Chapter 8 - Recording Adjusting and Closing Entries for a Service Business

Chapter Objectives

Record adjusting entries for a service business

Record closing entries for a service business

Prepare a post-closing trial balance

Adjusting Entries

Adjustments must be journalized so they can be posted to the general ledger accounts.

Journal entries recorded to update general ledger accounts at the end of a fiscal period are called adjusting entries.

Recorded on the next journal page following the page on which the last daily transactions for the month are recorded.

Analysis of your adjustment is done when the work sheet was completed.

All we are doing is recording the entry

Posting to general ledger account before the account balance changes.

Once the entry is posted the supplies account balance will reflect the amount of supplies on hand!

Adjusting Entries for Supplies

No source document is prepared for adjusting entries. They are identified with a heading in the journal.

Prepaid Insurance

The Prepaid Insurance account balance will reflect the amount of prepaid insurance premiums that remain at the end of the fiscal period.

Audit Your Understanding

Why are adjusting entries journalized?

To update general ledger accounts at the end of a fiscal period.

Where is the information obtained to journalize adjusting entries?

Adjustments column of the work sheet

What accounts are increased from zero balances after adjusting entries for supplies and prepaid insurance are journalized and posted?

Supplies Expense and Insurance Expense

8.2 Recording closing entries

Objectives

Record closing entries for a service business and identify accounting concepts related to closing entries.

Terms

Permanent Accounts

Accounts used to accumulate information from one fiscal period to the next.

Temporary Accounts

Accounts used to accumulating information until it is transferred to the owner’s capital account

Closing Entries

Journal entries used to prepare temporary accounts for a new fiscal period.

Need for Permanent and Temporary Accounts

Permanent accounts

Referred to as real accounts

Asset Accounts

Liability Accounts

Owner’s Capital Account

Ending account balance at the end of the fiscal period are the balances at the beginning of the next fiscal period.

Temporary Accounts

Accounts used to accumulate information until it is transferred to the owner’s capital account

Referred to as Nominal Accounts

Include

Revenue

Expense

Owner’s drawing accounts

Income Summary account

Show changes in the owner's capital for a single fiscal period

At the end of a fiscal period, the balance of temporary accounts are summarized and transferred to the owner’s capital account

Temporary accounts begin the fiscal period with a zero balance.

Closing Entries

Journal entries used to prepare temporary accounts for a new fiscal period

Temporary account balances must be reduced to zero at the end of each fiscal period.

We do this so the temporary account balances are not added to the previous fiscal period

Accounting Concept: Matching Revenue with Expenses

Transfers the balance of one account to another account

Procedure for closing an account includes entering an amount equal to the account balance on the side opposite its balance.

Need for the Income Summary Account

A temporary account title Income Summary is used to summarize the closing entries for revenue and expense accounts.

Income Summary

Does not have a normal balance side.

Balance is determined whether business earns a net income or a net loss.

Ex) Revenue is greater than total expenses – Net Income. The Income summary account has a Debit balance.

Net loss – account balance is Credit

Income Summary

Is a temporary account and is closed when the net income or loss is recorded

4 Closing Entries

Income statement accounts with credit balances

Sales / Income Summary

Income statement accounts with debit balances

Expenses / Income Summary

An entry to record net income or net loss and close income Summary

Capital / Income Summary

An entry to close owner’s equity drawing account

Capital / Drawing

Closing Entries

Why do we have to do closing entries?

To bring temporary accounts to a zero balance and to transfer the balance of each account to another account.

First closing entry closes all income statement accounts with credit balances

Income Summary Account is the other account used in the closing entry for revenues and expenses

Closing Entry for an Income Statement with a Credit Balance

Closing Entry for Income Statement Accounts with Debit Balances

Remember:

The purpose of closing entries is to bring the balance of temporary accounts to zero.

To transfer the balance of each account to another account.

Second Closing entry closes all income statement accounts that have debit balances.

Income summary account is the other account used in the closing entry for revenues and expenses

Closing Entry to Record Net Income or Loss and Close the Income Summary Account

Closing Entry to Record Net Income or Loss and Close the Income Summary Account

Third Closing Entry

Records Net Income or Net loss

Closes the income Summary Account

Amount of Net income increases the owner’s capital.

The entry to record net income should include a credit to the capital account

Other part closes income summary

Net income – the credit side of Income Summary revenues is larger than the debit side – expenses.

A debit is required to close Income Summary when there is a net income

Opposite happens for Net Loss – decreases Capital

Closing Entry for the Owner’s Drawing Account

Withdrawals are assets that the owner takes out of a business and which decrease the amount of the owner’s equity.

The drawing account is a temporary account that accumulates information for a fiscal period.

Drawing is either a revenue or expense account so it is not closed through Income Summary.

Closed directly to the Owner’s Capital Account.

Audit Your Understanding

What do the ending balances or permanent accounts for one fiscal period represent at the beginning of the next fiscal period?

Beginning balances

What do the balances of temporary accounts show?

Changes in the Owner's Equity Accounts

Audit Your Understanding

List the four closing entries?

An entry to close income statement accounts with credit balances

An entry to close income statement accounts with debit balances.

An entry to record net income or net loss and close the income summary account

An entry to close the owner’s drawing account.

8.3 Preparing a Post-Closing Trial Balance Objectives

Prepare a post-closing trial balance

Terms:

Post-closing trial balance

A trial balance prepared after the closing entries are posted.

Accounting Cycle

The series of accounting activities included in recording financial information for a fiscal period

GENERAL LEDGER ACCOUNTS AFTER ADJUSTING AND CLOSING ENTRIES ARE POSTED

Post-Closing Trial Balance

Post means after

Post-closing trial balance is a trial balance prepared after the closing entries.

Only general ledger accounts with balances are included on a post-closing trial balance.

Why is it important to prove that debits equal credits at the close of the fiscal period?

To prove that the work is correct before starting a new fiscal period so errors are not carried forward.

POST-CLOSING TRIAL BALANCE

ACCOUNTING CYCLE FOR A SERVICE BUSINESS

Audit Your Understanding

Which accounts go on the post-closing trial balance?

Only those with balances – permanent accounts

Why are temporary accounts omitted from a post-closing trial balance.

Because they are closed and have zero balances.