The accounts we've been learning about can be categorized a number of different ways.
We've categorized accounts by which financial statements they're reported on.
We've categorized accounts by whether not they are current or long-term.
And now, we're gonna learn a new way of categorizing our accounts - temporary or permanent.
Temporary accounts are closed at the end of the accounting period.
Closed means we want to zero the account balance.
Permanent accounts are unaffected by closing journal entries with the exception of retained earnings.
So the closing journal entry is a formal process of moving revenues, expenses, and dividends to retained earnings.
You recall very early on that we learned that revenues increase equity while expenses and dividends decrease 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.
Finally, we prepare the accounts to begin the next period with zero balances.
Here is some data from Coca-Cola's 2013 financial statements.
The operating revenues is 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
This is the amount of cash Coke at the end of the year. It wouldn't make sense to close this
account and start the new year with a zero balance in cash.
Coke would start the new year with the beginning balance which was last year's ending balance.
So let's look at the adjusted trial balance and learn how to make closing entries.
Here is an example of an adjusted trial balance.
We could've also used the financial statements to close the temporary accounts.
Let's start with service revenue which has a credit balance of $4000.
The first journal entry is to close revenues to retained earnings.
Since revenues have a $4000 credit balance we will debit service revenue to make the balance zero.
Retained earnings will then be credited.
After posting this closing entry,
the balance in the service revenue account 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 will close expenses.
The second journal entry is to close expenses to retained earnings. We record our
expenses separately in the journal entry because each account needs to be zeroed out.
You can see that in the example,
retained earnings then is debited for the total amount of the expenses.
After posting this journal entry all of our expenses will be zeroed out.
The final temporary account is dividends.
which has a debit balance of $1000.
The third journal entry is to close dividends to retained earnings.
Since dividend has a $1000 debit balance we will credit dividends to make the balance zero. Retained earnings will then be debited.
Let's look at the retained earnings account.
We started with a $4600 credit balance which came from the trial balance. We increased the account when we closed revenue.
Recall that revenues increase equity.
This journal entry is how that happens.
We decreased the account when we closed expenses and dividends. Recall that expenses and dividends decrease equity.
These two are the journal entries that make that happen.
Finally, we have an ending credit balance of $4300.
Let's compare that to the statement of retained earnings and see what we reported to our investors and creditors.
Now you can see that the ledger for retained earnings matches what we reported on the statement retained earnings.
It's like magic, only real.
That concludes this important video on closing journal entries.