Hey guys my name is James and in this quick video i'm going to show you how to post closing entries
in two different ways
a long way and a short way a lot of you have been asking for this one so thanks for all your requests
and an extra special thanks to my channel members
your contributions helped me make this so without further ado
let's begin
this is the accounting cycle it shows us how financial accounting works in eight steps
closing entries are tucked away at the very end of the cycle in step 8
we post them at the end of each accounting period after we're done creating financial statements
but what are they exactly?
closing entries are journal entries that reset temporary accounts to zero
they transfer their balances into retained earnings which is a permanent account held in a balance sheet
remember a journal entry is a record of a financial transaction
and retained earnings are a businesses profits held for future use but what are temporary and permanent accounts?
let me show you
if you've watched my videos before then you're probably familiar with dealer
but if you're new here dealer is a handy little acronym that can help us remember debit and credit accounts
it stands for dividends, expenses, assets, liabilities, equity and revenue
dividends, expenses and assets are normal debit accounts
whereas liabilities, equity and revenue are normal credit accounts
but here's the thing some of these are temporary accounts
and some are permanent
any idea which is which? hmm... i'll grab a drink while we think about it
Got it?
no worries if not
here's a little trick to help you remember
red ale
revenue, expenses and dividends are temporary accounts
and assets, liabilities and equity are permanent accounts
well i don't know about you but i'll cheers to that actually it's a bit early... yeah we'll put that away...
you can find dealer and red ale on my closing entries cheat sheet
which i'll leave a link to down in the description just for you...
so permanent accounts
assets, liabilities and equity
these guys live in the general ledger and their balances are always carried forwards from one accounting period into the next
on the other hand
revenue, expenses and dividends are temporary accounts
these also belong in the general ledger but they only correspond to one accounting period
once that period's over they need to be reset to zero and we do that using closing entries
if none of this is making sense don't sweat it i think this example might help clear things up
Happy new year!
this is a trial balance for a business called Unter
a late comer to the world of ride sharing apps
a trial balance is an accounting report showing the current balances in every general ledger account
and this is an opening trial balance because the date is January 1st
the start of Unter's new financial year
if we flick back to the accounting cycle we find ourselves right here
at the very beginning
now let's see how Unter's temporary and permanent accounts change as we move around this
at the moment they have some assets, some liabilities and some equity
A-L-E which means that all of these are permanent accounts making up Unter's balance sheet
but hang on where's revenue, where's expenses and dividends?
trial balances often have filters applied so that they only show accounts with numbers in them
if we expand this out then we find the usual suspects
revenue, expenses and dividends R-E-D
these are Unter's temporary accounts which were reset to zero at the end of last year
okay great now let's skip through steps one to six and get onto the good stuff
the adjusted trial balance
Unter drivers have been diligently moving customers from a to b for a whole year now
and we find ourselves at December 31st
here's Unter's adjusted trial balance
a whole year's worth of transactions have been posted and adjusted so that this represents a true and fair view of their business
as you can see all of the temporary R-E-D accounts have got numbers in them now these show us the revenue that Unter has earned
the expenses that it's incurred and the dividends that it's declared during the past year
now Unter can create some financial statements
revenue and expenses are temporary accounts that make up Unter's income statement
this summarizes Unter's performance over a one year period
we can see that they've made a tidy profit of three million nine hundred and fifty thousand dollars
but while the income statement only looks at revenues and expenses Unter's balance sheet is made up of everything
all of Unter's permanent and temporary accounts belong in here
assets, liabilities and equity are permanent accounts whereas current year dividends is a temporary account
and current year profit feeds directly through to here from the income statement
which as we saw is made up of temporary revenue and expense accounts
Unter has earned three million nine hundred and fifty thousand dollars in profit and they've declared half a million dollars in dividends
step eight
time to post the closing entries
i'm going to show you two ways to do this
the long way and the short way
the long way involves four steps and we'll move through these one by one
in step one we're going to reset Unter's revenue account to zero by transferring the balance
to the income summary account
what is an income summary account?
it's a very special, very temporary account that only exists while we're posting closing entries
and it works a bit like this
if we go back to the adjusted trial balance we're going to reset revenue to zero
but be careful with this because i can see three accounts with revenue in their descriptions
accrued revenue, deferred revenue and revenue revenue
accrued revenue is an asset and deferred revenue is a liability
they are both permanent accounts that we use for adjusting entries so we can leave them alone for this example
we're only interested in this temporary revenue account
so let's take a closer look at it
Unter earned 20 million dollars this year
this sits on the right hand side of their revenue t account
because revenue is a normal credit account
think dealer
we want to reset this temporary account to zero
so we need to post a closing journal entry on December 31st
we'll debit revenue by 20 million dollars and credit the income summary account by the same amount
as you can see this transfers the balance from the revenue account to the income summary account
so we're left with zero dollars in revenue and 20 million dollars in the income summary account
step two
now we need to do the same thing again but this time with all of the expense accounts
we'll reset them to zero and clear their balances to the income summary
account Unter has four different expense accounts
cost of services, overhead expenses
interest and tax
we can ignore accrued expenses because it's a permanent liability account
we need to post another closing entry and repeat what we did back in step one
expenses are normal debit accounts so their balances are on the left of these t accounts
if we want to reset them to nil then we need to post equal and opposite credits to each account
for cost of services, overhead expenses, interest and tax and that leaves us with a total balancing
amount of 16 million fifty thousand dollars which we'll debit to the income summary account
in every journal the total in the debit column has to match the total in the credit column
when we post this one we credit the right hand side of each expense account resetting all of them to zero
and we debit the left hand side of the income summary account now it's got a new balance of
three million nine hundred and fifty thousand dollars which is a net credit sitting on the right hand side
sound familiar?
it should do because this number is exactly the same as Unter's profit for the year which we saw in their income statement
step three it's time for us to clear out that balance in the income summary account and put it where it belongs
retained earnings which is a permanent equity account in Unter's balance sheet
back to our trial balance here's our income summary account and it has a three million nine hundred and fifty thousand dollar credit balance
which is a combination of Unter's revenues and expenses for the year
the closing entry for this one is nice and simple we have a three million nine hundred and fifty thousand dollar
credit balance in the income summary account so we need to debit it by the same amount and credit
the balance to retained earnings
when we post this Unter's retained earnings or their profits held for future use
increases to $13,950,000
and... bye bye income summary account
sorry this just isn't working out between us you know you're going to make a lucky accountant really happy someday
so job done right?
not quite
step four
we need to reset current year dividends to zero and clear the balance to retained earnings
Unter declared half a million dollars of dividends this year
these are the businesses profits that they've chosen to distribute to the owners of the business
it's shareholders and we know retained earnings are a businesses profits held for future use
so if Unter issues dividends then it's not holding on to these profits anymore
so its retained earnings are going to go down
as you'll see right now
Unter has five hundred thousand dollars of dividends which is a normal debit account so in this closing entry we're going to credit the dividend account
by five hundred thousand dollars and debit retained earnings by the same amount
when we post this closing entry Unter's dividends are reset to nil and its retained earnings
decrease to $13,450,000
just as we predicted
now can i get a drumroll please...
this is Unter's post closing trial balance it shows us what's left in each of Unter's accounts
after posting their closing entries you can see that all of their temporary accounts
have been reset to zero and their balances have been transferred to retained earnings
gee... that took a while didn't it?
thankfully there's a quicker way
the short way
this time we're going to take all of Unter's temporary accounts its revenue, expenses and dividends and clear their balances to retained earnings
using one closing entry so let's rewind and go back to the adjusted trial balance
here are Unter's temporary accounts we have revenue in the credit column and we have dividends and expenses in the debit column
we can reset all of these to zero using one closing entry
by debiting the revenue account and crediting the dividend and expense accounts
the balance of three million four hundred and fifty thousand dollars is credited to retained earnings
because in double entry accounting there are at least two equal and opposite sides to every
transaction when we post this closing entry all of the temporary accounts are reset to zero
fantastic!
we covered a lot there didn't we?
so here's a quick recap
when we post closing entries the long way there are four steps
first we clear revenue to the income summary account
then we clear expenses to the income summary account
then we clear the balance in the income summary account to retained earnings
and finally we clear the dividends straight to retained earnings
this might seem like a bit of a faff but if you're using a manual accounting system then the income summary account
can help you methodically work your way through this closing process
with the short way we clear all of these temporary accounts to retained earnings in one go often this happens automatically if you're using modern accounting software
but whichever method you're using we get to the same post-closing trial balance which usually looks like this
filtered to hide accounts with zero balances the post closing trial balance for this year becomes next year's opening trial balance
if you're enjoying these videos and you'd like to help support the channel well
thank you one way you can do that is by clicking on the join button below and
another way is by buying one of my cheat sheets there's one for closing entries which covers
yeah everything we just went through thanks for watching and i'll see you again soon!