Closing Process Notes

Closing Process & Closing Entries

Overview

  • Closing journal entries reset income and expense account balances to zero for the next period.
  • Occur only at the end of an accounting period.
  • Recorded in the general journal and posted to the general ledger.

Purpose of Closing Entries

  • To facilitate financial statement preparation.
  • To prepare accounting records for the next period.
  • Reset income and expense account balances to zero.

Temporary and Permanent Accounts

  • Temporary Accounts: Revenues, expenses, drawings/dividends. Closed each period.
  • Permanent Accounts: Assets, liabilities, equity (capital, retained earnings). Carried forward.

Closing Entries

  • Effectively close all temporary accounts to the permanent equity account (capital).
  • A 'Profit or Loss Summary' account is used to facilitate this.
  • Income and expense accounts start the next period at zero.

Steps in the Closing Process

  1. Close Income Accounts: Debit each income account, credit the P&L Summary account.
  2. Close Expense Accounts: Debit the P&L Summary account, credit each expense account.
  3. Close P&L Summary Account:
    • Sole Trader: To the owner’s Capital account.
      • If profit (credit balance): DR P&L Summary, CR Capital
      • If loss (debit balance): DR Capital, CR P&L Summary
    • Company: To Retained Earnings account.
      • If profit (credit balance): DR P&L Summary, CR Retained Earnings
      • If loss (debit balance): DR Retained Earnings, CR P&L Summary
  4. Close Drawings/Dividends Account:
    • Sole Trader: Close Drawings to the owner’s Capital account: DR Capital, CR Drawings
    • Company: Close Dividends to Retained Earnings account: DR Retained Earnings, CR Dividends

End Result

  • All income accounts have zero balances.
  • All expense accounts have zero balances.
  • The temporary P&L Summary account has a zero balance.
  • The Drawings (dividends) account has a zero balance.
  • The Capital (retained earnings) account reflects profit/loss and drawings/dividends.

Post-Closing Trial Balance

  • Verifies the equality of debits and credits.
  • Confirms only permanent accounts have balances.