Trial Balance

 

 

Debit

Credit

Cash

68,000

 

Accounts receivable

43,000

 

Inventory

32,000

 

Supplies

4,000

 

Equipment

300,000

 

Accumulated depreciation

 

75,000

Accounts payable

 

30,000

Notes Payable

 

50,000

Owner’s Capital

 

250,000

Owner’s Withdrawals

10,000

 

Commissions Earned

 

800,000

Wage expense

500,000

 

Advertising expenses

100,000

 

Rent expenses

148,000

        

Totals  

1,205,000

1,205,000

 

 

 

 

a.          Prepare the closing entries for Sample Company

b.         Prepare a post-closing trial balance for Sample Company

 

                                               


ANSWERS

 

I.          VOCABULARY

 

1.         income summary

2.         closing

3.         accounting cycle

 

II.        MULTIPLE CHOICE

1.         c                                              4.         b

2.         a                                               5.         a

3.         c                                              6.         c

 

III.       QUESTIONS/PROBLEMS

1.         Two major differences between an adjusted trial balance and a post-closing trial balance are the following:

1.         An adjusted trial balance has both balance sheet accounts and income statement accounts.  A post-closing trial balance has only balance sheet accounts since all income statement accounts and owner’s Withdrawals have been closed.

2.         The balance in the owner’s capital account on the adjusted trial balance is the balance at the beginning of the period.  The balance in the owner’s capital account on the post-closing trial balance is the balance at the end of the accounting period.  This is because the closing entries have transferred the effect of all the income statement accounts (as well as any Withdrawalss) into the owner’s capital account.

 

2.                                                                                       General Journal

 

      Date

 

                               Account Title

 

Ref

 

          Debit

 

         Credit

 

 

 

Commissions Earned

 

 

 

800,000

 

 

 

 

 

Income Summary

 

 

 

 

 

800,000

 

 

 

Income Summary

 

 

 

748,000

 

 

 

 

 

Wages Expense

 

 

 

 

 

500,000

 

 

 

Advertising Expenses

 

 

 

 

 

100,000

 

 

 

Rent Expenses

 

 

 

 

 

148,000

 

 

 

Income Summary

 

 

 

52,000

 

 

 

 

 

Owner’s Capital

 

 

 

 

 

52,000

 

 

 

Owner’s Capital

 

 

 

10,000

 

 

 

 

 

Owner’s Withdrawals

 

 

 

 

 

10,000

 

 


Sample Company

Post-closing Trial Balance

 

 

Debit

Credit

Cash

68,000

 

Accounts receivable

43,000

 

Inventory

32,000

 

Supplies

4,000

 

Equipment

300,000

 

Accumulated depreciation

 

75,000

Accounts payable

 

30,000

Notes Payable

 

50,000

Owner’s Capital

 

292,000

     Totals

$447,000

$447,000