The accounts we've been learning about can be categorized a number of different ways.
We categorized accounts by which financial statement they are reported on.
We've categorized accounts by whether or not they are current or long-term.
And now we're going to categorize our accounts a new way - whether they are permanent or temporary.
Temporary accounts are closed at the end of the period.
Closed means to zero the account balance.
Permanent accounts are unaffected by the closing journal entries with the exception of retained earnings.
The income summary account, which is a new account for us, it is a transitional account in which all revenues and expense
accounts are transferred to this account of the end of the period.
The net amount transferred equals
the net income or net loss for a period.
This account is rarely used by corporations,
but some textbooks still show this method so we wanna cover it.
So the closing journal entries is a formal process of moving revenues and expenses and dividends to retained earnings.
You recall very early on that we learned that revenues increase equity,
while expenses and dividends decreased equity.
Up until this point that has all been conceptual.
When we record the closing journal entries
this is when those impacts on equity actually happen.
And finally, we we prepare these accounts to begin the next period with zero balances.
Here are some data from Coca-Cola's 2013 financial statements.
The operating revenues as a temporary account.
The amounts shown are the amounts earned in that year, not the total amount of revenue Coke has ever earned.
So each year revenues are closed so that Coke can begin tracking revenues for the next year.
Cash on the other hand is not closed.
It is the amount of cash Coke on hand at the end of last year. It wouldn't make sense to
close this account and start the new year with a zero balance in the cash account.
Coke would start the new year with a beginning balance that was last year's ending balance.
So let's look at an adjusted trial balance and learn how to make the closing entries.
Here is an example of an adjusted trial balance. We could've used financial statements to close the temporary accounts as well.
Let's start with service revenue which had a credit balance of
$4000.
The first general journal entry is to close revenues to income summary.
Since revenues have a $4000 credit balance we will debit service revenue to make the balance zero.
Income summary will then be credited.
After posting this entry the balance in service revenue is zero.
Note that if we had more than one revenue account, like rent revenue and interest revenue,
we would include them in the journal entry like this.
Next, we'll close expenses.
The second journal entry is to close expenses to income summary.
We record our expenses separately in the journal entry because each account needs to be zeroed out.
You can see that in the example here.
Income summary will then be debited for the total of all the expenses.
After posting this journal entry all of our expenses will be zeroed out.
The third journal entry is to close income summary to retained earnings.
To do this we need to figure out the ending balance in income summary.
Once we post the first two closing entries we can determine the balance of income summary.
The balance, by the way, should equal our net income.
In this case, the balance is a $700 credit.
So to close income summary, we debit the account $700.
The balance is now zero and will remain zero until next period when we close our temporary accounts.
The credit is now to retained earnings.
The last temporary account to close is dividends.
The final journal entry is to close dividends to retained earnings. Since dividends has
a $1000 debit balance, we will credit dividends to make the balance zero.
Retained earnings will then be debited.
Note, dividends is not an income statement account so it is not closed to income summary first.
Now let's look at our retained earnings account. We started with a $4600 balance, which came from the trial balance, and that's a credit balance.
We increased the account when we closed income summary.
Recall that net income increases equity.
This journal entry is how that happens.
We decrease the account when we close dividends. Recall that dividends decrease equity
and this journal entry is how that happens.
Then we have an ending balance of $4300.
Now let's compare that to what we reported on the statement of retained earnings.
You can see that the ledger for retained earnings now matches what was reported on the statement of retained earnings.
It's like magic, only real.
And that concludes this important video on closing journal entries.