I'm Larry Walther, and this is priciplesofaccounting.com, Chapter 4.
In this module,
we will review the accounting cycle, as well as look at the closing process.
To review the accounting cycle, consider that the accounting cycle simply as a way
of describing how we capture transaction event data and move it through
the accounting system to the ultimate preparation of financial statements.
There are various steps in the accounting cycle.
Ordinarily we think about the first step being the examination of transactions and
events and the preparation of a journal entry.
Those journal entries are periodically posted to appropriate ledger accounts.
>From those ledger accounts a trial balance can be constructed.
And examining that trial balance may provide additional
reason to consider the need for adjusting entries so
that income is properly measured for the particular accounting period.
Those adjusting entries would be prepared, recorded in the journal and
posted to the ledger.
The ledger then provides a basis for
preparing an adjusted trial balance from which financial statements maybe prepaid.
Those financial statements maybe prepared directly from the adjusted trail balance
or a worksheet might be used to facilitate the process,
such as was illustrated in a previous module.
Moving on to the closing process, as we consider the closing process, and
consider why is this necessary,
it's important to recall that accounting information is for periods of time.
Income statements, operating statements, reflect revenues and expenses for
a particular period of time.
And so what we have in the ledger are accounts that reflect revenues for
the period, expenses for the period, and so forth.
That information needs to be closed out
before you begin another accounting period.
In other words, the revenue accounts and the expense accounts
need to be reset to zero so that what will be captured in the ledger going forward
Is information about revenues and expenses for the next accounting periods.
So I say on the slide that we need to update the Retained Earnings account in
the general ledger to equal the end-of-period balance.
We do that by periodically closing our revenue and expense and dividend accounts.
That is, we zero those out.
The revenue and expense and
dividend accounts are called temporary or nominal accounts.
In contrast to the balance sheet accounts that are refered to as real accounts.
So let's look at the closing process.
You could think of this in steps.
We could first think of closing the revenue account.
We might on the closing process introduce another account called income summary.
Essentially that's a corral where we're going to gather up all
the information about all revenues and expenses.
It's not a financial statement account at all.
It's just an account that is used temporarily in the closing process.
Similarly we would close the expense accounts income summary and
once that's done the balance of income summary would reflect
the amount of net income for the period that's then closed to retained earnings.
Additionally, we would need to close the dividend accounts.
So, let's look at this in journal entry form.
Here on the screen is an example of, the first entry, closing revenues.
Revenues have a credit balance, to close them we'll debit revenues and
credit income summary.
At this point we'll have $32,800 in the income summary account
reflective of the total revenue.
The next journal entry reflects the closing of the expense accounts.
Because the expense accounts have debit balances,
we need to credit them to close them or zero them out and
in turn debit income summary for the total of the expenses 30,200.
Now comparing you see there is 32,800 that has been credited to income summary for
all of the revenues, and 30,200 that's been debited to income summary for
all of the expenses.
That gives us a net balance of 2,600 in the income summary account.
That corresponds to the net income of the business, and
that is what is closed out then to retained earnings.
So here I'm debiting income summary 2,600, and
crediting retained earnings in this particular entry.
And notice now that would cause the income summary account to have a zero balance,
that would cause the expense accounts to all have zero balances,
that would cause the revenue accounts to all have zero balances.
And the retained earnings account has been brought forward
to its then current balance, reflecting the end-of-year condition.
We also, though, need to consider the dividends,
which are closed to retained earnings.
Retained earnings over time is the undistributed earnings of the company.
So here, I'm crediting dividends to close that temporary account, and
debiting retained earnings.
So to review the process then, this slide may prove helpful.
Here's our revenue accounts that I'm debiting 32,800 and
crediting income summary 32,800.
I in turn credit all the expense accounts and debit income summary.
Then in turn I close the income summary account to retained earnings.
Lastly I'll close my dividends to retained earnings.
That information then gives me a basis for preparing a post closing trial balance.
Now the only accounts that remain would be assets, liabilities, and
the equity accounts the end of period equity account balances.
So a post closing trial balance reveals the balance of the accounts
after the closing process, all the revenue expense,
the dividend accounts have been swept away or are zeroed out.
This simply demonstrates that the accounts are in balance.
It is not a formal financial statements.
Here is an example for England Tours Company.
After the closing process,
note that each of those accounts is a balance sheet account.
Total debits are 65,000, total credits are 65,000.
I'm fairly confident I've successfully completed the closing process.
Lastly, I would like to close this module by asking you to consider computerization.
First of all, computerization can do a lot with the need for
the closing process I've just described.
A number of accounting software programs are based on database logic
that will maintain revenue expense information indefinitely.
And so rather than needing to close and restart revenue and expense accounts, it's
sufficient to simply query the database for the period of time of interest.
So one could say give me the information about revenues and expenses for
the period January 1 year one through December 31 year one.
Or, January 1 year three through December 31 year three.
It's not necessary that you restart the accounts at each particular period
given the robust character of a sound computer based accounting system.
Financial results are almost any period of time, can be created, and
the closing account becomes far less relevant.