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Closing Process

Closing Process

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Author: Sophia Tutorial
Description:

Determine the accounts affected in a closing entry and calculate the amounts for the closing general journal entry.

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Tutorial
what's covered
This tutorial will cover the closing process, the last phase in the accounting cycle.

Our discussion breaks down as follows:

  1. Closing Process
  2. Closing Entries
    1. General Journal
    2. General Ledger
  3. Post Closing Trial Balance


1. Closing Process

Let's begin our discussion on the closing process by looking at the trial balance worksheet, specifically the adjusted trial balance. As you can see in the trial balance worksheet below, we have already worked through any adjustments, made the adjusted trial balance, and created the financial statements. Now it's time to close it out.

The next step is to look at the adjusted trial balance and clear out the temporary accounts, which are the revenues and expenses. If we populate the closing entries below, you'll see that we need to zero out the balances in all of the temporary accounts.

For example, if you look at owner drawings, we have a $2,000 debit balance in the adjusted trial balance. Therefore, we need to clear it out with a closing entry of $2,000 to the credit side. Similarly, if you take a look at sales, we have a $150,000 credit balance in the adjusted trial balance, so we need to enter a $150,000 debit as a closing entry.

Now, we complete this process for all of our revenue and expense accounts, as well as our drawing account, and any difference is put to income summary.

Then, we also have to close out the income summary account. If we close out the income summary account, you can see that there is now a debit and a credit, so there is going to be no balance in that account. The difference is put to the retained earnings for the end of the year.


2. Closing Entries

Now that we've gone through organizing the closing entries on the trial balance worksheet, let's look at journalizing those transactions--getting the closing entries into the general journal and ultimately posted to the ledger.

2a. General Journal
Remember, this is what the general journal looks like, below.

We need to enter all of the entries that we identified on the trial balance worksheet, starting with revenue. We are closing out the revenue account to income summary. Since revenue has a credit balance, we are going to debit it for the $150,000, to zero out the revenue account.

We're going to do the same thing with all of our expenses; now, all of our expenses are going to be credit entries in the closing process, because they have debit balances on the adjusted trial balance.

Now, we also have to close out the owner drawings, zeroing that account out because it is also an activity-based account. After we've zeroed all of those accounts out, we have one more entry to make, which is to close the income summary account to our cumulative equity or retained earnings.

2b. General Ledger

Now that we've listed all of general journal entries, we need to post them to the general ledger. Each individual account is going to have its own ledger.

Revenue had a $150,000 balance. We made our closing entry a debit of $150,000 to bring the balance in revenue to zero.

Owner drawings had a balance of $2,000, so we made our closing entry a credit for $2,000, to zero out the owner drawings account.

Now, just as with the revenue and owner drawings accounts, each of those expense accounts that we had cleared out on the adjusted trial balance is going to have this same general ledger, with a debit balance. A closing entry, then, will be a credit, bringing the balance in that expense account to zero.

In the income summary, the closing entry for our revenue left us with a $150,000 balance. Notice that we had no balance in the income summary account, because that is only used in the closing process. Next, we closed our expenses with a debit, bringing the balance in that income summary to $13,500. The last closing entry was our drawing account, and we also closed that to income summary, bringing the balance to $11,500. Finally, we have to clear that balance in our income summary account by closing it to retained earnings, bringing the balance in the income summary account to zero.

hint
Remember, income summary is only used in the closing process.

Retained earnings started with $12,000, and through all of our closing entries in the closing process we identified an additional $11,500 credit to retained earnings, bringing the balance to $23,500.


3. Post Closing Trial Balance

Once the entries have been posted to the general ledger, then we can move on to the post closing trial balance, which is another checkpoint in the accounting department to ensure that everything has proceeded accurately in the closing process. So, let's take a look at the post closing trial balance in the trial balance worksheet.

Note, we have taken our adjusted trial balance, identified our closing entries, journalized them, and posted them to the general ledger.

Now it's time to prepare the post closing trial balance. Looking at the post closing trial balance and all of the accounts that have balances remaining after we've entered our closing entries, you can see that it is only the permanent accounts--all of the assets, liabilities, and equity. All of the temporary accounts--drawings, revenues, and expenses--now have no balances in them. It is only the permanent accounts that carry forward to the next period.


summary
Today we learned about the closing process. We examined the trial balance worksheet., starting with the adjusted trial balance. We identified the necessary closing entries, put them in our general journal, and posted them to our general ledger. Once they were posted, we prepared the post closing trial balance.

Source: Adapted from Sophia instructor Evan McLaughlin.