Closing
Entries
After financial
statements are prepared, you are ready to get your books
ready for the next accounting period by clearing out the income
and expense
accounts in the general
ledger and transferring the net
income (or loss) to your owner's
equity account. This is done by preparing closing entries in
the general
journal.
Note the distinction between adjusting
entries and closing entries. Adjusting entries are required
to update certain accounts in your general ledger at the end of
an accounting period. They must be done before you can prepare
your financial statements and income tax return. Closing entries
are needed to clear out your revenue and expense accounts as you
start the beginning of a new accounting period.
Preparing your closing entries is a very simple, mechanical
process. Follow these steps:
- Close the revenue accounts. Prepare one journal
entry that debits
all the revenue accounts. (These accounts will have a credit
balance in the general ledger prior to the closing entry.)
Credit an account called "income summary" for the
total.
- Close the expense accounts. Prepare one journal
entry that credits all the expense accounts. (These accounts
will have a debit balance in the general ledger prior to the
closing entry.) Debit the income summary account for the
total.
- Transfer the income summary balance to a capital
account. Prepare a journal entry that clears out the
income summary account. This entry effectively transfers the
net income (or loss) of the business to the owner's equity
account.
- Close the drawing account. If your business is a
sole proprietorship or partnership, close the drawing
accounts (if any) by preparing a journal entry that
credits the drawing account and debits the owner's equity
account.
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As an example, assume that you have finalized
your general ledger and prepared a balance sheet
and income statement for the year ended December
31, 2001. You want to get your books ready for
next year. You prepare the four closing entries
as follows:
|
|
|
Debit |
Credit |
Sales |
462,452 |
|
Income summary |
|
462,452 |
To close the revenue account on 12/31/2001 |
|
Debit |
Credit |
Income summary |
399,871 |
|
Purchases |
|
230,934 |
Advertising |
|
1,850 |
Depreciation |
|
13,250 |
Insurance |
|
5,400 |
Payroll taxes |
|
8,200 |
Rent |
|
9,600 |
Repairs and maintenance |
|
13,984 |
Utilities |
|
17,801 |
Wages |
|
98,852 |
To close the expense accounts on
12/31/2001 |
|
Debit |
Credit |
Income summary |
62,581 |
|
Tom Beta, capital |
|
62,581 |
To transfer 12/31/2001 net income to the
capital account |
|
Debit |
Credit |
Tom Beta, capital |
12,000 |
|
Tom Beta, drawing |
|
12,000 |
To close drawing account for year ended
12/31/2001 |
After all closing entries are made, post
the entry totals to the general
ledger. Foot
the general ledger accounts to arrive at the beginning amounts
for the new accounting period. All revenue and expense accounts
should have a zero balance.
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