Source: Instrumental “Drops of H2O ( The Filtered Water Treatment )" by J.Lang (feat. Airtone),” Creative Commons, http://ccmixter.org/files/djlang59/37792
Hey everyone, and welcome to our video today-- "Merchandising, Adjusting, and Closing." So what's today's video all about? Well, we're going to be looking at closing entries for a merchandising company. We're going to be looking at the types of closing entries that are unique to a merchandising company. And then we're going to do a review of the procedure that we use for closing as it applies to a merchandising company.
So let's start with closing entries. What is a closing entry? It's an entry made at the end of an accounting period that is used to close out a temporary account. So where are our closing entries made? Where are they entered? Well they're entered into our general journal, and then that general journal gets posted to the general ledger. So our closing entries are entered in the general journal, and then posted to the general ledger.
So which accounts are involved when we close? When we make our closing entries? That's going to be our temporary accounts. So our revenues and expenses, as well as our owner drawings. So the revenue and expense accounts get closed, and now within a merchandising company, there's some unique revenue accounts that are going to be closed and have closing entries. So our sales discounts and sales returns and allowances. These are going to be closed in addition to our sales account.
Now on the expense side, we're going to have purchases that we need to close out, purchase discounts, purchase returns and allowances, as well as freight-in. So these are all of the accounts on the expense side that are unique to a merchandising company that will also be closed out, will also have closing entries, in addition to our operating expenses.
So what is the purpose of closing the accounting system? Why do we do this? Well it's really our reset button. So all of the temporary accounts are closed to ensure accurate reporting. So all of our period based accounts are closed so that we can have accurate reporting, hit reset for the next period. It allows us to track activity. So because it's activity for a specific period, we can track that activity, and then transfer net income or loss into cumulative equity. And then those temporary accounts are reopened for the following period, again, to report activity for only that one specific period. So that's why we need to make these closing entries.
So let's look at the closing procedure that we need to follow. Temporary account groups are closed by processing netting journal entries on their unnatural balance side. Let's talk a little bit more about that netting idea. If you look at the total balance in the account, whether it's debit or credit, and then book an entry for that amount to the opposite side. So if you have an account with a total balance that's a debit, so there's a total debit balance, you would book an entry for that amount to the opposite side, or credit. OK? So that's the idea of netting. To zero these accounts out, we need to create an entry that's to the opposite side of the balance of that account.
So R-E-D-I. What does that stand for? So R is our revenues. The revenues get closed out during our closing process. Our expenses get closed out, as does our owner drawings. And then we use income summary to record the close out of our revenues and expenses, and then the drawings get closed directly to the owners' capital account.
So that's our closing procedure. Now let's look at some closing entries that we would find in a merchandising company. And these are in addition to the regular closing entries that I mentioned-- so to close out our revenues and close out our operating expenses, these are just the additional closing entries that a merchandising company would need to make. So they're going to have to close out their sales returns and allowances, as well as their sales discounts.
And now you'll see here to close out those sales returns and allowances and sales discounts, they're closed out with a credit. That means they have a natural debit balance, which makes sense, because they're actually a reduction of our sales, which has a natural credit balance. And then we can close out our purchases, our purchase returns and allowances, as well as our purchase discounts. So you'll see that the purchases are closed out with a credit. That's because purchases are an expense, so they naturally have a debit balance.
And now our purchase returns and allowances, as well as purchase discounts, are closed out with debits. That's because they have a natural credit balance, because they reduce the purchases that we made. So that's our sales returns and allowances, sales discounts, purchases, purchase returns and allowances, purchase discounts. And there's one more entry we have to make. That's to our freight-in. And so we have to close out freight-in. And now freight-in, because it's an expense that we incur, is closed out with a credit, because it has a natural debit balance. So these are some of the closing entries that are unique to a merchandising company.
Let's summarize what we talked about today. In a nutshell, we did a review of what closing entries are. We looked at closing entries for a merchandising company, as well as creating those closing entries. We looked at R-E-D-I. Our revenues are closed out, our expenses are closed out. We close out drawings, and we use income summary to record the close out of our revenue and expenses.
I hope everybody enjoyed this video, and I hope to see you next time.